[May 08, 2013] KEYNOTE SYSTEMS INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations Tweet (Edgar Glimpses Via Acquire Media NewsEdge) The following discussion of the financial condition and results of operations of Keynote Systems, Inc. (referred to herein as "we," "us," "Keynote" or "the Company") should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in this report as well as the audited financial statements and notes thereto in our Annual Report on Form 10-K for the year ended September 30, 2012, and subsequent filings with the Securities and Exchange Commission. Except for historical information, this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements include, among others, statements including the words "expects," "anticipates," "intends," "believes" and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to these differences include, but are not limited to, those discussed in this section, the section entitled "Risk Factors" in Item 1A of Part II of this report, and in our annual report on Form 10-K for the fiscal year ended September 30, 2012 and elsewhere in that report. You should carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the quarterly reports on Form 10-Q and current reports on Form 8-K that we may file during the current year. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this quarterly report on Form 10-Q. Except as required by law, we undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document. Overview Keynote is a leading global provider of mobile and Web cloud testing and monitoring services. We maintain one of the world's largest on-demand quality testing and performance monitoring networks comprised of approximately 7,000 measurement computers and mobile devices in over 300 locations covering 180 countries. Our global network enables our customers to continuously test, monitor and assure the online and mobile experience. We offer a robust portfolio of cloud products and services to optimize the end-user customer experience to world-class telecommunications and enterprise customers, representing a broad cross-section of industries. Our cloud products and services are grouped into three categories: Internet, Enterprise Mobile and Telecommunications Mobile. We deliver our products and services primarily through a cloud-based model on a subscription basis (also referred to as Software-as-a-Service, or SaaS). Subscription fees range from monthly to multi-year commitments and vary based on the type of service selected, the number of measurements, transactions or devices monitored, the number of measurement locations and/or appliances, the frequency of the measurements, the communication protocols or services measured, privacy settings and any additional features ordered. Our System Integrated Test Environment ("SITE") and Test Center Enterprise ("TCE") systems, which include software and hardware, usually are offered via a software license fee model that is bundled with ongoing maintenance and support. Our engagement services, or professional services, complement and support our cloud products and services. Our engagement services provide our customers with a deeper and qualitative perspective of their performance data. Our net revenue decreased by $0.5 million, or 1%, from $63.7 million for the six months ended March 31, 2012 to $63.2 million for the six months ended March 31, 2013. Our net income decreased by $2.2 million from net income of $4.5 million for the six months ended March 31, 2012 to net income of $2.3 million for the six months ended March 31, 2013. The decrease in net revenue is primarily attributable to a $2.0 million decrease in Mobile net revenue, partially offset by a $1.5 million increase in Internet net revenue for the six months ended March 31, 2013 compared to the six months ended March 31, 2012. Total costs and expenses increased $1.4 million from $57.5 million for the six months ended March 31, 2012 to $58.9 million for the six months ended March 31, 2013, primarily due to the benefit recorded in the prior year's period of $2.0 million for the change in fair value of acquisition-related contingent consideration. We believe that important trends and challenges for our business include: † Continuing to drive revenue growth, especially in mobile markets served by our Enterprise Mobile products and services, which we believe is a key factor in creating stockholder value; † Meeting challenges faced due to the current global economic environment, especially in Europe, as this affects our customers' ability to purchase our products and services; † Developing and marketing new products and services that respond to competitive and technological developments and changing customer needs; 24 -------------------------------------------------------------------------------- Table of Contents † Growing our overall customer base and cross-selling our products within our existing customer base to support the growth of our revenue; and † Controlling expenses in fiscal 2013 to maintain profitability, particularly because of the economic uncertainties that continue to exist, project acceptance volatility that can affect the timing of revenue recognition and the costs we are incurring to take advantage of growth opportunities, especially our investment in salespeople. Refer to "Results of Operations," "Non-GAAP Financial Measures," "Liquidity and Capital Resources," and "Commitments" elsewhere in this section and the "Risk Factors" section for a further discussion of the risks, uncertainties and trends in our business. Critical Accounting Policies and Estimates Our condensed consolidated financial statements and accompanying notes included elsewhere in this quarterly report on Form 10-Q are prepared in accordance with accounting principles generally accepted in the United States. These accounting principles require us to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenue and expenses during the periods presented. