As Filed with the Securities and Exchange Commission on May 9, 2007

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-K

 

 

 

 

 

Commission File Number: 1-15045

 

Intervoice, Inc.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(972) 454-8000

 

Securities registered pursuant to Section 12(b) of the Act:

None

 

Securities registered pursuant to Section 12(g) of the Act:

 

Title of Each Class

Common Stock, No Par Value

Preferred Share Purchase Rights

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o     No þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

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 þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ

 

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

 

Large Accelerated Filer o     Accelerated Filer þ     Non-Accelerated Filer o

 

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

 

Aggregate Market Value of Common Stock held by Nonaffiliates as of August 31, 2006: $274,291,990

 

Number of Shares of Common Stock Outstanding as of April 13, 2007: 38,844,915

 

Documents Incorporated by Reference

 

Listed below are documents parts of which are incorporated herein by reference and the part of this Report into which such document is incorporated:

 

(1) Proxy Statement for the 2007 Annual Meeting of Shareholders — Part III.

 

 

TABLE OF CONTENTS

 

 

Intervoice, Inc. (NASDAQ:  INTV), a Texas corporation formed in 1983, is a world leader in unified communications, switch-independent software and professional services that power standards-based voice portals, multi-channel Internet Protocol (“IP”) contact centers, and next-generation enhanced messaging platforms and applications. We offer our contact center and network service provider customers flexible, scalable, integrated software platforms, powerful development and reporting tools, customized and packaged software applications, comprehensive consulting services, and post-sale support. With our recent acquisition of technology from Nuasis Corporation (“Nuasis”), an IP contact center provider, Intervoice now offers an end-to-end customer interaction solution for self-service and live assistance.

 

Intervoice has always been a voice industry innovator, introducing the world’s first PC-based Interactive Voice Response (“IVR”) system in 1983 for banks, retail outlets, insurance companies, government agencies and other institutions. Now, almost 25 years later, Intervoice remains dedicated to unified voice communications, providing contact center self-service solutions for corporate customers as well as value-added service solutions for network service providers. We are also an industry leader in the deployment of standards-based systems, with more than 48,000 VoiceXML (Voice eXtensible Mark-up Language) ports sold through February 2007.

 

Intervoice is committed to delivering end-to-end solutions that are compliant with industry standards, are hardware independent, and integrate seamlessly with other systems and software. We support standards including VoiceXML, SCXML (State Chart eXtensible Mark-up Language) and CCXML (Call Control eXtensible Mark-up Language) for voice-enabled web applications and contact center software architectures. We continuously assess evolving industry standards and are actively involved in industry associations such as the Eclipse Foundation, the VoiceXML Forum, and the Internet Engineering Task Force, as well as network-focused organizations such as the 3GPP (IMS), the GSM Association, TMIA, VMA and AVIOS.

 

Our contact center customer base is among the largest in the industry with more than 20,000 deployments. We offer our customers the option of deploying solutions as a customer-premise sale or as a hosted service, an option that we feel is a competitive differentiator. Our Hosted Solutions group manages more than 30,000 ports through our network operations centers.

 

Our contact center software and professional consulting services allow businesses to build brand loyalty by enriching their customers’ user experiences while lowering their overall cost of operations. For network service providers, Intervoice’s product and service suite includes next-generation IP-based voice messaging, text messaging, voice portal and payment systems — all providing network service providers with revenue-generating services that meet their customers’ growing demands for enhanced mobile services and access from any device, any place and any time.

 

The foundation of Intervoice’s decades-long success is a corporate strategy influenced by six key market trends:

 

 

 

 

Intervoice’s strategy is not only guiding our development of standards-based products, but is also sharpening our focus on enabling more complex and intelligent customer interactions throughout the enterprise. We help network service providers accelerate the rate at which they can bring new subscriber offerings to market by providing tools that support third-party application development. In addition, we are bringing new levels of quality and personalization to speech self-service through our global consulting services group — one of the most experienced in the industry. Our focus on ensuring exceptional value and usability helps our contact center and network service provider customers enhance the experience of their customers while lowering costs and increasing revenues.

 

Our activities in both the contact center and network service provider markets are supported by shared resources in sales, operational support, research and development and administrative areas. Our corporate headquarters is in Dallas, Texas, with remote facilities in Florida and California. Our global presence extends to office locations throughout the world, including Europe, the Middle East, Africa, South America and Asia.

 

We sell our products through a direct sales force and through an established network of distributors, system integrators and channel partners. For the fiscal year ended February 28, 2007, we reported revenues of approximately $196.3 million, including $92.4 million of solution sales, $83.2 million of maintenance and related service revenues and $20.7 million of hosted solutions revenues. Sales to North American customers totaled $127.7 million or 65% of total sales for the year.

 

Intervoice also delivers unique value through the integration of industry-standard hardware, software, and professional services provided by our numerous alliance partners. These strategic relationships are an integral part of our product strategy and allow us to create voice automation and network services solutions tailored to fit each of our customer’s specific business needs. Key Intervoice technology alliance partners include BEA, Nuance, Intel/Dialogic, and HP.

 

Intervoice is a leader in providing converged voice and data solutions and related services. We sell solutions that allow customers to access account data or order services from a company at a time they find convenient, using a communication device they find convenient (e.g. phone, computer and PDA) and with the option of engaging a live agent if required. We also sell solutions that support the use of various advanced phone messaging activities and prepaid phone services. When we use the term “solutions sales” in this Annual Report, we mean the sale of hardware and/or software applications and the related consulting services associated with designing, developing, integrating, installing and testing custom applications to perform these functions. When we use the term “recurring services,” we mean the sale of maintenance and software upgrade offerings and the provision of customized solutions to customers on a hosted-solution basis.

 

Intervoice Solutions Framework

 

The Intervoice Solutions Framework (“ISF”) is designed to simplify and illustrate the commonality of our products and services. This framework divides all Intervoice offerings into Platforms and Tools, Applications, and Services, all of which are centered on a core software element called Home Zone^tm. Home Zone, which includes patent-pending technology, is currently incorporated in our software platform allowing callers easy, single-session management of service selections and personal profiles to obtain a customized communications experience. Home Zone enables applications on the platform to take full advantage of all platform features and capabilities and provides carriers a services management capability which enhances the provisioning, administration and billing of mobile applications. The ISF Platform, called Media Exchange, is an IP-based, unified services platform that bridges the gap between traditional voice networks and IP networks. It supports the World Wide Web Consortium (“W3C”) compliant VXML, SCMXL, and CCXML browsers as well as our new development environment called Development Studio. The ISF fully accommodates a converged network and at the same time provides access to software components and services that can be implemented and shared among discrete business functions.

 

Contact Center Solutions

 

Intervoice Voice Portal

 

Intervoice is a recognized market leader in the creation and deployment of voice portal solutions, which include traditional and standards-based IVR systems and other voice portal solutions for businesses. Our voice portal solutions allow organizations of all types to automate their communications, reduce costs and improve interactions with customers, employees and business partners. Our solutions provide callers with access to information when, where, and how they want to receive it using speech-enabled and touch-tone interfaces that have been designed and optimized for usability — in other words, designed with the callers’ needs in mind. As speech recognition and text-to-speech technologies gain acceptance as natural user interfaces, our solutions allow for the automation of interactions previously seen as too complex for a traditional touch-tone interface. Businesses use our solutions to streamline access to account information, allow for secured access to sensitive information through voice verification, edit name and address information, and support workforce management activities. Enterprise-wide applications also enable customers to order products, activate accounts, pay bills, enroll for college courses, apply for jobs, execute securities trades, recharge prepaid accounts and many other increasingly complex interactions. All of these applications can be designed to give our customers the ability to offer their callers easy access to information and an exceptional user experience.

 

Intervoice Voice Portal is our advanced software-based solution that can be used to create and manage voice-based solutions. Intervoice Voice Portal is built on the Intervoice Solutions Framework. It delivers a flexible, modular and highly scalable design (built upon open industry standards including VoiceXML, SCXML, CCXML and others) that encourages the seamless integration of Web and enterprise-based systems into intuitive speech-enabled solutions with a clear business return-on-investment (“ROI”).

 

Companies in a wide range of industries use our contact center solutions to drive operational efficiencies. Our software delivers a true end-to-end converged voice and data solution and supports best-of-class deployments through our alliance partnerships with the leading names in information technology. Our software modules can be implemented individually to meet specific requirements or applied as a comprehensive solution to achieve enterprise-class voice automation results. The modules include leading technologies, proven applications, an award-winning development environment, and intuitive management tools that are backed by comprehensive professional consultation services and technical support. The modules can be deployed in a customer premise or hosted solutions environment.

 

Intervoice IP Contact Center

 

With the acquisition of the Nuasis technology, Intervoice has added a next-generation software solution for customer contact routing that is based on an IP platform consistent with the Intervoice Voice Portal architecture. The Intervoice IP Contact Center completes an end-to-end solution for self-service IVR and speech applications with live assistance support through contact center agents. It seamlessly integrates traditional automatic call distribution (“ACD”) for routing phone calls as well as other contact types such as e-mail response and web chat requests. All media types are handled with a single, consistent routing application and user interface for agents. The system also provides traditional computer telephony integration (“CTI”) functionality at a fraction of the cost of deployment in the traditional hardware based implementation. Lastly, the distributed IP architecture takes advantage of the distributed corporate network to allow low-cost networking of agents regardless of their location — in a call center, branch office, or at home — creating a single virtual call center.

 

Horizontal Application Modules

 

Intervoice delivers voice automation applications and solutions through a spectrum of easily re-usable application modules and components that can be bundled together or used separately. Our solutions combine horizontal applications, server-side software modules and components with our world-class consulting services to deliver an exceptional user experience. Examples of Intervoice’s horizontal solutions include:

 

Personalization — a rules-based engine that enables the voice portal to adapt its interaction with a user based on prior interactions

 

Survey Automation — provides an automated and confidential method of surveying customers, callers and clients

 

Auto-Attendant — provides an easy and automated way to self direct calls in place of a live operator

 

Locator Automation — portal application that provides callers with detailed location information about nearby ATMs, stores or other destinations

 

Password Reset (Identifier) — provides callers with a means to reset their password in the event they forget or lose it without going through an agent

 

Authenticator — provides voice authentication of a caller for access to sensitive or confidential applications or information

 

Voice or Web Convergence — working with BEA’s WebLogic Portal, Voice and Web Convergence accelerates a customer’s deployment for fully integrated, multi-channel customer service solutions

 

Field Force Automation — delivers voice-enabled, packaged solutions for improving the productivity of mobile workforces while reducing the cost to support them

 

Vertical Application Modules

 

Intervoice offers industry-specific vertical solutions, applications and reusable software modules. Our proven, pre-built components help accelerate development for faster ROI for our customers. Our offerings address needs in the following industries:

 

Banking & Financial Services
Healthcare
Public Sector
Retail & Manufacturing
Telecommunications
Transportation & Travel
Utilities

 

Network Service Provider Solutions

 

We offer network service providers an array of revenue generating solutions that include next generation IP-based messaging and media management applications, traditional Intelligent Network (“IN”)-based voice and text messaging applications and prepaid payment solutions. To date, our network service provider solutions have primarily been sold to wireless network service providers in Latin America, Europe, Asia Pacific, the Middle East and Africa.

