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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED
May 31, 2004 OR [  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 Commission file number: 1-15045 INTERVOICE, INC. (Exact name of registrant as specified in its charter)
 TEXAS
(State or other jurisdiction of
incorporation or organization)
    
    75-1927578
(I.R.S. Employer
Identification No.)
 17811 WATERVIEW PARKWAY, DALLAS, TX 75252
(Address of principal executive offices) 972-454-8000
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes
[ü] No [  ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ü] No [  ] The Registrant had 35,979,326 shares of common stock, no par value per share,
outstanding as of June 18, 2004.




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TABLE OF CONTENTS  PART I. FINANCIAL INFORMATIONItem 1 Financial StatementsCONSOLIDATED BALANCE SHEETSCONSOLIDATED STATEMENTS OF OPERATIONSCONSOLIDATED STATEMENTS OF CASH FLOWSCONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITYNOTES TO CONSOLIDATED FINANCIAL STATEMENTSItem 2 Managements Discussion and Analysis of Financial Condition and Results of OperationsItem 3 Quantitative and Qualitative Disclosures About Market RiskItem 4 Controls and ProceduresPART II. OTHER INFORMATIONItem 1 Legal ProceedingsItem 6 Exhibits and Reports on Form 8-KSIGNATURESCertification of Chief Executive OfficerCertification of Chief Financial OfficerCertification of Chief Executive OfficerCertification of Chief Financial Officer    Table of Contents  
 PART I. FINANCIAL INFORMATION 
 Item 1 Financial Statements 
 INTERVOICE, INC.
CONSOLIDATED BALANCE SHEETS (In Thousands, Except Share and Per Share Data)May 31, 2004
    
    February 29, 2004(Unaudited)ASSETSCurrent AssetsCash and cash equivalents
    
    $
    45,488
    
    
    $
    40,859Trade accounts receivable, net of allowance for
doubtful accounts of $963 in fiscal 2005 and
$947 in fiscal 2004
    
    
    28,031
    
    
    
    25,898Inventory
    
    
    8,294
    
    
    
    8,415Prepaid expenses and other current assets
    
    
    5,239
    
    
    
    5,08787,052
    
    
    
    80,259Property and EquipmentLand and buildings
    
    
    16,859
    
    
    
    16,857Computer equipment and software
    
    
    39,808
    
    
    
    39,073Furniture, fixtures and other
    
    
    3,160
    
    
    
    3,190Service equipment
    
    
    9,261
    
    
    
    9,42169,088
    
    
    
    68,541Less allowance for depreciation
    
    
    49,412
    
    
    
    48,32519,676
    
    
    
    20,216Other AssetsIntangible assets, net of accumulated amortization of $35,202
in fiscal 2005 and $34,443 in fiscal 2004
    
    
    5,604
    
    
    
    6,363Goodwill
    
    
    3,401
    
    
    
    3,401Other assets
    
    
    3,484
    
    
    
    3,491$
    119,217
    
    
    $
    113,730LIABILITIES AND STOCKHOLDERS EQUITYCurrent LiabilitiesAccounts payable
    
    $
    10,902
    
    
    $
    10,746Accrued expenses
    
    
    11,865
    
    
    
    11,919Customer deposits
    
    
    5,386
    
    
    
    6,625Deferred income
    
    
    28,310
    
    
    
    24,436Current portion of long-term borrowings
    
    
    400
    
    
    
    Income taxes payable
    
    
    6,367
    
    
    
    7,37963,230
    
    
    
    61,105Long-Term Borrowings
    
    
    12,201
    
    
    
    13,101Other Long-Term Liabilities
    
    
    77
    
    
    
    271Stockholders EquityPreferred stock, $100 par value2,000,000
shares authorized: none issuedCommon stock, no par value, at nominal
assigned value62,000,000 shares
authorized: 35,951,374 issued and
outstanding in fiscal 2005 and 35,691,389 issued
and outstanding in fiscal 2004
    
    
    18
    
    
    
    18Additional capital
    
    
    76,859
    
    
    
    75,276Accumulated deficit
    
    
    (32,264
    )
    
    
    (35,441
    )Accumulated other comprehensive loss
    
    
    (904
    )
    
    
    (600
    )Stockholders equity
    
    
    43,709
    
    
    
    39,253$
    119,217
    
    
    $
    113,730
 See notes to consolidated financial statements. 2




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INTERVOICE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) (In Thousands, Except Per Share Data)Three Months EndedMay 31, 2004
    
    May 31, 2003SalesSolutions
    
    $
    21,145
    
    
    $
    18,031Recurring services
    
    
    20,771
    
    
    
    20,37141,916
    
    
    
    38,402Cost of goods soldSolutions
    
    
    11,980
    
    
    
    11,213Recurring services
    
    
    7,081
    
    
    
    6,73119,061
    
    
    
    17,944Gross marginSolutions
    
    
    9,165
    
    
    
    6,818Recurring services
    
    
    13,690
    
    
    
    13,64022,855
    
    
    
    20,458Research and development expenses
    
    
    3,743
    
    
    
    3,870Selling, general and administrative expenses
    
    
    14,152
    
    
    
    13,471Amortization of acquisition related intangible assets
    
    
    705
    
    
    
    705Income from operations
    
    
    4,255
    
    
    
    2,412Other income (expense)
    
    
    367
    
    
    
    (187
    )Interest expense
    
    
    (274
    )
    
    
    (545
    )Income before taxes
    
    
    4,348
    
    
    
    1,680Income taxes
    
    
    1,171
    
    
    
    744Net income
    
    $
    3,177
    
    
    $
    936Net income
per share - basic
    
    $
    0.09
    
    
    $
    0.03Net income
per share - diluted
    
    $
    0.08
    
    
    $
    0.03
 See notes to consolidated financial statements. 3




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INTERVOICE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (In Thousands)Three Months EndedMay 31, 2004
    
    May 31, 2003Operating activitiesNet income
    
    $
    3,177
    
    
    $
    936Adjustments to reconcile net income to net cash
provided by operating activities:Depreciation and amortization
    
    
    2,284
    
    
    
    2,382Other changes in operating activities
    
    
    (836
    )
    
    
    284Net cash provided by operating activities
    
    
    4,625
    
    
    
    3,602Investing activitiesPurchases of property and equipment
    
    
    (933
    )
    
    
    (1,263
    )Net cash used in investing activities
    
    
    (933
    )
    
    
    (1,263
    )Financing activitiesPaydown of debt
    
    
    (500
    )
    
    
    (834
    )Premium on early extinguishment of debt
    
    
    (5
    )
    
    
    Exercise of stock options
    
    
    1,583
    
    
    
    Net cash provided by (used in) financing activities
    
    
    1,078
    
    
    
    (834
    )Effect of exchange rates on cash
    
    
    (141
    )
    
    
    88Increase in cash and cash equivalents
    
    
    4,629
    
    
    
    1,593Cash and cash equivalents, beginning of period
    
    
    40,859
    
    
    
    26,211Cash and cash equivalents, end of period
    
    $
    45,488
    
    
    $
    27,804
 See notes to consolidated financial statements. 4




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INTERVOICE, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
(Unaudited) (In Thousands, Except Share Data) Common Stock
    
    Additional
    
    Accumulated
    
    Accumulated OtherComprehensiveShares
    
    Amount
    
    Capital
    
    Deficit
    
    Loss
    
    TotalBalance at February 29, 2004
    
    
    35,691,389
    
    
    $
    18
    
    
    $
    75,276
    
    
    $
    (35,441
    )
    
    $
    (600
    )
    
    $
    39,253Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,177
    
    
    
    
    
    
    
    3,177Foreign currency translation
adjustment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (304
    )
    
    
    (304
    )Comprehensive income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,873Exercise of stock options
    
    
    259,985
    
    
    
    
    
    
    
    1,583
    
    
    
    
    
    
    
    
    
    
    
    1,583Balance at May 31, 2004
    
    
    35,951,374
    
    
    $
    18
    
    
    $
    76,859
    
    
    $
    (32,264
    )
    
    $
    (904
    )
    
