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EX-31.1 - EXHIBIT 31.1 - Interactive Intelligence Group, Inc.inin-2015930xexx311.htm
EX-31.2 - EXHIBIT 31.2 - Interactive Intelligence Group, Inc.inin-2015930xexx312.htm
EX-32.2 - EXHIBIT 32.2 - Interactive Intelligence Group, Inc.inin-2015930xexx322.htm
EX-32.1 - EXHIBIT 32.1 - Interactive Intelligence Group, Inc.inin-2015930xexx321.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
____________
FORM 10-Q
(Mark One)
 
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
Or
 
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: 000-54450  

INTERACTIVE INTELLIGENCE GROUP, INC.
(Exact name of registrant as specified in its charter)
Indiana
(State or other jurisdiction
of incorporation or organization)
 
45-1505676
(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. Yes No 
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
 
Non-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 
As of October 30, 2015, there were 21,700,835 shares outstanding of the registrant’s common stock, $0.01 par value.




TABLE OF CONTENTS
 
PART I. FINANCIAL INFORMATION
Page
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II. OTHER INFORMATION
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 6.
 
 
 
 


1



PART I. FINANCIAL INFORMATION
 
Item 1. Condensed Consolidated Financial Statements and Notes to Condensed Consolidated Financial Statements.

Interactive Intelligence Group, Inc.
Condensed Consolidated Balance Sheets
As of September 30, 2015 and December 31, 2014
(in thousands, except share amounts)
 
September 30,
2015
 
December 31,
2014
Assets
(unaudited)
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
93,044

 
$
36,168

Short-term investments
53,519

 
20,041

Accounts receivable, net of allowance for doubtful  accounts
 
 
 
of $1,378 at September 30, 2015 and  $1,052 at December 31, 2014
92,458

 
87,413

Prepaid expenses
33,109

 
29,417

Other current assets
14,785

 
14,655

Total current assets
286,915

 
187,694

Long-term investments
33,147

 
5,495

Property and equipment, net
46,002

 
44,785

Capitalized software, net
44,411

 
33,598

Goodwill
41,668

 
43,732

Intangible assets, net
14,925

 
16,517

Other assets, net
6,080

 
6,902

Total assets
$
473,148

 
$
338,723

Liabilities and Shareholders' Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
11,106

 
$
10,236

Accrued liabilities
14,393

 
18,299

Accrued compensation and related expenses
19,499

 
19,211

Deferred license and hardware revenues
10,474

 
5,945

Deferred recurring revenues
81,928

 
76,647

Deferred services revenues
11,423

 
9,925

Total current liabilities
148,823

 
140,263

Convertible notes
116,466

 

Long-term deferred revenues
17,358

 
18,158

Deferred tax liabilities, net
2,405

 
2,437

Other long-term liabilities
6,960

 
7,135

Total liabilities
292,012

 
167,993

Shareholders' equity:
 
 
 
Common stock, $0.01 par value; 100,000,000 authorized;
 
 
 
21,684,072 issued and outstanding at September 30, 2015,
 
 
 
21,278,858 issued and outstanding at December 31, 2014
217

 
213

Additional paid-in capital
230,309

 
196,691

Accumulated other comprehensive loss, net of tax
(10,482
)
 
(5,561
)
Accumulated deficit
(38,908
)
 
(20,613
)
Total shareholders' equity
181,136

 
170,730

Total liabilities and shareholders' equity
$
473,148

 
$
338,723

 
See Accompanying Notes to Condensed Consolidated Financial Statements

2



Interactive Intelligence Group, Inc.
Condensed Consolidated Statements of Operations
For the Three and Nine Months Ended September 30, 2015 and 2014
(in thousands, except share amounts)
(unaudited)
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Revenues:
 
 
 
 
 
 
 
Recurring
$
59,228

 
$
48,095

 
$
167,286

 
$
136,121

License and hardware
22,668

 
27,764

 
71,299

 
72,158

Services
15,473

 
13,603

 
44,590

 
40,461

Total revenues
97,369

 
89,462

 
283,175

 
248,740

Costs of revenues (1)(2):
 
 
 
 
 
 
 
Costs of recurring
21,626

 
16,816

 
59,623

 
46,196

Costs of license and hardware
5,777

 
7,109

 
18,858

 
20,632

Costs of services
11,318

 
11,550

 
34,083

 
33,365

Total costs of revenues
38,721

 
35,475

 
112,564

 
100,193

Gross profit
58,648

 
53,987

 
170,611

 
148,547

Operating expenses (1)(2):
 
 
 
 
 
 
 
Sales and marketing
32,400

 
30,651

 
97,384

 
89,559

Research and development
20,536

 
15,528

 
51,067

 
45,233

General and administrative
11,894

 
11,272

 
36,874

 
33,544

Total operating expenses
64,830

 
57,451

 
185,325

 
168,336

Operating loss
(6,182
)
 
(3,464
)
 
(14,714
)
 
(19,789
)
Other (expense) income:
 
 
 
 
 
 
 
Interest (expense) income, net
(1,963
)
 
274

 
(2,405
)
 
831

Other expense
(424
)
 
(279
)
 
(983
)
 
(665
)
Total other (expense) income
(2,387
)
 
(5
)
 
(3,388
)
 
166

Loss before income taxes
(8,569
)
 
(3,469
)
 
(18,102
)
 
(19,623
)
Income tax (expense) benefit
(1,183
)
 
1,326

 
(193
)
 
8,119

Net loss
$
(9,752
)
 
$
(2,143
)
 
$
(18,295
)
 
$
(11,504
)
Net loss per share:
 
 
 
 
 
 
 
Basic
$
(0.45
)
 
$
(0.10
)
 
$
(0.85
)
 
$
(0.55
)
Diluted
(0.45
)
 
(0.10
)
 
(0.85
)
 
(0.55
)
Shares used to compute net loss per share:
 
 
 
 
 
 
 
Basic
21,664

 
20,904

 
21,568

 
20,851

Diluted
21,664

 
20,904

 
21,568

 
20,851

 
 
 
 
 
 
 
 
(1) Amounts include amortization of purchased intangibles from business combinations, as follows:
Costs of license and hardware
$
178

 
$
177

 
$
532

 
$
363

General and administrative
439

 
472

 
1,330

 
1,420

Total intangible amortization expense
$
617

 
$
649

 
$
1,862

 
$
1,783

 
 
 
 
 
 
 
 
(2) Amounts include stock-based compensation expense, as follows:
 
 
 
 
 
 
 
Costs of recurring revenues
$
484

 
$
385

 
$
1,470

 
$
1,059

Costs of services revenues
183

 
117

 
476

 
338

Sales and marketing
1,199

 
1,248

 
2,914

 
3,381

Research and development
1,663

 
741

 
3,445

 
3,047

General and administrative
1,218

 
851

 
3,311

 
2,453

Total stock-based compensation expense
$
4,747

 
$
3,342

 
$
11,616

 
$
10,278

See Accompanying Notes to Condensed Consolidated Financial Statements

3



Interactive Intelligence Group, Inc.
Condensed Consolidated Statements of Comprehensive Loss
(in thousands)
(unaudited)

 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Net loss
$
(9,752
)
 
$
(2,143
)
 
$
(18,295
)
 
$
(11,504
)
Other comprehensive loss:
 
 
 
 
 
 
 
Foreign currency translation adjustment
(2,215
)
 
(2,641
)
 
(5,024
)
 
(1,985
)
Net unrealized investment gain (loss) - net of tax
53

 
(95
)
 
103

 
(121
)
Comprehensive loss
$
(11,914
)
 
$
(4,879
)
 
$
(23,216
)
 
$
(13,610
)

See Accompanying Notes to Condensed Consolidated Financial Statements


4



Interactive Intelligence Group, Inc.
Condensed Consolidated Statement of Shareholders' Equity
For the Nine Months Ended September 30, 2015
(in thousands)
(unaudited)