 

Media Exchange for Networks

 

Media Exchange for Networks is a flexible, IP-based multimedia enhanced services platform designed specifically for mobile network operators, cable service providers and fixed line operators. It is based on the ISF and designed specifically for high availability. It includes a customizable mix of multimedia service options including next generation messaging, voice activated dialing, web user interfaces, voice portal, calendar management and text to speech capabilities. Media Exchange for Networks offers touch tone, voice and web user interfaces.

 

Our Media Exchange solution helps network service providers accelerate the rate at which they can bring enhanced services to market. Our standards-based software platform incorporates tools which support third-party application development and provides easy access to enhanced services by subscribers through the Home Zone. Each unique combination of enhanced services allows network service providers to offer their subscribers a differentiated service that can enhance their brand, increase revenue per subscriber and increase subscriber loyalty and retention.

 

The Media Exchange for Networks suite of solutions includes the following packaged application options:

 

Voicemail MX — next-generation voice mail and unified messaging functionality offering a common message store and common data base

 

Video Mail — a store and forward video solution for messaging

 

Voice to MMS (“V2MMS”) — a media-independent message deposit and call completion utility that allows subscribers to record a voice message and have it delivered as a Multi-Media Message (“MMS”)

 

Voice Activated Dialing — a solution which lets end users create their own address books, store contact information and initiate calls with voice dialing

 

Traditional, IN-based Messaging

 

Our traditional, IN-based messaging solutions include voicemail, short message service (“SMS”) and missed-call notification. These solutions incorporate a range of advanced features, including intelligent call return, mailbox-to-mailbox messaging, universal mailboxes, missed-call alerts and conditional personal greetings. Our applications support network service providers in their efforts to build subscriber counts, loyalty and usage.

 

Portal

 

Our Media Exchange applications allow subscribers instant access to information content and entertainment services via a voice or touch-tone user interface or through a web browser. Portal applications include access to horoscope information, sports, weather, traffic and financial data and can be “branded” and customized to enhance subscriber loyalty and revenues.

 

Payment

 

We provide a range of products and services that allows network service providers to offer prepaid services. Providers can offer prepaid telephony services to facilitate subscriber acquisition and usage in selected markets where subscribers prefer to pay by cash or where collection might be an issue. We support a wide range of prepaid services, including prepaid calling cards, prepaid residential, prepaid wireless and automated operator services. Our prepaid solutions integrate seamlessly with other telco-grade, revenue-generating applications, including our messaging and portal solutions.

 

Intelligent Network Prepaid can be deployed to provide enhanced flexibility and efficiency in both wireline and wireless networks. Network service providers use IN Prepaid solutions to manage rapid subscriber growth, provide cost-effective roaming, and boost subscriber satisfaction.

 

Consulting Services

 

Intervoice offers the services of solution engineers, designers, developers and other consulting services specialists who provide our customers the benefit of the experience we have gained in the development of thousands of custom touch-tone and speech-enabled solutions. We offer customers a single source for needs assessment and application design, voice user interface (“VUI”) design, system integration, project management, effective training and optimization of their custom solution. With more than 150 solution-services experts worldwide and almost 25 years of experience designing, deploying and managing voice and multi-modal applications for contact center and network service provider customers across functions and industries, this team also possesses one of the highest concentrations of industry-recognized leaders in human factors and voice user interface design. Together our team has created 13 of the world’s statistical language modeling (“SLM”) deployments, which enable the deep focus on caller habits, preferences and needs required to generate customized dialogue and call flow, as well as innovative integration and presentation of data across all channels to help customers maximize personalization. Customers using Intervoice consulting services can access our industry-unique Center for User Experience (“CUE”) testing lab, as well as analysis based on caller goal completion rates and our Usability Grade Testing Metric that helps measure a voice application’s ease of use. Our consulting services are designed to reduce the time and cost of speech

automation deployments, improve customer communication and satisfaction, and drive higher return-on-investment performance through increased transaction resolution rates.

 

Recurring Services

 

Maintenance and Software Support

 

Intervoice offers the services and support needed to keep our solutions running at peak efficiency. We understand customers’ requirements to protect their investment through world-class technical support that is accessible, effective and responsive to the customers’ business requirements and objectives.

 

Our RealCare^® Services portfolio gives customers a choice of comprehensive plans to ensure the performance of their Intervoice solution — we offer 24x7x365 responsive and proactive services to help minimize or prevent service-impacting events. Our RealCare Advantage maintenance programs offer three levels of services in order to provide customers with choices when it comes to support. Our maintenance offerings include software support services as a subscription-based service that provides convenient, cost-effective software upgrades. In addition, we offer value-added services such as application consulting support and remote application monitoring to further support our customers’ operations. Maintenance is part of Intervoice’s ongoing commitment to provide immediate access to the people and information our customers need to keep their operations running smoothly.

 

Hosted Solutions

 

Intervoice Hosted Solutions offers our customers a portfolio of contact center applications delivered within our unique approach to hosted services. We offer a suite of hosted solutions designed to give contact centers and network service providers access to leading-edge applications while reducing the cost and risk of deploying state-of-the-art voice automation. Hosted applications also enable incremental and rapid integration of emerging technologies, as well as easier migration to speech-enabled services employing VoiceXML and next-generation network environments such as 2.5G, 3G, GPRS, IN and SIP-based VoIP.

 

Intervoice supplies hosted solutions for some of the world’s largest financial institutions, enterprises and network service providers with highly stringent network uptime and performance demands. Intervoice supports these customers from secure, inter-networked hosting locations in Orlando, Florida and Dallas, Texas in the U.S. We also have hosting agreements with Verizon and AT&T which enable us to deploy our solutions and services in most developed countries in the world.

 

Intervoice provides the platform, software and professional services that contact centers and network service providers need to create and support interactive speech-enabled technologies.

 

The contact center market confronts three ongoing challenges — to continuously improve customer service, increase user satisfaction and build brand loyalty — all while controlling the cost of communications. Automated communications are increasingly the norm for cost-conscious enterprises, and after initial reluctance, consumers are beginning to show a preference for well-designed self-service voice solutions that can speed them through the call process. Organizations in a wide range of industries are responding to customer demand for speed and easy access by deploying converged speech and data technologies, and Intervoice technologies have continued to evolve to meet the needs of the contact center marketplace.

 

Network service providers seek innovative, popular, and high-demand services that can generate immediate subscriber acceptance and an accelerated return-on-investment while keeping capital and operational expenditures to a minimum. Network service providers view “hot” consumer services such as text messaging, multimedia messaging, information portals, voice-activated dialing, video, personal alerts, voicemail, and other enhanced services as clear opportunities to increase their subscriber base, solidify brand loyalty and stimulate network usage. Intervoice network solutions are designed to support the needs of both wireline and wireless network service providers for rapid-return and lower-risk features that extend and enhance the useful life of their existing network infrastructure.

 

The markets we serve are fragmented and highly competitive. The principal competitive factors in our markets include breadth and depth of software and services, product features, product scalability, consulting services, maintenance services, the ability to implement solutions, and the ability to create and maintain a reference-able customer base. Our major competitors in our contact center market are Nortel, Genesys Telecommunications (a division of Alcatel/Lucent), and Avaya. All three of these companies are larger than Intervoice and focus on a larger portfolio of products beyond voice automation and contact routing. In addition, with respect to consulting services, we also compete with one of our alliance partners, Nuance Communications, the supplier of our embedded advanced speech recognition and text-to-speech licenses. Each of these competitors can offer compelling value propositions to the marketplace, but they do not provide all the same elements needed for a complete, end-to-end contact center self-service solution without the aid of third-party partners. We believe that our long history in the industry coupled with our unmatched speech-enabled product line, our professional consulting services, and our extensive customer base allow us to compete favorably in this market. The market is evolving rapidly, however, and we anticipate intensified competition not only from our traditional competitors but also from emerging vendors with non-traditional technologies and solutions. There is also continued competition from small venture-funded companies that attempt to build success by plundering the installed base of larger established companies such as Intervoice.

 

Competition in our network service provider market ranges from large telecommunication suppliers offering turnkey, multi-application solutions to niche companies that specialize in a particular enhanced service such as prepaid, voicemail or voice-activated dialing. Our primary competitors in this market are Comverse Technology, Alcatel/Lucent and Unisys, each of which provides a suite of enhanced services. Other companies that compete with us in various niche geographic and/or product markets include Openwave, Tecnomen, IP Unity Glenayre and LogicaCMG.

 

We believe that, with our current suite of integrated and interoperable payment, messaging and portal services, standards- and IP-based platform, our flexible business models, and our consulting services, we compare favorably with our competition. Nevertheless, we anticipate that competition will continue to grow from existing and new competitors, some of which may have greater financial, technological and marketing resources and greater market share than Intervoice.

 

We market our products directly, with a global sales force, and through more than 100 domestic and international distributors. We enter into arrangements with distributors to broaden distribution channels, to increase our sales penetration in specific markets and industries and to provide certain customer services. We select distributors based on their access to the markets, industries and customers that are candidates for Intervoice products. Our direct sales force consists of approximately 80 personnel, including area vice presidents, regional sales directors and sales representatives worldwide. During fiscal 2007, 60% of our solutions sales were attributable to direct sales to end-users and 40% came from sales to distributors.

 

Our major domestic distributors include Fiserv (multiple business units), Black Box, DDV, Siemens Business Communications, Symitar Systems, Verizon and Vexis. Our major international distributors include Ericsson (worldwide), Huawei (worldwide), Information Technologies Australia (Australia), ITApps (China), IVRS (Hong Kong, China), Loxbit (Thailand), NextCom K.K. (Japan), Black Box (Canada), OLTP (Venezuela and the Caribbean), Promotora Kranon (Mexico), Siemens AG (Worldwide), Switch (Chile), Tatung (Taiwan), Telia Promotor (Sweden), Voice Outsourcing (Latin America and the Caribbean) and Wittel (Brazil).

