10-Q 1 c09490e10vq.txt QUARTERLY REPORT ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2006 Commission File Number: 000-22194 SPSS Inc. (Exact name of registrant as specified in its charter) Delaware 36-2815480 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.)
233 S. Wacker Drive, Chicago, Illinois 60606 (Address of principal executive offices and zip code) Registrant's telephone number including area code: (312) 651-3000 Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (check one): Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No |X| The number of shares outstanding of the registrant's Common Stock, par value $0.01, as of October 27, 2006, was 19,720,917. ================================================================================ SPSS INC. FORM 10-Q QUARTER ENDED SEPTEMBER 30, 2006 INDEX
PAGE ---- PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS (UNAUDITED) CONSOLIDATED BALANCE SHEETS AS OF DECEMBER 31, 2005 AND SEPTEMBER 30, 2006......................................... 3 CONSOLIDATED STATEMENTS OF INCOME FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2006............ 4 CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME FOR THE THREE AND NINE MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2006... 5 CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE NINE MONTH PERIODS ENDED SEPTEMBER 30, 2005 AND 2006.................. 6 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.................... 7 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.................................. 12 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.... 18 ITEM 4. CONTROLS AND PROCEDURES....................................... 19 PART II - OTHER INFORMATION ITEM 6. EXHIBITS...................................................... 20
2 SPSS INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (In thousands, except share data) (Unaudited)
December 31, September 30, 2005 2006 ------------ ------------- ASSETS Current assets: Cash and cash equivalents.......................... $ 84,408 $119,528 Accounts receivable, net........................... 42,488 47,471 Inventories, net................................... 879 750 Deferred income taxes.............................. 5,624 5,193 Prepaid income taxes............................... 5,067 4,899 Other current assets............................... 5,233 4,827 -------- -------- Total current assets............................. 143,699 182,668 Property, equipment and leasehold improvements, net... 20,441 18,496 Capitalized software development costs, net........... 28,522 30,783 Goodwill.............................................. 41,207 41,655 Intangibles, net...................................... 3,627 3,490 Deferred income taxes................................. 32,938 35,136 Other noncurrent assets............................... 1,463 2,449 -------- -------- Total assets.................................... $271,897 $314,677 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Notes payable...................................... $ 2,500 $ -- Accounts payable................................... 9,678 7,355 Income taxes and value added taxes payable......... 9,024 7,891 Deferred revenues.................................. 63,980 67,697 Other accrued liabilities.......................... 21,102 20,853 -------- -------- Total current liabilities....................... 106,284 103,796 Noncurrent deferred income taxes...................... 449 506 Noncurrent notes payable.............................. 872 -- Other noncurrent liabilities.......................... 546 761 Stockholders' equity: Common Stock, $.01 par value; 50,000,000 shares authorized; 18,724,649 and 19,702,725 shares issued and outstanding in 2005 and 2006, respectively.................................... 187 197 Additional paid-in capital (See Note 2)............ 177,440 210,110 Deferred compensation.............................. (1,069) (6,253) Accumulated other comprehensive loss............... (9,420) (4,190) Retained earnings (accumulated deficit) (See Note 2).................................... (3,392) 9,750 -------- -------- Total stockholders' equity...................... 163,746 209,614 -------- -------- Total liabilities and stockholders' equity... $271,897 $314,677 ======== ========
See accompanying notes to consolidated financial statements. 3 SPSS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands, except per share data) (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, ------------------ ------------------- 2005 2006 2005 2006 ------- ------- -------- -------- Net revenues: License $27,359 $30,013 $ 77,769 $ 89,198 Maintenance 25,028 27,970 76,788 81,461 Services 5,905 6,701 19,272 19,730 ------- ------- -------- -------- Net revenues 58,292 64,684 173,829 190,389 ------- ------- -------- -------- Operating expenses: Cost of license and maintenance revenues 3,984 4,253 11,751 12,449 Cost of license and maintenance revenues--software write-off -- -- -- 1,283 Sales, marketing and services 28,322 31,448 87,847 93,405 Research and development 11,213 11,414 33,611 37,332 General and administrative 6,606 7,935 21,183 23,312 ------- ------- -------- -------- Operating expenses 50,125 55,050 154,392 167,781 ------- ------- -------- -------- Operating income 8,167 9,634 19,437 22,608 ------- ------- -------- -------- Other income (expense): Net interest income 68 929 21 1,934 Gain on divesture of Sigma-series product line -- 1,000 -- 1,000 Other (257) (2,621) (2,167) (4,682) ------- ------- -------- -------- Other income (expense) (189) (692) (2,146) (1,748) ------- ------- -------- -------- Income before income taxes 7,978 8,942 17,291 20,860 Income tax expense 3,926 3,189 7,089 7,718 ------- ------- -------- -------- Net income $ 4,052 $ 5,753 $ 10,202 $ 13,142 ======= ======= ======== ======== Basic net income per share $ 0.23 $ 0.29 $ 0.56 $ 0.67 ======= ======= ======== ======== Diluted net income per share $ 0.22 $ 0.28 $ 0.55 $ 0.63 ======= ======= ======== ======== Share data: Shares used in computing basic net income per share 17,901 19,697 18,111 19,642 ======= ======= ======== ======== Shares used in computing diluted net income per share 18,647 20,649 18,546 20,885 ======= ======= ======== ========
See accompanying notes to consolidated financial statements. 4 SPSS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (In thousands) (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, ----------------- ----------------- 2005 2006 2005 2006 ------ ------ ------- ------- Net income $4,052 $5,753 $10,202 $13,142 Other comprehensive income (loss): Foreign currency translation adjustment (207) 767 (544) 5,230 ------ ------ ------- ------- Comprehensive income $3,845 $6,520 $ 9,658 $18,372 ====== ====== ======= =======
See accompanying notes to consolidated financial statements. 5 SPSS INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
