Keynote Systems' CEO Discusses Preliminary Q2 2013 Results Conference (Transcript)

| About: Keynote Systems, (KEYN)

Keynote Systems, Inc. (NASDAQ:KEYN)

Preliminary Q2 2013 Results Conference

April 15, 2013 5:00 pm ET

Executives

Kirsten F. Chapman - Managing Director and Principal

Umang Gupta - Chairman and Chief Executive Officer

Curtis H. Smith - Chief Financial Officer and Secretary

Analysts

Matthew L. Williams - Evercore Partners Inc., Research Division

Kevin Liu - B. Riley Caris, Research Division

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Michael Latimore - Northland Capital Markets, Research Division

Operator

Good afternoon, everyone, and thank you for joining Keynote's Preliminary Results Conference Call for the Second Quarter of Fiscal 2013. Today's conference is being recorded. At this time, I'll -- I would now like to turn the call over to Kirsten Chapman from LHA for opening remarks and instructions.

Kirsten F. Chapman

The preliminary results for the second quarter of fiscal 2013 ended March 31, 2013. I'm here today with Umang Gupta, Chairman and Chief Executive Officer; and Curtis Smith, Chief Financial Officer. Hopefully, you have seen our press release that was distributed over the major wire services. For your convenience, the press release has also been posted on our website at www.keynote.com. The replay of this call will be made available by telephone by dialing (888) 843-7419. The pass code is 34686904# or by webcast at the Investor Relations section of our website at www.keynote.com.

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 or 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 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 most recent annual and quarterly reports filed with the SEC.

Today, we have provided preliminary guidance in our press release. This guidance assumes no acquisitions, no material change in interest rate or foreign currency exchange rates and no other significant or extraordinary transactions. Following this call, we will not comment on the guidance until our earnings call on April 30.

Before the company reviews the financials, I will review definitions for some metrics the company provides that are not in accordance with Generally Accepted Accounting Principles, commonly known as GAAP. Non-GAAP net income is calculated as GAAP net income or loss adjusted for the provision or benefit for income taxes, cash taxes from ongoing operations, stock-based compensation expense, amortization of purchased intangibles and any unusual items. Non-GAAP net income per diluted share equals non-GAAP income divided by the diluted weighted average shares outstanding for the period.

During the call, Umang Gupta, Chairman and CEO, will review the preliminary results for the second quarter of fiscal 2013, then we will open the call for questions.

It's my pleasure to introduce Umang Gupta. Please go ahead, sir.

Umang Gupta

Thank you, Kirsten. Ladies and gentlemen, thank you for joining us today for the call. We are speaking with you to discuss preliminary results for the second fiscal quarter of 2013. I will provide as much color as we can at this point until we deliver our final second fiscal quarter results on Tuesday, April 30.

As noted in our press release, we have lowered our guidance for financial results for the second quarter ended March 31, 2013. We now expect total revenue to be between $28.5 million and $29.5 million, primarily due to 4 contracted SITE Systems projects with revenue totaling approximately $1.6 million that were not accepted by our customers in the quarter.

It is important to note that these were systems that already had been sold in prior quarters, but project acceptance was necessary in order to achieve revenue recognition. While we are disappointed in the impact on our results, we are encouraged by the fact that the delays were not related to our product but to customer-specific factors. We are focused on getting these projects accepted in the June quarter. And while we do not expect delays to be a long-term trend, we will take into account greater project acceptance volatility in our ongoing forecasting process.

While the results are not yet final, we expect our total costs and expenses to come in lower than the prior quarter. Therefore, we expect GAAP net income per diluted share to be between $0.001 -- $0.01 and $0.03, and non-GAAP net income per diluted share to be between $0.07 and $0.09. We expect our cash in the balance sheet to increase by approximately $6 million to approximately $57 million.

Looking ahead, project acceptance volatility we experienced in our telecom mobile business plus some scope reductions we have experienced with load testing engagements as well as previously discussed bookings volatility in our enterprise mobile business may continue in the fiscal year -- in the current fiscal year. As a result, for the third quarter of fiscal 2013 ending June 30, we expect revenue and total costs and expenses to be consistent with the March quarter.

