Description
Filed with the SEC from Aug 30 to Sep 05:
Mattersight (MATR)
Sutter Hill Ventures increased its holdings to 3,737,293 shares (20.8%) by buying 302,545 shares from Aug. 17 to Sept. 4 for $4.81 to $5.40 apiece.
BUSINESS OVERVIEW
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Mattersight Corporation (together with its subsidiaries and predecessors, “Mattersight,” “we,” “us,” or the “Company”) is a leader in enterprise analytics focused on customer and employee interactions and behaviors. Mattersight’s Behavioral Analytics service captures and analyzes customer and employee interactions, employee desktop data, and other contextual information to improve operational performance and predict future customer and employee outcomes. Mattersight’s analytics are based on millions of proprietary algorithms and the application of unique behavioral models. The Company’s SaaS+ delivery model combines analytics in the cloud with deep customer partnerships to drive significant business value. Mattersight’s applications are used by leading companies in the healthcare, insurance, financial services, telecommunications, cable, utilities, and government industries.
Following the sale by the Company of its Integrated Contact Solutions (“ICS”) Business Unit on May 28, 2011, the Company changed its corporate name from eLoyalty Corporation to Mattersight Corporation, and began operating in a single business segment, focused primarily on its Behavioral Analytics service (“Behavioral Analytics”). Through Behavioral Analytics, the Company generates two types of revenue:
(1) Managed services revenue, which is recurring, annuity revenue from long-term (generally three- to five-year) contracts and includes subscription and amortized deployment revenue; and
(2) Consulting services revenue, which is generally project-based and sold on a time-and-materials or fixed-fee basis and includes follow-on consulting services revenue.
Set forth below is a more detailed description of the capabilities that the Company currently offers.
Behavioral Analytics
The Company’s multi-channel technology captures the unstructured data of voice interactions (conversations), related customer and employee data, and employee desktop activity, and applies millions of proprietary algorithms against those interactions. Each interaction contains hundreds of attributes that get scored and ultimately detect patterns of behavior or business process that provide the transparency and predictability necessary to enhance revenue, improve the customer experience, improve efficiency, and predict and navigate outcomes. Adaptive across industries, programs, and industry-specific processes, the Company’s Behavioral Analytics offerings enable its clients to drive measurable economic benefit through the improvement of contact center performance, customer satisfaction and retention, fraud reduction, and streamlined back office operations. Specifically, through its Behavioral Analytics offerings, Mattersight helps its clients:
• Automatically measure customer satisfaction and agent performance on every analyzed call;
• Identify and understand customer personality;
• Improve rapport between agent and customer;
• Reduce call handle times while improving customer satisfaction;
• Identify opportunities to improve self-service applications;
• Improve cross-sell and up-sell success rates;
• Improve the efficiency and effectiveness of collection efforts;
• Identify customer experience issues and score calls for retention risk;
• Measure and improve supervisor effectiveness and coaching;
• Improve agent effectiveness by analyzing key attributes of desktop usage;
• Predict likelihood of a customer attrition; and
• Identify fraud callers and improve authentication processes.
The Company has designed a highly-scalable, flexible, and adaptive application platform to enable the Company to implement and operate its Behavioral Analytics offerings for its clients. These offerings are primarily delivered through a SaaS+ model, as a managed subscription service from which Mattersight derives Managed services revenue and Consulting services revenue. Managed services revenue consists of deployment and subscription services and Consulting services revenue consists of post-deployment follow-on services, including coaching, training, and custom data analysis.
In addition to our Behavioral Analytics offerings, Mattersight also generates revenue from the following services:
Marketing Managed Services
Marketing Managed Services revenue, which is derived from marketing application hosting services.
CRM Services
CRM Services revenue, which is derived from operational consulting services that enhance business performance through improved process efficiencies and redesign of workflows.
Types of Revenue
Managed Services Revenue
Growth in Managed services revenue is primarily driven by the execution of new Behavioral Analytics contracts, under which we deploy and provide the ongoing hosting of our proprietary Behavioral Analytics System. Based on each client’s business requirements, the Behavioral Analytics System is configured and integrated into the client’s environment and then deployed in either a remote-hosted or, in one case, an on-premise hosted environment. Thereafter, the client’s selection of our Behavioral Analytics offerings is provided, on a subscription basis, for a term that is generally three to five years. The fees and costs related to the initial deployment are deferred and amortized over the term of the contract.
We also generate Managed services revenue from Marketing Managed Services, specifically, from hosted customer and campaign data management. This source of Managed services revenue is likely to diminish over time as we focus on growth through Behavioral Analytics.
Consulting Services Revenue
In addition to the Consulting services revenue generated by the Consulting services provided under our Behavioral Analytics contracts, we derive a portion of this type of revenue from CRM Services for long-standing accounts. Consulting services revenue from CRM Services is anticipated to diminish over time as demand for these services continues to decline and we focus on growth through Behavioral Analytics. We bill for Consulting services on a time-and-materials or fixed-fee basis.
Business Segments
The Company operated in two business segments, the Behavioral Analytics Service Business Unit and the ICS Business Unit, until May 28, 2011, the date of the close of the sale of the ICS Business Unit, at which point the Company began operating in a single business segment, focused primarily on Behavioral Analytics.
International Operations
The Company’s services are delivered to clients in North America (U.S. and Canada) and Europe (the United Kingdom). The Company’s long-lived assets are and have been predominately located in North America and consist of equipment, software, furniture and fixtures, and leasehold improvements (net of accumulated depreciation).
Methods of Distribution
Our Managed services revenue and Consulting services revenue are generated by direct contractual relationships with our clients.
Intellectual Property Rights
General
Our ability to protect our software, methodologies, and other intellectual property is important to our success and our competitive position. We view as proprietary the software (including source code), algorithms, analyses, and other ideas, concepts, and developments that we create in order to provide, improve, and enhance our service offerings, as well as the work product we create in the course of providing services for clients. We seek to protect our intellectual property rights in these developments and work product by relying on a combination of patent, copyright, trademark, and trade secret law, and confidentiality and non-disclosure agreements with our employees and third parties.
Patents
As of December 31, 2011, we hold six U.S. and one European patent and have applied for several additional patents. These patents cover a broad range of our analytics capabilities, including methods for analyzing language to assess customer personality and analyzing data to improve employee performance. We regularly review new areas of development in order to assess patentability.
Trademarks
In connection with the sale of our ICS business unit, we sold the “eLoyalty” trademark and logo. Effective as of May 31, 2011, we began doing business as Mattersight Corporation. We have applied to register the trademarks in “MATTERSIGHT”, our logo (the “eye”), and our tagline “SEE WHAT MATTERS”.