 

Intervoice subsidiaries maintain offices in the U.K., Germany, Switzerland, the Netherlands, the United Arab Emirates, and South Africa to support sales throughout Europe, the Middle East and Africa. A company office located in Singapore supports sales in the Pacific Rim. We support Latin American sales from our Dallas headquarters and through a regional office in Brazil.

 

Our international revenues were 35% of total revenues in fiscal 2007, 45% of total revenues in fiscal 2006 and 41% of total revenues in fiscal 2005. See “Risk Factors” under Item 1A for a discussion of risks attendant to our international operations.

 

See “Sales” in Item 7 — “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for additional information on sales by product line and geographic area and concentration of revenue.

 

Our solutions backlog at February 28, 2007, 2006 and 2005, which does not include the contracted value of future maintenance and hosted solutions to be recognized, was approximately $54 million, $34 million, and $35 million, respectively. Our service and support contracts range in original duration from one month to five years, with most hosted solutions contracts having initial terms of two to three years and most maintenance and related contracts having initial terms of one year. Because many of the longer duration contracts give customers early cancellation privileges, we do not consider our book of services contracts to be reportable backlog, as a portion of the potential revenue reflected in the contract values may never be realized. At February 28, 2007, a portion of our backlog related to long-term projects and cash basis customers. We generally expect all projects in our existing backlog to be initiated within fiscal 2008 and most of such backlog to be recognized as revenue during fiscal 2008. Approximately 10% to 20% of such backlog could revenue subsequent to fiscal 2008. Some of our sales are completed in the same fiscal quarter as ordered. Thus, our backlog at any particular date may not be indicative of actual sales for any future period.

 

Research and development expenses were approximately $24 million, $18 million and $16 million during fiscal 2007, 2006 and 2005, respectively, and included the design of new products and the enhancement of existing products.

 

Our research and development spending is focused in six key areas. First, we are developing software tools to aid in the development and deployment of customer applications incorporating speech recognition, text-to-speech, and other rich media technologies for enterprises and wireless and wireline providers. Next, we are developing server-based application software platforms for operations and management of contact center, speech and call completion applications. These software platforms are branded under the name Media Exchange. We will use these software platforms for deployment and management of enterprise, wireless and wireline network operator applications, which are designed to operate in both J2EE and Microsoft’s ^®.NET enterprise computing environments. Third, we are developing media servers, “voice browsers,” and call processing infrastructure based on open standards such as VoiceXML, CCXML and SALT. These media servers are VoIP enabled, allowing operation in soft-switch and hybrid PSTN and VoIP networks. Fourth, we are developing packaged, speech enabled applications for the network operator and enterprise markets. These include a range of vertical and horizontal applications that are designed to greatly enhance customer return-on-investment by providing many commonly used configurable functions that can be deployed more quickly than custom applications. Fifth, we are developing software and tools designed to provide integration of live agent positions in a customer contact center setting. This software covers a broad range of functions including agent call-screen transfer, workflow management, full call recording, agent and supervisor management systems and reporting and various integration functions. Finally, we are developing modular productivity and communications applications for wireless and wireline applications including speech driven voice mail, voice activated dialing, and enhanced personal information management. The network products are also branded under the product name Media Exchange.

 

We expect to maintain a strong commitment to research and development so that we can remain at the forefront of technology development in our markets.

 

We believe our existing patent, copyright, license and other proprietary rights in our products and technologies are material to the conduct of our business. To protect these proprietary rights, we rely on a combination of patent, trademark, trade secret, copyright and other proprietary rights laws, nondisclosure safeguards and license

agreements. As of February 28, 2007, we owned 86 patents and had 41 pending applications for patents in the United States. In addition, we have registered “Intervoice” as a trademark in the United States, which is part of our portfolio of 34 registered trademarks and service marks. Some of our patents and marks are also registered in certain foreign countries. Our software and other products are generally licensed to a customer under the terms of a nontransferable license agreement that restricts the use of the software and other products to the customer’s internal purposes. Although our license agreements prohibit a customer from disclosing proprietary information contained in our products to any other person, it is technologically possible for our competitors to copy aspects of our products in violation of our rights. Furthermore, even in cases where we hold patents, the detection and policing of the unauthorized use of the patented technology is difficult. Moreover, judicial enforcement of copyrights may be uncertain, particularly in foreign countries. The unauthorized use of our proprietary information by our competitors could have a material adverse effect on our business, operating results and financial condition.

 

We generally provide our customers a qualified indemnity against the infringement of third party intellectual property rights. From time to time, various owners of patents and copyrighted works send us or our customers letters alleging that our products do or might infringe upon the owner’s intellectual property rights, and/or suggesting that we or our customers should negotiate a license or cross-license agreement with the owner. Our policy is to never knowingly infringe upon any third party’s intellectual property rights. Accordingly, we forward any such allegation or licensing request to our outside legal counsel for their review, analysis and, where appropriate, opinion. We generally attempt to resolve any such matter by informing the owner of our position concerning non-infringement or invalidity, and/or, if appropriate, negotiating a license or cross-license agreement. Even though we attempt to resolve these matters without litigation, it is always possible that the owner of a patent or copyrighted work will sue us. Other than the current litigation with a patent holder discussed in Item 3 — “Legal Proceedings,” no such litigation is currently pending against us. As noted above, we currently have a portfolio of 86 United States patents, and we have applied for and will continue to apply for and receive a number of additional patents to protect our technological innovations. We believe our patent portfolio could allow us to assert counterclaims for infringement against certain owners of intellectual property rights if those owners were to sue us for infringement. In certain situations, it might be beneficial for us to cross-license certain of our patents for other patents which are relevant to the call automation industry. See Item 3 — “Legal Proceedings” for a discussion of certain patent matters. See “Risk Factors” in Item 1A for a discussion of risks associated with claims of intellectual property infringement.

 

Our manufacturing operations consist primarily of the final assembly, integration and extensive testing of subassemblies, host computer platforms, operating software and our run time software. We currently use third parties to perform printed circuit board assembly, sheet metal fabrication and customer-site service and repair. Although we generally use standard parts and components for our products, some of our components, including semi-conductors and, in particular, digital signal processors manufactured by Texas Instruments, are available only from a small number of vendors. Likewise, we license speech recognition technology from a small number of vendors. As we continue to migrate to open, standards-based systems, we will become increasingly dependent on our component suppliers and software vendors. To date, we have been able to obtain adequate supplies of needed components and licenses in a timely manner, and we expect to continue to be able to do so. Nevertheless, if our significant vendors are unable to supply components or licenses at current levels, we may not be able to obtain these items from another source or at historical prices. In such situations, we would be unable to provide products and services to our customers or generate historical operating margins, and our business and operating results would suffer.

 

As of April 13, 2007, we had 768 employees.

 

Our Internet website is www.intervoice.com. Our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of

the Securities Exchange Act of 1934 are posted on our website as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission (SEC).

 

 

Due to these and other factors, our revenue and operating results are difficult to forecast and are prone to fluctuate, which may cause a decline in our stock price. Our expense levels are based in significant part on our expectations of future revenue, and we may not be able to reduce our expenses quickly to respond to a shortfall in projected revenue. Therefore, our failure to meet revenue expectations could seriously harm our business, operating results and financial condition. See the discussion entitled “Sales” in Item 7 of Part II for a discussion of our system for estimating sales and tracking sales trends in our business.

 

 

 

 

 

 

 

 

As a result of these and other risks, we may not realize anticipated benefits from our acquisitions. Any failure to achieve these benefits or failure to successfully integrate acquired businesses and technologies could result in a material adverse affect on our business, results of operations and financial condition.

 

 

 

Intellectual Property Matters

 

From time to time Ronald A. Katz Technology Licensing L.P. (“RAKTL”) has sent letters to certain of our customers suggesting that the customer should negotiate a license agreement to cover the practice of certain patents owned by RAKTL. In the letters, RAKTL has alleged that certain of its patents pertain to certain enhanced services offered by network providers, including prepaid card and wireless services and postpaid card services. RAKTL has further alleged that certain of its patents pertain to certain call processing applications, including applications for call centers that route calls using a called party’s DNIS identification number. As a result of the correspondence, many of Intervoice’s customers have had discussions, or are in discussions, with RAKTL.

 

We offer certain products that can be programmed and configured to provide enhanced services to network providers and call processing applications for call centers. Our contracts with customers usually include a qualified obligation to indemnify and defend customers against claims that products as delivered by Intervoice infringe a third party’s patent. None of our customers has notified us that RAKTL has claimed that any specific product provided by us infringes any claims of any RAKTL patent. Accordingly, we have not been required to defend any customers against a claim of infringement under a RAKTL patent. We have, however, received letters from customers notifying us of the efforts by RAKTL to license its patent portfolio and reminding us of our potential obligations under the indemnification provisions of our agreements in the event that a claim is asserted.

 

Some of our customers have licensed certain rights under the RAKTL patent portfolio. Two such customers who had previously attempted to tender the defense of their products to us informed us that they had entered into agreements to license certain rights under the RAKTL patents and demanded we indemnify them for unspecified amounts, including attorney’s fees, paid in connection with the license agreements. We notified these customers that we believe we do not have any indemnity obligation in connection with the license agreements. We have received no further response from either customer.

 

A number of customers, including customers of ours and Edify Corporation’s (“Edify”) have been sued as defendants in several lawsuits brought by RAKTL in the United States District Court for the Eastern District of Texas and the United States District Court for the District of Delaware. Several of these defendants who are also customers have notified us or Edify of the lawsuits pursuant to the indemnity paragraphs of their respective sales agreements and have indicated to us that the lawsuits could potentially impact the defense and indemnity paragraphs of their respective sales agreements. Neither we nor Edify believe that we have a current obligation to defend or indemnify these customers in connection with the current allegations made in the RAKTL lawsuits and when contacted we have requested that the customers provide additional information concerning the assertions made by RAKTL.

 

In response to the correspondence from, and litigation initiated by, RAKTL a few of our customers and customers of Edify have attempted to tender to us the defense of our products under contractual indemnity provisions. We have informed these customers that, while we fully intend to honor any contractual indemnity provisions, we do not believe we currently have any obligation to provide such a defense because RAKTL does not appear to have made a claim, either in the correspondence or litigation, that any Intervoice product infringes a RAKTL patent. Some of these customers have disagreed with us and stated that they believe that the statements and

allegations contained within correspondence and/or litigation pleadings filed by RAKTL can be construed as a claim against Intervoice products.

