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Executives

Craig E. Holmes - Executive Vice President And Chief Financial Officer

David W. Brandenburg - Chairman Of The Board

Robert Ritchey - President And Chief Executive Officer

Jim Milton - Executive Vice President & Chief Operating Officer

Analysts

Daniel Ives - Friedman, Billings, Ramsey & Co.

Analyst for Shyam Patil - Raymond James

Analyst for Scott Sutherland - Wedbush Morgan Securities Inc.

Peter Jacobson - Brean Murray, Carret & Co.

Craig Nankervis - First Analysis Corp.

Christoph O'Donnell - Morgan, Keegan & Company, Inc.

Intervoice Inc. (INTV) F3Q08 Earnings Call January 8, 2008 5:00 PM ET

Operator

Good afternoon. My name is Felicia and I will be your conference operator today. At this time I would like to welcome everyone to the fiscal year 2008 Q3 earnings release conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question and answer session. (Operator Instructions) I would now like to turn the conference over to Mr. Craig Holmes. Sir, you may begin.

Craig E. Holmes

Thank you, Felicia, and Happy New Year to our shareholders and analysts joining us on the call today. Here with me in Dallas is David Brandenburg, our Chairman of the Board; Bob Ritchey, our President and Chief Executive Officer; and Jim Milton, our Chief Operating Officer. Our earnings release issued today was prepared and approved by company management and reviewed and approved by our audit committee.

During this call we may make some forward-looking statements and factors that could cause results to be materially different form our expectations are detailed in the risks, uncertainties, and contingency sections of our SEC filings and we also encourage investors to reference those risk factors as well as the Safe Harbor disclosures included in our earnings release.

Included with our press release are some preliminary GAAP basis financial statements which will be finalized and filed with the SEC and our 10-Q. In addition, we include schedules which show our revenues by product and by geography. Also attached to our press release is a schedule which reconciles our non-GAAP disclosures to GAAP disclosures. We believe that certain adjustments are necessary to enhance the comparability between reporting periods and we hope these additional schedules and disclosures enhance the transparency and overall quality of our report of results.

The remainder of this call will follow this format: Bob will give his overview and comments, Jim will then follow with an update on our sales and operating activities, I will then discuss the company’s financial results, and David will then wrap up the call with his comments. After our prepared comments, we will open up the call to a brief Q&A period.

Now let me turn the call over to Bob, our CEO.

Robert Ritchey

Well thank you Craig. Happy New Year, everyone and welcome to our conference call. As noted in our press release, Q3 was a good quarter for Intervoice and I look forward to further updating you regarding our Q3 success. As previously stated, our goal is to sequentially grow our total revenue quarter over quarter while improving our operating income proportionally to our revenue growth. I am pleased to say that we successfully met this goal in Q3. First and foremost, we exceeded our midrange revenue guidance and achieved $52.9 million. This is the highest quarterly revenue results that the company has generated in 24 quarters. This resulted in a $4.2 million increase quarter over quarter. This revenue increase was driven by the successful conversion of backlogged plus book and ship channel business that was closed during the quarter. Also, our operating income came in ahead of plan at $3.5 million and marked our second consecutive quarter of positive operating income growth. The quarter over quarter operating income growth was $1.2 million or 52%.

Jim Milton will provide more details of our Q3 sales and operations accomplishments later in the call. Now I’d like to spend a few minutes looking into our booking and backlog. Foremost, our backlog, our Q3 revenue success did result in a reduction of our total solutions backlog to $55.9 million. This was a decrease of 13% or $8.6 million which further drove a total Q3 book to bill ratio of 71%. This backlog decrease resulted in part due to several large deals slipping into Q4 plus the success we had in our hosted solutions category. Specifically during the quarter, we booked 9 new significant hosted solutions contracts. This was our second highest bookings quarter in over 3 years. While we do not report our hosted solutions booking as backlog, this category is a significant contributor to our future business success. Further, if these hosted deals had been sold as solutions sales, they would have significantly offset our referenced backlog reduction.

Overall our solutions backlog has increased year over year by $9.5 million or 21% and further good news is that based on our current pipeline of opportunities, we expect to regain positive backlog growth during Q4.

I would also like to address the financial services market which as you know makes up a large segment of our voice portal customer base. We have all read and heard about the challenges affecting the financial services market, specifically related to the subprime loan issue. While we continue to carefully watch this situation, we have not seen any materially negative effects on our business at this time. Interaction with our customers remains very positive and our pipeline of business in this market segment remains very strong.

One of the main attributes of our business is the ROI we provide our customers. Therefore in tough times we generally do not see the same negative business issues that affect other segments of the IT marketplace. As an example, during Q3, four of our larger hosted solutions deals were with notable bank customers, including the Bank of the West which we referenced in a press release earlier in the quarter.

In addition to this market issue, I’d like to focus on some additional market trends and also talk about some key business initiatives that we’re undertaking. First let’s talk about the industry technology and market trends. Our industry segment continues to be in a state of consolidation and change. Demand for new standards-based products and solutions are increasing. This requires us to redesign our products and method of delivery to a software and services model. I am pleased with the progress we’ve made and believe our current products and service offerings are industry leading and are meeting our customers’ expectations.

