Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are included below (in thousands, except per share amounts):
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. Such accounting policies require significant judgments, assumptions and estimates used in the preparation of our consolidated financial statements included in Item 8 of this Annual Report on Form 10-K, and actual results could differ materially from the amounts reported based on these policies. These policies, and our procedures related to these policies, are described below. See also Note 2 of Notes to Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K for a further summary of our significant accounting policies and methods used in the preparation of our consolidated financial statements.
Sources of Revenues and Revenue Recognition Policy
During the fourth quarter of 2010, we began reporting three types of revenues: product revenues, recurring revenues, and services revenues. Product revenues are generated from licensing the right to use our software applications and selling hardware as a component of our solution. Recurring revenues are generated by our cloud-based business, annual support fees, and annual renewal fees. Services revenues are generated primarily from professional services and educational services. Historical amounts were reclassified based on this new presentation. Revenues are generated by direct sales with customers and by indirect sales through a partner channel.
Product Revenues
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:
| | · | Persuasive evidence of an arrangement exists; |
| | · | The fee is fixed or determinable; |
| | · | Collection is probable; and |
For a perpetual license agreement, upon meeting the revenue recognition criteria above, we immediately recognize as product revenues the residual amount of the total fees if sufficient vendor specific objective evidence (“VSOE”) of fair value exists to support allocating a portion of the total fee to the undelivered elements of the arrangement. If sufficient VSOE of fair value for 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 fair value for support in perpetual agreements based on substantive renewal rates the customer must pay to renew the support. The VSOE of fair value for other services is based on amounts charged when the services are sold in stand-alone sales.
Although the majority of our product licenses are perpetual, certain customers, whose original license contracts were signed prior to 2004, have renewable term licenses. For an annually renewable license agreement, upon meeting the revenue recognition criteria above, we recognize the license fees under these agreements as product revenues ratably over the initial license period, which is generally 12 months, and the remainder of the license fees are recognized as recurring 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.
Recurring Revenues
We generate recurring revenues through our cloud-based business, and through annual support and renewal fees. The cloud-based business generates revenues by providing services to customers, in which the customers pay a minimum monthly fee to use a specified number of software licenses, plus any overages. Customers are billed the greater of their minimum monthly fee or actual usage, and revenue is recognized monthly as the service is performed. The total contract fee also includes an implementation fee, which is recognized ratably over the term of the contract.
For annually renewable license agreements, the allocation of the initial order between product revenues and recurring revenues is based on an average renewal rate for our time based contracts. We apply the allocation of product revenues and recurring revenues consistently to all annually renewable license 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 recurring revenue and the revenue is recognized ratably over the contract period. Under perpetual license agreements, we recognize annual support fees as recurring revenues ratably over the post-contract support period, which is typically 12 months, but may extend up to three years if prepaid.
Services Revenues
We generate revenues from other services that we provide to our customers and partners including fees for professional services and educational services. Revenues from professional services, which include implementing our products for a customer or partner, and educational services, which consist of training courses for customers and partners, are recognized as the related services are performed.
Recently Issued Revenue Recognition Guidance
In September 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Accounting Standards Update (“ASU”) 2009-13, Multiple-Deliverable Revenue Arrangements (“FASB ASU 2009-13”) and FASB ASU 2009-14, Certain Revenue Arrangements that Include Software Elements (“FASB ASU 2009-14”). As summarized in FASB ASU 2009-14, FASB Accounting Standards Codification (“ASC”) Topic 985, Software (“FASB ASC 985”), has been amended to remove from the scope of industry specific revenue accounting guidance for software and software related transactions, tangible products containing software components and non-software components that function together to deliver the product’s essential functionality. As summarized in FASB ASU 2009-13, FASB ASC Topic 605, Revenue Recognition has been amended (1) to provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and the consideration allocated; (2) to require an entity to allocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence (or third-party evidence of selling price); and (3) to eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method. The accounting changes in FASB ASU 2009-13 and FASB ASU 2009-14 are both effective on January 1, 2011. Our future revenue recognition for multiple element arrangements is not expected to differ materially from the results in the current period.
In April 2010, the FASB issued ASU 2010-17, Revenue Recognition-Milestone Method (Topic 605), that designates the milestone method and acceptable attribution method for revenue recognition. This guidance further clarifies the conditions in which a company can recognize revenue under this method. We do not expect this guidance will have a material effect on our financial statements.
Goodwill and Other Intangible Assets
We review goodwill and intangible assets with indefinite lives for impairment at least annually in accordance with FASB ASC Topic 350, Intangibles - Goodwill and Other. Identifiable intangible assets such as intellectual property trademarks and patents are amortized over a 10 to 15 year period using the straight-line method. In addition, other intangible assets, such as customer relationships, core technology and non-compete agreements are amortized over a five to 13 year period based upon historical patterns in which the economic benefits are expected to be realized. As of September 30, 2010 when our 2010 goodwill impairment test was performed, we had one reporting segment and therefore our impairment review of goodwill involved reviewing the impairment of the Company as a whole. The fair value of our reporting unit was substantially in excess of its carrying value as of the 2010 goodwill impairment test. This guidance requires us to perform the goodwill impairment test annually or when a change in facts and circumstances indicates that the fair value of an asset may be below its carrying amount. We determined no indication of impairment existed as of September 30, 2010 when the annual goodwill impairment test was performed. As there were no changes in facts and circumstances that indicated that the fair value of the reporting unit may have been below its carrying amount since September 30, 2010, no additional impairment test was performed during the fourth quarter of 2010.
The 2010 goodwill impairment test did not include the goodwill recorded as a result of the acquisition of Latitude, as the acquisition took place subsequent to September 30, 2010. We did not note any indications of impairment of the Latitude goodwill and will therefore test the goodwill of Latitude for impairment concurrent with the next annual goodwill impairment test in 2011, barring any triggering events that would prompt an impairment test prior to that date.
See Note 13 of Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for further information on goodwill and other intangible assets.
Stock-Based Compensation Expense
Consistent with FASB ASC Topic 718, Compensation – Stock Compensation (“FASB ASC 718”), 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 associated with awards granted in future periods, stock-based compensation expense may differ materially in the future from that recorded in the current period.
We record compensation expense for share-based awards using the straight-line method, which is recorded into earnings over the vesting period of the award. Stock-based compensation expense recognized under FASB ASC 718 for the years ended December 31, 2010, 2009 and 2008 was $4.0 million, $3.3 million and $3.0 million, respectively. See Note 5 of Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for further information on our stock-based compensation.
Income Taxes
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.
FASB ASC Topic 740, Income Taxes (“FASB ASC 740”), 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, our 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 prior to the period in which temporary differences such as loss carryforwards and tax credits expire. Management considers projected future taxable income and tax planning strategies in making this assessment.
Sales tax amounts collected from customers is recorded on a net basis.
See Note 10 of Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for further information on our income taxes.
FASB ASC 985 requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on our product development process, technological feasibility is established upon completion of a working model. Costs incurred by us between completion of the working model and the point at which the product is ready for general release have been insignificant. Through December 31, 2010, all research and development costs have been expensed. Research and development expense for 2010, 2009 and 2008 was $28.3 million, $24.1 million and $21.5 million, respectively.
Legal Proceedings
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 in connection with loss contingencies are expensed as incurred.
Financial Highlights
For the year ended December 31, 2010, we achieved 27% revenue growth from 2009, almost doubled our net income, and increased our cash balance by approximately $21 million. 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.
| Year: | | | | | | |
| 2010 | | $ | 166.3 | | | | 27 | % |
| 2009 | | | 131.4 | | | | 8 | |
| 2008 | | | 121.4 | | | | 10 | |
| 2007 | | | 109.9 | | | | 32 | |
| 2006 | | | 83.0 | | | | 32 | |
Factors affecting our revenue performance in any particular year include macroeconomic conditions, customer budget constraints, the availability of personnel to implement our solutions, and willingness of customers to implement critical telecommunications systems.
Our increased profitability in 2010 was primarily due to an improving global economy and an increase in both the dollar amount and number of orders received as we sold more of our products and services to larger customers, due in part to consultant and industry analyst recommending our solutions. We believe this trend will continue in 2011. We anticipate revenues of at least $200 million for 2011, with a non-GAAP targeted operating income margin, which excludes non-cash stock-based compensation expense and non-cash purchase accounting adjustments, of approximately 14%.
Our 2010 product revenues increase of 26% was primarily due to an increase in the dollar amount of orders received from both new and existing customers as we continued to make improvements to our products and licensed our software to larger organizations through our partner channels and direct sales force. We continue to drive the majority of our orders through our distribution channel, with 62% of orders coming from partners during 2010. The increase in orders was experienced in all three major geographies in which we operate.
Our cloud-based revenues increased $3.0 million in 2010 compared to 2009 as interest for our hosted solution continued to grow among current and prospective customers as cloud computing grew as an accepted alternative to premise-based solutions. Additionally, unlike offerings from our competitors, our solution allows customers to keep their voice traffic and data on their own networks. Moreover, our ability to offer both a premise-based and cloud-based solution enables us to market our solutions to a wider range of customers than our competitors.
As our cloud-based business has grown, the associated costs have also increased, which we expect to continue into 2011 as we expand our cloud-based infrastructure both domestically and internationally. Currently, we have two data centers in the United States and one in the United Kingdom. Data centers in Japan, Australia and Germany will be operational in 2011.
During 2010, we continued to invest in our operations by increasing our staffing company-wide by 26%, which resulted in increased compensation expenses and travel and entertainment costs. We anticipate our staffing levels will continue to increase in 2011.
On October 5, 2010, we entered into a stock purchase agreement with Latitude, a privately-held provider of accounts receivable management software and services. Pursuant to the terms of the stock purchase agreement, we purchased 100% of Latitude’s outstanding capital stock for an aggregate purchase price of $15.6 million, including $1.6 million related to the working capital of Latitude funded with cash-on-hand. We deposited $1.1 million of the purchase price into an escrow account to ensure funds are available to pay indemnification claims, if any. Latitude is operating as a subsidiary of Interactive Intelligence. We acquired Latitude as part of our growth strategy of adding industry-specific applications and expertise. Although the Latitude software suite is currently being sold as a standalone solution, we plan to integrate the solution with our Interaction Dialer® application and other third-party dialer products. Latitude’s results of operations were included in our consolidated financial statements since October 1, 2010 and accounted for $1.6 million in revenues. Latitude's operating costs and related charges totaled $1.7 million, resulting in a net operating loss of approximately $200,000.
Our effective tax rate was 34% for the year ended December 31, 2010 compared to 43% for the year ended December 31, 2009 primarily due to a lower effective tax rate in the fourth quarter of 2010. For the fourth quarter of 2010, we recorded tax expense equal to an effective tax rate of 22%, as we were able to reinstate the research and development credit and utilize certain other deductions because of our operating results. As of December 31, 2010, we had $4.4 million of various tax credit carryforwards and recorded income tax expense of $7.7 million in 2010. Due to the tax net operating loss carryforwards, the tax credit carryforwards and stock option compensation deductions, actual cash payments for income taxes in 2010 were minimal.
Historical Results of Operations
The following table sets forth, for the periods indicated, our consolidated financial information expressed as a percentage of total revenues:
| | | | |
| | | | | | | | | | |
| Revenues: | | | | | | | | | |
| Product | | | 48 | % | | | 48 | % | | | 50 | % |
| Recurring | | | 41 | | | | 43 | | | | 41 | |
| Services | | | 11 | | | | 9 | | | | 9 | |
| Total revenues | | | 100 | | | | 100 | | | | 100 | |
| Cost of revenues: | | | | | | | | | | | | |
| Product | | | 14 | | | | 13 | | | | 13 | |
| Recurring | | | 10 | | | | 10 | | | | 10 | |
| Services | | | 6 | | | | 7 | | | | 9 | |
| Amortization of intangible assets | | | 1 | | | | -- | | | | -- | |
| Total cost of revenues | | | 31 | | | | 30 | | | | 32 | |
| Gross profit | | | 69 | | | | 70 | | | | 68 | |
| Operating expenses: | | | | | | | | | | | | |
| Sales and marketing | | | 28 | | | | 30 | | | | 32 | |
| Research and development | | | 17 | | | | 18 | | | | 18 | |
| General and administrative | | | 10 | | | | 11 | | | | 12 | |
| Amortization of intangible assets | | | -- | | | | -- | | | | | |
| Total operating expenses | | | 55 | | | | 59 | | | | 62 | |
| Operating income | | | 14 | | | | 11 | | | | 6 | |
| Other income: | | | | | | | | | | | | |
| Interest income, net | | | 1 | | | | -- | | | | 1 | |
| Other expense | | | (1 | ) | | | -- | | | | -- | |
| Total other income | | | (0 | ) | | | -- | | | | 1 | |
| Income before income taxes | | | 14 | | | | 11 | | | | 7 | |
| Income tax expense | | | 5 | | | | 4 | | | | 3 | |
| Net income | | | 9 | % | | | 7 | % | | | 4 | % |
Comparison of Years Ended December 31, 2010, 2009 and 2008
Revenues
Primary Sources of Revenues
We generate revenues from: (i) product revenues, which include licensing the right to use our software applications and selling hardware as a part of our solutions; (ii) recurring revenues, which include support fees from perpetual license agreements, renewal fees from annually renewable license agreements, and fees from our cloud-based offerings; and (iii) services revenues, which include professional services fees and educational services fees. Prior to the fourth quarter of 2010, revenues were reported as two types, product and services. Historical amounts have been reclassified based on this new, three-revenue presentation. Our revenues are generated by direct sales to customers and through our partner channels.
| Product Revenues | | | |
| | | | | | | | | | |
| | | ($ in thousands) | |
| Product revenues | | $ | 79,817 | | | $ | 63,327 | | | $ | 60,491 | |
| Change from prior year | | | 26 | % | | | 5 | % | | | 5 | % |
| Percentage of total revenues | | | 48 | % | | | 48 | % | | | 50 | % |
Not all software and hardware product orders are recognized as revenues when they are received because of certain contractual terms or the collection history with particular customers or partners. Consequently, product revenues for any particular period not only reflect the orders received in the current period but also include certain orders received but deferred in previous periods and recognized in the current period. In addition, a portion of product orders are related to maintenance and support, and they are recognized over the maintenance and support period as recurring revenues.
Product revenues increased $16.5 million, or 26%, during 2010 compared to 2009, principally due to a 25% increase in the dollar amount of orders received from both new and existing customers due largely to the growing acceptance of our products by larger organizations. During 2010, we received 63 product orders greater than $250,000, with 14 of these orders greater than $1.0 million, compared to 45 product orders greater than $250,000 in 2009, with seven of those orders greater than $1.0 million.
