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Executives

Jack Noonan – President, Chief Executive Officer

Raymond Panza – Chief Financial Officer, Executive Vice President

Douglas Dow – Senior Vice President, Corporate Development

Analysts

Nathan Schneiderman - Roth Capital Partners

Steve Ashley - Robert W. Baird

Daniel Cummins - Banc of America Securities

Robert Schwartz - Jefferies

Sean Jackson - Avondale Partners

Peter Goldmacher - Cowen and Company

John Maietta - Needham & Co.

Frank Sparacino - First Analysis Corp.

Nabil Elsheshai - Pacific Crest Securities

SPSS, Inc. (SPSS) Q3 2007 Earnings Call October 30, 2007 6:00 PM ET

Operator

Good day everyone, and welcome to the SPSS 2007 third quarter conference call. With the exception of historical information, the matters discussed on this conference call include forward-looking statements that involve risks and uncertainties including but not limited to market conditions, competition, and other risks indicated in the company's filing with the Securities and Exchange Commission. A full Safe Harbor statement is available in the SPSS 2007 third quarter press release posted at www.spss.com.

At this time, I would like to introduce Mr. Jack Noonan, President and Chief Executive Officer; Mr. Raymond Panza, Executive Vice President and Chief Financial Officer; and Mr. Douglas Dow, Senior Vice President of Corporate Development.

Jack Noonan

Good evening and thank you for joining us to discuss our 2007 third quarter operating performance. I'll give some opening remarks and then Ray Panza, our CFO, will comment on our financial results and provide guidance for the fourth quarter of 2007. We will end with a Q&A session.

As announced earlier today in our press release, we again met our revenue goals and exceeded our earnings expectations. New license revenue for the quarter was up 15% from the 2006 third quarter and up 14% for the nine-month period compared to last year.

We have strong sales of our statistics and data mining product line, as well as success in closing several predictive analytic solutions transactions, including predictive claims to Infinity, Property, and Casualty Corporation and Royal and Sun Alliance.

As many of you know, we are talking to you today from our Annual Users’ Conference in Orlando, Florida, where one of our guest speakers is Tom Davenport, author of Competing on Analytics. He is also a founding partner of Waterstone Analytics, an executive level consulting firm with which we just announced a key strategic partnership.

Waterstone joins the growing number of management consultants, business leaders, and industry experts recognizing that decisions are now being made based on analytics over intuition and guesswork. In fact, Ian Ayres, author of the new book Super Crunchers writes, "We are in a historic moment of horse versus locomotive competition where intuition and experiential expertise is losing out time and time again to number crunching. Business and government professionals are relying more and more on databases to guide their decisions."

We know that SPSS is helping drive that train with a widespread adoption of predictive analytics as a core competitive advantage. With that, I'll now turn the call over to Ray Panza for his comments on our third quarter financial results, as well as our outlook for the fourth quarter of 2007.

Raymond Panza

Earlier today, we issued the 2007 third quarter earnings press release, including un-audited financial statements for the quarter and nine month period ended September 30, 2007. It is to those financial statements that I'll direct my comments.

As Jack stated, SPSS has again delivered a quarter of record earnings, exceeding expectations and realized record revenue within our previously stated expectations. Diluted earnings per share for the quarter was $0.41. These earnings include a charge of $1.2 million, or the equivalent of $0.03 per share, related to the previously announced planned closing and consolidation of certain R&D facilities.

This earnings growth was driven by a 29% increase in operating income, primarily resulting from revenue growth, wherefore the 2007 third quarter, SPSS reported record total revenue of $72.3 million, for a 12% increase over the same prior year quarter revenue of $64.7 million.

Furthermore, the 2007 third quarter revenue represents the 16th consecutive quarter-over-quarter prior year quarter comparison increase. This revenue improvement includes higher total revenue in all major geographies: the Americas, Europe, and the Pacific Rim, and is driven by new license revenue of $34.5 million, representing a 15% increase over new license revenue of $30 million in the 2006 third quarter.

In line with expectations, third quarter total revenues benefited from currency exchange rates by approximately $2.4 million, an impact less than the FX impact in the strong first quarter of this year.

For the quarter, total revenues, excluding the effects of currency exchange, were up 8% for the nine-month period, while total revenues, excluding currency exchange, were up 7% during that nine month period, thereby showing the decrease in the impact of currency. Excluding the effects of currency exchange, new license revenue would have increased 12% versus the 15% mentioned earlier.

