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Article by DailyStocks_admin    (09-10-08 03:48 AM)

Interactive Intelligence Inc. CEO DONALD E BROWN bought 40000 shares on 9-05-2008 at $9.63

BUSINESS OVERVIEW

Company Overview

Interactive Intelligence, Inc. (“Interactive Intelligence”, “we”, “us” or “our”) was formed in 1994 as an Indiana corporation and maintains its world headquarters and executive offices at 7601 Interactive Way, Indianapolis, IN 46278. Our telephone number is (317) 872-3000. We are located on the web at http://www.inin.com . We file annual, quarterly and current reports, proxy statements and other documents with the United States Securities and Exchange Commission (the “SEC”) under the Securities Exchange Act of 1934, as amended. These periodic and current reports and all amendments to those reports are available free of charge on the About Us – Investor Relations page located on our website.

Unified Business Communication Solutions

We are a leading provider of software applications for contact centers and we are leveraging that leadership position to provide mission-critical Voice over Internet Protocol (“VoIP”) applications to enterprises. Our solutions are installed by customers in a wide range of industries including, but not limited to, financial institutions, higher education, healthcare, retail, technology, government, business services and increasingly for the remote and mobile workforce. We also offer a pre-integrated all-software Internet Protocol Private Branch Exchange (“IP PBX”) system, a phone and communications solution for mid- to large-sized enterprises that rely on the Microsoft Corporation (“Microsoft”) platform. We offer innovative software products and services for multi-channel contact management, business communications, messaging, and VoIP solutions supported on the Session Initiation Protocol (“SIP”) global communications standard. Many of our solutions can be deployed at the customer’s site or can be provided in a Software as a Service model. See “Software as a Service as a Viable Hosted Business Communications Option” below.

Our application-based solutions are integrated on a platform developed to increase security, broaden integration to business systems and end-user devices, enhance mobility for today’s workforce, scale to thousands of users, and more wholly satisfy today’s diverse interaction needs in markets for:

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Contact Centers

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Enterprise IP Telephony

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Enterprise Messaging

By implementing our all-in-one solutions, businesses are able to unify multi-channel communications media, enhance workforce effectiveness and productivity, and more readily adapt to constantly-changing market and customer requirements. Moreover, organizations in every industry are able to reduce the cost and complexity of traditional “multi-point” legacy communications hardware systems that are seldom fully integrated.

Innovation and Value

Interactive Intelligence has long been recognized for its innovative, bundled contact center application solution, which allows contact centers to queue and manage multi-channel interactions including phone calls, faxes, e-mails and web interactions such as chats using a single integrated platform solution. Contact centers can leverage this same software platform for predictive outbound dialing, workforce management, quality monitoring, call and screen recording and agent scoring, interaction tracking, speech recognition, and other enhanced contact management and compliance capabilities.

Our principal competitors are vendors who follow traditional proprietary approaches (“legacy”) and offer a combination of hardware-centric PBX phone systems, automated call distributors (“ACD”), voice mail systems, interactive voice response (“IVR”) systems and associated equipment. Contrasting such multi-point systems, our unified platform is architected on open standards software developed to run on the Microsoft ® Windows ® operating system and servers certified by us, allowing businesses to reduce both the amount and cost of the historically more expensive communications hardware from proprietary vendors.

The added value of our open software approach is in the straightforward migration path it provides to VoIP via the SIP standard for networked voice and data. This open approach also supports broader integration to business systems and devices including end-user phone sets, while reducing overall costs for network management, system administration and functionality upgrades. Our application solutions also pre-integrate to popular business applications for customer relationship management (“CRM”), enterprise resource planning (“ERP”) and other processes, enabling businesses to fully integrate and automate their specific business rules with minimal interruption.

Continued Global Success and Recognition

We market our software solutions around the globe, directly to customers and through a channel of more than 250 value-added partners. Our software applications are available in 21 languages and are installed in more than 70 countries. We began licensing our software in 1997 and have experienced ten consecutive years of continued revenue growth. Partners and customers who license our products are certified through our professional education curriculum and are supported by a global support network of our technology and implementation partners. We employ approximately 600 personnel.

We have been an ISO 9001:2000 Certified company since January 2005 and obtained our re-certification in January 2008, marking our third consecutive year of compliance. Being certified to ISO 9001:2000 gives further assurance to our customers and partners that we are able to satisfy their most stringent quality, reliability, efficiency and cost-effectiveness requirements.

Other recent company recognition includes:

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Leaders quadrant, Gartner, Inc.'s Magic Quadrant for Contact Center Infrastructure, North America, 2007 report;

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Russell 2000 ® Index;

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Top 500 Global Software & Services Companies list, Software Magazine (seven consecutive years);

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2007 Product of the Year, Customer Interaction Solutions ® magazine; and

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2007 Product of the Year, Call Center Magazine .

Industry Overview and Current Developments

VoIP, high-speed Internet access, Internet-based commerce, process automation and the growing acceptance of data networks configured to transmit voice traffic continue to cause a major shift in business communications technologies and corporate decision-making. Organizations in many industries, and in increasing numbers, are moving from one-dimensional, hardware-based PBX phone systems to multi-channel software platforms on which phone calls and faxes as well as e-mails and web interactions, such as chats, are integrated. VoIP, IP telephony and unified communications bring networks and voice and data applications together. By doing so, businesses reduce communications equipment and administration costs, automate business processes to increase organizational efficiency and enhance workforce effectiveness, and provide better service to their customer base. The communications industry continues to experience increased demand for new application-based solutions for unified communications and multi-channel interaction management. We have followed the same open standards all-in-one software approach since 1994 to develop our industry-leading solutions for business communications requirements.

Business Process Automation

To be more efficient operationally and more proficient in meeting a customer's needs, contact centers and enterprises are looking at automation to improve the execution of their business processes, communications and customer service processes. We believe automation will improve a new or existing customer’s position in the global marketplace and strengthen their foundation for growth. Our applications have long taken an intelligence-based approach to automation, beginning with the ability to unify and handle multi-channel interactions in the same manner, and followed thereafter with features such as multimedia queuing, skills-based (agent) routing and speech-enabled interactive voice response and auto attendant processes structured according to an organization’s business rules. We are continuing this approach to automating business and interaction processes with features scheduled to be released during 2008 such as emotion detection, post-call surveys and automation of business processes using the functionality deployed in our solutions.

The Convergence of Voice and Data

In a technology trend that continues to gain acceptance worldwide, the Internet Protocol has prompted many businesses to begin moving voice traffic from circuit-switched networks and bulky hardware equipment to more agile “converged” voice and data networks, applications servers, and lower cost end-user devices based on the popular TCP/IP — a transition often referred to as the “VoIP movement.” One result of this transition is that traditional PBX phone systems hardware is being replaced by software-based solutions. This transition to software-based communications solutions is leading many businesses to look more closely at application-driven platforms that can integrate to, and work effectively with, IP-based systems for converged voice and data. We provide these software-based solutions along with other vendors including Cisco Systems, Inc. (“Cisco”), Nortel Networks Corporation (“Nortel”), Avaya Inc. (“Avaya”), 3Com Corporation (“3Com”) and others.

Unified Communications

According to industry analysts at Gartner, Inc., unified communications are defined as the “direct result of convergence in communication networks and applications.” Microsoft also has recently defined unified communications as a solution that “bridges the gap between telephony and computing to deliver real-time messaging, voice and conferencing to the desktop environment.” Preceding this unified approach, differing forms of communication have historically been developed, marketed and sold as individual applications. The convergence of voice and data communications on IP networks leveraging open standards software platforms is generating a new paradigm for unified communications and its impact on how people, groups and organizations communicate. Unified communications products based on software solutions, services and equipment such as servers, gateways and IP-based phones and end-user devices are proving to reduce costs over their proprietary counterparts, while at the same time enhancing organizational productivity by facilitating the integration and use of multiple enterprise communication methods. Unified communications products reflect most of their cost-effectiveness through the convergence of voice and data on a single network and at the desktop; by integrating multiple communication channels (media such as calls, faxes, e-mail and web chat), networks, systems, and business applications; and by consolidating controls and administration over these collective components. Most unified communications products are currently offered either as a stand-alone product solution or from a portfolio of integrated applications and platforms.

