Keynote Systems 10Q 2009 Q1 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended December 31, 2008


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. YESþ NOo

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


Large accelerated filero	Accelerated filerþ	Non-accelerated filero	Smaller reporting companyo
		(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.): YESo NOþ

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 February 3, 2009
Common Stock, $.001 par value		14,284,038 shares

KEYNOTE SYSTEMS, INC.


	Page
PART I—FINANCIAL INFORMATION
Item 1. Unaudited Financial Statements		3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		22
Item 3. Quantitative and Qualitative Disclosures About Market Risks		36
Item 4. Controls and Procedures		36
PART II—OTHER INFORMATION
Item 1. Legal Proceedings		37
Item 1A. Risk Factors		38
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		46
Item 3. Defaults Upon Senior Securities		46
Item 4. Submission of Matters to a Vote of Security Holders		46
Item 5. Other Information		46
Item 6. Exhibits		47

Signatures		48

EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I—FINANCIAL INFORMATION

Item 1. Unaudited Financial Statements.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

Index to Unaudited Condensed Consolidated Financial Statements


	Page
Condensed Consolidated Balance Sheets as of December 31, 2008 and September 30, 2008		4
Condensed Consolidated Statements of Operations for the three months ended December 31, 2008 and 2007		5
Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 2008 and 2007		6
Notes to Condensed Consolidated Financial Statements		7

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)


	December 31,			September 30,
	2008			2008
ASSETS
Current assets:
Cash and cash equivalents	$	50,759		$	46,769
Short-term investments		178			2,562

Total cash, cash equivalents, and short-term investments		50,937			49,331
Accounts receivable, less allowance for doubtful accounts of $188 and $118, at December 31, 2008 and September 30, 2008, respectively, and less billing adjustment of $199 and $150 at December 31, 2008 and September 30, 2008, respectively		8,528			7,316
Prepaids, deferred costs and other current assets		2,880			2,909
Inventories		1,230			1,081
Deferred tax assets		1,029			1,042

Total current assets		64,604			61,679
Deferred costs and other long term assets		2,748			2,788
Property, equipment, and software, net		35,634			36,405
Goodwill		64,195			64,396
Identifiable intangible assets, net		7,834			8,430
Deferred tax assets		1,936			2,146

Total assets	$	176,951		$	175,844


LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities:
Accounts payable	$	1,976		$	2,505
Accrued expenses		12,800			12,767
Current portion of capital lease obligation		14			14
Notes payable		255			256
Deferred revenue		18,234			19,029

Total current liabilities		33,279			34,571
Long-term portion of capital lease obligation		13			17
Deferred rent and other long-term liabilities		2,578			2,605
Long-term deferred revenue		1,592			904
Long-term deferred tax liability		256			236

Total liabilities		37,718			38,333


Commitments and contingencies (see Note 13)
Stockholders’ equity:
Common stock		14			14
Additional paid-in capital		277,115			275,316
Accumulated deficit		(142,321	)		(143,207	)
Accumulated other comprehensive income		4,425			5,388

Total stockholders’ equity		139,233			137,511


Total liabilities and stockholders’ equity	$	176,951		$	175,844

See accompanying notes to the condensed consolidated financial statements

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)


	Three months ended
	December 31,
	2008			2007
Net revenue:
Subscription services	$	11,473		$	10,872
Ratable licenses		6,043			4,002
Professional services		3,121			2,846

Total revenue, net		20,637			17,720

Costs and expenses
Costs of revenue
Direct costs of subscription services		2,256			2,111
Direct costs of ratable licenses		1,488			1,603
Direct costs of professional services		1,678			1,805
Development		3,083			3,133
Operations		2,162			2,003
Amortization of intangible assets — software		288			205

Total costs of revenue		10,955			10,860
Sales and marketing		6,180			5,767
General and administrative		2,820			2,487
Excess occupancy income		(220	)		(281	)
Amortization of intangible assets — other		269			537

Total costs and expenses		20,004			19,370


Income (loss) from operations		633			(1,650	)
Interest income		334			1,285
Other income (expenses)		339			(135	)

Income (loss) before provision for income taxes		1,306			(500	)
Provision for income taxes		(420	)		(244	)

Net income (loss)	$	886		$	(744	)

Net income (loss) per share:
Basic	$	0.06		$	(0.04	)

Diluted	$	0.06		$	(0.04	)

Shares used in computing basic and diluted net income (loss) per share:
Basic		14,186			18,237
Diluted		14,302			18,237

See accompanying notes to the condensed consolidated financial statements

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)


	Three Months Ended
	December 31,
	2008			2007
Cash flows from operating activities:
Net income (loss)	$	886		$	(744	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		1,328			1,287
Stock-based compensation		1,041			1,100
Charges to bad debt and billing adjustment reserves		137			51
Amortization (accretion) of debt investment premium (discount)		3			(551	)
Amortization of identifiable intangible assets		557			742
Amortization of prepaid tax asset		106			—
Collection of tax credit receivable within deferred tax assets		181			—
Deferred tax provision		20			—
Changes in operating assets and liabilities:
Accounts receivable		(1,393	)		(1,768	)
Inventories		(148	)		(87	)
Prepaids, deferred costs and other assets		69			(1,159	)
Accounts payable and accrued expenses		(785	)		1,501
Deferred revenue		18			(42	)

Net cash provided by operating activities		2,020			330


Cash flows from investing activities:
Purchases of property and equipment		(661	)		(1,351	)
Payment of acquisition costs for Zandan S.A.		(170	)		—
Maturities and sales of short-term investments		2,380			30,699
Purchases of short-term investments		—			(23,171	)

Net cash provided by investing activities		1,549			6,177


Cash flows from financing activities:
Repayment of credit facilities		(4	)		(7	)
Proceeds from issuance of common stock and exercise of stock options		752			1,595
Repurchase of outstanding common stock		—			(9,815	)

Net cash provided by (used in) financing activities		748			(8,227	)


Effect of exchange rate changes on cash and cash equivalents		(327	)		408

Net change in cash and cash equivalents		3,990			(1,312	)
Cash and cash equivalents at beginning of the period		46,769			42,875

Cash and cash equivalents at end of the period	$	50,759		$	41,563


Supplemental cash flow disclosure:
Income taxes paid (net of refunds)	$	150		$	198


Noncash operating and investing activities:
Acquisition of property, equipment and software on account	$	167		$	206

See accompanying notes to the condensed consolidated financial statements

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(1) Summary of Significant Accounting Policies

Basis of Presentation

The accompanying interim unaudited 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 Keynote Systems, Inc. and subsidiaries (the “Company”) as of December 31, 2008, and the results of operations and cash flows for the interim periods ended December 31, 2008 and 2007.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”), and therefore, do not include all information and footnotes necessary for a complete presentation of the Company’s results of operations, financial position and cash flows. This report should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended September 30, 2008 included in the Company’s Report on Form 10-K as filed with the 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 results of operations and cash flows for any interim period are not necessarily indicative of the Company’s results of operations and cash flows for any other future interim period or for a full fiscal year.

The preparation of 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 allowance, inventories and inventory valuation, allocation of purchase price for business combinations, useful lives of property, equipment and intangible assets, asset impairments, the fair values of options granted under the Company’s stock-based compensation plans and valuation allowances for deferred tax assets. Actual results could differ from those estimates, and such differences may be material to the financial statements.

Fair Value Measurements

Effective October 1, 2008, the Company adopted Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements”, which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements, but rather eliminates inconsistencies in guidance found in various other accounting pronouncements. The adoption of SFAS No. 157 did not have a material effect on the Company’s financial condition or operating results.

SFAS No. 157 establishes a hierarchy for information and valuations used in measuring fair value, which is broken down into three levels. 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 management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques.

The Company also adopted SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—including an amendment of FASB Statement No. 115”, during the first quarter of fiscal 2009. SFAS No. 159 allows companies to choose to measure eligible financial instruments and certain other items at fair value that are not required to be measured at fair value. SFAS No. 159 requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings at each reporting date. The Company adopted SFAS No. 159 but has not elected the fair value option for any eligible financial instruments as of December 31, 2008.

Refer to Note 5, “Fair Value Measurements” of this Form 10-Q for additional information on the adoption of SFAS Nos. 157 and 159.

Recent Pronouncements

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141R”), which replaces FASB Statement No. 141. SFAS No. 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non controlling interest in the acquiree and the goodwill acquired. The Statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. SFAS No. 141R is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, which will be the Company’s fiscal year beginning October 1, 2009. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS No. 141R on the Company’s consolidated financial position, results of operations and cash flows.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of Accounting Research Bulletin No. 51” (“SFAS No. 160”), which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. The statement also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, which will be the Company’s fiscal year beginning October 1, 2009. The Company is currently evaluating the potential impact, if any, of the adoption of SFAS No. 160 on its consolidated financial position, results of operations and cash flows.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”). SFAS No. 161 enhances financial disclosure by requiring that objectives for using derivative instruments be described in terms of underlying risk and accounting designation in the form of tabular presentation, requiring transparency with respect to the entity’s liquidity from using derivatives, and cross-referencing an entity’s derivative information within its financial footnotes. SFAS No. 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008. The Company is currently evaluating the impact, if any, that SFAS No. 161 may have on its consolidated financial position, results of operations and cash flows.

In April 2008, the FASB released FASB Staff Position No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP No. 142-3”), which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets”. The intent of the statement is to improve the consistency between the useful life of a recognized intangible asset under Statement 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement No. 141 (revised 2007) and other U.S. generally accepted accounting principles. FSP No. 142-3 is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, which will be the Company’s fiscal year beginning October 1, 2009. The Company is currently evaluating the potential impact, if any, of the adoption of FSP No. 142-3 on the Company’s consolidated financial position, results of operations and cash flows.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 162”). SFAS No. 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with accounting principles generally accepted in the United States of America for nongovernmental entities. SFAS No. 162 is effective beginning November 15, 2008. Any effect of applying the provisions of SFAS No. 162 is to be reported as a change in accounting principle in accordance with SFAS No. 154, “Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3.” The adoption of SFAS No. 162 had no effect on the Company’s condensed consolidated financial statements.

Stock Based Compensation

(a) Summary of Plans

As of December 31, 2008, the Company was authorized to issue up to approximately 8.3 million shares of common stock under its 1999 Equity Incentive Plan (“Incentive Plan”) to employees, directors, and consultants, including both nonqualified and incentive stock options. Options expire ten years after the date of grant. Vesting periods are determined by the Board of Directors and generally 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. As of December 31, 2008, options to purchase approximately 5.8 million shares were outstanding under the Incentive Plan, and approximately 561,000 shares were available for future issuance under the Incentive Plan.

The Incentive Plan will remain in effect until it expires on June 28, 2009. The Company is seeking stockholder approval to extend the term of the Incentive Plan until December 31, 2011.

As of December 31, 2008, the Company had reserved a total of approximately 1.4 million shares of common stock for issuance under its 1999 Employee Stock Purchase Plan (“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 purchase 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. As of December 31, 2008, approximately 972,000 shares had been issued under the Purchase Plan, and approximately 451,000 shares remain for future issuance.

The Purchase Plan will remain in effect until it expires on June 28, 2009. The Company is seeking stockholder approval to extend the term of the Purchase Plan for an additional ten years.

(b) Summary of Assumptions and Activity

The fair value of each option was estimated on the date of grant using the Black-Scholes option pricing model. Weighted-average assumptions for options granted and stock purchase rights under the equity incentive plans are as follows:


	Three Months Ended
	December 31,
	2008			2007
Stock Options Under Equity Incentive Plan:
Volatility		37.9	%		30.9	%
Risk free interest rate		2.6	%		3.9	%
Expected life (in years)		4.50			4.50
Dividend yield		—			—
Employee Stock Purchase Plan:
Volatility		43.4	%		24.4	%
Risk free interest rate		2.3	%		4.8	%
Expected life (in years)		1.25			1.25
Dividend yield		—			—

A summary of option activity through December 31, 2008, and changes during the quarter then ended, is presented below (in thousands except per share and term amounts):


						Average
				Weighted		Remaining		Aggregate
				Average		Contractual		Intrinsic
	Shares			Exercise Price		Term (years)		Value

Outstanding at September 30, 2008		5,948		$	14.67		6.5	$	10,820
Granted		61			10.36
Exercised		(100	)		7.52
Forfeited or canceled		(54	)		13.62
Expired		(32	)		13.10

Outstanding at December 31, 2008		5,823		$	14.77		6.3	$	223

Vested and expected to vest at December 31, 2008		5,479		$	14.93		6.2	$	222

Exercisable at December 31, 2008		4,112		$	15.84		5.5	$	220

The weighted average grant-date fair value of options granted during the quarter ended December 31, 2008 was $3.65 per share. The aggregate intrinsic value of options exercised during the quarter ended December 31, 2008 was approximately $241,000.

As of December 31, 2008, there was approximately $4.4 million of total unrecognized compensation cost (net of estimated forfeitures) related to nonvested share-based compensation (nonvested stock options) arrangements as determined using the Black-Scholes option pricing model. That cost is expected to be recognized over the next four fiscal years (or a weighted average period of 2.0 years).

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, such as property taxes, insurance, building depreciation, leasing broker fees and tenant improvement amortization. The costs are based upon actual square footage available to lease to third parties, which was approximately 75% for the three months ended December 31, 2008, and 60% for the three months ended December 31, 2007. Rental income was approximately $627,000 and $607,000 for the three months ended December 31, 2008 and 2007, respectively. As of December 31, 2008, the Company had leased space to 14 tenants of which 13 had noncancellable operating leases, which expire on various dates through 2014. At September 30, 2008, future minimum rents receivable under the leases, are as follows (in thousands):


Fiscal years:
2009 (remaining nine months)	$	1,796
2010		1,977
2011		1,866
2012		1,563
2013		218
Thereafter		89

Total future minimum rents receivable	$	7,509

(2) Revenue Recognition

Revenue consists of subscription services revenue, ratable licenses revenue and professional services revenue and is recognized when all of the following criteria have been met:

	•		Persuasive evidence of an arrangement exists.The Company considers a customer signed quote, contract, or equivalent document to be evidence of an arrangement.

	•		Delivery of the product or service.For subscription services, delivery is considered to occur when the customer has been provided with access to the subscription services. The Company’s subscription services are generally delivered on a consistent basis over the period of the subscription. For professional services, delivery is considered to occur when the services or milestones are completed. For ratable licenses, delivery occurs when all elements of the arrangement have either been delivered or accepted, if acceptance language exists.

	•		Fee is fixed and 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 occasionally provided to prospective customers who would like to try certain of the Company’s Perspective and other subscription services before they commit to purchasing the services. The services provided during the trial period are typically stand-alone transactions and are not bundled with other services. Revenue is not recognized for these free trial periods.