 

Even though no claims have been made by RAKTL that a specific product offered by Intervoice infringes any claim under the RAKTL patent portfolio, we have received opinions from our outside patent counsel that certain products and applications we offer do not infringe certain claims of the RAKTL patents. We have also received opinions from our outside counsel that certain claims under the RAKTL patent portfolio are invalid or unenforceable. Furthermore, based on the reviews by outside counsel, we are not aware of any valid and enforceable claims under the RAKTL portfolio that are infringed by our products. If we do become involved in litigation in connection with the RAKTL patent portfolio, under a contractual indemnity or any other legal theory, we intend to vigorously contest the claims and to assert appropriate defenses.

 

We have received letters from Webley Systems (“Webley”), a division of Parus Holdings, Inc. (“Parus”), and its counsel alleging that certain Webley patents cover one or more of our products and services. In the letters, Parus offers a license to the Webley patents. As a result of the correspondence, we conducted discussions with Parus. Based on reviews by our outside counsel, we are not aware of any valid and enforceable claims under the Webley patents that are infringed by our products or services.

 

Pending Litigation

 

David Barrie, et al., on Behalf of Themselves and All Others Similarly Situated v. InterVoice-Brite, Inc., et al.; No. 3-01CV1071-D, pending in the United States District Court, Northern District of Texas, Dallas Division:

 

Several related class action lawsuits were filed in the United States District Court for the Northern District of Texas on behalf of purchasers of common stock of Intervoice during the period from October 12, 1999 through June 6, 2000 (the “Class Period”). Plaintiffs have filed claims, which were consolidated into one proceeding, under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5 against us as well as certain named current and former officers and directors of Intervoice on behalf of the alleged class members. In the complaint, Plaintiffs claim that we and the named current and former officers and directors issued false and misleading statements during the Class Period concerning the financial condition of Intervoice, the results of the merger with Brite Voice Systems, Inc. (“Brite”) and the alleged future business projections of Intervoice. Plaintiffs have asserted that these alleged statements resulted in artificially inflated stock prices.

 

The District Court dismissed the Plaintiffs’ complaint because it lacked the degree of specificity and factual support to meet the pleading standards applicable to federal securities litigation. The Plaintiffs’ appealed the dismissal to the United States Court of Appeals for the Fifth Circuit, which affirmed the dismissal in part and reversed in part. The Fifth Circuit remanded a limited number of issues for further proceedings in the District Court.

 

On September 26, 2006, the District Court granted the Plaintiffs’ motion to certify a class of people who purchased Intervoice stock during the Class Period between October 12, 1999 and June 6, 2000. On November 14, 2006, the Fifth Circuit granted our petition to appeal the District Court’s decision to grant Plaintiffs’ motion to certify a class. The briefing on the merits of our appeal is now complete, and we are currently waiting for the Fifth Circuit to either schedule oral argument or issue a ruling on the merits. We filed a motion to stay further discovery pending the Fifth Circuit’s decision on the merits of our appeal, but. the District Court denied our motion. We are in the process of continuing to produce documents in response to the Plaintiffs’ requests for production. We believe that we and our officers and directors complied with the applicable securities laws and will continue to vigorously defend the case.

 

Phoenix Solutions, Inc. vs. Sony Electronics, Inc., Case No. C07-2112 (EMC), pending in the United States District Court for the Northern District of California, San Francisco Division: On December 13, 2006, Phoenix Solutions, Inc. (“Phoenix”) filed suit against Sony Electronics, Inc. (“Sony”) in the United States District Court for the Central District of California for infringement of U.S. Patent Nos. 6,615,172, 6,633,846, 6,665,640 and 7,050,977. On February 9, 2007, Sony filed its answer to Phoenix’s claims of infringement, denied any liability and filed a counterclaim alleging that the patents were neither valid nor infringed by Sony. On February 26, 2007, Sony filed a third party complaint against the Company for alleged breach of warranty of title and the warranty against

infringement related to the claims of infringement made by Phoenix against Sony. In its third party complaint, Sony seeks to recover actual damages suffered by it in the event a final judgment is entered against Sony or it is otherwise liable for any damages, fees or costs arising out of the claims of patent infringement made by Phoenix against the Sony interactive voice response system. On April 9, 2007, the Company filed its motion to dismiss the third party complaint. The trial court recently transferred the case to the United States District Court for the Northern District of California, San Francisco Division, and the case is now styled Phoenix Solutions, Inc. vs. Sony Electronics, Inc., Case No. C07-2112 (EMC). In the event that the court does not grant the pending motion to dismiss, the Company intends to vigorously defend itself against any and all claims made against it.

 

Audit Committee Investigation

 

During fiscal 2005, our Audit Committee conducted an investigation of certain transactions that occurred during our fiscal years 2000 through 2002. The Audit Committee was assisted in its investigation by separate independent legal counsel and a national accounting firm. The Audit Committee reported the results of its investigation to the SEC, and we are cooperating with the SEC in its own investigation regarding the transactions. We have provided documents to the SEC in response to a subpoena and informal requests for information about the transactions, and several of our current and former officers and non-officer employees have provided testimony to the SEC. Our Audit Committee and its counsel are continuing to monitor our response to the SEC, and they also have conducted a review of certain documents provided to the SEC which we located after the Audit Committee’s original investigation. Intervoice is presently in discussions with the SEC about a possible settlement of the matters covered by the Audit Committee investigation, but there is no assurance that agreement on any settlement will be reached. We have recorded approximately $0.9 million of expense based on the current status of such settlement discussions. Intervoice is also honoring our obligation to indemnify, to the extent appropriate, certain current and former officers and other employees of Intervoice, including our Chief Executive Officer, who received subpoenas to produce documents and provide testimony to the SEC in connection with the investigation. Furthermore, we are honoring our obligation to reimburse legal fees incurred by certain recipients of the subpoenas.

 

The Audit Committee investigation found that we accounted for certain transactions incorrectly during our fiscal years 2000 through 2002. The Audit Committee investigation concluded that a $0.9 million payment made by Intervoice to a publicly held supplier purportedly for certain prepaid licenses was linked to an agreement to amend a 1997 warrant issued to us by the supplier to permit our cashless exercise of the warrant. As a result, we believe the $0.9 million payment should have been recorded as a reduction in the $21.4 million gain we recognized on the sale of the shares underlying the warrant during the fourth quarter of fiscal 2001 and should not have been recorded as prepaid license inventory. Our payment to the supplier may have rendered unavailable a nonexclusive registration exemption for the sale of the shares underlying the warrant. The Audit Committee investigation also found that we intentionally provided the same supplier false or misleading documents for such supplier to use to support such supplier’s improper recognition of revenue in calendar 2001.

 

The Audit Committee investigation and review further found that six of the seven customer sales transactions the Committee investigated were accounted for incorrectly and that there was intentional misconduct in at least one of those sales transactions. These six transactions occurred at the end of quarters in which we just met analysts’ expectations with respect to earnings per share. The Audit Committee found that we improperly recognized revenue in a quarter-end barter transaction involving approximately 0.4% of annual revenues for fiscal 2000, and that we improperly accelerated the recognition of revenue in five quarter-end transactions totaling approximately 0.4% and 0.3% of annual revenues in fiscal 2000 and fiscal 2002, respectively. We, and certain of our current and former officers and the SEC have agreed that Intervoice and the officers will not assert any defenses based on a statute of limitations with respect to any action or proceeding against Intervoice or such officers brought, by or on behalf of the SEC arising out of the SEC investigation for the time periods set forth in the agreements. As a result of work performed in responding to the SEC subpoena, the Audit Committee has concluded that Intervoice also improperly recognized approximately $5.4 million of revenue in two sales transactions during the second and third quarters of fiscal 2002 because the transactions were subject to oral side agreements that gave our customer expanded rights of return. We subsequently reversed the $5.4 million of revenue during the fourth quarter of fiscal 2002 in connection with a return of the related systems. We also provided documents to the SEC concerning these two additional sales

transactions pursuant to a separate subpoena. Separately, the Audit Committee determined that in September 2001 one of our current executive officers improperly communicated Intervoice information to a shareholder.

 

Intervoice’s management has concluded, with the concurrence of the Audit Committee and our external auditors, that restatement of our prior period financial statements to adjust for the findings of the Audit Committee investigation and review is not necessary. In reaching this conclusion, we considered the impact of the incorrect accounting on each of the periods affected, the ages of the affected financial statements and the lack of any material changes in prior period trends as a result of the incorrect accounting. In addition, we noted that since the date of the most recent transaction reviewed in the investigation, we have restructured our business, made significant management changes, consolidated our physical operations, significantly reduced our fixed operating costs and refinanced and repaid all of our major debt obligations. We cannot predict whether we may have future losses relating to the matters investigated by the Audit Committee as a result of future claims, if any, including any claims by the government.

 

Not applicable.

 

Common Stock

 

Our outstanding shares of common stock are quoted on the NASDAQ National Market under the symbol INTV. We have not paid any cash dividends since our incorporation. We do not anticipate paying cash dividends in the foreseeable future.

 

High and low share prices as reported on the NASDAQ National Market are shown below for our fiscal quarters during fiscal 2007 and 2006.

 

 

 

On April 13, 2007, there were 618 shareholders of record and approximately 11,000 beneficial shareholders of Intervoice. The closing price of our common stock on that date was $6.63.

 

Securities Authorized for Issuance Under Equity Compensation Plans

 

We have maintained multiple compensation plans to provide for the issuance of our common stock to officers and other employees. These plans consisted of the 1990 Employee Stock Option Plan, 1999 Stock Option Plan, 1990 Non-Employee Stock Option Plan, 2003 Stock Option Plan, and the 2005 Stock Incentive Plan, which have been approved by the shareholders, and the 1998 Employee Non-Qualified Stock Option Plan which has not been approved by the shareholders. The following table sets forth information regarding outstanding options and shares

of common stock reserved for future issuance as of February 28, 2007. The 2005 Stock Incentive Plan replaced all other plans and became the sole plan from which options could be granted.

 

 

During fiscal 1999, we adopted a stock option plan, which was not approved by security holders, under which shares of common stock could be authorized for issuance by the Compensation Committee of the Board of Directors as non-qualified stock options to key employees. Option prices per share were the fair market value per share of stock based on the average of the high and low price per share on the date of grant. We granted options at various dates with terms under which options became exercisable at a rate of 25% or 33% per year and were exercisable for a period of ten years after the grant date. This plan is no longer a plan under which options can be granted.

