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Executives

Randy Jonkers - CFO

John Farr - President and CEO

Analysts

Kevin Louve - B. Riley & Co.

James Gilman - Capstone Investments

Pervasive Software, Inc. (PVSW) F1Q2012 Earnings Conference Call October 25, 2011 5:00 PM ET

Operator

Good afternoon. My name is Steve. And I will be your conference operator today. At this time I’d like to welcome everyone to the Pervasive Software Fiscal Year 2012 First Quarter Financial Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (Operator Instructions) Thank you.

I will now turn the call over to Randy Jonkers, Chief Financial Officer. Please go ahead.

Randy Jonkers

Thank you. Good afternoon and thank you for joining us. I’m Randy Jonkers, Chief Financial Officer of Pervasive Software. While we wait for others to join, I’ll go over the standard disclaimer regarding remarks on this call. This conference call may contain forward-looking statements within the meaning of the Federal Securities Laws, including statements regarding the company’s or management’s intension, hopes, beliefs, expectations and strategies for the future. Forward-looking statements may include without limitations statements regarding the following; future investments, sales, market growth and direction, competition, revenue growth, operating margins and profitability. A detailed discussion of risks and uncertainties that could cause actual results and events to differ materially from such forward-looking statements is included in Pervasive’ most recent filings with the Securities and Exchange Commission.

Pervasive does not undertake any obligation to update forward-looking statements to reflect events or circumstances after the date of this conference call. Also as a reminder our non-GAAP results for the quarter that is in September 30, 2011 and 2010 exclude the amortization of purchase intangibles and stock based compensation expense and present income taxes that are statutory rate of 34%. We believe that non-GAAP results described in today’s press release and in this conference call are useful for an understanding of our ongoing operations and to assist the investor community in comparing Pervasive non-GAAP results from period-to-period as well as comparing our results with those of similar companies.

We use these non-GAAP results compare our performance to that in prior periods for analysis of trends to evaluate the company’s financial strength, develop budgets, manage expenditures and develop our financial outlook. Non-GAAP results are supplemental and are not intended as a substitute for GAAP results. Note that our call today is being broadcast simultaneously via the Pervasive website. Welcome to those listeners.

In this call we will cover two primary agenda items. First I will provide some additional financial metrics from our first fiscal quarter to supplement those already provided with our press release today. And John will update you on our current operations and plans.

Today we released financial results for our first quarter of our fiscal year 2012. Results were consistent with our previously issued guidance. By geography our Q1 revenue was as follows; domestic revenue totaled approximately 6.5 million in Q1 or 56% of our revenue. Our international revenue principally Europe and Japan totaled 5.2 million or 44% of our revenue in Q1. At a product level, our database products represented approximately 60% of our business and our integration products represented approximately 35% in Q1 while our Business Xchange, DataSolutions and DataRush products accounted for the remainder.

Our G&A spend in Q1 increased approximately 500,000 over Q1 at fiscal year 2011. The increase was due to the timing of our external audit work related to our recently filed 10-K and what we believe to be a temporary increase in our patent litigation defense cost.

We had 247 employees at the end of Q1 which represents a decrease of 5 employees in the end of the fourth quarter.

Now looking forward and to supplement Q2 guidance is provided in today’s press release. We anticipate cash flows from operations to be between 1 and $2 million for the second quarter of fiscal year 2012. Our EPS calculation purposes, we expect our GAAP basis and non-GAAP fully diluted share count for the second quarter of fiscal year 2012 to be approximately 16.1 million and 16.6 million shares, respectively. Note that this share count estimate excludes the impact of any future share repurchases. Also as in prior quarters we are not providing specific guidance beyond Q2.

Now let me turn the call over to John Farr, our CEO of Pervasive.

John Farr

Thanks Randy. The Pervasive team delivered another solid quarter in September. Both our integration and our database core product teams grew revenue over the September quarter of last year representing revenue growth of 7% and contributing to our 43rd consecutive quarter of profitability. And we continue to leverage our profitability to make strategic investments for the future. Why? Because we believe the software market as a whole are going through rapid and disruptive change. The emerging a mainstreaming of cloud based infrastructure and applications it's estimate to the increasing demand for scalability and rapid deployment provided by the SaaS delivery model. Organizations increasingly demand software that provides ease of use, reusability, interoperability with widely adopted technologies and the flexibility to be deployed on-premises or in the cloud, all in a cost effective manner.

