Keynote Systems F4Q08 (Qtr End 9/30/08) Earnings Call Transcript

| About: Keynote Systems, (KEYN)

Keynote Systems (NASDAQ:KEYN)

F4Q08 Earnings Call

November 13, 2008 5:00 pm ET


Kirsten Chapman – Investor Relations

Umang Gupta – Chairman and Chief Executive Officer

Drew Hamer – Chief Financial Officer and Vice President of Finance


Eric Martinuzzi - Craig-Hallum Capital

Brian Kinstlinger – Sidoti & Co.

Kevin Liu - B. Riley & Company, Inc.

Derrick Wood - Pacific Growth Equities

Douglas Whitman - Whitman Capital


Good afternoon, everyone, and welcome to the Keynote conference call for the fourth quarter fiscal year 2008. (Operator Instructions)

At this time, I would like to turn the call over to Kirsten Chapman for opening remarks and instruction.

Kirsten Chapman

Thank you, [Christian]. Good afternoon, everyone, and welcome to Keynote's conference call for the fiscal fourth quarter and year ending September 30, 2008.

I'm here today with Umang Gupta, Chairman and Chief Executive Officer, and Drew Hamer, Chief Financial Officer. Umang and Drew will review our accomplishments for the quarter and then be available to answer questions.

Hopefully by now you have seen our press release that was distributed over Business Wire and the major wire services. For your convenience, the press release has also been posted to our website at

The replay of this call will be available by telephone by dialing 1-800-642-1687. The passcode is 67287586 or by webcast at the Investor Relations section of our website at

I would like to remind you that statements made during the course of this call that are not purely historical are forward-looking statements regarding the company are management's intentions, hopes, beliefs, expectations, and strategies for the future. Because such statements deal with future events, they are subject to various risks and uncertainties and actual results may differ materially from those projected in the forward-looking statements.

Important factors that could cause actual results to differ materially from those in the forward-looking statements are discussed in today's press release and in the company's annual report for fiscal 2007 and most recent quarterly report filed with the SEC.

We've provided detailed guidance on our earnings release today as we have in prior quarters. This guidance assumes no additional acquisitions or other significant or extraordinary transactions other than those described in our earnings release. We will not comment on this guidance during the quarter, but may provide an update to this guidance in the event of a material change during the quarter.

Before the company reviews the financials, I will review definitions for some metrics which are not in accordance with generally accepted accounting principals, commonly known as GAAP.

The company defines non-GAAP net income as net income adjusted for provision for income tax, stock-based compensation expense and amortization of purchased intangibles, less cash taxes from ongoing operations.

Non-GAAP net income per share equals non-GAAP net income divided by the weight average number of diluted shares outstanding for the period end.

Net deferred revenue represents the deferred revenue balance as reported on the consolidated balance sheet and gross deferred revenue represents net deferred revenue balance plus the unpaid deferred revenue that has an associated accounts receivable balance as of the balance sheet date.

During the call, Umang Gupta, Chairman and Chief Executive Officer, will review the fiscal fourth quarter accomplishments, and Drew Hamer, CFO, will detail the financial results. Then Umang will provide vision and open the call for questions.

Now it is my pleasure to introduce to you Umang Gupta. Please go ahead, sir.

Umang Gupta

Thanks, Kirsten. Welcome, everyone, and thank you for joining us today.

We achieved a solid fourth quarter and closing a very good year of revenue growth and improved profitability. Fourth quarter 2008 revenue reached $21.1 million, exceeding our guidance and rising 18% from the fourth quarter of 2007. Full year 2008 revenue reached record $76.9 million, a 13.5% increase from 2007.

Growth was driven primarily by our mobile test and measurements business. We feel we are well positioned for the coming year, with a strong balance sheet and a diversified product portfolio.

I will now review our performance by product category. First, our mobile test and measurements business.

In the fourth quarter, mobile revenue was $8.8 million, up 61% compared to the same period last year and 5% sequentially. Full year mobile revenues reached $28.7 million, up 63% compared to 2007.

Growth was driven primarily by Keynote SIGOS for mobile operators and supported by solid mobile subscription revenue growth from enterprise customers. In the fourth quarter Keynote SIGOS added 10 GlobalRoamer and SITE customers, brining our September 30 customer count up to 149. The new customers included AFD Technologies, Alcatel-Lucent, CTI Argentina, Megaphone for [inaudible], O2UK, Taiwan Mobile, Telecom Cell Indonesia, Telecom Italia, Telefonica Spain, UMC MTS Ukraine, Utel Russia, and Wind Italy.

By the end of 2008, Keynote's mobile application device perspective services were deployed by more than 40 enterprise customers, such as Google, Yahoo!, AOL and Microsoft. Key mobile content service deals in the fourth quarter included, [Cojawa], LinkedIn, Telesource Engineering, and 3C Interactive.

In early September at the CTIA wireless IT and entertainment show, we officially launched Keynote Mobile Interactive Test Environment or MITE 1.0. MITE is the industry's first desktop testing tool that enables mobile developers to interactively test and validate mobile content over the Internet or over live carrier networks across more than 1,000 simulated mobile handsets in order to quickly understand and certify the end user experience. Just as we do with our KITE product, we are planning to use MITE to expand the market for our mobile software to service monitoring offerings and broaden our user base. With MITE we are targeting mainly mobile developers and quality assurance personnel, as well as our traditional IT operations customers.

In addition, we continue to increase our investment in developing mobile interactive testing solutions for real devices. For example, in September we purchased a source code license from a mobile start up called PhoneJaxx Incorporated that enables remote interactive testing from real devices versus the simulated devices supported by MITE. We intend to incorporate this technology in the next version of our mobile device perspective service.