Internet-based Interactions

In addition to more traditional communications media such as the telephone, voice mail, and the fax machine, the Internet has expanded communications media to include e-mail, Internet chat sessions, web callback requests and VoIP calls. As consumers have continued to leverage these web-based contact options, companies have had to utilize the Internet as a key channel for sales, distribution and customer service. With customer service as an objective, many of these companies are deploying web applications for e-mail management, auto response, web collaboration and other online services to satisfy consumer habits and raise service levels. Though many online services are unified in an applications approach, most companies still support online media channels using separate e-mail platforms, web servers, chat servers and other disjointed equipment that can lead to inconsistencies and inefficiencies across customer touch points. If organizations have not already made the move to an applications-driven solution for online needs, many are at least re-evaluating their existing systems to determine the requirements for a more integrated environment.

Moving from Call Centers to Contact Centers

Until a few years ago, a call center consisting of phone banks and agents handling inbound and outbound calls was sufficient for businesses and their customers. While relegated to a single communications channel, these “call-only” centers nevertheless required multi-point systems consisting of a PBX, ACD, automated attendant, an IVR system, and optional systems such as a predictive outbound dialer and a call logger to handle voice-based interactions. Most call centers also were forced to spend time and money to integrate their disparate phone system devices. Increasingly, however, multi-channel communications technologies have paired e-mail and web interaction options alongside phone calls, creating the “contact center” and allowing businesses to differentiate themselves both with more contact options for customers and superior service and support as a consumer interacts. With multi-channel communications platforms now playing a broader role in customer service, as well as sales and other customer functions such as CRM, organizations are beginning to understand the value of formal contact centers. In turn, information technology leaders have begun to adopt a bundled application approach to multi-channel contact management, primarily to replace multiple hardware-centric systems and reduce costs, but also as a way to more easily migrate to network-based IP telephony.

The Need to Integrate Telecommunications and Information Systems

For most businesses, telecommunications systems and information systems remain distinct components in a communications infrastructure. To more effectively interact both internally and externally, businesses must be able to access and utilize these systems in a seamless manner. To integrate various types of telecommunications devices with information technology, many vendors offer computer telephony integration (“CTI”) middleware products and services to bring the two sides together. For example in a contact center, a CTI-based “screen pop” application enables a data window to pop up on an agent’s monitor, presenting information about a call at the same time the agent’s telephone or headset rings. For customer service in particular, screen pops allow the agent to view a customer’s account information, which is usually maintained in a CRM or ERP application.

While effective for customer service, however, we believe that using CTI middleware products to integrate communications and information systems raises a number of fundamental problems. In addition to being expensive and time-consuming to implement up front, the total cost of ownership for any CTI integration over time is high due to multiple points of configuration, administration and maintenance. Modifying and managing a traditionally integrated CTI infrastructure is also difficult in that each device may be independently configured by different vendors. For instance, adding only one new agent in a contact center may require configuring a new extension in the center’s PBX phone system, defining a new mail box in its voice mail system, and creating a new agent entry in an ACD to route calls to the new agent. This process can result in the new user’s information being entered into each device inconsistently, or getting lost all together. With an emphasis on web-based objectives in particular, we believe CTI used in this traditional multi-device approach makes it more difficult for businesses to interact over the Internet.

Broader Integration to Business/Data Systems and End-user Devices

With the business world’s increasing emphasis on business process, automation is key in broadening integration between a communications platform and business applications, information systems, databases, knowledge bases and end-user devices such as phone sets, hand-held devices, cell phones and laptop computers. IP-based applications and open standards, as compared to traditional communications hardware systems and CTI, increase integration capability to a wider range of business systems, industry-standard servers and low-cost IP devices for users across an organization. More so, integration within a dispersed multi-site organization is easier to accomplish, since different locations can easily leverage IP networks to integrate business system servers, SIP connections from the same network to integrate IP phones and devices at the desktop, and wireless connections to equip their mobile workers. Again, organizations that rely on separate PBX, ACD and associated equipment for communications are not afforded the same integration flexibility. Even though many proprietary vendors are now beginning to take an applications approach to their solution, they have yet to reach the same levels of openness that more established applications vendors reached years ago. Consequently, the customers of many proprietary vendors must still utilize expensive CTI methods, third-party integration services, and higher-priced proprietary devices to update their business and communications systems.

Enhanced Security

As IP telephony becomes more prevalent in business communications, the potential of attacks to an IP communications system makes security a critical priority for contact centers as well as for healthcare providers, financial institutions, government agencies, public companies and other organizations that manage confidential voice and data communications over an IP network. However, open standards such as SIP provide a rigorous approach to user authentication and message encryption in a VoIP environment. SIP is also the most regulated tool for security as a result of the actions of the Internet Engineering Task Force (“IETF”), which continually introduces, amends and strictly monitors SIP security specifications worldwide. Lending to stricter security measures as well are the new breed of all-in-one IP communications application suites. These suites pre-integrate applications on a single platform for all voice and data functions, and allow organizations to easily replace “multi-point” hardware systems, reduce the number of access points for potential attacks, and inherently streamline security down to a central underlying platform. Such software-based systems additionally extend security mechanisms to all critical points between an IP network and the desktop, allowing organizations to deploy virtual private networks, virtual local area networks, access lists, authentication, Transport Layer Security and Secure Real-time Transport Protocol mechanisms from the network to their IP communications system’s application server, gateway, data servers and phone devices.

Migration from Voice Mail to Unified Messaging and Enhanced Messaging

Unified messaging efficiently combines voice mail, fax and e-mail messages in an end-user’s “unified” inbox, which is often accessible through the desktop, a web browser, a handheld device, or even the telephone using Text-to-Speech technology. Though available for more than 10 years, many businesses organizations have failed to embrace unified messaging. With voice mail and fax systems reaching end-of-life status in businesses worldwide, and as e-mail continues to serve as a viable communication medium, enterprises are increasingly upgrading to unified messaging solutions that integrate with existing PBXs that are equipped for IP telephony and VoIP, and that natively support e-mail and directory servers certified by us that are already components in most technology and telecommunication infrastructures. As workers become more mobile, organizations are studying the value of enhanced messaging, which supplements unified communications with robust features such as customizable call rules and greetings for users, Follow-Me call routing, real-time presence management, speech- and browser-based voice mail access, workgroup capabilities, and more.

Software as a Service as a Viable Hosted Business Communications Option

Software as a Service (“SaaS”) is becoming a viable and increasingly recognized solution in the business communications and telecom industries. The term SaaS has generally replaced terms including “Application Service Provider”, “on-demand” and other similar notations. As an Internet-based service developed to leverage web browsers and other online technologies, SaaS business communications solutions are delivered by a software provider who may develop, customize, host and operate the applications that constitute a SaaS offering. Service offerings typically include IP PBX-based call processing, call routing, auto attendant, IVR, voice mail, e-mail, conferencing, messaging, automated notifications and other business communications services. For organizations that have substantial computing needs but that maintain little or no capability in software deployment, SaaS allows them to enjoy the same benefits of premise-based software, without on-site implementation and operation. Businesses pay only for using SaaS features and not for owning the software itself and may increase communications reliability since SaaS application servers often reside on a provider’s off-site location where disaster recovery mechanisms are provided as a part of the SaaS offering.

Target Markets

We have developed our solutions to meet the requirements of three distinct target markets in which our all-in-one approach delivers value. These markets also include a strong and growing demand for the inherent standards-based IP telephony, VoIP and unified communications functionality, which our application solutions offer.

Contact Centers

We remain an industry leader in the transition from TDM (time division multiplex) and CTI-based multi-point call center technology to pre-integrated IP-based open standards application solutions for today’s multi-channel contact centers. Our scalable all-in-one contact center solution enables centers to intelligently route, monitor, record, track, and report on phone calls, as well as fax, e-mail and web interactions, whether in a single center or across multi-site contact center operations. Contact centers can also easily license our pre-integrated applications for predictive dialing, workforce management, screen and multimedia recording and agent scoring, and other enhanced functionality.

