S-1/A 1 ds1a.htm AMENDMENT NO. 6 TO FORM S-1 Amendment No. 6 to Form S-1
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As filed with the Securities and Exchange Commission on May 13, 2008

Registration No. 333-146061

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

AMENDMENT NO. 6

TO

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

Varolii Corporation

(Exact Name of Corporation as Specified in Its Charter)

 

 

 

Washington   7374   91-2028910

(State or other jurisdiction of

incorporation or organization)

 

(Primary Standard Industrial

Classification Code Number)

 

(I.R.S. Employer

Identification No.)

821 2nd Avenue

Suite 1000, 10th Floor

Seattle, WA 98104

(206) 902-3900

(Address, including zip code and telephone number, including area code, of Registrant’s principal executive offices)

 

 

Jeffry A. Shelby

Vice President and General Counsel

821 2nd Avenue

Suite 1000, 10th Floor

Seattle, WA 98104

(206) 902-3900

(Name, Address, including zip code and telephone number, including area code, of Agent for Service)

 

 

Copies to:

 

Sonya Erickson

Heller Ehrman LLP

701 5th Avenue, Suite 6100

Seattle, WA 98104

(206) 447-0900

 

Patrick J. Schultheis

Wilson Sonsini Goodrich & Rosati

Professional Corporation

701 5th Avenue, Suite 5100

Seattle, WA 98104

(206) 883-2500

 

 

Approximate date of commencement of proposed sale to the public:    As soon as practicable following the effectiveness of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.  ¨

If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act of 1933, please check the following box and list the Securities Act registration number of the earlier effective registration statement for the same offering:  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering:  ¨

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act of 1933, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering:  ¨

The Registrant hereby amends this Registration Statement on such date or dates as may be necessary to delay its effective date until the Registrant shall file a further amendment which specifically states that this Registration Statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act or until the Registration Statement shall become effective on such date as the Securities and Exchange Commission, acting pursuant to said Section 8(a), may determine.

 

 

 


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The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.

 

SUBJECT TO COMPLETION. DATED May 13, 2008

PROSPECTUS

             Shares

LOGO

Common Stock

 

 

This is our initial public offering, and no public market currently exists for our shares of common stock. We are offering              shares of common stock. We anticipate that the initial public offering price will be between $         and $         per share.

 

 

We have applied to list our common stock on the NASDAQ Global Market under the symbol “VRLI”.

 

 

Investing in our common stock involves risks. See “ Risk Factors” beginning on page 8.

 

     Per share    Total

Initial public offering price

   $                 $             

Underwriting discount and commissions

   $      $  

Proceeds, before expenses, to us

   $      $  

To the extent that the underwriters sell more than             shares of common stock, the underwriters have the option to purchase up to an additional             shares from us at the initial public offering price less the underwriting discount.

 

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the accuracy or adequacy of this prospectus. Any representation to the contrary is a criminal offense.

The underwriters expect to deliver the shares on or about                     , 2008.

 

 

 

Lehman Brothers   JPMorgan

 

 

 

William Blair & Company    JMP Securities   RBC Capital Markets

Prospectus dated                     , 2008


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LOGO

 

VAROLii

CORPORATION™

On-Demand, interactive customer communications solutions delivered through a Software-as-a-Service model.

INITIATE

SERVICE

CUSTOMER LIFECYCLE

CUSTOMER INITIATION

CUSTOMER SERVICE

CUSTOMER RETENTION

COLLECTIONS

BUSINESS CONTINUITY

COLLECT

RETAIN

VAROLII’S APPLICATION SUITES enable communications for each stage of the customer lifecycle that are:

Automated

Actionable

Proactive

Personalized

Performance-Driven

Multi-Channel


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TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   8

Cautionary Notice Regarding Forward-Looking Statements

   22

Use of Proceeds

   23

Dividend Policy

   23

Capitalization

   24

Dilution

   26

Selected Consolidated Financial Data

   28

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   30

Business

   55

Management

   71

Executive Compensation

   77

Related Party Transactions

   94

Principal Shareholders

   95

Description of Capital Stock

   98

Shares Eligible for Future Sale

   102

Material United States Federal Income and Estate Tax Consequences to Non-U.S. Holders

   104

Underwriting

   107

Legal Matters

   112

Experts

   112

Where You Can Find Additional Information

   112

Index to Consolidated Financial Statements

   F-1

 

 

You should rely only on the information contained in this prospectus and any free writing prospectus prepared by us or on our behalf. We have not, and the underwriters have not, authorized anyone to provide you with information that is different from that contained in this prospectus. We are offering to sell shares of common stock and seeking offers to buy shares of common stock only in jurisdictions where offers and sales are permitted. The information in this prospectus or any related free writing prospectus is accurate only as of its date, regardless of the time of delivery or of any sale of our common stock.

Until                 , 2008 (25 days after commencement of this offering), all dealers selling shares of our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 

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PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus and does not contain all of the information you should consider before buying shares of our common stock. Before deciding to invest in shares of our common stock, you should read the entire prospectus carefully, including our consolidated financial statements and the related notes and the information set forth under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in each case included elsewhere in this prospectus.

Varolii Corporation

Overview

We provide on-demand, interactive customer communications solutions and, based on our size, breadth of products and number of customers, believe that we are the leader in this market. Our solutions consist of software applications and services that enterprises use on an as-needed, or on-demand, basis to create, manage and deliver automated, personalized communications to their customers through multiple media channels including voice, email, SMS, pager, web and fax. Examples of such communications include flight cancellation notices, credit card fraud detection alerts, scheduling of service calls, customer service feedback surveys, medication adherence notifications and payment reminders. Customers are able to interact with enterprises by receiving and responding directly to important personalized information provided by our automated communications. Enterprises who use our solutions typically experience higher levels of customer loyalty and satisfaction and, as a result, our solutions enable these enterprises to enhance revenues and to reduce costs by improving their communications processes.

Our customer communications solutions span the customer lifecycle with applications for customer initiation, customer service, customer retention and collections. We also provide business continuity solutions, which consist of software applications and services that organizations use to quickly and reliably communicate with employees and customers during inclement weather, disasters, network outages and other planned and unplanned incidents. Our applications provide our customers with significant incremental revenue benefits and help eliminate unnecessary costs by facilitating efficient, scalable and actionable communications.

We deploy our customer communications solutions on our computer infrastructure which has been designed to host multiple applications for numerous separate enterprises simultaneously. This multi-tenant platform currently hosts over 600 applications that result on average in over 3.5 million notifications, or discrete contacts by phone, email, SMS, pager, web or fax, each business day. We employ a software-as-a-service, or SaaS, model through which we deliver our applications and services on a fully-managed, as-needed basis. By providing our solutions to our customers on demand, customers may use our solutions without incurring significant upfront expense and can easily add new applications and services over time. We offer a full range of managed services that allow us to design and implement the most effective solution and to regularly evaluate and optimize each customer’s applications. This fully-managed approach allows us to deliver superior results for our customers.

Based on our analysis of the usage of customer communications solutions and publicly available information regarding industry sectors we target, we believe that our total addressable market in North America for interactive customer communications is in excess of $4.0 billion. We believe that on-demand solutions such as ours provide the functionality, flexibility, scalability and efficiency to best address this large and growing opportunity.

Over 350 organizations use our solutions, including more than 100 of the Fortune 1000. We target the largest and most sophisticated enterprises within key industry sectors, including financial services, telecommunications, utilities, healthcare and transportation, as well as government organizations. Our U.S. customers include five of the ten largest banks, four of the five largest wireless carriers, 25 utility companies, six

 

 

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of the top ten airlines, three of the top five pharmacy benefits management companies and over 25 government departments and agencies. An illustrative list of our large enterprise customers within these industry sectors includes Alaska Airlines, Dell, Delta Air Lines, Deutsche Bank AG, DTE Energy, Medco, SunTrust Mortgage, Time Warner Cable and UPS. Our customers typically broaden the deployment of our services across their organizations and increase the usage of our services by deploying additional applications and increasing the volume of notifications.

We generate revenues from our customers’ use of our on-demand customer communications and business continuity offerings. We generally provide our customer communications solutions pursuant to non-cancelable contracts with terms ranging from one year to three years that require our customers to commit to a minimum number of notifications per month. Our business continuity offerings are typically provided under annual or multi-year agreements pre-paid on an annual basis with revenues recognized pro-rata over the contract period. When an incident occurs and notifications are sent in excess of contracted minimum levels, we charge additional fees and recognize revenues as the additional notifications are delivered. We also generate revenues from professional services and customer management services. Over 90% of our revenues are derived from customer notifications and business continuity offerings, and less than 10% are derived from professional services and customer management services.

Our customers typically renew their contracts and a significant percentage of our revenues in any given period are derived from existing customers, and we expect this to continue. For example, during the year ended December 31, 2007, over 95% of our revenues were attributable to revenues from customers from whom we derived revenue in 2006. Our revenues grew from $29.7 million in 2005 to $50.9 million in 2006 and $68.0 million in 2007 and we generated a net loss of $490,000 in 2005, $5.0 million in 2006 and $4.6 million in 2007. During the three months ended March 31, 2008, we generated $19.3 million of revenue compared to $15.7 million in the three months ended March 31, 2007 and we experienced a net loss of $1.9 million compared to a net loss of $1.4 million in the prior year period. As of March 31, 2008, we had an accumulated deficit of $35.3 million and total shareholder’s deficit of $32.5 million.

Industry Background

Enterprises must effectively communicate with their customers in order to remain competitive and, to achieve this, have traditionally used call centers staffed with large numbers of customer service agents who directly interact with customers over the phone. Call centers, however, have several drawbacks, particularly the cost of hiring, training and retaining quality agents and the difficulty of optimizing call centers to meet the demands of constantly changing call volumes. Many companies have outsourced their call centers in the belief it would generate cost savings. However, a number of these companies have found that outsourcing does not consistently reduce overall costs and does not improve customer satisfaction.

Companies have also tried to reduce costs by automating the way they communicate with customers or by using different communication methods. For example, in the 1980s enterprises began using computer systems that automated the dialing and distribution of calls and permitted consumers to use self-service options. In the 1990s, email and instant messaging, customer relationship management, or CRM, products and computer-telephony integration broadened the number of ways enterprises could communicate with their customers while attempting to enhance the customer experience through integration of these technologies.

These approaches, however, have generally failed to meet the growing needs and demands of businesses and their customers for several reasons:

 

   

they tend to automate customer-initiated (inbound) rather than proactive (outbound) communications;

 

   

they fail to meet individual customer needs because they do not integrate with existing information technology, or IT, systems and do not incorporate specific data on individual customers;

 

   

they are impersonal and do not intelligently route communications;

 

   

they lack a unified platform for multi-channel communications;

 

 

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they are costly and lack the ability to scale to meet the needs of large, complex enterprises; and

 

   

they are exposed to technology risk, requiring costly and timely efforts to upgrade.

Due to the shortcomings of legacy solutions, enterprises are increasingly investing in new technologies and services that enable proactive, actionable, automated customer communications to help strengthen customer loyalty and improve business performance.

Our Solution

Our platform allows us to deliver communications for our customers through multiple channels including voice, email, SMS, pager, web and fax or any combination thereof. Our applications are hosted on our multi-tenant platform which is capable of supporting hundreds of different applications simultaneously and executing millions of automated communications per day. We currently have over 600 applications deployed that result on average in over 3.5 million notifications each business day. Our solutions are:

 

   

Proactive, Actionable and Revenue Enhancing.    Our solutions enable enterprises to proactively contact customers with important information, improving end-customer satisfaction and helping our customers to meaningfully enhance revenues and reduce costs. For example, our technology platform might send an outbound call or email to notify someone that a flight is delayed. Our applications also incorporate self-service functions that enable customers to act upon the information they receive.

 

   

Personalized.    Our solutions use sophisticated integration to leverage existing customer data that reside in various IT systems to provide more targeted communications that increase customer response rates and satisfaction.

 

   

Intelligent.    Our on-demand platform provides a flexible architecture that is able to intelligently route information and communications to the appropriate systems or individuals.

 

   

Fully-Managed.    We offer a full range of managed services that allow us to design, implement and fine-tune our applications and optimize the performance and effectiveness of our customers’ communications initiatives.

 

   

Scalable for Multi-Channel Communications.    Our platform is designed to scale to meet the communications needs of large and sophisticated enterprises and to allow our customers to deliver communications to individuals through their preferred communication channels.

 

   

Flexible and Easy to Implement.    Our platform is built using open standards that typically enable it to quickly and seamlessly integrate with our customers’ existing IT systems. Deployment typically occurs in three to six weeks, and in some cases within 24 hours.

 

   

Less Expensive to Implement and Operate.    We deliver our solution through a fully-managed SaaS model, which limits our customers’ upfront investments and provides them with predictable costs that scale with usage.

 

   

Less Prone to Obsolescence.    Our on-demand platform allows our customers to immediately receive the benefits of ongoing improvements to our applications without having to invest in new software or implement costly and time consuming system upgrades.

Our Strategy

Our objective is to enhance our market leadership position by:

 

   

increasing our existing customers’ use of our solutions;

 

   

selectively targeting new customers within our selected industry sectors while also targeting new industry sectors as our business evolves;

 

 

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leveraging our domain expertise to continuously improve our applications and tailoring our solutions to specific customer needs;

 

   

bolstering our product leadership position by continuing to develop our technology platform in order to continue to increase the effectiveness of our solutions and extend our competitive advantages; and

 

   

entering new geographic markets.

Risks Affecting Us

Our business is subject to numerous risks, which are highlighted in the section entitled “Risk Factors” immediately following this prospectus summary. These risks represent challenges to the successful implementation of our strategy and the growth of our business. Some of these risks include:

 

   

we have a history of net losses and we may not achieve or sustain profitability in the future;

 

   

we have substantial customer concentration, and the success of our business depends on customers renewing and expanding their usage of our applications and services;

 

   

we participate in a new and evolving market, which makes it difficult to evaluate our current business and future prospects;

 

   

our future success will depend on our ability to develop new applications and services, and if we are unable to do so our revenues may not grow as expected; and

 

   

defects in our platform, disruptions in our services or errors in execution could diminish demand for our services and subject us to substantial liability.

Company Information

We were incorporated in Washington in January 2000 as Alertonline, Inc. We changed our name to PAR3 Communications Inc. in October 2000 and to Varolii Corporation in March 2007. In December 2005, we acquired EnvoyWorldWide, Inc., a Delaware corporation, which provided enterprise notification services for business continuity and emergency communications. We merged our wholly-owned subsidiary EnvoyWorldWide, Inc. with and into us on December 31, 2006.

Our principal offices are located at 821 2nd Avenue, Suite 1000, Seattle, Washington 98104, and our telephone number is (206) 902-3900. Our world wide web address is http://www.varolii.com. The information found on, or accessible through, our website is not part of this prospectus.

Varolii™, our logo, Varolii Profiles™ and Message MasteringSM are trademarks and/or service marks of Varolii. All other trademarks, tradenames and service marks appearing in this prospectus are the property of their respective owners. Except where the context requires otherwise, in this prospectus, “Company,” “Varolii,” “we,” “us,” and “our” refer to Varolii Corporation, a Washington corporation.

 

 

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THE OFFERING

 

Shares of common stock offered by us

             shares

 

Shares of common stock to be outstanding after this offering

             shares

 

Use of proceeds

We estimate that we will receive net proceeds of approximately $        million from this offering, or approximately $        million if the underwriters exercise in full their option to purchase additional shares, based on an assumed initial public offering price of $         per share, the midpoint of the range set forth on the cover page of this prospectus, in each case after deducting the underwriting discount and commissions and estimated expenses payable by us. We intend to use approximately $8.2 million of the net proceeds of this offering to repay outstanding indebtedness. The remainder of net proceeds will be used for working capital, capital expenditures and general corporate expenditures. See “Use of Proceeds.”

 

Proposed NASDAQ Global Market symbol

VRLI

The number of shares of our common stock outstanding after this offering is based on 110,051,338 shares outstanding as of March 31, 2008. This number does not include:

 

   

369,028 shares of common stock issuable upon the exercise of warrants outstanding as of March 31, 2008, with a weighted-average exercise price of $1.01 per share, of which warrants to purchase 295,499 shares of common stock with a weighted-average price of approximately $1.09 per share will expire at the closing of this offering, if they have not been previously exercised;

 

   

373,259 shares of convertible preferred stock issuable upon the exercise of warrants outstanding as of March 31, 2008 with a weighted average price of $0.27 per share, all of which will expire at the closing of this offering, if they have not been previously exercised;

 

   

24,995,969 shares of common stock issuable upon the exercise of options outstanding as of March 31, 2008 at a weighted average exercise price of $0.59 per share;

 

   

2,502,627 shares of common stock available for issuance under our 2000 stock option plan as of March 31, 2008; and

 

   

10,000,000 shares of common stock reserved for future issuance under our 2007 Equity Incentive Plan and 2,500,000 shares of common stock reserved for future issuance under our 2007 Employee Stock Purchase Plan, each of which will become effective at the consummation of this offering and contains a provision that will automatically increase the number of shares reserved under such plan each year.

Except as otherwise noted, all information in this prospectus:

 

   

reflects a            to            reverse stock split of our common stock approved by our board of directors on                                  to be effected prior to consummation of this offering;

 

   

reflects the automatic conversion of all our outstanding shares of convertible preferred stock into an aggregate of 93,687,998 shares of common stock effective upon the completion of this offering;

 

   

assumes no exercise of the underwriters’ option to purchase additional shares.

 

 

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SUMMARY CONSOLIDATED FINANCIAL DATA

The following tables summarize certain consolidated financial data regarding our business and should be read together with our consolidated financial statements and related notes, as well as “Selected Consolidated Financial Data” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The consolidated statements of operations data for the years ended December 31, 2005, 2006 and 2007 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated statements of operations data for the three months ended March 31, 2007 and 2008 and the consolidated balance sheet data as of March 31, 2008 are derived from our unaudited consolidated financial statements included elsewhere in this prospectus. The unaudited consolidated financial statements have been prepared on a basis consistent with our audited consolidated financial statements contained in this prospectus and include, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for the fair statement of the financial information in those statements. The pro forma consolidated balance sheet data set forth below give effect to the conversion of all outstanding convertible preferred stock into common stock, including the resulting reclassification of the convertible preferred stock warrant liability to common stock upon the completion of this offering. The pro forma as adjusted consolidated balance sheet data set forth below further give effect to the sale of shares of common stock in this offering at an assumed initial public offering price of $          per share, which is the midpoint of the price range listed on the cover page of this prospectus, after deducting the underwriting discount and commissions and estimated offering expenses payable by us and the application of the net proceeds from such sale. Our historical results are not necessarily indicative of the results to be expected in any future period and interim results are not necessarily indicative of the results to be expected for the full year.

 

     Year Ended December 31,     Three Months Ended
March 31,
 
     2005     2006     2007     2007     2008  
     (Dollars in thousands, except per share data)  

Consolidated Statements of Operations Data (1):

          

Revenues

   $ 29,738     $ 50,914     $ 68,038     $ 15,657     $ 19,339  
                                        

Operating expenses (2):

          

Cost of operations and support (exclusive of amortization of intangible assets)

     7,792       14,711       21,895       4,928    

 

6,416

 

Cost of services

     3,526       8,150       9,264       2,080       2,278  

Engineering and product development

     4,276       7,408       11,274       2,633       2,946  

Sales and marketing

     10,569       16,228       18,544       4,778       5,600  

General and administrative

     3,678       7,202       9,400       2,102       3,448  

Amortization of intangible assets

     85       1,254       1,254       313       313  
                                        

Total operating expenses

     29,926       54,953       71,631       16,834       21,001  
                                        

Loss from operations

     (188 )     (4,039 )     (3,593 )     (1,177 )     (1,662 )
                                        

Other income (expense):

          

Interest income

     163       136       242       54       47  

Interest expense

     (198 )     (576 )     (991 )     (202 )     (307 )

Change in fair value of convertible preferred stock warrant liability (3)

     (35 )     (521 )     (225 )     (116 )     96  

Other, net

     (29 )     5                    
                                        

Total other expense, net

     (99 )     (956 )     (974 )     (264 )     (164 )
                                        

Loss before income taxes

     (287 )     (4,995 )     (4,567 )     (1,441 )     (1,826 )

Provision for income taxes

                             (67 )
                                        

Net loss before cumulative change in accounting principle

     (287 )     (4,995 )     (4,567 )     (1,441 )     (1,893 )

Cumulative effect of change in accounting principle

     (203 )                        
                                        

Net loss

   $ (490 )   $ (4,995 )   $ (4,567 )   $ (1,441 )   $ (1,893 )
                                        

Net loss per common share, basic and diluted

   $ (0.05 )   $ (0.51 )   $ (0.36 )   $ (0.14 )   $ (0.12 )

Shares used in computing basic and diluted net loss per common share

     9,304,327       9,872,180       12,514,998       10,290,181       15,658,611  

Pro forma net loss per common share, basic and diluted (unaudited) (4)

       $ (0.04 )     $ (0.02 )

Shares used in computing pro forma basic and diluted net loss per common share (unaudited)

         105,944,271         109,346,609  

 

 

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     As of March 31, 2008
     Actual     Pro Forma     Pro Forma
As Adjusted (5)
     (In thousands)

Consolidated balance sheet data:

      

Cash and cash equivalents

   $ 2,673     $ 2,673     $             

Working capital (deficit)

     (5,164 )     (5,164 )  

Total assets

     41,837       41,837    

Convertible preferred stock warrant liability

     530          

Total indebtedness, including current portion

     9,109       9,109    

Convertible preferred stock

     42,565          

Common stock and additional paid-in capital

     2,784       45,879    

Total shareholders’ equity (deficit)

     (32,520 )     10,575    

 

(1) On December 6, 2005, we acquired EnvoyWorldWide, Inc. a provider of notification services for business continuity and emergency communications. The results of operations of EnvoyWorldWide, Inc. have been included in our results of operations from December 6, 2005.

 

(2) Includes stock-based compensation expense as follows:

 

     Year Ended December 31,    Three Months Ended
March 31,
         2005            2006            2007        2007    2008
     (In thousands)

Cost of operations and support

   $    $ 12    $ 65    $ 6    $ 58

Cost of services

          62      135      23      44

Engineering and product development

          39      130      18      53

Sales and marketing

          35      255      15      216

General and administrative

          16      637      22      244
                                  

Total stock-based compensation

   $    $ 164    $ 1,222    $ 84    $ 615
                                  

 

(3) The change in the fair value of convertible preferred stock warrant liability for the years ended December 31, 2005, 2006 and 2007 and for the three months ended March 31, 2007 and the benefit for the three months ended March 31, 2008 are non-cash charges and credits reflecting the change in fair value of our outstanding warrants to purchase convertible preferred stock during these periods. These changes in fair value were recorded in accordance with Financial Accounting Standards Board Staff Position No. 150-5, which we adopted as of July 1, 2005. We may incur warrant charges reflecting changes in the fair value of these warrants in future periods prior to the completion of this offering. Upon completion of this offering, however, these warrants will become exercisable for common stock and no further charges will be made to adjust for changes in the fair value of the warrants. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Convertible Preferred Stock Warrants” and notes 2 and 11 to our consolidated financial statements.

 

     In 2007, we recorded a charge of $225,000 to reflect the change in the fair value of our convertible preferred stock warrants as compared to a charge of $521,000 for 2006. In August 2007, the convertible preferred stock warrants related to our Series A and B preferred stock expired. This resulted in a reduction of $177,000 to the recorded liability with a corresponding decrease to the charge for 2007. In the three months ended March 31, 2008, we recorded a benefit of $96,000 to reflect the change in the fair value of our convertible preferred stock warrants as compared to a charge of $116,000 for the same period in 2007.

 

(4) See Note 2 to our consolidated financial statements for a description of the method used to compute pro forma basic and diluted net loss per common share. Pro forma basic and diluted net loss per common share has been computed to give effect to the assumed conversion of convertible preferred stock as though the conversion had occurred on the original date of issuance.

 

(5) Each $1.00 increase (decrease) in the assumed initial public offering price of $          per share would increase (decrease) each of cash and cash equivalents, working capital, total assets, common stock and additional paid-in capital and total shareholders’ deficit by $             million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting the underwriting discount and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. Each increase (decrease) of one million shares in the number of shares offered by us would increase (decrease) each of cash and cash equivalents, working capital, total assets, common stock and additional paid-in capital and total shareholders’ deficit by approximately $          million, assuming that the initial public offering price remains the same, and after deducting the underwriting discount and commissions and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only and will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing.

 

 

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RISK FACTORS

An investment in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below and all of the other information contained in this prospectus before deciding whether to purchase our common stock. The market price of our common stock could decline due to any of these risks and uncertainties, and you might lose all or part of your investment in our common stock.

Risks Related to Our Business and Industry

We have a history of net losses and we may not achieve or sustain profitability in the future.

We experienced net losses of $5.0 million, $4.6 million and $1.9 for the years ended December 31, 2006 and 2007, and the three months ended March 31, 2008, respectively. As of March 31, 2008, our accumulated deficit was approximately $35.3 million. We expect to continue to make significant expenditures related to the development and expansion of our business. In addition, as a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. We may incur significant losses in the future for a number of reasons, including the other risks described in this prospectus, and other unforeseen circumstances. Although our revenues have grown in recent periods, this growth may be unsustainable and, as a result, we may not achieve sufficient revenues to achieve profitability and, if achieved, maintain profitability. Accordingly, we may continue to incur significant losses for the foreseeable future which could materially and adversely affect our financial condition and the market price for our common stock.

Our quarterly operating results can be difficult to predict and can fluctuate substantially, which could result in volatility in the price of our common stock.

Our quarterly revenues and other operating results have varied in the past and are likely to continue to vary significantly from quarter to quarter. Our agreements with customers provide for minimum required monthly levels of usage or payments, and our revenues therefore can and do fluctuate from quarter to quarter based on the actual usage of our services as minimum usage levels are exceeded. Quarterly fluctuations in our operating results also might be due to numerous other factors, including, but not limited to:

 

   

the financial condition and business success of our customers;

 

   

purchasing and budgeting cycles of our customers as well as seasonality for certain of our customers;

 

   

timing of our customers’ communications initiatives;

 

   

our ability to continue to broaden the deployment throughout, and increase the usage of our applications by, our existing customers;

 

   

technical difficulties or interruptions in our services;

 

   

timing of development, introduction and acceptance of new applications, services or enhancements by us or our competitors;

 

   

telecommunications and internet disruptions;

 

   

our ability to attract new customers and the length of our sales cycle;

 

   

changes in our pricing policies or the pricing policies of our competitors;

 

   

competition, including our customers’ ability to meet their communication requirement internally, entry into the market in which we compete by new competitors or new offerings by existing competitors;

 

   

our ability to hire, train and retain sufficient sales, engineering, service and support and other personnel;

 

   

severe weather conditions and other catastrophic events;

 

   

our ability to adjust expenses to match revenues; and

 

   

general economic and financial market conditions.

 

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Many of these factors are beyond our control, and the occurrence of one or more of them could cause our operating results to vary widely. Because of quarterly fluctuations, we believe that quarter-to-quarter comparisons of our operating results are not necessarily meaningful. You should not rely on the results of one quarter as an indication of future performance.

We may fail to forecast accurately the behavior of existing and potential customers for our solutions. Many of our expense levels are based, in significant part, on our expectations as to future revenues and are largely fixed in the short term. As a result, we could be unable to adjust spending in a timely manner to compensate for any unexpected decline in revenues. We intend to increase our operating expenses as we expand our engineering, customer service and support, sales and marketing and administrative organizations. If we incorrectly time these increases or if we experience an unexpected delay in the rate at which personnel become productive or customers respond to our initiatives, our operating results could be materially and adversely affected.

Our largest customers account for a substantial portion of our revenues and the loss of any key customer could materially harm our business.

We currently derive a significant portion of our revenues from our largest customers. For the years ended December 31, 2005, 2006 and 2007 and the three months ended March 31, 2008, Bank of America and its affiliates, our largest customer, accounted for approximately 25%, 11%, 11% and 12% of our revenues, respectively; our five largest customers accounted for approximately 57%, 39%, 36% and 38% of our revenues, respectively; and our 20 largest customers, accounted for approximately 87%, 70%, 70% and 74% of our revenues, respectively. We expect that sales to a limited number of customers will continue to account for a significant portion of our revenues for the next several years. The concentration of our business with a small number of customers means that the loss of a few major customers or any concurrent reduction in the use of our solutions by these major customers would likely reduce our revenues and materially and adversely affect our results of operations.