    $
    43,709
 See notes to consolidated financial statements. 5




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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED MAY 31, 2004 Note A - Basis of Presentation The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information. The consolidated balance sheet at February 29, 2004 has been
derived from audited financial statements at that date. In the opinion of
management, all adjustments considered necessary for a fair presentation of the
unaudited May 31, 2004 and 2003 consolidated financial statements have been
included. Such adjustments are of a normal recurring nature. These financial
statements should be read in conjunction with the audited financial statements
and related notes included in the Companys Fiscal 2004 Annual Report on Form
10-K. Operating results for the three-month period ended May 31, 2004 are not
necessarily indicative of the results that may be expected for the year ending
February 28, 2005, as they may be affected by a number of factors including the
timing and ultimate receipt of orders from significant customers which continue
to constitute a large portion of the Companys sales, the sales channel mix of
products sold, and changes in general economic conditions, any of which could
have an adverse effect on operations. In accordance with Statement of Financial Accounting Standards No. 130,
the following comprehensive income disclosures are provided. Total
comprehensive income for the first quarter of fiscal 2005 and 2004 was $2.9
million and $1.0 million, respectively. Total comprehensive income is
comprised of net income and foreign currency translation adjustments. Financial statements of the Companys foreign subsidiaries have been
translated into U.S. dollars at current and average exchange rates. Resulting
translation adjustments are recorded as a separate component of stockholders
equity. Any transaction gains or losses are included in the accompanying
consolidated statements of operations. Note B - Inventories Inventories consist of the following (in thousands): May 31, 2004
    
    February 29, 2004Purchased parts
    
    $
    4,147
    
    
    $
    4,138Work in progress
    
    
    4,147
    
    
    
    4,277$
    8,294
    
    
    $
    8,415
 Note C  Long-Term Borrowings At May 31, 2004 and February 29, 2004 the Companys long-term debt was
comprised of the following (in thousands, with the balance sheet classification
at May 31, 2004 reflecting the terms of a subsequent refinancing as further
discussed below): May 31, 2004
    
    February 29, 2004Mortgage loan, bearing interest payable
monthly at the greater of 10.5% or the
prime rate plus 2.0%; refinanced
in full as discussed below
    
    $
    8,000
    
    
    $
    8,500Line of credit, interest payable
monthly, accruing at a rate equal to
the prime rate plus 0.25% or the
London Inter-Bank Offering Rate plus
1.75%; (2.875% at May 31, 2004)
    
    
    4,601
    
    
    
    4,601Total debt outstanding
    
    
    12,601
    
    
    
    13,101Less: current portion
    
    
    400
    
    
    
    Long-term debt, net of current portion
    
    $
    12,201
    
    
    $
    13,101
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Mortgage Loan The Companys mortgage loan was secured by a first lien on the Companys
Dallas headquarters. In March 2004, the Company made a discretionary principal
payment of $0.5 million. The remaining $8.0 million outstanding under the loan
was repaid in full in June 2004 using the proceeds of a new $8.0 million term
loan discussed below. Line of Credit The Companys line of credit agreement provides for a revolving line of
credit equal to the lesser of $5.5 million or a defined borrowing base
comprised of eligible U.S. accounts receivable and $2.8 million held in a cash
collateral account ($11.4 million at May 31, 2004). The Company may borrow,
partially or wholly repay its outstanding borrowings without penalty, and
reborrow under the agreement so long as the total outstanding borrowings do not
exceed the available borrowing base. The revolving line of credit agreement
expires on January 31, 2007. The credit agreement contains terms, conditions and representations that
are generally customary for asset-based credit facilities including
requirements that the Company comply with certain financial and operating
covenants. In particular, the Company is required to maintain income after
taxes of not less than $1.00 for any fiscal year and for any two consecutive
fiscal quarters. The Company is also required to maintain a Fixed Charges
Ratio (EBITDA divided by Fixed Charges, as such terms are defined in the
agreement) for each prior four quarter period of at least 1.5 to 1.0, and a
total Funded Debt (as such term is defined in the agreement) to EBITDA ratio of
not greater than 1.5 to 1.0 as of each fiscal year end. In addition, the
Company is prohibited from making capital expenditures in excess of $8.0
million in any fiscal year, from incurring more than $3.0 million in new
purchase money and bank indebtedness and from incurring operating lease expense
(other than for building rents) in excess of $3.0 million for any fiscal year,
all without prior lender approval. Borrowings under the credit agreement are secured by first liens on the
Companys accounts receivable, general intangibles, equipment and inventory.
The agreement also requires the Company to maintain a minimum balance of $2.8
million in a cash collateral account to further secure the loan. This cash
account is included in Other Assets in the accompanying consolidated balance
sheets. As of May 31, 2004 the Company was in compliance with all financial
and operating covenants. The credit agreement was amended and restated as of
June 3, 2004, as discussed below. Amended and Restated Credit Agreement On June 3, 2004, the Company entered into an amended and restated credit
agreement with its lender that adds an $8.0 million term loan to its existing
line of credit. The Company used the proceeds of the new term loan to repay
all amounts outstanding under its mortgage loan. Terms, conditions and
representations for the line of credit remain as described above. Under the
amended and restated credit agreement, the lender is also granted a priority
security interest in the real property and fixtures comprising the Companys Dallas
headquarters. The term loan principal is due in monthly
installments of $33,333 beginning July 1, 2004 with a final balloon payment of
approximately $6.0 million due June 30, 2009. Interest on the term loan is
payable monthly and accrues at a rate equal to either 0.5% above the prime
rate, or 2.25% above the London Inter-Bank Offering Rate. The term loan may be
repaid in whole or in part without any penalty. Note D  Special Charges During the quarter ended May 31, 2003, the Company reduced its workforce
by 56 positions. In doing so, the Company incurred severance charges of
approximately $1.4 million, with approximately $0.6 million, $0.2 million, and
$0.6 million impacting cost of goods sold, research and development, and
selling, general and administrative expenses, respectively. All amounts
related to these severance charges have been paid. The Company had a liability
of $0.8 million at May 31, 2004, related to the early termination of a facility
lease recorded as a special charge in fiscal 2002. The Company will pay
approximately $0.2 million per quarter to settle this liability. Note E  Income Taxes Income taxes for the three months ended May 31, 2004 and 2003 were
provided based on an estimated annual rate. The estimated rate for fiscal 2005 is 27%.
This rate differs from the 35% U.S. federal statutory rate primarily because of
expected benefits to be realized in the U.S. from the use of previously
reserved net operating 7




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losses and from the effect of non-U.S. tax rates. For the three months
ended May 31, 2003, the Company recognized current income tax expense on the
pretax income of certain foreign subsidiaries. During the same period, the
Company incurred domestic pretax losses. The Company did not recognize current
income tax benefits as a result of such losses, however, because the existence
of recent domestic losses prevented it from concluding that it was more likely
than not that such benefits would be realized. Note F - Earnings Per Share Three Months Ended May 31(in thousands, except per share data)
    
    2004
    
    2003Numerator:Net income
    
    $
    3,177
    
    
    $
    936Denominator:Denominator for basic earnings per share
    
    
    35,847
    
    
    
    34,111Dilutive potential common shares:Employee stock options
    
    
    2,191
    
    
    
    249Outstanding warrants
    
    
    446
    
    
    
    Denominator for diluted earnings per share
    
    
    38,484
    
    
    
    34,360Net income per share:Basic
    
    
    0.09
    
    
    
    0.03Diluted
    
    
    0.08
    
    
    
    0.03
 Options to purchase 753,000 shares of common stock at an average exercise
price of $14.90 per share were outstanding at May 31, 2004, but were not
included in the computation of diluted earnings per share for the first quarter
of fiscal 2005 because the options prices were greater than the average market
price of the Companys common shares during such period and, therefore, the
effect would have been antidilutive. Options to purchase 4,847,606 shares of
common stock at an average exercise price of $8.62 per share and warrants to
purchase 621,304 shares at an exercise price of $4.0238 per share were
outstanding at May 31, 2003 but were not included in the computation of diluted
earnings per share for the first quarter of fiscal 2004 because the options
prices were greater than the average market price of the Companys common
shares during such period and, therefore, the effect would have been
antidilutive. The Company accounts for its stock-based compensation plans using the
intrinsic value method as defined in Accounting Principles Board Opinion No.
25, Accounting for Stock Issued to Employees (APB 25) and related
Interpretations. Under this approach, no compensation expense is recognized
for stock option grants if the exercise price of the Companys stock option
grants is at or above the fair market value of the underlying stock on the date
of grant. The Company has adopted the pro forma disclosure features of
Statement of Financial Accounting Standards No. 123, Accounting for
Stock-Based Compensation (SFAS 123), as amended by Statement of Financial
Accounting Standards No. 148, Accounting for Stock-Based
Compensation-Transition and Disclosure. The following table illustrates the
effect on net income and net income per share amounts for the three months
ended May 31, 2004 and 2003 if the Company had applied the fair value
recognition provisions of SFAS 123 to stock-based employee compensation (in
thousands, except per share amounts): Three Months Ended May 312004
    