For self-service automation in the contact center environment, including speech-enabled IVR and e-mail auto response technologies, we offer a full range of solutions that help organizations support their sales and service objectives while standardizing customer service options and reducing operations costs. Among the more popular self-service applications our customers have implemented are FAQ auto response via e-mail and IVR-based processes for order status inquiries.

Enterprise Messaging

We have defined enterprise messaging as being a comprehensive yet adaptable solution for voice mail, unified messaging (voice mail, e-mail and fax in one inbox), and enhanced messaging—which builds upon unified messaging with advanced features such as Find-Me/Follow-Me, customizable call rules, real-time presence management, and other features. With many existing voice mail systems continuing to near end-of-life status, companies evaluating their messaging solutions and requirements, and the increased popularity of e-mail and mobile communications technology, we believe we are well-positioned in the enterprise messaging space.

We offer a single, highly-scalable, multi-channel messaging platform that allows organizations to route live communications to mobile phones, telephony-enabled handheld devices and desk phones, and to help users manage their inbox for e-mail, voice mail and fax messages. Our platform’s inherent IP architecture also paves a straightforward migration path to VoIP for organizations looking to make the move to IP telephony. By providing flexible choose-by-function deployment and licensing options for voice mail, unified messaging, enhanced messaging, or a combination of all three, organizations can configure and centrally administer the precise messaging environment needed, by department or enterprise-wide. Our single IP platform/adaptable applications approach has been successfully deployed by universities and large companies.

Our All-in-One Platform, Single-System Approach, Products, Customer Support and Services

All-in-One Platform, Single-System Approach

We provide a comprehensive solution of contact management and business communications applications developed to run on our pre-integrated Interaction Center Platform ® multi-channel event processing platform and the Microsoft Windows operating system. Our platform-based software solutions do not require multi-point hardware or integrations to third party products or CTI middleware, and are capable of processing thousands of interactions per hour.

As a true all-in-one solution for voice and data, the Interaction Center Platform also does not require separate servers or integration, meaning contact centers and enterprises can seamlessly process telephone calls, e-mails, faxes, voice mail messages, Internet chat sessions, web collaborations and call-back requests, and IP telephony calls. Organizations can apply business rules across media types for consistent customer service and end-to-end tracking and reporting that improves workforce performance and service quality.

Our platform provides a single point of system management to simplify administration and maintenance, eliminates hardware “boxes” to reduce complexity as well as costs, and is flexibly deployed as a PBX/IP PBX or with an organization’s existing PBX/IP PBX.

These differentiating characteristics of our integrated software solutions allow businesses to more effectively communicate both internally and externally, and do so at a much lower total cost of ownership compared to legacy hardware systems and computer telephony integration products. Strategic advantages of our all-in-one, single-system approach to unified communications for business are described in the following sections.

Standards-Based All-Software Architecture and IP Capabilities

Our software applications incorporate native IP capabilities based on the international SIP communications standard developed by the IETF and adopted by a number of industry leaders including Microsoft. Unlike proprietary PBX phone systems and associated legacy hardware advertised as “IP-enabled,” our core platform and application solutions inherently incorporate SIP and open standards throughout, which eliminates the costly SIP extension “lock-ins” required when using proprietary communications hardware systems. To further reduce costs, our software runs on commodity servers with no need for expensive voice boards, allowing organizations to incrementally scale to more users and distributed office locations, and includes a built-in application generator and graphical user interface designer tools to integrate an organization’s specific business rules and required interaction processes. Combined, these open standards capabilities allow businesses to make use of a wide variety of low-cost IP soft phones and telephone devices, gateways, and other components from a number of different vendors.

Broader Range of Functions

Traditional legacy communications systems require contact center and business enterprise operations to purchase separate multi-point products to attain the voice and data functionality they need, such as a PBX for phone calls, a web server for chat, and others. Our pre-integrated application suites instead offer the following communications features in one software solution: PBX/IP PBX, telephony, e-mail processing, ACD, IVR, web interaction event processing, inbound and outbound fax, conferencing, multimedia recording and screen recording, quality monitoring and more. Our solutions also include supervisory features to view communications statistics in real time, supplemented by workforce management, coaching features, interaction tracking and end-to-end reporting to improve performance. Collectively, these capabilities allow our customers to improve customer satisfaction and increase internal efficiency.

No Need to Integrate Disparate Technologies

Traditional communications systems generally require multiple components for voice and data. To work together, these multi-point systems in turn require significant, and often complex, integration efforts that can require expensive hardware, middleware and services. Our software application suites pre-integrate all necessary components for converged voice and data and unified communications, allowing businesses to concentrate their efforts on improving business operations instead of maintaining disparate communications technologies. Additionally to protect system investments, businesses can use our software applications to supplement an existing PBX with web-based interaction management, unified messaging, IVR, departmental contact center services, and other phone system functions.

Greater Ability to Utilize the Internet

With online initiatives playing a significant sales and marketing role in many businesses, our solutions provide customers a number of web-based interaction options. These options include e-mail, FAQ auto response, web chat and callback requests, online forms, and VoIP calls. Such options are increasingly important for effective e-commerce, e-Services and online customer service as consumers continue to use the Internet to conduct business transactions.

Open Architecture and Greater Compatibility with Leading Technologies

To accommodate our standards-based approach to business communications, we developed our Interaction Center Platform on an open architecture that is completely different from traditional telecommunications systems that are based on a proprietary, closed architecture. Traditional systems limit an organization’s ability to readily adapt to change or customize communications processes. With proprietary systems, even simple changes such as adding a new employee or changing an employee’s location can require costly vendor services. Our solutions are built using industry-standard server, networking and software components such as Intel Corporation’s (“Intel”) microprocessors, the Microsoft Windows operating system, Dialogic Corporation’s (“Dialogic”) Host Media Processing (“HMP”) software, and gateways from a select list of certified vendors (including our own Interaction Gateway ™ ). Our open platform architecture allows organizations to easily configure our applications to meet precise communications requirements and to flexibly make hardware or software modifications as necessary. Our products also easily interact with popular technology products that include:



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E-mail servers such as Microsoft Exchange Server, International Business Machines Corporation (“IBM”) Lotus Notes and Novell GroupWise;



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Database systems from Microsoft, Oracle Corporation (“Oracle”) and IBM;



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Mainframe systems , including those that support 3270 and 5250 terminal emulation;



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Web servers from Apache Digital Corporation, IBM WebSphere and Microsoft;



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Network management systems , including Hewlett-Packard Company’s HP OpenView, IBM Tivoli NetView and Computer Associates International, Inc.’s Unicenter TNG;



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CRM and ERP systems such as those from Microsoft, Oracle, SAP Corporation and others; and



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Enterprise directories , including Microsoft Active Directory, Novell NDS e-Directory and Sun/iPlanet Directory Server.

Lower Total Cost of Ownership

We believe that our pre-integrated applications-based solutions result in a lower total cost of ownership compared to traditional multi-point communications systems with similar functionality. Our all-in-one platform and application solutions are developed specifically to reduce configuration and administration while delivering enhanced multi-channel communications features, by deploying applications on a single interaction server and licensing users rather than procuring products and incurring high integration costs from several different vendors. Adding to a lower total cost of ownership is the fact that our intuitive Windows-driven solutions reduce end-user training, along with the time and expense typically required to manage changes in a multi-component business communications system.

Greater Ability to Customize Communications to Meet Specific Needs

Our core Interaction Center Platform includes the built-in Interaction Designer ® application generator and graphical user interface that enables an organization to integrate specific business rules and required interaction processes. In addition to deploying applications quickly with minimal configuration, organizations can use the pre-built tool sets in Interaction Designer to customize nearly any aspect of their communications processing. This customization capability allows organizations to tailor communications processes for their customers, employees and other users using only a single tool to structure dial plans, call distribution rules, IVR menus, web services, voice mail system menus, fax applications and other communications applications.

Business Strategy

We intend to leverage our leadership position in the contact center marketplace to continue expanding our multi-channel IP telephony solutions into the enterprise market. Our strategy for achieving this mission has multiple elements as described below.