Our business depends substantially on our existing customers renewing and expanding their usage of our applications and services. Any decline in our customer renewals and expansions would harm our future operating results.

The growth of our business depends on our ability to renew agreements with existing customers and to sell additional applications and increase the volume of usage. However, our customers have no obligation to renew their agreements after their initial term and, even if agreements are renewed, our customers may not purchase additional applications or higher levels of services, or increase their level of usage. Moreover, in some circumstances, our customers have the right to cancel their agreements before they expire. Our customers’ renewal rates may decline or fluctuate because of several factors, including their satisfaction or dissatisfaction with our solutions, the prices of our solutions, the prices of services offered by our competitors or reductions in our customers’ spending levels. If our customers cancel their agreements with us, do not renew their agreements, renew on terms less favorable to us or do not purchase additional applications or usage volume, our operating results would be adversely affected.

Many of our customers are price sensitive and if the prices we charge for our solutions are unacceptable, our operating results will be harmed.

Many of our customers are price sensitive and we have limited experience with respect to determining the appropriate prices for our solutions. As the market for our solutions matures, or as competitors introduce new products or services that compete with ours, we may be unable to renew our agreements with existing customers or attract new customers at the same price or on other terms and conditions previously agreed to. As a result, it is possible that competitive dynamics in our market may require us to change our pricing model or reduce our prices, which could harm our operating results.

Prospective customers, especially large enterprise customers, may require extensive integration services in order to take advantage of our applications, which may be costly and take longer to install than the services of some of our competitors. In addition, prospective customers may request customized features and functions

 

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unique to their business processes, which may be more expensive than our agreements provided for. If prospective customers perceive our solutions to be too expensive or time consuming, our results of operations and prospects may be adversely affected.

We participate in a new and evolving market, which makes it difficult to evaluate our current business and future prospects. If the market for customer communication services does not develop as we anticipate, our revenues would decline or fail to grow and we could incur operating losses.

We derive, and expect to continue to derive for the foreseeable future, all of our revenues by providing communications solutions to businesses, government entities and other organizations. Due to advances in technology, the market for solutions like ours continues to evolve, and it is uncertain whether our applications and services will achieve and sustain high levels of demand and market acceptance.

In addition, many companies have invested substantial effort and financial resources to integrate traditional enterprise software into their businesses and may be reluctant or unwilling to switch to a different application or migrate these applications to offerings such as ours. Other factors that may affect market acceptance of our applications and services include, but are not limited to, the following:

 

   

the security capabilities, reliability and availability of on-demand products and services;

 

   

customer concerns with entrusting a third party to store and process their data, especially confidential or sensitive data such as financial or medical information;

 

   

our ability to minimize the time and resources required to implement our applications and services;

 

   

our ability to maintain high levels of customer satisfaction;

 

   

our ability to implement upgrades and other changes to our software without disrupting our services;

 

   

the level of customization or configuration we offer;

 

   

our ability to provide rapid response time during periods of intense customer activity; and

 

   

the price, performance and availability of competing products and services.

If organizations do not perceive the potential and relative benefits of our applications and services or believe that other products and services (including those that are internally developed) offer a better value, the market for our solutions might not continue to develop or might develop more slowly than we expect, either of which would significantly adversely affect our business, financial condition and operating results. The market for products and services like ours is developing and the manner of its development is difficult to predict. We could make errors in predicting and reacting to relevant business trends, which could harm our operating results. Further, since it is difficult to predict with any assurance the future growth rate and size of this market, our ability to accurately evaluate our future prospects and forecast quarterly or annual performance is constrained.

If we are unable to develop new applications or services, our revenues will not grow as expected.

Our ability to attract new customers and to increase revenues from existing customers will depend in large part on our ability to enhance and improve our existing applications and to introduce new applications and services. The success of any enhancement or new application or service depends on several factors, including the timely completion, introduction and market acceptance of the enhancement, application or service. Our applications and services are technologically sophisticated and require significant resources to develop. Any new applications or services we develop or acquire may not be introduced in a timely or cost-effective manner. If we are unable to successfully develop or acquire new applications or services, or enhance our existing applications and services to meet customer requirements, our revenues will not grow as expected.

 

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Defects in our platform, disruptions in our services or errors in execution could diminish demand for our solutions and subject us to substantial liability.

Our platform is complex and incorporates a variety of hardware and proprietary and licensed software. Web-based services such as ours frequently experience disruptions from undetected defects when first introduced or when new versions, applications or enhancements are released. From time to time, we have found and corrected defects in our platform. Other defects in our platform, or defects in new features, complementary services or upgrades released in the future, could result in service disruptions for one or more customers. Because customers use our applications and services for critical business processes, any defect in our platform, any disruption in our applications and services or any error in execution could cause existing or potential customers not to use our solutions, could harm our reputation, and could subject us to litigation and significant liability for damage to our customers’ businesses.

Customers use our solutions to assist them in creating and managing customer communications initiatives with their end users. In order for a customer communications initiative to be executed successfully, our support professionals and engineers must correctly design, implement, test and deploy these applications. The performance of these tasks can require significant skill and effort, and may result in errors that adversely affect a customer’s communications initiatives.

The insurers under our existing liability insurance policy could deny coverage of a future claim that results from an error or defect in our platform or a resulting disruption in our applications and services, or our existing liability insurance might not be adequate to cover all of the damages and other costs of such a claim. Moreover, we cannot be certain that our current liability insurance coverage will continue to be available to us on acceptable terms or at all. The successful assertion against us of one or more large claims that exceeds our insurance coverage, or changes in our liability insurance policy, including an increase in premiums or imposition of large deductible or co-insurance requirements, could have a material adverse effect on our business, financial condition and operating results. Even if we succeed in litigation with respect to a claim or settle a claim with proceeds received from our insurers, we are likely to incur substantial costs and our management’s attention will be diverted from our operations.

Actual or perceived breaches of our security measures could diminish demand for our solutions and subject us to substantial liability.

We store and use our customers’ proprietary information, including confidential information about their end customers. Web-based services such as ours are particularly vulnerable to security breaches by third parties. Breaches of our security measures also might result from employee error or malfeasance or other causes. In the event of a security breach, a third party could obtain unauthorized access to our customers’ customer information and other data. Techniques used to obtain unauthorized access or to sabotage systems change frequently, and they typically are not recognized until after they have been launched against a target. As a result, we could be unable to anticipate or implement adequate preventative measures against these techniques. Because of the increasing importance of data security, any actual or perceived breach of our security measures could cause existing or potential customers not to use our solutions, could harm our reputation, and could subject us to litigation and significant liability for damage to our customers’ businesses.

We provide service level commitments to our customers, which could cause us to issue credits for future services if the committed service levels are not met for a given period which could adversely affect our reputation and revenues.

A majority of our customer agreements have service level commitments that require us to guarantee the availability of our applications and services for defined periods of time and/or maintain levels of performance and permit customers to receive service credits, or to terminate their agreements, if we fail to meet those standards. If we are unable to meet the stated service level commitments or suffer extended periods of unavailability for our applications and services, we may be contractually obligated to provide these customers with credits for future services or customers may terminate their agreements. Our ability to meet these service

 

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level commitments may be affected by factors which we can not control, such as delays or interruptions resulting from earthquakes, hurricanes, floods, fires, terrorist attacks, power losses, telecommunication failures and similar events. Our reputation and revenues could be significantly reduced if we suffer unscheduled downtime that exceeds the allowed downtimes under our agreements with these customers. We do not currently have any reserves on our balance sheet for these commitments. Any extended service outages could harm our reputation, revenues and operating results.

We face intense competition, and our failure to compete successfully would make it difficult for us to add and retain customers and would impede the growth of our business.

Our future success will depend in part upon our ability to increase our share of the customer communication market, to maintain and increase our recurring revenues from existing and new customers and to sell additional existing applications and services and new applications and services to existing and new customers. Our market is intensely competitive, rapidly changing and fragmented. It is subject to rapidly developing technology, shifting customer requirements, frequent introductions of new services and increased marketing activities of industry participants. Increased competition could result in pricing pressure and reduced sales leaving us with lower margins, and could prevent our applications and services from achieving or maintaining broad market acceptance.

Currently, we principally compete with the internal information technology departments of our customers who develop and maintain solutions in-house. Often we compete to sell our solutions against existing systems in which our potential customers have already made significant investments to develop and install and as a result may be less inclined to use our applications. We also face competition from other vendors, who tend to be confined within certain specific industry sectors or offer broad product suites in which customer communications is a small component.

The market in which we compete is evolving, and some of our competitors have significantly greater financial, technical, marketing, service and other resources than we have. Moreover, we believe it is likely that some of our existing competitors may consolidate or be acquired and as a result have more resources available to them. Competitors with greater financial resources might be able to offer lower prices, additional products or services, or other incentives that we cannot match or offer. These competitors could be in a stronger position to respond quickly to new technologies and could be able to undertake more extensive marketing campaigns. We believe that existing competitors and new market entrants will continue to develop solutions that will compete with our applications. If we are unable to compete effectively, it will be difficult for us to retain and add customers and our business, financial condition and operating results will be seriously harmed.

If we fail to manage our growth effectively, we may be unable to execute our business plan, maintain high levels of service or address competitive challenges adequately.

We have experienced rapid growth in recent periods. We have increased our number of employees from 144 at December 31, 2005 to 287 at March 31, 2008 and have increased our revenues from $29.7 million in 2005 to $68.0 million in 2007. Our expansion has placed, and our anticipated growth may continue to place, a significant strain on our managerial, administrative, operational, financial and other resources. We intend to further expand our overall business, customer base, headcount and operations as we prepare to be a public company. We may expand our operations internationally. Creating an international organization and managing a geographically dispersed workforce will require substantial management effort and significant additional investment in our infrastructure. To manage our growth, we will need to continue to improve our operational, financial and management processes and controls and reporting systems and procedures. This effort may require us to make significant capital expenditures or to incur significant expenses, and may divert the attention of our personnel from our core business operations, any of which may adversely affect our financial performance. If we fail to successfully manage our growth, our business, operating results and financial condition will be adversely affected.

 

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If we fail to retain our chief executive officer and other key executives and personnel, our business would be harmed and we might not be able to implement our business plan successfully.

Our future success depends upon the continued service of our executive officers and other key sales, marketing, service, engineering and technical staff. In particular, each of Nicholas Tiliacos, our chief executive officer and president, John Flavio, our chief financial officer, Jeffrey Read, our executive vice president of sales, marketing and business development, and Jean Francois Thions, our executive vice president of professional services, technology and business operations, is critical to the management of our business and operations. All of our executive officers are employed on an at-will basis and can cease their employment with us at any time with no advance notice. We do not maintain key person life insurance on any of our employees. We depend on our executive officers and other key personnel, and the loss of them would harm our operations and could prevent us from successfully implementing our business plan.

Because competition for employees in our industry is intense, we might not be able to attract and retain the highly skilled employees we need to execute our business plan.

To continue to execute our business plan, we must attract and retain highly qualified software sales and engineering personnel, the competition for which is particularly intense. We have experienced from time to time in the past, and expect to continue to experience in the future, difficulty in hiring and retaining highly skilled employees with appropriate qualifications. For example, we are highly dependent on our direct sales force to obtain renewals at higher levels of service from our existing customers and to generate new customers. New hires require significant training and typically take more than a year before they achieve full productivity. Our recent and planned hires might not achieve full productivity as quickly as intended, or at all. If we fail to hire, successfully train or retain sufficient numbers of direct sales personnel, we will be unable to increase our revenues and the growth of our business will be impeded.

Many of the companies with which we compete for experienced personnel have greater resources than we have. In addition, in making employment decisions, particularly in technology-based industries, job candidates often consider the number and value of the stock options they are to receive in connection with their employment. The requirement to expense stock options could discourage us from granting the size or type of stock options awards that job candidates require to join our company. If we fail to attract new personnel or fail to retain and motivate our current personnel, our business plan and future growth prospects could be severely harmed.

Interruptions or delays in services from our key vendors would impair the delivery of our on-demand services and could substantially harm our business and operating results.

We rely in large part upon a combination of hosting providers, telecommunications carriers and data carriers to deliver our applications and services. We serve our customers from third party data center facilities in Seattle, Washington, Denver, Colorado, Chicago, Illinois and Watertown, Massachusetts. Our agreements with these data center facilities automatically renew annually unless either party provides a termination notice within a set period prior to the expiration of the then-current term. If these agreements are not renewed on commercially reasonable terms, we may be forced to incur significant expenses to relocate a data center or agree to the terms demanded by the hosting provider, either of which could harm our business, financial position and operating results.

We deliver notifications through a mix of telecommunications and data carriers. We rely on these carriers to handle millions of customer contacts each day. We have contracts with these carriers that can be terminated by either party at the end of the contract term upon written notice delivered by either party within a specified number of days before the end of the term. If any such contract is terminated, we might be unable to obtain pricing on similar terms from another carrier, which would affect our operating results.

Our hosting facilities and our carriers’ infrastructures are vulnerable to damage or interruption from floods, earthquakes, fires and similar natural events, as well as acts of terrorism, break-ins, sabotage, intentional acts of vandalism and similar misconduct. The occurrence of such a natural disaster or misconduct, a loss of power, a decision by either of our hosting providers to close the facilities without adequate notice, or other unanticipated

 

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problems could result in lengthy interruptions in our services. Any interruption or delay in our services, even if for a limited time, could have an adverse effect on our business, financial condition and operating results.

If we are unable to protect our intellectual property rights, we would be unable to protect our proprietary technology and our brand.

If we fail to protect our intellectual property rights adequately, our competitors could gain access to our technology and our business could be harmed. We rely on patent, trade secret, copyright and trademark laws, and confidentiality and assignment of invention agreements with employees and third parties, all of which offer only limited protection. The steps we have taken to protect our intellectual property might not prevent misappropriation of our proprietary rights. We have only five issued patents, eight patent applications pending in the United States and five foreign patent applications. Our issued patents and any patents issued in the future, may not provide us with any competitive advantages or may be successfully challenged by third parties. Legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in other countries are uncertain and might afford little or no effective protection of our proprietary technology. Consequently, we could be unable to prevent our intellectual property rights from being exploited abroad, which could diminish international sales or require costly efforts to protect our technology. Policing the unauthorized use of intellectual property rights is expensive, difficult and, in some cases, impossible. Litigation could be necessary to enforce or defend our intellectual property rights, to protect our trade secrets, or to determine the validity and scope of the proprietary rights of others. Any such litigation could result in substantial costs and diversion of management resources, either of which could harm our business. Accordingly, despite our efforts, we might not be able to prevent third parties from infringing upon or misappropriating our intellectual property.

Our development efforts could be constrained by the intellectual property of others, and we could be subject to claims of intellectual property infringement, which could be costly and time-consuming.

Our industry is characterized by the existence of a large number of patents, trademarks and copyrights, and by litigation based upon allegations of infringement or other violations of intellectual property rights. As we face increasing competition, the possibility of intellectual property claims against us grows. For example, we are aware that one of our competitors recently received correspondence from a third party alleging that the right party connect service it provides to its customers infringes such third party’s patent rights. Although this third party withdrew its patent infringement claims and covenanted not to sue our competitor on its issued patents, we could be subject to similar claims. Any intellectual property rights claim, with or without merit, could be expensive to litigate or settle and could divert management resources and attention.

We might not prevail in any future intellectual property infringement litigation given the complex technical issues and inherent uncertainties in litigation. Any claims, regardless of their merit, could be time-consuming and distracting to management, result in costly litigation or settlement, cause product development delays, or require us to enter into royalty or licensing agreements. If our applications or services violate any third-party proprietary rights, we could be required to re-engineer our applications or services or seek to obtain licenses from third parties, which might not be available on reasonable terms or at all. Any efforts to re-engineer our applications and services, obtain licenses from third parties on favorable terms or license a substitute technology might not be successful and, in any case, might substantially increase our costs and harm our business, financial condition and operating results. Furthermore most of our services agreements require us to indemnify our customers for third-party intellectual property infringement claims, which would increase our costs as a result of defending such claims and may require that we pay damages if there were an adverse ruling in any such claims. These types of claims could harm our relationships with our customers, may deter future customers from subscribing to our services or could expose us to litigation with respect to these claims.

In addition, our platform incorporates open source software components that are licensed to us under various public domain licenses. While we believe we have complied with our obligations under the various applicable licenses for open source software that we use, there is little or no legal precedent governing the interpretation of many of the terms of certain of these licenses and therefore the potential impact of such terms on our business is somewhat unknown.

 

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Our platform relies on technology licensed from third parties, and our inability to maintain licenses of this technology on similar terms or errors in the licensed technology could result in increased costs or impair the implementation or functionality of our solutions, which would adversely affect our business and operating results.

We rely on platform technology licensed from third parties to provide our customer communications. For example, we use Java, the JBoss application server, Nuance text-to-speech and automated speech recognition software, Oracle and Microsoft SQL Server database. The software runs on a combination of Linux, Microsoft Windows and Sun servers. We anticipate that we will need to continue to license technology from third parties in the future. There might not always be commercially reasonable software alternatives to the third- party software that we currently license. Any such software alternatives could be more difficult or costly to replace than the third-party software we currently license, and integration of that software into our platform could require significant work and substantial time and resources. Any undetected errors in the software we license could prevent the implementation of our applications and services, impair the functionality of our solutions, delay or prevent the release of new features, complementary services or upgrades and injure our reputation. Our use of additional or alternative third-party software would require us to enter into license agreements with third parties, which might not be available on commercially reasonable terms or at all.

Any expansion of our business into foreign markets would expose us to additional business risks, and failure to manage those risks could adversely affect our business and operating results.

To date, we have focused our sales and marketing efforts principally on organizations located in the United States. Organizations in the United States accounted for substantially all of our revenues in each of years ended December 31, 2005, 2006 and 2007 and the three months ended March 31, 2008. One of our growth strategies is to commence operations in one or more foreign countries. Operating internationally requires significant resources and management attention and will subject us to regulatory, economic and political risks that are different from those in the United States and with which we are unfamiliar. Because of our limited experience with international operations, we cannot be certain that any international expansion efforts will be successful. In addition, we will face risks of doing business internationally that could adversely affect our business, including:

 

   

differing technical and certification requirements outside the United States;

 

   

difficulties and costs associated with staffing and managing foreign operations;

 

   

changes in regulatory requirements;

 

   

difficulties in understanding and complying with local laws, regulations and customs in foreign jurisdictions;

 

   

the need to adapt our applications for specific countries and languages;

 

   

more limited protection for intellectual property rights in some countries;

 

   

adverse tax consequences;

 

   

fluctuations in currency exchange rates;

 

   

restrictions on the transfer of funds; and

 

   

new and different sources of competition.

Our failure to manage any of these risks successfully could harm the future growth of our business and adversely affect our operating results. Any expansion of our international operations could require a substantial financial investment and significant management efforts.

 

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If we fail to maintain proper and effective internal controls, our ability to produce accurate and timely financial reports could be impaired, which could harm our operating results, our ability to operate our business and investors’ views of us.

Prior to this offering, we have been a private company and have not filed reports with the SEC. We will become subject to the public reporting requirements of the Securities Exchange Act of 1934 upon the completion of this offering. As a public reporting company we will be required, among other things, to maintain a system of effective internal controls over financial reporting. We produce our consolidated financial statements in accordance with the requirements of generally accepted accounting principles in the United States, or U.S. GAAP, but our internal controls may not currently meet all of the standards applicable to companies with publicly traded securities.

We are in the process of enhancing our billing system and general ledger. Additionally, we are in the process of documenting, evaluating and adjusting certain of our internal control processes and systems, including among others, processes and controls over our billing system, information technology security and access controls, general accounting and financial reporting. Improvements in our internal control processes and systems can only be accomplished over time, and our initiatives ultimately may not result in an effective internal control environment.

Effective internal controls are necessary for us to produce reliable financial reports and are important in our effort to prevent financial fraud. As a public company, we will be required to evaluate periodically the effectiveness of the design and operation of our internal controls over financial reporting. These evaluations may result in the conclusion that enhancements, modifications or changes to our internal controls are necessary or desirable. Although we have begun recruiting additional finance and accounting personnel with public company experience, we will need to hire additional personnel to meet these requirements. Our ability to hire and retain qualified personnel may affect our ability to meet these requirements.

While management evaluates the effectiveness of our internal controls on a regular basis, these controls may not always be effective. There are inherent limitations on the effectiveness of internal controls including, but not limited to, collusion, management override, and failure of human judgment. Because of these limitations, control procedures are designed to reduce rather than eliminate business risks. If we fail to maintain an effective system of internal controls or if management or our independent registered public accounting firm were to discover material weaknesses in our internal controls, we may be unable to produce timely, reliable financial reports or prevent fraud and it could harm our financial condition and results of operations and result in loss of investor confidence and a decline in our stock price.

Our operating results may be harmed if we are required to collect sales or other taxes for our services, which we have not historically done.

We do not currently collect sales or other taxes related to the services we provide to our customers. We are currently evaluating whether our services are taxable in the states in which we do business. As part of this ongoing evaluation, we have identified certain jurisdictions where our activities may require us to collect sales tax and we have recorded a liability for those states where we believe it is probable that we have incurred this obligation. One or more states may seek to impose sales or other tax collection obligations on us in the future, including for past sales by us, and the amount we have recorded and may record in the future may be inadequate to satisfy this obligation. A successful assertion that we should be collecting sales or other taxes on our services could result in substantial tax liabilities for past sales, discourage customers from purchasing our applications and services or otherwise harm our business and operating results.

We could be subject to penalties and damages if we or our customers violate federal or state telemarketing restrictions, which could harm our financial position and operating results.

The use of our applications and services for marketing communications is affected by extensive federal and state telemarketing regulation in the United States. Both the Federal Trade Commission, or FTC, and the Federal Communications Commission, or FCC, regulate interstate telephone sales calling activities under the provisions

 

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of the Telemarketing and Consumer Fraud and Abuse Prevention Act and the Telephone Consumer Protection Act, and FTC and FCC telemarketing regulations that have been promulgated under the authority of these two acts. These U.S. federal regulations restrict the circumstances, timing, content and manner of telemarketing calls, text messages and facsimile communications. The restrictions include the use of automated dialing systems, predictive dialing techniques and artificial or prerecorded voice messages and facsimile advertisements and contact with wireless telephone numbers. Other U.S. federal regulations which may affect our business include regulations relating to restrictions on artificial and prerecorded messages in connection with the debt collection industry and the use of email or text messages sent for the purpose of advertising the sale of goods and services.

In addition to extensive U.S. federal telemarketing regulations, many states have also enacted prohibitions or restrictions on telemarketing calls into their states, specifically covering the use of automatic dialing systems, predictive dialing techniques and email or text messages and regulations relating to the debt collection industry. Some of those state requirements are more stringent than the comparable federal requirements. To the extent our customers are unable to use our applications and services because of these regulatory restrictions, our applications and services will be less useful to them. For a further description of some of the government regulations that may affect our business operations, see “Business — Government Regulation.”

Our agreements with our customers require them to comply with the regulations in this area. Nevertheless, if customers use our applications and services in a manner that violates any of these federal or state laws, federal or state authorities may seek to subject us to regulatory fines or other penalties, even if the violation did not result from a failure of our applications and services. Further, if because of a technical failure in our platform, we fail to comply with any applicable federal and state regulations, we may be subject to substantial regulatory fines or other penalties as well as contractual claims by customers for damages. Any of these events could harm our business, reputation, financial position and operating results.

Our failure to comply with numerous and overlapping information security and privacy requirements could subject us to fines and other penalties as well as claims by our customers for damages, any of which could harm our reputation and business.

Our collection and use of personal information are affected by numerous privacy, security and data protection regulations. These regulations include the FTC’s Gramm-Leach-Bliley Privacy and Safeguard Rules, which restrict disclosures of non-public, personal, consumer information received by our financial institution customers and limit uses of such information to prescribed purposes that are disclosed to consumers, and the Fair Credit Reporting Act, which defines permissible uses of consumer information furnished to or obtained from consumer credit reporting agencies. In addition, many jurisdictions, including the majority of states, have data security laws, including laws requiring notification of the affected consumers and regulatory authorities when data security has been breached. These other regulations include those implementing the federal Health Insurance Portability and Accountability Act, or HIPAA, which regulates the maintenance, use and disclosure of protected health information by certain health care-related entities. Some of these laws are inconsistent with one another, and it may be difficult or impossible to comply with all of them.

Further, where we record certain of our calls for quality assurance or other purposes, we must comply with state laws that require both parties to consent to such recording. These laws apply inconsistent standards defining what type of consent is required. For a further description of some of the government regulations that may affect our business operations, see “Business — Government Regulation.”

In some cases our contracts with our customers expressly require us to comply with some or all of these regulations. Compliance can be costly, and our failure to satisfy these requirements or any violations of these regulations could lead to regulatory fines or other penalties, criminal liability, or claims by our customers for damages. These could hurt our reputation or harm our business, financial position and operating results. In addition, we rely on our customers’ assurances that any information we are contractually required to provide them is used for permissible purposes, but we cannot be certain that our customers comply with these restrictions. We could incur costs or could be subject to fines or other penalties if the applicable government entity determines that we have mishandled protected information including failure to properly dispose of such information.

 

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In addition, if we experience a breach of data security, we could be subject to costly legal proceedings that could lead to civil damages, fines or other penalties as well as claims by customers or third parties for damages. We or our customers could be required to report such breaches to affected consumers or regulatory authorities, leading to disclosures that could damage our reputation or harm our business, financial position and operating results as well as lead to contract claims or other claims by customers or third parties for damages.

Some foreign information security and privacy laws, including some in Canada and the European Union, may also apply to our services. These foreign laws may make it difficult to serve foreign customers because of the restrictions they place on the communication of personal data between countries and the handling of personal data. We expect to expand our operations outside the United States, and any country in which we commence or expand our operations may have laws or regulations comparable to or more stringent than those affecting our domestic business. In addition, it may be impossible for us to comply with the different data protection regulations that affect us in different jurisdictions. Such conflicts could subject us and our customers to costs, liabilities or negative publicity that could impair our ability to expand our operations into some countries and therefore limit our future growth.

We derive a significant portion of our revenues from the sale of our solutions for use in the debt collections process, and our business and operating results could be substantially harmed if new U.S. federal and state laws or regulatory interpretations in one or more jurisdictions either make our solutions unavailable or less attractive for use in the collections process or expose us to regulation as a debt collector.

Our customers’ use of our applications and services for debt collections processes is affected by an array of complex federal and state laws and regulations. For example, the U.S. Fair Debt Collection Practices Act, or FDCPA, limits debt collection communications by customers in the collection agencies industry, including third parties retained by creditors. In addition, many states impose additional requirements on debt collection communications, including limits on the frequency of debt collection calls, and some of those requirements may be more stringent than the comparable federal requirements. Moreover, regulations governing debt collection calls are subject to changing interpretations that may be inconsistent among different jurisdictions. If customers use our applications and services in violation of limits on the content, timing and frequency of their debt collection communications, we could be subject to claims by debtors that result in costly legal proceedings and that lead to civil damages, fines or other penalties.

We provide collection services to creditors and debt collectors, but we do not believe that we are a debt collector for purposes of these U.S. federal or state regulations. An allegation by one or more jurisdictions that we are a debt collector for purposes of their regulations could cause existing or potential customers not to use our solutions, harm our reputation, subject us to administrative proceedings, or result in our incurring significant legal fees and other costs. If it were to be determined that we are a debt collector for purposes of the regulations of one or more jurisdictions, we could be exposed to government enforcement actions and regulatory penalties and would be subject to additional rules, including licensing and bonding requirements. The costs of complying with these rules could be substantial, and we might be unable to continue to offer our solutions for debt collection communications in those jurisdictions, which would have a material adverse effect on our business, financial condition and operating results.

Risks Related to this Offering and Ownership of Our Common Stock

An active, liquid or orderly trading market for our common stock may not develop and you may not be able to resell your shares at or above the initial public offering price.

There has not been a public trading market for shares of our common stock prior to this offering. An active trading market may not develop or be sustained after this offering. If an active trading market in shares of our common stock does not develop, you may have difficultly selling any of the shares that you buy. The initial public offering price for the shares of common stock sold in this offering will be determined by negotiations between us and representatives of the underwriters. This price may not be indicative of the price at which our common stock will trade after this offering. If you purchase shares of our stock in this offering, you may not be able to resell those shares at or above the initial public offering price.

