Interactive Intelligence Q4 2007 Earnings Call Transcript

Executives

Don Brown - President and CEO

Steve Head - CFO

Paul Weber - VP of Sales for North America

Analysts

Shayan Patel - Raymond James

Terry Tillman - SunTrust Robinson

Irit Jakoby - Susquehanna

Tavis McCourt - Morgan Keegan

Gramy Rein - Bears Capital

Paul Kaump - Northland Securities

Interactive Intelligence Inc.(ININ) Q4 2007 Earnings Call January 30, 2008 4:30 PM ET

Operator

Thank you for standing. Welcome to the Interactive Intelligence Fourth Quarter 2007 Earnings Conference Call. At this time, all lines are in a listen-only mode. Later, we will announce the opportunity for questions, and instructions will be given at that time. (Operator Instructions). As a reminder this call is being recorded.

At this time I would like to turn the conference call over to Dr. Don Brown, President and CEO of Interactive Intelligence. Dr. Brown, please go ahead.

Don Brown

Well, thanks for joining us everybody. Presenting with me on the call today is Steve Head, our CFO, and we're also joined by Paul Weber, our Vice President of Sales for North America. After our discussion and concluding remarks, we'll have a Q&A session at which time we will be available to answer your questions. And for any of you not able to ask questions today, please follow up with Steve after the call. I hope you've all received our Q4 earnings release by now. If not it's up on the website.

Before we get any further into the call, Steve will present the standard legal disclaimer.

Steve Head

Thanks, Don. Over the course of this conference call, we will make predictive statements about our results and performance or our plans and objectives, in an effort to assist you in understanding our company. The rapidly evolving enterprise software industry, combined with the uncertainties in the economic environment, makes predictions challenging and problematic. These predictive statements are forward-looking statements under Federal Securities laws.

Our actual results could differ materially as a result of a variety of potential risks and uncertainties. For more information, you should look to our 2006 Form 10-K, which we have filed with the SEC, and which describes factors, risks, and uncertainties that could cause our actual results to differ materially. The company disclaims any obligation or undertaking to update or revise any forward-looking statement.

Also, during this call, we may refer to non-GAAP financial measures. These non-GAAP results eliminate the impact of stock option expense and income tax benefits recorded in the fourth quarter of 2007 and the third quarter of 2006. Management uses these non-GAAP financial measures in analyzing the business.

And now Don will provide some overview comments on the just completed quarter.

Don Brown

Thanks Steve. I'll begin by providing an overview of our results for the quarter and Steve will then provide an added level of detail on the numbers. Following Steve's comments, I'll take a few minutes to update you on notable company events and our plans for 2008.

For the fourth quarter of 2007, we hit a new record with revenues of $29.3 million, which is 23% higher than the revenue of $23.9 million we posted in the fourth quarter of last year. For the full year of 2007, our revenues totaled $109.9 million, an increase of 32% over the full year of 2006.

Fourth quarter product revenues totaled $15.2 million, up 20% over the fourth quarter of 2006. For the full year of 2007, product revenue totaled $57.7 million, an increase of 34% compared to the previous year. We continue to have more large contracts. In the fourth quarter we had 12 customers that submitted orders totaling $0.25 million or more with one of those over a $1 million. Five of those were new customers.

We achieved record service revenues in the quarter of $14.1 million, an increase of 25%, from 11.3 million in the fourth quarter of 2006. For the full year of 2007, service revenues were $52.2 million, an increase of 30% over the full year of 2006.

We're reporting non-GAAP income and EPS in the earnings release. The non-GAAP numbers exclude the income tax credit and stock option expense in all periods. On a non-GAAP basis, earnings for the fourth quarter of 2007 were $3.1 million or $0.16 per diluted share. This is an increase of 47% from $2.1 million or $0.11 per diluted share in the fourth quarter of 2006. For the full year of 2007, non-GAAP net income was $12.5 million or $0.65 per share, an increase of 69% from $7.4 million or $0.40 per share in 2006.

I'll now turn the call over to Steve for some more detail on the numbers

Steve Head

Thanks. As usual, I'll comment on the operating performance, then balance sheet and cash flows. First, starting with the operating performance, I want to point out three major items that impacted the performance for the quarter and year. We recorded a tax credit of 8.1 million in the fourth quarter, to reverse the valuation allowance we had established for differed tax assets. As a result of this entry, we now have 13.4 million of differed tax assets recorded in our balance sheet. I will discuss that asset and tax payment expectations in later comments.

We recorded stock-option expenses of $840,000 for the quarter and $3.1 million for the year. Finally, we are showing quarterly operating results in the release that reflect an increased product revenue with some offsetting sales related expenses for the first three quarters of 2007. These changes result in an increase in the quarterly net income for each of the first three quarters of 2007.

As always, orders drive our product revenues. For the fourth quarter, orders were up 11% compared with the fourth quarter of 2006. For the year, orders were up 26% compared to 2006. For the fourth quarter 65% of the orders were from our current customers and our partners generated 55% of the orders.

