Keynote Systems, Inc. (NASDAQ:KEYN)
F2Q08 Earnings Call
April 29, 2008 5:00 pm ET
Kristen Chapman – Lipper/Heilshorn & Associates
Umang Gupta – Chairman of the Board & Chief Executive Officer
Andrew Hamer – Chief Financial Officer & Vice President Finance
Kevin Lui – B. Riley & Company, Inc.
Derrick Wood – Pacific Growth Equities
Welcome to Keynote’s conference call for the second quarter fiscal year 2008. (Operator Instructions) At this time I would like to turn this call over to Kristen Chapman, of Lippert/Heilshorn & Associates for opening remarks and instructions.
Good afternoon everyone and welcome to Keynote’s conference call for the second quarter fiscal year 2008 ending March 31, 2008. I am 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 will 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 on our website at www.Keynote.com. The replay of this call will be available by telephone by dialing 800-642-1687. The pass code is 42596169. Or by webcast at the investor relations section of our website.
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 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 and quarterly reports filed with the SEC.
We’ve provided detail guidance in our earnings release today as we have in prior quarters. This guidance assumes no additional acquisitions or other significant or other extraordinary transactions other than those described in the earnings release.
We will not comment on this guidance during the quarter but may provide an update to this guidance in the event of material changes during the quarter. Before the company reviews the financial I will review definitions for some metrics which are not in accordance with generally accepted account principals commonly known as GAAP.
The company defines non-GAAP net income or loss as net income or loss adjusted for a provision of income tax less cash tax expense, stock-based compensation expense and amortization of purchased intangibles. Non-GAAP net income per share equals non-GAAP net income divided by the weighted diluted share count as of that period end.
Non-GAAP net loss per share equals non-GAAP net loss divided by the weighted basic share count as of that period end. Net deferred revenue represents deferred revenue balance as recorded on the consolidated balance sheet and gross deferred revenue represents net deferred revenue plus the unpaid deferred revenue that has an associated accounts receivable balance as of the balance sheet date.
Now, I’d like to introduce Umang Gupta, Chairman and Chief Executive Officer.
Our second quarter fiscal 2008 revenue was $17.6 million meeting our guidance and improving from the $16.7 million in the second quarter of 2007. Our net deferred revenues continued to grow reaching $25.2 million up from $22.3 million at December 31, 2007. The growth was again fueled by strong bookings and new orders for our mobile test and measurement products.
I will review performance by product category. First our mobile test and measurements that’s MTM. For the quarter mobile revenue was $6.3 million, up 45% compared to the same period last year driven primarily by Keynote SIGOS and supported by solid subscription revenue growth. Keynote SIGOS mobile recently signed a long anticipated GlobalRoamer deal with T-Mobile in the United States.
I’m pleased to say that all North American GSM operators are now Keynote customers. Important new deals for Site or GlobalRoamer closed in the quarter included Intel, CTI Argentina, [inaudible], VMS, [Cutta] Telecom, Nova, [Roshan] and TBC Denmark. Now, our total Keynote SIGOS customer count is up to 130.
Key mobile content service deals in the quarter included a number of innovative young startups including [Mocha], Cellfire, [Sendme] Mobile, [Clickatell] and [Mblogs] all of whom will be using either our mobile application perspective or mobile device perspective services. Also during the quarter we received the acceptance of a significant Keynote SIGOS deal with a major telecom operator in Europe that we had alluded to on last quarter’s conference call. While the associated revenues did not have any impact on the second quarter, as the project was accepted at the end of the quarter, it will have a significant impact on revenues in future periods.
We remind you that our expected third quarter 2008 revenues are expected to be in the range of $18.5 to $19 million which is almost a million dollars higher than the second quarter revenues. Also at CTI held in early April in Las Vegas we launched the first of its kind SMS common short code monitoring services.
As you may be aware SMS common short codes enable enterprises to communicate directly with consumers via text messaging to buy mobile content, participate in polls and complete mobile commerce transactions. The nations market for SMS short codes is growing rapidly and our cracking hundreds of enterprises that are beginning to employ it for revenue generating or marketing purposes. Our mobile applications perspective monitoring services offer a cost efficient means to ensure the SMS short codes of getting to the intended audiences, identify transmission problems and recommend solutions that can lead to improved quality.
Last week we announced our acquisition of Zandan a private French based software company. We’re quite familiar with Zandan as about three years ago in a non-exclusive OEM deal we licensed its code to develop our mobile application perspective services. Additionally, the founder and former chief technology officer of Zandan joined Keynote a few months ago. In the transaction first, we secure exclusive rights to the technology.