Subscription Services Revenue:Subscription services revenue consists of fees from sales of subscriptions to the Company’s Perspective family of services, and Global Roamer.

Revenue is recognized in accordance with Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition” (“SAB 104”) and Emerging Issues Task Force (“EITF”) Issue 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”).

The Company also enters into multiple element arrangements where sufficient objective evidence of fair value does not exist for the allocation of revenue. As a result, the elements within its subscription arrangements do not qualify for treatment as separate units of accounting. Accordingly, the Company accounts for fees received under subscription arrangements as a single unit of accounting and recognizes the entire arrangement fee as revenue either ratably over the service period, generally over twelve months, or based upon actual monthly usage.

The Company’s WebEffective service can be sold on a subscription basis or as part of a professional services engagement. The Company recognizes revenue from the use of its WebEffective service that is sold on a subscription basis ratably over the subscription period, commencing on the day service is first provided, and such revenue is recorded as subscription services revenue. The Company recognizes revenue from the use of its WebEffective service as part of a professional services engagement and revenue is recorded as professional services revenue.

Ratable Licenses Revenue:Ratable licenses revenue consists of fees from the sale of mobile automated test equipment, maintenance, engineering and minor consulting services associated with Keynote SIGOS System Integrated Test Environment (“SITE”) as a result of the Company’s acquisition of SIGOS Systemintegration GmbH (“Keynote SIGOS”) in the third quarter of fiscal 2006. The Company frequently enters into multiple element arrangements with mobile customers, for the sale of its automated test equipment, including both hardware and software licenses, consulting services to configure the hardware and software (implementation or integration services), post contract support (maintenance) services, training services and other minor consulting services. These multiple element arrangements are within the scope of Statement of Position (“SOP”) No. 97-2, “Software Revenue Recognition” (“SOP 97-2”), and the EITF Issue 03-5, “Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software”. This determination is based on the hardware component of the Company’s multiple element arrangements being deemed to be a software related element. In addition, customers only purchase the software and hardware as a package, with payments due upon delivery of this hardware and software package.

None of the Keynote SIGOS implementation/integration services provided by the Company are 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 (generally within two to three months) compared to the length of the arrangement which typically ranges from twelve to thirty-six months. Additionally, the implementation/integration services are general in nature and the Company has a history of successfully gaining customer acceptance.

The Company cannot allocate the arrangement consideration to the multiple elements based on the vendor specific objective evidence (“VSOE”) of fair value because sufficient evidence of VSOE does not exist for the undelivered elements of the arrangement, typically maintenance. Therefore, the Company recognizes 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. Where acceptance provisions exist, the ratable recognition of revenue begins when evidence of customer acceptance of the software and hardware has occurred as intended under the respective arrangement’s contractual terms.

Professional Services Revenue:Professional services revenue consists of fees generated from LoadPro, Customer Experience Management and professional consulting services that are purchased as part of a professional service project. Revenue from these services is recognized as the services are performed, typically over a period of one to three months. For professional service projects that contain milestones, the Company recognizes revenue once the services or milestones have been delivered, based on input measures. Payment occurs either up-front or over time.

The Company also enters into multiple element arrangements, which generally consist of either: 1) the combination of subscription and professional services, or 2) multiple professional services. For these arrangements, the Company recognizes revenue in accordance with EITF 00-21. The Company allocates and defers revenue for the undelivered items based on objective evidence of fair value of the undelivered elements, and recognizes the difference between the total arrangement fee and the amount deferred for the undelivered items as revenue. When sufficient objective evidence of fair value does not exist for undelivered items when subscription and professional services are combined, the entire arrangement fee is recognized ratably over the applicable performance period.

Deferred Revenue:Deferred revenue is comprised of all unearned revenue that has been collected in advance, primarily unearned subscription services and ratable licenses revenue, and is recorded as deferred revenue on the balance sheet until the revenue is earned. Any unpaid deferred revenue reduces the balance of accounts receivable. 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 of the balance sheet date and primarily relates to ratable licenses revenue.

Deferred Costs:Deferred costs are mainly comprised of hardware costs associated with Keynote SIGOS revenue arrangements involving hardware. Deferred costs are categorized as short term for any arrangement for which the original service contracts are one year or less in length. Correspondingly, deferred costs associated with arrangements for which the original service contracts are greater than one year are classified as noncurrent deferred costs in the condensed consolidated balance sheets. Contract lives generally range from one to three years. These deferred costs are amortized to cost of ratable licenses over the life of the customer contract. Amortization of these deferred costs commences when revenue recognition commences which is typically when evidence of delivery or acceptance occurs.

(3) Other Comprehensive Income (Loss) and Foreign Currency Translation

The Company reports comprehensive income (loss) in accordance with the provisions of SFAS No. 130, “Reporting Comprehensive Income”, which establishes standards for reporting comprehensive income and its components in the financial statements. The components of comprehensive income consist of net income (loss), unrealized gains and losses on short-term investments in debt securities and foreign currency translation. The unrealized gains and losses on short-term investments in debt securities 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 not using the U.S. dollar as their functional currency since the majority of their economic activities are primarily denominated in their applicable local currency. The Company has subsidiaries located in Germany, United Kingdom, France and Canada. 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 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 (expenses) in the condensed consolidated statements of operations as incurred and were approximately $310,000 and ($134,000) for the three months ended December 31, 2008 and 2007, respectively.

The components of other comprehensive income (loss) are as follows (in thousands):


	Three Months Ended
	December 31,
	2008			2007
Net income (loss)	$	886		$	(744	)
Net unrealized gain on available-for-sale investments		—			10
Foreign currency translation gain (loss)		(963	)		1,227


Other comprehensive income (loss)	$	(77	)	$	493

The Company did not record deferred taxes on unrealized gains on its investments, as the Company intends to hold these investments to maturity. There is no tax effect on the foreign currency translation because it is management’s intent to reinvest the undistributed earnings of its foreign subsidiaries indefinitely.

(4) Financial Instruments and Concentration of Risk

The carrying value of the Company’s financial instruments, including cash and cash equivalents, short-term investments, accounts receivable, accounts payable, and accrued expenses approximates fair market value due to their short-term nature. 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, but exists in Europe as well. The Company generally requires no collateral from customers; however, throughout the collection process, it conducts an ongoing evaluation of customers’ ability to pay. The Company’s accounting for its 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 aging of accounts receivable, the age of each invoice, each customer’s expected ability to pay and the Company’s collection history with each customer. Management reviews invoices greater than 60 days past due to determine whether an allowance is appropriate based on the receivable balance. 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 allowance that represents the reserve for potential billing adjustments that are recorded as a reduction of revenue. The Company’s billing allowance is calculated as a percentage of revenue based on historical trends and experience.

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

(5) Fair Value Measurements

Effective October 1, 2008, the Company adopted SFAS No. 157 “Fair Value Measurements”, except as it applies to those nonfinancial assets and nonfinancial liabilities. SFAS No.157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and enhances disclosures about fair value measurements. Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. Valuation techniques used to measure fair value under SFAS No.157 must maximize the use of observable inputs and minimize the use of unobservable inputs. The standard describes a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last is considered unobservable, that may be used to measure fair value. The Company’s adoption of SFAS No.157 did not materially affect its financial position and results of operations, but SFAS No.157 does require new disclosures about how management values certain assets and liabilities. Much of the required disclosure relates to the inputs used to measure fair value, particularly in instances where the measurement uses significant unobservable (Level 3) inputs. The financial instruments are valued using quoted prices in active markets or based upon other observable inputs.

The following table presents the Company’s assets and liabilities measured at fair value on a recurring basis as of December 31, 2008 (in thousands):


	December 31, 2008
	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
	Instruments		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Total
Assets:

Cash and cash equivalents:

Money market funds	$	19,290	$	—	$	—	$	19,290

Short term investments:

Real estate funds		178		—		—		178


Total assets measured at fair value	$	19,468	$	—	$	—	$	19,468


Liabilities:

Notes payable	$	—	$	255	$	—	$	255


Total liabilities measured at fair value	$	—	$	255	$	—	$	255

The Company’s investments in money market funds are measured at fair value on a recurring basis. Its money market funds comply with Rule 2a-7 of the Investment Company Act of 1940 and are required to be priced and have a fair value of $1 net asset value per share. These money market funds are actively traded and reported daily through a variety of sources. Due to the structure and valuation required by the Investment Company Act of 1940 regarding Rule 2a-7 funds, the fair value of the money market fund investments are classified as Level 1.

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

The Company considers all highly liquid investments held at major banks, commercial paper, money market funds and other money market securities with original maturities of three months or less to be cash equivalents in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities”.

The Company classifies all of its short-term investments as available-for-sale. These investments mature or reset in one year or less as of the balance sheet dates, and consist of investment-grade corporate securities. 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, a component of stockholders’ equity. Realized gains and losses are recorded based on specific identification.

The following table summarizes the Company’s cash and cash equivalents as of December 31, 2008 (in thousands):


			Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Market Value
Cash	$	31,469	$	—	$	—	$	31,469
Money market mutual funds		19,290		—		—		19,290

Total	$	50,759	$	—	$	—	$	50,759

The following table summarizes the Company’s short-term investments as of December 31, 2008 (in thousands):


			Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Market Value
Real estate mutual funds	$	168	$	10	$	—	$	178

There was no impairment charge for the three months ended December 31, 2008. The Company recorded an impairment charge of $46,000 for the three months ended December 31, 2007.

(7) Consolidated Financial Statement Details

The following tables show the Company’s Consolidated Financial Statement details as of December 31, 2008 and September 30, 2008 (in thousands):

Prepaids, Deferred Costs and Other Current Assets:


	December 31, 2008		September 30, 2008
Prepaid expenses	$	1,588	$	1,332
Deferred costs of revenue		800		749
Other assets		278		576
Security deposits, advances, and interest receivable		214		252

Total	$	2,880	$	2,909

Property, equipment, and software:


	December 31, 2008			September 30, 2008
Computer equipment and software	$	27,435		$	27,094
Furniture and fixtures		1,835			1,839
Land		14,150			14,150
Building		21,639			21,639
Leasehold and building improvements		1,160			1,170
Construction in progress		124			288

Total		66,343			66,180
Less accumulated depreciation and amortization		(30,709	)		(29,775	)

Total	$	35,634		$	36,405

Deferred Costs and Other Long-Term Assets:


	December 31, 2008		September 30, 2008
Prepaid tax asset	$	1,282	$	1,429
Deferred costs of revenue		694		563
Tenant rent receivable		294		312
Deposits		166		162
Prepaid expenses		312		322

Total	$	2,748	$	2,788

Accrued Expenses:


	December 31, 2008		September 30, 2008
Accrued employee compensation	$	3,280	$	3,476
Accrued audit and professional fees		167		641
Income and other taxes		3,860		3,635
Other accrued expenses		5,493		5,015

Total	$	12,800	$	12,767


*Notes Payable*:

	December 31, 2008		September 30, 2008
Notes payable	$	255	$	256

As a result of acquiring all outstanding shares of Zandan (see Note 11), the Company assumed a loan agreement that Zandan entered into in 2007, with Oseo BDPME, a French State Bank of Innovation, to borrow approximately€182,000 or $255,000 to meet general working capital requirements. Amounts borrowed under this agreement are secured by Zandan’s 2005 research tax credit receivable in the amount of approximately€288,000 or $405,000. Amounts borrowed bear a variable interest based upon the Euro Overnight Interest Average rate of the month plus 3.8%. Interest and principal are due when the research tax credit receivable is collected from the French Tax Authorities, which is expected to be in the second quarter of fiscal year 2009.

(8) Inventories

Inventories related to SIGOS SITE systems were approximately $1.2 million and $1.1 million as of December 31, 2008 and September 30, 2008, respectively. Inventories primarily relate to direct costs associated with finished goods hardware and are stated at the lower of cost (determined on a first-in, first-out basis) or market. Current selling prices are primarily used for measuring any potential declines in market value below cost. Any adjustment for market value decreases is charged to cost of ratable licenses at the point management deems that the market value has declined. The Company evaluates inventories for excess quantities and obsolescence on a quarterly basis. This evaluation includes analysis of historical and forecasted sales of its product. Inventories on hand in excess of forecasted demand or obsolete inventories are charged to cost of ratable licenses. Obsolescence is determined considering several factors, including competitiveness of product offerings, market conditions, and product life cycles.

(9) Goodwill and Identifiable Intangible Assets

The following table represents the changes in goodwill during the three months ended December 31, 2008 (in thousands):


Balance at September 30, 2008	$	64,396
Additional goodwill for the acquisition of Zandan S.A. (Note 11)		158
Translation adjustments		(359	)

Balance at December 31, 2008	$	64,195

The Company tests goodwill for impairment annually as of September 30 and concluded that no impairment existed as of September 30, 2008. The Company also evaluates goodwill for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. These events or circumstances could include a significant change in the business climate, legal factors, operating performance indicators, competition, or sale or disposition of a significant portion of a reporting unit. Recoverability of goodwill is measured at the reporting unit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair value of the reporting unit, which is measured based upon, among other factors, market multiples for comparable companies as well as a discounted cash flow analysis. Reporting units represent components of the Company for which discrete financial information is available that is regularly reviewed by management. Management has determined that the Company currently has one reporting unit. If the recorded value of the assets, including goodwill, and liabilities (“net book value”) of the reporting unit exceeds its fair value, an impairment loss may be required.

Although there was a decline in the market capitalization of the Company, as well as comparable companies, during the quarter ended December 31, 2008, the Company concluded that there were no triggering events as of December 31, 2008 which would require a formal impairment analysis of the carrying value of goodwill. Management believes that the recent decline in the Company’s market capitalization is not due to any fundamental change or adverse events in the Company’s operations. Accordingly, the Company has not recognized any impairment of its goodwill in the accompanying condensed consolidated financial statements. The Company is continuing to monitor its economic situation and the need to perform an impairment analysis in light of recent macro-economic indications in the equity markets as well as recent volatility and downward pressure on 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 on September 30, 2009, management will perform an impairment analysis under SFAS No. 142, “Goodwill and Other Intangible Assets,” and could record an impairment charge to write down goodwill to its fair value. If the results of that impairment testing confirm that a write down of goodwill is necessary, then the Company will record an associated charge. Any such charge could be significant and accordingly, would 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.