For the 2007 quarter, new license revenue per staff tools and data mining tools were up over the same prior year period by 22% and 43% respectively. Maintenance revenue for the quarter was up 2%. While this increase was minimized due to asset mix, timing, and contractual changes, as will be discussed in more detail later, maintenance revenue for the nine months continues to be up strongly year-over-year at 8%.

Service revenue, which includes higher royalties from channel partners, was up $2.6 million or 39%. Total operating expenses for the 2007 third quarter were $59.8 million, up $4.8 million or 9% compared to the third quarter in 2006. As discussed earlier, the 2007 third quarter expenses include a charge of $1.2 million related to the previously announced planned closures and consolidation of certain R&D facilities. Also compared to the prior year, the third quarter 2007 charge for share-based compensation was approximately $900 thousand lower.

While the higher 2007 expenses are largely driven as a cost associated with the higher revenue, we continue to realize the benefits of past cost management initiatives, resulting in operational efficiencies and improved productivities. It is of note, that total operating expenses as a percent of revenue were 83% or lower than the 85% of revenues for the prior year third quarter period.

For the 2007 third quarter, operating income was $12.5 million, a 29% increase over the 2006 third quarter's $9.6 million. Operating income as a percent of revenue was 17% in the 2007 quarter compared to 15% in the 2006 third quarter. At $12.5 million and 17%, this represents a record quarter for operating income and operating margin.

In the 2007 third quarter, SPSS realized net other income of $2.1 million compared to net other expense of $0.7 million for the 2006 quarter. This turnaround includes $1.4 million of higher interest income reflecting the benefits of a higher cash balance and the ability to leverage the increasing financial strength of the company, and $2.4 million lower unrealized losses from balance sheet currency translation charges as we proactively were able to manage the negative currency translation risks.

Overall, the improvement in the other income expense line is all the more significant considering that 2007 excludes a $1 million gain recognized into 2006 third quarter, associated with the prior year divestiture of the Sigma-series product line.

For the 2007 third quarter, income before income taxes was $14.6 million, or 63% higher than the $8.9 million for the 2006 third quarter. As required by GAAP, the company continuously evaluates expected full-year effective income tax rate. During the 2007 third quarter, the company filed its 2006 U.S. federal income tax return as well as timely completing certain other income tax filings. For the full year and after giving consideration for various non-cash adjustments related to prior year income tax attributes, it is estimated that the 2007 full-year effective income tax rate will be 39%.

As a result of the required year-to-date true-up of the effective income tax rate, the effective income tax rate for the 2007 third quarter was 42.5% compared with 35.7% for the 2006 period. Income tax expense reported for the 2007 third quarter was approximately $1 million. This is equivalent to $0.05 per share higher than the prior year due to the year-over-year increase in the effective tax rate for the quarter.

Diluted earnings per share for the 2007 quarter ended September 30 were $0.41, up 46% or $0.13 from the $0.28 reported in the same 2006 quarter. The number of diluted shares used in the 2007 quarter's EPS calculation was down slightly, less than 2% compared to the prior year. The slightly lower share count had no impact on the diluted EPS calculation.

Turning to the nine months ended September 30, 2007, total revenues were $211.4 million, for an 11% increase over the $190.4 million in the same 2006 period. New license revenue for the nine months was up 14% in 2007 over 2006, led by a 14% increase in the U.S., a 20% increase in Europe, and a 37% increase in Australia. As discussed last quarter, Japan continues to under-perform and management actions have been taken to correct that situation.

For the first nine months of 2007, maintenance revenue was $87.9 million for an 8% increase over the same prior year period. As discussed in recent quarters, we believe that this rate of increase is above the norm and that maintenance revenue growth will continue to decline as it has in the current quarter, resulting in new license revenue growth to grow as a percentage of total revenue, and maintenance revenue decline as a percentage of total revenue.

For the 2007 nine-month period, approximately 57% of the reported total revenue was generated from outside the Americas. This amount is somewhat down from the previously reported six-month period. Total operating expenses for the 2007 nine-month period were up $8.8 million or approximately 5% over the 2006 nine-month period.

These higher expenses include $4.6 million related to the impact of currency exchange rates. 2007 expenses also include $1.9 million related to the previously discussed restructuring charge for R&D facilities consolidation; also include higher royalties and other expenses driven by the higher revenue. These higher expenses are somewhat offset by the benefits of improved productivities and operating efficiencies resulting from previous cost management initiatives.