Utilizing our IP based media exchange platform, we can address both our enterprise and network market segments and efficiently deliver high quality solutions. This trend will continue to benefit us from a cost and quality standpoint as our customer base is transitioned to this new product architecture. It will also allow us time to gain R&D and operational efficiencies while continuing to develop new and value added applications for our customers.

At the core of our product and service strategy is the mobile user. This is the definition of someone who is operating with a wireless telephone within integrated data activity. Our ability to deliver and converge multi-modal applications will improve the value of the user transaction and enhance customer satisfaction. Clearly our customer’s customers are looking for convenience and ease of communication with people, information, and while conducting transactions.

All this said, I believe that we continue to be on pace with the industry and market trends that affect our company and our customers. Given the substantial advances we have made with our products and services, our main focus today and going forward in Q4 is on execution. At the core of our execution strategy are six key initiatives. These initiatives are not listed in any order of importance but let me first start with channel expansion.

We continue to rely on channel partners outside the US and UK markets and specifically in our network business working with Ericsson and Huawei. I believe we’re still at the very early stage of developing the total potential for these two partners into our network market segments. Jim will talk later about some of the success that we’ve had during this past quarter specifically with Huawei. Further, we have selectively brought on new channel partners in the UK, Germany, and Spain that we expect will become productive in the near future. We also continue to rely on our traditional channel partners and VARs for booking ship business.

During the last two quarters over 50% of our solutions bookings were from our channel partners. I think if you remember we told you a quarter or two back that we were trying to change the balance and drive more out of our channel side of the business with a target of 60%, so we’re moving along very positively towards that goal.

The second area is direct sales. Our direct sales force is targeted to high end and strategic accounts in the US, the UK, and selected markets around the world. We have continued to refine our direct sales strategy to lever our consultive selling team and the process to close new business and expand our penetration in existing accounts. During FY08 we have conducted over 100, this would be year to date, consulting sales engagements with a very high close ratio. We plan to expand the selling capacity in FY09 by adding more sales representatives and consulting capabilities associated with them.

The third area is application expansion. With our media exchange product line becoming mature, we can now focus on delivering higher value applications that leverage our platform investment. Specific applications are planned for both our enterprise and network markets. The main enterprise application expansion area is our IPCC contact center product suite and a variety of notification and call completion applications are being added to our network product line. In both markets, having the ability to add multiple applications to a single platform is a winning strategy for our customers and for Intervoice.

The fourth area is partnership and alliances. We continue to value our strategic partnerships, alliances, and vendors who we work with to enhance our products and channels to market. Recently we have strengthened our partnership with IBM by signing an agreement to resell their speech products. The IBM relationship was driven by customer demand and will help balance the issue of having a single source for speech technology. We will consider additional partnerships as required going forward.

The fifth area is cost control. We have placed a lot of attention over this past year over cost control and operational efficiencies. The results are evident as we have returned to double digit operating income and plan to build on this base going forward. While growing our top line remains the key element of increasing operating income, we also plan to manage our costs as efficiently as possible. To this end we have been expanding our offshore R&D staff in New Delhi, India. We plan to continue this expansion of offshore resources as the cost benefits are significant. The main focus of this expanding offshore operation will be to expedite the delivery of the applications I previously mentioned.

The sixth area is innovation and operational efficiency. With our SAP system fully implemented, we have been targeting specific process improvements that have tangible benefits for our customers in operational efficiencies. During this year we effected change in the areas of product packaging and pricing plus we implemented a new billing and tracking module for our customer service base. We expect to finalize all open projects by fiscal year end and engage in additional projects as part of our FY09 business plan. We are targeting projects that can provide a payback in the $1 million plus range. One of the key target areas for FY09 will be to expand our CRM module.

While this is not an all-inclusive list of initiatives that we are undertaking to improve our financial results, they are representative of the kinds of actions that are being undertaken by the company now and will be carried forward into FY09. Looking forward into Q4, we have a strong sales push on to end the quarter and fiscal year ‘08 with positive top and bottom line momentum. Our goal in Q4 is to drive solutions bookings and revenue, grow our backlog, and continue building on our double digit operating income. Our sales team is very focused with several year-end sales incentives kicking in, plus we have just entered into a new budget year for most of our customers.

Operationally we are also focused on the six initiatives I mentioned earlier that will contribute to both the short and long term success of the company. Therefore, our guidance for Q4 revenue is $51 million to $56 million. This guidance is the best estimate of our future business at this time and in closing I’d like to thank you for your continued interest and support of Intervoice. The management team is very focused on achieving our Q4 goals while continuing to provide increased value to our shareholders.

At this time I’d like to turn the call over to Jim Milton, our COO.

Jim Milton

Thanks Bob. As Bob mentioned, Q3 represented the best quarter for revenue in 6 years, led by strong growth in our IP messaging business. The company recognized over $7 million from the pipeline and executed well on several large projects. We did have a reduction in solutions backlog after 7 consecutive quarters of backlog growth, however, I expect that our solutions bookings will drive an increase in backlog during Q4 based on our current pipeline of large deals, both network and enterprise, for the quarter.

Let me now turn to some of the highlights for the quarter. On the large project front, I am pleased to report that we have now completed the key acceptance testing phase of the IP messaging project with a large UK wireless service provider. Upon successful completion of overall acceptance testing, which is currently scheduled to be completed during Q1, this customer will begin deployment of the previously sold 10 million voice mail for media exchange subscribers. This project is important to the company as it represents the largest deployment of media exchange to date and this is a highly regarded tier 1 operator.