Nine Months Ended September 30, ------------------- 2005 2006 -------- -------- Cash flows from operating activities: Net income .................................... $ 10,202 $ 13,142 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization .............. 10,881 12,747 Deferred income taxes ...................... 3,073 (1,710) Amortization of share-based compensation ... 257 5,028 Write-off of software ...................... -- 1,283 Gain on sale of product line ............... -- (1,000) Changes in assets and liabilities: Accounts receivable ..................... 9,488 (3,468) Inventories ............................. (96) 135 Prepaid and other assets ................ 812 491 Accounts payable ........................ (234) (2,454) Accrued expenses ........................ (952) (681) Income taxes ............................ (1,252) (1,137) Deferred revenue ........................ 529 1,624 Other, net .............................. 1,390 1,952 -------- -------- Net cash provided by operating activities ........ 34,098 25,952 -------- -------- Cash flows from investing activities: Capital expenditures .......................... (4,229) (4,231) Capitalized software development costs ........ (8,092) (9,407) Proceeds from the divesture of Sigma-series product line ............................... -- 1,000 Purchase of business and intangibles .......... (780) -- -------- -------- Net cash used in investing activities ............ (13,101) (12,638) -------- -------- Cash flows from financing activities: Repayments under line-of-credit agreements .... (1,882) (3,372) Proceeds from stock option exercises and employee stock purchase plan ............... 4,876 18,530 Tax benefit from stock option exercises ....... -- 4,340 -------- -------- Net cash provided by financing activities ........ 2,994 19,498 -------- -------- Effect of exchange rates on cash ................. (2,021) 2,308 -------- -------- Net change in cash and cash equivalents .......... 21,970 35,120 Cash and cash equivalents at beginning of period ........................................ 37,107 84,408 -------- -------- Cash and cash equivalents at end of period ....... 59,077 $119,528 ======== ======== Supplemental disclosures of cash flow information: Interest paid ................................. $ 468 $ 88 Income taxes paid ............................. 6,531 6,390 Cash received from income tax refunds ......... (3,481) (1,802)
See accompanying notes to consolidated financial statements. 6 SPSS INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - BASIS OF PRESENTATION The accompanying consolidated financial statements of SPSS Inc. (the "Company") have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information, the instructions to United States Securities and Exchange Commission Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. It is presumed that the reader has already read the Company's Annual Report on Form 10-K for the year ended December 31, 2005. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included in these consolidated financial statements. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the fiscal year. For further information, refer to the consolidated financial statements and accompanying notes included in the Company's Annual Report on Form 10-K for the year ended December 31, 2005. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Where appropriate, some items relating to prior years have been reclassified to conform to the presentation in the current year. NOTE 2 - STOCK OPTION GRANTS In view of the recent media focus on stock option grants at other public companies, SPSS completed a detailed review of its accounting for stock option grants from the date of its initial public offering in 1993 to September 2006. The review indicated in a number of instances that the actual measurement dates for stock option grants differed from the measurement dates originally used for such awards. Based on the use of revised measurement dates, aggregate non-cash compensation expense of $5.3 million ($3.3 million net of tax) should have been recorded for those awards granted during the period under review. As a result of the review, the Company determined that certain stock compensation expense should have been recorded during 1993 through 2006. During the second quarter of 2006, the Company reclassified approximately $3.3 million of retained earnings to additional paid-in capital. This resulted in a reclassification to the December 31, 2005 balances decreasing retained earnings by $3.3 million and increasing additional paid in capital by a corresponding amount resulting in no net effect on total stockholders' equity. The Company has completed its review of stock option grants and has determined that no further accounting adjustments were necessary. The Company considers the impact on its current period quarterly and annual financial statements to be immaterial and does not intend to restate its financial statements for any prior periods. There was no effect on 2005 or 2006 previously reported results from operations. In addition, for the five-year period ended December 31, 2005, the net adjustment to previously reported diluted earnings per share due to additional compensation expense did not exceed $0.01 per diluted share in any individual year and the net cumulative five-year impact on net income was approximately $0.1 million, less than $0.01 per diluted share. NOTE 3 - STOCK BASED COMPENSATION In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment ("SFAS No. 123(R)" or the "Statement"). This Statement is a revision of SFAS No. 123, Accounting for Stock-Based Compensation ("SFAS No. 123"), and supersedes Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25"), and its related implementation guidance. On January 1, 2006, the Company adopted the provisions of SFAS No. 123(R) using the modified prospective method. SFAS No. 123(R) focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. The Statement requires entities to recognize compensation expense for awards of equity instruments to employees based on the grant-date fair value of those awards (with limited exceptions). SFAS No. 123(R) also requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow as prescribed under the prior accounting rules. This requirement reduces net operating cash flows and increases net financing cash flows in periods after adoption. Total cash flow remains unchanged from what would have been reported under prior accounting rules. 7 Prior to the adoption of SFAS No. 123(R), the Company followed the intrinsic value method in accordance with APB No. 25 to account for its employee stock options and share-based awards in 2005. Accordingly, no compensation expense was recognized for share-based awards granted in connection with the issuance of stock options under the Company's equity incentive plans; however, compensation expense was recognized in connection with the issuance of restricted share units and stock options granted to non-employees under the Company's equity incentive plans. The adoption of SFAS No. 123(R) primarily resulted in a change in the Company's method of recognizing the fair value of share-based compensation and estimating forfeitures for all unvested awards. Specifically, the adoption of SFAS No. 123(R) resulted in the Company recording compensation expense for employee stock options and employee share-based awards granted prior to the adoption using the Black-Scholes pricing valuation model. The Company's pre-tax compensation cost for stock-based employee compensation under SFAS No. 123(R) was $0.7 million ($0.4 million after tax effects) and $2.6 million ($1.6 million after tax effects) for the three and nine month periods ended September 30, 2006. As of September 30, 2006, there was approximately $3.7 million of unrecognized compensation cost related to unvested stock options granted prior to the adoption of SFAS No. 123(R). This cost is expected to be recognized over the weighted average life, straight line, expected at approximately four years. Additionally, the Company presented all tax benefits resulting from the exercise of stock options as operating cash flows in the Consolidated Statement of Cash Flows prior to the adoption of SFAS No. 123(R). It is now required that cash flows from the exercise of stock options resulting from tax benefits in excess of recognized cumulative compensation cost (excess tax benefits) be classified as financing cash flows. The Company's excess tax benefits, classified as financing cash flows, for the nine month period ended September 30, 2006 was $4.3 million. Stock based compensation expense, including expense related to restricted share units, under the provision of SFAS No. 123(R) and APB No. 25 for the three and nine month periods ended September 30, 2005 and 2006, respectively, was comprised as follows (in thousands):
