XNAS:KEYN Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2012

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                   to                   

 

Commission File Number: 000-27241

 

KEYNOTE SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

94-3226488

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

 

 

777 Mariners Island Blvd., San Mateo, CA

 

94404

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (650) 403-2400

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): YES o NO x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

 

Class

 

Shares outstanding as of May 2, 2012

Common Stock, $.001 par value

 

17,499,042 shares

 

 

 





Table of Contents

 

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts and par value)

(Unaudited)

 

 

 

March 31,
2012

 

September 30,
2011

 

ASSETS

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

31,622

 

$

85,573

 

Short-term investments

 

12,012

 

15,807

 

Total cash, cash equivalents and short-term investments

 

43,634

 

101,380

 

Accounts receivable, less allowance for doubtful accounts of $525 and $246, respectively, and less billing reserve of $189 and $150, respectively

 

19,311

 

14,738

 

Inventories

 

2,090

 

1,502

 

Deferred tax assets

 

6,010

 

7,582

 

Other current assets

 

3,465

 

3,002

 

Total current assets

 

74,510

 

128,204

 

Property, equipment and software, net

 

35,380

 

34,424

 

Goodwill

 

111,572

 

62,459

 

Identifiable intangible assets, net

 

12,053

 

1,653

 

Long-term deferred tax assets

 

33,604

 

32,851

 

Other long-term assets

 

987

 

810

 

Total assets

 

$

268,106

 

$

260,401

 

 

 

 

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

2,942

 

$

2,410

 

Accrued expenses

 

10,769

 

9,450

 

Deferred revenue

 

15,656

 

16,151

 

Total current liabilities

 

29,367

 

28,011

 

Long-term income tax payable

 

3,422

 

3,323

 

Long-term deferred revenue

 

1,993

 

2,388

 

Other long-term liabilities

 

462

 

488

 

Total liabilities

 

35,244

 

34,210

 

 

 

 

 

 

 

Commitments and contingencies (see Note 16)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Common stock—$0.001 par value; 100,000,000 shares authorized; 17,498,625 and 17,291,467 shares issued and outstanding, respectively

 

17

 

17

 

Additional paid-in capital

 

314,314

 

312,057

 

Accumulated deficit

 

(82,611

)

(87,066

)

Accumulated other comprehensive income (loss)

 

1,142

 

1,183

 

Total stockholders’ equity

 

232,862

 

226,191

 

Total liabilities and stockholders’ equity

 

$

268,106

 

$

260,401

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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Table of Contents

 

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

 

 

 

 

 

 

 

 

 

 

Net revenue (Note 4):

 

$

30,592

 

$

24,107

 

$

63,671

 

$

48,940

 

Costs and expenses:

 

 

 

 

 

 

 

 

 

Costs of revenue:

 

 

 

 

 

 

 

 

 

Direct costs of revenue

 

8,691

 

5,964

 

17,285

 

11,807

 

Development

 

4,688

 

3,186

 

9,067

 

6,221

 

Operations

 

2,667

 

1,967

 

5,163

 

3,878

 

Amortization of intangible assets — technology

 

525

 

419

 

990

 

838

 

Total costs of revenue

 

16,571

 

11,536

 

32,505

 

22,744

 

Sales and marketing

 

8,874

 

6,768

 

18,012

 

13,961

 

General and administrative

 

3,801

 

2,559

 

7,909

 

5,407

 

Change in estimated fair value of acquisition-related contingent consideration

 

 

 

(2,000

)

 

Excess occupancy income

 

(388

)

(273

)

(738

)

(519

)

Amortization of intangible assets — other

 

969

 

153

 

1,779

 

304

 

Total costs and expenses

 

29,827

 

20,743

 

57,467

 

41,897

 

Income from operations

 

765

 

3,364

 

6,204

 

7,043

 

Interest income

 

39

 

132

 

85

 

266

 

Other income (expense), net

 

(51

)

75

 

(37

)

157

 

Income before provision for income taxes

 

753

 

3,571

 

6,252

 

7,466

 

Provision for income taxes

 

(419

)

(240

)

(1,797

)

(508

)

Net income

 

$

334

 

$

3,331

 

$

4,455

 

$

6,958

 

 

 

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.02

 

$

0.21

 

$

0.26

 

$

0.45

 

Diluted

 

$

0.02

 

$

0.19

 

$

0.24

 

$

0.42

 

Shares used in computing basic and diluted net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

17,376

 

15,814

 

17,335

 

15,406

 

Diluted

 

18,553

 

17,160

 

18,540

 

16,498

 

 

 

 

 

 

 

 

 

 

 

Cash dividends declared per common share

 

$

0.06

 

$

0.06

 

$

0.12

 

$

0.12

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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Table of Contents

 

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Six Months Ended
March 31,

 

 

 

2012

 

2011

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

4,455

 

$

6,958

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation

 

2,704

 

2,066

 

Stock-based compensation

 

2,872

 

1,519

 

Amortization of identifiable intangible assets

 

2,769

 

1,142

 

Amortization of prepaid tax asset

 

65

 

351

 

Charges to bad debt and billing reserves

 

233

 

215

 

Amortization of debt investment premium

 

199

 

591

 

Deferred tax expense

 

1,523

 

40

 

Change in estimated fair value of acquisition-related contingent consideration

 

(2,000

)

 

Loss on disposal of equipment

 

9

 

21

 

Changes in operating assets and liabilities:

 

 

 

 

 

Accounts receivable

 

(2,103

)

(2,132

)

Inventories

 

(542

)

(598

)

Other assets

 

(489

)

(954

)

Accounts payable and accrued expenses

 

425

 

549

 

Deferred revenue

 

(4,004

)

(751

)

Net cash provided by operating activities

 

6,116

 

9,017

 

Cash flows from investing activities:

 

 

 

 

 

Purchases of property, equipment and software

 

(3,247

)

(2,163

)

Acquisition of Mobile Complete, Inc. (Note 3)

 

(60,000

)

 

Maturities and sales of short-term investments

 

5,363

 

12,955

 

Purchases of short-term investments

 

(1,649

)

(24,503

)

Net cash used in investing activities

 

(59,533

)

(13,711

)

Cash flows from financing activities:

 

 

 

 

 

Proceeds from issuance of common stock and exercise of stock options

 

1,466

 

14,486

 

Cash dividends declared and paid

 

(2,081

)

(1,868

)

Net cash provided by (used in) financing activities

 

(615

)

12,618

 

Effect of exchange rate changes on cash and cash equivalents

 

81

 

525

 

Net change in cash and cash equivalents

 

(53,951

)

8,449

 

Cash and cash equivalents at beginning of the period

 

85,573

 

23,241

 

Cash and cash equivalents at end of the period

 

$

31,622

 

$

31,690

 

Supplemental cash flow disclosure:

 

 

 

 

 

Income taxes paid (net of refunds)

 

$

20

 

$

30

 

Noncash operating and investing activities:

 

 

 

 

 

Acquisition of property, equipment and software on account

 

$

327

 

$

231

 

 

See accompanying notes to the condensed consolidated financial statements.

 

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Table of Contents

 

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

(1) Summary of Significant Accounting Policies

 

Organization

 

Keynote Systems, Inc. was incorporated on June 15, 1995 in California and reincorporated in Delaware on March 31, 2000. Keynote Systems, Inc. and its subsidiaries (the “Company”) develop and sell services, hardware and software to measure, test, assure and improve Internet and mobile communications quality of service.

 

Basis of Presentation

 

The accompanying condensed consolidated balance sheets, and condensed consolidated statements of operations and cash flows, reflect all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position of the Company as of March 31, 2012, and the results of operations and cash flows for the interim periods ended March 31, 2012 and 2011.

 

The results of operations and cash flows for any interim period are not necessarily indicative of the results to be expected for any other future interim period or for the full year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended September 30, 2011 included in the Company’s Annual Report on Form 10-K as filed with the Securities and Exchange Commission (“SEC”). The condensed consolidated financial statements include the accounts of the Company and its domestic and foreign subsidiaries. Intercompany balances have been eliminated in consolidation.

 

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Significant estimates made in preparing the condensed consolidated financial statements relate to revenue recognition, the allowance for doubtful accounts and billing reserve, the fair value of assets acquired and liabilities assumed in a business combination, useful lives of property, equipment, software and identifiable intangible assets, asset impairments, the fair value of awards granted under the Company’s stock-based compensation plans and valuation allowances against deferred tax assets. Actual results could differ from those estimates, and such differences may be material to the financial statements.

 

Fair Value Measurements

 

The Company defines fair value as the price that would be received from selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When determining the fair value measurements for assets and liabilities which are required to be recorded at fair value, the Company considers the principal or most advantageous market in which the Company would transact and the market-based risk measurements or assumptions that market participants would use in pricing the asset or liability. The fair values may therefore be determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques.

 

The Company applies the following fair value hierarchy, which prioritizes the inputs used to measure fair value into three levels and bases the categorization within the hierarchy upon the lowest level of input that is available and significant to the fair value measurement:

 

·             Level 1 inputs are based on quoted prices in active markets for identical assets or liabilities.

 

·             Level 2 inputs are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

·             Level 3 inputs are generally unobservable and typically reflect the use of model-based techniques and management’s estimates of assumptions that market participants would use in pricing the asset or liability.

