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  **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 SECURITIESEXCHANGE ACT OF 1934******For the quarterly period ended December 31, 2008******OR**   o **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES 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 bySection 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days. YES þNO oIndicate 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 filer o Accelerated filer þ Non-accelerated filer o Smaller reporting company o    (Do not check if a smaller reporting company)  Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act.): YES o NO þIndicate the number of shares outstanding of each of the issuer’s classes of common stock, as ofthe 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
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**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 
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**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 doubtfulaccounts of $188 and $118, at December 31, 2008 andSeptember 30, 2008, respectively, and less billingadjustment of $199 and $150 at December 31, 2008 andSeptember 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
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**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 netincome (loss) per share:        Basic  14,186   18,237 Diluted  14,302   18,237 See accompanying notes to the condensed consolidated financial statements
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**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
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**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 condensedconsolidated statements of operations and cash flows reflect all normal recurring adjustments thatare, in the opinion of management, necessary for a fair presentation of the financial position ofKeynote Systems, Inc. and subsidiaries (the “Company”) as of December 31, 2008, and the results ofoperations and cash flows for the interim periods ended December 31, 2008 and 2007.The accompanying unaudited condensed consolidated financial statements have been prepared inaccordance with the rules and regulations of the Securities and Exchange Commission (“SEC”), andtherefore, do not include all information and footnotes necessary for a complete presentation ofthe Company’s results of operations, financial position and cash flows. This report should be readin conjunction with the consolidated financial statements and notes thereto for the fiscal yearended September 30, 2008 included in the Company’s Report on Form 10-K as filed with the SEC. Thecondensed consolidated financial statements include the accounts of the Company and its domesticand foreign subsidiaries. Intercompany balances have been eliminated in consolidation. The resultsof operations and cash flows for any interim period are not necessarily indicative of the Company’sresults 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 acceptedin the United States requires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities, disclosure of contingent assets and liabilities at the date ofthe financial statements, and the reported amounts of revenue and expenses during the reportingperiod. Significant estimates made in preparing the condensed consolidated financial statementsrelate to revenue recognition, the allowance for doubtful accounts and billing allowance,inventories and inventory valuation, allocation of purchase price for business combinations, usefullives of property, equipment and intangible assets, asset impairments, the fair values of optionsgranted under the Company’s stock-based compensation plans and valuation allowances for deferredtax assets. Actual results could differ from those estimates, and such differences may be materialto 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”, whichdefines fair value, establishes guidelines for measuring fair value and expands disclosuresregarding 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 oroperating 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 marketsfor identical assets or liabilities. Level 2 inputs are based on quoted prices for similarinstruments in active markets, quoted prices for identical or similar instruments in markets thatare not active, and model-based valuation techniques for which all significant assumptions areobservable in the market or can be corroborated by observable market data for substantially thefull term of the assets or liabilities. Level 3 inputs are generally unobservable and typicallyreflect management’s estimates of assumptions that market participants would use in pricing theasset or liability. The fair values are therefore determined using model-based techniques thatinclude 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 FinancialLiabilities—including an amendment of FASB Statement No. 115”, during the first quarter of fiscal2009. SFAS No. 159 allows companies to choose to measure eligible financial instruments and certainother items at fair value that are not required to be measured at fair value. SFAS No. 159 requiresthat unrealized gains and losses on items for which the fair value option has been elected bereported in earnings at each reporting date. The Company adopted SFAS No. 159 but has not electedthe 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 theadoption of SFAS Nos. 157 and 159.