Three Months Ended Nine Months Ended September 30, September 30, ------------------ ----------------- 2005 2006 2005 2006 ---- ------ ---- ------ Sales, Marketing and Services ........... $ -- $ 321 $ -- $1,362 Research and Development ................ -- 312 -- 921 General and Administrative .............. 138 1,272 257 2,745 ---- ------ ---- ------ Total Stock based compensation expense .. $138 $1,905 $257 $5,028
The following table shows the effect of adopting SFAS No. 123(R) on selected reported items ("As Reported") and what those items would have been under previous guidance under ABP No. 25 ("Under APB No. 25") (in thousands, except share data):
Three Months Ended Nine Months Ended September 30, 2006 September 30, 2006 ------------------------ ------------------------ Under Under As Reported APB No. 25 As Reported APB No. 25 ----------- ---------- ----------- ---------- Income before income taxes............... $ 8,942 $ 9,619 $20,860 $23,475 Net Income............................... 5,753 6,167 13,142 14,742 Cash flows from operating activities..... 11,306 11,742 25,952 31,892 Cash flows from financing activities..... 901 879 19,498 15,158 Basic earnings per share................. $ 0.29 $ 0.31 $ 0.67 $ 0.75 Diluted earnings per share............... $ 0.28 $ 0.30 $ 0.63 $ 0.71
Results for fiscal 2005 have not been restated. Had compensation expense for employee stock options and employee share-based awards under the Company's equity incentive plans been determined based on fair value at the grant date consistent with SFAS No. 123, the Company's net income and earnings per share for the three and nine month periods ended September 30, 2005 would have been reduced to the pro forma amounts indicated below (in thousands, except share data): 8
Three Months Ended Nine Months Ended September 30, 2005 September 30, 2005 ------------------ ------------------ Net income, as reported ................. $4,052 $10,202 Add: Stock-based employee compensation cost, net of related tax, included in net income, as reported .............. 88 144 Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related taxes ......... (732) (2,098) ------ ------- Pro forma net income .................... $3,408 $ 8,248 ====== ======= Income per share: Basic-- as reported .................. $ 0.23 $ 0.56 Basic-- pro forma .................... $ 0.19 $ 0.46 Diluted-- as reported ................ $ 0.22 $ 0.55 Diluted-- pro forma .................. $ 0.18 $ 0.44
The Company has one active equity incentive plan with shares available for grant at September 30, 2006 as follows (in thousands):
1995 1999 2000 2002 Plan Plan Plan Plan ---- ---- ---- ----- Minimum exercise price as a percentage of fair market value at date of grant ................................ 100% 100% 100% 100% Plan termination year ................... 2002 2002 2002 Shares available for grant at September 30, 2006 ............................. -- -- -- 2,059
Additional information regarding options is as follows (in thousands, except per share data):
WEIGHTED AVERAGE WEIGHTED AVERAGE AGGREGATE EXERCISE REMAINING INTRINSIC OPTIONS PRICE CONTRACTUAL LIFE VALUE ------- -------- ---------------- --------- Outstanding at December 31, 2005......... 3,263 $18.95 6.10 Granted............................... 35 33.57 9.59 Forfeited and expired................. (127) 21.25 7.89 Exercised............................. (913) 18.78 4.72 Outstanding at September 30, 2006........ 2,258 $18.96 5.62 $27,463 Options exercisable at September 30, 2006.................................. 1,780 $19.53 7.13 $20,772 The total intrinsic value of stock options exercised during the three and nine month periods ended September 30, 2006 was $0.1 million and $14.6 million, respectively and $1.0 million and $1.4 million for the comparable 2005 periods, respectively.
WEIGHTED AVERAGE WEIGHTED AVERAGE GRANT DATE EXERCISE OPTIONS FAIR VALUE PRICE ------- ---------------- ---------------- Non-vested options at September 30, 2006.................................. 478 $8.52 $16.84 Vested options at September 30, 2006..... 1,780 $9.77 $19.53
For purposes of calculating the compensation expense consistent with SFAS No. 123(R), the fair value of each grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants during the nine month period ended September 30, 2006: 9
NINE MONTHS ENDED NINE MONTHS ENDED SEPTEMBER SEPTEMBER 30, 2005 30, 2006 ----------------- ----------------- Expected volatility...................... 38.17% 37.09% Expected dividend yield.................. --% --% Expected risk-free interest rate......... 4.06% 4.92% Expected term of options................. 8.00 years 6.15 years Maximum contractual term................. 10 years 10 years Weighted average grant date fair value of options granted....................... $9.61 $14.83
The Company uses historical data to estimate volatility, the expected term and forfeitures of awards due to employee terminations in order to estimate compensation cost for awards expected to vest. As of September 30, 2006, the Company has $3.7 million of total unrecognized compensation cost under the currently active equity incentive plan and the equity incentive plans that were terminated in 2002. This cost is expected to be recognized over a four year period. The Company received $4.9 million and $18.5 million from stock options exercised during the nine month periods ended September 30, 2005 and September 30, 2006, respectively. The Company's description of the active equity incentive plan has not changed from what was disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2005. NOTE 4 - DOMESTIC AND FOREIGN OPERATIONS Net revenues per geographic region are summarized as follows (in thousands):
Three Months Ended Nine Months Ended September 30, September 30, ------------------ ------------------- 2005 2006 2005 2006 ------- ------- -------- -------- Americas................................. $27,480 $28,891 $ 77,118 $ 81,304 ------- ------- -------- -------- United Kingdom........................... 7,399 8,469 24,447 24,805 The Netherlands.......................... 6,839 7,313 19,194 22,682 Other.................................... 9,213 11,145 27,882 32,567 ------- ------- -------- -------- Total Europe.......................... 23,451 26,927 71,523 80,054 ------- ------- -------- -------- Japan.................................... 4,451 5,194 16,266 18,102 Other.................................... 2,910 3,672 8,922 10,929 ------- ------- -------- -------- Total Pacific Rim..................... 7,361 8,866 25,188 29,031 ------- ------- -------- -------- Total revenues..................... $58,292 $64,684 $173,829 $190,389 ======= ======= ======== ========
NOTE 5 - EARNINGS PER COMMON SHARE Earnings per common share (EPS) are computed by dividing net income by the weighted average number of shares of common stock (basic) plus common stock equivalents outstanding (diluted) during the period. Common stock equivalents consist of contingently issuable shares and stock options, which have been included in the calculation of diluted weighted average shares outstanding using the treasury stock method. Basic weighted average shares reconciles to diluted weighted average shares as follows (in thousands): 10