    2003Net income, as reported
    
    $
    3,177
    
    
    $
    936Less: Total stock-based employee
compensation expense determined under
fair value based methods for all
awards, net of tax
    
    
    (914
    )
    
    
    1Pro forma net income
    
    $
    2,263
    
    
    $
    937
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Three Months Ended May 312004
    
    2003Net income per share:Basic  as reported
    
    $
    0.09
    
    
    $
    0.03Basic  pro forma
    
    $
    0.06
    
    
    $
    0.03Diluted  as reported
    
    $
    0.08
    
    
    $
    0.03Diluted  pro forma
    
    $
    0.06
    
    
    $
    0.03
 The pro forma stock-based compensation expense and related per share data
shown above are estimated using a Black-Scholes option pricing model. The
Black-Scholes model was developed for use in estimating the fair value of
publicly traded options that have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions including the expected stock price volatility. Because
the Companys employee stock options have characteristics significantly
different from those of publicly traded options, and because changes in the
subjective input assumptions can materially affect the estimate of the fair
value of stock-based compensation, in managements opinion, the existing models
do not necessarily provide a reliable single measure of the fair value of such
compensation. Note G - Operating Segment Information and Major Customers The Company operates as a single, integrated business unit. The Companys
chief operating decision maker assesses performance and allocates resources on
an enterprise wide basis. The Companys product line includes IVR/portal
solutions, messaging solutions, payment solutions, maintenance and related
services, and managed services provided for customers on an outsourced or
managed service provider basis. The Company believes that product line
distinction provides the most meaningful breakdown of quarterly and annual
sales activity. The Companys net sales by product line for the three months
ended May 31, 2004 and 2003 were as follows (in thousands): Three Months Ended May 312004
    
    2003IVR/portal solution sales
    
    $
    15,586
    
    
    $
    12,376Messaging solution sales
    
    
    2,405
    
    
    
    1,793Payment solution sales
    
    
    3,154
    
    
    
    3,862Total solution sales
    
    
    21,145
    
    
    
    18,031Maintenance and related services sales
    
    
    15,215
    
    
    
    13,586Managed service sales
    
    
    5,556
    
    
    
    6,785Total recurring services sales
    
    
    20,771
    
    
    
    20,371Total sales
    
    $
    41,916
    
    
    $
    38,402
 Geographic Operations Revenues are attributed to geographic locations based on locations of
customers. The Companys net sales by geographic area for the three-month
periods ended May 31, 2004 and 2003 were as follows (in thousands): Three Months Ended May 312004
    
    2003North America
    
    $
    25,336
    
    
    $
    24,245Europe, Middle East and Africa
    
    
    14,637
    
    
    
    13,194Pacific Rim
    
    
    839
    
    
    
    396Central and South America
    
    
    1,104
    
    
    
    567Total
    
    $
    41,916
    
    
    $
    38,402
 9




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Concentration of Revenue No customer accounted for 10% or more of the Companys revenue for the
first quarter of fiscal 2005. One customer, O2, accounted for approximately
11% of the Companys total sales during the quarter ended May 31, 2003. No
other customer accounted for 10% or more of the Companys revenue in the first
quarter of fiscal 2004. Note H  Contingencies Intellectual Property Matters The Company provides its customers a qualified indemnity against the
infringement of third party intellectual property rights. From time to time
various owners of patents and copyrighted works send the Company or its
customers letters alleging that the Companys products do or might infringe
upon the owners intellectual property rights, and/or suggesting that the
Company or its customers should negotiate a license or cross-license agreement
with the owner. The Companys policy is to never knowingly infringe upon any
third partys intellectual property rights. Accordingly, the Company forwards
any such allegation or licensing request to its outside legal counsel for their
review and opinion. The Company generally attempts to resolve any such matter
by informing the owner of its position concerning non-infringement or
invalidity, and/or, if appropriate, negotiating a license or cross-license
agreement. Even though the Company attempts to resolve these matters without
litigation, it is always possible that the owner of the patent or copyrighted
works will institute litigation. Owners of patent(s) and/or copyrighted work(s)
have previously instituted litigation against the Company alleging infringement
of their intellectual property rights, although no such litigation is currently
pending against the Company. The Company currently has a portfolio of 68
patents, and it has applied for and will continue to apply for and receive a
number of additional patents to reflect its technological innovations. The
Company believes that its patent portfolio could allow it to assert
counterclaims for infringement against certain owners of intellectual property
rights if those owners were to sue the Company for infringement. From time to time Ronald A. Katz Technology Licensing L.P. (RAKTL) has
sent letters to certain customers of the Company suggesting that the customer
should negotiate a license agreement to cover the practice of certain patents
owned by RAKTL. In the letters, RAKTL has alleged that certain of its patents
pertain to certain enhanced services offered by network providers, including
prepaid card and wireless services and postpaid card services. RAKTL has
further alleged that certain of its patents pertain to certain call processing
applications, including applications for call centers that route calls using a
called partys DNIS identification number. As a result of the correspondence,
an increasing number of the Companys customers have had discussions, or are in
discussions, with RAKTL. Certain products offered by the Company can be
programmed and configured to provide enhanced services to network providers and
call processing applications for call centers. The Companys contracts with
customers usually include a qualified obligation to indemnify and defend
customers against claims that products as delivered by the Company infringe a
third partys patent. None of the Companys customers have notified the Company that RAKTL has
claimed that any product provided by the Company infringes any claims of any
RAKTL patent. Accordingly, the Company has not been required to defend any
customers against a claim of infringement under a RAKTL patent. The Company
has, however, received letters from customers notifying the Company of the
efforts by RAKTL to license its patent portfolio and reminding the Company of
its potential obligations under the indemnification provisions of the
applicable agreements in the event that a claim is asserted. In response to
correspondence from RAKTL, a few customers have attempted to tender to the
Company the defense of its products under contractual indemnity provisions.
The Company has informed these customers that while it fully intends to honor
any contractual indemnity provisions, it does not believe it currently has any
obligation to provide such a defense because RAKTL does not appear to have made
a claim that a Company product infringes a patent. Some of these customers
have disagreed with the Company and believe that the correspondence from RAKTL
can be construed as claim(s) against the Companys products. One such customer
who had attempted to tender the defense of its products to the Company recently
informed the Company that the customer had entered into an agreement to license
certain rights under the RAKTL patents and demanded the Company indemnify the
customer for unspecified amounts, including attorneys fees, paid in connection
with the license agreement. The Company notified the customer that the Company
believes it does not have any indemnity obligation in connection with the
license agreement. Even though RAKTL has not alleged that a product provided by the Company
infringes a RAKTL patent, it is always possible that RAKTL may do so. In the
event that a Company product becomes the subject of 10