 

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Our stock price may be volatile and the value of your investment may decline significantly.

The market price of our common stock could be subject to wide fluctuations in response to, among other things, the risk factors described in this section of this prospectus, and other factors beyond our control, such as:

 

   

fluctuations in the market valuation of companies perceived by investors to be comparable to us;

 

   

changes in financial estimates by us or any research analysts who might cover our stock, or the failure to meet the estimates made by securities analysts;

 

   

publication of unfavorable research reports about us or our industry or withdrawal of research reports by research analysts;

 

   

regulatory developments in the United States, foreign countries or both;

 

   

actual or anticipated developments in our competitors’ businesses or the competitive landscape generally; and

 

   

the departure of key personnel.

Furthermore, the stock market in general and the market for the equity securities of technology companies in particular have experienced price and volume fluctuations that are unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions, may negatively affect the market price of our common stock.

In addition, many companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business.

In order to comply with the additional laws and regulations regarding corporate governance and public disclosure for public companies, our legal and accounting expenses and the demands upon management will increase substantially and we may not be able to attract and retain qualified individuals to serve on our board or as our officers.

Pursuant to Section 404 of the Sarbanes-Oxley Act, beginning with our Annual Report on Form 10-K for the fiscal year ending December 31, 2009, we will be required to furnish a report by our management on our internal control over financial reporting. Such report will contain, among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management. Such report must also contain a statement that our independent registered public accountants have issued an opinion on the effectiveness of our internal control over financial reporting. If we are unable to assert that our internal control over financial reporting is effective as of December 31, 2009 (or if our independent registered public accountants are unable to issue an opinion on the effectiveness of the Company’s internal control over financial reporting), we could lose investor confidence in the accuracy and completeness of our financial reports, which would have an adverse effect on our share price.

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. The Sarbanes-Oxley Act and rules implemented by the SEC, the Public Company Accounting Oversight Board and the NASDAQ Global Market have required changes in the corporate governance, compliance and financial reporting practices of public companies. As a result of these requirements, our legal and accounting compliance expenses, including expenses required in order to comply with the requirements under Section 404 of the Sarbanes-Oxley Act, and the demands on our management’s time will increase substantially. We are unable to currently estimate these costs with any degree of certainty and if they are greater than we currently expect, our operating results could be harmed. In addition, these rules and regulations may make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or

 

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similar coverage than used to be available. As a result, it may be more difficult for us to attract and retain qualified individuals to serve on our board of directors or as our executive officers which could adversely effect our ability to comply with SEC and NASDAQ Global Market director independence requirements.

Our principal shareholders, executive officers and directors own a significant percentage of our stock and will continue to have significant control of our management and affairs after the offering, and they can take actions that may be against your best interests.

Following the completion of this offering, our executive officers and directors, and entities that are affiliated with them, will beneficially own an aggregate of approximately         % of our outstanding common stock, or         % if the underwriters exercise in full their option to purchase additional shares. This significant concentration of share ownership may adversely affect the trading price for our common stock because investors often perceive disadvantages in owning stock in companies with controlling shareholders. For example, these shareholders, acting together, will have a significant influence over our management and affairs and may exert a controlling influence over matters requiring shareholder approval, including the election of directors and approval of significant corporate transactions, such as mergers, consolidations or the sale of substantially all of our assets. Consequently, this concentration of ownership may have the effect of delaying or preventing attempts by our shareholders to replace or remove members of our board of directors or transactions that may result in a change of control, even if such actions would benefit our other shareholders.

Our stock price could decline due to the large number of outstanding shares of our common stock eligible for future sale.

Sales of substantial amounts of our common stock in the public market following this offering, or the perception that these sales could occur, could cause the market price of our common stock to decline and could impair our ability to raise capital through the sale of additional equity securities.

Based on the number of shares of common stock outstanding as of March 31, 2008, and, assuming no exercise of outstanding options or warrants, upon completion of this offering, we will have              outstanding shares of common stock, or              shares if the underwriters exercise in full their option to purchase additional shares. The              shares sold pursuant to this offering will be immediately tradable without restriction. Of the remaining shares:

 

   

no shares will be eligible for sale on the date of this prospectus;

 

   

             shares will be eligible for sale upon the expiration of lock-up agreements;

 

   

             shares that are not subject to the lock-up agreements described below and are subject to market stand-off agreements with us will be eligible for sale upon expiration of the market stand-off agreements, beginning on the 181st day after the date of this prospectus, subject to early release by us, in our sole discretion, and subject in some cases to the provisions of Rule 144 and Rule 701 under the Securities Act of 1933, as amended, or Securities Act; and

 

   

the remainder of the shares will be eligible for sale in the public market from time to time thereafter upon the lapse of our right of repurchase with respect to any unvested shares.

Lehman Brothers Inc. and J.P. Morgan Securities Inc. may, in their sole discretion and at any time without prior notice, release all or any portion of the securities subject to lock-up agreement.

Certain parties to our investors’ rights agreement, who as of March 31, 2008 held 101,337,998 shares of common stock, will be entitled to demand that we register the offer and sale of such shares. Subject to the restrictions contained in the lock-up agreements, such holders may exercise those rights beginning 180 days after the date of this prospectus. In addition, upon the exercise of outstanding options, certain of our founders will be entitled to registration rights with respect to the shares of common stock underlying those options. See “Description of Capital Stock — Registration Rights.” Furthermore, shortly following this offering, we intend to register the offer and sale of approximately 24,777,219 shares of common stock that have been issued or reserved for issuance under our 2000 stock option plan.

 

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Our management has broad discretion in the use of the net proceeds from this offering and may not use the net proceeds effectively.

Our management will have broad discretion in the application of the net proceeds of this offering. Other than the anticipated repayment of debt, we cannot specify with certainty how we will apply the remaining net proceeds we will receive from this offering and we may spend or invest these proceeds in a way with which our shareholders disagree. We plan to invest the net proceeds of this offering in short-term, investment-grade, interest-bearing securities. These investments may not yield a favorable return for our shareholders. The failure by our management to apply these funds effectively could adversely affect our business and prospects.

Our charter documents and Washington law could prevent a takeover that shareholders consider favorable and could also reduce the market price of our stock.

Our articles of incorporation and bylaws contain provisions that could delay or prevent a change in control of our company. These provisions could also make it more difficult for shareholders to affect the composition of our board of directors and take other corporate actions. These provisions include:

 

   

providing for a classified board of directors with staggered, three-year terms;

 

   

not enabling cumulative voting in the election of directors;

 

   

authorizing the board to issue, without shareholder approval, preferred stock with rights senior to those of common stock;

 

   

prohibiting shareholder action by written consent;

 

   

limiting the persons who may call special meetings of shareholders; and

 

   

requiring advance notification of shareholder proposals and nominations of directors.

In addition, the provisions of Section 23B.19.040 of the Washington Business Corporation Act govern us. These provisions may prohibit large shareholders, in particular those owning 10% or more of our outstanding voting stock, from merging or combining with us for five years unless our board of directors approves such a transaction.

These and other provisions in our articles of incorporation, our bylaws and under Washington law could discourage potential takeover attempts, reduce the price that investors might be willing to pay for shares of our common stock in the future and result in the market price being lower than it would be without these provisions. See “Description of Capital Stock — Preferred Stock” and “Description of Capital Stock — Anti-Takeover Provisions.”

 

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CAUTIONARY NOTICE REGARDING FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements. These statements relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “expect,” “plan,” “intend,” “anticipate,” “believe,” “estimate,” “predict,” “potential” or “continue,” the negative of such terms or other comparable terminology. These statements are only predictions. Actual events or results may differ materially. In evaluating these statements, you should specifically consider various factors, including the risks outlined in “Risk Factors.” These factors may cause our actual results to differ materially from any forward-looking statement.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, events, levels of activity, performance or achievements. We are under no duty to update any of the forward-looking statements after the date of this prospectus to conform such statements to actual results or to changes in our expectations.

 

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USE OF PROCEEDS

We estimate that the net proceeds from this offering will be approximately $         million, or approximately $         million if the underwriters exercise in full their option to purchase additional shares, based on an assumed initial public offering price of $         per share, which is the midpoint of the price range listed on the cover page of this prospectus and after deducting the underwriting discount and commissions and estimated offering expenses payable by us.

The principal purposes of this offering are to create a public market for our common stock, to obtain additional equity capital and to facilitate future access to the public markets. We intend to use approximately $8.2 million of the net proceeds from this offering to repay outstanding indebtedness and prepayment premiums and the remainder for general corporate purposes, which may include working capital and capital expenditures. We currently anticipate that capital expenditures during 2008 will be between $7.5 million and $8.5 million. However, our plans for the proceeds of this offering are subject to change due to unforeseen events and opportunities, and the amounts and timing of our actual expenditures depend on several factors, including our expansion plans and the amount of cash generated or used by our operations. We may also use proceeds from this offering for potential acquisitions of businesses, products or technologies; however, we are not currently a party to any agreement or commitment for any acquisition, and we have no current understandings with respect to any acquisition. Except as we have specifically set forth in this prospectus, we cannot specify with certainty the particular uses for the net proceeds to be received upon completion of this offering. Accordingly, our management team will have broad discretion in using the net proceeds of this offering. Pending the use of the net proceeds, we intend to invest the net proceeds in short-term, investment-grade, interest-bearing instruments.

The indebtedness we anticipate repaying with the net proceeds of this offering consists of (1) a term loan with an interest rate of 10.71%, an outstanding balance of $3.0 million as of March 31, 2008 and a maturity date of May 1, 2010; (2) a term loan with an interest rate of 10.89%, an outstanding balance of $1.3 million as of March 31, 2008 and a maturity date of December 1, 2009; (3) a term loan with an interest rate of 10.0%, an outstanding balance of $174,000 as of March 31, 2008 and a maturity date of August 1, 2008; (4) a term loan with an interest rate of 10.75%, an outstanding balance of $249,000 on March 31, 2008 and a maturity date of December 1, 2008; and (5) a $16.0 million accounts receivable revolving line of credit, with an interest rate equal to the prime rate plus 1.5%, an outstanding balance of $3.5 million as of March 31, 2008 and a maturity date of July 30, 2009. The prime rate at March 31, 2008 was 5.25%. We used the proceeds of these loans for working capital purposes.

Each $1.00 increase (decrease) in the assumed initial public offering price of $         per share would increase (decrease) net proceeds to us by $         million, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same. We may also increase or decrease the number of shares we are offering. Each increase (decrease) of one million shares in the number of shares offered by us would increase (decrease) net proceeds to us by approximately $         million, assuming that the assumed initial public offering price remains the same, and after deducting the underwriting discount and commissions and estimated offering expenses payable by us. We do not expect that a change in the offering price or the number of shares would have a material effect on our uses of the proceeds of this offering, although it may accelerate the timing of attempts to obtain additional capital.

DIVIDEND POLICY

We have never declared or paid any cash dividends on our common stock. We currently intend to retain all available funds to support our operations and to finance the growth and development of our business. Any future determination relating to dividend policy will be made at the discretion of our board of directors and will depend on a number of factors, including our future earnings, capital requirements, financial condition, future prospects and other factors as our board of directors may deem relevant. Furthermore, certain of our loan agreements prohibit the payment of dividends without the applicable lender’s consent. We intend to repay all such indebtedness with the net proceeds of this offering.

 

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CAPITALIZATION

The following table sets forth our cash and cash equivalents and capitalization as of March 31, 2008:

 

   

on an actual basis;

 

   

on a pro forma basis to reflect (1) the conversion of all outstanding convertible preferred stock into common stock upon the completion of this offering, including the resulting reclassification of $530,000 of warrant liability to additional paid-in capital upon the conversion of the warrants to purchase our convertible preferred stock into warrants to purchase shares of our common stock and (2) the increase in the authorized number of shares of common stock under our articles of incorporation from 141,000,000 to 625,000,000 upon completion of this offering; and

 

   

on a pro forma as adjusted basis to reflect the pro forma adjustments described above and to give effect to the issuance of the shares of our common stock offered by us at an assumed initial public offering price of $         per share, the midpoint of the range set forth on the cover page of this prospectus, after deducting the underwriting discount and commissions and estimated offering expenses payable by us and the application of the net proceeds from this offering.

You should read this table together with “Use of Proceeds,” “Prospectus Summary — Summary Consolidated Financial Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes, each included elsewhere in this prospectus.

 

    As of March 31, 2008
    Actual   Pro Forma   Pro Forma
As Adjusted
   

(In thousands,

except share and per share data)

Cash and cash equivalents

  $ 2,673   $ 2,673  
               

Convertible preferred stock warrant liability

  $ 530      
               

Total indebtedness, including current portion

  $ 9,109   $ 9,109  

Convertible preferred stock, $0.001 par value per share:

     

Series A convertible preferred stock: 10,500,000 shares authorized, 9,865,003 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

    5,655      

Series B convertible preferred stock: 16,500,000 shares authorized, 16,314,323 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

    11,935      

Series C convertible preferred stock: 60,000,000 shares authorized, 56,362,210 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

    15,699      

Series C-1 convertible preferred stock: 12,000,000 shares authorized, 11,146,462 shares issued and outstanding, actual; no shares authorized, issued or outstanding, pro forma and pro forma as adjusted

    9,276      
               

Total preferred stock

    42,565      
               

 

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    As of March 31, 2008
    Actual     Pro Forma     Pro Forma
As Adjusted
   

(In thousands,

except share and per share data)

Shareholders’ equity (deficit):

     

Common stock, $0.001 par value per share: 141,000,000 shares authorized, 16,363,340 shares issued and outstanding, actual; 625,000,000 shares authorized, 110,051,338 shares issued and outstanding, pro forma; 625,000,000 shares authorized,                      shares issued and shares outstanding, pro forma as adjusted

    16       110    

Additional paid-in capital

    2,768       45,769    

Accumulated deficit

    (35,304 )     (35,304 )  
                     

Total shareholders’ equity (deficit)

    (32,520 )     10,575    
                     

Total capitalization

  $ 19,684     $ 19,684     $             
                     

The number of shares of our common stock outstanding after this offering is based on 110,051,338 shares outstanding as of March 31, 2008. This number does not include:

 

   

369,028 shares of common stock issuable upon the exercise of warrants outstanding as of March 31, 2008, with a weighted-average exercise price of $1.01 per share, of which warrants to purchase 295,499 shares of common stock with a weighted-average price of approximately $1.09 per share will expire at the closing of this offering, if they have not been previously exercised;

 

   

373,259 shares of convertible preferred stock issuable upon the exercise of warrants outstanding as of March 31, 2008, with a weighted average price of $0.27 per share, all of which will expire at the closing of this offering, if they have not been previously exercised;

 

   

24,995,969 shares of common stock issuable upon the exercise of options outstanding as of March 31, 2008, at a weighted average exercise price of $0.59 per share;

 

   

2,502,627 shares of common stock available for issuance under our 2000 stock option plan as of March 31, 2008; and

 

   

10,000,000 shares of common stock reserved for future issuance under our 2007 Equity Incentive Plan and 2,500,000 shares of common stock reserved for future issuance under our 2007 Employee Stock Purchase Plan, each of which will become effective at the consummation of this offering and contains a provision that will automatically increase the number of shares reserved under such plan each year.

 

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DILUTION

If you invest in our common stock, your interest will be immediately diluted to the extent of the difference between the initial public offering price per share of our common stock and the pro forma as adjusted net tangible book value per share of our common stock after this offering.

As of March 31, 2008, we had a pro forma net tangible book value of $980,000, or $0.01 per share of common stock outstanding. Pro forma net tangible book value per share is equal to our total tangible assets (total assets less total intangible assets) less total liabilities, divided by the pro forma number of shares of common stock outstanding, which gives effect to the conversion of all outstanding shares of our convertible preferred stock into common stock upon completion of this offering, including the resulting reclassification of $530,000 of warrant liability to additional paid-in-capital upon conversion of the warrants to purchase our convertible preferred stock into warrants to purchase shares of our common stock.

Dilution in pro forma net tangible book value per share represents the difference between the amount per share paid by investors in this offering and pro forma net tangible book value per share of our common stock immediately after the completion of this offering. After giving effect to the issuance and sale by us of              shares of our common stock in this offering at the assumed initial public offering price of $         per share, which is the midpoint of the range set forth on the cover page of this prospectus, and after deducting the underwriting discount and commissions and our estimated offering expenses, our pro forma as adjusted net tangible book value as of March 31, 2008 would have been approximately $         million, or approximately $         per share. This represents an immediate increase in pro forma net tangible book value of $         per share to our existing shareholders and an immediate dilution in pro forma net tangible book value of $         per share to our new investors purchasing shares of common stock in this offering. The following table illustrates this per share dilution:

 

Assumed initial public offering price per share

      $         

Pro forma net tangible book value per share as of March 31, 2008, before giving effect to this offering

   $ 0.01   

Increase in pro forma net tangible book value per share attributable to this offering

     
         

Pro forma as adjusted net tangible book value per share after giving effect to this offering

     
         

Dilution in pro forma net tangible book value per share to new investors

      $         
         

The following table shows, as of March 31, 2008, the total consideration paid, and the average price per share paid to us by existing shareholders, and the number of shares of common stock purchased from us, the total consideration paid, and the average price per share paid by existing shareholders and by new investors purchasing shares in this offering, based on an assumed initial public offering price of $         per share, which is the midpoint of the range set forth on the cover page of this prospectus, and before deducting the underwriting discount and commissions and estimated offering expenses payable by us.

 

     Shares Purchased     Total Consideration     Average Price
Per Share
     Number    Percent     Amount    Percent    

Existing shareholders

   110,051,338         %   $ 42,858,762         %   $ 0.40

New investors

            
                          

Total

      100.0 %      100.0 %  
                          

Each $1.00 increase (decrease) in the assumed initial public offering price of $             per share would increase (decrease) our pro forma as adjusted net tangible book value by approximately $            , or approximately $             per share, and the dilution in pro forma net tangible book value per share to new investors by approximately $             per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the underwriting discount and commissions and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are

 

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offering. An increase of one million shares in the number of shares offered by us would increase our pro forma as adjusted net tangible book value by approximately $             million, or $             per share, and the pro forma dilution per share to investors in this offering would be $             per share, assuming that the assumed initial public offering price remains the same, and after deducting the underwriting discount and commissions and estimated offering expenses payable by us. Similarly, a decrease of one million shares in the number of shares offered by us would decrease our pro forma as adjusted net tangible book value by approximately $             million, or $             per share, and the pro forma dilution per share to investors in this offering would be $             per share, assuming that the assumed initial public offering price remains the same, and after deducting the underwriting discount and commissions and estimated offering expenses payable by us. The pro forma as adjusted information discussed above is illustrative only and will be adjusted based on the actual initial public offering price and other terms of this offering determined at pricing.

The number of shares of our common stock outstanding after this offering is based on 110,051,338 shares outstanding as of March 31, 2008. This number does not include:

 

   

369,028 shares of common stock issuable upon the exercise of warrants outstanding as of March 31, 2008, with a weighted-average exercise price of $1.01 per share, of which warrants to purchase 295,499 shares of common stock with a weighted-average price of approximately $1.09 per share will expire at the closing of this offering, if they have not been previously exercised;

 

   

373,259 shares of convertible preferred stock issuable upon the exercise of warrants outstanding as of March 31, 2008, with a weighted average price of $0.27 per share, all of which will expire at the closing of this offering, if they have not been previously exercised;

 

   

24,995,969 shares of common stock issuable upon the exercise of options outstanding as of March 31, 2008, at a weighted average exercise price of $0.59 per share;

 

   

2,502,627 shares of common stock available for issuance under our 2000 stock option plan as of March 31, 2008; and

 

   

10,000,000 shares of common stock reserved for future issuance under our 2007 Equity Incentive Plan and 2,500,000 shares of common stock reserved for future issuance under our 2007 Employee Stock Purchase Plan, each of which will become effective at the consummation of this offering and contains a provision that will automatically increase the number of shares reserved under such plan each year.

 

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SELECTED CONSOLIDATED FINANCIAL DATA

The following tables summarize certain financial data regarding our business and should be read together with our consolidated financial statements and related notes, as well as “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this prospectus. The consolidated statements of operations data for the years ended December 31, 2005, 2006 and 2007 and the consolidated balance sheet data as of December 31, 2006 and 2007 are derived from our audited consolidated financial statements included elsewhere in this prospectus. The consolidated statement of operations data for the years ended December 31, 2003 and 2004 and the consolidated balance sheet data as of December 31, 2003, 2004 and 2005 are derived from audited consolidated financial statements not included in this prospectus. The consolidated statements of operations data for the three months ended March 31, 2007 and 2008 and the consolidated balance sheet data as of March 31, 2008 are derived from our unaudited consolidated financial statements included elsewhere in this prospectus. The unaudited consolidated financial statements have been prepared on a basis consistent with our audited consolidated financial statements contained in this prospectus and include, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for the fair statement of the financial information in those statements. Our historical results are not necessarily indicative of the results to be expected in any future period, and interim results are not necessarily indicative of the results to be expected for the full year.

 

    Year Ended December 31,     Three Months ended
March 31,
 
    2003     2004     2005     2006     2007     2007     2008  
    (Dollars in thousands, except per share data)        

Consolidated statements of operations data (1):

             

Revenues

  $ 8,741     $ 16,192     $ 29,738     $ 50,914     $ 68,038     $ 15,657     $ 19,339  
                                                       

Operating expenses (2):

             

Cost of operations and support (exclusive of amortization of intangible assets)

    1,886       4,285       7,792       14,711       21,895       4,928       6,416  

Cost of services

    899       1,484       3,526       8,150       9,264       2,080       2,278  

Engineering and product development

    2,208       2,066       4,276       7,408       11,274       2,633       2,946  

Sales and marketing

    4,369       6,367       10,569       16,228       18,544       4,778       5,600  

General and administrative

    2,447       2,474       3,678       7,202       9,400       2,102       3,448  

Amortization of intangible assets

                85       1,254       1,254       313       313  
                                                       

Total operating expenses

    11,809       16,676       29,926       54,953       71,631       16,834       21,001  
                                                       

Loss from operations

    (3,068 )     (484 )     (188 )     (4,039 )     (3,593 )     (1,177 )     (1,662 )
                                                       

Other income (expense):

             

Interest income

    100       81       163       136       242       54       47  

Interest expense

    (114 )     (138 )     (198 )     (576 )     (991 )     (202 )     (307 )

Change in fair value of convertible preferred stock warrant liability (3)

                (35 )     (521 )     (225 )     (116 )     96  

Other, net

                (29 )     5                    
                                                       

Total other expense, net

    (14 )     (57 )     (99 )     (956 )     (974 )     (264 )     (164 )
                                                       

Loss before income taxes

    (3,082 )     (541 )     (287 )     (4,995 )     (4,567 )     (1,441 )     (1,826 )

Provision for income taxes

                                        (67 )
                                                       

Net loss before cumulative effect of change in accounting principle

    (3,082 )     (541 )     (287 )     (4,995 )     (4,567 )     (1,441 )     (1,893 )

Cumulative effect of change in accounting principle

                (203 )                        
                                                       

Net loss

  $ (3,082 )   $ (541 )   $ (490 )   $ (4,995 )   $ (4,567 )   $ (1,441 )   $ (1,893 )
                                                       

Net loss per common share, basic and diluted

  $ (0.33 )   $ (0.06 )   $ (0.05 )   $ (0.51 )   $ (0.36 )   $ (0.14 )   $ (0.12 )

Shares used in computing basic and diluted net loss per common share

    9,286,447       9,302,972       9,304,327       9,872,180       12,514,998       10,290,181       15,658,611  

Pro forma net loss per common share, basic and diluted (unaudited) (4)

          $ (0.04 )     $ (0.02 )

Shares used in computing pro forma basic and diluted net loss per common share (unaudited)

            105,944,271         109,346,609  

 

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    As of December 31,     As of
March 31,
2008
 
    2003     2004     2005     2006     2007    
    (In thousands)        

Consolidated balance sheet data:

           

Cash and cash equivalents

  $ 8,136     $ 2,554     $ 3,283     $ 4,070     $ 1,854     $ 2,673  

Working capital (deficit)

    7,273       6,648       1,468       1,504       (4,084 )     (5,164 )

Total assets

    13,815       14,716       35,757       40,620       43,512       41,837  

Convertible preferred stock warrant liability

                431       952       626       530  

Total indebtedness, including current portion

    188       1,577       3,750       9,129       10,409       9,109  

Convertible preferred stock

    32,638       32,638       41,914       41,914       42,565       42,565  

Common stock and additional paid-in capital

    220       220       31       260       2,095       2,784  

Total shareholders’ deficit

    (22,598 )     (23,139 )     (23,818 )     (28,584 )     (31,316 )     (32,520 )

 

(1) On December 6, 2005, we acquired EnvoyWorldWide, Inc. a provider of notification services for business continuity and emergency communications. The results of operations of EnvoyWorldWide, Inc. have been included in our results of operations from December 6, 2005.

 

(2) Includes stock-based compensation expense as follows:

 

    Year Ended December 31,   Three Months Ended
March 31,
        2003           2004           2005           2006           2007           2007           2008    
    (In thousands)

Cost of operations and support

  $   $   $   $ 12   $ 65   $ 6   $ 58

Cost of services

                62     135     23     44

Engineering and product development

                39     130     18     53

Sales and marketing

                35     255     15     216

General and administrative

                16     637     22     244
                                         

Total stock-based compensation

  $   $   $   $ 164   $ 1,222   $ 84   $ 615
                                         

 

(3) The change in the fair value of convertible preferred stock warrant liability for the years ended December 31, 2005, 2006 and 2007 and for the three months ended March 31, 2007 and the benefit for the three months ended March 31, 2008 are non-cash charges and credits reflecting the change in fair value of our outstanding warrants to purchase convertible preferred stock during these periods. These changes in fair value were recorded in accordance with Financial Accounting Standards Board Staff Position No. 150-5, which we adopted as of July 1, 2005. We may incur warrant charges reflecting changes in the fair value of these warrants in future periods prior to the completion of this offering. Upon completion of this offering, however, these warrants will become exercisable for common stock and no further charges will be made to adjust for changes in the fair value of the warrants. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies — Convertible Preferred Stock Warrants” and notes 2 and 11 to our consolidated financial statements.

 

     In 2007, we recorded a charge of $225,000 to reflect the change in the fair value of our convertible preferred stock warrants as compared to a charge of $521,000 for 2006. In August 2007, the convertible preferred stock warrants related to Series A and B preferred stock expired. This resulted in a reduction of $177,000 to the recorded liability with a corresponding decrease to the charge for 2007. In the three months ended March 31, 2008, we recorded a benefit of $96,000 to reflect the change in the fair value of our convertible preferred stock warrants as compared to a charge of $116,000 for the same period in 2007.

 

(4) See Note 2 to our consolidated financial statements for a description of the method used to compute pro forma basic and diluted net loss per common share. Pro forma basic and diluted net loss per common share has been computed to give effect to the assumed conversion of convertible preferred stock as though the conversion had occurred on the original date of issuance.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis by our management of our financial condition and results of operations in conjunction with our consolidated financial statements and the accompanying notes included elsewhere in this prospectus. This discussion and other parts of this prospectus contain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in “Risk Factors.”

Overview

We provide on-demand, interactive customer communications solutions. Our solutions consist of software applications and services that enterprises use on an as-needed, or on-demand, basis to create, manage and deliver automated, personalized communications to their customers through multiple media channels including voice, email, SMS, pager, web and fax. Customers are able to interact with enterprises by receiving and responding directly to important personalized information provided by our automated communications. Enterprises who use our solutions typically experience higher levels of customer loyalty and satisfaction and, as a result, our solutions enable these enterprises to enhance revenues and to reduce costs by improving their communications processes. Our customer communications solutions span the customer lifecycle with applications for customer initiation, customer service, customer retention and collections. We also provide business continuity solutions, which consist of software applications and services that organizations use to quickly and reliably communicate with employees and customers during inclement weather, disasters, network outages and other planned and unplanned incidents.