During the quarter we also conducted two interesting Keynote Competitive Research - KCR - studies of mobile users. In September we measured the effectiveness of SMS technology in political campaigns, such as the news announcement of Senator Obama's running mate, Senator Joe Biden, sent to millions of Obama supporters via SMS text messaging.

In early October we announced results for the Keynote WebEffective Study for iPhones, which studied actual user satisfaction among iPhone users of popular mobile portals. This was the first ever formal study of iPhone usability conducted with an advanced customer experience measurement tool such as WebEffective. Notably, Keynote's mobile test and measurements infrastructure won a Gold Mobile Star Award from Mobile Village for enterprise software application testing.

Now, on to our Internet test and measurements business. Our Internet business delivered revenue of $12.3 million this quarter compared to $12.2 million in the third quarter of 2008, reflecting the acquisition of new customers, especially for our multi-page transaction and broadband offerings. Most notably, our legacy single-page, single-device business now constitutes less than 10% of overall Internet subscriptions revenue. Therefore, we believe any further reduction in this product category will have only a nominal impact on our overall Internet revenues.

The key Internet subscription and engagement deals done in the quarter included [Alagan], Citicorp, Discovery Communications, Eddie Bauer, Estee Lauder, Hasbro, Lexis, Nexis, Media General, Metronic, New York Life Investment, Sojourn, Sony Online Entertainment, and the Washington Post.

Of note, we also monitored the website performance for the 2008 Beijing Olympic Games. Keynote Streaming Perspective was chosen by Microsoft and China's CCTV to monitor the performance of 2200 hours of streaming video of the Olympic Games on and CCTV.

Last quarter we provided an update on KITE 2.0 and its capabilities, which enables product development, quality assurance and IT operations teams to interactively test the most sophisticated Web 2.0 sites and applications, both from their desktops and from five cities across the world. In September alone, more than 1,000 early adopter web developers and IT professionals downloaded KITE. In October, we made KITE generally available to anyone who wishes to download it and use it free of charge as a gateway to measure website performance from their desktops.

Also in October, Cloud Computing Journal highlighted the top 50 cloud computing companies and their offerings. [KITE] was highlighted as a free tool for developers looking to ensure superior end user experience.

Now I'd like to turn the call over to Drew for a more detailed discussion of our financials. Drew?

Drew Hamer

Thank you, Umang.

Ladies and gentlemen, I'm going to start by reviewing the financial details for the quarter, the year and then follow with our financial outlook for next quarter.

For the quarter ended September 30, 2008 we exceeded revenue guidance. Our fourth quarter total revenue was $21.1 million compared to $20.5 million last quarter and $17.8 million in the same period last year.

Total subscription services and ratable license revenue of $18.7 million or 89% of total revenue for the quarter increased from $17.9 million last quarter and $14.9 million in the same period last year, reflecting the continued success of our mobile test and measurements products.

As Umang noted, our legacy single-page, single-device subscriptions revenue was less than 10% of overall Internet subscription revenue last quarter and should therefore have only a nominal impact on our Internet revenue growth in the future.

For the quarter, professional services revenue contributed $2.4 million or 11% of total revenue compared to 13% of revenue contribution last quarter and 16% of revenue contribution last year.

Our customer count was approximately 2,800 companies. We tracked the number of customers, excluding Keynote SIGOS that purchased on an annualized basis at least $100,000 or more of our services. In the fourth quarter, 93 customers represented 67% of total revenue compared to 91 customers representing 65% of total revenue and 97 customers representing 79% of total revenue in the third quarter of 2008 and the fourth quarter of 2007, respectively.

At the end of September 2008, we measured approximately 14,100 pages through our web performance measurement services. This compares to 11,600 pages in the quarter a year ago and approximately [break in audio] last quarter.

For the fourth quarter 2008, revenue per page for the quarter was $176 compared to $202 and $169 for the quarter a year ago and last quarter, respectively.

Now I'll review our expenses.

Direct cost of services and ratable licenses was $5.8 million or 28% of revenue compared to $5.5 million or 27% of revenue last quarter.

Sales and market expenses were $6.7 million or 32% of revenue compared to $6.7 million or 33% of revenue in the third quarter of 2008.

Total operating expenses were $20.7 million compared to $21.1 million last quarter.

Net interest income for the quarter was $458,000 and was offset by an $842,000 foreign currency remeasurement expense related to intercompany transfers from Keynote's European entities to Keynote Systems Inc.

Also during the quarter we recorded a $605,000 charge for estimated income tax expense. This compares to a $140,000 charge for estimated income tax in the third quarter of 2008 and $4.1 million in the fourth quarter of 2007, which included a $2.8 million charge for deferred tax asset adjustment.

Our GAAP net loss was $631,000 or $0.05 per diluted share compared to $407,000 or $0.03 per share for the third quarter 2008 and $3.5 million or $0.19 per share for the fourth quarter of 2007.

The non-GAAP net income for the quarter was $1.4 million or $0.10 per diluted share compared to $1.3 million or $0.09 per diluted share for the last quarter and $2.2 million or $0.11 per diluted share for the same quarter a year ago.

For the quarter, cash provided by operating activities was $565,000. This compares to $1.5 million in the prior quarter and $3 million in the fourth quarter of 2007.

We invested $4.4 million in property, equipment and software this quarter, including the onetime source license purchase of $2.6 million of mobile technology compared to $1.6 million in the prior year quarter and $1.4 million for the same period last year.

