UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549





____________





FORM
10-Q





(Mark
One)





R
            QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934





For
the quarterly period ended March 31, 2009





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
              (State
      or other jurisdiction
              of
      incorporation or organization)
            
            35-1933097
              (I.R.S.
      Employer
              Identification
      No.)7601
      Interactive Way
              Indianapolis,
      IN 46278
              (Address
      of principal executive offices, including zip code)(317)
      872-3000
              (Registrant’s
      telephone number, including area code)Not
      Applicable(Former
      name, former address and former fiscal year, if changed since last
      report)




Indicate by check mark whether the
registrant (1) has filed all reports required to be filed by Section 13 or 15(d)
of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the registrant was required to file such reports), and
(2) has been subject to such filing requirements for the past 90
days. YesRNo*




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).
  Yes      ̈
                No       ̈




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check One):




Large
      accelerated filer
            *
            
            
            Accelerated
      filer
            RNon-accelerated
      filer
            *(Do not check if a
      smaller reporting company)
            Smaller
      reporting company
            *




Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act). Yes * No R





As of
April 30, 2009, there were 17,000,862
shares outstanding of the registrant’s common stock, $0.01 par
value.















TABLE OF
CONTENTS





PART
      I. FINANCIAL INFORMATION
                      
                      PageItem
      1.
                      Financial
      Statements.Condensed
      Consolidated Balance Sheets as of March 31, 2009 and December 31,
      2008
                      
                      
                      1Condensed
      Consolidated Statements of Income for the Three Months Ended March 31,
      2009 and 2008
                      
                      
                      2Condensed
      Consolidated Statement of Shareholders’ Equity for the Three Months Ended
      March 31, 2009
                      
                      
                      3Condensed
      Consolidated Statements of Cash Flows for the Three Months Ended March 31,
      2009 and 2008
                      
                      
                      4Notes
      to Condensed Consolidated Financial Statements
                      
                      
                      5Item
      2.
                      Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations.
                      
                      
                      10Item
      3.
                      Quantitative
      and Qualitative Disclosures About Market Risk.
                      
                      
                      17Item
      4.
                      Controls
      and Procedures.
                      
                      
                      17PART
      II. OTHER INFORMATIONItem
      1.
                      Legal
      Proceedings.
                      
                      
                      18Item
      1A.
                      Risk
      Factors.
                      
                      
                      18Item
      6.
                      Exhibits.
                      
                      
                      18SIGNATURES
                      
                      
                      19


i


PART
I. FINANCIAL INFORMATION





Item
1. Condensed Consolidated Financial Statements and Notes to Condensed
Consolidated Financial Statements.





Interactive Intelligence, Inc.


Condensed
Consolidated Balance Sheets


As
of March 31, 2009 and December 31, 2008


(In
thousands, except share and per share amounts)





March
      31,
                  2009
              
              
              December
      31,
                  2008(unaudited)AssetsCurrent
      assets:Cash
      and cash equivalents
              
              $
              45,930
              
              
              $
              34,705Short-term
      investments
              
              
              3,901
              
              
              
              10,805Accounts
      receivable, net of allowance for doubtful accounts of
                $964
      at March 31, 2009 and $1,004 at December 31, 2008
              
              
              23,318
              
              
              
              27,533Deferred
      tax assets, net
              
              
              6,017
              
              
              
              6,017Prepaid
      expenses
              
              
              5,064
              
              
              
              5,507Other
      current assets
              
              
              2,812
              
              
              
              1,995Total current assets
              
              
              87,042
              
              
              
              86,562Property
      and equipment, net
              
              
              10,024
              
              
              
              10,762Deferred
      tax assets, net
              
              
              4,466
              
              
              
              5,136Other
      assets, net
              
              
              2,651
              
              
              
              2,723Total
      assets
              
              $
              104,183
              
              
              $
              105,183Liabilities
      and Shareholders’ EquityCurrent
      liabilities:Accounts
      payable and accrued liabilities
              
              $
              10,161
              
              
              $
              11,361Accrued
      compensation and related expenses
              
              
              2,529
              
              
              
              3,486Deferred
      product revenues
              
              
              4,273
              
              
              
              4,754Deferred
      services revenues
              
              
              31,434
              
              
              
              31,457Total current liabilities
              
              
              48,397
              
              
              
              51,058Noncurrent
      deferred services revenues
              
              
              6,287
              
              
              
              6,878Total
      liabilities
              
              
              54,684
              
              
              
              57,936Commitments
      and contingencies
              
              
              --
              
              
              
              --Shareholders’
      equity:Preferred
      stock, no par value: 10,000,000 shares authorized; no shares issued and
      outstanding
              
              
              --
              
              
              
              --Common stock, $0.01 par value: 100,000,000 shares authorized;
                16,961,626 issued and outstanding at March 31, 2009 and
                16,928,089 issued and outstanding at December 31, 2008
              
              
              170
              
              
              
              169Treasury
      stock
              
              
              (9,505
              )
              
              
              (9,714
              )Additional
      paid-in capital
              
              
              84,522
              
              
              
              83,604Accumulated
      deficit
              
              
              (25,688
              )
              
              
              (26,812
              )Total shareholders’ equity
              
              
              49,499
              
              
              
              47,247Total
      liabilities and shareholders’ equity
              
              $
              104,183
              
              
              $
              105,183







See
Accompanying Notes to Condensed Consolidated Financial
Statements


1


Interactive Intelligence, Inc.
 Condensed
Consolidated Statements of Income (unaudited)
 For
the Three Months Ended March 31, 2009 and 2008
 (In
thousands, except per share amounts)


Three
      Months EndedMarch
      31,2009
              
              
              2008Revenues:Product
              
              $
              13,050
              
              
              $
              14,845Services
              
              
              16,426
              
              
              
              14,638Total
      revenues
              
              
              29,476
              
              
              
              29,483Cost
      of revenues:Product
              
              
              3,528
              
              
              
              3,130Services
              
              
              5,502
              
              
              
              5,897Total
      cost of revenues
              
              
              9,030
              
              
              
              9,027Gross
      profit
              
              
              20,446
              
              
              
              20,456Operating
      expenses:Sales
      and marketing
              
              
              9,233
              
              
              
              10,178Research
      and development
              
              
              5,626
              
              
              
              4,965General
      and administrative
              
              
              3,296
              
              
              
              3,827Total
      operating expenses
              
              
              18,155
              
              
              
              18,970Operating
      income
              
              
              2,291
              
              
              
              1,486Other
      income (expense):Interest
      income, net
              
              
              108
              
              
              
              459Other
      income (expense), net
              
              
              (298
              )
              
              
              97Total
      other income (expense), net
              
              
              (190
              )
              
              
              556Income
      before income taxes
              
              2,101
              
              
              
              2,042Income
      tax expense
              
              
              (878
              )
              
              
              (925
              )Net
      income
              
              $
              1,223
              
              
              $
              1,117Net
      income per share:Basic
              
              $
              0.07
              
              
              $
              0.06Diluted
              
              
              0.07
              
              
              
              0.06Shares
      used to compute net income per share:Basic
              
              
              16,948
              
              
              
              17,940Diluted
              
              
              17,635
              
              
              
              19,216








See
Accompanying Notes to Condensed Consolidated Financial Statements








2


Interactive Intelligence, Inc.