The same version of media exchange is being deployed at a large African wireless provider as previously announced. In Q3 we sold our first voice SMS application to this large African operator. This new application, which was sold via Ericsson, supplements our call completion suite and allows network operators to establish a new source of revenue and shortens the return on investment for media exchange.

We have now deployed over 2 million subscribers of voice mail from media exchange at a large wireless carrier in Venezuela. This customer is now current in their solutions over payment obligations and has previously placed orders for an additional 4 million plus subscribers, bringing the total deployment to close to 7 million subscribers of media exchange.

Speaking of customers in Latin America, during the quarter, we also successfully expanded the number of subscribers for our first media exchange customer in Latin America. This highlights our ability to drive incremental revenue from our media exchange customers after a successful initial deployment. The consulting service and operations teams also continue to execute well on large enterprise projects with new self service applications going into production at several large accounts.

Another highlight for the quarter was the closing of several contracts for our enterprise hosted solutions business in the US. We are benefiting from a trend of more and more customers seeing the value of outsourcing a portion of or their entire IVR infrastructure. A few of the hosted solution deals that we closed during the quarter were at existing on-premise based Intervoice IVR customers. These are significant wins as they represent an increase in recurring revenues to the company, protect these customers from competitors, and provide an easier platform to move these customers to our new VXML based Intervoice voice portal packages and applications.

As Bob mentioned, the financial services industry continues to embrace our hosted solution offerings. An example of one of these wins is at the Bank of the West. As an Executive Vice President of the bank commented in a press release announcing this win, “They explained to us an incredibly compelling ROI and it became a very easy decision to go with Intervoice.”

One of the other hosted solution wins was at a large US financial institution that had a mixture of Intervoice and a competitor’s IVR platform installed. With the significant win, Intervoice will displace the competitor in securing an important client for a term of at least 36 months subject to customer cancellation provisions. It is important to note that on average, Intervoice begins recognizing revenue on a monthly basis from a hosted solutions order generally 6 to 9 months after receipt of the order.

Solutions bookings from the channel were reasonably strong during Q3 as both the network channel led by Ericsson and Huawei and the enterprise channel led by our US horizontal and vertical VARs as well as our enterprise channels in China performed well. During the quarter, Intervoice announced an expansion of our strategic partnership with Contact Solutions, a provider of shared IVR services based in Reston, Virginia. Contact Solutions has selected Intervoice Voice Portal to host touch tone and speech applications for its customers.

In November, Intervoice announced that an independent research firm, Tern Systems, had reissued its annual market share report showing that Intervoice has the largest installed base of IVR and voice portal ports, as well as the number one position in ports shipped during 2006. This is further evidence that our investments in our voice portal technology consulting services and hosted solutions capabilities are paying off.

I am also pleased to announce that in December of 2007, we secured a $1 million win for a combined voice portal and IP contact center solution at a large credit card company in the US. This win would not have been possible if not for the assets acquired from Nuasis in September of 2006. The IPCC technology is allowing Intervoice to bid on contact center projects that we could not compete in previously.

On the marketing front, the intervoice.com was enhanced to include more updated solutions based content and improved navigation and functionality. A customer and prospect database of over 100,000 contacts is now in place and is being leveraged to drive ongoing outbound communications in addition to webinars and leads to our sales force and channel partners.

In Q4 we are continuing to focus on leveraging and monetizing investments that we have made in our growth initiatives while driving successful implementations of our IP messaging, voice portal, and IPCC solutions. We are hiring new solutions sales reps and are continuing to develop and support the channel partners that represent the highest growth potential for the company.

Now over to Craig Holmes, who will discuss our financial results in more detail.

Craig E. Holmes

Thank you, Jim. Overall our quarterly profitability exceeded our goals, principally because of our continued focus on operating expense management initiatives and improved operational efficiencies for the second quarter in a row. Earlier this year we indicated that it was our goal to achieve double digit non-GAAP operating margins in the third or fourth quarter. We actually achieved that goal ahead of plan in Q2 in our non-GAAP operating margin during Q3 was 10.9%. This helped our bottom line exceed consensus expectations. Our total revenues also exceeded the midpoint of our guidance and exceeded consensus expectations. Even though solutions backlog to client Intervoice achieved very good financial results during the quarter.

Now let me cover some of our detailed Q3 financial results, starting with the revenue line. Total revenues were up $4.2 million, up over 9 % over the prior quarter, and up about $100,000 over the same quarter last year. Recurring services revenues were up $800,000 sequentially and $1.1 million from the Q3 of last year. These increases primarily resulted from growth in our hosted solutions business. As Bob and Jim mentioned, this business continues to be an important competitive differentiator for our company. These recurring services revenues are highly visible and predictable revenues and we continue to be focused on growing this valuable revenue stream.

Our solutions sales include revenues from sales of our software as well as revenues we received for consulting services and third party components. Total solutions revenue for the quarter are driven by new bookings as well as the conversion of our solutions backlog into revenues. Our Q3 solutions revenues were $26.2 million, up $3.4 million from $22.7 million posted in the second quarter, but down from $27.2 million posted in the third quarter of last year. Our Q3 solutions revenues a year ago included higher than normal book and ship license revenues which I will cover in more detail in just a moment.