In this environment delivering flexibility and performance with high return on investment becomes increasingly critical. In addition, the rapid proliferation of commodity hardware along with exploding data volumes, aka, Big Data, provides opportunities for companies to leverage affordable multi-core servers and clusters of servers to extract value from large volumes of data. Why, only if they have software that can effectively scale on new hardware. As these disruptive market trends continue, we believe infrastructure software will be a key ingredient for all businesses as they seek to integrate and streamline their backend systems and eliminate delays in the management and execution of critical business processes, and seek to gain business insight and value from their vast data assets being generated in today’s increasingly digital business world.

In this context, Pervasive represents a uniquely well positioned combination of assets. We are a data innovation leader, delivering software to manage, integrate and analyze data in the cloud or on-premises throughout the entire data life cycle. Each of Pervasive’s investment areas produced in fiscal year 2011 and continue to produce in September, the first quarter of fiscal 2012 with our database products maintaining solid revenue levels and generating positive cash flows to fund our many activities and our integrations products growing revenue consistently in the here and now. While we invest significant resources, 25% plus of our revenue and technology and product development for the future, we now found ourselves in the midst of the rapidly evolving market with a combination of assets uniquely well suited to take advantage of the trends in cloud based infrastructure and applications markets and the Big Data explosion. We are also well positioned to effectively address the integration and data quality challenges and opportunities posed by each.

Quick overview of our resources. Database, representing approximately 60% of revenue in the September quarter, our database business is the most mature and most profitable of our product lines. Annual database revenue is being solidly in the 26 million to 29 million range in each of the past five fiscal years, excluding the occasional relatively large one-off transaction that we disclosed from time-to-time as we did in the recent June quarter. Variability from year-to-year is influenced in part by where we are in our version life cycle. And our database engineering team has done a tremendous job both keeping our database technology current and relevant to our large install-base of loyal customers.

Pervasive PSQL v11 released in fall of 2010 makes efficient use of commodity 2, 4 and 8 core servers with throughput gains of up to 4x of that of earlier versions. Its performance benefits is the full range of vendor applications whether or not those applications are multi-core optimized. And Pervasive is developing Pervasive PSQL VX, a product released for our partners who make extensive use of virtualization techniques enabling them to better deliver on the cloud with load balancing, fell over and multi instants of the capability.

Pervasive is also introducing a capacity based licensed model based on data volumes and active sessions to accommodate changing infrastructures for SaaS and cloud based IVs in our database business.

Now into integration. Representing approximately 35% of revenue in the September quarter, our integration products are well received by our existing and new customers including end users and commercial cloud and on-premises software to the authors alike. We have grown our integration product revenues to new record levels in each of the past four fiscal year's and have grown quarter over prior year quarter revenue now in each of the past 8 quarters achieving an increasing mix of contractually recurring revenue and what I like to call practically recurring partner based revenue.

Our year-over-year integration revenue growth in this Q1 in this September was a notable fee given that we were working through some attrition and management transition in our professional services grew during the quarter causing our PSG revenue results in Q1 to be a few $100,000 below recent run rates. Now we believe our PSG team has now reestablished itself from both revenue production and a capacity standpoint.

Pervasive Business Xchange business acquired in September 2009 they turned in a good quarter result in September, the Pervasive WebDI managed service provides trading partners with actionable insight into their cash flow related business documents including purchase orders and invoices. In fiscal 2011 we completed migration of all Pervasive WebDI customers to the Windows Azure and became one of the flagship partners featured on the Windows Azure marketplace. In June quarter, we expanded Business Xchange, marketing and sales efforts investing for better penetration of existing markets and account primarily in the energy industry, and proactively developing additional markets for managed integration as a service. The result in September was the signing of a new service agreement with a Fortune 500 oil and gas company the handle of subset of their non-standard electronic invoice communications. This is the first such win for Pervasive Business Xchange business in year's while the initial engagement may start out relatively small, it does give our Pervasive Business Xchange team an expandable total of in a $5 billion plus oil and gas company.

On the innovation front, our solid results in our core product lines allow us to continue to fund our commitment to innovation. We intend to continue to invest in innovation by allocating dedicating funds for research focused on new ways to serve our existing customers and to attract new customers. Our innovation efforts over the past few years resulted in the introduction and further development of several exciting product and service offerings Pervasive DataSolutions to take advantage of market trends and integration as a service and either on-demand data solutions. Pervasive data cloud provide a scalable cloud based platform for development and deployment of both Pervasive and partner developed on-demand services and Pervasive Big Data to support development and deployment of high throughput applications by capturing a parallel processing capabilities of proliferating multi-core technologies.

