Keynote Systems, Inc. Q2 2006 Earnings Conference Call Transcript (KEYN)

May. 3.06 | About: Keynote Systems, (KEYN)

Keynote Systems, Inc. (NASDAQ:KEYN)

Q2 2006 Earnings Conference Call

May 2nd 2006, 5:00 PM.


Jack Andrews, Investor Relations Contact

Andrew Hamer, Chief Financial Officer and VP of Finance

Umang Gupta, Chairman and Chief Executive Officer


Kevin Manthie, Craig-Hallum Capital

Kevin Liu, B. Riley & Company


Good afternoon everyone and welcome to Keynote's conference call for the second quarter of fiscal year 2006 ending March 31, 2006. Today's call is being recorded. At this time, I would like to turn the call over to Jack Andrews for opening remarks and instructions.

Jack Andrews, Investor Relations

Thank you. Good afternoon everyone, and welcome to Keynote's conference call for the fiscal 2006 second quarter ended March 31, 2006. I'm here today with Umang Gupta, Chairman and Chief Executive Officer, and Drew Hamer, Chief Financial Officer. Umang and Drew will review our accomplishments for the quarter and will be available to answer questions.

Hopefully by now, you have seen our press release that was distributed over Business Wire and major wire services. For your convenience, the press release has also been posted on our website at A replay of this call will be available by telephone by dialing 800-642-1687, the pass code is #7806076, or by webcast at the Investor Relations section of our website at

I would like to remind you that statements made during the course of this call that are not purely historical are forward-looking statements regarding the company 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 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 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. Now I would like to introduce Drew Hamer, Chief Financial Officer of Keynote.

Andrew Hamer, Chief Financial Officer and Vice President of Finance

Thank you Jack. First, I will summarize our financial highlights, and then I will provide more detail. Our second fiscal quarter of 2006 revenue met our preliminary guidance issued on April 3rd and we reported total revenue of $12.7 million. Additionally, we're quite pleased to report strong cash flow generation with cash provided by operating activities of $2.6 million, and free cash flow of $1.8 million.

Before I go into further detail, I would like to review definitions for some of our metrics, which are not in accordance with Generally Accepted Accounting Principles, commonly known as GAAP. The company defines non-GAAP net income as net income adjusted for provision for income taxes less cash tax expense, stock-based compensation, and amortization of purchased intangibles. Non-GAAP net income per diluted share equals non-GAAP net income divided by the weighted diluted share count as of that period end.

As a result of the recent acquisition of SIGOS and the requirement to amortize most of SIGOS' software license revenues over a twelve-month period, the company believes for the next three quarters both GAAP and non-GAAP income will be negatively impacted. Therefore, cash provided by operating activities and free cash flow will be important metrics to measure Keynote's financial performance during that period. Free cash flow is defined as cash flow from operations, less cash used for purchases of property, equipment and software.

Now I will review the financial details. First revenue. Our total revenue for the March quarter was $12.7 million compared to $13.2 million in the same period last year, and $13.7 million last quarter. As previously announced, the decrease was due to fewer Customer Experience Management, or CEM engagements.

Total subscription services revenue was $9.9 million or 78% of total revenue for the quarter. Subscription revenue posted a 3% increase compared to the same period last year, and a 1% increase compared to last quarter reflecting greater demand for transaction, broadband and mobile monitoring services.

Professional services revenue was $2.8 million, or 22% of total revenue for the quarter, and declined 21% compared to last year, and 28% compared to last quarter.

Now I'm going to talk about our customers. Our customer count was approximately 2,400 companies at the end of March, up from 2,200 a year ago, and 2,400 at the end of December. Our monthly customer retention rate continues to be an average of 99% for the quarter. The number of customers that purchased in the recently completed quarter on an annualized basis at least $100,000 or more of our services was 76. And the percentage of revenue from these customers was 70%.

In the second quarter of 2005 and the first quarter of 2006 we had 84 and 79 customers purchasing over $100,000 on an annualized basis, representing 71% and 80% of revenue respectively.

At the end of March 2006, we measured 9,269 URLs through all our Internet benchmarking services excluding mobile. This compared to 8,302 at the quarter a year ago and 8,996 last quarter. For the second quarter of 2006, overall average monthly benchmarking revenue per URL for the quarter was $234 compared to $258 and $242 for the quarter a year ago and last quarter respectively.

Now I will review our expenses. Total expenses were $13.7 million, including stock-based compensation of $812,000 compared to a year ago expense of $12.9 million, which did not include any stock-based compensation expenses. Last quarter, total expenses were $13.5 million, including $796,000 of stock-based compensation expenses.