One portion of our solutions revenue stream that I would also like to highlight is our messaging solutions revenue. Our messaging revenue growth is being driven by sales of our new media exchange product line and as a result, quarterly messaging solutions revenues have more than doubled from where they were a year ago. During the quarter about 14% of our Q3 revenues came directly from projects included in our solutions sales pipeline at the beginning of the quarter. These are our book and ship revenues. These revenues totaled $7.1 million in Q3, which is a little higher than we expected and up from $4.8 million in the prior quarter.

As you may recall, these pipeline revenues in Q3 of last year ran over $11 million or $4 million to $5 million over our normal run rate. Last year’s increase was driven by several large capacity upgrade orders. These significant one off license sales are great when they happen, but are definitely harder to predict than the smaller channel sales which make up the majority of our normal and recurring pipeline sales during the quarter.

At this point, based on our bottoms up forecast, we currently expect our pipeline and book and ship revenues in Q4 to continue to run in the $6 million to $7 million range. The remainder of our Q3 revenues or about 87% of our total come from the beginning period solutions backlog and backlog of services contracts. During the third quarter we converted about 30% of our beginning of period solutions backlog to revenues. Our bottoms up forecast indicates that we currently expect to see Q4 conversion rate return to the mid 30s percent range.

As I discussed last quarter, our recent conversion rates have been depressed because of large network deals were taking longer than normal to convert to revenue. We entered the current quarter expecting our gross margins for the third quarter to be negatively impacted by the effect of R&D expenses being incurred which are associated with a large network contract which we booked at the end of last year. However, the negative impact on gross margin is offset by a reduction in R&D expense during the quarter. So our Q3 solutions margins were negatively impacted by $1.2 million of incremental costs related to this project, but our R&D expenses on the face of the income statement were also reduced by approximately the same amount, so accordingly there is no impact on our bottom line.

Our non-GAAP R&D expenses were $4.2 million. If you add back the $1.2 million charged to the large network contract included in cost of goods sold, our non-GAAP R&D run rate is $5.4 million during the third quarter which is about flat with Q2. In addition, our Q3 gross margins were negatively impacted by approximately $1 million of incremental costs associated with two large network projects. The largest portion of these incremental costs related to installation and implementation delays at the first of several sites being deployed for a large network operator. The good news is that the remaining sites are going well and we expect Q4 gross margins to return to historical levels.

Now we’ll cover Q4 gross margins later in the call when I summarize Q4 guidance. Non-GAAP SG&A for Q3 was up about $200,000 from the prior quarter but still lower than what we expected. However, we have been adding incremental sales personnel and other SG&A costs to support our higher revenue levels that we have achieved. The tax provision for the quarter and the first nine months of the year is different than normal statutory rates due to several adjustments to prior year taxes resulting from work done to finalize fiscal year ’07 US and UK tax returns. In addition, current quarter adjustments were made to reverse prior period reserves on foreign deferred tax assets. As we show in our press release, we recalculate taxes based on a 34% estimated rate for non-GAAP purposes. We feel that this rate is a more normalized long term rate given our operations in the various geographies where we do business.

Now let’s move on to the balance sheet and cash flow statement. Our cash balance was $27.1 million, down from $30.6 million from the prior quarter. Our cash flow from operations from the first nine months of the year is up significantly from prior year levels. In fact, current year cash flows from operations would have been even higher had we not paid over $2.5 million related to the settlement with the SEC, the proxy battle settlement, and other severance and restructuring charges. In addition, our current year cash flows have been negatively impacted by the increase in inventories during the year. The good news is that the current year inventory increase substantially relates to costs being incurred on specific projects which are scheduled to revenue over the next couple of quarters.

Cash flow during the second and third quarters is typically lower than normal due to the timing of annual maintenance renewals. Many of our customers’ maintenance contracts renew at the beginning of the calendar year so we typically see strong cash flow from operations during the fourth quarter and first fiscal quarter of our fiscal years. At this point, based on strong Q4 collections to date, together with scheduled maintenance renewals, I expect Q4 cash to be up from Q3 just as it was in Q4 of last year. Our DSOs were 63 days which are improved from prior year levels but higher than last quarter. DSOs continue to run in the range I expect. Accounts receivable reserves and bad debt continues to be minimal. Our deferred income balance at the end of each quarter reflects the quarterly fluctuation in maintenance renewals which I discussed a minute ago. It is important to note that the balance at the end of Q3 is actually up over 11% from Q3 of last year. Year over year growth in our deferred income balance is a positive sign of strength in our maintenance revenue stream. Finally, during the quarter we spent about $2.3 million in capital expenditures and we currently expect quarterly CapEx to remain in the $2 million range for the next few quarters.

Now let me summarize our Q4 guidance. As Bob mentioned, we expect Q4 revenues to be in the $51 million to $56 million range. On the expense side, Q4 will continue to have unusual variations compared to prior year periods at the gross margin and R&D lines due to the effects of R&D development in connection with the network contract I mentioned earlier. These R&D costs specifically related to this contract are expected to decrease R&D expenses presented on the face of the income statement by about $500,000 in Q4 and accordingly will increase cost of goods sold on the income statement by about $500,000. Thus, our Q4 non-GAAP gross margins are expected to run in the 53% to 55% range, including the effect of this additional $500,000 R&D reclass.