The remainder of fiscal 2013 presents some hurdles. However, we have encountered soft patches before which we will successfully overcome. I am confident we will do that same thing now. My confidence is buoyed by the knowledge that our markets will continue to grow, particularly since the e-commerce and mobile telecom markets are a long way from saturation, and the enterprise mobile market is still in the early adoption stages. The key to success is solid execution, and we are committed to driving growth and profitability in fiscal year 2014 and beyond.

I would now like to open the call up to questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Matt Williams.

Matthew L. Williams - Evercore Partners Inc., Research Division

Just, I guess, to start off with, just any more color that you can provide around why the contracted projects weren't necessarily accepted. And then, I guess, sort of off of that going forward, what steps are you taking to sort of ensure that issues like this don't necessarily pop up in the future?

Umang Gupta

Yes. So first of all, let me just provide a color on the 4 contracts. Actually, out of the 4 contracts, only 2 are the ones that really made a big difference. Ultimately, there are always math situations where some projects that we forecasted go out of the quarter, but then some projects somehow end up coming in. And usually in the past, they have not been significant enough to make a difference or their revenue recognition effects have not been significant enough to make a difference. And we factor all those things in, frankly, in our own guidance as we give it. Some of you may realize, at least by my own reckoning, the last time I stood here and did this kind of pre-announcement was, I believe, I could be wrong, but I don't -- I think it was like 7 years ago, April 2006, and so usually, we try and factor all this in. This time, there are 2 things going on. Number one, there were 2 very large projects, one of them almost EUR 600,000, another about EUR 500,000 or maybe EUR 400,000. And one was in Saudi Arabia, the other was Australia. In both cases, the projects involved customers whom we already have dealt business with, so it wasn't an issue of doing business with a new customer. In both cases, there were new people involved on the other side, on the project acceptance or management side. And usually, our process involves making sure that our products work in a central location first and then any peripheral location. So if you, for example, have 15 cities you want to install our probes in, the main thing in Saudi Arabia is Riyadh, and Australia might be Sydney or Melbourne, and then you worry about all the other places these probes are located in. And this would -- and normally, if the project leaders on the other side know our product, know it well, are comfortable with the way we do business, they're willing to accept the fact that many times, the product has been tested properly and accepted by them for one location. But in the other end locations, it may be their problems that may be holding it up rather than our problems. In this particular case, a result of new people on the other side and more stringent procedures by these new people requiring all locations to be accepted, essentially put it out of reach. So we are pretty comfortable, even as we speak, that in both cases, the customer recognizes that they have to do some work on their side. 15 locations outside of Riyadh in Saudi Arabia. People are going out and checking these, and sometimes the problem is theirs. Maybe they don't have good antenna coverage, maybe there's no cell coverage. Those aren't our problems, but the customer recognizes that in those cases, it's still up to them to check it all out. They just hadn't done that as of the end of last quarter. They are doing that as we speak, and we are quite, at this point, at least, hopeful that with proper discussion with these new folks, making sure we give them extra time, given that they are new to at least our product line, they will go through that acceptance process. And that really, I think, is the key thing that happened. I'll add one more thing, and that is that 2 years ago, when we were in the old accounting, the method where you amortized all projects, and during the last 2 years, even as we move to new accounting, the effect of project slippage was less than it is today for a simple reason. Two years ago, if you had a product -- a project did not get accepted on March 31 and it was supposed to be accepted on March 30, well, at best, you would have 1 day of loss of revenue. But now because you either get all of your revenue or none of your revenue because of the new accounting rules, the result is there's greater volatility, period, and that's just one of the things we have to live with. And we have not been used to this level of volatility management, frankly, in the past, and it's a lesson for all of us to recognize that we need to live with this volatility with the new accounting rules and present that appropriately in our guidance going forward.