 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated Other
Comprehensive
Loss
 
Accumulated
Deficit
 
Total
 
Shares
 
Amount
 
 
 
 
Balances, December 31, 2014
21,279

 
$
213

 
$
196,691

 
$
(5,561
)
 
$
(20,613
)
 
$
170,730

Stock-based compensation expense

 

 
12,913

 

 

 
12,913

Exercise of stock options
131

 
4

 
2,465

 

 

 
2,469

Issuances of common stock
61

 

 
1,215

 

 

 
1,215

Tax withholding on restricted stock unit awards
153

 

 
(3,476
)
 

 

 
(3,476
)
Issuance of retirement plan shares
60

 

 
2,523

 

 

 
2,523

Equity component of convertible notes

 

 
31,756

 

 

 
31,756

Equity component of convertible notes issuance cost

 

 
(1,028
)
 

 

 
(1,028
)
Payment for capped call premiums

 

 
(12,750
)
 

 

 
(12,750
)
Net loss

 

 

 

 
(18,295
)
 
(18,295
)
Foreign currency translation adjustment

 

 

 
(5,024
)
 

 
(5,024
)
Net unrealized investment loss

 

 

 
103

 

 
103

Balances, September 30, 2015
21,684

 
$
217

 
$
230,309

 
$
(10,482
)
 
$
(38,908
)
 
$
181,136

 
 
See Accompanying Notes to Condensed Consolidated Financial Statements

5



Interactive Intelligence Group, Inc.
Condensed Consolidated Statements of Cash Flows
For the Nine Months Ended September 30, 2015 and 2014
(in thousands)
(unaudited)
 
Nine Months Ended September 30,
 
2015
 
2014
Operating activities:
 
 
 
Net loss
$
(18,295
)
 
$
(11,504
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation
12,586

 
11,376

Amortization
5,664

 
1,783

Other non-cash items
(3,053
)
 
(520
)
Stock-based compensation expense
11,616

 
10,278

Deferred income taxes
(32
)
 
(7,906
)
Amortization (accretion) of investment premium (discount)
(866
)
 
193

Loss on disposal of fixed assets
48

 
40

Amortization of convertible notes issuance costs
229

 

Amortization of convertible notes discount
1,819

 

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
(5,045
)
 
9,480

Prepaid expenses
(3,681
)
 
(6,663
)
Other current assets
(130
)
 
(5,004
)
Accounts payable
870

 
570

Accrued liabilities
(568
)
 
487

Accrued compensation and related expenses
288

 
927

Deferred license and hardware revenues
4,704

 
(3,957
)
Deferred recurring revenues
5,150

 
1,431

Deferred services revenues
654

 
(5,963
)
Other assets and liabilities
647

 
1,887

Net cash provided by (used in) operating activities
12,605

 
(3,065
)
Investing activities:
 
 
 
Sales of available-for-sale investments
22,159

 
35,350

Purchases of available-for-sale investments
(82,321
)
 
(32,967
)
Purchases of property and equipment
(14,470
)
 
(17,072
)
Capitalized software
(13,849
)
 
(13,320
)
Acquisitions, net of cash acquired

 
(9,173
)
Unrealized loss (gain) on investment
1

 
(35
)
Net cash used in investing activities
(88,480
)
 
(37,217
)
Financing activities:
 
 
 
Proceeds from issuance of convertible notes
150,000

 

Payment for convertible notes issuance costs
(4,674
)
 

Payment for capped call premiums
(12,750
)
 

Principal payments on capital lease obligations
(33
)
 

Proceeds from stock options exercised
2,469

 
6,454

Proceeds from issuance of common stock
1,215

 
914

Tax withholding on restricted stock unit awards
(3,476
)
 
(2,704
)
Net cash provided by financing activities
132,751

 
4,664

Net increase (decrease) in cash and cash equivalents
56,876

 
(35,618
)
Cash and cash equivalents, beginning of period
36,168

 
65,881

Cash and cash equivalents, end of period
$
93,044

 
$
30,263

Cash paid during the period for:
 
 
 
Interest
$
59

 
$

Income taxes
897

 
2,389

Other non-cash item:
 
 
 
Purchase of property and equipment payable at end of period
187

 
2,944

See Accompanying Notes to Condensed Consolidated Financial Statements

6



Interactive Intelligence Group, Inc.
Notes to Condensed Consolidated Financial Statements
September 30, 2015 and 2014 (unaudited)
 
1.
FINANCIAL STATEMENT PRESENTATION
The accompanying unaudited condensed consolidated financial statements of Interactive Intelligence Group, Inc. (“the Company,” “we,” “us” and “our”) have been prepared in conformity with accounting principles generally accepted in the United States of America (“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 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 financial statements as of December 31, 2014 have been derived from the Company’s audited consolidated financial statements at that date but do not include all of the information and notes required by 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, 2014, included in the Company’s most recent Annual Report on Form 10-K as filed with the SEC on February 27, 2015. 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 condensed 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
 
For a complete summary of the Company’s significant accounting policies and 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, 2014.

In April 2015, the Financial Accounting Standards Board ("FASB") issued FASB Accounting Standards Update ("ASU") No. 2015-05, Customer's Accounting for Fees Paid in a Cloud Computing Arrangement ("FASB ASU 2015-05"), which clarifies that if a cloud computing arrangement includes a software license, the customer should account for the license consistent with its accounting for other software licenses. If the arrangement does not include a software license, the customer should account for the arrangement as a service contract. Public business entities must apply the new requirement in fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. An entity can elect to adopt the amendments either prospectively for all arrangements entered into or materially modified after the effective date, or retrospectively. Early adoption is permitted for all entities. The Company is evaluating the effect that FASB ASU 2015-05 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the guidance on its ongoing financial reporting.

In April 2015, the FASB issued FASB ASU No. 2015-03, Simplifying the Presentation of Debt Issuance Costs, which requires an entity to present debt issuance costs on the balance sheet as a direct deduction from the debt liability instead of presenting the debt issuance costs as a separate asset. Public business entities must apply the new requirements in fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. All entities have the option of adopting the new requirements as of an earlier date for financial statements that have not been previously issued. The Company elected to early adopt FASB ASU 2015-03 in the second quarter of 2015 and has presented convertible notes issuance costs as a direct deduction from the convertible notes liability in the accompanying balance sheet as of September 30, 2015.


7



In May 2014, the FASB issued FASB ASU No. 2014-9, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. FASB ASU 2014-9 will replace most existing U.S. GAAP revenue recognition guidance when it becomes effective. As originally issued, the new standard was to become effective for the Company on January 1, 2017, and early adoption is not permitted.  In August 2015, the FASB issued FASB ASU No. 2015-14. Deferral of the Effective Date, which declared a one-year deferral of the effective date of the new revenue recognition standard. As a result, the new standard will become effective for the Company beginning with the first quarter of 2018. FASB ASU 2014-9 permits the use of either the retrospective or cumulative effect transition method. The Company is evaluating the effect that FASB ASU 2014-9 will have on its consolidated financial statements and related disclosures. The Company has not yet selected a transition method nor has it determined the effect of the guidance on its ongoing financial reporting.