Identifiable intangible assets amounted to approximately $7.8 million (net of accumulated amortization of approximately $21.7 million) and approximately $8.4 million (net of accumulated amortization of approximately $21.1 million) at December 31, 2008 and September 30, 2008, respectively. The components of identifiable intangible assets are as follows (in thousands):


	Technology			Technology
	Based-			Based-			Customer
	Software			Other			Based			Trademark			Covenant			Backlog			Total
As of December 31, 2008:
Gross carrying value	$	8,008		$	11,848		$	8,097		$	1,389		$	39		$	116		$	29,497
Accumulated amortization		(2,179	)		(11,786	)		(7,047	)		(580	)		(18	)		(53	)		(21,663	)


Net carrying value at December 31, 2008	$	5,829		$	62		$	1,050		$	809		$	21		$	63		$	7,834


As of September 30, 2008:
Gross carrying value	$	8,039		$	11,845		$	8,104		$	1,392		$	39		$	117		$	29,536
Accumulated amortization		(1,790	)		(11,767	)		(6,952	)		(532	)		(16	)		(49	)		(21,106	)


Net carrying value at September 30, 2008	$	6,249		$	78		$	1,152		$	860		$	23		$	68		$	8,430

Amortization expense for identifiable intangible assets for the three months ended December 31, 2008 and 2007 was approximately $557,000 and $742,000, respectively. Amortization of developed technology related to software was approximately $288,000 and $205,000 for the three months ended December 31, 2008 and 2007, respectively. These amounts were recorded to costs of revenue.

The estimated future amortization expense for existing identifiable intangible assets as of December 31, 2008 is as follows (in thousands):


	Total
Fiscal years:
2009 (remaining nine months)	$	2,105
2010		2,494
2011		2,258
2012		977

Total	$	7,834


Weighted-average remaining useful life as of December 31, 2008 (years)		3.2

(10) Net Income (Loss) Per Share

Basic net income (loss) per share is computed using the weighted-average number of outstanding shares of common stock, summarized below. Diluted net income (loss) per share is computed using the weighted-average number of shares of common stock outstanding and, when dilutive, potential shares from options and employee stock purchases to purchase common stock using the treasury stock method.

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


	Three Months Ended
	December 31,
	2008		2007
Numerator:
Net income (loss)	$	886	$	(744	)

Denominator:
Denominator for basic net income (loss) per share—weighted average shares		14,186		18,237
Effect of dilutive stock options		116		—

Denominator for diluted net income (loss) per share—weighted average shares		14,302		18,237

Basic net income (loss) per share	$	0.06	$	(0.04	)
Diluted net income (loss) per share	$	0.06	$	(0.04	)

For the three months ended December 31, 2008, 5.6 million options outstanding were excluded from the computation of diluted net income per share since their effect would have been antidilutive. For the three months ended December 31, 2007, 5.4 million options outstanding were excluded from the computation of diluted net loss per share since their effect would have been antidilutive. The weighted-average exercise price of excluded outstanding stock options was $14.88 and $14.42 for the three months ended December 31, 2008 and 2007, respectively.

(11) Acquisitions

As a result of acquiring all outstanding shares of Zandan S.A. (“Zandan”) on April 16, 2008, the Company assumed a liability for a legal settlement against Zandan involving a dispute alleging that Zandan had not complied with its systems support agreement. The matter was taken to court where the Swiss federal court ruled that Zandan pay€242,000 or $381,000, plus interest. Zandan was not successful on appeal, and as such, accrued expenses assumed on purchase of Zandan included an accrual of€265,000 or $417,000. However, as part of the purchase agreement, this liability is the responsibility of Zandan’s former shareholders, and as such, the amount has been set aside in escrow.

During the three months ended December 31, 2008, the former shareholders successfully reduced this legal settlement to€229,000 or $320,000. The amount was disbursed from the escrow account since this legal settlement was the responsibility of Zandan’s former

shareholders. Accordingly, the liability was reduced from€265,000 to€229,000 or approximately $320,000 as of December 31, 2008. In January 2009, the Company remitted the funds to the plaintiff.

During the three months ended December 31, 2008, the Company received a tax bill of€113,000 or $158,000 from URSAFF (French social contribution authority) related to Zandan’s social tax declarations between late calendar year 2006 and early calendar year 2007. Since this amount related to pre-acquisition liability, the Company recorded the liability of $158,000 with an offsetting increase to goodwill.

(12) Income Taxes

The Company’s effective tax rate for the three months ended December 31, 2008 and 2007 was 32% and (49%), respectively. The rate for the three months ended December 31, 2008 is less than the 35 percent U.S. federal statutory rate primarily due to the relative mix of foreign and domestic earnings and the fact that a portion of the earnings are being taxed in the U.S. where the Company has a low effective tax rate due to utilization of valuation allowance against current year projected income. The rate for the three months ended December 31, 2007 was higher than the 35 percent U.S. federal statutory rate primarily due to the fact that the Company did not benefit from losses incurred in the United States.

The effective tax rate is highly dependent upon the geographic distribution of the Company’s worldwide earnings or loss, tax regulations in each geographic region, the availability of tax credits and carry-forwards, 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.

At September 30, 2007, the Company determined that the projected sources of future taxable income in the United States were not sufficient to support any of the deferred tax assets located in the United States. Therefore, the Company established a valuation allowance against all of the deferred tax assets related to the United States. The net deferred tax assets recorded on the Company’s condensed consolidated balance sheets as of December 31, 2008 and September 30, 2008 are primarily related to foreign jurisdictions. In future quarters, the projected taxable income will be evaluated for this purpose, and it is possible that the valuation allowance would be reduced. If a valuation allowance is decreased, deferred tax expense may be reduced, goodwill may be reduced, or paid in capital may be increased, depending on the nature and source of the deferred tax assets. This analysis is applied on a jurisdiction by jurisdiction basis. In the event that management determines that the valuation allowance should be reduced, the tax effect would be recorded as a discrete event in the quarter in which the determination was made. This analysis is applied to US domestic taxes and to foreign, in particular German, taxes separately. SFAS No. 123R has the effect of increasing the effective tax rate due to compensation expense from incentive stock options and employee stock purchase plan shares, which have no associated tax benefit to the Company. In a future period, it is possible that a tax benefit would be realized on these options, at which time the tax rate may be reduced as a result.

The Company adopted the provisions of FIN 48 on October 1, 2007. Upon adoption of FIN 48 on October 1, 2007, the Company recognized a cumulative effect adjustment of $81,000, decreasing its income tax liability for unrecognized tax benefits, and decreasing the September 30, 2007 accumulated deficit balance. As of December 31, 2008, the total amount of gross unrecognized benefits was $6,406,000. Included in this balance was approximately $2,235,000 of unrecognized tax benefits that, if recognized, would affect the effective income tax rate. There have been no significant changes in these amounts during the quarter ended December 31, 2008

It is possible that the amount of liability for unrecognized tax benefits may change within the next 12 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 will 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 insignificant for the three months ended December 31, 2008.

Although the Company files U.S. federal, various state, and foreign tax returns, the Company’s only major tax jurisdictions are the United States, Canada, United Kingdom, Netherlands and Germany. Tax years 1994 — 2007 remain subject to examination by the appropriate governmental agencies due to tax loss carryovers from those years.

(13) Commitments and Contingencies

(A) Leases

The Company leases certain of its facilities and equipment under noncancelable capital and operating leases, which expire on various dates through October 2017. As of December 31, 2008, future minimum payments under the leases are as follows (in thousands):


	Operating		Capital
	Leases		Leases
Fiscal year:
2009 (remaining nine months)	$	752	$	14
2010		903		14
2011		710		—
2012		520		—
2013		421		—
Thereafter		791		—

Total minimum lease payments	$	4,097		28


Less amounts representing interest				(1	)

Present value of minimum lease payments				27
Less current portion of capital lease obligation				(14	)

Long-term portion of capital lease obligation			$	13

Rent expense for the three months ended December 31, 2008 and 2007 was approximately $343,000 and $241,000, respectively.

(B) Commitments

The Company has contingent commitments, which range in length from one to twenty-eight months, to bandwidth and co-location providers amounting to $1.7 million,which commitments become due if the Company terminates any of these agreements prior to their expiration.

As of December 31, 2008, the Company has outstanding guarantees totaling $173,000 in one of its foreign subsidiaries, 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 of $1.4 million as of December 31, 2008.

(C) Legal Proceedings

In August 2001, the Company and certain of its current and former officers were named as defendants in two securities class-action lawsuits based on alleged errors and omissions concerning underwriting terms in the prospectus for the Company’s initial public offering. A Consolidated Amended Class Action Complaint for Violation of the Federal Securities Laws (“Consolidated Complaint”) was filed on or about April 19, 2002, and alleged claims against the Company, certain of its officers, and underwriters of the Company’s September 24, 1999 initial public offering (“underwriter defendants”), under Sections 11 and 15 of the Securities Act of 1933, as amended, and under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The lawsuit alleged that the defendants participated in a scheme to inflate the price of the Company’s stock in its initial public offering and in the aftermarket through a series of misstatements and omissions associated with the offering. The lawsuit is one of several hundred similar cases pending in the Southern District of New York that have been consolidated by the court.

The Company was a party to a global settlement with the plaintiffs that would have disposed of all claims against it with no admission of wrongdoing by the Company or any of its present or former officers or directors. The settlement agreement had been preliminarily approved by the Court. However, while the settlement was awaiting final approval by the District Court, in December 2006 the Court of Appeals reversed the District Court’s determination that six focus cases could be certified as class actions. In April 2007, the Court of Appeals denied plaintiffs’ petition for rehearing, but acknowledged that the District Court might certify a more limited class. At a June 26, 2007 status conference, the Court approved a stipulation withdrawing the proposed settlement. On August 14, 2007, plaintiffs filed amended complaints in the focus cases, and a motion for class certification in the focus cases on September 27, 2007. On November 13, 2007, defendants in the focus cases filed a motion to dismiss the amended complaints for failure to state a claim, which the District Court denied on March 2008. Plaintiffs, the issuer defendants (including the Company), the underwriter defendants, and the insurance carriers for the defendants, have engaged in mediation and settlement negotiations. The parties have reached a settlement agreement in principle. As part of this tentative settlement, the Company’s insurance carrier has agreed to assume the Company’s entire payment obligation under the terms of the settlement. Although the parties have reached a tentative settlement agreement, there can be no guarantee that it will be finalized or receive approval from the District Court. The Company believes that it has meritorious defenses to these claims. If the tentative settlement is not implemented and the litigation continues against the Company, the Company would continue to defend against this action vigorously.

In addition, in October 2007, a lawsuit was filed in the United States District Court for the Western District of Washington by Vanessa Simmonds, captionedSimmonds v. JPMorgan Chase & Co., et al., No. 07-1634, alleging 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 seeks 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 names the Company as a nominal defendant, contains no claims against the Company, and seeks no relief from the Company. This lawsuit is 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. The parties entered into a stipulation, entered as an order by the Court, that the Company is 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. There was a hearing on the motions to dismiss on January 16, 2009, but the court has yet to rule on either motions. No amount has been accrued as of December 31, 2008 and September 30, 2008 since management believes that the Company’s liability, if any, is not probable and cannot be reasonably estimated.

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 will have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.

(D) 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 warranties, 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 December 31, 2008 or September 30, 2008, as costs to replace or correct product are generally reimbursable under the manufacturer’s warranty.

(E) 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 December 31, 2008 and September 30, 2008 in the condensed consolidated balance sheets.

(14) 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 quality of service of the Internet and of mobile communications. While the Company operates under one operating segment, management reviews revenue under two categories — Internet and Mobile services.

The following table identifies which services are categorized as Internet and Mobile services and where they are recorded in the Company’s condensed consolidated statements of operations.

Subscription

Ratable

Professional

Services

Licenses

Services

Internet Test and Measurement:

Application Perspective

Diagnostic Services

Enterprise Adapters

LoadPro

NetMechanic

Professional Services

Red Alert

Streaming Perspective

Test Perspective

Transaction Perspective

Web Site Perspective

Voice Perspective

Subscription

Ratable

Professional

Services

Licenses

Services

Performance Scoreboard

WebEffective

Financial Industry Scorecards

Mobile Test and Measurement:

Mobile Device Perspective

Mobile Application Perspective

SIGOS SITE

SIGOS Global Roamer

The following table summarizes Internet and Mobile services net revenue (in thousands):


	Three Months Ended December 31,
	2008		2007
Internet Subscriptions	$	9,664	$	9,532
Internet Engagements		3,121		2,846

Total Internet net revenue		12,785		12,378

Mobile Subscription		1,809		1,340
Mobile Ratable Licenses		6,043		4,002

Total Mobile Subscriptions net revenue		7,852		5,342

Total net revenue	$	20,637	$	17,720

Information regarding geographic areas is as follows (in thousands):



	Three Months Ended December 31,
	2008		2007
Revenues:
United States	$	12,048	$	11,253
Europe*		6,525		5,222
Other*		2,064		1,245

Total net revenue	$	20,637	$	17,720


*		No individual country represents more than 10% of total revenue.


	December 31,		September 30,
	2008		2008

Long Lived Assets:
United States	$	34,616	$	35,317
Germany		1,012		1,062
Other		6		26

	$	35,634	$	36,405

Revenue is attributable to countries based on the geographic location of the customers. Long-lived assets are attributed to the geographic location in which they are located. The Company includes in long-lived assets all tangible assets. Long-lived assets in Germany include tangible assets related to the acquisition of SIGOS.

For the three months ended December 31, 2008, no single customer accounted for 10% or more of total net revenue. For the three months ended December 31, 2007, one customer accounted for approximately 11% of total net revenue. As of December 31, 2008, one customer accounted for 10% of total accounts receivable. As of September 30, 2008, no single customer accounted for 10% or more of total accounts receivable.

Item 2. Management 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 Condensed Consolidated Financial Statements and the Notes thereto included in this report as well as in our Annual Report on Form 10-K for the year ended September 30, 2008, 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 involve risks and uncertainties, including, among other things, statements regarding our anticipated costs and expenses and revenue mix. 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, 2008 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

We develop and sell technology solutions to measure, test, assure and improve the quality of service of the Internet and of mobile communications. We offer Internet test and measurement (“Internet”) software-as-a-service solutions, and mobile test and measurement (“Mobile”) software-as-a-service and licensed solutions. Our Internet category includes all of our geographically distributed “on demand” Web site and transaction/application monitoring and measurement services, voice-over-IP (VOIP) and streaming measurement services, load testing services, customer experience management services, competitive research and industry scorecard services, and custom professional services. The Mobile category consists of our on-demand Mobile monitoring and testing services, our Global Roamer services and our SIGOS System Integrated Test Environment (“SITE”) systems.