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litigation, a customer could attempt to invoke the Companys indemnity
obligations under the applicable agreement. As with most sales contracts with
suppliers of computerized equipment, the Companys contractual indemnity
obligations are generally limited to the products and services provided by the
Company, and generally require the customer to allow the Company to have
control over any litigation and settlement negotiations with the patent holder.
The customers who have received letters from RAKTL generally have multiple
suppliers of the types of products that might potentially be subject to claims
by RAKTL. Even though no claims have been made that a specific product offered by
the Company infringes any claim under the RAKTL patent portfolio, the Company
has received opinions from its outside patent counsel that certain products and
applications offered by the Company do not infringe certain claims of the RAKTL
patents. The Company has also received opinions from its outside counsel that
certain claims under the RAKTL patent portfolio are invalid or unenforceable.
Furthermore, based on the reviews by outside counsel, the Company is not aware
of any valid and enforceable claims under the RAKTL portfolio that are
infringed by the Companys products. If the Company does become involved in
litigation in connection with the RAKTL patent portfolio, under a contractual
indemnity or any other legal theory, the Company intends to vigorously contest
the claims and to assert appropriate defenses. An increasing number of
companies, including some large, well-known companies and some customers of the
Company, have already licensed certain rights under the RAKTL patent portfolio.
RAKTL has previously announced license agreements with, among others, AT&T
Corp., Microsoft Corporation and International Business Machines Corporation. Pending Litigation David Barrie, et al., on Behalf of Themselves and All Others Similarly
Situated v. InterVoice-Brite, Inc., et al.; No. 3-01CV1071-D, pending in the
United States District Court, Northern District of Texas, Dallas Division: Several related class action lawsuits were filed in the United States
District Court for the Northern District of Texas on behalf of purchasers of
common stock of the Company during the period from October 12, 1999 through
June 6, 2000 (the Class Period). Plaintiffs have filed claims, which were
consolidated into one proceeding, under Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934 and Securities Exchange Act Rule 10b-5 against
the Company as well as certain named current and former officers and directors
of the Company on behalf of the alleged class members. In the complaint,
Plaintiffs claim that the Company and the named current and former officers and
directors issued false and misleading statements during the Class Period
concerning the financial condition of the Company, the results of the Companys
merger with Brite Voice Systems, Inc. and the alleged future business
projections of the Company. Plaintiffs have asserted that these alleged
statements resulted in artificially inflated stock prices. The Company believes that it and its officers and directors complied with
their obligations under the securities laws, and has vigorously defended the
lawsuit. The Company responded to this complaint by filing a motion to dismiss
the complaint in the consolidated proceeding. The Company asserted that the
complaint lacked the degree of specificity and factual support to meet the
pleading standards applicable to federal securities litigation. On this basis,
the Company requested that the United States District Court for the Northern
District of Texas dismiss the complaint in its entirety. On August 8, 2002, the
Court entered an order granting the Companys motion to dismiss the class
action lawsuit. In the order dismissing the lawsuit, the Court granted
plaintiffs an opportunity to reinstate the lawsuit by filing an amended
complaint. Plaintiffs filed an amended complaint on September 23, 2002. On September
15, 2003, the Court granted the Companys motion to dismiss the amended class
action complaint. Unlike the Courts prior order dismissing the original class
action complaint, the order dismissing the amended complaint did not grant
Plaintiffs an opportunity to reinstate the lawsuit by filing a new amended
complaint. On October 9, 2003, the Plaintiffs filed a notice of appeal to the
Fifth Circuit Court of Appeals from the trial courts order of dismissal
entered on September 15, 2003. The Plaintiffs filed their appellant brief on
February 20, 2004, and the Company filed its brief in opposition to the
Plaintiffs appeal on May 10, 2004. On June 7, 2004, Plaintiffs filed a
response to the Companys brief. Other Matters The Company is a defendant from time to time in lawsuits incidental to its
business. Based on currently available information, the Company believes that
resolution of all known lawsuits, including the matter described above, is
uncertain, and there can be no assurance that future costs related to such
matters would not be material to the Companys financial position or results of
operations. 11




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The Company is a party to many routine contracts in which it provides
general indemnities and warranties in the normal course of business to third
parties for various risks. These indemnities and warranties are discussed in
the following paragraphs. Except in specific circumstances where the Company
has determined that the likelihood of loss is probable and the amount of the
loss quantifiable, the Company has not recorded a liability for any of these
indemnities. In general, the Company is not able to estimate the potential
amount of any liability relating to these indemnities and warranties. Many of the Companys contracts, particularly for managed services,
foreign contracts and contracts with telecommunication companies, include
provisions for the assessment of liquidated damages for delayed project
completion and/or for the Companys failure to achieve certain minimum service
levels. The Company has had to pay liquidated damages in the past and may have
to pay additional liquidated damages in the future. Any such future liquidated
damages could be significant. The Companys contracts with its customers generally contain qualified
indemnifications against third party claims relating to the infringement of
intellectual property as described in Intellectual Property Matters above. The Companys contracts with its customers also generally contain
warranties and, in some cases, general indemnifications against other
unspecified third party and general liability claims. The Company has liability
insurance protecting it against certain obligations, primarily certain claims
related to property damage, that result from these indemnities. The Company is obligated under a $0.6 million letter of credit issued by a
bank to guarantee the Companys performance under a long-term international
managed services contract. The letter of credit is fully collateralized by a
restricted certificate of deposit and expires in September, 2004. The Company has employment agreements with three executive officers. Two
of these agreements require the Company to make termination payments to the
officer of two times the officers annual base compensation in the event the
officers services are terminated without cause or payments of up to 2.99 times
the officers annual compensation including bonuses in connection with a
termination of the officers services following a change in ownership of the
Company, as defined in the agreement, prior to the expiration of the agreement.
If both officers with such agreements were terminated for one of the preceding
reasons during fiscal 2005, the cost to the Company would range from $1.2
million to $1.8 million. The third employment agreement requires that in the
event the officers services are terminated without cause, the Company either
must make termination payments to the officer of one times the officers annual
base compensation and accelerate vesting on 33,333 shares of Company common
stock covered by a stock option or make termination payments to the officer of
two times the officers annual base compensation. If the officer covered by
this agreement were terminated during fiscal 2005, the Company would be
required to make payments ranging from $0.2 million to $0.5 million. The Company, under the terms of its Articles of Incorporation and Bylaws,
indemnifies its directors, officers, employees or agents or any other person
serving at the Companys request as a director, officer, employee or agent of
another corporation in connection with a derivative suit if he or she (1) is
successful on the merits or otherwise or (2) acted in good faith, and in a
manner he or she reasonably believed to be in or not opposed to the best
interests of the corporation, but the Company will not provide indemnification
for any claim as to which the person was adjudged liable for negligence or
misconduct unless the court determines that under the circumstances the person
is fairly and reasonably entitled to indemnification. The Company provides the
same category of persons with indemnification in a non-derivative suit only if
such person (1) is successful on the merits or otherwise or (2) acted in good
faith, and in a manner he or she reasonably believed to be in or not opposed to
the best interests of the corporation, and with respect to any criminal action
or proceeding, had no reason to believe his or her conduct was unlawful. In connection with certain lawsuits filed against the Company and certain
of its present and former officers and directors (see Pending Litigation
above), the Company has agreed to pay in advance any expenses, including
attorneys fees, incurred by such present and former officers and directors in
defending such litigation, in accordance with Article 2.02-1 of the Texas
Business Corporation Act and the Companys Articles of Incorporation and
Bylaws. Each of these parties has provided the Company with a 12




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written undertaking to repay the Company the expenses advanced if the
person is ultimately not entitled to indemnification. Texas corporations are authorized to obtain insurance to protect officers
and directors from certain liabilities, including liabilities against which the
corporation cannot indemnify its officers and directors. The Company has
obtained liability insurance for its officers and directors as permitted by
Article 2.02-1 of the Texas Business Corporation Act. 13




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##### Table of Contents



Item 2 Managements Discussion and Analysis of Financial Condition and Results
of Operations Cautionary Disclosures To Qualify Forward Looking Statements This report on Form 10-Q includes forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933, as amended, and Section
21E of the Securities Exchange Act of 1934, as amended. All statements other
than statements of historical facts included in this Form 10-Q, including,
without limitation, statements contained in this Managements Discussion and
Analysis of Financial Condition and Results of Operations and Notes to
Consolidated Financial Statements located elsewhere herein regarding the
Companys financial position, business strategy, plans and objectives of
management of the Company for future operations, and industry conditions, are
forward-looking statements. Although the Company believes that the
expectations reflected in such forward-looking statements are reasonable, it
can give no assurance that such expectations will prove to be correct. In
addition to important factors described elsewhere in this report, the Company
cautions current and potential investors that the following important risk
factors, among others, sometimes have affected, and in the future could affect,
the Companys actual results and could cause such results during fiscal 2005,
and beyond, to differ materially from those expressed in any forward-looking
statements made by or on behalf of the Company:  
    
    The Company is prone to quarterly sales fluctuations. Some of the
Companys transactions are completed in the same fiscal quarter as
ordered. The quantity and size of large sales (sales valued at
approximately $2.0 million or more) during any quarter can cause wide
variations in the Companys quarterly sales and earnings, as such sales
are unevenly distributed throughout the fiscal year. The Companys
accuracy in estimating future sales is largely dependent on its ability
to successfully qualify, estimate and close solution sales from its
pipeline of sales opportunities during a quarter. No matter how
promising a pipeline opportunity may appear, there is no assurance it
will ever result in a sale. The accuracy of any estimate of future
sales is also dependent on the Companys ability to accurately estimate
the amount of revenue to be contributed from beginning backlog during
any fiscal quarter. Accordingly, the Companys actual sales for any
fiscal reporting period may be significantly different from any
estimate of sales for such period. See the discussion entitled Sales
in this Item 2 for a discussion of the Companys system for estimating
sales and trends in its business.
    