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements: † Revenue recognition; † Fair value of assets acquired and liabilities assumed in a business combinations; † Allowance for doubtful accounts and billing allowance; † Goodwill, identifiable intangible assets and long-lived assets; † Stock-based compensation; and † Income taxes, deferred income tax assets and deferred income tax liabilities. We believe that there have been no significant changes during the six months ended March 31, 2013 to the items that we disclosed as our critical accounting policies and estimates in Management's Discussion and Analysis of Financial Condition and Results of Operation in our 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For a description of those critical accounting policies and estimates, please refer to our 2012 Annual Report on Form 10-K. On October 1, 2012, we adopted an accounting pronouncement on fair value measurements that are estimated using significant unobservable (Level 3) inputs, as well as an accounting pronouncement on the presentation of other comprehensive income. There have been no other changes in our critical accounting policies since the end of fiscal 2012. 25 -------------------------------------------------------------------------------- Table of Contents 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 Six Months Ended March 31, March 31, 2013 2012 2013 2012 Subscriptions and services revenue 88.9 % 86.8 % 86.5 % 84.6 % Systems licenses revenue 11.1 13.2 13.5 15.4 Net revenue 100.0 % 100.0 % 100.0 % 100.0 % Costs and expenses: Costs of revenue: Direct costs of revenue - subscriptions and services 26.8 24.9 24.5 23.3 Direct costs of revenue - systems licenses 2.7 3.5 3.6 3.8 Development 17.0 15.3 15.5 14.2 Operations 10.2 8.7 9.1 8.1 Amortization of intangible assets - technology 1.3 1.7 1.4 1.6 Sales and marketing 32.3 29.1 29.2 28.4 General and administrative 10.8 12.4 10.8 12.4 Change in fair value of acquisition-related contingent consideration - - - (3.1 ) Excess occupancy income (1.9 ) (1.3 ) (1.7 ) (1.2 ) Amortization of intangible assets - other 0.6 3.2 0.8 2.8 Total costs and expenses 99.8 97.5 93.2 90.3 Income from operations 0.2 2.5 6.8 9.7 Interest income and other, net 0.2 - (0.1 ) 0.1 Income before benefit (provision) for income taxes 0.4 2.5 6.7 9.8 Benefit (provision) for income taxes 0.7 (1.4 ) (3.1 ) (2.8 ) Net income 1.1 % 1.1 % 3.6 % 7.0 % 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, 2013 2012 % Change 2013 2012 % Change Internet: Web Measurement Subscriptions $ 9,489 $ 8,267 15 % $ 19,007 $ 16,386 16 % Other Subscriptions 2,907 3,269 (11 ) 7,027 7,564 (7 ) Engagements 2,637 2,821 (7 ) 5,400 5,911 (9 ) Total Internet net revenue 15,033 14,357 5 31,434 29,861 5 Mobile: Subscriptions 6,145 6,206 (1 ) 11,791 11,799 - Ratable Licenses 224 980 (77 ) 621 2,563 (76 ) Systems Licenses 3,243 4,023 (19 ) 8,562 9,778 (12 ) Maintenance and Support 4,685 5,026 (7 ) 10,834 9,670 12 Total Mobile net revenue 14,297 16,235 (12 ) 31,808 33,810 (6 ) Net revenue $ 29,330 $ 30,592 (4 )% $ 63,242 $ 63,671 (1 )% Mobile net revenue by customer type: Enterprise 5,416 5,884 (8 )% 10,665 11,827 (10 )% Telecommunications 8,881 10,351 (14 ) 21,143 21,983 (4 ) Total Mobile net revenue $ 14,297 $ 16,235 (12 )% $ 31,808 $ 33,810 (6 )% 26 -------------------------------------------------------------------------------- Table of Contents Subscription revenue is reflected in the above table as Web Measurement Subscriptions (which includes Application Perspective, Transaction Perspective, Streaming Perspective and Web Site Perspective products and services), Other Subscriptions (which includes all other Internet subscription products and services) and Mobile Subscriptions (which includes GlobalRoamer, Mobile Device Perspective, Mobile Web Perspective, TCE Interactive and Test Center Developer products and services). Licensing arrangements for monitoring and testing systems are reflected in the above table as Ratable Licenses (which includes SITE, TCE Automation and TCE Monitoring arrangements entered into prior to fiscal 2011, which is when new accounting guidance for revenue recognition was adopted), Systems Licenses (which includes the hardware and software elements of SITE, TCE Automation and TCE Monitoring arrangements) and Maintenance and Support (which includes all the other elements of SITE, TCE Automation and TCE Monitoring arrangements, stand-alone consulting services agreements and maintenance agreement renewals). Internet Net Revenue. Internet net revenue increased by $0.7 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012. Internet net revenue represented 51% and 47% of net revenue for the three months ended March 31, 2013 and 2012, respectively. The increase in Internet