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Keynote Systems, Inc. (NASDAQ:KEYN)

F3Q08 (Qtr End 06/30/08) Earnings Call Transcript

July 29, 2008 5:00 pm ET

Executives

Kirsten Chapman – IR

Umang Gupta – Chairman and CEO

Drew Hamer – CFO and VP of Finance

Analysts

Brian Kinstlinger – Sidoti & Co.

Justin Cable – Global Hunter

Ryan Bergen – Craig-Hallum Capital

Derrick Wood – Pacific Growth

Douglas Whitman – Whitman Capital

Kevin Liu – B. Riley & Co.

Operator

Good afternoon, everyone, and welcome to Keynote’s conference call for the third quarter fiscal year 2008. Today's conference is being recorded. At this time, I would like to turn the call over to Kirsten Chapman for opening remarks and introduction.

Kirsten Chapman

Thank you, Dory. Good afternoon, everyone, and welcome to Keynote’s conference call for the third quarter fiscal year 2008 ending June 30, 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've 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 at our website at www.keynote.com. The replay of this call will be available by telephone by dialing 1-800-642-1687. The passcode is 55216017, 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 the actual results might 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 have provided detailed guidance in 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 material changes during the quarter.

Before the company reviews the financials, I will review definitions for some metrics, which are not in accordance with the generally accepted accounting principles, commonly known as GAAP. The company defines non-GAAP net income or loss as net income or loss adjusted for provision of income taxes, less cash tax expense, stock-based compensation expense, and the 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. The 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 would like to introduce Umang Gupta, Chairman and CEO, and Drew Hamer, Chief Financial Officer. Please go ahead, Umang.

Umang Gupta

Thank you, Kirsten. Welcome everyone and thank you for joining us today. We posted a strong quarter, delivering the highest revenue in the company's 13-year history. Third quarter fiscal 2008 revenue reached $20.5 million, exceeding our guidance and rising 17.9% from the $17.4 million reported in the third quarter of 2007. It's been a very exciting quarter across all product lines.

I will review performance by category. First, our mobile test and measurements. For the quarter, mobile revenue was $8.3 million, up 81% compared to the same period last year and 33% sequentially, driven primarily by Keynote SIGOS and supported by solid mobile subscription revenue growth. Keynote SIGOS signed ten more GlobalRoamer and SITE deals, bringing our June 30 customer count up to 139.

The important new deals included Cell-Tel, Wind Hellas, Unitel, Claro Paraguay, Claro Uruguay, Vodafone Germany, Hutchison Hong Kong, Vip mobile in Serbia , Vip Operator in Macedonia, and as announced on the last conference call, T-Mobile here in the United States. Now we serve all of the top three North American GSM operators. And with the Zandan acquisition, we added wireless carriers, Telefonica and Bouygues to our customer base.

Key mobile content service deals in the quarter included ClairMail, MX Telecom, Twitter, Visto and ChaCha Search, all of whom will be using either our Mobile Application Perspective or Mobile Device Perspective services. And as announced last week, SendMe Mobile selected our on-demand Mobile Application Perspective for common short code performance monitoring to ensure that their SMS customers obtain reliable, speedy, and dependable service.

I would like to provide you with a quick refresher regarding our products and services in the mobile arena. With SITE and GlobalRoamer, we test and measure end-to-end service quality of mobile operator networks. With SITE and Mobile Application Perspective, or MAP, we test the quality of mobile content and applications for mobile developers and service providers.

With Mobile Device Perspective or MDP, we provide on-device monitoring of mobile application and services for operators and application owners. In April, we launched a first of its kind MAP service for monitoring SMS common short codes. Short codes enable consumers to buy mobile content, participate in polls, and complete mobile commerce transactions via text messaging. This message is – this market is growing rapidly as hundreds of enterprises begin to better understand how to generate sales through the use of common short codes.

Also in April we acquired Zandan, which secured our exclusive rights to the MAP technology and to their mobile test builder product. We intend to re-label this desktop software product as MITE or Mobile Internet Test Environment, which we expect to deliver shortly. It will follow the same marketing model as KITE, which I will elaborate on in a minute.

Now, onto Internet test and measurement, ITM. Our ITM business delivered revenue of $10.3 million this quarter compared to $9.9 million in the second quarter of 2008, reflecting the acquisition of new customers, especially for our multi-page transaction and broadband offerings. Notably, our multipage transaction and broadband services now represent 90% of ITM's subscriptions revenues. The single page, single device business has reached our stated goal of 10% of our ITM subscriptions revenue ahead of plan. As such, we believe any further reduction in this legacy product line should have a nominal impact on our Internet subscriptions revenue growth.

The key ITM subscription and engagement deals done in the quarter included CBS RADIO, Coupons.com, Costco, Espree, Federal Reserve Bank, ITV, MarketLive, Moody's Corp., Philip Morris, See’s Candy, Symantec, and US News & World Report. We continue to lead in product innovation in the Internet test and measurement space. At the Velocity Conference in June, we launched KITE 2.0, the Keynote Internet test environment for Web 2.0 sites.

As the Internet cloud becomes more and more complex, Keynote is again leading the industry with easy to use solutions that address the issue of service quality. With KITE 2.0, Keynote customers can now easily record and execute Web 2.0 transactions on the desktop and upload them to Keynote's on-demand global test and measurement network to assess the performance impact from the end-user perspective.

KITE 2.0 expands a target user base to enable IT operations, QA and web developers to work collaboratively. As such, test and measurement productivity advantages are broadened to the entire application lifecycle, which enables our customers to increase the reliability, responsiveness and effectiveness of their Web 2.0 sites. KITE 2.0 is currently available free of charge to Keynote customers, and next week we plan to extend the free offering to all web developers across the world.