    The Companys financing agreement includes financial and operating
covenants and default provisions.In addition to obligations requiring
the monthly payment of principal and interest, the Companys amended
and restated credit agreement contains financial covenants, operating
covenants and default provisions. If the Company does not comply with
any of these covenants and default provisions, the Companys secured
lender can accelerate all indebtedness outstanding under the facility
and foreclose on a significant portion of the Companys assets.
    
    The Company is subject to potential and pending lawsuits and other
claims.The Company is subject to certain potential and pending
lawsuits and other claims discussed in Item 1 Legal Proceedings of
Part II of this quarterly report on Form 10-Q. The Company believes the
pending lawsuit to which it is subject is without merit and intends to
defend the matter vigorously. The Company may not prevail in the
pending litigation or other matters. There can be no assurance that
expenses, including any potential settlement or judgment, related to
any lawsuit would not be material to the Companys financial position
or results of operations.
    
    The Company faces intense competition based on product capabilities
and experiences ever increasing demands from its actual and prospective
customers for its products to be compatible with a variety of rapidly
proliferating computing, telephony and computer networking technologies
and standards. The ultimate success of the Companys products is
dependent, to a large degree, on the Company allocating its resources
to developing and improving products compatible with those
technologies, standards and functionalities that ultimately become
widely accepted by the Companys actual and prospective customers. The
Companys success is also dependent, to a large degree, on the
Companys ability to implement arrangements with other vendors with
complementary product offerings to provide actual and prospective
customers greater functionality and to ensure that the Companys
products are compatible with the increased variety of technologies and
standards. The principal competitors for the Companys systems include
Alcatel, Avaya, IBM, Nortel, Aspect Communications, Edify, Comverse
Technology and Lucent Technologies. Many of the Companys competitors
have greater financial, technological and marketing resources than the
Company. 14




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Although the Company has committed substantial resources to enhance its
existing products and to develop and market new products, it may not be
successful.
    
    The Company may not be successful in transitioning its products and
services to an open, standards-based business model.The Company has
historically provided complete, bundled hardware and software solutions
using internally developed components to address its customers total
business needs. Increasingly, the markets for the Companys products
are requiring a shift to the development of products and services based
on an open, standards-based architecture such as the J2EE and
Microsofts®.NET environments utilizing VoiceXML and/or SALT standards.
Such an open, standards-based approach allows customers to
independently purchase and combine hardware components, standardized
software modules, and customization, installation and integration
services from individual vendors deemed to offer the best value in the
particular class of product or service. In such an environment, the
Company believes it may sell less hardware and fewer bundled systems
and may become increasingly dependent on its development and sale of
software application packages, customized software and consulting and
integration services. This shift will place new challenges on the
Companys management to transition its products and to hire and retain
the mix of personnel necessary to respond to this business environment,
to adapt to the changing expense structure that the new environment may
tend to foster, and to increase sales of services, customized software
and application packages to offset reduced sales of hardware and
bundled solutions. The shift to open standards will also challenge the
Company to accurately estimate the level of R&D expenditures that will
be necessary in future periods to comply with existing standards and,
potentially, to migrate to new open standards. If the Company is
unsuccessful in resolving one or more of these challenges, the
Companys revenues and profitability could decline.
    
    The Company may not be able to retain its customer base, and, in
particular, its more significant customers.The Companys success
depends substantially on retaining its significant customers. The loss
of one of the Companys significant customers could negatively impact
the Companys results of operations. The Companys installed base of
customers generally is not contractually obligated to place further
solutions orders with the Company or to extend their services contracts
with the Company at the expiration of their current contracts.
    
    The Company will be harmed if it loses key business and technical
personnel.The Company relies upon the services of a relatively small
number of key technical and senior management personnel, most of whom
do not have employment contracts. If the Company were to lose any of
its key technical, project management, or senior management personnel,
replacing them could be difficult and costly. If it were unable to
successfully and promptly replace such personnel, the business could be
materially harmed.
    
    If requirements relating to the accounting treatment for employee
stock options are changed, the Company may be forced to change its
compensation practices.The Company currently accounts for the
issuance of stock options using the intrinsic value method as defined
in Accounting Principles Board (APB) Opinion No. 25, Accounting for
Stock Issued to Employees. The Financial Accounting Standards Board
has issued an exposure draft that requires companies to include a
compensation expense in their statements of operations relating to the
issuance of employee stock options. The change in accounting for stock
options is presently anticipated to become effective for the Companys
fiscal year beginning March 1, 2005. If this change is adopted, the
Company will incur additional expense if it continues to use stock
options as part of its compensation strategy. Alternatively, the
Company could decide to decrease or eliminate the use of employee stock
options as an element of its overall compensation plan. Such an
action, however, could affect the Companys ability to retain existing
employees and attract qualified candidates for open positions, and/or
it could increase the cash compensation the Company would have to pay.
    
    The Companys reliance on significant vendor relationships could
result in significant expense or an inability to serve its customers if
it loses these relationships.Although the Company generally uses
standard parts and components for its products, some of its components,
including semi-conductors and, in particular, digital signal processors
manufactured by Texas Instruments, are available only from a small
number of vendors. Likewise, the Company licenses speech recognition
technology from a small number of vendors. As the Company continues to
migrate to open, standards-based systems, it will become increasingly
dependent on its component suppliers and software vendors. To date, the
Company has been able to obtain adequate supplies of needed components
and licenses in a timely manner. If the Companys significant vendors
are unable or cease to supply components or licenses at 15




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current levels, the Company may not be able to obtain these items from
another source or at historical prices. Consequently, the Company would
be unable to provide products and to service its customers or to generate
historical operating margins, which would negatively impact its business
and operating results.
    
    If third parties assert claims that the Companys products or
services infringe on their technology and related intellectual property
rights, whether the claims are made directly against the Company or
against the Companys customers, the Company could incur substantial
costs to defend these claims.If any of these claims is ultimately
successful, a third party could require the Company to pay substantial
damages, discontinue the use and sale of infringing products, expend
significant resources to acquire non-infringing alternatives, and/or
obtain licenses to use the infringed intellectual property rights.
Moreover, where the claims are asserted with respect to the Companys
customers, additional expenses may be involved in indemnifying the
customer and/or designing and providing non-infringing products.
    
    The Company is exposed to risks related to its international
operations that could increase its costs and hurt its business.The
Companys products are currently sold in more than 75 countries. The
Companys international sales, as a percentage of total Company sales,
were 40% and 37% for the fiscal quarters ending May 31, 2004 and 2003,
respectively. International sales are subject to certain risks,
including:  
    
    fluctuations in currency exchange rates;
    
    the difficulty and expense of maintaining foreign offices and distribution channels;
    
    tariffs and other barriers to trade;
    
    greater difficulty in protecting and enforcing intellectual property rights;
    
    general economic and political conditions in each country;
    
    loss of revenue, property and equipment from expropriation;
    
    import and export licensing requirements; and
    
    additional expenses and risks inherent in conducting
operations in geographically distant locations, including risks
arising from customers speaking different languages and having
different cultural approaches to the conduct of business.  
    
    The Companys inability to meet contracted performance targets
could subject it to significant penalties.Many of the Companys
contracts, particularly for managed services, foreign contracts and
contracts with telecommunication companies, include provisions for the
assessment of liquidated damages for delayed project completion and/or
for the Companys failure to achieve certain minimum service levels.
The Company has had to pay liquidated damages in the past and may have
to pay additional liquidated damages in the future. Any such future
liquidated damages could be significant.
    
    The Company is exposed to general economic conditions that may harm
its business.Although the general level of business activity
rebounded during the Companys fiscal year ended February 29, 2004, the
Company has been affected by the general economic downturn of the
preceding several years, including, particularly, the downturn in the
telecommunications markets. If United States or global economic
conditions deteriorate again in the future, it is possible that capital
spending for advanced technology such as that offered by the Company
will again decline. If such unfavorable economic conditions were to
occur in the United States or internationally, such conditions could
have a material adverse impact on the Companys business, operating
results and financial condition.
    
    Increasing consolidation in the telecommunications and financial
industries could affect the Companys revenues and profitability.The
majority of the Companys significant customers are in the
telecommunications and financial industries, which are undergoing
increasing consolidation as a result of merger and acquisition
activity. This activity involving the Companys significant customers
could decrease the number of customers purchasing the Companys
products and/or delay purchases of the Companys products by customers
that are in the process of reviewing their strategic alternatives in
light of a pending merger or acquisition. If the Company has fewer
customers or its customers delay purchases of the Companys products as
a result of merger and acquisition activity, the Companys revenues and
profitability could decline.
    