Matthew L. Williams - Evercore Partners Inc., Research Division

Okay, great. And then, if I might, just a quick follow-up. Outside of the mobile business, is there any color you can provide on how the Internet business held up in the quarter and how that seems to be churning for the year?

Umang Gupta

Sure. So I'll provide you more details, obviously, in 2 weeks. But I can say to you that we did mention in our press release, as you noticed, we mentioned, obviously, the SIGOS projects themselves, which really is manifested at project volatility, rather than any lack of our confidence and the ability to sell and deliver on an annual basis what we set out to do, achieve, it's just that it's affecting quarters or this particular quarter. On the enterprise mobile business, there were, frankly, no surprises from our side. We actually ended up doing pretty much what we thought we would do relative to DeviceAnywhere. And even though it's a work in progress, as we've mentioned in the past, there was no negative surprise at all for us over there. On the Internet side, relative to last year, our subscriptions are still holding up quite good, but relative to last year, our engagements definitely have not been growing the way we expected them to. And much of the -- this particular quarter's effect, last quarter I may have mentioned CEM that our customer effective -- customer experience management business was affected. This turned out just fine this quarter. It snapped back, but the load testing engagements were affected this last quarter. Now just remember, there is seasonality involved here. Typically, the Q1 December quarter is higher for load testing, then it goes steeply down in Q2. And Q2 this time was no different. It did go down compared to Q1 like it always does. It's just that it didn't -- we -- there were a few more deals relative to 1 year ago at least we could have done better but we didn't. So overall, I would say that our engagements business, the combination of CEM engagements in Q1 and load testing in Q2 have caused the first half ITM engagements, Internet engagements, to be not very much higher, if at all, than the first half of last year. And that is of concern to us. Having said that, we believe that this is fundamentally more internal issues for us. We've made some changes in the CEM side already as a result of what happened previously. On the Internet testing, load testing arrangements, we believe that had more to do with some product-related issues on our side. Our product does massive load test, and we were reaching a point where certain of those massive load tests had some technical issues from our side relating to the scale at which we could do these massively. We have to fix some of these issues and that -- from an engineering viewpoint over the last quarter or 2. And so many of those have affected the scale at which we do some of our tests, which, in turn, affects usage, which, in turn, affects revenue. So all of these are problems that we've had to wrestle with and work on. We are working on them, but we are cautious about the entire engagements business this year.

Operator

Our next question comes from Kevin Liu from B. Riley.

Kevin Liu - B. Riley Caris, Research Division

Quick follow-up on the SIGOS projects. Can you just talk a little bit about whether when you guys had built those, you've already collected the fees associated with it or is there any chance that some of your customers are delaying acceptance because they also don't necessarily want to pay at this point in time? And then beyond that, if you could comment a little bit on the bookings performance at SIGOS.

Umang Gupta

Sure. So on the collections, I'm pretty sure that neither one -- well, first of all, our normal standard practice in collections is, typically, we do a deal, we collect a certain amount upfront, and then we collect a certain amount after acceptance. And I don't believe in these -- these are huge operators. And I won't name them, but basically, Australia and Saudi Arabia, these are large, large operators, and there's no issue there relative to collections from our viewpoint. In fact, I'm doing this out of memory here, but I recall there may have been some discussions in Australia at least actually about collecting it pretty soon only for budgetary reasons, because the other side had to pay for it. So there -- this really has nothing to do with collections or any of that kind of stuff. It's really purely one of those political things where new guys came on board in both places and they've affected how acceptance occurs for us. As far as bookings goes, Kevin, our bookings, typically -- we don't reveal bookings, as you know. And for SIGOS at the end of each calendar year, we do reveal bookings. What we normally talk about -- actually, I don't think we believe bookings per se, but we normally talk about our German GAAP revenues, which is a closer metric of how we are doing in terms of bookings and cash than it is -- than the U.S. GAAP, simply because U.S. GAAP was, in the past, at least affected by this amortization business. But going forward, incidentally U.S. GAAP and German GAAP are pretty darn close to each other. So I don't think they will be affected that much. So having given you that preamble, let me say that for the year as a whole, last year, our German GAAP revenues that I'd revealed last calendar year ending December 31 were roughly EUR 30 million. And I gave perspective that said way back in 2005, these were EUR 12 million. And I think, 3 years before that, they were like EUR 24 million. So clearly, we are averaging somewhere between 10% to 15% growth rates on each year. There are some years, it's been even 20%, but on average, I would say it's a fair assessment to say that, typically, 1 year is 15%, but sometimes it can be as low as 10%. My guess is this year, we will be higher than last year on this German GAAP metric I've just mentioned based on everything I know so far. And if we just did a 10% above EUR 30 million, you'd end up with maybe EUR 33 million or so. So at least relative to our own internal expectations, but remember, this is only one quarter over and bookings-wise, and now I'm talking about purely sales and purchase orders, yes, they can change dramatically at the end of the calendar year. So is it possible that we will end up with about EUR 33 million of what you call bookings, which is purchase orders in by the end of this calendar year? Yes, it's certainly possible and doable. I have not got any indication so far telling me that things have slowed down there.