Three Months Ended Nine Months Ended September 30, September 30, ------------------ ----------------- 2005 2006 2005 2006 ------ ------ ------ ------ Basic weighted average common shares outstanding .... 17,901 19,697 18,111 19,642 Dilutive effect of stock options .................... 746 952 435 1,243 ------ ------ ------ ------ Diluted weighted average common shares outstanding .. 18,647 20,649 18,546 20,885 ====== ====== ====== ======
Anti-dilutive shares not included in the diluted EPS calculation for the three and nine month periods ended September 30, 2005 and September 30, 2006 were as follows (in thousands):
Three Months Ended Nine Months Ended September 30, September 30, ------------------ ----------------- 2005 2006 2005 2006 ---- ---- ---- ---- 359 45 654 32
NOTE 6 -- FINANCIAL INSTRUMENTS The Company accounts for derivative financial instruments in accordance with SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities. The Company recognizes all derivative financial instruments, such as foreign exchange contracts, in the consolidated financial statements at fair value. Changes in fair values of derivatives accounted for as fair value hedges are recorded in income along with the portions of the changes in the fair value of the hedged items that relate to the hedged risk(s). The Company is exposed to risk from fluctuations in foreign currency exchange rates. Since a substantial portion of the Company's operations and revenue occur outside of the United States, and in currencies other than the U.S. dollar, the Company's results can be significantly affected by changes in foreign currency exchange rates. Additionally, these changes can significantly affect intercompany balances that are denominated in different currencies. To reduce this risk, the Company entered into forward contracts during the third quarter of 2006 for the purpose of hedging future foreign currency exposure on intercompany balances between its subsidiaries. The principal currency hedged is the Japanese Yen. These contracts will call for the purchase of local currencies specified at a future date to settle the intercompany balance between the entities. The settlement date for these contracts is June 18, 2007. Additionally, the Company does not use derivative instruments for speculative or trading purposes. On the date the contracts were entered into, the Company designated them as fair value hedges. The Company formally documented its hedging relationship, including identification of the hedging instruments and the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transactions. Additionally, at inception, the Company formally assessed that the transactions will be highly effective in offsetting changes in the fair value of the hedged items. The change in the fair value of the contracts, since they were entered into, will be recorded as a current asset in the Consolidated Balance Sheets. The fair value is based upon foreign exchange spot rates at the end of the period. Any changes in the fair value of the instrument will be recorded as a component of other income/ expense. As of September 30, 2006, the change in fair value is $0.1 million. The notional amount of the forward contracts as of September 30, 3006 is $10.9 million. NOTE 7 -- GAIN ON DIVESTURE OF SIGMA-SERIES PRODUCT LINE On December 29, 2003, the Company entered into a distribution license and sale of assets agreement related to its Sigma-series product line with Systat Software, Inc., a subsidiary of Cranes Software International Ltd. ("Systat"). During the third quarter of 2006, Systat made a final payment of $1.0 million to SPSS to exercise its option to purchase the licensed property. This $1.0 million was recorded as other income in the third quarter of 2006. 11 NOTE 8 -- COST MANAGEMENT PROGRAMS During the nine month period ended September 30, 2005, the Company incurred certain expenses related to cost management programs totaling $2.0 million, respectively. This included $1.6 million for discontinued use of office space from consolidating certain activities and $0.4 million related to the layoff of approximately 24 employees in the sales, marketing and administrative functions. As of September 30, 2006, $44 thousand of these cost management programs remained in accrued liabilities. The Company expects the accrual to be utilized by January 31, 2007. NOTE 9 -- RECENT ACCOUNTING PRONOUNCEMENTS In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes--an Interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company is currently reviewing this new standard to determine its effects, if any, on our results of operations or financial position. In September 2006, the SEC issued Staff Accounting Bulleting (SAB) No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements." SAB No. 108 provides interpretive guidance on how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in the current year financial statements. SAB No. 108 requires registrants to quantify misstatements using both an income statement and balance sheet approach and evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. If prior year errors that have been previously considered immaterial now are considered material based on either approach, no restatement is required so long as management properly applied its previous approach and all relevant facts and circumstances were considered. If prior years are not restated, the cumulative effect adjustment is recorded in opening accumulated earnings as of the beginning of the fiscal year of adoption. SAB No. 108 is effective for the Company at December 31, 2006. The Company is currently reviewing the provisions of SAB No. 108, but does not expect it to have a material impact on its financial statements. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF SECTION 27A OF THE SECURITIES ACT OF 1933 AND SECTION 21E OF THE SECURITIES EXCHANGE ACT OF 1934, INCLUDING, WITHOUT LIMITATION, STATEMENTS REGARDING THE COMPANY'S EXPECTATIONS, BELIEFS, INTENTIONS OR FUTURE STRATEGIES THAT ARE SIGNIFIED BY THE WORDS "EXPECTS," "ANTICIPATES," "INTENDS," "BELIEVES," "ESTIMATES" OR SIMILAR LANGUAGE. ALL FORWARD-LOOKING STATEMENTS INCLUDED IN THIS DOCUMENT ARE BASED ON INFORMATION AVAILABLE TO SPSS ON THE DATE HEREOF. SPSS CAUTIONS INVESTORS THAT ITS BUSINESS AND FINANCIAL PERFORMANCE AND THE MATTERS DESCRIBED IN THESE FORWARD-LOOKING STATEMENTS ARE SUBJECT TO SUBSTANTIAL RISKS AND UNCERTAINTIES, INCLUDING THE RISKS DESCRIBED UNDER ITEM 1A, "RISK FACTORS," OF THE COMPANY'S ANNUAL REPORT ON FORM 10-K FOR FISCAL YEAR 2005 FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MARCH 6, 2006. BECAUSE OF THESE RISKS AND UNCERTAINTIES, SOME OF WHICH MAY NOT BE CURRENTLY ASCERTAINABLE AND MANY OF WHICH ARE BEYOND THE COMPANY'S CONTROL, ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE PROJECTED IN THE FORWARD-LOOKING STATEMENTS. DEVIATIONS BETWEEN ACTUAL FUTURE EVENTS AND THE COMPANY'S ESTIMATES AND ASSUMPTIONS COULD LEAD TO RESULTS THAT ARE MATERIALLY DIFFERENT FROM THOSE EXPRESSED IN OR IMPLIED BY THE FORWARD-LOOKING STATEMENTS. SPSS DOES NOT INTEND TO UPDATE THESE FORWARD-LOOKING STATEMENTS TO REFLECT ACTUAL FUTURE EVENTS. The following discussion should be read in conjunction with the Company's financial statements and accompanying notes, which appear elsewhere in this quarterly report on Form 10-Q. COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2005 TO THREE MONTHS ENDED SEPTEMBER 30, 2006, AND COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2005 TO NINE MONTHS ENDED SEPTEMBER 30, 2006. 12 NET REVENUES.