Now first, Pervasive data cloud and Pervasive DataSolutions. We began several years ago as an innovative way for us to deliver our deep integration capabilities to a different less developer centric segment of the market, i.e., subscription based integration of the service delivered on-premises or as a multi-tenant service hosted by Pervasive. Pervasive data cloud is now 300 plus subscribers strong. Pervasive data cloud is attracting a growing number of ISVs and systems integrated partners meeting a secure and reliable on-demand services platform for Pervasive and partners cloud developers to rapidly create on-demand data and application integration, on-demand analytics and on-demand data profiling.

Intuit recently deployed a tighter integration service for QuickBooks and Salesforce CRM, with Pervasive data cloud platform and Pervasive DataSynch technology at its core. We are very proud of the cloud based work that we have done in concert with Intuit and many other ISPs in the market and look forward to leveraging these relationships in the years to come.

Now second, Pervasive Big Data, using Pervasive DataRush, a software development platform unless developers rapidly build payroll application that deliver exceptionally high throughput on Big Data with low CapEx and OpEx costs, we allow developers to fully leverage payroll processing capabilities of multi-core processors on appliances or on (inaudible) to deliver unmatched performance. Our Pervasive DataRush initiative began in earnest several years ago as relatively raw technology, we have methodically been advancing the technology to achieve increased ease of use and adoptability by our customers. We are active in (inaudible) for Big Data and intend to increase our visibility in that community.

We have potential partners and customers looking for cost effective solutions to the challenges and opportunities posed by ever increasing data volumes, a growing range of data sources and types and the accelerating speed of business in hand in today’s Big Data landscape.

Now as many of you may remember from our call in July, I indicated that our results to-date with our DataRush initiatives were good, but that we can do much better. I announced then that I was making changes in Pervasive DataRush sales and marketing leadership and one additional dedicated DataRush sales resource.

We have now combined Pervasive DataRush and our innovation labs group into one team Pervasive Big Data products and solutions to focus aggressively on market and partnering opportunities in that area including the Hadoop ecosystem. Mike Hoskins, our Executive VP, Chief Technology Officer, largest shareholder and former GM of our Integration Product Group has assumed a role as General Manager of this new team. Lance Speck, a 10 plus year veteran in Pervasive and most recently Senior Director of Integration Sales and Marketing has untapped as the new GM for our Integration Products Group. And I’m looking forward to the exciting year ahead with both of them.

In short, we had a good start to fiscal 2012. We are making strategic investments and we are well positioned to capture a significant opportunities in the future while also maintaining our intense focused on profitability. And going forward, for the balance of fiscal year 2012, we will continue to focus on the continued marketing of our embedded database product Pervasive PSQL v11 released in September 2010 and the plan to release a Pervasive PSQL DX for highly virtualized environments. Growing our sales of our integration product line both through direct sales and through highly recurring leverageable direct and indirect channels. Growing our Pervasive WebDI managed services business and customer base. Continuing the investment in new product from service innovation including the further advancement of our innovation initiatives, Pervasive DataSolutions, Pervasive data cloud and Pervasive Big Data. And the continued focus on generating profitable results and positive cash flows while we look for opportunities to continue to reduce our shares issued in outstanding, putting to work our approved share repurchase program.

Now I personally observe, over the past year in particular, the increasing value our customers, partners and employees placed on Pervasive unique combination that have operational stability and the ability to innovate. The investments we are making in innovative new products and innovative new features for existing products are positioning us incredibly well for the intriguing trends in Big Data and the cloud.

These are truly exciting times to be a part of Pervasive Software and we are bullish on Pervasive and continue to buy back our outstanding shares as we have done now for the last 22 consecutive quarters.

Pervasive continues to enjoy many competitive advantages including solid and proven product lines, a well developed channel and operating leverage, a strong balance sheet, a furious focused on innovation and consistent profitability and positive cash flow.

A couple of quick Investor Relations notes. First I’d like to take a moment to welcome James Gilman an analyst with Capstone Investments to our call today. James initiated coverage on PVSW Pervasive in early October and joined Kevin Louve from B. Riley & Co. as one of our two covering research analyst contributing to first call estimates for Pervasive. Welcome to you James. Also we are scheduled to present at the AEA Classic in San Diego on November 8th and the three part advisors, Southwest Ideas Investor Conference in Dallas on November 16th. Now we hope to see many of you at these and coming events in the near future.

I’ll now open the floor for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Kevin Louve from B. Riley. Your line is open.

Kevin Louve - B. Riley & Co.

First question just on the caller ID, just in terms of some of the trend over in the professional services group, how much of that was anticipated when you guys first set your guidance for the quarter. And maybe if you could talk about what comp did some of the changes than the impact of the revenue standpoint was during the quarter?

