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Interactive's stock drop shows vagaries of Wall Street

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Greg Andrews

Interactive Intelligence Group Inc. CEO Don Brown was on quite a roll leading up to the company’s quarterly earnings announcement on May 5.

Just a few days earlier, he’d stood with Gov. Mike Pence to announce plans to create 430 Indiana jobs, an expansion that would swell its work force in the state beyond 1,400. At the press conference, Brown couldn’t resist making a reference to the fact his company was kicking the tail of the firms it competes against in the call center software market, an august group that includes Cisco Systems Inc.

The success was making investors a lot of money. Shares have more than quadrupled over four years, swelling the Indianapolis company’s market capitalization beyond $1 billion.

But in a lesson in the vagaries of Wall Street—and on analysts’ myopic obsession with whether companies hit quarterly projections—the financial results announced May 5 sent the company’s shares into a tailspin.

In the first day of trading after the announcement, the stock shed nearly 20 percent, and it’s since dropped another 4 percent.

Why the shellacking? On the surface, all was good—and, in fact, a deeper look into the numbers yields the same conclusion.

As Brown said on the conference call that followed the earnings release, “We are very pleased with our execution during the quarter, as our overall level of business activity remained high, and our global pipeline continues to increase.”

The culprit: Interactive reported unexpected red ink. Analysts had expected adjusted net income of 1 penny per share. Instead, Interactive reported an adjusted loss of $400,000, or 2 cents per share.

brown Brown

Not horrible, but on a price-to-projected-earnings basis, the shares already were pricey. So it didn’t take much for investors to pull the “sell” trigger.

The problem is that the disappointing results had more to do with the nuances of accounting than an operating glitch.

Interactive is in the process of evolving its business from selling call center software that customers install on-premises to selling cloud-based software. Interactive was a step ahead of its rivals in making the transition, and thus it’s in an enviable position.

Yet there’s a downside: On-premises software yields big up-front payments for Interactive, while cloud revenue recognition is spread over the life of a contract, perhaps five years. So the greater success Interactive enjoys transitioning customers to the cloud, the greater the drag on short-term results.

That’s exactly what happened in the first quarter. The investment firm Wedbush noted in a report that if cloud orders had represented 55 percent of orders, rather than the 59 percent Interactive reported, the company’s results would have topped analysts’ expectations.

As Motley Fool columnist Steve Symington wrote the day of the plunge, “If you already liked Interactive Intelligence Group before today, I don’t think its surprise loss should change your opinion of the stock.”

Brown—who co-founded the city’s first public software firm, Software Artistry Inc., before launching Interactive in 1999—never has had the obsession with quarter-to-quarter results that grips many public company executives. That’s partly because he got Interactive off the ground without venture capital, giving him the freedom to run the company his way.

Even if that weren’t his style, analysts say more volatility likely is in the offing.

“With about 15-20 percent of the revenues coming from cloud-based revenues, which is depressing margins and inhibiting revenue growth, near-term financial performance is difficult to project and longer-term margin structure is far from certain,” Raymond James analyst Tavis McCourt wrote in a report.

Yet if the company continues on the current trajectory, with business growing at a torrid rate even though the overall call center market is stagnant, investors may reap even larger rewards. Total orders rose 42 percent in the first quarter, compared with a year earlier, and many of those are from large customers that used to be beyond the company’s reach.

Interactive benefits as more of those customers flock to the cloud. But that won’t necessarily be the knee-jerk reaction on Wall Street.

Brown said on the conference call that one of his jobs is to “articulate to analysts and the markets what we are doing, and explain the apparent masking effect that happens with the reported financials when the cloud portion of the business ... lurches along even more quickly and hurts the apparent profitability.”•
 

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