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**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 andrequirements for how an acquirer recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed, any non controlling interest in the acquireeand the goodwill acquired. The Statement also establishes disclosure requirements which will enableusers to evaluate the nature and financial effects of the business combination. SFAS No. 141R iseffective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, whichwill be the Company’s fiscal year beginning October 1, 2009. The Company is currently evaluatingthe potential impact, if any, of the adoption of SFAS No. 141R on the Company’s consolidatedfinancial position, results of operations and cash flows.In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated FinancialStatements — an amendment of Accounting Research Bulletin No. 51” (“SFAS No. 160”), whichestablishes accounting and reporting standards for ownership interests in subsidiaries held byparties other than the parent, the amount of consolidated net income attributable to the parent andto the noncontrolling interest, changes in a parent’s ownership interest and the valuation ofretained noncontrolling equity investments when a subsidiary is deconsolidated. The statement alsoestablishes reporting requirements that provide sufficient disclosures that clearly identify anddistinguish 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 afterDecember 15, 2008, which will be the Company’s fiscal year beginning October 1, 2009. The Companyis currently evaluating the potential impact, if any, of the adoption of SFAS No. 160 on itsconsolidated financial position, results of operations and cash flows.In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and HedgingActivities” (“SFAS No. 161”). SFAS No. 161 enhances financial disclosure by requiring thatobjectives for using derivative instruments be described in terms of underlying risk and accountingdesignation in the form of tabular presentation, requiring transparency with respect to theentity’s liquidity from using derivatives, and cross-referencing an entity’s derivative informationwithin its financial footnotes. SFAS No. 161 is effective for financial statements issued forfiscal years beginning after November 15, 2008. The Company is currently evaluating the impact, ifany, that SFAS No. 161 may have on its consolidated financial position, results of operations andcash flows.In April 2008, the FASB released FASB Staff Position No. 142-3, “Determination of the Useful Lifeof Intangible Assets” (“FSP No. 142-3”), which amends the factors that should be considered indeveloping renewal or extension assumptions used to determine the useful life of a recognizedintangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets”. The intentof the statement is to improve the consistency between the useful life of a recognized intangibleasset under Statement 142 and the period of expected cash flows used to measure the fair value ofthe asset under FASB Statement No. 141 (revised 2007) and other U.S. generally accepted accountingprinciples. FSP No. 142-3 is effective as of the beginning of an entity’s fiscal year that beginsafter December 15, 2008, which will be the Company’s fiscal year beginning October 1, 2009. TheCompany is currently evaluating the potential impact, if any, of the adoption of FSP No. 142-3 onthe 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 AccountingPrinciples (“SFAS No. 162”). SFAS No. 162 is intended to improve financial reporting by identifyinga consistent framework, or hierarchy, for selecting accounting principles to be used in preparingfinancial statements that are presented in conformity with accounting principles generally acceptedin the United States of America for nongovernmental entities. SFAS No. 162 is effective beginningNovember 15, 2008. Any effect of applying the provisions of SFAS No. 162 is to be reported as achange in accounting principle in accordance with SFAS No. 154, “Accounting Changes and ErrorCorrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3.” The adoption of SFASNo. 162 had no effect on the Company’s condensed consolidated financial statements.**Stock Based Compensation**(a) Summary of PlansAs of December 31, 2008, the Company was authorized to issue up to approximately 8.3 million sharesof 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 yearsafter the date of grant. Vesting periods are determined by the Board of Directors and generallyprovide for shares to vest over a period of four years with 25% of the shares vesting one year fromthe 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 IncentivePlan, 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 seekingstockholder approval to extend the term of the Incentive Plan until December 31, 2011.
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As of December 31, 2008, the Company had reserved a total of approximately 1.4 million shares ofcommon stock for issuance under its 1999 Employee Stock Purchase Plan (“Purchase Plan”). Under thePurchase Plan, eligible employees may defer an amount not to exceed 10% of the employee’scompensation, as defined in the Purchase Plan, to purchase common stock of the Company. Thepurchase price per share is 85% of the lesser of the fair market value of the common stock on thefirst day of the applicable purchase period or the last day of each purchase period. The PurchasePlan is intended to qualify as an “employee stock purchase plan” under Section 423 of the InternalRevenue Code. As of December 31, 2008, approximately 972,000 shares had been issued under thePurchase 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 seekingstockholder approval to extend the term of the Purchase Plan for an additional ten years.(b) Summary of Assumptions and ActivityThe fair value of each option was estimated on the date of grant using the Black-Scholes optionpricing model. Weighted-average assumptions for options granted and stock purchase rights under theequity incentive plans are as follows:           Three Months Ended  December 31,  2008 2007Stock 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 quarterended December 31, 2008 was approximately $241,000.As of December 31, 2008, there was approximately $4.4 million of total unrecognized compensationcost (net of estimated forfeitures) related to nonvested share-based compensation (nonvested stockoptions) arrangements as determined using the Black-Scholes option pricing model. That cost isexpected to be recognized over the next four fiscal years (or a weighted average period of2.0 years).