Second, we gained access to the customer base including the large Spanish and French wireless carriers Telefonica and Bouygues. Finally, we believe we solidified our position as a worldwide leader in mobile test and measurement software as a service solutions. The total purchase price was $2 million Euros or approximately $3 million which included the share purchase price, debt repayment and expected restructuring costs.
Over the next six months we will restructure the Zandan business in an orderly way and then we expect the transaction to be accretive on a non-GAAP basis in Keynote’s fiscal year 2009 which begins October 1, 2008. We would like to officially welcome our new Keynote France employees from Zandan.
Lastly, I’d also like to announce a planned changing of the guard at Keynote SIGOS that will take place over the coming months. Johannes Reis who has been the president of Keynote SIGOS for the last 10 years will be retiring for his position as managing director. Taking his place is managing directors of Keynote SIGOS will be his two chief lieutenants Adil Kaya and Martin Lohlein who have been with the company ever since its founding over 20 years ago.
Both executives will report to me and are excited to take on these new responsibilities and look forward to taking Keynote SIGOS to new heights in the coming years. Johannes from whom I could not have asked for a better business partnership after the acquisition of Keynote SIGOS has longed expressed a desire to devote more time to personal pursuits. While he will not be an employee of the company after the end of this fiscal year in October, 2008 he will stay on as a business advisor to us for the next 18 months. I would like to thank him for the truly meticulous way in which he has prepared for the executive transition and I am confident that Keynote SIGOS will not miss a beat as we make this change in leadership.
Now, on to Internet test and measurement or ITM. Our ITM business delivered revenues of $9.9 million this quarter compared to $10.5 million in the first quarter of 2008. Virtually all of the decline was attributable to the reduction in consulting and load testing engagements which we believe is the direct result of the slowing economy. However, our ITM subscriptions business performed better than planned at approximately $8.9 million in revenue. This reflected the positive impact of additional revenues from new ITM customers and competitive wins especially with our multipage transaction and broadband offerings that offset the expected decline of single page, single device revenues.
We see signs that our investments in sales and marketing is beginning to pay off as our multipage broadband services continue to represent an increasing portion of ITM subscriptions reaching 84%. Also, we still believe that our single page single device business will contribute less than 10% of our ITM subscriptions revenue by the end of fiscal 2008. The key subscription and engagement deals done in the quarter, the majority of which were for multipage broadband services included Clear Channel, Apollo Group, University of Phoenix, [Astrasenica], France 24, McGraw Hill, American Airlines, Mood Networks, [Nvendi] Mobile, FaceBook, Eastman Kodak, Norwegian Cruise Line, Best Buy, American Honda, Telegraph Media and T-Mobile.
In ITM we’ve continued to innovate and delivery new products targeted at new groups of users within the companies with which we do business. We’ve always been well known for providing geographically distributed performance measurement and load testing services for [bev] operations teams and eBusiness groups.
As web 2.0 has evolved and become more complex our customers have demanded services that can be useful to them earlier in the web application cycle. Therefore, our upcoming Keynote Internet testing environment KITE 2.0 is now scheduled for release in fiscal fourth quarter, is expected to deliver innovative desktop based testing capabilities for web developers and QA personnel. We will start to talk more about this service in the coming months.
We’ve also begun to expand our reach to marketing people who may be interested in web performance measurement services. During the Ad Tech conference two weeks ago for example, we announced our search engine marketing known as SEM landing page performance reports. These are highly relevant to web advertisers since this month Google began including ad page loading time as an important factor of an ads overall Google quality score. In our SEM reports we deliver critical actionable performance data to enable customers to improve their Google quality score which in turn helps advertisers influence their position on the Google network.
Turning now to consumer experience test and measurement CEM. Quarterly revenues were $1.5 million, down compared to $1.9 million last quarter and again primarily due to a reduction in consulting engagements. Despite the challenges of growing this business, we remain positive about prospects in the long run especially with the booming use of mobile browsers such as iPhones. These new browsers spurn new performance and usability issues.
At the beginning of April we announced the first and only product on the market to run large scale task based mobile usability studies of iPhone customers interacting with the mobile web. Leveraging Keynotes on demand web effective user experience research tool researchers now have access to invaluable data revealing the motivations, perceptions and behavioral patterns of iPhone users.
Using web effective we can rapidly identify problems with the usability of iPhone applications so that our customers can truly improve their customers’ user experience. This quarter Keynote CEM deals included Auto Trader, Monster.com, Dell, JP Morgan Chase, Symantec, Microsoft, Yahoo, Travelocity and UPS.
Now, I’d like to turn the call over to Drew for a more detailed discussion of our financials.
Ladies and gentlemen I am going to start by reviewing the financial details for the quarter and then following with our financial outlook for next quarter.