Stock Performance Graph

 

The following graph sets forth the cumulative total shareholder return (assuming reinvestment of dividends) to our shareholders during the five-year period ended February 28, 2007 as well as an overall broad stock market index, the NASDAQ Market Index, and a peer group index for the Company, the index for SIC Code 3661 — Telephone and Telegraph Apparatus. The stock performance graph assumes $100 was invested on March 1, 2002 in our common stock and in each such index.

 

COMPARISON OF CUMULATIVE TOTAL RETURN
OF COMPANY, INDUSTRY INDEX AND BROAD MARKET(1)

 

 

 

 

 

The following selected consolidated financial data should be read in conjunction with our consolidated financial statements and related notes included in Item 8 and in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” set forth in Item 7.

 

 

 

 

Critical Accounting Policies

 

In preparing our consolidated financial statements in conformity with accounting principles generally accepted in the United States, we use estimates and projections that affect the reported amounts and related disclosures and that may vary from actual results. We consider the following accounting policies to be both those most important to the portrayal of our financial condition and those that require the most subjective judgment. If actual results differ significantly from management’s estimates and projections, there could be a material effect on our financial statements.

 

Revenue Recognition

 

Intervoice recognizes revenue from the sale of hardware and software solutions, from the delivery of recurring maintenance and other software support associated with installed solutions and from the provision of our enterprise and network solutions on a managed service basis. Our policies for revenue recognition follow the guidance in Statement of Position No. 97-2 “Software Revenue Recognition,” as amended (SOP 97-2), SEC Staff Accounting Bulletin No. 104 (SAB 104) and EITF 00-21 “Revenue Arrangements with Multiple Deliverables.” If contracts include multiple elements, each element of the arrangement is separately identified and accounted for based on the relative fair value of such element as evidenced by vendor specific objective evidence. In situations where vendor specific objective evidence exists for all undelivered elements, but does not exist for one or more of the delivered elements, the residual method is used. In these cases, the vendor specific objective evidence of fair value of the undelivered items is deferred and the residual is recognized as revenue related to the delivered elements. Revenue is not recognized on any element of the arrangement if undelivered elements are essential to the functionality of the delivered elements.

 

Sale of Hardware and Software Solutions:  Many of our sales are of customized software or customized hardware/software solutions. Such solutions incorporate newly designed software and/or standard building blocks of hardware and software which have been significantly modified, configured and assembled to match unique customer requirements defined at the beginning of each project. We account for sales of these customized solutions using contract accounting principles, following the relevant guidance in Statement of Position No. 81-1 “Accounting for Performance of Construction-Type and Certain Production-Type Contracts” (SOP 81-1), under either the percentage of completion (“POC”) or completed contract methodology, as further described below. In other instances, particularly in situations where we sell to distributors or where we are supplying only additional product capacity (i.e., similar hardware and software solutions to what is already in place) for an existing customer, we may sell solutions that do not require significant customization. In those situations, we recognize revenue when there is persuasive evidence that an arrangement exists, delivery has occurred, our fee is fixed or determinable, and collectibility is probable. Typically, this is at shipment when there is no installation obligation or at the completion of minor post-shipment installation obligations.

 

Generally, we use POC accounting for our more complex custom solutions. In determining whether a particular sale qualifies for POC treatment, we consider multiple factors including the value of the contract and the degree of customization inherent in the project. Projects normally must have an aggregate value of more than $500,000 to qualify for POC treatment. For a project accounted for under the POC method, we recognize revenue as work progresses over the life of the project based on a comparison of actual labor hours worked to current estimates of total labor hours required to complete the project. We review and update project estimates on a quarterly basis.

 

The terms of most POC projects require customers to make interim progress payments during the course of the project. These payments and a written customer acknowledgement at the completion of the project, usually following a final customer test phase, document the customer’s acceptance of the project. In some circumstances, the passage of a contractually defined time period or the customer’s use of the solution in a live operating environment may also constitute final acceptance of a project.

 

We use completed contract accounting for smaller custom projects not meeting the POC thresholds described above. We also use completed contract accounting in situations where the technical requirements of a project are so complex or are so dependent on the development of new technologies or the unique application of existing

technologies that our ability to make reasonable estimates is in doubt or in situations where a sale is subject to unusual “inherent hazards.” Such hazards are unrelated to, or only incidentally related to, our typical activities and include situations where the enforceability of a contract is suspect, completion of the contract is subject to pending litigation, or where the solutions produced are subject to condemnation or expropriation risks. These latter situations are extremely rare. For all completed contract sales, we recognize revenue upon customer acceptance as evidenced by a written customer acknowledgement, the passage of a contractually defined time period or the customer’s use of the solution in a live operating environment.

 

We generate a significant percentage of our sales, particularly sales of network solutions, outside the United States. Customers in certain countries are subject to significant economic and political challenges that affect their cash flow, and many customers outside the United States are generally accustomed to vendor financing in the form of extended payment terms. To remain competitive in markets outside the United States, we may offer selected customers such payment terms. In all cases, however, we only recognize revenue at such time as our solutions or service fee is fixed or determinable, collectibility is probable and all other criteria for revenue recognition have been met. In some limited cases, this policy causes us to recognize revenue on a “cash basis,” limiting revenue recognition on certain sales of solutions and/or services to the actual cash received to date from the customer, provided that all other revenue recognition criteria have been satisfied.

 

Sale of Maintenance and Software Support:  We recognize revenue from maintenance and software support when the services are performed or ratably over the related contract period. All significant costs and expenses associated with maintenance contracts are expensed as incurred. This approximates a ratable recognition of expenses over the contract period.

 

Sale of Hosted Solutions:  We provide enhanced communications solutions to some customers on an outsourced basis through our hosted solutions business. While specific arrangements can vary, we generally build a customized solution to address a specific customer’s business needs and then own, monitor, and maintain that system, ensuring that it processes the customer’s business transactions in accordance with defined specifications. For our services, we generally receive a one-time setup fee paid at the beginning of the contract and a service fee paid monthly over the life of the contract. Most contracts range from 12 to 36 months in length.

 

We combine the setup fee and the total service fee to be received from the customer and recognize revenue ratably over the term of the hosted solutions contract. We capitalize the cost of the computer system(s) and related applications used to provide the service and depreciate such costs over the contract life (for assets unique to the individual contract) or the life of the equipment (for assets common to the general hosted solutions operations or for assets whose useful lives are shorter than the related contract term). We expense all labor and other period costs required to provide the service as we incur them.

 

Loss Contracts:  We update our estimates of the costs necessary to complete all customer contracts in process on a quarterly basis. Whenever current estimates indicate that we will incur a loss on the completion of a contract, we immediately record a provision for such loss as part of the current period cost of goods sold.

 

Stock-Based Compensation

 

We adopted SFAS No. 123R, “Share-Based Payments,” effective March 1, 2006 using the modified prospective transition method. Determining the amount and classification of expense for stock-based compensation, as well as the associated impact to the balance sheets and statements of cash flows, requires us to develop estimates of the fair value of stock-based compensation expenses using fair value models. The most significant assumptions used in calculating the fair value include the expected volatility, expected lives and estimated forfeiture rates for employee stock option grants.

 

We use a weighted average of the implied volatility, the most recent one-year volatility and the median historical volatility for the period of the expected life of the option to determine the expected volatility to be used in our fair value calculation, with the median historical volatility receiving the heaviest weighting of the three factors. We believe that this is the best available estimate of expected volatility. The expected lives of options are determined based on our historical stock option exercise experience. We believe the historical experience method is the best estimate of future exercise patterns currently available. Estimated forfeiture rates are derived from historical

forfeiture patterns. We believe the historical experience method is the best estimate of forfeitures currently available. Changes to these assumptions or changes to our stock-based compensation plans, including the number of awards granted, could impact our stock-based compensation expense in future periods. We update these assumptions annually or as circumstances arise which would indicate the need for them to be updated more often.

 

Intangible Assets and Goodwill

 

Intangible Assets:  Intangible assets are comprised of separately identifiable intangible assets arising out of our fiscal 2007 acquisition of certain assets of Nuasis, our fiscal 2006 acquisition of Edify and our fiscal 2000 acquisition of Brite, and certain capitalized purchased software. We amortize intangible assets using the straight-line method over each asset’s estimated useful life. Such lives range from 18 months to 12 years. We review our intangible assets for possible impairment when events and circumstances indicate that the assets might be impaired and the undiscounted projected cash flows associated with such assets are less than the carrying amounts of the assets. In those situations, we recognize an impairment loss on the intangible asset equal to the excess of the carrying amount of the asset over the asset’s fair value, generally based upon discounted estimates of future cash flows.

 

We expense the cost of internally developed software products and substantial enhancements to existing software products for sale until technological feasibility is established, after which point any additional costs are capitalized. Technological feasibility of a computer software product is established when we have completed all planning, designing, coding, and testing activities necessary to establish that the product can be produced to meet its design specifications including functions, features, and technical performance requirements. No costs have been capitalized to date for internally developed software products and enhancements as our current process for developing software is essentially completed concurrent with the establishment of technological feasibility. We capitalize purchased software upon acquisition when such software is technologically feasible or if it has an alternative future use, such as use of the software in different products or resale of the purchased software.

 

Goodwill:  Goodwill is attributable to our fiscal 2006 acquisition of Edify and our fiscal 2000 purchase of Brite. Under the provisions of SFAS No. 141, “Business Combinations,” and SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is presumed to have an indefinite life and is not subject to annual amortization. We do, however, perform an impairment test on our goodwill balance on at least an annual basis and more frequently if we identify triggering events on an interim basis. Our impairment review follows the two-step approach defined in SFAS No. 142. The first step compares the fair value of Intervoice with its carrying amount, including goodwill. If the fair value exceeds the carrying amount, goodwill is considered not impaired. If the carrying amount exceeds fair value, we compare the implied fair value of goodwill with the carrying amount of that goodwill. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, we recognize an impairment loss in an amount equal to the lesser of that excess or the carrying amount of goodwill.

