The Daily Magic Formula Stock for 03/03/2009 is SPSS Inc. According to the Magic Formula Investing Web Site, the ebit yield is 13% and the EBIT ROIC is >100%.
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SPSS Inc., a Delaware corporation ("SPSS" or the "Company"), was incorporated in Illinois in 1975 under the name "SPSS, Inc." and was reincorporated in Delaware in 1993 under the name "SPSS Inc." SPSS is a global provider of predictive analytics software and solutions.
The Company's offerings connect data to effective action by enabling decision makers to draw reliable conclusions about current conditions and future events. Predictive analytics leverages an organization's business knowledge by applying sophisticated analytic techniques to enterprise data. The insights gained through the use of these techniques are then applied to improve business processes by increasing revenues, reducing costs and preventing fraudulent activities.
Many organizations focus on developing and retaining relationships with people, particularly in their roles as customers, employees, patients, students or citizens. To accomplish these goals, such organizations collect and analyze data related to people's actions, attributes and attitudes. Since its inception, SPSS has specialized in the analysis of such information about people, developing technology and services that incorporate decades of related "best practice" predictive analytic processes and techniques.
SPSS provides two types of software and service offerings to two distinct audiences. For analysts proficient in the use of data analytic methods, the Company offers statistical, data mining and business intelligence software tools to examine and predict from a broad range of enterprise data. For business people acquainted with, but not proficient in, data analysis techniques, SPSS delivers predictive analytic solutions that embed the power of predictive analytics directly into particular business processes, thereby enabling the widespread use of the power of prediction and an increased return on investments in information technology.
Approximately two-thirds of the Company's revenues come from commercial firms, many of which use SPSS technology to improve the profitability and effectiveness of their organizations by attracting new customers more efficiently, increasing the value of existing customers through improved cross- selling and retention, and detecting and preventing fraud. Among its government customers, SPSS offerings are primarily used to improve interactions between public sector agencies and their constituents or detect forms of non-compliance. At colleges and universities, SPSS statistical and data mining tools are often standards for teaching data analysis techniques and academic research.
SPSS has been a publicly traded company since the completion of its August 1993 initial public offering of common stock. SPSS common stock is listed on the NASDAQ Stock Market under the symbol "SPSS." In addition to the information contained in this report, further information regarding SPSS can be found on the Company's website at www.spss.com. The information on the Company's website is not incorporated into this annual report. The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are made available, free of charge, on the Company's website, www.spss.com, as soon as reasonably practical after the reports have been filed with or furnished to the Securities and Exchange Commission.
Predictive analytics is a set of procedures and related technologies that applies sophisticated analytic techniques to enterprise data. When combined with an organization's business knowledge, predictive analytics can lead to actions that demonstrably improve critical business processes, including those that directly affect how people act as customers, employees, patients, students and citizens.
The use of predictive analytics begins by exploring how an organization's business problems can be addressed through an examination of data pertaining to the organization's internal processes and describing characteristics, attitudes, and behavior of the people with whom the organization interacts. These structured and unstructured data sets, are cleaned, transformed, and evaluated using statistical, mathematical, and other algorithmic techniques. These techniques, often in conjunction with advanced visualization capabilities, then generate predictive models for classification, segmentation, forecasting, and propensity scoring, as well as the detection of patterns and anomalies. The resulting models are then used to predict which actions produce optimal outcomes. The predictions can be delivered as recommendations to people and customer-facing systems so that effective action can be taken. Such actions include identifying new revenue opportunities, finding measurable cost savings, identifying repeatable process improvements and detecting fraud.
The predictive analytics market emerged as a growing number of commercial, government and academic organizations discovered and experienced the benefits of using applied advanced analytics. The predictive analytics market initially developed with the convergence of statistical tools and data mining tools which combined to form a market for predictive analytic tools. These predictive analytic tools, in turn, combined with new deployment technologies to create an emerging market for predictive analytic solutions.
Predictive Analytic Tools. The Company has two main product lines that serve the market for predictive analytic tools:
Statistical Tools. SPSS is a leading provider of statistical software tools. Statistical software tools have been and remain an integral part of the Company's overall business.
Data Mining Tools. Data mining tools extend predictive analytics by providing a visual user interface that allows the analyst to build predictive models by drawing a diagram that describes the analytical process through which the data will be put. SPSS is a leading provider of data mining tools.
Predictive Analytic Solutions. Predictive analytic solutions are a synergistic combination of statistical tools, data mining tools, data collection technology, and new technologies (such as scoring engines, rules and optimization techniques) that are harnessed to implement real time decision making. Predictive analytic solutions are an important driver of future growth for the Company. Business process applications such as customer relationship management (CRM) and enterprise resource planning (ERP) create an environment where the predictive analytic applications are able to provide significant return on investment by improving the performance of these underlying systems.
The Company's strategy is to dominate the predictive analytics market by both continuing its focus on data about people and making feedback part of the solutions that the Company delivers. SPSS will seek to achieve this goal by integrating the Company's predictive analytic tools into an inter-operable product suite that builds upon its predictive analytic architecture. The Company will use the resulting software platform to deploy predictive analytic solutions for business process application in particular markets.
SPSS targets the following markets defined by International Data Corporation (IDC) in its research reports entitled Worldwide Business Intelligence Tools 2006 Vendor Shares, Worldwide Business Analytics Software 2007-2011 Forecast Update and 2006 Vendor Shares, Worldwide CRM Analytic Software Applications 2007-2011 Forecast and 2006 Vendor Shares:
- The global market for "Advanced Analytics" tools, an IDC sector that consolidates the former sectors of statistical software and data mining software. In 2006, this market was approximately $1.25 billion in size with SPSS holding approximately 14% of its market share. IDC estimates that this market will increase by approximately 10% per year and reach approximately $2.0 billion in size by 2011.
- The global market for analytical customer relationship management (CRM) applications. In 2006, this market was approximately $1.31 billion in size with SPSS holding approximately 3% of its market share. IDC estimates that this market will increase by approximately 13% per year and reach approximately $2.4 billion in size by 2011.
