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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2013

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from                     to                     

Commission file number: 001-33790

 

 

SoundBite Communications, Inc.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   04-3520763

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

22 Crosby Drive

Bedford, Massachusetts 01730

(Address of Principal Executive Offices) (Zip Code)

(781) 897-2500

(Registrant’s Telephone Number, Including Area Code)

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days:    Yes  þ    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No  ¨

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

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   þ

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

As of April 30, 2013, there were 16,519,250 shares of the registrant’s common stock, $.001 par value per share, outstanding.

 

 

 


Table of Contents

SOUNDBITE COMMUNICATIONS, INC. AND SUBSIDIARIES

FORM 10-Q

INDEX

 

          Page No.  

PART I. FINANCIAL INFORMATION

  

Item 1.

  

Financial Statements

  
  

Unaudited Condensed Consolidated Balance Sheets as of March 31, 2013 and December 31, 2012

     3   
  

Unaudited Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2013 and 2012

     4   
  

Unaudited Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2013 and 2012

     5   
  

Notes to Unaudited Condensed Consolidated Financial Statements

     6   

Item 2.

  

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

     12   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     18   

Item 4.

  

Controls and Procedures

     19   

PART II. OTHER INFORMATION

  

Item 1.

  

Legal Proceedings

     19   

Item 1A.

  

Risk Factors

     21   

Item 6.

  

Exhibits

     35   

 

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Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SOUNDBITE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

 

     March 31,
2013
    December 31,
2012
 
     (unaudited)        

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 14,768      $ 10,119   

Short-term investments

     1,398        4,896   

Accounts receivable, net of allowance for doubtful accounts of $89 and $91 at March 31, 2013 and December 31, 2012

     8,216        10,223   

Prepaid expenses and other current assets

     1,138        1,621   
  

 

 

   

 

 

 

Total current assets

     25,520        26,859   

Property and equipment, net

     1,944        2,026   

Intangible assets, net

     2,335        2,764   

Goodwill

     6,594        6,594   

Other assets

     78        89   
  

 

 

   

 

 

 

Total assets

   $ 36,471      $ 38,332   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Accounts payable

   $ 923      $ 1,448   

Accrued expenses

     4,116        4,464   

Other current liabilities

     435        417   
  

 

 

   

 

 

 

Total current liabilities

     5,474        6,329   

Long-term contingent consideration payable

     558        535   

Other liabilities

     165        97   
  

 

 

   

 

 

 

Total liabilities

     6,197        6,961   
  

 

 

   

 

 

 

Stockholders’ equity:

    

Common stock, $0.001 par value—75,000,000 shares authorized; 16,980,707 and 16,972,025 shares issued at March 31, 2013 and December 31, 2012; 16,507,039 and 16,498,357 shares outstanding at March 31, 2013 and December 31, 2012

     18        17   

Additional paid-in capital

     72,221        71,923   

Treasury stock, at cost—473,668 shares at March 31, 2013 and December 31, 2012

     (833     (833

Accumulated other comprehensive loss

     (72     (72

Accumulated deficit

     (41,060     (39,664
  

 

 

   

 

 

 

Total stockholders’ equity

     30,274        31,371   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 36,471      $ 38,332   
  

 

 

   

 

 

 

See notes to the unaudited condensed consolidated financial statements.

 

3


Table of Contents

SOUNDBITE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except share and per share amounts)

 

     Three Months Ended
March 31,
 
     2013     2012  

Revenues

   $ 11,254      $ 11,081   

Cost of revenues

     4,515        4,387   
  

 

 

   

 

 

 

Gross profit

     6,739        6,694   
  

 

 

   

 

 

 

Operating expenses:

    

Research and development

     1,888        1,694   

Sales and marketing

     4,160        3,869   

General and administrative

     2,021        2,304   
  

 

 

   

 

 

 

Total operating expenses

     8,069        7,867   
  

 

 

   

 

 

 

Operating loss

     (1,330     (1,173

Interest and other (loss) income

     (25     39   
  

 

 

   

 

 

 

Loss before income tax (provision) benefit

     (1,355     (1,134

Income tax (provision) benefit

     (41     887   
  

 

 

   

 

 

 

Net loss

   $ (1,396   $ (247
  

 

 

   

 

 

 

Net loss per common share:

    

Basic and diluted

   $ (0.08   $ (0.02

Weighted average common shares outstanding:

    

Basic and diluted

     16,501,478        16,436,046   

See notes to the unaudited condensed consolidated financial statements.

 

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Table of Contents

SOUNDBITE COMMUNICATIONS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in thousands)

 

     Three Months Ended
March 31,
 
     2013     2012  

Cash flows from operating activities:

    

Net loss

   $ (1,396   $ (247

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Depreciation of property and equipment

     342        337   

Amortization of intangible assets

     429        407   

Amortization of (discounts) premiums paid on short-term investments

     (2     5   

Adjustment to contingent consideration

     41        54   

Stock-based compensation

     292        242   

Deferred taxes

     41        (887

Change in operating assets and liabilities, net of effect of acquisition:

    

Accounts receivable

     2,007        586   

Prepaid expenses and other current assets

     483        56   

Other assets

     11        (15

Accounts payable

     (321     166   

Accrued expenses and other liabilities

     (321     (172
  

 

 

   

 

 

 

Net cash provided by operating activities

     1,606        532   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Cash paid related to Mobile Collect acquisition

     —          (271

Cash paid related to acquisition of 2ergo Americas, net of cash acquired

     —          (3,773

Purchases of short-term investments

     —          (2,934

Sales and maturities of short-term investments

     3,500        5,151   

Purchases of property and equipment

     (464     (381
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     3,036        (2,208
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from exercise of stock options

     7        68   

Treasury stock purchases

     —          (249
  

 

 

   

 

 

 

Net cash provided by (used in) provided by financing activities

     7        (181
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     4,649        (1,857

Cash and cash equivalents, beginning of period

     10,119        17,706   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 14,768      $ 15,849   
  

 

 

   

 

 

 

Supplemental disclosure of cash flow information:

    

Cash paid during the period for income taxes

   $ 5      $ 6   
  

 

 

   

 

 

 

Supplemental disclosure of non-cash investing activities:

    

Property and equipment, included in accounts payable

   $ 115      $ —     
  

 

 

   

 

 

 

Contingent cash payment to Mobile Collect, included in other current liabilities

   $ —        $ 227   
  

 

 

   

 

 

 

See notes to the unaudited condensed consolidated financial statements.

 

5


Table of Contents

SOUNDBITE COMMUNICATIONS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. NATURE OF BUSINESS

SoundBite Communications, Inc. (the Company) provides cloud-based, multi-channel services that enable businesses to design, execute and measure customer communication campaigns for a variety of marketing, customer care, and collection and payment processes. Clients can use the Company’s services to improve customer experience management by communicating proactively with their customers through automated voice messaging, predictive dialing, text messaging, emails and web communications. The Company was incorporated in Delaware in 2000, and its principal operations are located in Bedford, Massachusetts. The Company’s clients are located in the United States and Europe. The Company operates as and reports its operations as a single operating segment and single reporting unit.

2. BASIS OF PRESENTATION

The accompanying condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the SEC for interim financial information. Accordingly, they do not include all of the information and notes required by generally accepted accounting principles for complete financial statements. In the opinion of management, the unaudited interim financial statements include all adjustments, consisting of normal and recurring adjustments, necessary for the fair statement of the Company’s financial position as of March 31, 2013 and its results of operations and cash flows for the three months ended March 31, 2013 and 2012. The results for the three months ended March 31, 2013 are not necessarily indicative of the results to be expected for the year ending December 31, 2013. The Company considers events or transactions that occur after the balance sheet date but before the financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure. Subsequent events have been evaluated through the date of issuance of these financial statements. No subsequent events requiring adjustment or disclosure were identified. These condensed consolidated financial statements should be read in conjunction with the audited annual financial statements and notes thereto as of and for the year ended December 31, 2012 included in the Company’s Annual Report on Form 10-K filed with the SEC.

3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Short-term Investments

The Company invests any excess cash balances in short-term marketable securities, including high-grade corporate notes and bonds. These investments are classified as available-for-sale. The average remaining maturity of the marketable securities as of March 31, 2013 was four months. Gains or losses on the sale of investments classified as available-for-sale, if any, are recognized on the specific identification method. Unrealized gains or losses are included in accumulated other comprehensive income (loss) as a separate component of stockholders’ equity until the security is sold or until a decline in fair value is determined to be other than temporary. The unrealized gain or loss as of March 31, 2013 and December 31, 2012 was immaterial.

Revenues

The Company derives substantially all of its revenues by providing its service for use by clients in communicating with their customers through voice, text/SMS and email messages. The Company provides its service principally under a usage-based pricing model, with prices calculated on a per-message or per-minute basis in accordance with the terms of its pricing agreements with clients. The Company primarily invoices its clients on a monthly basis. The substantial majority of the pricing agreements do not require minimum levels of usage or payments.

The Company recognizes revenues when all of the following conditions are satisfied: (1) there is persuasive evidence of an arrangement; (2) the service has been provided to the client; (3) the amount of fees to be paid by the client is fixed or determinable; and (4) the collection of fees from the client is reasonably assured. Generally, this occurs when the services are performed.

The Company’s client management organization provides ancillary services to assist clients in selecting service features and adopting best practices that help clients make the best use of the Company’s on-demand service. The Company provides varying levels of support through these ancillary services, from managing an entire campaign to supporting self-service clients. In some cases, ancillary services may be billed to clients based upon a fixed fee or, more typically, a fixed hourly rate. Revenues from these arrangements are measured using management’s estimated selling price, as determined from a standard rate card. These services typically are of short duration, typically less than one month, and do not involve future obligations. The Company recognizes revenues from these services within the calendar month in which the ancillary services are completed if the four criteria set forth above are satisfied. Revenues attributable to ancillary services are not material and accordingly were not presented as a separate line item in the statements of operations.

 

6


Table of Contents

Basic and Diluted Loss per Common Share

Net loss per common share attributable to common stockholders has been computed using the weighted average number of shares of common stock outstanding during each period. Basic and diluted shares outstanding were the same for the periods presented as the impact of all potentially dilutive securities outstanding was anti dilutive. The following table presents the potentially dilutive securities outstanding that were excluded from the computation of diluted net loss per common share because their inclusion would have had an anti dilutive effect:

 

     Three Months Ended
March 31,
 
     2013      2012  

Stock options

     3,427,007         3,699,602   

Restricted stock

     332,538         39,476   
  

 

 

    

 

 

 

Total

     3,759,545         3,739,078   
  

 

 

    

 

 

 

Comprehensive Loss

For the periods ended March 31, 2013 and 2012, comprehensive loss was equal to net loss.

4. ACCRUED EXPENSES

Accrued expenses consisted of the following (in thousands):

 

     March 31,
2013
     December 31,
2012
 

Payroll related items

   $ 1,142       $ 1,353   

Telephony

     700         812   

Sales and use tax

     529         528   

Professional fees

     438         540   

Other

     1,307         1,231   
  

 

 

    

 

 

 

Total

   $ 4,116       $ 4,464   
  

 

 

    

 

 

 

5. COMMITMENTS AND CONTINGENCIES

Lease Commitment

In April 2013, the Company extended its lease through September 2014 for approximately 37,000 square feet of office space for its headquarters in Bedford, Massachusetts. The original terms of the lease commenced in September 2007 and would have expired in September 2013. Based upon the terms of the lease extension, monthly base rent payments of $69,000 will commence in October 2013 for an annual lease commitment of $828,000.

SmartReply Earn-out Payment

In June 2011, the Company acquired key assets and assumed certain liabilities of SmartReply, a mobile marketing company located in Irvine, California. The acquisition price included cash payments of $3.2 million upon closing and requires contingent cash payments initially estimated at $1.7 million, but up to a maximum of $8.9 million, in the form of an earn-out over a three year period. The first earn-out period was completed as of June 30, 2012 and a payment of $211,000 was made in the third quarter of 2012. The Company estimates that the remaining contingent cash payments will total approximately $1.2 million, which after discounting results in a fair value of $993,000. Subsequent annual payments will be determined over the next two years based upon year-over-year revenue growth in our mobile marketing business.

Litigation and Claims

Indemnification Regarding Karayan Litigation

Over the past two years, class action litigation has been initiated against a number of banks and retailers, including some of the Company’s clients, alleging that “mobile termination” text messages violate the U.S. Telephone Consumer Protection Act or TCPA, which seeks to protect the privacy interests of residential telephone subscribers. When a business receives a text message indicating that the sender wishes to “opt out” of further text communications from the business, a mobile termination text message may be transmitted automatically in order to confirm that the business received the opt-out message and will not send any additional text messages.