We also received $2.6 million from the issuance of common stock and exercise of stock options in the quarter compared to $3.7 million in the same period last year.

The total shares outstanding net of treasury shares at September 30, 2008 was $14.1 million compared to $18.3 million at September 30, 2007.

Now I'm going to talk about full year ending September 30, 2008.

Revenue reached a record total of $76.9 million and increased 13.5% over 2007's $67.8 million.

Our expenses of $81 million compared to $73.1 million in fiscal year 2007. This was primarily the result of incremental investments we made in sales, marketing and product development.

GAAP net loss for the year improved $3.1 million or $0.20 per share. Our 2007 net loss was $4.7 million or $0.27 per share.

2008 non-GAAP net income was $4.3 million or $0.27 per diluted share compared to $5.4 million or $0.29 per diluted share in 2007.

Now, moving to the balance sheet and our cash performance metrics, at September 30, 2008, our cash and short-term investments balance was $49.3 million.

As of September 30, 2008, accounts receivable net was $7.3 million. DSOs were 32 days and 97% of accounts receivable were less than 90 days old.

Total net deferred revenue at September 30, 2008 was $19.9 million compared to $24.2 million at June 30, 2008 and $22 million at September 30, 2007.

Now I will provide some general guidance for the first quarter of 2009 ending December 31, 2008.

Total revenue is expected to be between $19.5 million or $20 million.

GAAP earnings per share are expected to be between a loss of $0.03 to earnings of zero.

Non-GAAP earnings per share are expected to be between $0.09 and $0.12.

The guidance assumes the following:

A 14% reduction in the euro to U.S. dollar exchange rate in the first quarter 2009 compared to the fourth quarter 2008 and expected to result in reduced international revenues and lower European operating expenses on a sequential quarterly basis.

Total share-based compensation expense and amortization of intangible assets is expected to be approximately $1.9 million.

Depreciation is expected to be approximately $1.5 million.

Interest and other income net is expected to be approximately $200,000, assuming no material changes in interest rates, foreign exchange rates, and currently planned uses of cash.

Cash paid for income taxes for ongoing operations is expected to be approximately $195,000 assuming no changes in required tax payments.

And basic weighted average shares outstanding are expected to be approximately 14.3 million shares and diluted weighted average shares outstanding are expected to be approximately 14.8 million shares, assuming no additional issuances of equity or equity related securities.

With that, I would like to return the call to Umang.

Umang Gupta

Thank you, Drew.

Ladies and gentlemen, we're very pleased with our 2008 performance; however, as we look ahead to the coming year, we are mindful of the economic turmoil that has recently engulfed the world's major economies. Notwithstanding the worsening macro environment, we believe we are quite well positioned to navigate through this environment. We believe we offer the best test and measurement product portfolio for the online world. Also, we can count on a worldwide team of dedicated and talented Keynote employees who are supported by a very strong balance sheet to remain committed to service excellence for our customers and to long-term growth.

We have fortified both our mobile and Internet businesses with new products and are excited about their prospects. Since a large part of our Internet revenues come from a software as a service, pay as you subscriptions revenue model and such operating expenses are not typically as reduced as dramatically as capital expenditures during recessionary times, we believe we are in a stronger position than many other technology companies to keep our revenues stable or growing.

We also plan to be more aggressive in capturing market share from our competitors by emphasizing our more diverse product portfolio and our strong balance sheet.

We see signs that our investments in sales and marketing over the last year are beginning to pay off. During the past quarter, for example, we won many head-to-head competitive battles against Keynote's competition in the Internet space. We also do not have the overhang of a declining legacy web subscription business to overcome in the coming year.

In addition, sales compensation for our enterprise sales force has been adjusted to promote even more aggressive hunting for new customer acquisitions and competitive wins. In October we held our fiscal year 2009 sales kickoff meeting, and I left feeling quite excited about the confident attitude among our salespeople.

We're also making significant progress in selling our SIGOS SITE systems to mobile operators outside of our traditional European customer base. We now have relationships in North America with all three GSM operators - Rogers, T-Mobile, and AT&T - and we are also working with mobile operators across the emerging world from Angola to Argentina who are installing new and advanced mobile networks and need our testing solutions more urgently than ever before.

Last week I kicked off our first ever Keynote SIGOS Asia-Pacific user conference in Kuala Lumpur, where we had over 90 attendees from our customers and distribution partners across that entire region. While the mood reflected concern about the worldwide economic environment, I saw and heard plenty of customers discussing ways of increasing their usage next year of the SITE system and/or GlobalRoamer services.

Now Drew and I would be more than happy to take any questions you may have. Thank you.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Eric Martinuzzi - Craig-Hallum Capital.

Eric Martinuzzi - Craig-Hallum Capital

My question has to do with the outlook. I want to better understand the foreign currency impact to the guidance. It looks like given the quarter that you just finished up with we're down sequentially about $1.1 million to $1.6 million. How much of that is foreign exchange and how much of that is kind of macroeconomic pressures?

Umang Gupta

I'd say virtually 100% right now is based on foreign exchange. If you do the math at a very gross level, 45% of our revenues come from outside the United States. Either SIGOS or Keynote Internet-based revenues, 45% approximately speaking, come from outside of the United States.

So if you basically take about half our revenues and say that they had a haircut this quarter of roughly 14%, which means that there would be a 7% reduction for overall revenues for the quarter as a whole just simply for the business just based on foreign exchange. Take $21 million, multiply by 7% and you're down by $1.5 million automatically.

So you can see that from our guidance we are well within the range of assuming that much of the reduction, if any, that should come would be from foreign exchange. We do not expect reduction on an organic basis otherwise.