For the quarter ended March 31, 2008 meeting our guidance, our total revenue was $17.6 million compared to $16.7 million in the same period last year and $17.7 million last quarter. Total subscription services and routable license revenue of $15.7 million or 89% of total revenue for the quarter increased from $13.9 million in the same period last year and $14.9 million last quarter reflecting continued success in our mobile test and measurement products. For the quarter professional services revenue contributed $1.9 million or 11% of total revenue compared to 17% of revenue contribution last year and 16% of revenue contribution last quarter.
Our customer account was approximately 2,700 companies. We track the number of customers excluding Keynote SIGOS that purchased on an annualized basis at least $100,000 or more of our services. In the second quarter 90 customers represented 65% of total revenue compared to 82 customers representing 70% of total revenue and 92 customers representing 72% of total revenue in the second quarter of 2007 and the first quarter of 2008 respectively.
At the end of March, 2007 we measured approximately 13,000 pages through our Internet test and measurement business. This compares to 10,500 pages in the quarter a year ago and approximately 11,800 pages last quarter. For the second quarter 2008 overall average monthly revenue per page for the quarter was $183 compared to $220 and $194 for the quarter a year ago and last quarter respectively.
Now, I’ll review our expenses. Total expenses were $19.8 million including $1.2 million in stock-based compensation expenses and a $753,000 charge for amortization of intangible assets. Last quarter total expenses were $19.4 million including $1.1 million in stock-based compensation expense and a $742,000 charge for amortization of intangible assets. Expenses in the current year’s quarter were higher by $400,000 sequentially due primarily to our investment in sale and marketing.
In the second quarter 2007 total expenses were $18 million including $1 million of stock-based compensation expenses and a $760,000 charge for amortization of intangible assets. Also during the quarter we recorded a $45,000 charge for estimated income tax expense. This compares to a $244,000 charge for estimated income tax expense in the first quarter of fiscal year 2008 and a benefit of $193,000 in the second quarter of 2007.
Our GAAP net loss was $1.3 million or $0.08 per share compared to the first quarter of fiscal 2008 net loss of $744,000 or $0.04 per share and the second quarter of fiscal year 2007 GAAP net income of $30,000 or breakeven. The non-GAAP net income for the quarter was $496,000 or $0.03 per share compared to non-GAAP net income of $1.1 million or $0.06 per diluted share for last quarter and $1.4 million or $0.08 per diluted share for the same quarter a year ago.
For the quarter cash provided by operating activities was $2.5 million compared to $6.8 million for the same period last year. We invested $1 million in property, equipment and software this quarter and $1.4 million in the same quarter last year. We also received approximately $1.5 million from the issuance of common stock and the exercise of stock options in the quarter compared to $2.5 million in the same period last year.
As we previously announced, our board authorized four million shares of our common stock for repurchase. Subsequent to that the board authorized another one million shares for repurchase. During the second quarter of 2008 the company repurchased approximately 4.2 million shares for approximately $49.2 million. Thereby purchasing five million shares for approximately $60 million and completing the program established in November, 2007.
Cumulatively, the company has repurchased 19.3 million shares for approximately $195.3 million. The total shares outstanding net of treasury shares as of the end of March 31, 2008 was 13.8 million shares as it compared to 17.4 million shares as of March 31, 2007.
Now, moving to the balance sheet and our cash performance metrics. At March 31, 2008 our cash and short term investment balance was $55.1 million. As of March 31, 2008 accounts receivable net was $7.6 million. DSOs were 39 days and 96% of accounts receivables were less than 90 days old. Total net deferred revenue at March 31, 2008 was $25.2 million, up 29% compared to $19.5 million at March 31, 2007 and up 13% from $22.3 million at December 31, 2007.
Now, I will provide some general guidance for the 2008 fiscal third quarter ending June 30, 2008. Total revenue is expected to be between $18.5 million and $19 million. GAAP loss per share is expected to be between $0.08 and $0.03. Non-GAAP earnings per share are expected to be between $0.00 and $0.05.
The above guidance was based on the following assumptions: total stock-based compensation expense and amortization of intangible assets is expected to be approximately $1.9 million; depreciation is expected to be approximately $1.4 million; interest income net is expected to be approximately $500,000 assuming no material changes in interest rates and currently planned uses of cash; cash paid for income taxes is expected to be approximately $800,000 assuming no changes in required tax payments; basic weighted average shares outstanding are expected to be approximately 13.8 million shares and diluted weighted average shares outstanding are expected to be approximately 14.1 million shares assuming no additional issuances of equity of equity related securities.
This guidance does not reflect the impact of the recently announced Zandan acquisition and its associated costs which we plan on calling out separately over the next two quarters until the new subsidiary is well integrated and we begin the next fiscal year.