Innovation and Enhancing Our Core Product Offerings

Forward-thinking has been the cornerstone of our company. Since incorporating in 1994, we have gained significant experience and expertise in contact center, telecommunications, software, and Internet technologies. We will continue to leverage this knowledge to improve our solutions with enhanced functionality, maintainability, security, mobility, scalability and broader integration capability to differentiate our offerings in the markets we serve. We also will continue to improve and add to our global offerings for VoIP and unified communications by leveraging the international SIP communications standard. Currently, this combination of industry experience and our technological approach allows us to offer a single, open software solution for a variety of IP-based business communications needs in contact centers, enterprises and for the mobile workforce. We continue to invest in research and development of new and existing products for contact centers and enterprises, as well as for VoIP infrastructures. We are continually improving our technology to address the requirements of large-scale organizations with thousands of users for voice mail (including voice mail system replacement), unified messaging, and enhanced messaging. Our company was built on innovation, and we expect to continue breaking new ground with our solutions. New applications or functionality scheduled to be released by us in 2008 include integration with Microsoft's Office Communication Server, our Interaction Mobile Office application for remote enterprise messaging, post-call cusotmer surveys, real-time "emotion detection" and the ability to automate business processes leveraging our communications platform.

Expand in Our Markets

For all markets we serve, our strategy is to appeal to a broader audience of customers and partners by providing “whole solutions” for business communications.

We have leveraged the already strong position of our Customer Interaction Center® (“CIC”) IP application suite to appeal to larger single- and multi-site contact center operations with 50 to 5,000 ACD agents. The single-platform CIC solution utilizes VoIP via the international SIP communications standard, and offers a pre-integrated “all-in-one” application suite for multi-channel interaction management, CRM integration, screen pop, self-service automation, multi-lingual support, and communications features for enterprise business users as well as contact center agents, remote agents and supervisors.

We have positioned our pre-integrated Vonexus Enterprise Interaction Center ™ IP PBX offering (“Vonexus EIC”) for enterprises from 100 to 1,500 users. As a whole product model for businesses using the Microsoft platform, Vonexus EIC is delivered complete with the Vonexus EIC server and application solution, SIP proxy, gateways and IP phones. We are positioning the Vonexus EIC solution to a global audience of mid-sized enterprises, and especially to those that employ growing mobile workforces, that require increased contact center and workgroup capabilities, and that see the need for a more unified communications infrastructure using VoIP.

We have also enhanced our Messaging Interaction Center ™ ("MIC") enterprise messaging solution by positioning it as a combined application server/telephony user interface solution to deliver advanced voice and IP capabilities alongside its robust messaging features. With a number of notable enhancements in the past year, we believe MIC offers a clear path to VoIP messaging through a cost-effective, easy to use system that is easy to install and administer.

Promote Our Services Offerings

Led by our Customer Support and Services teams, we continue to add to the list of implementation and customization services we provide for our new and existing customers and partners. As hosted communications services become more popular among businesses, we plan to expand our SaaS offerings for contact centers and enterprises, which we launched in the first quarter of 2007, along with our business development and marketing efforts for our icNotify hosted notification services, which we introduced in the first quarter of 2006. We believe these combined services offerings will more firmly and effectively position us against our competitors.

CEO BACKGROUND

Donald E. Brown, M.D . co-founded Interactive Intelligence in October 1994 and has served as our Chief Executive Officer since April 1995 and President since inception. This is the third software company founded by Dr. Brown. Dr. Brown also serves as our Chairman of the Board, a position he has held since July 1998. Dr. Brown has been a director since our inception. In March 1988, Dr. Brown co-founded Software Artistry, Inc. (“Software Artistry”), a developer of customer support software that became a public company in March 1995 and was subsequently acquired by IBM in January 1998. At Software Artistry, Dr. Brown served as Chief Executive Officer and director from inception through September 1994. Dr. Brown’s first software company was acquired by Electronic Data Systems, Inc. in September 1987. Dr. Brown graduated from the Indiana University School of Medicine. He also holds two additional degrees from Indiana University, a M.S. in Computer Science and a B.S. in Physics.

Gary R. Blough has served as our Executive Vice President, Worldwide Sales since July 2004. Mr. Blough served as our Vice President of Sales for Europe, the Middle East and Africa from January 2002 to July 2004 and previously served as our Area Director and Vice President of Sales for Western U.S. and Latin America since joining us in February 1997. From January 1992 to February 1997, Mr. Blough held various sales positions at Software Artistry, including Manager of Western Region Sales. From January 1990 to December 1991, Mr. Blough was Director of Sales for On-Line Software, a developer of programmer productivity tools. Mr. Blough has a B.S. degree in Marketing from Virginia Polytechnic Institute and State University.

William J. Gildea III joined us in March 2008 as our Vice President, Business Development. Prior to joining us, Mr. Gildea was a sell-side financial analyst covering the communications technology industry at Janney Montgomery Scott from April 2004 to February 2008 and an associate analyst at Wachovia Securities from April 2000 to March 2004. Mr. Gildea started his career as a communications attorney in private practice in Washington, D.C. from October 1993 to June 1998. Mr. Gildea holds a B.A. from William & Mary, a J.D. from Catholic University, and an M.B.A. from the University of North Carolina .

Stephen R. Head has served as our Chief Financial Officer, Vice President of Finance, Secretary and Treasurer since joining us in November 2003 and our Vice President of Finance and Administration since February 2004. Mr. Head previously served as Chief Financial Officer of Gilian Technologies Ltd. (now Breach Security, Inc.), a Web security applications developer, from 2001 to 2003. Prior to Gilian Technologies, Mr. Head was Senior Vice President, Finance and Administration from 1999 to 2001 at planetU, Inc., an e-commerce company serving the consumer packaged goods industry, which was acquired by Transora in December 2000. Other financial roles Mr. Head has held in the software industry include Vice President, Finance and Administration and Chief Financial Officer at Made2Manage Systems, Inc. (now Consona Corporation), and Vice President, Finance and Chief Financial Officer of Software Artistry. Mr. Head began his career in public accounting at KPMG LLP. He has also served in positions in private industry. Mr. Head is a graduate of Indiana University, where he received both an M.B.A. and B.S. in Business with a concentration in Accounting.

Pamela J. Hynes has served as our Vice President, Customer Services since October 2004. Ms. Hynes served as our Vice President, Customer Loyalty from September 2003 to October 2004 and our Vice President, Client Services, the Americas and Europe, Middle East and Africa from July 2001 until September 2003. Ms. Hynes served as our Vice President, North American Client Services from September 1999 until July 2001 and prior to that as our Director of Client Services since joining us in November 1996. Ms. Hynes was an Account Manager at Software Artistry from July 1996 to October 1996 and the Support Services Manager of Software Artistry from August 1992 to July 1996. Prior to August 1992, she served in a number of technical roles at Software Artistry, including Application Development, Technical Instructor and Field Engineer. Before joining Software Artistry, she served as Technical Support Engineer at American Financial Resources, a software development company. Ms. Hynes holds a B.S. degree in Management Information Systems from New Hampshire College.

Joseph A. Staples has served as our Senior Vice President, Worldwide Marketing since joining us in January 2005. Prior to joining us, Mr. Staples was the principal of FirstLight Marketing, a marketing services company, from October 2002 to December 2004. For the six years prior to that, Mr. Staples was Executive Vice President of Corporate Marketing at Captaris, Inc., a provider of business communication solutions. Previously, Mr. Staples was the Vice President of Marketing for Callware Technologies, Inc., a provider of unified messaging software. He was also at Novell, Inc., in several management positions for five years. Mr. Staples earned a B.S. degree from the University of Phoenix with an emphasis in Marketing.
MANAGEMENT DISCUSSION FROM LATEST 10K

Business Strategy

In the coming year, we intend to leverage our position as an industry-leading software solutions provider to a full-service solution provider for contact center automation, enterprise business communications and VoIP foundation technologies. Our strategy for achieving this mission is:

1.

Innovation and Enhancing Our Core Product Offerings;

2.

Expand in Our Markets;

3.

Promote Our Services Offerings;

4.

Leverage Industry-Specific Solutions; and

5.

Go “Up-Market” Through Increased Scalability and Reliability.

Critical Accounting Policies and Estimates

We believe our accounting policies listed below are important to understanding our historical and future performance, as these policies affect our reported amounts of revenues and expenses and are applied to significant areas involving management’s judgments and estimates. These policies, and our procedures related to these policies, are described below. See also Note 2 of Notes to Consolidated Financial Statements for a further summary of our significant accounting policies and methods used in the preparation of our consolidated financial statements.