 

Income Taxes

 

We recognize deferred income taxes using the liability method and reflect the tax impact of temporary differences between the amounts of assets and liabilities for financial reporting purposes and such amounts as measured by tax laws and regulations. We provide a valuation allowance for deferred tax assets in circumstances where we do not consider realization of such assets to be more likely than not. This is a highly subjective assessment and requires us to evaluate the predictability of future taxable income while considering our operating history which includes significant losses in fiscal 2003 and 2002. In fiscal 2006, we reversed a significant portion of the valuation allowances originally recorded in fiscal 2002 and 2003 associated with deferred tax assets of our U.S. operations. We believe our profitability in the U.S. for fiscal 2007 and the previous three years and our projected future profitability make it more likely than not that we will realize the benefit of these previously reserved deferred tax assets. We continue to provide valuation allowances on foreign and state deferred tax assets and on certain U.S. federal deferred tax assets that will benefit equity if and when realized.

 

In June 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109” (“FIN 48”). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements. FIN 48 requires companies to

determine that it is “more likely than not” that a tax position will be sustained upon examination by the appropriate taxing authorities before any part of the benefit can be recorded in the financial statements. FIN 48 also provides guidance on the derecognition of tax benefits, measurement and classification of income tax uncertainties, along with any related interest and penalties. FIN 48 will also require significant additional disclosures regarding uncertain tax positions. FIN 48 is effective for years beginning after December 15, 2006 and we will be required to adopt the interpretation in the first quarter of fiscal 2008 on a prospective basis. We continue to evaluate the impact FIN 48 will have on our financial position and results of operations.

 

Results of Operations

 

The following table presents certain items as a percentage of sales for our last three fiscal years.

 

 

Sales

 

Intervoice is a leading provider of converged voice and data solutions and related services. As used in this report, solutions sales include the sale of hardware and/or software applications and the related consulting services associated with designing, integrating, and installing custom applications to address customers’ business needs. Recurring services include a suite of maintenance and software upgrade offerings and the provision of customized solutions to customers on a hosted solution (outsourced) basis. Our solutions product line includes voice portal, messaging, and payment solutions.

 

Our sales by product line for fiscal 2007, 2006 and 2005 were as follows (in millions):

 

We assign revenues to geographic locations based on the location of the customer. Our net sales by geographic area for fiscal years 2007, 2006 and 2005 were as follows (in millions):

 

 

International sales constituted 35% of total sales in fiscal 2007, 45% of total sales in 2006 and 41% of total sales in 2005.

 

Changes in foreign currency exchange rates from fiscal 2006 to 2007 served to increase sales for fiscal 2007 by approximately $1.3 million. Changes in foreign currency exchange rates from fiscal 2005 to 2006 served to decrease sales for fiscal 2006 by approximately $1.6 million.

 

Sales of voice portal solutions increased significantly in fiscal 2007 from fiscal 2006. All geographies except Europe reflected increases in voice portal sales during this timeframe, with the largest increase reflected in North America. This increase reflects the inclusion of sales to former Edify customers for the full year of fiscal 2007 including approximately $4.6 million recognized under an approximately $7.3 million sale to a major U.S. satellite television provider. Fiscal 2007 also included $2.5 million of revenue from a cash basis customer based in the Central and South American market as well as $3.5 million from a follow on order for incremental capacity from the same customer which was recognized on an accrual basis based upon several years of successful cash collections activities associated with this customer. Given the delays we are experiencing in collection of this receivable, we will return to the cash basis of accounting for future transactions with this customer. Sales of voice portal solutions declined significantly in fiscal 2006 from fiscal 2005 levels. A portion of the decline results from the fact that sales in fiscal 2005 included approximately $10.3 million recognized under an $11.4 million sale to a major U.S. wireless provider. There were no individual sales of this magnitude in fiscal 2006. The balance of the decline reflected weakness in our voice portal sales across all our major geographic markets, with the largest decline focused in North America. We believe some voice portal customers postponed investment decisions during fiscal 2006 while they continued to evaluate the effects of the market shift to open standards on their individual processing environments.

 

Fiscal 2006 included recognition of approximately $6.2 million under the first two contracts for our new advanced messaging product. Sales of messaging solutions decreased in fiscal 2007 from fiscal 2006. The largest decreases were reflected in the Middle East, Africa and Latin America where fiscal 2007 did not include any contracts of comparable size to the first two media exchange contracts recognized during fiscal 2006. One of these contracts was completed during the first quarter of fiscal 2007 and the second contract was completed during the first quarter of fiscal 2008.

 

Our sales of payment solutions in 2007 and 2006 primarily reflect sales of capacity upgrades to existing clients in the Middle East and Africa, Latin America and the Pacific Rim. The decline in such sales from fiscal 2005 to fiscal 2006 is largely attributable to the loss of an MEA customer who had purchased $4.9 million in payment solutions during fiscal 2005.

 

The 29.2% increase in maintenance and related service revenues in fiscal 2007 as compared to fiscal 2006 is comprised of increases of $19.6 million (35.3%) in maintenance revenues on voice portal solutions offset, in part, by decreases of $0.8 million (8.5%) in maintenance revenues on messaging and payment solutions. This increase resulted primarily from the acquisition of Edify. The 8.4% increase in our maintenance and related services revenues in fiscal 2006 as compared to fiscal 2005 is comprised of increases of $7.0 million (15.5%) in maintenance revenues on voice portal solutions offset, in part, by decreases of $2.0 million (13.8%) in maintenance revenues on messaging and payment solutions.

 

The 19.1% decrease in hosted solutions revenues in fiscal 2007 as compared to fiscal 2006 is comprised of growth of $2.1 million (16.2%) in revenues from our North American enterprise customers offset by reductions of $7.0 million (55.7%) from our international network customers. We recognized revenues totaling $3.0 million in fiscal 2007, $8.3 million in fiscal 2006 and $10.0 million in fiscal 2005 under one long-term international hosted solutions contract with a U.K. based network operator. This contract expired in July 2006. International hosted solutions revenues during fiscal 2007 included $1.4 million relating to services performed for an international hosted solutions customer for which we recognize revenue on a cash basis. We recognized $2.0 million and $1.5 million of similar sales to the same customer in fiscal 2006 and 2005, respectively. The 9.4% increase in hosted solutions revenues in fiscal 2006 as compared to fiscal 2005 is comprised of growth of $3.2 million (33.3%) in revenues from our North American enterprise customers offset, in part, by net reductions of $1.0 million (7.5%) in revenues from our international network customers.

 

No customer accounted for 10% of our total sales during fiscal 2007. We have historically made significant sales of solutions, maintenance and hosted solutions, including the hosted solutions described above, to O2. Such combined sales accounted for 10% of our total sales during fiscal 2006 and 2005. No other customer accounted for 10% or more of our sales during such periods.

 

We are prone to quarterly sales fluctuations. Some of our transactions are completed in the same fiscal quarter as ordered. The quantity and size of large sales (sales valued at approximately $2.0 million or more) during any quarter can cause wide variations in our quarterly sales and earnings, as such sales are unevenly distributed throughout the fiscal year. We use a system combining estimated sales from our recurring services contracts, “pipeline” of solution sales opportunities, and backlog of committed solution orders to estimate sales and trends in our business. For the years ended February 28, 2007, February 28, 2006 and February 28, 2005 sales were sourced as follows:

 

 

Our service and support contracts range in original duration from one month to five years, with most hosted solutions contracts having initial terms of two to three years and most maintenance and related contracts having initial terms of one year. Because many of the longer duration contracts give customers early cancellation privileges, we do not consider our book of services contracts to be reportable backlog, as a portion of the potential revenue reflected in the contract values may never be realized. Nevertheless, it is easier for us to estimate service and support sales than to estimate solution sales for future quarters because the service and support contracts generally span multiple quarters and revenues recognized under each contract are generally similar from one quarter to the next.

 

Our backlog is made up of customer orders for solutions for which we have received complete purchase orders. At February 28, 2007, 2006 and 2005, our backlog of solutions sales was approximately $54.1 million, $33.9 million and $35.4 million, respectively. We generally expect all projects in our existing backlog to be initiated within fiscal 2008 and most of such backlog to be recognized as revenue during fiscal 2008. Approximately 10% to 20% of such backlog could revenue subsequent to fiscal 2008. Our ability to estimate the amount of backlog that will be converted to revenue in any fiscal quarter can be affected by factors outside our control, including changes in project timing requested by our customers and cash collections from certain international customers.

 

Our pipeline of opportunities for solutions sales is the aggregation of our sales opportunities for which we have not received a purchase order, with each opportunity evaluated for the date the potential customer will make a purchase decision, competitive risks, and the potential amount of any resulting sale. No matter how promising a pipeline opportunity may appear, there is no assurance it will ever result in a sale. Accordingly, upward or

downward trends in our total pipeline are not considered meaningful from a financial analysis perspective. While we incorporate an estimate of sales from pipeline into our business planning and budgeting, pipeline estimates are necessarily speculative and may not consistently correlate to solutions sales in a particular quarter or over a longer period of time. While we know the amount of solutions backlog available at the beginning of a quarter, we must speculate on our pipeline of solutions opportunities for the quarter. Our accuracy in estimating total solutions sales for future fiscal quarters is, therefore, highly dependent upon our ability to successfully estimate which pipeline opportunities will close during the quarter.

 

To compete effectively in our target markets in fiscal 2008 and beyond, we believe we must continue to transition our products and services to an open, standards-based business model. We have historically provided complete, bundled hardware and software systems using internally developed components to address our customers’ total business needs. Increasingly, the markets for our products are requiring a shift to the development of products and services based on an open, standards-based architecture such as the J2EE and Microsoft’s^®. NET environments utilizing VoiceXML, CCXML, SCXML and/or SALT standards. Such an open, standards-based approach allows customers to independently purchase and combine hardware components, standardized software modules, and customization, installation and integration services from individual vendors deemed to offer the best value in the particular class of product or service. In such an environment, we believe we may sell less hardware and fewer bundled systems and may become increasingly dependent on our development and sale of software application packages, customized software and consulting and integration services. This shift will place new challenges on our management to transition our products and to hire and retain the mix of personnel necessary to respond to this business environment, to adapt to the changing expense structure that the new environment may tend to foster, and to increase sales of services, customized software and application packages to offset reduced sales of hardware and bundled systems.

 

Special Charges

 

Fiscal 2007

 

During fiscal 2007, we incurred approximately $2.5 million in special charges in connection with three severance and organizational changes affecting approximately 55 positions. In addition, we incurred approximately $1.2 million in special charges in connection with the elimination of redundant office leases. The following table summarizes the effect on reported operating results by financial statement category of all special charges activities for fiscal 2007 (in millions):

 

 

Of this amount, $1.0 million remained accrued at February 28, 2007.