net revenue for the three months ended March 31, 2013 was mainly attributable to an increase of $1.2 million in our Internet Web Measurement Subscriptions due primarily to an increase in the number of measurements that our customers performed to test their Web sites, partially offset by a $0.3 million decrease in our Internet Subscriptions Other due to reductions in LoadPro engagements and a $0.2 million decrease in Internet Engagements (also referred to as professional services) due to lower demand for customer experience management ("CEM") engagements. Internet net revenue increased by $1.6 million for the six months ended March 31, 2013 compared to the six months ended March 31, 2012. Internet net revenue represented 50% and 47% of net revenue for the six months ended March 31, 2013 and 2012, respectively. The increase in Internet net revenue for the six months ended March 31, 2013 was mainly attributable to an increase of $2.6 million in our Internet Web Measurement Subscriptions primarily due to an increase in the number of measurements that our customers are performing to test their Web sites, partially offset by a decrease of $0.5 million in our Internet Subscriptions Other due to reductions in LoadPro engagements and a decrease of $0.5 million in our Engagements due to lower demand for CEM engagements. Mobile Net Revenue. Mobile net revenue decreased by $1.9 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012. Mobile net revenue represented 49% and 53% of net revenue for the three months ended March 31, 2013 and 2012, respectively. The decrease in Mobile net revenue for the three months ended March 31, 2013 was mainly attributable to a $0.8 million decrease in Ratable Licenses revenue due to the change in revenue recognition guidance at the beginning of fiscal 2011 and a $0.8 million decrease in Systems Licenses revenue due to four large projects that were expected to be accepted in the second quarter of fiscal 2013 that were not accepted due to customer specific issues. Additionally, Maintenance and Support decreased by $0.3 million due to a large maintenance contract that was fully recognized at the end of the maintenance term in the second quarter of fiscal 2012 and recognized ratably in fiscal 2013 due to the terms of the arrangement. Mobile net revenue decreased by $2.0 million for the six months ended March 31, 2013 compared to the six months ended March 31, 2012. Mobile net revenue represented 50% and 53% of net revenue for the six months ended March 31, 2013 and 2012, respectively. The decrease in Mobile net revenue for the six months ended March 31, 2013 was mainly attributable to a $1.9 million decrease in Ratable License revenue due to the change in revenue recognition guidance at the beginning of fiscal 2011 and a $1.2 million decrease in System Licenses due to the large projects that were not accepted by the end of the second quarter of fiscal 2013 described above. These decreases were partially offset by a $1.2 million increase in Maintenance and Support due to an increase in systems under maintenance agreements and increased DemoAnywhere revenue. No single customer accounted for more than 10% of net revenue in the three and six month periods ended March 31, 2013. 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. No customer accounted for more than 10% of our net accounts receivable at March 31, 2013. One customer accounted for 12% of our net accounts receivable at September 30, 2012. International sales, principally in Europe, were approximately 41% and 44% of net revenue for the three and six months ended March 31, 2013, respectively, and were approximately 47% of net revenue for both the three and six months ended March 31, 2012, respectively. 27 -------------------------------------------------------------------------------- Table of Contents Direct Costs of Net Revenue For the three months ended March 31, For the six months ended March 31, 2013 2012 % Change 2013 2012 % Change Direct costs of revenue -subscriptions and services $ 7,841 $ 7,620 3 % $ 15,450 $ 14,813 4 % Direct costs of revenue - systems licenses $ 803 $ 1,071 (25 )% $ 2,285 $ 2,472 (8 )% Direct costs of revenue-subscriptions and services is comprised of telecommunication and network fees for our measurement and data collection network, costs for employees and consultants assigned to consulting engagements and to install monitoring and testing systems, depreciation of equipment related to our measurement and data collection network, and costs of supplies. Direct costs of revenue - subscriptions and services increased $0.2 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 and represented 30% and 29% of subscription and services revenue for the three months ended March 31, 2013 and 2012, respectively. The increase in direct costs of revenue - subscriptions and services was mainly attributable to additional telecommunication and network fees and equipment expenses due to higher monitoring volume associated with the increased subscriptions revenue. Direct costs of revenue - subscriptions and services increased $0.6 million for the six months ended March 31, 2013 compared to the six months ended March 31, 2012 and represented 28% and 27% of subscription and services revenue for the six months ended March 31, 2013 and 2012, respectively. The increase in direct costs of revenue - subscriptions