Kevin Liu - B. Riley Caris, Research Division

Okay, great. And then just with respect to your revised future outlook today, considering SIGOS would seem to be kind of the most uncertain part of your results, just wondering why there's still this $1 million range that you're looking at for the Q2 numbers?

Umang Gupta

Oh, oh, okay. So Curtis, you want to talk about the -- how we established the range at this point, given that closing rates, et cetera, please?

Curtis H. Smith

Yes, sure, Kevin. So we operate under a 10-day business close, which got us to Friday, where we have the numbers that we've put in front of you. These numbers are still subject to our review on the -- from management and also to our auditors review. So we have provided the range for those purposes until we get to the final number.

Kevin Liu - B. Riley Caris, Research Division

All right, and then one last one on just the load testing. It sounds like that was largely tied to kind of the engagements piece. So just wanted to make sure that, that was the case and that there aren't any sort of issues you're seeing with reduced usage from your customers who paid to use it on demand or on a more subscription-oriented basis.

Umang Gupta

Yes. So first of all, load testing is a combination of subscription and engagement. So what happens is when a person signs up, they can sign up for a 1 year's worth of measurement some number, and that's amortized and used -- shows up on the other subscriptions line, and then the rest is an engagement for whatever work we do with them. So the effects of what happens when load testing goes down are actually felt in 2 lines: on the line item called professional services; and also on the subscription, on the other subscriptions line. And you will see that when we present our final results in a couple weeks from now. So don't be surprised by that, but we -- when I was talking about it, I was just simply talking collectively, that the entire engagements business, which meant load testing combination of subscriptions engagements, were affected.

Operator

Our next question comes from Chad Bennett from Craig-Hallum.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

I guess, so on the SITE license deal. So what -- when were those -- were those deals all booked in the December quarter?

Umang Gupta

I can't -- I don't remember if they were December or even September, but they were definitely prior to this last quarter. Yes, they had nothing to -- typically, we rarely ever -- it's impossible typically for us to ship and deliver and accept something that is sold on that same quarter, at least, not a SITE deal. I mean, GlobalRoamer is different on maintenance, but not SITE. So I'm pretty sure it was -- certainly, the December quarter could have been earlier.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

So -- and you indicated you expect to recoup these deals in the June quarter?

Umang Gupta

Yes.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay. So is there something going on in the underlying growth of that business? I know you just answered a question that your annual bookings that you give for SIGOS -- I think you're trying to imply you're not changing your thought there. But what -- I mean, if you get $1.6 million theoretically, incrementally in the June quarter...

Umang Gupta

Why can't we just add it to the next quarter is basically your underlying question.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Yes, yes.