We offer our Internet services either on a subscription or on an engagement basis although, in some cases, we also offer Internet professional services on a per incident or per study basis. Subscription fees range from monthly to annual commitments, and vary based on the type of service selected, the number of pages, transactions or devices monitored, the number of measurement locations and/or appliances, the frequency of the measurements and any additional features ordered. 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. Our Mobile solutions are offered on a subscription basis or license basis. The subscriptions typically are for a fixed period, usually annual, and are based on the number of locations and devices from which monitoring and testing is performed, and the number of mobile operators and services covered by such monitoring and testing. The SIGOS SITE system is usually offered via a software license fee model, but because it is bundled with ongoing maintenance and support for a fixed contract period, with no vendor specific objective evidence of fair value on the undelivered elements, the license fees are amortized over the length of the contract and are therefore included in the ratable licenses category. The SIGOS Global Roamer service is offered via a subscription fee model, typically on a three to twelve month basis and is included in the subscriptions category.

We sell our non-SIGOS services through our field sales and telesales organization. In addition, domestically, we distribute our services through Web-hosting and Internet service providers such as IBM Global Services and EDS, who manage e-business Web sites for other companies. We also sell to content distribution providers, such as Akamai, who use our services as a pre-sales tool for their potential customers or in service level agreements with their existing customers. We also occasionally market our services through several other technology companies, such as Agilent, on a “lead referred” basis. Internationally, we use both direct and indirect sales approaches in the United Kingdom, Nordic Countries and Germany and sell indirectly through reseller partners throughout the rest of Europe, the Middle East, Africa and Asia. Our SIGOS SITE and Global Roamer sales are made by accounting management teams working for our Keynote SIGOS subsidiary.

As of December 31, 2008, we measured approximately 15,000 Internet pages, as compared to 11,840 Internet pages in the same quarter a year ago.

For the three months ended December 31, 2008, our 10 largest customers accounted for approximately 39% of total net revenue. We cannot be certain that customers that have accounted for significant revenue in past periods, individually or in aggregate, will renew our services and continue to generate revenue in any future period. In addition, our customers that have monthly renewal arrangements

may terminate their services at any time with little or no penalty. If we lose a major customer or a group of significant customers, our revenue could significantly decline.

We believe that the challenges for our business include 1) continuing to drive growth in our Internet and Mobile revenue, 2) growing multiple page/broadband related revenue such as Transaction Perspective and Application Perspective, 3) continuing to control our expenses in fiscal 2009 and 4) successfully navigating the global economic downturn.

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. Note 2, “Summary of Significant Accounting Policies,” to the consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended September 30, 2008 describes the significant accounting policies and methods used in the preparation of our condensed consolidated financial statements. 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

	•		Allowance for doubtful accounts and billing allowance

	•		Inventories and inventory valuation

	•		Allocation of purchase price for business combinations

	•		Goodwill, identifiable intangible assets and long-lived assets — Impairment assessments

	•		Stock-based compensation

	•		Income taxes, deferred income taxes and deferred income tax liabilities

Revenue Recognition

We recognize revenue in accordance with Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition” (“SAB 104”), Emerging Issues Task Force (“EITF”) Issue 00-21 “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”), Statement of Position (“SOP”) No. 97-2, “Software Revenue Recognition” (“SOP 97-2”), and the EITF Issue 03-5, “Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software” (“EITF 03-5”). We generally recognize revenue when all of the following criteria have been met:

	•		Persuasive evidence of an arrangement exists,

	•		Delivery of the product or service,

	•		Fee is fixed and determinable and

	•		Collection is deemed reasonably assured.

One of the critical judgments that we make is the assessment that “collectibility is probable.” Our recognition of revenue is based on our assessment of the probability of collecting the related accounts receivable on a customer-by-customer basis. If we determine that collection is not reasonably assured, then revenue is deferred and recognized upon the receipt of cash from that arrangement.

Our revenue consists of subscription services revenue, ratable license revenue and professional services revenue.

Subscription Services Revenue:Subscription services revenue consists of fees from sales of subscriptions to our Perspective family of services and Global Roamer.

Subscription service revenue is recognized in accordance with SAB 104 and EITF 00-21.

We also enter into multiple element arrangements where sufficient objective evidence of fair value does not exist for the allocation of revenue. As a result, the elements within our subscription arrangements do not qualify for treatment as separate units of accounting.

Accordingly, we account for fees received under subscription arrangements as a single unit of accounting and recognize the entire arrangement fee as revenue either ratably over the service period, generally over twelve months, or based upon actual monthly usage.

For customers that are billed the entire amount of their subscription in advance, subscription services revenue is deferred upon invoicing and is recognized ratably over the service period, generally ranging from one to twelve months, commencing on the day service is first provided. For customers that are billed on a monthly basis, revenue is recognized monthly based upon actual service usage for the month. Regardless of when billing occurs, we recognize revenue as services are provided and defer any revenue that is unearned. WebEffective service is sold on a subscription basis or as part of a professional services engagement. We recognize revenue from the use of our WebEffective service that is sold on a subscription basis ratably over the subscription period, commencing on the day service is first provided, and such revenue is recorded as subscription services revenue. We recognize revenue from the use of our WebEffective service as part of a professional services engagement and revenue is recorded as professional services revenue.

Ratable Licenses Revenue:Ratable licenses revenue consists of fees from the sale of mobile automated test equipment, maintenance, engineering and minor consulting services associated with SITE systems. We frequently enter into multiple element arrangements with mobile customers for the sale of our automated test equipment, including both hardware and software licenses, consulting services to configure the hardware and software (implementation or integration services), post contract support (maintenance) services, training services and other minor consulting services. These multiple element arrangements are within the scope of SOP 97-2, and EITF 03-5. This determination is based on the hardware component of our multiple element arrangements being deemed to be a software related element. In addition, customers only purchase the software and hardware as a package, with payments due upon delivery of this hardware and software package.

None of the Keynote SIGOS implementation/integration services provided by us are 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 (generally within two to three months) compared to the length of the arrangement which typically ranges from twelve to thirty-six months. Additionally, the implementation/integration services are general in nature and we have a history of successfully gaining customer acceptance.

We cannot allocate the arrangement consideration to the multiple elements based on the vendor specific objective evidence (“VSOE”) of fair value since sufficient evidence of VSOE does not exist for the undelivered elements of the arrangement, typically maintenance. Therefore, we recognize 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. Where acceptance provisions exist in the arrangement, the ratable recognition of revenue begins when evidence of customer acceptance of the software and hardware has occurred as intended under the respective arrangement’s contractual terms.

Professional Services Revenue:Professional services revenue consists of fees generated from our LoadPro, CEM and professional consulting services that are purchased as part of a professional service project. Revenue from these services is recognized as the services are performed, typically over a period of one to three months. For professional service projects that contain milestones, we recognize revenue once the services or milestones have been delivered, based on input measures. Payment occurs either up-front or over time.

We also enter into multiple element arrangements that generally consist of either: 1) the combination of subscription and professional services or 2) multiple professional services. For these arrangements, we recognize revenue in accordance with EITF 00-21. We allocate and defer revenue for the undelivered items based on objective evidence of fair value of the undelivered elements and recognize the difference between the total arrangement fee and the amount deferred for the undelivered items as revenue. When sufficient objective evidence of fair value does not exist for undelivered items when subscription and professional services are combined, the entire arrangement fee is recognized ratably over the applicable performance period.

Deferred Revenue:Deferred revenue is comprised of all unearned revenue that has been collected in advance, primarily unearned license and subscription services revenue, and is recorded as deferred revenue on the balance sheet until the revenue is earned. The addback of unpaid deferred revenue may change at any point in time as it is based upon the timing of when invoices are collected and whether there is any unpaid deferred revenue associated with such accounts receivable. 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, which primarily consists of Keynote SIGOS revenue, represents the unearned revenue that will be earned after twelve months of the balance sheet date.

We generally do not grant refunds. All discounts granted reduce revenue. Free trials are occasionally provided to prospective customers who would like to try certain of our Perspective and other subscription services before they commit to purchasing the

services. The services provided during the trial period are typically stand-alone transactions and are not bundled with other services. Revenue is not recognized for these free trial periods.

The table below represents the balances of gross deferred revenue (short-term and long-term aggregated) as of December 31, 2008 and September 30, 2008. Unpaid deferred revenue that has an associated accounts receivable balance as of the balance sheet dates is added back to net deferred revenue, resulting in gross deferred revenue. The amount of unpaid deferred revenue may change at any point in time as it is based upon the timing of when invoices are collected and whether there is any unpaid deferred revenue associated with such accounts receivable.


	Domestic		International		Total
Net deferred revenue	$	5,658	$	14,168	$	19,826
Addback: unpaid deferred revenue		2,693		5,033		7,726

Gross deferred revenue at December 31, 2008	$	8,351	$	19,201	$	27,552


Net deferred revenue	$	5,982	$	13,951	$	19,933
Addback: unpaid deferred revenue		2,425		2,331		4,756

Gross deferred revenue at September 30, 2008	$	8,407	$	16,282	$	24,689

Allowance for Doubtful Accounts and Billing Allowance

Accounts receivable are recorded net of an allowance for doubtful accounts receivable and billing allowance and unpaid deferred revenue to the extent that there is any associated accounts receivable balance.

Our allowance for doubtful accounts is determined based on historical trends, experience and current market and industry conditions. We regularly review the adequacy of our accounts receivable allowance after considering the age of each invoice of the accounts receivable aging, each customer’s expected ability to pay and our collection history with each customer. We review invoices greater than 60 days past due to determine whether an allowance is appropriate based on the receivable balance. In addition, we maintain a reserve for all other invoices, which is calculated by applying a percentage, based on historical collection trends, to the outstanding accounts receivable balance as well as specifically identified accounts that are deemed uncollectible.

Billing allowance represents the reserve for potential billing adjustments that are recorded as a reduction of revenue and represents a percentage of revenue based on historical trends and experience. The allowance for doubtful accounts and billing allowance represent management’s best estimate, but changes in circumstances relating to accounts receivable and billing adjustments, including unforeseen declines in market conditions and collection rates and the number of billing adjustments, may result in additional allowances in the future or reductions in allowances due to future recoveries or trends.

Inventories and Inventory Valuation

Inventories related to SIGOS SITE systems were approximately $1.2 million as of December 31, 2008, and relate to direct costs associated with finished goods hardware. Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market. Market is based on estimated replacement value. Determining market value of inventories involves numerous judgments, including average selling prices and sales volumes of future periods. We primarily utilize current selling prices for measuring any potential declines in market value below cost. Any adjustment for market value is charged to direct cost of ratable licenses at the point of market value decline.

We evaluate our ending inventories for excess quantities and obsolescence on a quarterly basis. This evaluation includes analysis of historical and forecasted sales of our product. Inventories on hand in excess of forecasted demand are provided for. In addition, we write off inventories that are considered obsolete. Obsolescence is determined from several factors, including competitiveness of product offerings, market conditions, and product life cycles.

Our inventories include mainly computer hardware and mobile hardware and accessories that may be subject to technological obsolescence. Our products are sold in a competitive industry. If actual product demand or selling prices are less favorable than we estimate, we may be required to take inventory write-downs. For the three months ended December 31, 2008 and 2007, we did not experience any write-down of inventories.

Allocation of Purchase Price for Business Combinations

We are required to allocate the purchase price of acquired companies to the tangible and intangible assets acquired and liabilities assumed, as well as any in-process research and development (“IPR&D”), based on their estimated fair values. Our methodology for allocating the purchase price relating to acquisitions is usually determined based on management’s assessment in conjunction with valuations performed by an independent third party. Such a valuation requires making significant estimates and assumptions, especially with respect to intangible assets. Critical estimates in valuing certain intangible assets include, but are not limited to, future expected cash flows from customer contracts, customer lists and acquired developed technologies, expected costs to develop IPR&D into commercially viable products and estimating cash flows from projects when completed and discount rates. Estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Other estimates such as accruals associated with the accounting for acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed.

Goodwill, Identifiable Intangible Assets and Long-Lived Assets — Impairment Assessments

Goodwill is measured as the excess of the cost of acquisition over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed.

We evaluate our identifiable goodwill for impairment on an annual basis, and whenever events or changes in circumstances indicate that the carrying value of an asset may not be fully recoverable for our single reporting unit. In addition we evaluate our intangible assets and other long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Factors we consider important which could trigger an impairment review include the following:

	•		significant changes in the manner of our use of the acquired assets or the strategy of our overall business;

	•		significant negative industry or economic trends;

	•		significant decline in our stock price for a sustained period; and

	•		our market capitalization relative to net book value.

Management continually applies its judgment when performing these evaluations to determine the timing of the testing, the undiscounted net cash flows used to assess recoverability of the intangible assets and the fair value of the asset group.

We performed an annual goodwill and long lived assets impairment review during the fourth quarter in fiscal 2006, 2007, and 2008. We did not record an impairment charge based on our reviews. The goodwill recorded on the condensed consolidated balance sheet as of December 31, 2008 was approximately $64.2 million as compared to $64.4 million as of September 30, 2008.

Given the continuing deterioration of economic conditions, we evaluated if there were any trigger events that would indicate an interim impairment analysis of our goodwill balances during the three months ended December 31, 2008 is necessary. Goodwill is tested for impairment on an annual basis and between annual tests if indicators of potential impairment exist. There was a decline in the market capitalization of our company, as well as comparable companies, during the quarter ended December 31, 2008. We concluded that there were no triggering events as of December 31, 2008 which would require a formal impairment analysis of the carrying value of goodwill. We believe that the recent decline in our market capitalization is not due to any fundamental change or adverse events in our company’s operations. Accordingly, we have not recognized any impairment of goodwill in the accompanying condensed consolidated financial statements. We will continue to monitor our economic situation and the need to perform an impairment analysis in light of recent macro-economic indications in the equity markets as well as recent volatility and downward pressure on our market capitalization. To the extent we conclude that there are any indicators of impairment prior to the date of the next annual goodwill impairment test on September 30, 2009, we will perform an impairment analysis under SFAS No. 142, “Goodwill and Other Intangible Assets,” and could record an impairment charge to write down goodwill to its fair value. If the results of that impairment testing confirm that a write down of goodwill is necessary, then we will record an associated charge. Any such charge could be significant and accordingly, would have a material impact on our financial position and results of operations, but would not be expected to have a material adverse effect on our cash flows from operations.

If future events or circumstances indicate that an impairment assessment is required on intangible or long-lived assets and an asset group is determined to be impaired, our financial results could be materially and adversely impacted in future periods.

Stock-Based Compensation

We issue stock options to our employees and outside directors and provide our employees the right to purchase common stock under employee stock purchase plans. Since October 1, 2005, we account for stock-based compensation in accordance with SFAS 123R. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the

fair value of the award and is recognized as expense over the service (vesting) period. The value of an option is estimated using the Black-Scholes option valuation model which requires the input of highly subjective assumptions. A change in our assumptions could materially affect the fair value estimate, and thus, the total calculated costs associated with the grant of stock options or the issue of stock under employee stock purchase plans. If actual forfeiture rates differ significantly from these estimates, stock-based compensation expense and our results of operations could be materially impacted. See Note 1 to the Notes to Condensed Consolidated Financial Statements for more detail.