 

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Table of Contents

On October 21, 2011, the Company received a notice from GameStop Corp. and GameStop Inc., which together the Company refers to as GameStop, requesting indemnification in connection with a class action litigation entitled Karayan v. GameStop Corp. and GameStop Inc., which the Company refers to as the Karayan Litigation, which had been initiated against GameStop in the U.S. District Court for the Southern District of California (later transferred to the U.S. District Court of the Northern District of Texas) based in part on mobile termination text messages. The Company was not a named defendant or other party in the Karayan Litigation.

On January 6, 2012, the Company delivered a letter agreement to GameStop, in which the Company agreed to indemnify GameStop in relation to the Karayan Litigation. After investigation, it was determined to deliver the letter agreement dated January 6, 2012 in order to, pursuant to the provisions of the Company’s Master Pricing Agreement with GameStop, (a) indemnify GameStop for damages, losses and fees resulting from the aspects of the Karayan Litigation relating to mobile termination text messages and (b) confirm that the Company will take sole control over the defense, and any settlement, of the Karayan Litigation. In addition to claims relating to mobile termination text messages, the Karayan Litigation also asserts claims alleging that GameStop is liable to certain of its customers because it failed to obtain prior express consent to the delivery of text messages. In the letter agreement, the Company reserved its rights concerning any argument that it may have as to its obligation to indemnify GameStop with respect to the aspects of the Karayan Litigation relating to the alleged lack of prior express consent.

On February 12, 2013, following a settlement between the parties, the court dismissed with prejudice the claims initiated against GameStop in the Karayan Litigation. For the purpose of avoiding additional litigation costs, the Company agreed to pay to the plaintiff, on behalf of GameStop, an immaterial amount, and the Company effectively has been relieved of any further indemnification obligations to GameStop relating to the Karayan Litigation.

Class action litigation has been initiated against a number of businesses to date with respect to claims under the TCPA involving mobile termination text messages. On November 29, 2012 the FCC issued a Declaratory Ruling indicating that the sending of a one-time mobile termination message is not a violation of the TCPA subject to certain possible exceptions. It is unclear what effect this ruling will have on claims initiated under the TCPA in relation to mobile termination messages, and it is possible that similar or new claims will be asserted in the future against businesses, some of which may be clients of the Company. If the Company is required to indemnify a client under such a future claim, the Company could incur material costs and expenses that would have a material adverse effect on its business, financial condition and operating results. Moreover, if the Company were obligated to indemnify clients with respect to multiple class actions of this type, the costs of defending those actions could, by themselves and without regard to the ultimate outcomes of the actions, have a material adverse effect on its business, financial condition and operating results.

A2P SMS Antitrust Litigation

On April 5, 2012, a class action litigation, which the Company refers to as the Club Texting Litigation, was filed against numerous defendants, including the Company. On April 6, 2012, a related class action litigation, which the Company refers to as the TextPower Litigation, was filed against numerous defendants, including the Company. On May 10, 2012, a further related class action litigation, which the Company refers to as the iSpeedBuy litigation, was filed against numerous defendants, including the Company. On June 14, 2012, a consolidated class action complaint, which the Company refers to as the A2P SMS Antitrust Litigation, was filed that amended and consolidated the Club Texting Litigation, TextPower Litigation and iSpeedBuy Litigation. In the A2P SMS Antitrust Litigation, the Company is named as alleged successor-in-interest to 2ergo Americas, which the Company acquired in February 2012. The A2P SMS Antitrust Litigation alleges that the named mobile telecom companies and alleged aggregators violated antitrust provisions set forth in the Sherman Act through the use of various common short code requirements related to the sending of text messages by businesses to consumers. Further, the A2P SMS Antitrust Litigation is seeking confirmation of a class of entities and persons who leased a common short code from Neustar, Inc. and sent or received text messages through one or more aggregators. The Company has served an indemnification claim on 2ergo Group plc, the former parent company of 2ergo Americas, in relation to the A2P SMS Antitrust Litigation. 2ergo Group plc did not object to the claim. In connection with the acquisition, $750,000 was deposited in an escrow account to secure claims by the Company for breaches of representations and warranties made with respect to 2ergo Americas. The Company intends to defend vigorously against the claims in the A2P SMS Antitrust Litigation that allege violations of the Sherman Act. At this time it is not possible for the Company to estimate the amount of damages, losses, fees and other expenses that it will incur as the result of the A2P SMS Antitrust Litigation, but such an amount could have a material adverse effect on its business, financial condition and operating results. Even if the Company succeeds in defending against the A2P SMS Antitrust Litigation, it is likely to incur substantial costs and management’s attention will be diverted from its operations.

 

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Table of Contents

Other Proceedings

The customer communications industry is characterized by frequent claims and litigation, including claims regarding patent and other intellectual property rights as well as improper hiring practices. As a result, the Company may be involved in various legal proceedings from time to time.

The Company’s recently acquired subsidiary, 2ergo Americas, received a notice from one of its clients requesting indemnification in connection with a patent infringement lawsuit initiated against the client based in part on various alleged web and mobile applications supplied by 2ergo Americas to that client. The Company is investigating this matter to evaluate the extent, if any, to which it is required to indemnify the client for damages, losses and fees resulting from the lawsuit. At this time it is not possible to estimate the amount, if any, for which the Company may be responsible under its indemnification obligations to this client, but it is possible that such an amount may be substantial. The Company has served an indemnification claim on 2ergo Group plc, the former parent company of 2ergo Americas, in relation to this request. 2ergo Group plc has not objected to the claim.

6. STOCK-BASED COMPENSATION

The following table presents stock-based compensation expense included in the condensed consolidated statements of operations (in thousands):

 

     Three Months Ended
March  31,
 
     2013      2012  

Cost of revenues

   $ 10       $ 11   

Research and development

     58         54   

Sales and marketing

     76         72   

General and administrative

     148         105   
  

 

 

    

 

 

 

Total stock-based compensation

   $ 292       $ 242   
  

 

 

    

 

 

 

As of March 31, 2013, the total compensation cost related to stock-based awards granted to employees and directors but not yet recognized was $1.4 million, net of estimated forfeitures. These costs will be amortized on a straight-line basis over a weighted average period of 2.0 years.

7. GOODWILL AND INTANGIBLE ASSETS

The carrying amount of goodwill during the three month period ended March 31, 2013, which is subject to future impairment considerations, remained unchanged as compared to the year ended December 31, 2012.

Intangible assets consisted of the following (in thousands):

 

     Gross Value      Accumulated
Amortization
     Net Carrying
Value
 

March 31, 2013

        

Technology (3 years)

   $ 600       $ 225       $ 375   

Non-compete agreements (3-5 years)

     40         29         11   

Customer relationships (3 years)

     4,540         2,749         1,791   

Tradenames (2 years)

     28         23         5   

Internal-use software (3 years)

     500         347         153   
  

 

 

    

 

 

    

 

 

 
   $ 5,708       $ 3,373       $ 2,335   
  

 

 

    

 

 

    

 

 

 

December 31, 2012

        

Technology (3 years)

   $ 600       $ 176       $ 424   

Non-compete agreements (3-5 years)

     40         26         14   

Customer relationships (3 years)

     4,540         2,417         2,123   

Tradenames (2 years)

     28         20         8   

Internal-use software (3 years)

     500         305         195   
  

 

 

    

 

 

    

 

 

 
   $ 5,708       $ 2,944       $ 2,764   
  

 

 

    

 

 

    

 

 

 

 

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Table of Contents

8. FAIR VALUE

The fair value hierarchy requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs are obtained from independent sources and can be validated by a third party, whereas unobservable inputs reflect assumptions regarding what a third party would use in pricing an asset or liability. The fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. There are three levels of inputs that may be used to measure fair value as follows:

Level 1—Quoted prices in active markets for identical assets or liabilities

Level 2—Other inputs that are directly or indirectly observable in the marketplace

Level 3—Unobservable inputs that are supported by little or no market activity

The carrying value of the Company’s financial instruments, including cash, short-term investments, accounts receivable and accounts payable, approximate their fair value because of their short-term nature. The Company measures cash equivalents, which are comprised of money market fund deposits, short-term investments, which are comprised of commercial paper, certificate of deposits and U.S. government agency bonds, and a contingent liability at fair value.

At March 31, 2013 and December 31, 2012, the money market funds and U.S. government agency bonds were valued based upon quoted prices for the specific securities in an active market and therefore classified as Level 1. At March 31, 2013 and December 31, 2012, the commercial paper and certificate of deposits were valued on the basis of valuations provided by third-party pricing services, as derived from such services’ pricing models. Inputs to the models may include, but are not limited to, reported trades, executable bid and asked prices, broker/dealer quotations, prices or yields of securities with similar characteristics, benchmark curves or information pertaining to the issuer, as well as industry and economic events. The pricing services may use a matrix approach, which considers information regarding securities with similar characteristics to determine the valuation for a security, and are therefore classified as Level 2.

The Level 3 liability consists of contingent consideration related to the SmartReply acquisition in the form of an earn-out for a maximum of $8.9 million that may become payable in annual installments over the three years following the acquisition, based upon year-over-year revenue growth in the Company’s mobile marketing business. The fair value of the contingent consideration was estimated by applying an income approach. The measure is based on significant inputs that are unobservable in the market. Key assumptions include a discount rate of 18.5% and probability weighted estimates of future revenues of the acquired business. Significant increases (decreases) in the projected future revenues, in isolation, would result in a significant increase (decrease) in the measurement of the fair value of the liability for contingent consideration.

 

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Assets and liabilities measured at fair value on a recurring basis consisted of the following types of instruments as of March 31, 2013 and December 31, 2012 (in thousands):

 

     Fair Value Measurements at Reporting Date Using  
     Quoted Prices in
Active Markets for
Identical Instruments

(Level 1)
     Significant Other
Observable Inputs

(Level 2)
     Significant
Unobservable  Inputs

(Level 3)
     Total Balance  

March 31, 2013:

           

Assets:

           

Money market fund deposits

   $ 12,417       $ —         $ —         $ 12,417   

Short-term investments

           

Commercial paper

     —           1,398         —           1,398   

Liabilities:

           

Liability for contingent consideration

     —           —           993         993   

December 31, 2012:

           

Assets:

           

Money market fund deposits

     8,916         —           —           8,916   

Short-term investments

           

Commercial paper

     —           4,896         —           4,896   

Liabilities:

           

Liability for contingent consideration

   $ —         $ —         $ 952       $ 952   

The liability for contingent consideration increased $41,000 from December 31, 2012 to March 31, 2013 due to a fair value adjustment based upon the passage of time and present value considerations. This amount was recognized in the statement of operations within general and administrative expenses. There were no significant changes in the projected revenue assumptions or the amounts expected to be paid to the selling stockholders of SmartReply. A reconciliation of the beginning and ending liability for contingent consideration is as follows (in thousands):

 

     Three Months Ended
March  31,
 
     2013      2012  

Beginning Balance

   $ 952       $ 1,256   

Changes in fair value (included within general and administrative expenses)

     41         54   
  

 

 

    

 

 

 

Ending Balance

   $ 993       $ 1,310   
  

 

 

    

 

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Investors should read the following discussion in conjunction with our financial statements and related notes appearing elsewhere in this report. In addition to historical information, this discussion contains forward-looking statements that involve risks, uncertainties and assumptions that could cause our actual results to differ materially from our expectations. Factors that could cause differences from our expectations include those described in Part II, Item 1A. “Risk Factors” below and elsewhere in this report.

Overview

We provide cloud-based, multi-channel services that enable businesses to design, execute and measure customer communication campaigns for a variety of marketing, customer care, and collection and payment processes. Clients can use our services to improve customer experience management by communicating proactively with their customers through automated voice messaging, predictive dialing, text messaging, emails and web communications that are relevant, timely, personalized and engaging.

Our services are provided using a multi-tenant, cloud-based architecture that enables us to serve all of our clients cost-effectively. “Cloud-based” refers to the delivery of technology services through the Internet, which includes delivery of software as a service or SaaS. Because our services are cloud-based, businesses using our services do not need to invest in or maintain new hardware or to hire and manage additional dedicated information technology staff. In addition, we are able to implement new features on our platforms that become part of our services automatically and can benefit all clients immediately. Our key platforms are designed to serve increasing numbers of clients and growing demand from existing clients, enabling the platforms to scale reliably and cost-effectively.

We serve two global markets: hosted contact centers and mobile marketing. Our hosted contact center services are used primarily by companies in the accounts receivable management (or collections), energy and utilities, financial services, retail, and telecommunications industries. Our mobile marketing client base consists principally of companies in the consumer package goods, retail, and telecommunications and media industries.

We derive, and expect to continue to derive for the foreseeable future, a substantial majority of our revenues from the hosted contact center market. Our strategy for achieving long-term, sustained growth in our revenues and net income is focused on building upon our leadership position in the hosted contact center market and leveraging our text capabilities in the rapidly growing mobile marketing market.