Condensed
Consolidated Statement of Shareholders’ Equity (unaudited)


For
the Three Months Ended March 31, 2009


(In
thousands)





Common
      Stock
              
              
              Treasury
              
              
              Additional
                Paid-in
              
              
              AccumulatedShares
              
              
              Amount
              
              
              Stock
              
              
              Capital
              
              
              Deficit
              
              
              TotalBalances,
      December 31, 2008
              
              
              16,928
              
              
              $
              169
              
              
              $
              (9,714
              )
              
              $
              83,604
              
              
              $
              (26,812
              )
              
              $
              47,247Issuances
      of common stock
              
              
              11
              
              
              
              --
              
              
              
              --
              
              
              
              69
              
              
              
              --
              
              
              
              69Exercise
      of stock options
              
              
              22
              
              
              
              1
              
              
              
              209
              
              
              
              
              
              
              
              (99
              )
              
              
              111Stock-based
      compensation
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              847
              
              
              
              --
              
              
              
              847Comprehensive
      income:Net
      income
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              1,223
              
              
              
              1,223Net
      unrealized investment loss
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              2
              
              
              
              --
              
              
              
              2Total
      comprehensive income
              
              
              --
              
              
              
              --
              
              
              
              --
              
              
              
              2
              
              
              
              1,223
              
              
              
              1,225Balances,
      March 31, 2009
              
              
              16,961
              
              
              $
              170
              
              
              $
              (9,505
              )
              
              $
              84,522
              
              
              $
              (25,688
              )
              
              $
              49,499





See
Accompanying Notes to Condensed Consolidated Financial
Statements


3


Interactive Intelligence, Inc.
 Condensed
Consolidated Statements of Cash Flows (unaudited)
 For
the Three Months Ended March 31, 2009 and 2008
 (In
thousands)





Three
      Months EndedMarch
      31,2009
                            
                            
                            2008Operating
      activities:Net
      income
                            
                            $
                            1,223
                            
                            
                            $
                            1,117Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
                            
                            
                            1,055
                            
                            
                            
                            795Stock-based
      compensation expense related to stock options
                            
                            
                            847
                            
                            
                            
                            932Deferred
      income tax
                            
                            
                            670
                            
                            
                            
                            821Accretion
      of investment income
                            
                            
                            5
                            
                            
                            
                            (4
                            )Changes
      in operating assets and liabilities:Accounts
      receivable
                            
                            
                            4,215
                            
                            
                            
                            154Prepaid
      expenses
                            
                            
                            443
                            
                            
                            
                            (782
                            )Other
      current assets
                            
                            
                            (817
                            )
                            
                            
                            159Other
      assets
                            
                            
                            72
                            
                            
                            
                            32Accounts
      payable and accrued liabilities
                            
                            
                            (1,251
                            )
                            
                            
                            1,871Accrued
      compensation and related expenses
                            
                            
                            (957
                            )
                            
                            
                            (1,056
                            )Deferred
      product revenues
                            
                            
                            (413
                            )
                            
                            
                            116Deferred
      services revenues
                            
                            
                            (682
                            )
                            
                            
                            1,190Net
      cash provided by operating activities
                            
                            
                            4,410
                            
                            
                            
                            5,345Investing
      activities:Sales
      of available-for-sale investments
                            
                            
                            7,800
                            
                            
                            
                            11,200Purchases
      of available-for-sale investments
                            
                            
                            (897
                            )
                            
                            
                            (6,604
                            )Purchases
      of property and equipment
                            
                            
                            (266
                            )
                            
                            
                            (2,583
                            )Unrealized
      loss on investment
                            
                            
                            (2
                            )
                            
                            
                            --Net
      cash provided by investing activities
                            
                            
                            6,635
                            
                            
                            
                            2,013Financing
      activities:Proceeds from stock options exercised
                            
                            
                            111
                            
                            
                            
                            282Proceeds
      from issuance of common stock
                            
                            
                            69
                            
                            
                            
                            62Net
      cash provided by financing activities
                            
                            
                            180
                            
                            
                            
                            344Net
      increase in cash and cash equivalents
                            
                            
                            11,225
                            
                            
                            
                            7,702Cash
      and cash equivalents, beginning of period
                            
                            
                            34,705
                            
                            
                            
                            29,359Cash
      and cash equivalents, end of period
                            
                            $
                            45,930
                            
                            
                            $
                            37,061Cash
      paid during the period for:Income
      taxes
                            
                            $
                            150
                            
                            
                            $
                            128Other
      non-cash item:Purchases
      of property and equipment payable at end of period
                            
                            $
                            (51)
                            
                            
                            $
                            (477
                            )








See
Accompanying Notes to Condensed Consolidated Financial
Statements


4


Interactive Intelligence, Inc.


Notes
to Condensed Consolidated Financial Statements


March
31, 2009 and 2008 (unaudited)





1.
            FINANCIAL
      STATEMENT PRESENTATION




The
accompanying unaudited condensed consolidated financial statements of
Interactive Intelligence, Inc. (the “Company”) have been prepared in conformity
with accounting principles generally accepted in the United States of America
(“US GAAP”) and with the instructions for Form 10-Q and Article 10 of Regulation
S-X for interim financial information. Accordingly, certain information and note
disclosures normally included in the Company’s financial statements prepared in
accordance with US GAAP have been condensed, or omitted, pursuant to the rules
and regulations of the United States Securities and Exchange Commission (the
“SEC”).





The
preparation of the Company’s condensed consolidated financial statements
requires management to make estimates and assumptions that affect reported
amounts of assets and liabilities, at the respective balance sheet dates, and
the reported amounts of revenues and expenses during the respective reporting
periods. Despite management’s best effort to establish good faith estimates and
assumptions, actual results could differ from these estimates. In management’s
opinion, the Company’s accompanying condensed consolidated financial statements
include all adjustments necessary (which are of a normal and recurring nature,
except as otherwise noted) for the fair presentation of the results of the
interim periods presented.





The
Company’s accompanying condensed consolidated balance sheet as of December 31,
2008 has been derived from the Company’s audited consolidated financial
statements at that date but does not include all of the information and notes
required by US GAAP for complete financial statements. These accompanying
condensed consolidated financial statements should be read in conjunction with
the Company’s audited consolidated financial statements for the year ended
December 31, 2008, included in the Company’s most recent Annual Report on Form
10-K as filed with the SEC on March 9, 2009. The Company’s results of operations
for any interim period are not necessarily indicative of the results of
operations for any other interim period or for a full fiscal year.





Principles
of Consolidation





The
accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries after elimination of all significant
intercompany accounts and transactions.




2.
            SUMMARY
      OF CERTAIN ACCOUNTING POLICIES AND RECENT ACCOUNTING
      PRONOUNCEMENTS





The
Company’s interim critical accounting policies and estimates include the
recognition of income taxes using an estimated annual effective tax
rate.  For a complete summary of the Company’s other significant
accounting policies and other critical accounting estimates, refer to Note 2 of
Notes to Consolidated Financial Statements included in the Company’s Annual
Report on Form 10-K for the year ended December 31, 2008.





During
the three months ended March 31, 2009, there were no material changes to the
Company’s significant accounting policies or critical accounting
estimates.




In
December 2007, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”)  No. 141 (revised
2007), Business
Combinations(“SFAS 141R”) and SFAS No. 160, Noncontrolling
Interests in Consolidated Financial Statements– an amendment to ARB No. 51(“SFAS 160”). SFAS 141R and SFAS 160 require most identifiable assets,
liabilities, noncontrolling interests, and goodwill acquired in a business
combination to be recorded at “full fair value” and require noncontrolling
interests (previously referred to as minority interests) to be reported as a
component of equity, which changes the accounting for transactions with
noncontrolling interest holders. Both SFAS 141R and SFAS 160 became
effective for periods beginning on or after December 15, 2008, and earlier
adoption was prohibited. SFAS 141R applies to business combinations occurring
after the effective date. SFAS 160 applies prospectively to all noncontrolling
interests, including any that arose before the effective date. Upon
adoption of SFAS 141R and SFAS 160, there was no material impact on
the Company’s condensed consolidated financial statements as the Company did not
participate in any business combinations and did not incur any noncontrolling
interests.
  In
February 2008, the FASB issued FASB Staff Position (“FSP”) No. 157-2, Effective
Date of FASB Statement No. 157 (“FSP 157-2”), which delays the effective
date of SFAS No. 157, Fair Value
Measurements ("SFAS 157"), for one year for all nonfinancial assets
and nonfinancial liabilities, except those that are recognized or disclosed at
fair value in the financial statements on a recurring basis. The Company elected
a partial deferral of SFAS 157 under the provisions of FSP 157-2 related to the
measurement of fair value used when evaluating goodwill, other intangible assets
and other long-lived assets for impairment. See Note 3 for further information
and related disclosures regarding the Company’s fair value measurements. Upon
adoption of FSP 157-2 during the first quarter of 2008, there was no material
impact on the Company’s condensed consolidated financial
statements.
  5
  In
May 2008, the FASB issued SFAS No. 162, The
Hierarchy of Generally Accepted Accounting Principles(“SFAS 162”). SFAS
162 identifies the sources of accounting principles and the framework for
selecting the principles to be used in the preparation of financial statements
of nongovernmental entities that are presented in conformity with US GAAP. SFAS
162 became effective beginning on November 15, 2008. Upon adoption of SFAS
162, there was no material impact on the Company's condensed
consolidated financial statements.
 In
October 2008, the FASB issued FSP No. 157-3, Determining
the Fair Value of a Financial Asset When the Market for that Asset is Not Active(“FSP 157-3”), which clarifies the application of SFAS 157 in an inactive
market. FSP 157-3 explains that when relevant and observable market information
is not available to determine the measurement of an asset’s fair value,
management must use their judgment about the assumptions a market participant
would use in pricing the asset in a current sale
transaction.  Appropriate risk adjustments that a market participant
would use must also be taken into account when determining the fair value.
Application of this guidance should be accounted for as a change in estimate and
FSP 157-3 was effective upon issuance. Upon adoption of FSP 157-3 during the
fourth quarter of 2008, there was no material impact on the Company’s condensed
consolidated financial statements.