As I mentioned, the effect of the R&D reclass on the bottom line is neutralized because the increase of cost of goods sold is offset by the reduction in R&D expense. We expect Q4 R&D expending to be about $5.5 million. Our non-GAAP R&D expense line on the Q4 income statement is expected to be about approximately $5 million because of the $500,000 reclass I mentioned a minute ago. We expect Q4 non-GAAP SG&A to be about $18 million and total amortization should continue to run around $700,000 per quarter and investment income should continue at around $300,000 per quarter.

Post-stock compensation expense in Q3 was $1.3 million and going forward we expect stock compensation expense to continue in the $1.4 million range. To sum it up, I believe our business model and financial position has continued to improve. Our Board and management team had invested in strategic and operational initiatives which have strengthened our market position and significantly improved our results. Furthermore, we continue to believe that the markets where we are focused provide good opportunities for long term growth. As always, I would like to thank all of our shareholders and analysts for their continued support. To the team at Intervoice, I would like to thank all of you for your continued hard work.

Now let me turn the call over to David Brandenburg, our Chairman of the Board.

David W. Brandenburg

Thanks Craig, and Happy New Year to everyone. I would like to take just a few minutes to look back over the first three quarters of this fiscal year and discuss a few things that should be important to investors.

First, the company had many goals, but my top two goals were to increase non-GAAP operating margins to double digits by Q3 and to increase annual revenue growth to double digits by Q4. Also, the major multi-year R&D development project for our new MX software platform is released with enhanced versions to come. Also, our two acquisitions are now complete. Due in large part to these two items, we were able to reduce $2 million per quarter expenses from the company and we have had two quarters of double digit non-GAAP operating margins. As Bob mentioned, we are still working on projects to increase gross margin further and also to reduce ongoing expenses in other areas.

Our services business is a huge asset for the company with a large book of business and good margins. We have moved many potential solutions revenue customers to our hosting business. This delays short term revenue growth and negatively affects solutions backlog but builds future revenue.

Also we have been working hard on increasing revenue growth starting in Q3 with the target of double digit annual revenue growth by Q4. As I mentioned, we will target double digit revenue growth in our fiscal year ’09 which starts March 1st of this year.

In addition, Intervoice has a potential for greatly expanding our market share in the voicemail and enhanced services business for wireless carriers using our new MX platform. Ericsson, Huawei, and our direct sales team are leading the way.

So what does this mean? The company has made great progress so far this year, which has been a transition year for Intervoice. Finally, given our performance, I am surprised that our stock price has suffered so significantly over the past six weeks or so. Let me assure you, our shareholders, that we are committed to working hard to return the value our shareholders deserve. So thank you all and now back to Craig.

Craig E. Holmes

Thank you, David. That actually concludes our prepared comments so at this point what I would like to do is turn the call back over to Felicia, our operator, who will facilitate a Q&A period. Thank you.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Daniel Ives with Friedman, Billings, and Ramsey.

Daniel Ives - Friedman, Billings, Ramsey & Co.

Thanks. Good quarter, guys. First more of like a macro question, not even just Intervoice specific, but when you guys are out in the field and you go into the pipeline, has there been any change in customer behavior quarter to quarter, month to month? Can you talk about what you guys are seeing in terms of customers and is it taking longer to get deals done versus signing more competitive discounts? Can you speak to that as more of like from a high level?

Jim Milton

Sure Daniel, it’s Jim here. Let me take a crack at that. So in terms of material changes in customer behavior, I would say no, not recently, and I think as both Bob and I mentioned, we haven’t seen much of an impact at all from the financial accounts that we do business with other than a little bit more interest in our hosted solution business, which I guess is not that surprising because that is an operating expense, it avoids them having to incur big capital expense so it helps them smooth out their spending over a period of time and allows them in some cases to get more efficient because we can take on the workload of what some of their people are doing, for example, in their IT departments. So a bit of a trend to the hosted model I would say is one we’ve been seeing for several quarters now and maybe accelerating a little bit. That would be more of an enterprise kind of comment.

We are also seeing and I think this is positioned as well, having now the IPCC product and I mentioned one transaction that we had with a credit card company. We’re seeing more and more opportunities where we can kind of cover from self service to live assistance within our accounts so that acquisition we did is turning out to be very strategically appropriate for us. I should have mentioned as well, one of the other reasons where we probably haven’t seen as much of an impact is maybe other companies in the IT sector is that our self service solutions in particular have an extraordinarily compelling ROI.

I quoted the Executive Vice President from the Bank of the West for example and if we can increase automation rates and deflect if you will the number of calls that are going to live agent, the cost of the self service call in many cases can be one-seventh to one-tenth the cost of a live agent call, so it’s a cost saving opportunity, even when those companies aren’t doing well, they’re seeking ways to reduce their expenses. A comment I’d like to make is on the network side. We are seeing very good growth as you know in our IP messaging business.