Licenses
A majority of our clients require that we grant to them licenses in and to the intellectual property rights associated with the work product we create in the course of providing services. In some cases, our clients require assignment of ownership in the intellectual property rights to such work product, typically where such work product embodies their confidential information or would provide them some competitive advantage in their industry. Absent an agreement to the contrary, each assignment of ownership in intellectual property rights would result in our inability to reuse the relevant work product with other clients. As a result, it is our practice to retain the rights in the underlying core intellectual property on which such work product is based, including methodologies, workplans, and software. Further, it is our policy to obtain from our clients a license to permit us to market custom software and other original materials to other clients. These arrangements may be nonexclusive or exclusive, and licensors to us may retain the right to sell products and services that compete with those of the Company.
Seasonality
Seasonal impact to our revenue and earnings is limited, as a significant portion of our revenue is earned through our Behavioral Analytics subscription services, which is a recurring annuity revenue stream that is not impacted by holidays and vacations.
Clients
During fiscal year 2011, our five and 10 largest clients accounted for 70% and 90% of our total revenue, respectively. In fiscal year 2011, there were three clients that accounted for 10% or more of total revenue. Vangent, Inc., Allstate Insurance Company, and Health Care Service Corporation, which accounted for 22%, 15%, and 14% of our total revenue, respectively. For fiscal year 2010, there were four clients accounting for more than 10% of the total revenue. Vangent, Inc., United HealthCare Services, Inc., Health Care Service Corporation, and Allstate Insurance Company accounted for 20%, 15%, 14%, and 13% of total revenue, respectively. For fiscal year 2009, three clients accounted for 10% of total revenue. Blue Shield of California, United HealthCare Services, Inc., and Health Care Service Corporation accounted for 16%, 14%, and 11% of total revenue, respectively. For fiscal years 2011, 2010, and 2009 seven, six and nine clients each accounted for over $1 million of total revenue. See Note Two “Summary of Significant Accounting Policies” of the “Notes to Consolidated Financial Statements” included in Part II Item 8 of this Form 10-K.
Competition
Although we view the manner in which we provide Behavioral Analytics, and its benefits, to be unique, we nonetheless operate in a highly competitive and rapidly changing market and compete with a variety of organizations that offer services that may be viewed as similar to ours. These competitive organizations include data analytics solutions providers, voice recording and voice analytic services providers and software licensors, and strategic consulting firms. In our opinion, few competitors offer the full range and depth of services that we can provide, but they may compete with us on individual factors such as expertise, price, or capacity.
Many of our competitors have longer operating histories, more clients, longer relationships with their clients, greater brand or name recognition, and significantly greater financial, technical, marketing, and public relations resources than we do. As a result, our competitors may be in a better position to respond quickly to new or emerging technologies and changes in client requirements. They may also develop and promote their products and services more effectively than we do. New market entrants also pose a threat to our business. Existing or future competitors may develop or offer solutions that are comparable or superior to ours at a lower price.
Environmental Issues
There are no known material compliance issues with any Federal, state, or local environmental regulations.
Employees
As of December 31, 2011, we employed 223 persons, none of whom is represented by a union. We consider our employee relations to be good.
Available Information and Other
Our principal internet address is www.Mattersight.com . Our Annual, Quarterly, and Current Reports on Forms 10-K, 10-Q, and 8-K, and any amendments thereto, as well as the Forms 3, 4, and 5 beneficial ownership reports filed with respect to our stock, are made available free of charge on our website as soon as reasonably practicable after the reports have been filed with, or furnished to, the Securities and Exchange Commission (“SEC”). However, the information found on our website is not part of this or any other report filed by us with the SEC. These reports may also be obtained at the SEC’s public reference room at 100 F Street, N.E., Washington, D.C. 20549. The SEC also maintains a website at www.sec.gov that contains reports, proxy statements, and other information regarding SEC registrants, including Mattersight.
CEO BACKGROUND
Tench Coxe, age 54, is a managing director of the general partner of Sutter Hill Ventures, a venture capital company located in Palo Alto, California, and has held that position since 1987. He has been in the venture capital investing business for 25 years. Mr. Coxe is a director of NVIDIA Corporation (NASDAQ: NDVA) and various private companies. He has been a director of Mattersight and the Chairman of the Board since February 2000.
John T. Kohler, age 65, is the former President and Chief Executive Officer of Technology Solutions Company (TSC) (Mattersight spun off from TSC in February 2000). Mr. Kohler held such office from 1995 until his retirement in February 2000. He joined TSC as Senior Vice President in 1992, was promoted to Executive Vice President and named to the Office of the Chairman in 1993, and became President and Chief Operating Officer in 1994. He has been a General Partner of American Home Technology since 2000. Mr. Kohler has been a director of Mattersight since May 1999.
Philip R. Dur, age 39, is a Managing Director of Investor Growth Capital (IGC). He has been involved in venture capital and private equity since 1995 and joined IGC’s technology investment team in 2004. Prior to joining IGC, Mr. Dur spent four and a half years with Morgan Stanley Venture Partners and two years with Morgan Stanley Capital Partners. He currently serves as a director of a number of private companies. He has been a director of Mattersight since December 2011 and was elected in connection with our sale of Common Stock to affiliates of IGC in a private placement on December 19, 2011.
Henry J. Feinberg, age 60, is Executive Chairman of Yield Management Systems located in Chicago, Illinois. Previously, Mr. Feinberg was a Partner at Technology Crossover Ventures, a venture capital firm located in Palo Alto, California. He currently serves as a director of a privately-held company. He has been a director of Mattersight since May 2007.
John C. Staley, age 70, is the former Managing Partner—Lake Michigan Area of Ernst & Young LLP, a global audit and tax firm, a position that he held from 1985 to his retirement in June 2001. Mr. Staley is presently a director of Hospira, Inc. (NYSE: HSP) and Nicor Inc. (NYSE: GAS), as well as various private companies. In the past five years, Mr. Staley also served on the board of CenterPoint Energy, Inc. (NYSE: CNP). He has been a director of Mattersight since August 2002.
Kelly D. Conway, age 55, is the President and Chief Executive Officer of Mattersight, a position he has held since its incorporation in May 1999 as a subsidiary of TSC. Mr. Conway joined TSC in November 1993 as Senior Vice President, assumed the position of Executive Vice President in July 1995, and became Group President in October 1998. He has been a director of Mattersight since May 1999.
David B. Mullen, age 61, is the former Executive Vice President and Chief Financial Officer of Navteq Corporation, having held that position from December 2002 to January 2010. Navteq was acquired by Nokia Corporation (NYSE: NOK) in July 2008 and is now a wholly-owned subsidiary thereof. Including his service with Navteq, he has over twenty-five years of experience as an executive for technology companies. Mr. Mullen currently acts as an independent consultant. He serves as a director of Avid Technology, Inc. (NASDAQ: AVID) and has been a director of Mattersight since March 2009.
