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INCONTACT, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis of financial condition and results of operations should be read in conjunction with the audited December 31, 2013 Consolidated Financial Statements and notes thereto, along with Management's Discussion and Analysis of Financial Condition and Results of Operations included in our 2013 Annual Report on Form 10-K, filed separately with the Securities and Exchange Commission. This document contains statements that are, or may be deemed to be, forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. All statements, other than statements of historical fact, which address activities, actions, goals, prospects, or new developments that we expect or anticipate will or may occur in the future, including such things as expansion and growth of our operations and other such matters are forward-looking statements. Any one or a combination of factors could materially affect our operations and financial condition. These factors include competitive pressures, success or failure of marketing programs, changes in pricing and availability of services and products offered to customers, legal and regulatory initiatives affecting software or long distance service, and conditions in the capital markets. Forward-looking statements made by us are based on knowledge of our business and the environment in which we operate as of the date of this report. Because of the factors discussed in our 2013 Annual Report on Form 10-K under Item 1A "Risk Factors," and factors disclosed in subsequent reports filed with the Securities and Exchange Commission, actual results may differ from those in the forward-looking statements. OVERVIEW inContact began in 1997 as a reseller of network connectivity services and has evolved to become a leading provider of cloud contact center software solutions. We help contact centers around the world create effective customer experiences through our powerful portfolio of cloud contact center contact routing, self-service and agent optimization software solutions. Our services and software solutions enable contact centers to operate more efficiently, optimize the cost and quality of every customer interaction, create new pathways to profit and ensure ongoing customer-centric business improvement and growth. We began offering cloud solutions to the contact center market in 2005. Our dynamic technology platform provides our customers a pay-as-you-go solution without the costs and complexities of premise-based systems. Our proven cloud delivery model provides compelling total cost of ownership savings over premise-based technology by reducing upfront capital expenditures, eliminating the expense of system management and maintenance fees, while providing agility that enables businesses to scale their technology as they grow. DEVELOPMENTS On May 6, 2014, we acquired CallCopy, Inc., a Delaware corporation doing business as Uptivity ("Uptivity"). Uptivity provides a complete mid-market workforce optimization suite of services to call centers comprised of speech and desktop analytics, agent coaching, call and desktop recording, as well as quality, performance, workforce management and satisfaction surveys. There were no material relationships between inContact and any of the stockholders of Uptivity prior to the acquisition. The purchase price was approximately $50.2 million, including Uptivity's unaudited adjusted net current assets of approximately $5.8 million as of the closing date, which was estimated for purposes of closing and subject to adjustment in certain circumstances and verification in a final closing balance sheet for Uptivity. The purchase price was paid with cash in the amount of $14.6 million and 4,256,244 shares of the Company's common stock valued at $35.6 million. SOURCES OF REVENUE We derive our revenues from two major business activities: (1) delivery and support of our inContact portfolio of software solutions and associated professional services and (2) reselling network connectivity services. Our primary business focus is marketing and selling our inContact portfolio. Software Software delivery and support of our inContact portfolio is provided on a monthly recurring subscription basis. Monthly recurring charges are billed in arrears and recognized for the period in which they are earned. In addition to the monthly recurring revenue, revenue is also received on a non-recurring basis for professional implementation services or on a recurring basis related to improving a customer's contact center efficiency and effectiveness metrics, as it relates to utilization of the inContact portfolio. Customers access cloud software and data through a secure Internet connection. Support services include technical assistance for our software products and product upgrades and enhancements on a when and if available basis. Our network connectivity and data network is fundamental to our inContact portfolio and allows us to provide the all-in-one inContact solution. Software service revenue also includes revenue 15 -------------------------------------------------------------------------------- related to minimum purchase commitments through July 2014, from a related party reseller referred to in Part I. Item 1 "Financial Statements" - Note 12 - Related Party Transactions." Network Connectivity We derive revenue from network connectivity services such as dedicated transport, VoIP connectivity, switched long distance and data services. These services are provided over our network or through third party network connectivity providers. Revenue for transactional network connectivity usage is derived based on customer specific rate plans and the customer's call usage and is recognized in the period the call is initiated. Customers are billed monthly charges in arrears and revenue is recognized for such charges over the billing period. If the billing period spans more than one month, earned but unbilled revenues are recognized as revenue for incurred usage to date. COSTS OF REVENUE AND OPERATING EXPENSES Costs of Revenue Costs of revenue consist primarily of payments to third party long distance service providers for resold network connectivity services to our customers. Costs of revenue also include labor costs (including stock-based compensation) and related expenses for our software services delivery, professional services and customer support organizations, equipment depreciation relating to our services, amortization of acquired intangible assets, amortization of capitalized internal use software development costs, and allocated overhead, such as rent, utilities and depreciation on property and equipment. As a result, overhead expenses are included in costs of revenue and each operating expense category. The cost associated with providing professional services is significantly higher as a percentage of revenue than the cost associated with delivering our software services due to the labor costs associated with providing professional services. We anticipate that we will incur additional costs for network connectivity service providers, hosting, support, labor costs and related expenses, to support delivery of our software solutions and services in the future. Selling and Marketing Selling and marketing expenses consist primarily of labor costs (including stock-based compensation) and related expenses for employees in sales and marketing, including commissions and bonuses, advertising, marketing events, corporate communications, expenses, travel costs and allocated overhead. Since our Software segment revenue is delivered and therefore recognized over time, we have experienced a delay between increasing sales and marketing expenses and the recognition of the corresponding revenue. We believe it is important to continue investing in selling and marketing to create brand awareness and lead generation opportunities, to increase market share and to support the resellers channels. Accordingly, we expect selling and marketing expenses to increase in absolute dollars as we continue to support growth initiatives. Research and Development Research and development expenses consist primarily of the non-capitalized portion of labor costs (including stock-based compensation) and related expenses for development personnel and costs related to the development of new products, enhancement of existing products, quality assurance, market research, testing, product management and allocated overhead. We expect research and development expenses to increase in absolute dollars in the future as we intend to release new features and functionality on a frequent basis, expand our content offerings, upgrade and extend our service offerings and develop new technologies. General and Administrative General and administrative expenses consist primarily of labor costs (including stock-based compensation) and related expenses for management, finance and accounting, legal, information systems and human resources personnel, professional fees, other corporate expenses and allocated overhead. We anticipate that we will incur additional employee salaries and related expenses, professional service fees and other corporate expenses related to the growth of our business and operations in the future. As such, we expect general and administrative expenses to increase in absolute dollars. 16 -------------------------------------------------------------------------------- RESULTS OF OPERATIONS Three Months Ended March 31, 2014 and 2013 The following is a tabular presentation of our condensed consolidated operating results for the three months ended March 31, 2014 compared to our condensed consolidated operating results for the three months ended March 31, 2013 (in thousands, except percentages): 2014 2013 $ Change % Change Net revenue $ 37,054 $ 31,645 $ 5,409 17 % Costs of revenue 19,073 16,468 2,605 16 % Gross profit 17,981 15,177 2,804 Gross margin 49 % 48 % Operating expenses: Selling and marketing 10,056 8,422 1,634 19 % Research and development 3,760 2,771 989 36 % General and administrative 5,268 5,045 223 4 % Total operating expenses 19,084 16,238 2,846 Loss from operations (1,103 ) (1,061 ) 42 Other expense (262 ) (85 ) 177 Loss before income taxes (1,365 ) (1,146 ) 219 Income tax expense (27 ) (17 ) 10 Net loss $ (1,392 ) $ (1,163 ) $ 229 Revenue Total revenues increased $5.4 million or 17% to $37.1 million during the three months ended March 31, 2014 compared to revenues of $31.6 million during the same period in 2013. The increase relates to an increase of $3.8 million in Software segment revenue due to continued focus and investment in selling and marketing efforts of our inContact portfolio of cloud contact center solutions through our direct sales and referral and reseller partner arrangements and revenue related to minimum purchase commitments from a reseller. Network connectivity segment revenue increased $1.6 million as the increase of Network connectivity revenue associated with our inContact portfolio customers exceeded the attrition of our Network connectivity only customers. We recognized $1.7 million of software revenue during the three months ended March 31, 2014 compared to $1.7 million during the same period in 2013, under our reseller agreement with Unify, which principally represents revenue from Unify's minimum purchase commitments. Under the arrangement, revenue from resold software services reduces Unify's obligation up to the amount of the quarterly minimum purchase commitments. These minimum purchase commitments were negotiated, in part to mitigate the risks associated with the investment in infrastructure to support our expanded reseller sales and marketing efforts initiated in 2011 and expire in the third quarter of 2014. As of March 31, 2014, Unify continues to resell our software services and has met its obligations under the revised reseller agreement; however, we believe revenue from resold software services will not meet the gross minimum purchase commitment in the third quarter of 2014. Therefore, we anticipate a reduction in software revenue from that reseller beginning in the fourth quarter of 2014 to the extent the revenue from resold software services is less than the minimum purchase commitment in the third quarter of 2014. Costs of revenue and gross margin Costs of revenue increased $2.6 million or 16% to $19.1 million during the three months ended March 31, 2014 compared to $16.5 million for the same period in 2013. Gross margin increased 1 percentage points to 49% for the three months ended March 31, 2014 compared to 48% for the same period in 2013. The increase in revenue from our inContact portfolio and the minimum purchase commitment offset increased costs attributable to greater professional service personnel costs incurred to service larger mid-market and enterprise customers and to support resellers, international infrastructure investments initiated in 2011 and increased amortization of previously capitalized software development costs. In addition, lower network connectivity costs due to increased efficiencies in call routing related to a continued investment in technology and lower negotiated direct costs contributed to the gross margin increase. Selling and marketing Selling and marketing expenses increased $1.6 million or 19% to $10.1 million during the three months ended March 31, 2014 from $8.4 million for the same period in 2013. This increase is primarily a result of headcount additions for direct and channel sales employees, increased commissions as a result of increased revenue and headcount, and to a lesser extent, higher levels of investment 17 -------------------------------------------------------------------------------- in marketing efforts to create increased awareness of our services as well as increased lead generation efforts for our Software segment. Research and development Research and development expense increased $989,000 or 36% to $3.8 million during the three months ended March 31, 2014 from $2.8 million during the same period in 2013. The increase relates to our efforts to expand our content offerings, upgrade and extend our service offerings and develop new technologies primarily through headcount additions. General and administrative General and administrative expense increased $223,000 or 4% to $5.3 million during the three months ended March 31, 2014 compared to $5.0 million during the same period in 2013. The increase is primarily due to increased costs incurred to support our domestic and international business expansion. Other expense Other expense increased $177,000 to $262,000 during the three months ended March 31, 2014 from $85,000 for the same period in 2013. The difference is primarily due to an increase in the amount interest expense in the first quarter of 2014 compared to the same period in 2013 related to a higher average balance on our term loans. Income taxes Income taxes, which consist of various state income taxes and foreign taxes, remained consistent for the three months ended March 31, 2014 compared to the same period in 2013. SEGMENT REPORTING We operate under two business segments: Software and Network connectivity. The Software segment includes all monthly recurring revenue related to the delivery of our software solutions plus the associated professional