Umang Gupta

I think that's the underlying question. Yes, okay, good. Let me try to respond to that. First of all, we will give you more detailed guidance 2 weeks from now. And at that level -- at that point, you will get from us the usual worksheet we provide with our press release that shows you the breakdown of revenues between the Internet versus mobile, between subscriptions versus other -- web subscriptions versus other subscription engagement and between mobile subscriptions, ratable licenses, system rights and maintenance, and even between mobile enterprise revenues versus mobile telecom revenue. So you will get all that, and I think, you will be in a better position to see how to do your models relative to the next quarter, which is, I think, the underlying issue behind this question. So all I can say to you is the following. Is that at this time, telecom revenue last quarter, I mean, if you just go look at what we announced for December 31, telecom mobile revenue was 12.262. And compared to the same quarter 1 year ago, which was 11.632, it was up and this -- and then the next quarter after that, Q2, was, actually, telecom was 10.351. And at this point, our expectation is that this quarter, it'll be less than 10.351. So I'm pretty sure about that. The question really is what's it going to be next quarter. And while we have not provided that guidance yet, and we'll not be in that position for you to even guess at that guidance without more detail from us, I can say to you that look at what happened 1 year ago in the third quarter, the June quarter. We were only $9 million of revenue. So there was a consistent process because of all this accounting headwind and other factors going on that, that number was getting rationalized down to about $9 million at that stage. And I can tell you right now that, that $9 million bogey is the one we look at to kind of beat for next quarter. And I can't tell you today sitting where I'm sitting how that'll be, but I can tell you that it's a much easier bogey for us to beat next quarter than it is for this previous quarter was. And similarly for the fourth quarter, the $9 million bogey is also pretty easy one to beat. So overall for the year as a whole, I'm still expecting that we will be higher than 1 year ago. And how much higher will all depend upon, A, the effect of this particular shortfall and any other variability if it occurred in the next 6 months.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

So when we get to the obviously, the full breakdown, the issues you cited in this release are the reason for the miss. So I'm assuming you're implying that the web measurement subscription business was in line with expectations.

Umang Gupta

I think from our own internal viewpoint, it was a little lower than we wanted it to be, because the Internet subscriptions are being affected by load testing, but relative to, I think, the guidance expectations, and therefore, if you look at the models, et cetera, Curtis, correct me if I'm wrong, but I don't know if we were that far off what the models said.

Curtis H. Smith

That's right.

Umang Gupta

Yes, so again, I don't want you to hold what I'm saying exactness, because I'm not at a point where I can give you these breakdowns that easily. But overall, my own feeling right now is of the engines I've just described, the enterprise mobile engine is the work in progress. There was nothing this quarter that would cause me to feel like we've turned the corner, and by next quarter, we're going to suddenly be back at the races. I personally believe that there's a lot of good things happening relative to our product line and some of the bookings metrics underneath the covers relating to pipelines and those kind of things, but we may very well be in for another 3 to 6 months of volatility there, and so I fully expect that, that will be whatever it was previously in terms of volatility. And relative to revenue and bookings, I'll cross those when I come to that. Relative to SIGOS, I have -- from an annualized basis, I am probably more likely to believe that this is a 10% grower year this year for the year as a whole rather than a 15% year grower of this year for the SIGOS business. But also, please remember that some of that SIGOS revenue is affected by some remaining trailing headwinds, a small amount, but I think we had about a $2.5 million headwind, which in itself is about a 5% affectation, and then, there may or may not be any foreign exchange headwinds going forward. There weren't any last quarter, but the quarter before that, definitely was. So net-net, in German GAAP at least, I think, 10% is where I'm hoping we can achieve. And relative to Internet, so far, relative to 1 year ago, our primary effect has been on load testing and CEM, that means engagements. And so relative to 1 year ago, our growth still remains healthy on subscriptions. However, on a quarter-to-quarter basis, I'll probably have a better idea of that in a couple of weeks, and then we can see where we are.

Chad M. Bennett - Craig-Hallum Capital Group LLC, Research Division

Okay. So if I remember correctly, the September quarter is typically flat, maybe even flat to slightly down from the June quarter. Is there any reason why we should feel differently about that?