Michael J. Murray, age 67, retired in July 2000 as President of Global Corporate and Investment Banking at Bank of America Corporation (NYSE: BAC), a position he had held since 1998. Mr. Murray has over 30 years’ experience in banking, including heading Bank of America’s Global Wholesale Bank, with responsibility for its business with large corporate, international, and government clients around the world. He currently serves as a director of Con-Way Inc. (NYSE: CNW), a publicly-traded transportation company, and serves on Con-Way’s Compensation and Nominating Committees. He also serves on the Advisory Board of a venture capital firm and a private equity firm. Mr. Murray has been a director of Mattersight since June 1999.
MANAGEMENT DISCUSSION FROM LATEST 10K
Critical Accounting Policies and Estimates
Our management’s discussion and analysis of financial condition and results of operations is based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to the costs and timing of completion of client projects, our ability to collect accounts receivable, the timing and amounts of expected payments associated with cost reduction activities, and the ability to realize our net deferred tax assets, contingencies, and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
The fiscal year-end dates referenced herein for fiscal years 2011, 2010, and 2009 are December 31, 2011, January 1, 2011, and December 26, 2009, respectively.
We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our consolidated financial statements.
Discontinued Operations
ICS Business Unit Transaction
The sale by the Company of the ICS Business Unit and “eLoyalty” registered trademark / trade name to Magellan Acquisition Sub, LLC, a Colorado limited liability company and wholly-owned subsidiary of TeleTech Holdings, Inc., a Delaware corporation, closed on May 28, 2011, and the Company changed its name from eLoyalty Corporation to Mattersight Corporation effective May 31, 2011. Therefore, the results of operations of the ICS Business Unit are reported as discontinued operations for all periods presented. Additionally, certain corporate and general costs that had historically been allocated to the ICS Business Unit were reallocated to the Company and are reflected in all periods presented.
Revenue Recognition
Continuing Operations
Behavioral Analytics Revenue
Behavioral Analytics revenue consists of Managed services revenue and Consulting services revenue.
Managed services revenue consists of planning, deployment, training, and subscription fees derived from Behavioral Analytics contracts. Planning, deployment, and training fees, which are considered to be installation fees related to long-term subscription contracts, are deferred until the installation is complete and are then recognized over the term of the applicable subscription contract. The terms of these subscription contracts generally range from three to five years. Installation costs incurred are deferred up to an amount not to exceed the amount of deferred installation revenue and additional amounts that are recoverable based on the contractual arrangement. These costs are included in Prepaid expenses and Other long-term assets. Such costs are amortized over the term of the subscription contract. Costs in excess of the foregoing revenue amount are expensed in the period incurred.
The amount of revenue generated from subscription fees is based on a number of factors, such as the number of agents accessing the Behavioral Analytics System and/or the number of hours of calls analyzed during the relevant month of the term of the subscription contract. This revenue is recognized as the service is performed for the client.
Consulting services revenue primarily consists of fees charged to the Company’s clients to provide post-deployment follow-on consulting services, which include custom data analysis, the implementation of enhancements, and training. These follow-on consulting services are generally performed for the Company’s clients on a fixed-fee basis. Revenue is recognized as the services are performed, with performance generally assessed on the ratio of actual hours incurred to date compared to the total estimated hours over the entire term of the contract.
Other Revenue
Other revenue consists of Marketing Managed Services revenue and CRM Services revenue.
Marketing Managed Services revenue is derived from marketing application hosting. This revenue is generally in the form of fixed monthly fees received from the Company’s clients and is recognized as the services are performed for each client. Any related setup fee would be recognized over the contract period of the hosting arrangement.
CRM Services revenue consists of fees generated from the Company’s operational consulting services, which are provided to the Company’s clients on a time-and-materials or fixed-fee basis. The Company recognizes revenue as the services are performed for time-and-materials projects. For fixed-fee projects, revenue is recognized based on the ratio of hours incurred to date compared to the total estimated hours over the entire term of the contract.
Reimbursed expenses revenue includes billable costs related to travel and other out-of-pocket expenses incurred while performing services for our clients. The cost of third-party product and support may be included within this category if the transaction does not satisfy the requirements for gross reporting. An equivalent amount of reimbursable expenses is included in Cost of revenue.
Payments received for Managed services contracts in excess of the amount of revenue recognized for these contracts are recorded as unearned revenue until revenue recognition criteria are met.
If the Company’s estimates indicate that a contract loss will occur, then a loss provision is recorded in the period in which the loss first becomes probable and can be reasonably estimated.
The Company maintains allowances for doubtful accounts for estimated losses resulting from clients not paying for unpaid or disputed invoices for contractual services provided. Additional allowances may be required if the financial condition of our clients deteriorates.
Discontinued Operations
ICS Business Unit
Managed services revenue included in the ICS Business Unit consisted of fees generated from the Company’s contact center support and monitoring services. Support and monitoring services generally were contracted for a fixed fee, and the revenue was recognized ratably over the term of the contract. Support fees that were contracted on a time-and-materials basis were recognized as the services were performed for the client.
For fixed fee Managed services contracts, where the Company provided support for third-party software and hardware, revenue was recorded at the gross amount of the sale. If the contract did not meet the requirements for gross reporting, then Managed services revenue was recorded at the net amount of the sale.
Consulting services revenue included in the ICS Business Unit consisted of the modeling, planning, configuring, or integrating of an Internet Protocol network solution within the Company’s clients’ contact center environments. These services were provided to clients on a time-and-materials or fixed-fee basis. For the integration of a system, the Company recognized revenue as the services were performed, with performance generally assessed on the ratio of hours incurred to date compared to the total estimated hours over the entire term of the contract. For all other consulting services, the Company recognized revenue as the services were performed for the client.
Revenue from the sale of Product, which was generated primarily from the resale of third-party software and hardware by the Company, was generally recorded at the gross amount of the sale when it was delivered to the client.
In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. In October 2009, the FASB also amended the accounting standards for multiple deliverable revenue arrangements to:
(i) provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;
(ii) require an entity to allocate revenue in an arrangement using estimated selling prices (“ESP”) of deliverables if a vendor does not have vendor-specific objective evidence of selling price (“VSOE”) or third-party evidence of selling price (“TPE”); and
(iii) eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.
The Company elected to adopt this accounting guidance at the beginning of its first quarter of fiscal 2011 on a prospective basis. The adoption of this guidance does not impact our revenue recognition with respect to Behavioral Analytics because the implementation services sold with our hosting service are not separated into multiple accounting units because there is no standalone fair value for these services. We recognize these services revenues over the anticipated term of the hosting services, currently the contract term. This accounting guidance does not change the units of accounting for the Company’s revenue transactions or the methods used to allocate consideration to the units of accounting. The revenue recognition for each of these offerings is discussed below.