Eric Martinuzzi - Craig-Hallum Capital

Okay, and then your cost structure, I understand the revenue is 45% ex U.S., what about the cost structure, what percentage of that is ex U.S.?

Umang Gupta

It's obviously not 50% because SIGOS does not represent 50% of our business and most of our costs outside the United States are really SIGOS costs. There are some costs associated with sales and marketing outside the United States, but that's a much smaller percentage of our overall revenues.

While we do not provide specific data in our model for what the costs are, I can say to you that there will be corresponding reductions in costs in the coming quarter because of SIGOS. SIGOS definitely will be less, and so you should not expect a one for one reduction at all. In other words, if you have $1 reduction in revenues, it does not imply a $1 reduction in profits, for example. Our costs will go down, maybe not by $1 million but even if they went down by $700,000 or so, it might affect us by a couple of cents, but probably no more than that based on that.

I'm just going to add one more point, there. So if you just do the math based on what I've just done very quickly, you'll say to yourself, "Well, gee, if the revenues go down by $1 or $1.5 million and let's say costs go down by not as much but still quite a bit and the profits go down by a couple of pennies, why are you forecasting potentially higher profits next quarter?" Which we are, by the way; as you can see, our guidance is $0.09 to $0.12 whereas the previous quarter we just did $0.10.

The reason is that the previous quarter - I'm talking about the fourth quarter that's just ended  we had a one time - I don't whether you want to use the word one time, but it was definitely an unusual situation charge of $800,000 of "foreign exchange remeasurement expense" that Drew can explain in a minute that we do not believe will happen this quarter. It was a very rare situation that caused that to occur, and Drew can explain more a bit. But because that won't happen or we don't expect it to happen, I believe that our profits, in fact, in the coming quarter ought to be stable or slightly better than last quarter.

Eric Martinuzzi - Craig-Hallum Capital

And then just vertical, obviously a vertical that matters very much to you is the wireless carrier side of the house. You talked about the global macroeconomic - you're as subject to that as other companies, but you're probably more so dependent on the mobile carriers. Are you getting any indications from them as far as reluctance to renew or pipeline slowdown? The carriers in particular, has there been a change in behavior with buying patterns?

Umang Gupta

I'd put it this way. A third of our business is SIGOS business and that business is capital goods acquisition. Two-thirds of our business is not capital goods; it's primarily subscriptions business. So, as I said, the subscription business should not be as affected as the capital business by a recession. It'll certainly be affected, but I don't believe it generally should be affected as much.

Now on the capital goods side, which is the SIGOS portions, most capital goods budgets of this type, the telecom budgets, get set at the end of the calendar year for the next year. So for sure at this point we have seen no shift or change in the current quarter, i.e., the December quarter. I mean, our December quarter typically is our strongest quarter for SIGOS from a bookings viewpoint, and I haven't seen anything so far to cause me to believe that shouldn't be the case again this year.

That said, as far as next year goes, we'll probably have a better idea by next quarter this time, essentially by the time we announce earnings, as to what the pipeline looks for and how our bookings might look in the coming year based on new budgets for the coming year.


Your next question comes from Brian Kinstlinger – Sidoti & Co.

Brian Kinstlinger – Sidoti & Co.

I understand the subscription side is less a piece that gets impacted in an economic downturn. I guess I'm curious - you know, you read stuff like Vodafone cutting huge costs and having lower sales expectations and I think and if I remember they used to be maybe your largest client in that business - and so I guess I'm curious, when you see massive cost cutting, does that suggest that everyone, even your business, will be significantly impacted, even if it's less than someone else's?

Umang Gupta

Well, ultimately, I don't believe anybody will escape the recession. We are no exception to that. However, the question is how much we might be affected versus somebody else, and all I can tell you is that we have not seen so far any changes to the bookings rates of SIGOS based on what's going on in the macroeconomic environment.

Now for next year, let's say, Vodafone is a good example. At the end of the day, our belief is that much of our revenues and projects are based on product cycles than economic cycles. And the amounts that people spend on SIGOS relative to what they spend on a Lucent or some of the other big equipment vendors are astronomically different. You're talking about SIGOS deals that are probably in the half a million dollar kind of range whereas some of these other deals are in the $500 million kind of range or $50 million range. So we're talking about much, much smaller amounts in the overall scheme of things.

So at this point at least, I'd argue that we are more likely to be affected by somebody deciding that they aren't going to install an entire 3D network in a particular country than we would be by a Vodafone deciding to cut budgets for testing, which is such a small, insignificant portion of their overall capital budget anyway.

Brian Kinstlinger - Sidoti & Co.

I guess when you look at the gross deferred revenue numbers, in the March quarter we were at $31.5 and then June quarter we were at $29.5 and now we're at $24.7. Is that not some indication that bookings is somewhat getting more difficult?

Umang Gupta

Not at all. It has everything to do with deferred revenue and foreign exchange and nothing to do with bookings. The foreign exchange, the way deferred revenues work is that they're basically multiplied by the foreign exchange rate at the end of the quarter. And so all you've got to do is take a look at the deferred revenue balance that we had a quarter ago and multiply it by the exchange rate haircut of almost 15% in the last quarter and you can start to see what significant affects have occurred.

Brian Kinstlinger - Sidoti & Co.

So you are down 16% quarter to quarter and you'd argue that most of that, if not all of that, was the currency move we saw in the dollar versus foreign currencies in this quarter?

Umang Gupta

Yes, exactly. And we are already reflecting it in our forward guidance.