Key Components of Results of Operations

Revenues

We currently derive a substantial portion of our revenues by providing our services for use by clients in communicating with their customers through voice, text and email messages. These revenues are seasonal in nature and typically are stronger during the second half of the year due to the increased demand from clients in the retail industry. We provide our services under a combination of usage and subscription-based models. Under our usage-based model, prices are calculated on a per-message or per-minute basis in accordance with the terms of pricing agreements with clients. We primarily invoice our clients on a monthly basis.

A substantial majority of our pricing agreements either do not require any minimum usage or payments, or require only an immaterial level of usage or payments. Each executed message represents a transaction from which we derive revenues, and we therefore recognize revenues based on actual usage within a calendar month. We do not recognize revenues until we can determine that persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable and we deem collection to be probable.

Cost of Revenues

Cost of revenues consist primarily of telephony and text message charges, compensation expense for our operations personnel, depreciation and maintenance expense for our platforms and lease costs for our data center facilities. As we continue to grow our business and add features to our platforms, we expect cost of revenues will continue to increase on an absolute dollar basis. Our gross margin was 59.9% in the first three months of 2013, 60.6% in 2012, 59.1% in 2011 and 59.6% in 2010. We currently are targeting a gross margin of 60% to 63% for the foreseeable future. Our gross margin may vary significantly from our target range for a number of reasons, including revenue levels, the mix of types of messaging campaigns executed, as well as the extent to which we build our infrastructure through, for example, significant acquisitions of hardware or material increases in leased data center facilities.

 

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Operating Expenses

Research and Development. Research and development expenses consist primarily of compensation expenses and depreciation expense of certain equipment related to the development of our services. We have historically focused our research and development efforts on improving and enhancing our platforms, as well as developing new features and offerings.

Sales and Marketing. Sales and marketing expenses consist primarily of compensation for our sales and marketing personnel, including sales commissions, as well as the costs of our marketing programs. We expect to further invest in developing our marketing strategy and activities to extend brand awareness and generate additional leads for our sales staff.

General and Administrative. General and administrative expenses consist of compensation expenses for executive, finance, accounting, administrative and management information systems personnel, accounting and legal professional fees and other corporate expenses.

Cost Savings Activity. In order to lower our cost of operations, in early January 2013, we eliminated two research and development positions, four sales and marketing positions and two general and administrative positions. Compensation expense was unaffected by this action in the first quarter of 2013, however, as termination costs offset the cost savings resulting from the reduction in headcount.

2ergo Americas Acquisition

In February 2012, we acquired 2ergo Americas, the U.S. operations of 2ergo Group plc, for a cash purchase price of $3.8 million. 2ergo Americas is a mobile business and marketing solutions company located in Arlington, Virginia and has a current annualized revenue run rate of approximately $3.5 million. Revenues generated from the 2ergo Americas acquisition for the three months ended March 31, 2013 were $910,000, as compared to $280,000 in the same period of 2012. Operating loss for the three months ended March 31, 2013 was $538,000, as compared to a loss of $55,000 in the same period of 2012.

Additional Key Measures of Financial Performance

We present information below with respect to Adjusted EBITDA, and certain revenue metrics. None of these metrics should be considered as an alternative to any measure of financial performance calculated in accordance with U.S. generally accepted accounting principles, or GAAP. Management believes the following financial measures are useful to investors because they permit investors to view our performance using the same tools that management uses to gauge progress in achieving our goals.

Adjusted EBITDA

We present information below with respect to Adjusted EBITDA. EBITDA, or earnings before interest, taxes, depreciation and amortization, equals net loss less interest income, foreign currency exchange gains and tax benefit, plus foreign currency exchange losses and depreciation and amortization expense. Adjusted EBITDA is a measure of financial performance that we calculate as EBITDA plus stock-based compensation expense, increases in adjustments to contingent consideration and severance expense, less decreases in adjustments to contingent consideration. Adjusted EBITDA is intended to eliminate the impact of items that are not indicative of our core operating performance. We have included Adjusted EBITDA because:

 

   

Our management recently has begun to use Adjusted EBITDA to monitor the performance of our business. They previously focused on free cash flows for this purpose, but believe Adjusted EBITDA has become a more appropriate way to view and manage our business as we seek to reach sustainable profitability in a more stable economic environment. Adjusted EBITDA is one of the key metrics to be applied in determining cash bonuses under the 2013 management cash compensation plan adopted by the compensation committee of our board of directors.

 

   

We believe Adjusted EBITDA and similar measures are often used by investors, security analysts and other interested parties as a measure of financial performance in evaluating technology companies.

 

   

We also believe Adjusted EBITDA facilitates operating performance comparisons from period to period by excluding potential differences caused by variations in capital structures affecting interest income, tax positions, and the impact of stock-based compensation expense.

The term “Adjusted EBITDA” is not defined under GAAP and is not a measure of operating income, operating performance or liquidity presented in accordance with GAAP. Adjusted EBITDA has limitations as an analytical tool, and when assessing our operating performance, you should not consider Adjusted EBITDA in isolation from, or as a substitute for, analysis of our results as reported under GAAP. These limitations include:

 

   

Although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements.

 

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Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs.

 

   

Adjusted EBITDA does not consider the potentially dilutive impact of equity-based compensation.

 

   

Adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us.

 

   

Other companies, including companies in our industry, may calculate Adjusted EBITDA differently, which reduces its usefulness as a comparative measure.

The following table presents a reconciliation of net loss to Adjusted EBITDA for each of the periods indicated:

 

     Three Months Ended March 31,  
     2013     2012  
     (in thousands)  

Net loss

   $ (1,396   $ (247

Interest income

     (5     (17

Foreign currency loss (gain)

     30        (22

Tax provision (benefit)

     41        (887

Depreciation of property and equipment

     342        337   

Amortization of intangible assets

     429        407   
  

 

 

   

 

 

 

EBITDA

   $ (559   $ (429

Stock-based compensation expense

     292        242   

Adjustments to contingent consideration

     41        54   

Severance expense

     176        —     
  

 

 

   

 

 

 

Adjusted EBITDA

   $ (50   $ (133
  

 

 

   

 

 

 

Adjusted EBITDA as percentage of total revenues

     (0.4 )%      (1.2 )% 
  

 

 

   

 

 

 

Revenue Metrics

Management tracks revenues by mobile, voice and other in order to review and evaluate our delivery channels. Mobile revenues are generated from any form of consumer interaction through a mobile device, excluding any of the voice channels. Voice revenues are generated from automated voice messaging and our hosted dialer. Other revenues include revenues attributable to email, professional services and access fees. For the three months ended March 31, 2013, voice revenues were $7.1 million, mobile revenues were $3.5 million and other revenues were $682,000, or 63%, 31% and 6% of total revenues, respectively. For the three months ended March 31, 2012, voice revenues were $7.8 million, mobile revenues were $2.7 million and other revenues were $639,000, or 70%, 24% and 6% of total revenues, respectively. The dollar and percentage increases in mobile revenues reflected both (a) growth in our existing business, which increased by 11% on a dollar basis, and (b) additional revenues from our acquisition of 2ergo Americas in February 2012. We expect mobile revenues to continue to increase, both in dollars and as a percentage of total revenues, for the foreseeable future.

Management also tracks revenues by certain quarterly client metrics:

 

   

Management evaluates client concentration in part by monitoring the aggregate percentage of total revenues generated in a quarter from our 20 largest clients (by revenue) in that quarter. Our 20 largest clients for the three months ended March 31, 2013 accounted for 65% of total revenues, compared to 69% in the three months ended March 31, 2012.

 

   

Management evaluates client retention in part by reviewing the aggregate percentage of total revenues generated in a quarter from the 50 largest clients in the previous quarter. Our 50 largest clients in the three months ended December 31, 2012 generated 87% of our total revenues in the three months ended March 31, 2013. In comparison, our 50 largest clients in the three months ended December 31, 2011 generated 84% of our total revenues in the three months ended March 31, 2012.

 

   

Management evaluates client momentum in part by tracking the number of clients that generated greater than $250,000 of revenue in a quarter. Twelve clients, one of which was a legacy client of 2ergo Americas, generated more than $250,000 in revenue for the three months ended March 31, 2013, as compared to nine in the comparable period of 2012.

 

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Results of Operations

The following table sets forth selected statements of operations data for the three months ended March 31, 2013 and 2012 indicated as percentages of revenues.

 

     Three Months Ended March 31,  
     2013     2012  

Statement of Operations Data:

    

Revenues

     100.0     100.0

Cost of revenues

     40.1        39.6   
  

 

 

   

 

 

 

Gross margin

     59.9        60.4   
  

 

 

   

 

 

 

Operating expenses:

    

Research and development

     16.7        15.3   

Sales and marketing

     37.0        34.9   

General and administrative

     18.0        20.8   
  

 

 

   

 

 

 

Total operating expenses

     71.7        71.0   
  

 

 

   

 

 

 

Operating loss

     (11.8     (10.6

Interest and other income

     (0.2     0.4   
  

 

 

   

 

 

 

Loss before income tax (provision) benefit

     (12.0     (10.2

Income tax (provision) benefit

     (0.4     8.0   
  

 

 

   

 

 

 

Net loss

     (12.4 )%      (2.2 )% 
  

 

 

   

 

 

 

Comparison of Three Months Ended March 31, 2013 and 2012

Revenues

 

     Three Months Ended March 31,     Quarter-to-
Quarter Change
 
     2013     2012    
     Amount      Percentage of
Revenues
    Amount      Percentage of
Revenues
    Amount      Percentage
Change
 
     (dollars in thousands)  

Revenues

   $ 11,254         100.0   $ 11,081         100.0   $ 173         1.6

The $173,000 increase in revenues for the three months ended March 31, 2013 as compared to the same period in 2012 was mainly due to the acquisition of 2ergo Americas in February 2012. A $538,000 increase in revenues from the acquisition of 2ergo Americas was partially offset by a $365,000 decrease in organic revenues. Overall, for the three months ended March 31, 2013 as compared to the same period in 2012, increases of $798,000 in mobile revenues and $42,000 in other revenues were partially offset by a decrease of $667,000 in voice revenues. Voice, mobile and other revenues as a percentage of total revenues were 63%, 31% and 6% in the first quarter of 2013, respectively, compared to 70%, 24% and 6% in the same period of 2012, respectively. We expect mobile revenues to continue to increase, in both dollars and as a percentage of total revenues, for the foreseeable future.

Cost of Revenues and Gross Profit

 

     Three Months Ended March 31,     Quarter-to-
Quarter Change
 
     2013     2012    
     Amount      Percentage of
Revenues
    Amount      Percentage of
Revenues
    Amount      Percentage
Change
 
     (dollars in thousands)  

Cost of revenues

   $ 4,515         40.1   $ 4,387         39.6   $ 128         2.9

Gross profit

     6,739         59.9        6,694         60.4        45         0.7   

The $128,000 increase in cost of revenues for the three months ended March 31, 2013 as compared to the same period in 2012 reflected a $229,000 increase in text and email costs primarily due to higher client usage, a $33,000 increase in amortization expense related to acquired technology, a $30,000 increase in non-capital computer hardware purchases, and a $24,000 increase in co-location costs mainly due to the additional data center from the acquisition of 2ergo Americas. These increases were partially offset by a $206,000 decrease in telephony expense mainly due to lower delivery costs. The $45,000 increase in gross profit for the three months ended March 31, 2013 as compared to the same period in 2012 reflected increased revenue levels offset by changes in our client and service mix.

 

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Operating Expenses

 

     Three Months Ended March 31,     Quarter-to-
Quarter Change
 
     2013     2012    
     Amount      Percentage of
Revenues
    Amount      Percentage of
Revenues
    Amount     Percentage
Change
 
     (dollars in thousands)  

Research and development

   $ 1,888         16.7   $ 1,694         15.3   $ 194        11.5

Sales and marketing

     4,160         37.0        3,869         34.9        291        7.5   

General and administrative

     2,021         18.0        2,304         20.8        (283     (12.3
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

Total operating expenses

   $ 8,069         71.7   $ 7,867         71.0   $ 202        2.6
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

   

Research and Development. The $194,000 increase in research and development expenses for the three months ended March 31, 2013 as compared to the same period in 2012 resulted from a $221,000 increase in personnel costs and a $34,000 increase in facility overhead costs, primarily related to the acquisition of 2ergo Americas. These increases were partially offset by a $76,000 decrease in consulting fees.

Sales and Marketing. The $291,000 increase in sales and marketing expenses for the three months ended March 31, 2013 as compared to the same period in 2012 resulted from a $275,000 increase in personnel costs, primarily related to the acquisition of 2ergo Americas.

General and Administrative. The $283,000 decrease in general and administrative expenses for the three months ended March 31, 2013 as compared to the same period in 2012 reflected a $232,000 decrease in legal fees and a $213,000 decrease in merger and acquisition activities. These decreases were partially offset by a $117,000 increase in professional services and a $91,000 increase in personnel costs.