The idea behind this aggressive program is that we want to encourage all web developers to freely use KITE to write scripts and test them from their own desktops. Then when they wish to test their scripts from the Internet cloud in order to uncover performance problems from an end-user perspective, they will be given an opportunity to purchase our on-demand test and measurement services via our website, which in turn should help us increase our Internet subscriptions and revenues in a very cost efficient manner.

Turning now to customer experience management, CEM. Quarterly revenues were $1.9 million, up from $1.5 million last quarter. CEM deals included Best Buy, Bank of America, Carnival Corporation, Capital One, Genentech, Hartford Insurance, Hertz, IBM, Kodak, Norwegian Cruise Lines and User Vision. We are seeing our products like WebEffective. We provide real user feedback and constructive areas of improvement for online services in mobile products like the iPhone.

Recently we have noticed a growing number of our customers have begun to purchase multiple engagements from us; spanning, Internet test and measurement, and customer experience management. So in July, we integrated all of our professional services groups under one senior executive in order to streamline delivery and maximize technical and business development synergies.

The primary mission of our consolidated professional services group is to help our customers gain better insights from the use of Keynote products and to drive increased revenues from our Internet subscriptions. It also helps us create and provide competitive research studies that act as a self-paid marketing tool for all of our Internet services. As a result of this reorganization, beginning in the fourth quarter we will present our ITM and CEM revenues under a single category called Internet revenues. And within that, we will call out the revenues associated with Internet subscriptions and Internet professional services separately.

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 and then follow with our financial outlook for next quarter. For the quarter ended June 30, 2008, we exceeded guidance and generated the highest quarterly revenue in our history. Our third quarter total revenue was $20.5 million compared to $17.6 million last quarter and $17.4 million in the same period last year. This stronger than anticipated performance was mostly due to greater SITE revenue, which reflected a number of accounts accepting and beginning recurring revenue recognition earlier than scheduled.

Total subscription services and routable license revenue of $17.9 million, or 87% of total revenue for the quarter, increased from $15.7 million last quarter and $14.3 million in the same period last year, reflecting continued success in our mobile test and measurement products. As Umang noted, our legacy single page, single device subscriptions declined to 10% of ITM subscription revenue this quarter.

For the quarter, professional services revenue contributed $2.6 million or 13% of total revenue compared to 11% of revenue contribution last quarter and 18% of revenue contribution last year. Our customer account 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 third quarter, 91 customers represented 65% total revenue compared to 90 customers representing 65% of total revenue and 80 customers representing 72% of total revenue in the second quarter of 2008 and the third quarter of 2007 respectively.

At the end of the June 2008, we measured approximately 13,900 pages through our web performance measurement services. This compares to 11,100 pages in the quarter a year ago and approximately 13,000 pages last quarter. For the third quarter of 2008, revenue per page for the quarter was $169 compared to $218 and $183 for the quarter a year ago and last quarter respectively.

Now I will review our expenses. Direct cost of services was $5.5 million or 27% of revenue compared to $5.1 million or 29% of revenue last quarter. With the Zandan acquisition, we brought on three engineers who are dedicated to the technology and three salespeople who have filled open positions in our European sales team. As such, this quarter the expenses attributable to Zandan engineers were mostly offset by Zandan's revenue contribution of $74,000.

Sales and marketing expenses were $6.7 million or 33% of revenue compared to $6.5 million or 37% of revenue in the second quarter of 2008. Excess occupancy income reflects rent received from tenants in our building, offset by expenses associated with the non-Keynote occupied portion of our building. This quarter it was $297,000 compared to $309,000 last quarter.

During the past quarter, we reduced Keynote occupancy from three floors to two floors, thus freeing almost a full floor for additional occupancy and also added more tenants thereby increasing rent. While this will clearly be good for the bottom line, since we are immediately lowering Keynote expenses, we will also end up with correspondingly lower excess occupancy income until we lease out our newly freed up space.

In summary, total expenses were $21.1 million, including $1.1 million in stock-based compensation expenses and $849,000 charge for amortization of intangible assets. In the second quarter of 2008, total expenses were $19.8 million, including $1.1 million in stock-based compensation expenses and a $753,000 charge for amortization of intangible assets. Expenses in the current year's quarter were higher by $1.3 million sequentially, primarily due to an increase in cost of goods sold reflecting higher revenue and $300,000 in G&A expense related to auditing and consulting services. In the fourth quarter, we expect the G&A expenses to return to the same levels as those in the second quarter of 2008.

Also during the quarter, we recorded a $140,000 charge for estimated income tax expense. This compares to a $45,000 charge for estimated income tax expense in the second quarter of 2008 and $1.3 million in the third quarter of 2007. Our GAAP net loss was $407,000 or $0.03 per diluted share compared to $1.3 million or $0.08 per share for the second quarter of 2008, and $1.5 million or $0.09 per share for the third quarter of 2007.

The non-GAAP net income for the quarter was $1.3 million or $0.09 per diluted share compared to $496,000 or $0.03 per diluted share for the last quarter and $1.3 million or $0.07 per diluted share for the same quarter a year ago. For the quarter, cash provided by operating activities was $2.1 million, which was negatively impacted by approximately $900,000 for payments of assumed liabilities that were incurred as part of the Zandan acquisition. This compares to $2.5 million in the prior quarter and $5.9 million in the third quarter of 2007.

We invested $1.6 million in property, equipment, and software this quarter compared to $1 million in the prior quarter and $2.1 million for the same period last year. We also received approximately $785,000 from the issuance of common stock and exercise of stock options in the quarter compared to $5.2 million in the same period of last year.