In 2006, these target markets, combined, represented approximately $2.6 billion in revenue with SPSS holding approximately 10% of the total market share. IDC estimates that these two target markets, together, will represent a total of approximately $4.4 billion in revenues by 2011.
SPSS provides its predictive analytic tools for research analysts and its predictive analytic solutions for business people. SPSS has historically operated with very little backlog because its tools and solutions are generally shipped as orders are received.
PREDICTIVE ANALYTIC TOOLS
SPSS software tools enable customers to access and prepare data for analysis, develop and deploy predictive models and generate reports and graphs to present the results. In 2007, the Company continued the process of streamlining the tools offerings into an integrated suite of products. Today there are three families of products that fit under the predictive analytic tools umbrella. These three product families are described below. Together, the predictive analytic tools represented 75%, 76% and 78% of total revenue in 2005, 2006 and 2007, respectively.
In general, the Company's predictive analytic tools are:
- Comprehensive in function, spanning the entire process of data analysis;
- Modular, allowing customers to purchase only the functionality they need;
- Integrated, enabling the use of various parts of the SPSS technology in combination to tackle particularly complex problems;
- Tailored to desktop operating environments for greater ease-of-use, including browser-based environments for the delivery of results;
- Available on most popular computing platforms; and
- For some products, translated and localized for use in France, Germany, Italy, Poland, Japan, Taiwan, Korea, China and Spanish-speaking countries.
Statistics Family. The Company's primary statistical tools are part of its SPSS product line. These tools are modular in nature and designed for use by research analysts working in a wide variety of commercial, governmental, and academic organizations. A typical purchase from the SPSS product line includes an SPSS Base product and related optional add-on modules. These optional offerings usually provide additional statistical functionality specific to particular types of analysis.
Data Mining Family. The Data Mining Family primarily consists of the Clementine data mining workbench with optional add-on modules for text mining and predictive web analytics. These products feature process-oriented visual user interfaces.
Business Intelligence Family. The Business Intelligence Family consists of the ShowCase product line. ShowCase products support query, reporting, and on- line analytical processing (OLAP) functions for the IBM eServer iSeries (AS/400) computer market.
PREDICTIVE ANALYTIC SOLUTIONS
Predictive analytic solutions combine SPSS tools with people-data collection technology and deployment technologies (Predictive Enterprise Services) along with a defined business discovery and implementation methodology to apply predictive analytics in business operational systems. The Company's solutions offerings represented 14%, 14% and 12% of total revenue in 2005, 2006 and 2007, respectively. In general, these predictive analytic solutions seamlessly integrate with operational software from other vendors to provide predictive capability to business users in their management of that operational system. Examples of business areas in which these applications are used include, but are not limited to, marketing campaigns, programs to improve call center effectiveness or efforts to identify fraudulent activity in the insurance claims processes.
People-data collection technology, represented by the Dimensions product family for surveys, is at the core of many of the solutions the Company delivers. Dimensions provides companies with a direct link to their customers allowing companies to capture feedback from their customers. The ability to capture customer feedback has become a fundamental differentiating point for the Company's solutions. The capture of customer feedback is becoming known as the enterprise feedback management market. The Dimensions product family also serves the market research industry for survey software where this product set remains the industry standard.
To support the implementation of its predictive analytic tools, SPSS offers a comprehensive training program with courses covering product operations, general data analytical concepts and processes, as well as the manner in which statistical and data mining techniques can be applied to address particular business problems. These courses are regularly scheduled in cities around the world or organizations can contract with the Company for on-site training tailored to their specific requirements. Many courses are now offered in an "on- demand" format over the Internet. Courseware is also made available to SPSS partners and integrators, which increases potential capacity for delivering customer solutions.
To support its predictive analytic solutions, SPSS offers consulting and customization services to assist in new implementations or configure existing applications to customer requirements. SPSS consultants also help organizations develop plans that align analytical efforts with organizational goals doing business discovery, assist with the collection and structuring of data, and facilitate the building of predictive analytic models. Services represented approximately 11%, 10% and 10% of total revenue in 2005, 2006 and 2007, respectively.
SPSS has a worldwide customer service and technical support infrastructure that engages with customers on-site or by telephone, fax, mail, e-mail and the Web. Technical support is provided to all licensees and includes assistance in software installation and operations as well as limited guidance in the selection of analytical methods and the interpretation of results. Additional technical support services are available on a time-and-materials basis.
SALES AND MARKETING
SPSS has an inside sales force that focuses on product-based transactions to sell the predictive analytic tools to research analysts. Sales made by the inside sales organization are typically driven by direct mail campaigns and customer references, are typically completed within thirty days and average about $2,800 per transaction. The database of existing SPSS customers provides an efficient source for selling add-on products, upgrades and training. SPSS continues to expand the scope of offerings sold through its inside sales organization to encompass most short sales cycle transactions. The Company maintains a network of over forty distributors around the world to increase its penetration into smaller international markets.
The SPSS field sales force is focused on enterprise customers and predictive analytic solutions. This field sales force is organized by the Company's primary targeted industries, including the financial services industry, the market research industry and the public sector. SPSS field sales personnel engage with line-of-business executives and information technology professionals to identify organizational problems that SPSS offerings can address. In many situations, SPSS professional services personnel are also involved to perform business discovery and plan implementations. The field sales force has partner relationships with other leading companies to participate in mutually beneficial joint sales opportunities or provide additional application implementation capabilities. Transactions completed by SPSS field sales personnel typically take from three to twelve months and range in value from $50,000 to $500,000 per transaction.
SPSS maintains a worldwide infrastructure to support these sales organizations. In addition to its headquarters in Chicago, the Company has offices in the United States in the following metropolitan areas: New York City, Washington D.C., and Cincinnati. SPSS international operations consist of 13 offices in Europe and the Pacific Rim. Transactions are customarily made in local currencies.