With that I’d like to return the call to Umang.
During the second quarter we were extremely encouraged by our mobile business and our progress in our ITM subscriptions business. While we believe economic pressures have impacted out engagements in both ITM and CEM we are confident that in the long run they too will experience growth. Keynote continues to do very well with mobile content companies like AOL and MSN as well as with the larger telecoms. Now, we are expanding our scope to work with enterprises big and small who are adopting common short codes for mobile marketing and mobile commerce.
The industry trends behind our business are quite positive particularly in the mobile world. Many Smartphones are incorporating browsers that support the latest capabilities such as [AJAX] and RSS as well as websites optimized for viewing on a mobile device. Recently AVI Research stated that this segment of the mobile browser market accounts for the fast majority of growth over the next five years as the open Internet browser segment for mobile will grow from 76 million in 2007 to nearly 700 million browsers in 2013.
As such, with this growth there will be many companies of all sizes attempting to play in this arena. To make their mark they will need a competitive edge in the quality of their content, the usability of their applications and the speed of their services. We stand ready to help them achieve these goals and to enhance their competitive position.
We feel good about our year-over-year growth and remain confident about our future prospects. Now, Drew and I will be happy to take any questions you may have.
(Operator Instructions) Your first question comes from the line of Kevin Lui – B. Riley & Company, Inc.
Kevin Lui – B. Riley & Company, Inc.
I guess first question just in terms of the CEM segment I know you guys are positive on the long term growth prospects there but just curious kind of what you guys can do in the near term to either try and drive some renewed growth there or maybe improve the profitability of the overall segment?
First of all let me just point out that while we are disappointed by CEM having kind of gone down below what I always thought was sort of like a low point at least until last quarter which was about $2 million. It is important to note that in this particular quarter the reduction of CEM was also accompanied by a pretty significant reduction of our load testing and ITM engagement business.
And, I have no reason to believe in this particular quarter at least that this was sort of limited to CEM. I think it was much more a situation where consulting engagements in general are very easy to defer or cut during an economic climate slowdown and that happened with both our ITM consulting engagements and our CEM consulting engagements.
Our CEM subscriptions remained constant, our CEM KSR studies did well and in fact, our Web Excellence, the score card business, the subscription portion of our CEM business did quite well. So, the real reduction was in the consulting custom engagement and like I said I think that may have very well had more to do with the economy than perhaps the CEM business per say.
Kevin Lui – B. Riley & Company, Inc.
Then last quarter you guys highlighted kind of a shift in terms of how you’re billing some of your larger customers to more of a utilization based model or a pricing in arrears. Can you talk about what the impact on revenues during the quarter from that initiative was?
I would be hard pressed to give you a direct correlation between that initiative and the impact of revenue but I can say to you in a pretty positive way that we’re feeling pretty good about our ITM subscriptions business. We really thought that our ITM subscription business was going to take a hit this quarter as we reduced our website perspective products down to the 10% goal but, it didn’t happen.
We were able to overcome that reduction which was expected but with unexpected growth in the subscription side from various customers, new deals we’ve done and I do believe that many of these are a result of the investments we’ve made in the sales and marketing and also in the changes we’ve made in how we sell these products where previously we were typically asking for a certain amount of money upfront or essentially getting people to commit to a certain amount for the year. With the bill in arrears method they still need to commit for a certain amount so the commitment is still required but they can dial up and down what they need and the good news is that they needed more last quarter which his pretty good for us?
Kevin Lui – B. Riley & Company, Inc.
So are you seeing this as a trend for more of your customers beyond just the larger ones or is this primarily concentrated amongst the larger customers?
No, it’s actually, that’s the other thing, if you take a look at our numbers, some of the data you just saw, the number of customers that are buying more than $100,000 has gone up to 90 if I recall, somewhere in that 90 range which is at the high end of the scale. I think over the last seven year period I don’t think we’ve ever exceed more than like 95 so it’s at the high end of the scale of customers buying $100,000 or more.
However, the fact is that that represented only 65% of our subscriptions revenues which says that the rest of the revenue is being pretty well spread out among the people who are not in our top 100 and I think I am seeing those trends and that’s all good news because it says that there’s a diversified growth going on and there’s not just growth going on from a few large customers.
Kevin Lui – B. Riley & Company, Inc.
Then just lastly in terms of the sales and marketing expenses I know you guys had been investing there and starting to drive some of the revenue growth. I’m just curious what level of incremental investment should we expect as we move throughout the rest of this year and then perhaps then talk about our initial plans for 09.
I think for now we’re pretty much full up until the marketing investment in the United States. We expect to make investments in Europe that will largely be SIGOS related or overseas, let me just probably say overseas but mostly Europe and elsewhere. That will be SIGOS related.