Umang Gupta

Oh, I see. I think the last 2 couple of years have been all very odd in this respect. I would not make any predictions of September versus June because, A, yes, it is true that under German -- under the new German GAAP, the September quarter can be affected if Europe, for example, all -- everybody's on vacation. But on the other hand, there is some level of upward bias in the sales process for the guys especially outside of Europe and there's so much -- so many of our sales going on outside of Europe that they may be counteracting any September effects. I'm now talking about SIGOS. Relative to the rest of the business, I don't believe there's any fundamental September bias that's negative. If anything, September actually is higher for load testing, because a whole bunch of people start up after July 1 to get ready for Christmas. So typically, September's higher on the load testing side.

Operator

Our next question comes from Mike Latimore from Northland Capital Markets.

Michael Latimore - Northland Capital Markets, Research Division

Just onto the SIGOS, there's nothing new in terms of the SIGOS system itself or maybe network deployments that your customers that make the deployments more complex and thus more lengthy. Is that right? [indiscernible]

Umang Gupta

No, this is not that. Well, first of all, one of them is Australia, the other is Saudi Arabia. I mean, these are not European and American customers with complex LTE arrangements, et cetera. Having said that, both of these -- certainly, Australia is a pretty advanced market, and so these are advanced systems, and there is always complexity in them. And in the Saudi Arabia case, that's a pretty large -- big installment -- installation of 15 different cities in all kinds of remote locations in the Saudi Arabia. So yes, there is complexity, but it's not unusual for us to have this complexity.

Michael Latimore - Northland Capital Markets, Research Division

Okay. And you mentioned on the enterprise mobile that -- you said, I think, bookings generally did what you thought they would do. Is that -- does that mean that they're roughly the same as last quarter?

Umang Gupta

No, I wouldn't -- first of all, please note, in fact, if anything, I will say to you that while bookings did what I thought they would do last quarter or this quarter, many of those bookings came from -- there's one other fact I can talk to you today about, though it's still early, and I'll have more information in 2 weeks from now. But if there's one thing I'm sensing, and actually, not just sensing, I'm seeing in the data in front of me, is that more and more of our DeviceAnywhere bookings are coming from some form of amortizable commitment. So first of all, we've got -- in the last quarter, many of our bookings came from maintenance agreements and support agreements that were renewed. So those clearly have a 1-year amortization effect. They don't have an immediate effect. If I sell $500,000 maintenance to somebody, it's going to amortize over 4 quarters, and I'll get 125k next quarter, not 500k next quarter if I were, for example, just sold the whole system for $0.5 million, whatever. So that's number one. That's happening. Second is that many of the underlying pipeline deals that I'm seeing more and more of, I have a pretty good healthy pipeline of deals in front of me that I could see in the forecast for DA today. Healthier than many, many quarters, frankly, and it's clear to me that these deals and forecasts are all coming in from both existing sales guys and new sales guys. So that's good news. That said, many of these are for SaaS-based deals. So whereas, previously, somebody might have gone in and sold $0.5 million deal that we might have been able to recognize right away, many of these are going to be SaaS deals that'll sell for $50,000. So it's all very nice long term to get SaaS business, but as you all know, it takes longer to get your revenues in line for that. And so I would not assume by looking at bookings that you should assume revenues for the next quarter to be based on that. Bookings are a better indicator, in my opinion, today for us, at least for the DA business, of long-term health of the business rather than short-term revenues. And overall, those are the things that are making me feel good about the DA side. I am seeing -- generally speaking, I'm feeling positive about both our product and our sales productivity getting better in terms of pipelines. I am not seeing it yet in actual closed bookings for me to feel rejoice about it, and certainly, I haven't seen enough in short-term revenues for me to say very much about it.

Operator

And at this time, we show no further questions.

Umang Gupta

All right. Well, I'm -- thank you very much for joining us today and your continued interest in Keynote. And we will conduct our final second fiscal quarter results conference call on Tuesday, April 30, and we hope to provide you with more information then. Thank you very much.

Operator

Thank you, ladies and gentlemen. This concludes today's teleconference. Thank you for participating. You may now disconnect.

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