 

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Table of Contents

 

(2) Net Income (Loss) Per Share

 

Basic net income (loss) per common share is computed by dividing net income (loss) available to common shareholders by the weighted-average number of shares of common stock outstanding during the period. Diluted net income (loss) per common share is computed by dividing net income (loss) available to common shareholders by the weighted-average number of shares of common stock outstanding during the period increased to include the number of additional shares of common stock that would have been outstanding if the potentially dilutive securities had been issued. Potentially dilutive securities include outstanding options, purchase rights under the employee stock purchase plan and unvested restricted stock units (“RSUs”). The dilutive effect of potentially dilutive securities is reflected in diluted earnings per common share by application of the treasury stock method. Under the treasury stock method, an increase in the fair market value of the Company’s common stock can result in a greater dilutive effect from potentially dilutive securities.

 

The following table sets forth the computation of basic and diluted net income per share (in thousands, except per share amounts):

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

Numerator:

 

 

 

 

 

 

 

 

 

Net income

 

$

334

 

$

3,331

 

$

4,455

 

$

6,958

 

Denominator:

 

 

 

 

 

 

 

 

 

Weighted average shares outstanding

 

17,376

 

15,814

 

17,335

 

15,406

 

Effect of dilutive securities

 

1,177

 

1,346

 

1,205

 

1,092

 

Weighted average shares—diluted

 

18,553

 

17,160

 

18,540

 

16,498

 

Net income per share:

 

 

 

 

 

 

 

 

 

Basic

 

$

0.02

 

$

0.21

 

$

0.26

 

$

0.45

 

Diluted

 

$

0.02

 

$

0.19

 

$

0.24

 

$

0.42

 

 

For the three months ended March 31, 2012 and 2011, there were 0.3 million and zero, respectively, shares of potentially dilutive securities excluded from the computation of diluted net income per share because their effect would be antidilutive. Potentially dilutive securities representing 0.3 million and 0.1 million shares of common stock for the six months ended March 31, 2012 and 2011, respectively, were excluded from the computation of diluted net income per share for these periods because their effect would be antidilutive.

 

(3) Business Combination

 

On October 18, 2011, the Company acquired Mobile Complete, Inc., doing business as DeviceAnywhere (“DeviceAnywhere”). DeviceAnywhere developed an enterprise-class, cloud-based mobile application lifecycle management testing and quality assurance platform. DeviceAnywhere’s products and services complement and expand the Company’s market for testing and monitoring the functionality, usability, performance and availability of mobile applications and mobile Web sites. The estimated acquisition date fair value of consideration transferred, assets acquired and liabilities assumed are presented below and represent our best estimates.

 

Fair Value of Consideration Transferred

 

Pursuant to the merger agreement, the Company made payments totaling $60.0 million in cash for all of the outstanding securities of DeviceAnywhere on October 18, 2011. Under the terms of the merger agreement, the former stockholders of DeviceAnywhere potentially could receive additional payments (“acquisition-related contingent consideration”) totaling up to $30.0 million in cash. The “2011 earnout” of up to $15.0 million in cash was based on achievement of certain DeviceAnywhere revenue and EBITDA targets for the period from January 1, 2011 through December 31, 2011.  The “2012 earnout” of up to $15.0 million in cash required achievement of 1) certain booking targets for the period from September 1, 2011 through December 31, 2011 and 2) revenue and EBITDA targets for the period from January 1, 2012 through December 31, 2012. The 2011 earnout and the 2012 earnout collectively represent the acquisition-related contingent consideration. The fair value of the acquisition-related contingent consideration was based on significant inputs not observed in the market and thus represented a level 3 measurement. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions to estimate fair value.

 

In preparing the preliminary purchase price allocation as of the acquisition date, management estimated the fair value of the acquisition-related contingent consideration based on the estimated level of achievement of the 2011 earnout and 2012 earnout. As a result, a $2.0 million liability was recorded at the acquisition date for the fair value of the acquisition-related contingent consideration. Any change in the fair value of the acquisition-related contingent consideration subsequent to the acquisition date, including changes from events after the acquisition date, such as changes in the estimate of revenues and EBITDA that are expected to be achieved, are recognized in earnings in the period the estimated fair value changes. In the quarter ended December 31, 2011, the Company concluded that the targets for both the 2011 earnout and 2012 earnout will not be met and the former stockholders of DeviceAnywhere will not receive any acquisition-related contingent consideration. Accordingly, during the first quarter of fiscal year 2012, the Company reversed the previously estimated liability and recorded a $2.0 million benefit in its operating results due to the change in the fair value of acquisition-related contingent consideration.

 

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Table of Contents

 

The total acquisition date fair value of the consideration transferred was $60.0 million, inclusive of $6.0 million in cash allocated to an escrow fund to satisfy indemnification obligations pursuant to the merger agreement and the settlement of various debt and transaction related liabilities of DeviceAnywhere totaling $4.5 million.

 

Allocation of Consideration Transferred

 

The identifiable assets acquired and liabilities assumed were recognized and measured as of the acquisition date based on their estimated fair values. The excess of the fair value of consideration transferred over estimated fair value of the net tangible assets and intangible assets was recorded as goodwill.

 

The following table summarizes the estimated fair values of the assets and liabilities assumed at the acquisition date based on the preliminary purchase price allocation.  The allocation is preliminary for certain items such as sales taxes and income taxes (in thousands):

 

Accounts receivable

 

$

2,758

 

Other assets, including deferred tax assets

 

1,031

 

Fixed assets

 

1,208

 

Identifiable intangible assets

 

13,170

 

Total identifiable assets acquired

 

18,167

 

Accounts payable and other liabilities

 

(2,334

)

Contingent consideration

 

(2,000

)

Deferred revenue

 

(3,126

)

Total liabilities assumed

 

(7,460

)

Net identifiable assets acquired

 

10,707

 

Goodwill

 

49,293

 

Amount paid

 

$

60,000

 

 

Identifiable Intangible Assets

 

Management engaged a third-party valuation firm to assist in the determination of the fair value of the identifiable intangible assets. In determining the fair value of the identifiable intangible assets, the Company considered, among other factors, the best use of acquired assets, analyses of historical financial performance and estimates of future performance of DeviceAnywhere’s products. The fair values of identifiable intangible assets were calculated considering market participant expectations and using an income approach. The rates utilized to discount estimated net cash flows to their present values were based on a weighted average cost of capital of 12.5%. This discount rate was determined after consideration of the rate of return on debt capital and equity that typical investors would require from an investment in companies similar in size and operating in similar markets as DeviceAnywhere. The following table sets forth the components of identifiable intangible assets associated with the DeviceAnywhere acquisition and their estimated useful lives (in thousands, except useful life):

 

 

 

Useful life
(Years)

 

Fair Value

 

Technology

 

3-6

 

$

6,470

 

Backlog

 

1

 

2,700

 

Customer relationships

 

6

 

2,600

 

Trademarks

 

8

 

1,100

 

Noncompete agreements

 

3

 

300

 

Total identifiable intangible assets

 

 

 

$

13,170

 

 

The Company determined the useful lives of the identifiable intangible assets based on the expected future cash flows associated with the respective asset. Technology is comprised of products that have reached technological feasibility and are part of DeviceAnywhere’s product line. There were no in-process research and development assets as of the acquisition date. Backlog represents the fair value of firm orders for products and services to be delivered to customers. Customer relationships represent the underlying relationships and agreements with DeviceAnywhere’s installed customer base. Trademarks represent the fair value of the brand and name recognition associated with the marketing of DeviceAnywhere’s products and services. Noncompete agreements represent the fair value of employee knowledge in the development of products and services. Amortization expense for technology is included in costs of revenue, and amortization expense for backlog, customer relationships, trademarks, and noncompete agreements are included in operating expenses.

 

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Table of Contents

 

Deferred Revenue

 

In connection with the allocation of consideration transferred, the Company estimated the fair value of the service obligations assumed from DeviceAnywhere as a consequence of the acquisition. The estimated fair value of the service obligations was determined using a cost build-up approach. The cost build-up approach determines fair value by estimating the costs related to fulfilling the obligations plus a normal profit margin. The sum of the costs and operating profit approximates, in theory, the amount that the Company would be required to pay a third party to assume the service obligations. The estimated costs to fulfill the service obligations were based on the historical direct costs engaged in providing service and support activities.  The estimated research and development costs associated with support contracts have not been included in the fair value determination, as these costs were not deemed to represent a legal obligation at the time of acquisition. Based on this approach, the Company recorded approximately $3.1 million of deferred revenue to reflect the estimate of the fair value of DeviceAnywhere’s service obligations assumed.

 

Results of Operations

 

The amount of revenue and net loss of DeviceAnywhere included in the Company’ condensed consolidated statement of operations for the three and six month periods ended March 31, 2012 were as follows (in thousands):

 

 

 

Three Months Ended
March 31, 2012

 

Six Months Ended
March 31, 2012

 

Total revenue

 

$

4,060

 

$

8,169

 

Net loss

 

$

(2,098

)

$

(3,692

)

 

Included in the net loss of DeviceAnywhere for the three months ended March 31, 2012 is $1.2 million of amortization of identifiable intangibles and $0.3 million of stock-based compensation. Included in the net loss of DeviceAnywhere for the six months ended March 31, 2012 is $2.1 million of amortization of identifiable intangibles, $0.5 million of stock-based compensation and $0.3 million of transaction and integration expenses. The $2.0 million benefit from reversing the previously estimated contingent consideration liability in the first quarter of 2012 is excluded from net loss above.