So, there are some expectations of cost increases in the sales and marketing in the next six months in the SIGOS side, maybe just a few more headcount that will occur on the Keynote side but, in fact, with the recent acquisition of Zandan you will in fact see certain increases that will occur in Europe anyway because of the sales and marketing increase that will occur from Zandan. But, for the next six months we won’t call that out separately.
But, other than those increases I really have no plans at this point for us to increase sales and marketing in the United States until we see more growth, more results of the investment that we’ve been making over the last couple of years.
Your next question comes from Derrick Wood – Pacific Growth Equities.
Derrick Wood – Pacific Growth Equities
First of all just curious on the quarter that you saw the gross margin on the services business come down quite a bit. Obviously, you saw some negative impact on services revenue so is that a fairly fixed cost and really gross margin is driven by revenue more than anything else?
I think largely so that is true while the [CUX] business some of our external costs went down that have to do with panel management and the amount of money we spend on panels clearly went down. It is a fixed cost business and all I can say to you is our gross margin goals typically in the service business are somewhere in the 50% kind of range and we did not make those goals in the past quarter. But much of them have to do with the reduction on top line rather than a bottom line issue.
Derrick Wood – Pacific Growth Equities
And, just curious about the currency benefit in the quarter and maybe what the international, what the percentage of revenue from international was?
No question we’ve been benefitting from the currency increase improvements. I believe currency has gone up over the last year from let’s say the Euro has gone from about $1.30 to $1.55 somewhere in that range so it probably has been about a 20% swing in the Euro and that has definitely helped us.
But, when we last did the math on this we were pretty confident that there was – I’m just going to guess this, please don’t hold me to it, but I thought maybe two thirds of the growth really had nothing to do with currency translations.
Derrick Wood – Pacific Growth Equities
The percentage of revenue that was from international do you have that?
We don’t have that off hand right here. International revenue represented in the quarter 40% of the total revenues.
Derrick Wood – Pacific Growth Equities
I guess moving on to mobile, Keynote mobile looks like it’s starting to take off there. Can you give us some idea of what, I guess we know what the drivers are. Is that coming from a couple of your large customers spending a lot more like AOL and MSN? Or, is that revenue growth coming from a lot of new customers coming on board?
The income I am pleased to say that it is not coming from just a few large customers. We have almost 30 customers right now in Keynote Mobile in the United States at work for the non SEGOS mobile portion.
Derrick Wood – Pacific Growth Equities
Then obviously just the drivers are the adoption.
Yes, whether it was just an AOL, or a Microsoft, or a Google or anybody else, people were using our products to do measurements much the same way they would do them on the Internet site except that these are tradition Internet customers who have large mobile presences and who now need our mobile services rather than just our Internet services.
And I’d point out that our goal really is that every one of our Internet customers one day opt to be a mobile customer. That may take many, many years but certainly the top 200 of our 2,700 Internet customers are all companies we believe who have a good potential overtime to become mobile customers for us.
Derrick Wood – Pacific Growth Equities
Is the pricing very different on the mobile?
It is different. Your question is, is the mobile pricing different from our Internet pricing? Yes. Ultimately the difference is that in the mobile world because the Internet is free so I can do measurements from 50 different cities and buy and all you can use plan and be confident that my cost will only go up a certain amount but not too much.
However, on the mobile world except for the United States most of the places don’t have all you can use plans and also the speed at which you can do these measurements because clearly even with 3D you’re talking about much, much lower speeds. Rather than gigabit speeds you’re talking about maybe megabit speeds. So, you end up doing fewer measurements for the same price and therefore the price per measurement is higher for mobile than for Internet and that’s just the nature of the business.
Derrick Wood – Pacific Growth Equities
Then on the SIGOS side in North America now that you’ve got the carrier signed up, how far penetrated are you? What’s the opportunity within those carriers?
The opportunity in the carriers in both North America and South America is huge for SIGOS. The fact is that there’s only three GSM carriers today that we’ve got and they’re all three that we’ve got here. Those are Rogers, Cingular and T-Mobile now but all of them are really only using our GlobalRoamer service and GlobalRoamer represents less than 10% of SIGOS revenue.
The bulk of SIGOS revenues come from [inaudible] licenses and those licensees if we were able to penetrate these accounts we are talking about potentially multimillion dollar deals. But, to do those we need to unseat an incumbent, the incumbent today is JDSU with a company they bought called [Captibyte] and we believe that for a long time [Captibyte] basically managed to penetrate these accounts because they had no competition in the United States. Now, they have competition and we expect to go after that.