For the ICS Business Unit, the Company utilized VSOE to allocate revenue to various elements in an arrangement. We determined VSOE based on our normal pricing and discounting practices for the product or service when sold separately. In determining VSOE, we required that a substantial majority of the selling prices for a product or consulting services fall within a reasonably narrow pricing range, generally evidenced by approximately 80% of such historical standalone transactions falling within plus or minus 20% of the median selling price. For the ICS Business Unit’s managed services, we established VSOE through the stated renewal approach. Previously, we were able to establish VSOE for our product and service offerings except for software. If we were not able to establish VSOE for an offering, we attempted to establish fair value by utilizing TPE. TPE is established by obtaining evidence from comparable offerings from a peer company. If the Company was unable to establish fair value using VSOE or TPE, then the Company used ESP in its allocation of revenue. To determine ESP, we applied significant judgment as we weighed a variety of factors, based on the facts and circumstances of the arrangement. These factors included internal costs, gross margin objectives, and existing portfolio pricing and discounting.
Within discontinued operations, some of our sales arrangements had multiple deliverables containing software and related software components. Such sale arrangements were subject to the accounting guidance in ASC 985-605, Software Revenue Recognition .
Stock-Based Compensation
Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. Determining fair value of stock-based awards at the grant date requires certain assumptions. The Company uses historical information as the primary basis for the selection of expected life, expected volatility, expected dividend yield assumptions, and anticipated forfeiture rates. The risk-free interest rate is selected based on the yields from U.S. Treasury Strips with a remaining term equal to the expected term of the options being valued.
Goodwill
In the fourth quarter of 2011, we early adopted ASU No. 2011-08, Intangibles—Goodwill and Other (Topic 350) – Testing Goodwill for Impairment, which allows an entity to use a qualitative approach to test goodwill for impairment. As a result, in performing our annual impairment test, we first perform a qualitative assessment to determine whether it is more-likely-than-not that the fair value of a reporting unit is less than its carrying value, including goodwill. If it is concluded that this is the case, we perform a detailed quantitative assessment. Our annual impairment test of goodwill is performed in the fourth quarter of each year. In 2011, after completing our annual qualitative review, we concluded that it was not more likely than not that the carrying value of any of our reporting units exceeded its fair value. Accordingly, we concluded that further quantitative analysis and testing was not required, and no goodwill impairment charge was required.
There has been no impairment identified as a result of the annual review of goodwill as of December 31, 2011 and January 1, 2011. The carrying value of goodwill was $1.0 million as of December 31, 2011 and January 1, 2011.
Intangible Assets
Intangible assets reflect costs related to patent and trademark applications, Marketing Managed Services customer relationships acquired in 2004, and the 2003 purchase of a license for certain intellectual property. Patent and trademark applications are amortized over 120 months. The other intangible assets are fully amortized. The original cost of intangible assets as of December 31, 2011 and January 1, 2011 was $2.8 million and $2.7 million, respectively. Accumulated amortization of intangible assets as of December 31, 2011 and January 1, 2011 was $2.6 million and $2.4 million, respectively. Currently, amortization expense of intangible assets is expected to be $40 thousand annually.
Severance and Related Costs
We recorded accruals for severance and related costs associated with our cost-reduction efforts undertaken during fiscal years 2007 through 2011. The portion of the accruals relating to employee severance represents contractual severance for identified employees and generally is not subject to a significant revision. The portion of the accruals that related to office space reductions, office closures, and associated contractual lease obligations are based in part on assumptions and estimates of the timing and amount of sublease rentals, which may be affected by overall economic and local market conditions. To the extent estimates of the success of our sublease efforts changed, adjustments increasing or decreasing the related accruals have been recognized.
Income Taxes
We have recorded income tax valuation allowances on our net deferred tax assets to account for the unpredictability surrounding the timing of realization of our U.S. and non-U.S. net deferred tax assets due to uncertain economic conditions. The valuation allowances may be reversed at a point in time when management determines realization of these tax assets has become more likely than not, based on a return to predictable levels of profitability.
The Company uses an asset and liability approach for financial accounting and reporting of income taxes. Deferred income taxes are provided when tax laws and financial accounting standards differ with respect to the amount of income for the year, the basis of assets and liabilities and for tax loss carryforwards. The Company does not provide U.S. deferred income taxes on earnings of U.S. or foreign subsidiaries, which are expected to be indefinitely reinvested.
The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Significant judgment is used to determine the likelihood of the benefit. There is additional guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods, and disclosure requirements.
Intraperiod tax allocation requires that the provision for income taxes be allocated between continuing operations and other categories of earnings (such as discontinued operations or other comprehensive income) for each tax jurisdiction. In periods in which there is a year-to-date pre-tax loss from continuing operations and pre-tax income in other categories of earnings, the tax provision is first allocated to the other categories of earnings. A related tax benefit is then recorded in continuing operations. While intraperiod tax allocation in general does not change the overall tax provision, it may result in a gross-up of the individual components, thereby changing the amount of tax provision included in each category. Included in our continuing operations income tax provision is a tax benefit of $5.9 million for the year ended December 31, 2011 and $1.7 million for the year ended January 1, 2011. Included in our discontinued operations income tax provision is tax expense of $6.8 million for the year ended December 31, 2011 and $1.8 million for the year ended January 1, 2011.
Other Significant Accounting Policies
For a description of the Company’s other significant accounting policies, see Note Two “Summary of Significant Accounting Policies” of the “Notes to Consolidated Financial Statements” included in Part II Item 8 of this Form 10-K.
Forward-Looking Statements
Statements in this Form 10-K that are not historical facts are “forward-looking statements” that are made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These forward-looking statements, which may be identified by use of words such as “plan,” “may,” “might,” “believe,” “expect,” “intend,” “could,” “would,” “should,” and other words and terms of similar meaning, in connection with any discussion of our prospects, financial statements, business, financial condition, revenues, results of operations, or liquidity, involve risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. In addition to other factors and matters contained or incorporated in this document, important factors that could cause actual results or events to differ materially from those indicated by such forward-looking statements include, without limitation, those noted under “Risk Factors” included in Part I Item 1A of this Form 10-K for the year ended December 31, 2011, as well as the following:
• Changes by the FASB or the SEC of authoritative accounting principles generally accepted in the United States or policies or changes in the application or interpretation of those rules or regulations;
• Acts of war or terrorism, including, but not limited to, actions taken or to be taken by the United States and other governments as a result of acts or threats of terrorism, and the impact of these acts on economic, financial, and social conditions in the countries where we operate; and
• The timing and occurrence (or non-occurrence) of transactions and events which may be subject to circumstances beyond our control.
We cannot guarantee any future results, levels of activity, performance, or achievements. The statements made in this Form 10-K represent our views as of the date of this Form 10-K, and it should not be assumed that the statements made in this Form 10-K remain accurate as of any future date. Moreover, we assume no obligation to update forward-looking statements, except as may be required by law.
Business Outlook
Based upon Mattersight’s business development efforts and third-party market research, we believe there has been a fundamental shift in the way large enterprises view data. The trends suggest that large enterprises today appreciate that there is value in data that can be derived from their front and back offices, but they have not yet established efficient and effective methods to capture, analyze, and create value from this data. We seek to help large enterprises capitalize on this data with our Behavioral Analytics solutions and, as the leader in this rapidly growing market, we believe we are uniquely positioned to capitalize on this opportunity. We estimate the market potential in the United States for all of our current analytics offerings at over $10 billion per year. The market for enterprise analytics is very new and we currently estimate it to be less than 5% penetrated.
