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KEYN > SEC Filings for KEYN > Form 10-Q on 6-Aug-2013All Recent SEC Filings

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Form 10-Q for KEYNOTE SYSTEMS INC


6-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of the financial condition and results of operations of Keynote Systems, Inc. (referred to herein as "we," "us," "Keynote" or "the Company") should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in this report as well as the audited financial statements and notes thereto in our Annual Report on Form 10-K for the year ended September 30, 2012, and subsequent filings with the Securities and Exchange Commission.

Except for historical information, this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and
Section 21E of the Securities Exchange Act of 1934. These forward-looking statements include, among others, statements including the words "expects," "anticipates," "intends," "believes" and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to these differences include, but are not limited to, those discussed in this section, the section entitled "Risk Factors" in Item 1A of Part II of this report, and in our annual report on Form 10-K for the fiscal year ended September 30, 2012 and elsewhere in that report. You should carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the quarterly reports on Form 10-Q and current reports on Form 8-K that we may file during the current year. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this quarterly report on Form 10-Q. Except as required by law, we undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

Overview

Keynote is a leading global provider of mobile and Web cloud testing and monitoring services. We maintain one of the world's largest on-demand quality testing and performance monitoring networks comprised of approximately 7,000 measurement computers and mobile devices in over 300 locations covering 180 countries. Our global network enables our customers to continuously test, monitor and assure the online and mobile experience. We offer a robust portfolio of cloud products and services to optimize the end-user customer experience to world-class telecommunications and enterprise customers, representing a broad cross-section of industries. Our cloud products and services are grouped into three categories: Internet, Enterprise Mobile and Telecommunications Mobile. On June 23, 2013, we entered into a definitive agreement to be acquired by an affiliate of Thoma Bravo for a purchase price of $20.00 per share of common stock.

We deliver our products and services primarily through a cloud-based model on a subscription basis (also referred to as Software-as-a-Service, or SaaS). Subscription fees range from monthly to multi-year commitments and vary based on the type of service selected, the number of measurements, transactions or devices monitored, the number of measurement locations and/or appliances, the frequency of the measurements, the communication protocols or services measured, privacy settings and any additional features ordered. Our System Integrated Test Environment ("SITE") and Test Center Enterprise ("TCE") systems, which include software and hardware, usually are offered via a software license fee model that is bundled with ongoing maintenance and support. Our engagement services, or professional services, complement and support our cloud products and services. Our engagement services provide our customers with a deeper and qualitative perspective of their performance data.

Our net revenue increased by $0.5 million, or 1%, from $93.9 million for the nine months ended June 30, 2012 to $94.4 million for the nine months ended June 30, 2013. Our net income decreased by $2.1 million from net income of $4.5 million for the nine months ended June 30, 2012 to net income of $2.4 million for the nine months ended June 30, 2013. The increase in net revenue is primarily attributable to a $3.2 million increase in Internet net revenue, partially offset by a $2.7 million decrease in Mobile net revenue for the nine months ended June 30, 2013 compared to the nine months ended June 30, 2012. Internet revenue has increased due to the continued increased in the number of measurements requested by our customers. Total costs and expenses increased $2.3 million from $87.8 million for the nine months ended June 30, 2012 to $90.1 million for the nine months ended June 30, 2013, primarily due to the benefit recorded in the prior year's period of $2.0 million for the change in fair value of acquisition-related contingent consideration and transaction expenses of $1.2 million recorded in the three months ended June 30, 2013 associated with the proposed acquisition by Thoma Bravo.

We believe that important trends and challenges for our business include:

Challenges related to the proposed acquisition by Thoma Bravo;

Continuing to drive revenue growth, especially in mobile markets served by our Enterprise Mobile products and services;


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Meeting challenges faced due to the current global economic environment, especially in Europe, as this affects our customers' ability to purchase our products and services;

Developing and marketing new products and services that respond to competitive and technological developments and changing customer needs;

Growing our overall customer base and cross-selling our products within our existing customer base to support the growth of our revenue; and

Controlling expenses in fiscal 2013 to maintain profitability, particularly because of the economic uncertainties that continue to exist, project acceptance volatility that can affect the timing of revenue recognition and the costs we are incurring to take advantage of growth opportunities, especially our investment in salespeople.