The Company capitalizes costs related to its PureCloud PlatformSM and certain projects described below for internal use in accordance with FASB Accounting Standards Codification (“ASC”) 350-40, Internal Use Software. Once a solution has reached the development stage, internal and external costs, if direct and incremental, are capitalized until the software is substantially complete and ready for its intended use. The capitalization of costs ceases upon completion of all substantial testing. Costs incurred in the preliminary stages of development, maintenance and training costs are expensed as incurred. During the three and nine months ended September 30, 2015, the Company capitalized $900,000 and $11.7 million, respectively, of costs related to the development of its PureCloud Platform, compared to the capitalization of $5.1 million and $9.6 million during the same periods in 2014. Of the total development costs capitalized related to PureCloud CollaborateSM, the Company began amortizing a small portion of those costs during the first quarter of 2015, with such amortization included in costs of recurring revenue. The Company began amortizing additional development costs related to PureCloud Collaborate, PureCloud CommunicateSM and PureCloud EngageSM during the third quarter of 2015. The Company will continue to capitalize development costs related to new PureCloud offerings and will begin amortizing such costs once those offerings are released for general availability.

Additionally, the Company is implementing new business systems to meet its internal business needs. The Company has no plans to market such software externally. During the three and nine months ended September 30, 2015, the Company capitalized $500,000 and $3.5 million, respectively, of costs associated with development and implementation of these systems, compared to the capitalization of $500,000 and $1.9 million during the same periods in 2014.
 
During the three and nine months ended September 30, 2015, there were no other material changes to the Company’s significant accounting policies or critical accounting estimates.
 
3.
NET LOSS PER SHARE
 
Basic net loss per share is calculated based on the weighted-average number of common shares outstanding in accordance with FASB ASC Topic 260, 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 a net loss, the calculation of diluted net loss per share excludes potential common shares as the effect would be anti-dilutive. Potential common shares consist of shares of common stock issuable upon the exercise of stock options and vesting of restricted stock units (“RSUs”). The calculation of diluted net loss per share excludes shares underlying stock options outstanding that would be anti-dilutive. The following table sets forth the calculation of basic and diluted net loss per share (in thousands, except per share amounts):
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Net loss, as reported (A)
$
(9,752
)
 
$
(2,143
)
 
$
(18,295
)
 
$
(11,504
)
Weighted average shares of common stock outstanding (B)
21,664

 
20,904

 
21,568

 
20,851

Dilutive effect of employee stock options and RSUs

 

 

 

Common stock and common stock equivalents (C)
21,664

 
20,904

 
21,568

 
20,851

Net loss per share:
 
 
 
 
 
 
 
Basic (A/B)
$
(0.45
)
 
$
(0.10
)
 
$
(0.85
)
 
$
(0.55
)
Diluted (A/C)
(0.45
)
 
(0.10
)
 
(0.85
)
 
(0.55
)
 

8



The Company’s calculation of diluted net loss per share for the three and nine months ended September 30, 2015 excludes RSUs and stock options to purchase approximately 404,000 and 368,000 shares of the Company’s common stock, respectively, compared to 1.2 million and 1.0 million shares during the same periods in 2014.

4.
INVESTMENTS
 
FASB ASC Topic 820, Fair Value Measurement (“FASB ASC 820”), 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. FASB ASC 820 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 short-term investments all mature in less than one year and its long-term investments all mature within three years. Both short-term and long-term investments are considered available for sale. The Company’s assets that are measured at fair value on a recurring basis are 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 money market securities and U.S government securities. Such instruments are 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 corporate notes, agency bonds, commercial paper and certificates of deposit. Such instruments are 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. 
 

9



The following table sets forth a summary of the Company’s financial assets, classified as cash and cash equivalents, short-term investments and long-term investments on its condensed consolidated balance sheets, measured at fair value as of September 30, 2015 and December 31, 2014 (in thousands):
 
 
 
Fair Value Measurements at September 30, 2015 Using
Description
 
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Cash & cash equivalents:
 
 
 
 
 
 
 
 
Cash
 
$
80,585

 
$
80,585

 
$

 
$

Money market funds
 
12,459

 
12,459

 

 

Total
 
$
93,044

 
$
93,044

 
$

 
$

Short-term investments:
 
 
 
 
 
 
 
 
Agency bonds
 
$
32,029

 
$

 
$
32,029

 
$

Corporate notes
 
21,490

 

 
21,490

 

Total
 
$
53,519

 
$

 
$
53,519

 
$

Long-term investments:
 
 
 
 
 
 
 
 
Corporate notes
 
$
33,147

 
$

 
$
33,147

 
$

Total
 
$
33,147

 
$

 
$
33,147

 
$

 
 
Fair Value Measurements at December 31, 2014 Using
Description
 
Total
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Cash & cash equivalents:
 
 
 
 
 
 
 
 
Cash
 
$
34,452

 
$
34,452

 
$

 
$

Money market funds
 
1,716

 
1,716

 

 

Total
 
$
36,168

 
$
36,168

 
$

 
$

Short-term investments:
 
 
 
 
 
 
 
 
Corporate notes
 
$
19,241

 
$

 
$
19,241

 
$

Commercial paper
 
800

 

 
800

 

Total
 
$
20,041

 
$

 
$
20,041

 
$

Long-term investments:
 
 
 
 
 
 
 
 
U.S. government securities
 
$
1,000

 
$
1,000

 
$

 
$

Corporate notes
 
4,495

 
$

 
4,495

 

Total
 
$
5,495

 
$
1,000

 
$
4,495

 
$

 

10



5.
ACCOUNTS RECEIVABLE AND CONCENTRATION OF CREDIT RISK
 
The Company evaluates the creditworthiness of its customers and partners on a periodic basis and generally does not require collateral. The Company records unbilled accounts receivable, which represents amounts recognized as revenues for invoices that have not yet been sent to customers. This balance fluctuates depending on the contractual billing milestones and work performed related to projects specified in the contract. When the work performed is ahead of the billing milestones related to a services engagement, unbilled accounts receivable will be recorded. The balance of unbilled accounts receivable recorded within accounts receivable on the condensed consolidated balance sheets as of September 30, 2015 and December 31, 2014 was $9.9 million and $8.0 million, respectively.

In addition, the Company records deferred revenues, which represent cash collections for which the Company cannot yet recognize revenues. The balance of deferred revenues also fluctuates depending on the contractual billing milestones and work performed related to projects specified in the contract. When the billing milestones and related cash collections occur prior to the product or service being delivered, deferred revenues will be recorded. The balance of deferred revenues recorded on the condensed consolidated balance sheets as of September 30, 2015 and December 31, 2014 was $121.2 million and $110.7 million, respectively.
 
No customer or partner accounted for more than 10% of the Company’s accounts receivable as of September 30, 2015 or December 31, 2014 or for more than 10% of the Company’s revenues for the three and nine months ended September 30, 2015 or 2014. The Company’s top five partners collectively represented 13% and 17% of the Company’s accounts receivables balance at September 30, 2015 and December 31, 2014, respectively.
 
6.
STOCK-BASED COMPENSATION
 
Stock Option Plan
 
The Company’s  2006 Equity Incentive Plan, as amended and as assumed by Interactive Intelligence Group, Inc. (the “2006 Plan”) authorizes the Board of Directors or the Compensation Committee, as applicable, to grant incentive and nonqualified stock options, stock appreciation rights, restricted stock, RSUs, 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. At the Company’s 2013 Annual Meeting of Shareholders held on May 22, 2013, the Company’s shareholders approved an amendment to the 2006 Plan which increased the number of shares available for issuance under the 2006 Plan by 2,000,000 shares. A maximum of 9,050,933 shares are available for delivery under the 2006 Plan. 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 Select Market, on the business day immediately preceding the date of grant. As of September 30, 2015, there were 1,548,731 shares of stock available for issuance for equity compensation awards under the 2006 Plan.

During 2014 and prior, the Company granted RSUs and three types of stock options. The first type of stock option was non-performance-based subject only to time-based vesting, and these stock options were granted by the Company as annual grants to executives, to certain new employees and to newly-elected non-employee directors.  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 requisite service period.
 
The second type of stock option granted by the Company was performance-based subject to cancellation if the specified performance targets 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 related service period, including the initial period for which the specified performance targets must be met.
 
