**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 ended  March 31, 2003**                                                                                                                                                                                                                                                                         |
|                                                                                                                                                                                                                                                                                                                       |                                                                                                                                 |
| **Or**                                                                                                                                                                                                                                                                                                                     |
|                                                                                                                                                                                                                                                                                                                       |                                                                                                                                 |
|                                                                                                                                                                                                                                                                                                                       | **o****     TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**     |
|                                                                                                                                                                                                                                                                                                                       |                                                                                                                                 |
| **For the transition period from                         to                       ** |
|                                                                                                                                                                                                                                                                                                                       |                                                                                                                                 |
| **Commission  File Number 000-27385**                                                                                                                                                                                                                                                                                      |

 

| **INTERACTIVE  INTELLIGENCE, INC.**                             |
|-----------------------------------------------------------------|
| (Exact name of registrant as specified in its charter)          |
|                                                            |   |   |
| **Indiana**                                                     |   | **35-1933097** |
| (State or other jurisdiction of  incorporation or organization) |   | (IRS Employer Identification No.) |
|                                                            |   |   |
| **7601  Interactive Way  Indianapolis, Indiana 46278**          |
| (Address of principal executive offices)                        |
|                                                            |   |   |
| **(317) 872-3000**                                              |
| (Registrant’s telephone number)                            |

 

Indicate by checkmark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

 

Yes  ý  No  o

 

Indicate by check mark whether the registrant is anaccelerated filer (as defined in Rule 12b-2 of the Exchange Act).  Yeso No ý

 

The number of shares of common stock outstanding onApril 30, 2003 was 15,598,947.

 

 

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TABLE OF CONTENTS

 
| PART I. FINANCIAL INFORMATION |
|-------------------------------|
|                          |   |
| Item 1.                       | Condensed  Consolidated Balance Sheets as of March 31, 2003 and December 31, 2002 |
|                          |   |
|                          | Condensed  Consolidated Statements of Operations for the three months ended March 31,  2003 and 2002 |
|                          |   |
|                          | Condensed  Consolidated Statements of Cash Flows for the three months ended March 31,  2003 and 2002 |
|                          |   |
|                          | 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 6.                       | Exhibits and Reports on Form 8-K |
|                          |   |
| SIGNATURES                    |
|                          |   |
| CERTIFICATIONS                |

 

2

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**PART I.****  FINANCIAL INFORMATION**

 

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

 

**InteractiveIntelligence, Inc.**

 

**CondensedConsolidated Balance Sheets**

**(inthousands, except share amounts)**

 
|                                                                                                                                                                    |   | **March 31,  2003** |   | **December 31,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|---------------------|--------|------------------------|--------|
|                                                                                                                                                                    |   | **(Unaudited)**     |   |                   |   |
| **Assets**                                                                                                                                                              |   |                |   |                   |   |
| Current assets:                                                                                                                                                         |   |                |   |                   |   |
| Cash and cash equivalents                                                                                                                                               |   | $                   | 12,694 |                   | $      | 5,913 |   |
| Short-term investments                                                                                                                                                  |   | 3,876               |   | 9,331                  |   |
| Accounts receivable, net of allowance for  doubtful accounts of $402 in 2003 and $671 in 2002                                                                           |   | 10,876              |   | 9,047                  |   |
| Prepaid expenses                                                                                                                                                        |   | 2,002               |   | 2,170                  |   |
| Other current assets                                                                                                                                                    |   | 96                  |   | 73                     |   |
| Total current assets                                                                                                                                                    |   | 29,544              |   | 26,534                 |   |
|                                                                                                                                                                    |   |                |   |                   |   |
| Property and equipment, net                                                                                                                                             |   | 7,490               |   | 7,586                  |   |
|                                                                                                                                                                    |   |                |   |                   |   |
| Other assets, net                                                                                                                                                       |   | 1,042               |   | 1,046                  |   |
| Total assets                                                                                                                                                            |   | $                   | 38,076 |                   | $      | 35,166 |   |
|                                                                                                                                                                    |   |                |   |                   |   |
| **Liabilities and shareholders’  equity**                                                                                                                          |   |                |   |                   |   |
| Current liabilities:                                                                                                                                                    |   |                |   |                   |   |
| Accounts payable and accrued liabilities                                                                                                                                |   | $                   | 3,334  |                   | $      | 3,203 |   |
| Accrued compensation and related expenses                                                                                                                               |   | 1,284               |   | 995                    |   |
| Deferred software revenues                                                                                                                                              |   | 11,685              |   | 12,102                 |   |
| Deferred services revenues                                                                                                                                              |   | 12,327              |   | 9,882                  |   |
| Total current liabilities                                                                                                                                               |   | 28,630              |   | 26,182                 |   |
|                                                                                                                                                                    |   |                |   |                   |   |
| 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;   15,565,920 issued and outstanding at March 31, 2003,   15,524,369 issued and outstanding at December 31, 2002 |   | 156                 |   | 155                    |   |
| Additional paid-in capital                                                                                                                                              |   | 64,254              |   | 64,140                 |   |
| Accumulated other comprehensive income                                                                                                                                  |   | 209                 |   | 162                    |   |
| Accumulated deficit                                                                                                                                                     |   | (55,173             | )      | (55,473                | )      |
| Total shareholders’ equity                                                                                                                                         |   | 9,446               |   | 8,984                  |   |
| Total liabilities and shareholders’ equity                                                                                                                         |   | $                   | 38,076 |                   | $      | 35,166 |   |

 

Seeaccompanying notes.

 

3

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**InteractiveIntelligence, Inc.**

 

**Condensed Consolidated Statementsof Operations (unaudited)**

**(inthousands, except per share amounts)**

 
|                                                 |   | **Three months ended  March 31,** |       |
|------------------------------------------------------|--------|-----------------------------------|------------|
|                                                 |   | **2003**                          |       | **2002** |   |
|                                                 |   |                              | ** ** |   | ** ** |
| Revenues:                                            |   |                              |       |   |   |
| Software                                             |   | $                                 | 8,621      |   | $ | 7,592 |   |
| Services                                             |   | 5,763                             |       | 4,361 |   |
| Total revenues                                       |   | 14,384                            |       | 11,953 |   |
|                                                 |   |                              |       |   |   |
| Costs and expenses:                                  |   |                              |       |   |   |
| Costs of software                                    |   | 292                               |       | 272 |   |
| Costs of services                                    |   | 3,186                             |       | 3,023 |   |
| Sales and marketing                                  |   | 5,207                             |       | 5,549 |   |
| Research and development                             |   | 3,495                             |       | 3,906 |   |
| General and administrative                           |   | 1,456                             |       | 1,497 |   |
| Restructuring charges                                |   | 448                               |       | — |   |
| Total costs and expenses                             |   | 14,084                            |       | 14,247 |   |
| Operating income (loss)                              |   | 300                               |       | (2,294 | ) |
|                                                 |   |                              |       |   |   |
| Interest income, net                                 |   | 53                                |       | 129 |   |
| Income (loss) before income taxes                    |   | 353                               |       | (2,165 | ) |
|                                                 |   |                              |       |   |   |
| Income taxes                                         |   | 53                                |       | 69 |   |
|                                                 |   |                              |       |   |   |
| Net income (loss)                                    |   | $                                 | 300        |   | $ | (2,234 | ) |
|                                                 |   |                              | ** ** |   | ** ** |
| Net income (loss) per share:                         |   |                              | ** ** |   | ** ** |
| Basic                                                |   | $                                 | 0.02       |   | $ | (0.15 | ) |
| Diluted                                              |   | $                                 | 0.02       |   | $ | (0.15 | ) |
|                                                 |   |                              |       |   |   |
| Shares used to compute net income (loss) per  share: |   |                              |       |   |   |
| Basic                                                |   | 15,565                            |       | 15,337 |   |
| Diluted                                              |   | 15,947                            |       | 15,337 |   |

 

Seeaccompanying notes.