Drew Hamer

But some of the decline - this is a natural cycle for the SIGOS business. The December quarter is the big quarter for the bookings. It will kind of fill up the deferred revenue again. So we are seeing more of the natural cycle, where we're taking more revenue out than we're putting in in bookings, but in the quarter the bookings weren't out of line.

Umang Gupta

Drew makes a good point that there is a seasonality to this and at the end of September quarter typically we'll see the trough of our deferred revenue balance, and it was just exacerbated by the foreign exchange rate difference. But we should expect to see a replenishment of it at the end of the December quarter.

Brian Kinstlinger - Sidoti & Co.

I think this quarter is generally the time when your Internet services and CEM business, but even more so Internet services business, is a little bit stronger. The retail environment's weak, obviously; we all know that. Is that still strong enough and that's what's offsetting the weakness from currency in revenue or is that business actually, do you expect it not to be as seasonally strong as it has been in all the years past?

Umang Gupta

Are you talking about the December quarter or are you talking about the September quarter just past?

Brian Kinstlinger - Sidoti & Co.

The December quarter coming forward on the services side.

Umang Gupta

Okay. So within our guidance, as I said, we are not projecting any reductions of revenue at the organic level. We are simply assuming some reductions because of exchange rate factors.

There is always a few hundred thousand dollar swing that can occur in any given quarter at an organic level. Historically, we've always taken the previous quarter's revenues and kind of reduced them by a few hundred thousand dollars and increased them by a few hundred thousand dollars, and that's usually our guidance range.

We haven't done anything different this quarter than last quarter. All we did beyond that was to account for foreign exchange.

Brian Kinstlinger - Sidoti & Co.

I guess what I'm trying to understand is it mobile that's offsetting the weakness from currency, increased volumes there, or is it the fact that your retail business in the December quarter on the Internet services engagements that you generally have is seasonally strong, so that is the piece  I mean, is it all of them offsetting it or is it one particular revenue item that is offsetting it?

Umang Gupta

I don't understand. Everything is offsetting what's going on in the foreign currency exchange, so clearly we expect to see some increases in services in the fourth quarter, in the December quarter, as a result of our engagements being stronger in the December quarter. That's true.

But on the other hand, we also expect to see some increases in our mobile service - I'm talking about our enterprise mobile services - compared to the previous quarter. And offsetting that will be the foreign exchange-related reductions, which come from either SIGOS or from, frankly, Keynote services sold in Europe.

Brian Kinstlinger - Sidoti & Co.

I'm interested a little bit in that $800,000 plus loss on the other income line and maybe if you can give us some perspective on that. When you're calculating that, is that based on the average rate of the December quarter, is that the quarter end? I'm trying to figure out why there might not be a flow through since it was the end of September that we even saw a drastic move in the dollar. Why might we not see that carry through into December?

Drew Hamer

Right. So this has to do with the payments or the payables and receivables between the legal entities that are created in Europe and then in the United States. And when they have an outstanding balance, at the end of each month the transactions are put on the books at a given FX rate and then the FX rates change at the end of each month when you compare them and you have to record a charge for the change in the FX rates effectively that goes through your P&L.

What we're able to do a little more to manage that, of course, is that we can reduce those balances by the transfer of funds or also by recording additional charges. So as it was in the last quarter, we had some large balances that were outstanding due to some tax transactions we recorded in June and then the FX rates moved very quickly, if you remember, [break in audio] August and the balances, we weren't in a position to pay them off.

So we've recorded additional payments into those accounts, essentially neutralizing them or possibly putting them in a position where we actually may realize gains. So this is an ongoing activity, but we will manage it more closely as we go forward.

Umang Gupta

Can I just say one thing? That ultimately the reason we don't believe it'll happen this quarter or in the future - it could always happen; I will say that, but we don't believe it should - is that there's a very freakish circumstance that occurred and, when I understood it, I finally figured out how freakish it was.

Basically, in the last year, in the last 12 months, for the first time in our relationship with SIGOS, we did a structured mechanism where we bought the IP of the company, SIGOS, and that then allows us to get royalties from SIGOS every quarter back into the United States, which allow us to them apply those royalties or those profits against tax loss carryforwards that we have in the United States. This transaction really started in November of last year. Before that, we never had to worry about these things.

So starting in November of '07, we essentially now get profits being repatriated to us or at least theoretically repatriated on our books from SIGOS every quarter. Well, for the first two quarters  in the January quarter and the December quarter, the March quarter, even the June quarter - the exchange rates didn't move at all, practically speaking. They were roughly the same. So it didn't really matter when you reported a transaction of the profits versus when, in fact, the actual transfer took place on your books.

In this last quarter, in the September quarter, virtually all of the foreign exchange drop that occurred occurred in the month of September, practically speaking, you know, some in August and then much in September. So what happened is that the sudden move of the dollar to the exchange rate ratio and the combination of that, along with our profit reconciliation of everything at the end of the fiscal year, caused us to have to retake all of this at one time.

Please note there was no fundamental change in the overall cash position of the company. These are purely things that are required by accounting rules to be put on the P&L as opposed to the balance sheet because they were intercompany transactions occurring between two subsidiaries of the company.

The reality is we still have about as much cash as we did at the beginning in our German banks and as much cash as we had in the American banks, you know, since the German banks' money's worth a little less because the euro's worth a little less and the dollar is worth what it is worth. So practically speaking, this is all really just based on how accounting rules work for doing P&L work. We don't believe this should happen in this coming quarter.

Brian Kinstlinger - Sidoti & Co.

And it only happened because there was crazy volatility from the beginning of the quarter to the end, it seems.