The accounting policies described below are significantly affected by critical accounting estimates. Such accounting policies require significant judgments, assumptions and estimates used in the preparation of our consolidated financial statements, and actual results could differ materially from the amounts reported based on these policies.

Sources of Revenues and Revenue Recognition Policy

We generate product revenues from licensing the right to use our software applications and in certain instances providing hardware as a component of our solution, and we generate services revenues primarily from annual support fees, annual renewal fees, professional services and educational services.

Product revenues

Our license agreements are either perpetual or annually renewable. For any revenues to be recognized from a license agreement, the following criteria must be met:

•

Persuasive evidence of an arrangement exists;

•

The fee is fixed or determinable;

•

Collection is probable; and

•

Delivery has occurred.

For a perpetual license agreement, upon meeting the revenue recognition criteria above, we immediately recognize as product revenues the amount of initial license fees if sufficient vendor specific objective evidence of fair value (“VSOE”) exists to support allocating a portion of the total fee to the undelivered elements of the arrangement. If sufficient VSOE of the undelivered elements does not exist, we recognize the initial license fee as product revenues ratably over the initial term of the support agreement once support is the only undelivered element. The support period is generally 12 months but may be up to 18 months for initial orders because support begins when the licenses are downloaded, when support commences, or no more than six months following the contract date. We determine VSOE of support in perpetual agreements based on substantive renewal rates the customer must pay to renew the support. The VSOE of other services is based on amounts charged when the services are sold in stand-alone sales.

For an annually renewable license agreement, upon meeting the revenue recognition criteria above, we recognize a majority of the initial license fees under these agreements as product revenues ratably over the initial license period, which is generally 12 months, and the remainder of the initial license fees are recognized as services revenues over the same time period.

We recognize revenues related to any hardware sales when the hardware is delivered and all other revenue recognition criteria are met.

Services revenues

Services revenues are primarily recognized for renewal fees and support related to annually renewable license agreements and support fees for perpetual license agreements. For annually renewable agreements, the allocation of the initial order between product revenues and services revenues is based on an average renewal rate for our time based contracts. We apply the allocation of product revenues and services revenues consistently to all annually renewable agreements. Under annually renewable license agreements, after the initial license period, our customers may renew their license agreement for an additional period, typically 12 months, by paying a renewal fee. The revenue from annual renewal fees is classified under services revenue and the revenue is recognized ratably over the contract period. Under perpetual license agreements, we recognize annual support fees as services revenues ratably over the post-contract support period, which is typically 12 months.

We also generate revenues from other services that we provide to our partners and customers. These additional revenues include fees for professional services and educational services. Revenues from professional services, which include implementing our products for a customer, and educational services, which consist of training courses for partners and customers, are recognized as the related services are performed.

Stock-Based Compensation Expense

We account for our employee and director stock options in accordance with SFAS No. 123 (revised 2004), Share-Based Payment (“SFAS 123R”) and the guidance of Staff Accounting Bulletin No. 107, Share-Based Payment ("SAB 107"), which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors, based on fair values. On December 21, 2007, the SEC released SAB No. 110, Share-Based Payment (“SAB 110”), which extended the permissibility of the simplified method, in certain circumstances, under SAB 107, for options granted after December 31, 2007.

As permitted by SFAS 123R, we continue to use the Black-Scholes option-pricing model as our method of valuation for share-based payment awards. Our determination of fair value of share-based payment awards on the date of grant using the Black-Scholes option-pricing model is affected by our stock price as well as assumptions regarding a number of highly complex and subjective variables. These variables include, but are not limited to, our expected stock price volatility over the term of the awards and an expected risk-free rate of return. If factors change and we use different assumptions for estimating stock-based compensation expense in future periods, stock-based compensation expense may differ materially in the future from that recorded in the current period.

We adopted SFAS 123R using the modified prospective transition method, which required the application of the accounting standard as of January 1, 2006. Our consolidated financial statements for periods beginning after January 1, 2006 reflect the impact of SFAS 123R. In accordance with the modified prospective transition method, as permitted by the standard, our consolidated financial statements for prior periods have not been restated to reflect, and do not include, the impact of SFAS 123R.

For additional information, refer to Note 6 of Notes to Consolidated Financial Statements. Stock-based compensation expense for employee and director stock options recognized under SFAS 123R for the years ended December 31, 2007 and 2006 was $3.1 million and $2.1 million, respectively.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

SFAS No. 109, Accounting for Income Taxes (“SFAS 109”), establishes financial accounting and reporting standards for the effect of income taxes. We are subject to income taxes in both the United States and numerous foreign jurisdictions. Significant judgment is required in evaluating our tax positions and determining our provision for income taxes. The objectives of accounting for income taxes are to recognize the amount of taxes payable or refundable for the current year and deferred tax liabilities and assets for the future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Variations in the actual outcome of these future tax consequences could materially impact our financial position, results of operations, or cash flows.

In assessing the recoverability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon generation of future taxable income during the periods in which temporary differences such as loss carryforwards and tax credits become deductible. Management considers projected future taxable income and tax planning strategies in making this assessment and ensuring that the deferred tax asset valuation allowance is adjusted as appropriate.

At December 31, 2007, we had $45.5 million of tax net operating loss carryforwards and $1.6 million in tax credit carryforwards. In the fourth quarter of 2007 and third quarter of 2006, we recorded a tax benefit of $8.1 million and $5.0 million, respectively, to reduce the valuation allowance for the deferred tax assets. There was no valuation allowance at December 31, 2007. We will continue to evaluate the recorded deferred tax assets in accordance with the requirements of SFAS 109.

Allowance for Doubtful Accounts Receivable

The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We evaluate bad debt expense based on a percentage of revenue reported each period. We then review the allowance for doubtful accounts each reporting period based on a detailed analysis of our accounts receivable. In the analysis, we primarily consider the age of the customer’s or partner’s receivable and also consider the creditworthiness of the customer or partner, the economic conditions of the customer’s or partner’s industry, and general economic conditions, among other factors. If any of these factors change, we may also change our original estimates, which could impact the level of our future allowance for doubtful accounts.

If payment is not made timely, we will contact the customer or partner to try to obtain payment. If this is not successful, we will institute other collection practices such as generating collection letters, involving our sales personnel and ultimately terminating the customer’s or partner’s access to future upgrades, licenses and technical support. Once all collection efforts are exhausted, the receivable is written off against the allowance for doubtful accounts.

Research and Development

For the years ending December 31, 2007, 2006 and 2005, all research and development expenditures have been expensed as incurred. Based on our product development process and technological feasibility, the date at which capitalization of development costs may begin is established upon completion of a working model. Costs incurred between completion of the working model and the point at which the product is ready for general release have been insignificant.

Legal Proceedings

Liabilities for loss contingencies arising from claims, assessments, litigation, fines, and penalties and other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated. Legal costs incurred in connection with loss contingencies are expensed as incurred.

Financial Highlights

For the year ended December 31, 2007, as compared to 2006, we achieved 32% annual revenue growth, a 61% increase in operating income and over $20 million of operating cash flow. Factors that affect revenues in any particular year include a customer’s or partner’s budget constraints, personnel resources to implement our solutions, historical product order patterns and willingness to implement a critical telecommunications system. Revenues in any particular period can greatly fluctuate from other periods.

The amount of orders we receive, while impacting product revenues, does not have an exact correlation to recognized revenues because the terms in the contracts, a customer’s or partner’s collection history, and any other contractual conditions affect whether we can recognize the order during the period or in subsequent periods. Consequently, product revenues for any particular period are impacted not only by orders received in the current period but also by orders received in previous periods that are being recognized in the current period.

Comparison of Years Ended December 31, 2007, 2006 and 2005

Revenues

Primary Sources of Revenues

We generate revenues from (i) licensing the right to use our software applications and, in certain instances, providing hardware as a component of our solution and (ii) annual support fees, annual renewal fees, professional services and educational services. Product revenues related to CIC represented approximately 47%, 42% and 46% of our total revenues for 2007, 2006 and 2005, respectively. Services revenues are primarily recognized for renewal fees and support related to annually renewable license agreements and support fees for perpetual license agreements. Revenues related to our renewal and support fees represented approximately 36%, 39% and 39% of our total revenues for 2007, 2006 and 2005, respectively.