 

4

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**InteractiveIntelligence, Inc.**

 

**Condensed Consolidated Statementsof Cash Flows (unaudited)**

**(inthousands)**

 
|                                                                                             |   | **Three months ended  March 31,** |   |
|--------------------------------------------------------------------------------------------------|--------|-----------------------------------|--------|
|                                                                                             |   | **2003**                          |   | **2002** |   |
| **Operating activities**                                                                         |   |                              |   |   |   |
| Net income (loss)                                                                                |   | $                                 | 300    |   | $ | (2,234 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided (used) by operating activities: |   |                              |   |   |   |
| Depreciation                                                                                     |   | 1,278                             |   | 1,248 |   |
| Amortization of deferred stock-based compensation                                                |   | 24                                |   | 23 |   |
| Changes in operating assets and liabilities:                                                     |   |                              |   |   |   |
| Accounts receivable                                                                              |   | (1,829                            | )      | (685 | ) |
| Prepaid expenses                                                                                 |   | 168                               |   | 38 |   |
| Other current assets                                                                             |   | (23                               | )      | 27 |   |
| Accounts payable and accrued liabilities                                                         |   | 131                               |   | (371 | ) |
| Accrued compensation and related expenses                                                        |   | 289                               |   | (17 | ) |
| Deferred software revenues                                                                       |   | (417                              | )      | (1,546 | ) |
| Deferred services revenues                                                                       |   | 2,445                             |   | 337 |   |
| Net cash provided (used) by operating activities                                                 |   | 2,366                             |   | (3,180 | ) |
|                                                                                             |   |                              |   |   |   |
| **Investing activities**                                                                         |   |                              |   |   |   |
| Purchases of property and equipment, net                                                         |   | (1,182                            | )      | (804 | ) |
| Purchases of available-for-sale investments                                                      |   | —                            |   | (13,613 | ) |
| Sales of available-for-sale investments                                                          |   | 5,502                             |   | 5,373 |   |
| Change in other assets                                                                           |   | 4                                 |   | (28 | ) |
| Net cash provided (used) by investing activities                                                 |   | 4,324                             |   | (9,072 | ) |
|                                                                                             |   |                              |   |   |   |
| **Financing activities**                                                                         |   |                              |   |   |   |
| Proceeds from issuances of common stock                                                          |   | 91                                |   | 129 |   |
| Proceeds from stock options exercised                                                            |   | —                            |   | 38 |   |
| Net cash provided by financing activities                                                        |   | 91                                |   | 167 |   |
| Net increase (decrease) in cash and cash  equivalents                                            |   | 6,781                             |   | (12,085 | ) |
|                                                                                             |   |                              |   |   |   |
| Cash and cash equivalents, beginning of period                                                   |   | 5,913                             |   | 14,503 |   |
| Cash and cash equivalents, end of period                                                         |   | $                                 | 12,694 |   | $ | 2,418 |   |

 

Seeaccompanying notes.

 

5

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InteractiveIntelligence, Inc

Notes to Condensed ConsolidatedFinancial Statements

(Unaudited)

 

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

 

Interactive Intelligence,Inc. (“I3” or the “Company”) is a leading provider of software-basedinteraction management solutions designed to automate communications forcontact centers, enterprises, and service providers. Based on an open, unifiedplatform, the Interactive Intelligence product line was designed as a flexibleand affordable alternative to traditional telecom solutions. The Company’sproducts provide a complete communications solution including PBX (privatebranch exchange), ACD (automated call distributor), IVR (interactive voiceresponse), unified communications, and Internet and wirelessfunctionality.  The Company currentlyderives substantially all of its revenues from licenses of its InteractionCenter Platform products and related services.

 

Principal operations ofthe Company commenced during 1997. Since then, the Company has established wholly-owned subsidiaries inAustralia, France, the Netherlands and the United Kingdom. The Company alsocurrently 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 accompanyingunaudited financial statements have been prepared in conformity with generallyaccepted accounting principles for interim financial information and with theinstructions for Form 10-Q and Article 10 of Regulation S-X.  Accordingly, certain information andfootnote disclosures normally included in financial statements prepared inaccordance with generally accepted accounting principles have been condensed,or omitted, pursuant to the rules and regulations of the Securities andExchange Commission.  In our opinion,the statements include all adjustments necessary  (which are of a normal and recurring nature) for the fairpresentation of the results of the interim periods presented.

 

The balance sheet atDecember 31, 2002 has been derived from the audited financial statements atthat date but does not include all of the information and footnotes required bygenerally accepted accounting principles for complete financial statements.

 

These financialstatements should be read in conjunction with our audited consolidatedfinancial statements for the year ended December 31, 2002, included in theCompany’s Form 10-K for the year ended December 31, 2002, filed with theSecurities and Exchange Commission on March 31, 2003.  Our results of operations for any interim period are notnecessarily indicative of the results of operations for any other interim periodor for a full fiscal year.

 

**2.****                 NetIncome (Loss) Per Common Share**

 

Basic net income (loss)per share is calculated based on the weighted-average number of outstandingcommon shares.  Diluted net income(loss) per share is calculated based on the weighted-average number ofoutstanding common shares plus the effect of dilutive potential commonshares.  Potential common shares arecomposed of shares of common stock of the Company issuable on the exercise ofstock options.  When potential commonshares are dilutive, the treasury stock method is used to compute the commonequivalent shares.  Under the treasurystock method, the assumed proceeds from the exercise of stock options areapplied solely to the repurchase of common stock.

 

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The following tablepresents the calculation of basic and diluted net income (loss) per share (inthousands, except per share amounts):

 
|                                                     |   | **Three Months Ended  March 31,** |   |
|----------------------------------------------------------|--------|-----------------------------------|--------|
|                                                     |   | **2003**                          |   | **2002** |   |
|                                                     |   |                              |   |   |   |
| Net  income (loss) (A)                                   |   | $                                 | 300    |   | $ | (2,234 | ) |
|                                                     |   |                              |   |   |   |
| Weighted  average outstanding shares of common stock (B) |   | 15,565                            |   | 15,337 |   |
| Dilutive  effect of options to purchase common stock     |   | 382                               |   | — |   |
| Common  stock and common stock equivalent shares (C)     |   | 15,947                            |   | 15,337 |   |
|                                                     |   |                              |   |   |   |
| Net  income (loss) per share:                            |   |                              |   |   |   |
| Basic  (A/B)                                             |   | $                                 | 0.02   |   | $ | (0.15 | ) |
|                                                     |   |                              |   |   |   |
| Diluted  (A/C)                                           |   | $                                 | 0.02   |   | $ | (0.15 | ) |

 

  The company’scalculation of diluted net income per share for the three months ended March31, 2003 excludes 2,374,477 options to purchase common stock with an exerciseprice ranging from $3.06 to $50.50 as the effect was anitdilutive. For thethree months ended March 31, 2002, the Company’s calculation of diluted netloss per share excludes all potential common shares as the effect would beantidilutive.  Options to purchase3,305,794 shares of common stock with exercise prices of $0.13 to $50.50 pershare were outstanding as of March 31, 2002.

 

**3.****                 Shareholders’ Equity**

 

The Company accounts forits stock option plans in accordance with Statement of Financial AccountingStandards No. 123, *Accounting forStock-Based Compensation*(“SFAS 123”)**and uses the intrinsic value method consistent with theexisting rules established by APB Opinion No. 25, *Accounting for Stock Issued to Employees,* and relatedInterpretations.  The majority ofoptions granted to employees under these plans had an exercise price equal tothe market value of the underlying common stock on the date of grant.  The table included below illustrates theeffect on the net income (loss) and earnings (loss) per share if the Companyhad applied the fair value recognition provisions of SFAS 123 to stock-basedemployee compensation.

 

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(*in thousands except per share amounts):*

 
|                                                                                                                                 |   | **Three Months Ended  March 31,** |       |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------|------------|
|                                                                                                                                 |   | **2003**                          |       | **2002** |   |
| Net income (loss), as  reported                                                                                                      |   | **$**                             | **300**    |   | $ | (2,234 | ) |
| Deduct: Total  stock-based compensation expense determined under fair value based method for  all awards, net of related tax effects |   | **(1,389**                        | )          | (1,467 | ) |
|                                                                                                                                 |   |                              |       |   |   |
| Pro forma net loss                                                                                                                   |   | **$**                             | **(1,089** | ) | $ | (3,701 | ) |
|                                                                                                                                 |   |                              |       |   |   |
| Income (loss) per  share:                                                                                                            |   |                              |       |   |   |
| Basic - as reported                                                                                                                  |   | **$**                             | **0.02**   |   | $ | (0.15 | ) |
| Diluted - as reported                                                                                                                |   | **$**                             | **0.02**   |   | $ | (0.15 | ) |
|                                                                                                                                 |   |                              |       |   |   |
| Basic - pro forma                                                                                                                    |   | **$**                             | **(0.07**  | ) | $ | (0.24 | ) |
| Diluted - pro forma                                                                                                                  |   | **$**                             | **(0.07**  | ) | $ | (0.24 | ) |

 

**4.****                 Concentrationof Credit Risk**

 

Onecustomer  represented approximately 16%of total revenues and 29% of accounts receivable for the three months endedMarch 31, 2003.

 

**5.****                 Contingencies**

 

In June 1999 andSeptember 1999, the Company received letters from a competitor in the callcenter market claiming that the Company’s products utilize technologiespioneered and patented by that competitor. The Company’s patent counsel has reviewed all of the patents listed inthe letters.  Based on the advice of theCompany’s patent counsel, the Company believes that its products do notinfringe any of the patents listed in either letter.  The Company has discussed its conclusion with the competitor andhas also discussed possible licensing of certain technologies from thecompetitor.  Although the Company hasnot heard from this competitor since early 2001, the Company cannot assure youthat this matter can be resolved amicably without litigation, or that it willultimately be able to enter into a licensing arrangement on terms andconditions that would not have a material adverse effect on the Company’sbusiness, financial condition or results of operations.

 

In June 2000 and October2001, the Company received letters from a competitor in the outbound callcenter market claiming that the Company’s products utilize technologies pioneeredand patented by the competitor. Although the Company’s patent counsel has not determined the validity ofthese patents, the Company has discussed the possible licensing of certaintechnologies from the competitor. Ownership of the technology has changed once since the original letters,and the technology and related business unit are being marketed for sale bytheir current owner, who has filed for bankruptcy protection.  The Company cannot assure you that theseclaims can be resolved amicably without litigation, or that it will be able toenter into licensing arrangements on terms and conditions that would not have amaterial adverse effect on the Company’s business, financial condition orresults of operations.