and services was mainly attributable to $0.2 million of additional telecommunication and network fees, $0.2 million of equipment expenses due to higher monitoring volume associated with the increased subscriptions revenue and an increase of $0.2 million in personnel costs associated with additional headcount primarily focused on mobile products and services. Direct costs of revenue - systems licenses include the material and labor costs of systems hardware to be installed as part of a systems license arrangement and related software royalty fees. Direct costs of revenue - systems licenses decreased $0.3 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 and represented 25% and 27% of systems licenses revenue for the three months ended March 31, 2013 and 2012, respectively. The decrease in direct costs of revenue - systems licenses was due to the lower system licenses revenue as compared to the same quarter last year. Direct costs of revenue - systems licenses decreased $0.2 million for the six months ended March 31, 2013 compared to the six months ended March 31, 2012 and represented 27% and 25% of systems licenses revenue for the six months ended March 31, 2013 and 2012, respectively. The decrease in direct costs of revenue - systems licenses was due to the lower system licenses revenue, partially offset by a higher hardware component of the systems licenses revenue. Development For the three months ended March 31, For thesix months ended March 31, 2013 2012 % Change 2013 2012 % Change Development $ 4,990 $ 4,688 6 % $ 9,828 $ 9,067 8 % Development expenses consist primarily of employee compensation, including stock-based compensation and other benefits, and other costs incurred by our development personnel. Development costs increased $0.3 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012. The increase was mainly attributable to higher personnel costs associated with additional headcount primarily focused on mobile products and services. Development costs increased $0.8 million for the six months ended March 31, 2013 compared to the six months ended March 31, 2012. The increase was mainly attributable to higher personnel costs associated with additional headcount primarily focused on mobile products and services. Operations For the three months ended March 31, For thesix months ended March 31, 2013 2012 % Change 2013 2012 % Change Operations $ 2,995 $ 2,667 12 % $ 5,744 $ 5,163 11 % Operations expenses consist primarily of employee compensation, including stock-based compensation and other benefits, for management and technical support personnel. Our operations personnel manage and maintain our field measurement and data collection network; provide basic and extended customer support; and ensure the reliability of our services. Operations expenses increased $0.3 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012. The increase was mainly attributable to $0.2 million of equipment expenses related to our data network to support the higher subscriptions revenue and higher personnel costs to support our data network. 28 -------------------------------------------------------------------------------- Table of Contents Operations expenses increased $0.6 million for the six months ended March 31, 2013 compared to the six months ended March 31, 2012. The increase was mainly attributable to $0.4 million of equipment expenses related to our data network to support the higher subscriptions revenue and $0.1million of higher personnel costs to support our data network. Sales and Marketing For the three months ended March 31, For the six months ended March 31, 2013 2012 % Change 2013 2012 % Change Sales and marketing $ 9,473 $ 8,874 7 % $ 18,494 $ 18,012 3 % Sales and marketing expenses consist primarily of salaries, benefits, commissions and bonuses earned by sales and marketing personnel, stock-based compensation, lead-referral fees, marketing programs and travel expenses. Sales and marketing expenses increased by $0.6 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. The increase was mainly attributable to higher personnel costs resulting from additional headcount in order to grow Mobile revenues. Sales and marketing expenses increased by $0.5 million for the six months ended March 31, 2013 as compared to the six months ended March 31, 2012. The increase was mainly attributable to higher personnel costs resulting from additional headcount in order to grow Mobile revenues. General and Administrative For the three months ended March 31, For the six months ended March 31, 2013 2012 % Change 2013 2012 % Change General and administrative $ 3,178 $ 3,801 (16 )% $ 6,829 $ 7,909 (14 )% General and administrative expenses consist primarily of employee compensation, including stock-based compensation and other benefits; professional service fees, including accounting, auditing, legal and bank fees; insurance; and other general corporate expenses. General and administrative expenses decreased by $0.6 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. The decrease was mainly attributable to $0.3 million of transaction expenses in connection with the acquisition of DeviceAnywhere that was included in the prior year quarter that did not repeat in this quarter, lower stock-based compensation due to vesting of RSUs in July 2012, and lower rent expense due to moving the DeviceAnywhere employees