Now I'm going to talk a bit about income taxes. Due to the relatively high amount of FAS 123R expenses associated with incentive stock options in relation to our projected pretax net income, our estimated annual effective tax rate varied significantly for a relatively small change in projected pretax GAAP income. Therefore, we're not using an estimated annual tax rate for calculating our tax expense, and are instead using the actual book income through the six months ended March 31, 2006 to calculate the tax for the six months ended March 31, 2006.

For the period ended March 31, 2006, this has resulted in a tax expense of $373,000 compared to a year ago expense of $69,000, which did not include a deferred income tax expense or the effect of FAS 123R. Last quarter, income taxes were $732,000.

For the second quarter of fiscal year 2006, the net loss was $58,000 or $0.00 per share, which included $812,000 in stock-based compensation expenses. For the second quarter of fiscal year 2005, the net income was $1 million or $0.05 per share. The non-GAAP net income for the quarter was $1.5 million, or $0.07 per diluted share, compared to non-GAAP net income of $1.6 million, or $0.08 per diluted share for the same quarter a year ago.

Now, moving to the balance sheet and our cash performance metrics. At March 31, 2006 our cash and short-term investments balance was $137.3 million. Please note, we used approximately $30 million of this to acquire SIGOS on April 3rd. For the quarter, cash provided by operating activities was $2.6 million compared to $1.8 million for the same period last year. We invested $843,000 in property, equipment and software this quarter, and $724,000 last year. Also, we generated free cash flow of $1.8 million for the quarter compared to $1.1 million for the second quarter of 2005.

As of March 31, 2006, accounts receivable net was $6.3 million. DSOs were 44 days and 98% of accounts receivable were less than 90 days old.

Before I turn the call over to Umang, I would like to provide some general guidance for the June 2006 quarter, which includes expectations for Keynote SIGOS, which was acquired on April 3rd. As noted at the beginning of my prepared remarks, as a result of the recent acquisition of SIGOS, and the requirement to amortize most of SIGOS’ software license revenues over a twelve-month period. For the next three quarters our GAAP and non-GAAP income will be negatively impacted.

As a result of the aforementioned accounting change, Keynote will be able to recognize as revenues only a fraction of SIGOS’ sales during the remainder of fiscal 2006. The acquisition will be dilutive to Keynote's U.S. GAAP net income for the three quarters after the acquisition, although cash flow from operations was expected to be positive throughout.

For these three quarters, the company intends to delineate Keynote’s SIGOS contribution to total revenues and net after-tax income or loss, as well as expected cash taxes to be paid in Germany. After three quarters, the company will have integrated Keynote SIGOS operations to a large extent, and the company will report consolidated revenues and income without calling out Keynote SIGOS separately.

That said, management is providing the following guidance. Total revenue is expected to be between $13.5 million and $14 million, including a net revenue contribution from Keynote SIGOS of between $700,000 and $800,000. Total stock-based compensation expense and amortization of intangible assets is expected to be approximately $2.6 million. Interest income net is expected to be approximately $1 million, absent any additional acquisition transactions, assuming no material changes in interest rates, and assuming Keynote continues to repurchase common stock under its approved plan at similar levels as it has recently.

Cash paid for income taxes is expected to be approximately $550,000 to $650,000, most of which will be due to Keynote SIGOS. Basic weighted average shares outstanding are expected to be approximately 18.0 million shares, and diluted weighted average shares outstanding are expected to be approximately 18.5 million shares.

Loss per share is expected to be between $0.11 and $0.13, with Keynote SIGOS contributing a loss per share between $0.08 and $0.10. Non-GAAP loss per share is expected to be between $0.07 and $0.09, with the pre-SIGOS Keynote contributing a non-GAAP earnings per share of between $0.02 and $0.04.

Cash provided by operating activities is expected to be between $2 million and $2.5 million. Capital expenditures will be approximately $1 million, absent any acquisition costs or other extraordinary transaction. Therefore, free cash flow is expected to be between $1 million and $1.5 million. Now, I would like to turn the call over to the Umang Gupta, Chairman and Chief Executive Officer of Keynote Systems.

Umang Gupta, Chairman and Chief Executive Officer

Thanks Drew. Welcome everyone, and thank you for joining us today. The quarter was challenging and yet exciting. I will review why in the context of our three product categories: Service Level Management, Customer Experience Management, and Mobile.

Our SLM business includes all over of our Internet measurements, monitoring and management services, comprising our traditional performance benchmarking services, enterprise private agent solutions, Voice over IP, load testing and professional services engagement.