 

In July 2002, the Companyreceived a letter from a consulting firm which has been retained by atelecommunication technology provider to develop and implement a licensingprogram based on

 

8

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the technology provider’spatents.  The consulting firm believes alicensing agreement between the Company and the technology provider isappropriate.  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.

 

In December 2002, theCompany received a letter from one of its resellers requesting indemnificationrelated to a request that it had received for indemnification from an end userthat had received a letter from a third party indicating that the end user maybe infringing patents held by the third party. To date, the Company’s patent counsel has not determined the validity orthe applicability of these patents as they relate to the Company’s products orwhether the reseller is entitled to indemnification.  The Company cannot assure you that this claim for indemnificationcan be resolved favorably in a manner that would not have a material adverseeffect on the Company’s business, financial condition or results of operations.

 

Other third parties couldclaim that our technology infringes their proprietary rights. 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.

 

In November 2002, theCompany received a notification from the French government as a result of a taxaudit that had been conducted encompassing the years 1998, 1999, 2000 and2001.  This assessment claims varioustaxes are owed related to Value Added Tax (“VAT”) and corporation taxes inaddition to what has previously been paid and accrued.  The assessment related to VAT isapproximately 2.3 million Euros or approximately $2.5 million as of March 31,2003 and the assessment related to corporation taxes is approximately 300,000Euros or approximately $330,000 as of March 31, 2003.  Based primarily on advice from the Company’s tax counsel, theCompany currently believes the possibility of the Company paying the assessmentrelated to VAT to be remote and the assessment related to corporation taxes tobe reasonably possible.  The Company isappealing the assessment, but cannot assure you this matter will be resolvedwithout litigation, that it will not take several years to resolve, or that theCompany will not have to pay some or all of the assessment.  Currently, the Company has accruedapproximately $97,000 related to the tax assessment.

 

From time to time, theCompany is also involved in certain legal proceedings in the ordinary course ofconducting our business. While the ultimate liability pursuant to these actionscannot currently be determined, the Company believes these legal proceedingswill not have a material adverse effect on the Company’s financial position.

 

**6.****               Restructuring and Other Charges**

 

In February 2003, theCompany announced its plan to downsize and reorganize resources in the Europe,Middle East, and Africa (“EMEA”) region. Of the 20 positions located in France, six positions were transferred toother EMEA offices, four will remain in France, and 10 were eliminated.  The reorganization affected all departmentsin EMEA.  For the three months endedMarch 31, 2003, a total of $448,000 was recognized in accordance with Statementof Financial Accounting Standards No. 146, *Accountingfor Costs Associated with Exit or Disposal Activities*(“SFAS 146”)as restructuring charges.  Of the totalamount, approximately $333,000 was related to severance and the remainingamount was related to professional fees.

 

The Company anticipatesadditional restructuring charges to be incurred in the second quarter as thereorganization is expected to be substantially completed by June 30, 2003.  The restructuring charges will be related toadditional severance , professional fees and to the facilities which are

 

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currently beingleased.  The Company anticipates thecharge in the second quarter related to the EMEA reorganization to range from$900,000 to approximately $1.2 million.

 

Additional charges willbe incurred in the second quarter 2003 related to unused leased facilities inthe North American region up to approximately $1.7 million.

 

**Item2.****  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

*Forward-LookingInformation*

 

Certain statements in this Form 10-Q contain “forward-looking”information (as defined in Section 27A of the Securities Act of 1933, asamended and Section 21E of the Securities Exchange Act of 1934, asamended) that involve risks and uncertainties which may cause actual results todiffer materially from those predicted in the forward-looking statements.Forward-looking statements can be identified by their use of such verbs as“expects,” “anticipates,” and “believes” or similar verbs or conjugations ofsuch verbs. If any of our assumptions on which the statements are based proveincorrect or should unanticipated circumstances arise, our actual results couldmaterially differ from those anticipated by such forward-looking statements.The differences could be caused by a number of factors or combination offactors, including, but not limited to, the “Factors Affecting OperatingResults” described herein and the Risk Factors described in our Securities andExchange Commission filings, including the Form 10-K filing for the yearended December 31, 2002.

 

*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, $27.3 million in 2000, $47.9 million in 2001, and$47.8 million in 2002. We cannot assure you that our revenues will grow inthe future.

 

We believe our investments in research and developmentand in marketing, services and sales operations will continue to be critical toany revenue growth we achieve. However, these investments have alsosignificantly increased our operating costs and expenses, contributing to thenet losses and operating losses that we have incurred in all but our lastfiscal quarter since our formation. In addition, we are likely to continue toexperience losses and negative cash flows from operations in future quarters.We cannot assure you when or if we will achieve profitability again 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.

 

As of March 31, 2003 we incurred approximately$448,000 in restructuring charges related to the restructuring of our EMEAorganization which was announced in February 2003.  These charges related primarily to severance and professionalservices.

 

*CriticalAccounting Policies and Estimates*

 

We believe the accounting policies that are related torevenue recognition and the allowance for doubtful accounts receivable areimportant to understanding our performance. These policies, which involvesignificant management judgment and estimates, and related procedures aredescribed in detail below.

 

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**Sourcesof Revenues and Revenue Recognition Policy**

 

The Company generates software revenues from licensingthe right to use its software products and generates services revenues from annuallicense fees, ongoing maintenance (post-contract technical support andunspecified product upgrades), educational services, and professional services.

 

Our software license fees primarily originate from themarketing efforts of our resellers, who are authorized to place orders forsoftware licenses with us on behalf of end-user customers. We share end-usercustomer software license fees with these resellers in varying percentages ofour list price, according to the terms of their reseller agreements. Inaddition to generating software license fees indirectly through resellers, wealso receive some software license fees from end-user customers that wecontract with directly. Our software license agreements are either annuallyrenewable or perpetual.

 

For any revenues to be recognized from a softwarelicense agreement, the following criteria must be met:

 

•                  persuasiveevidence of an arrangement exists;

 

•                  thefee is fixed or determinable;

 

•                  collectionis probable; and

 

•                  deliveryhas occurred.

 

Delivery is further defined in certain softwarelicense agreements as delivery of the product master or first copy fornon-cancelable product licensing arrangements under which the recipient,typically a reseller, has certain software distribution rights. For these licensingarrangements, the delivery criteria has been met when a binding order for aspecified end-user customer is placed, as the reseller already possesses aproduct master copy and the Company has no further delivery obligations.

 

Under our annually renewable license agreements, theinitial reseller order or end-user contract includes both an initial licensefee and an annual license fee. Upon meeting the revenue recognition criteria,we recognize the initial license fees under these annually renewable licenseagreements as software revenues ratably over the initial license period, whichis generally twelve months.  Under ourannually renewable license agreements, we also recognize annual license fees asservices revenues ratably over the term of the initial license period, which isgenerally twelve months. After the initial license period, our end-usercustomers may renew their license agreement for an additional annual period bypaying an additional annual license fee. We recognize these additional annuallicense fees as services revenues ratably over the term of the renewal period,which is also generally twelve months. If the annual license fee is not paid,the customer is no longer entitled to use the software and we may terminate itslicense agreement. Payment of the annual license fee also entitles the customerto ongoing maintenance (post-contract technical support and unspecified productupgrades) for the renewal period.

 

Under our perpetual license agreements, the initialreseller order or end-user contract includes both an initial license fee and anannual maintenance fee. Upon meeting the revenue recognition criteria, weimmediately recognize the entire amount of initial license fees under theseperpetual license agreements as software revenues if sufficient vendor specificobjective evidence exists to support allocating the total fee to all elementsof the arrangement. If sufficient vendor specific objective evidence does notexist, we typically recognize the initial license fee ratably over the initialterm of the license agreement, which is generally twelve months.

 

Under our perpetual license agreements, we alsorecognize annual maintenance fees as services revenues ratably over thepost-contract maintenance period, which is typically twelve months. Ourend-user customers may renew their maintenance term for an additional one-yearperiod by paying an additional maintenance fee. We recognize these additionalmaintenance fees as services revenues ratably over the term of the renewalperiod, which is also generally twelve months. Payment of the annualmaintenance fee entitles the customer to ongoing maintenance (post-contracttechnical support and unspecified product upgrades).

 

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We share annual license fees and ongoing maintenancefees with those resellers who provide initial technical support to end-usercustomers according to the terms of their reseller agreements. When theserevenues are shared with resellers, we typically receive between 50% and 70% ofthe amount charged to the end-user customer.

 

We also generate revenues from other services that weprovide to our resellers and end-user customers. In addition to annual licensefees and ongoing maintenance fees, services revenues include educationalservices and professional services. Revenues from educational services, whichconsist of training courses for resellers and end-user customers, andprofessional services, which include implementing and customizing our productsfor an end-user customer, are typically recognized as the related services areperformed.