Product revenues, which include software and hardware, increased in 2007, 2006 and 2005 compared to the previous years. The increase in 2007, compared to 2006, was principally due to a 27% increase in orders for our software across all regions. We also received an increase in hardware orders of 116% to over $6.6 million, which was primarily due to a higher demand for our media server and gateway appliances which have added to the scalability and functionality of our solutions. In 2007, we received five orders over $1.0 million and 48 orders between $250,000 and $1.0 million compared to four orders over $1.0 million and 30 orders between $250,000 and $1.0 million in 2006.

The increase in 2006, compared to 2005, was the result of product revenues related to Vonexus EIC of $5.2 million, a 14% increase in orders from existing customers purchasing additional licenses and products from 2005 to 2006, and a 50% increase in product revenues generated from our European customers and partners.

Product revenues can fluctuate from quarter to quarter depending on several factors including the mix of orders between perpetual licenses and annually renewable licenses. If other revenue recognition criteria are satisfied, we recognize license revenue upfront for perpetual licenses, and we recognize revenue for annually renewable licenses ratably over the term. The impact of the mix of contracts on our product revenues occurs only in the initial year of an order; subsequent renewal fees received for the annually renewable licenses and the renewal support fees for perpetual contracts are all allocated entirely to services revenues.

The amount of orders we receive, while impacting products revenues, does not have an exact correlation to revenues because the terms in the contracts, collection history with the customer or partner, and any other contractual conditions affect whether we can recognize the order during the quarter or in subsequent quarters. Consequently, product revenues for any particular quarter are impacted not only by orders received in the current quarter but also by orders received in previous quarters that are being recognized in the current quarter.


Services revenues include the portion of the initial license arrangement allocated from annually renewable and perpetual contracts, license renewals of annually renewable contracts, and support fees for perpetual contracts, as well as professional services (16% of total services revenues in 2007), education (5% of total services revenues in 2007) and other miscellaneous revenues.

The increase in services revenues in 2007, 2006 and 2005 was due to increases in our growing installed base of customers and related payments of annual license renewal fees and support fees for perpetual licenses. License renewal and support revenues increased $7.3 million in 2007, compared to 2006, and $8.2 million in 2006 compared to 2005. As we sign contracts and install our solutions with new customers and partners, we expect that our services revenues will continue to increase as customers and partners renew licenses and pay for support on our software applications. The actual percentage fee charged for renewal of annually renewable licenses and perpetual support agreements as compared to the initial annually renewable license fee and perpetual license, respectively, is comparable on a relative percentage basis, and therefore, the mix of these types of contracts in the future is not expected to impact our future services revenues.

In April 2007, we acquired the professional services division of Alliance, which added 13 engineers to our professional services group and increased our resources to serve our customers and partners which resulted in our professional services revenues increasing $4.3 million, or 117%, during 2007 compared to 2006. Professional services revenues increased 68% in 2006, compared to 2005, primarily due to more customers and partners attending our educational classes and more customers and partners using our professional services. These services revenues have and will fluctuate based on the number of customers and partners that attend our educational classes and the amount of assistance our customers and partners need for implementation and installation. We anticipate these services revenues will continue to increase in the future if the number of our customers continues to grow.

Costs of product consist of hardware costs, principally for media server and gateway appliances which we have developed, telephone handsets, royalties for third party software and other technologies included in our solutions and, to a lesser extent, software packaging costs, which include product media, duplication and documentation. Costs of product can fluctuate depending on which software applications are licensed to our customers and partners, third party software, if any, which is licensed by the end user from us as part of our software applications and the dollar amount of orders for hardware.

Cost of product for 2007 increased $4.8 million compared to 2006. Hardware costs incurred in 2007 represented $2.5 million of the increase as we continue to sell servers, gateways and telephone handsets with our CIC and Vonexus EIC solutions. Royalties paid to third parties increased $1.8 million during 2007 compared to 2006 as we continue our use of technologies licensed from third parties. We also increased staffing in our distribution center which resulted in a $388,000 increase in total compensation costs. Costs of product for 2006, compared to 2005, included an increase of $3.5 million for hardware costs related to our products and an increase of $117,000 in our shipping and software packaging costs. In addition, royalties increased $854,000 as we increased our use of technologies licensed from third parties and integrated them into our software applications. We also increased staffing in our distribution center which resulted in a $99,000 increase in total compensation costs.

Costs of services consist primarily of compensation expenses for technical support, educational and professional services personnel and other costs associated with supporting our customers and partners. These expenses increased in 2007, as compared to 2006, primarily due to a $5.0 million increase in compensation expense for our costs of services personnel, which resulted from to a 28% increase in staffing during this period principally as a result of our April 2007 acquisition of the professional services division of Alliance. We incurred $360,000 of additional travel-related expenses during 2007 principally due to an increase in the demand for our professional services personnel to install our applications at the customers’ sites. The increase in cost of services from 2005 to 2006 was mainly due to a $2.3 million increase in compensation expense, $751,000 related to contracting outsourced professionals and $545,000 for travel-related expenses.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

Comparison of Three Months Ended March 31, 2008 and 2007

Revenues

Product revenues, which include software and hardware revenues, increased $2.5 million during the first quarter of 2008 compared to the same period in 2007. During the three months ended March 31, 2008, orders received increased 39% and we received 15 orders between $250,000 and $1.0 million, compared to seven such orders received during the same quarter in 2007. Our existing installed customer base accounted for 75% of our orders received during the first quarter of 2008 while a majority of the orders entered into between $250,000 and $1.0 million were generated through new customers. We also received an increase in hardware orders of $882,000, or 96%, during the first quarter of 2008, compared to the same quarter in 2007, which was primarily due to a higher demand for our media server and interaction gateway appliances, which have added to the scalability and functionality of our solutions.

Product revenues can fluctuate from quarter to quarter depending on the mix of orders between perpetual licenses and annually renewable licenses. If other revenue recognition criteria are satisfied, we recognize license revenue upfront for perpetual licenses, and we recognize revenue for annually renewable licenses ratably over the term. The impact of the mix of contracts on our product revenues occurs only in the initial year of an order; subsequent renewal fees received for the annually renewable licenses and the renewal support fees for perpetual contracts are all allocated entirely to services revenues.


Services revenues include the portion of the initial license arrangement allocated to maintenance and support revenues from annually renewable and perpetual contracts, license renewals of annually renewable contracts, and support fees for perpetual contracts, as well as professional services, educational and other miscellaneous revenues.

The increase during the first quarter of 2008 compared to the same period in 2007 was primarily due to our growing installed base of customers, both in number and size, and the related payments of annual license renewal fees and support fees for perpetual licenses. License renewal and support revenues increased by $2.3 million, or 26%, during the three months ended March 31, 2008, compared to the same period in 2007. As we sign contracts and install our solutions with new customers and partners, we expect that our services revenues will continue to increase as customers and partners renew licenses and pay for support on our software applications. The actual percentage fee charged for renewal of annually renewable licenses and perpetual support agreements as compared to the initial annually renewable license fee and perpetual license, respectively, is comparable on a relative percentage basis, and therefore, the mix of these types of contracts in the future is not expected to impact our future services revenues.

During the first quarter of 2008, our professional services revenues increased $127,000, or 7%, and our educational and other services increased $255,000, or 22%, primarily due to the increased delivery of professional services, compared to the same period in 2007. These professional services revenues have and will fluctuate based on the number of customers and partners that attend our educational classes and the amount of assistance our customers and partners need for implementation and installation.


Costs of product consist of hardware costs, principally for media server and interaction gateway appliances which we have developed, servers, telephone handsets and gateways, royalties for third party software and other technologies included in our solutions and, to a lesser extent, software packaging costs, which include product media, duplication and documentation. Costs of product can fluctuate depending on which software applications are licensed to our customers, the third party software, if any, which is licensed by the end user from us as part of our software applications and the dollar amount of orders for hardware.