We sell our customer communications solutions primarily through our direct sales force and our business continuity offerings primarily through our channel partners. Our solutions are currently used by more than 350 organizations, including customers in the financial services, telecommunications, utilities, healthcare, transportation and other industries, as well as government organizations. Our customers are located principally in the United States and include more than 100 of the Fortune 1000. Our customers typically add applications, broaden the deployment of our solutions across their organizations and increase the usage of our services over time. We typically enter into usage-based, one-to-three-year contracts with our customers. Our customers typically renew their contracts and a significant percentage of our revenues in any given period are derived from existing customers, and we expect this to continue. For example, during the year ended December 31, 2007, over 95% of our revenues were attributable to revenues from customers from whom we derived revenues in 2006. We currently send on behalf of our customers on average over 3.5 million notifications each business day, including flight cancellation notices, credit card fraud detection alerts, service call scheduling, customer service feedback surveys, medication adherence notifications and payment reminders.

We were incorporated in January 2000, and in late 2000 we released our first applications and acquired our first customers. Our revenues grew from $29.7 million in 2005 to $50.9 million in 2006 and to $68.0 million in 2007. For three months ended March 31, 2008, we generated $19.3 million of revenue compared to $15.7 million in the three months ended March 31, 2007. In December 2005, we acquired all of the outstanding shares of EnvoyWorldWide, Inc., or Envoy, a provider of high availability business continuity and emergency communications for a total purchase price of $10.1 million including acquisition costs. We acquired Envoy to expand our business continuity offerings. Envoy’s business continuity services enable businesses to establish interactive voice and text communications between their customers, suppliers, partners and employees using outbound real-time message delivery to wired and wireless devices including phones, faxes, emails, pagers and other wireless devices. We have incurred losses to date and had an accumulated deficit of approximately $35.3 million at March 31, 2008.

Key Components of Our Results of Operations

Revenues

We generate revenues from our customers’ usage of our on-demand customer communications and business continuity offerings. We also generate revenues from professional services and customer management services.

 

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Over 90% of our revenues are derived from customer notifications and business continuity offerings, and less than 10% are derived from professional services and customer management services, which we expect to continue to constitute less than 10% of our revenues for the foreseeable future.

We generally provide our customer communications solutions pursuant to non-cancelable contracts with terms ranging from one year to three years that require our customers to commit to a minimum number of notifications per month. Our contracts typically provide that we bill our customers for the greater of their actual usage and their monthly minimum committed usage. For most customers, we bill the monthly minimum committed usage in advance, and bill actual usage above the minimum commitment monthly in arrears. We recognize revenue based upon actual usage within a calendar month. To allow for seasonality and normal business fluctuations in the operations of our customers, we permit our customers to carry over a portion, not to exceed 25% of their annual commitment in the aggregate, of their minimum monthly notifications to future periods. We record billings for carryover amounts as deferred revenue and at the end of the contract term we recognize deferred revenue, if any, related to unused carryover notifications. Historically, a small number of our customers have had such carryovers.

Our business model and pricing structure are attractive to our customers because they limit the risks of adopting our services. Our pricing structure also allows our customers to exceed their minimum commitments at the same contracted per unit rate. Our usage-based pricing model allows us to earn additional revenues as we incur additional variable expenses, such as telephony costs, associated with increased usage by our customers.

Our business continuity offerings are typically provided under annual or multi-year agreements pre-paid on an annual basis with revenues recognized pro-rata over the contract period. When an incident occurs and notifications are sent in excess of contracted minimum levels, we charge additional fees and recognize revenues as the additional notifications are delivered.

We generate revenues from professional services, which include configuration and integration of our customer communications applications and business continuity solutions with customer data and systems, and training. We bill upon completion of these projects and recognize revenue ratably over the life of the customer application, which we currently estimate to be two years. Related direct costs not exceeding the amount of associated deferred revenue are also deferred and expensed over the term of the related application and are presented as deferred professional services. We provide training for our customers and recognize revenue as these services are provided. We also provide customer management, support and services to improve and optimize our customers’ applications for a fixed monthly fee. We bill our customers, and recognize revenue from these services, on a monthly basis.

We expect to continue to generate a significant portion of our revenue from existing customers who add applications, broaden deployment of our solutions across their organizations and increase their usage over time. We will also continue our efforts to attract new customers to purchase our solutions.

Operating Expenses

We allocate to all operating expense categories certain overhead expenses such as facilities and other occupancy charges as well as the costs of our information technology department. Historically, our cost of facilities has increased as we have added space and made leasehold improvements, and we expect this trend to continue as we grow.

Cost of Operations and Support.     Cost of operations and support consists primarily of data center costs, which include telephony, software licensing fees, co-location, depreciation and expenses related to hosting and providing support for our servers and other equipment, compensation and benefits for our operations, customer support and customer management personnel, as well as professional engineering services. As we continue to add features and complementary services to our platform, we expect our cost of operations and support to continue to increase on an absolute dollar basis and to decline slightly as a percentage of revenues, in each case to the extent that revenues continue to increase. Our cost of operations and support for a quarter may vary for a number of

 

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reasons, including the mix of types of customer notification initiatives executed during the quarter and the extent and timing of our efforts to add capacity by purchasing additional servers, software and other equipment.

Cost of Services.     Cost of services consists of compensation and benefits for our professional services teams and is comprised of expenses related to configuration and integration of our solutions with customer data and systems as well as training of our customers. Costs relating to configuration and integration services are capitalized and amortized over the estimated two-year life of the customer application, but only to the extent they do not exceed related revenues. Costs relating to training and those costs relating to configuration and integration in excess of the related revenues are recorded in the period in which we perform the services.

As we continue to add features and complementary services to our platform, we expect cost of services to continue to increase on an absolute dollar basis but to decline slightly as a percentage of revenues, in each case to the extent that our revenues continue to increase. Our cost of services for a quarter may vary for a number of reasons, including the nature and type of services completed during the period.

Engineering and Product Development.     Engineering and product development expenses include compensation and benefits for our engineering and product development personnel, professional engineering services and other expenses. Engineering and product development costs are expensed as incurred. We have historically focused our engineering and product development efforts on improving and enhancing our platform by developing new features and functionality. We made significant investments in engineering and product development in 2007 to support the anticipated growth in our business. We expect that engineering and product development expenses will increase on an absolute dollar basis in the near term and will remain relatively constant or decrease slightly as a percentage of revenues to the extent that revenues continue to increase.

Sales and Marketing.     Sales and marketing expenses include compensation and benefits for our sales and marketing personnel, including commissions and incentives, travel and entertainment expenses, and marketing programs such as product marketing, events and other brand building expenses. We plan to further develop and execute our marketing strategy to extend brand awareness and generate additional leads for our sales staff. As a result, we expect that our sales and marketing expenses will continue to increase on an absolute dollar basis and remain relatively constant as a percentage of revenues to the extent that revenues continue to increase.

General and Administrative.     General and administrative expenses include compensation and benefits for executive, finance, human resources and legal personnel, as well as accounting and legal professional fees and other corporate expenses. General and administrative expenses also include Washington state business and occupation taxes, which are calculated as a percentage of revenues. We expect that during 2008 and for some period of time thereafter, general and administrative expenses will increase on an absolute dollar basis and as a percentage of revenues as we incur additional costs associated with being a public company. In particular, we will incur costs to implement, improve and maintain both new and existing financial systems and to hire additional personnel to enable us to meet our financial reporting and regulatory compliance requirements, including those under the Sarbanes-Oxley Act of 2002.

We do not currently collect sales or other taxes related to the services we provide to our customers. We are evaluating whether our services are taxable in the states in which we do business. As part of this ongoing evaluation, we have identified certain jurisdictions where our activities may require us to collect sales tax. We have currently recorded a liability for those states where we believe it is probable that we have incurred this obligation. A successful assertion that we should collect sales or other taxes on our services could result in substantial tax liabilities for past sales and impact future results. The current provision and any additional amounts provided for such obligation may prove inadequate.

Amortization of Intangible Assets.     Amortization of intangible assets includes the amortization of intangible assets (other than goodwill) acquired from the purchase of Envoy in December 2005. Approximately $6.3 million of the purchase price was allocated to developed technology and customer relationships and is being amortized over their estimated useful lives of five years.

 

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Other Income (Expense), Net and Cumulative Effect of Change in Accounting Principle

Other income (expense), net includes interest income on our cash balances and interest expense on our outstanding debt. In June 2005, the Financial Accounting Standards Board, or FASB, issued Staff Position, or FSP, No. 150-5, Issuer’s Accounting Under FASB Statement No. 150 for Freestanding Warrants and Other Similar Investments in Shares That Are Redeemable, or FSP 150-5. Upon adoption of FSP No. 150-5 on July 1, 2005, we reclassified the fair value of our convertible preferred stock warrants from shareholders’ deficit to a liability and recorded a cumulative charge from the change in accounting principle of $203,000. Other income (expense), net also includes the impact of valuing our outstanding convertible preferred stock warrants at their fair value at each reporting date including expirations. Upon completion of this offering, however, these warrants will become exercisable for common stock and no further charges will be made to adjust for changes in the fair value of the warrants.

Provision for Income Taxes

Since inception, we have incurred operating losses and, accordingly, have not recorded any significant provision for income taxes for any of the periods presented. Our provision for income taxes for the three month period ended March 31, 2008 relates to alternative minimum taxes. As of December 31, 2007, we had net operating loss carryforwards for federal income tax purposes of approximately $37.5 million. We also had federal research and development tax credit carryforwards of approximately $814,000. If not utilized, our federal net operating loss and federal research and development tax credit carryforwards will begin to expire in 2020. Federal tax laws impose substantial restrictions on the utilization of net operating losses and tax credits in the event of “ownership change” of a corporation, as defined in Section 382 of the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code. We have determined that a change in ownership of Envoy has occurred and, accordingly, our ability to utilize net operating losses and tax credit carryforwards may be limited as the result of such “ownership change.” We have included the appropriate limitations in determining the deferred tax asset associated with the net operating loss and federal research and development tax credit carryforwards. Realization of deferred tax assets depends upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, we have offset our entire $14.1 million deferred tax asset as of December 31, 2007 by a valuation allowance.

During the first quarter of 2008, our provision for income taxes of $67,000 represented alternative minimum taxes. Of this amount, $9,000, $47,000 and $11,000 relate to the years ended December 31, 2005, 2006 and 2007, respectively. We do not believe the impact of this out of period adjustment is material to the consolidated financial statements of the current or prior periods and, accordingly, we have not restated the prior period financial statements.

Key Operating Metrics

We monitor a number of key metrics to help forecast growth, establish budgets, measure the effectiveness of our sales and marketing efforts and operational efficiency. The following table presents key operating metrics for the years ended December 31, 2005, 2006 and 2007 and for the three months ended March 31, 2007 and 2008:

 

     Year Ended December 31,     Three Months Ended March 31,  
     2005     2006     2007     2007     2008  
     (Dollars in thousands)  

Revenues

   $ 29,738     $ 50,914     $ 68,038     $ 15,657     $ 19,339  

Net cash provided by (used in) operating activities

   $ 2,571     $ (2,128 )   $ 1,488     $ (103 )   $ 4,251  

Net loss

   $ (490 )   $ (4,995 )   $ (4,567 )   $ (1,441 )   $ (1,893 )

Customer notifications

     353,849,624       600,795,989       838,972,059       183,395,541       254,872,884  

Customers generating revenues greater than $100,000

     35       67       80       74       81  

Customer Notifications.     We closely monitor the number of customer notifications that we send. Historically, we have derived approximately 80% of our revenues from customer notifications. Our business

 

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continuity offerings are typically provided under annual or multi-year agreements pre-paid on an annual basis. Accordingly, revenues from our business continuity offerings are not significantly affected by the number of notifications and therefore the notification amounts provided above do not include notifications related to business continuity.

Customers Generating Revenues Greater than $100,000.     We closely monitor the number of customers from which we derive annual revenues in excess of $100,000. Our customers typically renew their contracts and a significant percentage of our revenues in any given period are derived from existing customers. Additionally, as customers gain experience with our solutions, they typically implement more of our applications and deploy our solutions at additional departments or business units which has resulted in four customers who have exceeded $4.0 million in annual revenues as of December 31, 2007. We believe that there is a significant growth opportunity by offering additional or upgraded solutions that our customers may not have considered previously, as well as selling our applications to additional business units within our existing installed base. This could also benefit our customers by increasing their efficiency that results from using us as a single supplier for multiple services.

Net Cash (Used in) Provided by Operating Activities.     We closely monitor operating cash flow as a measure of our performance. The deferral of recognition of revenue, even though customer payments have been received, has an impact on our cash flow from operations. In addition, various non-cash charges, such as changes in the fair value of the convertible preferred stock warrant liability, depreciation and amortization, and stock-based compensation expense increase our net loss. By closely tracking operating cash flow, we are better able to manage the cash needs of our business.

Net Loss.     For the years ended December 31, 2005 and 2006, net loss was $490,000 and $5.0 million, respectively, an increase of approximately $4.5 million. The increase was primarily driven by an increase in revenues of $21.2 million, which was more than offset by a $25.0 million increase in operating expenses related to the expansion of our operations, as well as additional expenditures related to the integration of Envoy. For the years ended December 31, 2006 and 2007, net loss was $5.0 million and $4.6 million, respectively, a decrease of approximately $400,000. The decrease was primarily driven by an increase in revenues of $17.1 million, which was offset partially by a $16.7 million increase in operating expenses related to the expansion of our operations. For the three months ended March 31, 2007 and 2008, net loss was $1.4 million and $1.9 million, respectively, representing an increase of $500,000. The increase in net loss was driven by an increase in revenues of $3.6 million, which was more than offset by a $4.2 million increase in operating expenses. Due to the uncertainties in the capital markets, we cannot predict the timing of our initial public offering and, therefore, have written off $1.0 million of deferred offering costs that have been incurred to date. The entire amount of the write-off was included in general and administrative expenses. In addition, we monitor net income exclusive of stock-based compensation, amortization of acquired intangible assets, and changes in the fair value of convertible preferred stock warrant liability as a measurement of our operating performance and this operating metric is used for internal management purposes. Factors contributing to our net loss are disclosed in “Results of Operations.”

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities.

We have identified the following critical accounting policies that we believe are essential to an understanding of our consolidated financial statements. These accounting policies require management to make complex and subjective judgments. By their nature, these judgments are subject to an inherent degree of uncertainty. These judgments are based on our historical experience, the terms of existing contracts, our observance of trends in the industry, information provided by our customers and information available from other outside sources. Additionally, changes in accounting estimates are reasonably likely to occur from period to period. These factors could have a material impact on the presentation of our financial condition or results of operations.

 

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Revenue Recognition

We recognize revenue in accordance with SEC Staff Accounting Bulletin, or SAB, No. 104, Revenue Recognition. Accordingly, we recognize revenue when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the service has been provided to the customer; (3) the amount of fees to be paid by the customer is fixed or determinable; and (4) the collection of fees from the customer is reasonably assured. We defer amounts billed for which we will provide services in a future period. Payments made in advance, including amounts for configuration and implementation, are deferred and recognized ratably over the life of the customer application, which we currently estimate to be two years based on our historical customer experience. See “— Key Components of Our Results of Operations” for a discussion of how we generate and recognize revenue.

Allowance for Doubtful Accounts

Accounts receivable are stated at the amount we expect to collect from our customers based on their outstanding invoices. We review accounts receivable regularly to determine if any receivable will be potentially uncollectible. Estimates are used to determine the amount of the allowance for doubtful accounts necessary to reduce accounts receivable to its estimated net realizable value. These estimates are made by analyzing the status of significant past due receivables and by establishing provisions for estimated losses by analyzing current and historical bad debt trends.

Income Taxes

We account for income taxes in accordance with Statement of Financial Accounting Standard, or SFAS, No. 109, Accounting for Income Taxes. We are subject to federal and various state income taxes in the United States, and we use estimates in determining our provision for these income taxes. Deferred income taxes are recognized for the tax consequences related to temporary differences between the carrying amount of assets and liabilities for financial reporting purposes and the amounts used for tax purposes at each period-end, based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Our deferred tax assets consist primarily of net operating loss carryforwards, federal research and development tax credit carryforwards and temporary differences. We establish a valuation allowance when, based on the weight of available evidence, we consider it more likely than not that all or some portion of the deferred tax assets will not be realized. This assessment requires judgment as to the likelihood and amounts of future taxable income by tax jurisdiction. At December 31, 2007, our valuation allowance was equal to 100% of our net deferred tax assets. Although we believe that our tax estimates are reasonable, the ultimate tax determination involves significant judgment that is subject to audit by tax authorities in the ordinary course of business.

Deferred Commissions

On January 1, 2006 we changed the manner in which we historically accounted for certain sales commissions to capitalize certain commission expenses directly related to entering into a customer agreement with a term of one year or greater in accordance with FASB Technical Bulletin 90-1, Accounting for Separately Priced Extended Warranty and Product Maintenance Contracts. Although we pay commissions at the time we enter into these agreements, we defer recognition of the expense of these commissions and amortize them as sales and marketing expenses over the terms of the related customer agreements, generally one year to three years. We believe that this is the appropriate method of accounting since the commission charges are closely related to the revenues from the customer agreements and the deferred commission amounts previously paid are recoverable through future revenue streams under these customer agreements. Gross costs capitalized for the years ended December 31, 2005, 2006 and 2007 were approximately $372,000, $760,000 and $515,000, respectively. Capitalized commission costs expensed during the years ended December 31, 2005, 2006 and 2007 were approximately $254,000, $424,000 and $608,000, respectively. During the three months ended March 31, 2007 and 2008, gross commission costs capitalized were $21,000 and $134,000, respectively, and we amortized to expense previously capitalized commission costs of $153,000 and $153,000, respectively.

 

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Stock-Based Compensation

Prior to 2006, we accounted for stock options granted to employees using the intrinsic value method in accordance with Accounting Principles Board, or APB, Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. The intrinsic value represents the difference between the per share fair value of the stock on the grant date and the per share exercise price of the related stock option. In accordance with APB Opinion No. 25, compensation expense was recorded for employee stock options granted at an exercise price less than the fair value of the underlying stock on the grant date.

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123 (revised 2004), Share-Based Payment, or SFAS No. 123(R), using the prospective transition method which requires us to apply the provisions of SFAS No. 123(R) to awards granted, modified, repurchased or cancelled after the adoption date. Under the prospective transition method, non-vested option awards outstanding prior to January 1, 2006 continued to be accounted for in accordance with APB Opinion No. 25. Under SFAS No. 123(R), stock-based compensation expenses with respect to an employee are measured at the grant date, based on the estimated fair value of the award on the grant date. The grant date fair value of stock option awards is determined using the Black-Scholes option pricing model, which requires, among other things, an estimate of the fair value of the underlying common stock on the date of grant, the expected term of the award and the expected volatility of the stock over the expected term of the related grants. The determined fair value is recognized as expense on a straight-line basis over the employee’s requisite service period, which generally is the vesting period.

Under SFAS 123(R), the fair value of employee stock options granted since January 1, 2006 was estimated at the grant date using the Black-Scholes option pricing model by applying the following assumptions:

 

Risk-free interest rates

  3.5–5.1%

Expected life (in years)

  5.4   

Dividend rate

  0.0%

Volatility

  60.3%

The risk-free interest rates were based on U.S. Treasury rates appropriate for the expected term. We calculated the expected term based on our stock option activity. We do not expect to declare dividends in the foreseeable future. We based our estimate of expected volatility on the estimated volatility of similar entities whose share prices are publicly available. We based our estimates of forfeitures on historical and expected future actions of employees and executives. If different assumptions and estimates were used to determine the fair value of our common stock, the amount of recognized and to be recognized stock-based compensation expense and net loss amounts could have been materially different.

Compensation expense associated with employee share-based awards totaled $120,000 for the year ended December 31, 2006, $1.1 million for the year ended December 31, 2007 and $560,000 for the three months ended March 31, 2008. These amounts were based on awards ultimately expected to vest and reflected an estimate of awards that would be forfeited. The total compensation cost under SFAS No. 123(R) related to share-based awards granted to employees and directors but not yet amortized, net of estimated forfeitures, was $6.8 million at December 31, 2007 and $6.6 million at March 31, 2008. These costs will be amortized on a straight-line basis over a weighted average period of 3.2 years as of December 31, 2007 and 2.9 years as of March 31, 2008.

We account for stock-based compensation arrangements with non-employees in accordance with SFAS No. 123(R) and FASB Emerging Issues Task Force, or EITF, No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or Services, and related interpretations using the fair value method. The fair value of the stock options granted to non-employees was estimated using the Black-Scholes option pricing model. This model utilizes the estimated fair value of our common stock at the measurement date, the contractual term of the option, the expected volatility of our common stock, risk-free interest rates and the expected dividend yield of our common stock. Stock-based compensation expense relating to awards to non-employees was $44,000 during 2006, $139,000 for the year ended December 31, 2007 and $56,000 for the three months ended March 31, 2008.

 

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Valuation of Common Stock

We have granted stock options at exercise prices believed to be equivalent to the fair value of our common stock, as of the grant date. Given the absence of any active market for our common stock, the fair value of the common stock underlying stock options granted was determined by our board of directors, with input from our management. Members of our board of directors and management team have extensive business, finance and venture capital experience.

Background.     In assessing the fair value of our common stock, we considered numerous objective and subjective factors, including the following:

 

   

our financial position and historical operating and financial performance, including progress against planned metrics and application development activities;

 

   

our financial projections and future prospects;

 

   

the fact that option grants involved illiquid securities of a private company;

 

   

the likelihood of achieving a liquidity event for the shares of common stock underlying the options, such as an initial public offering or sale of our company, given prevailing market conditions and our relative financial condition at the time of grant;

 

   

the stock price performance of selected publicly held companies identified as being comparable to us;

 

   

the consideration received in connection with the issuance of shares of Series A, B, C and C-1 preferred stock to outside investors in arm’s-length transactions and the related rights and preferences associated with such preferred stock; and

 

   

valuations performed as of December 31, 2006, July 31, 2007, August 31, 2007, November 30, 2007 and February 29, 2008.

Our board of directors and management believe the valuation methodology employed for each date of determination provided a reasonable basis for estimating the fair value of our common stock.

December 2006 Valuation.     In February 2007, our board of directors, with the assistance of management, determined the fair value of our common stock as of December 31, 2006 in connection with the preparation of our 2006 financial statements. In conducting this valuation, we used a two-step methodology that first estimated the fair value of the company as a whole and then allocated a portion of the enterprise value to our common stock. This approach is consistent with the methods outlined in the AICPA Practice Aid Valuation of Privately-Held-Company Equity Securities Issued as Compensation. The valuation methodology utilized the “income approach” to estimate enterprise value. The income approach involves applying appropriate risk-adjusted discount rates to estimated debt-free cash flows, based on our forecasted revenues and expenses. This enterprise value was then validated utilizing the “market approach,” which involved analyzing (1) a number of transactions in which the acquired business was reasonably similar to the company, which we refer to as the market transaction approach and (2) the stock prices of a number of publicly traded companies reasonably similar to us, which we refer to as the market guidance approach. The enterprise value suggested by the market transaction approach was consistent with that suggested by the income approach, each of which were higher than that suggested by the market guidance approach.

In order to allocate the enterprise value to the various securities that comprise our capital structure, we used the option-pricing method. The option-pricing method involves making assumptions regarding the anticipated timing of a potential liquidity event, such as an initial public offering, and estimates of the volatility of our equity securities. The anticipated timing was based on the plans of our board of directors and management. Estimating the volatility of the share price of a privately held company is complex because there is no readily available market for our shares. Our board of directors estimated the volatility of our stock based on available information on the volatility of stocks of publicly traded companies in our industry determined to be reasonably comparable to us. For purposes of applying the option-pricing method, we estimated our time to liquidity to be two years.

 

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In addition to the option-pricing method, we also considered the probability weighted expected return method. For the probability weighted expected return method, the per share value our common stock was derived utilizing a probability weighted scenario analysis. The per-share value was based on four possible scenarios: (1) an initial public offering (40% probability), (2) a private sale (40% probability), (3) continued operation as a private company (15% probability) and (4) dissolution (5% probability).

We considered the results of the option pricing method and the probability weighted expected return method and weighted with an emphasis toward the option pricing method, which was considered to be a more objective method of determining the fair value of our common stock. A 20% discount was applied to account for a lack of marketability of our common stock based on the assumed time to liquidity.

The income approach suggested an enterprise value that was greater than either the market transaction or market guidance approach. The option pricing method and probability weighted expected return method suggested a fair value of our common stock of $0.67 and $0.81 per share, respectively, as of December 31, 2006. Our board of directors made a determination that the fair market value of our common stock was $0.55 per share as of December 31, 2006 after applying the 20% lack of marketability discount and taking into consideration the valuation as well as other factors, including those identified in “— Background” above.

July 2007 Valuation.     In July 2007, our board of directors, with the assistance of management, determined the fair value of our common stock as of July 31, 2007 in anticipation of significant stock option grants expected in August 2007. The methodologies employed in this valuation were substantially similar to those employed during the December 2006 valuation, with the principal exceptions that (1) for purposes of applying the option-pricing method, we decreased our estimate of time to liquidity to one year and (2) for the purpose of applying the probability weighted expected return method, we increased the assumed probabilities of an initial public offering and continued operation as a private company to 45% and 18%, respectively, and reduced the assumed probabilities of a sale of the company and dissolution to 35% and 2%, respectively. We determined that the market transaction and market guidance approaches validated the enterprise value suggested by the income approach. The option pricing method and probability weighted expected return method suggested a fair value of our common stock of $1.23, and $1.36 per share, respectively, as of July 31, 2007. Our board of directors made a determination that the fair market value of our common stock was $1.00 per share as of July 31, 2007 after applying a 20% lack of marketability discount and taking into consideration the valuation as well as other factors, including those identified in “— Background” above.

August 2007 Valuation.     The compensation committee of our board of directors, with the assistance of management, determined the fair value of our common stock as of August 31, 2007. The methodologies employed in this valuation were substantially similar to those employed during the July 2007 valuation, with the principal exceptions that for the purpose of applying the probability weighted expected return, we increased the assumed probability of an initial public offering to 50% and reduced the assumed probability of continued operation as a private company to 13%. We determined that the market transaction and market guidance approaches validated the enterprise value suggested by the income approach. The option pricing method and probability weighted expected return method suggested a fair value of our common stock of $1.56, and $1.69 per share, respectively, as of August 31, 2007. Our compensation committee made a determination that the fair market value of our common stock was $1.25 per share as of August 31, 2007 after applying the 20% lack of marketability discount and taking into consideration the valuation as well as other factors, including those identified in “— Background” above.

On September 12, 2007, certain of our executives sold an aggregate 2,850,000 shares of our common stock to entities affiliated with Blue Run Ventures, one of our greater than 5% beneficial owners, for approximately $5.0 million, or $1.75 per share. In connection with this transaction, our preferred shareholders amended our investors’ rights to provide registration rights for these shares of common stock.

November 2007 Valuation.    In December 2007, our board of directors, with the assistance of management, determined the fair value of our common stock as of November 30, 2007 in anticipation of the preparation of our 2007 annual financial statements. In conducting this valuation, we completed a valuation based upon the income and market guidance approaches. We did not use the market transaction approach. The enterprise value suggested

 

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by the market guidance was higher than that suggested by the income approach. After estimating our enterprise value based upon the income and market guidance approaches, we then utilized the probability-weighted return method. For the probability weighted expected return method, the per share value our common stock was derived utilizing a probability weighted scenario analysis. For this purpose, we increased the assessment probabilities of an initial public offering and the sale of the Company to 50% and 40%, respectively and reduced the assumed probability of continued operation as a private company or dissolution to 10% and 0%, respectively. The probability weighted expected return method suggested a probable fair value of $1.80 per share as of November 30, 2007. Our board of directors made a determination that the fair market value of our common stock was $1.85 at November 30, 2007 after taking into consideration the valuation as well as other factors, including those identified in “— Background” above.

February 2008 Valuation.    In March 2008, our board of directors, with the assistance of management, determined the fair value of our common stock as of February 29, 2008. We completed this valuation based upon the income and market guidance approaches. We did not use the market transaction approach. The enterprise value suggested by the market guidance was higher than that suggested by the income approach. After estimating our enterprise value based upon the income and market guidance approaches, we then utilized the probability-weighted return method. For the probability weighted expected return method, the per share value of our common stock was derived utilizing a probability weighted scenario analysis. For this purpose, we increased the assessment probabilities of an initial public offering and the sale of our company to 50% and 40%, respectively and reduced the assumed probability of continued operation as a private company or dissolution to 10% and 0%, respectively. The probability weighted expected return method suggested a probable fair value of $1.68 per share as of February 29, 2008. Our average per share value has decreased by approximately 6.7% since the prior valuation date given the increase in the expected time to an IPO liquidity event and a decrease in stock prices of companies used in the market guidance approach. The average stock prices for the guideline companies and the NASDAQ index experienced a decrease of 22.2% and 14.6%, respectively, between valuation dates. Our board of directors made a determination that the fair market value of our common stock was $1.68 at February 29, 2008 after taking into consideration the valuation as well as other factors, including those identified in “—Background” above.