For the nine months ended September 30, 2007, total operating expenses were 84% of net revenues, a decrease from the 88% of net revenues in the first nine months of 2006, and 87% for the full year 2006.

Operating income for the 2007 nine-month period was $34.8 million, a 54% increase from the $22.6 million in the first nine months of 2006. The reported operating margin defined as operating income as a percent of net revenues was 16% for the 2007 nine months ended September 30, 2007, compared to a reported operating margin of 12% for the same 2006 period.

As set forth in the Reg. G non-GAAP reconciliation schedule, provided with the press release financial statements, as a percentage of revenue operating income excluding the effect of share-based compensation would have been 19% for both the three and nine-month period ended September 30, 2007.

Other income and expense for the 2007 nine-month period was a net other income of $4 million, compared with a net other expense of $1.8 million for the same 2006 period. The 2007 improvement is primarily due to favorable net financing costs; a $3.6 million improvement resulting from higher interest income; and $3.2 million lower currency translation expense. The improvement in other income expense line is somewhat offset by the 2007 absence of a $1 million gain recognized in 2006 third quarter associated with the prior period divestiture.

The effective income tax rate for the first nine months of 2007 is 39%, up from 38% recognized from the first nine months of 2006. Net income for the first nine months of 2007 was $23.7 million, for an 80% increase from the $13.1 million for the same 2006 period.

Reported diluted earnings per share for the nine months ended September 30, 2007, was $1.16 compared to $0.63 for the same period in 2006, slightly more than a 84% increase. The regulatory process for the consolidation of R&D facilities in Europe is proceeding and we remain on schedule for the closure and consolidation of certain facilities prior to year-end.

Moving on to the balance sheet, at September 30, 2007, the cash balance was $297.1 million, representing an increase of $156.9 million from the December 31, 2006 balance of $140.2 million. The increase in cash includes net proceeds of $95.7 million resulting from $150 million convertible debt offering, less both the completed $50 million share repurchase and approximately $4 million of issuance expenses. The convertible debt offering was completed in March of this year.

Net accounts receivable at September 30, 2007, were $47.8 million resulting in days outstanding, or DSO, of just under 61 days. This is down from net receivables of $50 million and 65 days at June 30 and down from the $53.8 million and DSO 70 days at December 31, 2006.

The balance sheet amount of capitalized software at September 30, 2007, was $34.5 million, an increase of $2.9 million from the 2006 year-end balance of $31.6 million. The amount of software capitalized through the first nine months of 2007 is $1.1 million higher than the first nine months of 2006. At the same time, software amortization was up $0.5 million for the nine months, such that the difference between software capitalization net of amortization continues to decline.

Software capitalized during the 2007 third quarter was only $2.7 million down from $5.4 million capitalized during the same 2006 third quarter, and as expected, was the lowest level of software capitalized during any quarter since the second quarter last year. As discussed on previous calls, the decline in software capitalized during the quarter was expected. The increase in software capitalized for the nine months was also expected, and is largely due to higher spending during the first six months of the current year and for a project began during the third quarter of the prior year.

As mentioned earlier, the company did complete $150 million convertible debt offering earlier this year. These funds have a five-year maturity and an annual coupon rate of 2.5%.

Turning to the statement of cash flow, net cash flow from operating activities was $51.5 million for the nine months ended September 30, 2007, for an increase of $25.6 million or nearly double the operating cash flow of $25.9 million for the first nine months of 2006 - and in excess of the 2006 full-year operating cash flow. Net cash flow from operations for the 2007 third quarter was $16.9 million compared with $11.3 million for the 2006 third quarter.

Looking ahead, for the 2007 fourth quarter, we expect revenues to be between $74 million and $76 million, with reported diluted earnings per share of between which $0.34 and $0.40. The 2007 fourth quarter EPS guidance includes an estimated $0.06 charge for share-based compensation and an estimated $0.09 charge related to the previously announced closure and consolidation of selected R&D facilities.

Including the charges for the fourth quarter, the total restructuring charges for the year are estimated to be $5 million or $0.14 per share. As a result of these initiatives, it is expected that the resulting savings to be realized in 2008 will more than exceed the restructuring cost. Earnings guidance assumes an effective income tax rate of 39% for the 2007 fourth quarter and fiscal year.

