**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

 

**Washington, D.C. 20549**

 

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**FORM 10-Q**

 

 

| **(Mark  One)**                                                                                                                                        |
|--------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                                                                                                                                   |   |
| **ý****        QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |

 

**For the quarterly period endedSeptember 30, 2002**

 

**Or**

 

| **o****        TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** |
|----------------------------------------------------------------------------------------------------------------------------------------------------|

 

**For the transition period from                to                **

 

**CommissionFile Number 000-27385**

 

**INTERACTIVE INTELLIGENCE, INC.**

(Exactname of registrant as specified in its charter)

 

| **Indiana**                                                     |   | **35-1933097**                    |
|-----------------------------------------------------------------|--------|-----------------------------------|
| (State or other jurisdiction of  incorporation or organization) |   | (IRS Employer Identification No.) |
| **8909  Purdue Road****Suite 300  Indianapolis, Indiana 46268** |
| (Address of principal executive offices)                        |
|                                                            |   |                              |
| **(317) 872-3000**                                              |
| (Registrant’s telephone number)                            |

 

Indicate by checkmarkwhether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days.

 

Yes ý  No o

 

The number of shares ofcommon stock outstanding on October 31, 2002 was 15,496,122.

 

 

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TABLE OF CONTENTS

 
| PART I. FINANCIAL  INFORMATION |
|--------------------------------|
|                           |   |
| Item  1.                       | Condensed  Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001 |
|                           |   |
|                           | Condensed  Consolidated Statements of Operations for the three and nine months ended  September 30, 2002 and 2001 |
|                           |   |
|                           | Condensed  Consolidated Statements of Cash Flows for the nine months ended September 30,  2002 and 2001 |
|                           |   |
|                           | Notes  to Condensed Consolidated Financial Statements |
|                           |   |
| Item  2.                       | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |
|                           |   |
| Item  3.                       | Quantitative  and Qualitative Disclosures About Market Risk |
|                           |   |
| Item 4.                        | Controls and  Procedures |
|                           |   |
| PART II. OTHER INFORMATION     |
|                           |   |
| Item 1.                        | Legal Proceedings |
|                           |   |
| Item 5.                        | Other Information |
|                           |   |
| Item 6.                        | Exhibits and  Reports on Form 8-K |
|                           |   |
|                           | Signature |
|                           |   |
|                           | Certifications |
|                                |  |  |

 

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**PARTI.  FINANCIAL INFORMATION**

 

**Item 1.****  Condensed Consolidated Financial Statementsand Footnotes.**

 

**Interactive Intelligence,Inc.**

 

**Condensed Consolidated Balance Sheets**

**(in thousands, except share amounts)**

 
|                                                                                                                                                                     |   | **September  30,  2002** |   | **December  31,  2001** |       |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------------|--------|-------------------------|------------|
|                                                                                                                                                                     |   | **(Unaudited****)**      |   |                    |       |
| **Assets**                                                                                                                                                               |   |                     |   |                    | ** ** |
| Current assets:                                                                                                                                                          |   |                     |   |                    |       |
| Cash and cash equivalents                                                                                                                                                |   | $                        | 5,627  |                    | $          | 14,503 |   |
| Short-term investments                                                                                                                                                   |   | 11,714                   |   | 7,581                   |       |
| Accounts receivable, net of allowance for doubtful accounts accounts  of $852 in 2002 and $677 in 2001                                                                   |   | 7,406                    |   | 8,424                   |       |
| Prepaid expenses                                                                                                                                                         |   | 827                      |   | 1,116                   |       |
| Other current assets                                                                                                                                                     |   | 90                       |   | 223                     |       |
| Total current assets                                                                                                                                                     |   | 25,664                   |   | 31,847                  |       |
|                                                                                                                                                                     |   |                     |   |                    |       |
| Property and equipment, net                                                                                                                                              |   | 8,232                    |   | 9,598                   |       |
|                                                                                                                                                                     |   |                     |   |                    |       |
| Other assets, net                                                                                                                                                        |   | 1,058                    |   | 1,064                   |       |
| Total assets                                                                                                                                                             |   | $                        | 34,954 |                    | $          | 42,509 |   |
|                                                                                                                                                                     |   |                     |   |                    |       |
| **Liabilities and shareholders’ equity**                                                                                                                            |   |                     |   |                    |       |
| Current liabilities:                                                                                                                                                     |   |                     |   |                    |       |
| Accounts payable and accrued liabilities                                                                                                                                 |   | $                        | 3,824  |                    | $          | 3,924 |   |
| Accrued compensation and related expenses                                                                                                                                |   | 975                      |   | 1,096                   |       |
| Deferred revenue                                                                                                                                                         |   | 9,437                    |   | 9,214                   |       |
| Total current liabilities                                                                                                                                                |   | 14,236                   |   | 14,234                  |       |
|                                                                                                                                                                     |   |                     |   |                    |       |
| Shareholders’ equity:                                                                                                                                               |   |                     |   |                    |       |
| Preferred stock,  no par  value;  10,000,000 authorized; no  shares issued and outstanding                                                                     |   | —                   |   | —                  |       |
| Common stock, $0.01 par value; 100,000,000 authorized; 15,454,843  issued and outstanding at September 30, 2002, 15,282,673 issued and  outstanding at December 31, 2001 |   | 155                      |   | 153                     |       |
| Additional paid-in capital                                                                                                                                               |   | 64,019                   |   | 63,485                  |       |
| Accumulated other comprehensive income                                                                                                                                   |   | 54                       |   | (13                     | )          |
| Accumulated deficit                                                                                                                                                      |   | (43,510                  | )      | (35,350                 | )          |
| Total shareholders’ equity                                                                                                                                          |   | 20,718                   |   | 28,275                  |       |
| Total liabilities and shareholders’ equity                                                                                                                          |   | $                        | 34,954 |                    | $          | 42,509 |   |

 

See accompanying notes.

 

 

1

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**Interactive Intelligence, Inc.**

 

**Condensed Consolidated Statements of Operations (unaudited)**

**(in thousands, except per share amounts)**

 
|                                       |   | **Three  months ended  September 30,** |       | **Nine  months ended  September 30,** |       |
|--------------------------------------------|--------|----------------------------------------|------------|---------------------------------------|------------|
|                                       |   | **2002**                               |       | **2001**                              | ** ** | **2002** | ** ** | **2001** | ** ** |
| Revenues:                                  |   |                                   |       |                                  |       |   |   |   |   |
| Software                                   |   | $                                      | 6,481      |                                  | $          | 7,811 |   | $ | 19,474 |   | $ | 25,102 |   |
| Services                                   |   | 5,147                                  |       | 4,132                                 |       | $ | 13,924 |   | 12,262 |   |
| Total revenues                             |   | 11,628                                 |       | 11,943                                |       | 33,398 |   | 37,364 |   |
|                                       |   |                                   |       |                                  |       |   |   |   |   |
| Costs and expenses:                        |   |                                   |       |                                  |       |   |   |   |   |
| Costs of software                          |   | 296                                    |       | 246                                   |       | 874 |   | 549 |   |
| Costs of services                          |   | 2,920                                  |       | 3,170                                 |       | 8,808 |   | 10,450 |   |
| Sales and marketing                        |   | 5,167                                  |       | 5,426                                 |       | 15,730 |   | 16,727 |   |
| Research and development                   |   | 3,739                                  |       | 3,814                                 |       | 11,357 |   | 11,632 |   |
| General and administrative                 |   | 1,369                                  |       | 1,643                                 |       | 4,247 |   | 5,279 |   |
| Special Charge                             |   | —                                 |       | 1,056                                 |       | 682 |   | 1,056 |   |
| Total costs and expenses                   |   | 13,491                                 |       | 15,355                                |       | 41,698 |   | 45,693 |   |
| Operating loss                             |   | (1,863                                 | )          | (3,412                                | )          | (8,300 | ) | (8,329 | ) |
|                                       |   |                                   |       |                                  |       |   |   |   |   |
| Interest income, net                       |   | 86                                     |       | 274                                   |       | 319 |   | 941 |   |
| Loss before income taxes                   |   | (1,777                                 | )          | (3,138                                | )          | (7,981 | ) | (7,388 | ) |
|                                       |   |                                   |       |                                  |       |   |   |   |   |
| Income taxes                               |   | 50                                     |       | 95                                    |       | 179 |   | 236 |   |
|                                       |   |                                   |       |                                  |       |   |   |   |   |
| Net loss                                   |   | $                                      | (1,827     | )                                     | $          | (3,233 | ) | $ | (8,160 | ) | $ | (7,624 | ) |
|                                       |   |                                   | ** ** |                                  | ** ** |   | ** ** |   | ** ** |
| Net loss per share:                        |   |                                   | ** ** |                                  | ** ** |   | ** ** |   | ** ** |
| Basic and diluted                          |   | $                                      | (0.12      | )                                     | $          | (0.21 | ) | $ | (0.53 | ) | $ | (0.51 | ) |
|                                       |   |                                   |       |                                  |       |   |   |   |   |
| Shares used to compute net loss per share: |   |                                   |       |                                  |       |   |   |   |   |
| Basic and diluted                          |   | 15,453                                 |       | 15,117                                |       | 15,396 |   | 14,987 |   |

 

See accompanying notes.