Product revenues increased by $2.8 million, or 5%, during 2009 compared to 2008, primarily due to a 6% increase in the dollar amount of orders received from existing customers, mainly in North America and Europe. The dollar amount of orders from new customers in 2009 was comparable to 2008. We believe the increases in the number and dollar amount of orders received were due to the economy beginning to stabilize during the second half of 2009 and customers making purchasing decisions they had previously delayed. We believe these increases reflect the acceptance of our products by larger organizations.
Product revenues can fluctuate from period to period depending on the mix of contracts sold between perpetual and annually renewable licenses. While the majority of our product licenses are perpetual, we have certain customers, whose original contracts were signed prior to 2004, with renewable term licenses, representing 9%, 14% and 16% of total product orders in 2010, 2009 and 2008, respectively. Generally, orders for perpetual licenses result in a significant portion of the contract value being recognized when received if recognition criteria are satisfied, while renewable term licenses are recognized ratably over the term of the agreement, generally one year. The impact of the mix of contracts on our product revenues occurs only in the year of a product order; subsequent renewal fees received for annually renewable licenses and renewal support fees for perpetual contracts are all allocated entirely to recurring revenues.
Our geographic mix of licenses has been relatively consistent over 2010, 2009 and 2008, with the Americas contributing 70% to 74%, Europe, the Middle East and Africa contributing 21% to 22%, and Asia-Pacific contributing 5% to 8% of the total dollar amount of contracts in any one year.
| Recurring Revenues | | | |
| | | | | | | | | | |
| | | ($ in thousands) | |
| Recurring revenues | | $ | 68,740 | | | $ | 55,798 | | | $ | 49,397 | |
| Change from prior year | | | 23 | % | | | 13 | % | | | 21 | % |
| Percentage of total revenues | | | 41 | % | | | 43 | % | | | 41 | % |
Recurring revenues include the portion of license arrangements allocated to maintenance and support from perpetual and annually renewable contracts, renewals of annually renewable licenses and maintenance contracts, and revenues from our cloud-based applications. Revenues related to our renewal and support fees represented approximately 91%, 94% and 96% of our total recurring revenues for 2010, 2009 and 2008, respectively. 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 recurring revenues.
Recurring revenues increased $12.9 million, or 23%, in 2010 compared to 2009 primarily due to an increase in renewal and support fees of $9.8 million in 2010 resulting from continued growth in the number and size of our installed base of customers. In addition, cloud-based revenues increased $3.0 million, or 92%, in 2010 compared to 2009 as more customers elected our cloud-based alternative to our premise-based solutions. Cloud-based orders totaled 10% of the total product revenues in 2010 compared to 5% in 2009. We believe recurring revenues will continue to grow with further expansion of our installed base of customers and growth of our cloud-based solutions.
Recurring revenues increased $6.4 million in 2009, or 13%, compared to 2008 primarily due to increased maintenance and support fees of $5.4 million resulting primarily from continued growth in our installed base of customers. The increase in recurring revenues was also due to increased cloud-based revenues of $1.2 million, or 59%, during 2009. During the third quarter of 2009, we received three large orders for our cloud-based solutions for at least $3.6 million in future revenues in which the majority was to be recognized from 2010 through 2013. We recognized $115,000 related to these contracts in 2009 and $1.2 million in 2010.
Support and license renewal rates were approximately 90% during each of the last three years.
Revenues from cloud-based contracts are recognized ratably over the life of the contract, which is typically three to four years. Our unrecognized cloud-based revenues were $12.6 million as of December 31, 2010 compared to $4.2 million as of December 31, 2009. These amounts are not included in deferred revenues on our balance sheet.
We believe our cloud-based revenues will continue to increase as more customers utilize hosted delivery of software for their information technology needs.
| Services Revenues | | | |
| | | | | | | | | | |
| | | ($ in thousands) | |
| Services revenues | | $ | 17,758 | | | $ | 12,293 | | | $ | 11,518 | |
| Change from prior year | | | 44 | % | | | 7 | % | | | 2 | % |
| Percentage of total revenues | | | 11 | % | | | 9 | % | | | 9 | % |
Services revenues primarily include revenues related to professional services and education.
Services revenues increased $5.5 million in 2010 compared to 2009 and $775,000 in 2009 compared to 2008. The increase in both years was primarily because of an increase in professional services due to larger customer installations.
During 2010, both the size and number of our professional services commitments increased, as we received over $6.0 million in professional services orders during the third quarter of 2010 that will be recognized in future periods as the work is completed. This increase was attributable to the larger direct contracts from both premise-based customers and cloud-based orders.
Services revenues have and will continue to fluctuate based on the number of attendees at our educational classes and the amount of assistance our customers and partners need for implementation. We believe services revenues will continue to increase as we continue to license our solutions to new customers and expand existing customer implementations.
| Cost of Revenues | | | |
| | | | | | | | | | |
| | | ($ in thousands) | |
| Cost of revenues: | | | | | | | | | |
| Product | | $ | 23,868 | | | $ | 17,452 | | | $ | 15,446 | |
| Recurring | | | 16,991 | | | | 12,913 | | | | 12,272 | |
| Services | | | 9,788 | | | | 9,489 | | | | 11,420 | |
| Amortization of intangible assets | | | 83 | | | | 40 | | | | -- | |
| Total cost of revenues | | $ | 50,730 | | | $ | 39,894 | | | $ | 39,138 | |
| Change from prior year | | | 27 | % | | | 2 | % | | | 11 | % |
| Product cost as a % of product gross revenues | | | 30 | % | | | 28 | % | | | 26 | % |
| Recurring cost as a % of recurring gross revenues | | | 25 | % | | | 23 | % | | | 25 | % |
| Services cost as a % of services gross revenues | | | 55 | % | | | 77 | % | | | 99 | % |
Cost of Product Revenues
Cost of product consists of hardware costs (including media servers and Interaction Gateway® appliances that we develop, as well as servers, telephone handsets and gateways that we purchase and resell), royalties for third-party software and other technologies included in our solutions, personnel costs and product distribution facility costs. Cost of product can fluctuate depending on which software applications are licensed to our customers and partners, the third-party software that is licensed by the end-user from us as part of our software applications and the dollar amount of orders for hardware and appliances.
Cost of product increased $6.4 million in 2010 compared to 2009 primarily because more customers chose to purchase our hardware offerings to implement our solutions. In addition, royalty expense increased $1.6 million year-over-year principally due to a contractual license for intellectual property. Cost of product increased $2.0 million in 2009 from 2008 as more customers purchased hardware from us when implementing our solutions.
Cost of Recurring Revenues
Cost of recurring revenues consists primarily of compensation expenses for technical support personnel as well as costs associated with our cloud-based offering. Cost of recurring revenues increased $4.1 million in 2010 compared to 2009 as a result in an increase in compensation expense of $2.1 million and travel and entertainment expenses of $295,000 due to an increase in the number of maintenance, support and cloud-based employees. Cloud-based expenses, primarily related to data center and associated hosting costs, increased $1.4 million year-over-year as more customers chose our cloud-based solution. Although some costs related to our cloud-based offerings are fixed, other are variable based on usage and call volume and, therefore, we would expect our recurring expenses to increase as the revenues from these orders are recognized.
Cost of recurring revenue increased $641,000 million in 2009 compared to 2008 primarily due to an increase of $609,000 related to data center and associated hosting costs for our cloud-based applications. In addition, cloud-based installation costs increased $213,000 year-over-year. Partially offsetting these increases were a decrease in compensation expense of $325,000 and a decrease in travel and entertainment expenses of $240,000 related to a reduction in maintenance and support staffing during the first three quarters of 2009.
Cost of Services Revenues
Cost of services consists primarily of compensation expenses for professional services and educational personnel. Cost of services increased by $299,000 in 2010 compared to 2009 primarily due to increased compensation expenses of $986,000 and increased travel and entertainment expenses of $421,000 due to increased professional services and education staffing. Partially offsetting these increases were professional services costs of $551,000 related to our cloud-based applications that were deferred and recognized ratably over the life of the related cloud-based contracts.
Cost of services decreased $1.9 million in 2009 compared to 2008 primarily due to a decrease in compensation expense of $848,000 and a decrease in travel and entertainment expenses of $523,000, both due to a reduction in services staff during the first three quarters of 2009. In addition, $366,000 of professional services costs related to our cloud-based applications was deferred and recognized ratably over the life of the related cloud-based contract.
Cost of services as a percentage of services revenues have decreased in each of the last two years. Although the cost associated with our professional and educational services remained consistent from 2009 to 2010, the decrease was primarily due to the significant increase in professional services revenues. The decrease from 2008 to 2009 was due to the decrease in costs of services as a result of a reduction in services staff during the first three quarters of 2009. In addition, the decrease for both years was also due to the transferring of installation services expenses associated with our cloud-based offering to costs of recurring revenues.
| Gross Profit | | | |
| | | | | | | | | | |
| | | ($ in thousands) | |
| Gross profit | | $ | 115,585 | | | $ | 91,524 | | | $ | 82,268 | |
| Change from prior year | | | 26 | % | | | 11 | % | | | 10 | % |
| Percentage of total revenues | | | 69 | % | | | 70 | % | | | 68 | % |
Gross profit as a percentage of total revenues in any particular period reflects the amount of product, recurring and services revenues recognized and cost of product, recurring and services incurred.
Gross profit increased by $24.1 million in 2010 compared to 2009 and by $9.3 million in 2009 compared to 2008 as a result of the impact of the factors discussed above.
Operating Expenses
| Sales and Marketing | | | |
| | | | | | | | | | |
| | | ($ in thousands) | |
| Sales and marketing expenses | | $ | 47,072 | | | $ | 39,141 | | | $ | 39,307 | |
| Change from prior year period | | | 20 | % | | | 0 | % | | | 8 | % |
| Percentage of total revenues | | | 28 | % | | | 30 | % | | | 32 | % |
| Percentage of net product revenues | | | 84 | % | | | 86 | % | | | 88 | % |
Sales and marketing expenses primarily include compensation, travel, and promotional costs related to our sales, marketing and channel management operations.These expenses increased by $7.9 million in 2010 compared to 2009 primarily due to increases in compensation expense of $4.5 million and travel and entertainment expense of $719,000 as sales and marketing staffing increased 19%. Additionally, corporate marketing expenses increased $2.3 million due to increased spending on promotional and branding initiatives of $1.5 million and increased fees paid to third parties for customer order referrals of $683,000.
Sales and marketing expenses decreased slightly during 2009 compared to 2008 due to reductions in travel and entertainment expenses of $636,000, fees paid to third parties for customer order referrals of $233,000, and outsourced services of $223,000 as we focused on cost management in 2009. Partially offsetting these decreases were increases in commissions and incentives of approximately $1.0 million resulting from increased sales.
| Research and Development | | | |
| | | | | | | | | | |
| | | ($ in thousands) | |
| Research and development expenses | | $ | 28,349 | | | $ | 24,103 | | | $ | 21,539 | |
| Change from prior year period | | | 18 | % | | | 12 | % | | | 26 | % |
| Percentage of total revenues | | | 17 | % | | | 18 | % | | | 18 | % |
Research and development expenses are comprised primarily of compensation and depreciation expenses. These expenses increased by $4.2 million during 2010 compared to 2009 primarily due to an increase in compensation expense of $3.9 million resulting from a 25% increase in research and development staffing.
Research and development expenses increased by $2.6 million during 2009 compared to 2008 primarily due to an increase in compensation expense of $1.8 million and a 16% increase in staff resulting from the AcroSoft acquisition in the second quarter of 2009 and other hires. In addition, corporate expenses allocated to research and development increased $721,000 primarily due to increased facility rental rates, a new office in Canada and increased depreciation costs primarily due to the expansion of our world headquarters.
We believe that investment in research and development is critical to our future growth, particularly because our competitive position in the marketplace is directly related to the timely development of new and enhanced solutions. As a result, we expect research and development expenses will continue to increase in future periods.
| General and Administrative | | | |
| | | | | | | | | | |
| | | ($ in thousands) | |
| General and administrative expenses | | $ | 16,584 | | | $ | 13,817 | | | $ | 14,474 | |
| Change from prior year period | | | 20 | % | | | (5 | )% | | | 10 | % |
| Percentage of total revenues | | | 10 | % | | | 11 | % | | | 12 | % |
General and administrative expenses include salary and incentive compensation expense as well as general corporate expenses that are not allocable to other departments, such as legal and other professional fees and bad debt expense. These expenses increased $2.8 million during 2010 compared to 2009 primarily due to an increase in compensation expense of $1.2 million as a result of an increase in staffing of 22% and an increase in travel and entertainment expenses of $181,000. Additionally, bad debt expense increased $430,000 related to losses on certain accounts and our analysis of accounts receivables, and expenses related to outside legal services increased $384,000.
General and administrative expenses decreased by $657,000 during 2009 compared to 2008. This decrease was due to reductions in salary expense of $655,000 resulting from staff reductions in late 2008, reduced fees paid to third parties for customer referrals of $262,000, decreased bad debt expense of $217,000 and decreased travel and entertainment expenses of $170,000. Partially offsetting these decreases was an increase in incentive expense of $800,000 resulting from the increased operating profit during the year.
Other Income (Expense)
Interest Income, Net
| | | | |
| | | | | | | | | | |
| | | ($ in thousands) | |
| Cash, cash equivalents and short-term investments (average) | | $ | 75,431 | | | $ | 55,245 | | | $ | 45,919 | |
| Interest income, gross | | | 340 | | | | 281 | | | | 1,288 | |
| Return on investments | | | 0.4 | % | | | 0.5 | % | | | 2.8 | % |
Interest income, net, primarily consists of interest earned from investments and interest-bearing cash accounts. Interest expense and fees, which were not material in any years reported, are also included in this category.
Interest earned on investments increased during 2010 compared to 2009 as a result of a higher cash and investment balance. Overall, the rate on our investments declined slightly in 2010 compared to 2009 due mainly to lower market investment rates.
Interest earned on investments decreased in 2009 compared to 2008 as a result of lower interest rates from decreasing interest yields on investments. In response to the financial crisis that began in 2008 and continued in 2009, we transferred the majority of our liquid investments into money market funds that are secured by low risk government securities.