services and setup fees and revenue related to quarterly minimum purchase commitments from Unify through July 2014. The Network connectivity segment includes all voice and data long distance services provided to customers. Management evaluates segment performance based on operating data (revenue, costs of revenue, and other operating expenses). Management does not evaluate and manage segment performance based on assets. For segment reporting, we classify operating expenses as either "direct" or "indirect." Direct expense refers to costs attributable solely to either selling and marketing efforts or research and development efforts. Indirect expense refers to costs that management considers to be overhead in running the business. Management evaluates expenditures for both selling and marketing and research and development efforts at the segment level without the allocation of overhead expenses, such as compensation, rent, utilities and depreciation on property and equipment. 18 -------------------------------------------------------------------------------- Software Segment Results The following is a tabular presentation and comparison of our Software segment unaudited condensed consolidated operating results for the three months ended March 31, 2014 and 2013 (in thousands, except percentages): Three Months Ended March 31, 2014 2013 $ Change % Change Net revenue $ 20,009 $ 16,172 $ 3,837 24 % Costs of revenue 8,235 6,435 1,800 28 % Gross profit 11,774 9,737 2,037 Gross margin 59 % 60 % Operating expenses: Direct selling and marketing 8,813 6,963 1,850 27 % Direct research and development 3,474 2,539 935 37 % Indirect 5,266 4,745 521 11 % Loss from operations $ (5,779 ) $ (4,510 ) (1,269 ) Three Months Ended March 31, 2014 and 2013 The Software segment revenue increased by $3.8 million or 24% to $20.0 million during the three months ended March 31, 2014 from $16.2 million for the same period in 2013. The increase relates primarily to revenue generated from our inContact portfolio of cloud contact center solutions and is due to our continued focus and investment in sales and marketing through our direct sales and referral and reseller partner arrangements. We recognized $1.7 million of software revenue during the three months ended March 31, 2014 compared to $1.7 million during the same period in 2013, under our reseller agreement with Unify, which principally represents revenue from Unify's minimum purchase commitments. Under the arrangement, revenue from resold software services reduces Unify's obligation up to the amount of the quarterly minimum purchase commitments. These minimum purchase commitments were negotiated, in part to mitigate the risks associated with the investment in infrastructure to support our expanded reseller sales and marketing efforts initiated in 2011 and expire at the end of July 2014. We believe that resold recurring software revenue will not meet the final quarterly gross minimum purchase commitment of $1.5 million in the third quarter of 2014 and there will be a reduction in software revenue from that reseller beginning in August 2014 to the extent the revenue from resold software services is less than the minimum purchase commitment at the end of July 2014. Gross margin decreased 1 percentage point to 59% for the three months ended March 31, 2014 compared to 60% for the same period in 2013. This decrease is largely a result of increased costs attributable to greater professional service costs incurred to service larger mid-market and enterprise customers and to support resellers, increased amortization of previously capitalized software development costs and amortization of intangibles purchased as a part of the Transcend acquisition. Direct selling and marketing expenses in the Software segment increased $1.9 million or 27% to $8.8 million during the three months ended March 31, 2014 compared to $7.0 million for the same period in 2013. This increase is a result of headcount additions for direct and channel sales employees and employees focused on managing and enhancing our partner relationships and higher levels of investment in marketing efforts to create increased awareness of our inContact portfolio of cloud contact center solutions. We also continue to develop the software applications and services provided in the Software segment by investing in research and development. During the three months ended March 31, 2014, we incurred $3.5 million in direct research and development costs compared to $2.5 million for the same period in 2013 and have capitalized an additional $2.3 million of costs incurred during the three months ended March 31, 2014 related to our internally developed software compared to $1.5 million for the same period in 2013. Indirect expenses, which consist of overhead, such as allocated general and administrative expenses, rent, utilities and depreciation on property and equipment, increased $521,000 or 11% to $5.3 million during the three months ended March 31, 2014 from $4.7 million for the same period in 2013 due to more indirect costs being allocated to the Software segment with the continued shift in revenue and direct expense mix from the Network connectivity segment to the Software segment and the general increase in indirect expenses. 