Due to the timing of trade settlement, our common stock repurchase program officially ended the first week of the quarter with 91,500 shares for $1.1 million. Since the company went public in 1999, cumulatively we have repurchased 19.3 million shares for approximately $195.3 million. The total shares outstanding net of treasury shares at June 30, 2008 was $13.8 million compared to $17.9 million at June 30, 2007.

Now, moving to the balance sheet and our cash performance metrics. At June 30, 2008, our cash short-term investments balance was $53.9 million. As of June 30, 2008, accounts receivable net was $7.3 million. DSOs were 32 days and 95% of accounts receivable were less than 90 days old. Total net deferred revenue at June 30, 2008 was $24.2 million, down 4% compared to $25.2 million at March 31, 2008 and up slightly from $24.1 million at June 30, 2007.

Now, I will provide some general guidance for the 2008 fourth quarter ending September 30, 2008. Total revenue is expected to be between $20.3 million and $20.7 million. GAAP earnings per share are expected to be between a loss of $0.02 and profit of $0.02. Non-GAAP earnings per share are expected to be between $0.09 and $0.13. The above guidance was based on the following assumptions. Total stock-based compensation expense and amortization of intangible assets is expected to be approximately $2.0 million. Depreciation is expected to be approximately $1.5 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 $500,000, assuming no changes or acquired tax payments. Basic weighted average shares outstanding are expected to be approximately 14.1 million shares and diluted weighted shares outstanding are expected to be approximately 14.6 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. We remain on track for executing our strategy for growth through product innovation and strength in sales and marketing across the internet and mobile space. As described, we are delivering new solutions such as KITE 2.0 and MITE 1.0 that enable companies to protect and increase revenues from their online and mobile initiatives, as well as improve productivity and the bottom line.

Our direct sales and telemarketing teams are leveraging our existing client base to offer our complete sweep of on-demand solutions and professional services and targeting many new companies too. Additionally, our markets continue to expand as evidenced by recent events. One, the rapid popularity of Internet savvy smart phones, including the iPhone, has created a buying phenomenon nationwide. We expect to benefit from the growing convergence of the mobile and Internet worlds as represented by these new devices.

Two, clearly the need for superior online performance is more important than ever. As cited in the New York Times at the beginning of July, companies large and small derive a significant portion of their revenues from the Internet. Website failures and slowdowns directly impact the companies' top line. Our products help our customers make sure their online efforts are effective and profitable.

We are on track to grow our revenues approximately 12% in fiscal 2008 compared to 2007. While we are optimistic about 2009 and expect our strength in sales force to have an even greater impact next year on revenue growth, we are mindful of the economic winds and are taking a cautious stand on costs. We will be ready to adjust rapidly to any changes in the economic environment that might affect us.

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

Question-and-Answer Session

Operator

(Operator instructions) And your first question comes from the line of Brian Kinstlinger from Sidoti & Co. Go ahead, sir, your line is open.

Brian Kinstlinger – Sidoti & Co.

Great, thank you. I'm curious in the second quarter, either Umang or Drew, maybe you can discuss the mobile segment. The sequential growth was dramatic, and did something happen earlier than expected to see that much growth in the quarter? Just to sort of take us through it and take us through the deferred revenues as well, Drew, if you could, the changes there and how we should read into that?

Umang Gupta

Let me answer first and then, Drew, you can answer with the deferred revenue question. But let me just start by saying, I think you mentioned third – you meant third quarter, because we are talking about what are in the third quarter right now.

Brian Kinstlinger – Sidoti & Co.

Absolutely. Sorry – yes.

Umang Gupta

So, yes, no question that the third quarter revenue growth of mobile was in fact greater than anyone of us anticipated, including our own guidance. And there were two reasons for it. One, you may recall that for the last couple of quarters there has been a logjam in the amount of revenues that could come on to our P&L because of a major telecom situation where a big deal was simply being held up for amortization purposes, even though it had been recognized under certain GAAP, but once that deal – the logjam cleared, which happened on March 31, literally at the end of last quarter, we were able to see the benefits of that happening this quarter and expect to continue to see the benefits over the coming quarters as the deal is amortized. So in effect, what you had was a situation where for the last couple of quarters, revenues were perhaps less than they should have been or at least based on run rates, simply because the deal was being held up for amortization purposes, and now we are actually coming the opposite way. But the other reason is also that we ended up with more acceptances, project acceptances earlier in the quarter. So, if a project was originally planned to be accepted in June and it was accepted in May or April, you end up with a pretty nice benefit in terms of amortization for an extra month or two. And it's just part of the way the accounting works. But the combination of that big deal, logjam breaking, and also the earlier acceptances of a number of deals allowed us to actually do much better than we expected this last quarter.

Brian Kinstlinger – Sidoti & Co.

Are you actually seeing earlier acceptances this quarter that we are currently in as well? Or is that–?

Umang Gupta

It's too early to tell. Remember, this is the September quarter. It's historically the quarter where everybody in Europe is on vacation. And I would not assume somehow that acceptances would occur earlier just because they occurred last quarter.

Brian Kinstlinger – Sidoti & Co.

And Drew, if you can take us through the deferred revenue trends and what happened based on–?

Drew Hamer

Sure. So just to kind of recap on deferred revenue, so – this business is subject to seasonality where they will have their largest buying periods in what I'll call the December quarter, which happens to be our first quarter of the fiscal year. So what you're seeing is a natural trend where we may recognize more revenue than we'll be putting into the deferred revenue accounts on the balance sheet this quarter and potentially next quarter. For the summer, as Umang just mentioned, it tends to be historically the slowest month of the quarter with our European customers. A lot of people are on vacation in the month of August. And then we'll look forward to have a bump-up in the December quarter of each year.

Brian Kinstlinger – Sidoti & Co.