into our headquarter building in January 2012. General and administrative expenses decreased by $1.1 million for the six months ended March 31, 2013 as compared to the six months ended March 31, 2012. The decrease was mainly attributable to $0.4 million of transaction expenses in connection with the acquisition of DeviceAnywhere that was included in the prior year six months ended March 31, 2012 that did not repeat in the six months ended March 31, 2013, lower stock-based compensation due to vesting of RSUs in July 2012, and lower rent expense due to moving the DeviceAnywhere employees into our headquarter building in January 2012. Change in estimated fair value of acquisition-related contingent consideration At the acquisition date, a $2.0 million liability was recorded based on the estimated fair value of the acquisition-related contingent consideration to the former stockholders of DeviceAnywhere based on DeviceAnywhere achieving 2011 and 2012 revenue, bookings and EBITDA targets. During the first quarter of 2012, we concluded that DeviceAnywhere would not achieve either the 2011 or the 2012 targets. Accordingly, we reversed the liability and recorded a benefit of $2.0 million due to the change in estimate of the fair value of acquisition-related contingent consideration. Excess Occupancy Income For the three months ended March 31, For the six months ended March 31, 2013 2012 % Change 2013 2012 % Change Rental income $ (891 ) $ (779 ) 14 % $ (1,765 ) $ (1,520 ) 16 % Related expenses 335 391 (14 )% 693 782 (11 )% Excess occupancy income $ (556 ) $ (388 ) 43 % $ (1,072 ) $ (738 ) 45 % 29 -------------------------------------------------------------------------------- Table of Contents Excess occupancy income consists of rental income from the leasing of space not occupied by us in our headquarters building, net of related expenses, which consists of property taxes, insurance, building depreciation, leasing broker fees and tenant improvement amortization. The expenses associated with excess occupancy income are based on the actual square footage available for lease to third parties, which was 75% prior to January 1, 2012 and 65% subsequent to that date. The square footage available for lease to third parties decreased because DeviceAnywhere employees and operations moved into our headquarters building in January 2012. The increase in excess occupancy income for the three and six months ended March 31, 2013 as compared to the three and six months ended March 31, 2012 was mainly attributable to new tenants occupying space in our building and annual tenant rent increases per the lease agreements. Expenses were relatively consistent for the periods presented. Amortization of Identifiable Intangible Assets For the three months ended March 31, For the six months ended March 31, 2013 2012 % Change 2013 2012 % Change Amortization of identifiable intangible assets - technology $ 383 $ 525 (27 )% $ 908 $ 990 (8 )% Amortization of identifiable intangible assets - other 168 969 (83 )% 466 1,779 (74 )% Total amortization of identifiable intangible assets $ 551 $ 1,494 (63 )% $ 1,374 $ 2,769 (50 )% Amortization of intangible assets-technology mainly relates to purchased technology for our mobile products and is reflected in costs of revenue in our condensed consolidated statements of operations. Amortization of intangible assets-other relates to all other intangibles, including customer lists, trademarks and customer backlog, and is reflected in operating expenses in our condensed consolidated statements of operations. Amortization of identifiable intangible assets-technology and amortization of identifiable intangible assets-other decreased for the three and six months ended March 31, 2013 as compared to the three and six months ended March 31, 2012 as a result of the backlog component of the identifiable intangible assets recorded in connection with the acquisition of DeviceAnywhere being fully amortized over a one year period ending in October 2012 and an identifiable intangible asset related to mobile technology that is incorporated in our subscriptions products and services becoming fully amortized in January 2013. We review our identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. No events or circumstances were identified in the period ended March 31, 2013 indicating that the carrying amount of these assets may not be recoverable. Interest Income and Other Income (Expense), Net For the three months ended March 31, For the six months ended March 31, 2013 2012 % Change 2013 2012 % ChangeInterest income $ 32 $ 39 (18 )% $ 57 $ 85 (33 )% Other income (expense), net 31 (51 ) 161 % (133 ) (37 ) 259 % Total $ 63 $ (12 ) 625 % $ (76 ) $ 48 (258 )% Interest income and other income (expense), net increased $0.1 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. Interest income declined slightly due to lower interest rates on invested funds. Other income (expense), net increased primarily due to slightly more favorable foreign exchange rates in the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. Interest income and other income (expense), net decreased $0.1 million for the six months ended March 31, 2013 as compared to the six months ended March 31, 2012. Interest income declined slightly due to lower interest rates on invested funds. Other income (expense), net decreased primarily due to