In April
2009, the FASB issued FSP No. 157-4, Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not Orderly
(“FSP 157-4”). This FSP provides guidance on determining fair values for assets
or liabilities when there is no active market or where the price inputs being
used represent distressed sales. The guidance reaffirms the need to use judgment
to ascertain if a formerly active market has become inactive and determining
fair values when markets have become inactive. This FSP will be effective for
interim and annual reporting periods ending after June 15, 2009, and will
be applied prospectively. Early adoption is permitted for periods ending after
March 15, 2009. The Company did not early adopt and does not expect that the
adoption of FSP 157-4 will have a material impact on its results of
operations or financial position.
  In April
2009, the FASB issued FSP No. 115-2 and No. 124-2, Recognition
and Presentation of Other-Than-Temporary Impairments (“FSP 115-2 and FSP
124-2”), which provides guidance on other-than-temporary impairments and is
intended to bring greater consistency to the timing of impairment recognition
and provide greater clarity to investors about the credit and noncredit
components of impaired debt securities that are not expected to be sold. The
measure of impairment in comprehensive income remains fair value. The FSP also
requires increased and timelier disclosures regarding expected cash flows,
credit losses, and an aging of securities with unrealized losses. This
FSP will be effective for interim and annual reporting periods ending after
June 15, 2009, and will be applied prospectively. Early adoption is not
permitted. The Company does not expect that the adoption of FSP 115-2 and FSP
124-2 will have a material impact on its results of operations or financial
position.


3.
            FAIR
      VALUE MEASUREMENTS




SFAS
157 ,
as amended, defines fair value as the exchange price that would be received
for an asset or paid to transfer a liability (an exit price) in the principal or
most advantageous market for the asset or liability in an orderly transaction
between market participants on the measurement date. SFAS 157 also establishes a
fair value hierarchy which requires an entity to maximize the use of observable
inputs and minimize the use of unobservable inputs when measuring fair value.
The standard describes the following three levels of inputs that may be used to
measure fair value:





·
            Level 1 - Unadjusted
      quoted prices in active markets that are accessible at the measurement
      date for identical, unrestricted assets or
  liabilities.





·
            Level 2 - Observable
      inputs other than Level 1 prices such as quoted prices for similar assets
      or liabilities; quoted prices in markets that are not active; or other
      inputs that are observable or can be corroborated by observable market
      data for substantially the full term of the assets or
      liabilities.





·
            Level 3 - Unobservable
      inputs that are supported by little or no market activity and that are
      significant to the fair value of the assets or
  liabilities.




The
Company’s assets that are measured at fair value on a recurring basis are
generally classified within Level 1 or Level 2 of the fair value
hierarchy.  The types of instruments valued based on quoted market
prices in active markets include most money market securities and equity
investments.  Such instruments are generally classified within Level 1
of the fair value hierarchy.  The Company invests in money market
funds that are traded daily and does not adjust the quoted price for such
instruments.  The types of instruments valued based on quoted prices
in less active markets, broker or dealer quotations, or alternative pricing
sources with reasonable levels of price transparency include the Company’s
corporate notes, commercial paper and certificates of deposits.  Such
instruments are generally classified within Level 2 of the fair value
hierarchy.  The Company uses consensus pricing, which is based on
multiple pricing sources, to value its fixed income investments.





6




The
following table sets forth a summary of the Company’s financial assets,
classified as cash and cash equivalents and short-term investments on its
condensed consolidated balance sheet, measured at fair value on a recurring
basis as of March 31, 2009 (in thousands):





Fair
      Value Measurements at
                  Reporting
      Date UsingDescription
                
                Total
                
                
                Quoted
      Prices
                    inActive
      Markets
                    for
                    Identical
      Assets
                    (Level
      1)
                
                
                Significant
                    Other
                    Observable
                    Inputs
                    (Level
      2)
                
                
                Significant
                    Unobservable
                    Inputs
                    (Level
      3)Cash
      & cash equivalents:Money
      Market Funds
                
                $
                25,317
                
                
                $
                25,317
                
                
                $
                --
                
                
                $
                --Short-term
      investments:Corporate
      Notes
                
                $
                1,002
                
                
                $
                --
                
                
                $
                1,002
                
                
                $
                --Commercial
      Paper
                
                
                898
                
                
                
                --
                
                
                
                898
                
                
                
                --Certificates
      of Deposit
                
                
                2,001
                
                
                
                --
                
                
                
                2,001
                
                
                
                --Total
                
                $
                3,901
                
                
                $
                --
                
                
                $
                3,901
                
                
                $
                --





4.
            NET
      INCOME PER SHARE





Basic net
income per share is calculated based on the weighted-average number of common
shares outstanding in accordance with SFAS No. 128, Earnings per Share. Diluted
net income per share is calculated based on the weighted-average number of
common shares outstanding plus the effect of dilutive potential common shares.
When the Company reports net income, the calculation of diluted net income per
share excludes shares underlying stock options outstanding that would be
anti-dilutive. Potential common shares are composed of shares of common stock
issuable upon the exercise of stock options. The following table sets forth the
calculation of basic and diluted net income per share (in thousands, except per
share amounts):


Three
      Months EndedMarch
      31,2009
              
              
              2008Net
      income, as reported (A)
              
              $
              1,223
              
              
              $
              1,117Weighted
      average shares of common stock outstanding (B)
              
              
              16,948
              
              
              
              17,940Dilutive
      effect of employee stock options
              
              
              687
              
              
              
              1,276Common
      stock and common stock equivalents (C)
              
              
              17,635
              
              
              
              19,216Net
      income per share:Basic
      (A/B)
              
              $
              0.07
              
              
              $
              0.06Diluted
      (A/C)
              
              
              0.07
              
              
              
              0.06





The
Company’s calculation of diluted net income per share for the three months ended
March 31, 2009 and 2008 excludes stock options to purchase approximately 1.8
million and 1.1 million shares of the Company’s common stock, respectively, as
their effect would be anti-dilutive.





5.
            STOCK-BASED
      COMPENSATION





Stock
Option Plans





The
Company’s Stock Option Plans, adopted in 1995, 1999 and 2006, authorize the
Board of Directors or the Compensation Committee, as applicable, to grant
incentive and nonqualified stock options, and, in the case of the 2006 Equity
Incentive Plan, as amended (the “2006 Plan”), stock appreciation rights,
restricted stock, restricted stock units, performance shares, performance units
and other stock-based awards. After adoption of the 2006 Plan by the Company’s
shareholders in May 2006, the Company may no longer make any grants under
previous plans, but any shares subject to awards under the 1999 Stock Option and
Incentive Plan and the Outside Directors Stock Option Plan (collectively, the
“1999 Plans”) that are cancelled are added to shares available under the 2006
Plan. A maximum of 5,850,933 shares are available for delivery under the 2006
Plan, which consists of (i) 2,150,000 shares, plus (ii) 320,000 shares available
for issuance under the 1999 Plans, but not underlying any outstanding stock
options or other awards under the 1999 Plans, plus (iii) up to 3,380,933 shares
subject to outstanding stock options or other awards under the 1999 Plans that
expire, are forfeited or otherwise terminate unexercised on or after May 18,
2006. The number of shares available under the 2006 Plan is subject to
adjustment for certain changes in the Company’s capital structure. The exercise
price of options granted under the 2006 Plan is equal to the closing price of
the Company’s common stock, as reported by The NASDAQ Global Market, on the
business day immediately preceding the date of grant. Non-qualified stock
options granted under the 2006 Plan have a term of six years.