Derrick Wood – Pacific Growth Equities
If we could talk about guidance, I mean you have a lot of moving parts on your various revenue line items here. What’s the environment right now on the services side? Are you expecting a rebound or is it pretty difficult to get stuff closed at this point? Then, I guess we’ve got visibility on the Internet side but mobile, if you could maybe talk about seasonality here?
Looking to start with mobile which is the easiest, we have seen no slowdown in mobile as you can see, in fact it’s gone up albeit from a small base in the Keynote mobile side. In the SIGOS mobile side we have a large base but on the other hand we have a large customer base at least right now worldwide that does not seem to be affected at all.
These are large telecom operators that have essentially built in their budget for this year last year and so right now it’s just a matter of going after those existing budgets. It’d be too hard for me to project in to next year. Seasonality wise, we fully expect the December quarter to be our best quarter at SIGOS. It has historically been that way and I don’t see any reason why that won’t again be the case.
Clearly, if we do well this year which we hope we will and [inaudible] our December quarter then we will essentially be basing in to 2009 hopefully good revenues on the GAAP side as a result of doing well with bookings this side. Just as we are doing now getting the benefits of everything that happened last year in 2007. That’s the mobile side.
On the Internet side I think there’s a huge difference between subscriptions and engagements. I really feel on the subscription side quite positive right now. I mean, we’ve gone through seven years with some parts of our business going down and other parts of our business going up. We’ve gone through a recession, we’ve gone through the worse tech depression we ever had after last time around and believe me at this stage it just feels more and more like this is more a product issue at this stage.
In other words, as long as I can get rid of the single pay, single device stuff now I don’t know if we should be too affected by the recession. I could be proven wrong later but right now at least we feel like if we can get past the next couple of quarters of reductions there should be good growth next year from this business based on at least the momentum we’re seeing so far among those customers.
On the engagement side it’s totally going to be dependent on the economy. We have definitely taken a hit last quarter on the engagement side. The good news is we’ve been very careful about our costs, we have not gone out and over hired people and obviously we continue to monitor our costs relative to our revenues in the engagement side. But, assuming this recession is short and shallow which is just a couple of two or three quarters then we ought to see it start to pick up towards the end of the year.
One other point to note about our business is that at the end of this year the calendar year, we usually see seasonal benefit in the engagement side. As you get towards the holidays people end up needing load testing, people end up needing usability testing so generally for us the September quarters and December quarters are the best regardless of recession or no recession.
I think we may have seen a pretty tough quarter on the services side last quarter. Maybe we’ll have more tough one but I’m hopeful after that we’ll start to see the uptick.
Derrick Wood – Pacific Growth Equities
I just wanted to kind of drill in to that a little bit more, you see total revenue flattish to slightly down over the last couple of quarters and all of a sudden you’ve got an expectation of a fairly big jump sequentially and I’m just trying to get a sense of what the biggest driver is for that sequential revenue jump?
Okay. Well, you may recall from our last quarter’s conference call we told everybody we would have had a much better quarter in the first quarter if we did not have this large telecom deal with SIGOS that was being held up because of German GAAP to US GAAP revenue recognition issues.
One particular project out of six or seven multinational deal projects had been held up and because of that being held up nothing got recognized for a couple of quarters. That’s what you’re really seeing here, two quarter of pretty much not that much growth in the SIGOS mobile. Not because SIGOS wasn’t growing on the booking side but mostly because their revenue wasn’t showing up on our US side. Now, that project got accepted in the last month of last year of last quarter and we’re starting to see the effects this quarter and the coming quarters.
Your next question comes from the line of [Brian Kenspointer].
The first question I have was related to the acquisition. You’ve said on a couple of occasions you plan on calling it out separately but I’m curious, I mean no one has really asked what you bought? We all understand the technology but in terms of showing revenue or earnings or profit? So I guess while you’ve talked about some expectations I’m curious how dilutive this is going to be to GAAP earnings because you keep saying only non-GAAP is going to be accretive and that is next year. So, if you can give us a sense that would be helpful.
Let me just start by explaining to you why we did the acquisition and what that was all about and then we can talk about earnings and dilution or otherwise. Zandan is a small company with sub $1 million Euros in revenues, less than $1 million Euro of revenues. They have 14 people but they were unprofitable. We did a deal with them three years ago and that deal was a non-exclusive deal which allowed us to build a very good product called mobile application perspective which is delivering up some pretty nice revenues in the United States right now.
But recently we found that Zandan was running in to some financial difficulties and we were worried that those financial difficulties might end up causing them to fall in to competitive hands. We felt at that stage that rather than have the same technology that we had showing up in competitive hands we would rather just buy the technology outright and make it essentially an exclusive deal.