The third type of stock option granted by the Company was director options granted to non-employee directors annually. These options were similar to the non-performance-based options described above except that the director options vest one year after the grant date. The fair value of these option grants is determined on the date of the grant and the related compensation expense is recognized over one year. These director options were generally granted at the Company’s Annual Meeting of Shareholders during the second quarter of each fiscal year.
 

11



In 2015, the Company began granting RSUs in lieu of stock options. The Company grants performance-based and non-performance-based RSUs to directors, executives, certain key employees, and certain new employees, and the fair value of the RSUs is determined on the date of grant. Non-performance-based RSUs granted to executives, certain key employees, certain new employees and new non-employee directors vest in four equal annual installments beginning one year after the grant date. Non-performance-based RSUs granted annually to non-employee directors vest in full one year after the grant date. Performance-based RSUs vest in four equal annual installments once the individual has achieved the performance targets. RSUs are not included in issued and outstanding common stock until the shares are vested and settlement has occurred.
 
The 2006 Plan 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 and RSUs under FASB ASC Topic 718, Compensation – Stock Compensation (“FASB ASC 718”) for the three and nine months ended September 30, 2015 and 2014 (in thousands):
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Stock-based compensation expense by category:
 
 
 
 
 
 
 
Costs of recurring revenues
$
484

 
$
385

 
$
1,470

 
$
1,059

Costs of services revenues
183

 
117

 
476

 
338

Sales and marketing
1,199

 
1,248

 
2,914

 
3,381

Research and development
1,663

 
741

 
3,445

 
3,047

General and administrative
1,218

 
851

 
3,311

 
2,453

Total stock-based compensation expense
$
4,747

 
$
3,342

 
$
11,616

 
$
10,278

Effect of stock-based compensation expense on net loss per share:
 
 
 
 
 
 
 
Basic
$
(0.22
)
 
$
(0.16
)
 
$
(0.54
)
 
$
(0.49
)
Diluted
(0.22
)
 
(0.16
)
 
(0.54
)
 
(0.49
)
 
During the three and nine months ended September 30, 2015, the Company capitalized $100,000 and $1.3 million, respectively, of stock-based compensation expense related to capitalized software, compared to $931,000 of stock-based compensation expenses that were capitalized during the three and nine months ended September 30, 2014.

Stock Option and RSU Valuation
 
The Company estimated the fair value of stock options using the Black-Scholes valuation model.

12



 
There were no stock options granted during the first nine months of 2015. The weighted-average estimated per option value of non-performance-based and performance-based options granted under the 2006 Plan during the nine months ended September 30, 2014 used the following assumptions:
 
 
Nine Months Ended 
 September 30,
Valuation assumptions for non-performance-based options:
2014
Dividend yield
%
Expected volatility
60.86
%
Risk-free interest rate
1.43
%
Expected life of option (in years)
4.00

 
 
 
Nine Months Ended 
 September 30,
Valuation assumptions for performance-based options:
2014
Dividend yield
%
Expected volatility
59.51
%
Risk-free interest rate
1.60
%
Expected life of option (in years)
4.50

 
 
 
Nine Months Ended 
 September 30,
Valuation assumptions for annual director options:
2014
Dividend yield
%
Expected volatility
61.70
%
Risk-free interest rate
1.17
%
Expected life of option (in years)
4.00

 
RSUs are valued using the fair market value of the Company’s stock on the date of grant and expense is recognized on a straight line basis taking into account an estimated forfeiture rate.
 
Stock Option and RSU Activity
 
The following table sets forth a summary of stock option activity for the nine months ended September 30, 2015:
 
Options
 
Weighted-Average Exercise Price
Balances, beginning of year
1,350,799

 
$
32.95

Options granted

 

Options exercised
(131,834
)
 
18.70

Options cancelled, forfeited or expired
(35,977
)
 
47.61

Options outstanding
1,182,988

 
34.09

Option price range
$ 6.66 - 66.39

 
 
Weighted-average fair value of options granted
$

 
 
Options exercisable
883,432

 
$
30.06



13



The following table sets forth information regarding the Company’s stock options outstanding and exercisable as of September 30, 2015:
 
 
 
 
 
 
 
Options Outstanding
 
Options Exercisable
Range of Exercise
Prices
 
Number
 
Weighted-
Average
Remaining
Contractual
Life
 
Weighted
Average
Exercise
Price
 
Number
 
Weighted
Average
Exercise
Price
$
6.66

 
 
$
18.90

 
51,225

 
0.66
 
$
13.17

 
51,225

 
$
13.17

19.66

 
 
19.66

 
218,130

 
0.46
 
19.66

 
218,130

 
19.66

19.77

 
 
22.92

 
3,400

 
1.64
 
21.76

 
2,150

 
21.09

24.50

 
 
24.50

 
224,379

 
2.48
 
24.50

 
154,379

 
24.50

25.00

 
 
30.92

 
63,250

 
2.55
 
27.06

 
49,500

 
26.72

32.33

 
 
32.33

 
182,250

 
1.49
 
32.33

 
176,625

 
32.33

32.53

 
 
37.76

 
60,500

 
2.14
 
33.36

 
48,000

 
33.31

39.97

 
 
39.97

 
137,905

 
3.56
 
39.97

 
62,471

 
39.97

48.12

 
 
66.21

 
87,000

 
4.14
 
50.30

 
81,750

 
49.33

66.39

 
 
66.39

 
154,949

 
4.44
 
66.39

 
39,202

 
66.39

Total shares/average price
 
1,182,988

 
2.36
 
$
34.09

 
883,432

 
$
30.06

 
The total intrinsic value of options exercised during the quarter ended ended September 30, 2015 was $3.2 million. The aggregate intrinsic value of options outstanding as of September 30, 2015 was $4.4 million and the aggregate intrinsic value of options currently exercisable as of September 30, 2015 was $4.0 million. The aggregate intrinsic value represents the total intrinsic value, based on the Company’s closing stock price per share of $29.71 as of September 30, 2015, which would have been realized by the option holders had all option holders exercised their options as of that date. The total number of in-the-money options exercisable as of September 30, 2015 represented approximately 467,884 shares with a weighted average exercise price of $21.12.
 
As of September 30, 2015, there was $5.2 million of total unrecognized compensation expense related to non-vested stock options. This expense is expected to be recognized over the weighted average remaining vesting period of 1.48 years.
 
The following table sets forth a summary of RSU activity for the nine months ended September 30, 2015:
 
Awards
 
Weighted-
Average Grant
Date Price
Balances, beginning of year
592,364

 
$
50.24

RSUs granted
490,155

 
43.16

RSUs vested
(231,003
)
 
46.23

RSUs forfeited
(61,505
)
 
48.63

RSUs outstanding
790,011

 
47.14

 
As of September 30, 2015, there was $32.6 million of total unrecognized compensation expense related to non-vested RSUs. This expense is expected to be recognized over the weighted average remaining vesting period of 2.53 years.


14



7.
INCOME TAXES

The Company’s effective tax rate, without the effect of discrete items, for the three and nine months ended September 30, 2015 was (12.7)% and (10.0)%, respectively, compared to 38.2% and 40.6%, respectively, for the same periods in 2014.  During the three months ended September 30, 2015, the Company recorded $101,000 of expense related to discrete items. During the nine months ended September 30, 2015, the Company recorded a net credit of $1.6 million related to discrete items, including a net credit of $1.9 million recorded during the first quarter of 2015 to correct an error in the Company's valuation reserve for deferred tax assets. The error is not considered material to the current or previously reported results. During the nine months ended September 30, 2014, the Company recorded a $150,000 credit related to a discrete item, and no discrete items were recorded during the three months ended September 30, 2014. With the effects of these discrete items, the Company’s effective tax rate was (13.9)% and (1.1)% for the three and nine months ended September 30, 2015, compared to 38.2% and 41.4% for the three and nine months ended September 30, 2014. The Company’s effective tax rate for the three and nine months ended September 30, 2015 was lower than the federal statutory tax rate of 35.0% primarily due to the allocation of book operating results between the U.S. and foreign entities and the impact of permanent tax differences on pre-tax operating results during the three and nine months ended September 30, 2015. In addition, we recorded a full U.S. valuation allowance in the fourth quarter of 2014 to reduce the carrying value of the Company's deferred tax assets and are no longer recognizing an income tax benefit for U.S. losses.