Our business strategy to increase revenue, profitability, and capture market share includes the following elements:
• Increase up-sell and cross-sell ratios by deepening and broadening our relationships with existing clients;
• Win business with new clients, focusing on analyzing customer interactions and back office activities in targeted industries;
• Continue to invest in innovative proprietary technology, new applications, and delivery methods;
• Continue bookings growth and improve operating leverage;
• Expand our sales and marketing efforts with seasoned enterprise sales agents and strategic marketing professionals; and
• Develop partnerships and strategic alliances to expand sales leverage, improve brand awareness, and reach new industries while providing value to our mutual clients.
Resulting from our delivery of measurable economic benefit to our clients, we have seen increasing penetration within existing accounts, due to an increase in adoption of our base Behavioral Analytics offerings across separate and distinct business units, as well as the adoption of new applications within existing business units. For this reason, we will continue to focus on further penetrating what we estimate to be a large existing base market with a less expensive cost of acquisition. In addition, our strategy to further invest in sales and marketing, coinciding with the fundamental shift in enterprise data utilization described above, has led to an increasing number of discussions with potential new clients and strategic partners.
Managed Services Backlog
As a result of the strategic and long-term nature of Managed services revenue, we believe it is appropriate to monitor the level of backlog associated with our Managed services agreements. The Behavioral Analytics Managed services backlog was $96.3 million as of December 31, 2011 and $84.5 million as of January 1, 2011. This increase in backlog is due to the value of the Managed services contracts signed in fiscal year 2011 exceeding the amount of Managed services revenue in fiscal year 2011. We expect Behavioral Analytics Managed service backlog to increase in fiscal year 2012 based on the impact of anticipated renewals of existing agreements and anticipated contract signings with clients included in our current sales pipeline.
The Company uses the term “backlog” to reflect the estimated future amount of Managed services revenue related to its Managed services contracts. The value of these contracts is based on anticipated usage volumes over the anticipated term of the agreement. The anticipated term of the agreement is based on the contractually agreed fixed term of the contract, plus agreed upon, but optional extension periods. Actual volumes may be greater or less than anticipated. In addition, actual agreement terms may vary from the anticipated terms because these contracts typically are cancellable without cause based on the customer making a substantial early termination payment or forfeiture of prepaid contract amounts. The reported Behavioral Analytics Managed service backlog is expected to be recognized as follows: $34.2 million in 2012; $28.2 million in 2013; $17.8 million in 2014; and $16.1 million in 2015 and thereafter.
Year Ended December 31, 2011 Compared with the Year Ended January 1, 2011
Services Revenue
Services revenue is total revenue excluding reimbursable expenses that are billed to our clients. Our services revenue decreased 5% to $28.8 million in fiscal year 2011 from $30.3 million in fiscal year 2010.
Behavioral Analytics revenue was $27.3 million in fiscal year 2011 and was $25.2 million in fiscal year 2010. Behavioral Analytics revenue increased $2.1 million in fiscal year 2011 due to increased subscription fees associated with the conversion of several deployments to the subscription phase of the agreement.
Other revenue decreased by $3.5 million in fiscal year 2011 to $1.5 million, from $5.0 million in fiscal year 2010, a decrease of 70%. The decrease in revenue was mainly due to the completion of several contracts for Marketing Managed Services and CRM Services performed for clients in fiscal year 2010 and lower demand for CRM Services from existing clients who utilize these services.
The Company’s top five clients accounted for 70% of total revenue in fiscal years 2011 and 2010. The top 10 clients accounted for 90% of total revenue in fiscal year 2011, compared to 86% in fiscal year 2010. In fiscal years 2011 and 2010, there were three and four clients, respectively, that accounted for 10% or more of total revenue. In fiscal year 2011, Vangent, Inc., Allstate Insurance Company, and Health Care Service Corporation accounted for 22%, 15%, and 14% of total revenue, respectively. In fiscal year 2010, Vangent, Inc., United HealthCare Services, Inc., Health Care Service Corporation, and Allstate Insurance Company accounted for 20%, 15%, 14%, and 13% of total revenue, respectively. Higher concentration of revenue with a single client or a limited group of clients creates increased revenue risk if one of these clients significantly reduces its demand for our services.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Types of Revenue
Managed Services Revenue
Growth in Managed services revenue is primarily driven by the execution of new Behavioral Analytics contracts, under which we deploy and provide ongoing managed services related to our proprietary Behavioral Analytics System and provide related Business Monitoring services. Based on each client’s business requirements, the Behavioral Analytics System is configured and integrated into the client’s environment and then deployed in either a remote-hosted or, in one case, an on-premise hosted environment. Thereafter, the client’s selection of our Behavioral Analytics offerings is provided, on a subscription basis, for a period that is generally three to five years after the go-live date or, in the cases where the Company contracts with a client for a short-term pilot of Behavioral Analytics prior to committing to a longer subscription period, the subscription or pilot periods generally range from three to twelve months after the go-live date. The fees and costs related to the initial deployment are deferred and amortized over the term of the contract.
We also generate Managed services revenue from Marketing Managed Services, specifically, from hosted customer and campaign data management. This source of Managed services revenue is likely to diminish over time as we focus on growth through Behavioral Analytics.
Consulting Services Revenue
In addition to the Consulting services revenue generated by the Consulting services provided under our Behavioral Analytics contracts, we derive a portion of this type of revenue from CRM Services for long-standing accounts. Consulting services revenue from CRM Services is anticipated to diminish over time as demand for these services continues to decline and we focus on growth through Behavioral Analytics. We bill for Consulting services on a time-and-materials or fixed-fee basis.
Business Outlook
Based upon Mattersight’s business development efforts and third-party market research, we believe there has been a fundamental shift in the way large enterprises view data. The trends suggest that large enterprises today appreciate that there is value in data that can be derived from their front and back offices, but they have not yet established efficient and effective methods to capture, analyze, and create value from this data. We seek to help large enterprises capitalize on this data with our Behavioral Analytics solutions and, as a leader in this rapidly growing market, we believe we are uniquely positioned to capitalize on this opportunity. We estimate the market potential in the United States for all of our current analytics offerings at over $10 billion per year. The market for enterprise analytics is very new and we currently estimate it to be less than 5% penetrated.
Managed Services Backlog
As a result of the strategic and long-term nature of Managed services revenue, we believe it is appropriate to monitor the level of backlog associated with our Managed services agreements. The Behavioral Analytics Managed services backlog was $104.6 million as of June 30, 2012 and $96.3 million as of December 31, 2011. This increase in backlog is due to the value of the Managed services contracts signed in the first six months of 2012 exceeding the amount of Managed services revenue in the first six months of 2012. We expect Behavioral Analytics Managed service backlog to increase in the second half of fiscal year 2012 based on the impact of anticipated renewals of existing agreements and anticipated contract signings with clients included in our current sales pipeline.