John Farr

First of all, there is a pretty rich business environment here in Austin unlike many parts of the nation and so the competition if you will for our finite set of technical resources in Austin is a competition for that talent is increasing first and foremost. So, some of the attrition had began in the June quarter so obviously, we laid that in to our thinking when we gave guidance for the September quarter in addition to the normal seasonality that we always experience in the September quarter a lot of variables go into that guidance adding for each of our quarters that September quarter in particular.

Why, I’d say the team we had including those that are here is a good team, and we had a lot of work that we were able to hand off to PSG to further enhance and speed adoption of our products by our customers and at some point the work starts to weigh heavily especially on PSG guy that spends 90% of their time on the road. It is a tough, tough job and at some point you just reach a point of meeting something else in your life. And so I think a lot of the attrition was about that, and when there is no relief in sight than that starts to cause other people to take a look around and have similar thought. So, I need to probably establish the magnitude here. And we’re talking about a handful of people and it's not like a mass of number of people, we will replace those resources and bought in more senior management, leaders for professional services in our business and they have made immediate positive changes in a business from process standpoint. So, as I say in the call, I think the disruption in our capacity and our ability to work on top notch revenue or normal rate per hour consulting work is has now been reestablished and we are in a good place coming into Q2.

Kevin Louve - B. Riley & Co.

Okay. So, really in the quarter it's more of lack of capacity as oppose to any sort of drop off in demand or utilization of your staff?

John Farr

No, the demand is there.

Kevin Louve - B. Riley & Co.

Okay. And then just looking at the sales and marketing line, it was I know in last quarter you guys had some extra approvals and the like even compared to the quarters prior to that sales and marketing seems to have come down quite a bit. So, maybe if you could talk about some of the drivers there and whether you would anticipating investing more aggressively over the course of the year?

John Farr

The items in Q4 if you are referring to, remember we did quite well on revenue line and so obviously there would be related commission expense in those numbers and we had a record attendance at our META ’11 customer conference out in San Jose, all of that happened in Q4. So, there was a couple of anomalies there. And coming into this Q1 again summer seasonality, I get a little bit more cautious especially on the new hiring wish list that we always get in the planning cycle and coming into the summer seasonal quarter we’re little bit more cautious on what we approve from hiring standpoints. So, what that means for the quarters to come, there are probably a handful of sales resources to hire in the coming quarter, but that’s about it a handful. I think we got a lot of capacity in the current sales and marketing line that we have invested up to a this point. And we would like to see better results coming out of that correct investment in sales and marketing capacity.

The next largest advance from a marketing standpoint for us we will have a reasonably sized, moderately sized European integration summit in the March quarter and then we will have a little bit larger non-America based event in Austin in the June quarter. So, we are not expecting any major event costs in this coming December quarter.

Kevin Louve - B. Riley & Co.

And just lastly before I turn it over. On the G&A line you talked about some patent defense cost there. What is that amount in the quarter and would you expect that to persist in the next quarter will it be lumpy depending on the timing of your quite schedule?

John Farr

Yes. So, first of all on our patent defense cost we disclosed in our 10-Ks and 10-Qs the status of a couple of patent litigation situation and in the one that in particular contributed to our spend in Q2 in the September quarter. This is called the JuxtaComm patent. And actually, the patent office overturned that patent in May and basically rendering the patent invalid. Now unfortunately the court system doesn’t just automatically yield to final office actions by the USPTO, and so we are still hoping that the judge in the case for JuxtaComm or the judge in this case will in fact stay litigation while the field’s process goes on the patent reversal or, however, I dismiss the case because of patent invalidity. The court has not yet ruled on all those motions to stay or dismiss and so consequently we all the defendants and plaintiffs, have continued to have to work through the court documented process of this litigation.

Now to us that meant damages experts, invalidity experts, non-infringement experts, all of them did their expert reports to research and reports and filed them with the court all in the September quarter and that was between 2 and $300,000 of that delta that you are looking at now. Is it recurring, it's not recurring from the standpoint of doing those research reports, are there services potentially recurring if the court continues to not file or respond to the motions to stay or dismiss than there is potential if those same experts are deposed in the case as we continue to march along. But again we are continue to be hopeful that court will see this as not the best use of the courts time, all talking got a patent that is in fact being reversed by the USPTO.

Operator

Your next question comes from the line of James Gilman with Capstone Investments. Your line is now open.

James Gilman - Capstone Investments

Nice license and database results, I did have some questions though following up on some things. So, given the services and you talked about the attrition and some of the challenges and that would led to maybe some of the attrition. Do you foresee that maybe expenses may go up incrementally there. So, you might have lower margin that compensate for higher travel you might need to pay a little bit more?