Refer to "Results of Operations," "Non-GAAP Financial Measures," "Liquidity and Capital Resources," and "Commitments" elsewhere in this section and the "Risk Factors" section for a further discussion of the risks, uncertainties and trends in our business.

Critical Accounting Policies and Estimates

Our condensed consolidated financial statements and accompanying notes included elsewhere in this quarterly report on Form 10-Q are prepared in accordance with accounting principles generally accepted in the United States. These accounting principles require us to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenue and expenses during the periods presented. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements:

Revenue recognition;

Fair value of assets acquired and liabilities assumed in a business combinations;

Allowance for doubtful accounts and billing allowance;

Goodwill, identifiable intangible assets and long-lived assets;

Stock-based compensation; and

Income taxes, deferred income tax assets and deferred income tax liabilities.

We believe that there have been no significant changes during the nine months ended June 30, 2013 to the items that we disclosed as our critical accounting policies and estimates in Management's Discussion and Analysis of Financial Condition and Results of Operation in our 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For a description of those critical accounting policies and estimates, please refer to our 2012 Annual Report on Form 10-K. On October 1, 2012, we adopted an accounting pronouncement on fair value measurements that are estimated using significant unobservable (Level 3) inputs, as well as an accounting pronouncement on the presentation of other comprehensive income. There have been no other changes in our critical accounting policies since the end of fiscal 2012.


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Results of Operations

The following table sets forth, as a percentage of total net revenue, certain condensed consolidated statements of operations data for the periods indicated. All information is derived from our condensed consolidated financial statements included in this report. The operating results are not necessarily indicative of the results for any future period.

                                      Three Months Ended        Nine Months Ended
                                           June 30,                  June 30,
                                      2013         2012         2013         2012
Subscriptions and services
revenue                                  87.7 %       85.5 %       86.9 %       84.9 %
Systems licenses revenue                 12.3         14.5         13.1         15.1
Net revenue                             100.0        100.0        100.0        100.0
Costs and expenses:
Costs of revenue:
Direct costs of revenue -
subscriptions and services               25.8         25.2         24.8         23.9
Direct costs of revenue -
systems licenses                          3.0          4.0          3.4          3.9
Development                              15.3         15.7         15.5         14.7
Operations                                9.7          8.5          9.3          8.2
Amortization of intangible
assets - technology                       1.0          1.7          1.3          1.6
Sales and marketing                      31.7         31.4         30.1         29.3
General and administrative               10.8         11.6         10.7         11.9
Transaction expenses                      3.8            -          1.3          0.3
Change in fair value of
acquisition-related contingent
consideration                               -            -            -         (2.1 )
Excess occupancy income                  (1.8 )       (1.3 )       (1.7 )       (1.2 )
Amortization of intangible
assets - other                            0.5          3.2          0.7          2.9
Total costs and expenses                 99.8        100.0         95.4         93.4
Income (loss) from operations             0.2            -          4.6          6.6
Interest income and other, net            0.1          0.4            -          0.2
Income before benefit
(provision) for income taxes              0.3          0.4          4.6          6.8
Benefit (provision) for income
taxes                                     0.2         (0.3 )       (2.0 )       (2.0 )
Net income                                0.5 %        0.1 %        2.6 %        4.8 %

The dollar amounts in the tables in this and the following sections are in thousands unless otherwise indicated.