    The occurrence of force majeure events could impact the Companys
results from operations.The occurrence of one or more of the
following events could potentially cause the Company to incur
significant losses: acts of God, war, riot, embargoes, acts of civil or
military authorities, acts of 16




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terrorism or sabotage, shortage of supply or delay in delivery by the
Companys vendors, the spread of SARS or other diseases, fire, flood,
explosion, earthquake, accident, strikes, radiation, inability to secure
transportation, failure of communications, failure of utilities or
similar events. Sales.The Companys total sales for the first quarter of fiscal 2005
were $41.9 million, up 9.2% from $38.4 million in the first quarter of fiscal
2004. Solutions sales of $21.1 million and recurring services sales of $20.8
million for the first quarter of fiscal 2005 reflected increases of 17.3% and
2.0%, respectively, over corresponding amounts for the first quarter of fiscal
2004. The Company operates as a single, integrated business unit. The Companys chief
operating decision maker assesses performance and allocates resources on an
enterprise wide basis. The Companys product line includes IVR/portal
solutions, messaging solutions, payment solutions, maintenance and related
services, and managed services provided for customers on an outsourced or
managed service provider basis. The Company believes that product line
distinction provides the most meaningful breakdown of quarterly and annual
sales activity. The Companys net sales by product line for the three months
ended May 31, 2004 and 2003 were as follows (in thousands): Three Months Ended May 312004
    
    2003IVR/portal solution sales
    
    $
    15,586
    
    
    $
    12,376Messaging solution sales
    
    
    2,405
    
    
    
    1,793Payment solution sales
    
    
    3,154
    
    
    
    3,862Total solution sales
    
    
    21,145
    
    
    
    18,031Maintenance and related services sales
    
    
    15,215
    
    
    
    13,586Managed service sales
    
    
    5,556
    
    
    
    6,785Total recurring services sales
    
    
    20,771
    
    
    
    20,371Total sales
    
    $
    41,916
    
    
    $
    38,402
 As identified in the preceding chart, the increase in solution sales from
fiscal 2004 levels is primarily attributable to growth in IVR/portal sales.
Such growth included sales increases in all of the Companys major geographic
regions with IVR/portal sales up 45.9% in North America and 54.1%
internationally. The 2.0% increase in recurring services sales is comprised of
growth in the sale of maintenance and related services, up $1.6 million or
12.0% from the fiscal 2004 first quarter, largely offset by a reduction in
managed services sales of $1.2 million or 18.1% for the first fiscal quarter of
2005, when compared to the first fiscal quarter of 2004. The decline in
managed services sales results primarily from a reduction in revenues from an
international managed services customer for which the Company recognizes
revenue on a cash basis. Such revenues totaled $0.4 million in the first
quarter of fiscal 2005 as compared to $1.9 million for the first quarter of
fiscal 2004. No customer accounted for 10% or more of the Companys revenue for the
first quarter of fiscal 2005. One customer, O2, which purchases both solutions
and recurring services from the Company, accounted for approximately 11% of the
Companys total sales during the three-month period ended May 31, 2003. No
other customer accounted for 10% or more of the Companys revenue in the first
quarter of fiscal 2004. Revenues are attributed to geographic locations based on locations of
customers. The Companys net sales by geographic area for the three-month
periods ended May 31, 2004 and 2003 were as follows (in thousands): Three Months Ended May 312004
    
    2003North America
    
    $
    25,336
    
    
    $
    24,245Europe, Middle East and Africa
    
    
    14,637
    
    
    
    13,194Pacific Rim
    
    
    839
    
    
    
    396Central and South America
    
    
    1,104
    
    
    
    567Total
    
    $
    41,916
    
    
    $
    38,402
 17




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As shown above, the Company experienced sales growth in each of its major
geographic markets. International sales comprised 40% of the Companys total
sales during the first quarter of fiscal 2005, up from 37% during the first
quarter of fiscal 2004. The Company uses a system combining estimated sales from its recurring
services contracts, its backlog of committed solutions orders and its
pipeline of solutions sales opportunities to project future sales and trends
in its business. For the quarters ended May 31, 2004 and 2003, sales were
sourced as follows: Three Months Ended May 312004
    
    2003Sales from recurring services contracts
    
    
    50
    %
    
    
    53
    %Sales from beginning solutions backlog
    
    
    35
    %
    
    
    40
    %Sales from the quarters pipeline
    
    
    15
    %
    
    
    7
    %100
    %
    
    
    100
    %
 The Companys recurring services contracts range in original duration from
one month to five years, with most managed service contracts having initial
terms of two to three years and most maintenance and related contracts having
initial terms of one year. Because many of the longer duration contracts give
customers early cancellation privileges, the Company does not consider its book
of services contracts to be reportable backlog, and a portion of the potential
revenue reflected in the contract values may never be realized. Nevertheless,
it is easier for the Company to estimate service and support sales than to
estimate solutions sales for the next quarter because the service and support
contracts generally span multiple quarters and revenues recognized under each
contract are generally similar from one quarter to the next. The Companys backlog is made up of customer orders for solutions for
which it has received complete purchase orders and which the Company expects to
ship within twelve months. Backlog as of the end of the Companys last five
fiscal quarters was as follows (in thousands): Quarter Ended
    
    BacklogMay 31,2004
    
    $
    43,174February 29, 2004
    
    $
    31,707November 30, 2003
    
    $
    34,003August 31, 2003
    
    $
    30,072May 31, 2003
    
    $
    29,540
 The 36% increase in backlog from February 29, 2004 to May 31, 2004
reflects the booking by the Company of an order totaling approximately $12.5
million from a major U.S. wireless telecommunications provider and an order
totaling approximately $4.2 million from a large European network provider.
The accuracy of any estimate of future sales is dependent, in part, on the
Companys ability to project the amount of revenue to be contributed from
beginning backlog during any fiscal quarter. This estimate, in turn, is
dependent on the Companys ability to successfully predict the amount and
timing of work to be performed on projects, the timing of customer acceptance
of certain projects and the amount and timing of cash to be received on
projects accounted for on a cash basis. The Companys pipeline of opportunities for future solution sales is the
aggregation of its sales opportunities, with each opportunity evaluated for the
date the potential customer will make a purchase decision, competitive risks,
and the potential amount of any resulting sale. No matter how promising a
pipeline opportunity may appear, there is no assurance it will ever result in a
sale. While this pipeline may provide the Company some reference point of
potential sales for use in its business planning and budgeting, pipeline
estimates are necessarily speculative and may not consistently correlate to
revenues in a particular quarter or over a longer period of time. Special Charges. During the quarter ended May 31, 2003, the Company
reduced its workforce by 56 positions. In doing so, the Company incurred
severance charges of approximately $1.4 million, with approximately $0.6
million, $0.2 million, and $0.6 million impacting cost of goods sold, research
and development, and selling, general and administrative expenses,
respectively. The Company incurred no such special charges during the quarter
ended May 31, 2004. Cost of Goods Sold. Cost of goods sold for the first quarter of fiscal
2005 was approximately $19.1 million or 45.5% of sales as compared to $17.9
million or 46.7% of sales for the first quarter of fiscal 2004. As described
above, the Company incurred special charges to cost of goods sold totaling $0.6
million (1.6% of 18