For the fourth quarter and beyond, our focus remains on building increasing sales momentum, with an efficient cost structure based on improving productivity in every aspect of our business. We are committed toward building a solid foundation for sustainable growth, by delivering superior customer value and long-term shareholder returns on investment through disciplined financial and operational management.

Question-and-Answer Session

Operator

Your first question comes from Nathan Schneiderman - Roth Capital Partners.

Nathan Schneiderman - Roth Capital Partners

I was hoping you could start us off talking about what exactly happened to maintenance revenue in the quarter? I don't recall seeing you take such a sequential decline before. Could you talk through that issue?

Raymond Panza

As you'll recall last quarter, we said that 8-9-10% year-over-year growth on maintenance was not typical, and that there are asset mix issues, currency issues, timing issues, and that we would expect that to get back more to normal, which would be in the mid-single-digits and that that would regress. All that happened was, we regressed back down to more of a normal change on a year-over-year basis. Wasn't unexpected; a tad lower than maybe we overall expected, but a decline was absolutely expected for the reasons I mentioned.

Nathan Schneiderman - Roth Capital Partners

To what extent did you have catch-up maintenance payments last quarter that did not recur this quarter?

Jack Noonan

There were not material catch-up payments in this period, and again I'd just point out, we looked at revenue in total, license, maintenance and services; at the end of the day, we're a software company serving the customers with selling software, focusing on new license revenue, and what we focus on is the fact that we produced record revenue for the quarter. The maintenance is one aspect of that and it continues to represent 42% of the overall revenue of the company.

Nathan Schneiderman - Roth Capital Partners

Last quarter you gave 2007 guidance of $285 to $295 million. If I've done the math right, you're now at $285 to $287, so you've taken it to the very low-end. Can you talk through the dynamics that have led to the change in guidance to help us understand that?

Jack Noonan

Sure I can. As you know, the economy itself has a number of uncertainties built into the fourth quarter just given what's been happening in the financial markets and elsewhere. The fact of the matter also is in the second quarter and third quarter we did come in slightly below the mid-point on our guidance but clearly within guidance, within what we expected, and so our current guidance is the visibility that we have at this stage.

Nathan Schneiderman - Roth Capital Partners

And then final question for you, you had a surprising sequential growth in professional services. Can you talk to that change? What drove that and, as I recall, you had intentionally tried to shift business towards partners going back a little more than a year ago. Are you changing your stance in that or is this a one-quarter anomaly?

Jack Noonan

Actually this is good news. We are focusing more on our channel partners and other sales channels/means of distribution and the fact of the matter is we had some successes during the period; now royalties from those sales go into the line called “services.” In the past this has been relatively small and “services,” to be correct about this, is really “services and others.” It includes publications, royalties; it includes a lot of miscellaneous stuff as well as the services which dominate it.

This past quarter we did, in fact, have some successes in some of the channel partners, as I mentioned in my comments, and that generated royalties that got included in that line item. So while services itself were up slightly and the additional royalties were about $800 thousand overall of the increase in the quarter, yes, we did have a good quarter in the services line.

Operator

Your next question comes from the line of Steve Ashley - Robert W. Baird.

Steve Ashley - Robert W. Baird

I'd actually just like to follow-up on Nathan's question regarding the guidance. If you look at just the fourth quarter, kind of the mid-point of where revenue suggests 6% year-over-year growth, that's a little bit below where the trend line is. You talked about being a little more cautious on the economy. Have you seen anything tangible, with respect to behavior change in the market, with respect to either products or specific geographic markets?

Jack Noonan

Well we had a slowdown in Japan, which we've made some changes there already. There's a couple things going on though in the market: we have a calendar that we knew from the beginning of the year is very unique, with the New Year’s falling on a Tuesday and Christmas before that, so when we look at it we've got an exposure of selling days in our transaction or a short-cycle channel which is our telesales.

Additionally, as I look at the pipeline, the pipeline is the same kind of numbers that we have seen in prior quarters for our long-cycle selling, so we're sitting with the same kind of overage we would expect, but we've got a big swing in the forecasts. When you look at ‘this is my low end, this is my target, and this is my high end,’ we've got a larger swing this quarter than we saw in prior quarters, and it's the uncertainty in the marketplace. So our pipeline is as large as any other one as compared to our revenue but we've got a larger swing bottom to top.

Raymond Panza

And, Steve, at the end of the day we're still putting up record numbers, good growth rates, good product mix, so it's within what we expected.