Net Revenue



                             For the three months ended June 30,            For the nine months ended June 30,
                             2013            2012          % Change          2013            2012        % Change
Internet:
Web Measurement
Subscriptions            $      9,592    $      8,803               9 %  $     28,599    $     25,189           14 %
Other Subscriptions             2,819           3,032              (7 )         9,846          10,596           (7 )
Engagements                     3,789           2,779              36           9,189           8,690            6
Total Internet net
revenue                        16,200          14,614              11          47,634          44,475            7
Mobile:
Subscriptions                   6,090           6,529              (7 )        17,881          18,328           (2 )
Ratable Licenses                  182             499             (64 )           803           3,062          (74 )
Systems Licenses                3,826           4,382             (13 )        12,388          14,160          (13 )
Maintenance and
Support                         4,903           4,252              15          15,737          13,922           13
Total Mobile net
revenue                        15,001          15,662              (4 )        46,809          49,472           (5 )
Net revenue              $     31,201    $     30,276               3 %  $     94,443    $     93,947            1 %

Mobile net revenue by
customer type:
Enterprise               $      4,454    $      6,600             (33 )% $     15,119    $     18,427          (18 )%
Telecommunications             10,547           9,062              16          31,690          31,045            2
Total Mobile net
revenue                  $     15,001    $     15,662              (4 )% $     46,809    $     49,472           (5 )%


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Subscription revenue is reflected in the above table as Web Measurement Subscriptions (which includes Application Perspective, Transaction Perspective, Streaming Perspective and Web Site Perspective products and services), Other Subscriptions (which includes all other Internet subscription products and services) and Mobile Subscriptions (which includes GlobalRoamer, Mobile Device Perspective, Mobile Web Perspective, Test Center Enterprise (TCE) Interactive and Test Center Developer products and services). Licensing arrangements for monitoring and testing systems are reflected in the above table as Ratable Licenses (which includes SITE, TCE Automation and TCE Monitoring arrangements entered into prior to fiscal 2011, which is when new accounting guidance for revenue recognition was adopted), Systems Licenses (which includes the hardware and software elements of SITE, TCE Automation and TCE Monitoring arrangements) and Maintenance and Support (which includes all the other elements of SITE, TCE Automation and TCE Monitoring arrangements, stand-alone consulting services agreements and maintenance agreement renewals).

Internet Net Revenue. Internet net revenue increased by $1.6 million for the three months ended June 30, 2013 compared to the three months ended June 30, 2012. Internet net revenue represented 52% and 48% of net revenue for the three months ended June 30, 2013 and 2012, respectively. The increase in Internet net revenue was mainly attributable to an increase of $0.8 million in our Internet Web Measurement Subscriptions due primarily to an increase in the number of measurements that our customers performed to test their Web sites and an increase of $1.0 million of engagements due primarily to increased engagements with new customers and existing customers, partially offset by a $0.2 million decrease in our Internet Other Subscriptions.

Internet net revenue increased by $3.2 million for the nine months ended June 30, 2013 compared to the nine months ended June 30, 2012. Internet net revenue represented 50% and 47% of net revenue for the nine months ended June 30, 2013 and 2012, respectively. The increase in Internet net revenue was mainly attributable to an increase of $3.4 million in our Internet Web Measurement Subscriptions due primarily to an increase in the number of measurements that our customers performed to test their Web sites.

Mobile Net Revenue. Mobile net revenue decreased by $0.7 million for the three months ended June 30, 2013 compared to the three months ended June 30, 2012. Mobile net revenue represented 48% and 52% of net revenue for the three months ended June 30, 2013 and 2012, respectively. The decrease in Mobile net revenue was mainly attributable to a $0.3 million decrease in Ratable Licenses revenue due to the change in revenue recognition guidance at the beginning of fiscal 2011 and a $0.4 million decrease in Mobile Subscription revenue primarily due to the non-renewal of a large North American mobile handset manufacturer's monitoring project based on our MDP service.

Mobile net revenue decreased by $2.7 million for the nine months ended June 30, 2013 compared to the nine months ended June 30, 2012. Mobile net revenue represented 50% and 53% of net revenue for the nine months ended June 30, 2013 and 2012, respectively. The decrease in Mobile net revenue was mainly attributable to a $2.3 million decrease in Ratable License revenue due to the change in revenue recognition guidance at the beginning of fiscal 2011 and a $1.8 million decrease in System Licenses due to fewer DeviceAnywhere licensing agreements in this fiscal year. These decreases were partially offset by a $1.8 million increase in Maintenance and Support due to an increase in systems under maintenance agreements and increased DemoAnywhere revenue.