8.
COMMITMENTS AND CONTINGENCIES
Legal Proceedings
 
From time to time, the Company has received notification from competitors and other technology providers claiming that the Company’s technology infringes upon 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.
 
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.
 
Guarantees
The Company provides indemnifications of varying scope and amount to certain customers against claims of intellectual property infringement made by third parties arising from the use of its solutions. The Company’s direct software license agreements include certain provisions for indemnifying customers, in material compliance with their license agreement, against liabilities if the Company’s 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, the Company may at any time and at its option and expense:  (i) procure the right of the customer to continue to use the Company’s software that may infringe a third party’s rights; (ii) modify its software so as to avoid infringement; or (iii) require the customer to return its software and refund the customer the fee actually paid by the customer for its 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 the Company of its obligations under this indemnification to the extent that it has been actually and materially prejudiced by such failure. To date, the Company has not incurred, nor does it expect to incur, any material related costs and, therefore, has not reserved for such liabilities, in accordance with FASB ASC Topic 460, Guarantees.  
The Company’s software license agreements also include a warranty that its software products will substantially conform to its software user documentation for a period of one year, provided the customer is in material compliance with the software license agreement. To date, the Company has not incurred any material costs associated with these product warranties, and as such, has not reserved for any such warranty liabilities in its operating results.

15




Lease Commitments
 
The Company’s world headquarters are located in approximately 425,000 square feet of space in four office buildings in Indianapolis, Indiana. In May 2014, the Company entered into new separate lease agreements with Duke Realty Limited Partnership for three of the office buildings, one of which expires in March 2018 and two of which expire on or after June 30, 2025. Also in May 2014, the Company entered into a lease agreement with Duke Construction Limited Partnership to expand its world headquarters to include a fourth, build-to-suit office building in Indianapolis, Indiana.  The construction of the fourth office building was completed in June 2015 and the lease term expires in June 2025.

Contractual Obligations

The following amounts set forth in the table are as of September 30, 2015 (in thousands): 
 
 
Payments Due by Period
 
Total
 
Less than
1 Year
 
1-3 Years
 
3-5 Years
 
More than
5 Years
Contractual Obligations
 
 
 
 
 
 
 
 
 
Convertible notes
$
159,405

 
$
1,905

 
$
3,750

 
$
153,750

 
$

Capital lease obligations
548

 
245

 
303

 

 

Operating lease obligations
96,009

 
3,850

 
26,716

 
19,404

 
46,039

Purchase obligations
11,580

 
6,255

 
5,325

 

 

Verint agreement
5,000

 
250

 
1,250

 
3,500

 

Other obligations
1,702

 

 

 
1,702

 

Total
$
274,244

 
$
12,505

 
$
37,344

 
$
178,356

 
$
46,039

 
As set forth in the Contractual Obligations table, the Company has operating lease obligations and purchase obligations that are not recorded in its consolidated financial statements. The operating lease obligations represent future payments on leases classified as operating leases and disclosed pursuant to FASB ASC Topic 840, Leases (“FASB ASC 840”). The obligations include the operating leases of the Company’s world headquarters, some of which extend to the year 2025, and the leases of several other locations for its offices in the United States and 20 other countries with initial lease terms of up to five years. The Company rents office space for sales, services, development and international offices under month-to-month leases. In accordance with FASB ASC 840, rental expense is recognized ratably over the lease period, including those leases containing escalation clauses.

The convertible notes obligation set forth in the Contractual Obligations table includes principal payments and estimated interest payments based on the terms of the Company's 1.25% convertible senior notes due 2020.

The capital lease obligations set forth in the Contractual Obligations table represent future payments on leases classified as capital leases and disclosed pursuant to FASB ASC 840. The obligations include capital leases of hardware and software assets with initial lease terms of up to three years.

Also set forth in the Contractual Obligations table are contingent amounts payable to Verint Americas Inc. ("Verint") in accordance with the terms of an agreement between the Company and Verint, entered into effective March 6, 2015, with an initial term of five years. Under the terms of the agreement, Verint granted to the Company limited rights to sell Verint product and the Company agreed to pay Verint license fees. If sales of Verint product are not maintained at levels as stated in the agreement, the Company could potentially owe Verint up to $5 million. No accrual has been recorded as of September 30, 2015, as the Company anticipates selling at least the minimum amounts of Verint product set forth in the agreement.
 

16



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 specified growth projections.  If the Company’s actual performance is 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.
ACQUISITIONS

OrgSpan Acquisition
 
On May 14, 2014, the Company entered into a stock purchase agreement and acquired OrgSpan, Inc. (“OrgSpan”), a privately held provider of cloud-based enterprise social communications solutions.  The Company purchased OrgSpan to leverage technology that provided efficient deployment of the Company’s PureCloud Platform. As previously disclosed, Donald E. Brown, the Company’s Chairman of the Board, President and Chief Executive Officer, was a founder and majority stockholder of OrgSpan.  The Company purchased OrgSpan for approximately $14.1 million, partially funded with cash on hand, which included the repayment of OrgSpan’s outstanding debt of approximately $8.0 million. OrgSpan’s outstanding debt consisted primarily of operating loans provided by Dr. Brown bearing interest at a rate of 4.25% per annum. Approximately $1.4 million in cash was paid to OrgSpan’s stockholders (other than Dr. Brown) and to holders of vested OrgSpan stock options. In exchange for his shares of OrgSpan stock, Dr. Brown has the right to receive an aggregate of 98,999 shares of the Company’s common stock (the “Restricted Shares”), representing approximately $4.7 million of the purchase price, which Restricted Shares vest and are to be issued by the Company upon the achievement of certain performance-based conditions tied to the launch and sales of the Company’s PureCloud Platform, which incorporates certain OrgSpan products and technology. The difference between the $15.6 million purchase price previously disclosed in the Form 8-K filed on May 14, 2014 and the $14.1 million noted above is a result of the difference in the value of the 98,999 Restricted Shares received by Dr. Brown for accounting purposes. The Company also retained 38 OrgSpan employees as part of the transaction.

With the first commercial release of its PureCloud Platform in June 2015, the Company met the first performance-based condition for the Restricted Shares set forth in the stock purchase agreement. As a result, the Company issued 32,999 of the Restricted Shares to Dr. Brown during July 2015, which shares were not registered under the Securities Act of 1933, as amended (the "Securities Act"), in reliance upon an exemption from registration provided by Section 4(a)(2) under the Securities Act. Any additional Restricted Shares issued to Dr. Brown will also be unregistered.

The acquisition was accounted for using the acquisition method of accounting in accordance with FASB ASC Topic 805, Business Combinations (“FASB ASC 805”). The results of OrgSpan’s operations were included in the Company’s condensed consolidated financial statements commencing on the acquisition date.