Steve Ashley - Robert W. Baird

Am I hearing that the short-cycle sales performance during the third quarter was pretty much as you had expected?

Jack Noonan

It was as we had expected. In fact, if we look at the distribution over the year between field sales and inside sales, there's about a 1% swing from the beginning of the year, first quarter to this quarter, so they're in line with our expectations.

Steve Ashley - Robert W. Baird

Terrific. In terms of the prospects for additional restructuring charges in 2008, Ray, can you talk about that, please?

Raymond Panza

I won't talk specifically about that, but as I've consistently said, what we're constantly focused on is improving productivity and efficiencies. At the end of the day this is all a revenue story, driving the growth of revenue but doing it efficiently, cost effectively, and we will continue to look at each of our business processes. We will look at ways to improve services to our customers, improve our margins.

We're not looking to do anything draconian. We're not looking for anything as a short-term hit, but we will continue to identify opportunities to operate more efficiently and I would hope that we would continue to find opportunities into 2008 and forever - this is a never-ending process.

Steve Ashley - Robert W. Baird

And just lastly, in terms of a revenue breakdown, can you give us the percentage total of tools versus deployment solutions and how that growth might have been in those businesses year-over-year?

Douglas Dow

The tools business for the third quarter year-on-year comparison was up 23%, and the solutions business for the third quarter again year-on-year comparison was down about 26%, and then if we look at how that splits out, 90% of the new license revenue was generated out of the tools business in the third quarter, whereas 10% came out of the solutions business. I think that the one comment we should add is what we saw are strong solution sales around our predictive price services and predictive claims offerings and they were offset by a decline in the dimensions revenue for the quarter year-on-year.

Operator

Your next question comes from the line of Daniel Cummins - Banc of America.

Daniel Cummins - Banc of America Securities

If your partner channel continues to perform well, or along the trend line, would you expect to see more royalty revenue along the lines of what you saw this quarter in the fourth quarter, and then I just had a quick follow-up.

Raymond Panza

The answer is yes. I don't know that it will be at the magnitude we saw in the third quarter. We're expecting it though for the year to be up year-over-year and also the partner-assisted revenue is at 13% this quarter, which is a record for us.

Daniel Cummins - Banc of America Securities

Terrific, and with respect to the uncertainties that you saw or the unexpected results you saw on maintenance, could you just scope that a little bit for us in terms of vertical? Was there anything perhaps either in government, financial, or hospitality?

Raymond Panza

Again, it's not any one particular vertical. It really had to do with what we said last quarter. The prior numbers were high. The current numbers aren't necessarily low, and so it was going to regress more to the mid-single-digits and if you go back the last couple years what we've consistently said is that's more the norm for us. It's difficult to move that number.

Jack Noonan

As Doug has stated on prior calls, that we have a number of transactions now. We're tracking transactions over a period of time with individual customers, as they do additional transactions, we align maintenance months when we do these types of transactions and this moves the booking of the maintenance from various quarters and you've got to look at the maintenance on an annual basis not on just a given quarter because it does move around.

Raymond Panza

Which is year-to-date; we're still at 8%.

Daniel Cummins - Banc of America Securities

Would you characterize the delta between the results and let's say towards the high end of the guidance more on the license line or on the services line this quarter?

Raymond Panza

On the license line.

Jack Noonan

For the fourth quarter?

Daniel Cummins - Banc of America Securities

For the third quarter.

Raymond Panza

Oh. Okay, I'm not sure I understand. Ask again, please, Dan?

Daniel Cummins - Banc of America Securities

Well, we could ask it for the entire second-half. We seem to be coming in a little bit below expectations for the second-half here, with respect to the third quarter below mid-point, and taking down the fourth quarter guidance, so I guess I'm just asking, is this more a depiction of what's happening on your services line or on your license line?

Raymond Panza

It is a little bit on the maintenance. I would not have expected 2%. I absolutely expected it to be lower. It came in a tad lower from where we were projecting. The other issue, though, is we did expect a little more from the license side of the business and there were certain deals that you expect to come in that sometimes don't close for various reasons, so it's a little bit of both. I would have expected both license and maintenance to be up a little more than what they are.

Jack Noonan

We were also within the range and you put the range together and you say that this is going to be your swing and optimum as you come in at the mid-point and we were just a little bit off.

Raymond Panza

And that's the point: it's a little bit; there’s nothing dramatic.

Operator

Your next question comes from Robert Schwartz - Jefferies.