We’re seeing this IMS, movement to IMS driving interest in our media exchange product. We’re seeing the fact that we’re now releasing multiple applications like voice SMS as being a powerful addition to our standard voicemail products and again most of our carrier business as you know is outside of the United States, in fact, virtually all of it is outside of the United States and I think we’re seeing robust growth as a result because in a lot of the sectors while we’re all very excited about tier 1 operators like the one in the UK that we are successfully moving forward with, in places like Africa and Latin America, there is just explosive growth in mobile adoption and we’re benefiting from that as are our partners like Ericsson and Huawei. So I guess I’m more optimistic than not, Daniel, and aren’t necessarily seeing the negative trends that maybe some other enterprise IT companies are.

Daniel Ives - Friedman, Billings, Ramsey & Co.

It’s good to hear. Just comparatively speaking, how has the landscape on the network side changed? Maybe talk about like what guys like Converse? Has it changed there? Have you seen more based on your success on the network side?

Jim Milton

Yeah, I would prefer not to talk about a specific competitor such as Converse although they’re a worthy competitor. I would say that the playing field in general on the network side of the house of our business is much more open and you have a large player as you know Converse with over 50% market share depending upon what analyst you look at, and then it falls off pretty dramatically and it’s a much more open playing field than you would see for example in the voice portal side where there are really 3 or 4 or 5 of us that fight it out on every deal, so that’s the first comment I would make. As a result, the competitors that we see vary geographically. The people that we run into in Africa may be different than in the UK, different from the US, so you see a little bit of smaller players for example that we may compete with. That all being said, I think that’s actually been a huge opportunity for us because we’ve executed well virtually all our media exchange implementations to date are now referenceable. I can’t overestimate how important that is to be able to reference cell, particularly in this space, so that is helping us secure more business. Many of our competitors have some colossal failures which hurt them and the last comment I would make is the fact that we have very good partnerships with both Ericsson and Huawei. That’s bringing us into a lot of new network operators that are building out infrastructure and we’re simply a component of their solution, so we have now... I didn’t mention in my prepared remarks but we have now closed 15 new network operators with Huawei as an example and we’ve actually closed a couple of new ones with Ericsson beyond our traditional space that we’ve been selling in places like eastern Europe which has not been a strong area for Intervoice historically. So I could probably ramble on for a lot longer but I’ll --

Daniel Ives - Friedman, Billings, Ramsey & Co.

Okay. I have just a last question for Dave or for Bob. You’ve been through some cycles with the business and just your history in the sector has gone through a number of different economic cycles. Is there anything that you guys do differently in regards to sales or pipeline or more handholding as different economic cycles start to play out, whether it’s softness or strength? Can you just kind of speak at it, maybe just historically and how you kind of view the landscape, if you make any tweaks or changes?

Craig E. Holmes

I think we look at what’s going on the macro level, Daniel, and try to adjust to that. I think the history of the company has been one of really taking care of our customers so whether it’s in a down time or not, we really stay very close to them. I think our competitors would say that it’s very tough once we get a customer to take them away from us because of the excellent services that we provide, so I wouldn’t say that we throw that away when times are better, I think we just consistently stay there and really knuckle down maybe even more when the times are getting tough. Certainly Jim, some of the strategies that we’re working right now with the new products that we have, we’re bringing on some new sales people to get some better coverage out there. We’ve beefed up our inside sales organization as well so we can address some of our customer issues that way so certainly in the last year or so I would say we’ve put more of an intense focus into the number of people that we’re interfacing the customers with but generally our theory is to protect the customer at all odds here and make sure they’re always happy.

David W. Brandenburg

Daniel, this is Dave. I wanted to add one really old time thing I guess. Back in the early 90s, you probably weren’t around then, but I was, and I can remember back when we were kind of in recessionary times and I was COO back then and just as Jim is dong now as COO, he’s been increasing the sales staff, and back then, we decided that our kind of products actually could sell well during bad times and because of that we actually increased our sales force also at that time and it made a big difference to a lot of our competitors who were kind of backing off a little bit. They kind of pulled back. So that’s kind of a... It’s not the same, it’s a different time then it was then, but there are some things that are the same and so it’s interesting how history repeats itself. Now because that second time I came back at 9/11, there’s nothing to explain that. I mean hopefully we’ll never see something like that again that would impact that. That was a terrible time that we couldn’t figure out how to deal with at the time.

Daniel Ives - Friedman, Billings, Ramsey & Co.

Thanks. Good quarter.

Operator

Your next question comes from the line of Shyam Patil with Raymond James.

Analyst for Shyam Patil - Raymond James

Congratulations on expanding margins. I was just wondering, what kind of expansion should we expect in ’09 and what would be the main drivers for that?

Craig E. Holmes

I think our longer term goals at this point is to continue to achieve double digit operating margins so we’re going to continue to work along those lines and grow our margins proportionally with revenues going forward, so that’s where we’re focused at this point.

Analyst for Shyam Patil - Raymond James

What do you guys view as the market growth rate for your voice portal business ad I guess when should we expect Intervoice to reach those levels?

Jim Milton

That’s a subject of great debate here because we have several industry analysts by the way who give different data and we have to kind of cross relate it to the addressable market for example that we participate in but we are seeing in some portions of the business mid single digits and other portions of the business low double digits. I know that’s not kind of a one line answer but I would say it’s high single digits, but you have to recognize that you have to dissect what we call layers of the stack. You have the platform, for example the voice portal, the browser, the base level browser, you have consulting services, you have hosted solutions, you have maintenance revenues which all have different growth rates associated with them, and I think it’s important to point that out. You also see there are within the VXML or the industry standard voice portal business is growing unquestionably in double digits as high as 23% in terms of number of ports shipped year over year.