The SPSS field marketing organization is charged with generating qualified leads for the Company's tools and applications through direct mail, e-mail, prospect seminars, advertising in trade and market-specific publications, exhibiting at trade shows, and conducting user group meetings. This organization also continually analyzes the SPSS customer database to identify likely prospects for the Company's new offerings.
SPSS has two marketing groups focused on products, one of which is devoted to product management and the other of which is to product marketing. The product management group is charged with building the products. Their tasks include translating customer needs into clear directives for specific product development projects, and working with the software engineering organization to develop "roadmaps" that chart the future direction of each product family. The product marketing group is responsible for delivering the products to the customers. The product marketing group focuses on actively engaging with the sales force in customer situations, understanding the current and future needs of customers, and understanding the markets and competitors for each product family.
SPSS also has a corporate communications group responsible for the broad visibility of the Company. This group works with the trade and financial press, industry analysts and financial analysts to establish the identity and presence of the Company as an industry leader. The SPSS corporate communications group also supports other important areas of Company visibility, including the development of expert reviews of SPSS tools and applications which appear in trade and market-specific publications, and participation in professional association meetings.
RESEARCH AND DEVELOPMENT
SPSS plans to develop new software technologies and products, enhance existing software technologies and products, acquire complementary technologies, and form partnerships with third parties providing particular software functionality or with domain expertise essential to serving selected markets. SPSS research and development initiatives are Company sponsored initiatives that will primarily focus on:
- Extending the capabilities of its primary software tools;
- Enhancing existing and developing new elements of the predictive analytic platform;
- Integrating and improving the interoperability of various SPSS tools and technologies;
- Continuing to build reusable components for use in developing new analytical tools;
- Establishing directions concerning future platforms and deployment, including J2EE and .NET, data visualization, in-database modeling and scoring, and the adoption of emergent standards; and
- Demonstrating industry leadership through active participation in standards organizations for predictive analytics, such as PMML and CRISP DM.
The SPSS research and development staff currently includes professionals organized into groups for product management, algorithm development, software engineering, user interface design, documentation, quality assurance and product localization. SPSS also uses independent contractors in its research and development efforts. SPSS has outsourced maintenance, conversion and new programming for some products to enable its internal development staff to focus on products that are of greater strategic significance. Expenditures by SPSS for research and development of new products, services and techniques, including capitalized software, were approximately $54.4 million in 2005, $64.4 million in 2006, and $63.9 million in 2007.
Most of the statistical algorithms used by SPSS in its software are published for the convenience of its customers. SPSS employs full-time statisticians who regularly research and evaluate new algorithms and statistical techniques for inclusion in its software. SPSS also employs professionals trained in the use of predictive analytics in its documentation, quality assurance, software design and software engineering groups.
In selling its predictive analytic tools and predictive analytic solutions, SPSS competes primarily on the basis of the return on investment that the use of its software produces. In addition, the Company competes on the basis of the usability, functionality, performance, reliability and connectivity of its software. The significance of each of these factors varies depending upon the anticipated use of the software and the analytical training and expertise of the customer. To a lesser extent, SPSS competes on the basis of price and thus maintains pricing policies to meet market demand. The Company also offers flexible licensing arrangements to satisfy customer requirements.
Historically, the Company's success has been driven by highly usable interfaces, comprehensive analytical capabilities, efficient performance characteristics, local language versions, consistent quality, connectivity capabilities, worldwide distribution, and widely recognized brand names. SPSS considers its primary worldwide competitor in each of its targeted markets to be the larger SAS Institute, although SPSS believes that the SAS Institute's revenues are derived primarily from offerings in areas other than predictive analytics.
Within the predictive analytic tools market, the Company competes with the SAS Institute, StatSoft, Inc., Minitab, Inc., Insightful Corporation and StataCorp with regard to products in the Company's Statistics Family. With the exception of the SAS Institute, the annual revenues of these companies from statistical products are believed to be considerably less than the revenues of SPSS. Also within the predictive analytic tools market, the Company competes with offerings from the SAS Institute, NCR Corporation, Fair Isaac Corporation, KXEN, Inc. and Angoss Software Corporation with regard to products in the Company's Data Mining Family. With the exception of the SAS Institute, none of the Company's competitors with regard to either statistical tools or data mining products are believed to currently offer the range of predictive analytic capability provided by SPSS.
Within the predictive analytic solutions market, SPSS faces indirect competition from well-financed companies such as Oracle Corporation, Fair Isaac Corporation, Choicepoint Inc., Unica Corporation, NCR Corporation and Infor. Within the enterprise feedback management (EFM) market, SPSS faces competition from companies such as Confirmit ASA, Vovici Corporation, Voxco and Global Market Insite, Inc. SPSS holds a strong position in this market and believes that no competitors in this market are larger and better financed. The annual revenues of competitors in the enterprise feedback management (EFM) market are thought to be less than the Company's revenues in this market.
In the future, SPSS may face competition from other new entrants into its markets. SPSS could also experience competition from companies in the business intelligence software sector, companies in the data provider sector, as well as from companies in other sectors of the broader market for enterprise applications, which could add predictive analytical functionality to their existing products. Some of these potential competitors have significant capital resources, marketing experience and research and development capabilities. New competitive offerings by these companies or other companies could have a material adverse effect on SPSS.
SPSS attempts to protect its proprietary software with trade secret laws and internal nondisclosure safeguards, as well as copyrights, patents and contractual restrictions on copying, disclosure and transferability that are incorporated into its software license agreements. SPSS licenses its software only in the form of executable code, with contractual restrictions on copying, disclosures and transferability. For multi-user licenses of its software, SPSS requires its customers to sign a license agreement. For single-user licenses of its software, SPSS licenses its software via a "shrink-wrap" license, as is customary in the industry. The source code for all SPSS products is protected as a trade secret. In addition, SPSS has common law copyright protection for its source code and has filed for copyright and patent protection under federal law with respect to certain source code. SPSS has also entered into confidentiality and nondisclosure agreements with its key employees. Despite these restrictions, the possibility exists for competitors or users to copy aspects of SPSS products or to obtain information which SPSS regards as a trade secret. Although SPSS holds six patents and has one patent in registration, judicial enforcement of patent laws, copyright laws and trade secrets may be uncertain, particularly outside of the United States. Preventing unauthorized use of computer software is difficult, and software piracy is expected to be a persistent problem for the packaged software industry. These problems may be particularly acute in international markets.