And the guidance, I'm just curious, the revenue was relatively flat quarter-to-quarter, which is not a concern. I'm just curious if that's the case, but you're looking for a range that's better in earnings, either a loss of $0.02 or a gain of $0.02, where are the efficiencies, which line items that – with revenue flat, earnings being up?

Umang Gupta

Let me just start by saying that part of the guidance issued, at least guidance for the coming quarter, is built around the expectation that because this is summer. And during the summer, revenues from SIGOS at least are always subject to potential delays because of the acceptances, et cetera. We have been very cautious in our guidance. So, by essentially giving you guidance where it says it could be a little up or a little bit low, we are sort of guiding for flat, but we are being conservative here. We could get positively surprised, but I just don't like to end up in a situation where if things go wrong, we end up missing guidance. Having said that, the benefit really is on the cost side in the coming quarter. And Drew, you might want to talk to the one-time special expenses associated in the previous quarter that won't occur in the coming quarter?

Drew Hamer

Okay. So, particularly the assumption is in the financials, of course, the cost of goods sold tends to move with increased revenues. However, in the current quarter, we have expenses related to our audit and professional services fee, annual fees that were related to internal testing, SOX controls, things like that, that brought our G&A expenses up by about $300,000 that won't be recurring in Q4. So in our guidance you could safely assume that about $300,000 down in G&A in the fourth quarter, and when you factor that with the shares outstanding, you'll see the growth even if revenues are flat in the earnings on the bottom line.

Brian Kinstlinger – Sidoti & Co.

Great. And the final question, and I will go back in the queue, you did say the share count will go up 400,000 shares. Is that your expectation quarter-to-quarter?

Drew Hamer

We have that in there, assuming that there may be some exercises of shares, and then of course we have an assumption in our fully diluted share count for the potential dilution effect of any increases in the stock price.

Brian Kinstlinger – Sidoti & Co.

I'm sorry, one last question. In terms of sales force also, you mentioned that the Zandan acquisition brought you your open positions for Europe. Are there other SIGOS hires that you need to make, or is that process complete, which you've been talking about for a couple of quarters? Thank you.

Umang Gupta

Yes, great question. I think in general I can safely say at this point that much of the process of increasing our sales force for this year is done. Certainly on the Keynote side, I'm quite comfortable in saying that we are full up. There could always be a few open positions because of resignations or changes, but by and large, in terms of headcount increases for the Keynote side of the sales force, there are no more plans per se other than to replace other changes. In the SIGOS side, we have been making actually quite a few significant increases in the last couple of quarters. I don't believe we will have too many in this quarter because it's again summertime. However, there may be a few in the last quarter of the year so that we are ready for any potential expectations for 2009, we need to make sure that we have the right number of salespeople. But overall, I can sort of say to you that we are pretty much done. I mean, any changes from here on out are not going to be anywhere near the magnitude of expense increase in sales and marketing that has occurred in the last year.

Brian Kinstlinger – Sidoti & Co.

Great, thank you very much.

Operator

Your next question comes from Justin Cable with Global Hunter. Go ahead, sir, your line is open.

Justin Cable – Global Hunter

Thank you. Just a couple of question on the growth that you see for mobile and Internet here. On the mobile side, it seems like you're getting the lion's share of the major carriers out there in the market. And while there are still lot more regional carriers to go after, how should we consider the growth opportunity in general? You've got these big customers. You just launched SMS. How big of an opportunity is SMS alone and how should we just think about the picture for mobile in general?

Umang Gupta

So I think you should define within the mobile market two separate markets. One is the telecom carrier market, mobile carrier market, and the other is the content provider enterprise portals market. Let's start with the carrier market, which is really where the bulk of our revenues come from today, especially SIGOS revenues. I think overall that's a reasonable market with about a 20% secular growth rate. At various times I've talked about the size of this market today being somewhere around $70 million or so, and we hold a pretty large chunk of that $70 million. We compete with a couple of players like JDS Uniphase and Datamat, but most companies most people haven't heard of because these are niche companies going there. And I'm comfortable in saying that this is a 20% secular growth rate market for a long time to come, mostly because it's not just a number of carriers that's going to drive – in other words, it's not just new carriers that's going to drive our sales, it's actually new networks. So, as people have moved from 2G to 3G, as they move over time from 3G to 4G and LTE, there is an amazing amount of new stuff that people need in terms of testing and monitoring to be able to test and monitor these new networks. And we are the beneficiaries of that. And I don't see that changing for the next two or three years. So first, at this point, we are comfortable in forecasting a 20% secular growth rate for the mobile market for the telecom side. In the non-telecom, I'm talking about the enterprise, content, et cetera side, we are still in a very, very early adopter market, because ultimately while everybody talks about the mobile Internet, we are not quite there yet. I think devices such as the iPhone and others will make it possible to allow for every one of our top 1,000 customers who are currently Internet customers to become mobile customers. But today, we're talking about maybe 35 or 40 customers for our mobile content services. So we have a long way to go until we penetrate or saturate that market. And it's my hope that one day that market for us will be as big as our Internet market is.

Justin Cable – Global Hunter

Going back to the carrier side, how much would you say you've penetrated the customers that you have there?

Umang Gupta

It depends. If you are talking about Germany, I would say we are pretty nicely penetrated. The company has been in operation for more than ten years, it's a German company, and so we have done very well with D2 and O2 and T-Mobile, et cetera, et cetera, and Vodafone is just – D2 is part of Vodafone. On the other hand, as you start to work your way outwards of the Germany within the European market, we are nowhere near penetrated. Certainly we have a long way to go to penetrate in France and the UK or in any of the other countries of Europe. And then when you go further out into South America, Africa, Asia, we are just a blip on the radar screen, I mean, in terms of potential penetration. Amazingly, we are seeing a lot of demand coming in from the Middle East and from Africa. All of these countries are putting in new mobile networks, and they are all there in lieu of the old landline networks that never got there. So we really are seeing some pretty nice growth from all these new markets too.