Beginning this quarter, we are breaking out our Mobile revenue separately, so they are not included in our SLM numbers. This quarter, the SLM business generated $9.8 million, representing 77% of total revenue. Our SLM subscription grew sequentially this quarter, albeit modestly. We believe the subscription trends reflect certain important long-term changes in our customers needs. They are far less interested in the basic single page, single device measurements from our legacy services, such as Web Site Perspective and Red Alert. Therefore, that type of revenue has been declining at an approximate rate of 3% each quarter over the past three years. Single page, single device revenues now represent 45% of our overall subscription for SLM, down from 51% a year ago.

As our customers website have become more complex, they require monitoring at a deeper level. Therefore, we are experiencing rising demand for multipage transactions, streaming and Voice over IP (VoIP) monitoring services. And importantly, use of these advanced products is growing faster and replacing our single page, single device measurement. This business grew at about 5% on average each quarter over the past three years.

Key SLM contracts included in the second quarter included NBC Universal, AT&T, Morgan Stanley, Associated Press, MCI, and Sony Ericsson.

Now to our Customer Experience Management, CEM revenues. CEM contributed 2.5 million, or 19% of revenue, and declined 17% compared to last year. As announced in early April, we made some significant organizational changes to increase overall sales growth, especially in the CEM business. We also believe that these changes will increase visibility in revenue forecasting.

We hope to leverage our upcoming WebEffective 5.0 product also, which makes our CEM offering more self-service oriented and potentially reduces the costs of CEM services. Also, we believe we can increase CEM margins by a greater focus of competitive intelligence studies that can be sold as a packaged product, in addition of course to custom consulting engagements.

Key CEM contracts included in the second quarter included Wonderman (phonetic) LLC, Microsoft, Pfizer, and IBM Corporation.

On to our Mobile revenue. While our fledgling mobile business represented only 4% of our total revenue this quarter, we are very pleased we signed two major agreements, with Sony Ericsson and Sprint. This category also delivered our most exciting news. We acquired SIGOS the day after quarter end. Now name Keynote SIGOS, our new subsidiary based in Germany is a technology leader in mobile data network testing and active service monitoring.

Keynote SIGOS has more than 55 customers, including many major mobile operators in Europe. Over a 16-year period, SIGOS amassed an impressive set of customers, including Vodafone, T-Mobile, Telephonica, and Orange. Our offerings of heavy-duty testing, access service monitoring, and alerting systems help operators eliminate expensive quality problems, such as dropped voice calls, inaccurate billing and loss data connections, thereby reducing churn.

We are pleased that Key Management as well as the staff of SIGOS will be joining the Keynote family. We have already started working closely with many members of the Keynote SIGOS team to help bring their products to market here in the U.S. and across the world. As we blend SIGOS solutions with our wireless benchmarking and competitive trending services, we believe we will catapult our overall Mobile business to the next level.

Given the greater penetration of mobile usage in Europe and the rest of the world, we think this acquisition is a sound strategy to expand our presence outside the U.S. and in the fast-growing mobile market space.

As noted by Drew, Keynote SIGOS license revenues will be required to be ratably recognized over the initial duration of each customer contract, which is usually 12 months. Keynote SIGOS has been profitable for the last three years. As a result of the aforementioned accounting change, Keynote will be able to recognize the revenues only a fraction of SIGOS sales during the remainder of fiscal 2006. The acquisition will be dilutive to Keynote's U.S. GAAP net income for the first three fiscal quarters after the acquisition, although cash flow from operation is expected to be positive throughout.

In fiscal 2007, the acquisition is currently expected to add $10 million of revenue to Keynote's P&L. Clearly, the acquisition broadens our scope into a very important emerging market: the mobile Internet. In addition to the desktop PC, we are providing now performance measurement and monitoring of pagers, PDAs, and smart phones, and more will come. Ultimately, our services ensure that mobile access and communications technologies run smoothly and optimally over the Internet.

In closing, we are working hard to renew growth in our CEM business. Overall, we are pleased with the general trends associated with the SLM business, and we believe they will get stronger in the coming years as our monitoring services associated with the new Internet overtake an importance and grow faster than those associated with the old Internet. And we are very excited about our acquisition, which targets mobile data network testing and active service monitoring, and therefore directly addresses the needs of the new Internet.

Keynote is the industry’s Internet Performance Authority, and as the Internet evolves so will we. Mobile technologies are impacting our businesses and our lives. The mobile Internet is rapidly growing, and we're excited about our expanded strategic path that Keynote SIGOS addresses.

As always we appreciate our stockholders interest, and are grateful for your support. Drew and I will be more than happy to take any questions you have. Thank you.

Question-and-Answer Session


Operator Instructions Your first question comes from Kevin Manthie with Craig-Hallum Capital.