 

 

2

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**Interactive Intelligence, Inc.**

** **

**Condensed Consolidated Statements of Cash Flows (unaudited)**

**(in thousands)**

 
|                                                                         |   | **Nine  months ended  September 30,** |   |
|------------------------------------------------------------------------------|--------|---------------------------------------|--------|
|                                                                         |   | **2002**                              |   | **2001** | ** ** |
| **Operating activities**                                                     |   |                                  |   |   |   |
| Net loss                                                                     |   | $                                     | (8,160 | ) | $ | (7,624 | ) |
| Adjustments to reconcile net loss to net cash used by operating  activities: |   |                                  |   |   |   |
| Depreciation                                                                 |   | 3,907                                 |   | 3,082 |   |
| Amortization of deferred stock-based compensation                            |   | 89                                    |   | 60 |   |
| Changes in operating assets and liabilities:                                 |   |                                  |   |   |   |
| Accounts receivable                                                          |   | 1,018                                 |   | 555 |   |
| Prepaid expenses                                                             |   | 289                                   |   | (239 | ) |
| Other current assets                                                         |   | 133                                   |   | (301 | ) |
| Accounts payable and accrued liabilities                                     |   | (100                                  | )      | 211 |   |
| Accrued compensation and related expenses                                    |   | (121                                  | )      | 185 |   |
| Deferred revenue                                                             |   | 223                                   |   | 2,037 |   |
| Net cash used by operating activities                                        |   | (2,722                                | )      | (2,034 | ) |
|                                                                         |   |                                  |   |   |   |
| **Investing activities**                                                     |   |                                  |   |   |   |
| Purchases of property and equipment, net                                     |   | (2,541                                | )      | (4,397 | ) |
| Purchases of available-for-sale investments                                  |   | (15,026                               | )      | (10,156 | ) |
| Sales of available-for-sale investments                                      |   | 10,960                                |   | 5,904 |   |
| Change in other assets                                                       |   | 6                                     |   | 266 |   |
| Net cash used by investing activities                                        |   | (6,601                                | )      | (8,383 | ) |
|                                                                         |   |                                  |   |   |   |
| **Financing activities**                                                     |   |                                  |   |   |   |
| Principal payments on capital lease obligations                              |   | —                                |   | (297 | ) |
| Proceeds from issuances of common stock                                      |   | 338                                   |   | 296 |   |
| Proceeds from stock options exercised                                        |   | 109                                   |   | 15,330 |   |
| Net cash provided by financing activities                                    |   | 447                                   |   | 15,329 |   |
|                                                                         |   |                                  |   |   |   |
| Net increase (decrease) in cash and cash equivalents                         |   | (8,876                                | )      | 4,912 |   |
|                                                                         |   |                                  |   |   |   |
| Cash and cash equivalents, beginning of period                               |   | 14,503                                |   | 1,999 |   |
| Cash and cash equivalents, end of period                                     |   | $                                     | 5,627  |   | $ | 6,911 |   |

 

See accompanying notes. 

 

 

3

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InteractiveIntelligence, Inc

Notes to  Condensed Consolidated Financial Statements

(Unaudited)

 

**1.****              Descriptionof Business and Basis of Presentation**

 

Interactive Intelligence, Inc. (“I3” or the “Company”)is a leading provider of software-based interaction management solutionsdesigned to automate communications for contact centers, enterprises, andservice providers. Based on an open, unified platform, the InteractiveIntelligence product line was designed as a flexible and affordable alternativeto traditional telecom solutions. The Company’s products provide a completecommunications solution including PBX (private branch exchange), ACD (automatedcall distributor), IVR (interactive voice response), unified communications,and Internet and wireless functionality. The Company currently derives substantially all of its revenues fromlicenses of its Interaction Center platform products and related services.

 

Principal operations of the Company commenced during1997.  Since then, the Company hasestablished wholly-owned subsidiaries in France, Australia, the United Kingdomand the Netherlands. The Company also currently has  branch offices in Japan, Korea and Malaysia.  The Company’s products are marketed in NorthAmerica, Central America, South America, Europe, the Asia/Pacific region,Australia, and South Africa.

 

The accompanying unaudited financial statements havebeen prepared in conformity with generally accepted accounting principles forinterim financial information and with the instructions for Form 10-Q andArticle 10 of Regulation S-X. Accordingly, certain information and footnote disclosures normallyincluded in financial statements prepared in accordance with generally acceptedaccounting principles have been condensed, or omitted, pursuant to the rulesand regulations of the Securities and Exchange Commission.  In our opinion, the statements include alladjustments necessary  (which are of anormal and recurring nature) for the fair presentation of the results of theinterim periods presented.

 

The balance sheet at December 31, 2001 has beenderived from the audited financial statements at that date but does not includeall of the information and footnotes required by generally accepted accountingprinciples for complete financial statements.

 

These financial statements should be read inconjunction with our audited consolidated financial statements for the yearended December 31, 2001, included in the Company’s Form 10-K for the year endedDecember 31, 2001, filed with the Securities and Exchange Commission on April1, 2002.  Our results of operations forany interim period are not necessarily indicative of the results of operationsfor any other interim period or for a full fiscal year.

 

**2.****              NetLoss Per Common Share**

 

Basic loss per share is calculated based on theweighted-average number of outstanding common shares.  Diluted loss per share is calculated based on theweighted-average number of outstanding common shares plus the effect ofdilutive potential common shares.

 

4

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The following table presents the calculation of basicand diluted net loss per share (in thousands, except per share amounts):

 
|                                                         |   | **Three  Months Ended  September 30,** |   | **Nine  Months Ended  September 30,** |       |
|--------------------------------------------------------------|--------|----------------------------------------|--------|---------------------------------------|------------|
|                                                         |   | **2002**                               |   | **2001**                              | ** ** | **2002** | ** ** | **2001** | ** ** |
|                                                         |   |                                   |   |                                  |       |   |   |   |   |
| Net Loss:                                                    |   | $                                      | (1,827 | )                                     | $          | (3,233 | ) | $ | (8,160 | ) | $ | (7,624 | ) |
|                                                         |   |                                   |   |                                  |       |   |   |   |   |
| Basic and diluted:                                           |   |                                   |   |                                  |       |   |   |   |   |
| Weighted-average shares  used to compute net loss per share: |   | 15,453                                 |   | 15,117                                |       | 15,396 |   | 14,987 |   |
|                                                         |   |                                   |   |                                  |       |   |   |   |   |
| Basic and diluted net loss per common share:                 |   | $                                      | (0.12  | )                                     | $          | (0.21 | ) | $ | (0.53 | ) | $ | (0.51 | ) |

 

The Company’s calculation of diluted net loss pershare excludes potential common shares as the effect would beantidilutive.  Potential common sharesare composed of shares of common stock of the Company issuable on the exerciseof stock options.  Options to purchase3,312,608 shares of common stock with exercise prices of $0.13 to $50.50 pershare were outstanding as of September 30, 2002 and options to purchase2,482,337 shares of common stock with exercise prices of $0.13 to $50.50 pershare were outstanding as of September 30, 2001.

 

**3.****              BankLine of Credit**

 

The Company had an unsecured line of credit with abank in the amount of $5,000,000 with interest to be charged at the bank’sprime rate (4.75% at June 22, 2002). This line of credit expired June 22, 2002.

 

**4.****              Reclassifications**

 

Certain reclassifications have been made to prior yearamounts to conform with the current year presentations.

 

**5.     Contingencies**

 

In June 1999 and September 1999, the Company receivedletters from a competitor in the call center market claiming that the Company’sproducts utilize technologies pioneered and patented by that competitor.  The Company’s patent counsel has reviewedall of the patents listed in the letters. Based on the advice of the Company’s patent counsel, the Companybelieves that its products do not infringe any of the patents listed in eitherletter.  The Company has discussed itsconclusion with the competitor and has also discussed possible licensing ofcertain technologies from the competitor. The Company cannot assure you that this matter can be resolved amicablywithout litigation, or that it will ultimately be able to enter into alicensing arrangement on terms and conditions that would not have a materialadverse effect on the Company’s business, financial condition or results ofoperations.

 

In June 2000 and October 2001, the Company receivedletters from a competitor in the outbound call center market claiming that theCompany’s products utilize technologies pioneered and patented by thecompetitor.  Although the Company’spatent counsel has not determined the validity of these patents, the Companyhas discussed the possible licensing of certain technologies from thecompetitor.  The Company cannot assureyou that these claims can be resolved amicably without litigation, or that itwill be able to enter into licensing arrangements on terms and

 

5

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conditions that would not have a material adverseeffect on the Company’s business, financial condition or results of operations.

 

In July 2000, the Company received a letter fromAvaya, Inc., a competitor in the call center market, claiming that theCompany’s products utilize technologies pioneered and patented by them.  As a result of subsequent discussions, theCompany accrued an appropriate amount for the licensing of certain technologiesrelated to 2001 and prior years in the financial statements for the year endedDecember 31, 2001.  An agreement wasfinalized and executed in February 2002 and the Company believes the terms andconditions of the licensing arrangement will not have a material adverse effecton the Company’s business, financial condition or results of operations.

 

In July 2002, the Company received a letter from aconsulting firm which has been retained by a telecommunication technologyprovider to develop and implement a licensing program based on the technologyprovider’s patents.  The consulting firmbelieves a licensing agreement between the Company and the technology provideris appropriate.  The Company’s patentcounsel is in the process of reviewing the patents listed in the letter.  To date, the Company’s patent counsel hasnot determined the validity or applicability of these patents.  The Company cannot assure you that thismatter can be resolved amicably without litigation, or that it will be able toenter into a licensing arrangement on terms and conditions that would not havea material adverse effect on the Company’s business, financial condition orresults of operations.

 

Other third parties could claim that our technologyinfringes their proprietary rights. Infringement claims, even if without merit,can be time consuming and expensive to defend. A third party asserting infringementclaims against us or our customers with respect to our current or futureproducts may require us to enter into costly royalty arrangements orlitigation, or otherwise materially adversely affect us.