Justin Cable – Global Hunter

Okay. And do you have a pretty strong presence in those other markets?

Umang Gupta

Yes, exactly. What’s going on with the increase of the sales force, we've almost doubled, by the way, the number of salespeople, our overall headcount of SIGOS in the last 12 months or so, or will have doubled certainly by the end of this year. What’s going on is we are adding new people, key account managers as we call them. One for the Middle East, one for Asia, one for Africa, someone for the East – for Asia. We have now somebody here up in North America who also takes care of South America. So these are the outlying parts of the world where we are adding people, where previously SIGOS had no such people when it was a private company. That's all part of the investment that is being made now. And I don't think we’ve actually seen the full results of all that investment yet, because much of our revenues are still coming from Europe, but I think over time, we will see them coming from Asia and Africa.

Justin Cable – Global Hunter

Okay, great. And then just a couple more questions. On the Internet side, it’s great progress there and it sounds like we are finally at this inflection point. And I was curious about the revenue per page metric, do you think that we will start to see that uptick going forward, now that most of the revenues, over 90% of the revenues are from the new platform?

Umang Gupta

I wouldn't say they should uptick. The real question is whether they will downtick anymore. And the reason they shouldn't uptick is because ultimately we are done with the old high-priced product, so there is no more decline of the old high-priced product. But it isn't like at this point we are going to raise prices for our other product. So there is no reason to believe they will uptick. Whether they will downtick or go down further will all depend, frankly, at this point from here on out on the competition. We are not at this point in a situation where we believe that our products are overpriced relative to the competition. If anything, we have gone from the point where we were terribly overpriced two or three years ago to the point where we might even say we are somewhat underpriced relative to the competition, but not dramatically underpriced. So unless there were a fresh round of price competition, I do not at this point see significant changes, but I would not state my life on that. It's possible. It all depends on what happens with the competition.

Justin Cable – Global Hunter

Okay. So ultimately we should really be focusing on the number of pages measured in the customer count?

Umang Gupta

Absolutely. Number of pages – even if there is a decline on price per page, hopefully the decline should not be anywhere near as precipitous as occurred in the last two years. And therefore it should be well managed against the increase in number of pages.

Justin Cable – Global Hunter

Okay. And then last question is just on kind of long-term profitability plans. I know in the past you've stated kind of pro forma targets, obviously not giving any kind of time frame, but what do you see as sort of the ultimate profitability picture in terms of EBITDA margin or–?

Umang Gupta

Yes. As you can tell, we did pretty good this last quarter with EBITDA. We ended up with from what I can tell about it 12% or maybe 14% EBITDA in Q3. And in some of the various times I've talked about what a potential EBITDA for this company ought to be. I certainly believe it ought to be north of 20%, could very well be 22% to 25%. We don't try and give a time frame on that, but from a business modeling viewpoint, no question we did quite good this last quarter. And from here on out, it is my goal at least to generally try and manage to the – both the revenue growth and EBITDA numbers. So, while we have a certain level of costs, I don't see any disproportionate increases in costs occurring in the coming year relative to revenues. And if anything we want to try and get leverage out of the business, probably through more efficiencies in gross margins and R&D et cetera, though from a sales and marketing viewpoint, I think at spending, what, I think $0.33 to $1.00, we are pretty efficient right now. We feel pretty good relative to the competition. Many enterprise companies spend 40% and 50% on sales and marketing. So we are pretty efficient today. And I can't imagine us trying to spend less than that, but certainly I wouldn't want to spend very much more than that unless I have to.

Justin Cable – Global Hunter

Okay. Great, thank you.

Operator

The next question comes from the line of Ryan Bergen from Craig-Hallum Capital. Go ahead, your line is open, sir.

Ryan Bergen – Craig-Hallum Capital

Good afternoon and thanks for taking my question. Can you please address a little bit further the competitive landscape for both ITM, specifically with the Gomez IPO, and then of course with mobile tests?

Umang Gupta

With what, please?

Ryan Bergen – Craig-Hallum Capital

With Internet test and measurements and with –

Umang Gupta

And versus mobile did you say?

Ryan Bergen – Craig-Hallum Capital

Well, not versus mobile, but including or additionally with mobile.

Umang Gupta

Okay. So let's start with – who is our competition? In the Internet space, we really only have one major competitor today, and that is Gomez. We don't see Mercury much, frankly, and maybe that's because they have been bought up by HP, and HP is not focusing in that area. But the primary competition we see is Gomez. There are a couple of other smaller players, but they are not significant in the United States. Outside the United States, there are many other players, but they are all individually to some company. I would say at this point that going forward we believe that Gomez and we will probably split the market to some degree. And how much we split it will all come down to execution and our ability to do a better job than them or vice versa. But it's not like this is a multi-horse race; this is two-horse race. And if the market is growing by a certain size, as long as we get our fair share, you ought to see growth from us in the Internet side. I don't see at this stage kind of like new players coming in and suddenly changing the landscape. It's not a huge market that you're suddenly going to have lots and lots of people coming in. It's a niche market with two niche players fighting for it, and it all comes down to how much money are you willing to spend to be able to get market share versus profitability. And historically, as you've seen us, we have been judicious of this matter. We don't go out of our way to kind of overspend to get market share. But on the other hand, there have been times when we have probably underspent in order to go for profitability. And over the last year or two, we've been trying to make up for that. But sitting where we're sitting right now, I'd say we ought to probably slow and steady as she goes, is the way I would put it. Let's just go make sure we get the right amount of growth and the right amount of profitability. On the mobile side, it's a whole different situation. Within mobile, there are two groups. There's the Internet – there's the, what I call, the mobile Internet side, which is still an early adopter market and is still an investment market. I mean, we literally doubled our quarterly revenues from Q4 to Q4 in mobile subscriptions for the Internet – for the internet mobile side, which is the content player, et cetera. And it's growing very, very fast, but it's still growing from a small base. And clearly we are still in the investment phase. It's almost like running a startup within a bigger company at that stage. And so, all I can tell you is that we continue to expect to invest in that market because it's a huge potential market, certainly as big as our current Internet market, and we expect to grow that business. And much of the increases of sales and marketing that we've done in the last couple of years in the Keynote side have been based on the presumption that our salespeople will not just sell the Internet stuff, but will also sell mobile. And we are certainly seeing the results of that in the growth of the mobile side for us. Now on the SIGOS side of mobile, there too – I would say it's a niche market. We are not talking about lots and lots of players. It's SIGOS, JDS Uniphase, maybe a company called Datamat and a company called Argo that's just got bought up by a Swiss company. And so we are talking about probably if not a two-horse race, maybe a three-horse race. And there too, we believe today Keynote SIGOS is roughly – is somewhere around 30% – 30% to 40% market share leader in that space. I fully believe that that market as it grows, our job will be to make sure that we remain the market leader but also remain a profitable market leader, and that's really finding the right balance between those two.