(In Thousands) -------------------------------------- Percent of Total Revenues September 30, September 30, Amount Percentage ------------------------- Three Months Ended 2005 2006 Change Change 2005 2006 ------------------ ------------- ------------- ------ ---------- ---- ---- License $27,359 $30,013 $2,654 10% 47% 46% Maintenance 25,028 27,970 2,942 12% 43% 43% Services 5,905 6,701 796 13% 10% 11% ------- ------- ------ Net revenues $58,292 $64,684 $6,392 11% 100% 100%
(In Thousands) --------------------------------------- Percent of Total Revenues September 30, September 30, Amount Percentage ------------------------- Nine Months Ended 2005 2006 Change Change 2005 2006 ------------------ ------------- ------------- ------- ---------- ---- ---- License $ 77,769 $ 89,198 $11,429 15% 45% 47% Maintenance 76,788 81,461 4,673 6% 44% 43% Services 19,272 19,730 458 2% 11% 10% -------- -------- ------- Net revenues $173,829 $190,389 $16,560 10% 100% 100%
The increases in license revenues were 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. In addition, changes in currency exchange rates resulted in an increase of $0.3 million in the three month period ended September 30, 2006 and a decrease of $1.1 million in the nine month period ended September 30, 2006. The increases in maintenance revenues were primarily due to higher and consistent renewal rates for the Company's major offerings including increases in all geographic regions. Foreign currency resulted in maintenance revenue increase of $0.5 million in the three month period ended September 30, 2006 and a decrease of $0.9 million for the nine month period ended September 30, 2006. The increases in services revenues were primarily due to an increase in consulting projects as a consequence of higher license revenue during 2006. Changes in foreign currency resulted in an increase of $0.1 million for the three month period ended September 30, 2006 and a decrease of $0.2 million for nine month period ended September 30, 2006. Net revenues per geographic region, percent changes and percent of total revenues for the three and nine month periods ended September 30, 2005 and September 30, 2006 were as follows:
(In thousands) -------------------------------------- Percent of Total Revenues September 30, September 30, Amount Percentage ------------------------- Three Months Ended 2005 2006 Change Change 2005 2006 ------------------------- ------------- ------------- ------ ---------- ---- ---- Americas ................ $27,480 $28,891 $1,411 5% 47% 45% ------- ------- ------ --- --- --- United Kingdom .......... 7,399 8,469 1,070 14% 13% 13% The Netherlands ......... 6,839 7,313 474 7% 12% 12% Other ................... 9,213 11,145 1,932 21% 15% 17% ------- ------- ------ --- --- --- Total Europe ......... 23,451 26,927 3,476 15% 40% 42% ------- ------- ------ --- --- --- Japan ................... 4,451 5,194 743 17% 8% 8% Other ................... 2,910 3,672 762 26% 5% 5% ------- ------- ------ --- --- --- Total Pacific Rim .... 7,361 8,866 1,505 20% 13% 13% ------- ------- ------ --- --- --- Total International .. 30,812 35,793 4,981 16% 53% 55% ------- ------- ------ --- --- --- Total revenues .... $58,292 $64,684 $6,392 11% 100% 100% ======= ======= ====== === --- ---
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(In thousands) Percent of ---------------------------------------- Total Revenues September 30, September 30, Amount Percentage -------------- Nine Months Ended 2005 2006 Change Change 2005 2006 ----------------- ------------- -------------- ------- ---------- ---- ---- Americas................. $ 77,118 $ 81,304 $ 4,186 5% 44% 43% -------- -------- ------- --- --- --- United Kingdom........... 24,447 24,805 358 1% 14% 13% The Netherlands.......... 19,194 22,682 3,488 18% 11% 12% Other.................... 27,882 32,567 4,685 17% 16% 17% -------- -------- ------- --- --- --- Total Europe.......... 71,523 80,054 8,531 12% 41% 42% -------- -------- ------- --- --- --- Japan.................... 16,266 18,102 1,836 11% 10% 10% Other ................... 8,922 10,929 2,007 22% 5% 5% -------- -------- ------- --- --- --- Total Pacific Rim..... 25,188 29,031 3,843 15% 15% 15% -------- -------- ------- --- --- --- Total International... 96,711 109,085 12,374 13% 56% 57% -------- -------- ------- --- --- --- Total revenues..... $173,829 $190,389 $16,560 10% 100% 100% ======== ======== ======= === --- ---
Net revenue growth in 2006 reflects the increased demand for certain market research and statistical products and a strong renewal base for the Company's products, particularly in the Company's international markets. Net revenues derived internationally increased 13% from the nine month period ended September 30, 2005 to the nine month period ended September 30, 2006. This increase resulted from expansion in generally all significant international markets including the United Kingdom, the Netherlands, Japan, Germany, France, Denmark, Belgium, Southeast Asia and Australia. The increases in international revenues were partially offset by changes in foreign currency exchange rates which resulted in a decrease in international revenues of $2.3 million, including $1.2 million in Japan, $0.3 million in the United Kingdom and $0.3 million in the Netherlands. Net revenues derived from the United States increased by 5% from 2005 to 2006 reflecting increases in license and maintenance revenue categories. COST OF LICENSE AND MAINTENANCE REVENUES.