The purchase price allocations for the OrgSpan transaction were prepared by the Company’s management utilizing a third-party valuation report, which was prepared in accordance with the provisions of FASB ASC 805, and other tools available to the Company, including conversations with OrgSpan’s management and historical data from the Company’s other acquisitions. The following table summarizes the fair value of the intangible and other assets acquired and liabilities assumed at the date of the acquisition (in thousands):
 
 
May 1, 2014
Cash and cash equivalents
$
61

Prepaid expenses
54

Property and equipment, net
144

Intangible assets, net
5,766

Goodwill
8,202

Total assets acquired
14,227

Accrued accounts payable
(5
)
Other current liabilities
(44
)
Other long-term liabilities
(128
)
Net assets acquired
$
14,050

 

17



Professional fees related to this acquisition and recognized as of September 30, 2015 totaled $613,000, and included transaction costs such as legal, accounting, and valuation services, which were expensed as incurred. These costs are included within general and administrative expenses on the condensed consolidated statements of operations for the periods incurred. All of these costs were incurred and recognized during 2014.
 
The premium paid over the fair value of the net assets acquired in the purchase, or goodwill, was primarily attributed to OrgSpan’s existing trained workforce. The goodwill is expected to be deductible for tax purposes, as the Company made a Section 338(h)(10) election for this acquisition.
 
Intangible assets acquired resulting from this acquisition consisted of technology, which is amortized on a straight-line basis. The following sets forth the current net book value of technology acquired and its original economic useful life (dollars in thousands):
 
 
As of September 30, 2015
 
 
 
Gross Amount
 
Accumulated
Amortization
 
Net Amount
 
Economic
Useful Life
(in years)
Technology
$
5,766

 
$
817

 
$
4,949

 
10

Pro Forma Results
 
The Company has not furnished pro forma financial information related to its acquisition of OrgSpan because such information is not material individually or in the aggregate to the overall financial results of the Company.

10.
DERIVATIVES
 
The Company enters into derivative contracts to mitigate its foreign currency risk associated with transacting business internationally.  The Company uses foreign currency forward contracts to hedge the revaluation exposure of its net monetary assets and liabilities including cash, accounts receivable, accounts payable and certain intercompany payables and receivables.  These hedges are not designated under GAAP, and all realized and unrealized gains and losses are recorded as incurred within other income (expense) on the Company’s condensed consolidated statements of operations.  The objective is to offset the gains and losses on the underlying exposures with the gains and losses from the forward contracts.  The Company’s hedging policy prohibits entering into hedge contracts that are speculative in nature.

The Company records the fair value of its outstanding hedge contracts in other current assets and accrued liabilities depending upon the market value of the forward contracts at each balance sheet date.  The following table summarizes the notional amount and fair value of the Company’s outstanding currency contracts at September 30, 2015 and December 31, 2014, respectively (in thousands):
 
 
USD Equivalent Notional Amount
 
September 30,
2015
 
December 31,
2014
Euro
$
2,915

 
$
3,041

Japanese Yen
1,501

 

US Dollar
600

 
600

Swedish Krona
119

 
249

Australian Dollar

 
738

Total
$
5,135

 
$
4,628

 
 
 
 
 
Fair Value USD (1)
 
September 30,
2015
 
December 31,
2014
Derivative Asset
$
32

 
$
17

___________
(1)
The fair value measurement of these derivative contracts falls within Level 2 of the fair value hierarchy as defined in FASB ASC 820. See Note 4 - Investments for further information.
 

18



During the three and nine months ended September 30, 2015, the Company recorded a hedging loss of $139,000 and a hedging gain of $281,000, respectively, compared to a hedging gain of $305,000 and a hedging loss of $82,000 for the same periods last year.

In May 2015, the Company issued $150 million aggregate principal amount of its 1.25% convertible senior notes (the "Notes") due June 1, 2020, unless earlier purchased by the Company or converted. In connection with the pricing of the Notes, the Company entered into privately-negotiated capped call transactions (the "capped call transactions") with each of Morgan Stanley & Co. LLC, JPMorgan Chase Bank, National Association, London Branch and Royal Bank of Canada. The capped call transactions cover, subject to anti-dilution adjustments substantially similar to those applicable to the Notes, the number of shares of the Company's common stock that underlie the Notes. The Company used approximately $12.8 million of the net proceeds from the issuance of the Notes to pay the cost of the capped call transactions. The strike price of the purchased call option is the same as the initial conversion price per share of the Notes of $61.24. The capped call transactions have an initial cap price of $79.38 per share. These capped call transactions are recorded within equity on the condensed consolidated balance sheet as of September 30, 2015 and are not remeasured as long as they continue to meet the conditions for equity classification.


11.
CONVERTIBLE NOTES

In May 2015, the Company issued $150 million aggregate principal amount of its Notes due June 1, 2020, unless earlier purchased by the Company or converted. Interest is payable semi-annually, in arrears, on June 1 and December 1 of each year.

The Notes were sold in a private placement under a purchase agreement entered into by and among the Company and Morgan Stanley & Co. LLC, J.P. Morgan Securities LLC and RBC Capital Markets, LLC, as representatives of the several initial purchasers named therein, for resale to qualified institutional buyers as defined in, and in reliance on, Rule 144A under the Securities Act.

The Notes are governed by an indenture between the Company, as issuer, and U.S. Bank National Association, as trustee (the "indenture"). The Notes are unsecured and do not contain any financial covenants or any restrictions on the payment of dividends or the incurrence of senior debt or other indebtedness.

If converted, holders of the Notes will receive, at the Company's election, cash, shares of the Company's common stock, or a combination of cash and shares. The initial conversion terms are as follows:
 
 
Initial Conversion
Rate per $1,000
Principal Amount
 
Initial
Conversion
Price per
Share
1.25% Convertible Senior Notes
 
16.3303

 
$
61.24


Throughout the term of the Notes, the conversion rate may be adjusted upon the occurrence of certain events. Except for certain circumstances set forth in the indenture, holders of the Notes will not receive any cash payment representing accrued and unpaid interest upon conversion of a Note. Accrued but unpaid interest will be deemed to be paid in full upon conversion rather than canceled, extinguished or forfeited.

Holders may convert the Notes under the following circumstances:
during any calendar quarter commencing after the calendar quarter ending on September 30, 2015 (and only during such calendar quarter), if the last reported sale price of the Company's common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day;
during the five business day period after any 5 consecutive trading day period (the ‘‘measurement period’’) in which the trading price (as defined below) per $1,000 principal amount of Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company's common stock and the conversion rate on each such trading day;
upon the occurrence of specified corporate transactions pursuant to the indenture; or
at any time on or after March 3, 2020.


19



Holders of the Notes have the right to require the Company to repurchase for cash all or a portion of the Notes prior to maturity upon the occurrence of a fundamental change, including, among other things, a change of control, at a purchase price equal to 100% of the principal amount of the Notes to be repurchased plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, following certain corporate transactions that constitute a fundamental change, the Company is required to increase the conversion rate for a holder who elects to convert the Notes in connection with such change of control.

In connection with the pricing of the Notes, the Company entered into capped call transactions. The capped call transactions cover, subject to anti-dilution adjustments substantially similar to those applicable to the Notes, the number of shares of the Company's common stock that underlie the Notes. The Company used approximately $12.8 million of the net proceeds from the issuance of the Notes to pay the cost of the capped call transactions. The strike price of the purchased call option is the same as the initial conversion price per share of the Notes of $61.24. The capped call transactions have an initial cap price of $79.38 per share. These capped call transactions are recorded within equity on the condensed consolidated balance sheet as of September 30, 2015 and are not remeasured as long as they continue to meet the conditions for equity classification.

In accounting for the issuances of the Notes, the Company separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar liability that does not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the Notes as a whole. The excess of the principal amount of the liability component over its carrying amount (“convertible notes discount”) is amortized to interest expense over the term of the Notes using the effective interest rate method. The equity component is not remeasured as long as it continues to meet the conditions for equity classification.
  