Ryan Bergen – Craig-Hallum Capital

Have you started to see pricing pressures from any of the competitors in the mobile area?

Umang Gupta

Yes, we do see mobile, not in the – not in the telecom side, not in the side where SIGOS competes. I think most of the pressures there are known. I mean, it's either JDS Uniphase or others. I think the real place where it's still too early to call and where we see potential competitors coming out of the woodwork, frankly, that we wouldn't otherwise know would be in the Internet mobile side. We compete with a bunch of private companies. There is a particular private company that here is in San Mateo called Mobile Complete we compete with. They have done quite well, they raised a lot of money, and they are going after the interactive testing marketplace. We've been focused more on the automated monitoring marketplace. But long-term, I don't think one will tell the difference between interactive testing and automated monitoring. And so some of the new products we are coming out with such as MITE, for example, our Mobile Interactive Test Environment, are designed to go after the interactive test environment. And I think there are a couple of other players I've seen, little ones, that may very well be potential competitors to us or may even be potential acquisition candidates. We will see.

Ryan Bergen – Craig-Hallum Capital

Great. And my last question is, are you seeing any impact from recent softness in the retailers or financial services?

Umang Gupta

I don't see – I don't believe we have seen significant effects on the retailer side yet. However, in the financial services side, we have clearly seen people start to get cautious. We have not seeing effects of any of that in the subscription side yet, but we have seen the effects on the engagement side. So you saw our engagement business took a dip in the March quarter. Now that was probably a combination of what is going on in the economy plus the fact that the March quarter is historically seasonally less because you have come off a holiday season and everybody slows down for a bit. But as you can see, our revenues went up this time, this last quarter, on the consulting side. And if things continue to go well, hopefully by this Christmas we will be back to normal. So, we will see.

Ryan Bergen – Craig-Hallum Capital

Thanks and congratulations on the quarter.

Umang Gupta

Thank you.

Drew Hamer

Thank you.

Operator

And your next question comes from Derrick Wood with Pacific Growth. Go ahead, sir, your line is open.

Derrick Wood – Pacific Growth

Thanks. Nice job on the quarter, guys.

Drew Hamer

Thanks, Derrick.

Derrick Wood – Pacific Growth

So – you guys have been drawing down the legacy product on the Internet side for a few years now, two or three years. You're finally where you wanted to be on the 10% of total subscription revenue. If you look back at overall growth over the last few years, it's been about 1%. So, marginal growth. Now that we are done with this legacy drawdown, what can we expect for growth going forward?

Umang Gupta

So, just factor out the WS, the Website Perspective, to climb in the single page, single page kind of stuff, I'd say that our historic growth rates of the rest of our business have been somewhere in the 15% to 20% range. I've seen numbers between 3% and 4% per quarter growth of all the other pages, the transaction broadband, et cetera, et cetera. Am I right guys on that one?

Drew Hamer

That's right.

Umang Gupta

But somewhere in that range. So, if I'm right, which is that historically we have done, let's say for this discussion, between 15% to 18%, can we continue to grow at those rates now that we have nothing else declining? I would like to think so. Certainly our URL count has gone up around that much and more. The question that is an open question in everybody's mind is, how much of these growth rates were substitution effect? In other words, we were simply substituting declines in one place with increases in other, versus how much were they fundamentally that people were actually growing your business and buying that. My belief is that in fact there are a lot of people who are literally buying the new stuff, and that it was (inaudible) of the decline of everything else. But that's a belief. I can't prove that. In some customers, that is absolutely true because the customers never had any of the old stuff, they just bought new. In other customers, it's not quite as true. So I think the next couple of quarters will tell us the answer to that question. If we are able to show sustainable growth in the next few quarters of somewhere in the order of 3% to 4% growth rate per year – per quarter, quarter-on-quarter, for the subscription side, then I think you can start to sort of see the trend coming back, which is 3% to 4% per quarter applies 12% to 15% per year on a quarter-over-quarter basis. And hopefully, we will be able to achieve that.

Derrick Wood – Pacific Growth

And you would expect some level of revenue stream going forward on the single page?

Umang Gupta

It’s very less. The single page is done. Remember, the single page, single device business really consisted of two products – three products. One of them was Website Prospective, which is done. We are actually going to start ripping out the boxes that do all that measurement starting next month. And we replaced it with all of our other products. And then there is also our old Red Alert product that's still a legacy product. It's not going up, it's going down very, very mildly, but it's pretty stable. And then there is also a legacy product called NetMechanic that is so minuscule that even if it goes to zero, nobody would notice. So I think at this stage I'm not too worried about any decline. Even if they were to occur, they would be manageable there.