Percent of (In thousands) Total Revenues ----------------- Amount Percentage -------------- Period 2005 2006 Change Change 2005 2006 ------ ------- ------- ------ ---------- ---- ---- Three months ended September 30,.. $ 3,984 $ 4,253 $269 7% 7% 7% Nine months ended September 30,... $11,751 $12,449 $698 6% 7% 6%
Cost of license and maintenance revenues consists of costs of goods sold, amortization of capitalized software development costs and royalties paid to third parties. These costs increased in the three and nine month periods ended September 30, 2006 from the respective periods in 2005 primarily due to higher amortization expense of capitalized software development costs. Cost of license and maintenance revenues should remain relatively constant as a percentage of total revenues in the remaining quarter of the 2006 fiscal year. COST OF LICENSE AND MAINTENANCE REVENUES-SOFTWARE WRITE-OFF.
Percent of (In thousands) Total Revenues -------------- Amount Percentage -------------- Period 2005 2006 Change Change 2005 2006 ------ ---- ------ ------ ---------- ---- ---- Three months ended September 30,.. $-- $ -- $ -- --% --% --% Nine months ended September 30,... $-- $1,283 $1,283 NM --% 1%
Costs of license and maintenance revenues-software write-off was $1.3 million in the nine month period ended September 30, 2006. During the first quarter of 2006, the Company wrote off certain software to a fair value of zero as the Company determined that the future use of the software was no longer likely. 14 SALES, MARKETING AND SERVICES.
Percent of (In thousands) Total Revenues ----------------- Amount Percentage -------------- Period 2005 2006 Change Change 2005 2006 ------ ------- ------- ------ ---------- ---- ---- Three months ended September 30,.. $28,322 $31,448 $3,126 11% 49% 49% Nine months ended September 30,... $87,847 $93,405 $5,558 6% 51% 49%
Sales, marketing and services expenses increased from the three and nine month periods ended September 30, 2005 to the three and nine month periods ended September 30, 2006 primarily due to higher travel and organization meeting costs, annual compensation merit increases and share-based expense of $0.3 million and $1.4 million for the three and nine month periods ended September 30, 2006. Changes in foreign currency exchange rates contributed $0.5 million to the increase in the three month period ended September 30, 2006, while foreign currency decreased sales, marketing and services expense $1.1 million in the nine month period ended September 30, 2006. RESEARCH AND DEVELOPMENT.
Percent of (In thousands) Total Revenues ----------------- Amount Percentage -------------- Period 2005 2006 Change Change 2005 2006 ------ ------- ------- ------ ---------- ---- ---- Three months ended September 30,.. $11,213 $11,414 $ 201 2% 19% 18% Nine months ended September 30,... $33,611 $37,332 $3,721 11% 19% 20%
Research and development costs increased from the three and nine month periods ended September 30, 2005 to the three and nine month periods ended September 30, 2006 primarily due to increased project related expenses, annual compensation merit increases and increased costs due to share-based expense of $0.3 million and $0.9 million for the three and nine month periods ended September 30, 2006. During the three month period ended September 30, 2006, research and development cost increases were offset by $0.5 million higher capitalization of labor development costs than the respective period in 2005 due to timing of development projects. GENERAL AND ADMINISTRATIVE.
Percent of (In thousands) Total Revenues ----------------- Amount Percentage -------------- Period 2005 2006 Change Change 2005 2006 ------ ------- ------- ------ ---------- ---- ---- Three months ended September 30,.. $ 6,606 $ 7,935 $1,329 20% 11% 11% Nine months ended September 30,... $21,183 $23,312 $2,129 10% 12% 12%
General and administrative expenses increased from the three and nine month periods ended September 30, 2005 to the three and nine month periods ended September 30, 2006 primarily due to increased compensation related to share-based expense of $1.3 million and $2.7 million for the three and nine month periods ended September 30, 2006. Additionally in the nine month period ended September 30, 2005, one-time charges of $1.5 million were incurred related to the exit costs for office space ceased to be used as a result of consolidating activities. NET INTEREST INCOME.
Percent of (In thousands) Total Revenues -------------- Amount Percentage -------------- Period 2005 2006 Change Change 2005 2006 ------ ---- ------ ------ ---------- ---- ---- Three months ended September 30,.. $68 $ 929 $ 861 NM --% 1% Nine months ended September 30,... $21 $1,934 $1,913 NM --% 1%
Net interest income increased in the three and nine month periods ended September 30, 2006 principally due to higher investment cash balances. In addition, the Company had lower interest expense in 2006 compared to 2005 resulting from the repayment of the remainder of the Company's term loan in March 2006. Net interest income should continue to increase in the fourth quarter of the 2006 fiscal year as cash balances continue to increase from the Company's operating cash flows. 15 GAIN ON DIVESTURE OF SIGMA-SERIES PRODUCT LINE.
Percent of (In thousands) Total Revenues -------------- Amount Percentage --------------- Period 2005 2006 Change Change 2005 2006 ------ ---- ------ ------ ---------- ---- ---- Three months ended September 30,.. $-- $1,000 $1,000 NM --% 2% Nine months ended September 30,... $-- $1,000 $1,000 NM --% --%
On December 29, 2003, the Company entered into a distribution license and sale of assets agreement related to its Sigma-series product line with Systat Software, Inc., a subsidiary of Cranes Software International Ltd. ("Systat"). During the third quarter of 2006, Systat made a final payment of $1.0 million to SPSS to exercise its option to purchase the licensed property. This $1.0 million payment was recorded as other income in the three months ended September 30, 2006. OTHER EXPENSE.