 
Par Value Outstanding
 
Equity
Component Recorded at Issuance
 
 
 
Liability Component of Par Value as of
(In thousands)
 
September 30, 2015
 
December 31, 2014
1.25% Convertible Senior Notes
 
$
150,000

 
$
31,756

 
(1)
 
$
116,466

 
$

___________ 
(1) This amount represents the equity component recorded at the initial issuance of the Notes.

In accounting for the transaction costs related to the issuance of the Notes, the Company allocated the total amount incurred to the liability and equity components based on their relative values. Transaction costs attributable to the liability component are being amortized to expense using the effective interest rate method over the term of the Notes, and transaction costs attributable to the equity component were netted with the equity component in shareholders’ equity.

The Notes consisted of the following (in thousands):
 
 
 
As of
 
 
September 30, 2015
 
December 31, 2014
Liability component:
 
 
 
 
1.25% Convertible Senior Notes (1)
 
$
150,000

 
$

Less: convertible notes discount, net (2)
 
(29,937
)
 

Less: convertible notes issuance costs (2)
 
(3,597
)
 

Net carrying amount
 
$
116,466

 
$

___________ 
(1) The effective interest rate of the Notes is 6.25%. The interest rate is based on the interest rates of similar liabilities at the time of issuance that did not have an associated convertible feature.
(2) Included in the condensed consolidated balance sheet as of September 30, 2015 within convertible notes and is amortized over the term of the Notes using the effective interest rate method.

The total estimated fair value of the Notes at September 30, 2015 was $121.2 million. The fair value was determined based on inputs that are observable in the market (Level 2) and was based on the closing trading price per $100 of the Notes as of the last day of trading for the third quarter of 2015.


20



Based on the closing price of the Company’s common stock of $29.71 on September 30, 2015, the if-converted value of the Notes fell below the principal amount by approximately $77.2 million. Based on the terms of the Notes, the Notes were not convertible at any time during the three or nine months ended September 30, 2015.


21



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, 2014. The following will be discussed and analyzed:

Forward-Looking Information
Overview
Revenue, Order Trends, Outlook and Business Highlights
Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2015 and 2014
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 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that involve 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 the 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. This forward-looking information includes but is not limited to statements regarding our plans, objectives, expectations, intentions, future financial performance (including our outlook for 2015 and beyond), future financial condition and other statements that are not historical facts. 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, worldwide economic conditions and their impact on customer purchasing decisions; rapid technological changes and competitive pressures in the industry; our profitability; and our ability to: manage successfully our growth, meet debt service requirements, manage successfully our increasingly complex third-party relationships resulting from the software and hardware components being licensed or sold with our solutions, maintain successful relationships with certain suppliers which may be impacted by the competition in the technology industry, maintain successful relationships with our current and any new partners, maintain and improve our current products, develop new products, protect our proprietary rights and sensitive customer information adequately, successfully integrate acquired businesses and improve our brand and name recognition, as well as other factors set forth in our Securities and Exchange Commission (“SEC”) filings.
 
Overview
 
We are a global provider of software and cloud services for customer engagement, unified communications and collaboration. We are a recognized leader in the worldwide contact center market, where our software applications provide a range of inbound and outbound communications functionality. We offer three types of solutions for our customers' needs: on-premises, single-tenant cloud and multi-tenant cloud. Our customers select the delivery model that best meets their needs. Our solutions are used by businesses and organizations in various industries, including teleservices, insurance, banking, accounts receivable management, utilities, healthcare, retail, technology, government and business services. We continue to invest in the development of our technology, particularly in our next generation cloud communication platform, Interactive Intelligence PureCloud (“PureCloud”). Our PureCloud PlatformSM is a multi-tenant, single instance platform that leverages Amazon Web Services (“AWS”) technology. Our PureCloud CollaborateSM service was released in March 2015, and our PureCloud CommunicateSM and PureCloud EngageSM services were released in June 2015.
 
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, 2014.


22



Our management monitors certain key measures to assess our financial results. In particular, we track trends in recurring revenues as well as on-premises orders, the annual contract values of cloud subscriptions, overage fees from cloud subscriptions and contracted professional services from quarter to quarter and in comparison to the prior year actual results and current year projected amounts. We also review leading market indicators to identify trends in economic conditions. In addition to orders and revenues, management reviews costs of revenue, operating expenses and staffing levels to ensure we are controlling costs. We also regularly examine operating cash flow and free cash flow, which we define as operating cash flow less capital expenditures. Trends in revenue, operating expenses and net income will affect cash flow, as will other factors such as cash collections on accounts receivables, cash used for vendor payments and capital expenditures. For additional discussions regarding trends, see “Revenue,  Order Trends, Outlook and Business Highlights,” “Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2015 and 2014” and "Liquidity and Capital Resources" below.
 
Our management also monitors diluted earnings per share (“EPS”), a key measure of performance also used by analysts and investors, based on accounting principles generally accepted in the United States of America (“GAAP”). In addition to measures based on GAAP, our management monitors non-GAAP operating income and margin, non-GAAP net income and non-GAAP EPS to analyze our business. These non-GAAP measures include revenue which was not recognized on a GAAP basis due to purchase accounting adjustments, exclude non-cash stock-based compensation expense, certain acquisition-related expenses, the amortization of certain intangible assets related to acquisitions and the amortization of the convertible notes discount and issuance costs, and adjust for non-GAAP income tax expense. These measures are not in accordance with, or an alternative for, GAAP, and may be different from non-GAAP measures used by other companies. Stock-based compensation expense, amortization of intangibles related to acquisitions and amortization of the convertible notes discount and issuance costs are non-cash, and non-GAAP income tax expense is pro forma based on non-GAAP earnings. We believe that the presentation of non-GAAP results, when shown in conjunction with corresponding GAAP measures, provides useful information to management and investors regarding financial and business trends related to our results of operations. Further, our management believes that these non-GAAP measures improve management’s and investors’ ability to compare our financial performance with other companies in the technology industry. Because stock-based compensation expense, certain acquisition-related expenses, amortization of the convertible notes discount and issuance costs and amortization of intangibles related to acquisitions amounts can vary significantly between companies, it is useful to compare results excluding these amounts. Our management also reviews financial statements that exclude stock-based compensation expense, certain acquisition-related expenses, amortization of intangibles related to acquisitions, amortization of the convertible notes discount and issuance costs and pro forma income tax expense for our internal budgets.


23



Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are included below (in thousands, except per share amounts):
 
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
Net loss, as reported
$
(9,752
)
 
$
(2,143
)
 
$
(18,295
)
 
$
(11,504
)
Purchase accounting adjustments:
 
 
 
 
 
 
 
Increase to revenues
2

 
4

 
8

 
14

Reduction of operating expenses:
 
 
 
 
 
 
 
Customer relationships
387

 
427

 
1,171

 
1,285

Acquired technology
178

 
177

 
532

 
363

Non-compete agreements
53

 
45

 
159

 
135

Acquisition costs

 
10

 
1

 
610

Total
620

 
663

 
1,871

 
2,407

Non-cash stock-based compensation expense:
 
 
 
 
 
 
 
Costs of recurring revenues
484

 
385

 
1,470

 
1,059

Costs of services revenues
183

 
117

 
476

 
338

Sales and marketing
1,199

 
1,248

 
2,914

 
3,381

Research and development
1,663

 
741

 
3,445

 
3,047

General and administrative
1,218

 
851

 
3,311

 
2,453

Total
4,747

 
3,342

 
11,616

 
10,278

Amortization of convertible notes discount and issuance costs
1,535

 

 
2,047

 

Non-GAAP income tax expense adjustment
1,899

 
(1,606
)
 
1,254

 
(5,016
)
Non-GAAP net (loss) income
$
(951
)
 
$
256

 
$
(1,507
)
 
$
(3,835
)
 
 
 
 
 
 
 
 
Operating loss, as reported
$
(6,182
)
 
$
(3,464
)
 
$
(14,714
)
 