As we noted in the press release, we signed 93 new customers in the quarter for our contact center enterprise messaging and IP PBX solutions. The overall, average new customer order was $76,000, with the average order of $83,000 for our CIC and large enterprise IP PBX licenses. The increase in orders was distributed around the world. Geographically, the orders were generally consistent with prior quarters, with 69% from North America and the remainder from the rest of the world principally Europe, Middle East and Africa.

We continue to have orders for hardware from our CIC customers. This is in part the result of the Interaction Media Server and Interaction Gateway, two appliances which we developed and delivered to enhance scalability and functionality. The timing of revenue recognition for orders is dependent on a number of considerations and only a portion of orders were recognized in the quarter, with some of the unrecognized amounts reflected in the balance sheet.

We had no significant change in deferred product revenues compared to September 30th, while we did have a sequential increase of 4.4 million in deferred services revenues.

Our product revenues were 52% of our total revenues for both the quarter and for the full year. And for the fourth quarter of 2007, services revenues increased as the number of users and related support fees increased, along with increases in revenue for professional services and education. Support revenues were 80% of services revenue for the quarter and 76% for the full year.

Product margin was 74% for the fourth quarter. The same was in the fourth quarter a year ago and up slightly from the 73% on the third quarter of this year of 2007. For the full year 2007, product margins were 75%, down from 78% in the full year of 2006.

As we have discussed in previous calls, we have received significantly increased order amounts in 2007 compared to 2006 for Interaction Media Server and Interaction Gateways, along with Polycom phones and other items we resell as part of our CIC and IP PBX Solutions.

Cost of services increased principally due to an increase in staffing and related travel. Our services margin in the fourth quarter of 2007 was 60%, which is inline with the fourth quarter of 2006. And for the full year the services margin was 60% compared to 63% for 2006. As part of this change in margin is the relatively faster increase in professional services revenue compared to support revenues and the related increases in the number of staff in our services area.

Our gross profit was a record $19.7 million for the fourth quarter and the margin was 67% of total revenues. For the full year 2007, our gross profit totaled $74.6 million, compared to $59.1 million in 2006 and the margin was 68% in 2007 compared to 71% in 2006. The margin decrease year-over-year is due to the increased cost of product and cost of services.

Total operating expenses on a GAAP basis for the fourth quarter were $17.8 million, an increase of 20% over the fourth quarter of 2006. These operating expenses were 61% of total revenues for the fourth quarter of 2007, a slight decrease from 62% of total revenues in the fourth quarter of 2006.

Non-GAAP operating income which excludes stock-option expenses was $2.8 million or 9.4% of revenues in the fourth quarter of 2007, compared to $1.9 million or 7.8% of revenues in the fourth quarter of 2006. Other income, principally interest income was $426,000 in the fourth quarter of 2007, an increase compared to the prior year because of the larger cash and investment balances. Foreign and miscellaneous other taxes totaled $91,000 in the fourth quarter of 2007.

In the fourth quarter, we did record an $8.1 million tax credit to recognize tax net operating loss carry forwards, tax credit carry forwards and temporary differences, which had been reduced by an allowance against deferred tax assets. As the company continues to report profits, it was our conclusion that it is more likely than not that these deferred tax assets will be realized and accordingly the valuation allowance we have recorded is no longer appropriate.

At the end of 2007, we have over $23 million of tax operating loss carry forwards, which will offset about $9 million of taxes otherwise payable, plus tax credit carry forwards to offset an additional $1.5 million of taxes. Also because of stock option exercises, there are additional compensation deductions for tax purposes of $23 million, which will result in reduction of taxes otherwise payable of approximately $9 million. The value of these compensation deductions are not recorded as an asset, but will only be recognized when they are realized.

Since we have recognized the deferred tax assets, we will record tax expenses beginning in the first quarter of 2008. The effective tax rate is expected to be about 40%. However, because of the tax operating loss carry forwards, tax credit carry forwards and stock option compensation deductions, we do not expect to pay any significant cash taxes on close to $50 million of future pre-tax earnings.

Our global staffing at December 31 totaled 567 people, and for the year we increased our staffing by 92. Our outstanding shares for both basic and diluted calculations have increased slightly in this quarter. The increase for both counts is principally due to stock option exercises. During the fourth quarter of 2007, a total of 362,000 shares were issued as a result of option exercises.

Before turning to the balance sheet, I'll comment on changes to the first three quarters that were included as a statement in the press release. We identified certain revenue amounts that we had deferred and did not recognized timely during the first three quarters of 2007. Because the adjustments to these amounts do not significantly alter the results in those quarters, we have elected to reflect the changes to those quarters and revise those previous amounts and the statement included in this earnings release.

But now turning to the balance sheet. At December we had $46.3 million of cash and short-term investments. This compares to $34.4 million at September 30, 2007 and $27.1 million at December 31, 2006. The increase in cash in the fourth quarter is a result of cash flows from operation, option exercises, and offset in part by distance to equipment. We continue to be debt free.