7


Stock
options granted by the Company are categorized into two types.  The
first type is performance-based stock options that are subject to cancellation
if the specified performance targets, as approved by the Company's Compensation
Committee, are not met.  If the applicable performance targets have
been achieved, the options will vest in four equal annual installments beginning
one year after the performance-related period has ended.  The
fair value of these stock option grants is determined on the date of grant and
the related compensation expense is recognized over the requisite service
period, including the initial period for which the specified performance targets
must be met.




The
second type of stock options granted by the Company is non-performance-based
options that are subject only to time-based vesting.  These stock
options vest in four equal annual installments beginning one year after the
grant date.  The fair value of these option grants is determined on
the date of grant and the related compensation expense is recognized for the
entire award on a straight-line basis over the vesting period.




The plans
may be terminated by the Company’s Board of Directors at any time.





Stock-Based
Compensation Expense Information





The
following table summarizes the allocation of stock-based compensation expense
related to employee and director stock options under SFAS No. 123 (revised
2004), Share-Based
Payment, and the guidance of Staff
Accounting Bulletin No. 107, as amended by Staff Accounting Bulletin No.
110, for the three months ended March 31, 2009 and 2008 (in
thousands):





Three
      Months EndedMarch
      31,2009
              
              
              2008Stock-based
      compensation expense by category:Cost
      of services
              
              $
              65
              
              
              $
              72Sales
      and marketing
              
              
              308
              
              
              
              362Research
      and development
              
              
              245
              
              
              
              208General
      and administrative
              
              
              229
              
              
              
              290Total
      stock-based compensation expense
              
              $
              847
              
              
              $
              932





Valuation
Assumptions





The
Company estimated the fair value of stock options using the Black-Scholes
valuation model. There were no material changes in the way the assumptions were
calculated as previously disclosed in our Annual Report on Form 10-K for the
year ended December 31, 2008.  The weighted-average estimated per
option value of non-performance and performance based options granted
during the three months ended March 31, 2009 and March 31, 2008 used
the following assumptions:


Three
      Months Ended March 31,
                  
                  
                  Three Months Ended
      March 31,Valuation
      assumptions for non-performancebased options:
                  
                  2009
                  
                  
                  2008Dividend
      yield
                  
                  
                  --
                  %
                  
                  
                  --
                  %Expected
      volatility
                  
                  
                  67.88
                  %
                  
                  
                  64.12
                  %Risk-free
      interest rate
                  
                  
                  1.64
                  %
                  
                  
                  2.22
                  %Expected
      life of option (in years)
                  
                  4.25
      years
                  
                  
                  4.25
      years  Three
      Months Ended March 31,
                        
                        
                        Three
      Months Ended March 31,Valuation
      assumptions for performancebased options:
                        
                        2009
                        
                        
                        2008Dividend
      yield
                        
                        
                        --
                        %
                        
                        
                        --
                        %Expected
      volatility
                        
                        
                        67.35
                        %
                        
                        
                        63.66
                        %Risk-free
      interest rate
                        
                        
                        1.77
                        %
                        
                        
                        2.39
                        %Expected
      life of option (in years)
                        
                        4.75
      years
                        
                        
                        4.75
      years


8







Stock
Option Activity





The
following table sets forth a summary of option activity for the three months
ended March 31, 2009:


As
      of March 31, 2009Options
              
              
              Weighted-
                  Average
                  Exercise
                  PriceBalances,
      beginning of year
              
              
              3,300,565
              
              
              $
              9.46Options
      granted
              
              
              499,375
              
              
              
              6.73Options
      exercised
              
              
              (22,235
              )
              
              
              4.98Options
      cancelled
              
              
              (17,229
              )
              
              
              13.09Options
      outstanding
              
              
              3,760,476
              
              
              
              9.11Option
      price range
              
              $
              2.51
      - 50.50Weighted-average
      fair value of options granted
              
              $
              3.61Options
      exercisable
              
              
              2,394,985
              
              
              $
              7.90Options
      available for grant
              
              
              893,994





6.
            CONCENTRATION
      OF CREDIT RISK





No
customer or partner accounted for 10% or more of the Company’s accounts
receivable as of March 31, 2009 and December 31, 2008. In addition, no customer
or partner accounted for 10% or more of the Company’s revenues for the three
months ended March 31, 2009 and 2008.





7.
            COMMITMENTS
      AND CONTIGENCIES





Legal
Proceedings





From time
to time, the Company has received notification from competitors and other
technology providers claiming that the Company’s technology infringes their
proprietary rights. The Company cannot assure you that these matters can be
resolved amicably without litigation, or that the Company will be able to enter
into licensing arrangements on terms and conditions that would not have a
material adverse effect on its business, financial condition or results of
operations.





During
the fourth quarter of 2008, the Company reached a settlement with the French
Taxing Authority ("FTA") as a result of a tax audit that had been conducted
encompassing the years 1998 through 2004.Subsequent to the
settlement, the Company received a letter from another division within the FTA
that claimed Interactive Intelligence France SARL owes penalties and interest in
the amount of $651,000 as of March 31, 2009. The Company has submitted an
appeal for this amount as it believes penalties and interest were agreed to and
paid in the previous settlement. The Company does not believe it will have to
pay any money related to this claim, therefore no amount has been accrued as of
March 31, 2009. Although the Company is appealing this claim, it cannot assure
you that these matters will be resolved without further litigation or that we
will not have to pay some or all of this amount.





From time
to time, the Company is also involved in certain legal proceedings in the
ordinary course of conducting its business. While the ultimate liability
pursuant to these actions cannot currently be determined, the Company believes
these legal proceedings will not have a material adverse effect on its financial
position or results of operations. Litigation in general, and intellectual
property litigation in particular, can be expensive and disruptive to normal
business operations. Moreover, the results of complex legal proceedings are
difficult to predict.





Lease
Commitments




The
Company’s world headquarters are located in a 200,000 square foot space in two
office buildings in Indianapolis, Indiana. The Company leases the space under an
operating lease agreement and amendments which expire on March 31, 2018. In
addition to the Company’s world headquarters, it occupies two regional offices
in the United States, one in Herndon, Virginia that it opened in October 2006,
and one in Irvine, California that it opened in September 2006. The Company also
leases offices for each of its Europe,
the Middle East and Africa (“EMEA”) and Asia-Pacific (“APAC”)operations in Berkshire, United Kingdom and Kuala Lumpur, Malaysia,
respectively, and has several other office leases throughout the United
States and in 11 other countries. The Company rents office space for sales,
services, development and international offices under month-to-month leases. In
accordance with SFAS No. 13, Accounting
for Leases, rental expense is recognized ratably over the lease period,
including those leases containing escalation clauses.
 
 The
Company believes that all of its facilities, including its world headquarters,
regional offices and international offices in EMEA and APAC, are adequate and
well suited to accommodate its business operations. The Company continuously
reviews space alternatives to ensure it has adequate room for growth in the
future.


Other
Contingencies





The
Company has received and may continue to receive certain payroll tax credits and
real estate tax abatements that were granted to the Company based upon certain
growth projections.  If the Company’s actual results are less than those
projections, the Company may be subject to repayment of some or all of the tax
credits or payment of additional real estate taxes in the case of the
abatements.  The Company does not believe that it will be subject to
payment of any money related to these taxes; however, the Company cannot provide
assurance as to the outcome.