Drew Hamer

That's right.

Brian Kinstlinger - Sidoti & Co.

The last question I have is you've tied the CEM business into the Internet business and one of the things I was tracking was how fast broadband transaction Internet subscriptions were kind of progressing, which would make it easier if you gave us a sense for how much CEM was in the quarter?

Umang Gupta

Oh, yes, sure. Even though we're not reporting CEM anymore separately, as you all know, I think it's only fair that we let you know how we did in the previous quarter because then it would close out the last year and we'll have a basis for comparison. But please note going forward we will not be reporting CEM.

And in the last quarter, the CEM portion of our business was roughly $1.5 million or so, give or take--

Brian Kinstlinger - Sidoti & Co.

In revenue?

Umang Gupta

Yes, in revenue. That's some consulting and some subscription, but overall that's how much it was.

Brian Kinstlinger - Sidoti & Co.

Can you give me a rough sense - you said the subscription side, that's the piece, I think, that is -

Umang Gupta

No, we've never reported that separately and I'd be hesitant to do that, but I can tell you if what you're trying to figure out is did our subscriptions increase last quarter come from the CEM portion or from the web subscriptions portion, I can absolutely tell you virtually all of it was from the web subscriptions portion. We did very nicely in our web subscriptions increases last quarter.

And that last point, by the way, I might just say that's exactly what I've been saying for some time, that as soon as we can get over the hump of reducing our legacy business we should start to see increase in web subscriptions business. We did see that this last quarter. While I can't guarantee that for the next quarter and the next quarter, you know, on a quarterly basis, I feel reasonably confident that we ought to be able to see year-over-year increases going forward in the Internet subscriptions area.


Your next question comes from Kevin Liu - B. Riley & Company, Inc.

Kevin Liu - B. Riley & Company, Inc.

Turning to the Internet business, you mentioned that you guys had some nice competitive wins during the quarter. Could you just comment on kind of how your competitors are responding to the current environment, what you're seeing on the pricing side and then also if you're just seeing less of them now?

Umang Gupta

Sure. We clearly are not seeing less of them. I mean, we really only have one main competitor relative to the Internet side and that is Gomez. They have always been aggressive and they're still very aggressive, no question about it. We see them in pretty much every major deal we're in.

The difference I think now is that our sales force, first of all, it had very little - I mean, we've got an increased sales force over the last 12 - 18 months. There has been virtually no turnover in our sales force compared to our competitor, who has had, from what we can tell, some turnover. We have people who are extremely motivated through their sales compensation plans to go hunting after Gomez accounts. We pay them bounties for that. That happens.

And so when you add up all that plus the fact that we now have pretty much everybody focused on growth rather than displacement of the old legacy business, you just have a lot more activity. And in that situation, we seem to be doing better, I think. Not that our competition is not somebody we don't worry about; we worry about them every day. But overall in lots and lots of situations, we won against them, mostly based on the strength of our products, though sometimes we've also had to be aggressive on pricing.

Kevin Liu - B. Riley & Company, Inc.

And then just kind of as a follow on for the Internet side of the business, when you guys look at kind of the renewal rates for some of your older customers and also you guys, I think, a couple of quarters ago talked about a transaction to utilization-based pricing for some of the larger players, can you just give us a sense on where you are today, both in terms of how much of your customer base is on a utilization-based model and also whether your existing customers are either asking for price reductions or what kind of requests do they have once renewal times comes around?

Umang Gupta

So let me start with the second question first, which has to do with, I think, how many of them are on what we call the bill in arrears model, which is the utilization model. More and more customers - I'd say at this point probably our top 200 customers, I'm going to say more than 50% of them, maybe even 60% or 70%, but certainly 50% - are on a bill in arrears model.

And we are making efforts to get virtually 100% of our customers on a bill in arrears model. The only people we think who shouldn't be on a bill in arrears model with us are those who are much smaller customers, who know exactly what they want to use. Otherwise, we want them all to be on the telephone-like model. And we're actually building technology to make it easier and easier for them to do that in an automated way rather than in a sort of manual billing way for us. So that's going very, very nicely.

On the second part, which has to do with renewals - and one other point, even if you're on a bill in arrears model with us, you still have to sign up for a PO with us, so it doesn't really matter whether you're a Microsoft or Akamai or a much smaller customer, if you're on bill in arrears and you're paying us as you go, you still end up signing for a certain amount of a PO with us for a year. And you may exceed that PO, but in general we generally know when somebody is hesitating to kind of come up with a new PO or not renew, which means maybe your next question, which is how much hesitation are we seeing in renewals or how is that going so far?

So far so good. We haven't really seen any significant cases. I mean, there's always a case here or there where a customer says, "You know what? I 'm just not going to use any measurements at all." The company's in financial trouble and they just sort of shut down completely on their measurements with us. But in general what we have seen is that we have rinsed our customers over the last year or two of so much excess usage, so that people really, really value what they use with Keynote today because for years and years we've been trying to get them to the point where they only take what they need. At this stage, we really haven't seen too much trimming going on.

That said, in just the last couple of weeks I would say to you we have probably seen situations where some of our customers are saying, "You know what? We need to be a little cautious about how much increases we might do next year." So I would say it might affect our growth expectations for next year, but overall we feel reasonably confident at this point of maintaining a stable revenue base in subscriptions just as we have done for the last seven years.

Kevin Liu - B. Riley & Company, Inc.

And then just lastly, with the stock price where it is, again, could you just talk a little bit about your appetite and maybe kind of what the Board's thinking is on potentially buying back stock again?