 

Fiscal 2006

 

During fiscal 2006, we incurred approximately $1.9 million in charges in connection with restructuring expenses for severance and organizational changes affecting approximately 50 persons made at the time of the acquisition of Edify. The following table summarizes the effect on reported operating results by financial statement category of such special charges (in millions):

 

 

All amounts related to these special charges have been paid.

 

Cost of Goods Sold

 

Cost of goods sold was comprised of the following for the three years ended February 28, 2007, 2006 and 2005 (in millions):

 

 

During fiscal 2007 and 2006, we incurred special charges to cost of goods sold totaling $1.0 million (0.5% of sales) and $0.5 million (0.3% of sales), respectively, as described in the preceding Special Charges section. Cost of goods sold for fiscal 2007 included approximately $0.9 million of stock compensation expense, resulting from the adoption of SFAS No. 123R which requires us to include a compensation expense in our financials related to share-based awards. A significant portion of our solutions cost of goods sold is comprised of labor costs that are fixed over the near term as opposed to direct material and license/royalty costs that vary directly with sales volume. The increase in solutions cost of goods sold as a percentage of solutions sales in fiscal 2007 as compared to fiscal 2006 resulted primarily from the recording of a loss provision of approximately $1.9 million related to a $10.3 million media exchange contract entered into in February 2007. Progress on this percentage of completion project resulted in approximately $0.8 million of revenue on which we recognized no net margin during fiscal 2007. In addition, we recognized no net margin on approximately $0.7 million of revenue recognized on the first two contracts for our advanced messaging product — media exchange for networks. The increase in solutions costs of goods sold as a percentage of solutions sales in fiscal 2006 as compared to fiscal 2005 resulted largely from the changes in solution sales volume across the period which occurred without proportional increases or decreases in our fixed labor costs. In addition, as discussed in the Sales section above, we performed significant work during fiscal 2006 on the first two contracts for our new advanced messaging product — media exchange for networks. Because of the significant effort involved in these initial deployments of this product, we realized no net margin on approximately $6.2 million of revenue recognized during fiscal 2006.

 

During fiscal 2007, our services cost of goods sold increased in dollar amount and remained relatively unchanged as a percentage of services revenues as compared to fiscal 2006 levels. The increase in actual costs related to the increase in services revenues. During fiscal 2006, our services cost of goods sold declined both in dollar amount and as a percentage of services revenues over fiscal 2005 levels. The reduction in actual costs resulted primarily from contractual reductions in third party costs associated with our international hosted solutions business, reduced telecommunications costs negotiated based on higher volumes in our domestic hosted solutions business, and lower warranty and repairs and maintenance costs. The reduction in cost as a percent of recurring revenues resulted from these cost savings and from our ability to support net revenue growth in both our maintenance and hosted solutions business with limited additions to our existing cost structure. Our cost of goods sold percentage also benefited from a shift in the geographic mix of some maintenance revenues from areas with a relatively higher cost structure to lower cost areas.

 

Research and Development

 

Research and development expenses for the three years ended February 28, 2007, 2006 and 2005 were as follows (in millions):

 

 

Research and development expenses for fiscal 2007 included approximately $0.5 million of stock compensation expense resulting from our adoption of SFAS No. 123R which requires us to include a compensation expense

in our financial statements related to share-based awards. In addition, fiscal 2007 included a full year of the impact of the acquisition of Edify and the addition of resources to support the technology acquired from Nuasis. We incurred special charges of $0.3 million (0.2% of sales) and $0.2 million (0.1% of sales) in fiscal 2007 and 2006, respectively, as described in Special Charges above. Expenses were up approximately $0.9 million in fiscal 2006 as compared to fiscal 2005 as a result of the acquisition of Edify. The remainder of the increase in year-over-year R&D expenditures from fiscal 2005 to fiscal 2006 relates to the continued investment in various research and development initiatives involving packaged applications and voice over IP (“VoIP”) as well as network product offerings. Recurring research and development expenses included the design of new products and the enhancement of existing products.

 

Our research and development spending is focused in six key areas. First, we are developing software tools to aid in the development and deployment of customer applications incorporating speech recognition, text-to-speech, and other rich media technologies for enterprises and wireless and wireline providers. Next, we are developing server-based application software platforms for operations and management of contact center, speech and call completion applications. These software platforms are branded under the name Media Exchange. We will use these software platforms for deployment and management of enterprise, wireless and wireline network operator applications, which are designed to operate in both J2EE and Microsoft’s ^®.NET enterprise computing environments. Third, we are developing media servers, “voice browsers,” and call processing infrastructure based on open standards such as VoiceXML, CCXML, SCXML and SALT. These media servers are VoIP enabled, allowing operation in soft-switch and hybrid PSTN and VoIP networks. Fourth, we are developing packaged, speech enabled applications for the network operator and enterprise markets. These include a range of vertical and horizontal applications that are designed to greatly enhance customer return-on-investment by providing many commonly used configurable functions that can be deployed more quickly than custom applications. Fifth, we are developing software and tools designed to provide integration of live agent positions in a customer contact center setting. This software covers a broad range of functions including agent call-screen transfer, workflow management, full call recording, agent and supervisor management systems and reporting and various integration functions. Finally, we are developing modular productivity and communications applications for wireless and wireline applications including speech driven voice mail, voice activated dialing, and enhanced personal information management. The network products are also branded under the product name Media Exchange.

 

We expect to maintain a strong commitment to research and development so that we can remain at the forefront of technology development in our markets.

 

Selling, General and Administrative

 

Selling, general and administrative expenses for the three years ended February 28, 2007, 2006 and 2005 were as follows (in millions):

 

 

Selling, general and administrative expenses for fiscal 2007 included approximately $3.4 million due to our adoption of SFAS No. 123R which requires us to include a compensation expense in our financial statements related to share-based awards. Fiscal 2007 reflects a full year of the impact of the acquisition of Edify which affected salaries, commissions and related expenses. Sales and marketing expenses increased approximately $11.1 million from fiscal 2006 to fiscal 2007. In addition, depreciation expense increased by approximately $1.4 million for the same time frame, largely as a result of the start of depreciation related to the SAP system which went into production during the third quarter of fiscal 2007. Fiscal 2006 included increases of approximately $1.0 million for legal expenses primarily related to increased patent and merger and acquisition activities, $0.6 million for non-capitalizable contract labor associated with our SAP implementation and $0.3 million for website development and rebranding efforts. We incurred SG&A charges in connection with the Audit Committee and SEC investigations described in Item 3 of Part I of this Form 10-K of approximately $1.7 million, or 0.9% of total sales, during fiscal 2007, $1.1 million, or 0.7% of total sales, during fiscal 2006 and $2.0 million, or 1.1% of total sales, during fiscal

2005. SG&A expenses included special charges of $2.4 million (1.2% of sales) and $1.2 million (0.7% of sales) in fiscal 2007 and 2006, respectively, as described in “Special Charges” above.

 

Settlement provision

 

Fiscal 2007 includes approximately $0.9 million of expense related to an expected payment to the SEC based on the current status of discussions with the SEC regarding its investigation.

 

Amortization and Impairment of Goodwill and Acquired Intangible Assets

 

In connection with our purchase of certain assets from Nuasis in fiscal 2007, our purchase of Edify in fiscal 2006 and Brite in fiscal 2000, we recorded intangible assets and goodwill totaling $1.9 million, $35.5 million and $103.8 million, respectively. The separately identifiable intangible assets were assigned useful lives ranging from 18 months to 10 years. For the fiscal years ended February 28, 2007, 2006 and 2005, we recognized amortization expenses related to these intangible assets as follows (in millions):

 

 

At February 28, 2007, we had $9.5 million in remaining net intangible assets other than goodwill which will be subject to amortization in future periods. The estimated amortization expense attributable to our intangible assets for each of the next five years is as follows (in millions):

 

 

We conducted our required annual test of goodwill impairment during the fourth quarters of fiscal 2007, 2006 and 2005. No impairment of goodwill was indicated.

 

Interest Income

 

Interest income was approximately $1.5 million, $2.2 million and $0.9 million in fiscal 2007, 2006 and 2005, respectively. The increase in interest income during fiscal 2006 resulted from our positive cash flow and from rising interest rates. During the fourth quarter of fiscal 2006, we used approximately $34.3 million of cash in connection with our acquisition of Edify. As a result, we earned less interest income in fiscal 2007 than in fiscal 2006.

 

Other Income (Expense)

 

Other income (expense) during fiscal 2007, 2006 and 2005 totaling approximately ($0.3) million, $0.1 million and $0.1 million, respectively, was comprised primarily of foreign currency transaction gains and losses. Fiscal 2007 also includes approximately $0.6 million primarily resulting from the sale of MetLife common stock acquired as a result of MetLife’s demutualization which offsets the foreign currency loss reported in fiscal 2007.

 

Income Taxes

 

We recognized an income tax benefit of $0.2 million (11% of pretax loss) and $5.3 million (47% of pretax income) for fiscal 2007 and fiscal 2006, respectively, and income tax expense of $2.6 million (10% of pretax income) for fiscal 2005. The fiscal 2007 percentage differs from the U.S. statutory rate of 35% primarily as a result of the geographic mix of our operating results in foreign markets with varying tax rates and other permanent differences. The fiscal 2006 percentage differs from the U.S. statutory rate of 35% primarily as a result of the release of valuation allowances previously maintained against certain U.S. deferred tax assets and the favorable resolution of certain tax contingencies during the year offset, in part, by additional tax expense incurred on the repatriation of certain foreign earnings, all as further discussed below. The fiscal 2005 percentage differs from the U.S. statutory rate of 35% primarily as a result of the taxability in the U.S. of certain dividends deemed to have been received from

our foreign subsidiaries, the use of certain fully reserved net operating loss carryforwards and other fully reserved deferred tax assets as further described below and the favorable resolution of certain tax contingencies.

 

During fiscal 2003 and 2002, we incurred significant losses. As a result, we were unable to conclude that it was more likely than not that we would recognize the benefit of our net deferred tax assets, and, accordingly, we established a valuation allowance against such assets. For the three years ended February 28, 2006, we reported profits on both our consolidated and U.S. operations. Given this history of profitability and our belief that we would continue to generate sufficient taxable income in the future to realize the benefits of certain of our remaining U.S. federal deferred tax assets, in February 2006 we benefited our fiscal 2006 income tax provision by reversing $4.4 million of valuation allowance associated with such assets. We continue to provide valuation allowances on foreign and state deferred tax assets and on certain U.S. federal deferred tax assets that will benefit equity if and when realized. These valuation allowances are provided because of remaining uncertainty about the realizability of such assets.

