inContact, Inc. (SAAS) provides cloud-based (hosted) call cen­ter solutions and also resells basic telecommunication services. In 2005, SAAS made a strategic decision to focus exclusively on growing its call center solutions business, developing a hosted software solution and transitioning into a “Software-as-a-Ser­vice” (SaaS) business model. The company derives the major­ity of its software revenues from its automatic call distributor (ACD) and interactive voice response (IVR) products.SAAS has positioned itself to benefit from the evolution of the call center market away from capital intensive, on-premise solu­tions towards hosted, decentralized call centers. The company’s customers prefer to deploy a hosted solution and avoid the high fixed costs associated with on premise call centers. This trend should continue for at least the next five years due to the strong value proposition of hosted solutions, which reduce capital spending requirements and have a lower total cost of ownership than on premise solutions.

Over the past several years, SAAS focused on building out its distribution capabilities by forming partnerships. The company is a premier partner of salesforce.com (CRM) and has many other important channel partners, including Agent Alliance and Astadia. These strategic relationships, combined with the company’s internal investments in sales and marketing, should help generate strong brand awareness. SAAS continues to hire more salespeople and these efforts are starting to pay dividends, as the company experienced a record number of new contract wins in the software segment in both Q2 2010 and Q3 2010 and posted year over year growth in new contract wins in Q4 2010 and Q1 2011. The company also posted 96% year over year growth in bookings in Q4 2010 followed by 91% growth in Q1 2011. We expect SAAS to continue to capture market share as it grows its direct sales force, leverages its distribution rela­tionships, and builds on its growing brand awareness.

We like the transition to a SaaS business model, as this should provide a strong recurring revenue stream going forward. Additionally, as software revenues continue to grow, the overall gross margins of the company should improve. Revenues in the legacy telecom business experienced unsettling declines for six consecutive quarters before experiencing sequential growth in the first quarter of 2011; the telecom business generates solid cash flow to help finance growth within the software segment.

 In the near-term, we expect SAAS to lose money, as they face a near-term trade-off between profitability and investing in sales, marketing, and other areas of the business that will drive future growth. However, they should start to experience some significant software revenue growth in the second half of 2011, stemming from new customers they won in recent quar­ters. (It takes 5-6 months to recognize any revenue from a new customer.)

We believe that 2011 is an extremely important year for SAAS as it will provide the company with an opportunity to execute on their investments in sales and marketing and show solid revenue growth in the software segment. Management stated on their last earnings call that they expect year over year software revenue growth between 25%-30% in Q4 2011. If SAAS can successfully grow its top line, we expect management to scale the business and achieve profitability in the long-term.

SAAS Stock Price: January 2009 – May 2011

Source: Bloomberg

While we like SAAS as an investment idea, we continue to monitor several key risks. Software revenue growth has slowed, the company’s balance sheet is not great, and competition from larger, better capitalized players such as Cisco (CSCO) could emerge if they deem the space very attractive. SAAS also histori­cally has not operated profitably. We view the company’s ability to sell as a key risk and are closely monitoring revenue growth within the software segment.

Despite these risks, we believe that SAAS is well positioned to grow and unlock value for shareholders. The company has a solid technology portfolio, continues to grow its sales force, and also continues to capitalize on and increase the number of stra­tegic partnerships to strengthen its distribution infrastructure. SAAS operates in a niche market which we expect to experience strong secular growth over the next several years. With inves­tors hungry for “cloud” companies and “Software-as-a-Service” business models, SAAS could eventually become an attractive acquisition target. This is a growth stock, and it is not cheap, but we expect big things from inContact over the next few years, as we think the future prospects for this company are very bright.

Joel A. Hainsfurther, Senior Associate Investment Analyst,
Wanger Investment Management, Inc.