Operating Loss and Other (Loss) Income

 

     Three Months Ended March 31,     Quarter-to-
Quarter Change
 
     2013     2012    
     Amount     Percentage of
Revenues
    Amount     Percentage of
Revenues
    Amount     Percentage
Change
 
     (dollars in thousands)  

Operating loss

   $ (1,330     (11.8 )%    $ (1,173     (10.6 )%    $ (157     (13.4 )% 

Interest and other (loss) income

     (25     (0.2     39        0.4        (64     (164.1
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

Loss before income tax (provision) benefit

   $ (1,355     (12.0 )%    $ (1,134     (10.2 )%    $ (221     (19.5 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

The $64,000 decrease in interest and other (loss) income for the three months ended March 31, 2013 as compared to the same period in 2012 was primarily due to a foreign currency loss of $30,000 recognized in the three month period ended March 31, 2013, compared to a foreign currency gain of $22,000 in the same period of 2012. This was a result of the revaluation of cash, accounts receivable and accounts payable balances denominated in foreign currencies.

Income Tax Benefit and Net Loss

We recognized a net loss of $1.4 million for the three months ended March 31, 2013 as compared to $247,000 in the same period of 2012. The difference principally reflects an increase in our operating loss of $157,000, in addition to a decrease in income tax (provision) benefit of $928,000 mainly due to the $887,000 release of valuation allowance against our deferred tax assets in the first quarter of 2012 due to the recognition of deferred tax liabilities related to the acquisition of intangible assets from 2ergo Americas. .

Liquidity and Capital Resources

Resources

We believe our existing cash and cash equivalents and short-term investments, our projected cash flows from operating activities, and our borrowings available under our existing credit facility will be sufficient to meet our anticipated cash needs for at least the next twelve months. Our future working capital requirements will depend on many factors, including the rates of our revenue growth, our introduction of new features for our multi-channel services, and our expansion of research and development and sales and marketing activities. To the extent our cash and cash equivalents, short-term investments and cash flows from operating activities are insufficient to fund our future activities, we may need to raise additional funds through bank credit arrangements or 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 bank credit arrangements or to effect an equity or debt financing on terms acceptable to us or at all.

 

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Credit Facility Borrowings

In February 2013 we renewed a credit facility with Silicon Valley Bank that provides a working capital line of credit at an interest rate of 4.5% per annum for up to the lesser of (a) $1.5 million or (b) 80% of eligible accounts receivable, subject to specified adjustments. Accounts receivable serve as collateral for any borrowings under the credit facility. There are certain financial covenant requirements as part of the facility, including an adjusted quick ratio and certain minimum quarterly revenue requirements, none of which are restrictive to our overall operations. The credit facility will expire by its terms on February 18, 2015 and any amounts outstanding must be repaid on that date.

As of March 31, 2013, no amounts were outstanding under the existing credit agreement and letters of credit totaling $426,000 had been issued in connection with our facility leases.

Summary of Sources and Uses of Cash

The following table summarizes our sources and uses of cash over the periods indicated:

 

     Three Months Ended
March 31,
 
     2013      2012  
     (in thousands)  

Net cash provided by operating activities

   $ 1,606       $         532   

Net cash provided by (used in) investing activities

     3,036         (2,208

Net cash provided by (used in) financing activities

     7         (181
  

 

 

    

 

 

 

Increase (decrease) in cash and cash equivalents

   $     4,649       $ (1,857
  

 

 

    

 

 

 

Cash provided by operating activities increased by $1.1 million in the three months ended March 31, 2013, compared to the same period in the prior year. Our operating cash flow in the three months ended March 31, 2013 reflected a net loss of $1.4 million, which included non-cash charges and changes in working capital of $3.0 million consisting primarily of (a) a decrease in accounts receivable, prepaid expenses and other assets of $2.5 million, (b) depreciation and amortization expense of $771,000, and (c) stock-based compensation expense of $292,000, partially offset by a decrease in accounts payable and accrued expenses of $642,000. The decrease in accounts receivable and prepaid expenses mainly reflected the timing of receipts from our clients and the decrease in accounts payable and accrued expenses was due to timing of payments.

Cash provided by (used in) investing activities increased by $5.2 million in the three months ended March 31, 2013, compared to the same period in the prior year. This increase was due to the $4.0 million cash payment made during the first quarter of 2012 primarily related to the acquisition of 2ergo Americas.

Cash provided by (used in) financing activities increased by $188,000 in the three months ended March 31, 2013, compared to the same period in the prior year. This increase was primarily related to there being no treasury stock purchases during the three months ended March 31, 2013, as compared to $249,000 in the same period of 2012.

Working Capital

The following table sets forth selected working capital information:

 

     March 31,      December 31,  
     2013      2012  
     (in thousands)  

Cash and cash equivalents

   $ 14,768       $ 10,119   

Short-term investments

     1,398         4,896   

Accounts receivable, net of allowance for doubtful accounts

     8,216         10,223   

Working capital

   $     20,046       $     20,530   

Our cash and cash equivalents at March 31, 2013 were unrestricted and held for working capital purposes. These funds were invested primarily in money market funds. We do not enter into investments for trading or speculative purposes.

Our short-term investments are comprised of commercial paper, certificate of deposits and U.S. government agency bonds.

 

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Our accounts receivable balance fluctuates from period to period, which affects our cash flow from operating activities. Fluctuations vary depending on cash collections, client mix and the volume of monthly usage of our services.

Requirements

Capital Expenditures

In recent years, we have made capital expenditures 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 $464,000 for the three months ended March 31, 2013. We intend to continue to invest in our infrastructure in an effort to ensure our continued ability to enhance our platform, introduce new features and maintain the reliability of our network. We also intend to continue to make investments in our computer equipment and systems. We expect our capital expenditures for these purposes will approximate $1.2 million for the last nine months of 2013.

Stock Repurchase Program

On March 26, 2010, we announced that the board of directors had authorized the repurchase of up to $2.5 million of common stock from time to time on the open market or in privately negotiated transactions. We will determine the timing and amount of any shares repurchased based on an evaluation of market conditions and other factors. Repurchases may be made under a Rule 10b5-1 plan, which would permit shares to be repurchased when we might otherwise be precluded from doing so under insider trading laws. The repurchase program may be suspended or discontinued at any time.

No shares of common stock were repurchased under the program during the first three months of 2013. As of March 31, 2013, we had repurchased a total of 278,283 shares at a cost of $709,000 under the program.

Contractual Obligations and Requirements

In April 2013, we extended the term of the lease for our headquarters in Bedford, Massachusetts through September 2014. The original terms of the lease commenced in September 2007 and would have expired in September 2013. Based upon the terms of the lease extension, monthly base rent payments of $69,000 will commence in October 2013 for an annual lease commitment of $828,000.

In June 2011, we acquired key assets and assumed certain liabilities of SmartReply, a mobile marketing company located in Irvine, California. The acquisition price included cash payments of $3.2 million upon closing and requires contingent cash payments initially estimated at $1.7 million, but up to a maximum of $8.9 million, in the form of an earn-out over a three year period. The first earn-out period was completed as of June 30, 2012 and a payment of $211,000 was made in the third quarter of 2012. We estimate that the remaining contingent cash payments will total approximately $1.2 million, which after discounting represents a fair value of $993,000. Subsequent annual payments will be determined over the next two years based upon year-over-year revenue growth in our mobile marketing business.

Except for the lease extension noted above, our contractual obligations have remained substantially unchanged from those reported in our Annual Report on Form 10-K for the year ended December 31, 2012.

Off-Balance-Sheet Arrangements

As of March 31, 2013, we did not have any significant off-balance-sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K of the SEC.

Critical Accounting Policies

We prepare our unaudited condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses and related disclosures. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions. We reaffirm the critical accounting policies and estimates as reported in our Annual Report on Form 10-K for the year ended December 31, 2012.

Item 3. Quantitative and Qualitative 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. We do not hold or issue financial instruments for trading purposes.

 

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At March 31, 2013, we had unrestricted cash and cash equivalents totaling $14.8 million. These amounts were invested primarily in money market funds. The unrestricted cash and cash equivalents were held for working capital purposes. At March 31, 2013, we also had short-term investments of $1.4 million, consisting primarily of commercial paper, which were all classified as available-for-sale. 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 and a hypothetical ten-percent change in interest rates would not have a material effect on our financial statements. Declines in interest rates, however, would reduce future investment income.

Item 4. Controls and Procedures

Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of March 31, 2013. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of March 31, 2013, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the control. The design of any system of controls also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, control may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended March 31, 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

Indemnification Regarding Karayan Litigation

Over the past two years, class action litigation has been initiated against a number of banks and retailers, including some of our clients, alleging that “mobile termination” text messages violate the U.S. Telephone Consumer Protection Act or TCPA, which seeks to protect the privacy interests of residential telephone subscribers. When a business receives a text message indicating that the sender wishes to “opt out” of further text communications from the business, a mobile termination text message may be transmitted automatically in order to confirm that the business received the opt-out message and will not send any additional text messages.

On October 21, 2011, we received a notice from GameStop Corp. and GameStop Inc., which together we refer to as GameStop, requesting indemnification in connection with a class action litigation entitled Karayan v. GameStop Corp. and GameStop Inc., which we refer to as the Karayan Litigation, which had been initiated against GameStop in the U.S. District Court for the Southern District of California (later transferred to the U.S. District Court of the Northern District of Texas) based in part on mobile termination text messages. We were not a named defendant or other party in the Karayan Litigation.

On January 6, 2012, we delivered a letter agreement to GameStop, in which we agreed to indemnify GameStop in relation to the Karayan Litigation. After investigation, we determined to deliver the letter agreement dated January 6, 2012 in order to, pursuant to the provisions of our Master Pricing Agreement with GameStop, (a) indemnify GameStop for damages, losses and fees resulting from the aspects of the Karayan Litigation relating to mobile termination text messages and (b) confirm that we will take sole control over the defense, and any settlement, of the Karayan Litigation. In addition to claims relating to mobile termination text messages, the Karayan Litigation also asserts claims alleging that GameStop is liable to certain of its customers because it failed to obtain prior express consent to the delivery of text messages. In the letter agreement, we reserved our rights concerning any argument that we may have as to our obligation to indemnify GameStop with respect to the aspects of the Karayan Litigation relating to the alleged lack of prior express consent.

 

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On February 12, 2013, following a settlement between the parties, the court dismissed with prejudice the claims initiated against GameStop in the Karayan Litigation. For the purpose of avoiding additional litigation costs, we agreed to pay to the plaintiff, on behalf of GameStop, an immaterial amount, and we effectively have been relieved of any further indemnification obligations to GameStop relating to the Karayan Litigation.

Class action litigation has been initiated against a number of businesses to date with respect to claims under the TCPA involving mobile termination text messages. On November 29, 2012 the FCC issued a Declaratory Ruling indicating that the sending of a one-time mobile termination message is not a violation of the TCPA subject to certain possible exceptions. It is unclear what effect this ruling will have on claims initiated under the TCPA in relation to mobile termination messages, and it is possible that similar or new claims will be asserted in the future against businesses, some of which may be our clients. If we are required to indemnify a client under such a future claim, we could incur material costs and expenses that would have a material adverse effect on our business, financial condition and operating results. Moreover, if we were obligated to indemnify clients with respect to multiple class actions of this type, the costs of defending those actions could, by themselves and without regard to the ultimate outcomes of the actions, have a material adverse effect on our business, financial condition and operating results.

See “Item 1A. Risk Factors – We could be subject to substantial damages and expenses if our clients violate U.S. Telephone Consumer Protection Act restrictions as the result of the use of mobile termination text messages.”

A2P SMS Antitrust Litigation

On April 5, 2012, a class action litigation, which we refer to as the Club Texting Litigation, was filed against numerous defendants, including us. On April 6, 2012, a related class action litigation, which we refer to as the TextPower Litigation, was filed against numerous defendants, including us. On May 10, 2012, a further related class action litigation, which we refer to as the iSpeedBuy litigation, was filed against numerous defendants, including us. On June 14, 2012 a consolidated class action complaint, which we refer to as the A2P SMS Antitrust Litigation, was filed which amended and consolidated the Club Texting Litigation, TextPower Litigation and iSpeedBuy Litigation. In the A2P SMS Antitrust Litigation, we are named as alleged successor-in-interest to 2ergo Americas, which we acquired in February 2012. The A2P SMS Antitrust Litigation alleges that the named mobile telecom companies and alleged aggregators violated the Sherman Act through the use of various common short code requirements related to the sending of text messages by businesses to consumers. Further, the A2P SMS Antitrust Litigation is seeking confirmation of a class of entities and persons who leased a common short code from Neustar, Inc. and sent or received text messages through one or more aggregators. We have served an indemnification claim on 2ergo Group plc, the former parent company of 2ergo Americas, in relation to the A2P SMS Antitrust Litigation, and 2ergo Group plc has not objected to that claim, and we intend to defend vigorously against the claims in the A2P SMS Antitrust Litigation that allege violations of the Sherman Act. At this time it is not possible for us to estimate the amount of damages, losses, fees and other expenses that we will incur as the result of the A2P SMS Antitrust Litigation, but such an amount could have a material adverse effect on our business, financial condition and operating results. Even if we succeed in defending against the A2P SMS Antitrust Litigation, we are likely to incur substantial costs and our management’s attention will be diverted from our operations.