9


8.
            INCOME
      TAXES





The
following table is a reconciliation of the difference between the actual
provision for income taxes and the provision computed by applying the federal
statutory rate, 35%,
on income before income taxes (in thousands):


Three
      Months EndedMarch
      31,2009
                              
                              2008Expected
      income tax expense at 35%
      tax rate
                              
                              $
                              (735)
                              
                              $
                              (715
                              )State
      taxes, net of federal benefit
                              
                              
                              (116)
                              
                              
                              (117
                              )Non-deductible
      stock-based compensation expense
                              
                              
                              (140)
                              
                              
                              (190
                              )Foreign
      income tax expense
                              
                              
                              79
                              
                              
                              104Other
                              
                              
                              34
                              
                              
                              7Income tax expense
                              
                              $
                              (878)
                              
                              $
                              (925
                              )




Upon
adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes an interpretation of FASB Statement No. 109 in 2007, the
Company identified an uncertain tax position related to certain tax credits that
the Company currently believes meets the “more likely than not” recognition
threshold to be sustained upon examination. The balance of the unrecognized
tax benefit was approximately $750,000 at December 31, 2008 and, if recognized,
would impact the effective tax rate. As of March 31, 2009, the unrecognized tax
benefit has not changed.
 
 The
Company and its subsidiaries file federal income tax returns and income tax
returns in various states and foreign jurisdictions.  Tax years 2005
and forward remain open for examination for federal tax purposes and tax years
2004 and forward remain open for examination for the Company’s more significant
state tax jurisdictions.  To the extent utilized in future years’ tax
returns, net operating loss and capital loss carryforwards at March 31,
2009 will remain subject to examination until the respective tax year is
closed.





Item 2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations.





The
following Management’s Discussion and Analysis of Financial Condition and
Results of Operations is intended to provide our investors with an understanding
of our past performance, our financial condition and our prospects and should be
read in conjunction with other sections of this Quarterly Report on Form 10-Q.
Investors should carefully review the information contained in this report under
Part II, Item 1A “Risk Factors” and in the Part I, Item 1A “Risk Factors”
section of our Annual Report on Form 10-K for the fiscal year ended December 31,
2008. The following will be discussed and analyzed:




·      
Forward-Looking Information




·       Overview




·       Financial Highlights




·      
Historical Results of Operations




·     
 Liquidity and Capital Resources




·       Critical Accounting Policies
and Estimates





Forward-Looking
Information





Certain
statements in this Quarterly Report on Form 10-Q contain “forward-looking”
information (as defined in the Private Securities Litigation Reform Act of
1995,Section 27A
of the Securities Act of 1933, as amended and Section 21E of the Securities
Exchange Act of 1934, as amended) that involves risks and uncertainties which
may cause actual results to differ materially from those predicted in the
forward-looking statements. Forward-looking statements can often be identified
by their use of such verbs as “expects”, “anticipates”, “believes”, “intend”,
“plan”, “may”, “should”, “will”, “would”, “will be”, “will continue”, “will
likely result”, or similar verbs or conjugations of such verbs. If any of our
assumptions on which the statements are based prove incorrect or should
unanticipated circumstances arise, our actual results could materially differ
from those anticipated by such forward-looking statements. The differences could
be caused by a number of factors or combination of factors, including, but not
limited to, unstable economic conditions, rapid technological changes in the
industry, our ability to maintain profitability, to manage successfully our
growth and increasingly complex third party relationships, to maintain
successful relationships with our current and any new partners, to maintain and
improve our current products and to develop new products and to protect our
proprietary rights adequately, and other factors set forth in our Securities and
Exchange Commission (“SEC”) filings.




10




Overview





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




We are a
leading provider of software application suites for Voice over Internet Protocol
(“VoIP”) business communications, and are increasingly leveraging our leadership
position in the worldwide contact center market to offer our solutions to
enterprises. In addition to the contact center sector, businesses utilize our
solutions in industries including, but not limited to, teleservices, financial
services (banks, credit unions), insurance, higher education (universities),
healthcare, retail, technology, government and business services. Organizations
that employ remote and mobile workers incorporate our solutions as well. For
enterprises that rely on the Microsoft® Corporation (“Microsoft”) platform, we
offer a pre-integrated all-software Internet Protocol Private Branch Exchange
phone and communications system that enables straightforward integration to
Microsoft applications for data management. In all, our innovative software
products and services are designed expressly for multichannel contact
management, business communications and messaging using the Session Initiation
Protocol (“SIP”)  global communications standard that supports VoIP.
To supplement our software solutions, our product lineup includes a
full-featured media server, media gateways and SIP proxy for IP-based
communications networks and infrastructures. Our customers can deploy our
solutions as an on-premise system at their site or as Communications as a
Service (“CaaS”).





Our
application-based solutions are integrated on a single software platform.
Overall, our platform has been developed to deliver security, broaden
integration to business systems and end-user devices, enhance mobility for
today’s workforce, scale to thousands of users, and more wholly satisfy diverse
business communications and interaction management needs in markets
for:




·
            The
      Contact Center




·
            Enterprise
      IP Telephony




·
            Enterprise
      Messaging




By
implementing our all-in-one solutions, businesses are able to unify multichannel
communications media (phone, fax, e-mail and web chat); improve workforce
performance, effectiveness and productivity; and more readily adapt to changing
market and customer requirements. Organizations in the industries we serve are
further able to reduce equipment and maintenance costs over traditional
“multi-point” communications hardware, and additionally reduce the complexity of
such non-integrated systems.





For
further information on our business and the products and services we offer,
refer to the Part I, Item 1 “Business” section of our Annual Report on Form 10-K
for the year ended December 31, 2008.




Our management monitors certain key measures to assess our financial results. In
particular, we track trends on product orders and contracted professional
services and CaaS quarter to quarter and in comparison to the prior year and
budget.  We monitor our level of staffing which impacts our
compensation expense, our largest expense. As noted below, as a result of the
worldwide economic downturn, we have seen a negative impact on our orders
received. In addition to orders and revenues, management reviews costs of
revenue and operating expenses to ensure we are minimizing new expenditures and
reducing costs, and we have adjusted our staffing levels to reduce expenses.
Finally, management monitors diluted earnings per share, which is a key measure
of performance that is also used by analysts and investors.
 The table
below shows our total revenues (in millions) for the most recent five quarters
and the years ended December 31, 2008, 2007 and 2006 and the percentage change
over the previous period (including the impact of reclassifications and
adjustments for 2006 and 2007 as discussed in Note 1 of Notes to Condensed
Consolidated Financial Statements in the respective year's Annual Report on Form
10-K).
 
 Period
                      
                      Revenues
                      
                      
                      Growth %Three Months Ended:March
      31, 2009
                      
                      $
                      29.5
                      
                      
                      
                      (6
                      )%December
      31, 2008
                      
                      
                      31.3
                      
                      
                      
                      4
                      %September
      30, 2008
                      
                      
                      30.1
                      
                      
                      
                      (2
                      )%June
      30, 2008
                      
                      
                      30.6
                      
                      
                      
                      4
                      %March
      31, 2008
                      
                      
                      29.5
                      
                      
                      
                      1
                      %Year Ended December 31:2008
                      
                      $
                      121.4
                      
                      
                      
                      10
                      %2007
                      
                      
                      109.9
                      
                      
                      
                      32
                      %2006
                      
                      
                      83.0
                      
                      
                      
                      32
                      %
  As shown
in the 2008 annual growth rate and the quarterly growth rates in 2008 and for
the first quarter of 2009, our revenue growth trend has slowed.  We
believe that this is primarily due to the downturn in the economy worldwide,
which has resulted in longer sales cycles, as potential customers are hesitant
to spend money on capital purchases.  In addition, we have seen a
decrease in our existing customers licensing additional software and purchasing
hardware, in part because many customers are experiencing minimal growth in
revenues or revenue reductions and some customers are reducing their number of
employees.
 11
 Given the
current economic conditions, we do not believe that we can accurately make
predictions for the upcoming quarters. We will continue to focus on maintaining
profitability through our sales and marketing efforts for our products and
services and continued management of operating expenses. As our profitability
allows, we will position the company for future growth through our research
and development initiatives which may increase expenses in the future
as we focus on these efforts.





Financial
Highlights




During
the first quarter of 2009, product revenues decreased $1.8 million compared to
the same quarter in 2008, as a result of lower order activity
across all product lines and all major regions. This
decrease was offset by an increase in services revenues of $1.8
million primarily due to additional support fees and annually renewable
license fees as well as a $383,000 increase in CaaS.