We continue to monitor the allocation of funds in which we have invested to maximize our return on investment while utilizing safe investment alternatives within our established investment policy. We do not have any investments in subprime assets.
| Other Income (Expense), Net | | | |
| | | | | | | | | | |
| | | ($ in thousands) | |
| Other income (expense), net | | $ | (1,146 | ) | | $ | 298 | | | $ | (435 | ) |
Other income (expense), net includes foreign currency transaction gains and losses. These gains and losses can fluctuate based on the amount of receivables that are generated in certain international currencies (particularly the Euro), the exchange gain or loss that results from foreign currency disbursements and receipts, and the cash balances and exchange rates at the end of a reporting period. Other expense in 2010 included $1.1 million of foreign currency losses (including losses of $1.4 million in the first half of the year), other income in 2009 included $310,000 related to foreign currency gains and other expense in 2008 included $399,000 related to foreign currency losses. The expense in 2010 and 2008 showed an overall weakening of the Euro and British Pound in relation to the U.S. dollar and the income in 2009 reflected the strengthening of the Euro and British Pound compared to the U.S. dollar.
During February 2010, we transferred the majority of our Euro cash balances to a U.S. dollar account and in May 2010, we instituted a currency hedging program to help mitigate future effects of fluctuations in the foreign exchange rates on cash and receivables. We continue to explore ways to mitigate the impact of currency fluctuations in the future.
| Income Tax Expense | | | |
| | | | | | | | | | |
| | | | |
| Income tax expense | | $ | 7,662 | | | $ | 6,380 | | | $ | 3,464 | |
As of December 31, 2010, we had $4.4 million of various tax credit carryforwards. There was no valuation allowance at December 31, 2010, 2009 or 2008. We recorded income tax expense of $7.7 million in 2010; however, due to the tax net operating loss carryforwards, the tax credit carryforwards and stock option compensation deductions, actual cash payments for income taxes were minimal in 2010.
We have significant remaining credits to offset taxable income and taxes payable as described in Note 10 of Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K. Our effective tax rate was 34% for the year ended December 31, 2010 compared to 43% for the year ended December 31, 2009. The decrease in the tax rate was primarily due to an effective tax rate of 22% during the fourth quarter of 2010 as we were able to reinstate the research and development credit and utilize certain other deductions because of our operating results. The tax rate is determined by considering the federal tax rate, rates in various states and international jurisdictions in which we have operations, and a portion of the amount of stock-based compensation that is not deductible for income tax purposes.
During 2011, we expect an income tax rate of approximately 36%. We expect that a portion of the GAAP tax will be offset by compensation deductions we will generate in 2011 and tax credits, including both existing carryforward credits and research and development credits which have already been enacted for 2011.
Liquidity and Capital Resources
We generate cash from the collection of payments related to licensing our products as well as from selling hardware, renewals of annual licenses and maintenance and support agreements, and the delivery of other services. During 2010, 2009 and 2008, we also received $6.4 million, $2.2 million and $879,000, respectively, in cash from the exercise of stock options and $350,000, $252,000 and $284,000, respectively, from purchases of common stock under our Employee Stock Purchase Plan. We use cash primarily for paying our employees (including salaries, commissions and benefits), leasing office space, paying travel expenses, marketing activities, paying vendors for hardware, other services and supplies, and purchasing property and equipment. In addition, we acquired AcroSoft for $2.2 million in cash during the second quarter of 2009 and Latitude for $15.6 million in cash during the fourth quarter of 2010. We continue to be debt free.
We determine liquidity by combining cash and cash equivalents and short-term investments as shown in the table below. Based on our recent performance and current expectations, we believe that our current liquidity position, when combined with our anticipated cash flows from operations, will be sufficient to satisfy our working capital needs and current or expected obligations associated with our operations over the next 12 months. Our future requirements will depend on many factors, including cash flows from operations, territory expansion and product development decisions and potential acquisitions. If our liquidity is not sufficient to cover our needs, we may be forced to raise additional capital, either through the capital markets or debt financings, and may not be able to do so on favorable terms or at all.
| | | | |
| | | | | | | |
| | | ($ in thousands) | |
| Cash and cash equivalents | | $ | 48,300 | | | $ | 48,497 | |
| Short-term investments | | | 37,582 | | | | 16,482 | |
| Total liquidity | | $ | 85,882 | | | $ | 64,979 | |
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 investments is reported as a source of cash.
The following table shows cash flows from operating activities, investing activities and financing activities for the stated periods:
| | | Years Ended December 31, | |
| | | | | | | | | | |
| | | ($ in thousands) | |
| Beginning cash and cash equivalents | | $ | 48,497 | | | $ | 34,705 | | | $ | 29,359 | |
| Cash provided by operating activities | | | 28,697 | | | | 15,083 | | | | 15,180 | |
| Cash used in investing activities | | | (41,969 | ) | | | (9,676 | ) | | | (1,162 | ) |
| Cash provided by (used in) financing activities | | | 13,075 | | | | 8,385 | | | | (8,672 | ) |
| Ending cash and cash equivalents | | $ | 48,300 | | | $ | 48,497 | | | $ | 34,705 | |
Cash provided by operating activities during all three years was generated primarily by our net income adjusted for routine fluctuations in our operating assets and liabilities. The cash used in investing activities during 2010 increased from 2009 due to transferring a portion of our cash to short-term investments as well as the purchase of Latitude during the fourth quarter. The cash used in investing activities in 2009 increased from 2008 due to the transfer of the majority of our liquid investments into money market funds during 2009 in response to the financial crisis. Cash provided by financing activities during 2010 and 2009 was primarily due to tax benefits from stock-based payment arrangements and proceeds from stock options exercised.
Contractual Obligations
The following amounts set forth in the table are as of December 31, 2010 (in thousands).
| | | | |
| | | | | | | | | | | | | | | | |
| Contractual Obligations | | | | | | | | | | | | | | | |
| Operating lease obligations | | $ | 35,608 | | | $ | 5,302 | | | $ | 10,066 | | | $ | 9,802 | | | $ | 10,438 | |
| Purchase obligations | | | 10,406 | | | | 1,972 | | | | 8,434 | | | | -- | | | | -- | |
| Other obligations reflected on the consolidated balance sheet under GAAP | | | 910 | | | | -- | | | | -- | | | | 910 | | | | -- | |
| Total | | $ | 46,924 | | | $ | 7,274 | | | $ | 18,500 | | | $ | 10,712 | | | $ | 10,438 | |
As set forth in the 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 FASB ASC Topic 840, Leases. These obligations include the amended operating lease of our world headquarters and the leases of several other locations for our offices in the United States and eleven other countries. See Note 7 of Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for further discussion on our lease commitments.
In addition, we have signed obligations for activities after December 31, 2010, such as the build-out of on-site space at our world-headquarters and marketing related initiatives, which are included in our purchase obligations. Finally, other obligations include amounts regarding our tax liabilities and uncertain tax positions related to FASB ASC 740. See Note 10 of Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for further discussion on our uncertain tax positions.
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 also have a purchase obligation with a third party in which the payments due are based on a percentage of our revenues, and are therefore unknown. 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 in the Contractual Obligations table, we have no off-balance sheet arrangements that have or are reasonably likely to have a current or future material impact on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources as of December 31, 2010.
We provide indemnifications of varying scope and amount to certain customers against claims of intellectual property infringement made by third parties arising from the use of our products. Our software license agreements, in accordance with FASB ASC Topic 460, Guarantees, include certain provisions for indemnifying customers, in material compliance with their license agreement, against liabilities if our software products infringe upon a third party's intellectual property rights, over the life of the agreement. We are not able to estimate the potential exposure related to the indemnification provisions of our license agreements but have not incurred expenses under these indemnification provisions. We may at any time and at our option and expense: (i) procure the right of the customer to continue to use our software that may infringe a third party’s rights; (ii) modify our software so as to avoid infringement; or (iii) require the customer to return our software and refund the customer the fee actually paid by the customer for our software less depreciation based on a five-year straight-line depreciation schedule. The customer’s failure to provide timely notice or reasonable assistance will relieve us of our obligations under this indemnification to the extent that we have been actually and materially prejudiced by such failure. To date, we have not incurred, nor do we expect to incur, any material related costs and, therefore, have not reserved for such liabilities.
Our software license agreements also include a warranty that our software products will substantially conform to our software user documentation for a period of one year, provided the customer is in material compliance with the software license agreement. To date, we have not incurred any material costs associated with these product warranties, and as such, we have not reserved for any such warranty liabilities in our operating results.
| ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. |
We develop software application products in the United States and license our products worldwide. As a result, our financial results could be affected by market risks, including changes in foreign currency exchange rates, interest rates or weak economic conditions in certain markets. Market risk is the potential of loss arising from unfavorable changes in market rates and prices.
Foreign Currency Exchange Rates
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. During 2010, we began hedging both our accounts receivable and cash that are held in Euros due to the effects of the fluctuations in the foreign currency exchange rates. Prior to 2010, we had 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 continue 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. If this were to occur, foreign currency fluctuations would have a greater impact on us and may have an adverse effect on our results of operations. For the year ended December 31, 2010, approximately 9% of our revenues and 15% of our expenses were denominated in a foreign currency. As of December 31, 2010, we had net monetary assets valued in foreign currencies subject to foreign currency transaction gains or (losses), consisting primarily of cash and receivables, partially offset by accounts payable, with a carrying value of approximately $10.0 million. A 10% change in foreign currency exchange rates would have changed the carrying value of these net assets by approximately $1.0 million as of December 31, 2010 with a corresponding foreign currency gain (loss) recognized in our consolidated statement of income.
As of December 31, 2010 and December 31, 2009, we had accounts with Euro balances of approximately $5.6 million and $14.6 million, respectively, British pound balances of $207,000 and $289,000, respectively, and balances of seven other foreign currencies totaling $332,000 and $371,000, respectively.
Interest Rate Risk
We invest cash balances in excess of operating requirements in securities that 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.
| ITEM 8. | CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. |
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Interactive Intelligence, Inc.:
We have audited the accompanying consolidated balance sheets of Interactive Intelligence, Inc. (the Company) and subsidiaries as of December 31, 2010 and 2009, 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, 2010. 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, 2010, 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 consolidated 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, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related consolidated financial statement Schedule II – Valuation and Qualifying Accounts, when considered in relation to the 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. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
/s/ KPMG LLP
Indianapolis, Indiana
March 16, 2011
Interactive Intelligence, Inc.
Consolidated Balance Sheets
As of December 31, 2010 and 2009
(in thousands, except share and per share amounts)
| | | | |
| | | | | | | |
| Assets | | | | | | |
| Current assets: | | | | | | |
| Cash and cash equivalents | | $ | 48,300 | | | $ | 48,497 | |
| Short-term investments | | | 37,582 | | | | 16,482 | |
| Accounts receivable, net of allowance for doubtful accounts of $1,148 in 2010 and $1,094 in 2009 | | | 36,130 | | | | 32,092 | |
| Deferred tax assets, net | | | 5,499 | | | | 5,808 | |
| Prepaid expenses | | | 7,456 | | | | 5,976 | |
| Other current assets | | | 4,989 | | | | 3,935 | |
| Total current assets | | | 139,956 | | | | 112,790 | |
| Property and equipment, net | | | 10,336 | | | | 8,499 | |
| Deferred tax assets, net | | | 2,765 | | | | 6,505 | |
| Goodwill | | | 11,371 | | | | 2,842 | |
| Intangible assets, net | | | 11,001 | | | | 1,343 | |
| Other assets, net | | | 803 | | | | 689 | |
| Total assets | | $ | 176,232 | | | $ | 132,668 | |
| | | | | | | | | |
| Liabilities and Shareholders’ Equity | | | | | | | | |
| Current liabilities: | | | | | | | | |
| Accounts payable and accrued liabilities | | $ | 16,364 | | | $ | 11,903 | |
| Accrued compensation and related expenses | | | 6,553 | | | | 4,946 | |
| Deferred product revenues | | | 3,350 | | | | 5,567 | |
| Deferred services revenues | | | 43,281 | | | | 36,225 | |
| Total current liabilities | | | 69,548 | | | | 58,641 | |
| Deferred revenue | | | 7,420 | | | | 6,420 | |
| Total liabilities | | | 76,968 | | | | 65,061 | |
| | | | | | | | | |
| Commitments and contingencies | | | -- | | | | -- | |
| | | | | | | | | |
| Shareholders’ equity: | | | | | | | | |
| Preferred stock, no par value: 10,000,000 shares authorized; no shares issued and outstanding | | | -- | | | | -- | |
| Common stock, $0.01 par value; 100,000,000 shares authorized; 18,157,789 issued and outstanding at December 31, 2010, 17,276,990 issued and outstanding at December 31, 2009 | | | 182 | | | | 173 | |
| Treasury stock, at cost: none as of December 31, 2010, 815,875 shares as of December 31, 2009 | | | -- | | | | (6,242 | ) |
| Additional paid-in capital | | | 103,837 | | | | 92,807 | |
| Accumulated other comprehensive (expense) income | | | (290 | ) | | | 8 | |
| Accumulated deficit | | | (4,465 | ) | | | (19,139 | ) |
| Total shareholders’ equity | | | 99,264 | | | | 67,607 | |
| Total liabilities and shareholders’ equity | | $ | 176,232 | | | $ | 132,668 | |
See Accompanying Notes to Consolidated Financial Statements
Interactive Intelligence, Inc.