 

From time to time, the Company is also involved incertain legal proceedings in the ordinary course of conducting our business.While the ultimate liability pursuant to these actions cannot currently bedetermined, the Company believes these legal proceedings will not have amaterial adverse effect on the Company’s financial position.

 

**6.    Special Charges**

 

On April 4, 2002, the Company commenced arestructuring program to reduce expense and improve efficiency due tomacro-economic and capital spending issues affecting our industry.  The restructuring program was substantiallycompleted by the end of the second quarter of 2002 and totaled approximately$682,000, which was classified as operating expenses.  The restructuring program consisted of reducing approximately 10%of the Company’s worldwide workforce. The reduction in staff affected most business functions and geographicregions.  Nearly all of the $682,000recorded as restructuring charges related to severance payments and fringebenefits.

 

**Item2.  Management’s Discussion and Analysisof Financial Condition and Results of Operations**

 

## *Forward-LookingInformation*

 

Certain statements inthis Form 10-Q contain “forward-looking” information (as defined in Section 27Aof the Securities Act of 1933, as amended) that involves risks anduncertainties, which may cause actual results to differ materially from thosepredicted in the forward-looking statements. Forward-looking statements can beidentified by their use of such verbs as “expects,” “anticipates,” and“believes” or similar verbs or conjugations of such verbs. If any of ourassumptions on which the statements are based prove incorrect or shouldunanticipated circumstances arise, our actual results could materially differfrom those anticipated by such forward-looking statements. The differences couldbe caused by a number of factors or combination of factors, including, but notlimited to, the “Factors Affecting Operating Results” described herein and theRisk Factors described in our Securities and Exchange Commission filings,including the Form 10-K filing for the year ended December 31, 2001.

 

6

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### *Overview*

 

We commenced operations in October 1994. Throughthe end of 1996, we focused primarily on research and development activities.Our first product was released in March 1997. In 1997 and 1998, weexpanded our operations to capitalize on the increased market demand forcommunications and interaction management software. We decided, at the expenseof profitability, to continue investing significantly in research anddevelopment, and to accelerate our investments in marketing, services and salesoperations. We had no revenue in 1996, and our total revenues were$1.6 million in 1997, $9.0 million in 1998, $19.1 million in1999, $38.6 million in 2000, and $50.1 million in 2001.   Our revenues have declined in 2002 and wecannot assure you that our revenues in the future.    Webelieve our investments in research and development and in marketing, servicesand sales operations will continue to be critical to our revenue growth.However, these investments have also significantly increased our operatingcosts and expenses, contributing to the net losses and operating losses that wehave incurred in each fiscal quarter since our formation. In addition, we maycontinue to experience losses and negative cash flows from operations in futurequarters. We cannot assure you when or if we will achieve profitability or, ifachieved, that we will be able to sustain profitability. Our operating resultshave varied significantly from quarter to quarter and may continue to do so inthe future. As a result, we believe that period-to-period comparisons of ouroperating results are not necessarily meaningful, and you should not rely onthem as an indication of our future performance.

 

On April 4, 2002, we commenced a restructuring programto reduce expenses and improve efficiency due to macro-economic and capitalspending issues affecting our industry. The restructuring program resulted in the reduction of approximately 10%of the worldwide workforce.  This reduction affected most businessfunctions and geographic regions.  The financial impact of therestructuring and other special charges was $682,000, which was expensed in the second quarter of 2002.

 

**Sources of Revenue and RevenueRecognition Policy**

 

We generate a majority of our revenues from softwarelicense fees. Most of our software license fees originate from the marketingefforts of our resellers, who are authorized to place software orders with uson behalf of end-user customers. We share end-user customer software licensefees with these resellers in varying percentages of our list price, accordingto the terms of their reseller agreements. In addition to generating softwarelicense fees indirectly through resellers, we also receive some softwarelicense fees from end-user customers that we deal with directly.

 

In accordance with AICPA Statement of Position (SOP)97-2 as amended by SOP 98-4 and SOP 98-9, software license revenues can berecognized upon the shipment of software if:

 

• persuasiveevidence of an arrangement exists,

• sufficientvendor-specific objective evidence exists to support allocating the total feeto all elements of the arrangement,

• the fee isfixed or determinable, and

• collectionis probable.

 

As a result, we typically recognize software licensefees only when a reseller places a binding order for our software, which givesthe reseller the right to distribute our products to end-user customers, orwhen an end-user customer signs a binding contract which gives them the rightto use our software. If the order includes an acceptance period, we recognizerevenues upon the earlier of order acceptance or the expiration of theacceptance period.

 

We also generate revenues from services that weprovide to our resellers and end-user customers. Services revenues includeproduct maintenance revenues, which consist of technical support and productupgrades, educational services and professional services. Our initial softwarelicense generally includes one

 

7

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year of maintenance. Generally, to continue using our software afterthis initial period, our end-user customers must purchase annual ongoingproduct maintenance, which is priced at approximately 18% of the current listprice of the licensed product. We share maintenance revenues with thoseresellers who provide first-level technical support according to the terms oftheir reseller agreements. When these revenues are shared with resellers, wetypically receive between 50% and 70% of the amount charged to the end-usercustomer. We recognize product maintenance revenues on a straight-line basisover the term of the initial software license and each subsequent annualproduct maintenance purchase. Revenues from educational services, which consistof training courses for resellers and end-user customers, and professionalservices, which include implementing and customizing our products for anend-user customer, are typically recognized as the related services are performed.

 

8

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*HistoricalResults of Operations*

 

The following table presents certain financial data,derived from our unaudited statements of operations, as a percentage of totalrevenues for the periods indicated.  Theoperating results for the three and nine months ended September 30, 2002 and2001 are not necessarily indicative of the results that may be expected for thefull year or for any future period.

 
|                        |   | **Three  months ended  September 30,** |   | **Nine  months ended  September 30,** |       |
|-----------------------------|--------|----------------------------------------|--------|---------------------------------------|------------|
|                        |   | **2002**                               |   | **2001**                              | ** ** | **2002** | ** ** | **2001** | ** ** |
| Revenues:                   |   |                                   |   |                                  |       |   |   |   |   |
| Software                    |   | 56                                     | %      | 65                                    | %          | 58 | % | 67 | % |
| Services                    |   | 44                                     |   | 35                                    |       | 42 |   | 33 |   |
| Total revenues              |   | 100                                    |   | 100                                   |       | 100 |   | 100 |   |
|                        |   |                                   |   |                                  |       |   |   |   |   |
| Costs and  expenses:        |   |                                   |   |                                  |       |   |   |   |   |
| Costs of  software          |   | 3                                      |   | 2                                     |       | 3 |   | 1 |   |
| Costs of  services          |   | 25                                     |   | 27                                    |       | 26 |   | 28 |   |
| Sales and  marketing        |   | 44                                     |   | 45                                    |       | 47 |   | 45 |   |
| Research and  development   |   | 32                                     |   | 32                                    |       | 34 |   | 31 |   |
| General and  administrative |   | 12                                     |   | 14                                    |       | 13 |   | 14 |   |
| Special Charges             |   | —                                 |   | 9                                     |       | 2 |   | 3 |   |
| Total costs and  expenses   |   | 116                                    |   | 129                                   |       | 125 |   | 122 |   |
|                        |   |                                   |   |                                  |       |   |   |   |   |
| Operating loss              |   | (16                                    | )      | (29                                   | )          | (25 | ) | (22 | ) |
| Interest income             |   | 1                                      |   | 3                                     |       | 1 |   | 3 |   |
| Loss before  income taxes   |   | (15                                    | )      | (26                                   | )          | (24 | ) | (19 | ) |
| Income taxes                |   | —                                 |   | 1                                     |       | 1 |   | 1 |   |
| Net loss                    |   | (15                                    | )%     | (27                                   | )%         | (25 | )% | (20 | )% |

 

### *Revenues*

 

Our total revenues decreased 3% from $11.9 million forthe three months ended September 30, 2001 to $11.6 million for the three monthsended September 30, 2002.  Totalrevenues decreased 11% from $37.4 million for the nine months ended September30, 2001, to $33.4 million for the nine months ended September 30, 2002.  Non-North American revenues slightlyincreased from  $2.3 million for thethree months ended September 30, 2001 to $2.4 million for the three monthsended September 30, 2002.  However,overall non-North American revenues decreased from $8.3 million for the ninemonths ended September 30, 2001 to $5.4 million for the nine months endedSeptember 30, 2002.  Our revenues arederived primarily from software license fees and charges for services,including product maintenance, education services, and professional services.The decrease in total revenues resulted from lower software sales.  While it is difficult to project revenues inthe current economic environment, we currently anticipate software revenueswill continue to represent the majority of our revenues for the foreseeablefuture.

 

*Software.*  Our software revenues decreased 17% from$7.8 million for the three months ended September 30, 2001, to $6.5 million forthe three months ended September 30, 2002. Software revenues decreased 22% from $25.1 million for the nine monthsended September 30, 2001, to $19.5 million for the nine months ended September30, 2002.  We believe the decrease insoftware revenues resulted from a continued weak economic environment, particularlyin the technology markets, causing many of our customers to delay and/or reducetheir capital spending.

 

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*Services.*  Services revenues increased 25% from $4.1million for the three months ended September 30, 2001, to $5.1 million for thethree months ended September 30, 2002. Services revenues increased 14% from $12.3 million for the nine monthperiod ended September 30, 2001, to $13.9 million for the nine month periodended September 30, 2002.  The increasein service revenues was primarily due to an increase in product maintenancerevenues which is related to our growing installed base of end-user customers.