See “Item 1A. Risk Factors - Our acquisitions to date and any future acquisitions may be difficult to integrate, disrupt our business, dilute stockholder value, divert management attention, and subject us to third-party claims or other unexpected costs.”

Other Proceedings

The customer communications industry is characterized by frequent claims and litigation, including claims regarding patent and other intellectual property rights as well as improper hiring practices. As a result, we may be involved in various legal proceedings from time to time.

2ergo Americas, which we acquired in February 2012, received a notice from one of its clients requesting indemnification in connection with a patent infringement lawsuit initiated against the client based in part on various alleged web and mobile applications supplied by 2ergo Americas to that client. We are investigating this matter to evaluate the extent, if any, to which we are required to indemnify the client for damages, losses and fees resulting from the lawsuit. At this time it is not possible for us to estimate the amount, if any, for which we may be responsible under our indemnification obligations to this client, but it is possible that such an amount may be substantial. We have served an indemnification claim on 2ergo Group plc, the former parent company of 2ergo Americas, in relation to this request, and 2ergo Group plc has not objected to that claim.

 

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Item 1A. Risk Factors

An investment in our common stock involves a high degree of risk. Investors should consider carefully the risks and uncertainties described below and all of the other information contained in this report 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 investors might lose all or part of their investments in our common stock.

Risks Related to Our Business and Industry

Our hosted contact center services face intense competition, and our failure to compete successfully would make it difficult for us to add and retain clients and would impede the growth of our business.

We derive, and expect to continue to derive for the foreseeable future, a substantial majority of our revenues from sales of our hosted contact center services. The market for hosted contact center services is characterized by aggressive competition, particularly on pricing, that could result in reduced sales or lower margins, and could prevent our current or future services from achieving or maintaining broad market acceptance. If we are unable to compete effectively in this market, it will be difficult for us to add and retain clients and our business, financial condition and operating results will be seriously harmed.

The market for hosted contact center services is fragmented and changing rapidly. Most vendors focus on providing a basic service with limited features and compete principally on the basis of price, but we also compete with a small number of hosted contact center vendors that deliver services utilizing multiple channels on a software-as-a-service delivery model similar to ours.

Our hosted contact center voice service also competes with on-premise predictive dialers from both established and smaller vendors, some of which offer forms of hosted solutions. Predictive dialers have been the basic method of automated customer communications for the last two decades, particularly for telemarketing and collections activity. The vast majority of telephony customer contact today is completed using predictive dialer technology. Many businesses are likely to continue using on-premise predictive dialers that have been purchased and are still operative, despite the availability of new features and functionality in alternative services.

Some of our competitors have significantly greater financial, technical, marketing, service and other resources than we have, and some competitors have larger installed client bases and longer operating histories. Competitors with greater financial resources may be able to offer lower prices, additional products or services, or other incentives that we cannot match or offer. These competitors may be in a stronger position to respond quickly to new technologies and may be able to undertake more extensive marketing campaigns.

We increasingly are focusing on our mobile marketing offerings, and our business would be adversely affected if the market for mobile marketing services does not develop as we expect or if we fail to offer services that successfully address the needs of a rapidly changing market.

In recent years we increasingly have focused our internal development and sales efforts on mobile marketing services and have invested, and expect to continue to invest, significant financial and management resources in building and offering our mobile marketing services. In June 2011 we acquired key assets of SmartReply, a provider of text messaging and mobile communications solutions, and in February 2012 we acquired 2ergo Americas, a provider of mobile business and marketing solutions.

With our introduction of mobile marketing solutions, we have entered a market that is not fully mature. Market acceptance of these types of services is subject to consumer and industry preferences that are continually changing and developing rapidly. Many businesses still have limited experience with mobile marketing and may continue to devote larger portions of their marketing budgets to more traditional marketing methods, instead of shifting additional resources to mobile marketing. In addition, our current and potential clients ultimately may find mobile marketing to be less effective than traditional marketing methods or other technologies for promoting their products and services, and they may even reduce their spending on mobile marketing from current levels as a result. Market acceptance also is subject to a variety of other factors such as security, reliability, performance, consumer concerns with entrusting a third party to store and manage their data, public concerns regarding privacy, and the enactment of laws or regulations that restrict our ability to provide such services to clients in the United States or internationally. If the market for mobile marketing deteriorates, or develops more slowly than we expect, we may not be able to increase our revenues and our business will suffer.

The growth of our business depends in large part on our ability to deliver compelling mobile marketing solutions to businesses. Our mobile marketing business is at an early stage of development, and we may not achieve or sustain demand for our mobile marketing offerings. The market for mobile marketing services is emerging and is characterized by rapid technological change, evolving industry standards, frequent new product introductions and short product life cycles. To succeed, we need to enhance our current services and develop new services on a timely basis to keep pace with market needs and satisfy the increasingly sophisticated requirements of clients. Consumers may choose not to allow marketing on their mobile devices, and consumer requirements could impact the willingness of businesses to adopt and use some or all of our mobile marketing services. To the extent we incorrectly predict business or consumer requirements for our mobile marketing services, or if there is a delay in market acceptance of those services, our business could be harmed.

 

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Our success in establishing and growing our mobile marketing business will depend in part on the performance, availability and pricing of our mobile marketing services in comparison to a wide array of competing products and services. Competition in the market of mobile marketing applications and services is intense. New products and services based on emerging technologies, consumer demands, industry standards or regulatory requirements could render our services obsolete and unmarketable.

Our mobile marketing endeavors involve significant risks and uncertainties, including distraction of management from other operations, insufficient revenues to offset associated expenses and inadequate return on capital. We cannot assure you that our mobile marketing strategies and offerings will be successful and will not materially adversely affect our reputation, financial condition or operating results. As a result our mobile marketing services may not achieve and sustain market acceptance sufficient to generate enough revenues to cover our costs and allow our mobile marketing operations to become profitable.

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. The substantial majority of our pricing agreements do not require minimum levels of usage or payments, and our revenues therefore fluctuate based on the actual usage of our services each quarter by existing and new clients. Quarterly fluctuations in our operating results also might be due to numerous other factors, including:

 

   

our ability to attract new clients, including the length of our sales cycles;

 

   

our ability to sell new solutions and increased usage of existing solutions to existing clients;

 

   

technical difficulties or interruptions in our cloud-based services;

 

   

changes in privacy protection and other governmental regulations applicable to the communications industry;

 

   

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

 

   

changes in the rates we incur for services provided by telecommunication or data carriers or by text or email aggregators;

 

   

the financial condition and business success of our clients;

 

   

purchasing and budgeting cycles of our clients;

 

   

acquisitions of businesses and products by us or our competitors;

 

   

competition, including entry into the market by new competitors or new offerings by existing competitors;

 

   

our ability to hire, train and retain sufficient sales, client management and other personnel;

 

   

restructuring expenses, including severance and other costs attributable to terminations of employment;

 

   

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

 

   

concentration of marketing expenses for activities such as trade shows and advertising campaigns;

 

   

expenses related to any new or expanded data centers;

 

   

expenses related to merger and acquisition activities; and

 

   

general economic and financial market conditions.

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 may not be meaningful.

Recently, our quarterly revenues have been affected by seasonal factors as the result of the level of revenues we have derived from companies in the retail industry, following our acquisition of SmartReply and our increasing focus on selling to retail companies. These factors have caused our revenues in the second half of the year to increase from the level of revenues in the first half of the year. We believe these factors reflect a higher level of retail marketing activities attributable to the holiday season in the second half of the year.

 

 

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We may fail to forecast accurately the behavior of existing and potential clients or the demand for our services. 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 shortfall in revenues.

Variability in our periodic operating results could lead to volatility in our stock price as equity research analysts and investors respond to quarterly fluctuations. Moreover, as a result of any of the foregoing or other factors, our operating results might not meet our announced guidance or expectations of investors and analysts, in which case the price of our common stock could decrease significantly.

We could be subject to substantial damages and expenses if our clients violate U.S. Telephone Consumer Protection Act restrictions as the result of the use of mobile termination text messages

Class action litigation has been initiated against a number of banks and retailers, including some of our clients, alleging that “mobile termination” text messages violate the U.S. Telephone Consumer Protection Act or TCPA, which seeks to protect the privacy interests of residential telephone subscribers.

In 2011 and 2012, several class action litigation proceedings were commenced against businesses with respect to mobile termination text messages confirming receipt of “opt-out” text requests. When a business receives a text message indicating that the sender wishes to “opt out” of further text communications from the business, a mobile termination text message may be transmitted automatically in order to confirm that the business received the opt-out message and will not send any additional text messages. In January 2012, for example, we agreed to indemnify GameStop Corp. and GameStop Inc. in connection with a now-concluded class action litigation entitled Karayan v. GameStop Corp. and GameStop Inc. that was initiated against the GameStop entities based in part on opt-out confirmation text messages. In November 2012 the FCC issued a Declaratory Ruling indicating that the sending of a one-time opt-out confirmation text message is not a violation of the TCPA subject to specified exceptions. It is unclear what effect this ruling will have on claims under the TCPA in relation to opt-out confirmation text messages.

In the future, new claims under the TCPA may be asserted against businesses, including some of our clients, as the result of mobile termination messages. The nature and materiality of those types of claims cannot be foreseen at this time. If we are required to indemnify a client under such a claim, we could incur material costs and expenses that would have a material adverse effect on our business, financial condition and operating results. If we were obligated to indemnify clients with respect to multiple class actions of this type, the costs of defending those actions could, by themselves and without regard to the ultimate outcomes of the actions, have a material adverse effect on our business, financial condition and operating results. Moreover, the possibility of such future claims could discourage or dissuade existing or potential clients from taking full advantage of our offerings, which would have an adverse effect on our revenues and operating results.

Our business will be harmed if we fail to develop new features that keep pace with technological developments and emerging consumer trends.

Businesses can use a variety of communication channels to reach their customers. Emerging consumer trends have forced a greater focus on alternative channels, customer preferences and communications via mobile devices and a failure to address these trends would be a threat to the adoption of our services. Our business, financial condition and operating results will be adversely affected if we are unable to complete and introduce, in a timely manner, new features for our existing services that keep pace with technological developments. In particular, we must continue to update our services to support consumers’ increasing use of mobile applications and devices.

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

Our multi-channel platforms are complex and incorporate a variety of hardware and proprietary and licensed software. From time to time we have found and corrected defects in a platform. Cloud-based services such as ours frequently experience issues from undetected defects when first introduced or when new versions or enhancements are released. Defects in either of our platforms could result in service disruptions for one or more clients. For example, in October 2008 we experienced a partial outage of the SoundBite Engage platform, which precluded some clients from executing their campaigns in their desired timeframes. Our clients might use our services in unanticipated ways that cause a service disruption for other clients attempting to access their contact list information and other data stored on a platform. In addition, a client may encounter a service disruption or slowdown due to high usage levels of our services.

Clients engage our client management organization to assist them in creating and managing a campaign. As part of this process, we typically construct and test a script, map the client’s input file into our platforms, and map our output files to a client-specific format. In order for a campaign to be executed successfully, our client management staff must correctly design, implement, test and deploy these work products. The performance of these tasks can require significant skill and effort, and from time to time has resulted in errors that adversely affected a client’s campaign.

 

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Because clients use our services for critical business processes, any defect in one of our platforms, any disruption in our services or any error in execution could cause existing or potential clients not to use our services, could harm our reputation, and could subject us to litigation and significant liability for damage to our clients’ businesses.

The insurers under our existing liability insurance policy could deny coverage of a future claim that results from an error or defect in our platforms or a resulting disruption in our 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 assure you that our insurance premiums will not increase as a result of recent litigation or 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 exceed our insurance coverage, or the occurrence of 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, we are likely to incur substantial costs and our management’s attention will be diverted from our operations.

Interruptions, delays in service or errors in execution from our key vendors would impair the delivery of our services and could substantially harm our business and operating results.

In delivering our cloud-based services, we rely upon a combination of hosting providers, telecommunication and data carriers, and text and email aggregators. We serve our clients from five hosting facilities that are owned and operated by third parties. Three of the lease agreements for these facilities effectively renew for one-year periods, subject to three months’ advance notice of termination, and one renews monthly, subject to thirty days’ advance notice of termination. The fifth lease agreement terminates in 2014. If one of these lease agreements terminates and we are unable to renew the agreement on commercially reasonable terms, we may need to incur significant expense to relocate the data center or to agree to the terms demanded by the hosting provider, either of which could harm our business, financial position and operating results.