 

Unaudited Pro Forma Financial Information for DeviceAnywhere Acquisition

 

The following table presents the Company’s actual results, including the actual results of DeviceAnywhere for the period from October 18, 2011 to March 31, 2012, and the pro forma results of DeviceAnywhere as if the acquisition had occurred as of the first day of each period presented. The pro forma information is presented for informational purposes only and is not indicative of the results of operations that would have been achieved if the acquisition had taken place at the beginning of each period presented. The pro forma results presented include amortization charges for acquired intangible assets, stock-based compensation, eliminations of intercompany transactions, adjustments to interest expense and related tax effects (in thousands, except per share amounts):

 

 

 

Six Months Ended March 31,

 

 

 

2012

 

2011

 

Net revenue

 

$

64,270

 

$

58,744

 

Net income

 

$

4,202

 

$

1,599

 

Basic net income per share

 

$

0.24

 

$

0.10

 

Diluted net income per share

 

$

0.23

 

$

0.10

 

 

(4) Revenue Recognition

 

Revenue from Internet and Mobile products and services is summarized in the following table (in thousands):

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

Internet:

 

 

 

 

 

 

 

 

 

Web measurement subscriptions

 

$

8,267

 

$

7,373

 

$

16,386

 

$

14,648

 

Other subscriptions

 

3,269

 

2,784

 

7,564

 

6,232

 

Engagements

 

2,821

 

2,600

 

5,911

 

4,785

 

Internet net revenue

 

14,357

 

12,757

 

29,861

 

25,665

 

Mobile:

 

 

 

 

 

 

 

 

 

Subscriptions

 

6,206

 

3,234

 

11,799

 

6,429

 

Ratable licenses

 

980

 

3,687

 

2,563

 

8,258

 

System licenses

 

4,023

 

1,262

 

9,778

 

3,254

 

Maintenance and support

 

5,026

 

3,167

 

9,670

 

5,334

 

Mobile net revenue

 

16,235

 

11,350

 

33,810

 

23,275

 

Net revenue

 

$

30,592

 

$

24,107

 

$

63,671

 

$

48,940

 

 

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Table of Contents

 

Subscriptions revenue consists primarily of revenue from the sale of products and services sold through a cloud-based model on a subscription basis (also referred to as Software-as-a-Service, or SaaS). Subscription arrangements with customers do not provide the customer with the right to take possession of the software supporting the on-demand application service at any time. Subscription revenue is reflected in the above table as Web Measurement Subscriptions (which include Application Perspective, Transaction Perspective, Streaming Perspective and Web Site Perspective products and services), Other Subscriptions (which include all other Internet subscription product and services) and Mobile Subscriptions (which include GlobalRoamer, Mobile Device Perspective, Mobile Web Perspective, Test Center Enterprise (“TCE”) Interactive and Test Center Developer products and services).

 

The Company also sells monitoring systems to mobile network operators and monitoring and testing systems to enterprise mobile customers under licensing arrangements. Licensing arrangements with mobile customers typically include software licenses, hardware, consulting services to configure the systems (installation services), post contract support (maintenance) services, training services and other consulting services associated with the Company’s System Integrated Test Environment (“SITE”) system, TCE Automation and TCE Monitoring products and services. Licensing arrangements are reflected in the above table as Ratable Licenses (which includes SITE, TCE Automation and TCE Monitoring arrangements entered into prior to fiscal year 2011), 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).

 

The Company supplements its cloud-based subscriptions and licensing arrangements with engagement services.

 

Revenue is recognized in accordance with appropriate accounting guidance when all of the following criteria have been met:

 

·             Persuasive evidence of an arrangement exists. The Company considers a customer signed quote, contract, or purchase order to be evidence of an arrangement.

 

·             Delivery of the product or service. Subscription based services are considered delivered when the customer has been provided with access to the subscription services. Subscription services are generally delivered on a consistent basis over the period of the subscription with the customer having flexibility to define and change measurements with respect to the type, frequency, location and complexity of each measurement. Engagement services are considered delivered when the services are performed or the contractual milestones are completed. System licensing arrangements, excluding maintenance, are considered delivered when all elements of the arrangement have either been delivered or accepted, if acceptance language exists.

 

·             Fee is fixed or determinable. The Company considers the fee to be fixed or determinable if the fee is not subject to refund or adjustment and payment terms are standard.

 

·             Collection is deemed reasonably assured. Collection is deemed reasonably assured if it is expected that the customer will be able to pay amounts under the arrangement as payments become due. If it is determined that collection is not reasonably assured, then revenue is deferred and recognized upon cash collection.

 

The Company does not generally grant refunds. All discounts granted reduce revenue. Free trials are typically stand-alone transactions occasionally provided to prospective customers, for which no revenue is recognized.

 

Subscription based services can either be billed in advance or in arrears. For customers that are billed in advance of providing measurements, revenue is deferred upon invoicing and is recognized over the service period, generally ranging from one to twelve months, commencing on the day service is first provided. For customers that are billed in arrears, revenue is recognized based upon actual usage of the subscription services and typically invoiced on a monthly basis. Regardless of when billing occurs, the Company recognizes revenue as services are provided and defers any revenue that is unearned.

 

Revenue associated with licensing system hardware, software essential to the functionality of the system (“essential software”), installation services and training is deferred until the later of delivery of the complete system or until acceptance, under the customer contractual terms. Revenue associated with system maintenance and support is recognized ratably over the maintenance term, usually one year. Non-essential software purchased by customers in bundled arrangements is deemed to be a software element that does not qualify for treatment as a separate unit of accounting as the Company does not have sufficient vendor specific objective evidence (“VSOE”) of fair value for the undelivered elements of the arrangement, typically maintenance. Accordingly, non-essential software revenue is recognized ratably over the product maintenance term.

 

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Table of Contents

 

Engagements revenue consists of fees generated from our professional consulting services and includes services such as Performance Insights, Customer Research Products and DemoAnywhere. Revenue from these services is recognized as the services are performed, typically over a period of one to three months. For engagement service projects that contain project milestones, as defined in the arrangement, the Company recognizes revenue once the services or milestones have been delivered, based on input measures.

 

Revenue Recognition for Arrangements with Multiple Deliverables

 

The Company enters into multiple element arrangements that generally consist of 1) systems combined with maintenance, installation and other consulting services, 2) subscription services combined with engagement services which includes LoadPro and WebEffective, and 3) multiple engagement services.

 

For Arrangements Entered into Prior to Adoption of ASU 2009-13 and ASU 2009-14:

 

Prior to the adoption of the amended accounting guidance for revenue arrangements with multiple deliverables, the Company was not able to establish VSOE for all of the undelivered elements associated with monitoring and testing systems, primarily maintenance. Therefore, the Company recognized the entire arrangement fee into revenue ratably over the maintenance period, historically ranging from twelve to thirty-six months, once the implementation and integration services are completed, usually within two to three months following the delivery of the hardware and software. Ratable recognition of revenue began when evidence of customer acceptance of the software and hardware had occurred in accordance with the arrangement’s contractual terms.

 

Ratable licenses revenue consists of fees from the sale of mobile automated test equipment, related software and maintenance, and engineering and consulting services associated with SITE, TCE Automation and TCE Monitoring systems. The hardware component of the Company’s system arrangements is deemed to include an essential software related element. Customers do not purchase the hardware without also purchasing the software. None of the services provided by the Company is considered to be essential to the functionality of the licensed products. This assessment is due to the implementation/integration services being performed during a relatively short period compared to the length of the arrangement. Additionally, the implementation/integration services are general in nature and the Company has a history of successfully gaining customer acceptance. SITE, TCE Automation and TCE Monitoring orders received prior to the beginning of fiscal year 2011 continue to be recognized ratably and are reported as Ratable license revenue.

 

Subscription arrangements are treated as a single unit of accounting given that the elements within the subscription arrangements do not qualify for treatment as separate units of accounting because sufficient objective evidence of fair value did not exist for the allocation of revenue. As a result the entire arrangement fee was recognized as revenue either ratably over the service period, generally over twelve months, or based upon actual monthly usage.

 

For Arrangements Entered into Subsequent to Adoption of ASU 2009-13 and ASU 2009-14:

 

In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting guidance for multiple-element revenue arrangements to:

 

·             Provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;

 

·             Require an entity to allocate revenue in an arrangement using best estimated selling prices (“BESP”) of each deliverable if a vendor does not have VSOE or third-party evidence (“TPE”) of selling price; and

 

·             Eliminate the use of the residual method and require a vendor to allocate revenue using the relative selling price method.

 

Also in October 2009, the FASB amended the accounting guidance for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry specific software revenue recognition guidance.

 

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Table of Contents

 

The Company evaluates each deliverable in an arrangement to determine whether they represent separate units of accounting. For arrangements within the scope of the new revenue accounting guidance, a deliverable constitutes a separate unit of accounting when it has standalone value and there are no customer-negotiated refunds or return rights for the delivered elements. Allocation of the consideration is determined at arrangement inception on the basis of each unit’s relative selling price.