Derrick Wood – Pacific Growth

Okay. I guess the second part of that question would be, now that you have brought down your price per page to a much more competitive level, I mean, are you seeing any change in win rates against your main competitor?

Umang Gupta

Absolutely. Absolutely yes. It is just with sheer pleasure nowadays to see some of the reports that have come from our sales guys compared to a couple of years ago when we always felt like we were losing. Even if the customer would tell us, we love your product, but the price is too high, or many times we had situations where we didn't have enough salespeople. We just literally didn't have enough courage. And we'd lose the deal and we wouldn't even know until we lost the deal. That was two years ago. That's not true today. We feel we are the hunters today, not the hunted. And there are a number of situations where we have essentially removed the competition, or in other cases, where we have held them to a draw where literally we take a bet and they take a bet. But there are a very few cases that I know of today where – that we have made, there have been major losses to us or losses on our side.

Derrick Wood – Pacific Growth

Okay. Okay, that's helpful. On the mobile side, just wondering how the lifecycle of a potential customer tracks. Say, you sign – I guess YouTube is a customer of yours, you sign a deal with them. What's the initial – what percentage of the penetration would you get just first on an initial deal, and how much more revenue could you get going forward from a big customer? Just trying to see what the purchasing life cycle would be.

Umang Gupta

It really totally depends. You could have a situation where a customer starting with about $10,000 a year or $15,000 a year, and literally within six months to a year, that's almost a pilot and they could start to bet into $100,000 or $200,000 per year kind of rates. I've also seen situations where they started 10 or 15 and stayed 10 or 15 for years and years, because even though they are a big company, they just somehow don't see the value beyond a certain level. And so I think really there is no one formula here. You just sort of work it. It's a numbers game. When you have 2,600 customers, there is always a top 200 that are doing a lot more with you. And your goal always, in our particular case, is to get the next 200 to become as big as the top 200. And that requires direct salespeople to spend time with them, telesales people to spend time with them, SCs to spend time with them. And you just identify them and work on it.

Derrick Wood – Pacific Growth

So do you feel like you are pretty well penetrated in your top 100 on the mobile or not even close yet?

Umang Gupta

I'm sorry, is the question having to do with mobile or Internet?

Derrick Wood – Pacific Growth

Mobile.

Umang Gupta

Oh, I'm sorry, I thought the question had to do with Internet. I was responding on the Internet question. On mobile, it's a whole different case. I think the typical mobile deal that starts off, they range. If it's a small little company, it's a small little web developer, they might just buy one our public measurement system services, which could be as little as $500 a month, which would be like $6,000 a year, or occasionally they might a couple of measurements, they pay us $10,000 to $12,000. However, I've seen customers, they start at $100,000, because they want to do measurements not using our public infrastructure but using private agents where they literally will place the agents in certain locations of their choosing. And we put those agents for that then. So it's – the business is quite different. And the bigger companies – well, you asked me about YouTube. My recollection is YouTube started with some public measurements that were certainly a smaller – some $100,000, less than $100,000. Since then, they've become part of Google, and the combination of Google and YouTube are doing very well for us.

Derrick Wood – Pacific Growth

Okay. One last question and I'll get off. Drew, just in terms of the mobile ratable license revenue, what was the contribution from the big deal that you signed in Q1? I'm just trying to get a sense for what the –

Drew Hamer

We generally don't break that out, unfortunately. So I don't have that available to give to you.

Derrick Wood – Pacific Growth

Okay.

Drew Hamer

It was a nice sized number though.

Umang Gupta

Yes, it was a material number.

Derrick Wood – Pacific Growth

Without that, would you have seen growth sequentially?

Umang Gupta

Oh, yes.

Drew Hamer

Oh, yes. I’m sorry, yes, absolutely. So that – while it was a large part of the growth that we anticipated in our guidance, with the amounts beyond the guidance (inaudible) the effect that Umang was discussing earlier about people accepting products earlier in the quarter.

Derrick Wood – Pacific Growth

Okay. All right. Thanks very much.

Operator

Your next question comes from the line of Douglas Whitman with Whitman Capital. Go ahead, sir, your line is open.

Douglas Whitman – Whitman Capital

A quick question on Europe on the mobile side, there has been a lot of companies in the wireless side who had a lot of push-outs for various reasons, and you're obviously seeing the opposite experience. Is there a particular reason or feature that's prompting them not to give you what is going on in the rest of the world kind of effect?

Umang Gupta

I've heard people ask me this question, and I must tell you I just haven’t seen any effects. I think partly what happens is that when people buy our product, they really buy it in line with changes in their own network. So if you installed a brand new – let’s say, T-Mobile is an example. T-Mobile is installing new systems in the United States. They are putting in big networks in the United States. And so, as you start to put in these big systems, there is a sort of knock-on effect. People need to buy testing and monitoring, because you don't want to end up spending billions of dollars installing a new network and not spend hundreds of thousands of dollars making sure you're testing it and monitoring it. So in general, we are a beneficiary whenever somebody installs new networks or new equipment for those networks. And that is happening. If people were to slow down some of that, that I think would affect us. But so far at least we have not seen that.

Douglas Whitman – Whitman Capital

Okay. Is there a particular feature that you've added that – or a function that people are excited about that are also adding to your success?