slightly less favorable foreign exchange rates in the six months ended March 31, 2013 as compared to the six months ended March 31, 2012. Benefit (Provision) for Income Taxes For the three months ended March 31, For the six months ended March 31, 2013 2012 % Change 2013 2012 % ChangeBenefit (provision) for income taxes $ 204 $ (419 ) (149 )% $ (1,968 ) $ (1,797 ) 10 % 30 -------------------------------------------------------------------------------- Table of Contents Our effective tax rate for the three months ended March 31, 2013 and 2012 was (173) %, or a benefit, and 56%, respectively. The rate for the three months ended March 31, 2013 differs from the 35% United States federal statutory rate due in part to the relative mix of foreign and domestic earnings and enacted tax rates. Additionally, on January 2, 2013, The American Taxpayer Relief Act of 2012 became law and extended the research credit to December 31, 2013. The extension of the research credit is retroactive and includes amounts paid or incurred after December 31, 2011. As a result of the retroactive extension, we recognized a benefit of approximately $0.3 million for qualifying amounts incurred during fiscal 2012. 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. Our effective tax rate for the six months ended March 31, 2013 and 2012 was 46% and 29%, respectively. The rate for the six months ended March 31, 2013 differs from the 35% United States federal statutory rate due in part to the relative mix of foreign and domestic earnings and enacted tax rates. Additionally, the effective tax rate was 11% higher than the statutory rate due to recording the effects of Section 162(m) limitations on deferred tax assets that should have been recorded in fiscal 2011 and 2012. This was partially offset by the $0.3 million benefit discussed above related to the research credit for qualifying amounts incurred during fiscal 2012. 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 in that period. Stock based Compensation Expense Stock-based compensation expense, which is included in total costs and expenses by category decreased $0.3 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 and was mainly attributable to the vesting in July 2012 of the RSUs granted in 2009 and to certain executives departing the Company. Stock-based compensation expense decreased $0.3 million for the six months ended March 31, 2013 as compared to the six months ended March 31, 2012 primarily due to the vesting in July 2012 of the RSUs granted in 2009 and to certain executives departing the Company. Stock-based compensation related to employee stock options, RSUs and employee stock purchase rights was reflected in the condensed consolidated statements of operations as follows: Three Months Ended Six Months Ended March 31, March 31, 2013 2012 2013 2012 Direct costs of revenue -subscriptions and services $ 165 $ 203 $ 241 $ 369 Development 291 375 563 680 Operations 154 160 282 303 Sales and marketing 346 519 803 950 General and administrative 246 287 652 570 Total $ 1,202 $ 1,544 $ 2,541 $ 2,872 Non-GAAP Financial Measures and Other Operational Data We also consider certain financial measures that are not prepared in accordance with accounting principles generally accepted in the United States ("GAAP"), including Non-GAAP net income, Non-GAAP net income per share, Adjusted EBITDA, and free cash flow, in managing and measuring the performance of our business. We use these non-GAAP financial measures internally in analyzing our financial results and believe they are useful to investors, as a supplement to GAAP measures, in evaluating our ongoing operational performance against other technology companies and enhancing an overall understanding of our past financial performance, as they help illustrate underlying trends in our business that could otherwise be masked by the effect of the non-cash expenses that we exclude in these non-GAAP financial measures. Furthermore, we use Adjusted EBITDA to establish budgets and bonus compensation targets for managing our business and evaluating our performance. The Non-GAAP measures are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similar measures presented by other companies. However, we believe that this non-GAAP information is useful as an additional means for investors to evaluate our operating performance, when reviewed in conjunction with our GAAP financial statements. Therefore, these measures should not be considered in isolation or as a substitute for measures prepared in accordance with GAAP, and because these amounts are not determined in accordance with GAAP, they should not be used exclusively in evaluating our business and operations. 