Our clients’ campaigns are handled through a mix of telecommunication and data carriers as well as text and email aggregators. We rely on these service providers to handle millions of customer contacts each day. From time to time these service providers may fail to handle contacts correctly, which could cause existing or potential clients not to use our services, could harm our reputation, and could subject us to litigation and significant liability for damage to our clients’ businesses for which we are not fully indemnified or insured. While we have entered into contracts with multiple telecommunication carriers and text aggregators, we currently do not have fully redundant data, text or email services. Our contracts with carriers and aggregators generally can be terminated by either party at the end of the contract term upon written notice delivered by the party a specified number of days before the end of the term. In addition, we generally can terminate a contract at any time upon written notice delivered a specified number of days in advance, subject to the payment of specified termination charges. If a contract is terminated, we might be unable to obtain pricing on similar terms from another provider, which would affect our gross margins and other operating results.

Our hosting facilities and the infrastructures of our service providers are vulnerable to damage or interruption from floods, 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 a hosting provider to close a facility without adequate notice or other unanticipated problems could result in lengthy interruptions in our provision of our services. Any interruption or delay in providing our services, even if for a limited time, could have an adverse effect on our business, financial condition and operating results.

Actual or perceived breaches of our security measures, including cybersecurity incidents, could diminish demand for our services and subject us to substantial liability.

Our services involve the storage and transmission of clients’ proprietary information. Cloud-based services such as ours are particularly subject to security breaches by third parties, including attacks on information technology and infrastructure by hackers, viruses, and other disruptions. Breaches of our security measures also might result from employee error or malfeasance or other causes, including as a result of adding new communications services and capabilities to our platforms. In the event of a security breach, a third party could obtain unauthorized access to our clients’ contact list information and other data. Failure to prevent, detect and recover from security breaches also could result in loss of revenues, disruptions in our business, misuse of our assets, loss of trade secrets and confidential information, incurrence of legal claims or proceedings, errors in reporting, inefficiencies in processing, negative media attention, loss of sales, and interference with regulatory compliance.

We rely on information technology and other systems to maintain, use and transmit clients’ proprietary information. 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, and implement adequate preventative measures against, these techniques.

Although management does not believe that our company has experienced any losses to date related to security breaches, including cybersecurity incidents, we cannot assure you that we will not experience a material loss in the future. Because of the critical nature of data security, any actual or perceived breach of our security measures could subject us to litigation and significant liability for damage to our clients’ businesses, could cause existing or potential clients not to use our services, and could harm our reputation. Moreover, as security threats continue to evolve, particularly around cybersecurity, we may be required to expend significant resources to enhance its control environment, processes, practices and other protective measures.

 

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The insurers under our existing liability insurance policy could deny coverage of a future claim that results from claims related to security breaches, 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 assure you 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 exceed our insurance coverage, or the occurrence of 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, we are likely to incur substantial costs and our management’s attention will be diverted from our operations.

Our acquisitions to date and any future acquisitions may be difficult to integrate, disrupt our business, dilute stockholder value, divert management attention, and subject us to third-party claims or other unexpected costs.

In June 2011 we acquired key assets of SmartReply, a provider of text messaging and mobile communications solutions, and in February 2012 we acquired 2ergo Americas, a provider of mobile business and marketing solutions. We are completing the migration of former clients of SmartReply to our platforms.

We are continuing to integrate the operations, technology and personnel of 2ergo Americas. This process has been more complex than in our previous acquisitions due to the need to integrate elements of the 2ergo Americas software platform with our platforms and due to the complexities involved in addressing certain technologies previously shared by 2ergo Americas and its parent. We acquired 2ergo Americas in order to broaden our client base and gain technology and personnel, and we will be unable to recognize the anticipated benefits of the acquisition if we are unable to integrate the acquired technology effectively in a timely manner or if we fail to maintain and incentivize the former 2ergo Americas employees in a manner that enables us to maintain existing clients and add additional mobile marketing clients. In April and May 2012, three related class action litigations, which have now been consolidated, were filed against numerous defendants, including us in our alleged capacity as successor-in-interest to 2ergo Americas, alleging violations of antitrust laws that purportedly occurred before we acquired 2ergo Americas. We may incur damages and other expenses as a result of these litigations, or as the result of other actions of 2ergo Americas occurring prior to the acquisition, that could have a material adverse effect on our business, financial condition and operating results. In addition, any such matters could divert management’s attention from our operations.

If we encounter unforeseen technical or other challenges in these integration and migration processes, our business and results of operations could be harmed. In particular, challenges or difficulties in migrating or expanding the legacy 2ergo Americas’ client base may distract our management’s attention from focusing on our other business operations and may result in our recognizing a lower level of revenues than we expected when we entered into the transactions.

Our business strategy contemplates that we will seek to identify and pursue additional acquisitions of businesses, technologies and products that will complement our existing operations. We cannot assure you that any acquisition we make in the future will provide us with the benefits we anticipated in entering into the transaction. Acquisitions are typically accompanied by a number of risks, including:

 

   

difficulties in integrating the operations and personnel of the acquired companies;

 

   

maintenance of acceptable standards, controls, procedures and policies;

 

   

potential disruption of ongoing business and distraction of management;

 

   

impairment of relationships with employees and clients as a result of any integration of new management and other personnel;

 

   

inability to maintain relationships with suppliers and clients of the acquired business;

 

   

difficulties in incorporating acquired technology and rights into our services and platforms;

 

   

unexpected expenses resulting from the acquisition;

 

   

potential unknown liabilities associated with acquired businesses; and

 

   

unanticipated expenses related to acquired technology and its integration into our existing technology.

Acquisitions could result in the incurrence of debt, restructuring charges and large one-time write-offs. Acquisitions could also result in goodwill and other intangible assets that are subject to impairment tests, which might result in future impairment charges. Furthermore, if we finance acquisitions by issuing convertible debt or equity securities, our existing stockholders would be diluted and earnings per share could decrease.

 

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From time to time, we might enter into negotiations for acquisitions that are not ultimately consummated. Those negotiations could result in diversion of management time and significant out-of-pocket costs. If we are unable to evaluate and execute acquisitions properly, we could fail to achieve our anticipated level of growth and our business and operating results could be adversely affected.

Our product 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 success depends in part upon non-infringement of intellectual property rights owned by others and being able to resolve claims of intellectual property infringement without major financial expenditures or adverse consequences. The customer communications and telecommunications industries – and in particular the rapidly developing mobile industry – are characterized by the existence of a large number of patents, trademarks and copyrights, and by frequent litigation based upon allegations of infringement or other violations of intellectual property rights. In the past we have been subject to litigation, now concluded, with a third party that alleged that our services violated the third party’s intellectual property rights. As we seek to extend and expand our services, we could be constrained by the intellectual property rights of others.

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 services violate any third-party proprietary rights, we could be required to re-engineer our platforms 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 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. Further, our platforms incorporate 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.

The expansion of our business into international markets exposes us to additional business risks, and failure to manage those risks could adversely affect our business and operating results.

Historically we targeted substantially all of our sales and marketing efforts principally to businesses located in the United States. In recent years, however, we have focused on increasing resources on businesses located outside the United States, particularly in the United Kingdom. The continued expansion of our international operations will require substantial financial investment and significant management efforts and will subject us to a number of risks and potential costs, including:

 

   

difficulty in establishing, staffing and managing sales and other operations in countries outside of the United States;

 

   

compliance with multiple, conflicting and changing laws and regulations, including employment and tax laws and regulations;

 

   

uncollectability of receivables or longer payment cycles in some countries;

 

   

currency exchange rate fluctuations;

 

   

limited protection of intellectual property in some countries outside of the United States;

 

   

challenges encountered under local business practices, which vary by country and often favor local competitors;

 

   

challenges caused by distance, language and cultural differences; and

 

   

difficulty in establishing and maintaining reseller relationships.

Our failure to manage the risks associated with our international operations could limit the growth of our business and adversely affect our operating results.

Our clients typically are not obligated to pay any minimum amount for our services on an on-going basis, and if those clients discontinue use of our services or do not use our services on a regular basis, our revenues would decline.

The substantial majority of the pricing agreements we enter into with our clients do not require minimum levels of usage or payments and are terminable at will by our clients. The periodic usage of our services by an existing client could decline or fluctuate as a result of a number of factors, including the client’s level of satisfaction with our services, the client’s ability to satisfy its customer contact processes internally, and the availability and pricing of competing products and services. If our services fail to generate consistent business from existing clients, our business, financial condition and operating results will be adversely affected.

 

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We derive a significant portion of our revenues from the sale of our services for use in the collections process, and any event that adversely affects the accounts receivable management industry or in-house accounts receivable management departments would cause our revenues to decline.

We sell our hosted customer contact services for use in the collections process by accounts receivable management agencies and by large in-house accounts receivable management departments. Revenues from these businesses represented 60% of our revenues in the first three months of 2013, 55% of our revenues in 2012, and 70% of our revenues in 2011. We expect that revenues from accounts receivable management businesses will continue to account for a substantial part of our revenues for the foreseeable future.

Accounts receivable management businesses are particularly subject to changes in the overall economy. In a sustained economic downturn such as the recession experienced globally since 2009, accounts receivable management agencies can be affected adversely by declines in liquidation rates as a result of higher debt and lower disposable income. A prolonged economic downturn will impact these agencies as fewer loans are granted due to the imposition by lenders of conditions on the extension of credit that are not acceptable to potential borrowers. Accounts receivable management businesses also can be affected adversely by a sustained economic upturn, which may result in lower levels of consumer debt default rates. In addition, these businesses may be affected adversely by tightening of credit granting practices as well as technological advances and regulatory changes that affect the collection of outstanding indebtedness. Any such changes, conditions or events that adversely affect these businesses could cause us to lose some or all of the recurring business of our clients in the accounts receivable management industry, which in turn could have a material adverse effect on our business, financial condition and operating results.

Moreover, two clients accounted for a total of 16% of our revenues in the first three months of 2013, 17% of our revenues in 2012, and 23% of our revenues in 2011. One of these clients is an accounts receivable management agency and the other is a large in-house accounts receivable management department of a telecommunications business. In addition to the risks associated with accounts receivable management businesses in general, our business, financial condition and operating results would be negatively affected if either of these clients were to significantly decrease the extent to which it uses our hosted customer contact services.

Mergers or other strategic transactions involving our competitors could weaken our competitive position, which could harm our operating results.

Our industry is highly fragmented, and we believe it is likely that some of our existing competitors will consolidate or will be acquired, particularly in the market for mobile marketing solutions.

 

   

In August 2011 Augme Technologies, a mobile marketing service, acquired substantially all of the assets of Hipcricket, a mobile marketing and advertising company.

 

   

In October 2011 Velti, a mobile marketing and advertising technology provider, acquired Air2Web, a provider of mobile customer relationship management solutions.

 

   

In December 2011 Lenco Mobile, a provider of advertising and technical platforms primarily for mobile and online marketing sectors, acquired iLoop Mobile, a mobile marketing service organization.

 

   

In September 2012 FICO a provider of decision management solutions, acquired Adeptra, a provider of cloud-based customer engagement and risk intervention solutions.

 

   

In September 2012 Noble Systems, a provider of unified contact center technology solutions, acquired assets of ALI Solutions (formerly Austin Logistics), a provider of contact center decisioning and analytics applications.

In addition, some of our competitors may enter into new alliances with each other or may establish or strengthen cooperative relationships with systems integrators, third-party consulting firms or other parties. Any such consolidation, acquisition, alliance or cooperative relationship could lead to pricing pressure and our loss of market share and could result in a competitor with greater financial, technical, marketing, service and other resources, all of which could have a material adverse effect on our business, operating results and financial condition.

Failure to maintain our direct sales force will impede our growth.

We are highly dependent on our direct sales force to obtain new clients and to generate repeat business from our existing client base. It is therefore critical that our direct sales force maintain regular contact with our clients, both to gauge client satisfaction with our services as well as to highlight the value that use of our services adds to their enterprises. There is significant competition for direct sales personnel. Our ability to achieve growth in revenues in the future will depend in large part on our success in recruiting, training and retaining sufficient numbers of direct sales personnel. 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 keep, hire and successfully train sufficient numbers of direct sales personnel, we will be unable to increase our revenues and the growth of our business will be impeded.

 

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The loss of, or a deterioration in our relationship with, indirect sales partners, or our inability to establish new indirect sales channels, could harm our sales, gross margins and other operating results.

We partner with resellers, solution providers, original equipment manufacturers or OEMs, and international distributors in order to broaden our distribution reach. Establishing new indirect sales channels is an important part of our strategy to drive revenue growth. Our operating results would be adversely affected if our contracts with these channel partners were terminated, if our relationships with channel partners were to deteriorate, if any of our competitors were to enter into strategic relationships with or acquire a significant channel partner, or if the financial condition of our channel partners were to weaken. In addition, we may expend time, money and other resources on developing and maintaining channel relationships that are ultimately unsuccessful. There can be no assurance that we will be successful in maintaining, expanding or developing relationships with channel partners. If we are not successful, we may lose sales opportunities, customers and market share. In addition, there could be channel conflict among our varied sales channels, which could harm our business, financial condition and results of operations.