 

When applying the relative selling price method, the Company determines the selling price for each deliverable using its BESP, as the Company has determined it is unable to establish VSOE or TPE of selling price for the deliverables. BESP reflects the Company’s best estimates of what the selling prices of elements would be if they were sold regularly on a stand-alone basis. The Company determines BESP for a deliverable by considering multiple factors including analyzing historical prices for standalone and bundled arrangements against price lists, market conditions, competitive landscape and internal costs.

 

Direct Costs of Revenue and Deferred Revenue

 

Direct Costs of Revenue: Direct costs of revenue 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 licensed systems, depreciation of equipment related to our measurement and data collection network, licensed systems hardware and supplies.

 

Deferred Revenue: Deferred revenue is comprised of all unearned revenue that has been collected in advance and is recorded as deferred revenue on the balance sheet until the revenue is earned. Any accounts receivable with associated deferred revenue reduces the balance of both accounts receivable and deferred revenue. Short-term deferred revenue represents the unearned revenue that has been collected in advance that will be earned within twelve months of the balance sheet date. Correspondingly, long-term deferred revenue represents the unearned revenue that will be earned after twelve months from the balance sheet date.

 

(5)  Concentration of Risk

 

Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments and accounts receivable. Credit risk is concentrated in North America and Europe, but exists in other regions of the world as well. The Company generally requires no collateral from customers; however, throughout the collection process, it conducts an ongoing evaluation of its customers’ ability to pay. The Company’s allowance for doubtful accounts is determined based on historical trends, experience and current market and industry conditions. Management regularly reviews the adequacy of the Company’s allowance for doubtful accounts by considering the age of each outstanding invoice, each customer’s expected ability to pay and the Company’s collection history with each customer. Management reviews customers with invoices greater than 60 days past due to determine whether a specific allowance is appropriate. In addition, the Company maintains a reserve for all other invoices, which is calculated by applying a percentage to the outstanding accounts receivable balance, based on historical collection trends.

 

In addition to the allowance for doubtful accounts, the Company maintains a billing reserve that represents the reserve for potential billing adjustments that will be recorded as a reduction of revenue. The Company’s billing reserve is calculated as a percentage of revenue based on historical trends and experience.

 

The allowance for doubtful accounts and billing reserve represent management’s best estimates as of the balance sheet dates, but changes in circumstances, including unforeseen declines in market conditions, actual collection rates and the number of billing adjustments, may result in additional allowances or recoveries in the future.

 

 One customer accounted for 12% of net revenue for the three months ended March 31, 2012 and no single customer accounted for more than 10% of net revenue for the six months ended March 31, 2012. One customer accounted for 14% of net revenue for the three months ended March 31, 2011 and for 11% of net revenue for the six months ended March 31, 2011. As of March 31, 2012, no single customer accounted for more than 10% of the Company’s net accounts receivable. As of September 30, 2011, one customer accounted for 14% of the Company’s net accounts receivable.

 

(6)  Cash, Cash Equivalents, and Short-Term Investments

 

The Company considers all highly liquid investments held at major banks, money market funds and other securities with original maturities of three months or less to be cash equivalents.

 

The Company classifies all of its investments as available-for-sale at the time of purchase because it is management’s intent that these investments are available for current operations, and includes these investments on its balance sheets as short-term investments. Investments with original maturities longer than three months include fixed-term deposits, commercial paper, and investment-grade corporate and government debt securities with Moody’s ratings of A3 or better. Investments classified as available-for-sale are recorded at fair market value with the related unrealized gains and losses included in accumulated other comprehensive income (loss), a component of stockholders’ equity. Realized gains and losses are recorded based on specific identification.

 

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Table of Contents

 

The following tables summarize the amortized cost, gross unrealized gains, gross unrealized losses and fair value by significant investment category recorded as cash and cash equivalents or short-term investments (in thousands):

 

 

 

March 31, 2012

 

 

 

 

 

Gross

 

Gross

 

Estimated Market Value

 

 

 

Amortized
Cost

 

Unrealized
Gains

 

Unrealized
Losses

 

Cash and
Cash Equivalents

 

Short-term
Investments

 

Cash

 

$

21,377

 

$

 

$

 

$

21,377

 

$

 

Level 1

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

8,595

 

 

 

8,595

 

 

Corporate and municipal bonds

 

4,591

 

 

(6

)

 

4,585

 

 

 

13,186

 

 

(6

)

8,595

 

4,585

 

Level 2

 

 

 

 

 

 

 

 

 

 

 

Corporate and municipal bonds

 

5,785

 

 

(6

)

 

5,779

 

Commercial paper

 

3,298

 

 

 

1,650

 

1,648

 

 

 

9,083

 

 

(6

)

1,650

 

7,427

 

Total

 

$

43,646

 

$

 

$

(12

)

$

31,622

 

$

12,012

 

 

 

 

September 30, 2011

 

 

 

 

 

Gross

 

Gross

 

Estimated Market Value

 

 

 

Amortized
Cost

 

Unrealized
Gains

 

Unrealized
Losses

 

Cash and
Cash Equivalents

 

Short-term
Investments

 

Cash

 

$

24,512

 

$

 

$

 

$

24,512

 

$

 

Level 1

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

61,061

 

 

 

61,061

 

 

Corporate bonds

 

6,585

 

 

(82

)

 

6,503

 

Government agencies

 

2,000

 

3

 

 

 

2,003

 

 

 

69,646

 

3

 

(82

)

61,061

 

8,506

 

Level 2

 

 

 

 

 

 

 

 

 

 

 

Corporate and municipal bonds

 

5,854

 

 

(53

)

 

5,801

 

Commercial paper

 

1,499

 

1

 

 

 

1,500

 

 

 

7,353

 

1

 

(53

)

 

7,301

 

Total

 

$

101,511

 

$

4

 

$

(135

)

$

85,573

 

$

15,807

 

 

The Company utilizes the FASB’s guidance to determine the fair value of financial instruments and to determine if the gross unrealized loss on investments represents an other than temporary impairment. The Company evaluates whether an impairment of a debt security is other than temporary each reporting period using the following guidance:

 

·                  If management intends to sell an impaired debt security, the impairment is considered other than temporary. If the entity does not intend to sell the impaired debt security, it must still assess whether it is more likely than not that it will be required to sell the security.

 

·                  If management determines that it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis of the security, the impairment is considered other than temporary.

 

·                  If management determines that it does not intend to sell an impaired debt security and, that it is not more likely than not that it will be required to sell such a security before recovery of the security’s amortized cost basis, the entity must assess whether it expects to recover the entire amortized cost basis of the security.

 

The Company has the intent and ability to hold securities until their value recovers.

 

Market values were determined for each individual security in the investment portfolio. Investments are reviewed periodically to identify possible impairment and if impairment does exist, the charge would be recorded in the condensed consolidated statement of operations. The Company considers factors such as the length of time an investment’s fair value has been below cost, the financial condition of the investee, and the Company’s ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery in market value. There were no impairment charges recorded in the three and six month periods ended March 31, 2012 and 2011.

 

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Table of Contents

 

Contractual maturities of available-for-sale securities at March 31, 2012 were as follows (in thousands):

 

 

 

Amortized Cost

 

Estimated Fair Value

 

Due in less than one year

 

$

10,767

 

$

10,755

 

Due in more than one year and less than two years

 

1,257

 

1,257

 

Total

 

$

12,024

 

$

12,012

 

 

(7) Consolidated Financial Statement Details

 

The following tables present the Company’s condensed consolidated financial statement details (in thousands):

 

Other Current Assets

 

 

 

March 31, 2012

 

September 30, 2011

 

Prepaid expenses

 

$

2,594

 

$

2,227

 

Security deposits, advances, and interest receivable

 

276

 

169

 

Income tax receivable

 

210

 

219

 

Deferred costs of revenue

 

91

 

128

 

Prepaid tax assets

 

 

65

 

Other assets

 

294

 

194

 

Total

 

$

3,465

 

$

3,002

 

 

Property, Equipment and Software

 

 

 

March 31, 2012

 

September 30, 2011

 

Land

 

$

14,150

 

$

14,150

 

Computer equipment and software

 

38,639

 

35,882

 

Building and building improvements

 

22,413

 

21,869

 

Furniture and fixtures

 

2,219

 

2,108

 

Leasehold improvements

 

1,213

 

1,209

 

Construction in progress

 

284

 

296

 

 

 

78,918

 

75,514

 

Less accumulated depreciation and amortization

 

(43,538

)

(41,090

)

Total

 

$

35,380

 

$

34,424

 

 

Other Long-Term Assets

 

 

 

March 31, 2012

 

September 30, 2011

 

Prepaid expenses

 

$

405

 

$

326

 

Deposits

 

238

 

222

 

Deferred costs of revenue

 

79

 

140

 

Tenant rent receivable

 

265

 

122

 

Total

 

$

987

 

$

810

 

 

Accrued Expenses

 

 

 

March 31, 2012

 

September 30, 2011

 

Accrued employee compensation

 

$

5,795

 

$

5,228

 

Income and other taxes

 

1,184

 

618

 

Accrued audit and professional fees

 

977

 

885

 

Other accrued expenses

 

2,813

 

2,719

 

Total

 

$

10,769

 

$

9,450

 

 

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Table of Contents

 

(8) Inventories

 

Inventories primarily relate to direct costs associated with systems hardware and are stated at the lower of cost (determined on a first-in, first-out basis) or market. If the cost of the inventories exceeds their market value, provisions are made currently for the difference between the cost and the market value. The Company evaluates inventories for excess quantities and obsolescence on a quarterly basis. This evaluation includes an analysis of historical and forecasted product sales. Obsolescence is determined considering several factors, including competitiveness of product offerings, market conditions, and product life cycles. Any adjustment for market value decreases, inventories on hand in excess of forecasted demand or obsolete inventories are charged to direct cost of revenue in the period that management identifies the adjustment.