Consolidated Statements of Income
For the Years Ended December 31, 2010, 2009 and 2008
(in thousands, except per share amounts)
| | | | |
| | | | | | | | | | |
| Revenues: | | | | | | | | | |
| Product | | $ | 79,817 | | | $ | 63,327 | | | $ | 60,491 | |
| Recurring | | | 68,740 | | | | 55,798 | | | | 49,397 | |
| Services | | | 17,758 | | | | 12,293 | | | | 11,518 | |
| Total revenues | | | 166,315 | | | | 131,418 | | | | 121,406 | |
| Cost of revenues: | | | | | | | | | | | | |
| Product | | | 23,868 | | | | 17,452 | | | | 15,446 | |
| Recurring | | | 16,991 | | | | 12,913 | | | | 12,272 | |
| Services | | | 9,788 | | | | 9,489 | | | | 11,420 | |
| Amortization of intangible assets | | | 83 | | | | 40 | | | | -- | |
| Total cost of revenues | | | 50,730 | | | | 39,894 | | | | 39,138 | |
| Gross profit | | | 115,585 | | | | 91,524 | | | | 82,268 | |
| Operating expenses: | | | | | | | | | | | | |
| Sales and marketing | | | 47,072 | | | | 39,141 | | | | 39,307 | |
| Research and development | | | 28,349 | | | | 24,103 | | | | 21,539 | |
| General and administrative | | | 16,584 | | | | 13,817 | | | | 14,474 | |
| Amortization of intangible assets | | | 211 | | | | 22 | | | | -- | |
| Total operating expenses | | | 92,216 | | | | 77,083 | | | | 75,320 | |
| Operating income | | | 23,369 | | | | 14,441 | | | | 6,948 | |
| Other income (expense): | | | | | | | | | | | | |
| Interest income, net | | | 340 | | | | 281 | | | | 1,288 | |
| Other (expense) income , net | | | (1,146 | ) | | | 298 | | | | (434 | ) |
| Total other (expense) income, net | | | (806 | ) | | | 579 | | | | 854 | |
| Income before income taxes | | | 22,563 | | | | 15,020 | | | | 7,802 | |
| Income tax expense | | | 7,662 | | | | 6,380 | | | | 3,464 | |
| Net income | | $ | 14,901 | | | $ | 8,640 | | | $ | 4,338 | |
| | | | | | | | | | | | | |
| Net income per share: | | | | | | | | | | | | |
| Basic | | $ | 0.85 | | | $ | 0.51 | | | $ | 0.24 | |
| Diluted | | | 0.79 | | | | 0.47 | | | | 0.23 | |
| | | | | | | | | | | | | |
| Shares used to compute net income per share: | | | | | | | | | | | | |
| Basic | | | 17,563 | | | | 17,096 | | | | 17,746 | |
| Diluted | | | 18,894 | | | | 18,268 | | | | 18,740 | |
See Accompanying Notes to Consolidated Financial Statements
Interactive Intelligence, Inc.
Consolidated Statements of Shareholders’ Equity
For the Years Ended December 31, 2010, 2009 and 2008
(in thousands)
| | | | | | Treasury | | | Additional Paid-in | | | Accumulated Other Comprehensive Income | | | Accumulated | | | | |
| | | | | | | | | | | | | | | | | | | | | | |
| Balances, January 1, 2008 | | | 17,901 | | | $ | 179 | | | $ | -- | | | $ | 79,405 | | | $ | -- | | | $ | (30,965 | ) | | $ | 48,619 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Stock-based compensation | | | -- | | | | -- | | | | -- | | | | 2,966 | | | | -- | | | | -- | | | | 2,966 | |
| Exercise of stock options | | | 207 | | | | 2 | | | | 286 | | | | 776 | | | | -- | | | | (185 | ) | | | 879 | |
| Issuances of common stock | | | 24 | | | | -- | | | | -- | | | | 284 | | | | -- | | | | -- | | | | 284 | |
| Tax benefits from stock-based payment arrangements | | | -- | | | | -- | | | | -- | | | | 177 | | | | -- | | | | -- | | | | 177 | |
| Purchase of treasury stock | | | (1,204 | ) | | | (12 | ) | | | (10,000 | ) | | | -- | | | | -- | | | | -- | | | | (10,012 | ) |
| Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | | | | 4,338 | | | | 4,338 | |
| Net unrealized investment loss | | | -- | | | | -- | | | | -- | | | | -- | | | | (4 | ) | | | -- | | | | (4 | ) |
| Total comprehensive income | | | -- | | | | -- | | | | -- | | | | -- | | | | (4 | ) | | | 4,338 | | | | 4,334 | |
| Balances, December 31, 2008 | | | 16,928 | | | | 169 | | | | (9,714 | ) | | | 83,608 | | | | (4 | ) | | | (26,812 | ) | | | 47,247 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Stock-based compensation | | | -- | | | | -- | | | | -- | | | | 3,322 | | | | -- | | | | -- | | | | 3,322 | |
| Exercise of stock options | | | 321 | | | | 4 | | | | 3,129 | | | | (3 | ) | | | -- | | | | (967 | ) | | | 2,163 | |
| Issuances of common stock | | | 28 | | | | -- | | | | 343 | | | | (91 | ) | | | -- | | | | -- | | | | 252 | |
| Tax benefits from stock-based payment arrangements | | | -- | | | | -- | | | | -- | | | | 5,971 | | | | -- | | | | -- | | | | 5,971 | |
| Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | | | | 8,640 | | | | 8,640 | |
| Net unrealized investment gain | | | -- | | | | -- | | | | -- | | | | -- | | | | 12 | | | | -- | | | | 12 | |
| Total comprehensive income | | | -- | | | | -- | | | | -- | | | | -- | | | | 12 | | | | 8,640 | | | | 8,652 | |
| Balances, December 31, 2009 | | | 17,277 | | | | 173 | | | | (6,242 | ) | | | 92,807 | | | | 8 | | | | (19,139 | ) | | | 67,607 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Stock-based compensation | | | -- | | | | -- | | | | -- | | | | 3,979 | | | | -- | | | | -- | | | | 3,979 | |
| Exercise of stock options | | | 861 | | | | 9 | | | | 6,078 | | | | 580 | | | | -- | | | | (227 | ) | | | 6,440 | |
| Issuances of common stock | | | 20 | | | | -- | | | | 164 | | | | 186 | | | | -- | | | | -- | | | | 350 | |
| Tax benefits from stock-based payment arrangements | | | -- | | | | -- | | | | -- | | | | 6,285 | | | | -- | | | | -- | | | | 6,285 | |
| Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net income | | | -- | | | | -- | | | | -- | | | | -- | | | | -- | | | | 14,901 | | | | 14,901 | |
| Net unrealized investment loss | | | -- | | | | -- | | | | -- | | | | -- | | | | (298 | ) | | | -- | | | | (298 | ) |
| Total comprehensive income | | | -- | | | | -- | | | | -- | | | | -- | | | | (298 | ) | | | 14,901 | | | | 14,603 | |
| Balances, December 31, 2010 | | | 18,158 | | | $ | 182 | | | $ | -- | | | $ | 103,837 | | | $ | (290 | ) | | $ | (4,465 | ) | | $ | 99,264 | |
See Accompanying Notes to Consolidated Financial Statements
Interactive Intelligence, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2010, 2009 and 2008
(in thousands)
| | | | |
| | | | | | | | | | |
| Operating activities: | | | | | | | | | |
| Net income | | $ | 14,901 | | | $ | 8,640 | | | $ | 4,338 | |
| Adjustments to reconcile net income to net cash provided by operating activities: | | | | | | | | | | | | |
| Depreciation, amortization and other non-cash items | | | 4,621 | | | | 4,287 | | | | 3,352 | |
| Stock-based compensation expense | | | 3,979 | | | | 3,322 | | | | 2,966 | |
| Tax benefits from stock-based payment arrangements | | | (6,285 | ) | | | (5,970 | ) | | | (177 | ) |
| Deferred income tax | | | (245 | ) | | | (1,114 | ) | | | 2,200 | |
| Accretion of investment income | | | (235 | ) | | | (149 | ) | | | (109 | ) |
| Changes in operating assets and liabilities: | | | | | | | | | | | | |
| Accounts receivable | | | (2,040 | ) | | | (4,497 | ) | | | (6 | ) |
| Prepaid expenses | | | (1,423 | ) | | | (439 | ) | | | (6 | ) |
| Other current assets | | | (1,054 | ) | | | (1,939 | ) | | | (581 | ) |
| Other assets | | | (114 | ) | | | 109 | | | | (32 | ) |
| Accounts payable and accrued liabilities | | | 10,350 | | | | 6,534 | | | | 1,885 | |
| Accrued compensation and related expenses | | | 1,370 | | | | 1,460 | | | | (895 | ) |
| Deferred product revenues | | | (2,329 | ) | | | 918 | | | | (1,788 | ) |
| Deferred services revenues | | | 7,201 | | | | 3,921 | | | | 4,033 | |
| Net cash provided by operating activities | | | 28,697 | | | | 15,083 | | | | 15,180 | |
| | | | | | | | | | | | | |
| Investing activities: | | | | | | | | | | | | |
| Sales of available-for-sale investments | | | 21,815 | | | | 14,300 | | | | 24,150 | |
| Purchases of available-for-sale investments | | | (42,978 | ) | | | (19,815 | ) | | | (17,890 | ) |
| Purchases of property and equipment | | | (5,478 | ) | | | (1,912 | ) | | | (7,430 | ) |
| Acquisition of intangible and other assets, net of cash and cash equivalents acquired | | | (15,328 | ) | | | (2,249 | ) | | | -- | |
| Unrealized gain on investment | | | -- | | | | -- | | | | 8 | |
| Net cash used in investing activities | | | (41,969 | ) | | | (9,676 | ) | | | (1,162 | ) |
| | | | | | | | | | | | | |
| Financing activities: | | | | | | | | | | | | |
| Proceeds from stock options exercised | | | 6,440 | | | | 2,163 | | | | 879 | |
| Proceeds from issuance of common stock | | | 350 | | | | 252 | | | | 284 | |
| Repurchase of treasury stock | | | -- | | | | -- | | | | (10,012 | ) |
| Tax benefits from stock-based payment arrangements | | | 6,285 | | | | 5,970 | | | | 177 | |
| Net cash provided by (used in) financing activities | | | 13,075 | | | | 8,385 | | | | (8,672 | ) |
| | | | | | | | | | | | | |
| Net (decrease) increase in cash and cash equivalents | | | (197 | ) | | | 13,792 | | | | 5,346 | |
| Cash and cash equivalents, beginning of year | | | 48,497 | | | | 34,705 | | | | 29,359 | |
| Cash and cash equivalents, end of year | | $ | 48,300 | | | $ | 48,497 | | | $ | 34,705 | |
| | | | | | | | | | | | | |
| Cash paid during the year for: | | | | | | | | | | | | |
| Interest | | $ | 1 | | | $ | -- | | | $ | -- | |
| Income taxes | | | 853 | | | | 743 | | | | 431 | |
| | | | | | | | | | | | | |
| Other non-cash item: | | | | | | | | | | | | |
| Purchase of property and equipment payable at end of year | | $ | (23 | ) | | $ | 29 | | | $ | 59 | |
See Accompanying Notes to Consolidated Financial Statements
Interactive Intelligence, Inc.
Notes to Consolidated Financial Statements
December 31, 2010, 2009 and 2008
Interactive Intelligence, Inc. (the “Company”) is a leading provider of software applications. The Company’s principal product is a suite of applications that provides customers with a software-based multi-channel communications platform. The Company is a recognized leader in the worldwide contact center market, where its software applications provide a range of pre-integrated functionality. The Company uses this same platform to offer its solutions for business communications, including business process automation. The Company’s solutions are delivered both on-premise and through “cloud-based” models using hosted data centers. The Company’s solutions are used by businesses and organizations in industries such as teleservices, financial services, higher education, utilities, healthcare, retail, technology, government and business services.
The Company commenced principal operations in 1994 and revenues were first recognized in 1997. Since then, the Company has established wholly-owned subsidiaries in nine other countries. The Company’s world headquarters are located in Indianapolis, Indiana with regional offices throughout the United States and 11 other countries. The Company markets its software applications in the Americas, Europe, the Middle East and Africa, and Asia-Pacific.
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries after elimination of all significant intercompany accounts and transactions.
Use of Estimates
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. On an on-going basis, management reevaluates these estimates including those related to revenue recognition, allowance for doubtful accounts, stock-based compensation, other assets and accounting for income taxes. Despite management’s best effort to establish good faith estimates and assumptions, actual results could differ from these estimates.
Reclassifications and Adjustments
Certain reclassifications have been made to prior year amounts to conform to the current period presentation.
Effective December 31, 2010, the Company began separately classifying revenues and their related expenses on the Consolidated Statements of Income into three separate lines presented as product, recurring and services. Product revenues consist of revenues related to licenses and hardware delivered, recurring revenues consists of maintenance and cloud-based revenues and services revenues are principally revenues related to professional and educational services. The new presentation was reflected in all three years shown on the Consolidated Statements of Income. The reclassification did not have any impact on the overall results previously reported.
Subsequent to the acquisition of Global Software Services, Inc., doing business as Latitude Software (“Latitude”), which generated significant goodwill and intangible assets, the Company began separately categorizing intangible assets and goodwill on the Consolidated Balance Sheets. Previously, intangible assets and goodwill were included within other assets as their amount was immaterial. In addition, the Company also began separately classifying the related amortization expense of the intangible assets on the Consolidated Statements of Income within cost of revenues and operating expenses. Amortization expense related to the technology intangible asset is included within costs of revenues and amortization expense related to the remaining intangible assets is included within operating expenses. The new presentation was reflected in both years shown on the Consolidated Balance Sheets and all three years shown on the Consolidated Statements of Income. The reclassification did not have any impact on the overall results previously reported.
Revenue Recognition
The Company reports three types of revenues: product revenues, recurring revenues, and services revenues. Product revenues are generated from licensing the right to use its software applications, and in certain instances, selling hardware as a component of its solution. Recurring revenues are generated by annual support and renewal fees and by the Company’s cloud-based business. Services revenues are generated primarily from professional services and educational services. Revenues are generated by direct sales with customers and by indirect sales through a partner channel.
Product Revenues
The Company’s license agreements are either perpetual or annually renewable. For any revenues to be recognized from a license agreement, the following criteria must be met:
| | · | Persuasive evidence of an arrangement exists; |
| | · | The fee is fixed or determinable; |
| | · | Collection is probable; and |
For a perpetual license agreement, upon meeting the revenue recognition criteria above, the Company immediately recognizes as product revenues the residual amount of the total fees if sufficient vendor specific objective evidence (“VSOE”) of fair value exists to support allocating a portion of the total fee to the undelivered elements of the arrangement. If sufficient VSOE of fair value for the undelivered elements does not exist, the Company recognizes 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. The Company determines VSOE of fair value for support in perpetual agreements based on substantive renewal rates the customer must pay to renew the support. The VSOE of fair value for other services is based on amounts charged when the services are sold in stand-alone sales.
Although the majority of the Company’s product licenses are perpetual, certain customers, whose original license contracts were signed prior to 2004, have renewable term licenses. For an annually renewable license agreement, upon meeting the revenue recognition criteria above, the Company recognizes the license fees under these agreements as product revenues ratably over the initial license period, which is generally 12 months, and the remainder of the license fees are recognized as recurring revenues over the same time period.
The Company recognizes revenues related to any hardware sales when the hardware is delivered and all other revenue recognition criteria are met.
Recurring Revenues
The Company generates recurring revenues through its cloud-based business, and through annual support and renewal fees. The cloud-based business generates revenues by providing services to customers, in which the customers pay a minimum monthly fee to use a specified number of software licenses, plus any overages. Customers are billed the greater of their minimum monthly fee or actual usage, and revenue is recognized monthly as the service is performed. The total contract fee also includes an implementation fee, which is recognized ratably over the term of the contract.