Umang Gupta

I think it's not one particular feature, Doug. What happens is, our job is to be able to test end-to-end quality of a network. As you move from one standard to another, so as people have moved from the older – from – let's say, it’s to the UMTS and the HSDPA networks, it becomes incumbent upon us to support those networks via radio interfaces and various interfaces in our system. So, you could argue those features are very important, because if we don't support those new networks, we won't even get in the door. Now, combine that with additional capabilities we've done using – by the way, some of the Zandan technology we purchased many years ago and that we have now incorporated into SIGOS that does WAP testing and additional levels of testing of the content level, that's causing more people to get interested in our product. And then combine that with a level of more sophisticated interfaces that go beyond just creating a test to actually monitoring the health of an entire network at the management level. So we just had a user conference a few months ago, in June in Nuremberg, and we had 100 people show up for that, 100 customers. Last year there were 50. The year before there were 25. And all these folks come there because they really are charged with the idea of fully taking advantage of all these new features that we are adding to the system. So, it’s no single feature; it's just the breadth of the system is moving very rapidly as a result of the R&D investments that have been made into it over the last few years.

Douglas Whitman – Whitman Capital

Thank you. Congratulations on the great numbers you guys put up in a tough economic environment and also for your great job on the DSOs as usual.

Umang Gupta

Thank you.

Drew Hamer

Thank you very much.

Operator

Your next question comes from the line of Kevin Liu with B Riley & Co. Go ahead, your line is open.

Kevin Liu – B. Riley & Co.

Hi. Nice quarter, guys. Most of my questions have been answered, but just curious, now that you guys are taking a more cautious approach in terms of increasing the expenses and then with the conclusion of your repurchase program last quarter, I was wondering what your preferred usages of cash were from here on out? And then also if you could comment on the current acquisition environment in terms of any compelling opportunities you see that to add to your business internationally on the Internet side or maybe in the mobile business?

Umang Gupta

So, let me start by saying, take a look at our cash position, it's roughly $54 million. Half of that $54 million is in Europe, as part of our German subsidiary and the change of – we bought a bunch of IPs from our German subsidiary to save on our taxes. So, that cash cannot be touched, it stays in Germany. So we have, what, $27 million. And that's a pretty small number for an $80 million-type company right now. We're running at $20 million times four is $80 million run rate company. So it's a pretty small number to hold. I don't see us at all being sort of cash rich at this stage or having too much cash, believe me. If anything, relative to our competition, even some private companies who will have more cash than we do, and frankly even relative to our – Gomez who has filed to do an IPO, if they raise $80 million, they will end up with a lot more cash than we do have. So, what we've got going for us beyond the cash is really the building. And that building – let's say it's worth $60 million. You take that $60 million and add the rest, we probably got $100 million of liquid. I would call this building a relatively liquid asset. I mean, we could essentially sell it if we wanted to at any given time within some number of months and be able to use that cash for anything ranging from buying back more shares to potentially doing an acquisition or anything of that kind. At this stage, I don't have any other acquisitions that need that kind of cash, and certainly it's not burning a hole in my pocket to do that. The building, on the other hand, is earning some nice interest. If you see, it’s actually – the latest calculation we did showed us that it is probably earning roughly somewhere between a 4% to 5% cash-on-cash return, which is a lot better than the 2% that I earn on my cash. So overall I feel pretty good. We're making good use of our cash and we're making good use of the building. But if it turned out we needed money to be able to make another asset purchase somewhere, we know we could swap assets at that stage.

Kevin Liu – B. Riley & Co.

All right. And then, sorry if I missed this earlier, but just curious in terms of the cost from the Zandan acquisition, just wondering how far along in terms of the integration process you guys are and how much more we could expect to come out of the operating expenses?

Umang Gupta

The Zandan was a myth this last quarter. Frankly, we end up with six people out of the, I think, 14 or 15 that they had. We paid off the folks who we let go according to French law, which is why you saw a significant cash impact this last quarter on our operating cash flow. But practically speaking, at this point, Zandan, out of the six people, three of them engineers we intend to keep as long as the technology stays alive. But at some point, even that technology will end up being completely replaced with Keynote technology, and that may take a year or so. But the other three people are very much part of our sales and marketing group right now. So they were open headcount that I had to fill, and we filled them with Zandan folks. And they've done a great job for us in both the French marketplace and the Western Europe marketplace. So there is no more integration to be done at this stage.

Kevin Liu – B. Riley & Co.

All right, great. Thanks.

Operator

And your last question comes from the line of Brian Kinstlinger with Sidoti & Co. Go ahead, sir, your line is open.

Brian Kinstlinger – Sidoti & Co.

Hi. Two follow-ups. The first, one of the analysts asked you about the retailers and I think your answer was, not yet. I'm curious how far in advance of your busy season you typically start to see that demand come in? Would you even see it now or would it take you more until September or November, if you know what that market would take [ph]?

Umang Gupta

No, we should see it now. I think we have in fact seen a certain amount of demand for this quarter. We are just being, frankly, very cautious, because who knows what could happen in the economy? But overall we have seen demand start to pick up relative to our ITM business this quarter. I’ve got a lot of load testing, et cetera. And I think what happens typically is you start to do projects in July, maybe August, a lot gets done in September, and then a fair number gets done in October. And then by November and December, things start to button up. I mean, when you start getting close to Christmas, nobody wants to touch that website and do anything with it. So in general, the peak months to do this work are really September, October, and maybe some November.

Brian Kinstlinger – Sidoti & Co.

Okay, thank you.

Drew Hamer

Okay, thank you.

Operator

And at this time, there are no further questions in queue. Do you have any closing remarks?

Umang Gupta

Yes. Ladies and gentlemen, thank you again for joining us today and for your support. We are very pleased with our successes to date and we look ahead, and we are very excited about our prospects. We look forward to discussing our company with you at various investor conferences we have scheduled in the upcoming months, including the B. Riley & Company Cash-Rich Technology Stock Conference on August 12 in San Francisco. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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Source: Keynote Systems, Inc. F3Q08 (Qtr End 06/30/08) Earnings Call Transcript
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