Our
costs of product increased $398,000 during the first quarter of 2009 compared to
the same period in 2008 due to additional hardware delivered by us.
  Our costs
of services and operating expenses, which include sales and marketing, research
and development and general and administrative expenses, decreased for the three
months ended March 31, 2009, compared to the same period in 2008, primarily
due to a $400,000, or 1%, decrease in company-wide staffing at March 31, 2009,
compared to March 31, 2008, and a decrease in travel and entertainment related
costs of $536,000. Both decreases were partially offset by an increase
in allocated rent and depreciation costs of $296,000 and $259,000, respectively,
during the quarter ended March 31, 2009, compared to the same period in 2008, as
a result of our opening additional offices and expanding some of our
current offices subsequent to March 31, 2008.





Historical
Results of Operations





The
following table presents certain financial data, derived from our unaudited
statements of income, as a percentage of total revenues for the periods
indicated. The operating results for the three months ended March 31, 2009 and
2008 are not necessarily indicative of the results that may be expected for the
full year or for any future period.





Three
      Months EndedMarch
      31,2009
              
              
              2008Revenues:Product
              
              
              44
              %
              
              
              50
              %Services
              
              
              56
              
              
              
              50Total
      revenues
              
              
              100
              
              
              
              100Cost
      of revenues:Product
              
              
              12
              
              
              
              11Services
              
              
              19
              
              
              
              20Total
      cost of revenues
              
              
              31
              
              
              
              31Gross
      profit
              
              
              69
              
              
              
              69Operating
      expenses:Sales
      and marketing
              
              
              31
              
              
              
              34Research
      and development
              
              
              19
              
              
              
              17General
      and administrative
              
              
              11
              
              
              
              13Total
      operating expenses
              
              
              61
              
              
              
              64Operating
      income
              
              
              8
              
              
              
              5Other
      income (expense):Interest
      income, net
              
              
              --
              
              
              
              2Other
      income (expense), net
              
              
              (1
              )
              
              
              --Total
      other income (expense)
              
              
              (1
              )
              
              
              2Income
      before income taxes
              
              
              7
              
              
              
              7Income
      tax expense
              
              
              (3
              )
              
              
              (3
              )Net
      income
              
              
              4
              %
              
              
              4
              %





12




Comparison
of Three Months Ended March 31, 2009 and 2008





Revenues





Product
      Revenues
                  
                  Three
      Months EndedMarch
      31,2009
                  
                  
                  2008($
      in thousands)Product
      revenues
                  
                  $
                  13,050
                  
                  
                  $
                  14,845Change
      from prior year period
                  
                  
                  (12
                  )%
                  
                  
                  20
                  %Percentage
      of total revenues
                  
                  
                  44
                  %
                  
                  
                  50
                  %




Product
revenues, which include software and hardware revenues, decreased $1.8 million
during the first quarter of 2009 compared to the same period in 2008. During the
three months ended March 31, 2009, the dollar amount of orders received was down
24% across all major regions and all product lines. This decrease was primarily
due to the current economic conditions, which are causing companies to delay
commitments for capital expenditures.  Partially offsetting this
decrease was an increase of 25% in the dollar amount of third party
hardware orders primarily as a result of our increased marketing efforts during
the quarter to encourage customers to purchase hardware from us rather than from
other vendors.
 
 Product
revenues can fluctuate from period to period depending on the mix of contracts
sold between perpetual licenses and annually renewable licenses. The majority of
our product licenses are perpetual but we do also have certain customers with
renewable term licenses. Perpetual orders are recognized when received, if other
recognition criteria are satisfied, while renewable term licenses are deferred
and generally recognized over one year. The impact of the mix of contracts on
our product revenues occurs only in the year of a product order; subsequent
renewal fees received for annually renewable licenses and renewal support fees
for perpetual contracts are all allocated entirely to services
revenues.





Services
      Revenues
                  
                  Three
      Months EndedMarch
      31,2009
                  
                  
                  2008($
      in thousands)Services
      revenues
                  
                  $
                  16,426
                  
                  
                  $
                  14,638Change
      from prior year period
                  
                  
                  12
                  %
                  
                  
                  23
                  %Percentage
      of total revenues
                  
                  
                  56
                  %
                  
                  
                  50
                  %





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





The
increase in our services revenues during the first quarter of 2009 compared to
the same period in 2008 was primarily due to our growing installed base of
customers, both in number and size, and the related payments of annual license
renewal fees and support fees for perpetual licenses. License
renewal and support revenues, which comprise 76% of total services
revenues, increased by $1.3 million, or 11%, during the three months ended
March 31, 2009, compared to the same period in 2008.As we sign contracts
and install our solutions with new end-customers and expand product usage at
existing customers, we expect that our services revenues will continue to
increase as customers renew licenses and pay for support on our software
applications. The actual percentage fee charged for renewal of annually
renewable licenses and perpetual support agreements as compared to the initial
annually renewable license fee and perpetual license, respectively, is
comparable on a relative percentage basis, and therefore, the mix of these types
of contracts in the future is not expected to impact our future services
revenues.


During the first quarter
of 2009, CaaS revenues increased $383,000, or 85%, primarily due to an
increase in the dollar amount of contracted CaaS services compared to the
same period in 2008. Services revenues have and will fluctuate based on the
dollar amount of orders and license renewals, the number of attendees at our
educational classes, the amount of assistance our customers and partners need
for implementation and installation and CaaS adoption. We anticipate these
services revenues will continue to increase in the future if the number of our
customers continues to increase.


Although
we have not experienced a significant increase in our customers choosing not to
renew their licenses and support fees, if more of our customers choose to not
renew, those decisions could have an adverse effect on our future services
revenue.




13


Cost of
      Revenues
                              
                              Three
      Months EndedMarch
      31,2009
                              
                              
                              2008Cost
      of revenues:
                              
                              ($
      in thousands)Product
                              
                              $
                              3,528
                              
                              
                              $
                              3,130Services
                              
                              
                              5,502
                              
                              
                              
                              5,897Total
      cost of revenues
                              
                              $
                              9,030
                              
                              
                              $
                              9,027Change
      from prior year period
                              
                              
                              --
                              %
                              
                              
                              25
                              %Product
      costs as a % of product revenues
                              
                              
                              27
                              %
                              
                              
                              21
                              %Services
      costs as a % of services revenues
                              
                              
                              33
                              %
                              
                              
                              40
                              %




Costs
of product consist of hardware costs, primarily for media server and Interaction
Gateway appliances that we developed; servers, telephone handsets and gateways
that we purchase and resell; royalties for third party software and other
technologies included in our solutions; personnel costs; and, to a lesser
extent, software packaging costs, which include product media, duplication and
documentation. Costs of product can fluctuate depending on which software
applications are licensed to our customers and partners, the third party
software that is licensed by the end user from us as part of our software
applications and the dollar amount of orders for hardware. Costs of
product increased during the three months ended March 31, 2009 compared to the
same period in 2008 primarily as a result of a $337,000 increase in hardware
costs from $1.7 million to $2.0 million.




Costs of
services consist primarily of compensation expenses for technical support,
educational and professional services personnel and costs associated with our
CaaS offering. These expenses decreased primarily due to a $360,000
decrease in compensation expense as a result of a 9% staffing decrease in our
services personnel at March 31, 2009 compared to March 31, 2008. Travel
related expenses also decreased $181,000, partially offset by a $130,000
increase in depreciation due to office expansions subsequent to March 31,
2008.




Gross
    Profit
                  
                  Three
      Months EndedMarch
      31,2009
                  
                  
                  2008($
      in thousands)Gross
      profit
                  
                  $
                  20,446
                  
                  
                  $
                  20,456Change
      from prior year period
                  
                  
                  --
                  %
                  
                  
                  20
                  %Percentage
      of total revenues
                  
                  
                  69
                  %
                  
                  
                  69
                  %





Gross
profit as a percentage of total revenues remained consistent during the first
quarter of 2009, compared to the same period in 2008.Gross margin in any
particular quarter is dependent upon revenues recognized versus costs of product
and costs of services incurred and can vary.