 

(9) Goodwill and Identifiable Intangible Assets

 

The Company tests for impairment at least annually, in the fourth quarter of each fiscal year, and whenever events or changes in circumstances indicate that the carrying amount of goodwill or indefinite lived intangible assets may not be recoverable. These tests are performed at the reporting unit level using a two-step, fair-value based approach. The Company has determined that it has only one reporting unit. The first step determines the fair value of the reporting unit using the market capitalization value and compares it to the reporting unit’s carrying value. The Company determines its market capitalization value based on the number of shares outstanding, its average stock price and other relevant market factors, such as merger and acquisition multiples and control premiums. If the fair value of the reporting unit is less than its carrying amount, a second step is performed to measure the amount of impairment loss, if any. The second step allocates the fair value of the reporting unit to the Company’s tangible and intangible assets and liabilities. This derives an implied fair value for the reporting unit’s goodwill. If the carrying amount of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized equal to that excess.

 

Based on the results of the first step of the Company’s impairment test performed at September 30, 2011, the Company determined that its goodwill had not been impaired. The Company continuously monitors for events and circumstances that could negatively impact the key assumptions in determining fair value, including long-term revenue growth projections, discount rates, recent market valuations from transactions by comparable companies, volatility in the Company’s market capitalization and general industry, market and macro-economic conditions. It is possible that changes in such circumstances, or in the variables associated with the judgments, assumptions and estimates used in assessing the fair value of the reporting unit, would require the Company to record a non-cash impairment charge.

 

During the quarter ended March 31, 2012, the Company concluded that there were no triggering events which would require an impairment analysis of the carrying value of goodwill, primarily due to the Company’s market capitalization and cash flows during the period. The Company is continuing to monitor the need to perform an impairment analysis in light of current economic factors in the equity markets as well as the recent volatility of its market capitalization. To the extent the Company concludes that there are any indicators of impairment prior to the date of the next annual goodwill impairment test, management will perform an impairment analysis to determine if an impairment charge should be recorded to write down goodwill to its fair value. If the results of any impairment testing indicate that a write down of goodwill is necessary, such charge could be significant and, accordingly, could have a material impact on the Company’s financial position and results of operations, but would not be expected to have a material adverse effect on the Company’s cash flows from operations.

 

The following table presents the changes in goodwill during the six months ended March 31, 2012 (in thousands):

 

September 30, 2011 balance

 

$

62,459

 

Goodwill recorded in connection with the acquisition of DeviceAnywhere

 

49,293

 

Translation adjustments

 

(180

)

March 31, 2012 balance

 

$

111,572

 

 

The components of identifiable intangible assets are as follows (in thousands):

 

 

 

Technology

 

Customer
Based

 

Trademark

 

Covenant

 

Backlog

 

Total

 

As of March 31, 2012:

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross carrying value

 

$

10,326

 

$

3,868

 

$

1,741

 

$

333

 

$

2,800

 

$

19,068

 

Accumulated amortization

 

(3,669

)

(1,366

)

(592

)

(76

)

(1,312

)

(7,015

)

Net carrying value

 

$

6,657

 

$

2,502

 

$

1,149

 

$

257

 

$

1,488

 

$

12,053

 

As of September 30, 2011:

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross carrying value

 

$

3,868

 

$

1,272

 

$

643

 

$

33

 

$

100

 

$

5,916

 

Accumulated amortization

 

(2,619

)

(1,076

)

(455

)

(28

)

(85

)

(4,263

)

Net carrying value

 

$

1,249

 

$

196

 

$

188

 

$

5

 

$

15

 

$

1,653

 

 

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Table of Contents

 

Amortization of technology is recorded to costs of revenue. Amortization of all other identifiable intangible assets is recorded to operating expenses. The following table presents amortization of identifiable intangible assets for the three and six months ended March 31, 2012 and 2011 (in thousands):

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

Amortization of intangible assets — technology

 

$

525

 

$

419

 

$

990

 

$

838

 

Amortization of intangible assets — other

 

969

 

153

 

1,779

 

304

 

Total amortization of intangible assets

 

$

1,494

 

$

572

 

$

2,769

 

$

1,142

 

 

The estimated future amortization expense for existing identifiable intangible assets as of March 31, 2012 was as follows (in thousands):

 

Fiscal Year

 

Total

 

2012 (remaining six months)

 

$

2,992

 

2013

 

2,333

 

2014

 

1,918

 

2015

 

1,768

 

2016

 

1,761

 

Thereafter

 

1,281

 

Total

 

$

12,053

 

Weighted average remaining useful lives as of March 31, 2012 (years)

 

2.6

 

 

(10) Lease Abandonment Accrual

 

The Company leases a facility in New York under an operating lease that expires in October 2015. The Company ceased using the facility in the fourth quarter of fiscal 2009 and, effective October 1, 2009, subleased the facility to a third party for the remainder of its lease term. In the fourth quarter of fiscal 2009, the Company recorded lease abandonment expense of $0.6 million related to its discontinued use of this facility. The changes in the lease abandonment liability for the six months ended March 31, 2012 was as follows (in thousands):

 

September 30, 2011 balance

 

$

363

 

Lease payments to lessor

 

(140

)

Sublease proceeds

 

83

 

Imputed interest expense

 

2

 

March 31, 2012 balance

 

$

308

 

 

(11)      Stock-Based Compensation

 

1999 Equity Incentive Plan

 

On March 16, 2012, the stockholders of the Company authorized an additional 0.6 million shares of common stock for issuance under the 1999 Equity Incentive Plan (“Incentive Plan”) and approved an extension of its term until December 31, 2015. As of March 31, 2012, the Company was authorized to issue up to approximately 4.1 million shares of common stock under its Incentive Plan. Vesting periods are determined by the Board of Directors and generally, in the case of stock options, provide for shares to vest over a period of four years with 25% of the shares vesting one year from the date of grant and the remainder vesting monthly over the next three years. RSUs generally vest in full either three years or four years from the date of grant. Options expire ten years after the date of grant. Approximately 1.4 million shares were available for future issuance under the Incentive Plan as of March 31, 2012.

 

Under the Incentive Plan, the exercise price for incentive stock options is at least 100% of the stock’s fair market value on the date of grant for employees owning less than 10% of the voting power of all classes of stock, and at least 110% of the stock’s fair market value on the date of grant for employees owning more than 10% of the voting power of all classes of stock. For nonqualified stock options, the exercise price must be at least 110% of the stock’s fair market value on the date of grant for employees owning more than 10% of the voting power of all classes of stock and no less than 85% of the stock’s fair market value for employees owning less than 10% of the voting power of all classes of stock.

 

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Table of Contents

 

1999 Employee Stock Purchase Plan

 

In September 1999, the Company adopted the 1999 Employee Stock Purchase Plan (“Purchase Plan”), which will expire on June 28, 2019. As of March 31, 2012, the Company had reserved a total of approximately 0.3 million shares of common stock for future issuance under the Purchase Plan. Under the Purchase Plan, eligible employees may defer an amount not to exceed 10% of the employee’s compensation, as defined in the Purchase Plan, to purchase common stock of the Company. The purchase price per share is 85% of the lesser of the fair market value of the common stock on the first day of the applicable offering period or the last day of each purchase period. The Purchase Plan is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code.

 

Restricted Stock Units

 

Since fiscal 2009, the Company has been issuing RSUs rather than stock options to eligible employees as the primary type of long-term equity-based award. Stock-based compensation cost for RSUs is measured based on the value of the Company’s stock on the grant date, reduced by the present value of the dividend yield expected to be paid on the Company’s common stock. Upon vesting, the RSUs are generally net share-settled to cover the required withholding tax and the remaining amount is converted into an equivalent number of shares of common stock.

 

Recipients of RSU awards generally must remain employed by the Company on a continuous basis through the end of the applicable performance period in order to receive any portion of the shares subject to that award. RSUs do not have dividend equivalent rights and do not have the voting rights of common stock until earned and issued following the end of the applicable performance period. The expense for these awards, net of estimated forfeitures, is recorded over the requisite service period based on the number of awards that are expected to be earned.