 

 

### *Cost and Expenses*

 

### *Our*total costs and expenses decreased 12% from $15.4million for the three months ended September 30, 2001, to $13.5 million for thethree months ended September 30, 2002. Similarly, total costs and expenses decreased 9% from $45.7 million forthe nine months ended September 30, 2001, to $41.7 million for the nine monthsended September 30, 2002.  The decrease in amount was primarily due tothe result of the implementation of our restructuring plans to reduce expensesand due to lower software revenues.

 

*Costsof Software*.  Costs ofsoftware consist primarily of product royalties paid to third-parties for theuse of their technologies in our products and, to a lesser extent, softwarepackaging costs, which include product media, duplication anddocumentation.  Costs of softwareincreased from $246,000 for the three months ended September 30, 2001, to$296,000 for the three months ended September 30, 2002. This represents 3% and5% of software revenues for the three months ended September 30, 2001 and 2002,respectively.  Costs of softwareincreased from $549,000 for the nine months ended September 30, 2001 to$874,000 for the nine months ended September 30, 2002. This represents 2% ofsoftware revenues for the nine months ended September 30, 2001 and 4% ofsoftware revenues for the nine months ended September 30, 2002. The dollarincreases were primarily due to royalties owed as a result of higher softwarerevenues associated with our Interaction Center  PlatformTM and other related products. We expect product royaltiesto continue to increase as we release additional products, release additionalversions of our existing products, and integrate additional third-partyfunctions and features into our product offerings.

 

*Costsof Services.*  Costs ofservices consist primarily of compensation expenses for technical support,education, and professional services personnel and other costs associated withsupporting and enabling our resellers and end-user customers.  Costs of services decreased from $3.2million for the three months ended September 30, 2001, to $2.9 million for thethree months ended September 30, 2002. Costs of services decreased from $10.5 million for the nine months endedSeptember 30, 2001, to $8.8 million for the nine months ended September 30,2002.  As a percentage of servicerevenues, costs of services decreased from 77% to 57% for the three months ended September 30, 2001 and 2002,respectively, and decreased from 85% to 63% for the nine months ended September30, 2001 and 2002, respectively. The dollar decrease was the result of areduction in employees and expenditures as part of our restructuring plans andincreased operating efficiencies.

 

*Salesand Marketing.*  Salesand marketing expenses consist of trade shows, advertising, telemarketingcampaigns, public relations and other promotional expenses, compensationexpenses, including sales commissions, and travel expenses.  Sales and marketing expenses decreased from$5.4 million for the three months ended September 30, 2001, to $5.2 million forthe three months ended September 30, 2002. Sales and marketing expenses decreased from $16.7 million for the ninemonths ended September 30, 2001 to $15.7 million for the nine months ended September30, 2002.  The decrease was the resultof a reduction in employees and marketing program expenditures following theimplementation of our restructuring plans, and decreased commissions due tolower sales. As we continue to focus on sales growth and develop awareness forour products, we plan to continue investing significantly in sales andmarketing efforts.

 

*Researchand Development.* Research and development expenses consist primarily of compensationexpenses for our developers and third party efforts to develop and enhance ourproducts, including adapting our products for specific non-English languagesand allowing our products to effectively run with

 

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alternative hardware configurations. Research and development expenses decreased from $3.8 million for thethree months ended September 30, 2001, to $3.7 million for the three monthsended September 30, 2002.   Research anddevelopment expenses decreased from $11.6 million for the nine months endedSeptember 30, 2001, to $11.4 million for the nine months ended September 30,2002.  Currently, all costs related toresearch and development of our products are charged to research anddevelopment expense as incurred.  Thesedecreases are the result of a reduction in employees following theimplementation of our restructuring plans. We believe that a significant investment in research and development hasbeen, and will continue to be, critical to market acceptance of our products.

 

*Generaland Administrative.* General and administrative expenses consist primarily of compensationfor our administrative, financial, and information technology personnel, and anumber of non-allocable costs, including legal and other professional servicefees.  General and administrativeexpenses decreased from $1.6 million for the three months ended September 30,2001, to $1.4 million for the three months ended September 30, 2002.  General and administrative expensesdecreased from $5.3 million for the nine months ended September 30, 2001 to$4.2 million for the nine months ended September 30, 2002.  The decreases were primarily due to lowerbad debt expense and savings associated with our restructuring initiatives,including lower staffing levels and cost controls.

 

*Special Charges.*  For the nine months ended September 30,2002, we incurred a special charge of $682,000, primarily consisting ofseverance, benefits and other related costs from the reduction of our workforceby 10%, or approximately 45 people. Global functions impacted by the restructuring included sales and salesinfrastructure, support services, marketing, research and development, andadministration.

 

### *Interest income, net*

 

Interest income, net is generated primarily frominvested funds from our initial public offering completed in September 1999 andthe equity investment made by Cisco Systems, Inc. (“Cisco”) on January 25,2001.  Net interest income decreasedfrom $274,000 for the three months ended September 30, 2001 to $86,000 for thethree months ended September 30, 2002. Net interest income decreased from $941,000 for the nine months endedSeptember 30, 2001 to $319,000 for the nine months ended September 30,2002.  This decrease can be attributedto the decrease in interest rates and less cash on hand.

### * *

### *Income taxes*

 

For U.S. corporate incometax purposes, we did not recognize a tax benefit related to U.S. federal orstate income taxes during the three months or nine months ended September 30,2001 or September 30, 2002 because of the uncertainty of eventually realizingthese benefits.  However, we didrecognize a tax expense related to our international operations of $50,000 forthe three months ended September 30, 2002, and $179,000 for the nine monthsended September 30, 2002.

### * *

### *Liquidity and Capital Resources*

 

As of September 30, 2002,we had cash and cash equivalents of $5.6 million, $11.7 million in short terminvestments, and a working capital balance of $11.4 million.

 

In September 1999, wesold 3.0 million shares of common stock in our initial public offering,generating $39.0 million in cash, before offering expenses. Prior to ourinitial public offering, we funded our operations primarily through equity anddebt infusions from our principal stockholder, Dr. Brown, and a $5.0 millionequity investment by Dialogic Investment Corporation (formerly a subsidiary ofDialogic Corporation), and borrowings under commercial lines of credit.

 

On January 25, 2001 wereceived an equity investment from Cisco Systems, Inc.  We sold 515,517 shares of common stock at aprice of $29.00 per share, yielding approximately $15.0 million in cash.

 

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Our operating activitiesresulted in net cash outflows of $2.7 million for the nine months endedSeptember 30, 2002 and $2.0 million for the nine months ended September 30,2001.  The net operating cash outflowfor the first nine months of 2002 was primarily due to the operating loss,partially offset by an increase in accounts receivable and the non-cashdepreciation amount.  The net operatingcash outflow for the first nine months of 2001 was primarily due to theoperating loss, primarily offset by an increase in deferred revenue andthe non-cash depreciation amount.

 

Our investing activities have consisted primarily ofcapital expenditures for property and equipment and purchases and sales ofinvestments.  Our activities resulted ina $6.6 million outflow for the nine month period ended September 30, 2002 and a$8.4 million outflow for the nine month period ending September 30, 2001.  The difference in cash outflow between thefirst nine months of 2001 and 2002 was attributed to lower capital expendituresfor property and equipment.  AtSeptember 30, 2002, we did not have any material commitments for future capitalexpenditures.

 

In April 2001, we enteredinto a 15 year non-cancelable lease agreement for a new, approximately 120,000square foot corporate headquarters building with a targeted occupation date ofApril 2003.  Over the life of the lease,we are committed to expend approximately $35.0 million in rent payments.

 

For the nine months ended September 30, 2002 wegenerated $447,000 in net proceeds from financing activities attributed to theissue of common stock and stock option exercises.

 

Our line of credit expired on June 22, 2002 and we didnot renew the line of credit.  At thetime of expiration, we were in compliance with all related covenants andrestrictions.

 

We believe that our existing cash and cash equivalentsand short-term investments will be sufficient to meet our working capital andcapital expenditure requirements for at least the next 12 months. After thattime, we may require additional funds to support our working capitalrequirements or for other corporate purposes, and we may seek to raiseadditional funds through public or private equity or debt financings or fromother sources. We cannot assure you that additional financing will be availableat all or that, if available, will be on terms favorable to us or that anyadditional financing will not dilute your ownership interest in InteractiveIntelligence.

 

*FactorsAffecting Operating Results*

 

**WEHAVE HISTORICALLY INCURRED LOSSES AND WE MAY NOT ACHIEVE PROFITABILITY**

 

We have not operatedprofitably to date. We incurred net losses of $9.0 million, $4.6 million, and$7.1 million in 2001, 2000, and 1999, respectively. At September 30, 2002, wehad accumulated losses since inception of $43.5 million. We intend to continueto make significant investments in our research and development, marketing,services and sales operations. We anticipate that these expenses couldsignificantly precede any revenues generated by the increased spending. As aresult, we may continue to experience losses and negative cash flow fromoperations in future quarters. If we do become profitable, we may not sustainor increase our profitability.

 

**OURQUARTERLY OPERATING RESULTS HAVE VARIED SIGNIFICANTLY AND, IF SEVERAL****FACTORSAFFECTING OUR BUSINESS CAUSE THEM TO CONTINUE TO DO SO, THE MARKET PRICE OF OURCOMMON STOCK COULD BE AFFECTED**

 

Our operating resultshave varied significantly from quarter to quarter and may continue to do so inthe future depending on a number of factors affecting us or our industry,including many that are beyond our control. As a result, we believe thatperiod-to-period comparisons of our operating results are not necessarilymeaningful, and you should not rely on them as an indication of our futureperformance. In

 

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addition, our operating results in a future quarter orquarters may fall below expectations of securities analysts or investors and,as a result, the price of our common stock may fluctuate.