We cannot be certain we will be able to continue to attract additional indirect channel partners or retain our current channel partners. In addition, we cannot be certain our competitors will not attempt to recruit certain of our current or future channel partners. Such competitive actions may have an adverse effect on our ability to attract and retain channel partners, which, in turn, may have a material adverse effect on our business, financial condition and operating results.

Moreover, the gross margin on our products and services may differ depending upon the channel through which they are sold and we may have greater difficulty in forecasting the mix of our products and the timing of orders from our customers for sales derived from our indirect sales channels. Changes in the balance of our distribution model in future periods therefore may have an adverse effect on our gross margins and profitability.

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 personnel. Competition for these personnel is intense, especially for software engineers and senior sales executives. We might not be successful in attracting and retaining qualified personnel. 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. 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 value of the stock options they are to receive in connection with their employment. Volatility in the price of our common stock could therefore, adversely affect our ability to attract or retain key employees. Furthermore, 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.

If we are unable to protect our intellectual property rights, we would be unable to protect our 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 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 seven issued patents and ten patent applications pending in the United States. 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. Furthermore, 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.

We are subject to risks associated with outsourcing services to third parties, and failure to manage those risks could adversely affect our business and operating results.

We contract with several third-party vendors that provide services to us or to whom we delegate selected functions. These third-party vendors supplement our internal engineering efforts. Our arrangements with these third-party vendors may make our operations vulnerable if the third parties fail to satisfy their obligations to us:

 

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The failure of a third-party vendor to provide high-quality services that conform to required specifications or contractual arrangements could impair our ability to enhance our solutions or to develop new solutions, could create exposure for non-compliance with our contractual commitments to our clients, or could otherwise adversely affect our business and operating results. In particular, a client may impose specific requirements on us, such as an obligation to provide our solutions using only personnel in the United States, with which it may be difficult or impossible for a third-party vendor to comply or for which we may be unable to monitor compliance.

 

   

If a third-party vendor fails to maintain and protect the security and confidentiality of data to which it has access, we could be exposed to lawsuits or damage claims that, if upheld, could materially and adversely affect our profitability or we could be subject to substantial regulatory fines or other penalties.

 

   

If a third-party vendor fails to comply with other applicable regulatory requirements, we may be held liable for the vendor’s failures or violations. We cannot assure you that our third-party vendors are, or will be, in full compliance with all applicable laws and regulations at all times or that our third-party vendors will be able to comply with any future laws and regulations.

Our third-party vendor arrangements could be adversely impacted by changes in a vendor’s operations or financial condition or other matters outside of our control. There is no assurance that our third-party vendors will continue to provide services to us or that they will renew or not terminate their arrangements with us. Any interruption in their services could adversely affect our operations unless and until we can identify a new vendor or replace an existing vendor’s services with internal resources at additional cost.

Our platforms rely 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 cloud-based services, which would adversely affect our business and operating results.

Our multi-tenant customer communication platforms rely on technology licensed from third-party providers. For example, we use the Oracle WebLogic application server, Nuance Communications text-to-speech and automated speech recognition software, and the Oracle database. 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 platforms could require significant work and substantial time and resources. Any undetected errors in the software we license could prevent the implementation of our cloud-based services, impair the functionality of our services, delay or prevent the release of new features or offerings, 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.

Some of our services and technologies may use “open source” software, which may restrict how we use or distribute our services or require that we release the source code of certain services subject to those licenses.

Our services contain software modules licensed to us by third-party authors under “open source” licenses. Use and distribution of open source software may entail greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. Some open source licenses contain provisions that require attribution or that we make available source code for modifications or derivative works we create based upon the type of open source software used. If we combine our proprietary software with open source software in a certain manner, we could, under certain open source licenses, be required to release the source code of our proprietary software to the public at no cost. This would allow our competitors to create similar products with lower development effort and time and ultimately could result in an adverse impact upon our intellectual property rights and ability to commercialize our products.

Although we monitor our use of open source software to avoid subjecting our products to conditions we do not intend, the terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that these licenses could be construed in a way that could impose unanticipated conditions or restrictions on our ability to commercialize our products. Moreover, we cannot assure you that our processes for controlling our use of open source software in our products will be effective. If we are held to have breached the terms of an open source software license, we could be required to seek licenses from third parties to continue offering our products on terms that are not economically feasible, to re-engineer our products, to discontinue the sale of our products if re-engineering could not be accomplished on a timely basis, or to make generally available, in source code form, our proprietary code, any of which could adversely affect our business, operating results and financial condition.

Industry consolidation could reduce the number of our clients and adversely affect our business.

Some of our significant clients from time to time may merge, consolidate or enter into alliances with each other. The surviving entity or resulting alliance may subsequently decide to use a different service provider or to manage customer contact campaigns internally. Alternatively, the surviving entity or resulting alliance may elect to continue using our services, but its strengthened financial position or enhanced leverage may lead to pricing pressure. Either of these results could have a material adverse effect on our business, operating results and financial condition. We may not be able to offset the effects of any such price reductions, and may not be able to expand our client base to offset any revenue declines resulting from such a merger, consolidation or alliance.

 

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Our ability to use net operating loss carryforwards in the United States may be limited.

As of December 31, 2012, we had net operating loss carryforwards of $29.8 million for U.S. federal tax purposes and an additional $5.3 million for state tax purposes. These carryforwards expire between 2014 and 2032. To the extent available, we intend to use these net operating loss carryforwards to reduce the corporate income tax liability associated with our operations. Section 382 of the Internal Revenue Code generally imposes an annual limitation on the amount of net operating loss carryforwards that may be used to offset taxable income when a corporation has undergone significant changes in stock ownership. We experienced ownership changes for these purposes in 2007, which resulted in an annual limitation amount of approximately $8.0 million on the use of net operating loss carryforwards generated from November 29, 2001 through November 8, 2007. To the extent our use of net operating loss carryforwards is limited, our income could be subject to corporate income tax earlier than it would if we were able to use net operating loss carryforwards, which could result in lower profits.

If we are unable to raise capital when needed in the future, we may be unable to execute our growth strategy, and if we succeed in raising capital, we may dilute investors’ percentage ownership of our common stock or may subject our company to interest payment obligations and restrictive covenants.

We may need to raise additional funds through public or private debt or equity financings in order to:

 

   

fund ongoing operations;

 

   

take advantage of opportunities, including more rapid expansion of our business or the acquisition of complementary products, technologies or businesses;

 

   

develop new services and products; and

 

   

respond to competitive pressures.

Any additional capital raised through the sale of equity may dilute investors’ percentage ownership of our common stock. Capital raised through debt financing would require us to make periodic interest payments and may impose potentially restrictive covenants on the conduct of our business. Furthermore, additional financings may not be available on terms favorable to us, or at all. A failure to obtain additional funding could prevent us from making expenditures that may be required to grow or maintain our operations.

Risks Related to Regulation of Use of Our Services

We derive a significant portion of our revenues from the sale of our services for use in the 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 services unavailable or less attractive for use in the collections process or expose us to regulation as a debt collector.

Revenues from clients in the accounts receivable management industry and large in-house, or first-party, accounts receivable management departments represented 60% of our revenues in the first three months of 2013, 55% of our revenues in 2012, and 70% of our revenues in 2011. These clients’ use of our services is affected by an array of complex federal and state laws and regulations. The U.S. Fair Debt Collection Practices Act, or FDCPA, limits debt collection communications by clients in the accounts receivable management industry, including third parties retained by creditors. For example, the FDCPA prohibits abusive, deceptive and other improper debt collection practices, restricts the timing and content of communications regarding a debt or a debtor’s location, and allows consumers to opt out of receiving debt collection communications. In general, the FDCPA also prohibits the use of debt collection communications to cause debtors to incur more debt. 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, debt collection communications are subject to new regulations, as well as changing regulatory interpretations that may be inconsistent among different jurisdictions. For example, in February 2012 the FCC modified its rules to require opt-in for all prerecorded calls made to mobile phones, which limits our clients’ ability to use our services to call a mobile phone for the purposes of collections without having prior consent from a customer. Our business, financial position and operating results could be substantially harmed by the adoption or interpretation of U.S. federal or state laws or regulations that make our services either unavailable or less attractive for debt collection communications by existing and potential clients.

We provide our services for use by 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 clients not to use our services, 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 services for debt collection communications in those jurisdictions, which would have a material adverse effect on our business, financial condition and operating results. In addition, if clients use our services in violation of limits on the content, timing and frequency of their debt collection communications, we could be subject to claims by consumers that result in costly legal proceedings and that lead to civil damages, fines or other penalties.

 

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We could be subject to significant penalties or damages if our clients violate U.S. federal or state restrictions on the use of artificial or prerecorded messages to contact wireless telephone numbers, and our business and operating results could be substantially harmed if those restrictions make our service unavailable or less attractive.

Under the TCPA, 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 communication. In February 2012 the FCC modified its rules and will require, effective as of October 16, 2013, a written opt-in for all autodialed or prerecorded telemarketing calls made to mobile phones, which will limit our clients’ ability to use our service to call a mobile phone for telemarketing purposes without having prior written consent from a customer. Many states have enacted restrictions on using automatic dialing systems and artificial and prerecorded messages to contact wireless telephone numbers, and some of those state requirements may be more stringent than the comparable federal requirements.

Our services provide our clients with the capability to transmit artificial and prerecorded messages. Although our services are designed to enable a client to screen a contact list to remove wireless telephone numbers, a client may determine that prerecorded communication to certain wireless telephone numbers are permitted because the recipients previously have consented to receiving such communication. We cannot ensure that, in using our services for a campaign, a client removes from its contact list the names of all persons who are associated with wireless telephone numbers and who have not consented to receiving artificial or prerecorded communication. For example, in January 2012 a now-concluded class action litigation was filed against Bank of America and us alleging that we and Bank of America sent text messages to the plaintiff without the plaintiff’s prior express consent, in violation of the TCPA.

In May 2008, a federal district court in California held that the Telemarketing and Consumer Fraud and Abuse Prevention Act prohibits any autodialed or prerecorded telephone call to a consumer’s cell phone unless the consumer had specifically consented to such calls. The same provision of such Act also applies to the sending of commercial text messages to cell phones. The ruling overturned an earlier FCC interpretation that permitted autodialed and prerecorded calls to the cell phone of any consumer who had provided the cell phone number in connection with requesting a product or service. The ruling applied only in California and was subsequently overturned but, as a result of the initial decision, some existing or potential clients may decide to limit their use of our service to reach consumers on wireless numbers, which could materially adversely affect our revenues and other operating results.

If clients use our services in a manner that violates any of these governmental regulations, 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 service. If clients use our services to screen for wireless telephone numbers and our screening mechanisms fail, we may be subject to regulatory fines or other penalties as well as contractual claims by clients for damages, and our reputation may be harmed.

Regulatory restrictions on the use of artificial and prerecorded messages present particular problems for businesses in the accounts receivable management industry. These third-party accounts receivable management 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 autodialed 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. For example, an accounts receivable management agency frequently must evaluate whether past actions taken by a debtor, such as providing a cellular telephone number in a loan application, constitute consent sufficient to permit the agency to contact the debtor using autodialed or prerecorded messages. Moreover, a significant period of time elapses between the time at which a loan is made and the time at which a accounts receivable management agency or debt buyer seeks to contact the debtor for repayment, which further complicates the determination of whether the accounts receivable management agency or debt buyer has the required consent to use an automatic telephone dialing system or prerecorded messages. The difficulties encountered by these third-party accounts receivable management businesses are becoming increasingly problematic as the percentage of U.S. consumers using cellular telephones continues to increase. If these third-party accounts receivable management businesses are unable to use an automatic telephone dialing system or prerecorded messages to contact a substantial portion of their debtors, our services will be less useful to them. If our clients in the accounts receivable management industry significantly decrease their use of our services, our business, financial position and operating results would be substantially harmed.

We could be subject to penalties if we or our clients violate U.S. federal or state telemarketing restrictions due to a failure of our services or otherwise, which could harm our financial position and operating results.