 

The fair value of each RSU was estimated on the date of grant using the Black-Scholes option pricing model to reflect the impact of dividends on the fair value of each RSU granted. Weighted-average assumptions for each RSU granted in the three and six months ended March 31, 2012 and 2011 under the Incentive Plan were as follows:

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

Volatility

 

48.3

%

54.6

%

55.1

%

55.9

%

Risk free interest rate

 

0.6

%

1.1

%

0.7

%

0.9

%

Expected life (in years)

 

3.0

 

2.9

 

3.5

 

2.9

 

Dividend yield

 

1.2

%

1.4

%

1.1

%

1.6

%

 

A summary of RSU activity under the Company’s Incentive Plan for the six months ended March 31, 2012 is presented below (in thousands, except per share amounts):

 

 

 

Shares

 

Weighted Average
Grant Date Fair Value

 

Outstanding at September 30, 2011

 

743

 

$

12.43

 

Granted

 

406

 

22.06

 

Vested

 

(95

)

8.25

 

Cancelled

 

(14

)

19.84

 

Outstanding at March 31, 2012*

 

1,040

 

$

16.09

 

 


*        Included in the total outstanding RSU balance at March 31, 2012, are 35,000 Performance Stock Units (“PSUs”). Each PSU award reflects a target number of shares that may be issued to the award recipient before adjusting for performance conditions. The vesting period and/or the actual number of shares the PSU recipient receives is based on pre-established targets such as net revenue and operating results.

 

As of March 31, 2012, there was $10.0 million of total unrecognized compensation cost (net of estimated forfeitures) related to nonvested RSUs that is expected to be recognized over a weighted average period of 2.0 years.

 

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Stock Options

 

A summary of option activity under the Company’s Incentive Plan for the six months ended March 31, 2012 is presented below (in thousands, except per share and term amounts):

 

 

 

Shares

 

Weighted
Average
Exercise Price

 

Average
Remaining
Contractual
Term (Years)

 

Aggregate
Intrinsic
Value

 

Outstanding at September 30, 2011

 

1,779

 

$

11.92

 

4.4

 

 

 

Granted

 

 

 

 

 

 

 

Exercised

 

(53

)

10.89

 

 

 

 

 

Forfeited or canceled

 

(4

)

9.94

 

 

 

 

 

Outstanding at March 31, 2012

 

1,722

 

$

11.95

 

4.0

 

$

13,440

 

Vested and expected to vest

 

1,721

 

$

11.95

 

4.0

 

$

13,435

 

Exercisable at March 31, 2012

 

1,674

 

$

11.96

 

3.9

 

$

13,058

 

 

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value that would have been received by the options holders had they exercised all their options on March 31, 2012.

 

As of March 31, 2012, there was $0.1 million of total unrecognized compensation cost (net of estimated forfeitures) related to nonvested stock options that are expected to be recognized over a weighted average period of 0.2 years.

 

Employee Stock Purchase Plan

 

The Purchase Plan provides for twenty-four month offering periods with four six-month purchase periods. The six-month purchase periods end on the earlier of January 31st and July 31st of each year or the last business day prior to those dates. The fair value of each stock purchase right is estimated on the first day of the offering period using the Black-Scholes option pricing model.

 

Weighted-average assumptions for stock purchase rights under the Purchase Plan were as follows:

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

Volatility

 

50.3

%

56.4

%

50.6

%

57.9

%

Risk free interest rate

 

0.3

%

0.5

%

0.3

%

0.5

%

Expected life (in years)

 

1.3

 

1.3

 

1.3

 

1.3

 

Dividend yield

 

1.4

%

0.9

%

1.4

%

0.7

%

 

Stock-Based Compensation Expense

 

The following table provides a summary of the stock-based compensation expense included in the condensed consolidated statements of operations as follows (in thousands):

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

Direct costs of revenue

 

$

203

 

$

99

 

$

369

 

$

195

 

Development

 

375

 

171

 

680

 

348

 

Operations

 

160

 

47

 

303

 

154

 

Sales and marketing

 

519

 

284

 

950

 

575

 

General and administrative

 

287

 

123

 

570

 

247

 

Total

 

$

1,544

 

$

724

 

$

2,872

 

$

1,519

 

 

(12) Dividends

 

During the six months ended March 31, 2012 and the year ended September 30, 2011, the Company declared and paid the following cash dividends (in thousands except per share amounts):

 

Record Date

 

Payment Date

 

Dividend Per Share

 

Total Dividend Paid

 

Fiscal 2012

 

 

 

 

 

 

 

December 1, 2011

 

December 15, 2011

 

$

0.06

 

$

1,038

 

March 1, 2012

 

March 15, 2012

 

 

0.06

 

 

1,043

 

 

 

 

 

 

 

 

 

Fiscal 2011

 

 

 

 

 

 

 

December 1, 2010

 

December 15, 2010

 

 

0.06

 

 

898

 

March 1, 2011

 

March 15, 2011

 

 

0.06

 

 

970

 

June 1, 2011

 

June 15, 2011

 

 

0.06

 

 

991

 

September 1, 2011

 

September 15, 2011

 

$

0.06

 

$

1,036

 

 

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(13) Comprehensive Income (Loss) and Foreign Currency Translation

 

The components of comprehensive income (loss) consist of net income (loss), unrealized gains and losses on available-for-sale investments and foreign currency translation. The unrealized gains and losses on available-for-sale investments and foreign currency translation are excluded from earnings and reported as a component of stockholders’ equity. The foreign currency translation adjustment results from those subsidiaries, primarily the Company’s German subsidiary, not using the United States dollar as their functional currency since the majority of their economic activities are primarily denominated in their applicable local currency. Accordingly, all assets and liabilities related to these operations are translated at the current exchange rates at the end of each period. The resulting cumulative translation adjustments are recorded directly to the accumulated other comprehensive income (loss) account in stockholders’ equity. Revenues and expenses are translated at average exchange rates in effect during the period. Gains (losses) from foreign currency transactions are reflected in other income (expense), net in the condensed consolidated statements of operations as incurred and were approximately ($0.1) million and $0.1 million for the three months ended March 31, 2012 and 2011, respectively. Gains (losses) from foreign currency transactions were approximately zero and $0.2 million for the six months ended March 31, 2012 and 2011, respectively.

 

The components of comprehensive income were as follows (in thousands):

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net income

 

$

334

 

$

3,331

 

$

4,455

 

$

6,958

 

Net unrealized gain (loss) on available-for-sale investments

 

67

 

(50

)

119

 

(65

)

Foreign currency translation gain (loss)

 

1,569

 

3,506

 

(160

)

2,290

 

Comprehensive income

 

$

1,970

 

$

6,787

 

$

4,414

 

$

9,183

 

 

The components of accumulated other comprehensive income (loss) in the equity section of the balance sheets are as follows (in thousands):

 

 

 

March 31, 2012

 

September 30, 2011

 

Net unrealized losses on short-term investments

 

$

(12

)

$

(131

)

Cumulative foreign currency translation

 

1,154

 

1,314

 

Accumulated other comprehensive income

 

$

1,142

 

$

1,183

 

 

The Company did not record deferred taxes on unrealized losses on its investments due to the full valuation allowance on deferred tax assets for capital losses in the United States. There is no tax effect on the foreign currency translation because it is management’s intent to reinvest indefinitely the undistributed earnings of its foreign subsidiaries to which the foreign currency translation relates.

 

(14) Excess Occupancy Income

 

Excess occupancy income consists of rental income from the leasing of space not occupied by the Company in its headquarters building, net of related fixed costs, which consists of property taxes, insurance, building depreciation, leasing broker fees and tenant improvement amortization. Property taxes, insurance and building depreciation are based upon actual square footage available to lease to third parties, which was approximately 75% prior to January 1, 2012 and 65% subsequent to that date.  Rental income was approximately $0.8 million and $0.6 million for the three months ended March 31, 2012 and 2011, respectively. Rental income was approximately $1.5 million and $1.3 million for the six months ended March 31, 2012 and 2011, respectively. As of March 31, 2012, the Company had leased space to 16 tenants, of which 15 had noncancellable operating leases, which expire on various dates through 2018. At March 31, 2012, future minimum rents receivable under the leases were as follows (in thousands):

 

Fiscal year

 

 

 

2012 (remaining six months)

 

$

1,364

 

2013

 

2,308

 

2014

 

1,946

 

2015

 

1,621

 

2016

 

717

 

Thereafter

 

446

 

Total future minimum rents receivable

 

$

8,402

 

 

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(15) Income Taxes

 

The Company’s effective tax rate for the three months ended March 31, 2012 and 2011 was 56% and 7%, respectively.  The Company’s effective tax rate for the six months ended March 31, 2012 and 2011 was 29% and 7%, respectively. The rate for the three months ended March 31, 2012 differs from the 35% United States federal statutory rate primarily due to the relative mix of foreign and domestic earnings and enacted tax rates. The rate for the six months ended March 31, 2012 differs from the 35% United States federal statutory rate primarily due to the relative mix of foreign and domestic earnings, enacted tax rates, and the fact that the change in estimated fair value of acquisition-related contingent consideration is a non-taxable, discrete transaction.  The rate for the three and six months ended March 31, 2011 differs from the 35% United States federal statutory rate primarily due to the relative mix of foreign and domestic earnings, enacted tax rates, and the fact that a portion of the earnings are being taxed in the United States where the Company has a low effective tax rate due to utilization of net operating loss carryforwards not recognized previously as a result of valuation allowances.

 

The effective tax rate is highly dependent upon the geographic distribution of the Company’s worldwide earnings or losses, tax regulations in each geographic region, and the effectiveness of the Company’s tax planning strategies. Management regularly monitors the assumptions used in estimating its annual effective tax rate and adjusts its estimates accordingly. If actual results differ from management’s estimates, future income tax expense could be materially affected.