Income Taxes, Deferred Income Tax Assets and Deferred Income Tax Liabilities

We are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax liabilities, including the impact, if any, of additional taxes resulting from tax examinations together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that our deferred tax assets will be recoverable from future taxable income and, to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase the valuation allowance in a period, our deferred tax expense increases. If a valuation allowance is decreased, deferred tax expense may be reduced, goodwill may be reduced, or paid in capital may be increased, depending on the nature and source of the deferred tax assets. This analysis is applied on a jurisdiction by jurisdiction basis.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against our net deferred tax assets. Tax exposures can involve complex issues and may require an extended period to resolve. Tax planning strategies may be implemented which would affect the tax rate. Changes in the geographic mix or estimated level of annual income before taxes can affect the overall effective tax rate. We perform an analysis of our effective tax rate and we assess the need for a valuation allowance against our deferred tax assets quarterly.

The uncertainties which could affect the realization of our deferred tax assets include various factors such as the amount of deductions for tax purposes related to our stock options, potential successful challenges to the deferred tax assets by taxing authorities, and a mismatch of the period during which the type of taxable income and the deferred tax assets are realized or a mismatch in the tax jurisdiction in which taxable income is generated and the company with the deferred tax assets.

As of October 1, 2007, we adopted Financial Accounting Standards Board’s Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109” (“FIN 48”) to account for uncertain tax positions. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The evaluation of a tax position in accordance with FIN 48 is a two-step process. The first step is recognition: we determine whether it is “more-likely-than-not” that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the “more-likely-than-not” recognition threshold, we presume that the position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information. The second step is measurement: A tax position that meets the “more-likely-than-not” recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely to be realized upon ultimate settlement.

We establish liabilities or reserves when we believe that certain tax positions are not probable of being sustained if challenged, despite our belief that our tax returns are fully supportable. We evaluate these tax reserves and related interest each quarter and adjust the reserves in light of changing facts and circumstances regarding the probability of realizing tax benefits, such as the progress of a tax audit or the expiration of a statute of limitations. We believe that our tax positions comply with applicable tax laws and that we have adequately provided for known material tax contingencies; however, due to the inherent complexity and uncertainty relating to tax matters, including the likelihood and potential outcome of any tax audits, management is not able to estimate the range of reasonably possible losses in excess of amounts recorded.

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
	December 31,
	2008			2007
Net revenue:
Subscription services		55.6	%		61.3	%
Ratable licenses		29.3	%		22.6	%
Professional services		15.1	%		16.1	%

Total revenue, net		100.0	%		100.0	%

Costs and expenses:
Costs of revenue:
Direct costs of subscription services		10.9	%		11.9	%
Direct costs of ratable licenses		7.2	%		9.0	%
Direct costs of professional services		8.1	%		10.2	%
Operations		10.5	%		11.3	%
Development		14.9	%		17.7	%
Amortization of intangible assets — software		1.4	%		1.2	%
Sales and marketing		29.9	%		32.6	%
General and administrative		13.7	%		14.0	%
Excess occupancy income		(1.0	%)		(1.6	%)
Amortization of intangible assets — other		1.3	%		3.0	%

Total costs and expenses		96.9	%		109.3	%

Income (loss) from operations		3.1	%		(9.3	%)

Interest income and other, net		3.3	%		6.5	%


Income (loss) before provision for income taxes		6.3	%		(2.8	%)

Provision for income taxes		(2.0	%)		(1.4	%)


Net income (loss)		4.3	%		(4.2	%)

Comparison of the Quarters Ended December 31, 2008 and 2007

Our net income increased by approximately $1.6 million, from a net loss of $744,000 for the three months ended December 31, 2007 to net income of $886,000 for the three months ended December 31, 2008. The increase was mainly attributable to the increase of approximately $2.9 million, or 16%, in total net revenue with approximately $2.0 million attributable to increases in our ratable licenses revenue as a result of our SIGOS products and services. Other factors impacting net income include:

	•		Increase of $634,000, or 3%, in total costs and expenses, from approximately $19.4 million for the three months ended December 31, 2007 to approximately $20.0 million for the three months ended December 31, 2008. Of the increase, $413,000 was attributable to increased investment in our sales force primarily related to additional personnel from 89 at the beginning of the first quarter of fiscal 2008 to 98 at the end of the first quarter of fiscal 2009. $153,000 was attributable to higher professional fees in general and administration expenses related to the fiscal year 2008 annual audit. The remaining increase in total costs and expenses was attributable to three additional headcount in general and administration.

	•		Decrease in net interest income and other of $477,000 due to reduction in interest income attributable to lower cash balances during the three months ended December 31, 2008 as compared to December 31, 2007.

Net Revenue


	2008		2007		% Change
	(In thousands)
For the three months ended December 31:
Subscription services	$	11,473	$	10,872		6	%
Ratable licenses		6,043		4,002		51	%
Professional services		3,121		2,846		10	%

Total revenue, net	$	20,637	$	17,720		16	%

Subscription Services. Net revenue from subscription services increased by $601,000 for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007. The increase in subscription services net revenue for the three months ended December 31, 2008 was mainly attributable to increased sales of our multiple page/broadband subscription services of approximately $1.3 million and Global Roamer services of $427,000, offset by a decrease in our single-page device subscription services of approximately $1.1 million. We have reduced our single-page/single device subscriptions revenue to less than 5% of Internet subscription revenue.

Ratable Licenses.Net revenue from ratable licenses increased by approximately $2.0 million for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007. The increase in ratable licenses net revenue for the three months ended December 31, 2008 was mainly attributable to revenue growth from the sale of new SIGOS SITE systems. Net revenue from these sales is being recognized in revenue over the maintenance period for each contract which is typically twelve to thirty-six months. We expect revenue growth for ratable licenses will be much less than experienced in the past. This is primarily attributable to the amount of revenue being recognized from prior periods normalizing with new sales contracts that will be amortized over twelve to thirty-six months as well as the weakening of the dollar against the Euro in the future compared to prior quarters.

Professional Services. Net revenue from professional services increased by $275,000 for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007. The increase in professional services net revenue for the three months ended December 31, 2008 was mainly attributable to increased contributions from our professional consulting engagements, namely load testing engagements, related to preparing websites for the holiday shopping season.

In addition to analyzing revenue for subscription services and professional services, management also internally analyzes revenue categorized as Internet Test and Measurement (“Internet”) and Mobile Test and Measurement (“Mobile”).

The following table identifies which services are categorized as Internet and Mobile services and where they are recorded in our condensed consolidated statements of operations.

Subscription

Ratable

Professional

Services

Licenses

Services

Internet Test and Measurement:

Application Perspective

Diagnostic Services

Enterprise Adapters

LoadPro

NetMechanic

Professional Services

Red Alert

Streaming Perspective

Test Perspective

Transaction Perspective

Web Site Perspective

Voice Perspective

Performance Scoreboard

WebEffective

Financial Industry Scorecards

Mobile Test and Measurement:

Mobile Device Perspective

Mobile Application Perspective

SIGOS SITE

SIGOS Global Roamer

The following table summarizes Internet and Mobile services net revenue (in thousands):



	2008		2007		% Change
	(In thousands)
For the Three Months Ended December 31,
Internet Subscriptions	$	9,664	$	9,532		1	%
Internet Engagements		3,121		2,846		10	%

Total Internet net revenue		12,785		12,372		3	%


Mobile Subscription		1,809		1,340		35	%
Mobile Ratable Licenses		6,043		4,002		51	%

Total Mobile net revenue		7,852		5,342		47	%

Total net revenue	$	20,637	$	17,720		16	%

Internet net revenue increased by $413,000 for the three months ended December 31, 2008 compared to three months ended December 31, 2007. Internet net revenue represented 62% and 70% of total net revenue for the three months ended December 31, 2008 and 2007, respectively. The increase in Internet net revenue in absolute dollars for the three months ended December 31, 2008 was mainly attributable to an increased contribution of approximately $1.3 million from our multiple-page/broadband services and $396,000 from our professional consulting engagements which consist of our load testing, VoIP, enterprise solutions and customer experience engagements, primarily related to preparing websites for the holiday shopping season. The increase in total Internet net revenue was offset by the decline of approximately $1.1 million from our single-page/single device subscriptions.

Mobile net revenue increased by approximately $2.5 million for the three months ended December 31, 2008 compared to the three months ended December 31, 2007. Mobile net revenue represented 38% and 30% of total net revenue for the three months ended December 31, 2008 and 2007, respectively. The increase for the three months ended December 31, 2008 was mainly attributable to revenue growth from the sale of new SIGOS SITE systems and existing customers renewing maintenance agreements. In addition, to a lesser extent, the increase in mobile net revenue was attributable to $427,000 of increased contribution from our Global Roamer subscription services.

For the three months ended December 31, 2008, no single customer accounted for more than 10% of total net revenue. For the three months ended December 31, 2007, one customer accounted for approximately 11% of total net revenue. As of December 31, 2008, one customer accounted for 10% of total accounts receivable. As of September 30, 2008, no single customer accounted for 10% or more of total accounts receivable. International sales were approximately 42% and 36% of total net revenue for the three months ended December 31, 2008 and 2007, respectively.

Expenses:

Direct Costs of Subscription Services, Ratable Licenses and Professional Services


	2008		2007		% Change
	(In thousands)
For the three months ended December 31:
Direct costs of subscription services	$	2,256	$	2,111		7	%
Direct costs of ratable licenses	$	1,488	$	1,603		(7	)%
Direct costs of professional services	$	1,678	$	1,805		(7	)%

Direct Costs of Subscription Services. Direct costs of subscription services consist of connection fees to major telecommunication and internet access providers for bandwidth usage of our measurement computers, which are located around the world and depreciation, maintenance and other equipment charges for our measurement and data collection infrastructure and Global Roamer services. Direct costs of subscription services increased by $145,000 for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007 and represented 20% and 19% of subscription services net revenue for the three months ended December 31, 2008 and 2007, respectively. The increase was mainly attributable to the increase in bandwidth and connection fees related to our multi-page measurements. We do not anticipate that direct costs of subscription services for the second quarter of fiscal 2009 will change significantly in absolute dollars compared to the first quarter of fiscal 2009.

Direct Costs of Ratable Licenses.Direct costs of ratable licenses include cost of materials, supplies, maintenance, support personnel related costs and consulting costs related to the sale of our SIGOS SITE systems. Direct costs of ratable licenses decreased by $115,000 for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007 and represented

25% and 40% of ratable licenses net revenue for the three months ended December 31, 2008 and 2007, respectively. The cost of the test equipment as part of each new customer contract is expensed ratably over the same initial twelve to thirty-six month period as the revenue to which it is associated. The decreases in direct costs of ratable licenses in absolute dollars and as a percentage of the ratable license revenue are due to the fact that there was a higher amount of revenue being recognized in the three months ended December 31, 2008 for maintenance renewals that did not have any significant associated direct costs for test equipment.

Direct Costs of Professional Services.Direct costs of professional services consist of compensation expenses and related costs for professional services personnel, external consulting expenses to deliver our professional services revenue, panel and reward costs associated with our customer experience engagements, all load-testing bandwidth costs and related network infrastructure costs. Direct costs of professional services decreased by $127,000 for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007, and represented 54% and 63% of professional services revenue for the three months ended December 31, 2008 and 2007, respectively. The decrease in costs of professional services for the three months ended December 31, 2008 was primarily due to lower personnel related costs associated with our customer experience management services due to stringent cost containment. We do not anticipate that direct costs of professional services for the second quarter of fiscal 2009 will change significantly in absolute dollars compared to the first quarter of fiscal 2009.

Development


	2008		2007		% Change
	(In thousands)
For the three months ended December 31:
Development	$	3,083	$	3,133		(2	)%

Development expenses consist primarily of personnel related costs, external contractors and other costs associated with the development of our products and services. Development expenses decreased by $50,000 for the three months ended December 31, 2008 compared to the three months ended December 31, 2007. The decrease in development costs for the three months ended December 31, 2008 was primarily due to lower consulting costs. During the three months ended December 31, 2008, all internal development expenses have been expensed as incurred. We do not anticipate that development expenses for the second quarter of fiscal 2009 will change significantly in absolute dollars compared to the first quarter of fiscal 2009.

Operations


	2008		2007		% Change
	(In thousands)
For the three months ended December 31:
Operations	$	2,162	$	2,003		8	%

Operations expenses consist primarily of compensation and related expenses for management and technical support personnel who manage and maintain our field measurement and collection infrastructure and headquarters data center, and provide basic and extended customer support. Our operations personnel also work closely with other departments to assure the reliability of our services. Our operations expenses increased by $159,000 for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007. The increase in operations expenses for the three months ended December 31, 2008 was primarily attributable to costs associated with our new data center that was completed in the third quarter of fiscal year 2008. We do not anticipate that operations expenses for the second quarter of fiscal 2009 will change significantly in absolute dollars compared to the first quarter of fiscal 2009.

Sales and Marketing


	2008		2007		% Change
	(In thousands)
For the three months ended December 31:
Sales and marketing	$	6,180	$	5,767		7	%

Sales and marketing expenses consist primarily of salaries, commissions and bonuses earned by sales and marketing personnel, lead-referral fees, marketing programs and travel expenses. Our sales and marketing expenses increased by approximately $413,000 for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007. The increase in sales and marketing costs for the three months ended December 31, 2008 was mainly attributable to our continued investment in our sales and

marketing, primarily related to additional personnel from 89 at the beginning of the first quarter of fiscal 2008 to 98 at the end of the first quarter of fiscal 2009. We do not anticipate that sales and marketing expenses for the second quarter of fiscal 2009 will change significantly in absolute dollars compared to the first quarter of fiscal 2009.

General and Administrative


	2008		2007		% Change
	(In thousands)
For the three months ended December 31:
General and administrative	$	2,820	$	2,487		13	%

General and administrative expenses consist primarily of compensation and related costs, accounting, legal and administrative expenses, insurance, professional service fees and other general corporate expenses. General and administrative expenses increased $333,000 for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007. The increase in general and administrative expenses are primarily attributable a $153,000 increase in professional fees related to our fiscal 2008 annual audit and a $88,000 increase related to three additional headcount. We believe that general and administrative expenses for the second quarter of fiscal 2009 will decrease in absolute dollars compared to the first quarter of fiscal 2009 due to decreased costs in professional fees in the second quarter of fiscal 2009.