The majority of the increase in costs of product resulted from a $527,000 increase in hardware costs from $1.2 million to $1.7 million. The additional increase was due to slightly higher shipping costs and royalties paid to third parties.

Costs of services consist primarily of compensation expenses for technical support, educational and professional services personnel and other costs associated with supporting our partners and customers. These expenses increased primarily due to a $962,000 increase in compensation expense, as a result of a 25% staffing increase in our services personnel at March 31, 2008 compared to March 31, 2007. In the second quarter of 2007, we acquired the professional services division of Alliance Systems Ltd. (“Alliance”), which added 13 engineers to our professional services group and contributed significantly to our increased compensation expenses in the first quarter of 2008 compared to the same period in 2007. As a result of the increased professional services staff during the first quarter of 2008, travel related expenses also increased $125,000, compared to the same period in 2007. In addition, because of our Alliance acquisition, our expenses related to outsourced services decreased by $393,000 during the first quarter of 2008, compared to the same period in 2007.

We anticipate costs of services will continue to increase based on additional personnel costs and delivery of professional services to our existing installed customer base and potential new customers.


Gross profit as a percentage of total revenues decreased slightly during the first quarter of 2008, compared to the same period in 2007, primarily due to additional costs of product as discussed previously. The gross margin on our hardware sales is less than the gross margin on our software licenses; therefore, as we continue to sell more hardware such as media servers, interaction gateways and telephone handsets, our total gross margin percentage may decrease compared to historical margins. Gross margins in any particular quarter are dependent upon revenues recognized versus costs of product and costs of services incurred and are expected to vary.

Operating Expenses

Sales and marketing expenses are comprised primarily of compensation expenses, travel and entertainment expenses and promotional costs related to our sales, marketing, and channel management operations. Compensation expense increased $471,000 during the three months ended March 31, 2008, which was due in part to an 8% staffing increase in our sales and marketing personnel at March 31, 2008, compared to March 31, 2007. We increased our corporate marketing efforts during the first quarter of 2008 compared to the same period in 2007, which included increased advertising and brand promotions, seminars, web seminars and tradeshows resulting in an increased cost of $436,000. Outsourced services increased $213,000 during the first quarter of 2008, compared to the same period in 2007, primarily due to lead generation activities and redevelopment of our corporate website. We also incurred an increase of $118,000 during the first three months in 2008, compared to the same period in 2007, primarily due to more referral fees paid to our customers and partners. General corporate expenses such as rent, communication and depreciation expenses increased a combined $198,000 during the first quarter of 2008, compared to the same period in 2007 and were mainly due to leasehold improvements and related purchases in several new sales and marketing offices.

We expect sales and marketing costs to continue to increase primarily due to additional personnel costs and expansion of our marketing and channels efforts to increase our brand awareness and distribution.

CONF CALL

Steve Head

…As a result of a variety of potential risks and uncertainties. For more information, you should look to our 2007 Form 10-K which we 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 non-cash stock option expense, and non-cash income tax expense and benefits. 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 start with the big picture and then Steve will drill down into the details. Following Steve's comments, I'll take a few minutes to update you on the progress of our 2008 plans.

For second quarter of 2008, we recognized revenues of $30.6 million, which is up 13% compared to the revenues that we posted in the second quarter of last year. Revenues were strong for new customers with 95 new customers signed during the second quarter. We had two new customers submitting orders totaling over $1million, and one over $900,000. And as we have reported in our earlier announcement, our lower overall top line revenue growth is associated with a lower dollar amount of orders received from existing customers. The volume for number of orders was fine. But the dollar amount was less than expected. As we've done further analysis, and spoken to customers and partners, we think there are a couple of conclusions we can draw.

One, we aren't seeing evidence that the upgraded orders from our installed base are going away, or being replaced by competitors. But two, customers are being a bit more cautious as they work on analyzing trends in their own businesses. So why the greater slowdown in add-on business, and not the same pullback in new orders? Often, these add-on orders are for additional applications, that are not as critical to the core operation, things like speech recognition, work force management, or screen recording. They also are sometimes tied to additional user licenses which aren't required if our customer has slowed the pace of their own hiring.

To contrast this situation to new customer orders, those most often include core functionalities such as the ACD or IP PBX. They often replace an old legacy system that's being phased out. And those purchases were more likely to have been planned over a longer period of time. In the second quarter we had 11 customers that submitted orders totaling $250,000 or more, including the two mentioned above that exceeded $1 million. And seven of these 11 were new customers.

We achieved record services revenues in the quarter of $15.3 million, an increase of 22% from the second quarter of last year. We are reporting non-GAAP income, and EPS in earnings release. On a non-GAAP basis, earnings for the second quarter were $2.4 million, or $0.13 per diluted share. This compares to $3.2 million or $0.17 per diluted share, the same quarter last year.

Given those highlights, I'll now turn the call over to Steve for some more detail, and then come back with some additional comments.

Steve Head

Thanks, Don. As usual I will comment on our operating performance, then the balance sheet and then the cash flows.

Starting with our operating performance, we had two major items that impact the information that we'll discuss. First, on a GAAP basis, we recorded income tax expense of $700,000 in the second quarter, which compares to $103,000 in the same quarter last year. As we've discussed in prior calls, we recorded a large tax credit in the fourth quarter of 2007, to recognize deferred tax assets related to tax operating loss and credit carry-forwards. As a result of recognizing that asset we are now recording tax expense. Most of which does not require cash payments. On a non-GAAP basis our tax expense was $44,000. We recorded non-cash stock option expense of $944,000 for the second quarter of 2008, compared to $806,000 in the second quarter of 2007.

Our partners continue to generate the majority of our orders, with 66% of orders coming from the channel during the second quarter. As Don stated, we signed 95 new customers in the quarter for our products, our contacts center enterprise messaging, and IP PBX solutions. The overall average new customer order in the quarter was $92,000, with the average new customer order of $111,000 for contact center and large enterprise IP PBX licenses.

Geographically, the orders were generally consistent with prior quarters, with 69% from North America, and the remainder from the rest of the world, principally EMEA. We continue to have orders for specialized hardware from our CIC customers, this is in part a result of the Interaction Media Server, and the Interaction Gateway, two appliances, which we developed and delivered to enhance scalability and functionality. The orders of these appliances increased significantly, compared to the second quarter last year.

The timing of revenue recognition for orders is dependent on a number of considerations and only a portion of the orders were recognized in the quarter. For the second quarter of 2008, services revenue increased as the number of users, and the related support fees increased. Services revenue includes professional services, and education services. Support revenues were 78% of services revenues for the quarter. Product margin was 74% in the second quarter up 2008, down from 76% in the second quarter a year ago. As we discussed in prior calls, the product margin varies from quarter-to-quarter, based on the number of media server and gateway appliances licensed, and the cost related to third party software, and IP PBX handset sales.

Cost of services increased principally, due to an increase in staffing and related travel. Our services margin in the second quarter of 2008 was 60%, which is up from 59% in the second quarter of 2007. Gross profit was a record $20.6 million in the second quarter of 2008, and the margin was 67% of total revenues, compared to 68% in the second quarter of last year. Total operating expenses on a GAAP basis for the second quarter of 2008 were $19.4 million, a sequential increase of about $400,000 over the first quarter of this year.

These operating expenses were 63% of total revenues in the second quarter, compared to 60% in the second quarter of 2007. Non-GAAP operating income, which excludes the stock option expense, was $2.2 million or 7.2% of revenues, compared to $3 million or 10.9% of revenues in the second quarter of 2007. This change reflects operating expense increases relatively greater than the revenue increase. We are taking actions to minimize expense increases in the near-term, until we see revenue acceleration.

Other income, principally interest income was $292,000 in the second quarter of 2008. This is a decrease primarily as a result of lower interest rates earned on cash and investments. And as I've mentioned non-GAAP foreign and miscellaneous other taxes totaled $44,000 in the second quarter.

We continue to have over $20 million of tax operating loss carry-forwards which will offset about $8 million of taxes, otherwise payable plus tax credit carry forwards to offset another $1.5 million of taxes. The tax effect of these amounts is included in the June 30 deferred tax assets of $11.9 million. Also because of stock option exercises, there are additional compensation deductions for tax purposes, of $23 million, which will result in a reduction of taxes otherwise payable, of approximately $9 million. The value of these compensation deductions are not recorded as an asset, and will only be recognized when they are realized.