The Company uses the term “backlog” to reflect the estimated future amount of Managed services revenue related to its Managed services contracts. The value of these contracts is based on anticipated usage volumes over the anticipated term of the agreement. The anticipated term of the agreement is based on the contractually agreed fixed term of the contract, plus agreed upon, but optional extension periods. Actual volumes may be greater or less than anticipated. In addition, actual agreement terms may vary from the anticipated terms because these contracts typically are cancellable without cause based on the customer making a substantial early termination payment or forfeiture of prepaid contract amounts. The reported Behavioral Analytics Managed service backlog is expected to be recognized as follows: $17.0 million in 2012; $31.5 million in 2013; $23.6 million in 2014; and $17.3 million in 2015; $15.2 million in 2016 and thereafter.
Critical Accounting Policies and Estimates
Our management’s discussion and analysis of financial condition and results of operations is based upon our condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to the costs and timing of completion of client projects, our ability to collect accounts receivable, the timing and amounts of expected payments associated with cost reduction activities, and the ability to realize our net deferred tax assets, contingencies, and litigation. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions.
We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our condensed consolidated financial statements.
Discontinued Operations
ICS Business Unit Transaction
The sale by the Company of the ICS Business Unit and “eLoyalty” registered trademark / trade name to Magellan Acquisition Sub, LLC, a Colorado limited liability company and wholly-owned subsidiary of TeleTech Holdings, Inc., a Delaware corporation, closed on May 28, 2011, and the Company changed its name from eLoyalty Corporation to Mattersight Corporation effective May 31, 2011. Therefore, the results of operations of the ICS Business Unit are reported as discontinued operations for all periods presented. Additionally, certain corporate and general costs that had historically been allocated to the ICS Business Unit were reallocated to the Company and are reflected in all periods presented.
Revenue Recognition
Continuing Operations
Behavioral Analytics Revenue
Behavioral Analytics revenue consists of Managed services revenue and Consulting services revenue.
Managed services revenue consists of planning, deployment, training, and subscription fees derived from Behavioral Analytics contracts. Planning, deployment, and training fees, which are considered to be installation fees related to Behavioral Analytics subscription contracts, are deferred until the installation is complete and are then recognized over the subscription period of the applicable subscription contract. The subscription periods of these contracts generally range from three to five years after the go-live date or, in cases where the Company contracts with a client for a short-term pilot of Behavioral Analytics prior to committing to a longer subscription period, the subscription or pilot periods generally range from three to twelve months after the go-live date. Installation costs incurred are deferred up to an amount not to exceed the amount of deferred installation revenue and additional amounts that are recoverable based on the contractual arrangement. These costs are included in Prepaid expenses and Other long-term assets. Such costs are amortized over the subscription period of the contract. Costs in excess of the foregoing revenue amount are expensed in the period incurred.
The amount of revenue generated from subscription fees is based on a number of factors, such as the number of agents accessing the Behavioral Analytics System and/or the number of hours of calls analyzed during the relevant month of the subscription period. This revenue is recognized as the service is performed for the client.
Consulting services revenue primarily consists of fees charged to the Company’s clients to provide post-deployment follow-on consulting services, which include custom data analysis, the implementation of enhancements, and training. These follow-on consulting services are generally performed for the Company’s clients on a fixed-fee basis. Revenue is recognized as the services are performed, with performance generally assessed on the ratio of actual hours incurred to date compared to the total estimated hours over the entire term of the contract.
Other Revenue
Other revenue consists of Marketing Managed Services revenue and CRM Services revenue.
Marketing Managed Services revenue is derived from marketing application hosting. This revenue is generally in the form of fixed monthly fees received from the Company’s clients and is recognized as the services are performed for each client. Any related setup fee would be recognized over the contract period of the hosting arrangement.
CRM Services revenue consists of fees generated from the Company’s operational consulting services, which are provided to the Company’s clients on a time-and-materials or fixed-fee basis. The Company recognizes revenue as the services are performed for time-and-materials projects. For fixed-fee projects, revenue is recognized based on the ratio of hours incurred to date compared to the total estimated hours over the entire term of the contract.
Reimbursed expenses revenue includes billable costs related to travel and other out-of-pocket expenses incurred while performing services for our clients. An equivalent amount of reimbursable expenses is included in Cost of revenue.
Payments received for Managed services contracts in excess of the amount of revenue recognized for these contracts are recorded as unearned revenue until revenue recognition criteria are met.
If the Company’s estimates indicate that a contract loss will occur, then a loss provision is recorded in the period in which the loss first becomes probable and can be reasonably estimated.
The Company maintains allowances for doubtful accounts for estimated losses resulting from clients not paying for unpaid or disputed invoices for contractual services provided. Additional allowances may be required if the financial condition of our clients deteriorates.
Discontinued Operations
ICS Business Unit
Managed services revenue included in the ICS Business Unit consisted of fees generated from the Company’s contact center support and monitoring services. Support and monitoring services generally were contracted for a fixed fee, and the revenue was recognized ratably over the term of the contract. Support fees that were contracted on a time-and-materials basis were recognized as the services were performed for the client.
For fixed fee Managed services contracts, where the Company provided support for third-party software and hardware, revenue was recorded at the gross amount of the sale. If the contract did not meet the requirements for gross reporting, then Managed services revenue was recorded at the net amount of the sale.
Consulting services revenue included in the ICS Business Unit consisted of the modeling, planning, configuring, or integrating of an Internet Protocol network solution within the Company’s clients’ contact center environments. These services were provided to clients on a time-and-materials or fixed-fee basis. For the integration of a system, the Company recognized revenue as the services were performed, with performance generally assessed on the ratio of hours incurred to date compared to the total estimated hours over the entire term of the contract. For all other consulting services, the Company recognized revenue as the services were performed for the client.
Revenue from the sale of Product, which was generated primarily from the resale of third-party software and hardware by the Company, was generally recorded at the gross amount of the sale when it was delivered to the client.
In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting standards for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry-specific software revenue recognition guidance. In October 2009, the FASB also amended the accounting standards for multiple deliverable revenue arrangements to:
(i) provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;
(ii) require an entity to allocate revenue in an arrangement using estimated selling prices (“ESP”) of deliverables if a vendor does not have vendor-specific objective evidence of selling price (“VSOE”) or third-party evidence of selling price (“TPE”); and
(iii) eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method.
The Company elected to adopt this accounting guidance at the beginning of its first quarter of fiscal year 2011 on a prospective basis. The adoption of this guidance does not impact our revenue recognition with respect to Behavioral Analytics because the implementation services sold with our Managed services are not separated into multiple accounting units because there is no standalone fair value for these services. We recognize these services revenues over the anticipated subscription period. This accounting guidance does not change the units of accounting for the Company’s revenue transactions or the methods used to allocate consideration to the units of accounting. The revenue recognition for each of these offerings is discussed below.