John Farr

I think that potentially cost will go up nominally, but I think margins tend to go up, because I think we are much more effective organization now than we were 180 days ago. There has been capacity there, lot of the shortcoming have been to some degree on project management where you get behind on a project and you start scrambling and chasing the finite expert resources in our group. So, I think that it might be a nominal lift in the spend but perhaps a improvement in the margin as we continue to get back where we were and perhaps beyond with the revenue side of thing, i.e., we have the capacity today to return to our previous revenue levels and we are.

James Gilman - Capstone Investments

Okay. So, you mentioned that if I look at numbers correctly around or some of the data that you gave in the past until today around geographic results. And if I were to maybe connect the dots would the weakness in the services lead to explain why U.S. sales were down year-over-year if I look at my numbers correctly?

John Farr

That would be one of them yes. We are talking about services and integration division, or the preponderance of our services revenue is in integration and the bulk of our integration revenue is in North America. So, yes.

James Gilman - Capstone Investments

Okay. You might have mentioned during the call, but the release date of VX?

John Farr

Like all the fall release. So, that is as much of the, I have been cautioned internally to fit our VX release in the proper context. So, we have been shipping version 11 since last fall, VX version is not like the 12, it is more like 11.5 or less. In other words there is only a portion of our large install-base of database customers who do actually operate in highly virtualized environments. So, this is a release that is coming in time for some of our customers but we believe actually probably even a little bit ahead of it's time for many of our customers. So, lot of our database customers tend to be more laagered in their technology adoption, there are not as cutting edge as they are customers in integration and certainly in data cloud and DataRush, but we believe that they all will began to embrace more of virtualized environments and need the kind of flexibility in our licensing and capabilities in our product that will support those environments.

James Gilman - Capstone Investments

I think maybe in past calls you stated that your database business is somewhat built around releases. I mean do you think this will be a one that really drive much of a database sales or just continue to where in that range you mentioned that on an annual basis to 26, 29 something like that.

John Farr

I think it is very much in response to where we believe our customers will need in the future coming years. So, again it is not like version 12 the database business that starts as something new version or life cycle.

James Gilman - Capstone Investments

Last question here and you mentioned this in the call, I know when you talked about the Xchange business with the oil and gas, in this department when you talked about and I missed, looking at things that led to that success and maybe if you could give a little bit of color around maybe some of the opportunity there and timeframe around that?

John Farr

So, what led to the success, well, we bought company back in 2009, summer 2009 called ChanneLinx that is the business now that I’m referring to as our Business Xchange business. And again you are relatively new to the business here so you may not have necessarily read that we made a change back in April of this year, where I still have the couple of senior sales resources in the ChanneLinx business that I had retained from their preacquisition roles and quite frankly they are based in Greenville, we weren’t getting far enough quickly enough with the integration of the acquired business with all things Pervasive. In other words the acquired business was still acting like the 16% business in Greenville that they were before we acquired versus a part of the 256 person organization that they had now become. And so we made some changes there and introduced three sales and marketing resources senior manager of sales and marketing and one sales resource, one marketing resource, all Austin base so they are connected to Austin in many ways. And I’d say that they are bringing a much higher level of productivity and activity around sales and marketing functions and so a lot of this is just getting out and back locking and tackling around sales and marketing activities with the install base customers and those other vendors out in the industry here are connected to them. The interesting thing about the Business Xchange business is that there is a multitude of oil and gas industry participants that we serve, some maybe large hubs connected to many different trading partners downstream or many of those trading partners downstream may in fact be large hubs of other ecosystems downstream from them. And so with hungry sales and hungry marketing we can start playing in that world and penetrating that world further and further and further. So, that’s what these resources they have been in our integration business for years, but what these guys nearly assigned to Business Xchange are in fact doing.

In this particular oil and gas case, again relatively small start, but we believe that our capabilities and our pricing and our service and our customer satisfaction around the service we deliver is the thing that once you have total you will grow those accounts to be large overtime. And how much time is anyone to guess but we got to going in the right direction. And so we are looking forward to what this new team in sales and marketing resources can do and how they can press more appropriately point our engineering team now that our engineering team has completed the migration of our install base customers over to Microsoft Azure which was the rather consuming focus of their roles laying up to about the same time back in April. So, basically its new sales and marketing activities little existed before.

Operator

We have no further questions at this time, will turn it back for any closing comments.

John Farr

All right. As always we appreciate your time here in earnings release season and appreciate your interest in Pervasive Software. Have a great evening.

Operator

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.

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