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sales) in the first quarter of fiscal 2004. Cost of goods sold on
solution sales was $12.0 million, or 56.7% of solution sales in the first
quarter of fiscal 2005, as compared to $11.2 million, or 62.2% of solution
sales, for the first quarter of fiscal 2004. The reduction in the cost of
sales percentage results from the absence of special charges in fiscal 2005,
the existence of a lower fixed cost component of cost of goods sold as a result
of cost reduction initiatives in recent years, and the increase in solutions
sales volume. Cost of goods sold on recurring services sales was $7.1 million,
or 34.1% of such sales, for the first quarter of fiscal 2005 versus $6.7
million, or 33.0% of services sales, for the same period of fiscal 2004. This
increase in the recurring services cost of sales as a percent of revenue is
comprised of an improvement in the cost ratio on maintenance services offset by
an increase in the managed services cost ratio as a result of the effect on the
calculation of the decrease in cash basis managed service revenues recognized
in the quarter. The costs of such cash basis managed service contracts are
expensed as incurred. Research and Development Expenses. Research and development expenses
during the first quarter of fiscal 2005 were approximately $3.7 million, or
8.9% of the Companys total sales. During the first quarter of fiscal 2004,
research and development expenses were $3.9 million, or 10.0% of the Companys
total sales. The Company incurred R&D charges described above in Special
Charges totaling $0.2 million (0.5%) in the first quarter of fiscal 2004. Research and development expenses include the design of new products and
the enhancement of existing products. The Companys research and development
spending is focused in four key areas. First, software tools are being
developed to aid in the development, deployment and management of customer
applications incorporating speech recognition and text-to-speech technologies.
Next, server-based software platforms are being developed for runtime services
for the management of contact center resources and speech applications.
Software platforms are being developed for deployment and management of
wireless and wireline network operator applications. These software platforms
are designed to operate in both J2EE and Microsofts®.Net enterprise computing
environments. Third, media servers and voice browsers based on open
standards such as SALT and VoiceXML are being developed. Finally, the Company
is developing packaged, speech-enabled applications for the network operator
and enterprise markets. These include a range of vertical and horizontal
applications that are designed to greatly enhance customer return on investment
by providing many commonly used, configurable functions that can be more
quickly deployed than custom applications. The Company expects to maintain a strong commitment to research and
development to remain at the forefront of technology development in its
markets, which is essential to the continued improvement of the Companys
position in the industry. Selling, General and Administrative Expenses. Selling, general and
administrative expenses during the first quarter of fiscal 2005 were
approximately $14.2 million, or 33.8% of the Companys total sales. SG&A
expenses during the first quarter of fiscal 2004 were $13.5 million, or 35.1%
of the Companys total sales. The Company incurred SG&A charges described
above in Special Charges totaling $0.6 million (1.6% of its total sales) in
the first quarter of fiscal 2004. Interest Expense. Interest expense was $0.3 million during the first
quarter of fiscal 2005, versus $0.5 million for the same period of fiscal 2004.
The reduction relates to the decrease in the Companys outstanding debt, which
totaled $13.1 million as of the beginning of the first quarter of fiscal 2005
as compared to $19.1 million at the beginning of fiscal 2004. In addition,
interest under the Companys current line of credit facility accrues at a
significantly lower rate than that in effect under a prior credit facility in
place during the first quarter of fiscal 2004. Income Taxes.Income taxes for the three months ended May 31, 2004 and
2003 were provided based on an estimated annual rate. The estimated rate for fiscal 2005
is 27%. This rate differs from the 35% U.S. federal statutory rate primarily
because of expected benefits to be realized in the U.S. from the use of
previously reserved net operating losses and from the effect of non-U.S. tax
rates. For the three months ended May 31, 2003, the Company recognized current
income tax expense on the pretax income of certain foreign subsidiaries.
During the same period, the Company incurred domestic pretax losses. The
Company did not recognize current income tax benefits as a result of such
losses, however, because the existence of recent domestic losses prevented it
from concluding that it was more likely than not that such benefits would be
realized. Income from Operations and Net Income. The Company generated operating
income of $4.3 million and net income of $3.2 million during the first quarter
of fiscal 2005. During the first quarter of fiscal 2004, the Company generated
operating income of $2.4 million, and net income of $0.9 million. The
improvement 19




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resulted primarily from an increase in sales volume, an elimination of
special charges incurred in fiscal 2004, the benefit of lower interest costs
and a lower effective tax rate. Liquidity and Capital Resources. The Company had approximately $45.5
million in cash and cash equivalents at May 31, 2004, while borrowings under
the Companys long-term debt facilities totaled $12.6 million. The Companys
cash reserves increased $4.6 million during the three months ended May 31,
2004, with operating activities providing $4.6 million of cash, net investing
activities using $0.9 million of cash and net financing activities providing
$1.1 million of cash. Operating cash flow for the quarter ended May 31, 2004 was favorably
impacted by the Companys continuing profitability in the quarter and by its
related continuing focus on operating expense control and balance sheet
management. The Company held its days sales outstanding of accounts receivable
to 60 days, up slightly from 56 days at February 29, 2004. For sales of certain of its more complex, customized systems (generally
ones with a sales price of $500,000 or more), the Company recognizes revenue
based on a percentage of completion methodology. Unbilled receivables accrued
under this methodology totaled $5.6 million (19.9% of total net receivables) at
May 31, 2004, down $3.2 million from February 29, 2004. The Company expects to
bill and collect unbilled receivables as of May 31, 2004 within the next twelve
months. While the Company continues to focus on the level of its investment in
accounts receivable, it generates a significant percentage of its sales,
particularly sales of enhanced telecommunications services systems, outside the
United States. Customers in certain countries are subject to significant
economic and political challenges that affect their cash flow, and many
customers outside the United States are generally accustomed to vendor
financing in the form of extended payment terms. To remain competitive in
markets outside the United States, the Company may offer selected customers
such payment terms. In all cases, however, the Company only recognizes revenue
at such time as its system or service fee is fixed or determinable,
collectibility is probable and all other criteria for revenue recognition have
been met. In some limited cases, this policy may result in the Company
recognizing revenue on a cash basis, limiting revenue recognition on certain
sales of systems and/or services to the actual cash received to date from the
customer, provided that all other revenue recognition criteria have been
satisfied. The Company used $0.9 million of cash during the first quarter of fiscal
2005 to purchase equipment. The Company anticipates spending up to $5.4 million
for such purchases during the balance of fiscal 2005. As further described
below, the Company is prohibited by the terms of its credit agreement from
spending more than $8.0 million on capital expenditures in a fiscal year
without the advance approval of its lender. During the quarter ended May 31, 2004, the Companys financing activities
provided $1.1 million in net cash flow. In response to the Companys
continuing profitability and to related favorable movement in its stock price,
the Companys option holders exercised options for 0.3 million shares of common
stock and, in so doing, provided the Company with $1.6 million of cash. The
Company used a portion of these funds to make $0.5 million in discretionary
payments under its mortgage loan. The Company cannot predict the level of cash
flow from option exercises in any future quarter. At May 31, 2004, the Company had $12.6 million in outstanding debt,
including $8.0 million under a mortgage loan and $4.6 million under a revolving
line of credit. The Company refinanced its mortgage loan in June 2004 as
described below. As of May 31, 2004 the Company was in compliance with all
financial and operating covenants under its credit agreements. Amended and Restated Credit Agreement On June 3, 2004, the Company entered into an amended and restated credit
agreement with its lender that adds an $8.0 million term loan to its existing
$5.5 million line of credit. The Company used the proceeds of the new term
loan to repay all amounts outstanding under its mortgage loan. Terms,
conditions and representations for the line of credit under the amended and
restated agreement were not changed and are described below. The credit agreement contains terms, conditions and representations that
are generally customary for asset-based credit facilities including
requirements that the Company comply with certain financial and 20




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operating covenants. In particular, the Company is required to maintain
income after taxes of not less than $1.00 for any fiscal year and for any two
consecutive fiscal quarters. The Company is also required to maintain a Fixed
Charges Ratio (EBITDA divided by Fixed Charges, as such terms are defined in
the agreement) for each prior four quarter period of at least 1.5 to 1.0, and a
total Funded Debt (as such term is defined in the agreement) to EBITDA ratio of
not greater than 1.5 to 1.0 as of each fiscal year end. In addition, the
Company is prohibited from making capital expenditures in excess of $8.0
million in any fiscal year, from incurring more than $3.0 million in new
purchase money and bank indebtedness and from incurring operating lease expense
(other than for building rents) in excess of $3.0 million for any fiscal year,
all without prior lender approval. Borrowings under the credit agreement are secured by first liens on the
Companys accounts receivable, general intangibles, equipment and inventory,
and by a priority security interest in the real property and fixtures comprising the
Companys Dallas headquarters. The agreement also
requires the Company to maintain a minimum balance of $2.8 million in a cash
collateral account to further secure the loan. Term Loan The term loan principal is due in monthly installments of $33,333
beginning July 1, 2004 with a final balloon payment of approximately $6.0
million due June 30, 2009. Interest on the term loan is payable monthly and
accrues at a rate equal to either 0.5% above the prime rate, or 2.25% above the
London Inter-Bank Offering Rate. Interest under the retired mortgage loan
accrued at a rate equal to the greater of 10.5% or the prime rate plus 2.0%.
The term loan may be prepaid in whole or in part without penalty. Line of Credit The Companys line of credit agreement provides for a revolving line of
credit equal to the lesser of $5.5 million or a defined borrowing base
comprised of eligible U.S. accounts receivable and $2.8 million held in a cash
collateral account ($11.4 million at May 31, 2004). The Company may borrow,
partially or wholly repay its outstanding borrowings without penalty, and
reborrow under the agreement so long as the total outstanding borrowings do not
exceed the available borrowing base. The revolving line of credit agreement
expires on January 31, 2007. Adequacy of Cash Reserves The Company believes it cash reserves and internally generated cash flow
along with any cash availability under its line of credit will be sufficient to
meet its cash requirements for at least the next 12 months. Impact of Inflation The Company does not expect any significant short-term impact of inflation
on its financial condition. Technological advances should continue to reduce
costs in the computer and communications industries. Further, the Company
presently is not bound by long-term fixed price sales contracts. The absence
of such contracts reduces the Companys exposure to inflationary effects. 
 Item 3 Quantitative and Qualitative Disclosures About Market Risk Interest Rate Risks The Company invests cash balances in excess of operating requirements in
short-term securities that generally have maturities of 90 days or less. The
carrying value of these securities approximates market value, and there is no
long-term interest rate risk associated with this investment. 21