No single customer accounted for more than 10% of net revenue in the three and nine month periods ended June 30, 2013 and 2012. No single customer accounted for more than 10% of our net accounts receivable at June 30, 2013. One customer accounted for 12% of our net accounts receivable at September 30, 2012.

International sales, principally in Europe, were approximately 45% and 44% of net revenue for the three and nine months ended June 30, 2013, respectively, and were approximately 43% and 46% of net revenue for the three and nine months ended June 30, 2012, respectively.


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Direct Costs of Net Revenue



                            For the three months ended June 30,           For the nine months ended June 30,
                           2013           2012          % Change           2013            2012        % Change
Direct costs of
revenue
-subscriptions and
services                $     8,068    $     7,611                6 %  $     23,518    $     22,424            5 %
Direct costs of
revenue - systems

licenses $ 945 $ 1,215 (22 )% $ 3,230 $ 3,687 (12 )%

Direct costs of revenue-subscriptions and services is comprised of telecommunication and network fees for our measurement and data collection network, costs for employees and consultants assigned to consulting engagements and to install monitoring and testing systems, depreciation of equipment related to our measurement and data collection network, and costs of supplies.

Direct costs of revenue - subscriptions and services increased $0.5 million for the three months ended June 30, 2013 compared to the three months ended June 30, 2012 and represented 29% of subscription and services revenue for both the three months ended June 30, 2013 and 2012. The increase in direct costs of revenue - subscriptions and services was mainly attributable to additional telecommunication and network fees and equipment expenses due to higher monitoring volume associated with the increased subscriptions revenue and higher consulting costs to deliver engagements.

Direct costs of revenue - subscriptions and services increased $1.1 million for the nine months ended June 30, 2013 compared to the nine months ended June 30, 2012 and represented 29% and 28% of subscription and services revenue for the nine months ended June 30, 2013 and 2012, respectively. The increase in direct costs of revenue - subscriptions and services was mainly attributable to $0.3 million of additional telecommunication and network fees, $0.7 million of equipment expenses due to higher monitoring volume associated with the increased subscriptions revenue and an increase in personnel costs associated with additional headcount primarily focused on mobile products and services.

Direct costs of revenue - systems licenses include the material and labor costs of systems hardware to be installed as part of a systems license arrangement and related software royalty fees.

Direct costs of revenue - systems licenses decreased $0.3 million for the three months ended June 30, 2013 compared to the three months ended June 30, 2012 and represented 25% and 28% of systems licenses revenue for the three months ended June 30, 2013 and 2012, respectively. The decrease in direct costs of revenue - systems licenses was due to the lower system licenses revenue as compared to the same quarter of the last fiscal year and a lower hardware component of the systems licenses revenue.

Direct costs of revenue - systems licenses decreased $0.5 million for the nine months ended June 30, 2013 compared to the nine months ended June 30, 2012 and represented 26% of systems licenses revenue for both the nine months ended June 30, 2013 and 2012. The decrease in direct costs of revenue - systems licenses was due to the lower system licenses revenue as compared to the same period of the last fiscal year.

Development

For the three months ended June 30, For the nine months ended June 30, 2013 2012 % Change 2013 2012 % Change Development $ 4,765 $ 4,754 - % $ 14,593 $ 13,821 6 %

Development expenses consist primarily of employee compensation, including stock-based compensation and other benefits, and other costs incurred by our development personnel.

Development costs for the three months ended June 30, 2013 were consistent with the three months ended June 30, 2012. Development costs increased $0.8 million for the nine months ended June 30, 2013 compared to the nine months ended June 30, 2012. The increase was mainly attributable to higher personnel costs primarily focused on mobile products and services.