 

The Company’s accounting for deferred taxes involves the evaluation of a number of factors concerning the realizability of the Company’s deferred tax assets. Assessing the realizability of deferred tax assets is dependent upon several factors, including the likelihood and amount, if any, of future taxable income in relevant jurisdictions during the periods in which those temporary differences become deductible. The Company forecasts taxable income by considering all available positive and negative evidence including its history of operating income or losses and its financial plans and estimates which are used to manage the business. These assumptions require significant judgment about future taxable income. The amount of deferred tax assets considered realizable is subject to adjustment in future periods if estimates of future taxable income are reduced.

 

In the fourth quarter of fiscal year 2011, the Company determined, based on its recent history of earnings coupled with its forecasted profitability, that it is more likely than not that $41.5 million of deferred tax assets will be realized in the foreseeable future and a valuation allowance should be maintained against the remaining deferred tax assets. Accordingly, in the fourth quarter of fiscal year 2011, the Company released $37.3 million of the valuation allowance on its deferred tax assets, primarily related to its federal deferred tax assets. The Company’s remaining deferred tax assets subject to valuation allowance because management does not believe that it is more likely than not that they will be realized primarily consist of foreign net operating losses in certain jurisdictions, net operating losses resulting from windfall stock option deductions which when realized will be credited to additional paid in capital and certain state deferred tax assets.

 

Any subsequent increases in the valuation allowance will be recognized as an increase in deferred tax expense. Any decreases in the valuation allowance will be recorded either as a reduction of the income tax provision or as a credit to paid-in-capital if the associated deferred tax asset relates to excess deductions on the exercise of stock options.

 

As a result of our acquisition of DeviceAnywhere, the Company acquired approximately $11.4 million of federal net operating losses. Due to section 382 of the Internal Revenue Code, the Company is limited to the utilization of the acquired net operating losses. As a result of this limitation, the Company will be limited to utilization of the net operating losses in the amount of approximately $2.4 million per year.

 

As of March 31, 2012, the total amount of gross unrecognized benefits of $7.9 million related to uncertain tax positions remained consistent with the balance as of September 30, 2011. Included in this balance was approximately $6.6 million of unrecognized tax benefits that, if recognized, would affect the effective income tax rate.

 

In November 2011, the German tax authorities began auditing the Company’s 2006 through 2009 German income tax returns. As of March 31, 2012, the audit was not complete and the Company had not received any preliminary results from the examination. The Company believes it has made adequate tax payments and accrued adequate amounts such that the outcome of this audit will have no material adverse effects on its results of operations or financial condition.

 

It is possible that the amount of liability for unrecognized tax benefits, including the unrecognized tax benefits related to the audit in Germany, may change within the next twelve months. However, an estimate of the range of possible changes cannot be made at this time. In addition, over the next twelve months, the Company’s existing tax positions may continue to generate an increase in liabilities for unrecognized tax benefits. In accordance with the Company’s accounting policy, it recognizes accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. Interest and penalties were $0.1 million for the six months ended March 31, 2012.

 

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Table of Contents

 

As of March 31, 2012, the fiscal tax years that remain subject to examination in the Company’s major tax jurisdictions are:

 

Jurisdiction

 

Open Tax Years

United States—federal

 

1997 through 2010

United States—California

 

2000 through 2010

Germany

 

2006 through 2010

 

(16) Commitments and Contingencies

 

Leases

 

The Company leases certain of its facilities and equipment under noncancelable leases, which expire on various dates through October 2015. As of March 31, 2012, future minimum payments under these operating leases were as follows (in thousands):

 

Fiscal year

 

 

 

2012 (remaining six months)

 

$

511

 

2013

 

526

 

2014

 

373

 

2015

 

314

 

2016

 

25

 

Total minimum lease payments*

 

$

1,749

 

 


*            Future minimum lease payments exclude sublease proceeds of approximately $0.7 million.

 

Rent expense was approximately $0.4 million and $0.3 million for the three months ended March 31, 2012 and 2011, respectively. Rent expense was approximately $0.7 million and $0.5 million for the six months ended March 31, 2012 and 2011, respectively.

 

Commitments

 

The Company had, as of March 31, 2012, $2.7 million of contingent commitments to bandwidth and co-location providers. These contingent commitments have a remaining term ranging from one to thirty-three months and become due if the Company terminates any of these agreements prior to their expiration.

 

As of March 31, 2012, the Company, through one of its foreign subsidiaries, had outstanding guarantees totaling $0.3 million to customers and vendors as a form of security. The guarantees can only be executed upon agreement by both the customer or vendor and the Company. The guarantees are secured by an unsecured line of credit in the amount of $1.3 million as of March 31, 2012.

 

Legal Proceedings

 

In October 2007, a lawsuit was filed in the United States District Court for the Western District of Washington by Vanessa Simmonds, captioned Simmonds v. JPMorgan Chase & Co., et al., No.07-1634. The complaint alleged that the underwriters violated section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. section 78p(b), by engaging in short-swing trades, and sought disgorgement to the Company of profits from the underwriters in amounts to be proven at trial. On February 28, 2008, Ms. Simmonds filed an amended complaint. The suit named the Company as a nominal defendant, contained no claims against the Company, and sought no relief from the Company. This lawsuit was one of more than fifty similar actions filed in the same court. On July 25, 2008, the underwriter defendants in the various actions filed a joint motion to dismiss the complaints for failure to state a claim. In addition, certain issuer defendants in the various actions filed a joint motion to dismiss the complaints for failure to state a claim. The parties entered into a stipulation, entered as an order by the Court, that the Company was not required to answer or otherwise respond to the amended complaint. Accordingly, the Company did not join the motion to dismiss filed by certain issuers. On March 12, 2009, the Court dismissed the complaint in this lawsuit with prejudice. On April 10, 2009, the plaintiff filed a notice of appeal of the District Court’s order, and thereafter the underwriter defendants filed a cross appeal to a portion of the District Court’s order that dismissed 30 of the cases without prejudice. On June 22, 2009 the Ninth Circuit issued an order granting the parties’ joint motion to consolidate the 54 appeals and 30 cross appeals. The Ninth Circuit heard oral argument on October 5, 2010, and the Court issued its written opinion on December 2, 2010. The Ninth Circuit affirmed the District Court’s decision that the demand letters that plaintiff submitted to the 30 moving issuers were inadequate and directed the District Court to dismiss those actions with prejudice. The Ninth Circuit further directed the District Court to consider in the first instance whether the demand letters submitted to the other 24 issuers (including the Company) were sufficiently similar as also to require dismissal with prejudice. The Ninth Circuit reversed the District Court’s decision in favor of the underwriter defendants on statute of limitations grounds. On December 16, 2010, plaintiff and the underwriter defendants separately petitioned for a rehearing of the original three judge panel of the Court and a rehearing by the entire Court, which petitions were denied on January 18, 2011. On January 25 and 26, 2011, the Ninth Circuit granted the motions of the underwriter defendants and of the plaintiff to stay the issuance of the court’s mandate pending those parties’ respective petitions for review by the United States Supreme Court. On April 5 and April 15, 2011, respectively, plaintiff and the underwriter defendants filed their petitions for review in the United States Supreme Court. On June 27, 2011, the Supreme Court granted the petition of the underwriter defendants and denied plaintiff’s petition. On November 29, 2011 the Supreme Court heard oral argument.  On March 26, 2012, the Supreme Court reversed the Ninth Circuit’s ruling that plaintiff’s claim was not barred by the applicable statute of limitations, and remanded for further proceedings on plaintiff’s alternative claim that the statute of limitations was extended by the doctrine of equitable tolling.  The District Court had determined that equitable tolling did not apply, but the Ninth Circuit had not considered that issue. No amount has been accrued as of March 31, 2012 since management believes that the Company’s liability, if any, is not probable and cannot be reasonably estimated.

 

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Table of Contents

 

The Company is subject to other legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters—consisting of the fees and costs that are required for a litigation matter from its commencement to final disposition or settlement— will have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.  No amount has been accrued as of March 31, 2012 since management believes that the Company’s liability, if any, is not probable and cannot be reasonably estimated.

 

Warranties

 

The Company’s products are generally warranted to perform for a period of one year. In the event there is a failure of such products, the Company generally is obliged to correct or replace the product to conform to the warranty provision. No amount has been accrued for warranty obligations as of March 31, 2012 and September 30, 2011, as costs to replace or correct are generally reimbursable under the manufacturer’s warranty.

 

Indemnification

 

The Company does not generally indemnify its customers against legal claims that its services infringe third-party intellectual property rights. Other agreements entered into by the Company may include indemnification provisions that could subject the Company to costs and/or damages in the event of an infringement claim against the Company or an indemnified third-party. However, the Company has never been a party to an infringement claim and its management is not aware of any liability related to any infringement claims subject to indemnification. As such, no amount is accrued for infringement claims as of March 31, 2012.

 

(17) Geographic and Segment Information

 

The Company operates in a single reportable segment encompassing the development and sale of services, hardware and software to measure, test, assure and improve the service quality of Internet and mobile communications.