 

**Allowancefor Doubtful Accounts for Accounts Receivable**

 

We record our allowance for doubtful accounts for eachreporting period based on a detailed analysis of our accounts receivable at theend of that period. In estimating the allowance for doubtful accounts, weprimarily consider the age of the customer’s accounts receivable and alsoconsider the creditworthiness of the customer, the economic conditions of thecustomer’s industry, and general economic conditions, among other factors.Should any of these factors change, the estimates made by us will also change,which could impact the level of our future allowance for doubtful accounts.Specifically, if the financial condition of our customers were to deteriorate,affecting their ability to make payments, increases to allowances for doubtfulaccounts may be required.

 

*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. The operating results for the three monthsended March 31, 2003 and 2002 are not necessarily indicative of the resultsthat may be expected for the full year or for any future period.

 

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|                               |   | **Three months ended  March 31,** |   |
|------------------------------------|--------|-----------------------------------|--------|
|                               |   | **2003**                          |   | **2002** |   |
| Revenues:                          |   |                              |   |   |   |
| Software                           |   | 60                                | %      | 64 | % |
| Services                           |   | 40                                |   | 36 |   |
| Total  revenues                    |   | 100                               |   | 100 |   |
|                               |   |                              |   |   |   |
| Costs  and expenses:               |   |                              |   |   |   |
| Costs  of software                 |   | 2                                 |   | 2 |   |
| Costs  of services                 |   | 22                                |   | 25 |   |
| Sales  and marketing               |   | 36                                |   | 46 |   |
| Research  and development          |   | 24                                |   | 33 |   |
| General  and administrative        |   | 10                                |   | 13 |   |
| Restructuring  charges             |   | 3                                 |   | — |   |
| Total  costs and expenses          |   | 97                                |   | 119 |   |
|                               |   |                              |   |   |   |
| Operating  income (loss)           |   | 3                                 |   | (19 | ) |
| Interest  income, net              |   | 0                                 |   | 1 |   |
| Income  (loss) before income taxes |   | 3                                 |   | (18 | ) |
| Income  taxes                      |   | 0                                 |   | 1 |   |
| Net  income (loss)                 |   | 3                                 | %      | (19 | )% |

 

*Revenues*

 

Our total revenues increased 20% from$12.0 million for the three months ended March 31, 2002 to$14.4 million for the three months ended March 31, 2003. Non-NorthAmerican revenues decreased slightly from $2.3 million for the threemonths ended March 31, 2002 to $2.1 million for the three months endedMarch 31, 2003. Our revenues are derived from software license fees and chargesfor services, including annual license fees and ongoing maintenance fees,education services, and professional services. The increase in total revenuesresulted from higher software revenues, including a perpetual license agreementwith one customer which comprised approximately 16% of total revenues, andhigher services revenues mainly related to annual license and ongoingmaintenance fees from our growing customer base.

* *

*Software.*  Oursoftware revenues increased 14% from $7.6 million for the three monthsended March 31, 2002, to $8.6 million for the three months ended March 31,2003. The increase in software revenues included a perpetual license agreementwith one customer, which accounted for 27% of software revenues.  Because this license agreement was perpetualand met all revenue recognition criteria, all software revenue related to thislicense agreement was recognized immediately.

 

While we experienced growth of our software revenuesfor the three months ended March 31, 2003, we continue to expect the remainderof 2003 to be a challenging sales environment for capital investments.  Factors that could impact our softwarerevenues and deferred software revenues in 2003 compared to 2002 include whetherwe can increase the amount of our enterprise product licenses (e.g., CommunitéTMand Enterprise Interaction Center®), the license mix of perpetual compared toannually renewable licenses, and seasonality, which is typically weightedtoward the end of a calendar year.

* *

*Services.*  Servicesrevenues increased 32% from $4.4 million for the three months ended March31, 2002, to $5.8 million for the three months ended March 31, 2003. Theincrease in services revenues was

 

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primarily due to an increase in annual license fees and ongoingmaintenance fees, both of which are related to our growing installed base ofend-user customers.  To a lesser extent,we also saw growth in revenues from professional services.  As we add more customers and focus on servicingour existing customer base, we believe our services revenues will continue togrow.

 

*Costand Expenses*

 

Our total costs and expenses decreased 1% from$14.2 million for the three months ended March 31, 2002 to$14.1 million for the three months ended March 31, 2003. The decrease inamount was primarily due to the results following the implementation of ourrestructuring plans to reduce expenses beginning in April 2002 and February2003, as well as increased operating efficiencies, offset by higher variablecosts primarily related to higher software revenues.

* *

*Costsof Software.*  Costs of software consist primarilyof product royalties paid to third-parties for the use of their technologies inour products and, to a lesser extent, software packaging costs, which includeproduct media, duplication and documentation. Costs of software increased from$272,000 for the three months ended March 31, 2002 to $292,000 for the threemonths ended March 31, 2003. This represents approximately 4% of software revenuesfor the three months ended March 31, 2002 and 3% for the three months endedMarch 31, 2003. The slight dollar increase was primarily attributable to theincrease in software revenues.  Wecurrently expect product royalties to continue to increase as we releaseadditional products, release additional versions of our existing products, andintegrate additional third-party software functions and features into ourproduct offerings.

* *

*Costsof Services.*  Costs of services consist primarilyof compensation expenses for technical support, education, and professionalservices personnel and other costs associated with supporting our resellers andend-user customers. Costs of services increased from $3.0 million for thethree months ended March 31, 2002, to $3.2 million for the three monthsended March 31, 2003. As a percentage of services revenues, cost of servicesrepresented 69% and 55% for the three months ended March 31, 2002 and 2003,respectively.  The dollar increase is aresult of increased services revenues and the need to continue to support thegrowing customer base.  The decrease ofcost of services as a percent of services sales is related to continuedoperating efficiencies being realized by our support, education, andprofessional services resources as our customer base grows.  While we anticipate that costs of serviceswill increase as we add more customers and service our existing customer base,we also currently believe there is a continued opportunity for costs ofservices to continue to slightly decline as a percentage of services revenues.

* *

*Salesand Marketing.*  Sales and marketing expensesprimarily consist of compensation expenses (including sales commissions),travel expenses, trade shows, telemarketing campaigns, public relations andother promotional expenses.  Sales andmarketing expenses decreased from $5.5 million for the three months endedMarch 31, 2002 to $5.2 million for the three months ended March 31, 2003.  The decrease was primarily the result ofreduced compensation and discretionary marketing expenditures following theimplementation of our 2002 restructuring plans, somewhat offset by highervariable compensation expenses associated with higher software revenues.  We continue to expect sales and marketingexpense to be essentially flat in 2003 from 2002, although we will add salesand marketing personnel and increase sales and marketing efforts if performancedictates and/or attractive opportunities present themselves in the remainder of2003.

* *

*Researchand Development.*  Research and development expensesconsist primarily of compensation expenses for our developers and, to a lesserextent, and third party efforts to develop new products and enhance existingproducts, including adapting our products for specific non-English languages andallowing our products to effectively run with alternative hardwareconfigurations.  Research anddevelopment expenses decreased from $3.9 million for the three monthsended March 31, 2002 to $3.5 million for the three months ended March 31,2003.  The decrease is a result of theimplementation of our 2002  and 2003restructuring plans.  Currently, allcosts related to research and development of our products are charged to researchand development expense as incurred.

 

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*Generaland Administrative.*  General and administrativeexpenses consist primarily of compensation for our administrative, financial,and information technology personnel, and a number of non-allocable costs,including bad debt, legal and other professional service fees. General andadministrative expenses remained constant at $1.5 million for the threemonths ended March 31, 2002 and March 31, 2003.  We continue to believe our general and administrative expenseswill be slightly higher in the remainder of 2003 over 2002 due to increasedcosts from our new headquarters building.

 

*RestructuringCharges.* For the three months ended March 31, 2003, weincurred $448,000 in restructuring charges related to our resourcereorganization in the EMEA region.  InFebruary 2003, the Company announced its plan to downsize and reorganizeresources in the EMEA region.  Of the 20positions located in France, six positions were transferred to other EMEAoffices, four positions remained in France, and 10 positions wereeliminated.  The reorganization affectedall departments in EMEA.  Of the totalrestructuring charges recognized, approximately $333,000 was related toseverance and the remaining amount was related to professional fees.  The Company anticipates additionalrestructuring charges related to the EMEA region reorganization to be incurredin the second quarter of 2003, as we expect to be substantially complete withthe reorganization by June 30, 2003. The restructuring charges are expected to range from $900,000 to $1.2million and will be related to additional severance, related professional feesand to the facilities which are currently being leased.

 

Additional other charges will be incurred in thesecond quarter 2003 related to unused leased facilities in the North Americanregion as further discussed below in Liquidity and Capital Resources.

 

*Interestincome, net*

 

Interest income, net decreased from $129,000 for thethree months ended March 31, 2002 to $53,000 for the three months ended March31, 2003.  This decrease resulted fromthe substantial decrease in interest rates and less invested cash.

 

*Incometaxes*

 

For U.S. corporate income tax purposes, we did notrecognize a tax benefit related to U.S. federal or state income taxes duringthe three months ended March 31, 2002 or March 31, 2003 because of theuncertainty of eventually realizing the benefits of our operating losses.However, we did recognize a tax expense related to our international operationsof $69,000 for the three months ended March 31, 2002, and $53,000 for the threemonths ended March 31, 2003.