Robert Schwartz - Jefferies

I'm going to go back to maintenance like a junkyard dog on a pork chop. A swing from 11% to 2% is probably more than I would have taken from your language last quarter. Is there any other explanation for the decline other than the fact that some people just didn't renew their maintenance contracts, or is there something else flowing in there that I need to understand?

Jack Noonan

This is literally mix. You've got to look at it annualized and we'll walk it the end of the year somewhere in the 4% to 5% for the year and that's what our expectation was and it's moved around. We were exceedingly high early and we're going to come in a little bit lower the second-half but you'll see our maintenance exactly what you saw it in the prior year, somewhere around 4% or 5%.

Robert Schwartz - Jefferies

But for it to decline sequentially, wouldn't that mean that some people came off contract?

Raymond Panza

No, not necessarily. Again, it gets back to mix; it gets back to currency. Mix both in product, mix in geography, mix in types of contracts and, remember, every time I saw a license I take a certain portion of it, 17% to 20%, it's amortized over the subsequent 12 months and over time, just how that overlaps has an impact on when that revenue gets recognized, and so we predicted it was coming down. We knew, and we said so.

Robert Schwartz - Jefferies

You're taking some pretty strong steps to control your R&D expenses. How should we think about run rate R&D expense going forward after you're done with all of this?

Raymond Panza

Let me push back just a little bit, Rob. Now, we're not taking steps to push down R&D. What we're trying to do though is get certainly more efficient in R&D.

Robert Schwartz - Jefferies

Fair enough.

Raymond Panza

Yes there is a rationalization of resources. But what has been happening here is capitalization was up previously because, and some spending was up previously because of the new front-end on the flagship product and some other special projects we were spending on. We said a year ago that those projects will be done at the end of June. Those projects were done on time and so now the spending has dropped off, and the capitalization dropped dramatically, so that shouldn't be read as pulling back on R&D spending.

Robert Schwartz - Jefferies

What I meant to say was that you're taking steps to consolidate, I understand that but my question really is, how should we think about run rate R&D going forward once the consolidation is done? As a percent of revenue or some other way to think about it?

Jack Noonan

We're all going through the budgeting thing for next year. You should look at our percentage of expense and we'll talk in the first quarter about what's going to happen next year, but we're aligning in a similar kind of percentage as we were this year. The capitalized software walks into the R&D side, but it's the amortization of that over time, so you're going to look at next year in a similar kind of percentage that you see this year. It won't move up as a percentage; if it moves down, it will move a point. You should expect next year to look like this year.

Raymond Panza

It's still in the mid-teens, maybe on a little more on the high side of the mid-teens.

Robert Schwartz - Jefferies

One last question if I may. Last quarter you talked about increasing median deal value by about 22% and you had real strength in the 25K to 100K segment. Any color trends there in how it's continued?

Douglas Dow

What we saw was again an increase in median deal value in the quarter. It was 7% overall, year-to-date, we're running about 13%, so we're continuing to increase the median transaction values, and then we also saw a growth of about 21% in terms of the number of deals we did in the 25 to 100K range, and we increased the total value of deals we did in that range about 14% on the quarter, so the middle action and the large deal size were about flat in terms of the number, but we increased total revenue coming through by about 10%. So, again, we're increasing the average transaction value.

Operator

Your next question comes from the line of Sean Jackson - Avondale Partners.

Sean Jackson - Avondale Partners

I wanted to hone again in on the R&D expense side. Now, the charges that you took in the third quarter and fourth quarter, are those recorded in that R&D line?

Raymond Panza

I'm not sure I understand your question. Is it the savings that we're getting from last year's closure or the charges this year?

Sean Jackson - Avondale Partners

Charges this year.

Raymond Panza

They're in the R&D line.

Sean Jackson - Avondale Partners

Okay. So if the charges are in the R&D line this year, and then you said in the press release you expect cost savings of at least $5 million going forward, and those cost savings are going to be in the R&D line?

Raymond Panza

Well, for example, last year in December we closed our Amsterdam facility and we've been recognizing those savings through this year so you're already seeing those savings come in. Next year, we will continue to spend, in terms of product development, but you'll see the spendings offset by the savings that we're realizing from this year.

Sean Jackson - Avondale Partners

So I'm just trying to get at if the savings are in excess of $5 million then you'd have to really offset that by a bunch to not have an absolute decline in R&D in '08. Is that fair to say?