The use of our services for marketing communications is affected by extensive federal and state telemarketing regulation. The Telemarketing and Consumer Fraud and Abuse Prevention Act and the TCPA, among other U.S. federal laws, empower both the Federal Trade Commission, or FTC, and the FCC to regulate interstate telephone sales calling activities. The FTC’s Telemarketing Sales Rule and analogous FCC rules require us to, for example, transmit Caller ID information, disclose certain information to call recipients, and retain certain business records. FTC and FCC rules proscribe misrepresentations, prohibit the abandonment of telemarketing calls and limit the timing of calls to consumers. Both the FTC and FCC also prohibit telemarketing calls to persons who have placed their numbers on the national Do-Not-Call Registry, except for calls made with an existing business relationship, or EBR,

 

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or subject to other limited exceptions. If we fail to comply with applicable FTC and FCC telemarketing regulations, we may be subject to substantial regulatory fines or other penalties as well as contractual claims by clients for damages, and our reputation may be harmed. The FTC’s Telemarketing Sales Rule, for example, imposes fines of up to $16,000 per violation. The FCC may also impose forfeitures of up to $16,000 per violation of its telemarketing rules. If clients use our services in a manner that violates any of these telemarketing regulations, the FTC or FCC may seek to subject us to regulatory fines or other penalties, even if the violation did not result from a failure of our services.

In addition, in 2008 the FTC adopted an amendment to the Telemarketing Sales Rule requiring that “express written consent” be obtained for all pre-recorded sales calls that are delivered as of September 1, 2009. Thus, a business that attempts to sell goods or services through the use of prerecorded messages will need to take the extra step to obtain “opt-in” from consumers before pre-recorded sales calls can be delivered, even with respect to consumers with whom the business has an EBR. We cannot ensure that, in using our services for a campaign, a client will obtain appropriate “opt-in” authorization before placing prerecorded telemarketing calls or that the client properly interprets and applies the “opt-in” requirement. If clients use our services to place unauthorized calls or in a manner that otherwise violates FTC or FCC restrictions on prerecorded telemarketing calls, U.S. federal or state authorities may seek to subject us to substantial regulatory fines or other penalties, even if the violation did not result from a failure of our screening mechanisms.

Many states have enacted prohibitions or restrictions on telemarketing calls into their states, specifically covering the use of automatic dialing system and predictive dialing techniques. Some of those state requirements are more stringent than the comparable federal requirements. If clients use our services in a manner that violates any of these telemarketing regulations, 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 services.

To the extent that our services are used to send text or email messages, our clients will be, and we may be, affected by regulatory requirements in the United States. Businesses may determine not to use these channels because of prior consent, or opt-in, requirements or other regulatory restrictions, which could harm our future business growth.

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

Our collection, use and disclosure of personal information are affected by numerous U.S. federal and state privacy, security and data protection regulations. We are subject to the Gramm-Leach-Bliley Privacy Act when we receive nonpublic personal information from clients that are treated as financial institutions under those rules. These rules restrict disclosures of consumer information and limit uses of such information to certain purposes that are disclosed to consumers. The related Gramm-Leach-Bliley Safeguards Rule requires our financial institution clients to impose administrative, technical and physical data security measures in their contracts with us. Compliance with these contractual requirements can be costly, and our failure to satisfy these requirements could lead to regulatory penalties or contractual claims by clients for damages.

In some instances our services require us to 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 reporting agencies. We generally rely on our clients’ assurances that any such information is requested and used for permissible purposes, but we cannot be certain that our clients comply with these restrictions. We could incur costs or could be subject to fines or other penalties if the FTC determines that we have mishandled protected information.

Many U.S. jurisdictions, including the majority of states, have data security laws including data security breach notification laws. When our clients 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 personally identifiable health information by certain health care-related entities. States may adopt privacy and security regulations that are more stringent than federal rules, and we may be required by such regulations to establish comprehensive data security programs that could be costly. 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. We or our clients 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.

Since 2007 we have been certified in the United States as compliant with the Payment Card Industry, or PCI, Data Security Standard, which mandates a set of comprehensive requirements for protecting payment account data. Our continuing PCI compliance is essential for many of our customer communication offerings, such as fully-automated payment transactions and payment authorizations, and is particularly important for financial institutions, credit card issuers and retailers. We must seek and receive certification of PCI compliance on an annual basis. PCI compliance measures are rigorous and subject to change, and our implementation of new customer communication platform technology and solutions could adversely affect our ability to be re-certified. As a result, we cannot assure you that we will be able to maintain our certification for PCI compliance. Our loss of PCI certification could make our customer communication solutions less attractive to potential customers, particularly those in the financial and retail industries, which in turn could have an adverse effect on our revenues and other operating results.

 

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We may record certain of our calls for quality assurance, training or other purposes. Many states require both parties to consent to such recording, and may adopt inconsistent standards defining what type of consent is required. Violations of these rules could subject us to fines or other penalties, criminal liability, or claims by clients for damages, any of which could hurt our reputation or harm our business, financial position and operating results.

The insurers under our existing liability insurance policy could deny coverage of a future claim that results from claims related to information security and privacy breaches, 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 assure you 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 exceed our insurance coverage, or the occurrence of 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, we are likely to incur substantial costs and our management’s attention will be diverted from our operations.

Government regulation of the mobile industry is evolving, and unfavorable changes or our failure to comply with regulations could harm our mobile marketing business and operating results.

As the mobile industry continues to evolve, we believe greater governmental regulation, both within and outside the United States, becomes more likely. For example, we believe increased regulation is likely in the area of data privacy, and laws and regulations applying to the solicitation, collection, processing or use of personal or consumer information and other mobile marketing regulations could affect clients’ ability to use and share data, potentially reducing their ability to utilize this information for the purpose of continued improvement of the overall mobile marketing experience. In addition, any regulation of the requirement to treat all content and application provider services the same over the mobile Internet, sometimes referred to as net neutrality regulation, could reduce our clients’ ability to make full use of the value of our services. Further, taxation of services provided over the Internet or other charges imposed by government agencies or by private organizations to access the Internet may be imposed. Any regulation imposing greater fees for Internet use or restricting information exchange over the Internet could result in a decline in the use of the Internet via a mobile device and in the viability of mobile data service providers, which could harm our business and operating results.

The expansion of our business into international markets requires us to comply with additional debt collection, telemarketing, data privacy or similar regulations, which may make it costly or difficult to operate in these markets.

Although historically we have targeted substantially all of our sales and marketing efforts principally to businesses located in the United States, more recently we have begun focusing more resources on businesses located in the United Kingdom. Countries other than the United States have laws and regulations governing debt collection, telemarketing, data privacy or other communications activities comparable in purpose to the U.S. federal and state laws and regulations described above. Compliance with these requirements may be costly and time consuming, and may limit our ability to operate successfully in one or more foreign jurisdictions.

Many of the regulations governing our activities in the European Union result from EU legislation on privacy and data protection. As a result, the principal lawmakers for our purposes are European institutions – the European Commission, the European Parliament and the Council of Ministers. We take into account developments in the European Union as well as developments in the United Kingdom. Because our primary international business is driven from the United Kingdom, our regulatory due diligence to date has been focused on this member State. In terms of enforcement, the U.K. regulators of primary importance to us are:

 

   

Ofcom, the independent regulator and competition authority for the U.K. communications industry;

 

   

the Information Commissioner, an independent authority whose role is to uphold information rights in the public interest, promoting openness by public bodies and data privacy for individuals; and

 

   

the Office of Fair Trading, an independent authority that enforces consumer protection and competition laws and reviews proposed mergers.

The Communications Act of 2003 gives Ofcom the power to issue and enforce notifications when it has reasonable grounds to believe a person has persistently misused an electronic communications network or service in such a manner, or otherwise engage in conduct that has either the effect, or likely effect, of causing another person unnecessarily to suffer annoyance, inconvenience or anxiety. The other sector-specific legislation governing our U.K. operations consists of The Privacy and Electronic Communications (EC Directive) (Amendment) Regulations (2003) as amended in 2011 to implement the new e-privacy EU Directive. These regulations contain marketing rules governing businesses that send marketing and advertising by electronic means such as telephone, fax, email, text message and picture (including video) message and by using an automated calling system. These regulations also cover related areas such as telephone directories, traffic and location data, and the use of cookies.

It may be impossible for us to comply with the different data protection regulations that affect us in different jurisdictions. 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 laws, including some in the European Union, prohibit such disclosures. Such conflicts could subject us and clients to costs, liabilities or negative publicity that could impair our ability to expand our operations into some countries and therefore limit our future growth.

 

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Risks Related to Ownership of Our Common Stock

If equity research analysts do not publish research or reports about our business or if they issue unfavorable commentary or downgrade our common stock, the price of our common stock could decline.

The trading market for our common stock depends in part on the research and reports that equity research analysts publish about our company and business. The price of our common stock could decline if one or more equity research analysts downgrade our common stock or if those analysts issue other unfavorable commentary or cease publishing reports about our company and business.

Future sales of our common stock by existing stockholders could cause our stock price to decline.

If our existing stockholders sell substantial amounts of our common stock in the public market, the market price of our common stock could decrease significantly. The perception in the public market that our stockholders might sell shares of common stock could also depress the market price of our common stock. The market price of shares of our common stock could drop significantly if our officers, directors or other stockholders decide to sell shares of our common stock into the market.

Our directors, executive officers and their affiliated entities will continue to have substantial control over us and could limit the ability of other stockholders to influence the outcome of key transactions, including changes of control.

As April 30, 2013, our executive officers and directors and their affiliated entities, in the aggregate, beneficially owned 47% of our common stock. In particular, affiliates of North Bridge Ventures Partners, including William J. Geary, one of our directors, in the aggregate, beneficially owned 29% of our common stock. Our executive officers, directors and their affiliated entities, if acting together, are able to control or significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other significant corporate transactions. These stockholders may have interests that differ from those of other investors, and they might vote in a way with which other investors disagree. The concentration of ownership of our common stock could have the effect of delaying, preventing, or deterring a change of control of our company, could deprive our stockholders of an opportunity to receive a premium for their common stock as part of a sale of our company, and could negatively affect the market price of our common stock.

Our corporate documents and Delaware law make a takeover of our company more difficult, which could prevent certain changes in control and limit the market price of our common stock.

Our charter and by-laws and Section 203 of the Delaware General Corporation Law contain provisions that could enable our management to resist a takeover of our company. These provisions could discourage, delay, or prevent a change in the control of our company or a change in our management. They could also discourage proxy contests and make it more difficult for stockholders to elect directors and take other corporate actions. The existence of these provisions could limit the price that investors are willing to pay in the future for shares of our common stock. Some provisions in our charter and by-laws could deter third parties from acquiring us, which could limit the market price of our common stock.

 

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Item 6. Exhibits

 

Exhibit
Number

  

Description of Exhibit

  10.1    Internap Sales Order dated February 10, 2010 and Addendum to Master Services Agreement dated September 22, 2011, each amending Internap Master Services Agreement dated August 28, 2003 between Internap Network Services Corporation and the Registrant
  10.2    Third Loan Modification Agreement dated February 14, 2013 to Loan and Security Agreement dated November 2, 2009 between Silicon Valley Bank and the Registrant
  10.3    First Amendment dated April 30, 2013 to Lease dated May 18, 2007 between RAR2-Crosby Corporate Center QRS, Inc. and the Registrant
  31.1    Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  31.2    Certification of principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  32.1    Certification of principal executive officer and principal financial officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. 1350
101.INS#    XBRL Instance Document
101.SCH#    XBRL Taxonomy Extension Schema Document
101.CAL#    XBRL Taxonomy Calculation Linkbase Document
101.LAB#    XBRL Taxonomy Label Linkbase Document
101.PRE#    XBRL Taxonomy Extension Presentation Linkbase Document

 

# Pursuant to Rule 406T of Regulation S-T, XBRL (Extensible Business Reporting Language) information is deemed not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934 and otherwise is not subject to liability under these sections.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    SoundBite Communications, Inc.
Date: May 9, 2013     By:   /s/ James A. Milton
      James A. Milton
      President and Chief Executive Officer
Date: May 9, 2013     By:   /s/ Robert C. Leahy
      Robert C. Leahy
      Chief Operating Officer and Chief Financial Officer

 

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EXHIBIT INDEX

 

Exhibit
Number

  

Description of Exhibit

  10.1    Internap Sales Order dated February 10, 2010 and Addendum to Master Services Agreement dated September 22, 2011, each amending Internap Master Services Agreement dated August 28, 2003 between Internap Network Services Corporation and the Registrant
  10.2    Third Loan Modification Agreement dated February 14, 2013 to Loan and Security Agreement dated November 2, 2009 between Silicon Valley Bank and the Registrant
  10.3    First Amendment dated April 30, 2013 to Lease dated May 18, 2007 between RAR2-Crosby Corporate Center QRS, Inc. and the Registrant
  31.1    Certification of principal executive officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  31.2    Certification of principal financial officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
  32.1    Certification of principal executive officer and principal financial officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. 1350
101.INS#    XBRL Instance Document
101.SCH#    XBRL Taxonomy Extension Schema Document
101.CAL#    XBRL Taxonomy Calculation Linkbase Document
101.LAB#    XBRL Taxonomy Label Linkbase Document
101.PRE#    XBRL Taxonomy Extension Presentation Linkbase Document

 

# Pursuant to Rule 406T of Regulation S-T, XBRL (Extensible Business Reporting Language) information is deemed not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934 and otherwise is not subject to liability under these sections.

 

 

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