By the way, that was one of the reasons we were very pleased when I mentioned in my prepared remarks one of the analysts that actually tracks port shipments, they had actually issued a report and had to issue a correction to the report which subsequently showed us as the number one voice portal provider in 2006 so we felt good about that because that’s an indicator of, you’d think revenue would follow in terms of port shipment, so along with an answer, but I think we’re probably in the mid to high single digits in the addressable space that we participate in the voice portal space.

Analyst for Shyam Patil - Raymond James

Can you guys comment on what percent of IVR shipments in the quarter had speech recognition software?

Jim Milton

We had not done that analysis yet. I apologize. So I can’t give you the exact percentage.

Analyst for Shyam Patil - Raymond James

I know you guys have talked about improving the competitive landscape in the past. Can you just comment on win rates today in the market versus say 6 or 12 months ago? Any of the enterprise or the [inaudible] business?

Jim Milton

Bob actually mentioned in his remarks that in particular in the US and the UK, on the enterprise business which is essentially where our strength is with the consulting services and in the hosted business, our win rates are very high and the reasons... By the way, increasing primarily because our value prop is very strong with our services capabilities both again consulting services and hosted solutions. Internationally and even in the US where we have channel partner sales, it’s a little harder to track win ratios because it’s actually the channel partners themselves who are competing against let’s say other channel partners with other vendors, so we don’t have as accurate a view since we’re one step removed but I would say in our enterprise deals where we have consulting and hosted solution content, it’s certainly north of 50% I would say categorically. We have been investing and we may have talked about this on previous calls and certainly in the shareholders meeting, we’ve been investing in doing these engagements, consulting engagements, or what we call discovery sessions where we will send teams on site to our customers and they’ll live in the contact center for a couple of days and they’ll come back with a strong value prop for the customer. When that happens we tend to see a win ratio substantially higher than 50%.

Analyst for Shyam Patil - Raymond James

All right. Thank you.

Operator

Your next question comes from the line of Scott Sutherland of Wedbush Morgan.

Analyst for Scott Sutherland - Wedbush Morgan Securities Inc.

You mentioned the solutions backlog had declined this quarter sequentially but you had indicated that you thought it would grow next quarter. I was hoping that you could give us maybe some additional detail behind your confidence for that growth. You said the pipeline was strong but maybe some additional detail if you can.

Robert Ritchey

Kerry, Bob here. A couple things. One, I did mention that several deals pushed out into Q4 so obviously we would expect those deals would be part of the bookings for Q4 so we have a little bit of that. In fact, we’re off to a pretty good start here in the early stages of this quarter, bringing in some pretty substantial bookings, so couple that with the strength of the pipeline that we have, Q4 typically is a good quarter for us all. The incentives are ramping properly through the sales organization. Jim is cracking his whip very hard here right now, so we have a lot of momentum that’s building for us so we do expect that with a little luck here, everything should fall in a pretty good way and we’ll get back to a nice growth curve into the back log for the quarter.

Analyst for Scott Sutherland - Wedbush Morgan Securities Inc.

As far as the deals that were delayed, is there any way to maybe quantify it or maybe differentiate the size? Are they the larger deals or more smaller deals?

Robert Ritchey

They were substantial significant deals that moved forward. I’d be reluctant to get into the details of them but they would be something of significance, all of them.

Analyst for Scott Sutherland - Wedbush Morgan Securities Inc.

Okay and then can you provide maybe a little more detail about IVR bookings and just kind of what you’re seeing there?

Robert Ritchey

How do you mean specifically?

Analyst for Scott Sutherland - Wedbush Morgan Securities Inc.

The plans, to see if they’re growing, I guess just maybe more macro trends on the IVR side?

Jim Milton

Let me maybe tackle that. So first of all the good news is our backlog in our voice portal business is up since the beginning of the year so on a positive note we are seeing improvement in our backlog for voice portal or IVR business. Obviously we want that business to grow faster than it has been so no question about it, we’ve put a lot of our time and effort and initiatives for that matter on getting the IVR and voice portal business growing. We saw, as kind of Craig mentioned, actually he talked about book and ship for example for last year. We saw a couple of big quarters in book and ship revenue last year and we have had, actually it was a question earlier I think someone asked around sales cycles.

Some of the sales cycles particularly when they’re including self service to live assistance, i.e. IPCC and voice portal, have elongated a little bit and of course in the hosting side of the equation we do see some impact there. That all being said, as we look forward, we’re feeling pretty optimistic that we are starting to see a recovery in this business.

First of all we did see a revenue growth by the way in our voice portal business from Q2 to Q3, albeit modest. As I mentioned before, we’re starting to see success now with IPCC as indicated by the large deal that I indicated in my prepared remarks. That isn’t surprising, by the way, if you remember we spent the first 6 to 9 months or so post-acquisition of assets of Nuasis stabilizing the product, making sure that the sales reps were confident in the product, the existing customers that we brought over were happy and referenceable, and last but not least, signing a couple of channels to sell our IPCC products so we’re feeling optimistic that that will be a growth driver for us going forward.