SPSS uses a variety of trademarks with its products. Management believes the following are material to its business:
- SPSS is a registered trademark used in connection with virtually all of the technology, solutions, and products of the Company;
- Clementine is a registered trademark and is used in connection with the product line that SPSS acquired from Integral Solutions Limited;
- Dimensions is an unregistered trademark used in connection with the Company's market research products on all platforms;
- Quantime is an unregistered trademark used in connection with the Company's market research products on all platforms; and
- ShowCase is an unregistered trademark used with products licensed by SPSS in its Business Intelligence family of products.
Some of these trademarks comprise portions of other SPSS trademarks. SPSS has registered some of its trademarks in the United States and some of its trademarks in a number of other countries, including the Netherlands, France, Germany, the United Kingdom, Japan, Singapore and Spain. SPSS is currently party to a lawsuit regarding its right to use the SPSS trademark. See Item 1A, "Risk Factors," and Item 3, "Legal Proceedings."
Due to the rapid pace of technological change in the software industry, SPSS believes that patent, trade secret, and copyright protection are less significant to its competitive position than factors such as the knowledge, ability, and experience of the Company's personnel, new research and development, frequent technology and product enhancements, name recognition and ongoing reliable technology maintenance and support.
SPSS believes that its software tools, predictive analytic solutions, trademarks and other proprietary rights do not infringe the proprietary rights of third parties. There can be no assurance, however, that third parties will not assert infringement claims in the future or that the claim will not have a material adverse affect on SPSS if it is decided adversely to SPSS.
RELIANCE ON THIRD PARTIES
SPSS licenses various software programs from third-party developers and incorporates them into SPSS products. Many of these are exclusive worldwide licenses that terminate on various dates. SPSS believes that it will be able to renew non-perpetual licenses or obtain substitute products if needed.
Data Direct licenses to SPSS software products that enable data to transfer between SPSS products and third party databases. SPSS has an agreement with Data Direct that expires in May 2009. This agreement enables SPSS to embed and distribute, as an integral part of its offerings, an unlimited number of copies of the Data Direct products for a fixed annual license and maintenance fee.
BANTA GLOBAL TURNKEY SOFTWARE DISTRIBUTION AGREEMENT
Banta Global Turnkey manufactures, packages and distributes a majority of the Company's software products in the United States and multiple international locations. Banta has provided these services to SPSS since 1997, and SPSS and Banta amended and renewed their distribution agreement in January 2006. The agreement with Banta has a three-year term and automatically renews thereafter for successive one-year periods. Either party may terminate the agreement for cause if the other party materially breaches its obligations.
In January 2007, SPSS renewed its strategic relationship with Hyperion Solutions. This renewal extended the term of the Company's contract with Hyperion until 2012. Under the revised agreement, SPSS has the non-exclusive right to license, market and distribute earlier releases of Hyperion's Essbase and Analyzer software. Such right will not extend to Release 9 or subsequent releases of Hyperion's software. SPSS will, however, continue to port future releases of the software to the i-Series computer platform and provide customer support for that software in exchange for a portion of the support fees charged to end-users.
Following the acquisition of Hyperion by Oracle Corporation, the Company's contract with Hyperion has been assigned to Oracle USA, Inc.
As of December 31, 2007, SPSS had 1,246 full-time employees, 664 domestically and 582 internationally. Of the 1,246 employees, there were 536 in sales, marketing and professional services, 489 in research and development, and 221 in general and administrative. SPSS believes it has generally good relationships with its employees. None of the Company's employees are members of labor unions. The Company also had 52 part-time employees as of December 31, 2007.
THE BOARD OF DIRECTORS RECOMMENDS THAT THE STOCKHOLDERS VOTE FOR
THE ELECTION OF EACH OF THE DIRECTOR NOMINEES NAMED ABOVE.
INFORMATION CONCERNING EXECUTIVE OFFICERS AND DIRECTORS
The following table shows information as of March 17, 1999 with respect to each person who is an executive officer or director of SPSS.
NAME AGE POSITION
---- --- --------
Norman Nie........................... 55 Chairman of the Board of Directors
Jack Noonan.......................... 51 Director, President and Chief Executive Officer
Edward Hamburg....................... 47 Executive Vice President, Corporate Operations, Chief
Financial Officer and Secretary
Louise Rehling....................... 55 Executive Vice President, Product Development
Mark Battaglia....................... 39 Executive Vice President, Corporate Marketing
Ian Durrell.......................... 56 Executive Vice President, SPSS Market Research
Susan Phelan......................... 42 Executive Vice President, SPSS Products and Services
Bernard Goldstein(1)(2).............. 68 Director
Merritt Lutz(1)...................... 56 Director
Michael Blair(1)(2).................. 54 Director
MANAGEMENT DISCUSSION FROM LATEST 10K
SPSS is a global provider of predictive analytics software and solutions. The Company's offerings connect data to effective action by enabling decision makers to draw reliable conclusions about current conditions and future events. Predictive analytics leverages an organization's business knowledge by applying sophisticated analytic techniques to enterprise data. The insights gained through the use of these techniques are then applied to improved business processes by increasing revenues, reducing costs, and preventing fraudulent activities.
The Company sells its products and services to a broad scope of industries. Approximately 64% of the Company's 2007 revenues came from sales to customers in corporate settings, with another 21% in academic institutions, 12% in government agencies and 3% from nonprofit and healthcare organizations.