Q - Kevin Manthie

Hi guys. If you could give me a couple of figures on your mobile unit, you said it was down to 4% of overall revs this last quarter, where is that down from sequentially then year-over-year? And you said you're going to try to take it to the next level, is there some kind of guidance what you’d hoped that unit could achieve in the future percentage of overall rev?

A - Umang Gupta

Let me just start by saying that it's roughly -- we've got historical numbers, but I think what we said is 4%, I don't think I used the word “down to”, because it was pretty much around that number for a while right now. What was it a year ago? We have been in our --

A - Andrew Hamer


A - Umang Gupta

$488,000. So they are about roughly the same. I wouldn't exactly say it’s down or up, it's roughly the same. In between, I think somewhere about 18 months ago or longer, it had a higher spike because of a special deal we have done with AT&T. But by and large it's about a $2 million a year business. That is about 4% of our business, excluding SIGOS. The question of longer-term, we don't give guidance beyond a quarter, as you know.

Q - Kevin Manthie


A - Umang Gupta

But I think you can take a look and say that if our current business is $2 million a year, excluding SIGOS, and the SIGOS business adds for next year, we said approximately $10 million based on how the revenue recognition flows, then at least 12 million would seem to be a logical result.

Q - Kevin Manthie


A - Umang Gupta

Looking, nothing else changes.

Q - Kevin Manthie

I appreciate it. Thank you guys.


Your next question comes from Kevin Liu of B. Riley & Company.

Q - Kevin Liu

Hi guys. The first question just on the CEM environment, are you seeing any kind of pickup in demand, or anything that suggests that we should see results improving from this point?

A - Umang Gupta

Well, it's too early this month for me to say that, I could give you anything more than the overall guidance for the company. I will say, however, that now getting to really get involved with the nuances of the business, because I'm acting as a de facto head of the unit this time, I'm actually feeling quite good about our longer-term prospects for this business. There are clearly execution issues in the last quarter that related to sales that are being fixed very, very rapidly, we are opening up a lot of new territories. It takes some time to have some of the sales folks get up to speed, so that may or may not have an effect this quarter. We had some attrition in consulting support for the CEM business and some of our consultants are also kind of rainmakers for the business, so that affects revenues, but we’ve actually replaced those folks, so we're actually feeling pretty good about the capability of our consulting group to help keep the business going, and even potentially modestly grow it. But clearly the longer-term effects will depend upon our ability to have a full complement of sales folks who are capable of selling both the SLM and CEM business.

Q - Kevin Liu

Okay. And would you guys happen to be able to break out 123R cost by line?

A - Umang Gupta


A - Andrew Hamer

We actually break that out. You will see the stock-based compensation in one of the schedules. So we have given you $812,000 for the current quarter and we expect it to be about that, maybe a little bit higher next quarter.

Q - Kevin Liu

Okay, I see it, thanks. And last question, just in terms of the integration of SIGOS so far, are you guys seeing any potential opportunities to improve on the cost structure, or how far along are you in that integration process?

A - Umang Gupta

I'm going to start by saying that there is absolutely no expectation of attempting to cut costs relative to this integration. If anything, we expect to spend a little bit more money from the profits that SIGOS has been generating into more investments in the mobile business. So, as I said earlier, this is all about growth, and not attempting to find cost synergies, this is a nicely profitable business we bought and we're really trying to grow it faster so that's number one. Number two, relative to synergies, I'm actually very pleased with some of the synergies we have seen, we have actually -- we have seen situations -- if I could speak personally, anecdotally about a situation in India recently where the fact that Keynote has now purchased SIGOS, has an Indian connection there. There is also our well-known name in India decently so has helped us in a major deal that we believe SIGOS will be the beneficiary of, a fairly large deal. We're talking about multiple six-figure deals here. And similarly there are places in America we're now starting to see uptick or interest in the SIGOS product whereas previously SIGOS was just a European unit, but us being here in America, many of our major telecom providers are starting to get quite interested in it. So I'm quite hopeful that we will see the effects of all this.

Q - Kevin Liu

All right, thank you.


Operator Instructions At this time, there are no further questions.

Umang Gupta, Chairman and Chief Executive Officer

Well, ladies and gentlemen, thank you very much for joining us today. Just to summarize, during the third fiscal quarter, we will continue our efforts to stimulate our growth in the CEM business, and increase growth in our SLM business. As a new Internet requiring more complex services emerges, it will drive our SLM business further. And additionally, the Keynote SIGOS unit targets the mobile Internet, which strategically expands our service offerings and growth opportunities. We're very excited about the future. Thank you again for your support.


This concludes your conference. You may now disconnect.

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