Accounts receivables, day sales outstanding at December 31, 2007 were 85 days. This is a decrease from the September 30, 2007 DSO at 91 days. When adjusted for the increase in deferred revenues day sales outstanding was 71 days, a decrease from adjusted DSO of 82 days at September 30.

We continue to believe, there is an opportunity to reduce the amount, and are focused on improving the DSO number again this quarter. However, as always the timing of licenses will impact the amount we were able to collect before a quarter-end. Total deferred revenues at December 31, were $40.8 million, an increase of $4.4 million from September 30, 2007.

Deferred revenue amounts are typically recognized over the next 12 months, deferred services amounts usually increase quarter-to-quarter, while the amount of deferred products revenue will depend on the nature of orders received and any conditions related to those orders that result in the deferral of revenue.

We have included the statement of cash flows in the earnings statement; I will make a few comments on those numbers. 2007 fourth quarter cash flow was $10.3 million cash flow from operations. For the full year 2007, cash flow from operations was $20.2 million compared to $10.6 million for 2006. The improvement in cash flow for the year was a result of net earnings and increases in deferred revenues that were greater than the increase in accounts receivable.

However, major uses on sources of cash were repurchased property and equipment totaling $493,000 in the fourth quarter and for the year purchases totaled $4.1 million compared to $3.3 million in 2006, and we received proceeds from stock option exercises of $1.9 million in the fourth quarter. For the year, option exercises generated $3.5 million, compared to $4.4 million in 2006. Don, there wraps up my comments on the financials.

Don Brown

Okay, thanks Steve. I'll now try to give you some additional insights into our business during the quarter and what we see moving forward. As we wrapped up 2007, we ended a very busy development year with the release of version 3.0 of our flagship, Interaction Center platform. This release includes several key pieces of functionality. We now offer market-leading security with complete encryption of calls, data connections and recordings. Setup and implementation is now dramatically easier because of the addition of auto provisioning functionality for IP phones.

We added a browser-based version of the Interaction client opening up our system to Mac and Linux desktop users. We also announced some great mobility enhancements including the ability to access your Microsoft Exchange calendar from a mobile phone using speech recognition, as well as a version of the interaction client that runs on Smartphones and Pocket PCs. These are only a few of the new features of 3.0. We continue to push innovation to deliver the most advanced IP Telephony product on the market, and we have no plans of letting up on that mission.

As part of the launch of 3.0, we did a five-country media and analysts tour. We briefed over 30 editors and analysts and saw some good media coverage as a result. During 2007, we also released an updated version of Interaction Director, which supports the routing of calls in Interaction's across multiple sites, and we released the second generation of our Interaction Gateway appliances and have been very pleased with the sales volume of that producing. Producing our own gateway just makes the Integration and Implementation piece of our sale that much easier.

Shifting over to marketing, our marketing activities continue to generate greater brand awareness and more lead activity in addition to our corporate marketing team. We now have in-country marketing resources in the U.K., Germany, the Netherlands, Australia and Malaysia, with Japan scheduled to be added in Q1.

In the latter half of 2007, our lead generation process was very effective. The number of leads that we generated more than doubled in 2007 compared to 2006. And we have aggressive plans to continue to grow that lead pipeline in 2008. As most of you know the majority of our new business is still driven by our partner channel of more than 250 certified resellers. That said our ability to generate leads is an essential part of growing our business and attracting and retaining channel partners.

A few other marketing highlights to note. We moved up into the Leader's quadrant on the Gartner, a North American contact center analysis. No doubt about it, this is giving us additional sales opportunities as large corporations often used the Gartner Magic Quadrant report as a method of identifying their shortlist of vendors.

We're seeing more business being influenced in our favor by industry consultants. We now have over 600 consultants in our consultant liaison program over 100 of those participating under signed non-disclosure agreements giving them access to training and product education materials.

We held our Annual Partner Conference during Q4 in Phoenix and had record attendance at the three-day event, presenting more than 80 business and technical sessions to the attendees.

Our media coverage during the year was very strong for a company our size. We had about 2000 article placements during the year, including over 150 feature articles. Placements included Network World, Business Communication Review, Investor's Business Daily, Internet Telephony magazine, Smart Business, CIO magazine and CRM magazine.

Also for 2007, our Customer Interaction Center product was given a Product of the Year Award from CIS magazine and Call Center magazine and our Vonexus EIC product won a Product of the Year Award from Internet Telephony magazine.

Now, turning to 2008, the pillars of our 2008 operating plan are the following. We will continue to go up-market, pushing key issues like security. We think our success in these larger organizations has shown that we are a very good option for contact centers and enterprises of any size. And these large deal opportunities that expand on our strong reputation in the mid-sized market continue to be there. We have many large deals already in the pipeline. We will focus this year on positioning ourselves more as a solutions provider rather than just a software company. We have the consulting and professional services to support infrastructure, experienced channel partners and a strong mix of on-premise and hosted products to make this as a selling advantage for us.

We have plans to grow Japan as our next major international success. Japan is the second largest economy in the world. We have a good install base already in Japan and the business climate there is a positive one. We are investing in sales and marketing in Japan, both with additional personnel, as well as an increased brand presence. Our plan is to double our sales in Japan in 2008, and to continue growing at a rapid clip in 2009 and beyond.