 

Because we do not knowwhen our potential end-user customers will place orders and finalize contracts,we cannot accurately forecast our revenues and operating results for futurequarters. We recognize revenues on satisfaction of the requirements of AICPAStatement of Position 97-2, which generally occurs in the same quarter that theorder is received. As a result, our quarterly revenues and operating resultsdepend primarily on the size, quantity and timing of orders received for ourproducts during each quarter. If a large number of orders or several largeorders do not occur or are deferred or delayed, our revenues in a quarter couldbe substantially reduced. This risk is heightened by the significant investmentand executive level decision making typically involved in our end-usercustomers’ decisions to license our products. Since a large portion of ouroperating expenses, including rent and salaries, is fixed and difficult toreduce or modify, our business, financial condition or results of operationscould be materially adversely affected if revenues do not meet ourexpectations.

 

Because of our limitednumber of products, changes in pricing policies and the timing of thedevelopment, announcement and sale of new or upgraded versions of our productsare some of the additional factors that could cause our revenues and operatingresults to vary significantly from quarter to quarter.

 

**WEHAVE A LENGTHY PRODUCT SALES CYCLE, WHICH HAS CONTRIBUTED, AND MAY CONTINUE****TOCONTRIBUTE, TO THE QUARTER-TO-QUARTER VARIABILITY OF OUR REVENUES AND****OPERATINGRESULTS, WHICH COULD AFFECT THE MARKET PRICE OF OUR COMMON STOCK**

 

We have generallyexperienced a lengthy product sales cycle, averaging approximately six to ninemonths. The lengthy sales cycle is one of the factors that has caused, and mayin the future continue to cause, our software revenues and operating results tovary significantly from quarter to quarter, which could affect the market priceof our common stock. It also makes it difficult for us to forecast productlicense revenues. Because of the unique characteristics of our products, ourprospective end-user customers’ decisions to license our products often requiresignificant investment and executive level decision making. We believe thatmany companies currently are not aware of the benefits of interactionmanagement software of the type we license or of our products and capabilities.For this reason, we must provide a significant level of education toprospective end-user customers about the use and benefits of our products,which can cause potential end-user customers to take many months to make thesedecisions. As a result, sales cycles for end-user customer orders varysubstantially from customer to customer. Excessive delay in product sales couldmaterially adversely affect our business, financial condition or results ofoperations.

 

The length of the salescycle for end-user customer orders depends on a number of other factors overwhich we have little or no control, including:

 

• an end-user customer’s budgetary constraints;

 

• the timing of an end-user customer’s budget cycles;

 

• concerns by end-user customers about the introductionof new products by us or our competitors; and

 

• downturns in general economic conditions, includingreductions in demand for call center services.

 

In addition, the sales cycle for our products ininternational markets has been, and is expected to continue to be, longer thanthe sales cycle in the United States. The average sales cycle for our productsmay lengthen as we expand internationally.

 

**OURINABILITY TO MANAGE SUCCESSFULLY OUR INCREASINGLY COMPLEX****THIRD PARTYRELATIONSHIPS COULD ADVERSELY AFFECT US**

 

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As the complexity of ourproduct technology and our reseller and other third-party relationships haveincreased, the management of those relationships and the negotiation of contractualterms sufficient to protect our rights and limit our potential liabilities hasbecome more complicated, and we expect this trend to continue in the future. Asa result, our inability to successfully manage these relationships or negotiatesufficient contractual terms could have a material adverse effect on us.

 

**WEFACE COMPETITIVE PRESSURES, WHICH MAY HAVE A MATERIAL ADVERSE EFFECT ON US**

 

The market for oursoftware products is highly competitive and, because there are relatively lowbarriers to entry in the software market, we expect competition to increasesignificantly in the future. In addition, because our industry is new andevolving and characterized by rapid technological change, it is difficult forus to predict whether, when and by whom new competing technologies or newcompetitors may be introduced into our markets. Currently, our competitioncomes from several different market segments, including computer telephonyplatform developers, computer telephony applications software developers, telecommunicationsequipment vendors and data networking equipment vendors. We cannot assure youthat we will be able to compete effectively against current and futurecompetitors. In addition, increased competition or other competitive pressuresmay result in price reductions, reduced margins or loss of market share, any ofwhich could have a material adverse effect on our business, financial conditionor results of operations.

 

Many of our current andpotential competitors have longer operating histories, significantly greaterfinancial, technical, marketing, customer service and other resources, greatername recognition and a larger installed base of customers than we do. As aresult, these competitors may be able to respond to new or emerging technologiesand changes in customer requirements faster and more effectively than we can,or to devote greater resources to the development, promotion and sale ofproducts than we can. Current and potential competitors have established, andmay in the future establish, cooperative relationships among themselves or withthird parties, including mergers or acquisitions, to increase the ability oftheir products to address the needs of our current or prospective end-usercustomers. If these competitors were to acquire significant market share, itcould have a material adverse effect on our business, financial condition orresults of operations.

 

**WEMAY NOT BE ABLE TO GROW OUR BUSINESS IF WE DO NOT MAINTAIN****SUCCESSFULRELATIONSHIPS WITH OUR RESELLERS AND OEM PARTNERS AND CONTINUE TO RECRUIT ANDDEVELOP****ADDITIONAL SUCCESSFUL RESELLERS AND OEM PARTNERS**

 

Our ability to achieverevenue growth in the future will depend in part on our success in maintainingsuccessful relationships with our existing and future resellers and OEM partnersand in recruiting and training additional resellers and OEM partners. We relyprimarily on resellers to market and support our products, and plan on relyingmore on our OEM partners in the future. We are still developing and refiningour reseller and OEM distribution networks and may be unable to attractadditional resellers with both voice and data expertise or appropriate OEMpartners that will be able to market our products effectively and that will bequalified to provide timely and cost-effective customer support and service. Wegenerally do not have long-term or exclusive agreements with our resellers orOEM partners, and the loss of specific larger resellers or OEM partners or asignificant number of resellers or OEM partners could materially adverselyaffect our business, financial condition or results of operations.

 

**OURMARKETS ARE CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE WHICH MAY CAUSE US****TO INCURSIGNIFICANT DEVELOPMENT COSTS AND PREVENT US FROM ATTRACTING NEW****CUSTOMERS**

 

The market for ourproducts is characterized by rapid technological change, frequent new productintroductions and enhancements, uncertain product life cycles and changingend-user customer demands. The introduction of products embodying newtechnologies and the emergence of new industry standards

 

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could render existing products obsolete orunmarketable and cause us to incur significant development costs.

 

**THE GROWTH OF OUR BUSINESS MAY BEIMPEDED WITHOUT INCREASED USE OF THE INTERNET**

 

The use of the Internetas a commercial marketplace is at an early stage of development. Demand andmarket acceptance for recently introduced products and services available overthe Internet are still uncertain. In addition, governmental regulation of theInternet, such as imposing sales and other taxes, access charges, and pricingcontrols and inhibiting cross-border commerce, may reduce the use of theInternet by businesses for their electronic commerce and customer serviceneeds. To date, governmental regulations have not materially restrictedcommercial use of the Internet. However, the legal and regulatory environmentthat pertains to the Internet is uncertain and may change. New regulationscould reduce the use of the Internet by our end-user customers and, in turn,their customers. The lack of acceptance of the Internet as a forum forconducting business could reduce growth in demand for our products and limitthe growth of our revenue.

 

**OUR BUSINESS WILL BE ADVERSELYAFFECTED IF WEB-BASED ELECTRONIC BUSINESS SOLUTIONS ARE NOT WIDELY ADOPTED**

 

Our products address arelatively new and emerging market for Web-based, interactive electronicbusiness solutions. Therefore, our future success depends on the widespreadadoption of the Web as a primary medium for commerce and business applications.The failure of this market to develop, or a delay in the development of thismarket, could have a material adverse effect on our business, financialcondition or results of operations. The Web has experienced, and is expected tocontinue to experience, significant user and traffic growth, which has, attimes, caused user frustration with slow access and download times. The Webinfrastructure may not be able to support the demands placed on it by the continuedgrowth on which our success depends. Moreover, critical issues concerning thecommercial use of the Web, such as security, reliability, cost, accessibilityand quality of service, remain unresolved and may negatively affect the growthof Web use or the attractiveness of commerce and business communication overthe Web. In addition, the Web could lose its viability due to delays in thedevelopment or adoption of new standards and protocols to handle increasedactivity or due to increased government regulation and taxation of Internetcommerce.

 

**ADECLINE IN MARKET ACCEPTANCE FOR MICROSOFT CORPORATION TECHNOLOGIES ON WHICH****OURPRODUCTS RELY COULD HAVE A MATERIAL ADVERSE EFFECT ON US**

 

Our products currentlyrun only on Microsoft Windows 2000® servers. In addition, our products useother Microsoft Corporation technologies, including Microsoft Exchange Server®and Microsoft SQL Server®. A decline in market acceptance for Microsofttechnologies or the increased acceptance of other server technologies could causeus to incur significant development costs and could have a material adverseeffect on our ability to market our current products. Although we believe thatMicrosoft technologies will continue to be widely used by businesses, we cannotassure you that businesses will adopt these technologies as anticipated or willnot in the future migrate to other computing technologies that we do notcurrently support. In addition, our products and technologies must continue tobe compatible with new developments in Microsoft technologies.