 

As described in Note 5 of our Notes to the CondensedConsolidated Financial Statements, we have received a notification from theFrench government as a result of a tax audit that had been conductedencompassing the years 1998, 1999, 2000, and 2001.  The total assessment is approximately 2.6 million Euros orapproximately $2.7 million.  We areappealing the assessment, but cannot assure you that this matter will beresolved without litigation, that it will not take several years to resolve orthat we will not have to pay some or all of the assessment.

 

*Liquidityand Capital Resources*

 

As of March 31, 2003, we had cash and cash equivalentsof $12.7 million, $3.9 million in short term investments and aworking capital balance of $914,000.

 

As of March 31, 2003, we had one customer thatrepresented 29% of our total accounts receivable balance.  The payment terms related to thistransaction are one-third due by April 30, 2003, one-third due by May 30, 2003and one-third due by June 30, 2003.  Wehave received the first installment timely.

 

Our operating activities resulted in a net cash inflowof $2.4 million for the three month period ended March 31, 2003, and a netcash outflow of $3.2 million for the three month period ended March 31,2002. The net operating cash inflow for the first three months of 2003 wasprimarily the result of our net income, non-cash depreciation amount, and anincrease in deferred services revenue, partially offset by an increase inaccounts receivable.  The net operatingcash outflow for the first three months of 2002 was primarily the

 

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result of our operating loss, a decrease in deferred software revenues,and an increase in accounts receivable, partially offset by the non-cashdepreciation amount.

 

Our investing activities have consisted primarily ofcapital expenditures for property and equipment and purchases and sales ofinvestments. Our activities resulted in a $4.3 million inflow for the threemonth period ended March 31, 2003 and a $9.1 million outflow for the threemonth period ended March 31, 2002. The inflow for the first three months of2003 was attributed to the net sale of available-for-sale investments, partiallyoffset by capital expenditures for property and equipment. The net outflow forthe first three months of 2002 was attributable to net purchases ofavailable-for-sale investments and capital expenditures for property andequipment.  At March 31, 2003, otherthan approximately $440,000 in primarily leasehold improvements related to thecompletion of our new corporate headquarters building, we did not have anymaterial commitments for future capital expenditures.

 

In April 2001, we entered into a non-cancelable leaseagreement for a new, approximately 120,000 square foot corporate headquartersbuilding that we moved into in April 2003. Over the life of the lease, 15 years, we are committed to expendapproximately $35.1 million in rent payments.

 

As of April 2003, we had approximately 78,000 squarefeet of unused office facilities related to our prior headquarters andassociated facilities which we continue to market for sublease.  As the overall sublease market is difficultand we have less than one year left on the substantial majority of theseleases, we believe it is not probable that our sublease efforts will besuccessful.  The remaining rentobligation on the unused space is approximately $1.5 million as of April 2003,and there are approximately $220,000 of leasehold improvements related to thisunused space which will no longer be useful. We expect to incur a charge related to both the unused facilities andunused leasehold improvements in the second quarter of 2003 up to $1.7 million.

 

For the three months period ended March 31, 2003 wegenerated $91,000 from financing activities attributed to the issuance ofcommon stock.  For the three monthsended March 31, 2002 we generated $167,000 related to the issuance of commonstock and stock option exercises.

 

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. Afterthat time, 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, it will be on terms favorable to us or that anyadditional financing will not dilute your ownership interest in the Company.

 

**Factorsthat may affect our future operating results are set forth below:**

 

**THEOVERALL ECONOMIC CLIMATE CONTINUES TO BE WEAK**

 

Our products typically represent substantial capitalcommitments by customers, involving a potentially long sales cycle. As aresult, customer purchase decisions may be significantly affected by a varietyof factors, including general economic trends in the allocation of capitalspending budgets for communication software, services and systems, lengthenedsales cycles, customer approval processes, and market conditions, which haveresulted in many of our customers delaying and/or reducing their capitalspending related to information systems. If the economy continues to be weak,demand for our products could decrease, resulting in lower revenues.

 

**WE HAVEHISTORICALLY INCURRED LOSSES AND WE MAY NOT SUSTAIN PROFITABILITY**

 

Since inception, the first quarter of 2003 is the onlyquarter we have been profitable. We incurred net losses of $7.7 million,$11.0 million, and $15.1 million in 2002, 2001, and 2000,respectively. At March 31, 2003, we had accumulated net losses since inception of$55.2 million. We intend to continue to make

 

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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 are likely to continue to experience losses and negative cash flowfrom operations in future quarters.

 

**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 results have varied significantly fromquarter to quarter and may continue to do so in the future depending on anumber of factors affecting us or our industry, including many that are beyondour control. 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. In addition, our operatingresults in a future quarter or quarters may fall below expectations ofsecurities analysts or investors and, as a result, the price of our commonstock may fluctuate.

 

Because we do not know if or when our potential end-usercustomers will place orders and finalize licenses, and it is difficult topredict the mix of annually renewable licenses and perpetual licenses in aquarter, we cannot accurately forecast our licensing activity, our revenues andour operating results for future quarters. We recognize revenues from differentlicenses over different periods on satisfaction of the requirements of AICPAStatement of Position 97-2, Statement of Position 97-2, and all related AICPATechnical Practice Aids (5100.38 - 5100.76). As a result, ourquarterly revenues and operating results depend on many factors, including thetype of license, and the size, quantity and timing of orders received for ourproducts during each quarter. If a large number of orders or several large ordersdo not occur or are deferred or delayed, our revenues in a quarter could besubstantially 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 limited number of products, changes inpricing policies and the timing of the development, announcement and sale ofnew or upgraded versions of our products are some of the additional factorsthat could cause our revenues and operating results to vary significantly fromquarter to quarter.

 

**WE HAVEA 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 generally experienced a lengthy product salescycle, averaging approximately six to nine months. The lengthy sales cycle isone of the factors that has caused, and may in the future continue to cause,our software revenues and operating results to vary significantly from quarterto quarter, which could affect the market price of our common stock. It alsomakes it difficult for us to forecast product license revenues. Because of theunique characteristics of our products, our prospective end-user customers’decisions to license our products often require significant investment andexecutive level decision making. We believe that many companies currently arenot aware of the benefits of interaction management software of the type welicense or of our products and capabilities. For this reason, we must provide asignificant level of education to prospective end-user customers about the useand benefits of our products, which can cause potential end-user customers totake many months to make these decisions. As a result, sales cycles forend-user customer orders vary substantially from customer to customer.Excessive delay in product sales could materially adversely affect ourbusiness, financial condition or results of operations.

 

The length of the sales cycle for end-user customerorders depends on a number of other factors over which we have little or nocontrol, including:

 

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•                  anend-user customer’s budgetary constraints;

 

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

 

•                  concernsby end-user customers about the introduction of new products by us or ourcompetitors; and

 

•                  downturnsin general economic conditions, including reductions in demand for call centerservices.

 

In addition, the salescycle for our products in international markets has been, and is expected tocontinue to be, longer than the sales cycle in the United States. The averagesales cycle for our products may lengthen as we expand internationally.

 

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

 

As the complexity of our product technology and ourreseller and other third-party relationships have increased, the management ofthose relationships and the negotiation of contractual terms sufficient toprotect our rights and limit our potential liabilities has become morecomplicated, and we expect this trend to continue in the future. As a result,our inability to successfully manage these relationships or negotiatesufficient contractual terms could have a material adverse effect on us.

 

**WE FACECOMPETITIVE PRESSURES, WHICH MAY HAVE A MATERIAL ADVERSE EFFECT ON US**

 

The market for our software products is highly competitiveand, because there are relatively low barriers to entry in the software market,we expect competition to increase significantly in the future. In addition,because our industry is new and evolving and characterized by rapidtechnological change, it is difficult for us to predict whether, when and bywhom new competing technologies or new competitors may be introduced into ourmarkets. Currently, our competition comes from several different marketsegments, including computer telephony platform developers, computer telephonyapplications software developers and telecommunications equipment vendors. Wecannot assure you that we will be able to compete effectively against currentand future competitors. In addition, increased competition or other competitivepressures may result in price reductions, reduced margins or loss of marketshare, any of which could have a material adverse effect on our business,financial condition or results of operations.

 

Many of our current and potential competitors havelonger operating histories, significantly greater financial, technical,marketing, customer service and other resources, greater name recognition and alarger installed base of customers than we do. As a result, these competitorsmay be able to respond to new or emerging technologies and changes in customerrequirements faster and more effectively than we can, or to devote greaterresources to the development, promotion and sale of products than we can.Current and potential competitors have established, and may in the futureestablish, cooperative relationships among themselves or with third parties,including mergers or acquisitions, to increase the ability of their products toaddress the needs of our current or prospective end-user customers. If thesecompetitors were to acquire significant market share, it could have a materialadverse effect on our business, financial condition or results of operations.