In connection with the preparation of the consolidated financial statements included in this prospectus, our board of directors assessed the fair value of our common stock to determine whether there was a compensatory element in our historical options. As discussed above, valuations were performed as of December 31, 2006, July 31, 2007, August 31, 2007, November 30, 2007 and February 29, 2008. During the first seven months of 2007, we granted options to purchase our common stock at dates that fell between the dates of the valuations performed by our board of directors. In those instances, we granted awards with an exercise price equal to the per-share fair market value most recently determined by our board of directors. Subsequently, our board of directors determined that a 10% lack of marketability discount on the July 31 and August 31, 2007 valuations would be appropriate and that the fair value of our common stock had continued to increase during the first seven months of 2007 to $1.13 per share as of July 31, 2007, and from there to $1.40 per share as of August 31, 2007 and to $1.49 as of September 7, 2007. The board of directors reached this conclusion based on a number of factors, including the initiation of the process for this offering and the request for proposals from several investment banks, and the addition of key management team personnel, in anticipation of becoming a public company, including our chief financial officer in April 2007, a vice president, general counsel in June 2007, a vice president, finance and controller in July 2007, and an executive vice president sales and marketing in August 2007. In addition, the board of directors took into consideration the September 12, 2007 sale of common stock by certain of our executives to third parties at a per share price of $1.75. A portion of the sale price of these shares was attributable to registration rights that are not generally available to holders of common stock. As a result, the board of directors estimate of the fair value of our common stock was less than the sale price. Given that we were experiencing continued increases in revenue during the intervening periods, and that industry and market conditions remained stable, such interpolations resulted in progressions to the fair value of our common stock that were essentially linear between the valuation dates as there were no individually significant factors impacting fair value. As a result, the stock options we granted from February 2007 through September 2007 had an exercise price less than the subsequently estimated fair value of the common stock at the date of grant, which is included in the options’ SFAS 123(R) fair value determination.

 

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Information on stock options granted during the year ended December 31, 2007 and the three months ended March 31, 2008 is summarized as follows:

 

Date of Grant

   Number of
Options Granted
   Exercise
Price
   Estimated Fair
Value per
Common Share
   Intrinsic
Value per
Option
Share

February 28, 2007

   3,871,000    $ 0.55    $ 0.62    $ 0.07

April 20, 2007

   1,624,500      0.55      0.76      0.21

May 29, 2007

   150,000      0.55      0.88      0.33

June 18, 2007

   915,000      0.55      0.96      0.41

August 31, 2007

   3,922,000      1.25      1.40      0.15

September 7, 2007

   190,000      1.43      1.49      0.06

October 5, 2007

   583,000      1.85      1.85     

October 8, 2007

   107,000      1.85      1.85     

October 31, 2007

   25,000      1.85      1.85     

November 15, 2007

   745,000      1.85      1.85     

December 20, 2007

   88,000      1.85      1.85     

January 25, 2008

   390,000      1.85      1.85     

January 28, 2008

   40,000      1.85      1.85     

The aggregate intrinsic value of vested and unvested stock options as of March 31, 2008 based on the initial public offering price of $             per share, which is the midpoint of the range set forth on the cover page of the prospectus, was $             million and $             million, respectively.

Convertible Preferred Stock Warrants

In connection with our entry into convertible loan agreements in August 2000 and 2002, we issued warrants exercisable to acquire shares of our convertible preferred stock. Prior to July 1, 2005, we recorded the estimated fair value of each of these warrants as a component of equity, with charges to interest expense recorded over the life of the debt or lease agreement with respect to which the warrant was issued.

In June 2005, the FASB issued FSP No. 150-5, which affirms that freestanding warrants relating to redeemable shares are liabilities that should be recorded at fair value. We adopted FSP No. 150-5 as of July 1, 2005 and recorded a cumulative effect of change in accounting principle of $203,000 to reflect the change in the estimated fair value of the convertible preferred stock warrants as of that date. We recorded warrant charges of $521,000 in 2006, $225,000 in 2007 and a benefit of $96,000 for the three months ended March 31, 2008 to reflect the change in fair value of the convertible preferred stock warrants during those periods. In August 2007 the convertible preferred stock warrants related to the Series A and B preferred stock expired. This resulted in a reduction of $177,000 to the recorded liability with a corresponding decrease to the warrant charge in 2007. In September 2007, holders of convertible preferred stock warrants exercised warrants to purchase 373,259 shares of Series C Preferred Stock for a total purchase price of $100,000.

We estimated the fair value of the convertible preferred stock warrants at the respective balance sheet dates using the Black-Scholes option valuation model. This model utilizes as inputs the estimated fair value of the underlying convertible preferred stock at the valuation measurement date, the remaining contractual term of the warrants, risk-free interest rates, expected dividends and expected volatility of the price of the underlying convertible preferred stock. The estimated fair value of the convertible preferred stock and the expected volatility were determined on a basis consistent with the valuation methodologies described above in “— Valuation of Common Stock.” These convertible preferred stock warrants are subject to revaluation at each future reporting period and changes in the fair value of the warrants will be recognized as a component of other income (expense) until the earlier of the exercise or expiration of the warrants or the completion of a liquidation event, including the consummation of an initial public offering, at which time the warrant liability will be reclassified into additional paid in capital.

 

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Results of Operations

The following table sets forth selected statements of operations data for the years ended December 31, 2005, 2006 and 2007, and for the three months ended March 31, 2007 and 2008 as percentages of revenues.

 

     Year Ended December 31,     Three Months Ended
March 31,
 
         2005             2006             2007             2007             2008      

Revenues

   100 %   100 %   100 %   100 %   100 %
                              

Operating expenses:

          

Cost of operations and support (exclusive of amortization of intangible assets)

   26.2     28.9     32.2     31.5     33.2  

Cost of services

   11.9     16.0     13.6     13.3     11.8  

Engineering and product development

   14.4     14.6     16.6     16.8     15.2  

Sales and marketing

   35.5     31.9     27.3     30.5     29.0  

General and administrative

   12.4     14.0     13.8     13.4     17.8  

Amortization of intangible assets

   0.2     2.5     1.8     2.0     1.6  
                              

Total operating expenses

   100.6     107.9     105.3     107.5     108.6  
                              

Loss from operations

   (0.6 )   (7.9 )   (5.3 )   (7.5 )   (8.6 )

Total other income (expense), net

   (0.4 )   (1.9 )   (1.4 )   (1.7 )   (0.8 )
                              

Loss before income taxes

   (1.0 )   (9.8 )   (6.7 )   (9.2 )   (9.4 )

Provision for income taxes

                   (0.3 )
                              

Net loss before cumulative effect of change in accounting principle

   (1.0 )   (9.8 )   (6.7 )   (9.2 )   (9.7 )

Cumulative effect of change in accounting principle

   (0.6 )                
                              

Net loss

   (1.6 )%   (9.8 )%   (6.7 )%   (9.2 )%   (9.7 )%
                              

Comparison of Three Months Ended March 31, 2007 and 2008

 

     Three Months Ended March 31,     Period-Over-
Period Change
 
      2007     2008    
      Amount    Percentage of
Revenues
    Amount    Percentage of
Revenues
    Amount    Percentage  
     (Dollars in thousands)  

Revenues

   $ 15,657    100.0 %   $ 19,339    100.0 %   $ 3,682    23.5 %

Revenues.    Of the $3.7 million increase in revenues, $2.4 million was attributable to increases in the number of applications utilized by, and increased notification activity from customers from whom we derived revenues in both periods, which we refer to as existing customers. In addition, $1.3 million was attributable to revenues derived from new customers. For the three months ended March 31, 2007 and 2008, Bank of America and its affiliates represented 11% and 12% of revenues, respectively.

 

     Three Months Ended March 31,     Period-Over-
Period Change
 
     2007     2008    
     Amount    Percentage of
Revenues
    Amount    Percentage of
Revenues
    Amount    Percentage  
     (Dollars in thousands)  

Cost of operations and support (exclusive of amortization of intangible assets)

   $ 4,928    31.6 %   $ 6,416    33.2 %   $ 1,488    30.2 %

Cost of services

     2,080    13.4       2,278    11.8       198    9.5  

Engineering and product development

     2,633    16.9       2,946    15.2       313    11.9  

Sales and marketing

     4,778    30.7       5,600    29.0       822    17.2  

General and administrative

     2,102    13.5       3,448    17.8       1,346    64.0  

Amortization of intangible assets

     313    2.0       313    1.6           
                                       

Total operating expenses

   $ 16,834    108.1 %   $ 21,001    108.6 %   $ 4,167    24.8 %
                                       

 

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Cost of Operations and Support.    Cost of operations and support increased faster than revenues due to increased capacity and additions to our operations and customer management teams in anticipation of continued growth in notification volumes and support requirements. Of the $1.5 million increase in cost of operations and support, $709,000 was attributable to increased employee compensation and benefits as we increased headcount from 46 employees at March 31, 2007 to 55 at March 31, 2008. Telephony and hosting costs increased by $674,000 due to increased notification activities for our customers. Depreciation expense and occupancy costs increased $340,000 due to investments in our data centers. Offsetting these increases were reductions in outside professional engineering services totaling $217,000, as the company managed its use of outside services.

Cost of Services.    Cost of services increased by $198,000. Occupancy costs accounted for $78,000 of the increase due to expansion of our facilities. Cost of services for the three months ended March 31, 2008 reflect a net amortization of deferred service costs of $257,000 more than the amount that we capitalized in the three months ended March 31, 2007. These increases were offset by a decrease of $161,000 in employee compensation and benefits as we decreased headcount from 62 employees at March 31, 2007 to 55 at March 31, 2008.

Engineering and Product Development.    Engineering and product development expenses increased by $313,000, in support of investments in development projects, to meet the needs of our customers and to enhance our quality assurance capabilities. Employee compensation and benefits increased by $241,000 as we increased headcount from 55 at March 31, 2007 to 58 at March 31, 2008 as we continue to increase the size of our engineering team in connection with growth in our operations and in support of continued development and improvement of our platform. Occupancy costs accounted for $157,000 of the increase, related to expansion of our facilities. Offsetting these increases were reductions in the use of outside professional engineering services totaling $85,000.

Sales and Marketing.    Sales and marketing expenses increased by $822,000. Employee compensation and benefits increased by $785,000, due in part to increased commissions related to higher revenues and increased headcount. Headcount increased to 78 employees at March 31, 2008 from 71 employees at March 31, 2007. Included in employee compensation and benefits was stock-based compensation expenses of $216,000 for the three months ended March 31, 2008 compared to $15,000 for the three months ended March 31, 2007. During the three months ended March 31, 2008, we incurred a $100,000 increase in marketing program expenses related to promotional, advertising activities and our annual sales conference which took place in January 2008 and a $162,000 increase in occupancy costs related to expansion of our facilities. These increased expenses were offset by a $225,000 decrease in professional service fees and travel and entertainment.

General and Administrative.    General and administrative expenses increased by $1.3 million. Employee compensation and benefits increased by $767,000 as we increased headcount from 27 at March 31, 2007 to 40 at March 31, 2008. Included in employee compensation and benefits was stock-based compensation expenses of $244,000 for the three months ended March 31, 2008 compared to $22,000 for the three months ended March 31, 2007. The additional employee-related expenses and professional services fees were primarily the result of our ongoing efforts to build our finance, information technology and legal functions to support the growth of our business. Although we continue to update this Registration Statement with the Securities and Exchange Commission, due to continuing uncertainties in the capital markets, we do not believe that the completion of this offering will occur in the near term and, accordingly, we have written off the deferred offering costs of $1.0 million to general and administrative expenses as these costs are not expected to be recoverable in the near term. Occupancy costs allocated to general and administrative expenses decreased by $329,000, due to headcount in general and administrative groups increasing at a slower rate than other operating categories.

Amortization of Intangible Assets.    Amortization of intangible assets related to our acquisition of Envoy were $940,000 for each of the three months ended March 31, 2007 and 2008, respectively.

 

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     Three Months Ended March 31,     Period-Over-
Period Change
 
     2007     2008    
     Amount     Percentage of
Revenues
    Amount     Percentage of
Revenues
    Amount     Percentage  
     (Dollars in thousands)  

Loss from operations

   $ (1,177 )   (7.5 )%   $ (1,662 )   (8.6 )%   $ (485 )   41.2 %
                                          

Other income (expense), net:

            

Interest income

     54     0.3       47     0.2       (7 )   (13.0 )

Interest expense

     (202 )   (1.3 )     (307 )   (1.6 )     (105 )   52.0  

Change in fair value of convertible preferred stock warrant liability

     (116 )   (0.7 )     96     0.5       212     (182.7 )
                                          

Total other income (expense), net

     (264 )   (1.7 )     (164 )   (0.8 )     100     (37.9 )
                                          

Loss before income taxes

     (1,441 )   (9.2 )     (1,826 )   (9.4 )     (385 )   (26.7 )

Provision for income taxes

               (67 )   (0.3 )     (67 )    
                                          

Net loss

   $ (1,441 )   (9.2 )%   $ (1,893 )   (9.7 )%   $ (452 )   (31.4 )%
                                          

Other Income (Expense), Net.    Other expense, net decreased by $100,000 for the three months ended March 31, 2008 compared to the same period in 2007. Interest expense increased $105,000 as a result of higher average borrowings during the three months ended March 31, 2008 compared to the same period in 2007. During the three months ended March 31, 2008, we recorded a credit of $96,000 to reflect the change in the fair value of our convertible preferred stock warrants as compared to a charge of $116,000 for the same period in 2007. The impact of the change in fair value of our convertible preferred stock was offset in part by the increase in interest expense as a result of higher average borrowings in the three months.

Provision for Income Taxes.    During the first quarter of 2008, we recorded a provision for income taxes of $67,000 related to alternative minimum taxes. Of this amount, $9,000, $47,000 and $11,000 relate to the years ended December 31, 2005, 2006 and 2007, respectively. We do not believe the impact of this out of period adjustment is material to the consolidated financial statements of the current or prior periods and, accordingly, we have not restated the prior period financial statements.

Comparison of Years Ended December 31, 2006 and 2007

 

     Year Ended December 31,     Period-Over-
Period Change
 
     2006     2007    
     Amount    Percentage of
Revenues
    Amount    Percentage of
Revenues
    Amount    Percentage  
     (Dollars in thousands)  

Revenues

   $ 50,914    100.0 %   $ 68,038    100.0 %   $ 17,124    33.6 %

Revenues.    Of the $17.1 million increase in revenues, $15.6 million was attributable to increases in the number of applications utilized by, and increased notification activity from existing customers. In addition, $1.5 million was attributable to revenues derived from new customers. For each of 2006 and 2007, Bank of America and its affiliates represented 11% of revenues.

 

     Year Ended December 31,     Period-Over-
Period Change
 
     2006     2007    
     Amount   Percentage of
Revenues
    Amount   Percentage of
Revenues
    Amount   Percentage  
     (Dollars in thousands)  

Cost of operations and support (exclusive of amortization of intangible assets)

   $ 14,711   28.9 %   $ 21,895   32.2 %   $ 7,184   48.8 %

Cost of services

     8,150   16.0       9,264   13.6       1,114   13.7  

Engineering and product development

     7,408   14.6       11,274   16.6       3,866   52.2  

Sales and marketing

     16,228   31.9       18,544   27.3       2,316   14.3  

General and administrative

     7,202   14.0       9,400   13.8       2,198   30.5  

Amortization of intangible assets

     1,254   2.5       1,254   1.8          
                                    

Total operating expenses

   $ 54,953   107.9 %   $ 71,631   105.3 %   $ 16,678   30.3 %
                                    

 

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Cost of Operations and Support.    Cost of operations and support increased faster than revenues due to increased capacity and additions to our operations and customer management teams in anticipation of continued growth in notification volumes and support requirements. Of the $7.2 million increase in cost of operations and support, $3.1 million was attributable to increased employee compensation and benefits as we increased headcount from 41 employees at December 31, 2006 to 56 at December 31, 2007 (consisting of 15 new customer management employees). Telephony and hosting costs increased by $2.6 million due to increased notification activities for our customers. Of the remaining increase, $1.4 million was attributable to additional depreciation expense and occupancy costs due to investments in our data centers.

Cost of Services.    Cost of services increased by $1.1 million. Employee compensation and benefits increased by $1.1 million because we increased headcount from 53 employees at December 31, 2006 to 59 at December 31, 2007. This increase was offset by a $927,000 allocation of employee costs to product engineering in support of development activities. Occupancy costs accounted for $442,000 of the increase due to expansion of our facilities. Cost of services reflects a net amortization of deferred service costs of $745,000 more than the amount that we capitalized in 2007 compared to 2006. In addition, travel and entertainment and outside professional service fees decreased by a total of $11,000.

Engineering and Product Development.    Engineering and product development expenses increased faster than revenues due to investments in development projects, to perform maintenance on our platform, as well as add additional reports to meet the needs of our customers and to enhance our quality assurance capabilities. Engineering and product development expenses increased by $3.9 million. Employee compensation and benefits increased by $3.2 million as we increased headcount from 41 at December 31, 2006 to 55 at December 31, 2007. We increased the size of our engineering team in connection with our continued development and improvement of our platform and to allow us to conduct appropriate levels of quality control. In addition, our professional services team provided $927,000 of engineering support to our development activities. Occupancy costs accounted for $372,000 of the increase due to expansion of our facilities. Offsetting these increases were reductions in professional engineering services totalling $538,000 due to a temporary reduction in our use of outside services and in travel and entertainment, and other expenses totaling $93,000.

Sales and Marketing.    Sales and marketing expenses increased by $2.3 million. Headcount decreased to 77 employees at December 31, 2007 from 95 employees at December 31, 2006, as a result of consolidation efforts following our acquisition of Envoy; however, employee compensation and benefits increased by $1.7 million, due in part to increased commissions related to higher revenues. Included in employee compensation and benefits was stock-based compensation expenses of $255,000 for 2007 compared to $35,000 for 2006. We experienced a $583,000 increase in rebranding and marketing program expenses related to increased tradeshow, promotional and advertising activities. Occupancy costs accounted for $219,000 of the increase due to expansion of our facilities. These increased expenses were offset by a $140,000 decrease in travel and entertainment expenses.

General and Administrative.    General and administrative expenses increased by $2.2 million. Employee compensation and benefits increased by $1.9 million as we increased headcount from 21 at December 31, 2006 to 40 at December 31, 2007. Included in employee compensation and benefits was stock-based compensation expenses of $637,000 for 2007 compared to $16,000 for 2006. The additional employee-related expenses and professional services fees were primarily the result of our ongoing efforts to build our legal, financial, human resources and information technology functions to support the growth of our business. Certain of our services may be subject to sales and other local taxes. Based upon our estimate of our probable exposure, we provided $584,000 for this obligation during 2007. Outside professional service costs increased by $770,000 period over period due to accounting and outside consultant fees incurred in preparation for this offering. Occupancy costs allocated to general and administrative expenses decreased by $1.1 million, due to headcount in general and administrative groups increasing at a lower rate than other operating categories while total occupancy costs also increased at a lower rate.

 

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Amortization of Intangible Assets.    Amortization of assets related to our acquisition of Envoy were $1.3 million for each of 2006 and 2007, respectively.

 

    Year Ended December 31,     Period-Over-
Period Change
 
    2006     2007    
    Amount     Percentage of
Revenues
    Amount     Percentage of
Revenues
   
            Amount     Percentage  
    (Dollars in thousands)  

Loss from operations

  $ (4,039 )   (7.9 )%   $ (3,593 )   (5.3 )%   $ 446     11.0 %
                                         

Other income (expense), net:

           

Interest income

    136     0.2       242     0.4       106     77.9  

Interest expense

    (576 )   (1.1 )     (991 )   (1.5 )     (415 )   (72.0 )

Change in fair value of convertible preferred stock warrant liability

    (521 )   (1.0 )     (225 )   (0.3 )     296     56.8  

Other, net

    5                     (5 )   (100.0 )
                                         

Total other income (expense), net

    (956 )   (1.9 )     (974 )   (1.4 )     (18 )   (1.9 )
                                         

Net loss

  $ (4,995 )   (9.8 )%   $ (4,567 )   (6.7 )%   $ 428     8.6 %
                                         

Other Income (Expense), Net.    Other income (expense), net increased by $18,000 for 2007 as compared to 2006. The increase in expense was primarily due to an increase in interest expense as a result of higher average borrowings in 2007 compared to 2006. In 2007, we recorded a charge of $225,000 to reflect the change in the fair value of our convertible preferred stock warrants as compared to a charge of $521,000 for the same period in 2006. In August 2007 the convertible preferred stock warrants related to Series A and B preferred stock expired. This resulted in a reduction of $177,000 to the recorded liability with a corresponding decrease to the charge for 2007.

Comparison of Years Ended December 31, 2005 and 2006

 

     Year Ended December 31,     Year-to-Year Change  
     2005     2006    
     Amount    Percentage of
Revenues
    Amount    Percentage of
Revenues
   
               Amount    Percentage  
     (Dollars in thousands)  

Revenues

   $ 29,738    100.0 %   $ 50,914    100.0 %   $ 21,176    71.2 %

Revenues.    Of the $21.2 million increase in revenues, $10.0 million resulted from the acquisition of Envoy, and $2.8 million was attributable to revenues derived from new customers. The remainder of the increase was due to increased usage of our services as a result of the deployment of additional applications utilized by, and increased notification activity from, existing customers. For 2006, Bank of America and its affiliates accounted for 11% of our revenues. For 2005, Bank of America and its affiliates accounted for 25% of our revenues and Citigroup and its affiliates accounted for 16%.

 

     Year Ended December 31,     Year-to-Year Change  
     2005     2006    
     Amount    Percentage of
Revenues
    Amount    Percentage of
Revenues
   
               Amount    Percentage  
     (Dollars in thousands)  

Cost of operations and support (exclusive of amortization of intangible assets)

   $ 7,792    26.2 %   $ 14,711    28.9 %   $ 6,919    88.8 %

Cost of services

     3,526    11.9       8,150    16.0       4,624    131.1  

Engineering and product development

     4,276    14.4       7,408    14.6       3,132    73.2  

Sales and marketing

     10,569    35.5       16,228    31.9       5,659    53.5  

General and administrative

     3,678    12.4       7,202    14.0       3,524    95.8  

Amortization of intangible assets

     85    0.2       1,254    2.5       1,169    1,375.3  
                                       

Total operating expenses

   $ 29,926    100.6 %   $ 54,953    107.9 %   $ 25,027    83.6 %
                                       

 

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Cost of Operations and Support.    Cost of operations and support increased faster than revenues due to growth of our customer management team and, to a lesser degree, our operations team as we expanded capacity in anticipation of continued future growth in notification volumes and support requirements. Of the $6.9 million increase in cost of operations and support, $3.2 million was due to increased telephony and hosting costs resulting from increased notification activities for our customers, and $2.2 million was attributable to increased employee compensation and benefits as we increased headcount from 13 employees at December 31, 2005 to 41 at December 31, 2006 (including 18 new customer management employees). Of the remaining increase, $1.2 million was attributable to additional depreciation related to capital investments in our data centers and occupancy costs. In addition, professional engineering services expenses increased by $221,000 over the prior year.

Cost of Services.    Cost of services grew more rapidly than revenues as a result of our decision to add staff to support customer integration projects and to build more efficient tools to integrate our applications with our customers’ systems. Cost of services increased by $4.6 million due primarily to a $5.0 million increase in employee compensation and benefits as we increased headcount from 26 employees at December 31, 2005 to 53 at December 31, 2006. Occupancy costs and travel expenses contributed $321,000 and $171,000, respectively, to the increase. These increases were offset in part by the net capitalization of $876,000 more in professional services costs in 2006 as compared to 2005.

Engineering and Product Development.    Of the $3.1 million increase in engineering and product development expense, $2.7 million was attributable to increased employee compensation and benefits as we increased headcount from 30 at December 31, 2005 to 41 at December 31, 2006 (including five new employees in connection with our acquisition of Envoy). We increased the size of our engineering team in connection with our continued routine enhancements to our platform for reporting and data routing and to allow us to conduct appropriate levels of quality control. In addition, professional engineering services expenses increased by $224,000 and occupancy costs increased by $90,000.

Sales and Marketing.    Of the $5.7 million increase in sales and marketing expenses, $3.4 million was attributable to increased employee compensation and benefits as we increased headcount from 61 employees at December 31, 2005 to 95 employees at December 31, 2006 (including 26 new employees in connection with the acquisition of Envoy). We also incurred a $930,000 increase in marketing program expenses related to increased tradeshow, promotional and advertising activities and a related $856,000 increase in travel and entertainment expenses. Occupancy costs increased by $406,000 as a result of a higher number of employees.

General and Administrative.    General and administrative expenses grew faster than revenues due to increased headcount necessary to support the growth of our business and an increase in outside professional service fees. Of the $3.5 million increase in general and administrative expenses, $1.9 million was attributable to employee compensation and benefits as we increased headcount from 14 at December 31, 2005 to 21 at December 31, 2006. The headcount growth relates to increases in our finance, human resource, information technology and administrative functions to support the growth of our business. Outside professional service expenses increased by $535,000 as a result of increases in audit, tax and legal services and a $210,000 increase in Washington state business and occupation taxes. Occupancy costs allocated to general and administrative expenses increased by $904,000 due to rent and other costs associated with the expansion of our facilities.

 

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Amortization of Intangible Assets.    Amortization of intangible assets related to our acquisition of Envoy were $1.3 million for the year ended December 31, 2006 as compared to $85,000 for 2005, as the acquisition closed in December 2005.

 

    Year Ended December 31,     Year-to-Year Change  
    2005     2006    
    Amount     Percentage of
Revenues
    Amount     Percentage of
Revenues
   
          Amount     Percentage  
    (Dollars in thousands)  

Loss from operations

  $ (188 )   (0.6 )%   $ (4,039 )   (7.9 )%   $ (3,851 )   (2,048.0 )%
                                         

Other income (expense), net:

           

Interest income

    163     0.5       136     0.2       (27 )   (16.6 )

Interest expense

    (198 )   (0.7 )     (576 )   (1.1 )     (378 )   (190.9 )

Change in fair value of convertible preferred stock warrant liability

    (35 )   (0.1 )     (521 )   (1.0 )     (486 )   (1,388.6 )

Other, net

    (29 )   (0.1 )     5           34     117.2  
                                         

Total other income (expense), net

    (99 )   (0.4 )     (956 )   (1.9 )     (857 )   (865.7 )
                                         

Net loss before cumulative effect of change in accounting principle

    (287 )   (1.0 )     (4,995 )   (9.8 )     (4,708 )   (1,640.4 )

Cumulative effect of change in accounting principle

    (203 )   (0.6 )               203     100.0  
                                         

Net loss

  $ (490 )   (1.6 )%   $ (4,995 )   (9.8 )%   $ (4,505 )   (919.4 )%
                                         

Other Income (Expense), Net.    Other income (expense), net increased by $857,000 primarily due to a charge of $521,000 to reflect the increase in the fair value of the convertible preferred stock warrant, which represents a $486,000 increase in 2006 relative to the charge in 2005, and a $378,000 increase in interest expense in 2006 relative to 2005 as a result of higher average borrowings and interest rates on our borrowings in 2006 compared to 2005.

Cumulative Effect of Change in Accounting Principle.    Upon adoption of FSP No. 150-5 on July 1, 2005, we reclassified the fair value of our freestanding convertible preferred stock warrants from equity to a liability and recorded a cumulative charge from the change in accounting principle of $203,000.

 

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Quarterly Results of Operations

The following table sets forth our unaudited condensed consolidated quarterly statement of operations data in dollars and as a percentage of total revenues for each of the nine most recent quarters in the period ended March 31, 2008. This information has been prepared on the same basis as our audited consolidated financial statements and includes all adjustments, consisting only of normal recurring adjustments, necessary for the fair statement of the information for the quarters presented. You should read these data together with our audited consolidated financial statements and the related notes included elsewhere in this prospectus.