Because of the nature of the Company's business, management frequently discusses the timing of deferred revenue and the impact of this timing on the Company's financial results. The Company generates a significant portion of its revenue by selling software licenses. Software licenses may be term licenses or perpetual licenses. If SPSS sells a term license, the revenue associated with this license is recognized over the term of the license. If SPSS sells a perpetual license, the license revenue is generally recognized immediately but the revenue associated with maintenance of this license is deferred over the contracted maintenance period which is typically a 12-month period. Both the mix of licenses (i.e. number of annual licenses and the number of perpetual licenses) and the timing of when such licenses are executed in a given quarter or fiscal year significantly affect the portion of revenue that must be deferred for such period.
REFERENCES TO "NOTES" WITHIN THIS ITEM 7 REFER TO THE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS IN ITEM 8, "FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA." The following discussion should be read in conjunction with the Company's consolidated financial statements and the notes thereto.
2006 Compared with 2007
The increase in license revenues from 2006 to 2007 was primarily driven by higher sales volume of SPSS data mining and desktop statistical analysis tools in all major geographic regions. From 2006 to 2007, license revenues increased by $7.6 million in the United States, $9.9 million in Europe and $1.4 million in the Pacific Rim. The impact of foreign currency exchange rates increased license revenue by $4.5 million in 2007.
The increase in maintenance revenue from 2006 to 2007 occurred in all major geographic regions. The increase was due to foreign currency, higher pricing and increased renewal rates, which increased maintenance revenue by $6.5 million in Europe, $1.5 million in the Pacific Rim and $1.0 million in the United States. Foreign currency increased maintenance revenue by $5.4 million in 2007.
The increase in service revenue from 2006 to 2007 was primarily due to foreign currency and due to an increased number of solution-related projects in Europe and the Pacific Rim as a result of higher license revenue during 2007. During 2007, service revenues increased by $1.3 million in Europe and by $0.4 million in the Pacific Rim offset by a $0.2 million decrease in the United States. The impact of foreign currency exchange rates increased service revenues by $1.1 million in 2007.
2005 Compared with 2006
The increase in license revenues from 2005 to 2006 was primarily driven by higher sales of SPSS desktop statistical analysis tools in all major geographic regions and by higher market research product revenues in the United States. The impact of foreign currency decreased license revenue by $0.3 million in 2006 compared with 2005.
The increase in maintenance revenues from 2005 to 2006 was primarily due to higher and consistent renewal rates for the Company's major offerings, including increases in all geographic regions. The impact of foreign currency increased maintenance revenue by $0.2 million in 2006 compared with 2005.
The increase in services revenues from 2005 to 2006 was primarily due to an increase in consulting projects as a result of higher license revenue during 2006. Currency exchange rates had an immaterial impact on services revenue in 2006.
Net revenue growth in 2006 and 2007 reflected the increased demand for certain data mining and desktop statistical analysis tools, a strong renewal base for the Company's product offerings and the impact of foreign currency exchange rates.
2006 Compared with 2007
Net revenues derived internationally increased 14% from 2006 to 2007. This increase resulted from revenue growth in major international markets including Europe and the Pacific Rim. Net revenues from international regions also increased due to changes in foreign currency exchange rates which resulted in a total increase in international revenues of $11.0 million for 2007. The most significant portions of these 2007 increases were $2.9 million in the United Kingdom, $2.9 million in the Netherlands, $3.4 million in other Euro-denominated countries and $1.0 million in Australia. Net revenues derived from the United States increased by 8% from 2006 to 2007 reflecting increases in the license revenue category.
2005 Compared with 2006
Net revenues derived internationally increased 14% from 2005 to 2006. This increase resulted from expansion in generally all significant international markets including Europe and the Pacific Rim. The increases in international revenues were partially offset by changes in foreign currency exchange rates which resulted in a decrease in international revenues of $0.1 million in 2006 compared with 2005. Significant foreign currency impacts on 2006 net revenues included increases of $0.4 million in the United Kingdom, $0.3 million in the Netherlands and $0.2 million in other European offices offset by decreases of $1.1 million in the Pacific Rim. Net revenues derived from the United States increased by 7% from 2005 to 2006 reflecting increases in license and maintenance revenue.
Cost of license and maintenance revenues consists of costs of goods sold, amortization of capitalized software development costs and royalties incurred related to third parties. These costs increased from 2006 to 2007 primarily due to higher royalty expense associated with higher revenue and higher amortization expense of capitalized software development costs.
The increase in cost of license and maintenance revenues from 2005 to 2006 was primarily due to higher royalty expense associated with higher revenue and higher amortization expense of capitalized software development costs.
COST OF LICENSE AND MAINTENANCE REVENUES -- SOFTWARE WRITE-OFFS
YEAR ENDED DECEMBER
31, AMOUNT CHANGE PERCENTAGE CHANGE
-------------------- ----------------------- -----------------------
2005 2006 2007 '05 VS '06 '06 VS '07 '05 VS '06 '06 VS '07
---- ------ ---- ---------- ---------- ---------- ----------
Cost of License and Maintenance
Revenues-Software Write-offs..... $-- $1,283 $-- $1,283 $(1,283) NM NM
Percent of Total Revenues........ --% --% --%
During 2006, the Company wrote off certain software to a fair value of zero after the Company determined that the future use of this software was no longer likely.
SALES, MARKETING AND SERVICES
YEAR ENDED DECEMBER 31, AMOUNT CHANGE PERCENTAGE CHANGE
------------------------- ----- ----------------------- -----------------------
2005 2006 2007 '05 VS '06 '06 VS '07 '05 VS '06 '06 VS '07
-------- -------- -------- ---------- ---------- ---------- ----------
Sales, Marketing and Services.. $117,872 $124,127 $139,386 $6,255 $15,259 5% 12%
Percent of Total Revenues.... 50% 47% 48%
Sales, marketing and services expenses increased from 2006 to 2007 primarily due to higher travel and organization meeting costs and higher compensation costs associated with higher revenues. These increases were consistent with revenue growth of 11% in 2007. Changes in foreign currency exchange rates contributed $5.1 million to the increase in sales, marketing and services expenses.