For annually renewable license agreements, the allocation of the initial order between product revenues and recurring revenues is based on an average renewal rate for the Company’s time based contracts. The Company applies the allocation of product revenues and recurring revenues consistently to all annually renewable license agreements. Under annually renewable license agreements, after the initial license period, the Company’s 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 recurring revenue and the revenue is recognized ratably over the contract period. Under perpetual license agreements, the Company recognizes annual support fees as recurring revenues ratably over the post-contract support period, which is typically 12 months, but may extend up to three years if prepaid.
Services Revenues
The Company generates revenues from other services that it provides to its customers and partners including fees for professional services and educational services. Revenues from professional services, which include implementing the Company’s products for a customer or partner, and educational services, which consist of training courses for customers and partners, are recognized as the related services are performed.
Recently Issued Revenue Recognition Guidance
In September 2009, the Financial Accounting Standards Board (“FASB”) issued FASB Accounting Standards Update (“ASU”) 2009-13, Multiple-Deliverable Revenue Arrangements (“FASB ASU 2009-13”), which addresses criteria for separating consideration in multiple-element arrangements. The guidance requires companies to:
| i. | determine whether an arrangement contains multiple deliverables, how the deliverables in an arrangement should be separated, and how the arrangement consideration should be allocated among its elements, |
| ii. | allocate the revenue using VSOE, third party evidence of selling price (“TPE”), or estimated selling prices (“ESP”) of the deliverables if neither VSOE nor TPE exists, and |
| iii. | use the ESP method instead of the residual method for arrangements containing multiple deliverables. |
The Company will adopt this guidance on January 1, 2011 for all contracts entered into or materially modified on or after this date. In accordance with this new guidance, the total arrangement fees are allocated to all the software and non-software deliverables based on VSOE or TPE if available, and their respective ESP if VSOE and TPE are not available. This new guidance is not expected to have a significant effect on total revenues in periods after the initial adoption.
Accounts Receivable and Allowance for Doubtful Accounts Receivable
Trade accounts receivable are recorded at the invoiced amount. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company estimates bad debt expense based on a percentage of revenue reported and other measures each period. The Company then reviews the allowance for doubtful accounts each reporting period based on a detailed analysis of its accounts receivable. In the analysis, the Company primarily considers the age of the customer’s or partner’s receivable and also considers 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, the Company may also change its original estimates, which could impact the level of its future allowance for doubtful accounts.
If payment is not made timely, the Company will contact the customer or partner to try to obtain the payment. If this is not successful, the Company will institute other collection practices such as generating collection letters, involving 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.
Cash and Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less from date of purchase to be cash equivalents. Cash and cash equivalents consist primarily of cash on deposit with financial institutions and high quality money market instruments.
Investments
The Company’s investments, which consist primarily of taxable corporate and government debt securities, are classified as available-for-sale. Such investments are recorded at fair value and unrealized gains and losses are excluded from earnings and recorded as a separate component of equity until realized. Premiums or discounts are amortized or accreted over the life of the related security as an adjustment to yield using the effective interest method. Realized gains and losses from the sale of available-for-sale securities are determined on a specific identification basis. A decline in the market value of securities below cost judged to be other than temporary results in a reduction in the carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. Interest and dividends on all securities are included in interest income when earned.
Financial Instruments
The fair value of financial instruments, including cash and cash equivalents, short-term investments and accounts receivable, approximate their carrying values.
Property and Equipment
Property and equipment are stated at cost. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized using the straight-line method over the lesser of the term of the related lease or the estimated useful life. The Company leases its office space under operating lease agreements. In accordance with the FASB Accounting Standards Codification (“ASC”) Topic 840, Leases (“FASB ASC 840”), for operating leases with escalating rent payments, the Company records these rent payments on a straight-line basis over the life of the lease.
Impairment of Long-Lived Assets
In accordance with FASB ASC Topic 360, Property, Plant and Equipment, certain of the Company’s assets, such as property and equipment and intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset.
Goodwill and Other Intangible Assets
The Company reviews its goodwill and intangible assets with indefinite lives for impairment at least annually in accordance with FASB ASC Topic 350, Intangibles - Goodwill and Other. Identifiable intangible assets such as intellectual property trademarks and patents are amortized over a 10 to 15 year period using the straight-line method. In addition, other intangible assets, such as customer relationships, core technology and non-compete agreements are amortized over a five to 13 year period based upon historical patterns in which the economic benefits are expected to be realized. As of September 30, 2010 when the Company’s 2010 goodwill impairment test was performed, the Company had one reporting segment and therefore its impairment review of goodwill involved reviewing the impairment of the Company as a whole. The fair value of the reporting unit was substantially in excess of its carrying value as of the date of the 2010 goodwill impairment test. The guidance requires the Company to perform the goodwill impairment test annually or when a change in facts and circumstances indicates that the fair value of an asset may be below its carrying amount. The Company determined no indication of impairment existed as of September 30, 2010 when the annual goodwill impairment test was performed. As there were no changes in facts and circumstances that indicated that the fair value of the reporting unit may have been below its carrying amount since September 30, 2010, no additional impairment test was performed during the fourth quarter of 2010.
The 2010 goodwill impairment test did not include the goodwill recorded as a result of the acquisition of Latitude as the acquisition took place subsequent to September 30, 2010. The Company did not note any indications of impairment of the Latitude goodwill and will therefore test the goodwill of Latitude for impairment concurrent with the next annual goodwill impairment test in 2011, barring any triggering events that would prompt an impairment test prior to that date.
Advertising
The Company expenses all advertising costs as incurred. Advertising expense for 2010, 2009 and 2008 was $1.4 million, $788,000, and $1.3 million, respectively.
Research and Development
Research and development expenditures are expensed as incurred. FASB ASC Topic 985, Software, requires capitalization of certain software development costs subsequent to the establishment of technological feasibility. Based on the Company’s product development process, technological feasibility is established upon completion of a working model. Costs incurred by the Company between completion of the working model and the point at which the product is ready for general release have been insignificant. Through December 31, 2010, all research and development costs have been expensed. Research and development expense for 2010, 2009 and 2008 was $28.3 million, $24.1 million and $21.5 million, respectively.
Stock-Based Compensation
Consistent with FASB ASC Topic 718, Compensation – Stock Compensation (“FASB ASC 718”), the Company continues to use the Black-Scholes option-pricing model as its method of valuation for share-based payment awards. The Company’s determination of fair value of share-based payment awards on the date of grant using the Black-Scholes option-pricing model is affected by the Company’s stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, the Company’s expected stock price volatility over the term of the awards and an expected risk-free rate of return. If factors change and the Company uses different assumptions for estimating stock-based compensation expense associated with awards granted in future periods, stock-based compensation expense may differ materially in the future from that recorded in the current period.
The Company records compensation expense for share-based awards using the straight-line method, which is recorded into earnings over the vesting period of the award. Stock-based compensation expense for employee and director stock options recognized under FASB ASC 718 for the years ended December 31, 2010, 2009 and 2008 was $4.0 million, $3.3 million and $3.0 million, respectively. See Note 5 for further information on the Company’s stock-based compensation.
Fair Value Measurements
The carrying amounts of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities, approximate their respective fair market values due to the short maturities of these financial instruments. The fair values of short-term investments are valued in accordance with FASB ASC Topic 820, Fair Value Measurements and Disclosures (“FASB ASC 820”).
Income Taxes
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.
FASB ASC Topic 740, Income Taxes (“FASB ASC 740”), establishes financial accounting and reporting standards for the effect of income taxes. The Company is subject to income taxes in both the United States and numerous foreign jurisdictions. Significant judgment is required in evaluating the Company’s tax positions and determining its 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 the Company’s 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 prior to the period in which temporary differences such as loss carryforwards and tax credits expire. Management considers projected future taxable income and tax planning strategies in making this assessment.
As of December 31, 2010, the Company had $4.4 million in tax credit carryforwards recorded as deferred tax assets. There was no valuation allowance at December 31, 2010. The Company will continue to evaluate the valuation of deferred tax assets in accordance with the requirements of FASB ASC 740. See Note 10 for further information on the Company’s income taxes.
The revenue from sales tax collected from customers is recorded on a net basis.
Net Income per Share
Basic net income per share is calculated based on the weighted-average number of common shares outstanding in accordance with FASB ASC Topic 260, Earnings per Share. Diluted net income per share is calculated based on the weighted-average number of common shares outstanding plus the effect of dilutive potential common shares. When the Company reports net income, the calculation of diluted net income per share excludes shares underlying stock options outstanding that would be anti-dilutive. Potential common shares are composed of shares of common stock issuable upon the exercise of stock options. The following table sets forth the calculation of basic and diluted net income per share (in thousands, except per share amounts):
| | | | |
| | | | | | | | | | |
| Net income, as reported (A) | | $ | 14,901 | | | $ | 8,640 | | | $ | 4,338 | |
| | | | | | | | | | | | | |
| Weighted-average outstanding shares of common stock (B) | | | 17,563 | | | | 17,096 | | | | 17,746 | |
| Dilutive effect of stock options | | | 1,331 | | | | 1,172 | | | | 994 | |
| Common stock and common stock equivalents (C) | | | 18,894 | | | | 18,268 | | | | 18,740 | |
| | | | | | | | | | | | | |
| Net income per share: | | | | | | | | | | | | |
| Basic (A/B) | | $ | 0.85 | | | $ | 0.51 | | | $ | 0.24 | |
| Diluted (A/C) | | | 0.79 | | | | 0.47 | | | | 0.23 | |
Anti-dilutive shares not included in the diluted per share calculation for 2010, 2009 and 2008 were 820,000, 1.1 million and 1.3 million, respectively.
Comprehensive Income
Comprehensive income is comprised of net income and other comprehensive income (loss). The only item of other comprehensive income (loss) that the Company currently reports is unrealized gains (losses) on marketable securities.
Legal Proceedings
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.
The Company’s short-term investments all mature in less than one year and are considered available for sale. In 2010 and 2009, the Company purchased short-term investments for $43.0 million and $19.8 million, respectively. As of December 31, 2010 and 2009, $37.6 million and $16.5 million in short-term investments were outstanding, respectively, which were recorded at their fair values. The Company does not invest in subprime assets.
Gross realized gains and gross realized losses included in interest income, net totaled less than $10,000 in each of 2010, 2009 and 2008.
Interest income was $340,000, $281,000 and $1.3 million in 2010, 2009 and 2008, respectively.
The Company measures investments at fair value in accordance with FASB ASC 820. FASB ASC 820 as amended defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. FASB ASC 820 also establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes the following three levels of inputs that may be used to measure fair value:
| · | Level 1 - Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. |
| · | Level 2 - Observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. |
| · | Level 3 - Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. |
The Company’s assets that are measured at fair value on a recurring basis are generally classified within Level 1 or Level 2 of the fair value hierarchy. The types of instruments valued based on quoted market prices in active markets include mostly money market securities and equity investments. Such instruments are generally classified within Level 1 of the fair value hierarchy. The Company invests in money market funds that are traded daily and does not adjust the quoted price for such instruments. The types of instruments valued based on quoted prices in less active markets, broker or dealer quotations, or alternative pricing sources with reasonable levels of price transparency include corporate notes, commercial paper and certificates of deposits. Such instruments are generally classified within Level 2 of the fair value hierarchy. The Company uses consensus pricing, which is based on multiple pricing sources, to value its fixed income investments.
The following table sets forth a summary of the Company’s financial assets, classified as cash and cash equivalents and short-term investments on its consolidated balance sheet, measured at fair value on a recurring basis as of December 31, 2010 (in thousands):
| | | Fair Value Measurements at Reporting Date Using | |
| | | | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | | Significant Other Observable Inputs (Level 2) | | | Significant Unobservable Inputs (Level 3) | |
| Cash & cash equivalents: | | | | | | | | | | | | |
| Money Market Funds | | $ | 15,593 | | | $ | 15,593 | | | $ | -- | | | $ | -- | |
| Commercial paper | | | 2,400 | | | | 2,400 | | | | -- | | | | -- | |
| Total | | $ | 17,993 | | | $ | 17,993 | | | $ | -- | | | $ | -- | |
| | | | | | | | | | | | | | | | | |
| Short-term investments: | | | | | | | | | | | | | | | | |
| Agency Bond | | $ | 8,882 | | | $ | -- | | | $ | 8,882 | | | $ | -- | |
| Commercial Paper | | | 5,297 | | | | -- | | | | 5,297 | | | | -- | |
| Corporate Notes | | | 20,803 | | | | -- | | | | 20,803 | | | | -- | |
| T-Bill | | | 2,600 | | | | -- | | | | 2,600 | | | | -- | |
| Total | | $ | 37,582 | | | $ | -- | | | $ | 37,582 | | | $ | -- | |
Property and equipment are summarized as follows as of December 31, 2010 and 2009 (in thousands):
| | | | | | | |
| Computer equipment | | $ | 14,733 | | | $ | 11,656 | |
| Leasehold improvements | | | 8,573 | | | | 7,904 | |
| Furniture and fixtures | | | 4,581 | | | | 4,014 | |
| Software | | | 1,476 | | | | 836 | |
| Office equipment | | | 1,009 | | | | 759 | |
| Trade show equipment and other | | | 418 | | | | 414 | |
| Construction in process | | | 312 | | | | 6 | |
| Total property and equipment | | | 31,102 | | | | 25,589 | |
| Less accumulated depreciation | | | (20,766 | ) | | | (17,090 | ) |
| Net property and equipment | | $ | 10,336 | | | $ | 8,499 | |
Property and equipment is depreciated over useful lives of 3 to 5 years, except for leasehold improvements, which are depreciated over the lesser of the term of the related lease or the estimated useful life, and vary from 3 to 15 years. During the year ended December 31, 2010, the Company reduced assets and accumulated depreciation by $1.4 million for fully depreciated computer and software equipment that was seven years old or older and was no longer in use.