We continue to work on our hosted contact center offering. We see a slice of the market moving towards software as a service and we're working to expand our SAS offering and make it a larger part of our business. And we have some aggressive products plans for 2008. We'll introduce the first release of a speech analytics product that will allow the real time detection of emotion changes on either side of a customer service conversation. Giving contact center supervisors an enhanced ability to catch potential customer dissatisfaction issues immediately.

The speech analytics market is starting to take-off and we feel we will be well positioned with the powerful offering that is many times easier to deploy than those from our competitors. Our customers will only need to download a license key to turn on speech analytics, with no need for additional servers or expensive speech recognition engines. We'll launch feedback management application that automates the process of gathering customer satisfaction survey data, benchmarking it against established standards and reporting progress as corrective actions are implemented.

We think that as companies continue to focus on customer service as a key business differentiator this application will be a great tool. And this year, we will release tight integration with Microsoft Office Communication Server, we already have an integration, but we think we can strengthen our already strong Microsoft story. Functionally it will allow customers to use the Office Communicator client in conjunction with our CIC or EIC communication system. Companies will be able to deploy a mixed environment of Office Communicator for standard users and our interaction client for those users that require advanced functionality such as contact center automation.

Our interaction client application will use the same Microsoft API as Communicator allowing it to inter-operate seamlessly with Office Communication Server. And we plan on a major push at our messaging product, Messaging Interaction Center or MIC. We feel that the market is really prime for a replacement cycle, given the end of life status and many legacy voice mail systems and the eight years that have now passed since Y2K, the last real significant messaging market update.

And finally, as we discussed during our Analyst Conference in Q4, we are making very nice progress in developing functionality in our product to provide business process automation. In conversations that we've had with our partners and customers, we think this can be really big. What we are talking about is using the advanced contact center functions already built into the Interaction Center Platform and enhancing them to automate core business processes, such as loan application processing, collections, claims processing, contract management, and application processing, just to name a few.

The business process automation initiative is a very natural extension of our platform and something we've been thinking about for a long time. This move is in keeping with our efforts to go upmarket and to provide comprehensive solutions. We believe it will make our technology attracted to the entire organization not just the contact center, and provide us a great entry higher up the corporate chain. We think this is a very strategic opportunity for us to grow our business.

Now some guidance. Relative to the financial guidance for 2008, as we presented in the earnings release, we are targeting annual revenue growth of between 20% and 25% and operating earnings on a non-GAAP basis of at least 10 to 11%. We believe that we have the technology and plans to do much better than that, but the current state of the economy causes us to be somewhat cautious in our guidance.

In conclusion, we are optimistic about our business, our growing significance in the market and the technology that we are delivering to our customers. That said, there is a level of uncertainty based on the current economic climate and other factors that aren't within our control. We are pretty conservative by nature and our plan is to not get ahead of ourselves, but instead to set a vision in a strategic operating plan that grows our market share and positions us as a strategic part of our customers' business communication plans.

We are pleased with our progress and happy to have blown past the guidance numbers we provided last year. We like the product plans that we have in place for 2008; they are aggressive, but they fit right into what customers and prospects are looking for. Our sales and marketing teams are positive about the progress we are making and our ever increasing strength as a competitive force in the markets that we play. We are looking forward to a good year.

And that's the conclusion of our prepared remarks; we are ready to answer any questions you might have.

Question-and-Answer Session

Operator

(Operator Instructions). We'll take our first question from [Shayan Patel] with Raymond James.

Shayan Patel - Raymond James

Hi good afternoon. Could you maybe give us a sense of the percentage or the amount of deals that were sort of pushed out of the fourth quarter, and how many are closed already in the first quarter and how many of the balance are still in the pipeline?

Don Brown

Well we thought you guys might ask a question like that. So what we've done is to ask Paul Weber to go through a list of at least the big deals that slipped from Q4 and give you a current status. So Paul?

Paul Weber

Yes. There were really two or three significant new customers that we were pretty sure we were going to get closed in December and ended up slumping. One of them was a nationwide distributor of auto parts and a pretty significant deal in the $700,000 range. And towards the end of that week, the last week of the year they hired a new CFO and obviously put us into another analysis stage within the nature that he bought into it. They have since gotten an internal approval and we're working through the leasing process right now. So we are confident that will come-in in relative quickly.

Another opportunity of significance was an outsourcer, up in the Northwest, call center outsourcer, again probably a $700,000 to $800,000 deal. On that one we just ran out of time, they were doing site visits and schedules, got kind of [rattled] at the end of the year. That one slipped, but we have since gotten the actual word on that contract and they are also a partner I should say, and in final contract negotiations with them.

And then one other opportunity was a utility company in the Southwest for about 0.5 million and that deal came right down to the wire. And they really believed they were going to get it done. We thought they would get it done and again some schedules were kind of a little bit loose at the end with people taking time off, and slipped. For that opportunity, we had also gotten a kind of written confirmation, the year of the product, product of choice and now let's get the contracts and that partner is also working through those. So, we did have a few deals slip, but I will tell you that the quarter, we are off to a very good start and the quarter looks real strong from pipeline and forecast perspectives.