Excess Occupancy Income


	2008			2007			% Change
	(In thousands)
For the three months ended December 31:
Rental income	$	(627	)	$	(607	)		3	%
Rental and other expenses		407			326			25	%

Excess occupancy income	$	(220	)	$	(281	)		(22	)%

Excess occupancy income consists of rental income from the leasing of space not occupied by us in our headquarters building, net of related fixed costs, such as property taxes, insurance, building depreciation, leasing broker fees and tenant improvement amortization. The costs are based on the actual square footage available for lease to third parties, which was approximately 75% and 60% for the three months ended December 31, 2008 and 2007, respectively. The decrease in excess occupancy income for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007 was primarily due to the net increase in expenses related to depreciation, property taxes and insurance. We expect the excess occupancy income will be approximately the same in the second quarter, as the first quarter, of fiscal 2009.

Amortization of Identifiable Intangible Assets


	2008		2007		% Change
	(In thousands)
For the three months ended December 31:
Amortization of identifiable intangible assets — software	$	288	$	205		40	%
Amortization of identifiable intangible assets — other		269		537		(50	)%

Total amortization of identifiable intangible assets	$	557	$	742		(25	)%

Total amortization of identifiable intangible assets decreased by $185,000 for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007. The decrease in total amortization is due to certain intangibles becoming fully amortized in the second half of fiscal 2008, offset by increase in amortization associated with intangible assets purchased in the Zandan acquisition that occurred in April 2008. Amortization of intangible assets — software mainly relates to our Keynote SIGOS developed technology related to our SIGOS SITE system and, to a lesser extent, to Zandan’s developed technology related to mobile, and is reflected in direct costs of revenue in our condensed consolidated statements of operations.

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. At December 31, 2008, we had a remaining balance of approximately $7.8 million of identifiable intangible assets that are being amortized over a three to six and one half-year expected life. We expect the amortization

of identifiable intangible assets to be approximately $702,000 for the second quarter of fiscal 2009, assuming no additional acquisitions or impairment charges. We expect the remaining carrying value of the identifiable intangible assets as of December 31, 2008, as listed in the table below, will be fully amortized by September 2012 (in thousands):


	Technology		Technology
	Based -		Based -		Customer
	Software		Other		Based		Trademark		Covenant		Backlog		Total
Net carrying value at December 31, 2008	$	5,829	$	62	$	1,050	$	809	$	21	$	63	$	7,834

Interest Income and Other Income (Expenses)


	2008		2007			% Change
	(In thousands)
For the three months ended December 31:
Interest income	$	334	$	1,285			(74	)%
Other income (expenses)		339		(135	)		351	%

Interest income and other income (expenses), net	$	673	$	1,150			(41	)%

Interest income and other income (expenses), net decreased by $477,000 for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007. The decrease was mainly due to lower interest income earned on lower balance of invested cash and cash equivalents. The decrease in interest income was offset partially by a foreign exchange gain associated with remeasurements of foreign currency transactions. We expect that interest income and other income (expenses), net, for the second quarter of fiscal 2009 will be approximately $300,000, absent any additional transactions, and assuming no material changes in interest rates, foreign exchange rate, and currently planned use of cash.

Provision for Income Taxes


	2008		2007		% Change
	(In thousands)
For the three months ended December 31:
Provision for income taxes	$	420	$	244		72	%

Our effective tax rate for the three months ended December 31, 2008 and 2007 was 32% and (49%), respectively. The rate for the three months ended December 31, 2008 is less than the 35 percent U.S. federal statutory rate primarily due to the relative mix of foreign and domestic earnings and the fact that a portion of the earnings are being taxed in the U.S. where we have a low effective tax rate due to utilization of valuation allowance against current year projected income. The rate for the three months ended December 31, 2007 was higher than the 35 percent U.S. federal statutory rate primarily due to the fact that we did not benefit from losses incurred in the United States.

Stock-based Compensation Expense

Stock-based compensation expense, which is included in cost of revenues and operating expenses by category, was approximately $1.0 million and approximately $1.1 million for the three months ended December 31, 2008 and 2007, respectively. Stock-based compensation expense decreased by $59,000 for the three months ended December 31, 2008 as compared to the three months ended December 31, 2007. The following table summarizes stock-based compensation related to employee stock options and employee stock purchase plan purchases under SFAS 123R which was allocated as follows:


	Three months ended December 31,
	2008		2007
	(In thousands)
Direct costs of ratable licenses	$	29	$	49
Direct costs of professional services		80		115
Development		230		230
Operations		123		145
Sales and marketing		365		327
General and administrative		214		234

Stock-based compensation expense related to stock options and employee stock purchase plan	$	1,041	$	1,100

Liquidity and Capital Resources


	December 31,		September 30,
	2008		2008
	(In thousands)
Cash, cash equivalents and short-term investments	$	50,937	$	49,331
Accounts receivable, net	$	8,528	$	7,316
Working capital	$	31,325	$	27,108
Days sales in accounts receivable (DSO) (a)		38		32


(a)		DSO is calculated as: ((ending net accounts receivable) / net revenue for the three months period) multiplied by number of days in the period

		The DSO’s presented in the table above reflect the three months ended December 31, 2008 and September 30, 2008.


	2008		2007
	(In thousands)
For the three months ended December 31
Cash provided by operating activities	$	2,020	$	330
Cash provided by investing activities	$	1,549	$	6,177
Cash provided by (used in) financing activities	$	748	$	(8,227	)

Cash, cash equivalents and short-term investments

As of December 31, 2008, we had approximately $50.8 million in cash and cash equivalents and $178,000 in short-term investments, for a total of approximately $50.9 million. Cash and cash equivalents consist of highly liquid investments held at major banks, money market mutual funds and other money market securities with original maturities of three months or less. We do not hold auction rate securities.

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. For the three months ended December 31, 2008, net cash provided by operating activities was approximately $2.0 million. Net cash provided was mainly due to net income of $886,000 adjusted for $3.2 million of non-cash adjustments to reconcile net income to net cash provided by operating activities and a $2.2 million net decrease in operating assets and liabilities. The non-cash adjustments primarily consist of depreciation, amortization and stock-based compensation expense offset by bad debt and billing adjustment reserves. The net decrease in operating assets and liabilities was primarily due to an increase in accounts receivable of $1.4 million, and a decrease in accounts payable and accrued expenses of $785,000. The increase in accounts receivable during the first quarter of fiscal 2009 was mainly related to higher DSO for the period as evidenced by our higher DSO of 38 days for the first quarter of fiscal 2009 as compared to 32 days for the quarter ended September 30, 2008. The change in accounts payable and accrued expenses during the first quarter of fiscal 2009 was mainly related to timing of payments of legal and audit services related to regulatory compliance and the timing of when payments are made.

Cash provided by investing activities

The changes in cash flows from investing activities primarily relate to the timing of purchases and maturities of investments and acquisitions. We also use cash to invest in capital and other assets to support our growth and infrastructure. For the three months ended December 31, 2008, net cash provided by our investing activities was approximately $1.5 million. We received $2.4 million of cash from the net sales of short-term investments. We also utilized $661,000 to purchase property and equipment, primarily for our production infrastructure and information systems, and tenant improvements associated with space that we have leased in our headquarters building.

Cash provided by financing activities

The changes in cash flows from financing activities primarily relate to payments made for stock repurchases and proceeds received from the issuance of common stock associated with our employee stock option plan and employee stock purchase plan. For the three months ended December 31, 2008, net cash provided by financing activities was $748,000, which was primarily due to proceeds from the issuance of common stock and the exercise of stock options of $752,000.

Commitments

As of December 31, 2008, our principal commitments consisted of approximately $4.1 million in real property operating leases and equipment capital and operating leases, with various lease terms, the longest of which expires in October 2017. Additionally, we had contingent commitments ranging in length from one to twenty-eight months to bandwidth and collocation providers amounting to $1.7 million, which commitments 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 invest in capital and other assets to support our growth.

As of December 31, 2008, we have outstanding guarantees totaling $174,000 in one of our foreign subsidiaries, to customers and vendors as a form of security. The guarantees can only be executed upon agreement by both the customer or vendor and us. The guarantees are secured by a unsecured line of credit of $1.4 million as of December 31, 2008.

We believe that our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. Factors that could affect our cash position include potential acquisitions, additional stock repurchases, decreases in customers or renewals, decreases in revenue or changes in the value of our short-term investments. If, after some period of time, 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 term 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 risk or credit risk support to us.

Recently Issued Accounting Pronouncements

In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (“SFAS No. 141R”), which replaces FASB Statement No. 141. SFAS No. 141R establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed any non controlling interest in the acquiree and the goodwill acquired. The Statement also establishes disclosure requirements which will enable users to evaluate the nature and financial effects of the business combination. SFAS No. 141R is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, which will be our fiscal year beginning October 1, 2009. We are currently evaluating the potential impact, if any, of the adoption of SFAS No. 141R on our consolidated financial position, results of operations and cash flows.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of Accounting Research Bulletin No. 51” (“SFAS No. 160”), which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. The Statement also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. SFAS No. 160 is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, which will be our fiscal year beginning October 1, 2009. We are currently evaluating the potential impact, if any, of the adoption of SFAS No. 160 on our consolidated financial position, results of operations and cash flows.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS No. 161”). SFAS No. 161 enhances financial disclosure by requiring that objectives for using derivative instruments be described in terms of underlying risk and accounting designation in the form of tabular presentation, requiring transparency with respect to the entity’s liquidity from using derivatives, and cross-referencing an entity’s derivative information within its financial footnotes. SFAS No. 161 is effective for financial statements issued for fiscal years beginning after November 15, 2008. We are currently evaluating the impact, if any, that SFAS No. 161 may have on our consolidated financial position, results of operations and cash flows.

In April 2008, the FASB released FASB Staff Position 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP No. 142-3”), which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets”. The intent of the statement is to improve the consistency between the useful life of a recognized intangible asset under Statement 142 and the period of expected cash flows used to measure the fair value of the asset under FASB Statement No. 141 (revised 2007) and other U.S. generally accepted accounting principles. FSP No. 142-3 is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, which will be our fiscal year beginning October 1, 2009. We are currently evaluating the potential impact, if any, of the adoption of FSP No. 142-3 on our consolidated financial position, results of operations and cash flows.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles” (“SFAS No. 162”). SFAS No. 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with accounting principles generally accepted in the United States of America for nongovernmental entities. SFAS No. 162 is effective beginning November 15, 2008. Any effect of applying the provisions of SFAS No. 162 is to be reported as a change in accounting principle in accordance with SFAS No. 154, “Accounting Changes and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3.” The adoption of SFAS No. 162 had no effect on our condensed consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risks

Interest Rate Sensitivity.Our interest income and expense is sensitive to changes in the general level of U.S. interest rates, particularly because most of our cash, cash equivalents and short-term investments are invested in short-term debt instruments. If market interest rates were to change immediately and uniformly by ten percent (10%) from levels at December 31, 2008, the interest earned on those cash, cash equivalents, and short-term investments could increase or decrease by approximately $33,000 on an annualized basis.

Foreign Currency Fluctuations.A majority of our revenue and expenses are transacted in U.S. dollars. However, we do enter into transactions in other currencies, primarily the Euro and British Pound. We operate internationally and are exposed to potentially adverse movements in foreign currency rate changes. Revenue derived from customers outside of the United States, which are billed from our headquarters, in San Mateo, CA, and have the U.S. dollar as the functional currency is collected in foreign currencies. Revenue derived from customers outside of the United States, which are billed from our Nuremberg, Germany office are typically billed in Euros. Similarly, substantially all of the expenses of operating our international subsidiaries are incurred in foreign currencies. As a result, our U.S. dollar earnings and net cash flows from international operations may be adversely affected by changes in foreign currency exchange rates. Net foreign exchange transaction gains (losses) included in “Interest and Other Expenses” in the accompanying condensed consolidated statements of operations, primarily due to fluctuations in the Euro and the British Pound, totaled $310,000 and ($134,000) for the three months ended December 31, 2008 and 2007, respectively.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Based on an evaluation under the supervision and with the participation of the Company’s management, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures as defined in

Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“Exchange Act”) were effective as of December 31, 2008 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission rules and forms and (ii) accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting during the first quarter of fiscal 2009, which were identified in connection with management’s evaluation required by paragraph (d) of Rules 13a-15 and 15d-15 under the Exchange Act, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

In August 2001, we and certain of our current and former officers were named as defendants in two securities class-action lawsuits based on alleged errors and omissions concerning underwriting terms in the prospectus for our initial public offering. A Consolidated Amended Class Action Complaint for Violation of the Federal Securities Laws (“Consolidated Complaint”) was filed on or about April 19, 2002, and alleged claims against us, certain of its officers, and underwriters of our September 24, 1999 initial public offering (“underwriter defendants”), under Sections 11 and 15 of the Securities Act of 1933, as amended, and under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The lawsuit alleged that the defendants participated in a scheme to inflate the price of our stock in its initial public offering and in the aftermarket through a series of misstatements and omissions associated with the offering. The lawsuit is one of several hundred similar cases pending in the Southern District of New York that have been consolidated by the court.

We are a party to a global settlement with the plaintiffs that would have disposed of all claims against it with no admission of wrongdoing by us or any of its present or former officers or directors. The settlement agreement had been preliminarily approved by the Court. However, while the settlement was awaiting final approval by the District Court, in December 2006 the Court of Appeals reversed the District Court’s determination that six focus cases could be certified as class actions. In April 2007, the Court of Appeals denied plaintiffs’ petition for rehearing, but acknowledged that the District Court might certify a more limited class. At a June 26, 2007 status conference, the Court approved a stipulation withdrawing the proposed settlement. On August 14, 2007, plaintiffs filed amended complaints in the focus cases, and a motion for class certification in the focus cases on September 27, 2007. On November 13, 2007, defendants in the focus cases filed a motion to dismiss the amended complaints for failure to state a claim, which the District Court denied on March 2008. Plaintiffs, the issuer defendants (including us), the underwriter defendants, and the insurance carriers for the defendants, have engaged in mediation and settlement negotiations. The parties have reached a settlement agreement in principle. As part of this tentative settlement, our insurance carrier has agreed to assume our entire payment obligation under the terms of the settlement. Although the parties have reached a tentative settlement agreement, there can be no guarantee that it will be finalized or receive approval from the District Court. We believe that we have meritorious defenses to these claims. If the tentative settlement is not implemented and the litigation continues against us, we would continue to defend against this action vigorously.

In addition, in October 2007, a lawsuit was filed in the United States District Court for the Western District of Washington by Vanessa Simmonds, captionedSimmonds v. JPMorgan Chase & Co., et al., No. 07-1634, alleging 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 seeks disgorgement to us of profits from the underwriters in amounts to be proven at trial. On February 28, 2008, Ms. Simmonds filed an amended complaint. The suit names us as a nominal defendant, contains no claims against us, and seeks no relief from us. This lawsuit is 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. The parties entered into a stipulation, entered as an order by the Court, that we are not required to answer or otherwise respond to the amended complaint. Accordingly, we did not join the motion to dismiss filed by certain issuers. There was a hearing on the motions to dismiss on January 16, 2009, but the court has yet to rule on either motions. No amount has been accrued as of December 31, 2008 and September 30, 2008 since our liability, if any, is not probable and cannot be reasonably estimated.