So net/net think of this as essentially a two stage acquisition. We bought the source code three years ago and then we bought the company this time around with the people. The total cost of the acquisition is about as I said $3 million but if you look at our 8K you’ll find that we paid less than $1 million Euros to the shareholders so much of what we had to do was to clean up the books, the company, the debt, restructuring the company and all of that will take place in the next six months and that will probably cost us another $1 million Euros.
When we’re done, like everything else we do we expect this business to be accretive starting next year. And, accretive means on a cash flow basis revenues will be greater than costs. So, whatever the number of employees are which will be less than 14 we’ll expect to do it in a way so that the revenues will be greater or the same of what it costs us.
Will the revenues be any greater than what we had when we bought the company? Unlikely next year which means it will definitely be less than $1 million Euros and dollars. That’s why we are not making a big deal of the accretion versus non-accretion. We’re saying, “Look worse case it will be kind of breakeven. It might make a little bit of money.” But, the real benefit of this is we now have exclusive technology.
Again, you’re going back to non-GAAP so I’m curious today what are we looking at in terms of both GAAP and non-GAAP before you restructure the profits of this company?
Well, we’ve given you our guidance for GAAP and non-GAAP for the coming quarter. Those guidance are in our press release and those have not changed. What we said is they do not include the effects of the restructuring simply because they would just confuse the nature by putting them in.
So minus the $1 million restructuring Zandan would be breakeven other than that?
Yes. Once we’ve done the restructuring starting next year it will be breakeven. Absolutely.
I’m going to follow up on some of the questions people asked about professional services and unless I’m wrong, I put the wrong expenses, there looks like you had a gross margin of 7%, $1.8 of costs and $1.9 million of revenue. I’m wondering at what point and I think the first person asked the question is there anything you can do to get rid of some of those fixed costs? I know it’s people intensive but it we’re not sure demand is going to come back so soon at what point do you say, “I need to cut some of those costs.”
That’s a fair statement. I mean guys ultimately we look at this on an annual basis. We believe that we are going to see some uptick in the September and December quarters of this year simply based on seasonal factors alone. So, unless we really had a bad Christmas I would be hesitant to letting go people because I do believe the revenue will come back. But, at some point, for example if we really had a bad Christmas and everything was terrible, the recession was going on in to next year then we’d have to take a look at it.
I’m taking a look at growth in what I think is broadband services it’s posed as a single page testing, based on the data you gave the 16% if I take a look at, and I’m excluding this quarter you just reported, if I exclude this quarter you had three consecutive quarters of 20% to almost 30% of year-over-year growth on broadband transaction services. And, this quarter was only 6% so I’m curious what the underlying factor for such a dramatic slowdown?
I think I would say at this point this is hard to say on any given quarter what happens. I think what you will find is that next quarter we fully expect that we will be coming back, the current quarter we’re now in, coming back to those kind of numbers that you’ve seen in the past. At least the currently preliminary URL top that I’ve seen tells me that we’re doing pretty good and so I’d be hesitant to just look at one quarter and try and make a trend out of it.
Based on your guidance that’s more so because June’s a weak quarter of last year at $2.3 million and not really because there’s going to be a sequential bump?
No, no. There will be a sequential bump this quarter in our subscriptions business based on the data we have today which is the end of the first month of the current quarter, we are reasonably confident we will see an increase in subscriptions this quarter.
In terms of sales and marketing, in December it was clear, I think even now that the costs when you’ve gone up $1.3 million in costs it’s about 40% more costs in two quarters going on the sales and marketing line. Is all of that going in to the SIGOS hiring? You explained it a little bit but I thought after the first quarter it was mostly done and now you’ve had a huge jump up again sequentially. What is the dollar value because you’ve really positioned this as a leverage business that you’re looking for to get the total sales and marketing line to before there’s pretty much no additions other than the variable pay portion.
First of all, please note that at any given quarter the reasons these cost could go up are all kinds of extraneous reasons. For example, in this most recent quarter our sales and marketing sales line actually went up because we did our president’s club so that costs a few $100,000 and I think there was one other thing. There was another customer event. There was a time when you’d be allowed to amortize these once a year events over an annual period, we’re not allowed to do that.
So, in effect when we have the event we pay for it so that’s really what happened in this last quarter. I would not say that we had significant increases in headcount this last quarter for Keynote sales people. I think we did have headcount increases on the SIGOS side but on the Keynote sales side I do not believe there were significant increases. I’m looking at the data in front of me.
I guess two follow ups to that is in the second quarter how much of the $6.5 million do you characterize that you just said to the non-recurring? Was it more like a $6 million non-recurring number? Or, was it more like $5.8 like the first quarter?
[Inaudible] $300,000 of non-recurring costs in sales and marketing.