5. STOCK-BASED COMPENSATION
Stock Option Plans
The Company’s stock option plans, adopted in 1995, 1999 and 2006, authorize the Board of Directors or the Compensation Committee, as applicable, to grant incentive and nonqualified stock options, and, in the case of the 2006 Equity Incentive Plan, as amended (the “2006 Plan”), stock appreciation rights, restricted stock, restricted stock units (“RSUs”), performance shares, performance units and other stock-based awards. After adoption of the 2006 Plan by the Company’s shareholders in May 2006, the Company may no longer make any grants under previous plans, but any shares subject to awards under the 1999 Stock Option and Incentive Plan and the Outside Directors Stock Option Plan (collectively, the “1999 Plans”) that are cancelled are added to shares available under the 2006 Plan. A maximum of 7,050,933 shares are available for delivery under the 2006 Plan, which consists of (i) 3,350,000 shares, plus (ii) 320,000 shares available for issuance under the 1999 Plans, but not underlying any outstanding stock options or other awards under the 1999 Plans, plus (iii) up to 3,380,933 shares subject to outstanding stock options or other awards under the 1999 Plans that expire, are forfeited or otherwise terminate unexercised on or after May 18, 2006. The number of shares available under the 2006 Plan is subject to adjustment for certain changes in the Company’s capital structure. The exercise price of options granted under the 2006 Plan is equal to the closing price of the Company’s common stock, as reported by The NASDAQ Global Select Market, on the business day immediately preceding the date of grant.
Stock options granted by the Company are categorized into three types. The first type of stock options granted by the Company to employees and newly-elected non-employee directors is non-performance-based stock options that are subject only to time-based vesting. These stock options vest in four equal annual installments beginning one year after the grant date. The fair value of these option grants is determined on the date of grant and the related compensation expense is recognized for the entire award on a straight-line basis over the vesting period.
The second type is performance-based stock options that are subject to cancellation if the specified performance targets are not met. If the applicable performance targets have been achieved, the options will vest in four equal annual installments beginning one year after the performance-related period has ended. The fair value of these stock option grants is determined on the date of grant and the related compensation expense is recognized over the requisite service period, including the initial period for which the specified performance targets must be met.
The third type of stock options granted by the Company are director options granted to non-employee directors annually which are similar to the non-performance-based options described above except that the director options vest one year after the grant date. The fair value of these option grants is determined on the date of the grant and the related compensation expense is recognized over one year.
Commencing in January 2011, the Company began granting equity incentive awards in the form of RSUs to certain key employees. The fair value of the RSUs is determined on the date of grant and the RSUs vest in four equal annual installments beginning one year after the grant date. RSUs are not included in issued and outstanding common stock until the shares are vested and settlement has occurred.
The plans may be terminated by the Company’s Board of Directors at any time.
Valuation Assumptions
The Company estimated the fair value of stock options using the Black-Scholes valuation model. The fair value of each option grant is estimated on the date of grant and is amortized on a straight-line basis over the vesting period. The weighted-average estimated per option value of non-performance-based, performance-based and director options under the stock option plans during the year ended December 31, 2010, 2009 and 2008 was $10.43, $4.16 and $7.29, respectively, using the following assumptions:
| | | | |
| Valuation assumptions for non-performance-based options: | | | | | | | | | |
| Dividend yield | | | -- | % | | | -- | % | | | -- | % |
| Expected volatility | | | 64.74-69.10 | % | | | 67.88-69.56 | % | | | 63.21-66.87 | % |
| Risk-free interest rate | | | 1.19-2.06 | % | | | 1.64-2.36 | % | | | 1.36-3.34 | % |
| Expected life of option (in years) | | | 4.25 | | | | 4.25 | | | | 4.25 | |
| | | | |
| Valuation assumptions for performance-based options: | | | | | | | | | |
| Dividend yield | | | -- | % | | | -- | % | | | -- | % |
| Expected volatility | | | 67.81 | % | | | 67.35 | % | | | 63.66 | % |
| Risk-free interest rate | | | 2.30 | % | | | 1.77 | % | | | 2.39 | % |
| Expected life of option (in years) | | | 4.75 | | | | 4.75 | | | | 4.75 | |
The Company granted performance-based options only during the first quarter of each of 2010, 2009 and 2008.
| | | | |
| Valuation assumptions for director options: | | | | | | | | | |
| Dividend yield | | | -- | % | | | -- | % | | | N/A | |
| Expected volatility | | | 64.43 | % | | | 71.48 | % | | | N/A | |
| Risk-free interest rate | | | 1.41 | % | | | 2.01 | % | | | N/A | |
| Expected life of option (in years) | | | 3.50 | | | | 3.50 | | | | N/A | |
The Company granted annual director options that vest one year after the grant date only during the second quarter of each of 2009 and 2010.
Expected Dividend: The Black-Scholes valuation model calls for a single expected dividend yield as an input. The Company has never declared or paid cash dividends on its common stock and does not expect to declare or pay any cash dividends in the foreseeable future.
Expected Volatility: The Company’s volatility factor was based exclusively on its historical stock prices over the most recent period commensurate with the estimated expected life of the stock options.
Risk-Free Rate: The Company bases the risk-free interest rate on the implied yield currently available on U.S. Treasury zero-coupon issues with an equivalent remaining term commensurate with the estimated expected life of the stock options.
Expected Term: The Company’s expected term represents the period that the Company’s stock options are expected to be outstanding and was determined using the simplified method as described in FASB ASC 718. The Company chose to use the simplified method given the lack of historical data at the current expiration term of six years and the non-employee director options that fully vest in one year. FASB ASC 718 permits the continued use of this option after December 31, 2007 if the Company does not believe it has sufficient historical data to support another method.
Estimated Pre-vesting Forfeitures: Beginning January 1, 2006, the Company included an estimate for forfeitures in calculating stock option expense. When estimating forfeitures, the Company considers historical termination behavior as well as any future trends it expects.
For most options granted through December 31, 2004, the term of each option is ten years from the date of grant. In 2005, the Company began issuing options with a term of six years from the date of grant.
If an incentive stock option is granted to an employee who, at the time the option is granted, owns stock representing more than 10% percent of the voting power of all classes of stock of the Company, the exercise price of the option may not be less than 110% of the market value per share on the date the option is granted and the term of the option shall be not more than five years from the date of grant.
Expense Information under FASB ASC 718
The following table summarizes the allocation of stock-based compensation expense related to stock options under FASB ASC 718 for the years ended December 31, 2010, 2009 and 2008 (in thousands, except per share amounts):
| | | | |
| | | | | | | | | | |
| Stock-based compensation expense by category: | | | | | | | | | |
| Cost of services | | $ | 321 | | | $ | 239 | | | $ | 203 | |
| Sales and marketing | | | 1,230 | | | | 1,128 | | | | 1,094 | |
| Research and development | | | 1,178 | | | | 952 | | | | 833 | |
| General and administrative | | | 1,250 | | | | 1,003 | | | | 836 | |
| Total stock-based compensation expense | | $ | 3,979 | | | $ | 3,322 | | | $ | 2,966 | |
| | | | | | | | | | | | | |
| Effect of stock-based compensation expense on net income per share: | | | | | | | | | | | | |
| Basic | | $ | (0.23 | ) | | $ | (0.19 | ) | | $ | (0.17 | ) |
| Diluted | | | (0.21 | ) | | | (0.18 | ) | | | (0.16 | ) |
At each quarter end, the Company evaluates the probability that the performance awards granted during the first quarter will be forfeited at year-end for non-performance and reverses the associated expense recorded in previous periods. During the fourth quarter of 2010 and 2009 and during the third and fourth quarters of 2008, the Company reversed the stock option expense recorded in previous periods associated with these options totaling $54,000 in 2010, $22,000 in 2009 and $496,000 in 2008. After taking into account the options that were cancelled during 2010, 2009 and 2008, the estimated total grant date fair value, not accounting for estimated forfeitures, is as follows (in thousands):
| | | Number of Options Granted | | | Number of Options Cancelled | | | | |
| Year: | | | | | | | | | |
| 2010 | | | 642 | | | | 26 | | | $ | 6,400 | |
| 2009 | | | 571 | | | | 47 | | | | 2,200 | |
| 2008 | | | 599 | | | | 252 | | | | 2,500 | |
As required by FASB ASC 718, management has made an estimate of expected forfeitures and is recognizing compensation expense only for those stock awards expected to vest. For the year ended December 31, 2010, the Company estimated that the total stock-based compensation expense for the awards not expected to vest was $315,000, with such amounts deducted to arrive at the fair value of $6.1 million.
Stock Option Activity
The following table sets forth a summary of option activity for the years ended December 31, 2010, 2009 and 2008:
| | | | |
| | | | | | | | | | |
| | | | | | Weighted- Average Exercise Price | | | | | | Weighted- Average Exercise Price | | | | | | Weighted- Average Exercise Price | |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Balances, beginning of year | | | 3,425,743 | | | $ | 9.36 | | | | 3,300,565 | | | $ | 9.45 | | | | 3,232,483 | | | $ | 8.71 | |
| Options granted | | | 641,500 | | | | 19.48 | | | | 571,375 | | | | 7.81 | | | | 599,315 | | | | 14.12 | |
| Options exercised | | | (860,669 | ) | | | 7.48 | | | | (320,993 | ) | | | 6.73 | | | | (206,958 | ) | | | 4.23 | |
| Options cancelled, forfeited or expired | | | (77,201 | ) | | | 25.02 | | | | (125,204 | ) | | | 14.01 | | | | (324,275 | ) | | | 13.12 | |
| Options outstanding, end of year | | | 3,129,373 | | | | 11.58 | | | | 3,425,743 | | | | 9.36 | | | | 3,300,565 | | | | 9.46 | |
| Option price range at end of year | | $ | 2.51 - $35.00 | | | | | | | $ | 2.51 - $50.50 | | | | | | | $ | 2.51 - $50.50 | | | | | |
| Weighted-average fair value of options granted during the year | | $ | 10.43 | | | | | | | $ | 4.16 | | | | | | | $ | 7.29 | | | | | |
| Options exercisable at end of year | | | 1,804,922 | | | $ | 8.92 | | | | 2,187,357 | | | $ | 8.07 | | | | 2,086,610 | | | $ | 7.30 | |
| Options available for grant at end of year | | | 1,714,554 | | | | | | | | 915,794 | | | | | | | | 1,388,969 | | | | | |
The change in options available for grant at the end of the year from 2010 compared to 2009 was primarily related to the Company’s shareholders approving an amendment to the 2006 Plan in May 2010, which increased the number of shares available for grant by 1,200,000 shares.
The following table sets forth information regarding the Company’s stock options outstanding and exercisable at December 31, 2010:
| | | | | | | | | | |
| Range of Exercise Prices | | | | | Weighted- Average Remaining Contractual Life | | Weighted- Average Exercise Price | | | | | | Weighted- Average Exercise Price | |
| $ | 2.51 – $6.10.............................. | | | | 1,028,805 | | 2.40 years | | $ | 4.78 | | | | 1,028,805 | | | $ | 4.78 | |
| $ | 6.66 – $6.66.............................. | | | | 399,392 | | 4.12 years | | | 6.66 | | | | 72,767 | | | | 6.66 | |
| $ | 6.70 – $14.09............................ | | | | 441,055 | | 2.63 years | | | 11.59 | | | | 292,243 | | | | 10.95 | |
| $ | 14.37 – $17.28.......................... | | | | 421,033 | | 3.12 years | | | 16.08 | | | | 205,451 | | | | 15.85 | |
| $ | 18.24 – $19.34.......................... | | | | 116,834 | | 4.12 years | | | 19.01 | | | | 40,334 | | | | 19.15 | |
| $ | 19.66 – $19.66.......................... | | | | 488,500 | | 5.15 years | | | 19.66 | | | | -- | | | | -- | |
| $ | 19.77 – $35.00.......................... | | | | 233,754 | | 2.35 years | | | 21.13 | | | | 165,322 | | | | 20.97 | |
| Total shares/average price | | | | 3,129,373 | | | | | 11.58 | | | | 1,804,922 | | | | 8.92 | |
The total intrinsic value of options exercised during the year ended December 31, 2010 was $13.5 million. The aggregate intrinsic value of options outstanding as of December 31, 2010 was $45.7 million and the aggregate intrinsic value of options currently exercisable as of December 31, 2010 was $31.1 million. The aggregate intrinsic value represents the total intrinsic value, based on the Company’s closing stock price per share of $26.16 as of December 31, 2010, which would have been realized by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of December 31, 2010 was 1.8 million with a weighted average exercise price of $8.86.
As of December 31, 2010, there was $7.0 million of total unrecognized compensation cost related to non-vested stock options. These costs are expected to be recognized over the weighted average remaining vesting period of 2.2 years.
2000 Employee Stock Purchase Plan
In May 2000, the Company adopted the 2000 Employee Stock Purchase Plan (the “2000 Purchase Plan”). A total of 500,000 shares of common stock were reserved for issuance under the 2000 Purchase Plan. On May 19, 2005, the shareholders of the Company approved an amendment to the 2000 Purchase Plan that increased the number of shares of common stock available for purchase and issuance to 750,000. The 2000 Purchase Plan permits eligible employees to acquire shares of the Company’s common stock through periodic payroll deductions of up to 20% of their total compensation up to a maximum of $1,000 per pay period. The price at which the Company’s common stock may be purchased is 95% of the fair market value of the Company’s closing common stock price, as reported on The NASDAQ Global Select Market, on the last business day of the quarter. The actual purchase date is generally on the first business day of the next calendar quarter. An employee may set aside up to $25,000 to purchase shares annually. The initial offering period commenced on April 1, 2000. A total of 20,130 shares, 27,261 shares and 24,501 shares were purchased and issued during 2010, 2009 and 2008, respectively, under the 2000 Purchase Plan at an average price of $16.69, $11.13 and $12.90, respectively. As of December 31, 2010, there were 150,286 shares available for purchase and issuance under the 2000 Purchase Plan.
The 2000 Purchase Plan was modified, as of January 1, 2006, to ensure that it was considered non-compensatory under FASB ASC 718. As a result, the Company has not recognized any stock-based compensation expense related to its 2000 Purchase Plan.
6. SHARE REPURCHASE PROGRAM
On July 28, 2008, the Company’s Board of Directors approved a share repurchase program to facilitate the repurchase of its common stock over the course of one year. Under this program, the Company was authorized to purchase shares of its common stock up to a maximum aggregate purchase price of $10.0 million. Repurchases could be made from time to time in the open market and in privately negotiated transactions, based on business and market conditions under plans designed to comply with Rule 10b5-1 and Rule 10b-18 under the Securities Exchange Act of 1934, as amended. The program could be amended, suspended or discontinued at any time and did not commit the Company to repurchase shares of its common stock.
During 2008, the Company repurchased 1.2 million shares of its common stock at an aggregate cost of $10.0 million. The share repurchase program was completed on November 12, 2008. The shares acquired were used for stock-based compensation awards and other corporate purposes and were fully depleted in December 2010.