Don Brown

No, I will throw one more in there. That was outside Paul's area. We had a large city government deal in EMEA for about three quarters of a million dollars and we've heard that has now been awarded to our partner and we expect to receive that order this quarter.

Shayan Patel - Raymond James

Great, thank you. Going to the guidance, can you maybe comment on what the 25, 20 to 25% revenue growth guidance in '08 assumes in terms of the pipeline the conversion rate, relative to '07's guidance? And also, what the coverage or visibility is into the guidance relative to what it was when you gave '07's guidance?

Don Brown

That’s a tough one. Obviously when we put out our guidance last year, we said we'd grow 25% and it's not like we had some magical insight into the entire year. We just had to look at our business and our pipelines, our infrastructure, our product plan and growth rate of the market. And that was a number that we felt was realistic. And as you know we ended up blowing well past that. And this year, we've sat down to do the same sort of thing, we go through the same process, really talking with, especially our sales management, trying to get a feel for what they see, the deals that we know about, again what we have in our product pipeline, what we think the market is doing, and what we think the global economy is doing. And at this point, sitting here at the end of January, the best we can do is tell you that we're targeting a 20% to 25% growth.

Now internally we are hoping and planning to do a lot more than that, just as we were planning to do more than the number we gave you last year. But as we said, they are just things that are outside our control. But we feel at this point pretty good about being able to hit that sort of number and I'd say we're especially happy to see the forecast that came in from sales management for Q1. Steve and I have been around the block more times than we care to count with this sort of stuff. And typically after a sales force is disappointed, as ours was in a quarter, the forecast of the comeback are pretty conservative, people are pretty gun-shy. And we have been gratified to find that even after billing on these guys multiple times, they are swearing up and down that the numbers they are giving us are good and they lead us to expect a good strong Q1.

Shayan Patel - Raymond James

Okay. And then this is my last question. One of the major drivers for the company has been the upgrade cycles IP as existing CDM systems they have now come to end of life. How long do you think realistically customers can continue to hold off on purchasing and continue to use their older systems?

Don Brown

You know I think customers can certainly hold off as long as they want to and just upgrading to IP. But it's important to understand that, that's not the crux of our value proposition, certainly we have been able to, and we benefited from that transition. But what we really offer to our customers is a way to better service their customers and especially as we move into process automation to do so more efficiently.

I went to a function a couple of weeks ago for a Fortune 500 insurance company prospect or actually a customer of ours, also a prospect for a wider deployment and was able to hoist a couple of beers with their CIO. It was really interesting, because he said that in years past things have been so good that they really haven't had to be really aggressive about customer service technology. Now, they could kind of sit back and count the checks coming in and be somewhat of a technology follower, but as the market has gotten more competitive, as things have become less certain they feel a greater sense of urgency in terms of upgrading the sort of services that they offer to their customers in order to hang on to their customers.

So we feel really good about that. You know we are not a company just selling an IP PBX. If we were I think I'd be a little bit worried right now. What we do is offer what eWeek came up in its 2008 survey recently, is the top two priorities of IT organizations, which were, number one, a way to offer better service to customers and number two, a way to improve business process. So those are our themes and why we are no more immune from economic factors than anybody else, but I think these are some mitigating factors that caused us to be maybe a little bit more optimistic than say just pure [IT] hardware vendors.

Shayan Patel - Raymond James

Great. Thank you.

Operator: We'll take our next question from Terry Tillman with SunTrust Robinson.

Terry Tillman - SunTrust Robinson

Yeah, hey guys, good afternoon. I was hoping first to put Paul on the spot, don't have Paul still around. But I had a question for Paul as a follow up to his comment earlier. Paul I don't know if you are still there but, you had talked about feeling optimistic in the first quarter, and I guess to Don's point, we've been around the block a few times. The pipeline sounds good in all, but how does January, I mean January is effectively over, how does that compare to maybe last January? I mean are you actually closing good business early in the quarter or is that all more on the hopes of a good March finish?

Paul Weber

That's a good question. We don't bet much on hope on this. What we do is we look at overall pipeline at the beginning of January, and then during that first three to four weeks of January, we do some pretty tight analysis of where each of these opportunities are in the process. Then I start feeling optimistic about our Q1 forecast, because we have had a certain number of contracts, have actually been awarded to us. So, we're not in a dogfight and we don't like feeling good, that we're going to beat Cisco. We've already been told you are the selected vendor, now we need to work though the contract negotiation phase.

Obviously, you can lose the deal during the contract negotiation phase, but it's not very likely. So I think the difference of saying only our pipeline looks good and everybody is pumped and I know there are a significant number of deals that are at that final stage of closing, and the dollar amount of those deals are significant enough but aren’t [confident] in our number.