19 -------------------------------------------------------------------------------- Network Connectivity Segment Results The following is a tabular presentation and comparison of our Network connectivity segment condensed consolidated operating results for the three months ended March 31, 2014 and 2013 (in thousands, except percentages): Three Months Ended March 31, 2014 2013 $ Change % Change Net revenue $ 17,045 $ 15,473 $ 1,572 10 % Costs of revenue 10,838 10,033 805 8 % Gross profit 6,207 5,440 767 Gross margin 36 % 35 % Operating expenses: Direct selling and marketing 757 992 (235 ) (24 %) Indirect 774 999 (225 ) (23 %) Income from operations $ 4,676 $ 3,449 $ 1,227 Three Months Ended March 31, 2014 and 2013 Network connectivity segment revenue increased $1.6 million or 10% to $17.0 million during the three months ended March 31, 2014 compared to $15.5 million for the same period in 2013 due to the increase of network connectivity revenue associated with our inContact portfolio customers exceeding the attrition of our Network connectivity only customers. Our costs of revenue increased 8% due to the increase in revenue and Network connectivity gross margin increased 1% due to increased efficiencies in call routing related to a continued investment in technology and lower negotiated direct costs. Selling and marketing expenses decreased $235,000 or 24% during the three months ended March 31, 2014 as compared to the same period in 2013, primarily due to a decrease in employees commissions from connectivity product sales. Indirect expenses, which consist of overhead, such as allocated general and administrative expense, rent, utilities and depreciation on property and equipment decreased $225,000 or 23% during the three months ended March 31, 2014 compared to the same period in 2013 as a result of a decrease in compliance related activities. LIQUIDITY AND CAPITAL RESOURCES Current Financial Condition Our principal sources of liquidity are cash and cash equivalents, cash available to draw under a term loan agreement ("2013 Term Loan") and available borrowings under our Revolving Credit Agreement, which expires in July 2015. At March 31, 2014, we had $44.7 million of cash and cash equivalents. In addition to our $44.7 million of cash and cash equivalents, we have access to additional available borrowings under our Revolving Credit Agreement with Zions, subject to meeting our covenant requirements, and our 2013 Term Loan with Zions. The available borrowings under the Revolving Credit Agreement at March 31, 2014 were $15.0 million, based on the maximum available advance amount calculated on the March 20, 2014 borrowing base certificate. The available borrowings under the 2013 Term Loan at March 31, 2014 was $1.0 million. Total cash and additional availability under the Revolving Credit Agreement and 2013 Term Loan was $60.7 million at March 31, 2014. The Revolving Credit Agreement is collateralized by substantially all our assets. We experienced a net loss of $1.4 million during the quarter ended March 31, 2014. Significant non-cash expenses affecting operations during the first quarter of 2014 were $3.2 million of depreciation and amortization and $1.0 million of stock-based compensation. The non-cash expenses were partially offset by decreases from accounts receivable, other assets and accrued liabilities resulting in $418,000 of cash from operating activities during the first quarter of 2014. We continue to take a proactive approach in managing our operating expenditures and cash flow from operations. We expect to rely on internally generated cash, our Revolving Credit Agreement and our 2013 Term Loan to finance operations and capital requirements. We believe that existing cash and cash equivalents, cash from operations, available borrowings under our Revolving Credit Agreement and available borrowings under our 2013 Term Loan will be sufficient to meet our cash requirements during the next twelve months. CRITICAL ACCOUNTING POLICIES AND ESTIMATES A summary of our significant accounting policies and estimates is discussed in Management's Discussion and Analysis of Financial Condition and Results of Operations and in Note 1 of our Annual Report on Form 10-K for the year ended December 31, 2013. The preparation of the financial statements in accordance with U.S. generally accepted accounting principles requires us to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities. Significant areas of uncertainty that require judgments, estimates and assumptions include the accounting for income taxes and other contingencies as well as asset impairment and collectability of accounts receivable. We use historical and other information that we 20 -------------------------------------------------------------------------------- consider to be relevant to make these judgments and estimates. However, actual results may differ from those estimates and assumptions that are used to prepare our financial statements. |