We are 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 will have a material adverse effect on our consolidated financial position, results of operations, or cash flows.

Item 1A. Risk Factors

We have incurred in the past and may, in the future, incur losses, and we may not sustain profitability.

We may not be able to sustain GAAP profitability in the future. We have incurred net losses on a GAAP basis in each of our last three fiscal years. As of December 31, 2008, we had an accumulated deficit of approximately $142.3 million. In addition, we are required under generally accepted accounting principles to review our goodwill and identifiable intangible assets for impairment when events or circumstances indicate that the carrying value may not be recoverable. As of December 31, 2008, we had approximately $7.8 million of net identifiable intangible assets and approximately $64.2 million of goodwill. We have in the past and may in the future, incur expenses in connection with a write-down of goodwill and identifiable intangible assets due to changes in market conditions. During the three months ended December 31, 2008, we did not incur any impairment charges. In addition, we have deferred tax assets which may not be fully realized, which may contribute to additional losses. We are also required to record as compensation expense in accordance with SFAS No. 123R “Share Based Payment”, the cost of stock-based awards. As a result, we may not be able to sustain profitability.

The success of our business depends on customers renewing their subscriptions for our services and purchasing additional services as well as obtaining new customers.

To maintain and grow our revenue, we must achieve and maintain high customer renewal rates for our Internet and Mobile services. Our customers have no obligation to renew our products and services after the term and therefore, they could cease using our services at any time. In addition, our customers may renew for fewer services or at lower prices. Further, our customers may reduce their use of our services during the term of their subscription. We cannot project the level of renewal rates or the prices at which customers renew subscriptions. Our customer renewal rates and renewal prices may decline as a result of a number of factors, including competition, consolidations in the Internet or mobile industries or if a significant number of our customers cease operations.

Further, we depend on sales of Mobile products and services to new and existing customers and sales of additional services to our existing customers. Renewals by existing customers or purchases of our services by new customers may be limited as companies limit or reduce their technology spending in response to the significant global economic downturn. We could experience reduced spending, cancellations, non-renewals and/or reductions in service levels. If we experience reduced renewal rates or if customers renew for a lesser amount of our services, or if customers, at any time, reduce the amount of products or services they purchase from us for any reason, our revenue could decline unless we are able to obtain additional customers or sources of revenue, sufficient to replace lost revenue.

Our business could be harmed by adverse economic conditions or reduced spending on information technology.

Our operations and performance depend significantly on worldwide economic conditions. Uncertainty about current global economic conditions poses a risk as consumers and businesses may postpone spending in response to tighter credit, negative financial news and/or declines in income or asset values, which could have a material negative effect on the demand for our products and services. Other factors that could influence demand include labor and healthcare costs, access to credit, consumer confidence, and other macroeconomic factors affecting spending behavior. These and other economic factors could have a material adverse effect on demand for our products and services. The decrease in consumer demand could have a variety of negative effects on our financial results, and in certain cases, may reduce our revenue, increase our costs, and lower our gross margin percentage, or require us to recognize impairments of our assets. Our results could also differ materially from our expectations since our international sales and expenses will be affected by the effects of the strength of the U.S. dollar.

Our quarterly financial results are subject to significant fluctuations, and if our future results are below the expectations of investors, the price of our common stock may decline.

Our results of operations could vary significantly from quarter to quarter. If revenue or other operating results fall below our expectations, we may not be able to reduce our spending rapidly in response to the shortfall. Other factors that could affect our quarterly operating results include those described below and elsewhere in this report:

	•		Fluctuations of the foreign exchange rates used to prepare our consolidated financial statements;

	•		The rate of new and renewed subscriptions to our services;

	•		The effect of the global economic downturn on customers and partners;

	•		The effect of any unforeseen or unplanned operating expenses;

	•		The amount and timing of any reductions by our customers in their usage of our services;

	•		Our ability to increase the number of Web sites we measure and the scope of services we offer for our existing customers in a particular quarter;

	•		Our ability to attract and retain new customers in a quarter, particularly larger enterprise customers;

	•		The timing and service period of orders received during a quarter;

	•		Our ability to successfully introduce new products and services to offset any reductions in revenue from services that are not as widely used or that are experiencing decreased demand such as some of our Internet services;

	•		The level of sales of our Mobile products and services and timing of customer acceptance during the period;

	•		The timing and amount of professional services revenue, which is difficult to predict because this is dependent on the number of professional services engagements in any given period, the size of these engagements, and our ability to continue our existing engagements and secure new engagements from customers;

	•		Our ability to increase sales of each of our service lines;

	•		The timing and amount of operating costs, including sales and marketing investments, and capital expenditures;

	•		The timing and amount, if any, of impairment charges related to potential write-down of acquired assets in acquisitions or charges related to the amortization of intangible assets from acquisitions.

	•		Future accounting pronouncements and changes in accounting policies; and

	•		Future macroeconomic conditions in our domestic and international markets, as well as the level of discretionary IT spending generally.

Due to these and other factors, we believe that period-to-period comparisons of our results of operations are not meaningful and should not be relied upon as indicators of our future performance. It is possible that in some future periods, our results of operations may be below the expectations of public-market analysts and investors. If this occurs, the price of our common stock may decline.

The market price of our common stock is volatile.

The stock market in recent years has experienced significant price and volume fluctuations, and has recently experienced substantial declines and volatility that have affected the market prices of technology companies. These fluctuations have often been unrelated to or disproportionately impacted by the operating performance of these companies. The market for our common stock may be subject to similar fluctuations. Factors such as fluctuations in our operating results, announcements of events affecting other companies in the technology industry, currency fluctuations and general market conditions may cause the market price of our common stock to decline. In addition, because of the relatively low trading volume and the fact that we have 14.2 million shares outstanding at December 31, 2008, our stock price could be more volatile than companies with higher trading volumes and larger numbers of shares available for trading in the public market.

If we were required to write down all or part of our goodwill, our net income and net worth could be materially adversely affected.

We had $64.2 million of goodwill recorded on our condensed consolidated balance sheet as of December 31, 2008. Goodwill represents the excess of cost over the fair market value of net assets acquired in business combinations. If our market capitalization drops significantly below the amount of net equity recorded on our balance sheet, it could indicate a decline in the fair value of the Company and would require us to further evaluate whether our goodwill has been impaired. We also perform an annual review, at September 30, of our goodwill to determine if it has become impaired, in which case we would write down the impaired portion of our goodwill. We also evaluate goodwill for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If we were required to write down all or a significant part of our goodwill, our net earnings and net worth could be materially adversely affected.

Our operating results could be harmed if sales of Internet subscriptions decline.

Sales of our Internet subscription services, primarily our Application Perspective and Transaction Perspective services have generated a majority of our total revenue in the past. Revenue from our Web site Perspective Services, a single page, single device measurement, has been decreasing. If revenues from our Application Perspective and Transaction Perspective Services, multi page, multi device measurements, do not continue to increase, we may not be able to increase our Internet revenue and our operating results could suffer

if we are not able to increase revenue from other services. Therefore, the success of our business currently depends, and for the immediate future will continue to substantially depend on sales and renewals of these Internet services

If our Mobile services decline, we may not be able to grow our revenue and our results of operations will be harmed.

Revenue from our Mobile services has increased from approximately $5.3 million for the three months ended December 31, 2007 to approximately $7.9 million for the three months ended December 31, 2008. We also experienced increased bookings during the same period. We cannot assure you that we will continue to experience similar growth rates for this business in future periods. Future growth for these services could be adversely affected by a number of factors, including, but not limited to: the market for mobile services is an emerging market and therefore it is difficult to predict the level of demand for the types of services we offer; currency rates; adverse global economic conditions; and we may not be able to successfully compete against current or new competitors in this area. Our business and our operating results could be harmed if we are not able to continue to grow revenue from our Mobile services.

Improvements to the infrastructure of the Internet and mobile networks could reduce or eliminate demand for our Internet and Mobile services.

The demand for our services could be reduced or eliminated if future improvements to the infrastructure of the Internet or mobile networks lead companies to conclude that the measurement and evaluation of the performance of their Web sites and services is no longer important to their business. We believe that the vendors and operators that supply and manage the underlying infrastructure still look to improve the speed, availability, reliability and consistency of the Internet. If these vendors and operators succeed in significantly improving the performance of these networks, which would result in corresponding improvements in the performance of companies’ Web sites and services, demand for our services would likely decline, which would harm our operating results.

If we do not continually improve our services in response to technological changes, including changes to the Internet and mobile networks, we may encounter difficulties retaining existing customers and attracting new customers.

The ongoing evolution of the Internet and mobile networks has led to the development of new technologies such as Internet telephony, wireless devices, wireless fidelity, and WI-FI networks. These developing technologies require us to continually improve the functionality, features and reliability of our services, particularly in response to offerings of our competitors. If we do not succeed in developing and marketing new services that respond to competitive and technological developments and changing customer needs, we may encounter difficulties retaining existing customers and attracting new customers.

We must also introduce any new services as quickly as possible. The success of new services depends on several factors, including proper definition of the scope of the new services and timely completion, introduction and market acceptance of our new services. If new Internet, networking or telecommunication technologies or standards are widely adopted or if other technological changes occur, we may need to expend significant resources to adapt our services to these developments or we could lose market share or some of our services could become obsolete.

We face competition that could make it difficult for us to acquire and retain customers.

The market for our services is rapidly evolving. Our competitors vary in size and in the scope and breadth of the products and services that they offer. We face competition from companies that offer Internet software and services with features similar to our services such as Gomez, Hewlett-Packard, Segue Software (acquired by Borland Software) and a variety of other Internet and mobile companies that offer a combination of testing, market research capabilities and data. Customers could choose to use these services or these companies could enhance their services to offer all of the features we offer. As we expand the scope of our products and services, we expect to encounter many additional market-specific competitors.

In addition, Hewlett-Packard’s acquisition of Mercury Interactive, whom we had a relationship in the past, could result in additional competition for us depending on which products and services the combined company offers in the future. Furthermore, Hewlett-Packard may find additional uses for services of Mercury Interactive which compete with our services, and as a result of its acquisition of Mercury Interactive, it may not promote our services at the same level as it had in the past which could result in a decrease in our Internet revenue.

We could also face competition from other companies, which currently do not offer services similar to our services, but offer software or services related to Web analytics services, such as Webtrends, Omniture and Coremetrics, and free services that measure Web site availability. In addition, companies that sell systems Management software, such as BMC Software, CompuWare, CA-Unicenter, HP-Openview, Quest Software, Attachmate, Precise Software, and IBM’s Tivoli Unit, with some of whom we have strategic relationships, could choose to offer services similar to ours. We also face competition for our mobile services from companies such as Argogroup, Casabyte (acquired by JDS Uniphase), Agilent, Datamat and Mobile Complete.

In the future, we intend to expand our service offerings and continue to measure and manage the performance of emerging technologies such as Internet telephony, wireless devices, and wireless fidelity, or WI-FI, networks and, as a result, could face competition from other companies. Some of our existing and future competitors have or may have longer operating histories, larger customer bases, greater brand recognition in similar businesses, and significantly greater financial, marketing, technical and other resources. In addition, some of our competitors may be able to devote greater resources to marketing and promotional campaigns, to adopt more aggressive pricing policies, and to devote substantially more resources to technology and systems development.

There are also many experienced firms that offer computer network and Internet-related consulting services. These consulting services providers include consulting companies, such as Accenture, as well as consulting divisions of large technology companies such as IBM. Because we do not have an established reputation for delivering professional services, because this area is very competitive, and because we have limited experience in delivering professional services, we may not succeed in selling these services.

Increased competition may result in price reductions, increased costs of providing our services and loss of market share, any of which could seriously harm our business. We may not be able to compete successfully against our current and future competitors.

A limited number of customers account for a significant portion of our revenue, and the loss of a major customer could harm our operating results.

Our ten largest customers accounted for approximately 39% and 32% of our total net revenue for the three months ended December 31, 2008 and 2007. We cannot be certain that customers that have accounted for significant revenue in past periods, individually or as a group, will renew, will not cancel or will not reduce their services and, therefore, continue to generate revenue in any future period. In addition, our customers that do not have written contracts or that have monthly renewal arrangements may terminate their services at any time with little or no penalty. If we lose a major customer or group of customers, our revenue could decline.

Our investment in sales and marketing may not yield increased customers or revenue.

We have invested and are continuing to invest in our sales and marketing activities to help grow our business, including hiring additional sales personnel. Typically, additional sales personnel can take time before they become productive, and our additional marketing programs may also take time before they yield additional business, if any. We cannot assure you that these efforts will be successful, or that these investments will yield significantly increased sales in the near or long term.

Our cash and cash equivalents and short-term investments are managed through various banks around the world and the current capital and credit market conditions are extremely volatile, putting pressure on the ability of banks to provide service levels and in some cases to fail, both of which would likely have an adverse affect on our ability to timely access funds.

The capital and credit markets have been experiencing extreme volatility and disruption. In recent months, the volatility and disruption have reached unprecedented levels and has pressured the solvency of some financial institutions. These financial institutions, including banks, have had difficulty timely performing regular services and in some cases have failed or otherwise been largely taken over by governments. We maintain our cash, cash equivalents and short-term investments with a number of financial institutions around the world. Should some or all of these financial institutions fail, we would likely have a limited ability to quickly access our cash deposited with such institutions. If we are unable to quickly access such funds, we may need to increase our use of our lines of credit or access more expensive credit, if available. If we are unable to access our cash or if we access existing or additional credit or are unable to access additional credit, it could have a negative impact on our operations.

The current financial turmoil affecting the banking system and financial markets and the possibility that financial institutions may consolidate or go out of business have resulted in a tightening in the credit markets, a low level of liquidity in many financial markets, and extreme volatility in fixed income, credit, currency and equity markets. Other income and expense could also vary materially from expectations depending on gains or losses realized on the sale or exchange of financial instruments; impairment charges related to debt securities as well as equity and other investments; interest rates; and cash balances. The current volatility in the financial markets and overall economic uncertainty increases the risk that the actual amounts realized in the future on our financial instruments could differ significantly from the fair values currently assigned to them. Uncertainty about current global economic conditions could also continue to increase the volatility of our stock price.

If we do not complement our direct sales force with relationships with other companies to help market our services, we may not be able to grow our business.

To increase sales of services worldwide, we must complement our direct sales force with relationships with companies to help market and sell our services to their customers. If we are unable to maintain our existing marketing and distribution relationships, or fail to enter into additional relationships, we may have to devote substantially more resources to the direct sale and marketing of our services.