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**Excess Occupancy Income**Excess occupancy income consists of rental income from the leasing of space not occupied by theCompany in its headquarters building, net of related fixed costs, such as property taxes,insurance, building depreciation, leasing broker fees and tenant improvement amortization. Thecosts are based upon actual square footage available to lease to third parties, which wasapproximately 75% for the three months ended December 31, 2008, and 60% for the three months endedDecember 31, 2007. Rental income was approximately $627,000 and $607,000 for the three months endedDecember 31, 2008 and 2007, respectively. As of December 31, 2008, the Company had leased space to14 tenants of which 13 had noncancellable operating leases, which expire on various dates through2014. At September 30, 2008, future minimum rents receivable under the leases, are as follows (inthousands):     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 professionalservices revenue and is recognized when all of the following criteria have been met: **•** *Persuasive evidence of an arrangement exists.*The Company considers a customer signedquote, contract, or equivalent document to be evidence of an arrangement.  **•** *Delivery of the product or service.*For subscription services, delivery is considered tooccur when the customer has been provided with access to the subscription services. TheCompany’s subscription services are generally delivered on a consistent basis over theperiod of the subscription. For professional services, delivery is considered to occur whenthe services or milestones are completed. For ratable licenses, delivery occurs when allelements of the arrangement have either been delivered or accepted, if acceptance languageexists.  **•** *Fee is fixed and determinable.*The Company considers the fee to be fixed or determinableif 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 itis expected that the customer will be able to pay amounts under the arrangement as paymentsbecome due. If it is determined that collection is not reasonably assured, then revenue isdeferred and recognized upon cash collection.The Company does not generally grant refunds. All discounts granted reduce revenue. Free trials areoccasionally provided to prospective customers who would like to try certain of the Company’sPerspective and other subscription services before they commit to purchasing the services. Theservices provided during the trial period are typically stand-alone transactions and are notbundled with other services. Revenue is not recognized for these free trial periods.     *Subscription Services Revenue:*Subscription services revenue consists of fees from sales ofsubscriptions to the Company’s Perspective family of services, and Global Roamer.Revenue is recognized in accordance with Staff Accounting Bulletin (“SAB”) 104, “RevenueRecognition” (“SAB 104”) and Emerging Issues Task Force (“EITF”) Issue 00-21, “Revenue Arrangementswith Multiple Deliverables” (“EITF 00-21”).The Company also enters into multiple element arrangements where sufficient objective evidence offair value does not exist for the allocation of revenue. As a result, the elements within itssubscription arrangements do not qualify for treatment as separate units of accounting.Accordingly, the Company accounts for fees received under subscription arrangements as a singleunit of accounting and recognizes the entire arrangement fee as revenue either ratably over theservice period, generally over twelve months, or based upon actual monthly usage.
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For customers that are billed the entire amount of their subscription in advance, subscriptionservices 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. Forcustomers that are billed on a monthly basis, revenue is recognized monthly based upon actualservice usage for the month. Regardless of when billing occurs, the Company recognizes revenue asservices are provided and defers any revenue that is unearned.The Company’s WebEffective service can be sold on a subscription basis or as part of a professionalservices engagement. The Company recognizes revenue from the use of its WebEffective service thatis sold on a subscription basis ratably over the subscription period, commencing on the day serviceis first provided, and such revenue is recorded as subscription services revenue. The Companyrecognizes revenue from the use of its WebEffective service as part of a professional servicesengagement and revenue is recorded as professional services revenue.     *Ratable Licenses Revenue:*Ratable licenses revenue consists of fees from the sale of mobileautomated test equipment, maintenance, engineering and minor consulting services associated withKeynote SIGOS System Integrated Test Environment (“SITE”) as a result of the Company’s acquisitionof SIGOS Systemintegration GmbH (“Keynote SIGOS”) in the third quarter of fiscal 2006. The Companyfrequently enters into multiple element arrangements with mobile customers, for the sale of itsautomated test equipment, including both hardware and software licenses, consulting services toconfigure the hardware and software (implementation or integration services), post contract support(maintenance) services, training services and other minor consulting services. These multipleelement arrangements are within the scope of Statement of Position (“SOP”) No. 97-2, “SoftwareRevenue Recognition” (“SOP 97-2”), and the EITF Issue 03-5, “Applicability of AICPA Statement ofPosition 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-IncidentalSoftware”. This determination is based on the hardware component of the Company’s multiple elementarrangements being deemed to be a software related element. In addition, customers only purchasethe software and hardware as a package, with payments due upon delivery of this hardware andsoftware package.None of the Keynote SIGOS implementation/integration services provided by the Company areconsidered to be essential to the functionality of the licensed products. This assessment is due tothe implementation/integration services being performed during a relatively short period (generallywithin two to three months) compared to the length of the arrangement which typically ranges fromtwelve to thirty-six months. Additionally, the implementation/integration services are general innature and the Company has a history of successfully gaining customer acceptance.The Company cannot allocate the arrangement consideration to the multiple elements based on thevendor specific objective evidence (“VSOE”) of fair value because sufficient evidence of VSOE doesnot exist for the undelivered elements of the arrangement, typically maintenance. Therefore, theCompany recognizes the entire arrangement fee into revenue ratably over the maintenance period,historically ranging from twelve to thirty-six months, once the implementation and integrationservices are completed, usually within two to three months following the delivery of the hardwareand software. Where acceptance provisions exist, the ratable recognition of revenue begins whenevidence of customer acceptance of the software and hardware has occurred as intended under therespective arrangement’s contractual terms.     *Professional Services Revenue:*Professional services revenue consists of fees generated fromLoadPro, Customer Experience Management and professional consulting services that are purchased aspart of a professional service project. Revenue from these services is recognized as the servicesare performed, typically over a period of one to three months. For professional service projectsthat contain milestones, the Company recognizes revenue once the services or milestones have beendelivered, 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 Companyallocates and defers revenue for the undelivered items based on objective evidence of fair value ofthe undelivered elements, and recognizes the difference between the total arrangement fee and theamount deferred for the undelivered items as revenue. When sufficient objective evidence of fairvalue does not exist for undelivered items when subscription and professional services arecombined, 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 inadvance, primarily unearned subscription services and ratable licenses revenue, and is recorded asdeferred revenue on the balance sheet until the revenue is earned. Any unpaid deferred revenuereduces the balance of accounts receivable. Short-term deferred revenue represents the unearnedrevenue that has been collected in advance that will be earned within twelve months of the balancesheet date. Correspondingly, long-term deferred revenue represents the unearned revenue that willbe earned after twelve months of the balance sheet date and primarily relates to ratable licensesrevenue.