 

**OURFUTURE BUSINESS PROSPECTS DEPEND IN PART ON OUR ABILITY TO MAINTAIN AND****IMPROVEOUR CURRENT PRODUCTS AND DEVELOP NEW PRODUCTS**

 

We believe that ourfuture business prospects depend in large part on our ability to maintain andimprove our current products and to develop new products on a timely basis. Ourproducts will have to achieve market acceptance, maintain technologicalcompetitiveness and meet an expanding range of end-user customer requirements.As a result of the complexities inherent in our products, major new productsand product enhancements require long development and testing periods. We maynot be successful in

 

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developing and marketing, on a timely and cost effectivebasis, product enhancements or new products that respond to technologicalchange, evolving industry standards or end-user customer requirements. We mayalso experience difficulties that could delay or prevent the successfuldevelopment, introduction or marketing of product enhancements, and our newproducts and product enhancements may not achieve market acceptance.Significant delays in the general availability of new releases of our productsor significant problems in the installation or implementation of new releasesof our products could have a material adverse effect on our business, financialcondition or results of operations.

 

**SLOWGROWTH, OR A DECLINE IN DEMAND FOR INTERACTION MANAGEMENT SOFTWARE OF THE TYPEWE****LICENSE, COULD MATERIALLY ADVERSELY AFFECT OUR GROWTHPROSPECTS**

 

If the demand forinteraction management software of the type we license does not grow withineach of our targeted markets, our ability to grow our business could bematerially adversely affected. All of our revenues have been generated fromlicenses of our Interaction Center Platformäsoftware or complementary products, and related support, educational andprofessional services. We expect these products and services to account for themajority of our revenues for the foreseeable future. Although we believe demandfor the functions performed by our products is high, the market for ourproducts and services is still emerging. Further, our growth plans require usto successfully attract enterprise and service provider end-user customers.

 

**IF OUR END-USER CUSTOMERS DO NOTPERCEIVE OUR PRODUCTS OR THE RELATED SERVICES PROVIDED BY US OR OUR RESELLERSOR OEM PARTNERS TO BE EFFECTIVE OR OF HIGH QUALITY, OUR BRAND AND NAMERECOGNITION WILL SUFFER**

 

We believe thatestablishing and maintaining brand and name recognition is critical forattracting, retaining and expanding end-user customers in our target markets.We also believe that the importance of reputation and name recognition willincrease as competition in our market increases. Promotion and enhancement ofour name will depend on the effectiveness of our marketing and advertisingefforts and on our success in providing high-quality products and relatedservices, neither of which can be assured. If our end-user customers do notperceive our products or related services to be effective or of high quality,our brand and name recognition would suffer which could have a material adverseeffect on our business, financial condition or results of operations.

 

**IFWE ARE UNABLE TO ADAPT OUR SOFTWARE IN A WAY THAT WILL PERMIT US TO SERVE****LARGE,SINGLE-SITE END-USER CUSTOMERS, THE MARKETABILITY OF OUR PRODUCTS COULD BE****ADVERSELYAFFECTED**

 

Our products cannotcurrently meet the communications needs of organizations with more than 500users at a single call center location. As these organizations expand to include multiple locations, ourproducts can be customized to increase the number of telephone lines,extensions and users. We will need to adapt our software to serve largersingle-site organizations.  Although weare currently developing and testing solutions that would enable our softwareto significantly increase the number of users that our products can serve at asingle location, we cannot assure you that we will be able to successfullyintroduce this technology into a currently available version of ourproducts.  Further, we may not be ableto adapt our software in a timely or cost effective manner in a way that willpermit us to serve these customers. This inability could have a material adverseeffect on our business, financial condition or results of operations.

 

**OUR MAINSUPPLIERS OF VOICE PROCESSING BOARDS MAY BECOME UNWILLING OR UNABLE TO CONTINUETO MANUFACTURE AND SUPPLY US WITH VOICE PROCESSING BOARDS, REQUIRING US TOINTRODUCE A SUBSTITUTE SUPPLIER WHICH COULD PROVE DIFFICULT OR COSTLY**

 

Dialogic Corporation andAcuLab plc are our primary suppliers of the voice processing boards that areused by a majority of our end-user customers for the operation of ourproducts.  If a majority of future end-

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user customers desire to utilize the voice processingboards to enable our products and these suppliers become unable or unwilling tocontinue to manufacture and supply these voice processing boards in the volume,price and technical specifications we require, then we would have to adapt ourproducts to a substitute supplier.  Wemay not be able to successfully introduce voice processing boards made by asubstitute supplier into the available versions of our products. In addition,introducing a substitute supplier of voice processing boards could result inunforeseen additional product development or customization costs and could alsointroduce hardware and software operating or compatibility problems. We cannotassure you that these issues will not affect product shipments, will not becostly to correct, will not damage our reputation in the markets in which weoperate, or will not have a material adverse affect on our business, financialcondition or results of operations.

 

In addition, DialogicCorporation’s CT MediaTM  server softwareoffers some of the functionality that our Interaction Center Platformäproducts provide and consequently could make it easier for competitors orpotential competitors to provide products competitive with ours. If CT MediaTMserver software were to become an industry standard, our failure to adopt itcould disadvantage us in competitive situations.  In addition, although neither of our primary suppliers of voiceprocessing boards nor their affiliates currently offer a product that competeswith our Interaction Center Platformä products, theycould potentially develop a competitive or superior product.

 

**WEMAY NOT BE ABLE TO PROTECT OUR PROPRIETARY RIGHTS ADEQUATELY, WHICH COULD****ALLOWTHIRD PARTIES TO COPY OR OTHERWISE OBTAIN AND USE OUR TECHNOLOGY WITHOUT****AUTHORIZATION**

 

We regard our softwareproducts as proprietary. In an effort to protect our proprietary rights, werely primarily on a combination of copyright, trademark and trade secret laws,as well as licensing and other agreements with consultants, suppliers,strategic and OEM partners, resellers and end–user customers, andemployee and third–party non–disclosure agreements. These laws andagreements provide only limited protection of our proprietary rights. Inaddition, we have not signed agreements containing these types of protectiveprovisions in every case, and the contractual provisions that are in place andthe protection they provide vary and may not provide us with adequateprotection in all circumstances. We have filed patent applications directed toseveral inventions embodied in our software products.  We currently hold two patents. We hold eight U.S. trademark registrations and 21 foreign trademarkregistrations, and have numerous other trademark applications pendingworldwide, as well as having common law rights in other trademarks and servicemarks.  We hold one registeredcopyright. Because our means of protecting our proprietary rights may not beadequate, it may be possible for a third party to copy or otherwise obtain anduse our technology without authorization. A third party could also developsimilar technology independently. In addition, the laws of some countries inwhich we sell our products do not protect our software and intellectualproperty rights to the same extent as the laws of the United States.Unauthorized copying, use or reverse engineering of our products couldmaterially adversely affect our business, results of operations or financialcondition.

 

We license technologythat is embedded in our products from others. If one or more of these licensesterminates or cannot be renewed on satisfactory terms, we would have to modifythe affected products to use alternative technology or eliminate the affectedproduct function, either of which could have a material adverse effect on us.

 

**INFRINGEMENTCLAIMS COULD ADVERSELY AFFECT US**

 

In June 1999 andSeptember 1999, we received letters from a competitor in the call center marketclaiming that our products utilize technologies pioneered and patented by thatcompetitor.  Our patent counsel hasreviewed all of the patents listed in the letters.  Based on the advice of our patent counsel, we believe that ourproducts do not infringe any of the patents listed in either letter.  We have discussed our conclusion with thecompetitor and have also discussed possible licensing of certain technologiesfrom the competitor.  We cannot assureyou that this matter can be resolved amicably without litigation, or that we

 

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will ultimately be able to enter into a licensingarrangement on terms and conditions that would not have a material adverseeffect on our business, financial condition or results of operations.

 

In June 2000 and October 2001, we received letters from a competitor inthe outbound call center market claiming that our products utilize technologiespioneered and patented by the competitor. Although our patent counsel has not determined the validity of thesepatents, we have discussed the possible licensing of certain technologies fromthe competitor.  We cannot assure youthat these claims can be resolved amicably without litigation, or that we willbe able to enter into licensing arrangements on terms and conditions that wouldnot have a material adverse effect on our business, financial condition orresults of operations.

 

In July 2000, we receiveda letter from Avaya, Inc., a competitor in the call center market, claimingthat our products utilize technologies pioneered and patented by them.  As a result of subsequent discussions, weaccrued an appropriate amount for the licensing of certain technologies relatedto 2001 and prior years in the financial statements for the year ended December31, 2001.  An agreement was finalizedand executed in February 2002 and we believe the terms and conditions of thelicensing arrangement will not have a material adverse effect on our business,financial condition or results of operations.

 

In July 2002, we receiveda letter from a consulting firm which has been retained by a telecommunicationtechnology provider to develop and implement a licensing program based on thetechnology provider’s patents.  Theconsulting firm believes a licensing agreement between the Company and thetechnology provider is appropriate.  Ourpatent counsel is in the process of reviewing the patents listed in theletter.  To date, our patent counsel hasnot determined the validity or applicability of these patents.  We cannot assure you that this matter can beresolved amicably without litigation, or that we will be able to enter into alicensing arrangement on terms and conditions that would not have a materialadverse effect on our business, financial condition or results of operations.

 

Other third parties couldclaim that our technology infringes their proprietary rights. As the number ofsoftware products in our target markets increases and the functionality ofthese products overlap, we believe that software developers may faceinfringement claims. For example, various patent rights have been assertedagainst interfaces between PBX hardware and computer network systems. Althoughwe believe that our products do not infringe any of these patents because,among other reasons, our products are designed to replace PBXs and not tocreate such interfaces, if these patents were interpreted broadly, claims ofinfringement of these patents could have a material adverse affect on us.

 

Infringement claims, evenif without merit, can be time consuming and expensive to defend. A third partyasserting infringement claims against us or our customers with respect to ourcurrent or future products may require us to enter into costly royaltyarrangements or litigation, or otherwise materially adversely affect us.