Operations

For the three months ended June 30, For the nine months ended June 30, 2013 2012 % Change 2013 2012 % Change Operations $ 3,030 $ 2,587 17 % $ 8,774 $ 7,750 13 %


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Operations expenses consist primarily of employee compensation, including stock-based compensation and other benefits, for management and technical support personnel. Our operations personnel manage and maintain our field measurement and data collection network; provide basic and extended customer support; and ensure the reliability of our services. Operations expenses increased $0.4 million for the three months ended June 30, 2013 compared to the three months ended June 30, 2012. The increase was mainly attributable to $0.2 million of equipment expenses related to our data network to support the higher subscriptions revenue and $0.1 million higher personnel costs to support our data network.

Operations expenses increased $1.0 million for the nine months ended June 30, 2013 compared to the nine months ended June 30, 2012. The increase was mainly attributable to $0.5 million of equipment expenses related to our data network to support the higher subscriptions revenue and $0.2 million of higher personnel costs to support our data network.

Sales and Marketing

For the three months ended June 30, For the nine months ended June 30,
2013 2012 % Change 2013 2012 % Change
Sales and marketing $ 9,895 $ 9,506 4 % $ 28,389 $ 27,518 3 %

Sales and marketing expenses consist primarily of salaries, benefits, commissions and bonuses earned by sales and marketing personnel, stock-based compensation, lead-referral fees, marketing programs and travel expenses. Sales and marketing expenses increased by $0.4 million for the three months ended June 30, 2013 as compared to the three months ended June 30, 2012, primarily attributable to higher marketing promotion and user conference fees in order to grow Mobile revenue.

Sales and marketing expenses increased by $0.9 million for the nine months ended June 30, 2013 as compared to the nine months ended June 30, 2012. The increase was mainly attributable to higher personnel costs resulting from additional headcount primarily to grow mobile revenues.

General and Administrative

For the three months ended June 30, For the nine months ended June 30,
2013 2012 % Change 2013 2012 % Change
General and administrative $ 3,355 $ 3,525 (5 )% $ 10,184 $ 11,106 (8 )%

General and administrative expenses consist primarily of employee compensation, including stock-based compensation and other benefits; professional service fees, including accounting, auditing, legal and bank fees; insurance; and other general corporate expenses. General and administrative expenses decreased by $0.2 million for the three months ended June 30, 2013 as compared to the three months ended June 30, 2012, primarily attributable to the lower stock-based compensation due to vesting of RSUs in July 2012.

General and administrative expenses decreased by $0.9 million for the nine months ended June 30, 2013 as compared to the nine months ended June 30, 2012. This was mainly attributable to $0.6 million lower professional service fees and $0.2 million lower rent expense due to moving the DeviceAnywhere employees into our headquarter building in January 2012.

Transaction Expenses

For the three months ended June 30, For the nine months ended June 30,
2013 2012 % Change 2013 2012 % Change
Transaction expenses $ 1,185 - 100 % $ 1,185 328 261 %

During the third quarter of fiscal 2013, $1.2 million of transaction expenses were incurred in connection with the proposed merger with Thoma Bravo. During the first quarter of fiscal 2012, $0.3 million of transaction expenses were incurred in connection with the acquisition of DeviceAnywhere.

Change in estimated fair value of acquisition-related contingent consideration

At the acquisition date, a $2.0 million liability was recorded based on the estimated fair value of the acquisition-related contingent consideration to the former stockholders of DeviceAnywhere based on DeviceAnywhere achieving 2011 and 2012 revenue, bookings and EBITDA targets. During the first quarter of 2012, we concluded that DeviceAnywhere would not achieve either the 2011 or the 2012 targets. Accordingly, we reversed the liability and recorded a benefit of $2.0 million due to the change in estimate of the fair value of acquisition-related contingent consideration.


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Excess Occupancy Income



                              For the three months ended June 30,           For the nine months ended June 30,
                              2013          2012          % Change           2013            2012        % Change
. . .
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