 

During fiscal 2006, we resolved various tax contingencies arising out of our U.S., U.K., German and MEA operations. The resolution of all such items resulted in a $3.2 million reduction in our tax expense for fiscal 2006 and was associated with the completion of audits of certain of our international tax returns and with the closing of certain tax periods due to the passage of time.

 

On October 22, 2004, the American Jobs Creation Act (the “AJCA”) was signed into law. The AJCA provides for a deduction of 85% of certain foreign earnings that are repatriated, as defined in the AJCA. During the fourth quarter of fiscal 2006, we elected to repatriate $10.3 million from our U.K. subsidiary pursuant to the provisions of the AJCA. In doing so, we incurred related income tax expense of approximately $1.0 million.

 

Our U.S. taxable income for fiscal 2005 included distributions deemed to have been made to our U.S. company by several of our foreign subsidiaries, including, particularly, our U.K. subsidiary. Such deemed distributions stemmed from the existence and ultimate settlement of intercompany debt owed by the U.S. entity to certain of our foreign subsidiaries and from the pledging of certain U.K. assets as collateral for a term loan that was outstanding for a portion of fiscal 2004.

 

During fiscal 2005, we used net operating losses carried forward from previous years and the reversal of certain temporary differences to offset virtually all of our U.S. taxable income. As a result, our current tax expense was limited to a small amount of U.S. alternative minimum tax expense and to tax expense on our international operations. The reversal of a portion of our deferred tax asset valuation allowances offset the deferred tax expense we would otherwise have incurred as a result of using the assets, and, as a result, our overall effective tax rate for the years was substantially less than the statutory rates. Tax expense for fiscal 2005 also reflected the benefit of a $0.9 million favorable tax settlement with a foreign government reached during the year.

 

At February 28, 2007, we had U.S. federal net operating loss carryforwards totaling $1.3 million. This amount, if not used, will expire beginning in fiscal 2021. All of these federal net operating loss carryforwards arose from employee stock option exercises. As a result, the realization of such carryforwards when used to reduce federal tax payments in fiscal 2008 and future years will increase equity and will not reduce our tax provision for those years.

 

Income From Operations and Net Income

 

We generated loss from operations of $3.1 million and net loss of $1.7 million during fiscal 2007 and income from operations and net income were $9.0 million and $16.5 million, respectively, during fiscal 2006. In fiscal 2007, our loss was primarily attributable to the increased research and development and other operating expenses to support the two acquisition activities undertaken late in fiscal 2006 and in fiscal 2007 and the increased investment in sales initiatives and marketing rebranding efforts to increase sales as well as stock-based compensation expense, increased restructuring expenses and loss provisions for a contract and the current status of settlement discussions with the SEC. In fiscal 2006, our reduced operating profitability was primarily attributable to the significant decline in our solution sales from prior year levels. The effect of this sales reduction on our fiscal 2006 net income was mitigated, in part, by the large tax benefits associated with the reversal of valuation allowances on deferred tax assets as described above.

 

Liquidity and Capital Resources

 

At February 28, 2007, we had $28.2 million in cash and cash equivalents, and we had no debt outstanding.

 

Operating cash flows for fiscal 2007 were impacted by increases in accounts receivable and inventory. Our accounts receivable at February 28, 2007 included approximately $2.7 million from a Venezuelan customer. Given the delays that we have experienced in collection of this receivable, we will return to the cash basis of accounting for future transactions with this customer. Our days sales outstanding of accounts receivable was 70 days at February 28, 2007, up from 57 days at February 28, 2006 due to the timing of billings within the quarter combined with the effect of the delayed collection of the Venezuelan receivable.

 

For sales of certain of our more complex, customized solutions (generally those with a sales price of $500,000 or more), we recognize revenue based on a percentage of completion methodology. Unbilled receivables accrued under this methodology totaled $7.3 million (19.7% of total net receivables) at February 28, 2007, as compared to $5.1 million (19.8% of total receivables) at February 28, 2006. We expect to bill and collect unbilled receivables as of February 28, 2007 within the next twelve months.

 

We generate a significant percentage of our sales, particularly sales of network solutions, outside the United States. Customers in certain countries are subject to significant economic and political challenges that affect their cash flow, and many customers outside the United States are generally accustomed to vendor financing in the form of extended payment terms. To remain competitive in markets outside the United States, we may offer selected customers such payment terms. In all cases, however, we only recognize revenue at such time as our solution or service fee is fixed or determinable, collectibility is probable and all other criteria for revenue recognition have been met. In some limited cases, this policy may result in our recognizing revenue on a “cash basis,” limiting revenue recognition on certain sales of solutions and/or services to the actual cash received to date from the customer, provided that all other revenue recognition criteria have been satisfied.

 

We used $16.9 million of cash in net investing activities during fiscal 2007. Of this amount, we used $0.9 million for payment of expenses related to the acquisition of Edify, $2.4 million in the purchase of certain assets from Nuasis, $3.1 million to purchase equipment to expand our hosted solutions business, $7.3 million for costs in connection with our SAP implementation, and the remaining $3.2 million for replacement and expansion of our computing infrastructure and other capital purchases. We expect to make capital expenditures of approximately $8.0 million in fiscal 2008. Actual capital expenditures, however, are dependent, in part, on the level of expenditures made in connection with expansion of our hosted solutions business and could vary from this amount.

 

During fiscal 2007, our financing activities provided $2.4 million in net cash flow. Our option holders exercised options for 0.3 million shares of common stock and, in so doing, provided us with $0.7 million of cash. Financing activities also included approximately $1.7 million related to excess tax benefits resulting from the exercise of stock options.

 

Letter of Credit Facility

 

In February 2006, we terminated our existing line of credit and entered into a new letter of credit line with the lender. The letter of credit line provides that the lender will issue letters of credit not to exceed the principal amount of $2.0 million. At February 28, 2007, letters of credit totaling approximately $0.5 million were outstanding. Any draft actually paid by the lender will bear interest at a rate of one-fourth of one percent (0.25%) above the prime rate until the amount is repaid. This agreement contains certain representations and warranties, certain negative and affirmative covenants, and certain conditions and events of default which are customarily required for similar financings. As of February 28, 2007, we were in compliance with all such covenants.

 

Summary of Future Obligations

 

The following table summarizes our obligations and commitments as of February 28, 2007, to be paid in fiscal 2008 through 2012 (in millions):

 

 

The operating lease payments shown above were our only off-balance sheet arrangements at February 28, 2007.

 

Most of our purchases are executed under cancelable purchase orders. The firm purchase commitments shown above are comprised of non-cancelable commitments for certain communications charges and royalties.

 

We believe our cash reserves and internally generated cash flow will be sufficient to meet our operating cash requirements for at least the next twelve months.

 

Impact of Inflation

 

We do not expect any significant short-term impact of inflation on our financial condition. Technological advances should continue to reduce costs in the computer and communications industries. Further, we presently are not bound by long-term fixed price sales contracts. The absence of such contracts should reduce our exposure to inflationary effects.

 

Selected Quarterly Financial Data (Unaudited)

 

 

 

 

 

 

We invest cash balances in excess of operating requirements in short-term securities that generally have maturities of 90 days or less. The carrying value of these securities approximates market value, and there is no long-term interest rate risk associated with these investments.

 

Foreign Currency Risks

 

We transact business in certain foreign currencies including, particularly, the British pound and the Euro. Our primary software application development, research and development and other administrative activities are conducted from offices in the United States and the United Kingdom, and our primary manufacturing operations are conducted in the United States. Virtually all sales arranged through our U.S. offices are denominated in U.S. dollars, which is the functional and reporting currency of our U.S. entity. Sales arranged through our U.K. subsidiary are denominated in various currencies, including the British pound, the U.S. dollar and the Euro; however, the U.K. subsidiary’s functional currency is the British pound.

 

For the fiscal year ended February 28, 2007, sales originating from our U.K. subsidiary represented approximately 23% of consolidated sales. As a result of our international operations, we are subject to exposure from adverse movements in certain foreign currency exchange rates. We have not historically used foreign currency options or forward contracts to hedge our currency exposures because of variability in the timing of cash flows associated with our larger contracts, and we did not have any such hedge instruments in place at February 28, 2007. Rather, we attempt to mitigate our foreign currency risk by generally transacting business in the functional currency of each of our major subsidiaries, thus creating natural hedges by paying expenses incurred in the local currency in which revenues will be received.

 

As noted above, our operating results are exposed to changes in certain exchange rates including, particularly, those between the U.S. dollar, the British pound and the Euro. When the U.S. dollar strengthens against the other currencies, our sales are negatively affected upon the translation of U.K. operating results to the reporting currency. The effect of these changes on our operating profits varies depending on the level of British pound denominated expenses and the U.K. subsidiary’s overall profitability. For the fiscal year ended February 28, 2007, the result of a hypothetical, uniform 10% strengthening in the value of the U.S. dollar relative to the British pound and the Euro would have been a decrease in sales of approximately $2.5 million and an increase in net income of approximately $1.7 million. In addition to the direct effects of changes in exchange rates, which are a changed dollar value of the resulting sales and/or operating expenses, changes in exchange rates also could affect the volume of sales or the foreign currency sales price as competitors’ products become more or less attractive. This sensitivity analysis of the effects of changes in foreign currency exchange rates does not factor in a potential change in sales levels or local currency prices.

 

The Report of Independent Registered Public Accounting Firm Ernst & Young LLP and the Consolidated Financial Statements of Intervoice as of February 28, 2007 and 2006 and for each of the three years in the period ended February 28, 2007 follow.

 

Stockholders and Board of Directors
Intervoice, Inc.

 

We have audited the accompanying consolidated balance sheets of Intervoice, Inc. as of February 28, 2007 and 2006 and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended February 28, 2007. Our audits also included the financial statement schedule listed in the index at Item 15(a). These consolidated financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Intervoice, Inc. at February 28, 2007 and 2006, and the consolidated results of its operations and its cash flows for each of the three years in the period ended February 28, 2007, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

As discussed in Note B and Note J to the consolidated financial statements, the Company changed its method of accounting for stock-based compensation effective March 1, 2006.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Intervoice, Inc.’s internal control over financial reporting as of February 28, 2007, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated May 8, 2007 expressed an unqualified opinion thereon.

 

 

Dallas, Texas

May 8, 2007

INTERVOICE, INC.

 

 

See notes to consolidated financial statements.

INTERVOICE, INC.

 

 

See notes to consolidated financial statements.

INTERVOICE, INC.