The Company’s world headquarters are located in approximately 260,000 square feet of space in two office buildings in Indianapolis, Indiana. The Company leases the space under an operating lease agreement and amendments which expire on March 31, 2018. The Company also occupies a product distribution center in Indianapolis, Indiana and has several other office leases throughout the United States and in eleven other countries with initial lease terms of up to five years. The Company rents office space for sales, services, development and international offices under month-to-month leases. In accordance with FASB ASC 840, rental expense is recognized ratably over the lease period, including those leases containing escalation clauses.
The Company believes that all of its facilities are adequate and well suited to accommodate its business operations. The Company continuously reviews space requirements to ensure it has adequate room for growth in the future.
Rent expense, net was $5.7 million, $5.7 million and $4.9 million for the years ended December 31, 2010, 2009 and 2008, respectively. Minimum future lease payments under the Company’s operating leases as of December 31, 2010 are summarized as follows (in thousands):
| 2011 | | $ | 5,302 | |
| 2012 | | | 5,001 | |
| 2013 | | | 5,064 | |
| 2014 | | | 4,971 | |
| 2015 | | | 4,831 | |
| Thereafter | | | 10,438 | |
| Total minimum lease payments | | $ | 35,607 | |
| 8. | CONCENTRATION OF CREDIT RISK |
No customer or partner accounted for 10% or more of the Company’s revenues in 2010, 2009 and 2008. No one partner or customer accounted for 10% or more of the Company’s accounts receivable as of December 31, 2010 and 2008; however, one partner accounted for 13% of the Company’s accounts receivable as of December 31, 2009. The Company’s top five partners collectively represented 25% and 30% of the Company’s accounts receivable balance at December 31, 2010 and 2009, respectively. The Company evaluates the creditworthiness of its customers and partners on a periodic basis. The Company generally does not require collateral. The Company manages its operations as a single segment for purposes of assessing performance and making operating decisions. No individual country accounted for more than 10% of the Company's revenues, with the exception of the United States, for the years ended December 31, 2010, 2009 and 2008.
| 9. | RETIREMENT SAVINGS PLAN |
The Company maintains a 401(k) retirement savings plan (the “Plan”) to provide retirement benefits for substantially all of its North American employees. Participants in the Plan may elect to contribute up to 50% of their pre-tax annual compensation to the Plan, limited to the maximum amount allowed by the Internal Revenue Code, as amended. The Company, at its discretion, may also make annual contributions to the Plan.
Effective January 1, 2007, the Plan Administrator approved a restated Plan Document, which included amendments to the Plan since January 1, 2003, including new benefits added to the Plan such as a Company matching contribution potential and a Roth 401(k) option.
For the year ended December 31, 2010, subject to meeting specified operating targets, the Company matched up to 33% of the first 9% of a participant’s pre-tax compensation contributed to the Plan. For the year ended December 31, 2010, the Company’s performance resulted in a match for the full amount of $909,000 which was contributed to the employee’s accounts in March of 2011.
For the years ended December 31, 2009 and 2008, subject to meeting specified operating targets, the Company matched up to 25% of the first 8% of a participant’s pre-tax compensation contributed to the Plan. For the year ended December 31, 2009, the Company’s performance resulted in a match for the full amount of $564,000 and, for the year ended December 31, 2008, the Company’s performance resulted in a match of $348,000, which was less than the full amount as the specified operating targets were not met.
For an eligible participant who has worked for the Company for less than four years at the time of the Company matching contribution, the contribution will vest in equal installments over four years based on the anniversary date of the participant’s employment. For an eligible participant who has worked for the Company for four or more years at the time of contribution, the contribution is 100% vested.
The Company match criteria for 2011 will be the same as the criteria in 2010.
Although the Company has not expressed any intent to terminate the Plan, it has the option to do so at any time subject to the provisions of the Employee Retirement Income Security Act of 1974. Upon termination of the Plan, either full or partial, participants become fully vested in their entire account balances.
The following table sets forth information regarding the United States and foreign components of income tax expense (benefit) for 2010, 2009 and 2008 (in thousands):
| | | Current | | | Deferred | | | Total | |
| 2010: | | | | | | | | | |
| United States Federal | | $ | 5,659 | | | $ | 502 | | | $ | 6,161 | |
| State and local | | | 1,364 | | | | (552 | ) | | | 812 | |
| Foreign jurisdiction | | | 689 | | | | -- | | | | 689 | |
| Total | | $ | 7,712 | | | | (50 | ) | | $ | 7,662 | |
| | | | | | | | | | | | | |
| 2009: | | | | | | | | | | | | |
| United States Federal | | $ | 5,380 | | | $ | (1,327 | ) | | $ | 4,053 | |
| State and local | | | 1,253 | | | | 213 | | | | 1,466 | |
| Foreign jurisdiction | | | 861 | | | | -- | | | | 861 | |
| Total | | $ | 7,494 | | | $ | ( 1,114 | ) | | $ | 6,380 | |
| | | | | | | | | | | | | |
| 2008: | | | | | | | | | | | | |
| United States Federal | | $ | 829 | | | $ | 2,081 | | | $ | 2,910 | |
| State and local | | | 173 | | | | 118 | | | | 291 | |
| Foreign jurisdiction | | | 263 | | | | -- | | | | 263 | |
| Total | | $ | 1,265 | | | $ | 2,199 | | | $ | 3,464 | |
The tax effects of temporary differences that gave rise to significant portions of the deferred tax assets at December 31, 2010 and 2009 are presented below (in thousands):
| | | | | | | |
| Deferred tax assets: | | | | | | |
| Allowance for doubtful accounts | | $ | 459 | | | $ | 438 | |
| Accrued expenses | | | 1,337 | | | | 731 | |
| Deferred revenues | | | 2,371 | | | | 2,748 | |
| Stock-based compensation expense | | | 2,881 | | | | 1,632 | |
| Depreciation and amortization expense | | | 902 | | | | 706 | |
| Tax net operating loss carryforwards | | | 60 | | | | 121 | |
| Foreign tax credit carryforwards | | | 1,359 | | | | 3,119 | |
| Research tax carryforwards | | | 3,061 | | | | 2,818 | |
| Total deferred tax assets | | | 12,430 | | | | 12,313 | |
| Deferred tax liabilities: | | | | | | | | |
| Intangibles | | | (4,166 | ) | | | -- | |
| Total deferred tax liabilities | | | (4,166 | ) | | | -- | |
| Net deferred tax assets | | $ | 8,264 | | | $ | 12,313 | |
In assessing the realizability 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 the generation of future taxable income prior to the periods in which those temporary differences such as loss carryforwards and tax credits expire. Management considers the scheduled reversal of deferred tax liabilities, if any (including the impact of available carryback and carryforward periods), projected future taxable income, and tax-planning strategies in making this assessment. The Company will need to generate future taxable income of approximately $12.0 million to realize the deferred tax assets prior to the expiration of the net operating loss carryforwards and credits in 2029. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, management believes it is more likely than not that the Company will realize the benefits of these deductible differences at December 31, 2010. The amount of the deferred tax asset considered realizable, however, could be reduced in the near term if estimates of future taxable income during the carryforward period are reduced.
The following table sets forth the items accounting for the difference between expected income tax expense (benefit) compared to actual income tax expense (benefit) recorded in the Company’s consolidated financial statements (in thousands):
| | | | |
| | | | | | | | | | |
| Expected income tax expense at 35% tax rate | | $ | 7,897 | | | $ | 5,257 | | | $ | 2,731 | |
| State taxes, net of federal benefit | | | 632 | | | | 1,217 | | | | 189 | |
| Stock-based compensation expense related to non-deductible stock option expense | | | (288 | ) | | | 461 | | | | 685 | |
| Change in deferred tax asset valuation allowance | | | -- | | | | -- | | | | -- | |
| Research tax credit | | | (366 | ) | | | (393 | ) | | | (278 | ) |
| Other | | | (213 | ) | | | (162 | ) | | | 137 | |
| Income tax expense | | $ | 7,662 | | | $ | 6,380 | | | $ | 3,464 | |
During 2010, the Company utilized its remaining net operating losses generated from tax benefits related to the exercise of stock options. Tax benefits related to the exercise of stock options during 2010, 2009 and 2008 were $6.3 million, $6.0 million and $177,000, respectively. The Company did not have a deferred tax asset on its balance sheet for the tax benefits from these deductions. At December 31, 2010, the Company had approximately $4.4 million of alternative minimum tax, federal and state research tax credit carryforwards and foreign tax credits available to offset taxes payable. In addition, the Company had a deferred tax asset of $60,000 available to offset future taxable income of a subsidiary.
The Company and its subsidiaries file federal income tax returns and income tax returns in various states and foreign jurisdictions. Tax years 2007 and forward remain open for examination for federal tax purposes and tax years 2006 and forward remain open for examination for the Company’s more significant state tax jurisdictions. To the extent utilized in future years’ tax returns, net operating loss and capital loss carryforwards at December 31, 2010 will remain subject to examination until the respective tax year is closed.
FASB ASC 740 prescribes a recognition threshold and measurement attributes for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The Company has identified an uncertain tax position related to certain tax credits that the Company currently believes meets the “more likely than not” recognition threshold to be sustained upon examination. Prior to the fourth quarter of 2007, this uncertain tax position had not been recognized because the Company had a full valuation allowance established. The balance of the reserve was approximately $1.1 million at December 31, 2010.
The Company accounts for provisions related to the accounting for uncertainty in income taxes under FASB ASC 740. The Company did not record a cumulative effect adjustment to retained earnings as a result of the implementation of this accounting pronouncement. The Company recognizes financial statement benefits for positions taken for tax return purposes when it is more-likely-than-not that the position will be sustained. A reconciliation of the beginning and ending amount of the gross unrecognized tax benefits is as follows (in thousands):
| Balance at January 1, 2009 | | $ | 750 | |
| Increase in balance due to current year tax position | | | 80 | |
| Increase in balance due to prior year tax position | | | 80 | |
| Balance at December 31, 2009 | | | 910 | |
| Increase in balance due to current year tax position | | | 217 | |
| Balance at December 31, 2010 | | $ | 1,127 | |
If recognized, the entire remaining balance of unrecognized tax benefits would impact the effective tax rate. Over the next 12 months, we do not anticipate the total amount of our unrecognized tax benefits to significantly change. We recognize interest income, interest expense, and penalties relating to tax exposures as a component of income tax expense. There was no interest expense and penalties related to the above unrecognized tax benefits as of December 31, 2010.
In accordance with FASB ASC Topic 280, Segment Reporting, the Company views its operations and manages its business as principally one segment which is interaction management software applications licensing and associated services. As a result, the financial information disclosed herein represents all of the material financial information related to the Company’s principal operating segment.
Revenues derived from non-North American customers accounted for approximately 27% in 2010, 2009 and 2008 of the Company’s total revenues. The Company attributes its revenues to countries based on the country in which the customer or partner is located. The sales and licensing revenues in each individual non-North American country accounted for less than 10% of total revenues in 2010, 2009 and 2008. As of December 31, 2010, approximately 13% of the Company’s net property and equipment, which included computer and office equipment, furniture and fixtures and leasehold improvements, were located in foreign countries.
| 12. | COMMITMENTS AND CONTINGENCIES |
Legal Proceedings
From time to time, the Company has received notification from competitors and other technology providers claiming that the Company’s technology infringes their proprietary rights. The Company cannot assure you that these matters can be resolved amicably without litigation, or that the Company will be able to enter into licensing arrangements on terms and conditions that would not have a material adverse effect on its business, financial condition or results of operations.
From time to time, the Company is also involved in certain legal proceedings in the ordinary course of conducting its business. While the ultimate liability pursuant to these actions cannot currently be determined, the Company believes these legal proceedings will not have a material adverse effect on its financial position or results of operations. Litigation in general, and intellectual property litigation in particular, can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict.
Guarantees
The Company provides indemnifications of varying scope and amount to certain customers against claims of intellectual property infringement made by third parties arising from the use of its products. The Company’s direct software license agreements, in accordance with FASB ASC Topic 460, Guarantees, include certain provisions for indemnifying customers, in material compliance with their license agreement, against liabilities if the Company’s software products infringe upon a third party's intellectual property rights, over the life of the agreement. There is no maximum potential amount of future payments set under the guarantee. However, the Company may at any time and at its option and expense: (i) procure the right of the customer to continue to use the Company’s software that may infringe a third party’s rights; (ii) modify its software so as to avoid infringement; or (iii) require the customer to return its software and refund the customer the fee actually paid by the customer for its software less depreciation based on a five-year straight-line depreciation schedule. The customer’s failure to provide timely notice or reasonable assistance will relieve the Company of its obligations under this indemnification to the extent that it has been actually and materially prejudiced by such failure. To date, the Company has not incurred, nor does it expect to incur, any material related costs and, therefore, has not reserved for such liabilities.
The Company’s software license agreements also include a warranty that its software products will substantially conform to its software user documentation for a period of one year, provided the customer is in material compliance with the software license agreement. To date, the Company has not incurred any material costs associated with these product warranties, and as such, has not reserved for any such warranty liabilities in its operating results.
Lease Commitments and Other Contingencies
See Note 7 for further information on the Company’s lease commitments.
The Company has received and may continue to receive certain payroll tax credits and real estate tax abatements that were granted to the Company based upon certain growth projections. If the Company’s actual results are less than those projections, the Company may be subject to repayment of some or all of the tax credits or payment of additional real estate taxes in the case of the abatements. The Company does not believe that it will be subject to payment of any money related to these taxes; however, the Company cannot provide assurance as to the outcome.
13. ACQUISITION
Latitude Acquisition
The Company entered into a stock purchase agreement, dated as of October 5, 2010, with Latitude, a privately-held provider of accounts receivable management software and services. Pursuant to the terms of the stock purchase agreement, the Company purchased 100% of Latitude's outstanding capital stock for an aggregate purchase price of $15.6 million, including $1.6 million related to the working capital of Latitude, funded with cash-on-hand. The Company deposited $1.1 million of the purchase price into an escrow account to ensure funds are available to pay indemnification claims, if any. Latitude is operating as a subsidiary of the Company. The Company acquired Latitude as part of its growth strategy of adding industry-specific applications and expertise. With a broader focus on Latitude, the Company intends to create tighter integration between Latitude’s applications and its core Interaction Center Platform® technology, enhance Latitude solutions for first-party debt collections, incorporate Latitude’s solutions in the Company’s cloud-based offerings, and internationalize Latitude’s solutions for sale around the world. The acquisition was accounted for using the acquisition method of accounting in accordance with FASB ASC Topic 805, Business Combinations (“FASB ASC 805”), and the results of Latitude’s operations were included in the Company’s consolidated financial statements commencing on October 1, 2010.