The increase in sales, marketing and services expenses from 2005 to 2006 was primarily due to higher travel and organization meeting costs, higher compensation costs associated with higher revenues and increased costs due to share-based expense of $2.0 million arising out of the implementation of SFAS No. 123 (R) in 2006.
- Financing activities provided cash proceeds of $96.0 million primarily from the issuance of long-term debt, which provided $150 million.
- Debt issuance costs related to the issuance of long-term debt were $4.3 million.
- Purchases of outstanding common stock used $71.8 million of the cash generated from financing activities.
- Cash proceeds of $16.7 million were generated from the exercise of stock options.
- Tax benefits recognized from stock option exercises were $5.4 million.
Cash flows from operating activities in 2007 were more than adequate to fund capital expenditures and software development costs of $18.9 million. Management believes that the Company has ample capacity in its property and equipment to meet expected needs for future growth.
On March 19, 2007, the Company issued $150 million aggregate principal amount of 2.50% Convertible Subordinated Notes due 2012 (the "Convertible Notes") in a private placement. The Convertible Notes bear interest at a rate of 2.50% per year payable semiannually in arrears on March 15 and September 15 of each year. The Convertible Notes will mature on March 15, 2012.
The Convertible Notes will be convertible into cash and, if applicable, shares of the Company's common stock based on an initial conversion rate of 21.3105 shares of common stock per $1,000 principal amount of Convertible Notes (which is equal to an initial conversion price of approximately $46.93 per share) only under the following circumstances: (1) during any calendar quarter beginning after June 30, 2007 (and only during such calendar quarter), if the closing sale price of the common stock for at least 20 trading days in the 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is more than 120% of the conversion price per share, which is $1,000 divided by the then applicable conversion rate; (2) during any five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of Convertible Notes for each day of that period was less than 98% of the product of the closing price of the common stock for each day in that period and the conversion rate; (3) if specified distributions to holders of the common stock occur; (4) if a fundamental change occurs; or (5) during the period beginning on February 15, 2012 and ending on the close of business on the business day immediately preceding the maturity date. If the Company makes a physical settlement election as described below, the Convertible Notes will become convertible at the option of the holder at any time after the date of such physical settlement election and prior to the close of business on the business day immediately preceding the maturity date of the Convertible Notes.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
PART II â€” OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
On May 1, 2007, the Company announced that its Board of Directors had authorized the Company to repurchase up to a maximum of 2,000,000 shares of its issued and outstanding common stock. This authorization extends until December 31, 2008. As of March 31, 2008, 539,000 shares remained available for repurchase in connection with this authorization. During the second quarter of 2008, the Company did not repurchase any shares pursuant to this authorization or otherwise.
Item 4. Submission of Matters to a Vote of Security Holders
The Companyâ€™s 2008 Annual Meeting of Stockholders was held on April 24, 2008. The following persons were nominated and elected to serve as directors of the Company for a term of three years or until their successors have been duly elected and qualified.
NOMINEE FOR WITHHELD
Charles R. Whitchurch
In addition, Michael Blair, Michael Lavin, Merritt Lutz, Patricia B. Morrison and Jack Noonan remained as directors of the Company after the meeting.
The Companyâ€™s stockholders also approved the adoption of the SPSS Inc. Long Term Incentive Plan. This proposal received the following votes:
FOR AGAINST ABSTAIN NON-VOTES
1,653,612 336,079 1,643,846
The Companyâ€™s stockholders ratified the appointment of Grant Thornton LLP to serve as the Companyâ€™s independent auditor for fiscal year 2008 by the following votes:
FOR AGAINST ABSTAIN NON-VOTES
3,423 6,593 n/a
Thank you for joining us to discuss our 2008 third quarter performance. Iâ€™ll give some opening remarks and then Ray Panza, our CFO, will comment on our financial results and provide guidance for the fourth quarter. Weâ€™ll end with a Q&A session. Before I comment on the quarter I think itâ€™s important in this very challenging economic environment to review the core strengths of SPSS.
First, we have a large and loyal customer base that has continued to buy our software in previous economic downturns. Second, weâ€™re operationally nimble have moved quickly to implement cost savings initiatives and third, we are financially strong with a very solid balance sheet and strong cash flow. This is why we remain confident in our ability to manage through this global economic downturn.
Turning to our third quarter results as I commented in our press release issued this afternoon in the face of a very challenging economic environment we met our revenue and earnings expectations for the quarter. As larger transactions became more difficult to close we were able to offset this by focusing on smaller ones. In fact we closed 11% more transactions and sales under $25,000 in the quarter. We also saw a good uptick in sales from SPSS Statistics 17.0 which was released midway through the quarter to good customer reception.
With the global economy expected to remain challenging for the foreseeable future we will continue to focus on driving more sales trough our inside channel. Itâ€™s now time to turn the call over to Ray Panza to review our third quarter results and outlook for the remainder of the year.
Raymond H. Panza
Earlier today we issued the 2008 third quarter earnings press release including unaudited financial statements for the quarter and nine-month period ending September 30, 2008. It is those financial statements that Iâ€™ll direct my comments. The current global economic environment including increasingly less favorable foreign exchange currency rates has presented significant challenges.
While we expected much of this we in no way could have anticipated the events that have transpired over the recent months. For that reason alone we are especially satisfied with the results SPSS has reported for the most recent quarter and nine-month period. This is significant given the comparison against a relatively stronger operating environment that existed during the 2007 third quarter.
As a point of reference the largest single transaction in the 2008 third quarter was only slightly more than half the $1.1 million transaction completed in the 2007 quarter. To further illustrate this point in the 2008 third quarter the four largest transactions totaled less than $2 million while in the same 2007 quarter the four largest transactions totaled approximately $3 million. In the current economic environment we are seeing extended sales cycles, budget limitations by customers, delays in purchases and a shift to smaller deal sizes.