 

    Quarter Ended  
    March 31,
2006
    June 30,
2006
    September 30,
2006
    December 31,
2006
    March 31,
2007
    June 30,
2007
    September 30,
2007
    December 31,
2007
    March 31,
2008
 
    (In thousands)  

Revenues

  $ 11,176     $ 11,990     $ 13,291     $ 14,457     $ 15,657     $ 15,972     $ 17,590     $ 18,819     $ 19,339  
                                                                       

Operating expenses:

                 

Cost of operations and support (exclusive of amortization of intangibles)

    3,241       3,315       3,682       4,473       4,928       5,456       5,337       6,174       6,416  

Cost of services

    1,948       2,104       2,258       1,840       2,080       2,315       2,660       2,209       2,278  

Engineering and product development

    1,689       1,699       1,963       2,057       2,633       2,956       3,143       2,542       2,946  

Sales and marketing

    4,036       4,062       4,125       4,005       4,778       4,425       4,549       4,792       5,600  

General and administrative

    1,651       1,756       1,840       1,955       2,102       1,998       2,775       2,525       3,448  

Amortization of intangible assets

    313       314       313       314       313       313       314       314       313  
                                                                       

Total operating expenses

    12,878       13,250       14,181       14,644       16,834       17,463       18,778       18,556       21,001  
                                                                       

(Loss) income from operations

    (1,702 )     (1,260 )     (890 )     (187 )     (1,177 )     (1,491 )     (1,188 )     263       (1,662 )

Total other income (expense), net

    (186 )     (191 )     (269 )     (310 )     (264 )     (285 )     (155 )     (270 )     (164 )
                                                                       

Loss before income taxes

    (1,888 )     (1,451 )     (1,159 )     (497 )     (1,441 )     (1,776 )     (1,343 )     (7 )     (1,826 )

Provision for income taxes

                                                    (67 )
                                                                       

Net loss

  $ (1,888 )   $ (1,451 )   $ (1,159 )   $ (497 )   $ (1,441 )   $ (1,776 )   $ (1,343 )   $ (7 )   $ (1,893 )
                                                                       
    Quarter Ended  
    March 31,
2006
    June 30,
2006
    September 30,
2006
    December 31,
2006
    March 31,
2007
    June 30,
2007
    September 30,
2007
    December 31,
2007
    March 31,
2008
 
    (Percentages of revenues)  

Revenues

    100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %     100.0 %
                                                                       

Operating expenses:

                 

Cost of operations and support (exclusive of amortization of intangibles)

    29.0       27.6       27.7       31.0       31.5       34.1       30.3       32.8       33.2  

Cost of services

    17.4       17.5       17.0       12.7       13.3       14.5       15.1       11.7       11.8  

Engineering and product development

    15.1       14.2       14.8       14.2       16.8       18.5       17.9       13.5       15.2  

Sales and marketing

    36.1       33.9       31.0       27.7       30.5       27.7       25.9       25.5       29.0  

General and administrative

    14.8       14.7       13.8       13.5       13.4       12.5       15.8       13.4    

 

17.8

 

Amortization of intangible assets

    2.8       2.6       2.4       2.2       2.0       2.0       1.8       1.7       1.6  
                                                                       

Total operating expenses

    115.2       110.5       106.7       101.3       107.5       109.3       106.8       98.6       108.6  
                                                                       

(Loss) income from operations

    (15.2 )     (10.5 )     (6.7 )     (1.3 )     (7.5 )     (9.3 )     (6.8 )     1.4       (8.6 )

Total other income (expense), net

    (1.7 )     (1.6 )     (2.0 )     (2.1 )     (1.7 )     (1.8 )     (0.8 )     (1.4 )     (0.8 )
                                                                       

Loss before income taxes

    (16.9 )     (12.1 )     (8.7 )     (3.4 )     (9.2 )     (11.1 )     (7.6 )           (9.4 )

Provision for income taxes

                                                    (0.3 )
                                                                       

Net loss

    (16.9 )%     (12.1 )%     (8.7 )%     (3.4 )%     (9.2 )%     (11.1 )%     (7.6 )%     %     (9.7 )%
                                                                       

 

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Our operating results may fluctuate due to a variety of factors. As a result, comparing our operating results on a period-to-period basis may not be meaningful. You should not rely on our past results as an indication of our future performance. Our quarterly results may not be indicative of the results of operations for a full year or any future period. For example, during the fourth quarters of 2006 and 2007, relative to the respective third quarters, cost of services decreased due to an increase in the net capitalized professional service cost. In addition, during the fourth quarter of 2007, we incurred lower engineering and product development expenses than in prior quarters. This was due to a temporary reduction in the number of outside consultants utilized during the quarter. We anticipate an increase in engineering and product development as we continue to invest in our products and solutions, but that as a percentage of revenue, these costs will remain relatively constant. Due to the uncertainties in the capital markets we cannot predict the timing of our initial public offering and, therefore, have written off $1.0 million of deferred offering costs that have been incurred to date.

Our quarterly results are influenced by seasonal factors which affect our customers’ use of our solutions. For example, our financial services customers typically experience higher notification activity in the first quarter of each year primarily due to increased credit card activity and defaults related to holiday-season expenditures. In addition, our utility customers generally experience higher notification activities in the fourth quarter related to larger customer bills due to adverse winter weather conditions and higher collection activities associated with the larger customer bills.

Revenues have been sequentially higher for each quarter due primarily to increasing notification activity and product penetration within our existing customers, and to a lesser extent from the increases to our customer base as a result of our selling efforts.

Total operating expenses have generally increased sequentially in each quarter, principally as the result of increases in employee compensation costs attributable to increased headcount and increased facility costs. Total operating expenses as a percentage of revenues have varied due to the timing of additions to headcount, the increases in telephony and network capacity as well as timing of increases to the size of our facilities. We have made significant investments in engineering and product development, cost of operations and support and cost of services in support of existing requirements and in advance of anticipated future growth.

Liquidity and Capital Resources

Since inception, we have funded our operations primarily with proceeds from issuances of convertible preferred stock, borrowings under credit facilities and cash flow from operations. We have raised $33.5 million in net proceeds through sales of shares of our Series A, B and C convertible preferred stock between 2000 and 2002. We have also funded our operations through debt financings. See “— Debt Obligations” for a more detailed description of our indebtedness. As of March 31, 2008, we had cash and cash equivalents of $2.7 million and accounts receivable of $14.5 million and outstanding indebtedness of $9.1 million.

Our future working capital requirements will depend on many factors, including the rate of our revenue growth, introduction of new applications and complementary services for our on-demand solutions and our expansion of engineering and product development and sales and marketing activities. To the extent our cash and cash equivalents, cash flow from operating activities and the net proceeds of this offering are insufficient to fund our future activities, we may need to raise additional funds through public or private equity or debt financings. We also may need to raise additional funds in the event we determine in the future to effect one or more acquisitions of businesses, technologies and products. If additional funding is required, we may not be able to obtain financing on terms acceptable to us or at all.

 

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Cash Flow Analysis

Comparison of three months ended March 31, 2007 and March 31, 2008.    The following table presents a summary of our cash flows and beginning and ending cash balances for the three months ended March 31, 2007 and 2008:

 

     Three Months
Ended
March 31,
 
     2007     2008  
     (In thousands)  

Cash (used in) provided by operating activities

   $ (103 )   $ 5,249  

Cash used in investing activities

     (908 )     (3,134 )

Cash used in financing activities

     (247 )     (1,296 )
                

Net (decrease) increase in cash and cash equivalents

     (1,258 )     819  

Cash and cash equivalents at beginning of period

     4,070       1,854  
                

Cash and cash equivalents at end of period

   $ 2,812     $ 2,673  
                

Cash provided by operating activities was $5.2 million for the three months ended March 31, 2008 due to the net loss from operations adjusted for non-cash expenses, which include depreciation, amortization and stock-based compensation that totaled $3.2 million. Additionally, prepaid assets and accounts receivable declined by $2.2 million offset by a reduction in deferred rent, accounts payable and accrued liabilities. Cash used in operating activities was $103,000 for the three months ended March 31, 2007 due to the net loss from operations and an increase in accounts receivable, offset in part by non-cash expenses of depreciation and amortization.

Cash used in investing activities for purchases of property and equipment totaled $3.1 million for the three months ended March 31, 2008 compared to $908,000 for the same period in 2007 and consisted of computer equipment, software and leasehold improvements to support the expansion of our operations.

Cash used in financing activities during the three months ended March 31, 2008 and 2007 consisted primarily of principal repayments on borrowings, offset, to a lesser degree, proceeds from the issuance of stock from the exercise of stock options and warrants.

Comparison of years ended December 31, 2005, 2006 and 2007.    The following table presents a summary of our cash flows and beginning and ending cash balances for the years ended December 31, 2005, 2006 and 2007:

 

     Year Ended December 31,  
     2005     2006     2007  
     (In thousands)  

Cash (used in) provided by operating activities

   $ 2,571     $ (2,128 )   $ 1,488  

Cash used in investing activities

     (2,934 )     (2,529 )     (3,354 )

Cash provided by (used in) financing activities

     1,092       5,444       (350 )
                        

Net (decrease) increase in cash and cash equivalents

     729       787       (2,216 )

Cash and cash equivalents at beginning of period

     2,554       3,283       4,070  
                        

Cash and cash equivalents at end of period

   $ 3,283     $ 4,070     $ 1,854  
                        

During the year ended December 31, 2005, operating activities generated $2.6 million in cash. The cash provided by operating activities during 2005 was the result of a net loss of $490,000 adjusted for non-cash expenses of depreciation, amortization and change in convertible preferred stock warrant liability totaling $2.3 million and a working capital decrease of $735,000, as a result of increases in accrued expenses, deferred revenue and deferred rent offsetting increases in accounts receivable. The use of cash in 2006 was due to a net loss of $5.0 million adjusted for non-cash expenses of $5.5 million and reduced by a decrease in operating assets and liabilities of $2.6 million. The cash provided by operating activities during 2007 was the result of a net loss of $4.6 million adjusted for non-cash expenses totaling $6.9 million and an operating asset and liability decrease of $843,000.

 

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Purchases of property and equipment totaled $4.9 million in 2005 compared to $4.0 million in 2006 and $3.4 million in 2007. These amounts consisted mainly of computer equipment, software purchases, and leasehold improvements. During the years ended December 31, 2005 and 2006, we received cash of $4.7 million and $1.5 million, respectively from maturities of marketable securities. Purchases of marketable securities were $2.7 million for the year ended 2005.

Our financing activities provided $1.1 million in 2005 and $5.4 million in 2006. Proceeds from financing activities during these periods consisted mainly of proceeds from borrowings to fund continued growth in our operations and, to a lesser extent, proceeds from the issuance of stock from the exercise of stock options. During 2005, we borrowed $2.0 million pursuant to our equipment term loan and assumed a $738,000 term loan and a $348,000 capital lease obligation in connection with the acquisition of Envoy. During 2006, we incurred $2.0 million of revolver borrowings and $5.7 million in term loan borrowings pursuant to our loan and security agreement. Funds used by financing activities of $350,000 during 2007 included cash outlays of $1.0 million in connection with offering costs associated with our filing for an initial public offering. During 2007, we borrowed $2.0 million under our revolving line of credit. Payments made on our borrowings of $1.1 million, $2.3 million, and $2.0 million accounted for the majority of cash outflows from financing activities for the years ended December 31, 2005, 2006 and 2007, respectively.

Capital Expenditures

In recent years, we have made cash outlays primarily to acquire computer hardware and software and, to a lesser extent, furniture and leasehold improvements to support the growth of our business. Our capital expenditures totaled $4.9 million, $4.0 million, $3.4 million and $3.1 million in 2005, 2006 and 2007 and for the three months ended March 31, 2008, respectively. We intend to continue to invest in our infrastructure to ensure our continued ability to enhance our platform, introduce new features and complementary services, and maintain the reliability of our network. We also intend to make investments in computer equipment and systems and fixed assets as we expand our facilities and add personnel. Although our investment in capital in 2007 was at recent historical levels, we expect that it will increase over the next few years.

Debt Obligations

Loan and Security Agreement.    On April 28, 2006, we entered into a loan and security agreement with Ritchie Debt Acquisition Fund, Ltd., the predecessor to Blue Crest Venture Finance Master Fund Limited, the current lender, pursuant to which we incurred $5.7 million in term borrowings, and may, from time to time, incur borrowings under an accounts receivable revolving line of credit. The term loan borrowings must be repaid in 33 equal consecutive monthly installments after an initial nine-month interest only period and bear interest at a rate equal to the sum of 5.9% and the greater of (1) 4.81% and (2) the yield on Three-Year U.S. Treasury Notes on the date of the loan. In July 2007, the revolving line of credit was amended to increase the maximum amount of borrowings from $6.3 million to $16.0 million and the interest rate was reduced to the prime rate plus 1.5%. Our borrowings under the revolving line of credit are limited to a borrowing base equal to 85% of our accounts receivable (other than specified accounts) less reserves. The lender has broad discretion to lower the borrowing base, increase required reserves and thus reduce the amount we may borrow under the revolving line of credit. The revolving line of credit borrowings may be repaid and re-borrowed under the agreement with the entire unpaid principal amount to be paid in full on July 30, 2009. Our obligations under this agreement are collateralized by a security interest in our receivables, property and equipment, intangible assets and cash and investments.

In connection with the amended and restated loan and security agreement, the we issued to Blue Crest a warrant to purchase 245,499 shares of our common stock at an exercise price of $1.22 per share. The warrant was immediately exercisable and expires the earlier of seven years from the date of the issuance and the consummation of an initial public offering by us. The fair value of the warrant was estimated using the Black-Scholes option pricing model and was recorded as a deferred issue cost and will be amortized into interest expense over the term of the borrowing facilities.

Equipment Term Loan & Revolving Line of Credit.    On April 28, 2006, we entered into a loan and security agreement with a financial institution which was amended in July 2007. Under the loan and security agreement, the

 

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Company incurred $5.7 million in term loans, and may, from time to time, incur borrowings under an accounts receivable revolving line of credit, not to exceed $16.0 million. The term loan borrowing must be repaid in 33 equal consecutive monthly installments and bear interest at rates ranging from 10% to 10.75% per year. The revolving line of credit borrowings may be repaid and re-borrowed under the agreement with the entire unpaid principal amount to be paid in full on July 30, 2009. The revolving line of credit borrowings bear interest at a rate equal to the prime rate plus 1.50%. The Company’s obligations under this agreement are collateralized by a security interest in the Company’s receivables, property and equipment, intangible assets and cash and investments. At March 31, 2008, the Company had outstanding term loan borrowings of $4.3 million and revolver borrowings of $3.5 million under this agreement.

Loan and Security Agreement.    On August 10, 2005, the Company entered into a loan and security agreement with a financial institution. Under the agreement, the Company may borrow up to $2.0 million in the aggregate. The Company’s obligations are collateralized by a security interest in the specific computer and office equipment and furniture and fixtures funded by the advances. Borrowings under this agreement bear interest at rates ranging from 10.00% to 10.75% per year and are required to be repaid in 36 equal consecutive monthly installments commencing the month following the date of incurrence. At March 31, 2008, outstanding borrowings under this agreement totaled $423,000.

Financing Arrangement.    In August 2007, we entered into a financing arrangement for the purchase of certain software licenses and related maintenance totaling $1.2 million. The arrangement specifies an initial payment of $200,000, then quarterly payments of $150,707, with the final payment due on July 1, 2009.

We intend to repay our borrowings under the loan and security agreement and equipment term loan with a portion of the net proceeds of this offering.

Future Liquidity and Capital Resource Requirements

Based upon our current plans, we believe that our existing cash and cash equivalents, cash flow from operating activities and borrowing capacity under existing credit facilities, together with the net proceeds from this offering, will be sufficient to cover our estimated liquidity needs for at least the next 12 months. Over the next 12 months we anticipate capital expenditures of approximately $7.0 to $8.5 million for data center expansion as well as expansion of our corporate facilities.

Our future long-term capital requirements will depend on many factors, including our rate of revenue growth, the rate of expansion of our workforce, the timing and extent of our expansion into new markets, the timing of introductions of new functionality and enhancements to our platform, and the continued market acceptance of our services. Although we are not currently party to any agreement or letter of intent with respect to potential investments in, or acquisitions of, complementary businesses, services or technologies, we may enter into these types of arrangements in the future, which could also require us to seek additional equity or debt financing. Additional funds may not be available on terms favorable to us, or at all.

Contractual Obligations

The following table summarizes certain of our contractual obligations under our debt obligations and payments under our facility lease obligations and purchase commitments, as of December 31, 2007:

 

     Less Than
1 Year
   1 to 3
Years
   More Than
3 Years
   Total
     (In thousands)

Principal on long-term debt

   $ 6,591    $ 2,775    $    $ 9,366

Interest on long-term debt (1)

     795      422           1,217

Operating leases

     1,098      2,471      3,325      6,894

Capital leases and other financial arrangements

     577      466           1,043
                           

Total

   $ 9,061    $ 6,134    $ 3,325    $ 18,520
                           

 

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(1) Interest calculations assume that the term loans would be repaid based on the contractual repayment schedules and interest rates and the borrowings under the revolving line of credit would remain at $4.0 million through a repayment date of July 30, 2009 at the December 31, 2007 prime rate of 7.25% plus 1.50%. At March 31, 2008, the prime rate was 5.25%.

Recent Accounting Pronouncements

In February 2007, the FASB issued SFAS, No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, Including an Amendment of FASB Statement No. 115. SFAS No. 159 allows entities to measure many financial instruments and certain other assets and liabilities at fair value on an instrument-by-instrument basis (the fair value option). The fair value option expands the ability of entities to select the measurement attribute for certain assets and liabilities. Effective January 1, 2008, we adopted SFAS 159. The adoption of SFAS 159 had no impact on our results of operations and financial position.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which defines the fair value, establishes a framework for measuring fair value and expands disclosure about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Early adoption is encouraged, provided that we have not yet issued financial statements for that fiscal year, including any financial statements for an interim period within that fiscal year. In February 2008, the FASB issued FASB Staff Position 157-2, Effective Date of FASB Statement No. 157, which provides a one-year deferral of the effective date of SFAS 157 for non-financial assets and liabilities. The adoption of SFAS 157 relating to our financial assets and liabilities had no impact on our results of operations and financial position.

In December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations, or SFAS 141(R). SFAS 141(R) establishes principles and requirements for how an acquirer accounts for business combinations and includes guidance for the recognition, measurement and disclosure of the identifiable assets acquired, the liabilities assumed and any noncontrolling or minority interest in the acquiree. It also provides guidance for the measurement of goodwill, the recognition of contingent consideration and the accounting for pre-acquisition gain and loss contingencies, as well as acquisition-related transaction costs and the recognition of changes in the acquirer’s income tax valuation allowance. SFAS 141(R) applies prospectively and is effective for us beginning January 1, 2009. We are currently evaluating the impact, if any, that our adoption of SFAS No. 141 (revised 2007) may have on our results of operations and financial position.

Effects of Inflation

Inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future. However, the impact of inflation on replacement costs of equipment, cost of operations and support, cost of services and operating expenses, primarily employee compensation and benefits, may not be readily recoverable in the price of services offered by us.

Off-Balance-Sheet Arrangements

As of March 31, 2008, we did not have any significant off-balance-sheet arrangements.

Qualitative and Quantitative Disclosures about Market Risk

Market risk represents the risk of loss that may impact our financial position due to adverse changes in financial market prices and rates. Our market risk exposure is primarily the result of fluctuations in interest rates.

At March 31, 2008, we had unrestricted cash and cash equivalents totaling $2.7 million. These amounts were invested primarily in money market funds. The unrestricted cash and cash equivalents were held for working capital purposes. We do not enter into investments for trading or speculative purposes. Due to the short-term nature of these investments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, would reduce future investment income.

 

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We are exposed to market risk from changes in interest rates with respect to our loan and security agreement with BlueCrest Venture Finance Master Fund Limited and an equipment term loan with Silicon Valley Bank, which have interest rates based on prime rates. There was $8.2 million outstanding indebtedness as of March 31, 2008 under these agreements. Accordingly, we are exposed to potential losses related to increases in interest rates. A hypothetical one percent increase in the floating rate used as the basis for the interest charged under these agreements as of March 31, 2008 would result in an $35,000 increase in annualized interest expense assuming a constant balance outstanding of $3.5 million related to the revolving line of credit.

 

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BUSINESS

Overview

We provide on-demand, interactive customer communications solutions and, based on our size, breadth of products and number of customers, believe that we are the leader in this market. Our solutions consist of software applications and services that enterprises use on an as-needed, or on-demand, basis to create, manage and deliver automated, personalized communications to their customers through multiple media channels including voice, email, SMS, pager, web and fax. Examples of such communications include flight cancellation notices, credit card fraud detection alerts, scheduling of service calls, customer service feedback surveys, medication adherence notifications and payment reminders. Customers are able to interact with enterprises by receiving and responding directly to important personalized information provided by our automated communications. Enterprises who use our solutions typically experience higher levels of customer loyalty and satisfaction and, as a result, our solutions enable these enterprises to enhance revenues and to reduce costs by improving their communications processes.

Our customer communications solutions span the customer lifecycle with applications for customer initiation, customer service, customer retention and collections. We also provide business continuity solutions, which consist of applications and services that organizations use to quickly and reliably communicate with employees and customers during inclement weather, disasters, network outages and other planned and unplanned incidents. Our applications provide our customers with significant incremental revenue benefits and help eliminate unnecessary costs by driving efficient, scalable and actionable communications.

We deploy our customer communications solutions on our computer infrastructure which has been designed to host multiple applications for numerous separate enterprises simultaneously. This multi-tenant platform currently hosts over 600 separate applications for over 350 organizations and handles on average over 3.5 million notifications, or discrete contacts by phone, email, SMS, pager, web or fax, each business day. Our solutions are connected to and tightly integrated with our customers’ IT systems and are thereby able to use existing customer data to create communications that are contextual and personalized.

We employ a software-as-a-service, or SaaS, model through which we deliver our applications and services on a fully-managed, as-needed basis. Our customers do not need to install, configure, manage or maintain any meaningful hardware, software or services in order to use our solutions. By providing our solutions to our customers on demand, our customers may use our solutions without incurring significant upfront expense and can easily add new applications and services over time. We offer a full range of managed services that allow us to design and implement the most effective solution and to regularly evaluate and optimize each customer’s applications. This fully-managed approach allows us to deliver superior results for our customers.

Based on our analysis of the usage of customer communications solutions and publicly available information regarding the industry sectors we target, we believe that the total addressable market in North America for interactive customer communications is in excess of $4.0 billion. We believe that on-demand solutions such as ours provide the functionality, flexibility, scalability and efficiency to best address this large and growing opportunity. We also believe that our ability to penetrate and address this market opportunity is enhanced by enterprises increasing their adoption of on-demand software. International Data Corporation, or IDC, a leading market research firm, estimates the worldwide software on-demand market to be $5.7 billion in 2007 and expects it to grow to $14.8 billion in 2011, representing a compound annual growth rate of 27%. IDC defines this market as software, services, and support offerings that are specifically built and designed for delivery over the Internet.

Over 350 organizations use our solutions, including more than 100 of the Fortune 1000. We target the largest and most sophisticated enterprises within key industry sectors, including financial services, telecommunications, utilities, healthcare and transportation, as well as government organizations. Our U.S. customers include five of the ten largest banks, four of the five largest wireless carriers, 25 utility companies, six of the top ten airlines, three of the top five pharmacy benefits management companies and over 25 government departments and agencies. An illustrative list of our large enterprise customers within these industries includes Alaska Airlines, Dell, Delta Air Lines, Deutsche Bank AG, DTE Energy, Medco, SunTrust Mortgage, Time

 

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Warner Cable and UPS. Our customers typically broaden the deployment of our services across their organizations and increase the usage of our services by deploying additional applications and increasing the volume of notifications.

We typically enter into usage-based, one-to-three-year contracts with our customers. Our customers typically renew their contracts and a significant percentage of our revenues in any given period are derived from existing customers, and we expect this to continue. For example, during the year ended December 31, 2007, over 95% of our revenues were attributable to revenues from existing customers.

Our revenues grew from $29.7 million in 2005 to $50.9 million in 2006 and $68.0 million in 2007. In the three months ended March 31, 2007, we generated $15.7 million of revenues compared to $19.3 million in the three months ended March 31, 2008. We have incurred losses to date and had an accumulated deficit of approximately $35.3 million at March 31, 2008.

Industry Background and Trends

Enterprises must effectively communicate with their customers in order to remain competitive and, to achieve this, have traditionally used call centers staffed with large numbers of customer service agents who directly interact with customers over the phone. Call centers, however, have several drawbacks, particularly the cost of hiring, training and retaining quality agents and the difficulty of optimizing call centers to meet the demands of constantly changing call volumes. As a result, many call centers employ large agent workforces to handle peak call volumes, resulting in excess agent capacity during non-peak call volumes. Conversely, an insufficient number of agents can result in long customer wait times, hang-ups or busy signals, all of which lead to customer dissatisfaction and attrition.

Many companies have outsourced their call centers in the belief it would generate cost savings. However, a number of these companies have found that outsourcing does not consistently reduce overall costs and does not improve customer satisfaction. Companies have also tried to reduce costs by automating the way they communicate with customers or by using different communication methods. For example, in the 1980s enterprises began using computer systems that automated the dialing and distribution of calls and permitted consumers to use self-service options. In the 1990s, email and instant messaging, customer relationship management, or CRM, products and computer-telephony integration broadened the number of ways enterprises could communicate with their customers while attempting to enhance the customer experience through integration of these technologies.

While these approaches have improved upon the legacy call center concept, they have generally failed to meet the growing needs and demands of businesses and their customers for several reasons:

 

   

They tend to automate customer-initiated (inbound) rather than proactive (outbound) communications.     Existing solutions have typically been designed to reduce the burden on call center personnel by automating the handling of inbound calls or by offering automated communication alternatives to customers calling the call center. These existing solutions, however, are designed to react to inbound customer questions and concerns rather than actively managing customer relationships in ways that help enhance revenues and customer satisfaction.

 

   

They fail to meet individual customer needs.     Existing solutions tend to be stand-alone systems that do not integrate with existing enterprise IT systems. As a result, these solutions are generally unable to incorporate specific data on individual customers and fail to differentiate one customer issue from another. In addition, most of these legacy solutions do not maintain historical records of customer interactions, which can lead to frustrated customers who must repeat information during subsequent interactions. Because of these shortcomings, existing solutions do not provide contextualized or targeted communications, resulting in inefficient communications.

 

   

They are impersonal.    Use of legacy computer-generated systems such as interactive voice response systems can fail to understand voice requests, mispronounce names and other terms and often misroute calls, creating a frustrating user experience. Rather than interact with these impersonal systems, customers will often insist on reaching a live agent, eliminating any potential benefits of automation.

 

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They do not intelligently route communications.    Many legacy solutions do not effectively integrate contacts with voice calling systems, and lack the ability to intelligently transfer an automated notification to an appropriate live agent for escalation and resolution. As a result, customers who interact with these systems often speak to multiple agents before resolving their issues. This lack of integration results in inefficient communications, wasted company resources and unsatisfied customers.

 

   

They lack a unified platform for multi-channel communications.    Many enterprises have deployed multiple individual systems for communicating with customers via different channels, such as live call centers, email contact systems, and websites. These individual systems tend to be separate and distinct from one another and are therefore unable to share or synchronize data. As a result, these systems cannot easily adapt communications to a customer’s preferred delivery channel.

 

   

They are costly and lack the ability to scale to meet the needs of large, complex enterprises.    The IT infrastructure and staff required to support in-house customer communications represent a substantial initial investment and ongoing costs for enterprises to deploy and operate. Further, many legacy approaches are inflexible and do not readily enable customers to self-serve, ultimately requiring call center agents to satisfy customer needs. As a result, existing approaches are unable to adapt to evolving communications initiatives or to handle large increases in traffic, requiring enterprises to purchase additional stand-alone systems and hire large numbers of new agents in order to meet high volumes of personalized customer communications.

 

   

They are exposed to technology risk.    Large enterprises invest substantial amounts of money in hardware and software systems that can quickly become outdated. As communications technologies continue to change and improve, such enterprises are increasingly exposed to the risk of obsolescence of their technologies and are forced to perform costly hardware or software upgrades.