The preliminary purchase price allocations for the Company’s acquisition of Latitude are based on a third-party valuation report which was prepared in accordance with the provisions of FASB ASC 805. The following table summarizes the fair value of the intangible and other assets acquired and liabilities assumed at the date of the acquisition (in thousands):
| | | | |
| Cash | | $ | 338 | |
| Accounts receivable, net | | | 1,998 | |
| Prepaids | | | 57 | |
| Property, plant and equipment, net | | | 697 | |
| Accounts payable | | | (448 | ) |
| Accrued compensation | | | (237 | ) |
| Intangible assets | | | 10,000 | |
| Goodwill | | | 8,519 | |
| Total assets acquired | | | 20,924 | |
| Deferred services revenue | | | (967 | ) |
| Deferred tax liability | | | (4,294 | ) |
| Net assets acquired | | $ | 15,663 | |
The fair value of financial assets acquired includes accounts receivable with a fair and contractual value of $2.0 million. The receivables consist of amounts due from customers for products sold and/or services rendered.
The Company has recorded a deferred tax liability of $4.3 million associated with the intangible assets recorded in connection with the Latitude acquisition. This resulted in a corresponding adjustment recorded to goodwill. The Company plans to complete a research and development study for Latitude for 2010 and the fourth quarter of 2009, which may result in a related research and development credit recorded as a deferred tax asset. Adjustments for these tax matters will result in a corresponding adjustment to recorded goodwill.
Acquisition-related professional fees recognized as of December 31, 2010 totaled approximately $89,000 and include transaction costs such as legal, accounting, valuation and other professional services, which were expensed as incurred. These costs are included within general and administrative expenses on the consolidated statements of income.
The premium paid over the fair value of the net assets acquired in the purchase, or goodwill, was primarily attributed to expected synergies from Latitude’s debt collection software, experienced staff and existing client base. Included within goodwill is the assembled workforce, comprised of 40 employees, which does not qualify for separate recognition. None of the goodwill is expected to be deductible for tax purposes.
Customer relationships, core technology and non-competition agreements are amortized based upon historical patterns in which the economic benefits are expected to be realized. Other finite-lived identifiable intangible assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired and their respective economic useful lives at the date of acquisition:
| | | | |
| | | | | | | | | | | | Economic Useful Life (in years) | |
| Trade name | | $ | 1,670,000 | | | $ | -- | | | $ | 1,670,000 | | | Indefinite | |
| Customer relationships | | | 6,270,000 | | | | 130,600 | | | | 6,139,400 | | | | 12 | |
| Core technology | | | 980,000 | | | | 18,800 | | | | 961,200 | | | | 13 | |
| Non-competition agreements | | | 1,080,000 | | | | 45,000 | | | | 1,035,000 | | | | 6 | |
| Total | | $ | 10,000,000 | | | $ | 194,400 | | | $ | 9,805,600 | | | | | |
Pro Forma Results
The following table shows unaudited pro forma results of operations as if we had acquired Latitude on January 1, 2009 (in thousands, except per share amounts):
| | | Years Ended | |
| | | | |
| | | | | | | |
| Revenue | | $ | 172,811 | | | $ | 137,229 | |
| Net Income | | | 15,954 | | | | 9,273 | |
| EPS – Basic | | | 0.91 | | | | 0.54 | |
| EPS - Diluted | | | 0.84 | | | | 0.51 | |
The unaudited pro forma results of operations are not necessarily indicative of the actual results that would have occurred had the transaction actually taken place at the beginning of the periods indicated.
AcroSoft Acquisition
On May 15, 2009, the Company entered into a stock purchase agreement with AcroSoft Corporation (“AcroSoft”), a provider of insurance content management solutions, pursuant to which the Company purchased 100% of AcroSoft’s issued and outstanding shares of capital stock for an aggregate purchase price of $2.2 million funded with cash-on-hand. Ten percent of the purchase price, or $240,000, was deposited into an escrow account to ensure funds are available to pay indemnification claims, if any. The Company acquired AcroSoft to integrate its document management and workflow functionality into the Company’s Interaction Center Platform®, including its Interaction Process Automation® application. Over time, the Company also anticipates extending the integrated solution to other document-intensive industry vertical and horizontal processes. The acquisition was accounted for using the acquisition method of accounting in accordance with FASB ASC 805, and the results of AcroSoft’s operations were included in the Company’s consolidated financial statements commencing on the acquisition date.
The purchase price allocation for the Company’s acquisition of AcroSoft is based on a third-party valuation report which was prepared in accordance with the provisions of FASB ASC 805. The following table summarizes the fair value of the intangible and other assets acquired and liabilities assumed at the date of the acquisition (in thousands):
| | | | |
| Cash | | $ | 149 | |
| Investments | | | 2 | |
| Accounts receivable | | | 62 | |
| Prepaid royalties | | | 30 | |
| Other current assets | | | 1 | |
| Property, plant and equipment | | | 26 | |
| Current tax asset | | | 122 | |
| Deferred tax asset | | | 136 | |
| Accounts payable | | | (8 | ) |
| Deferred tax liability | | | (212 | ) |
| Intangible assets | | | 530 | |
| Goodwill | | | 1,846 | |
| Total assets acquired | | | 2,684 | |
| Deferred services revenue | | | (284 | ) |
| Net assets acquired | | $ | 2,400 | |
The fair value of financial assets acquired includes accounts receivable with a fair and contractual value of $62,000. The receivables consist of amounts due from customers for products sold and/or services rendered.
Acquisition-related costs recognized as of December 31, 2009 include transaction costs such as legal, accounting, valuation and other professional services, which were expensed as incurred. Acquisition-related costs totaled approximately $65,000 during 2009. These costs are included within general and administrative expenses on the consolidated statements of income.
The premium paid over the fair value of the net assets acquired in the purchase, or goodwill, was primarily attributed to expected synergies from AcroSoft’s document management software, experienced document management staff and an existing client base. Included within goodwill is the assembled workforce, comprised of 12 employees, which does not qualify for separate recognition. None of the goodwill is expected to be deductible for tax purposes.
Customer relationships and core technology are amortized based upon historical patterns in which the economic benefits are expected to be realized. Other finite-lived identifiable intangible assets are amortized on a straight-line basis. The following are the identifiable intangible assets acquired and their respective economic useful lives:
| | | | |
| | | | | | | | | | | | Economic Useful Life (in years) | |
| Customer relationships | | $ | 210,000 | | | $ | 56,900 | | | $ | 153,100 | | | | 6 | |
| Core technology | | | 320,000 | | | | 104,000 | | | | 216,000 | | | | 5 | |
| Total | | $ | 530,000 | | | $ | 160,900 | | | $ | 369,100 | | | | | |
Goodwill and Other Intangible Assets
Goodwill is reviewed for impairment at least annually in accordance with the provisions of FASB ASC Subtopic 350-20, Intangibles - Goodwill and Other. The goodwill impairment test is a two-step test. Under the first step, the fair value of the reporting unit is compared with its carrying value (including goodwill). Fair value of the reporting unit is determined using a discounted cash flow analysis. If the fair value of the reporting unit exceeds its carrying value, step two does not need to be performed. If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the enterprise must perform step two of the impairment test (measurement). Under step two, an impairment charge is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance with FASB ASC 805. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill. The following table presents a roll forward of goodwill, which is included within other assets, net on the accompanying consolidated balance sheets, as of December 31, 2010 (in thousands):
| Balance as of December 31, 2009 | | $ | 2,852 | |
| Latitude goodwill | | | 8,519 | |
| Balance as of December 31, 2010 | | $ | 11,371 | |
The Company performed a goodwill impairment test as of September 30, 2010 and concluded that no impairment existed. As there were no changes in facts and circumstances that indicated that the fair value of the reporting unit may have been below its carrying amount, no additional impairment tests were performed during the fourth quarter of 2010.
14. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In September 2009, the FASB issued FASB ASU 2009-13, which addresses criteria for separating consideration in multiple-element arrangements. The guidance requires companies allocating the overall consideration to each deliverable to use an ESP of individual deliverables in the arrangement in the absence of vendor-specific objective evidence or other third-party evidence of the selling price for the deliverables. This guidance will be effective for fiscal years beginning on or after June 15, 2010 and early adoption is permitted. The Company will adopt this guidance on January 1, 2011 and does not expect a material impact on the Company’s consolidated financial statements.
In September 2009, the FASB issued FASB ASU 2009-14, Certain Revenue Arrangements that Include Software Elements, which excludes from the scope of the FASB’s software revenue guidance tangible products that contain both software and non-software components that function together to deliver a product’s essential functionality. This guidance will be effective prospectively for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010 with early adoption permitted. If a company chooses to early adopt this guidance and the adoption is not at the beginning of its fiscal year, the requirements must be applied retrospectively to the beginning of the fiscal year. The Company will adopt this guidance on January 1, 2011 and does not expect a material impact on the Company’s consolidated financial statements.
In January 2010, the FASB issued FASB ASU 2010-06, Improving Disclosures About Fair Value Measurements, which amends FASB ASC 820. The updated guidance requires new disclosures about recurring or nonrecurring fair-value measurements including significant transfers into and out of Level 1 and Level 2 fair-value measurements and information on purchases, sales, issuances, and settlements on a gross basis in the reconciliation of Level 3 fair-value measurements. The guidance also clarified existing fair-value measurement disclosure guidance about the level of disaggregation, inputs, and valuation techniques. The guidance became effective for interim and annual reporting periods beginning on or after December 15, 2009, with an exception for the disclosures of purchases, sales, issuances and settlements on the roll-forward of activity in Level 3 fair value measurements. Those disclosures will be effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The Company will adopt this guidance on January 1, 2011 and does not expect a material impact on its consolidated financial statements.
In December 2010, the FASB issued FASB ASU 2010-29, Disclosure of Supplementary Pro Forma Information for Business Combinations, which amends FASB ASC 805. The updated guidance requires that if a public entity presents comparative financial statements, the acquirer should disclose revenue and earnings of the combined entity as though the business combination that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. This updated guidance also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. The guidance is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The Company will adopt this guidance if it has any business combinations subsequent to January 1, 2011.
15. UNAUDITED SELECTED QUARTERLY FINANCIAL DATA
The following selected quarterly data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. This information has been derived from unaudited consolidated financial statements of the Company that, in management’s opinion, reflect all recurring adjustments necessary to fairly present the Company’s financial information when read in conjunction with its consolidated financial statements and notes thereto. The results of operations for any quarter are not necessarily indicative of the results to be expected for any future period. As discussed in Note 2, certain reclassifications have been made to the prior year amounts to conform to the current period presentation (in thousands, except per share amounts):
| | | | |
| | | | |
| | | | | | | | | | | | | |
| Total revenues | | $ | 35,023 | | | $ | 38,811 | | | $ | 41,831 | | | $ | 50,650 | |
| Gross profit | | | 24,611 | | | | 27,106 | | | | 28,850 | | | | 35,018 | |
| Operating income | | | 3,989 | | | | 4,659 | | | | 5,607 | | | | 9,114 | |
| Net income | | | 1,868 | | | | 2,456 | | | | 3,503 | | | | 7,074 | |
| | | | | | | | | | | | | | | | | |
| Net income per share: | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.11 | | | $ | 0.14 | | | $ | 0.20 | | | $ | 0.39 | |
| Diluted | | | 0.10 | | | | 0.13 | | | | 0.19 | | | | 0.37 | |
| | | | | | | | | | | | | | | | | |
| Shares used to compute net income per share: | | | | | | | | | | | | | | | | |
| Basic | | | 17,320 | | | | 17,445 | | | | 17,524 | | | | 17,956 | |
| Diluted | | | 18,708 | | | | 18,772 | | | | 18,695 | | | | 19,302 | |
| | | | |
| | | | |
| | | | | | | | | | | | | |
| Total revenues | | $ | 29,476 | | | $ | 32,895 | | | $ | 33,170 | | | $ | 35,877 | |
| Gross profit | | | 20,446 | | | | 22,338 | | | | 23,654 | | | | 25,086 | |
| Operating income | | | 2,417 | | | | 2,979 | | | | 4,275 | | | | 4,770 | |
| Net income | | | 1,223 | | | | 2,097 | | | | 2,801 | | | | 2,519 | |
| | | | | | | | | | | | | | | | | |
| Net income per share: | | | | | | | | | | | | | | | | |
| Basic | | $ | 0.07 | | | $ | 0.12 | | | $ | 0.16 | | | $ | 0.15 | |
| Diluted | | | 0.07 | | | | 0.12 | | | | 0.15 | | | | 0.14 | |
| | | | | | | | | | | | | | | | | |
| Shares used to compute net income per share: | | | | | | | | | | | | | | | | |
| Basic | | | 16,948 | | | | 17,015 | | | | 17,148 | | | | 17,267 | |
| Diluted | | | 17,635 | | | | 18,070 | | | | 18,486 | | | | 18,643 | |
16. SUBSEQUENT EVENTS
Subsequent to December 31, 2010, the Company entered into a stock purchase agreement, dated as of February 28, 2011, with Agori Communications, GmbH (“Agori”), a reseller of its multichannel contact center solutions. Pursuant to the terms of the stock purchase agreement, the Company purchased 100% of the outstanding privately held stock of Agori funded with cash-on-hand. The Company acquired Agori as part of its growth strategy to accelerate business in key international markets. The allocation of the purchase price was not completed as of the date of this Annual Report on Form 10-K and the results of Agori’s operations were not included in the Company’s consolidated financial statements set forth above. The acquisition will be accounted for using the acquisition method of accounting in accordance with FASB ASC 805.
Interactive Intelligence, Inc.
Schedule II – Valuation and Qualifying Accounts
For the Years Ended December 31, 2010, 2009 and 2008
| | Balance at Beginning of Period | | | Charged (Credited) to Revenue and Expenses, net | | | | | | | |
| Allowance for Doubtful Accounts Receivable: | | | | | | | | | | | | |
| 2010 | | $ | 1,094,000 | | | $ | 1,259,000 | | | $ | 1,205,000 | | | $ | 1,148,000 | |
| 2009 | | | 1,004,000 | | | | 627,000 | | | | 537,000 | | | | 1,094,000 | |
| 2008 | | | 1,076,000 | | | | 1,258,000 | | | | 1,330,000 | | | | 1,004,000 | |
| (1) | Uncollectible accounts written off, net of recoveries. |