 

**WEDEPEND ON KEY PERSONNEL AND WILL NEED TO RECRUIT ADDITIONAL SKILLED****PERSONNEL,FOR WHICH COMPETITION IS INTENSE, TO CONDUCT AND GROW OUR BUSINESS****EFFECTIVELY**

 

Our success depends inlarge part on the continued service of our key personnel, particularlyDr. Donald E. Brown, our Chief Executive Officer and principalstockholder.  The loss of the servicesof  Dr. Donald E Brown or any keypersonnel could have a material adverse effect on our business, financialcondition or results of operations.  Wedo not have key man life insurance on any of our employees.  Our future success also depends on ourability to attract, train, assimilate and retain additional qualifiedpersonnel. Competition for persons with skills in the software industry isintense, particularly for those with relevant technical and/or salesexperience. We cannot assure you that we will be able to retain our keyemployees or that we can attract, train, assimilate or retain other highlyqualified personnel in the future.

 

**OUR WORKFORCE REDUCTION AND FINANCIALPERFORMANCE MAY ADVERSELY AFFECT THE MORALE AND PERFORMANCE OF OUR PERSONNELAND OUR ABILITY TO HIRE NEW PERSONNEL**

 

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In connection with oureffort to streamline operations, reduce costs and rationalize our staffing andstructure, we had a reduction in both 2001 and April 2002 of our worldwideworkforce of approximately 10% each. There were and may continue to be substantial costs associated with theworkforce reductions related to severance and other employee-related  costs, and our restructuring plans may stillyield unanticipated consequences, such as attrition beyond our implementedreduction in workforce.  As a result,our ability to respond to unexpected challenges may be impaired and we may beunable to take advantage of new opportunities. The reduction in workforce mayreduce employee morale and may create concern among existing employees aboutjob security, which may lead to increased turnover.  These reductions in headcount may still subject us to the risk oflitigation.  In addition, recent tradinglevels of our common stock have decreased the value of the stock optionsgranted to employees pursuant to our stock option plans.  As a result of these factors, our remainingpersonnel may seek employment with larger, more established companies orcompanies they perceive as having less volatile stock prices.

 

**WEMAY PURSUE ACQUISITIONS THAT BY THEIR NATURE PRESENT RISKS AND THAT MAY NOT****BESUCCESSFUL**

 

In the future we maypursue additional acquisitions to diversify our product offerings and customerbase or for other strategic purposes. We have no prior history of makingmaterial acquisitions and we cannot assure you that any future acquisitionswill be successful. The following are some of the risks associated withacquisitions that could have a material adverse effect on our business,financial condition or results of operations:

 

•                  We cannot assurethat any acquired businesses will achieve anticipated revenues, earnings orcash flow.

 

•                  We may be unableto integrate acquired businesses successfully and realize anticipated economic,operational and other benefits in a timely manner, particularly if we acquire abusiness in a market in which we have limited or no current expertise, or witha corporate culture different from our own. If we are unable to integrateacquired businesses successfully, we could incur substantial costs and delaysor other operational, technical or financial problems.

 

•                  Acquisitionscould disrupt our ongoing business, distract management, divert resources andmake it difficult to maintain our current business standards, controls andprocedures.

 

•                  We may financefuture acquisitions by issuing common stock for some or all of the purchaseprice. This could dilute the ownership interests of our stockholders. We mayalso incur additional debt or be required to recognize amortization expenserelated to goodwill and other intangible assets purchased in futureacquisitions.

 

•                  We would becompeting with other firms, many of which have greater financial and otherresources, to acquire attractive companies. We believe this competition willincrease, making it more difficult to acquire suitable companies on acceptableterms.

 

**OURINTERNATIONAL OPERATIONS AND EXPANSION INVOLVE FINANCIAL AND OPERATIONAL****RISKS**

 

The expansion ofour international operations will require significant management attention andfinancial resources to establish additional foreign operations, hire additionalpersonnel and recruit additional international resellers. Non-North Americanrevenues accounted for 21%, 25%, and 19% of our total revenues in 2001, 2000,and 1999, respectively. To date, our products have been licensed outside NorthAmerica primarily in Western Europe, South Africa, and Australia. We are alsoexpanding our marketing efforts in Japan, Korea, China and Central and SouthAmerica. We intend to continue to expand our international operations and enteradditional international markets. Revenues from international expansion may beinadequate to cover the expenses of international expansion. In addition toforeign currency fluctuation risks described in the next risk factor, otherrisks inherent in our international business activities, in the countries inwhich we have licensed our products to date and in those countries in which weintend to expand, generally could include the following:

 

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•                  economic andpolitical instability;

 

•                  unexpectedchanges in foreign regulatory requirements and laws;

 

•                  tariffs andother trade barriers;

 

•                  timing, cost andpotential difficulty of adapting our software products to the local language inthose foreign countries that do not use the alphabet that English uses, such asJapan, Korea and China;

 

•                  lack ofacceptance of our products in foreign countries;

 

•                  longer salescycles and accounts receivable payment cycles;

 

•                  potentiallyadverse tax consequences; and

 

•                  restrictions onthe repatriation of funds.

 

**FLUCTUATIONS IN THE VALUE OFFOREIGN CURRENCIES COULD RESULT IN LOSSES**

 

Our internationalrevenues are generally denominated in U.S. Dollars with the exception of someEuropean resellers and end-user customers located in countries who have adoptedthe Euro as their official currency. Our international expenses are generally denominated in local foreigncurrencies. Although foreign currency translation gains and losses have beenimmaterial to date, fluctuations in exchange rates between the U.S. Dollar andother currencies could have a material adverse effect on our business, financialcondition or results of operations, and particularly on our operating margins.To date, we have minimally sought to hedge the risks associated withfluctuations in exchange rates, but we may more actively undertake to do so inthe future. Any hedging techniques we implement in the future may not besuccessful. Exchange rate fluctuations could also make our products moreexpensive than competitive products not subject to these fluctuations, whichcould adversely affect our revenues and profitability in international markets.

 

**OURPRODUCTS COULD HAVE DEFECTS FOR WHICH WE ARE POTENTIALLY LIABLE AND WHICH****COULDRESULT IN LOSS OF REVENUE, INCREASED COSTS OR LOSS OF OUR CREDIBILITY OR****DELAY INACCEPTANCE OF OUR PRODUCTS IN THE MARKET**

 

Our products,including components supplied by others, may contain errors or defects,especially when first introduced or when new versions are released. Despiteinternal product testing, we have in the past discovered software errors insome of our products after their introduction. Errors in new products orreleases could be found after commencement of commercial shipments, and thiscould result in additional development costs, diversion of technical and otherresources from our other development efforts, or the loss of credibility withcurrent or future end-user customers. This could result in a loss of revenue ordelay in market acceptance of our products, which could have a material adverseeffect on our business, financial condition or results of operations.

 

Our license agreementswith our end-user customers typically contain provisions designed to limit ourexposure to potential product liability and some contract claims. However, notall of these agreements contain these types of provisions and, where present,these provisions vary as to their terms and may not be effective under the lawsof some jurisdictions. A product liability, warranty, or other claim broughtagainst us could have a material adverse effect on our business, financialcondition or results of operations.

 

Because oursolution currently consists of our software running on a Windows NT® server andvoice processing boards, it is inherently more prone to performanceinterruptions for our end-user customers than traditional non-software basedproducts. Performance interruptions at our end-user customer sites, most ofwhich currently do not have back-up systems, could affect demand for ourproducts or give rise to claims against us.

 

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From time to time,we are also involved in certain legal proceedings in the ordinary course ofconducting our business. While the ultimate liability pursuant to these actionscannot currently be determined, we believe these legal proceedings will nothave a material adverse effect on our financial position.

 

**WEMAY NOT BE ABLE TO OBTAIN ADEQUATE FINANCING TO IMPLEMENT OUR STRATEGY**

 

Successfulimplementation of our strategy may require continued access to capital. If wedo not generate sufficient cash from operations, our growth could be limitedunless we are able to obtain capital through additional debt or equityfinancings. We cannot assure you that debt or equity financings will beavailable as required for acquisitions or other needs. Even if financing isavailable, it may not be on terms that are favorable to us or sufficient forour needs. If we are unable to obtain sufficient financing, we may be unable tofully implement our growth strategy.

 

**OUR STOCK PRICE HAS BEEN AND COULDCONTINUE TO BE HIGHLY VOLATILE**

 

Our stock pricehas been and could continue to be highly volatile due to a number of factors,including:

 

•                  actualor anticipated fluctuations in our operating results;

 

•                  announcementsby us, our competitors or our end–user customers;

 

•                  changesin financial estimates of securities analysts or investors regarding us, ourindustry, our competitors or our end-user customers;

 

•                  technologicalinnovationsby others;

 

•                  theoperating and stock price performance of other comparable companies or of ourcompetitors or end-user customers;

 

•                  thelow number of our shares typically traded in any trading session;

 

•                  theavailability for future sale, or sales, of a substantial number of shares ofour common stock in the public market; and

 

•                  generalmarketor economic conditions.

 

This risk may be heightened because our industry is new and evolving,characterized by rapid technological change and susceptible to the introductionof new competing technologies or competitors.

 

In addition, thestock market has experienced significant price and volume fluctuations thathave particularly affected the trading prices of equity securities of manytechnology companies, including us. These price and volume fluctuations oftenhave been unrelated to the operating performance of the affected companies. In thepast, following periods of volatility in the market price of a company’ssecurities, securities class action litigation has often been institutedagainst that company. This type of litigation, regardless of the outcome, couldresult in substantial costs and a diversion of management’s attention andresources, which could materially and adversely affect our business, financialcondition or results of operations.