Due to the shortcomings of legacy solutions, enterprises are seeking new technologies and services that enable proactive, actionable, automated customer communications to help strengthen customer loyalty and improve business performance.

Our Solution

We believe we are the leading provider of on-demand, interactive customer communications solutions, delivered through a fully-managed SaaS model. Enterprises use our solutions to automate processes required to deploy proactive, personalized communications to customers throughout the customer lifecycle. Our suite of applications provides automated communications for customer initiation, customer service, customer retention and collections. Examples of such communications include flight cancellations, credit card fraud detection, scheduling of service calls, customer service feedback surveys, medication adherence notifications and payment reminders. We also provide business continuity applications that enable organizations to quickly and reliably communicate with first responders and notify, inform and account for employees and customers in the event of planned and unplanned incidents. These communications can be delivered through multiple channels including voice, email, SMS, pager, web and fax or any combination thereof. By using our solutions, enterprises are able to deliver valuable information to the right individual at the right time and in the right form, which enables the recipient to take action in response to this information. As a result, our solutions help organizations across multiple industries enhance customer relationships, increase revenue, improve operational performance and reduce operating costs.

Our applications are hosted on our multi-tenant platform called Varolii Interact, which is capable of supporting hundreds of different applications simultaneously and executing millions of automated communications per day. We currently have over 600 applications deployed that result on average in over 3.5 million notifications each business day. We offer our solutions through an on-demand, fully-managed service, which enables our customers to easily deploy new communications initiatives while reducing their investments in technology, implementation services, and IT personnel, and also allows us to continually optimize our solutions for our customers.

 

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Key benefits of our solution include:

 

   

Proactive, Actionable and Revenue Enhancing Customer Communications.    Our solutions enable enterprises to proactively contact customers with important information, rather than waiting for customers to contact call centers for information or to resolve problems. For example our technology platform might send outbound call or email to notify someone that a flight is delayed. Our solutions also incorporate self-service functions that enable customers to act upon the information they receive. For example, customers can make payments, schedule appointments, renew contracts, buy products and services, complete surveys, and verify account activity using our solutions. As a result, consumers that interact with our solutions are more informed, empowered, and connected to these organizations. Our solutions improve end-customer satisfaction and reduce costly inbound call volume, which helps our customers to meaningfully enhance revenues and reduce costs.

 

   

Personalized Customer Communications.    Our solutions leverage existing customer data that reside in various IT systems to provide detailed information that is specific to individual customers. In addition, we use professional voice talent in pre-recording a wide range of names, numbers, words and phrases to be used in our proactive voice notifications. As a result, the communications generated by our solutions provide more targeted information to customers and sound more natural than traditional automated communications, which increases customer response rates and satisfaction.

 

   

Intelligent Routing of Communications.    Our on-demand platform provides a flexible architecture that is able to deliver information and communications independent of our customers’ infrastructures. As a result, our solutions are able to intelligently route callers to the most appropriate system or individual. For example, our customers are able to automatically contact an individual regarding questionable credit card usage and enable self-service customer resolution or, if necessary, connect the individual with a fraud specialist. Our intelligent routing capabilities allow customers to receive more effective and efficient service which strengthens customer loyalty and optimizes enterprise resources.

 

   

Fully-Managed Service for Communications.    We offer our enterprise customers a full range of managed services that are focused on designing, implementing the most effective automated customer communications solutions. We collaborate with our customers to create customized applications that deliver measurable results that meet their specific communications needs. Drawing on the results of the customer interactions that we manage, we utilize analytical tools to evaluate these results and gain critical insights into customer behavior based on responses to our applications. With this analysis, we are able to fine-tune our applications and optimize the performance and effectiveness of our customers’ communications initiatives.

 

   

Scalable Solution for Multi-Channel Communications.    Our platform is designed to scale to meet the communications needs of large and sophisticated enterprises. Our current customer base represents a range of U.S. industries, including five of the ten largest banks, four of the five largest wireless carriers, 25 utility companies, six of the top ten airlines, three of the top five pharmacy benefits management companies and over 25 government departments and agencies. We currently have over 600 applications deployed that result on average in over 3.5 million notifications each business day. In addition, our solution is designed to deliver communications through multiple channels, such as voice, email, SMS, pager, web and fax, which enables our customers to contact individuals by their preferred method. Finally, our business continuity solutions are capable of immediately delivering large volumes of notifications during a crisis.

 

   

Flexible Integration and Ease of Implementation.    Our platform is built using open standards, such as Java and XML, which enables it to quickly and seamlessly integrate with our customers’ existing back office enterprise resource planning, CRM and call center systems. As a result, our solutions are able to fully integrate with and extend the value of our customers’ existing systems. Our on-demand delivery model allows us to deploy our solutions typically in three to six weeks, and in some cases within 24 hours, enabling our customers to quickly receive the benefits of automated communications.

 

   

Low Total Cost of Ownership.    We deliver our solution through a fully-managed SaaS model. Because our customers do not need to install and maintain our applications, they are able to limit upfront

 

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investments in hardware and third-party software and systems and better leverage existing IT personnel. Our usage-based pricing model eliminates expensive software license and maintenance fees and provides our customers with predictable costs that scale with usage.

 

   

Reduced Technology Risk.    Our on-demand platform allows our customers to immediately receive the benefits of ongoing improvements to our applications without having to invest in new software or implement costly and time consuming system upgrades. For example, as new communication channels such as email and SMS have become prevalent, we have been able to add these new channels seamlessly to our solutions, enabling customers to avoid re-architecture or replacement of their solutions. As technology changes our customers do not have to invest in additional infrastructure to support the services we provide.

We enable enterprises to deliver automated, actionable and customized communications that improve customer satisfaction and loyalty. Our solutions allow customers to generate higher revenue, reduce costs of customer and business continuity communications, and improve cash flow. As a result, our customers achieve significant and measurable returns on investments in our solutions.

Our Strategy

Our objective is to enhance our market leadership position by:

Increasing Our Existing Customers’ Use of Our Solutions.    Over 350 organizations use our solutions in a number of industries including financial services, telecommunications, utilities, healthcare and transportation, as well as government organizations. As customers gain experience with our solutions, they typically implement more of our applications and deploy our solutions at additional departments or business units. We will continue to collaborate closely with our customers to develop new applications that address their evolving requirements. We believe there is a significant growth opportunity in increasing sales of our solutions to our existing customers, selling new and additional solutions to these customers, and selling our solutions to additional constituencies within our existing customers’ organizations. We intend to continue to sell additional deployments of new and existing applications to our existing customer base and to encourage customers to increase their usage of deployed applications.

Selectively Targeting New Customers.    Our customers include more than 100 of the Fortune 1000 and we intend to continue to target the largest and most sophisticated enterprises within our selected industry sectors. We believe these potential customers can derive substantial, incremental benefits from our solutions and will act as valuable references as we target additional customers in each key industry sector. We also intend to selectively target new industry sectors as our business evolves. We believe we can accomplish these objectives through our direct sales force, which is our primary sales channel, and through our indirect channel partners. We have existing relationships with over 20 such partners and intend to selectively increase the number of these alliances.

Leveraging Our Domain Expertise.    Over the last seven years we have gained a deep understanding of the specific communication challenges facing our customers. We believe that the subject matter expertise we have developed will continue to allow us to tailor our solutions to address our customers’ specific needs. We intend to continue to develop and leverage our knowledge of our customers’ industries and insights from analyzing our existing operations in order to build innovative applications which will improve our solutions and expand our addressable end markets.

Bolstering Our Product Leadership Position.    We believe our technology platform, which was purposely built for on-demand customer communications, provides us with significant technology advantages. This platform is used by many of the largest and most sophisticated enterprises across a number of industry sectors. We intend to continue to invest in the scalability, performance, security and reliability of our existing technology platform in order to continue to increase the effectiveness of our solutions and extend our competitive advantages. We also intend to continue to invest in innovative technologies that will enhance the efficiency and the effectiveness of our platform.

 

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Entering New Geographic Markets.    We believe substantial demand exists for our solutions in markets outside of North America, such as Europe, Asia and Latin America. In addition, many of our customers are large, multi-national enterprises who have significant customers and employees located outside North America. We currently provide automated communications solutions for these multi-national customers from our U.S. operations. We believe there is significant opportunity to further expand our markets by increasing our international presence to better serve global customer communications needs. We intend to make the necessary investments in our direct sales force and develop additional channel partnerships to strengthen our distribution capabilities in select markets where we believe there are meaningful near-term and long term growth opportunities.

Our Products and Services

We develop, host and deliver automated interactive communications solutions through our on-demand platform, Varolii Interact. We use Varolii Interact to deploy customer initiation, customer service, customer retention, collections and business continuity applications. These applications enable our corporate customers to proactively engage with their customers, to provide their customers with valuable information in a timely fashion and to empower them to take action.

Varolii Application Suites.    Our application suites are tailored for the specific industries in which our customers operate, including financial services, telecommunications, utilities, healthcare and transportation, as well as government organizations. Customers, according to their need, choose among a spectrum of existing pre-built applications or fully-customized applications that we tailor to meet their unique communications requirements.

 

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The following table provides a summary of the types of applications we presently offer:

 

Application Suite    Description    Illustrative Examples

Customer Initiation

  

Applications that:

•   introduce or confirm the brand

•   confirm enrollment information

•   capture customer preferences

•   allow customers to respond to unclear information

  

•   Welcome new customers

•   Verify service terms

•   Special instructions

•   Obtain missing information

•   Introduction to service confirmation

Customer Service

  

Applications that:

•   schedule appointments

•   inform customers of any impending problems or difficulties with service

•   seek customer feedback

•   protect consumers from fraudulent activity

•   improve medication adherence and patient wellness

  

•   Fraud notification

•   Customer survey

•   Shipment order status

•   Refill reminders

•   Health risk assessments

•   Appointment scheduling

•   Claim status

•   Loan status and origination

•   Flight status and cancellations

Customer Retention

  

Applications that:

•   manage the selling of additional goods and services to existing customers

•   inform customers about expiring services

•   deflect and manage unpredictable inbound call volumes

  

•   Delivery scheduling

•   Account updates

•   Win-back

•   Service renewal

•   401(k) rollover

•   Loan consolidation

•   Rate change notices

•   Policy renewals

Collections

  

Applications that:

•   automate the collections process

•   proactively and immediately address all stages of customer delinquencies

•   remind customers of due payments

•   automate authentication before transferring customers to a collection agent

  

•   Payment reminders

•   Early stage collections

•   Late stage collections

•   Right party generator

•   Margin calls

•   Overdraft notifications

Business Continuity

  

Applications that:

•   notify employees of important events or issues

•   deliver fast and reliable communications during a crisis

•   provide valuable information to organizations’ workforces

•   centralize and manage information interchange

  

•   Pandemic planning

•   First responder

•   Employee accountability

•   Workforce continuity

•   Unplanned events

•   Demand response

•   Network outage

Add-on Services.    We offer a range of complementary services that are delivered through our on-demand platform. These services include automated payment processing and Varolii Locate, which provides updated and validated contact data through one or more third-party value-added address and contact databases.

The Varolii Interact Platform.    Our Varolii Interact platform hosts our applications in a multi-tenant, multi-language and multi-channel environment. We currently have over 600 applications deployed that result on average in over 3.5 million notifications each business day. Our platform also stores the results of interactions

 

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and we analyze these results to gain critical business insights that allow subsequent interactions to be optimized, resulting in performance and efficiency gains and improved effectiveness across customer solutions. We have received a number of prestigious technology awards, including: Top 100 Collection Technology Products for 2006 from Collection Advisor Magazine; CRM Excellence Award from Customer Inter@ction Solutions, February 2005; Best Multi-Channel Solution from ContactCenterWorld.com, February 2005; and 2002 Product of the Year Award from Communications Convergence Magazine.

Our Varolii Interact Platform consists of several distinct components that are used together to create, deploy, and manage our hosted applications. First, Varolii Tools is a web-based software suite that our engineers and our customers use to create and manage our hosted applications. Second, Varolii Integration Gateway is a software component that links our hosted applications with our customers’ existing IT systems in order to incorporate existing data into customized communications that are generated by our applications. Finally, Varolii Application Engine is a software component that processes, routes and delivers communications by phone, email, SMS, pager, web, fax, or any combination thereof.

The following diagram provides an overview of our platform:

LOGO

Additional details about our platform components are as follows:

 

   

Varolii Integration Gateway enables integration and implementation of complex business rules. Customers can run customized versions of our gateway software to provide real-time integration, customized data filtering and pre- or post-processing activities. We accept data from our customers in any format and apply the appropriate treatment strategy based on proprietary decisioning, file manipulation and list creation, and analytical techniques. We provide an extensive web-services application programming interface, or API, for partners and customers to access our critical communication features with their own product or integration platforms.

 

   

Varolii Application Engine is the main delivery and execution component of our platform. This component provides multi-language and multi-channel capabilities, including voice, email, SMS, pager, web, fax, or any combination thereof. The Varolii Application Engine incorporates service level agreement technology that allows us to guarantee platform throughput and delivery timelines that support both high and low volumes of usage. Our platform integrates into the existing call center infrastructure, allowing live-agent interactions in conjunction with our automated solutions, along with reporting, statistics and pacing technologies, to optimize live-agent resources.

 

   

Varolii Tools is a web-based software suite that allows our customers to run and manage their hosted communications applications and processes. We provide customers with a real time monitoring dashboard to evaluate the performance of their applications. In addition, we provide a fully integrated, drag and drop, graphical workbench which our employees and customers use to quickly create and modify sophisticated, feature-rich applications. We also provide historical reporting and analysis tools, allowing the continuous monitoring of applications. Varolii Profiles™ is our business continuity tool,

 

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which allows for the management of automated communications in urgent or emergency situations. This component stores recipient contact and profile information, organizes messaging and teaming strategies, and tracks the status of outbound and inbound notifications by recipient and event.

Professional Services and Support.    We offer a full range of professional services, and customer management and support to enhance our suite of communications applications.

Our key services include:

 

   

Configuration and Integration Services.    We guide our customers throughout initial configuration and integration of our solutions with their systems. We establish strong working relationships with our customers and employ best practices during deployment and training. We have the ability to tailor applications to best meet individual business requirements. Our unique technology and deployment model allows us to tightly integrate our solution with our corporate customers’ existing systems, minimizing organizational disruption while retaining future flexibility.

 

   

Monitoring and Tuning Services.    We work with our corporate customers to analyze response data, apply best practices, and continually tune and refine their applications. We help customers maximize the benefit of our solutions even as their customer communications needs change. Our team evaluates evolving industry standards and shifting business environments, comparing our customers’ communications results with industry benchmarks, to identify opportunities for improvement.

 

 

 

Media Services.    We incorporate our customers’ brand and persona into our solutions using a library of “Golden Voices,” pre-recorded by professional voice actors, that includes an extensive number of drug names, automobile manufacturers, merchants, and common first and last names. Our technology is configured for broadcast quality audio for different types and uses of voice-based applications. Through our Message MasteringSM process, our team of experienced recording studio professionals works with voice actors to record variations of customer-specified scripts in real-time so that adjustments to audio content can be made prior to final production and deployment of a customer’s application.

 

   

Support Services.    Our support professionals handle network connectivity, file transmission, notification service performance, and application management. Our customers can contact our support center 24 hours a day, 7 days a week and 365 days a year.

Customers

Over 350 organizations use our solutions, including more than 100 of the Fortune 1000. We target the largest and most sophisticated enterprises within key industry sectors, including financial services, telecommunications, utilities, healthcare and transportation, as well as government organizations. Our U.S. customers include five of the ten largest banks, four of the five largest wireless carriers, 25 utility companies, six of the top ten airlines, three of the top five pharmacy benefits management companies, and over 25 government departments and agencies. Our customers include Alaska Airlines, Dell, Delta Air Lines, Deutsche Bank AG, DTE Energy, Medco, SunTrust Mortgage, Time Warner Cable and UPS. Our customers typically increase the number of applications, broaden the deployment of our services across their organizations, and increase their usage of our services over time. Bank of America and its affiliates accounted for more than 11% of our revenues in 2006 and 2007, and 12% of our revenues in the three months ended March 31, 2008.

Customers in a number of industry sectors use our applications to solve a wide variety of communications objectives. Selected examples include:

Financial Services: BOK Financial.    BOK Financial, or BOKF, a multi-bank holding company, uses our interactive collections solution to reduce its mortgage delinquency ratio. BOKF uses our solution to automate much of the communications process around early stage delinquencies, enabling the company to focus its call center resources on more complex, high-priority accounts. Additionally, our solution enables BOKF’s customers to self-manage their mortgages by making payments or by immediately connecting to a loan counselor to gather

 

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additional information. Since deploying our solutions, BOKF realized a 12% reduction in average mortgage delinquency ratios in the first four months of 2007, as compared to the same period in 2006 (declining from an average of 2.51% in the first four months of 2006 to an average of 2.20% in the first four months of 2007). This was achieved at a time when U.S. mortgage defaults hit a high of 2.87% in the first quarter of 2007, surpassing the worst levels since the 2001 recession. By using our solution, BOKF has improved its collections performance while making its collections process more convenient for its customers.

Travel & Transportation: Alaska Airlines.    This customer was regularly forced to redeploy agents from inbound sales calls to inform passengers of flight delays and cancellations. During such incidents, inbound call wait times regularly surged from under five minutes to as much as 30 minutes, which negatively impacted customer satisfaction and loyalty. We integrated our applications with the Alaska Airlines reservation system and, using our multi-channel capabilities, communicated all itinerary changes to passengers promptly. This resulted in a three-month return on investment in the Varolii solution, 40 times more peak capacity than using agents for outbound contact and a 66% cost saving per successful contact in comparison to using agents.

Telecommunications: Major Wireless Carrier.    Our interactive customer communications solutions allowed this customer to improve its customer retention. Our “win-back” application was designed to automatically contact customers who have cancelled their wireless phone service, present them with customized offers and transfer interested parties directly to a customer service representative. This carrier experienced a 416% increase in customer saves as it was able to re-contract 98% of those customers that transferred to a customer service agent compared to only 10-15% before implementing our solution. Additionally, this carrier’s agent handle times, call handling times, hold times and time spent between calls were reduced by 50-70%.

Business Continuity: Southern California Edison.    Southern California Edison’s, or SCE’s, high-need customers, whose lives depend on electric-powered critical-care devices, require reliable and timely customer communications, specifically in the event of power outages. By using our solution, SCE reduced notification time from hours to just 15 minutes, significantly reduced dependency on agent resources, and increased agent utilization and customer satisfaction.

Sales and Marketing

Sales.    We sell our products and services primarily through our direct sales organization and to a lesser extent through indirect channels. Our direct sales organization is divided into new business and installed base sales groups. Our sales process for new customers typically begins with the generation of a sales lead from a marketing program or customer referral. In our new business sales group, we employ personnel to make initial calls to potential customers, qualify customer leads, set appointments and direct sales representatives to close sales with prospective customers. We also have sales engineers who work closely with our sales representatives to discuss the applications and business needs with a customer and to provide a seamless transition to our professional services group for implementation. Our installed base sales organization focuses on managing existing customer relationships, further penetrating and selling additional solutions within customers’ organizations.

We offer pilot programs whereby a prospective customer can purchase our applications for a limited time to determine whether our solutions meet its needs prior to committing to a long-term contract. A pilot program typically lasts 30 to 60 days. As a result of this program, we believe we have experienced shorter sales cycles, higher closure rates and larger deal sizes. Our sales cycle for new business typically ranges from three to nine months, but can vary based on the specific application, the size and complexity of the potential customer’s business and integration needs and other factors. We experienced substantially shorter sales cycles when selling new applications to existing customers or broadening deployment of applications within existing customers’ organizations.

Our indirect channels consist of relationships with resellers and original equipment manufacturers, or OEMs. As of March 31, 2008, we had relationships with more than 20 indirect resellers and OEMs which primarily are involved in reselling our business continuity offerings. Our focus is on building relationships that can derive substantial, incremental benefits from our solutions. These relationships include ADS Alliance Data Systems, Inc., Fort Knox National and Strohl Systems. We have a dedicated business development staff in our sales

 

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organization that specializes in developing and managing these strategic relationships. In the future, we intend to establish additional strategic relationships with market alliance partners.

Marketing.    We tailor our marketing efforts to key industry sectors, customer sizes and application categories. Our marketing department refines our market strategy and direction, generates customer leads, and manages public and industry analyst relations. We conduct ongoing media, public relations, direct mail and email campaigns, develop and place web advertising, develop and maintain our web site, and create sales tools such as product brochures, web and electronic demonstrations. We also conduct webinars and prospect road shows, sponsor and participate in trade shows, marketing events and industry conferences, publish white papers relating to customer communications issues, and develop customer reference programs, such as written and video customer case studies.

Competition

The market for on-demand communication solutions is competitive, changing rapidly and fragmented. It is subject to rapidly developing technology, shifting customer requirements, frequent introductions of new products and services and increased marketing activities of industry participants. Although we believe that none of our competitors currently offers a solution as comprehensive as ours, potential customers do evaluate us against a number of alternatives including in-house developed solutions.

Currently, we principally compete with the internal information technology departments of our customers who develop and maintain solutions in-house. Often we compete to sell our solutions against existing systems that our potential customers have already made significant expenditures to develop and install, and as a result may be less inclined to use our applications. We also face competition from other vendors of customer communications and business continuity solutions. These vendors tend to be confined within certain specific industry sectors or offer broad product suites in which interactive customer communications is a small component.

The market in which we compete is evolving, and some of our competitors have significantly greater financial, technical, marketing, service and other resources than we have. We expect the intensity of competition to increase in the future as existing competitors continue to develop their capabilities, as new companies enter our market and as we expand into broader markets.

The principal competitive factors in our industry include the following:

 

   

effectiveness in improving the quality and value of customers’ relationships with their customers;

 

   

total cost of ownership and easily demonstrable cost-effective benefits for customers;

 

   

the ability to provide enterprise-wide solutions and support;

 

   

the ability to provide multi-channel and multi-lingual support;

 

   

expertise in delivering solutions through a fully-managed service;

 

   

breadth and depth of capabilities and functionality to meet complex customer business and process requirements;

 

   

quality of care delivered to customers and our customers’ customers;

 

   

speed and ease of deployment and use of solutions;

 

   

ease of integration with existing applications, data, communications infrastructure and processes;

 

   

proven performance, configurability, security, scalability and reliability of solutions;

 

   

ability to innovate and respond to customer needs rapidly;

 

   

size of customer base and level of user adoption; and

 

   

financial stability and reputation of the vendor.

 

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Product Development, Technology and Operations

Product Development and Technology.     Our product development efforts are focused on improving and enhancing our existing solutions, as well as developing new proprietary technology to ensure that we respond to our customers’ evolving needs. Our product development philosophy incorporates our long-term strategic view of our market and incorporates customer feedback to improve and enhance our applications. Our engineering and product development expenses totaled approximately $4.3 million in 2005, $7.4 million in 2006, $11.3 million in 2007 and $2.9 million in the three months ended March 31, 2008.

Our customer communication platform is a secure, scalable code base written primarily in Java using the Java 2 Enterprise Edition, or J2EE, development framework, built on top of JBoss application servers and Oracle databases. Our business continuity platform is written primarily in C++, using Microsoft technology and utilizing Microsoft SQL Server databases.

We use a combination of proprietary, open source and commercially available software, including Java, the JBoss application server, Nuance text-to-speech and automated speech recognition software, Oracle and Microsoft SQL Server database. The software runs on a combination of Linux, Microsoft Windows and Sun servers. We use commercially available hardware, including NMS Communications and Intel telephony cards.

Operations.     We service our customers from third-party data center facilities in Seattle, Washington, Denver, Colorado, Chicago, Illinois and Watertown, Massachusetts. All facilities are staffed by trained personnel, provide physical access controls, and provide full backup power, including generators in case of power failure.

Our platform’s architecture enables us to deploy hundreds of applications simultaneously and manage millions of notifications per day while providing our customers with enterprise-class scalability, flexibility and security. We host multiple customers on a load-balanced server farm, with each customer’s data kept separate. Our platform is highly scalable, while the number of servers and instances can be increased or decreased as necessary to match demand. Changes or fixes are rolled out to multiple tenants simultaneously.

We own substantially all the hardware deployed in support of our platform, and we monitor the performance and availability of our service. We designed our service infrastructure using load-balanced web server pools, redundant interconnected network switches and firewalls, replicated database servers, clustered application servers, and fault-tolerant storage devices. Production databases are backed up on a regular basis to ensure transactional integrity and restoration capability.

Security is of paramount importance when using a single platform to host applications for numerous enterprises. We ensure the security of our customers’ implementations by using separate data stores for each customer and operating system level controls to ensure that one customer cannot gain access to another’s applications. Our security infrastructure includes firewalls, intrusion prevention and detection, encryption and network security protection. We have a chief security officer who leads our data protection and information security protection efforts. We have instituted periodic internal and third-party reviews of our security infrastructure. In addition, our customers regularly audit our operations according to their own internal security protocols. We have also implemented a robust access control and permissions system that allows our customers to control which individuals have access to which sets of information or perform which actions.

Intellectual Property

We rely on a combination of patent, copyright, trademark and trade secret laws, as well as nondisclosure agreements and other contractual provisions to protect our intellectual property.

We currently have five issued patents by the United States Patent and Trademark Office. We currently have eight patents applications in the United States and five foreign patent applications, all of which are foreign equivalents of the United States applications. The expiration dates of our issued patents range from January 31,

 

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2020 to August 18, 2024. We do not know whether any of our patent applications will result in the issuance of any further patents or whether the examination process will require us to narrow the scope of our claims. To the extent any of our applications proceed to issuance as a patent, the future patent may be opposed, contested, circumvented, designed around by a third party, or found to be unenforceable or invalidated in the applicable jurisdiction. In addition, our future patent applications may not be issued with the scope of the claims sought by us, if at all, or the scope of claims we are seeking may not be sufficiently broad to protect our proprietary technologies. It is also possible that any of our granted patents may be re-examined or found to be unenforceable or invalidated. Others may develop technologies that are similar or superior to our proprietary technologies, duplicate our proprietary technologies or design around patents owned or licensed by us. If our products are found to infringe on any patent held by third parties, we could be prevented from selling our products. If our patents or patent applications are found to conflict with any patent or patent application held by third parties, our patents could be declared invalid or our patent applications might not result in issued patents. The laws and regulations applicable to patents are undergoing significant change in the United States and other countries. Certain changes may have retroactive effect and may also result in the denial of some of our patent applications or the narrowing of the claims contained therein.

We have filed trademark applications for the Varolii trademark and the Varolii logo in the United States, and for the Varolii trademark in Canada, China, Japan, the European Union and certain other countries. We have filed applications for other trademarks and service marks in the United States and certain other countries. While some of these applications have reached registration status, our outstanding trademark applications may not be allowed for registration. If they are not granted, we may not be able to brand our products and services as effectively as we had planned or we may be compelled to change our branding strategy. Even if these applications are allowed, they may not provide us a competitive advantage.

In addition to filing patent applications and registering trademarks, we also rely in part on United States and international copyright laws to protect our software. Furthermore, we control access to and use of our proprietary software and other confidential information through the use of internal and external controls, including signing non-disclosure agreements with contractors, customers and partners. In addition, all of our employees and consultants are required to execute proprietary information and invention assignment agreements in connection with their employment and consulting relationships with us, pursuant to which they agree to maintain the confidentiality of our proprietary information and they grant us ownership rights in all inventions they reduce to practice in the scope of performing their employment or consulting services. However, we cannot provide any assurance that employees and consultants will abide by these agreements.

Some of the software we use to provide products and services to our customers are licensed to us by third parties. Some of those licenses, and our rights to use such third-party software, may be revoked or terminated under certain circumstances, and such revocation or termination may made it impossible or difficult to continue to provide our services to our customers. Furthermore, some of the third-party software we use to provide products and services is licensed to us under certain “open source” license agreements. These agreements may contain provisions that may require us to disclose our proprietary source code to customers or other third parties or distribute our source code for free in certain circumstances.

Despite our efforts to protect our trade secrets and proprietary rights through patents, licenses and confidentiality agreements, unauthorized parties may still copy or otherwise obtain and use our software and technology. In addition, we expect to expand internationally and effective patent, copyright, trademark and trade secret protection may not be available or may be limited in foreign countries. If we fail to protect our intellectual property and other proprietary rights, our business could be harmed. In addition, the internet, software and technology industries are characterized by the existence of a large number of patents, copyrights, trademarks and trade secrets and by frequent litigation based on allegations of infringement or other violations of intellectual property rights. As we face increasing competition, the possibility of intellectual property rights claims against us grows. Our technologies may not be able to withstand any third-party claims or rights against their use. Many of our service agreements require us to indemnify our customers for third-party intellectual property infringements claims, which would increase our costs as a result of defending those claims and might require that we pay damages if there were an adverse ruling in any such claims.