Terry Tillman - SunTrust Robinson

Okay. And then, I don’t know if this is for Paul or for Don, but in terms of the 3.0 product, I recall the [annual] statement, there was excitement around the product release, and I think you all had a partner there as well, who talked about how it would be an instigator for new business. Is this a security kind of feature? I know that you all had talked about, maybe that being something that could create battles purposely versus Cisco and others, where there might be vulnerability on the security front. Are you starting to see that play out, have you started to use that security feature as a ploy or a tactic in deals or is it still a little too early for those sales cycles?

Paul Weber

I am sorry Don, you want to answer that or --.

Don Brown

I will try and man that, but you give some specifics, Paul. We're definitely pushing the security notion and anecdotally it’s helping us in the field. Customers are increasing concerned about security, data theft and the sorts of mandates that are being passed out. So, it's something that is certainly giving us an important differentiator, and it's kind of surprising to me, the number of vendors out there in the market that really don’t have their security act together yet. Paul, are you trending with any specifics you want to say.

Paul Weber

In general, when it’s the future, like that we'll talk about it, but you don’t pick too many correct battles with it. One exception is in the federal government space. We are getting ready to complete JITC certification and part of that is meeting Voice-over-IP security and they have, the group that actually works with us on that certification has been extremely expressed with the level of security we're offering and the flexibility and the way that we're going to be implement this security.

So the one area that I think we're really going to be seeing some gains from this is in the federal space. And just to back up again, as far as just general [camp] competitive opportunities with Cisco and those guys, once we have this product really out running in a lot of production sites, that's when we'll start bringing that up more effectively.

Terry Tillman - SunTrust Robinson

Okay. Thanks Paul. And then just two real quick ones: In terms of -- I know at the Analyst Day there had been talk around a quantification of the channel partner expansion, I think it was 75 partners if I'm not mistaken? And there is also some sort of expansion plan for territory account managers. Could you guys update us on that, and is that still on-plan or are you thinking about maybe accelerating or what do you stand for '08 on those expansion plans?

Paul Weber

From a territory manager perspective, we are expanding; we are aggressively expanding in the major account role. People have at the beginning of last year and that has been extremely successful. We're going add two more, one of which will -- one have already moved into a vertical major accounts base in a partnership with Ontario Systems that has a significant customer base in the collection space. About 400 customers is a matter of fact are -- most of them are or a lot of them are some of our -- the largest outsourcers out there and they have announced a partnership with us that we're going to go into their customer base and act as a communications platform for their collections application.

And to give you an idea of the potential scope, there are several thousand dollar seats implemented around the world are actually around the USA and Canada I should say. And now they are actually coming into these customers and in new prospects, and when they start those very powerful collections application, we are going to be the communications platform. And we have promoted an individual on both the [teams] that will go after than market as a vertical market. We will also continue to hire and -- on process of interviewing for our major account position on the West Coast as well. So, we are pretty excited and that growth you are going to see happen throughout the year in the vertical space for sure.

Regarding channels, Don I think we were pretty close to hitting our numbers as far as the number we've targeted for '07 and I will tell you that in '08 we are having a bigger emphasis on the quality and in the enablement of these partners that we recruit and have today. So, our target in ICF numbers for '08, not be real high compared to '07, but (inaudible) of the existing partners and the new partners that we bring in.

Terry Tillman - SunTrust Robinson

Okay. I appreciate that and then just lastly. Steve not to keep you out here of the questions, earlier there was talk about a -- more of a solution approach to the market, does that mean that maybe the relative growth rates in products and services could vary to a greater degree in '08, how should we think about the relative growth rates? Thanks.

Steve Head

No we would expect the growth rates to be somewhat comparable just as we have seen. Again most of the services number we have is support these and that just continues to increase. We have seen relatively faster increases in the professional services part of total services and we are expecting to see good growth there. But we are still expecting to see good product growth too. So, as we look at the financials for next year we would expect that the, this clip, which was 52/48 between product and service this year would be something in the same neighborhood by the end of next year. It may be a percentage two or three, different a little bit, but there is not going to be a radical change.

Operator: And we'll take our next question from Irit Jakoby with Susquehanna

Irit Jakoby - Susquehanna

Hi, thank you. So, with respect to your somewhat conservative outlook for 2008, as you -- I think as you said you are basing it more on what you are seeing in the macro economy than on your product cycles and what you are seeing them as a company. Do you see more of a slowdown in enterprise or in the contact center spending?

Don Brown

Well, I'd first of all just say that it's difficult for us to tease out the different elements. When we look out for the year, we're looking at the big picture, the uncertainty that's out there, but obviously we still feel good enough to target a number of that. I don't think it's too shabby, I am not sure exactly how many companies there are growing in excess of 20% at our size. So, I think it's actually a fairly aggressive forecast or target given the environment we are in.

Now, we think that contact center adoption will continue at a pretty good clip for all the reasons that I mentioned, I don't really see that as an area that people are going to cutback on. If anything, our expectation would be that it might be more on the enterprise side, but there again as long as our value proposition shows customers how they can actually save money. We think that we can prosper even in a down environment.