We have been closing a few very important to us channel partners on the enterprise side in countries like Germany, the UK, Spain, and in China, which are at early stages, the term I like to use is monetizing, i.e. getting lots of deals, and last but not least we are adding more sales reps, more feet on the street, to balance the channel growth that we have as well. So all of those things are giving me some confidence that we will see some improvement in our enterprise business going forward.

Operator

Your next question comes from the line of Peter Jacobson.

Peter Jacobson - Brean Murray, Carret & Co.

Hi, thanks. Good evening, everyone. I just had a question on the five categories breaking out sales for the quarter. Can you just review how those five line items break out between network operators and enterprises?

Craig E. Holmes

Sure. I think you’re referencing one of the schedules that we attached to the press release. What we do is we identify the voice automation IVR line --

Peter Jacobson - Brean Murray, Carret & Co.

Portal messaging, payment, support, and hosted.

Craig E. Holmes

So the voice portal line is enterprise. Messaging and payment are network specific products. Hosted would be both network and enterprise.

Jim Milton

Proportionally more enterprise.

Craig E. Holmes

Definitely. A lot stronger enterprise and then maintenance is also both network and enterprise and here once again, proportionally more enterprise.

Peter Jacobson - Brean Murray, Carret & Co.

Great. Thanks. That’s all I had, thank you.

Operator

Your next question comes from the line of Craig Nankervis of First Analysis.

Craig Nankervis - First Analysis Corp.

Thanks, good evening. Several of my questions have been asked. Craig, could you give the backlog mix in the quarter?

Craig E. Holmes

The backlog mix at the end of the quarter, it is split pretty evenly between voice portal and our network products and weighted a little bit more heavily toward network products this quarter as it was last quarter.

Craig Nankervis - First Analysis Corp.

Can you break out Nuasis revenue in the quarter?

Craig E. Holmes

Our Nuasis product line is just now being integrated. We do have some early successes that Jim highlighted. I think the revenue contribution from Nuasis associated with the original acquired customers has been minimal at best, so less than a half million dollars a quarter.

Craig Nankervis - First Analysis Corp.

So it’s still in that zone.

Craig E. Holmes

Right.

Craig Nankervis - First Analysis Corp.

Perhaps you spoke to this but I might have missed it, maintenance revenue was like actually down slightly sequentially and that was a little surprising to me. Can you explain that?

Craig E. Holmes

You can see there’s a little bit of volatility from quarter to quarter due to the timing of renewals and maybe some catch up adjustments. Our maintenance revenues actually came in very consistent with what we expected so it’s down a little bit quarter to quarter like you said, about $100,000, still up year over year and up the prior two quarters to that, so we’re very comfortable with our overall maintenance stream and like I mentioned earlier, one of the data points that you could reference is just looking at the deferred income balance on our balance sheet and seeing the year over year growth and that balance, that’s a good indication that our maintenance programs continue to be working and growing.

Craig Nankervis - First Analysis Corp.

I guess that’s all I have for now. Thank you.

Operator

Your next question comes from the line of Christoph O'Donnell with Morgan Keegan.

Christoph O'Donnell - Morgan, Keegan & Company, Inc.

Hi guys. Thanks for taking my question. Just on a follow up on the solutions revenue. I’m trying to understand the margin profile there after backing out that R&D expense. It looks like the margins were down still significantly. Is that just still entirely due to the higher percentage revenue from the messaging business and as you see a recovery of IVR would you expect that to come up to more normalized level? So that’s the first question and the second, what is that normalized level, talking kind of historical 35% to 40% range or how do I think about that?

Craig E. Holmes

Sure, let me help you. So we mentioned two things in the call. One was the impact of the R&D reclass that you just highlighted. The second was really $1 million of incremental cost of goods sold that hit during Q3 associated with a couple of significant network implementations. We don’t believe that that incremental dilution at the gross margin line related to those additional costs will continue. Some of those additional costs are tied to the fact that we are implementing new products and some of our new customers the effort, the cost associated with those early implementations is higher than where we expect to be longer term, so as we look forward to Q4, we do expect those solutions revenues to return to that more normalized level that you were just describing.

Christoph O'Donnell - Morgan, Keegan & Company, Inc.

And actually backing out that extra million does make sense. That brings everything in lien. Thanks for the help.

Craig E. Holmes

I’m glad the math worked for you.

Operator

Your next question comes from the line of Scott Sutherland.

Analyst for Scott Sutherland - Wedbush Morgan Securities Inc.

Hi this is Kerry again for Scott. I think maybe you’ve answered this question in this previous question that I was going to ask about margins and it was just pretty much a shift to the network biz or more network business and then maybe the million dollar cost that won’t recur.

Craig E. Holmes

Right, so do you have any further questions related to that?

Analyst for Scott Sutherland - Wedbush Morgan Securities Inc.

No. I think that answers it. Thanks.

Craig E. Holmes

Good. Appreciate it. Felicia?

Operator

At this time there no further questions.

Craig E. Holmes

Well thank you and thank you Felicia, and once again I’d like to wish a Happy New Year to everybody on the call and on behalf of the team here at Intervoice, I’d like to thank everybody for joining us this evening. Thank you and goodnight.

Operator

Ladies and gentlemen this does conclude today’s conference call. At this time you may disconnect.

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Source: Intervoice Inc. F3Q08 (Qtr End 11/30/07) Earnings Call Transcript
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