The results reported today reflect a strong customer base, a customer base not dependent on any one product family, business segment or geography. It reflects the ability to leverage our lower price point products through our efficient transaction based inside sales organization. The SPSS 2008 financial results reflect focused operational execution and sound financial management. SPSS possesses a strong financial foundation with a net cash balance in excess of $150 million, good cash flow and well-managed working capital.
With technology proven to add measurable value to a broad and loyal customer base and possessing a track record of disciplined operational and financial management SPSS has again delivered a quarter of record earnings per share and while there never can be any guarantee of future performance SPSS has once again proven an ability to consistently delivery revenue and earnings within or above our previously stated expectations.
Diluted earnings per share for the 2008 third quarter was a record $0.55. This represents a 34% increase over the 2007 third quarter despite the fact that the 2008 quarter includes a net $0.01 higher charge for unusual items. Specifically 2008 includes $0.03 higher cost per share-based compensation due to the 2008 absence of a favorable $800,000 adjustment recognized in 2007.
In addition the current 2008 quarter includes approximately $500,000 or a $0.02 earnings per share charge for the launch of cost management initiatives thereby bringing the total 2008 unusual items to $0.05 per share. This compares with a $1.2 million or $0.04 per share charge recognized in the prior year quarter for rationalization of our facility in the UK and closing of an R&D facility.
Also contributing to the 2008 increase in EPS was a lower than expected effective income tax rate compared to an unusually higher effective income tax rate reported for the 2007 third quarter. The 2008 lower effective tax rate was driven by a more favorable geographic income mix, availability of tax planning opportunities and improved utilization of tax attributes such as NOLs and foreign tax credits.
While a 5% lower number of shares used in the EPS calculation added $0.03 to the 2008 reported earnings per share the impact was partially offset by the lower available cash for investments and a lower average interest rate. The lower number of shares largely reflects the share repurchase program conducted during the 2007 fourth quarter and the 2008 first quarter.
Turning to revenue in the quarter SPSS reported total revenue for the 2008 third quarter of $74.9 million for a 4% increase over the 2007 third quarter revenue of $72.3 million representing the 20th consecutive quarter-over-quarter increase in revenue and the fourth highest reported revenue quarter in the history of the company. This revenue improvement includes higher total revenue in all major geographies, the Americas, Europe and the Pac-Rim with approximately 58% of total revenue coming from outside the Americas.
Total 2008 third quarter revenues benefited from currency exchange rates of approximately $2.1 million an amount totaling less than half the except benefit realized in either of the preceding two quarters. For the quarter total revenue excluding the effects of favorable currency exchange was up 1% over the same quarter a year ago. For the 2008 quarter new license revenue was down 2% compared to the same prior year quarter reflecting not only the more challenging economy and longer sales cycles for large transactions and a notable decline in average deal sizes especially in Europe.
Excluding the benefit of currency exchange rates new license revenue was down 5% from the same prior year period. As discussed however last quarter and as expected in the 2008 third quarter Japan new license revenue improved 32% a 24% improvement the benefits of FX over the prior year quarter. Also as expected Northern Europe while completing the ramp up of the relocated sales organization was down 11% with Holland down 23% causing total new license revenue in Europe to be down 14%.
Maintenance revenue for the quarter was up 18% including 3% for favorable currency exchange rates and a 10% improvement in maintenance renewal rates. Service revenues for the 2008 third quarter were $7.6 million an amount consistent with the preceding four quarters. However, at $7.67 million service revenues in the quarter were down $1.7 million or 18% compared to the 2007 third quarter. This decline was not unexpected.
In addition to the prior year third quarter being a difficult comparison due to timing of service projects last year service revenue generally trails license revenue as services are typically sold with larger transactions. As previously discussed those larger size transactions have been on the decline as we see the economy driving to shift from larger deals specifically with those having a value in excess of $250,000 to a greater number of smaller transactions. Those generally sold without a service component.
Total operating expenses for the 2008 third quarter were $62.1 million up $2.2 million or 4% compared to third quarter in 2007. This increase includes the previously discussed $800,000 of higher share-based compensation charges reflecting the absence of favorable adjustment recognized in the 2007 third quarter and a $1.4 million increase in the cost of revenue line largely including $600,000 higher R&D amortization and $600,000 for higher material costs related to [inaudible] hardware sales.
As expected the benefits of prior R&D facility rationalizations and productivity improvements resulted in lower R&D costs while a determined focus on G&A drove that cost lower. These savings were largely offset by higher sales marketing and services expenses related to the higher level of revenue and the previously discussed special $500,000 charge for management cost initiatives.
Overall operating expenses in total represented 83% of revenue an amount equal to the prior year period. As a result we maintained a solid operating margin of 17% equaling the operating margin reported for the 2007 period. For the 2008 third quarter operating income was $12.8 million of a 3.8% increase over the 2007 third quarterâ€™s reported operating income of $12.5 million.
In the 2008 third quarter SPSS realized other net income of $1 million compared to net other income of $2.1 million for the 2007 quarter. This decline is nearly entirely due to lower interest income reflecting a decline in investment rates. As a result of the lower interest income able to be realized income before income taxes for the 2008 third quarter was down 5% to $13.8 million.
As previously discussed however a favorable change in the expected annual effective income tax rate from 36% to 32% drove a true up 24% effective income tax rate in the 2008 third quarter resulting in record reported net income for a 25% increase over the 2007 third quarter. The company continuously evaluates its expected full year effective income tax rates. Turning to the nine months ended September 30, 2008 total revenues were $228.8 million for an 8% over the $211.4 million in the same 2007 period.
For the 2008 nine-month period approximately 60% of the reported total revenue was generated from outside the Americas. For the 2008 nine-month period total revenue excluding the FX of favorable currency exchange rates was up 3% over the same period a year ago. New license revenues for the nine months was $107 million up 5% in 2008 over 2007. The reported increase in license for the nine-month period was led by an 8% increase in the US and a 12% increase in the Pac-Rim primarily Japan partially offset by a 1.5% decline in Europe.