31 -------------------------------------------------------------------------------- Table of Contents Non-GAAP Net Income and Non-GAAP Net Income Per Share Non-GAAP net income is calculated by adjusting GAAP net income (loss) for the provision (benefit) for income taxes, cash taxes paid (net of refunds), stock-based compensation expense, amortization of purchased intangibles, and any unusual items. Cash taxes paid (net of refunds) consists of payments made to tax authorities less any refunds received from tax authorities related to income taxes. In the three months ended December 31, 2011, the $2.0 million change in fair value of acquisition-related contingent consideration was considered an unusual item. Non-GAAP net income per share is calculated by dividing Non-GAAP net income by the weighted average number of diluted shares outstanding for the period. The following table details our calculation (and reconciliation to GAAP) of non-GAAP net income and non-GAAP net income per share (in thousands, except per share amounts): Three Months Ended Six Months Ended March 31, March 31, 2013 2012 2013 2012 GAAP net income $ 322 $ 334 $ 2,266 $ 4,455 Stock-based compensation 1,202 1,544 2,541 2,872 Amortization of intangible assets - technology 383 525 908 990 Amortization of intangible assets - other 168 969 466 1,779 Provision (benefit) for income taxes (204 ) 419 1,968 1,797 Change in fair value of acquisition-related contingent consideration - - - (2,000 ) Cash taxes paid (net of refunds) (120 ) 66 (377 ) (20 ) Non-GAAP net income $ 1,751 $ 3,857 $ 7,772 $ 9,873 Weighted average diluted common shares outstanding 18,677 18,553 18,539 18,540 Non-GAAP net income per share $ 0.09 $ 0.21 $ 0.42 $ 0.53 Adjusted EBITDA Adjusted EBITDA is defined as earnings before interest income, provision (benefit) for income taxes, stock-based compensation, depreciation, amortization of purchased intangibles, other income (expense), net and any unusual items. In the first quarter of fiscal 2012, the change in fair value of acquisition-related contingent consideration was considered an unusual item. Adjusted EBITDA Margin is defined as Adjusted EBITDA as a percentage of net revenues. The following table details our calculation (and reconciliation to GAAP) of Adjusted EBITDA: Three Months Ended Six Months Ended March 31, March 31, 2013 2012 2013 2012 GAAP net income $ 322 $ 334 $ 2,266 $ 4,455 Stock-based compensation 1,202 1,544 2,541 2,872 Amortization of intangible assets - technology 383 525 908 990 Amortization of intangible assets - other 168 969 466 1,779 Depreciation 1,495 1,370 2,973 2,704 Provision (benefit) for income taxes (204 ) 419 1,968 1,797 Change in fair value of acquisition-related contingent consideration - - - (2,000 ) Interest income and other income (expense), net (63 ) 12 76 (48 ) Adjusted EBITDA $ 3,303 $ 5,173 $ 11,198 $ 12,549 Adjusted EBITDA Margin 11 % 17 % 18 % 20 % Free Cash Flow Free cash flow is defined as cash flow from operations less cash used to purchase property, equipment, and software. The following table details our calculation (and reconciliation to GAAP) of free cash flow: Three Months Ended Six Months Ended March 31, March 31, 2013 2012 2013 2012 Cash flow provided by operations $ 5,852 $ 4,606 $ 9,675 $ 6,116 Purchases of property, equipment and software (1,270 ) (1,639 ) (2,723 ) (3,247 ) Free cash flow $ 4,582 $ 2,967 $ 6,952 $ 2,869 32 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources March 31, 2013 September 30, 2012 Cash, cash equivalents and short-term investments $ 57,914 $ 49,939 Accounts receivable, net $ 15,492 $ 17,395 Working capital $ 57,970 $ 48,846 Days sales outstanding (DSO) for the three months ended (a) 48 53 -------------------------------------------------------------------------------- (a) DSO is calculated as: (ending net accounts receivable / net revenue for the three month period) multiplied by number of days in the period. Days sales outstanding decreased by 5 days from September 30, 2012 to March 31, 2013. The decrease is due to increased collections, primarily in Europe, and due to not being able to bill customers due to delays in obtaining customer acceptance for a few large SITE projects at the end of the second quarter of fiscal 2013. During the period, our customers' payment history remained consistent with prior periods and contractual payment terms. During recent periods, our customers have requested longer payment terms. We expect this trend towards longer terms to continue. Six Months Ended March 31, 2013 2012 Cash provided by operating activities $ 9,675 $ 6,116 Cash used in investing activities $ (8,550 ) $ (59,533 ) Cash provided by (used in) financing activities $ 1,097 $ (615 ) As of March 31, 2013, we had $31.1 million in cash and cash equivalents and $26.8 million in short-term investments, for a total of $57.9 million. Cash and cash equivalents consist of highly liquid investments held at major banks, money market funds and other investments with original maturities of three months or less. Short-term investments consist of investments with original maturities longer than three months, including commercial paper and investment-grade corporate and government debt securities with Moody's ratings of A3 or better. As of March 31, 2013, $44.7 million of our cash, cash equivalents and short-term investments was held in the United States. The remainder of our cash, cash equivalents and short-term investments was held in foreign financial institutions, primarily in Germany, by our subsidiaries. If these foreign cash, cash equivalents and short-term investments are distributed to the United States in the form of dividends or otherwise, we may be subject to additional United States income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes. Cash provided by operating activities We expect that cash provided by operating activities may fluctuate in future periods as a result of a number of factors, including fluctuations in our operating results, accounts receivable collections, and the timing and amount