Percent of (In thousands) Total Revenues ----------------- Amount Percentage -------------- Period 2005 2006 Change Change 2005 2006 ------ ------- ------- ------- ---------- ---- ---- Three months ended September 30,.. $ (257) $(2,621) $(2,364) 920% --% (4)% Nine months ended September 30,... $(2,167) $(4,682) $(2,515) 116% (1)% (2)%
Other expense increased from the three and nine month period ended September 30, 2005 to the three and nine month periods ended September 30, 2006 primarily due to transactional losses resulting from changes in the value of U.S dollar and British Pound denominated intercompany receivables/payables. These losses in the three and nine month periods ended September 30, 2005 and September 30, 2006 were primarily due to the decrease in value of U.S. dollar-denominated receivables held in international locations principally related to the British Pound and Euro and British Pound-denominated receivables held in international locations principally related to the Japanese Yen and Euro. INCOME TAX EXPENSE.
Percent of (In thousands) Pre-Tax Revenues --------------- Amount Percentage ---------------- Period 2005 2006 Change Change 2005 2006 ------ ------ ------ ------ ---------- ---- ---- Three months ended September 30,.. $3,926 $3,189 $(737) (19)% 49% 36% Nine months ended September 30,... $7,089 $7,718 $ 629 9% 41% 37%
The income tax provision increased from the nine month period ended September 30, 2005 to the nine month period ended September 30, 2006 reflecting higher income. The income tax provision was 37% of pretax income for the nine month period ended September 30, 2006. In 2005, the higher income tax provision was principally caused by certain book to tax adjustments recorded in September 2005 in conjunction with the filing of the 2004 United States tax return. Additionally, the Company recorded increases in 2005 related to the valuation allowance for certain foreign tax credits. The Company's effective tax rate is expected to remain at or near 37% for the remainder of the 2006 fiscal year. LIQUIDITY AND CAPITAL RESOURCES During the nine month period ended September 30, 2006, SPSS generated cash in excess of its operating requirements. As of September 30, 2006, SPSS had $119.5 million in cash and cash equivalents compared with $84.4 million at December 31, 2005. Factors affecting cash and cash equivalents during the nine month period ended September 30, 2006 include: OPERATING CASH FLOWS: - Cash derived from operating activities was $26.0 million. This cash resulted primarily from net income partially offset by timing of accounts payable disbursements, receivable billing and income tax payments. 16 - Accounts receivable decreased operating cash flow by $3.5 million reflecting higher revenue and less favorable collections. Average days sales outstanding were 68 days at September 30, 2006, compared to 63 days at December 31, 2005 and 60 days at September 30, 2005. - Timing of accounts payable disbursements decreased cash from operating activities by $2.5 million. - Increases in deferred revenue contributed $1.6 million to cash from operating activities. INVESTING ACTIVITIES: - Capital expenditures were $4.2 million. - Capitalized software costs were $9.4 million. - Proceeds from the divesture of Sigma-Series product line were $1.0 million. FINANCING ACTIVITIES: - Financing activities provided cash proceeds of $18.5 million from the issuance of common stock, primarily through the exercise of stock options. - The Company paid off the remaining balance of its term loan in the amount of $3.4 million. - Tax benefits recognized from stock option exercises were $4.3 million. Cash flows from operating activities were more than adequate to fund capital expenditures and software development costs of $13.6 million. Management believes that cash flows from future operating activities will be more than adequate to meet future capital expenditures and software development costs. On March 31, 2003, SPSS entered into a four (4) year, $25.0 million credit facility with Wells Fargo Foothill, Inc. (f/k/a Foothill Capital Corporation). The Wells Fargo Foothill facility includes a four (4) year term loan in the amount of $10.0 million (all of which has been repaid), two revolving lines of credit and a letter of credit facility not to exceed $3.0 million. The maximum amount SPSS may borrow under Revolver A will depend upon the value of the Company's eligible accounts receivable generated within the United States. Revolver B provides for a credit facility of up to $3.5 million provided that no event of default exists. As of September 30, 2006, the Company has availability of $7.0 million under its lines of credit. The terms and conditions of the Wells Fargo Foothill credit facility are specified in a Loan and Security Agreement, dated as of March 31, 2003, by and between Wells Fargo Foothill and SPSS. One component of the revolving line of credit bears interest at a rate of prime plus 3.0%. On the remainder of the revolving line of credit, SPSS may select interest rates of either prime plus 0.25% or LIBOR plus 2.5% with respect to each advance made by Wells Fargo Foothill. The credit fee rate for letters of credit is 2.0% per annum times the daily balance of the undrawn amount of all outstanding letters of credit. In May 2003, the Company began paying down the term loan of $10.0 million in equal annual installments over the scheduled four (4) year repayment period. During the first fiscal quarter of 2006, the Company repaid the balance of the term loan in full and, at September 30, 2006, the Company did not have any amounts outstanding under its line of credit with Wells Fargo Foothill. The Wells Fargo Foothill facility requires SPSS to meet certain financial covenants including minimum EBITDA targets and includes additional requirements concerning, among other things, the Company's ability to incur additional indebtedness, create liens on assets, make investments, engage in mergers, acquisitions or consolidations where SPSS is not the surviving entity, sell assets, engage in certain transactions with affiliates, and amend its organizational documents or make changes in capital structure. The Company was in compliance with all covenants as of September 30, 2006. The Wells Fargo Foothill facility is secured by all of the Company's assets located in the United States. ShowCase Corporation, a Minnesota corporation and wholly owned subsidiary of SPSS, and NetGenesis Corp., a Delaware corporation and wholly owned subsidiary of SPSS, have guaranteed the obligations of SPSS under the Loan and Security Agreement. This guaranty is secured by all of the assets of ShowCase and NetGenesis. SPSS intends to fund its future capital needs through operating cash flows and borrowings on our credit facility. SPSS anticipates that amounts available from cash and cash equivalents on hand, under its line of credit, and cash flows generated from operations, will be sufficient to fund the Company's operations and capital requirements at the current level of operations. However, no assurance can 17 be given that changing business circumstances will not require additional capital for reasons that are not currently anticipated or that the necessary additional capital will then be available to SPSS on favorable terms or at all. During the third quarter of 2006, the Company entered into forward contracts for the purpose of hedging future foreign currency exposure on intercompany balances between certain subsidiaries. The notional amount of these contracts is $10.9 million and the principal currency hedged is the Japanese Yen relative to the British Pound. These contracts will call for the purchase of local currencies specified at a future date to settle certain intercompany balances between its U.K. and Japan-based entities. The settlement date for these contracts is June 18, 2007. Additionally, the Company does not use derivative instruments for speculative or trading purposes. CRITICAL ACCOUNTING POLICIES The Company's consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. As such, SPSS makes certain estimates, judgments and assumptions that it believes are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. The Company's critical accounting policies include revenue recognition, capitalization of software development costs, impairment of long-lived assets, impairment of goodwill and intangible assets, the estimation of credit losses on accounts receivable and the valuation of deferred tax assets. Additionally, the Company has implemented FASB Statement No. 123 (R) in accordance with the guidelines as set forth in the SPSS Annual Report on Form 10-K for the year ended December 31, 2005. For a discussion of these critical accounting policies, see "Critical Accounting Policies and Estimates" in the SPSS Annual Report on Form 10-K for the year ended December 31, 2005, filed with the Securities and Exchange Commission. RECENT ACCOUNTING PRONOUNCEMENTS In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes--an Interpretation of FASB Statement No. 109" ("FIN 48"). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements in accordance with SFAS No. 109, "Accounting for Income Taxes." FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently reviewing this standard to determine its effects, if any, on our results of operations or financial position. In September 2006, the SEC issued Staff Accounting Bulleting (SAB) No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements." SAB No. 108 provides interpretive guidance on how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in the current year financial statements. SAB No. 108 requires registrants to quantify misstatements using both an income statement and balance sheet approach and evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. If prior year errors that have been previously considered immaterial now are considered material based on either approach, no restatement is required so long as management properly applied its previous approach and all relevant facts and circumstances were considered. If prior years are not restated, the cumulative effect adjustment is recorded in opening accumulated earnings as of the beginning of the fiscal year of adoption. SAB No. 108 is effective for the Company at December 31, 2006. The Company is currently reviewing the provisions of SAB No. 108, but does not expect it to have a material impact on its financial statements. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK. Historically, the Company was exposed to market risk from fluctuations in interest rates on borrowings under its borrowing arrangement that would bear interest at either the prime rate or the Eurodollar rate. During the first fiscal quarter of 2006, the Company repaid the balance of its outstanding term loan in full. As a result of this repayment, the Company is not currently exposed to market risks from fluctuations in interest rates. The Company is exposed to risk from fluctuations in foreign currency exchange rates. Since a substantial portion of the Company's operations and revenue occur outside of the United States, and in currencies other than the U.S. dollar, the Company's 18 results can be significantly affected by changes in foreign currency exchange rates. Additionally, these changes can significantly affect intercompany balances that are denominated in different currencies. To reduce this risk, the Company entered into forward contracts during the third quarter of 2006 for the purpose of hedging future foreign currency exposure on intercompany balances between its subsidiaries. The principal currency hedged is the Japanese Yen. These contracts will call for the purchase of local currencies specified at a future date to settle the intercompany balance between the entities. The settlement date for these contracts is June 18, 2007. Additionally, the Company does not use derivative instruments for speculative or trading purposes. On the date the contracts were entered into, the Company designated them as Fair Value Hedges. The Company formally documented its hedging relationship, including identification of the hedging instruments and the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transactions. Additionally, at inception, the Company formally assessed that the transactions will be highly effective in offsetting changes in the fair value of the hedged items. The change in the fair value of the contracts, since they were entered into, will be recorded as a current asset in the Consolidated Balance Sheets. The fair value is based upon foreign exchange spot rates at the end of the period. Any changes in the fair value of the instrument will be recorded as a component of other income/ expense. As of September 30, 2006, the change in fair value is $0.1 million. The notional amount of the forward contracts as of September 30, 3006 is $10.9 million. Were the foreign currency exchange rates to depreciate immediately and uniformly against the U.S. dollar by 10 percent from levels at September 30, 2006, the reported cash balance would decrease $9.4 million, or 7.9 percent. Management expects that the decrease would have a material adverse effect on the Company's financial results. ITEM 4. CONTROLS AND PROCEDURES Disclosure Controls and Procedures. SPSS maintains disclosure controls and procedures that have been designed to ensure that information related to the Company is recorded, processed, summarized and reported on a timely basis. The Company's Chief Executive Officer and Chief Financial Officer, with the participation of the Company's Corporate Governance Committee, evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures as of the end of the period covered by this report, as required by Rule 13a-15 of the Securities Exchange Act of 1934. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that as of the end of the period covered by this report, the Company's disclosure controls and procedures were effective in ensuring that the information required to be disclosed by the Company in the reports it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Changes in Internal Control Over Financial Reporting. There has been no change in the Company's internal control over financial reporting that occurred during the Company's fiscal quarter ended September 30, 2006 that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting. 19 PART II - OTHER INFORMATION ITEM 6. EXHIBITS
INCORPORATION EXHIBIT BY REFERENCE NUMBER DESCRIPTION OF DOCUMENT (IF APPLICABLE) ------- ---------------------------------------------------- --------------- 31.1 Certification of the Chief Executive Officer and President pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of the Chief Executive Officer and President pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
20 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SPSS Inc. Date: November 2, 2006 By: /s/ Jack Noonan ------------------------------------ Jack Noonan President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the undersigned, in his capacity as the principal financial officer of the Registrant. Date: November 2, 2006 By: /s/ Raymond H. Panza ------------------------------------ Raymond H. Panza Executive Vice President, Corporate Operations, Chief Financial Officer and Secretary 21 SPSS INC. EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION ------- ---------------------------------------------------------------------- 31.1 Certification of the Chief Executive Officer and President pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 31.2 Certification of the Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. 32.1 Certification of Chief Executive Officer and President pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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