For the ICS Business Unit, the Company utilized VSOE to allocate revenue to various elements in an arrangement. We determined VSOE based on our normal pricing and discounting practices for the product or service when sold separately. In determining VSOE, we required that a substantial majority of the selling prices for a product or consulting services fall within a reasonably narrow pricing range, generally evidenced by approximately 80% of such historical standalone transactions falling within plus or minus 20% of the median selling price. For the ICS Business Unit’s managed services, we established VSOE through the stated renewal approach. Previously, we were able to establish VSOE for our product and service offerings except for software. If we were not able to establish VSOE for an offering, we attempted to establish fair value by utilizing TPE. TPE is established by obtaining evidence from comparable offerings from a peer company. If the Company was unable to establish fair value using VSOE or TPE, then the Company used ESP in its allocation of revenue. To determine ESP, we applied significant judgment as we weighed a variety of factors, based on the facts and circumstances of the arrangement. These factors included internal costs, gross margin objectives, and existing portfolio pricing and discounting.
Within discontinued operations, some of our sales arrangements had multiple deliverables containing software and related software components. Such sale arrangements were subject to the accounting guidance in ASC 985-605, Software Revenue Recognition .
Stock-Based Compensation
Stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. Determining fair value of stock-based awards at the grant date requires certain assumptions. The Company uses historical information as the primary basis for the selection of expected life, expected volatility, expected dividend yield assumptions, and anticipated forfeiture rates. The risk-free interest rate is selected based on the yields from U.S. Treasury Strips with a remaining term equal to the expected term of the options being valued.
Severance and Related Costs
We recorded accruals for severance and related costs associated with our cost-reduction efforts undertaken during fiscal years 2008 through 2012. The portion of the accruals relating to employee severance represents contractual severance for identified employees and generally is not subject to a significant revision. The portion of the accruals that related to office space reductions, office closures, and associated contractual lease obligations are based in part on assumptions and estimates of the timing and amount of sublease rentals, which may be affected by overall economic and local market conditions. To the extent estimates of the success of our sublease efforts changed, adjustments increasing or decreasing the related accruals have been recognized.
Income Taxes
We have recorded income tax valuation allowances on our net deferred tax assets to account for the unpredictability surrounding the timing of realization of our U.S. and non-U.S. net deferred tax assets due to uncertain economic conditions. The valuation allowances may be reversed at a point in time when management determines realization of these tax assets has become more likely than not, based on a return to predictable levels of profitability.
The Company uses an asset and liability approach for financial accounting and reporting of income taxes. Deferred income taxes are provided when tax laws and financial accounting standards differ with respect to the amount of income for the year, the basis of assets and liabilities and for tax loss carryforwards. The Company does not provide U.S. deferred income taxes on earnings of U.S. or foreign subsidiaries, which are expected to be indefinitely reinvested.
The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. Significant judgment is used to determine the likelihood of the benefit. There is additional guidance on derecognition, classification, interest and penalties on income taxes, accounting in interim periods, and disclosure requirements.
Intraperiod tax allocation requires that the provision for income taxes be allocated between continuing operations and other categories of earnings (such as discontinued operations or other comprehensive income) for each tax jurisdiction. In periods in which there is a year-to-date pre-tax loss from continuing operations and pre-tax income in other categories of earnings, the tax provision is first allocated to the other categories of earnings. A related tax benefit is then recorded in continuing operations. While intraperiod tax allocation in general does not change the overall tax provision, it may result in a gross-up of the individual components, thereby changing the amount of tax provision included in each category. In the first and second quarters of 2012, the intraperiod allocation was not applicable because we had a pretax loss in both continuing operations and discontinued operations.
CONF CALL
Kelly Conway - President and CEO
Thank you, and thank you for joining me on the call today. With me here in Chicago is Chris Min, our CFO and Steve Pollema, our Vice President and Head of ICS and CRM business unit.
Before we start the call, I want to refer you in the webinar and those of you listening to the Safe Harbor language that goes along with this conference call. So let's go into the agenda for the call. I would like to overview and give you a summary of Q4 and then talk about fourth quarter highlights.
As you know, we have organized into two new business units and I would like to give everyone an overview of the business units and then provide guidance for the first quarter, do take questions and wrap up.
So, let me overview the fourth quarter. Fourth quarter revenue performance was disappointing to us. It was within the range of our revised guidance, but it was disappointing relative to where we started out the quarter. Certainly, we are always hit in the fourth quarter by some seasonality, but we did have numerous delays at a number of integrated contact solutions or ICS projects which did affect us.
But despite of that, we are very pleased with the number of other things that happened in Q4 and we believe we have achieved a number of very important milestones that we think will benefit us in Q1 and the quarters to come.
First and foremost, we had a record Behavioral Analytics contract signings. In the quarter, we signed six new assessments and four new deployments, both of those would be record totals.
Our Manage Services revenues reached a record of $10.3 million, up from $9.8 million in the previous quarter. We achieved a record backlog of almost $73 million in the quarter. We restructured eLoyalty into two business units, our Behavioral Analytics and Integrated Contact Solutions, last yearend business unit, providing as much greater focus and clarity on each of these individual business units and service lines. And as a result of that restructuring, we are going to be able to complete actions, which reduced our annual cash expenses by approximately $9 million on a go forward basis from the fourth quarter. So, all of those things we think are extremely significant.
In addition and importantly, the outlook for the first quarter shows an improvement in our [four] services revenue and I want to emphasis both in amount and quality. Our current guidance is $21.1 million in total services revenue, which is up about 5% or 6% sequentially from Q4.
And importantly, again, we expect another record quarter in Managed Services revenues in the first quarter. We currently expect Managed Services revenues in the first quarter will be approximately $10.9 million, again up from $10.3 million in the fourth quarter.
Let me now give you a brief summary of Q4. We did $20.1 million of services revenues. Our total revenues were $21.6 million. We had an adjusted earnings loss of $1.8 million. We had $23 million of cash at the end of the quarter, $11.4 million in accounts receivables on our 48 day DSO. And again importantly, we increased our backlog almost little over $10 million to $72.8 million again a record. And from an employee headcount standpoint, our employee headcount was actually down quarter-over-quarter. It was down 21, primarily as a result of reducing -- making a number of employee reductions, which totaled to about 41.
Now let's talk about some of the other highlights for Q4. So, as we look at the data, the first thing that we notice as we look over the last four years is that the degree at which our strategy of focusing on Integrated Contact Solutions and Behavioral Analytics, the degree at which that is really working, those revenue have been rapidly growing. So, if you look at the chart, they have grown from approximately $15 million in 2004 to almost $50 million in services revenues in 2007. And in 2007, the growth rate of those service lines was 46% year-over-year, so very strong.