Raymond Panza

That could happen. The idea is we will continue to invest in products, and remember we're launching a facility in China that continues to expand. This year alone we've added close to 100 people, so there is some spending going on, but at the end of the day, we're a technology company and we will continue to invest in R&D.

Sean Jackson - Avondale Partners

Real quick, on the stock compensation expense, why was it so low in the third quarter and it looks like it's going to go back to normal in the fourth?

Raymond Panza

It's going to go back to normal in the fourth. We did, through a calculation of some changes organizationally, had a true-up in the quarter for about $0.5 million. It's favorable.

Sean Jackson - Avondale Partners

Lastly, just the tax rate expectations into '08, I think you said in the past you attempted to utilize some tax attributes that you had. Are you going to see a measurable change in the tax rate in '08?

Raymond Panza

We're still looking at that. To be real blunt with you, I've been disappointed with our effective target. It's non-cash, non-operating, largely related to prior year, prior attributes. When we filed the return this year, we reevaluated some of the attributes, particularly in the EMP, and it's caused our rate to have to go up for this year and for the quarter. We are taking some steps to try to bring that back down into next year and that's still part of the planning process.

Sean Jackson - Avondale Partners

Okay, and lastly, you had the metric of number of application deals in the past. I know it's not quite as meaningful anymore, but do you have that metric on you?

Douglas Dow

We did 14 of those deals in the quarter, and the amount of revenue we produced out of those deals was up about 25% as compared to what we did in Q2.

Operator

Your next question comes from Peter Goldmacher - Cowen & Co.

Peter Goldmacher - Cowen & Co.

Doug, just following up on that last question, 14 deals in the queue, up 25% from Q2. Do you know what it was year-over-year?

Douglas Dow

I do not have year-over-year with me, Peter. The sequence looks like I've got numbers as far back as Q4, so we had nine deals in Q4, 11 in Q1, 17 in Q2, so as we said we're off a little bit in terms of number, but we generated more revenue from them, including some significant deals. I mean, Royal and SunAlliance, it was a significant deal. It approached just a little over $1 million in software. We had a couple other deals, one with the government that was in the mid–six-digit range and then the Infinity Property and Casualty that Jack mentioned was also in the upper six-digit-range.

Peter Goldmacher - Cowen & Co.

Ray, you addressed the services business in your earlier comments. What are the other things that are going into that revenue line now?

Raymond Panza

The principal items, Peter, are the training, the consulting, publications, royalties. It is everything that's not directly license-related and, in the past, most of those items were fairly small; now that we're seeing some successes of notable size and the channels, there are some additional numbers. To be real blunt about it, if that continues and the good news continues we'll probably have to break that out as a separate line. What we saw in the period is total services for the quarter we were up about $2.6; about $800 of it was in the royalties increase, and about another $700 of it, which is the most significant other number in there, was in the consulting, the true services.

Peter Goldmacher - Cowen & Co.

I'm sorry, Ray, I don't understand. You're generating a revenue from your partners and it's going in the services line?

Raymond Panza

There's a royalty that is paid when they sell our products and we get that money, but that's not really a license so it needs to be booked somewhere and it goes into the services line, and in the past it's not been material.

Douglas Dow

Peter, it's a very technical point on the accounting side. If the contract reads that it is a royalty agreement, that we are paid a royalty percentage as a part of someone else's product that's OEMing it; the software is technically licensed in either way, but when it's written up as a royalty agreement that's when it goes into the services bucket.

Peter Goldmacher - Cowen & Co.

I see, so that's why there was no commensurate increase in cost, because the services delivery is relatively consistent?

Douglas Dow

Yes. I would say so.

Peter Goldmacher - Cowen & Co.

Can you give us a breakout on what the actual implementation services were? In the quarter?

Raymond Panza

Excuse me, Peter, are you asking for the OEM stuff?

Peter Goldmacher - Cowen & Co.

What I'm asking about is all the stuff that's normally in the services line. It's 1.5 million, right?

Raymond Panza

Right.

Operator

Your next question comes from John Maietta - Needham & Co.

John Maietta - Needham & Co.

Jack, as you look at the pipeline going forward here, could you comment on the level of activity by industry vertical and maybe how the level of activity that you're seeing for Q4's pipeline compares to last quarter versus the year ago period?

Jack Noonan

When I look across the verticals, there's literally no change. Again, we cross all of them, so I would say I don't see anything exceptional as I look at the pipeline.