$
(19,789
)
Purchase accounting adjustments
620

 
663

 
1,871

 
2,407

Non-cash stock-based compensation expense
4,747

 
3,342

 
11,616

 
10,278

Non-GAAP operating (loss) income
$
(815
)
 
$
541

 
$
(1,227
)
 
$
(7,104
)
 
 
 
 
 
 
 
 
Diluted loss per share, as reported
$
(0.45
)
 
$
(0.10
)
 
$
(0.85
)
 
$
(0.55
)
Purchase accounting adjustments
0.03

 
0.03

 
0.09

 
0.12

Non-cash stock-based compensation expense
0.22

 
0.16

 
0.54

 
0.49

Amortization of convertible notes discount and issuance costs
0.07

 

 
0.09

 

Non-GAAP income tax expense adjustment
0.09

 
(0.08
)
 
0.06

 
(0.24
)
Non-GAAP diluted (loss) income per share
$
(0.04
)
 
$
0.01

 
$
(0.07
)
 
$
(0.18
)



24



Revenue, Order Trends, Outlook and Business Highlights
 
The tables below show our total revenues (in millions) for the most recent five quarters and the years ended December 31, 2014, 2013 and 2012 and the percentage change over the prior year period, and a summary of on-premises orders received and cloud subscription annual contract values (“ACV”) during the three and nine months ended September 30, 2015 and 2014. ACV is the annual minimum dollar value of cloud subscription revenues from contracts signed during the applicable period.
 
Period
Revenues
 
Year-over-Year Growth %
Three Months Ended:
 
 
 
September 30, 2015
$
97.4

 
9
%
June 30, 2015
96.3

 
21

March 31, 2015
89.5

 
13

December 31, 2014
92.6

 
2

September 30, 2014
89.5

 
15

 
 
 
 
Year Ended December 31:
 
 
 
2014
$
341.3

 
7
%
2013
318.2

 
34

2012
237.4

 
13

 
On-Premises Orders and Cloud Subscription Annual Contract Values (ACV)
 
 
Three Months Ended 
 September 30,
 
 
Nine Months Ended 
 September 30,
 
 
2015
 
2014
 
 
2015
 
2014
 
Increase (decrease) in dollar amount from prior year period:
 
 
 
 
 
 
 
 
 
On-premises orders
(14
)%
 
(9
)%
 
 
6
 %
 
(14
)%
 
Cloud subscription ACV
(34
)%
(1)
89
 %
(2)
 
(19
)%
(3)
30
 %
(4)
Number of new on-premises customers
30

 
43

 
 
107

 
124

 
Number of new cloud subscription customers
39

 
28

 
 
91

 
71

 
Total orders greater than $250,000
50

 
56

 
 
128

 
129

 
______
(1)
Includes one large contract signed in the third quarter of 2014. Excluding this contract, cloud subscription ACV growth was 4%.
(2)
Includes one large contract signed in the third quarter of 2014. Excluding this contract, cloud subscription ACV growth was 20%.
(3)
Includes two large contracts signed in the first quarter of 2014, one large contract signed in the second quarter of 2014, and one large contract signed in the third quarter of 2014. Excluding these contracts, cloud subscription ACV growth was 28%.
(4)
Includes one large contract signed in the second quarter of 2013, two large contracts signed in the first quarter of 2014, one large contract signed in the second quarter of 2014, and one large contract signed in the third quarter of 2014. Excluding these contracts, cloud subscription ACV growth was 23%.
 

25



Geographic Mix
 
The following table shows the percentage of on-premises orders and cloud subscription ACV derived from each of our geographic regions for the periods presented:
 
 
Three Months Ended September 30,
 
Nine Months Ended 
 September 30,
 
2015
 
2014
 
2015
 
2014
On-premises orders:
 
 
 
 
 
 
 
     Americas
78
%
 
77
%
 
72
%
 
72
%
     Europe, Middle East, and Africa
16

 
15

 
22

 
20

     Asia-Pacific
6

 
8

 
6

 
8

 
 
 
 
 
 
 
 
Cloud subscription ACV:
 
 
 
 
 
 
 
     Americas
74
%
 
87
%
 
71
%
 
84
%
     Europe, Middle East, and Africa
18

 
7

 
20

 
11

     Asia-Pacific
8

 
6

 
9

 
5


Foreign Currency Impact on Profitability

Due to the continued strengthening of the US dollar against international currencies, we recognized $4.0 million and $9.7 million less in revenue for the three and nine months ended September 30, 2015, respectively, than we would have utilizing foreign exchange rates in effect during the prior year periods. Since we operate in many international locations, the year-over-year change in foreign exchange rates positively impacted the expenses we recorded for the three and nine months ended September 30, 2015, resulting in a net negative impact on operating income of $500,000 and $1.2 million for the three and nine months ended September 30, 2015, respectively.

Outlook for 2015
 
As our business continues to shift towards the licensing of cloud solutions, and revenues related to these licenses are recognized over the contract period, we have reported and may continue to report periods of operating losses. We are currently projecting non-GAAP operating income in the range of $500,000 to $1.3 million for the full year of 2015. There can be no assurance that our outlook for 2015 as provided in our Annual Report on Form 10-K for the year ended December 31, 2014, and as modified above or otherwise, will be achieved, and actual results may be materially and adversely different from our current projections. 

Convertible Notes Issuance

In May 2015, we issued $150 million aggregate principal amount of 1.25% convertible senior notes (the "Notes") due June 1, 2020, unless earlier purchased by us or converted. Interest is payable semi-annually, in arrears, on June 1 and December 1 of each year. See Note 11 of Notes to Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for additional information related to our issuance of the Notes. For a discussion of the impact of the Notes offering on our liquidity and the expected use of the proceeds from the offering, see "Liquidity and Capital Resources" below.

Comparison of Results of Operations for the Three and Nine Months Ended September 30, 2015 and 2014
 
Revenues
 
Our revenues include: (i) recurring revenues; (ii) license and hardware revenues; and (iii) services revenues. These revenues are generated through direct sales to customers and through our partner channels.
 

26



Recurring revenues include renewals of the support fees from on-premises license agreements and revenues from our implemented cloud solutions. The support fees are recognized over the support period, generally between one and three years. Cloud subscriptions have historically been for periods of up to five years; however, beginning in 2015, we began offering one year contracts to simplify the contracting process, accelerate the sales cycle and encourage annual upfront cash payments.

License and hardware revenues include license fees for on-premises software and sale of hardware. Not all on-premises software and hardware product orders are recognized as revenue when they are received because of product general availability, certain contractual terms or the collection history with particular customers or partners. Consequently, license and hardware revenues for any particular period not only reflect certain orders received in the current period, but also include certain orders received but deferred in previous periods and recognized in the current period. In addition, a portion of license and hardware orders are related to support and recognized over the support period as recurring revenues.
 
Services revenues primarily include professional and educational services fees. Services revenues fluctuate based on the solution implementation requirements of our customers and partners as well as the number of attendees at our training classes.
 
Total revenues for the three and nine months ended September 30, 2015 were negatively impacted by $4.0 million and $9.7 million, respectively, due to year-over-year changes in foreign exchange rates.

 
 
 
Percent of Total Revenues
 
Increase or (Decrease)
 
Three Months Ended 
 September 30,
 
Three Months Ended 
 September 30,
 
 
2015
 
2014
 
2015
 
2014
 
2015 vs. 2014
 
($ in thousands)
 
 
 
 
 
 
Recurring
$
59,228

 
$
48,095

 
60.8
%
 
53.8
%
 
23
 %
License and hardware
22,668

 
27,764

 
23.3

 
31.0

 
(18
)
Services
15,473

 
13,603

 
15.9

 
15.2

 
14

Total revenues
$
97,369

 
$
89,462

 
 
 
 
 
9


 
 
 
Percent of Total Revenues
 
Increase or (Decrease)