of tax and other payments. Our largest source of operating cash flow is cash collections from our customers. Payments from subscription services customers are generally collected either at the beginning of the subscription period or monthly during the life of the subscription period. Payments for our systems licenses are generally collected at or after delivery of the hardware and software. Payments for our engagement services customers are generally collected at the completion of the service period or as milestones are completed. Our primary use of cash from operating activities, are for personnel related expenditures, measurement and data collection infrastructure costs, insurance, professional services, regulatory compliance and other expenses associated with operating our business. For the six months ended March 31, 2013, net cash provided by operating activities was $9.7 million. Net cash provided was mainly due to net income of $2.3 million, adjusted for $9.0 million of non-cash adjustments to reconcile net income to net cash provided by operating activities and a $(1.6) million net change in operating assets and liabilities. The non-cash adjustments consist primarily of depreciation, amortization, stock-based compensation expense, changes in bad debt and billing reserves, deferred tax expenses, the change in the estimated fair value of acquisition-related contingent consideration and amortization of debt instruments purchase discount or premium. The net change in operating assets and liabilities was primarily due to a decrease in accounts receivable of $1.7 million as a result of increased customer cash collections and a decrease in accounts payable and accrued expenses of $1.5 million and a decrease in deferred revenue of $0.8 million. Cash used in investing activities Cash flows related to investing activities consist primarily of purchases, sales and maturities of investments and purchases of property, equipment and software to support our growth, to expand and improve our monitoring infrastructure and to make tenant improvements associated with space we lease in our headquarters building. Net cash used in investing activities was $8.6 million for the six months ended March 31, 2013 consisting of purchases of property, equipment and software of $2.7 million, and $21.1 million short-term investments purchases, offset by $15.3 million of proceeds from the sale and maturity of short-term investments. 33 -------------------------------------------------------------------------------- Table of Contents Cash provided by (used in) financing activities Cash flows from financing activities primarily relate to payments of common stock dividends and proceeds received from the issuance of common stock under our employee stock option plan and employee stock purchase plan. For the six months ended March 31, 2013, net cash provided by financing activities was $1.1 million primarily due to $3.3 million of proceeds from the issuance of common stock, offset by the payment of common stock dividends in the amount of $2.2 million. Commitments As of March 31, 2013, our principal commitments consisted of $1.5 million in real property and equipment operating leases. These leases expire at various times through March 2018. Additionally, we had $1.0 million of contingent commitments to bandwidth and co-location providers. These contingent commitments have a remaining term of up to twenty-one months and become due if we terminate any of these agreements prior to their expiration. At present, we do not intend to terminate any of these agreements prior to their expiration. We expect to continue to purchase equipment and other assets to support our growth. As of March 31, 2013, we have outstanding guarantees totaling $0.2 million to customers and vendors of one of our foreign subsidiaries. These guarantees can only be executed upon agreement by both the customer or vendor and us. These guarantees were secured by a $1.3 million unsecured line of credit. We believe that our existing cash, cash equivalents and short-term investments will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next twelve months. Factors that could affect our cash position include potential acquisitions, cash dividends, decrease in customer collections or renewals, decreases in revenue, increased expenditure levels or changes in the value of our short-term investments. If, after some period of time, our existing cash, short-term investments and cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or to obtain a credit facility. If additional funds are raised through the issuance of debt securities, these securities could have rights, preferences and privileges senior to holders of common stock, and the terms of this debt could impose restrictions on our operations. The sale of additional equity or convertible debt securities could result in dilution to our stockholders, and we may not be able to obtain additional financing on acceptable terms, if at all. If we are unable to obtain this additional financing, our business may be harmed. Off Balance Sheet Arrangements We did not enter into any transactions with unconsolidated entities whereby we have financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in a unconsolidated entity that provides financing, liquidity, market or credit risk support to us. [ Back To TMCnet.com's Homepage ]