A couple things though that I'm seeing in the pipeline is one, when Doug shared with you the dimensions, which is the data collection technology focused on enterprise feedback management, we are seeing transaction level, so the ASP is dropping but the number of transactions is up the last quarter and so we're looking at the same thing going forward.

That's about the only change if I look across the pipeline is the ASP of the dimensions; the number of transactions is going up but the ASP is going down.

John Maietta - Needham

Doug, do you happen to have the total headcount for the quarter?

Douglas Dow

Headcount was 1238 total.

Operator

Your next question comes from Frank Sparacino - First Analysis.

Frank Sparacino - First Analysis

Two questions: one is, how did the public sector perform this quarter relative to expectations given it's been somewhat mixed to cost various vendors?

Jack Noonan

They struggled this quarter. This was a tough quarter for them, and we pushed out a deal that looks like it's pushed out for a full year because they run the budgeting cycle, so other than that though, there was a tremendous amount of work and it wasn't that they were off substantially. They were off this quarter.

Frank Sparacino - First Analysis

Okay, and then lastly, just maybe some comments around the new release of the base product this quarter and impact maybe relative to the year ago quarter given the timing being somewhat similar?

Douglas Dow

Well, Frank, it was a strong release. I mean, we're seeing real good growth in that category year-on-year. It did come a little later in the quarter than usual so I think that one would have thought that would have mitigated the growth, but I think we were able to have the sales force working pretty effectively and what we're seeing is the growth in the statistical tools is in line with the category. It's right around 20%, so we're real happy with that one. It's performing well.

Jack Noonan

This is the first time we've ever done a multi-platform release for SPSS and it was because we rewrote the front-end. We were able to release on Windows, Mac and Linux, and we found that we saw some nice growth. Again, on a small number with the Mac platform.

Operator

Your next question comes from Nabil Elsheshai – Pacific Crest Securities.

Nabil Elsheshai - Pacific Crest Securities

A couple things: following up on that royalty deal, is that with one customer and is that a recurring royalty or was that a one-time thing in the services numbers to go back to closer to what we've seen over the last few quarters?

Douglas Dow

Well, a big chunk of that number was part of the ongoing OEM agreement we had with HP, and we think that that's going to continue. What we saw with HP, we talked about HP a little bit in the last quarter when we got into the partner revenues this year. I mean this quarter rather, what we saw is seven of the deals we did were with HP, and we did about 40 odd-deals in total, so that partner influence number includes both just purely influence as well as our OEM when we shared that with you. I think HP's going to continue to build. I think it's going to be slow and steady. I don't think it's going to be rocket fire.

Nabil Elsheshai - Pacific Crest Securities

And then just to follow-up what Jack said about maintenance, if you guys did 5% for the full year, we would see a similar sequential decline in Q4 in the maintenance line?

Raymond Panza

It's going to be flat or slightly down.

Nabil Elsheshai - Pacific Crest Securities

And then lastly on the AP side, you had mentioned one predictive claims deal. Were most of those deals predictive enterprise services or were there other applications deals in there?

Doug Dow

Two predictive claims and the majority of the rest were predictive enterprise services. As long as we're on the topic, the other interesting thing is we continue to see strong drag along, so that seven of the deals brought along data mining tools, two of them brought along statistical tools and another two brought along both statistics and data mining, so what you're seeing is 11 out of the 14 drag along a pretty good size of tools business as well.

Nabil Elsheshai - Pacific Crest Securities

And then lastly, on dimensions, I think you have been expecting a little bit of a rebound for dimensions and it sounds like it didn't this quarter. What is your expectation going forward?

Jack Noonan

I think we had much higher expectations on deal size than the market has actually shown. Gartner has said similar kind of things about the EFM market. If you go back two years ago, they were expecting a substantial number of seven-figure deals in the enterprise feedback management space and I think they've backed off of that and what we've seen is the same thing. Our transactions are up but they're smaller.

Doug Dow

And really just to add to that, Nabil, I think what we're seeing is we're able to use our telesales channel here to effectively seed the market, and that we think we're planting seeds that we should be able to harvest in the future, so I don't think it's all bad news here. We think it's still very much an evolving market especially on the EFM space.

Operator

There are no further questions at this time.

Jack Noonan

Well, thank you all for joining us to hear our third quarter results. Look forward to talking to you after the first of the year.

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Source: SPSS Q3 2007 Earnings Call Transcript
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