 

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**Item 3. Quantitative and Qualitative Disclosures about MarketRisk.**

 

We developproducts in the United States and sell licenses in North America, Europe, theAsia/Pacific region, South Africa, and Central and South America. As a result,our financial results could be affected by various factors, including changesin foreign currency exchange rates or weak economic conditions in foreignmarkets. As most sales are currently made in U.S. dollars, a strengthening ofthe dollar could make our products less competitive in foreign markets.  Additionally, as our business matures inforeign markets, we may offer our products and services in certain localcurrencies.  As a result, we will besubject to foreign currency fluctuations which may have an adverse affect onthe company.

 

We manage ourinterest rate risk by maintaining an investment portfolio with debt instrumentsof high credit quality and relatively short average maturities. We also manageinterest rate risk by maintaining sufficient cash and cash equivalent balancessuch that we are typically able to hold our investments to maturity.

 

**Item4. Controls and Procedures.**

 

We maintain a setof disclosure controls and procedures that are designed to ensure thatinformation required to be disclosed by us in the reports filed by us under theSecurities Exchange Act of 1934, as amended (“Exchange Act”) is recorded,processed, summarized and reported within the time periods specified in theSEC’s rules and forms.  Within the 90days prior to the filing date of this report, we carried out an evaluation,under the supervision and with the participation of our management, includingour President and Chief Executive Officer and our Chief Financial Officer andTreasurer, of the effectiveness of the design and operation of our disclosurecontrols and procedures pursuant to Rule 13a-14 of the Exchange Act.  Based on that evaluation, our President andChief Executive Officer and our Chief Financial Officer and Treasurer concludedthat our disclosure controls and procedures are effective.

 

There have been no significant changes in our internal controls orother factors that could significantly affect those controls subsequent to thedate of their evaluation, including any corrective actions with regard tosignificant deficiencies and material weaknesses.

 

**P**ART II. OTHER INFORMATION

 

**Item1. Legal Proceedings.**

 

In June 1999 andSeptember 1999, we received letters from a competitor in the call center marketclaiming that our products utilize technologies pioneered and patented by thatcompetitor.  Our patent counsel has reviewedall of the patents listed in the letters. Based on the advice of our patent counsel, we believe that our productsdo not infringe any of the patents listed in either letter.  We have discussed our conclusion with thecompetitor and have also discussed possible licensing of certain technologiesfrom the competitor.  We cannot assureyou that this matter can be resolved amicably without litigation, or that wewill ultimately be able to enter into a licensing arrangement on terms andconditions that would not have a material adverse effect on our business,financial condition or results of operations.

 

In June 2000 andOctober 2001, we received letters from a competitor in the outbound call centermarket claiming that our products utilize technologies pioneered and patentedby the competitor.  Although our patentcounsel has not determined the validity of these patents, we have discussed thepossible licensing of certain technologies from the competitor.  We cannot assure you that these claims canbe resolved amicably without litigation, or that we will be able to enter intolicensing arrangements on terms and conditions that would not have a materialadverse effect on our business, financial condition or results of operations.

 

In July 2000, wereceived a letter from Avaya, Inc., a competitor in the call center market,claiming that our products utilize technologies pioneered and patented bythem.  As a result of subsequentdiscussions, we accrued an appropriate amount for the licensing of certaintechnologies related to 2001 and prior years in the financial statements forthe year ended December 31, 2001.  Anagreement was finalized

 

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and executed inFebruary 2002 and we believe the terms and conditions of the licensingarrangement will not have a material adverse effect on our business, financialcondition or results of operations.

 

In July 2002, wereceived a letter from a consulting firm which has been retained by atelecommunication technology provider to develop and implement a licensingprogram based on the technology provider’s patents.  The consulting firm believes a licensing agreement between theCompany and the technology provider is appropriate.  Our patent counsel is in the process of reviewing the patentslisted in the letter.  To date, ourpatent counsel has not determined the validity or applicability of thesepatents.  We cannot assure you that thismatter can be resolved amicably without litigation, or that we will be able toenter into a licensing arrangement on terms and conditions that would not havea material adverse effect on our business, financial condition or results ofoperations.

 

Other thirdparties could claim that our technology infringes their proprietary rights. Asthe number of software products in our target markets increases and thefunctionality of these products overlap, we believe that software developersmay face infringement claims. For example, various patent rights have beenasserted against interfaces between PBX hardware and computer network systems.Although we believe that our products do not infringe any of these patentsbecause, among other reasons, our products are designed to replace PBXs and notto create such interfaces, if these patents were interpreted broadly, claims ofinfringement of these patents could have a material adverse affect on us.

 

Infringementclaims, even if without merit, can be time consuming and expensive to defend. Athird party asserting infringement claims against us or our customers withrespect to our current or future products may require us to enter into costlyroyalty arrangements or litigation, or otherwise materially adversely affectus.

 

**Item5. Other Information.**

 

Mr. Phillip A. Bounsallresigned from our Board of Directors and related Committees.  He advised us that his resignation was dueto personal reasons.  At the Board ofDirectors meeting on November 12, 2002, the remaining Board members elected Mr.McWhirter to fill the vacancy created by the resignation of Mr. Bounsall.  Mr. McWhirter retired from Peoples Bank& Trust where he served as Chairman of the Board and Chief ExecutiveOfficer.  Mr. McWhirter currently serveson the Executive Committee and is Chairman Emeritus of Fifth Third Bank,Indiana.

 

**Item6. Exhibits and Reports on Form 8-K.**

 

(a)          Exhibits

 

99.1 Certificationpursuant to 18 U.S.C  Section 1350,Donald E. Brown, CEO

 

99.2 Certificationpursuant to 18 U.S.C Section 1350, Keith A. Midkiff, CFO

 

 

(b)         Reports on Form 8-K

No reports on Form 8-Kwere filed during the quarter covered by this Form 10-Q.

 

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**SIGNATURES**

 

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned thereunto duly authorized.

 
|                    | Interactive Intelligence, Inc.                                  |         |
|-------------------------|-----------------------------------------------------------------|--------------|
|                    |                                                            | (Registrant) |   |
|                    |                                                            |         |
| Date: November 14, 2002 | By  /s/ Keith  A. Midkiff                                  |         |   |
|                    |                                                            |         |
|                    | Keith A. Midkiff                                                |         |
|                    | Chief Financial Officer, Secretary and Treasurer                |         |
|                    | (Principal Financial Officer and Principal  Accounting Officer) |         |
|                         |                                                                 |              |  |  |

 

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**CERTIFICATIONS**

 

I, Donald E. Brown, M.D., certify that:

 

1.             I have reviewed this quarterly report on Form 10-Q ofInteractive Intelligence, Inc.;

 

2.             Based on my knowledge, this quarterly report does notcontain any untrue statement of a material fact or omit to state a materialfact necessary to make the statements made, in light of the circumstances underwhich such statements were made, not misleading with respect to the periodcovered by this quarterly report;

 

3.             Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.             Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)             designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

 

b)            evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

c)             presented in this quarterly report our conclusions aboutthe effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.             Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)             all significant deficiencies in the design or operationof internal controls which could adversely affect the registrant’s ability torecord, process, summarize and report financial data and have identified forthe registrant’s auditors any material weaknesses in internal controls; and

 

b)            any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.             Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

Date: November 14, 2002

 

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|   | /s/ Donald E. Brown                   |   |
|--------|---------------------------------------|--------|
|   | Donald E. Brown, M.D.                 |
|   | President and Chief Executive Officer |

 

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**CERTIFICATION**

 

I, Keith A. Midkiff, certify that:

 

1.             Ihave reviewed this quarterly report on Form 10-Q of Interactive Intelligence,Inc.;

 

2.             Basedon my knowledge, this quarterly report does not contain any untrue statement ofa material fact or omit to state a material fact necessary to make the statementsmade, in light of the circumstances under which such statements were made, notmisleading with respect to the period covered by this quarterly report;

 

3.             Basedon my knowledge, the financial statements, and other financial informationincluded in this quarterly report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant asof, and for, the periods presented in this quarterly report;

 

4.             Theregistrant’s other certifying officer and I are responsible for establishingand maintaining disclosure controls and procedures (as defined in Exchange ActRules 13a-14 and 15d-14) for the registrant and we have:

 

a)             designed such disclosure controls and procedures toensure that material information relating to the registrant, including itsconsolidated subsidiaries, is made known to us by others within those entities,particularly during the period in which this quarterly report is beingprepared;

 

b)            evaluated the effectiveness of the registrant’sdisclosure controls and procedures as of a date within 90 days prior to thefiling date of this quarterly report (the “Evaluation Date”); and

 

c)             presented in this quarterly report our conclusions aboutthe effectiveness of the disclosure controls and procedures based on ourevaluation as of the Evaluation Date;

 

5.             Theregistrant’s other certifying officer and I have disclosed, based on our mostrecent evaluation, to the registrant’s auditors and the audit committee ofregistrant’s board of directors (or persons performing the equivalentfunction):

 

a)             all significant deficiencies in the design or operationof internal controls which could adversely affect the registrant’s ability torecord, process, summarize and report financial data and have identified forthe registrant’s auditors any material weaknesses in internal controls; and

 

b)            any fraud, whether or not material, that involvesmanagement or other employees who have a significant role in the registrant’sinternal controls; and

 

6.             Theregistrant’s other certifying officer and I have indicated in this quarterlyreport whether or not there were significant changes in internal controls or inother factors that could significantly affect internal controls subsequent tothe date of our most recent evaluation, including any corrective actions withregard to significant deficiencies and material weaknesses.

 

Date: November 14, 2002

 

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|   | /s/ Keith A. Midkiff                  |   |
|--------|---------------------------------------|--------|
|   | Keith A. Midkiff                      |
|   | Chief Financial Officer and Treasurer |

 

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