 

Information regarding geographic areas from which the Company’s net revenues are generated, based on the location of the Company’s customers, is as follows (in thousands):

 

 

 

Three Months Ended
March 31,

 

Six Months Ended
March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

United States

 

$

16,203

 

$

11,970

 

$

33,705

 

$

24,214

 

Europe*

 

8,370

 

8,042

 

15,630

 

16,383

 

Other*

 

6,019

 

4,095

 

14,336

 

8,343

 

Net revenue

 

$

30,592

 

$

24,107

 

$

63,671

 

$

48,940

 

 


*            No individual country represented more than 10% of net revenue for the three and six months ended March 31, 2012 and 2011.

 

Information regarding geographic areas which the Company has long lived assets (includes all tangible assets) is as follows (in thousands):

 

 

 

March 31, 2012

 

September 30, 2011

 

United States

 

$

33,809

 

$

33,016

 

Germany

 

1,547

 

1,393

 

Other

 

24

 

15

 

Total

 

$

35,380

 

$

34,424

 

 

(18)      Subsequent Events

 

In April 2012, the Board of Directors approved the payment of a quarterly dividend of $0.06 per share to stockholders of record as of June 1, 2012. In the future, the Company intends to pay a similar dividend on a quarterly basis; however, its ability to continue to do so will be affected by its future results of operations, financial position and the various other factors that may affect its overall business.

 

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Table of Contents

 

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, 2011, 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, 2011 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 Internet and mobile cloud monitoring and testing solutions. We provide cloud-based testing, monitoring and measurement products and services that enable our customers to know how their Web sites, content, and applications perform on nearly any combination of actual browsers, networks and mobile devices. Since our founding in 1995, we have built and optimized a global monitoring network comprised of over 7,000 measurement computers and mobile devices in over 300 locations and 180 metropolitan areas worldwide and execute more than 525 million performance measurements every day. We deliver our products and services primarily through a cloud-based model on a subscription basis to a world-class customer base, representing a broad cross-section of industries.

 

We deliver our products and services primarily through a cloud-based model on a subscriptions 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”) systems, which include monitoring software and hardware, usually are offered via a software license fee model that is bundled with ongoing maintenance and support. Our Real User Experience Testing services, which we also refer to as our professional services or engagement services, primarily are offered on an engagement, per incident or per study basis. Engagements typically involve fixed price contracts based on the complexity of the project, the size of a panel, and the type of testing to be conducted.

 

On October 18, 2011, we acquired Mobile Complete, Inc., doing business as DeviceAnywhere (“DeviceAnywhere”). DeviceAnywhere developed an enterprise-class, cloud-based mobile application lifecycle management testing and quality assurance platform. DeviceAnywhere offers products and services for testing and monitoring the functionality, usability, performance and availability of mobile applications and Web sites. Their complementary enterprise mobile cloud solutions enable us to address a wider spectrum of the mobile market by offering enterprises leading solutions in both mobile performance monitoring and mobile testing and quality assurance. DeviceAnywhere products and services are sold to customers on both a subscription fee basis and a software license fee model that is bundled with ongoing maintenance and support.  Additionally, DeviceAnywhere provides support, professional services and online mobile device tutorials to its customers.

 

Our net revenue increased by $6.5 million, or 27%, from $24.1 million for the three months ended March 31, 2011 to $30.6 million for the three months ended March 31, 2012. Our net income decreased by $3.0 million from net income of $3.3 million for the three months ended March 31, 2011 to net income of $0.3 million for the three months ended March 31, 2012. The increase in net revenue is primarily attributable to a $4.9 million increase in Mobile net revenue and a $1.6 million increase in Internet net revenue for the three months ended March 31, 2012 compared to the three months ended March 31, 2011. Of the $4.9 million increase in Mobile net revenue, $4.1 million was from sales of products and services from our recent acquisition, DeviceAnywhere. The increase in net revenue was partially offset by an increase in total costs and expenses of $9.1 million from $20.7 million for the three months ended March 31, 2011 to $29.8 million for the three months ended March 31, 2012. Of the $9.1 million increase in total costs and expenses, $2.9 million was due to higher costs of revenue associated with increased net revenue, increases in headcount and the reinstatement of domestic salaries previously reduced by 10% in April 2009. The remaining increase in total costs and expenses was primarily due to $6.2 million of DeviceAnywhere related expenses, which includes $1.4 million of amortization of intangible assets and stock compensation expense.

 

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Table of Contents

 

Our net revenue increased by $14.7 million, or 30%, from $48.9 million for the six months ended March 31, 2011 to $63.7 million for the six months ended March 31, 2012. Our net income decreased by $2.5 million from net income of $7.0 million for the six months ended March 31, 2011 to net income of $4.5 million for the six months ended March 31, 2012. The increase in net revenue is primarily attributable to a $10.5 million increase in Mobile net revenue and a $4.2 million increase in Internet net revenue for the six months ended March 31, 2012 compared to the six months ended March 31, 2011. Of the $10.5 million increase in Mobile net revenue, $8.2 million was from sales of products and services from our recent acquisition, DeviceAnywhere. The increase in net revenue was offset by an increase in total costs and expenses of $15.6 million from $41.9 million for the six months ended March 31, 2011 to $57.5 million for the six months ended March 31, 2012. Of the $15.6 million increase in total costs and expenses, $3.7 million was due to higher costs of revenue associated with increased net revenue, increases in headcount and the reinstatement of domestic salaries previously reduced by 10% in April 2009. The remaining increase in total costs and expenses was primarily due to $11.9 million of DeviceAnywhere related expenses, which includes $2.6 million of amortization of intangible assets and stock compensation expense. Partially offsetting the increase in total costs and expenses is the $2.0 million benefit from the change in fair value of contingent consideration associated with the DeviceAnywhere acquisition earnout liability.

 

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

 

·                  Continuing to drive growth in our Internet and Mobile Cloud products and services, as we believe that revenue growth is the primary factor in creating stockholder value;

 

·                  Successfully integrating our recent acquisition, DeviceAnywhere, with our existing culture, products, procedures, controls and systems and achieving revenue from sales of DeviceAnywhere’s products and services;

 

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

 

·                  Controlling expenses in fiscal year 2012 to maintain profitability, particularly because of the economic uncertainties that continue to exist and the costs we are incurring to take advantage of growth opportunities; and

 

·                  Meeting challenges faced due to the current economic environment as this affects our customers’ ability to purchase our products and services.

 

Refer to “Results of Operations,” “Non-GAAP Financial Measures and Other Operational Data,” “Liquidity and Capital Resources,” and “Commitments” elsewhere in this 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 combination;

 

·                  Allowance for doubtful accounts and billing allowance;

 

·                  Goodwill, identifiable intangible assets and long-lived assets;

 

·                  Stock-based compensation; and

 

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

 

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Except for the fair value of assets acquired and liabilities assumed in connection with the DeviceAnywhere acquisition (see Note 3 to the condensed consolidated financial statements in Part 1 Item 1 of this Form 10-Q), management believes that there have been no significant changes during the six months ended March 31, 2012 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 2011 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 2011 Annual Report on Form 10-K.

 

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
March 31,

 

Six Months Ended
March 31,

 

 

 

2012

 

2011

 

2012

 

2011

 

Net revenue

 

100.0

%

100.0

%

100.0

%

100.0

%

Costs and expenses:

 

 

 

 

 

 

 

 

 

Costs of revenue:

 

 

 

 

 

 

 

 

 

Direct costs of revenue

 

28.4

 

24.7

 

27.1

 

24.1

 

Development

 

15.3

 

13.2

 

14.2

 

12.7

 

Operations

 

8.7

 

8.2

 

8.1

 

7.9

 

Amortization of intangible assets — technology

 

1.7

 

1.7

 

1.6

 

1.7

 

Sales and marketing

 

29.1

 

28.1

 

28.4

 

28.6

 

General and administrative

 

12.4

 

10.6

 

12.4

 

11.1

 

Change in fair value of acquisition-related contingent consideration

 

 

 

(3.1

)

 

Excess occupancy income

 

(1.3

)

(1.1

)

(1.2

)

(1.1

)

Amortization of intangible assets — other

 

3.2

 

0.6

 

2.8

 

0.6

 

Total costs and expenses

 

97.5

 

86.0

 

90.3

 

85.6

 

Income from operations

 

2.5

 

14.0

 

9.7

 

14.4

 

Interest income and other, net

 

 

0.8

 

0.1

 

0.9

 

Income before provision for income taxes

 

2.5

 

14.8

 

9.8

 

15.3

 

Provision for income taxes

 

(1.4

)

(1.0

)

(2.8

)

(1.1

)

Net income

 

1.1

%

13.8

%

7.0

%

14.2

%

 

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 March 31,

 

For the six months ended March 31,

 

 

 

2012

 

2011

 

% Change

 

2012

 

2011

 

% Change

 

Internet:

 

 

 

 

 

 

 

 

 

 

 

 

 

Web Measurement Subscriptions

 

$

8,267

 

$

7,373

 

12

%

$

16,386

 

$

14,648

 

12

%

Other Subscriptions

 

3,269

 

2,784

 

17

 

7,564

 

6,232

 

21

 

Engagements

 

2,821

 

2,600

 

9

 

5,911

 

4,785

 

24

 

Total Internet net revenue

 

14,357

 

12,757

 

13

 

29,861

 

25,665

 

16

 

Mobile:

 

 

 

 

 

 

 

 

 

 

 

 

 

Subscriptions

 

6,206

 

3,234

 

92

 

11,799

 

6,429

 

84

 

Ratable Licenses

 

980

 

3,687

 

(73

)