Don Brown and Interactive Intelligence and Manufacturing & Technology and Technology

Persistence pays for Interactive Intelligence

September 4, 2006

Interactive Intelligence Inc. quietly reached a milestone over the summer. Its stock finally climbed back to $13, its initial-public-offering price seven years ago, at the height of the technology boom.

It's been a wild ride for the maker of communications software, which saw its shares shoot as high as $50 in its first few months of trading, only to have them wallow below $5 for years after the tech bubble burst.

But now Interactive Intelligence is back in favor on Wall Street, pumped up by steadily improving financial results. So far this year, the stock is up 134 percent. It spiked as high as $16.74 in July and now trades for around $12, giving the Indianapolis-based company a market value of $200 million.

"We're just in the right place at the right time with the right product," said Interactive Intelligence CEO Don Brown. But there's clearly more than serendipity at work. With 450 employees and offices around the globe, Interactive Intelligence makes software that manages and unifies a business's communications--everything from phones, faxes and voice mail to e-mail and Web chats.

Upbeat profit guidance from Brown sparked the stock rally. The prospect of a sales force sent elephant-hunting sustained it.

In the fourth quarter of last year, Brown, 50, provided earnings guidance for the first time since the Internet boom. He said Interactive's revenue would increase up to 20 percent in 2006 and that, consequently, profit would double.

That was a bold forecast for a firm that spent more than a decade in the red. Brown still chafes at the memory of mass layoffs that Interactive's sinking prospects forced five years ago.

But 10 consecutive quarters in the black bolstered his confidence. So did his sales pipeline, which increasingly includes deals with large corporations.

"There's a danger in giving guidance in the first place," Brown said. "If you miss, there are people who will take you to task for it."

When Interactive surpassed its targets for the first half of 2006, its stock surged. And some observers still see plenty of upside.

Analyst Mike Latimore, who follows Interactive Intelligence for Raymond James & Associates Inc., rates the company a "strong buy" and has set a $17 stock price target.

Latimore forecasts Interactive's annual revenue will reach $90.8 million next year--a nearly $30 million increase from 2005.

For leaders of the Indianapolis technology community, the company's gains provide vindication. Interactive is one of only two publicly traded software firms in Indiana. The other is Indianapolis-based CTI Group Inc., a bulletin-board stock with just $15 million in annual revenue.

"It's a great win for us," said David Becker, CEO of Indianapolis-based First Internet Bancorp. "It just shows you can build public IT-based companies here."

Tempered expectations

After Brown beat his first forecast, some observers thought he would formally raise earnings expectations after releasing second-quarter results last month. But Brown didn't, preferring to remain conservative in his guidance, and he wasn't surprised when the stock retreated as a result.

Nor was he concerned.

Once the market understands that Interactive has overcome a hardware issue that had constrained sales, Brown said, the stock price will take care of itself.

"We're just taking it one quarter at a time," he said.

Brown founded Interactive in 1994 with a vision to innovate business telephone systems beyond clunky handsets and trunk lines. The company would aim to synchronize, streamline, automate and improve clients' communications with an entirely software-based system. Teams of engineers began developing it.

There was just one problem. The software Interactive wrote was still limited by hardware. Clients had to purchase a proprietary circuit board to connect their telephones to their computer servers.

The boards sometimes undermined system reliability. Worse, they cost up to $10,000 each, a major expense that deterred many customers--especially once they learned multiple boards were necessary to roll the system out for lots of users.

Consequently, Interactive gained a reputation as a company whose sexy technical innovations weren't suited for businesses with more than 200 employees.

That reputation lingers today. Many still see Interactive as a niche player in the telephone-software field, which is crowded with much larger competitors.

"This is a market that is consolidating. The big are getting bigger at the expense of the smaller," said Drew Kraus, an analyst for Stamford, Conn.-based technology research firm Gartner Inc.

"[Interactive Intelligence's] challenge will be to continue to be nimble, and to continue to keep going to the spaces the bigger guys aren't fast enough to go to, and to avoid seeing their market share stolen. They've done well so far."

But Brown believes Interactive is finally poised to service large customers in any industry, directly challenging much larger competitors such as Avaya Inc., Cisco Systems Inc. and Nortel Networks Corp.

Eight years ago, Brown began steering Interactive toward an emerging technology called voice over Internet protocol, or VOIP, in the hopes of moving past those pesky circuit boards toward a system that transmits calls entirely online.

Trouble was, there were no industry standards for VOIP back then. Big players like Avaya and Cisco built their new systems on one standard. Interactive Intelligence chose another: the so-called session initiation protocol.

"We felt we had seen the future when we saw the SIP standard, and we decided to make a big bet," Brown said. "You talk about betting the future of the company. That's what we did."

In 2001, Microsoft Corp. moved to the SIP standard. Then, Interactive Intelligence landed Microsoft as a customer. That sale led to another elephant: Motorola.

Opening doors

Just mentioning those names as clients now opens doors, Brown said. This spring, Interactive Intelligence hired Cranbury, N.J.-based Miercom to independently test its software, which has been on the market several years. The Miercom study showed it could simultaneously support 5,000 users and a million calls a day.

Brown hopes the new research finally puts his company's niche-application reputation to rest. In the meantime, he's reorganized the company's sales force and changed compensation incentives to favor large, new accounts.

Analysts are starting to come around. Brown said he was thrilled to see the most recent research report from Jeff Nevins, a longtime skeptic of Interactive's potential to serve large corporations.

Nevins' July 26 report for First Analysis Securities Corp. was titled "Joining the big dogs."

"Interactive Intelligence is making compelling headway into the large end of the call-center segment, defined as greater than 250 workstations," Nevins wrote.

"While [Interactive Intelligence] has had the ability to scale to large deployments for quite some time, it has only been in the last year or so that large customer orders have started to snowball into a consistent and meaningful revenue contribution."

Wall Street's favor may open doors that had been closed to the company for years.

Brown said he's most gratified that employees who stuck with the company for years, despite its slumping stock, are finally seeing their loyalty pay off. He said retaining a core group of engineers for more than a decade led to the software that's now the company's calling card.

But Brown also has expansion on his mind. He said Interactive Intelligence is now contemplating raising money through a stock sale to fuel growth, whether internal or through acquisition.

"It's something we want to take a look at and think about. Obviously, as the stock price goes up, it becomes more palatable to [sell] some equity and increase our cash," he said.

"You can do interesting things which would have been prohibitively expensive at $4 per share."

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