Umang Gupta

Yes. As you know, Kevin, and I think I've mentioned this to everybody, we would love to buy back more stock, but part of our problem at this stage is we are limited based on certain change of control - it's called a Section 382 provision with the IRS where, if you end up buying too much stock back or enough change of control occurs on your company's stock ownership, you literally lose your tax loss carryforwards.

And as you know, the company has almost $50 million of tax loss carryforwards, which are extremely valuable to us, especially now that we have a whole bunch of profits against them coming in from our German subsidiary with whom we've done the tax transaction. So this is not theoretical anymore. This is real money that we would lose if we ended up in a situation where we end up over that kind of 50% change of control threshold that the IRS puts on us.

We feel pretty good about where we are today. We are not at 50%, but we're not so far away that we can keep buying more, but we are not so close that we could inadvertently get into it with a few percentage points here and there. But I hesitate to buy anymore stock at this stage based on that reason.

Kevin Liu - B. Riley & Company, Inc.

Actually, could you just give us a sense for when you guys might get farther away and when it would become perhaps a more valid consideration?

Umang Gupta

Well, since we bought a whole bunch of stock early this year, at least that portion, in other words, everything we did earlier this year has a three-year look back. So at least, you know, we bought like [break in audio] and so that could be three years before we have to look back on that. On the other hand, there were other things going on last year and the year before that every year things get, you know, some things drop off and some things have to come off. There's always a three-year look back.

My judgment is that about a year from now would be the right time for us to take a look at this again.


Your next question comes from Derrick Wood - Pacific Growth Equities.

Derrick Wood - Pacific Growth Equities

You've historically talked about the growth rate for both the mobile and the Internet business on the overall market. Given the change in the economy, do you think these forecasts have changed and, if so, can you give us some color?

Umang Gupta

Well, as you know, we don't do guidance for the year as a whole, but I have been open in saying what I thought the secular potential growth rates of each market segment were for us. And I've generally said look, once we're past our kind of declining revenue stream relative to the singlepage, single-device, that ought to be a 15%. Maybe, you know, you could argue a 10% to 20% kind of growth rate scenario, 15% average. And I think the same would be true for the mobile business, maybe higher, maybe its 15% to 20% kind of growth rate scenario.

So I think I'm not going to back off that. I'd say take a look at our subscription revenues. They haven't gone up. But take a look at our URL usage; it went up by 22% last year. And so there's no reason for us to believe that that will change in the coming years. Even with the recession, more and more people are starting to - you know, people cut down branch offices of banks; they do more online banking. You cut down a bunch of regular brick and mortar stores; you end up trying to build more online retail.

So I think in general there will be a greater trend towards using more Internet to make up for the cost reductions in brick and mortar, and that should affect us positively. And the same should be true for mobile. I mean, mobile isn't stopping anytime soon, either here in the United States or, frankly, overseas, where I see potential in places like China and India and elsewhere. I just came back from Malaysia and I see that and I think, you know, if it weren't for what's going on in the West, these economies would just keep barreling away.

So my feeling is that at the big picture level, we still believe that a 15% to 20% - let's say 15% average growth rate per year is both a reasonable and desirable capability for the business we're in and for the markets we're in.

Now, for the coming 12 months, it's a whole different story because, to the extent that you can have a 15% swing in foreign exchange alone, I mean, if you had a 15% growth rate of SIGOS, it could be affected by a 15% negative swing on foreign exchange alone, making it a zero percent growth rate.

And so clearly we are taking a cautious stand, both on the mobile side and the Internet side for the coming year. Our current posture from a planning viewpoint is to assume the worst and to assume that we've got to keep our costs in control and assume that our revenues won't go up beyond whatever we're forecasting in our Q1 numbers. And so, if the revenues stay flat and we can keep our costs in control, then you can probably do a reasonable model of what our business might look like relative to profits based on our first quarter guidance.

On the other hand, if things get worse, I don't know. But certainly at this point, that's our internal planning model.

Derrick Wood - Pacific Growth Equities

I'm sorry, you were saying that flat revenue beyond Q1 or are you just referring to Q1?

Umang Gupta

For Q1 the numbers are what we've given them - 19.5 to 20. But I think your question to me had to do with beyond Q1 for the year as a whole, and what I was just trying to give you is that, while I don't give guidance for the year as a whole, our planning posture is that they won't go up and therefore we'll keep our costs in control and then see what happens.

Derrick Wood - Pacific Growth Equities

And I guess on the cost side it looks like G&A came down quite a bit sequentially. Can you just give us some color on what drove this and if this is a sustainable number going forward?

Drew Hamer

Sure. As we discussed last quarter, debt came down due to a decline in professional services fees. We will see that go up some couple hundred thousand dollars in the first quarter because of the year end audit and all the associated professional services fees with that. So I think you're going to see more variability in that going forward. It'll depend upon the amount of professional resources required based upon the activities of the business. Probably more of that around the third quarter and then see a decline again in the fourth quarter of next year as well.

So it could be an up and down kind of a swing based upon the usage of professional resources based upon the time of the year.

Derrick Wood - Pacific Growth Equities

I guess on the Internet services consulting services side, has the economy impacted that business and will you expect a little bit more weakness in that line item relative to what subscription will do?

Umang Gupta

I think it's fair to state that that's a business that's seasonal, and so we are now seeing the benefits of the seasonality in this current quarter and also in the previous quarter just finished. And when the quarter's over, we may see the full brunt of the economy affecting that consulting business in Q2 for us, which is our March quarter.