Steve Head

As we talked about in the past, enterprise is really part of our Vonexus solution, but it's also part of what we do with our CIC product. But for Vonexus itself we had the best quarter in our company's history in the fourth quarter and they are expecting to have a good quarter in Q1. So, we're clearly seeing good enterprise business opportunity out there.

Don Brown

And Paul without identifying anybody: is there anything you have liberty to talk about with respect to some of the large enterprise moves that we have going on?

Paul Weber

I think, yeah, I do, I think its just the other point and asking, pull down in the contact center space is unlikely, because most of the contact center business we're dealing with its more of working with people that are generating revenues. So, when they buy our system, especially a blended system that incorporates the outbound dialing side. The reason they are buying our dialer and implementing it, is because the contact rate and hit rate and of course what revenue they can make increases with that implementation of the dialer.

So, that’s I don’t see -- people aren’t buying our product because it’s a productivity gain and just kind of a generic type thing. These are pretty much hard case ROIs in the contact center space. And that’s why I am still pretty confident that although I am sure we will see some type of impact from the problems in the economy. I am not terribly concerned on the contact center side.

On the enterprise side, our approach to the enterprise market, especially in some of these real large opportunities is that, when you are in a tough time like this, I am not saying you are -- I will say a mid size financial institution or you’re an insurance company. We are going into companies and we're trying to tell them that they need to take a different way to -- that how their customers view them. And in order for them to compete with these big conglomerates they have to out customer service them. That’s not just in the customer service center, that’s anytime, anybody context, an employee of the company, they want to give them options, they want to say if he email me, we're going to treat you with the same type of urgency and response and (inaudible) give a phone call. So, we actually have seen some pretty decent enterprise deals and actually are looking at a couple of real significant ones in '08, because again the applications we offer, they feel that it will give that company a competitive advantage.

Irit Jakoby - Susquehanna

Okay, great. That's helpful. And moving to the operating expense line: It seems like the target operating margins that you're targeting for 2008 are really in the same range that you ended 2007, and whereas in the past it looks like you are planning to grow expenses a little bit lower than revenues. So unless there are significant changes that you are anticipating in the growth margins: is that a higher rate of investment than you would have thought that you would be doing in 2008?

Steve Head

Really, (inaudible) that's kind of the other way around. We're continuing to plan on, we're planning on the investment that we had always planned on; it's just that we're a little more cautious about the revenue side of the equation at this point. And if revenues would growth faster than we're expecting, then the margin would be greater than what we've said we've targeted today. So it's not a question of expense growth, it's a matter of -- it's an issue of what will the revenue growth be this year.

Irit Jakoby - Susquehanna

Okay. So basically you're not expecting much operating leverage unless there is upside to the revenues that you are contemplating.

Steve Head

Right, because we're working on -- we are still looking at the long-term. We're still investing obviously in the product, the development, in our sales organization with our partners and Territory managers and with the other things we are doing, building up professional services. So we are going to continue to do the things we've planned on at this point.

Irit Jakoby - Susquehanna

Okay. And lastly from me, any anticipated changes in growth margins as you're adding solution sales and then as you are adding business process to the mix?

Steve Head

At this point we wouldn't expect any significant change. We did see a change over the last couple of years, but it's been pretty stable the last few quarters. Services were pretty stable all year, product margin has stabilized in the last couple of quarters, and depending again on the mix of business in the quarter, we would expect that the margins will continue to be about where they were the last few quarters.

Irit Jakoby - Susquehanna

Okay, great thank you.

Operator: (Operator Instructions). We'll go next to Tavis McCourt with Morgan Keegan.

Tavis McCourt - Morgan Keegan

Thanks a lot for taking my question. A couple of follow-ups, first on the order growth of 11% is a little bit [sub-path] for Interactive Intelligence anyway, but it's tough to know exactly we got relatively small numbers, would that have been more than kind of a normal 20% plus range if a few of those deals you would expect it to hit?

Steve Head

Well if we just added in those four deals that we talked about, it would have been more like 25%. They were all large deals, and it would have also affected if the partners were lower at 55% than normal and they would have affected -- the partner percentage would have been a higher part of the total because three of those four were partner related deal. So those deals pushing out clearly affected the order growth rate, the total orders and the product revenue we recognized in the quarter.

Tavis McCourt - Morgan Keegan

Got you. And then in terms of the '08 guidance and the seasonality of the cost structure, should we be expecting kind of an operating margin ramp throughout the year or a pretty consistent operating margin through the year? Do you know at this point?

Steve Head

Our historical pattern has been an operating margin that's down a little bit in Q1 and rises through the year. You know Q4 of this year we obviously came up a little further of where we had hoped to be because product revenue slipped. Otherwise we would have been up nicely from Q3. Our expectation right now is that it would ramp during the year and probably higher at the end of the year than it is at the beginning.

Tavis McCourt - Morgan Keegan

Got you. And I know, maybe in last year, you guys were pretty strapped in terms of support personnel and being able to implement projects on time -- kind of: where does your capacity in that point stand at this point?

Steve Head

I think we're in a pretty good shape with professional services and we did assimilate their group that we acquired last year, and we did a number of additional hires. So we are in good shape, but we'll continue to grow that team as the business warrants it.