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At May 31, 2004, the Companys outstanding long-term debt was comprised of the following (in thousands): May 31, 2004Mortgage loan, bearing interest payable monthly at the greater
of 10.5% or the prime rate plus 2.0%; principal due May 28, 2005,
subsequently refinanced in full
    
    $
    8,000Line of credit, interest payable monthly, accruing at a rate
equal to the prime rate plus 0.25% or the London Inter-Bank
Offering Rate plus 1.75% (2.875% at May 31, 2004)
    
    
    4,601$
    12,601
 In June 2004, the Company used the proceeds of a new term loan to pay all
amounts outstanding under the mortgage loan. The term loan principal is due in
monthly installments of $33,333 beginning July 1, 2004 with a final balloon
payment of approximately $6.0 million due June 30, 2009. Interest on the term
loan is payable monthly and accrues at a rate equal to either 0.5% above the
prime rate, or 2.25% above the London Inter-Bank Offering Rate (3.5% as of the
closing date of the loan). The following table provides information about the Companys credit
agreements that are sensitive to changes in interest rates. Amounts are
adjusted to reflect the effects of the refinancing that took place subsequent
to quarter end. For the credit agreements, the table presents cash flows for
scheduled principal payments and related weighted-average interest rates by
expected maturity dates. Weighted-average variable rates are based on rates in
effect as of June 2004. Fiscal2005
    
    2006
    
    2007
    
    2008
    
    2009
    
    2010(Dollars in thousands)Long-term debt 
variable rate, U.S. $
    
    $
    267
    
    
    $
    400
    
    
    $
    5,001
    
    
    $
    400
    
    
    $
    400
    
    
    $
    6,133Projected weighted average
interest rate
    
    
    3.3
    %
    
    
    3.3
    %
    
    
    3.3
    %
    
    
    3.5
    %
    
    
    3.5
    %
    
    
    3.5
    %
 
 Item 4 Controls and Procedures The Companys chief executive officer and chief financial officer have
reviewed and evaluated the effectiveness of the Companys disclosure controls
and procedures (as defined in Rules 240.13a-15(e) and 15d-15(e) promulgated
under the Securities Exchange Act of 1934) as of May 31, 2004. Based on that
review and evaluation, which included inquiries made to certain other employees
of the Company, the chief executive officer and chief financial officer have
concluded that the Companys current disclosure controls and procedures, as
designed and implemented, are effective to ensure that they are provided with
material information relating to the Company required to be disclosed in the
reports the Company files or submits under the Securities Exchange Act of 1934.
There has been no change in the Companys internal control over financial
reporting identified in connection with that evaluation that occurred during
the Companys most recent fiscal quarter that has materially affected, or is
reasonably likely to materially affect, the Companys internal control over
financial reporting. 22




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PART II. OTHER INFORMATION 
 Item 1 Legal Proceedings David Barrie, et al., on Behalf of Themselves and All Others Similarly
Situated v. InterVoice-Brite, Inc., et al.; No. 3-01CV1071-D, pending in the
United States District Court, Northern District of Texas, Dallas Division: Several related class action lawsuits were filed in the United States
District Court for the Northern District of Texas on behalf of purchasers of
common stock of the Company during the period from October 12, 1999 through
June 6, 2000 (the Class Period). Plaintiffs have filed claims, which were
consolidated into one proceeding, under Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934 and Securities Exchange Act Rule 10b-5 against
the Company as well as certain named current and former officers and directors
of the Company on behalf of the alleged class members. In the complaint,
Plaintiffs claim that the Company and the named current and former officers and
directors issued false and misleading statements during the Class Period
concerning the financial condition of the Company, the results of the Companys
merger with Brite Voice Systems, Inc. and the alleged future business
projections of the Company. Plaintiffs have asserted that these alleged
statements resulted in artificially inflated stock prices. The Company believes that it and its officers and directors complied with
their obligations under the securities laws, and has vigorously defended the
lawsuit. The Company responded to this complaint by filing a motion to dismiss
the complaint in the consolidated proceeding. The Company asserted that the
complaint lacked the degree of specificity and factual support to meet the
pleading standards applicable to federal securities litigation. On this basis,
the Company requested that the United States District Court for the Northern
District of Texas dismiss the complaint in its entirety. On August 8, 2002, the
Court entered an order granting the Companys motion to dismiss the class
action lawsuit. In the order dismissing the lawsuit, the Court granted
plaintiffs an opportunity to reinstate the lawsuit by filing an amended
complaint. Plaintiffs filed an amended complaint on September 23, 2002. On September
15, 2003, the Court granted the Companys motion to dismiss the amended class
action complaint. Unlike the Courts prior order dismissing the original class
action complaint, the order dismissing the amended complaint did not grant
Plaintiffs an opportunity to reinstate the lawsuit by filing a new amended
complaint. On October 9, 2003, the Plaintiffs filed a notice of appeal to the
Fifth Circuit Court of Appeals from the trial courts order of dismissal
entered on September 15, 2003. The Plaintiffs filed their appellant brief on
February 20, 2004, and the Company filed its brief in opposition to the
Plaintiffs appeal on May 10, 2004. On June 7, 2004, Plaintiffs filed a
response to the Companys brief. 
 Item 6 Exhibits and Reports on Form 8-K (a) Exhibits 10.1
    
    Amended and Restated Credit and Security Agreement dated as of June
3, 2004, between the Company and Wells Fargo Bank, N.A. (1)10.2
    
    Term Note dated June 3, 2004, executed by the Company in favor of
Wells Fargo Bank, N.A. (2)10.3
    
    Deed of Trust dated June 3, 2004, executed by the Company in favor of
Wells Fargo Bank, N.A. (3)31.1
    
    Certification of Chief Executive Officer of Periodic Report Pursuant
to Rule 13a-14(a) or Rule 15d-14(a). (4)31.2
    
    Certification of Chief Financial Officer of Periodic Report Pursuant
to Rule 13a-14(a) or Rule 15d-14(a). (4)32.1
    
    Certification by Chief Executive Officer of Periodic Report Pursuant
to 18 U.S.C. Section 1350. (4)32.2
    
    Certification by Chief Financial Officer of Periodic Report Pursuant
to 18 U.S.C. Section 1350. (4)
   (1)
    
    Incorporated herein by reference to Exhibit 10.1 to the Registrants
Current Report on Form 8-K, filed with the SEC on June 4, 2004.(2)
    
    Incorporated herein by reference to Exhibit 10.2 to the Registrants
Current Report on Form 8-K, filed with the SEC on June 4, 2004. 23




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(3)
    
    Incorporated herein by reference to Exhibit 10.3 to the Registrants
Current Report on Form 8-K, filed with the SEC on June 4, 2004.(4)
    
    Filed herewith. (b) Reports on Form 8-K  1.
    
    A report on Form 8-K was filed March 9, 2004 to announce
the appointment of Donald B. Reed to the Companys Board of
Directors.2.
    
    A report on Form 8-K was filed March 9, 2004 to announce
that the Company had received a $12.5 million order from a major
United States wireless telecommunications provider.3.
    
    A report on Form 8-K was filed April 7, 2004 to announce
the financial results for the quarter and year ended February 29,
2004. 24




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. INTERVOICE, INC.Date: July 1, 2004
    
    By:
    
    /s/ Mark C. FalkenbergMark C. FalkenbergChief Accounting Officer
 25