Overall excluding FX impact new license revenue was down 1% for the nine month year-on-year period. For the nine months of 2008 maintenance revenue was $98.9 million for a 13% increase over the same prior year period. Excluding currency maintenance revenue for the nine-month period was up 7%. Total operating expenses for the 2008 nine-month period were up $14.6 million or 8% over the 2007 nine-month period.
These higher expenses include $4.8 million related to the impact of currency exchange rates, $3.2 million related to higher cost of revenue, higher R&D amortization and material costs and the previously discussed $1.3 million of unusual third quarter charges. The net balance of the year-over-year increase is primarily driven by higher level of sales.
For the nine months ended September 30, 2008 total operating expenses were 84% of net revenues equal to the same prior year period. Operating income for the 2008 nine-month period was $37.6 million or 8% higher than the $34.8 million for the first nine months of 2007. The reported operating margin defined as operating income as a percent of net revenues was 16% for the 2008 nine months ended September 30, 2008 equal to the reported operating margin for the same 2007 period.
As set forth in the Reg. G non-GAAP reconciliation schedule provided with the press release financial statements as a percent of revenue operating income excluding the effects of share-based compensation would have been 17% and 20% for the three and nine months ended September 30, 2008 respectively.
Other income and expense for the 2008 nine month period was a net other income of $3.8 million compared with a net other income of $4.0 million for the same 2007 period. The net decline is primarily due to less favorable interest rates largely offset by improvement and lower currency translation expenses. The effective income tax rate for the first nine months of 2008 is 32% compared with 39% for the first nine months of 2007.
As previously discussed the change in the effective income tax rate mainly reflects a more favorable income mix, tax planning opportunities and the ability to utilize certain tax attributes. Net income for the first nine months of 2008 was $28.2 million for a 19% increase from the $23.7 million for the same 2007 period. Reported diluted earnings per share for the nine months ended September 30, 2008 was $1.47 compared to $1.16 for the same period in 2007 for a 27% increase.
Moving on to the balance sheet at September 30, 2008 the cash balance was $307 million an amount equal to the 2007 year end cash balance. While cash flow from operations for the nine-month period totaled $45.5 million approximately $28 million was used for share repurchases and $18 million was reinvested in the business. The currency exchange rate negatively affected the cash balance by $7.2 million.
The only debt is a five-year non-callable $150 million convertible debt-offering due in 2012. Those bonds have a 2.5% annual coupon rate. The liquidity of the company is further supported by a focus on non-cash working capital. At September 30, 2008 non-cash working capital not including deferred revenue and deferred income taxes was 3.2% of trailing 12 months revenue.
Net accounts receivable at September 30, 2008 were $40.4 million resulting in days sales outstanding, DSO, of 50 days. This is down from net receivables of $56.6 million and 65 days at December 31, 2007. The balance sheet amount of capitalized software at September 30, 2008 is $37.1 million an increase of $3 million from the 2007 year end balance of $34.1 million.
The amount of R&D spend capitalized through the first nine months of 2008 is $1.2 million net of amortization specifically $10 million capitalized offset with $9 million of amortization. The balance of the increase in capitalized software on the balance sheet is approximately a $2 million one-time expenditure for purchased software whereby the company embeds third party software in its showcase product.
Turning to the statement of cash flow as previously noted net cash flow provided by operating activities was $45.5 million for the nine months ended September 30, 2008 or $6 million less than the $51.5 million provided during the same nine-month period last year. This decrease includes a $7.4 million payment related to accrued expenses recorded at year-end 2007 and paid in early 2008 relative to the timing of share repurchases under the authorized share repurchase program.
Net cash flow from operations for the 2008 third quarter was $16.7 million representing the highest quarterly operating cash flow for the year. Looking ahead we expect to face a continued slowing global economy including increasingly unfavorable foreign exchange rates. In response we have initiated cost management measures including expected staff reduction of approximately 10% by the end of the fourth quarter so as to better align our expenses with our revenue expectations for the near and longer term and to ensure continued solid operating margins and profitability.
For the 2008 fourth quarter we expect revenues to be between $73 million and $78 million. Before considering charges estimated of between $3.5 million and $4.5 million or $0.12 and $0.16 per share related to the cost management and staff reduction initiatives we expect 2008 fourth quarter diluted earnings per share of between $0.41 and $0.49. The 2008 fourth quarter EPS guidance includes an estimated $0.06 charge for share-based compensation and an estimated effective income tax rate of 32%.
For the 2008 fiscal year we expect revenues of between $302 million and $308 million with EPS in the range of $1.90 to $1.98 again before considering any special charges either already incurred in the third quarter or yet expected to be incurred in the fourth quarter. The 2008 full year EPS guidance includes an estimated $0.26 charge for share-based compensation and an estimated effective income tax rate of 32%.
Annual savings from the cost management initiatives and staff reductions are expected to exceed $10 million. In 2009 we will continue to focus on capital preservation to allow for acquisitions that satisfy our strategic filter and accelerate revenue growth. We will continue to drive productivity improvement efforts to grow operating margins and as we continually adjust to align expenses with our revenue expectations.
Specific guidance for 2009 will be provided with the announcement of our 2008 fiscal year results. Making a profit is core to our company values with a goal to drive revenue growth efficiently and not merely focused on reducing costs. As always we remain committed to delivering superior customer value and long-term shareholder returns through disciplined financial and operational management.
At this time Iâ€™d like to turn the meeting back over to Jack.
In closing Iâ€™d like to add some perspective to our fourth quarter outlook. We view our guidance as an expectation for solid financial performance when measured against a very challenging economic environment and strengthening dollar. The operational actions weâ€™ve taken along with our go-to-market strategy should give us a solid foundation moving forward. We canâ€™t change the current economic slowdown but we can execute effectively through it.
Christa, weâ€™ll now open the call up for questions.