 

**WE MAYNOT BE ABLE TO GROW OUR BUSINESS IF WE DO NOT MAINTAIN SUCCESSFUL RELATIONSHIPSWITH OUR RESELLERS AND OEM PARTNERS AND CONTINUE TO RECRUIT AND DEVELOPADDITIONAL SUCCESSFUL RESELLERS AND OEM PARTNERS**

 

Our ability to achieve revenue growth in the futurewill depend in part on our success in maintaining successful relationships withour existing and future resellers and OEM partners and in recruiting andtraining additional resellers and OEM partners. We rely primarily on resellersto market and support our products and plan on continuing to rely heavily onsuch partners in the future. We are still developing and improving our resellerand OEM distribution networks and may be unable to attract additional resellers

 

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with both voice and data expertise or appropriate OEM partners thatwill be able to market our products effectively and that will be qualified toprovide timely and cost-effective customer support and service. We generally donot have long-term or exclusive agreements with our resellers or OEM partners,and the loss of specific larger resellers or OEM partners or a significantnumber of resellers or OEM partners could materially adversely affect ourbusiness, financial condition or results of operations.

 

**OURMARKETS ARE CHARACTERIZED BY RAPID TECHNOLOGICAL CHANGE WHICH MAY CAUSE US TOINCUR SIGNIFICANT DEVELOPMENT COSTS AND PREVENT US FROM ATTRACTING NEWCUSTOMERS**

 

The market for our products is characterized by rapidtechnological change, frequent new product introductions and enhancements,uncertain product life cycles and changing end-user customer demands. Theintroduction of products embodying new technologies and the emergence of newindustry standards could render existing products obsolete or unmarketable andcause us to incur significant development costs.

 

**THEGROWTH OF OUR BUSINESS MAY BE IMPEDED WITHOUT INCREASED USE OF THE INTERNET**

 

The use of the Internet as a commercial marketplace isat an early stage of development. Demand and market acceptance for recentlyintroduced products and services available over the Internet are still uncertain.In addition, governmental regulation of the Internet, such as imposing salesand other taxes, access charges, and pricing controls and inhibitingcross-border commerce, may reduce the use of the Internet by businesses fortheir electronic commerce and customer service needs. To date, governmentalregulations have not materially restricted commercial use of the Internet.However, the legal and regulatory environment that pertains to the Internet isuncertain and may change. New regulations could reduce the use of the Internetby our end-user customers and, in turn, their customers. The lack of acceptanceof the Internet as a forum for conducting business could reduce growth indemand for our products and limit the growth of our revenues.

 

**OURBUSINESS WILL BE ADVERSELY AFFECTED IF WEB-BASED ELECTRONIC BUSINESS SOLUTIONSARE NOT WIDELY UTILIZED**

 

Our products address a market for Web-based,interactive electronic business solutions. Therefore, our future successdepends on the widespread adoption of the Web as a primary medium for commerceand business applications. The failure of this market to expand, or a delay inthe development of this market, could have a material adverse effect on ourbusiness, financial condition or results of operations. The Web hasexperienced, and is expected to continue to experience, significant user andtraffic growth, which has, at times, caused user frustration with slow accessand download times. The Web infrastructure may not be able to support thedemands placed on it by the continued growth on which our success depends.Moreover, critical issues concerning the commercial use of the Web, such assecurity, reliability, cost, accessibility and quality of service, remainunresolved and may negatively affect the growth of Web use or theattractiveness of commerce and business communication over the Web. Inaddition, the Web could lose its viability due to delays in the development oradoption of new standards and protocols to handle increased activity or due toincreased government regulation and taxation of Internet commerce.

 

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

 

Our products currently run only on Microsoft Windowsoperating systems. In addition, our products use other Microsoft Corporationtechnologies, including Microsoft Exchange Server® and Microsoft SQL Server®. Adecline in market acceptance for Microsoft technologies or the increasedacceptance of other server technologies could cause us to incur significantdevelopment costs and could have a material adverse effect on our ability tomarket our current products. Although we believe that Microsoft technologieswill continue to be widely used by businesses, we cannot assure you thatbusinesses will adopt these technologies as anticipated or will not in thefuture migrate to other computing technologies that we do not

 

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currently support. In addition, our products and technologies mustcontinue to be 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 our future business prospects dependin large part on our ability to maintain and improve our current products andto develop new products on a timely basis. Our products will have to achievemarket acceptance, maintain technological competitiveness and meet an expandingrange of end-user customer requirements. As a result of the complexitiesinherent in our products, major new products and product enhancements requirelong development and testing periods. We may not be successful in developingand marketing, on a timely and cost effective basis, product enhancements ornew products that respond to technological change, evolving industry standardsor end-user customer requirements. We may also experience difficulties thatcould delay or prevent the successful development, introduction or marketing ofproduct enhancements, and our new products and product enhancements may notachieve market acceptance. Significant delays in the general availability ofnew releases of our products or significant problems in the installation or implementationof new releases of our products could have a material adverse effect on ourbusiness, financial condition or results of operations.

 

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

 

If the demand for interaction management software ofthe type we license does not grow within each of our three targeted markets,our financial results and ability to grow our business could be materiallyadversely affected. All of our revenues have been generated from licenses ofour Interaction Center Platform® software or complementary products, andrelated support, educational and professional services. We expect theseproducts and services to account for the majority of our revenues for theforeseeable future. Although we believe demand for the functions performed byour products is high, the market for our products and services is stillemerging. Further, our growth plans require us to successfully attractenterprise and service provider end-user customers in significantly largernumbers than we have historically achieved.

 

**IF OUREND-USER CUSTOMERS DO NOT PERCEIVE OUR PRODUCTS OR THE RELATED SERVICESPROVIDED BY US OR OUR RESELLERS OR OEM PARTNERS TO BE EFFECTIVE OR OF HIGHQUALITY, OUR BRAND AND NAME RECOGNITION WILL SUFFER**

 

We believe that establishing and maintaining brand andname recognition is critical for attracting, retaining and expanding end-usercustomers in our target markets. We also believe that the importance ofreputation and name recognition will increase as competition in our marketincreases. Promotion and enhancement of our name will depend on theeffectiveness of our marketing and advertising efforts and on our success inproviding high-quality products and related services, neither of which can beassured. If our end-user customers do not perceive our products or relatedservices to be effective or of high quality, our brand and name recognitionwould suffer which could have a material adverse effect on our business,financial condition or results of operations.

 

**OURSERVICES REVENUES ARE DEPENDENT ON OUR INSTALLED BASE OF CUSTOMERS**

 

We have depended and will continue to depend on ourinstalled customer base for additional future revenues from services, includingannual license fees and ongoing maintenance fees. There can be no assurancethat current installed customers will renew their licenses or pay ongoingmaintenance fees in future periods. As a consequence, our operating results,cash flows and liquidity would likely be adversely affected. Our failure toobtain new customers or additional orders form existing customers could alsomaterially affect our operating results.

 

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**ANYDECREASE IN OUR LICENSING ACTIVITY IS LIKELY TO RESULT IN REDUCED SERVICESREVENUES IN FUTURE PERIODS**

 

Our services revenues are generated primarily fromannual license fees, ongoing maintenance (post-contract technical support andunspecified product upgrades), educational services, and professional services.A decrease in our services revenues could follow a decrease in our licensesrevenues. Our ability to maintain or increase our services revenues depends inlarge part on our ability to increase our software licensing activity.

 

**IF WEARE 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 BEADVERSELY AFFECTED**

 

Our products cannot currently meet the communicationsneeds of organizations with more than 500 users at a single call centerlocation. 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 we are currently developing and testingsolutions that would enable our software to significantly increase the numberof users that our products can serve at a single location, we cannot assure youthat we will be able to successfully introduce this technology into a currentlyavailable version of our products. Further, we may not be able to adapt oursoftware in a timely or cost effective manner in a way that will permit us toserve these customers. This inability could have a material adverse effect onour 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 and AcuLab plc are our primarysuppliers of the voice processing boards that are used by a majority of ourend-user customers for the operation of our products. If a majority of futureend-user customers desire to utilize the voice processing boards to enable ourproducts and these suppliers become unable or unwilling to continue tomanufacture and supply these voice processing boards in the volume, price andtechnical specifications we require, then we would have to adapt our productsto a substitute supplier. We may not be able to successfully introduce voiceprocessing boards made by a substitute supplier into the available versions ofour products. In addition, introducing a substitute supplier of voiceprocessing boards could result in unforeseen additional product development orcustomization costs and could also introduce hardware and software operating orcompatibility problems. We cannot assure you that these issues will not affectproduct shipments, will not be costly to correct, will not damage ourreputation in the markets in which we operate, or will not have a materialadverse affect on our business, financial condition or results of operations.

 

In addition, Dialogic Corporation’s CT MediaTM serversoftware offers some of the functionality that our Interaction Center Platform®products 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 neitherof our primary suppliers of voice processing boards nor their affiliatescurrently offer a product that competes with our Interaction Center Platform®products, they could potentially develop a competitive or superior product.