We don't give guidance beyond Q1, but I can tell you that overall, just to emphasize what I'm saying, I am basically assuming a scenario that says my revenues are not going to go up beyond what they are in Q1 in Q2, Q3 and Q4 and therefore I've got to keep my costs in control. And if it turns out that they go up, well then I'll do better in profitability. On the other hand, if they start to go down, then we'll have to take appropriate measures.

Derrick Wood - Pacific Growth Equities

And you do believe that, with flat revenue, you can improve profitability with just cost synergies or would you maintain profitability as well?

Umang Gupta

Well, our current goal is to maintain profitability at Q1 levels beyond that, assuming revenue stays the same because costs will stay the same. On the other hand, there may be some volatility on a quarter basis, so please don't assume it'll happen the same each quarter. But for the year as a whole, that's sort of a good way to model our business, at least for us.

If it turns out that our revenues go up substantially and they require some cost investment somewhere to make it happen, we will make those steps. But by and large our business will not at this point - you should not assume that we will be making cost increases betting on the come.

Derrick Wood - Pacific Growth Equities

And last question, just around the acquisition of the technology that you announced, it doesn't sound like there's going to be any material revenue impact in the next few quarters?

Umang Gupta

Which one? Which acquisition?

Derrick Wood - Pacific Growth Equities


Umang Gupta

Yes, PhoneJaxx, yes. So that wasn't an acquisition of a company. That was really more an acquisition of a technology, and the answer is no, not in the next six months. I mean, we probably will see a version of mobile device perspective some time around the June quarter and so we might start to see some effect by the end of this fiscal year, but more of it will be for next year.


(Operator Instructions) Your next question comes from Douglas Whitman - Whitman Capital.

Douglas Whitman - Whitman Capital

I wanted to make sure I understood correctly because the earlier comment was kind of, despite the very bad economy - and you're obviously concerned about it - you haven't really seen the effects yet on your business and certainly your numbers demonstrated that last quarter and even your guidance this quarter, and so I want to make sure I'm understanding that you're not giving guidance but you're being prudent in running the expenses of the company. Am I understanding you guys correctly there?

Umang Gupta

Absolutely. Yes, that's exactly what I was saying, Doug.

Douglas Whitman - Whitman Capital

And then given kind of we talked a little bit about cash flow and the question that came from one of the analysts about the low valuation of the company, Drew, could you give any color on your  and I know it's hard to pinpoint - but California real estate hasn't really come down like the rest of the country, particularly commercial real estate in the area that you're in. Can you give us a little color on kind of any feedback you're getting on the approximate value of the building at this point in time? I realize you never really know unless you were selling it.

Drew Hamer

Yes. So without getting a full appraisal done, which would require me to be giving you a hard number, we're hearing it's probably in the range of a value of $50 million or so on the building in today's market given our current levels of occupancy.

Umang Gupta

I'll add to that a little bit. We were both - Drew and I were on a phone call just this morning with some folks in anticipation of this possible question.

You know, last year about this time there was a building about our size - 180,000 square feet, not too far away from us, located near Genentech - and it sold for about $67 million. And right now the number people are talking about that building, it's somewhere around $50 million.

Well, that's how we're coming up with this number. Basically, you know, our business, many of you may remember last year we were saying you know, it's possible the building might be worth $65 million or so, but right now we're being conservative and saying well, maybe it's only worth $50 million.

But the important thing to note is that the building is making money for us today. At the present run rate of money we are making on this building, if you factor in the Keynote rent, the imputed rent, so to speak, if we had just simply left this building and gone off and rented ourselves at $3 a square foot or something but just paid ourselves here, we are currently making about 4% cash on cash on this building today. And if we are able to rent out the remaining one floor that we just vacated a quarter ago, we believe that number will go up to about 5%.

So this building today is a pretty good asset for us given the turmoil outside and the fact that we probably won't make more than 1% or 2% on our cash anywhere.

Douglas Whitman - Whitman Capital

Well, Umang, it's probably the first time I won't argue for you to sell the building given that you can't do a buyback right now.

Umang Gupta

Thank you very much.

Douglas Whitman - Whitman Capital

The last question would be kind of related to that, the change of control. You're basically, if you add the $250 millions together, the cash and the building, you're basically at cash value right now and you're a very profitable company, so if someone was to make a run at you guys, what is the tax - we haven't even talked about the $50 million of tax loss carryforwards. If it was a corporation, does any of those tax loss carryforwards, given the change of control, potentially carry forward? I realize you're not looking to see yourself at these prices.

Umang Gupta

I think change of control for the 382 provision is purely based on public ownership. So in other words, they do a bunch of calculations based on everybody who's a greater than 5% shareholder and do all that work. On the other hand, if somebody were to just buy us and they were a change of control, whether it's an investment company or, for that matter, a strategic buyer, it really doesn't matter, we would definitely lose all those tax loss carryforwards. That would just be a consideration. I mean, most of them would be lost.

Drew Hamer

No, they would carryover to the acquirer. If they bought 100% of the company, they would carry over.

Umang Gupta

Yes, but they are not very useful to them, I don't believe.


There are no further questions at this time. Do you have any closing remarks?

Umang Gupta

Okay, thank you very much indeed, everybody joining us today and for your support. We are pleased with our successes to date and we're looking ahead. We're still quite excited about our prospects, notwithstanding the cautionary environment we all live in today. We look forward to discussing our company with you at various investor conferences we've scheduled in the upcoming months, most immediately at the UBS Global Technology Services Conference next week on November 20 in New York, when both Drew and I will be there. Thank you very much.


Ladies and gentlemen, this concludes today's conference call. You may not disconnect.

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