Tavis McCourt - Morgan Keegan

Got you. And then I guess a comment from Paul, for Paul. It looks like there were three or four deals, and all of them kind of had different issues with them: why they didn't get closes and none of them seemed to be, kind of companies backing down due to the economy. I know its kind of a [fractional] thing to be cautious about the economy right now, but can you at this point, point to anything in terms of sales cycle lengthening or anything specific that you feel like your end market demand is slowing or is it just more of a -- just trying to be cautious in terms of what may happens three to six months?

Paul Weber

All right. We've done a lot of talking about this among the sales management team and the territory managers, and for the significant projects that we have in our forecast and pipeline, we're not seeing these deals noticeably being put on hold or shrinking considerably at the last stage. And again, as I was talking to Don earlier, I don’t want to appear naïve to the potential impact that they could have, but from everything we've done and we've spent a lot of time looking at new business potential, add-on business potential, talking to the partners, I am with a bunch of partners this week as a matter of fact. They are not seeing it right now.

Tavis McCourt - Morgan Keegan

Great! Thanks a lot.

Paul Weber

Okay.

Operator

(Operator Instructions). We'll go next to [Gramy Rein] with Bears Capital.

Gramy Rein - Bears Capital

Hi, guys. Paul if I could just ask you a couple of things. Are you seeing anything new competitively in terms of any company's out there or any new products? And then also, if you could comment a little bit about, when you guys do loose a deal: what are usually the reasons that someone might have chosen another provider?

Paul Weber

Sure. On the first question from a product or any competitors that are all of a sudden tougher to compete with, we really have not seen any impact in the last quarter. We still see the usual competitors. When we are going to an opportunity, we are typically replacing Avaya or Nortel or an Aspect and we will always compete with Cisco because they will get some look when anybody is making an IP decision of course.

From a technology perspective, especially in the [kind that] you are seeing the application space, I should say that, they are not making any significant gains that we have seen. So, everything there looks pretty strong. Avaya, we keep breaking to see something because we do believe that at some point it's going to have a negative impact of this acquisition. We have seen some resumes, but you know that’s typical. But again, nothing significant and the change from Avaya either.

When we lose an opportunity, typically the challenge we have a lot of times is the political nature of a lot of these decisions is that, someone has or is pushing for standard IP platform and our challenge is to convince them, but even more they are going with the Cisco IP platform, they still have a choice for an application set on the communication side, and that we are technically superior and cost testified after. But we can lose deals just strictly from you know what, we're not going to get a look or we'll give you a look but really sticking with this one vendor to see if they can make it happen or not. So, that's probably the most significant challenge we have is that kind of political power those guys have.

Gramy Rein - Bears Capital

Okay. Are you still having to educate customers on the merits of being software only and device independent or is that sort of becoming more widely accepted now?

Paul Weber

Well we always have to educate them, when somebody sees our application they definitely understand the value of the software based solution and the all-in-one. I will say that the all-in-one, that's something more common term. Early on we would white boarded -- make the, oh I get it as opposed to a point solution. I will tell you that I believe that the acceptance of all-in-one versus best-of-breed has made some gains in the last six months to a year. But we do -- we still kind of hammer that software based message pretty heavy, because it really is the core of our strength.

Gramy Rein - Bears Capital

And Don when do you -- I know there has been a lot of talk about process automation. If you just have the ballpark: when do you start to see that show up in your finance? Also: when do you start to get products out there? Is that six months off or is that a couple of years away?

Don Brown

We are hoping to deliver something this year, it is, and we're coming along. We have things that we're actually demonstrating internally now. So, I'm optimistic. But again, been through enough of these things to know that it's foolish to point to a particular quarter when something might be released. But, we're hoping we can get into that game, we think we've got a great product and a different direction than anybody else in the market. Gartner is predicting that business process management is going to have a 24% compounded annual growth rate from now until 2011. It's going to grow to be a $2.5 million market. So, you take that and then the fact that IT managers when they are surveyed are listing process improvement, the high in terms of their priorities and I think there is a real possibility out there, a real opportunity out there and it really is a chance for us to do what we did in the early days with telephony, where back then you had to buy all these separate systems that Paul mentions, these best-of-breed systems in order to put together a solution and we prove that and all-in-one solution could be superior. We think we can bring exactly that sort of benefit to process automation.

Gramy Rein - Bears Capital

And the last thing. Any thoughts on the cash balance: what you plan to do with it or you just plan to let it kind of accumulate for a while?

Steve Head

Well we like the accumulation part of it, and we like earning interest. Fed fund rate cuts are nice I guess, except for our interest income they go down a little bit. We have looked at acquisitions and as said before we will continue to look at acquisitions, we think you know though that we have the cash balance and as we are becoming a larger company there is potentially some strategic things that would make sense for us, but we haven't identified any. So, at this point is to accumulate cash and continue to look at where we could compliment what we are doing and grow a little faster.

Gramy Rein - Bears Capital

Thanks for your time.

Operator: We'll go next to Paul Kaump with Northland Securities.