We would also lose anticipated revenue from customer referrals and other co-marketing benefits. In the past, we have had to terminate relationships with some of our international resellers, and we may be required to terminate other reseller relationships in the future. As a result, we may have to commit resources to supplement our direct sales effort to find additional resellers in foreign countries.

Our success depends in part on the ability of these companies to help market and sell our services. Our existing relationships do not, and any future relationships may not, afford us any exclusive marketing or distribution rights. Therefore, they could reduce their commitment to us at any time in the future. Many of these companies have multiple relationships and they may not regard us as significant for their business. In addition, these companies generally may terminate their relationships with us, pursue other relationships with our competitors or develop or acquire products or services that compete with our services. Even if we succeed in entering into these relationships, they may not result in additional customers or revenue.

We must retain qualified personnel in a competitive marketplace, or we may not be able to grow our business.

We may be unable to retain our key employees, namely our management team and experienced engineers, or to attract, assimilate or retain other highly qualified employees. There is substantial competition for highly skilled employees. If we fail to attract and retain key employees, our business could be harmed.

If the market does not accept our professional services, our results of operations could be harmed.

Professional services revenue represented approximately 15% and 16% of total net revenue for the three months ended December 31, 2008 and 2007, respectively. Professional services revenue has increased in absolute dollars, but has decreased as a percentage of total net revenue. We will need to successfully market these services in order to increase professional services revenue. The market for these services is very competitive. Each professional services engagement typically spans a one- to three-month period, and therefore, it is more difficult for us to predict the amount of professional services revenue recognized in any particular quarter. Our business which includes our operating results could be harmed if we cannot increase our professional services revenue.

The success of our business depends on the continued use of the Internet and mobile networks by business and consumers for e-business and communications and if usage of these networks declines, our operating results and working capital would be harmed.

Because our business is based on providing Internet and Mobile services, the Internet and mobile networks must continue to be used as a means of electronic business, and communications. In addition, we believe that the use of the Internet and mobile networks for conducting business could be hindered for a number of reasons, including, but not limited to:

	•		security concerns including the potential for fraud or theft of stored data and information communicated over the Internet and mobile networks;

	•		inconsistent quality of service, including outages of popular Web sites and mobile networks;

	•		delay in the development or adoption of new standards;

	•		inability to integrate business applications with the Internet; and

	•		the need to operate with multiple and frequently incompatible products.

The inability of our services to perform properly could result in loss of or delay in revenue, injury to our reputation or other harm to our business.

We offer complex services, which may not perform at the level our customers expect. We have occasionally given credits to customers as a result of past problems with our service. Despite our testing, our existing or future services may not perform as expected due to unforeseen problems, which could result in loss of or delay in revenue, loss of market share, failure to achieve market acceptance, diversion of development resources, injury to our reputation, increased insurance costs or increased service costs. In addition, we have in the past, and may in the future, acquire, rather than develop internally, some of our services. Upgrades to our services may not perform at the level we or our customers expect.

These problems could also result in tort or warranty claims. Although we attempt to reduce the risk of losses resulting from any claims through warranty disclaimers and liability-limitation clauses in our customer agreements, these contractual provisions may not be enforceable in every instance. Furthermore, although we maintain errors and omissions insurance, this insurance coverage may not adequately cover us for claims. If a court refused to enforce the liability-limiting provisions of our contracts for any reason, or if liabilities arose that were not contractually limited or adequately covered by insurance, we could be required to pay damages.

A disruption to our network infrastructure could impair our ability to serve and retain existing customers or attract new customers

All data collected from our measurement computers are generally stored in and distributed from our operations center, which we maintain at a single location. Our operations depend upon our ability to maintain and protect our computer systems, most of which are located at our corporate headquarters in San Mateo, California, which is an area susceptible to earthquakes and possible power outages. We have occasionally experienced outages of our services in the past and if we experience power outages at our operations centers, we might not be able to promptly receive data from our measurement computers and we might not be able to deliver our services to our customers on a timely basis.

Although we maintain insurance against fires, earthquakes and general business interruptions, the amount of coverage may not be adequate in any particular case. If our operations centers is damaged, this could disrupt our services, which could impair our ability to retain existing customers or attract new customers.

Any outage for any period of time or loss of customer data could cause us to lose customers. Our operations systems are also vulnerable to damage from break-ins, computer viruses, unauthorized access, vandalism, fire, floods, earthquakes, power loss, telecommunications failures and similar events. Our insurance may not be adequate in any particular case.

Individuals who attempt to breach our network security, such as hackers, could, if successful, misappropriate proprietary information or cause interruptions in our services. We might be required to expend significant capital and resources to protect against, or to alleviate, problems caused by hackers. We may not have a timely remedy against a hacker who is able to breach our network security. In addition to intentional security breaches, the inadvertent transmission of computer viruses could expose us to litigation or to a material risk of loss.

Our measurement computers and mobile devices are located at sites that we do not own or operate, and it could be difficult for us to maintain or repair them if they do not function properly.

Our measurement computers and mobile devices that we use to provide many of our services are located at facilities that are not owned by our customers or us. Instead, these devices are installed at locations near various Internet access points worldwide. We do not own or operate the facilities, and we have little control over how these devices are maintained on a day-to-day basis. We do not have long-term contractual relationships with the companies that operate the facilities where our measurement computers are located. We may have to find new locations for these computers if we are unable to develop relationships with these companies or if these companies cease their operations as some have done due to bankruptcies or are acquired. In addition, if our measurement computers and mobile devices cease to function properly, we may not be able to repair or service these computers on a timely basis, as we may not have immediate access to our measurement computers and measurement devices. Our ability to collect data in a timely manner could be impaired if we are unable to maintain and repair our computers and devices should performance problems arise.

Others might bring infringement claims which could harm our business.

In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. We could become subject to intellectual property infringement claims as the number of our competitors grows and our services overlap with competitive offerings. In addition, we are also subject to other legal proceedings, claims, and litigation arising in the ordinary course of our business. Any of these claims, even if not meritorious, could be expensive and divert management’s attention from operating our company. If we become liable to others for infringement of their intellectual property rights, we could be required to pay a substantial damage award and to develop noninfringing technology, obtain a license or cease selling the services that contain the infringing intellectual property. We may be unable to develop non-infringing technology or to obtain a license on commercially reasonable terms, or at all.

Our business which includes our operating results and financial conditions will be susceptible to additional risks associated with international operations.

We derive a significant portion of our revenue and earnings from our international operations. As a result, our financial condition and operating results could be significantly affected by risks associated with international activities, including economic and labor conditions, political instability, tax laws (including U.S. taxes on foreign subsidiaries and the negative tax implications related to moving cash from international locations to the U.S.), and changes in the value of the U.S. dollar versus local currencies. Margins on sales of our products and services in foreign countries could be materially adversely affected by foreign currency exchange rate fluctuations.

Our primary exposure to movements in foreign currency exchange rates relate mainly to non-U.S. dollar denominated sales in Europe, as well as non-U.S. dollar denominated operating expenses incurred throughout the world. Weakening of foreign currencies relative to the U.S. dollar will adversely affect the U.S. dollar value of our foreign currency-denominated sales and earnings. Conversely, a strengthening of foreign currencies would generally be beneficial to our foreign currency-denominated sales and earnings.

International sales were approximately 42% and 36% our total net revenue for the three months ended December 31, 2008 and 2007, respectively. We expect to continue to commit our resources to expand our international sales and marketing activities. Conducting international operations subjects us to risks we do not face in the United States. These include:

	•		currency exchange rate fluctuations;

	•		seasonal fluctuations in purchasing patterns;

	•		unexpected changes in regulatory requirements;

	•		maintaining and servicing computer hardware in distant locations;

	•		costs associated with repatriating funds from outside the U.S.;

	•		longer accounts receivable payment cycles and difficulties in collecting accounts receivable;

	•		difficulties in managing and staffing international operations;

	•		potentially adverse tax consequences, including restrictions on the repatriation of earnings;

	•		the burdens of complying with a wide variety of foreign laws;

	•		reduced protection for intellectual property rights in some countries; and

	•		political or economic instability, war or terrorism in the countries where we are doing business.

The Internet may not be used as widely in other countries and the adoption of e-business may evolve slowly or may not evolve at all. As a result, we may not be successful in selling our services to customers in markets outside the United States.

Industry consolidation may lead to stronger competition and may harm our operating results.

There has been a trend toward industry consolidation in our markets for several years. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. For example, HP acquired Mercury Interactive, one of our prior competitors, and Borland acquired Seque. We believe that industry consolidation may result in stronger competitors that are better able to compete for customers. This could lead to more variability in operating results and could have a material adverse effect on our business, operating results, and financial condition. Furthermore, rapid consolidation could also lead to fewer customers and partners, with the effect that loss of a major customer could harm our revenue.

Failure to maintain effective internal controls may cause us to delay filing our periodic reports with the SEC and adversely affect our stock price.

The SEC, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiring public companies to include a report of management on internal control over financial reporting in their annual reports on Form 10-K that contain an assessment by management of the effectiveness of the Company’s internal control over financial reporting. In addition, our independent registered public accounting firm must attest to and report on the effectiveness of our internal control over financial reporting. Although we review our internal control over financial reporting in order to ensure compliance with the Section 404 requirements, our failure to maintain adequate internal controls over financial reporting could result in an adverse reaction in the financial marketplace due to a loss of investor confidence in the reliability of our financial statements, which ultimately could negatively impact our stock price.

We may face difficulties assimilating, and may incur costs associated with, any future acquisitions.

We have completed several acquisitions, and as a part of our business strategy we may seek to acquire or invest in additional businesses, products or technologies that we feel could complement or expand our business, augment our market coverage, enhance our technical capabilities or that may otherwise offer growth opportunities. Future acquisitions could create risks for us, including:

	•		difficulties in assimilating acquired personnel, operations and technologies;

	•		difficulties in managing a larger organization with geographically dispersed operations;

	•		unanticipated costs associated with the acquisition or incurring of additional unknown liabilities;

	•		diversion of management’s attention from other business concerns;

	•		entry in new businesses in which we have little direct experience;

	•		difficulties in marketing additional services to the acquired companies’ customer base or to our customer base;

	•		adverse effects on existing business relationships with resellers of our services, our customers and other business partners;

	•		the need to integrate or enhance the systems of an acquired business;

	•		impairment charges related to potential write-down of acquired assets in acquisitions;

	•		failure to realize any of the anticipated benefits of the acquisition; and

	•		use of substantial portions of our available cash or dilution in equity if stock is used to consummate the acquisition and/or operate the acquired business.

We have anti-takeover protections that may delay or prevent a change in control that could benefit our stockholders.

Our amended and restated certificate of incorporation and bylaws contain provisions that could make it more difficult for a third party to acquire us without the consent of our Board of Directors. These provisions include:

	•		our stockholders may take action only at a meeting and not by written consent;

	•		our Board must be given advance notice regarding stockholder-sponsored proposals for consideration at annual meetings and for stockholder nominations for the election of directors; and

	•		special meetings of our stockholders may be called only by our Board of Directors, the Chairman of the Board, our Chief Executive Officer or our President, not by our stockholders.

We have also adopted a stockholder rights plan that may discourage, delay or prevent a change of control and make any future unsolicited acquisition attempt more difficult. The rights will become exercisable only upon the occurrence of certain events specified in the rights plan, including the acquisition of 20% of our outstanding common stock by a person or group. In addition, it is the policy of our Board of Directors that a committee consisting solely of independent directors will review the rights plan at least once every three years to consider whether maintaining the rights plan continues to be in the best interests of Keynote and our stockholders. The Board may amend the terms of the rights without the approval of the holders of the rights.

If we are unable to raise additional capital, our business could be harmed.

We believe that our available cash, cash equivalents and short term investments will enable us to meet our capital requirements for at least the next 12 months. However, if cash is required for unanticipated needs, we may need additional capital during that period. If the market for our products develops at a slower pace than anticipated, we could be required to raise substantial additional capital. We cannot be certain that additional capital will be available to us on favorable terms, or at all. If we were unable to raise additional capital when required, our business could be seriously harmed.

If the protection of our proprietary technology is inadequate, our competitors may gain access to our technology, and our market share could decline.

Our success is heavily dependent on our ability to create proprietary technology and to protect and enforce our intellectual property rights in that technology, as well as our ability to defend against adverse claims of third parties with respect to our technology and intellectual property. To protect our proprietary technology, we rely primarily on a combination of contractual provisions, confidentiality procedures, trade secrets, copyright and trademark laws, and patents. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Our means of protecting our proprietary rights may not be adequate and unauthorized third parties, including our competitors, may independently develop similar or superior technology, duplicate or reverse engineer aspects of our products, or design around our patented technology or other intellectual property.

There can be no assurance or guarantee that any products, services or technologies that we are presently developing, or will develop in the future, will result in intellectual property that is subject to legal protection under the laws of the United States or a foreign jurisdiction and that produces a competitive advantage for us.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

EXHIBIT INDEX


	Incorporated by Reference
					Filed
Exhibit	Form	File No.	Filing Date	Exhibit No.	Herewith
3.01 Amended and Restated Bylaws	8-K	000-1032761	12/10/2008	3.01

31.1 Certification of Periodic Report by Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002					X

31.2 Certification of Periodic Report by Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002					X

32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *					X

32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *					X


*		As contemplated by SEC Release No. 33-8212, these exhibits are furnished with this Quarterly Report on Form 10-Q and are not deemed filed with the Securities and Exchange Commission and are not incorporated by reference in any filing of Keynote Systems, Inc. Under the Securities Act of 1933 or the Securities Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in such filings.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Mateo, State of California, on this 6th day of February 2009.


		KEYNOTE SYSTEMS, INC.

By:		/s/ UMANG GUPTA
		Umang Gupta
		Chairman of the Board and Chief Executive Officer
		(Principal Executive Officer)

By:		/s/ ANDREW HAMER
		Andrew Hamer
		Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)

EXHIBIT INDEX


	Incorporated by Reference
					Filed
Exhibit	Form	File No.	Filing Date	Exhibit No.	Herewith
3.01 Amended and Restated Bylaws	8-K	000-1032761	12/10/2008	3.01

31.1 Certification of Periodic Report by Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002					X

31.2 Certification of Periodic Report by Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002					X

32.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *					X

32.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 *					X


*		As contemplated by SEC Release No. 33-8212, these exhibits are furnished with this Quarterly Report on Form 10-Q and are not deemed filed with the Securities and Exchange Commission and are not incorporated by reference in any filing of Keynote Systems, Inc. Under the Securities Act of 1933 or the Securities Act of 1934, whether made before or after the date hereof and irrespective of any general incorporation language in such filings.

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Keynote Systems (KEYN) Inactive 10-Q2009 Q1 Quarterly report

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