Then SIGOS where are you in terms of total sales force compared to maybe a year ago? I think you only had one sort of team up there but I could be wrong. So maybe give a sense of the SIGOS hiring, we’re you’re at now versus a year ago?
Let’s put it this way, SIGOS hiring sales force wise in terms of headcount has gone up by about 25% or so over a year ago and we probably have another 25% to go.
What kind of cost do you expect that might have over an annual, let’s say two years from now or a year from now that’s completed, what kind of costs does 25% more sales people on a fixed basis costs?
I honestly rather have Drew try and work these out with you individually because I don’t want to try and guess at these numbers. Typically, when we add people it’s whatever number of people are at costs. We don’t provide detailed guidance at individual line item levels but we can tell you that it will go up some.
The last question I’ve got is on the tax line you mentioned $800,000 I think is what’s going to run through the P&L actually? In the last quarter was $45,000, the quarter before $244,000. Why such a spike in the taxes? If you could just give us a sense of what’s going on there.
We actually talked about this last quarter where we were anticipating we would have about an $800,000 cash tax. This is used for non-GAAP purposes it’s not GAAP. The payment that was necessary last quarter wasn’t required so we didn’t pay it so it’s rolling over in to this quarter and the net effect is just a quarter-to-quarter roll over on that item.
Please note we’re talking about these are largely German taxes because there’s not that much transactions we pay in the United States. These are Germany taxes, they take place once a year and the basic kind of definition we have of our non-GAAP is that we exclude all of the sort of GAAP tax factors out of it but we do add back any real cash taxes we pay and it just happened hear from last quarter to this quarter.
So that $800,000 is more of cash flow number, it’s not going to be reported on the P&L which was the $45,000 you mentioned today?
That’s right. What’s recorded on the P&L according to US GAAP.
Can you remind me where your cash is and what your, especially pertaining to how much is in the US versus not? I’m just going to take a venture to say none of it’s in auction rate securities.
That’s a safe guess. Where is cash and what’s it invested in? We have about $55.5 million in cash that you see on the balance sheet. About $20 million of that is offshore it’s in Germany and its invested in money market funds in Europe. The balance is here about $35 million in cash and a lot of that is probably about two thirds is in money market accounts at this point with the remainder in bonds that are maturing, all safe high quality bonds. No auction rates or any fancy investments where we’re trying to squeeze out an extra half percent or anything.
I guess my last question is I’m still, and what leaves me uncomfortable is I’m confused about the acquisition. Forgetting the fact that if you are restructuring a million dollars, after that’s all said and done how dilutive it still is for getting that million dollars in the numbers, I guess it’s still unclear.
Let’s just do the math for a second. We have 14 people and let suppose for this discussion and I don’t want to be held to this but let’s say we went from 14 down to six or seven people. Well, even if an average person where to cost you $100,000 Euros per person fully loaded with all the other costs associated with it, that six or seven people might cost you $600 or $700,000 of costs.
If it’s costing you $600 to $700,000 in costs and our revenues are let’s say less than $1 million Euros, let’s say $600 or $700,000, that’s a breakeven business. The point is we’re not going to get to six or seven people for another few months because it retracts as you do the restructuring, it takes you some time. You have to give a certain amount of notice, you have to tell people, you have to pay them a certain amount of severance. All that has to occur and that’s what’s going to occur over the next six months.
Is their revenue subscription where it’s also perpetual or how do they recognize revenue?
It’s a combination. They have some amount of revenues which is pure subscription revenues and we hope to be able to keep all of that and simply transfer those products over to our products. But then some of it was also deals that they’ve done that involved some kind of license deal and to the extent that some of those we might be able to sell them SIGOS, we’ll sell them SIGOS products. To the extent that we can sell them our mobile application perspective service, we’ll sell them our mobile application perspective product. It depends on the customer. We’re only talking about a half dozen customers that we have to move.
Your final question comes from the line of [Matt Hewitt].
Just quickly, you’ve got a nice step up here in guidance for revenues for next quarter. Do you expect that to be sustainable? I mean it’s kind of stepping up above 18.5%. Do you expect that to stay above the 18.5% as you look out in to Q4 and in to next year? Or, do you think there was a one-time impact because of the European deal?
Let me just start by saying that we do not give guidance beyond one quarter, as you know. That said, we have been I think quite clear to say to you that this increase of revenues is a multi quarter revenue increase because it is SIGOS revenues that are being ratably recognized over multiple quarters. So, clearly it’s not just a one quarter event.
There are no further questions at this time.
Ladies and gentlemen thank you again for joining us today and for your continued support. We look forward to discussing our company with you at various investor conferences we’ve schedule in the upcoming months including the AeA Micro Cap Conference in Monterey, California next week and at the Cowen Technology Conference in New York at the end of May. Thank you very much.
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