Operating
Expenses




Sales
      and Marketing
                  
                  Three
      Months EndedMarch
      31,2009
                  
                  
                  2008($
      in thousands)Sales
      and marketing expenses
                  
                  $
                  9,233
                  
                  
                  $
                  10,178Change
      from prior year period
                  
                  
                  (9
                  )%
                  
                  
                  18
                  %Percentage
      of total revenues
                  
                  
                  31
                  %
                  
                  
                  34
                  %Percentage
      of net product revenues
                  
                  
                  97
                  %
                  
                  
                  87
                  %




Sales and marketing expenses are comprised primarily of compensation expenses,
travel and entertainment expenses and promotional costs related to our sales,
marketing and channel management operations. Total compensation costs
decreased $409,000 during the three months ended March 31, 2009, which was due
primarily to a 13% decrease in our sales commissions during the three months
ended March 31, 2009, compared to the three months ended March 31, 2008. 
Commissions paid to sales employees decreased due to the decrease in product
revenues during the quarter. Travel and entertainment related expenses decreased
by $207,000, as our employees limited these expenses. Outsourced services
decreased $183,000, primarily due to a decreased use of outsourced services
within our marketing efforts. In addition, our corporate marketing costs
decreased $133,000, which included decreased advertising, brand promotions and
public relations.  Referral fees increased $104,000, as we paid
more to third parties for customer referrals related to product orders during
the most recent quarter.


14




Research
      and Development
                  
                  Three
      Months EndedMarch
      31,2009
                  
                  
                  2008($
      in thousands)Research
      and development expenses
                  
                  $
                  5,626
                  
                  
                  $
                  4,965Change
      from prior year period
                  
                  
                  13
                  %
                  
                  
                  27
                  %Percentage
      of total revenues
                  
                  
                  19
                  %
                  
                  
                  17
                  %





Research
and development expenses are comprised primarily of compensation and
depreciation expenses.Research and development
expenses increased during the three months ended March 31, 2009, as compared to
the same period in 2008, primarily due to an increase in compensation expense of
$470,000, resulting from a 10% staffing increase in our research and development
personnel at March 31, 2009 compared to March 31, 2008. In addition,
the rent allocated to research and development increased by $177,000
due to the staffing additions in the research and development department and our
office expansions at our world headquarters subsequent to March 31,
2008.





We
believe that investment in research and development is critical to our future
growth and competitive position in the marketplace and is directly related to
timely development of new and enhanced solutions that are central to our
business. As a result, we expect research and development expenses will continue
to increase in future periods as our profitability allows.





General
      and Administrative
                  
                  Three
      Months EndedMarch 31,2009
                  
                  
                  2008($
      in thousands)General
      and administrative expenses
                  
                  $
                  3,296
                  
                  
                  $
                  3,827Change
      from prior year period
                  
                  
                  (14
                  )%
                  
                  
                  25
                  %Percentage
      of total revenues
                  
                  
                  11
                  %
                  
                  
                  13
                  %




General and administrative expenses are comprised of compensation expense and
general corporate expenses that are not allocable to other departments, such as
legal and other professional fees and bad debt expense. General and
administrative expenses decreased during the three months ended March 31, 2009,
as compared to the same period in 2008, primarily due to a decrease in
compensation expense of $172,000, as a result of an 11% staffing decrease in our
general and administrative personnel at March 31, 2009 compared to March 31,
2008. Travel and entertainment related expenses decreased $108,000 during the
first quarter of 2009, compared to the same period in 2008. Professional and
outsourced services also decreased by $97,000 and $70,000, respectively.
Professional services decreased due to a decrease in general accounting and
legal fees, and outsourced services decreased due to a decrease in tax
accounting fees. Bad debt costs decreased $71,000 due to strong collections and
no bad debt write-offs during the most recent quarter.




Other
Income (Expense)




Interest
      Income, Net
                  
                  Three
      Months Ended March
      31,2009
                  
                  
                  2008($
      in thousands)Cash,
      cash equivalents and short-term investments (average)
                  
                  $
                  45,720
                  
                  
                  $
                  47,882Interest
      income
                  
                  
                  108
                  
                  
                  
                  459Return
      on investment (annualized)
                  
                  
                  0.9
                  %
                  
                  
                  3.8
                  %





Interest
earned on investments decreased due to lower interest rates during the quarter
ended March 31, 2009, compared to the same period in 2008. We
continue to monitor the allocation of funds in which we have invested to
maximize our return on investment while utilizing safe investment alternatives
within our established investment policy.





Other Income (Expense),
      Net
                  
                  Three
      Months EndedMarch
      31,2009
                  
                  
                  2008($
      in thousands)Other
      income (expense)
                  
                  $
                  (298
                  )
                  
                  $
                  97





Other income (expense), net includes
foreign currency transaction gains and losses. Foreign currency transaction
gains and losses can fluctuate based on the amount of revenue that is generated
in certain international currencies, particularly the Euro, and the exchange
gain or loss that results from foreign currency disbursements and receipts. The
expense for the first three months of 2009 consisted of $298,000 of losses
compared to $209,000 of gains related to foreign currency transactions for the
same period during 2008. In addition, we had $112,000 of foreign tax
withholdings at March 31, 2008  that were reserved during 2008, as a
result of a study of our foreign tax withholding from which we
determined that we had sufficient and appropriate foreign source income to
record our foreign withholdings as a credit for tax purposes instead of as a
deduction to net income.





15


Income
      tax expense
                  
                  Three
      Months EndedMarch
      31,2009
                  
                  
                  2008($
      in thousands)Income
      tax expense
                  
                  $
                  (878
                  )
                  
                  $
                  (925
                  )





We incurred $878,000 of
income tax expense during the three months ended March 31, 2009 compared to
$925,000 of income tax expense recorded during the three months ended March 31,
2008. Of the $878,000 of income tax expense incurred during the first
quarter of 2009, $79,000 is expected to result in cash payments and the
remaining $799,000 was associated with the utilization our deferred tax
assets.


Liquidity
and Capital Resources




We
generate cash from the collections we receive related to licensing our products
and from annual license renewals, maintenance and support and other services
revenues. We use cash primarily for paying our employees (including salaries,
commissions and benefits), leasing office space, paying travel expenses and
marketing activities, paying vendors for hardware, other services and supplies
and purchasing property and equipment and, during the third and fourth quarters
of 2008, repurchasing $10.0 million of our common stock. We continue to be debt
free.





We
determine liquidity by combining cash and cash equivalents and short-term
investments as shown in the table below. Based on our recent performance and
current expectations, we believe that our current liquidity position, when
combined with our anticipated cash flows from operations, will be sufficient to
satisfy our working capital needs and current or expected obligations associated
with our operations over the next 12 months. Our future requirements will depend
on many factors, including cash flows from operations, territory expansion and
product development decisions and potential acquisitions. If our liquidity is
not sufficient to cover our needs, we may be forced to raise additional capital,
either through the capital markets or debt financings, and may not be able to do
so on favorable terms or at all.





Our
liquidity position at March 31, 2009 and December 31, 2008 was as
follows:





March
      31,
                
                
                December
      31,2009
                
                
                2008($
      in thousands)Cash
      and cash equivalents
                
                $
                45,930
                
                
                $
                36,972Short-term
      investments
                
                
                3,901
                
                
                
                12,465Liquidity,
      net
                
                $
                49,831
                
                
                $
                49,437


The
amount that we report as cash and cash equivalents or as short-term investments
fluctuates depending on investing decisions in each period. Purchases of
short-term investments and property and equipment are reported as a use of cash
and the related receipt of proceeds upon maturity of investment is reported as a
source of cash.




The
following table shows the total increase in cash and cash equivalents from
operating activities, investing activities and financing activities for the
stated periods:




Three
      Months Ended March 31,2009
                      
                      
                      2008($
      in thousands)Cash
      provided by operating activities
                      
                      $
                      4,410
                      
                      
                      $
                      5,345Cash provided
      by investing activities
                      
                      
                      6,635
                      
                      
                      
                      2,013Cash
      provided by financing activities
                      
                      
                      180
                      
                      
                      
                      344Total increase in cash and cash equivalents
                      
                      $
                      11,225
                      
                      
                      $
                      7,702




Operating
cash was generated by our net income and a decrease in accounts receivable. The
increase in net cash provided by investing activities was due primarily to the
maturity of investments which are now being held as cash and cash
equivalents.