 

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Government Regulation

Our business operations are affected, directly or indirectly, by a wide range of U.S. federal and state laws and regulations that restrict customer communications using our service, our handling of information and other aspects of our business.

The Telemarketing and Consumer Fraud and Abuse Prevention Act and the Telephone Consumer Protection Act, among other U.S. federal laws, empower both the Federal Trade Commission, or FTC, and the Federal Communications Commission, or FCC, to regulate interstate telephone sales calling activities. FCC and FTC regulations impose certain requirements on or prohibitions against certain activities. For example, the FTC’s Telemarketing Sales Rule requires us to transmit caller ID information, disclose information to call recipients and retain business records. In addition, FCC and FTC regulations restrict the use of automatic telephone dialing systems, predictive dialing techniques, and artificial or prerecorded voice messages for many purposes, including telemarketing calls. Moreover, under the U.S. Telephone Consumer Protection Act, it is unlawful to use an automatic telephone dialing system or an artificial or prerecorded message to contact any cellular or other wireless telephone number, unless the recipient previously has consented to receiving this type of message or is not charged for the message.

Regulatory restrictions on artificial and prerecorded messages present particular problems for businesses in the debt collection industry. The Fair Debt Collection Practices Act regulates the timing and content of debt collection communications, including communications with a wireless telephone number. These restrictions also apply to third parties retained by creditors. Third-party collection agencies and debt buyers do not have direct relationships with the consumer debtors and therefore typically do not have the ability to obtain from a debtor the consent required to permit the use of artificial or prerecorded messages in contacting a debtor at a wireless telephone number. These businesses’ lack of a direct relationship with debtors also makes it more difficult for them to evaluate whether a debtor has provided such consent. The difficulties encountered by these third-party collection businesses are becoming increasingly problematic as the percentage of U.S. consumers using cellular telephones continues to increase. Although we have only a few collection agencies as customers, if these businesses are unable to use artificial or prerecorded messages to contact many of their debtors, our applications and services will be less useful to them.

To the extent our applications and services are used to send email or text messages, our customers will be, and we may be, affected by regulatory requirements in the United States and other countries. For example, the U.S. federal government and a number of states restrict email sent for the purpose of advertising the sale of goods and services if the recipient has not consented to receiving ads, does not have an existing business relationship with the sender or does not have the ability to opt not to receive email advertisements. Moreover, certain text messages may be subject to the prohibitions contained in the Telephone Consumer Protection Act and the CAN-SPAM Act, such that consent may be required prior to the transmission of messages or other content requirements may exist.

Our business is subject to data security laws, including laws that may require notification of the affected customers or consumers and regulatory authorities when data security has been breached. These are discussed below. For example, we are subject to the FTC’s Gramm-Leach-Bliley Privacy Rule which restricts disclosures of non-public, personal, consumer information received by our financial institution customers and limit uses of such information to prescribed purposes that are disclosed to consumers. The related Gramm-Leach-Bliley Safeguards Rule imposes administrative, technical and physical data security measures requirements. We also receive consumer information that is protected by the Fair Credit Reporting Act, which defines permissible uses of consumer information furnished to or obtained from consumer credit reporting agencies.

When our customers operate in industries that have specialized data privacy and security requirements, they may be subject to additional data protection restrictions. For example, the federal Health Insurance Portability and Accountability Act, or HIPAA, regulates the maintenance, use and disclosure of protected health information by certain health care-related entities. If we experience a breach of data security, we could be subject to costly legal proceedings that could lead to civil damages, fines or other penalties as well as claims by customers or third

 

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parties for damages. We or our customers could be required to report such breaches to affected consumers or regulatory authorities, leading to disclosures that could damage our reputation or harm our business, financial position and operating results as well as lead to contract claims or other claims by customers or third parties for damages.

Furthermore, many states and state agencies have also adopted and promulgated laws and regulations governing debt collection, telemarketing, and data security and privacy. These laws and regulations may, in certain cases, impose restrictions that are more stringent than the federal measures discussed above. For example, unlike federal law, many state telemarketing laws require telemarketing firms to register with state authorities before engaging in telemarketing. Some states regulate how long a telemarketer may let the telephone ring. Some laws require the telemarketer to receive a written confirmation by the buyer of any sale.

Similarly, as of February 2008, 38 states and the District of Columbia will have enacted data security breach laws. Many of these differ on the scope of protected data, the data holder’s obligations in the event of a security breach, and the mechanism through which the law may be enforced. Some of these federal and state laws are inconsistent with one another, and it may be difficult or impossible to comply with all of them. To date, our employees have performed a significant portion of our activities in complying with U.S. federal and state laws and regulations and we have not incurred material out-of-pocket compliance costs. We may not be able to avoid such costs in the future.

We may also record certain of our calls for quality assurance, or other purposes. Federal law and many state laws require both parties to consent to such recording and may have inconsistent standards defining what type of consent is required. Violations of these rules could subject us to this or other penalties, criminal liability, or claims by our customers for damages, any of which could hurt our reputation or harm our business, financial position and operating results.

Moreover, some foreign information security and privacy laws, including some in Canada and the European Union, may also apply to our services. These foreign laws may make it difficult to serve foreign customers because of the restrictions they place on the communication of personal data between countries. We intend to expand our operations outside the United States, and any country in which we commence or expand our operations may have laws or regulations comparable to or more stringent than those affecting our domestic business. For example, the USA PATRIOT Act provides U.S. law enforcement authorities certain rights to obtain personal information in the control of U.S. persons and entities without notifying the affected individuals. Some foreign jurisdictions, including Canada and the European Union, prohibit such disclosures. Such regulations could subject us and our customers to costs, liabilities or negative publicity that could impair our ability to expand our operations into some countries and therefore limit our future growth.

Our business, operating results and reputation may be significantly harmed if we violate, or are alleged to have violated, U.S. federal, state or foreign laws or rules covering customer communications. In the agreements they enter into with us, our customers typically agree to comply in all material respects with all applicable legal and regulatory requirements relating to their use of our service. We cannot be certain, however, that our customers comply with these obligations, and typically we cannot verify whether customers are complying with their obligations. Violations by our customers may subject us to costly legal proceedings and if we are found to be wholly or partially responsible for such violations, may subject us to damages, fines or other penalties.

Employees

As of March 31, 2008, we had 287 employees, of which 78 were in sales and marketing, 168 in services and support, engineering and operations, and 41 were in finance and administrative functions. None of our employees are covered by a collective bargaining agreement. We have never experienced employment-related work stoppages and we consider our employee relations to be good.

 

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Facilities

Our headquarters are located in Seattle, Washington where we lease approximately 46,000 square feet of office space. This lease will expire in 2013. We lease approximately 12,000 square feet of office space in Bedford, Massachusetts, pursuant to a lease that expires in November 2009. We also have a small office in Thornton, Colorado.

We believe that our current facilities, as we plan to expand them, are suitable and adequate to meet our current needs. We believe that suitable additional or substitute space will be available on commercially reasonable terms as needed to accommodate our operations.

Legal Proceedings

From time to time, we may become involved in litigation relating to claims arising from the ordinary course of our business. We believe that there are no claims or actions pending or threatened against us, the ultimate disposition of which would have a material adverse effect on us.

 

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MANAGEMENT

Executive Officers and Directors

The following table sets forth information about our executive officers and directors as of April 30, 2008:

 

Name

   Age   

Position

Executive Officers

     

Nicholas Tiliacos

   53    President, Chief Executive Officer and Director

John Flavio

   60    Chief Financial Officer

Jeffrey Read

   39    Executive Vice President, Sales, Marketing and Business Development

Jean Francois Thions, Ph.D.

   69    Executive Vice President, Professional Services, Technology and Business Operations

Jeffry Shelby

   42    Vice President and General Counsel

Directors

     

Raj Atluru (3)

   39    Director

Steve Bowsher (1)(2)

   39    Director

H. Robert Gill (1)(2)

   71    Director

Elliott H. Jurgensen, Jr. (2)

   63    Director

John Malloy (1)

   48    Director

John G. McDonald (3)

   70    Director

Doug Pepper (3)

   34    Director

 

(1) Member of the compensation committee.
(2) Member of the audit committee.
(3) Member of the nominating and corporate governance committee.

Nicholas Tiliacos has served as our president and chief executive officer and director since 2000. Prior to joining Varolii, Mr. Tiliacos served as president and chief executive officer of Mosaix, Inc., a provider of customer relationship management software and services, from 1997 until it was acquired by Lucent Technologies, Inc. in 1999. From 1996 to 1997, Mr. Tiliacos served as vice president international and chief operating officer of Mosaix. Prior to joining Mosaix, Mr. Tiliacos was co-founder and managing director of VenTech International, Inc., an international consulting and business development company, from 1988 to 1996. Mr. Tiliacos holds a B.S. in business administration from Florida State University and an M.A. in international management from the American Graduate School of International Management.

John Flavio has served as our chief financial officer since April 2007. Prior to joining Varolii, Mr. Flavio served as the chief financial officer of Postini, Inc., a provider of on-demand solutions for security and compliance, from February 2004 to February 2007. From 1999 to 2003, Mr. Flavio served as chief financial officer for Keynote Systems, Inc., a NASDAQ-listed provider of on-demand test and measurement systems for internet performance. In addition, Mr. Flavio served as a member of our board of directors from July 2006 to April 2007. Mr. Flavio holds a B.S. in finance from Santa Clara University and is a Certified Public Accountant.

Jeffrey Read has served as our executive vice president of sales, marketing and business development since August 2007. Prior to joining Varolii, Mr. Read worked and served as president and chief operating officer for Cape Clear Software Inc., a provider of software integration tools, from 2005 to 2007. From 1996 to 2005, Mr. Read was employed by PeopleSoft, Inc., an enterprise application software company, where he held a variety of executive positions, most recently as managing director and vice president for the channel sales and distribution group. Prior to joining PeopleSoft, Mr. Read was an account executive and sales and marketing manager for SAS Institute, a developer and marketer of computer software programs primarily for business applications, from 1992 to 1996. Mr. Read holds a B.A. in business administration from Wilfrid Laurier University.

 

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Jean Francois Thions has served as our executive vice president of professional services, technology and business operations since October 2006. From 2003 to 2006, Dr. Thions was the chief executive officer of e-Vision SA de CV, a Mexican corporation providing information technology consulting and software development for the transportation industry. From March through September 2006, as a consultant for e-Vision, Dr. Thions advised us on various operational matters, including the structure and reorganization of our professional services, technology and business operations. From 1993 to 2003, Dr. Thions served as chief executive officer of Pluricom, an international communications consulting company, based in Mexico. Prior to joining Pluricom, Dr. Thions served as country manager for Digital Equipment de Mexico, a computer manufacturer, and provider of computer-related products and services, and a subsidiary of Compaq Computers Corporation, from 1989 to 1992. Dr. Thions holds a B.A. in physics and a B.A. in mathematics, each from the National University of Mexico, an M.S. in physics from the University of California at Berkeley and a Ph.D. in mathematics from the University of Grenoble.

Jeffry Shelby has served as our vice president and general counsel since June 2007. Prior to joining Varolii, Mr. Shelby was in private practice at Heller Ehrman LLP, an international law firm, from 2001 to 2007. From 1999 to 2001, Mr. Shelby was an attorney with Cooley Godward LLP, a national law firm. Prior to law school, Mr. Shelby served in several roles in aircraft operations management at United Airlines, Inc., an airline, from 1990 to 1995. Mr. Shelby holds a B.S. from Embry-Riddle Aeronautical University, an M.B.A. from San Francisco State University, and a J.D. from the University of Washington.

Raj Atluru has served as a member of our board of directors since 2002. Mr. Atluru is a managing director at Draper Fisher Jurvetson, a venture capital firm. Prior to joining Draper Fisher Jurvetson in 2000, Mr. Atluru served as principal of TL Ventures, a venture capital firm, from 1997 to 1999, where he focused on early stage software, wireless communications and energy technologies. From 1992 to 1995, Mr. Atluru worked in the leveraged finance and Asian corporate finance groups at Credit Suisse First Boston, an investment bank, in New York, Hong Kong and Singapore. Mr. Atluru holds a B.S. in civil and environmental engineering, an M.S. in civil and environmental engineering, and an M.B.A., each from Stanford University.

Steve Bowsher has served as a director since 2002. Mr. Bowsher is a managing partner and executive vice president at In-Q-Tel, an independent, not-for-profit company that provides technology solutions for the intelligence community. Prior to In-Q-Tel in 2006, Mr. Bowsher served as a general partner with InterWest Partners from 1999 to 2006. In addition, Mr. Bowsher held a variety of management positions during his employment at E*TRADE Financial Corp., an online brokerage concern, from 1997 to 1999. Mr. Bowsher holds a B.A. from Harvard University and an M.B.A. from Stanford University.

H. Robert Gill has served as a director since 2003. Mr. Gill has served as a principal with The Topaz Group, a consulting services firm for corporations and investors, which he joined in 1996. Mr. Gill was the president and chief executive officer, and a director of ConferTech International, Inc., a provider of communication systems and services, from 1989 to 1995. Mr. Gill holds a M.B.A. from Pepperdine University, an M.S.E.E. from Purdue University and a B.S.E.L.E. from Indiana Institute of Technology.

Elliott H. Jurgensen, Jr. has served as a director since August 2007. Mr. Jurgensen retired in 2003 from KPMG LLP, an independent registered public accounting firm. Mr. Jurgensen served as an audit partner at KPMG from 1980 to 2003, and he was employed in various other positions with KPMG from 1971 to 1980. Mr. Jurgensen held a number of leadership roles with KPMG, including managing partner of the Bellevue, Washington office from 1982 to 1991, and managing partner of the Seattle, Washington office from 1993 to 2002. Mr. Jurgensen has served as president of Three Mates LLC, a family retail business since 2001. He is also a director of BSQUARE Corporation, Isilon Systems, Inc., and McCormick & Schmick’s Seafood Restaurants, Inc. Mr. Jurgensen holds a B.S. in accounting from San Jose State University.

John Malloy has served as a director since 2001. Mr. Malloy serves as a managing partner of BlueRun Ventures (formerly known as Nokia Venture Partners), a venture capital firm that Mr. Malloy founded in 1998. Prior to founding BlueRun Ventures, Mr. Malloy held management and executive roles at Nokia Corporation, a wireless communications device manufacturer, from 1996 to 1998, GO Communications, a wireless

 

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communications company, from 1994 to 1996, and MCI Communications Corporation, a telecommunications company, from 1986 to 1994. Mr. Malloy holds a B.A. from Boston College and a J.D. from George Mason School of Law.

John G. McDonald has served as a director since October 2007. Professor McDonald is the Stanford Investors Professor at the Graduate School of Business at Stanford University, where he has been a faculty member since 1968. Professor McDonald also serves as a director of iStar Financial, Inc., a finance company focused on commercial real estate; Plum Creek Timber, Inc., a timber and land company; Scholastic Corp., a publishing company; Varian, Inc., an instruments company; and eight mutual funds managed by Capital Research and Management Company. Professor McDonald holds an M.B.A and Ph.D. from Stanford University.

Doug Pepper has served as a director since August 2007. Mr. Pepper has been a partner with InterWest Partners, a venture capital firm, since 2000, where he focuses on enterprise applications and services, digital media and consumer internet. Prior to joining InterWest Partners, Mr. Pepper worked in business development at Amazon.com, Inc., an internet retailer in 1999, where he helped launch Amazon’s Auction and Z-Shops businesses. Prior to Amazon.com, Mr. Pepper was a financial analyst in the corporate finance department at Goldman Sachs, an investment bank, from 1995 to 1998. Mr. Pepper holds a B.A. from Dartmouth College, and an M.B.A. from Stanford University.

Board Composition

Our board of directors currently consists of eight members. Pursuant to an investors’ rights agreement among us and certain of our preferred and common shareholders, including entities with which certain of our directors are affiliated, certain of our shareholders have the right to designate representatives to serve on our board of directors. Pursuant to the investors’ rights agreement, Messrs. Gill and Tiliacos were designated by the holders of a majority of our common stock and preferred stock, voting together as a single class; Mr. Atluru was designated by the holders of a majority of our Series A preferred stock; Mr. Malloy was designated by the holders of a majority of our Series B preferred stock; and Mr. Pepper was designated by the holders of a majority of our Series C preferred stock. Upon the completion of this offering, the provisions of this investors’ rights agreement that relate to these voting rights will terminate, and no shareholders will have any contractual rights with us regarding the election of our directors.

Effective upon the completion of this offering, our board of directors will be divided into three classes of directors who will serve in staggered three-year terms as follows:

 

   

Class 1 will consist of Messrs. Atluru, Malloy and Pepper, whose terms will expire at our annual shareholders meeting to be held in 2009;

 

   

Class 2 will consist of Messrs. Bowsher, Gill and McDonald, whose terms will expire at our annual shareholders meeting to be held in 2010;

 

   

Class 3 will consist of Messrs. Tiliacos and Jurgensen, whose terms will expire at our annual shareholders meeting to be held in 2011.

Effective upon the completion of this offering, our articles of incorporation will provide that the authorized number of directors may be changed only by resolution of the board of directors. Any additional directorships resulting from an increase in the number of directors will be distributed among the three classes with three-year terms so that, as nearly as possible, each class will consist of one-third of the directors. At each annual meeting of shareholders, the successors to directors whose terms then expire will be elected to serve from the time of election and qualification until the third annual meeting following election. As a result, only one class of directors will be elected at each annual meeting of our shareholders, with the other classes continuing for the remainder of their respective three-year terms. The division of our board of directors into these three classes may delay or prevent a change of our management or a change in control. See “Description of Capital Stock — Anti-Takeover Provisions.”

 

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Director Independence

We have applied to have our common stock listed on the NASDAQ Global Market. The rules of the NASDAQ Global Market require that a majority of the members of our board of directors be independent within specified periods following the completion of this offering. Our board of directors has adopted the definitions, standards and exceptions to the standards for evaluating director independence provided in the NASDAQ Global Market rules, and determined that Messrs. Atluru, Bowsher, Gill, Jurgensen, McDonald, Malloy and Pepper are “independent directors” as defined under such rules.

Board Committees

Our board of directors has established an audit committee, a compensation committee and a nominating and corporate governance committee. Each committee will have the composition and responsibilities described below as of the closing of this offering.

Audit Committee

Our audit committee oversees our corporate accounting and financial reporting process and internal controls over financial reporting. Our audit committee evaluates the independent registered public accounting firm’s qualifications, independence and performance; engages and provides for the compensation of the independent registered public accounting firm; approves the retention of the independent registered public accounting firm to perform any proposed permissible non-audit services; reviews our consolidated financial statements; reviews our critical accounting policies and estimates and internal controls over financial reporting; and discusses with management and the independent registered public accounting firm the results of the annual audit and the reviews of our quarterly consolidated financial statements.

Our audit committee consists of Messrs. Bowsher, Gill and Jurgensen, with Mr. Jurgensen serving as chairperson. Our board of directors has determined that Mr. Jurgensen is an “audit committee financial expert” as defined in applicable SEC rules and regulations. We believe that our audit committee complies with the applicable requirements of the NASDAQ Global Market and SEC rules and regulations prior to the consummation of this offering. We believe that our audit committee members meet the requirements for independence and financial literacy under the current requirements of the NASDAQ Global Market and SEC rules and regulations. We intend to comply with future requirements to the extent they become applicable to us.

Compensation Committee

Among other matters, our compensation committee reviews and recommends policy relating to compensation and benefits of our officers and employees. The compensation committee reviews and approves corporate goals and objectives relevant to compensation of the chief executive officer and other senior officers, evaluates the performance of these officers in light of those goals and objectives and sets the compensation of these officers based on such evaluations. The compensation committee also administers the issuance of stock options and other awards under our stock plans.

Our compensation committee consists of Messrs. Bowsher, Gill and Malloy, with Mr. Malloy serving as the chairperson. We believe that the composition of our compensation committee meets the requirements for independence under, and the functioning of our compensation committee complies with, any applicable requirements of the NASDAQ Global Market, SEC rules and regulations, and Section 162(m) of the Internal Revenue Code. We intend to comply with future requirements to the extent they become applicable to us.

Nominating and Corporate Governance Committee

Our nominating and corporate governance committee, among other things, assists our board of directors in identifying prospective director nominees and recommending nominees for each annual meeting of shareholders to the board of directors; develops and recommends governance principles applicable to us to our board of

 

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directors; oversees the evaluation of our board of directors; and recommends potential members for each board committee to our board of directors. Our nominating and corporate governance committee consists of Messrs. Atluru, McDonald and Pepper, with Mr. McDonald serving as chairperson.

Compensation Committee Interlocks and Insider Participation

No member of the board of directors or the compensation committee serves as a member of the board of directors or compensation committee of any other entity that has one or more executive officers serving as a member of our board of directors or compensation committee. Our compensation committee consists of Messrs. Malloy, Bowsher and Gill. For a discussion of certain transactions between certain of our executive officers and BlueRun Ventures, an entity affiliated with John Malloy, see “Related Party Transactions.”

Director Compensation

The compensation received by our non-employee directors in 2007 is set forth below.

 

Name

   Fees Earned
or Paid in
Cash
   Option Awards     Total

H. Robert Gill

   $ 30,500    $ 7,706 (1)   $ 38,206

John Flavio (2)

   $ 3,000    $     $ 3,000

Steve Bowsher

      $ 15,575 (3)   $ 15,575

John G. McDonald

   $ 9,500    $ 15,575 (4)   $ 25,075

Elliott H. Jurgensen, Jr.

   $ 13,808    $ 19,182 (5)   $ 32,990

 

(1) On February 28, 2007, Mr. Gill received a stock option to purchase up to 100,000 shares of our common stock at an exercise price of $0.55 per share. Valuation of awards is based on the recognized expense for 2007, determined pursuant to the assumptions discussed in note 12 to our consolidated financial statements included elsewhere in this prospectus. The grant date fair value of the option was $37,350.

 

(2) Mr. Flavio became our chief financial officer in April 2007. Amounts included are solely for his services as a director.

 

(3) On October 5, 2007, Mr. Bowsher received a stock option to purchase up to 250,000 shares of our common stock at an exercise price of $1.85 per share. Valuation of awards is based on the recognized expense for 2007, determined pursuant to the assumptions discussed in note 12 to our consolidated financial statements included elsewhere in this prospectus. The grant date fair value of the option was $264,675.

 

(4) On October 5, 2007, Mr. McDonald received a stock option to purchase up to 250,000 shares of our common stock at an exercise price of $1.85 per share. Valuation of awards is based on the recognized expense for 2007, determined pursuant to the assumptions discussed in note 12 to our consolidated financial statements included elsewhere in this prospectus. The grant date fair value of the option was $264,675.

 

(5) On August 31, 2007, Mr. Jurgensen received a stock option to purchase up to 250,000 shares of our common stock at an exercise price of $1.25 per share. Valuation of awards is based on the recognized expense for 2007, determined pursuant to the assumptions discussed in note 12 to our consolidated financial statements included elsewhere in this prospectus. The grant date fair value of the option was $209,175. On October 31, 2007, Mr. Jurgensen received a stock option to purchase up to 25,000 shares of our common stock at an exercise price of $1.85 per share. Valuation of awards is based on the recognized expense for 2007, determined pursuant to the assumptions discussed in note 12 to our consolidated financial statements included elsewhere in this prospectus. The grant date fair value of the option was $26,972.

In August 2007, we adopted a board compensation policy pursuant to which we will pay non-employee directors who are not affiliated with shareholders owning more than 5% of our common stock $7,000 per quarter of service as a director, which was increased to $9,500 per quarter in December 2007. In December 2007, we adopted a board compensation policy, which will be effective as of the completion of this offering. This policy provides that we will pay non-employee directors an annual retainer of $25,000 and an annual retainer of $7,500

 

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for membership of the audit committee and $4,000 for membership on each of the compensation committee and nominating and corporate governance committees. In lieu of the committee member retainer, the chairperson of the audit committee will receive an additional annual retainer of $15,000 per year and the chairperson of both our compensation committee and nominating and corporate governance committee will receive an annual retainer of $9,000. In addition, each non-employee director will receive $2,000 for each regularly scheduled in-person board meeting attended and $1,000 for each regularly scheduled telephonic board meeting attended. We also will reimburse all board members for reasonable expenses incurred by them in connection with attendance at board and committee meetings.

From time to time, certain of our non-employee directors received grants of options to purchase shares of our common stock under our equity incentive plans as compensation for their services as members of the board of directors. In February 2007, Mr. Gill was granted an option to purchase 100,000 shares of our common stock at a price of $0.55 per share. This option will vest with respect to 25,000 shares on February 23, 2008, with the remainder vesting thereafter in 36 equal monthly installments. In August 2007, Mr. Jurgensen was granted an option to purchase 250,000 shares of our common stock at a price of $1.25 per share. In October 2007, Messrs. Bowsher, McDonald and Jurgensen were granted options to purchase 250,000, 250,000 and 25,000 shares of our common stock, respectively, at a price of $1.85 per share. The option grants to Messrs. Jurgensen, Bowsher and McDonald vest in 48 equal monthly installments.

Directors will be eligible to participate in our stock plans and non-employee directors will receive options as compensation for their services after the completion of this offering as described below. See “Executive Compensation — Equity Benefit Plans — 2007 Equity Incentive Plan.”

 

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EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

The following discussion and analysis of compensation arrangements of our named executive officers for 2007 should be read together with the compensation tables and related disclosures set forth below. This discussion contains forward-looking statements that are based on our current plans, considerations, expectations and determinations regarding future compensation programs. The actual amount and form of compensation and the compensation programs that we adopt may differ materially from currently planned programs as summarized in this discussion.

Evolution of our Compensation Approach

Our historical executive compensation programs were developed and implemented while we were a private company. To date, our compensation programs and the process by which they were developed, were less formal than that typically employed by public companies. Until July 20, 2001, in lieu of a formally-established compensation committee, non-employee members of our board of directors reviewed and approved executive compensation and benefits policies and administered our 2000 Equity Incentive Plan, or 2000 Plan. In 2001, a compensation committee was formed and consisted of Mr. Malloy and one other non-employee director, who was replaced by Mr. Bowsher in 2002. The compensation committee was charged with overseeing our executive compensation programs and making recommendations to our board of directors concerning executive compensation.

Historically, compensation decisions for our executive officers were approved by our board of directors based upon the recommendation of our compensation committee, which in turn relied upon the recommendation of our chief executive officer and chief financial officer. We have traditionally placed significant emphasis on the business judgment of the members of our compensation committee and the recommendation of our chief executive officer and chief financial officer with respect to the determination of executive compensation (other than their own compensation). While each of the chief executive officer and chief financial officer attends portions of the compensation committee meetings to discuss the performance of, and recommendations regarding, compensation for executive officers other than himself, the compensation committee routinely meets in executive session without management present, as well as informally discusses compensation matters for all executive officers outside of meetings.

In making recommendations for our executive officers to the compensation committee, our chief executive officer and chief financial officer reviewed third-party compensation data from surveys of private technology companies with a similar range of annual revenue and from a similar geographic area, as well as company-compiled reports on compensation levels at private technology companies and other compensation information. For our chief financial officer, our chief executive officer made the compensation recommendations to the compensation committee using these same surveys. For our chief executive officer, the compensation committee relied on these third-party compensation surveys, their own business judgment and also benchmarked the compensation on an informal basis by comparing the compensation of our chief executive officer to that of other chief executives employed at the portfolio companies of the venture capital firms with which the compensation committee members are affiliated. In approving all executive compensation, the board of directors relied on these compensation surveys, the recommendation of our compensation committee, the directors’ business judgment and also benchmarked the compensation on an informal basis against other executives employed at the portfolio companies of the venture capital firms with which the directors are affiliated. We believe our compensation packages for our executive officers were at or near the median when compared to these other companies.

As we gain experience as a public company, we expect the specific direction, emphasis and components of our compensation program will evolve and become more formalized. For example, we expect to increase our reliance on a more empirically based approach that involves benchmarking the compensation paid to our executive officers against peer companies iden