Since we recognize the deferred tax assets in the fourth quarter of 2007 we recorded income tax expense for GAAP purposes beginning in the first quarter of this year. We continue to record taxes based on an effective rate of 45%. We had expected the rate to be lower due to research and experimentation tax credits. However, that credit has expired, and has not yet been reinstated. Also, our non-cash option expense related incentive stock option is added back to the taxable amount for the tax calculation, which results in an increase in the effective rate. As I again already mentioned, most of the expense is non-cash, and reduce the deferred tax asset on the balance sheet.

At the end of June, our staffing worldwide totaled 638 people. Our outstanding shares for basic earnings for share calculations increased because of stock option exercises. However, our outstanding shares for diluted per share calculations decreased in the quarter, as a result of the decline in the stock price, and resulting impact on the calculated shares outstanding.

Turning to the balance sheet. At June 30, we have $49.7 million of cash and short-term investments. This compares to $49.4 million at March 31. This increase in cash is primarily the result of cash flows from operations, offset in part by additions of equipment, and we continue to be debt free.

Accounts receivable day sales outstanding at June 30, were 76 days. This is a decrease from March 31, DSO of 84 days.

Totaled deferred revenues at June 30 were $39.1 million, a decrease of $3.1 million since March 31. And there's two pieces that we report on the balance sheet. The first is deferred product revenues, which decreased $1.4 million compared to March 31. This is a function of the fact that we recorded a lower dollar amount of term license orders from existing customers in the quarter compared to the past. The second item is deferred services revenue, which had a sequential decrease of $1.7 million.

As we analyze the deferred services revenue, the reduction was principally because of two factors. First, professional services have shifted more to time and material contracts from fixed bid contracts, together with fewer new professional services engagements in the second quarter. And second, we signed several multi-year support agreements in 2007, that are not yet due for renewal. The balance in deferred services has decreased $463,000 from December 31, but is still up $6.2 million from June 30 last year. Based on our analysis of renewal billings and revenue to be recognized, we currently expect an increase in the balances of deferred services by September 30, of this year.

We have included a statement of cash flows in the release. I'll make a few comments on those numbers. In 2008 second quarter cash flow from operations was $1.4 million compared to $2.1 million in 2007. Other major uses and sources of cash included the purchase of property and equipment, totaling $1.5 million in the second quarter of this year. During this year, we are expanding into two floors of a new building, that is next to our existing corporate office. Which is resulting in various property additions over amounts incurred in the prior year.

Don, that wraps up my comments on the financials.

Don Brown

Thanks, Steve. Before shifting into the Q&A let me address some additional business items relative to the quarter. In May, we hosted our annual user forum. We had over 300 customers in attendance, along with 25 strategic partners, such as Polycom and [Nuance], as well as a large number of our own employees. The conference was held here in Indianapolis, and we presented 63 breakout sessions, during the three-day event, covering everything from core CIC functionality to messaging Interaction Dialer, Optimizer and EIC. Pretty much every part of our product line. The conference received an overall satisfaction rating of 98% by the attendees. And although we hold regional user forums in other parts of the world, we also had several large multinational customers attend this event.

Selling through a channel can sometimes make it challenging to maintain a close relationship with our customers. Our user forum is a way to help accomplish this, and be sure our customers know about all the ways they can best utilize our products and services. We appreciate the time our customers made to be with us. And congratulate those within our company for putting on such a fine event.

On the product front we made several significant product announcements during the quarter. We released version 3.0 of Interaction Dialer, this is a really powerful release, offering skills based dialing, which can significantly enhance the success of dialing campaigns by ensuring that agents are matched appropriately with the calls that are being initiated. Additionally version 3.0 increases the scalability of the product, and also made available the ability to integrate our dialer with the collection management application from Ontario Systems. The dialer market is still a very strong segment for us, and we think these enhancements and additions will make our product even more competitive.

We also announced early in the quarter, as part of our spring media tour, our integration with Microsoft Office Communications Server or OCS. As most of you know, Microsoft has made significant marketing noise around OCS, and its role as the basis for their unified communications strategy. Our integration, adds significant value to OCS, including the addition of Call Center and IP PBX capabilities, synchronized presence, and a company wide directory for all CIC, EIC, and OCS users. We continue to get good cooperation from Microsoft, including marketing assistance, and sales leads.

The final product announcement we made in Q2 focused on an area we label as customer feedback management. With this announcement we launched a product called Interaction Feedback, which is a software application that automates the gathering of customer satisfaction survey data. Capturing this voice of the customer, is a missing part of many contact center metrics, and one we've seen significant interest for from our customers and prospects.

As a part of the customer feedback management announcement, we also disclosed our development plans in the area of realtime speech analytics. Though this won't be deliverable until next year, we're making good progress with this development, and think it will be a major differentiator for us.

During the quarter we launched a new corporate website, and I'd invite you to take a look at it, at inin.com. We think the redesign improves navigation, does a better job of showcasing the three market segments that we address, and overall helps to reinforce our brand messaging. By the way, I am happy to let you know that we have improved our brand recognition to 72% among our target contact center audience, up from 58% a year ago.

The second quarter also seemed to be awards season. We were recognized by CIO Zone as one of the 60 fastest growing software companies. Business Week named us among its top 50 hot growth companies. And Fortune Small Business ranked us as one of America's fastest growing small public companies. Each of these awards takes into account several different metrics over the past two to three years. And we were recognized by the Indiana Chamber of Commerce as one of the best places to work in the fine State of Indiana, an award that we're all very proud of.

Turning to our operating plan. The pillars of our plan for this year, which we presented back in January, are the following. We'll continue to go up market. We think our success in these larger organizations has shown that we are a very good option for contact centers and enterprises, of just about any size. And that these large deals expand on our strong reputation in the mid-size and larger market. We have many large deals already in the sales process.

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, the support infrastructure, experienced channel partners, and a strong mix of on-premise and hosted products to make this a selling advantage for us. And we'll continue to expand geographically with special emphasis on specific countries, including Japan, Germany, and the UK, where we feel we have a great opportunity to grow our revenues.

I'll wrap up my comments with a few additional items. As we've reported, this last quarter had some challenges for us. In some areas we did really well. Yet in others we saw weakness. We've analyzed the business as a management team, spoken to customers, met with partners, and we're still optimistic. We're not losing business to competitors, but instead seeing delays in purchases, even sometimes when we have verbal approvals, because of a more cautious buying environment.

Our products are still being well received. The migration to voice-over-IP by businesses is still in full swing, with several years of growth ahead. Industry analysts indicate there is a significant IP adoption remaining, and strong growth rate for IP telephony. We continue to win more large deals, in line with our strategy of moving up market. We are being positively recognized by analyst firms such as Gartner, Yankee, and Frost & Sullivan. And our brand is more recognized than it ever has been, in the history of our company. We see a lot of positives to our business.

Given this backdrop, I'll address the share repurchase plan that we announced in the earnings release, and our outlook for the rest of the year. As we stated in the release, our board has reviewed our outlook for the future, and our current cash position, and the current stock price. And has authorized the repurchase of up to $10 million of our common stock. We believe this is a prudent investment, and good use of our cash. We're generating positive cash flow. However, the interest we're earning in the bank has declined, as rates have gone down this year. We believe that the repurchase of our shares is a good alternative use of the cash. If over time, we're able to generate higher levels of earnings, then the repurchase of our shares will provide a good return to our shareholders.

Regarding our outlook, we continue to manage our business for the long-term. We think that's the smart thing to do, and the thing that will deliver satisfaction to our customers, a good return for our shareholders, and a great place to work for our employees. However, our experience in the quarter indicates that companies may defer decisions, when they're business outlook for the year is not as clear. As a result, we are revising our guidance for the year, to reflect our expectation of annual revenue growth in the range of 10% to 15%. And if we're able to hit those revenue levels, non-GAAP operating income in the range of 7.5% to 8.5%. We fully expect to increase operating income in future years, but see this is a year that given the revised revenue expectation and investment decisions already made, may not achieve the level of earnings we'd anticipated at the beginning of the year.


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