 

**WE MAYNOT BE ABLE TO PROTECT OUR PROPRIETARY RIGHTS ADEQUATELY, WHICH COULD ALLOWTHIRD PARTIES TO COPY OR OTHERWISE OBTAIN AND USE OUR TECHNOLOGY WITHOUTAUTHORIZATION**

 

We regard our software products as proprietary. In aneffort to protect our proprietary rights, we rely primarily on a combination ofcopyright, trademark and trade secret laws, as well as licensing and otheragreements with consultants, suppliers, strategic and OEM partners, resellersand end-user customers, and employee and third-party non-disclosure agreements.These laws and agreements provide only limited

 

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protection of our proprietary rights. In addition, we have not signedagreements containing these types of protective provisions in every case, andthe contractual provisions that are in place and the protection they providevary and may not provide us with adequate protection in all circumstances. Wecurrently hold three patents and have filed numerous other patent applicationsrelating to technology embodied in our software products. We hold 12 U.S.trademark registrations and 12 foreign trademark registrations, and havenumerous other trademark applications pending worldwide, as well as havingcommon law rights in other trademarks and service marks. 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 in whichwe sell our products do not protect our software and intellectual propertyrights to the same extent as the laws of the United States. Unauthorizedcopying, use or reverse engineering of our products could materially adverselyaffect our business, results of operations or financial condition.

 

We license technology that is embedded in our productsfrom others. If one or more of these licenses terminates or cannot be renewedon satisfactory terms, we would have to modify the affected products to usealternative technology or eliminate the affected product function, either ofwhich could have a material adverse effect on us.

 

**INFRINGEMENTCLAIMS COULD ADVERSELY AFFECT US**

 

In June 1999 and September 1999, we receivedletters from a competitor in the call center market claiming that our productsutilize technologies pioneered and patented by that competitor. Our patentcounsel has reviewed all of the patents listed in the letters. Based on theadvice of our patent counsel, we believe that our products do not infringe anyof the patents listed in either letter. We have discussed our conclusion withthe competitor and have also discussed possible licensing of certaintechnologies from the competitor. Although we have not heard from thiscompetitor since early 2001, we cannot assure you that this matter can beresolved amicably without litigation, or that we will ultimately 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.

 

In June 2000 and October 2001, we receivedletters from a competitor in the outbound call center market claiming that ourproducts utilize technologies pioneered and patented by the competitor.Although our patent counsel has not determined the validity of these patents,the Company has discussed the possible licensing of certain technologies fromthe competitor.  Ownership of thetechnology has changed once since the original letters, and the technology andrelated business unit are being marketed for sale by their current owner, whohas filed for bankruptcy protection.  Wecannot assure you that these claims can be resolved amicably withoutlitigation, or that we will be able to enter into licensing arrangements onterms and conditions that would not have a material adverse effect on ourbusiness, financial condition or results of operations.

 

In July 2002, we 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 firm believes a licensing agreement betweenthe Company and the technology provider is appropriate. Our patent counsel isin the process of reviewing the patents listed in the letter. To date, ourpatent counsel has not determined the validity or applicability of thesepatents. We cannot assure you that this matter can be resolved amicably withoutlitigation, or that we will be able to enter into a licensing arrangement onterms and conditions that would not have a material adverse effect on ourbusiness, financial condition or results of operations.

 

In December 2002, the Company received a letterfrom one of its resellers requesting indemnification related to a request thatit had received for indemnification from an end user that had received a letterfrom a third party indicating that the end user may be infringing patents heldby the third party. To date, the Company’s patent counsel has not determined thevalidity or the applicability of these patents as they relate to the Company’sproducts or whether the reseller is entitled to indemnification. The Companycannot assure you that this claim for indemnification can be resolved favorablyin a manner that would not have a material adverse effect on the Company’sbusiness, financial condition or results of operations.

 

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Other third parties could claim that our technologyinfringes their proprietary rights. As the number of software products in ourtarget markets increases and the functionality of these products overlap, webelieve that software developers may face infringement claims. For example,various patent rights have been asserted against interfaces between PBXhardware and computer network systems. Although we believe that our products donot infringe any of these patents because, among other reasons, our productsare designed to replace PBXs and not to create such interfaces, if thesepatents were interpreted broadly, claims of infringement of these patents couldhave a material adverse affect on us.

 

Infringement claims, even if without merit, can betime 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.

 

**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 in large part on the continuedservice of our key personnel, particularly Dr. Donald E. Brown, our ChiefExecutive Officer and principal stockholder. The loss of the services ofDr. Donald E Brown or any key personnel could have a material adverseeffect on our business, financial condition or results of operations. We do nothave key man life insurance on any of our employees. Our future success also dependson our ability 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.

 

**OURWORKFORCE REDUCTION AND FINANCIAL PERFORMANCE MAY ADVERSELY AFFECT THE MORALEAND PERFORMANCE OF OUR PERSONNEL AND OUR ABILITY TO HIRE NEW PERSONNEL**

 

In connection with our effort to streamlineoperations, reduce costs and rationalize our staffing and structure, we hadreductions in both 2001 and 2002 of our worldwide workforce of approximately10% -12% each year. There were and may continue to be substantial costsassociated with the workforce reductions related to severance and otheremployee-related costs, and our restructuring plans may still yieldunanticipated consequences, such as attrition beyond our implemented reductionin workforce. As a result, our ability to respond to unexpected challenges maybe impaired and we may be unable to take advantage of new opportunities. Thereduction in workforce may reduce employee morale and may create concern amongexisting employees about job security, which may lead to increased turnover.These reductions in headcount may still subject us to the risk of litigation.In addition, recent trading levels of our common stock have decreased the valueof the stock options granted to employees pursuant to our stock option plans.As a result of these factors, our remaining personnel may seek employment withlarger, more established companies or companies they perceive as having lessvolatile stock prices.

 

**WE MAYPURSUE ACQUISITIONS THAT BY THEIR NATURE PRESENT RISKS AND THAT MAY NOT BESUCCESSFUL**

 

In the future we may pursue additional acquisitions todiversify our product offerings and customer base or for other strategicpurposes. We have no prior history of making material acquisitions and wecannot assure you that any future acquisitions will be successful. Thefollowing are some of the risks associated with acquisitions that could have amaterial adverse effect on our business, financial condition or results ofoperations:

 

•                  Wecannot assure that any acquired businesses will achieve anticipated revenues,earnings or cash flow.

 

•                  Wemay be unable to integrate acquired businesses successfully and realizeanticipated economic, operational and other benefits in a timely manner,particularly if we acquire a

 

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business in a market inwhich we have limited or no current expertise, or with a corporate culturedifferent from our own. If we are unable to integrate acquired businessessuccessfully, we could incur substantial costs and delays or 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.

 

•                  Wemay finance future acquisitions by issuing common stock for some or all of thepurchase price. This could dilute the ownership interests of our stockholders.We may also incur additional debt or be required to recognize amortizationexpense related to goodwill and other intangible assets purchased in futureacquisitions.

 

•                  Wewould be competing with other firms, many of which have greater financial andother resources, to acquire attractive companies. We believe this competitionwill increase, making it more difficult to acquire suitable companies onacceptable terms.

 

**OURINTERNATIONAL OPERATIONS INVOLVE FINANCIAL AND OPERATIONAL RISKS**

 

Our international operations require significantmanagement attention and financial resources to establish and operate,including hiring appropriate personnel and recruiting effective internationalresellers. Non-North American revenues accounted for 19%, 22%, and 25% of ourtotal revenues in 2002, 2001, and 2000, respectively. To date, our productshave been licensed outside North America primarily in Western Europe, SouthAfrica, and Australia. We also have marketing efforts in Japan, Korea, Chinaand Central and South America. We intend to continue to emphasize our internationaloperations and we may enter additional international markets. Revenues frominternational operations may be inadequate to cover the expenses of thoseoperations. In addition to foreign currency fluctuation risks described in thenext risk factor, other risks inherent in our international businessactivities, in the countries in which we have licensed our products to date andin those countries in which we operate and could expand into, generally couldinclude the following:

 

•                  economicand political instability;

 

•                  unexpectedchanges in foreign regulatory requirements and laws;

 

•                  tariffsand other trade barriers;

 

•                  timing,cost and potential difficulty of adapting our software products to the locallanguage in those foreign countries that do not use the alphabet that Englishuses, such as Japan, Korea and China;

 

•                  lackof acceptance of our products in foreign countries;

 

•                  longersales cycles and accounts receivable payment cycles;

 

•                  potentiallyadverse tax consequences;

 

•                  restrictionson the repatriation of funds; and

 

•                  increasedgovernment regulations related to increasing or reducing business activity invarious countries.

 

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**FLUCTUATIONSIN THE VALUE OF FOREIGN CURRENCIES COULD RESULT IN LOSSES**

 

Our international revenues are generally denominatedin U.S. Dollars with the exception of some European resellers and end-usercustomers located in countries who have adopted the Euro as their officialcurrency. 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 DELAYIN ACCEPTANCE OF OUR PRODUCTS IN THE MARKET**

 

Our products, including components supplied by others,may contain errors or defects, especially when first introduced or when newversions are released. Despite internal product testing, we have in the pastdiscovered software errors in some of our products after their introduction.Errors in new products or releases could be found after commencement ofcommercial shipments, and this could result in additional development costs,diversion of technical and other resources from our other development efforts,or the loss of credibility with current or future end-user customers. Thiscould result in a loss of revenue or delay in market acceptance of ourproducts, which could have a material adverse effect on our business, financialcondition or results of operations.