In addition, when you look at that as a percentage of our services revenues, you see a similarly strong story. In 2004, the percentage of our services revenues which came from ICS and Behavioral Analytics was approximately 20% and for 2007, it was about 55% and in Q1, as we look forward, we think that will be 60% or greater coming from those two services lines. So again, we are seeing strong growth in those revenue streams coming from our new services lines and an increasing amount of our total revenues coming from them.
These new services lines are very important, because they drive a lot of backlog and they drive much greater visibility in our revenues. And this is also illustrated on the chart on slide 8. When you go back and you look at 2004, our backlog or any backlog was about $10 million and it has grown by almost seven X between 2004 and 2007 to again, approximately $73 million, which was about a 20% year-over-year growth from 2006.
The implication of all of that and Behavioral Analytics is driving not only rapid growth in all of our revenues but rapid growth in high-quality Managed Services revenue. So, we are not only increasing the total from those, we are increasing the quality. And you can see that on the chart on slide 9. Going back to 2004, we had about $15 million of our revenues coming from Managed Services, and in 2007, it was almost $38 million and that was a 40% increase year-over-year and that has been a very consistent increase. You can see over the last three years, strong consistent increases in the growth of our Managed Services revenue.
In addition, what you can see, that, importantly, we are increasing the percentage of our revenues that are coming from Managed Services. That’s growing over the period from 2004 to 2007 from about 22% to about 45% and in fact it reached a record percentage in Q4 of 52%. We will continue to strive and endeavor to grow the percentage of our revenues coming from Managed Services and we would hope in the next 12 to 18 months to drive that percentage up to 60% of our service revenues. The importance of that, of course, is that it drives greater visibility, greater predictability and frankly, greater financial leverage as we grow those renewing revenue streams, recurring revenue streams.
Let me now turn to Behavioral Analytics and how we did in the fourth quarter. We continue to see the momentum gradually increasing in Behavioral Analytics and again, we are very pleased with our record quarter of contract signs we had. Just to remind you about our business model and how we flow engagements through our pipeline, typically we start with low cost assessments with our customers. Our goal is to build those applications and build business cases around those assessments and turn those assessments in the multi-year deployment contracts.
Those deployment contracts typically average about $3 million or $4 million for a three-year contract or in general, about a $1 million a year per subscription. Some have been significantly larger, some have been smaller, but on average, we kind of plan for them to be about $1 million of yearend subscription per customer.
Again as I noted, we had a record Q4 contract signings. We signed six new assessments and four new deployments. And you can see on the charts on the right, we are starting to build traction in building customers in Behavioral Analytics. Our deployment customers, if you look at the chart on the top of the right column on slide 10, has now reached 16 which has roughly doubled year-over-year and our total customer account, when you look at the chart on the right, reached 30, which has also roughly doubled year-over-year.
So, it does show that we are starting to pick up momentum moving forward in Behavioral Analytics and that is also very encouraging.
Let me now talk about expense reductions. In the fourth quarter of 2007, as I mentioned, we restructured eLoyalty into two business units. Again, just to remind you, that's our ICS and CRM Consulting business units and Behavioral Analytics. As a result of that, we were able to significantly [flatten] the organization and streamline our expenses.
The primary cost reduction actions include reducing our work force by 41 employees and significantly reducing non-billable expenses in almost all areas. These actions, we estimate will have $9 million annual impact going forward from Q4 and as you look into Q1, as compared to Q4, about $2.2 million run rate reduction. However, we will note, this amount is partially offset in the first quarter by an approximately $1 million increase in Q1 over Q4 in payroll taxes and vacation accruals.
In general, we see that vacation accruals and payroll taxes are highest in Q1 and trend down over the year from two significantly lower amounts in Q4.
Let me now talk about the business units and really introduce you and orient you to the way we are running the business and the service lines that are driving these businesses. Our ICS and CRM business unit consists of the following services; ICS Consulting and Implementation services, ICS Managed services, ICS Product Resale and our CRM Consulting.
The objectives of this business unit is take advantage of the Voice over IP wave to rapidly grow our consulting and integration services and product re-sales really leveraging our partnership with Cisco.
We believe that taking advantage of that strategy it will enable us to rapidly grow the managed services component of our business there. We also look to optimize our existing consulting accounts and leverage our consulting expertise with a number of our ICS customers to strengthen and deepen our relationships.
And importantly, this business unit does generate significant business unit margins which are important to the overall economics of the company and in particular, help us fund our Behavioral Analytics investments.
As we also noted today in our press release that we noted today we are pleased with the number of the contract signings that we had quarter today. We had a number of very important wins in the first weeks in the quarter. And you see those outlined, four significant contracts totaling $7.6 million. Certainly, that's an important amount for us booking new contract and also highlights the depth and strength and variety that we have around integrated contact solutions both in deployments and managed services. So, we are very pleased with the initial progress in the first part of the quarter with our ICS service line.
Chris, now let's talk about our Behavioral Analytics service line. Our Behavioral Analytics business unit consist of the following activities and revenue streams; Behavioral Analytics deployment and subscriptions, Behavioral Analytics consulting, which is their consulting is really driven by the assessments we do with our clients. We record those of consulting revenues, and marketing managed services. So, those are some services that we do as our managed service to, manage marketing databases, campaigns and some e-mail accounts.
Our business unit objectives for this area is to rapidly grow our Behavioral Analytics customer and revenue base, to continue to develop new Behavioral Analytics functionality and to manage the business unit investment. It still is in the investment mode. We expect it will remain in investment mode throughout the remainder of this year. But we want to manage that amount and make sure that investment is well spent and prudently expensed.
We did have a very strong quarter in Q1 and probably should expect a slight lower activity in Q1 as related to Q4. Again, we had a tremendous Q4 and there could be a slight low on the activity just as we replenish those things in our pipeline.
Let me look at the revenue types and just go over that for you for a second. As you can see, our Q1 projection for Behavioral Analytics is about $5 million. 86% of that is Managed Services. So, it is a lot of recurring revenues and again, the Behavioral Analytics components of that are growing rapidly at this point.
Let's now turn to our first quarter guidance. As you know, we only provide guidance for services revenues and we do expect our first quarter services revenues will improve as compared to the fourth quarter. And we've seen good activities so far in the quarter and are quite confident at this point in our guidance based on the activities we've seen.
Our total guidance is $21.1 million for the quarter. Let me point out a couple of things from that. First of all, about $10.9 million of that, we expect to come from Managed Services, which again is another record total. And of that $21.1 million, about $16.1 million we expect will come from the ICS, CRM business unit, and about $5 million will come from the Behavioral Analytics business.
Again, just the notes there that our guidance is up from last quarter. Our Manage Services revenues are up from last quarter and we are pleased with the activity quarter-to-date that we've seen relative to hitting this guidance.
With that, operator, I would like to now turn the call open to questions and comments.
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Fund Letters