As of
March 31, 2009, there have been no material changes in our contractual
obligations as set forth in the Contractual Obligations table disclosed in our
Annual Report on Form 10-K for the year ended December 31, 2008.




16


Off-Balance
Sheet Arrangements





Except as
set forth in the Contractual Obligations table disclosed in our Annual Report on
Form 10-K for the year ended December 31, 2008, we have no off-balance sheet
arrangements that have or are reasonably likely to have a current or future
material impact on our financial condition, changes in financial condition,
revenues or expenses, results of operations, liquidity, capital expenditures or
capital resources as of March 31, 2009.




We provide indemnifications of varying scope and amount to certain customers
against claims of intellectual property infringement made by third parties
arising from the use of our products. Our direct software license agreements, in
accordance with FASB Interpretation No. 45, Guarantor’s Accounting and
Disclosure Requirements for Guarantees, Including Indirect Guarantees of
Indebtedness of Others - an interpretation of FASB Statement No. 5, No. 57 and
No. 107, include certain provisions for indemnifying customers, in
material compliance with their license agreement, against liabilities if our
software products infringe upon a third party's intellectual property rights,
over the life of the agreement. There is no maximum potential amount of future
payments set under the guarantee. However, we may at any time and at our option
and expense:  (i) procure the right of the customer to continue to use our
software that may infringe a third party’s rights; (ii) modify our software so
as to avoid infringement; or (iii) require the customer to return our software
and refund the customer the fee actually paid by the customer for our software
less depreciation based on a five-year straight-line depreciation
schedule. The customer’s failure to provide timely notice or reasonable
assistance will relieve us of our obligations under this indemnification to the
extent that we have been actually and materially prejudiced by such failure. To
date, we have not incurred, nor do we expect to incur, any material related
costs and therefore, have not reserved for such liabilities.




Our
direct software license agreements also include a warranty that our software
products will substantially conform to our software user documentation for a
period of one year, provided the customer is in material compliance with the
software license agreement. To date, we have not incurred any material costs
associated with these product warranties, and as such, we have not reserved for
any such warranty liabilities in our operating results.





Critical
Accounting Policies and Estimates




The
preparation of our condensed consolidated financial statements requires us to
make estimates and judgments that affect the reported amount of assets,
liabilities, revenue and expenses. Actual results may differ from those
estimates and judgments under different assumptions or conditions. We have
discussed the critical accounting policies that we believe affect our more
significant estimates and judgments used in the preparation of our consolidated
financial statements in the “Management’s Discussion and Analysis of Financial
Condition and Results of the Operations—Critical Accounting Policies and
Estimates” section of our Annual Report on Form 10-K for the year ended December
31, 2008. For a further summary of certain accounting policies, see Note 2 of
Notes to Condensed Consolidated Financial Statements included in Part I, Item 1
of this Quarterly Report on Form 10-Q.





Item 3.
            Quantitative
      and Qualitative Disclosures about Market
Risk.





We
develop software application products in the United States and license our
products worldwide. As a result, our financial results could be affected by
market risks, including changes in foreign currency exchange rates, interest
rates or weak economic conditions in certain markets. Market risk is the
potential of loss arising from unfavorable changes in market rates and
prices.





Foreign
Currency Exchange Rates





We
transact business in certain foreign currencies including the British pound and
the Euro. However, as a majority of the orders we receive are denominated in
United States dollars, a strengthening of the dollar could make our products
more expensive and less competitive in foreign markets. We have not historically
used foreign currency options or forward contracts to hedge our currency
exposures because of variability in the timing of cash flows associated with our
larger contracts. We did not have any such hedge instruments in place at March
31, 2009. Rather, we attempt to mitigate our foreign currency risk by generally
transacting business and paying salaries in the functional currency of each of
the major countries in which we do business, thus creating natural hedges.
Additionally, as our business matures in foreign markets, we may offer our
products and services in certain other local currencies. If this were to occur,
foreign currency fluctuations would have a greater impact on us and may have an
adverse effect on our results of operations. Historically, our gains or losses
on foreign currency exchange translations have been immaterial to our
consolidated financial statements. For the period ended March 31, 2009, our
foreign currency exchange translation loss amounted
to $424,000.




Interest
Rate Risk





We invest
cash balances in excess of operating requirements in securities that have
maturities of one year or less. The carrying value of these securities
approximates market value, and there is no long-term interest rate risk
associated with these investments.





Item 4.
            Controls
      and Procedures.





We
maintain a set of disclosure controls and procedures that are designed to ensure
that information required to be disclosed by us in the reports filed by us under
the Securities Exchange Act of 1934, as amended (the “Exchange Act”) is (a)
recorded, processed, summarized and reported within the time periods specified
in the SEC’s rules and forms; and (b) accumulated and communicated to our
management, including our principal executive and principal financial officers,
to allow timely decisions regarding required disclosures. We carried out an
evaluation, under the supervision and with the participation of our management,
including our President and Chief Executive Officer (principal executive
officer) and our Chief Financial Officer (principal financial officer), of the
effectiveness of the design and operation of our disclosure controls and
procedures as of March 31, 2009 pursuant to Rule 13a-15 of the Exchange Act.
Based on that evaluation, our principal executive officer and principal
financial officer concluded that our disclosure controls and procedures were
effective March 31, 2009.





There
have been no changes in our internal control over financial reporting that
occurred during the three months ended March 31, 2009 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.





17




PART
II. OTHER INFORMATION





Item 1.
            Legal
      Proceedings.




The
information set forth  under "Legal Proceedings" in Note 7 of Notes to
Condensed Consolidated Financial Statements included in Part I, Item 1 of this
Quarterly Report on Form 10-Q is incorporated herein by reference.




Item 1A.
            Risk
      Factors.





In
addition to the information set forth in this Quarterly Report on Form 10-Q and
before deciding to invest in, or retain, shares of our common stock, you also
should carefully review and consider the information contained in our other
reports and periodic filings that we make with the SEC, including, without
limitation, the information contained under the caption Part I, Item 1A “Risk
Factors” in our Annual Report on Form 10-K for the year ended December 31, 2008.
Those risk factors could materially affect our business, financial condition and
results of operations.





The risks
that we describe in our public filings are not the only risks that we face.
Additional risks and uncertainties not currently known to us, or that we
presently deem to be immaterial, also may materially adversely affect our
business, financial condition and results of operations. There have been no
material changes from risk factors previously disclosed in our Annual Report on
Form 10-K for the year ended December 31, 2008.





Item
      6.
            Exhibits.





(a)
            Exhibits





Incorporated
      by ReferenceExhibit
      Number
                            
                            Exhibit
      Description
                            
                            Form
                            
                            Exhibit
                            
                            Filing
      Date
                            
                            Filed
      Herewith3.1
                            
                            Restated
      Articles of Incorporation of the Company, as currently in
      effect
                            S-1
                              (Registration
      No. 333-79509)
                            
                            3.1
                            
                            5/28/19993.2
                            
                            Amended
      By-Laws of the Company, as currently in effect
                            
                            8-K
                            
                            3.2
                            
                            8/21/200731.1
                            
                            Certification
      of the Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the
      Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002
                            
                            
                            
                            
                            
                            
                            X31.2
                            
                            Certification
      of the Chief Financial Officer pursuant to Rule 13a-14(a)/15d-14(a) of the
      Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the
      Sarbanes-Oxley Act of 2002
                            
                            
                            
                            
                            
                            
                            X32.1
                            
                            Certification
      of the Chief Executive Officer, pursuant to 18 U. S. C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002
                            
                            
                            
                            
                            
                            
                            X32.2
                            
                            Certification
      of the Chief Financial Officer, pursuant to 18 U. S. C. Section 1350, as
      adopted pursuant to Section 906 of the Sarbanes-Oxley Act of
      2002
                            
                            
                            
                            
                            
                            
                            X







18


SIGNATURES




Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned hereunto
duly authorized.




Interactive
      Intelligence, Inc.
              (Registrant)Date:   May
      11, 2009
            
            
            
            By:
            
            /s/     Stephen R.
      HeadStephen
      R. Head
              Chief
      Financial Officer,
              Vice
      President of Finance and Administration,
              Secretary
      and Treasurer
              (Principal
      Financial Officer and Principal Accounting
  Officer)




19