 

Our license agreements with our end-user customerstypically contain provisions designed to limit our exposure to potentialproduct liability and some contract claims. However, not all of theseagreements contain these types of provisions and, where present, these provisionsvary as to their terms and may not be effective under the laws of somejurisdictions. A product liability, warranty, or other claim brought against uscould have a material adverse effect on our business, financial condition orresults of operations.

 

Because our solution currently consists of oursoftware running on a Windows NT® server and voice processing boards, it isinherently more prone to performance interruptions for our end-user customersthan traditional non-software based products. Performance interruptions at ourend-user customer sites, most of which currently do not have back-up systems,could affect demand for our products or give rise to claims against us.

 

**WE MAYNOT BE ABLE TO OBTAIN ADEQUATE FINANCING TO IMPLEMENT OUR STRATEGY**

 

Successful implementation of our strategy may requirecontinued access to capital. If we do not generate sufficient cash fromoperations, our growth could be limited unless we are able to obtain capitalthrough additional debt or equity financings. We cannot assure you that debt orequity financings will be available as required for acquisitions or otherneeds. Even if financing is available, it may not be on terms that arefavorable to us or sufficient for our needs. If we are unable to obtainsufficient financing, we may be unable to fully implement our growth strategy.

 

**OURSTOCK PRICE HAS BEEN AND COULD CONTINUE TO BE HIGHLY VOLATILE**

 

Our stock price has been and could continue to behighly volatile due to a number of factors, including:

 

•                  actualor anticipated fluctuations in our operating results;

 

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

 

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

 

•                  technologicalinnovations by 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

 

•                  generalmarket or economic conditions.

 

This risk may be heightened because our industry isnew and evolving, characterized by rapid technological change and susceptibleto the introduction of new competing technologies or competitors.

 

In addition, the stock market has experiencedsignificant price and volume fluctuations that have particularly affected thetrading prices of equity securities of many technology companies, including us.These price and volume fluctuations often have been unrelated to the operatingperformance of the affected companies. In the past, following periods ofvolatility in the market price of a company’s securities, securities classaction litigation has often been instituted against that company. This type oflitigation, regardless of the outcome, could result in substantial costs and adiversion of management’s attention and resources, which could materially andadversely affect our business, financial condition or results of operations.

 

**REGULATORYCHANGES MADE TO GENERALLY ACCEPTED ACCOUNTING PRINCIPLES OR CORPORATEGOVERNANCE MATTERS MAY IMPACT OUR BUSINESS**

 

Revisions to generally accepted accounting principleswill require us to review our accounting and financial reporting procedures inorder to ensure continued compliance with required policies. From time to time,such changes may have a short-term impact in the reporting that we do, andthese changes may impact market perception of our financial condition.

 

•                  Pendingor new legislation may lead to an increase in our costs related to audits inparticular and regulatory compliance generally

 

•                  Pendingor new legislation may force us to seek other service providers fornon-audit-related services, which may raise costs

 

•                  Changesin the legal climate may lead to additional liability fears which may result inincreased insurance costs.

 

**WE ARESUBECT TO THE RISK OF TERRORISM, INCLUDING THE RESULTING POSSIBLE DISRUPTIONSIN BUSINESS ACTIVITIES AND LOSS OF BUSINESS**

 

Our business can be affected by the disruptions causedby terrorist activities. Terrorist acts can create disruptions in our ordinarybusiness activities, including, but not limited to communications, businesstravel, and the availability of key personnel and physical assets.Additionally, terrorist acts may cause uncertainty about business continuityand the effectiveness of our disaster recovery plans and the disaster recoveryplans of our suppliers and resellers, and may adversely affect the confidenceand behavior of our customers, employees, suppliers, and resellers.

 

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**WECANNOT PREDICT EVERY EVENT AND CIRCUMSTANCE THAT MAY IMPACT OUR BUSINESS AND,THEREFORE, THE RISKS AND UNCERTAINTIES DISCUSSED ABOVE MAY NOT BE THE ONLY ONESYOU SHOULD CONSIDER**

 

The risks and uncertainties discussed above are inaddition to those that apply to most businesses generally. In addition, as wecontinue to grow our business, we may encounter other risks of which we are notaware at this time. These additional risks may cause serious damage to ourbusiness in the future, the impact of which we cannot estimate at this time.

 

**Item3.****Quantitative and Qualitative Disclosures about MarketRisk.**

 

We develop products in the United States and selllicenses in North America, Europe, the Asia/Pacific region, South Africa, andCentral and South America. As a result, our financial results could be affectedby various factors, including changes in foreign currency exchange rates orweak economic conditions in foreign markets. As most sales are currently madein U.S. dollars, a strengthening of the dollar could make our products lesscompetitive in foreign markets. Additionally, as our business matures in foreign markets, we may offerour products and services in certain local currencies.  As a result, we will be subject to foreigncurrency fluctuations which may have an adverse affect on the company.

 

We manage our interest rate risk by maintaining aninvestment portfolio with debt instruments of high credit quality andrelatively short average maturities. We also manage interest rate risk bymaintaining sufficient cash and cash equivalent balances such that we aretypically able to hold our investments to maturity.

 

**Item 4.****  Controls and Procedures**

 

We maintain a set of disclosure controls andprocedures that are designed to ensure that information required to bedisclosed by us in the reports filed by us under the Securities Exchange Act of1934, as amended (“Exchange Act”) is recorded, processed, summarized andreported within the time periods specified in the SEC’s rules and forms.  Within the 90 days prior to the filing dateof this report, we carried out an evaluation, under the supervision and withthe participation of our management, including our President and ChiefExecutive Officer and our Chief Financial Officer and Treasurer, of theeffectiveness of the design and operation of our disclosure controls andprocedures 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 internalcontrols or other factors that could significantly affect those controlssubsequent to the date of their evaluation, including any corrective actionswith regard to significant deficiencies and material weaknesses.

 

**PART II.****OTHERINFORMATION**

 

**Item 1. LegalProceedings.**

 

See Note 5 of our Notes to the Condensed ConsolidatedFinancial Statements for a description of various legal issues andcontingencies.

 

We are also subject to ordinary and routine claims,lawsuits and proceedings incidental to our business, none of which is expectedto be material to our results of operations, financial condition or cash flows.

 

**Item 6.****Exhibitsand Reports on Form 8-K.**

 

(a)          Exhibits

99.1 Certification ofDonald E. Brown, M.D., CEO, pursuant to 18 W.S. C. Section 1350

 

99.2 Certification ofKeith A. Midkiff, CFO, pursuant to 18 W.S. C. Section 1350

 

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(b)         Reports on Form 8-K

On February 3, 2003, theCompany filed a Current Report on Form 8-K under Item 5 to report that theCompany was revising its accounting practice and would restate certain of itsprior results to conform to Technical Practice Aid (TPA) 5100.53.

 

On February 13, 2003, theCompany filed a Current Report on Form 8-K under Item 5 to report the Company’sfourth quarter and total 2002 results including the restatement of its priorresults.

 

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**SIGNATURES**

 

Pursuant to therequirements of the Securities Exchange Act of 1934, the Registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|               | Interactive  Intelligence, Inc.                                 |
|--------------------|-----------------------------------------------------------------|
|               |                                                            | (Registrant) |
|               |                                                            |
| Date: May 14, 2003 | 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.                                       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 thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

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)                                      designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

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 equivalent function):

 

a)                                      allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                                     anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal 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: May 14, 2003 |                                   |
|--------------------|----------------------------------------|
|               |                                   |
|               | /s/ Donald E. Brown                    |   |
|               | Donald E. Brown, M.D.                  |
|               | President and Chief  Executive Officer |

 

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I, Keith A. Midkiff, certifythat:

 

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 thestatements made, in light of the circumstances under which such statements weremade, not misleading with respect to the period covered by this quarterlyreport;

 

3.                                       Basedon my knowledge, the financial statements, and other financial information includedin this quarterly report, fairly present in all material respects the financialcondition, results of operations and cash flows of the registrant as of, andfor, 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)                                      designedsuch disclosure controls and procedures to ensure that material informationrelating to the registrant, including its consolidated subsidiaries, is madeknown to us by others within those entities, particularly during the period inwhich this quarterly report is being prepared;

 

b)                                     evaluatedthe effectiveness of the registrant’s disclosure controls and procedures as ofa date within 90 days prior to the filing date of this quarterly report (the“Evaluation Date”); and

 

c)                                      presentedin this quarterly report our conclusions about the effectiveness of thedisclosure controls and procedures based on our evaluation as of the EvaluationDate;

 

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)                                      allsignificant deficiencies in the design or operation of internal controls whichcould adversely affect the registrant’s ability to record, process, summarizeand report financial data and have identified for the registrant’s auditors anymaterial weaknesses in internal controls; and

 

b)                                     anyfraud, whether or not material, that involves management or other employees whohave a significant role in the registrant’s internal 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: May 14, 2003 |                                   |
|--------------------|----------------------------------------|
|               |                                   |
|               | /s/ Keith A. Midkiff                   |   |
|               | Keith A. Midkiff                       |
|               | Chief Financial Officer  and Treasurer |

 

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