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     *Deferred Costs:*Deferred costs are mainly comprised of hardware costs associated with KeynoteSIGOS revenue arrangements involving hardware. Deferred costs are categorized as short term for anyarrangement for which the original service contracts are one year or less in length.Correspondingly, deferred costs associated with arrangements for which the original servicecontracts are greater than one year are classified as noncurrent deferred costs in the condensedconsolidated balance sheets. Contract lives generally range from one to three years. These deferredcosts 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 istypically 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 incomeand its components in the financial statements. The components of comprehensive income consist ofnet income (loss), unrealized gains and losses on short-term investments in debt securities andforeign currency translation. The unrealized gains and losses on short-term investments in debtsecurities and foreign currency translation are excluded from earnings and reported as a componentof stockholders’ equity. The foreign currency translation adjustment results from thosesubsidiaries not using the U.S. dollar as their functional currency since the majority of theireconomic activities are primarily denominated in their applicable local currency. The Company hassubsidiaries located in Germany, United Kingdom, France and Canada. Accordingly, all assets andliabilities related to these operations are translated at the current exchange rates at the end ofeach period. The resulting cumulative translation adjustments are recorded directly to theaccumulated other comprehensive income account in stockholders’ equity. Revenues and expenses aretranslated at average exchange rates in effect during the period. Gains (losses) from foreigncurrency transactions are reflected in other income (expenses) in the condensed consolidatedstatements of operations as incurred and were approximately $310,000 and ($134,000) for the threemonths 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 Companyintends to hold these investments to maturity. There is no tax effect on the foreign currencytranslation because it is management’s intent to reinvest the undistributed earnings of its foreignsubsidiaries 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 approximatesfair market value due to their short-term nature. Financial instruments that subject the Company toconcentrations of credit risk consist primarily of cash and cash equivalents, short-terminvestments and accounts receivable.Credit risk is concentrated in North America, but exists in Europe as well. The Company generallyrequires no collateral from customers; however, throughout the collection process, it conducts anongoing evaluation of customers’ ability to pay. The Company’s accounting for its allowance fordoubtful accounts is determined based on historical trends, experience and current market andindustry conditions. Management regularly reviews the adequacy of the Company’s allowance fordoubtful accounts by considering the aging of accounts receivable, the age of each invoice, eachcustomer’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 isappropriate based on the receivable balance. In addition, the Company maintains a reserve for allother invoices, which is calculated by applying a percentage to the outstanding accounts receivablebalance, 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 billingadjustments that are recorded as a reduction of revenue. The Company’s billing allowance iscalculated as a percentage of revenue based on historical trends and experience.
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The allowance for doubtful accounts and billing allowance represent management’s best estimate asof the balance sheet dates, but changes in circumstances relating to accounts receivable andbilling adjustments, including unforeseen declines in market conditions and collection rates andthe 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 itapplies 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 andenhances disclosures about fair value measurements. Fair value is the price that would be receivedto sell an asset or paid to transfer a liability in an orderly transaction between marketparticipants in the market in which the reporting entity transacts. Valuation techniques used tomeasure fair value under SFAS No.157 must maximize the use of observable inputs and minimize theuse of unobservable inputs. The standard describes a fair value hierarchy based on three levels ofinputs, 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 resultsof operations, but SFAS No.157 does require new disclosures about how management values certainassets and liabilities. Much of the required disclosure relates to the inputs used to measure fairvalue, 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 uponother observable inputs.The following table presents the Company’s assets and liabilities measured at fair value on arecurring 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 requiredto be priced and have a fair value of $1 net asset value per share. These money market funds areactively traded and reported daily through a variety of sources. Due to the structure and valuationrequired by the Investment Company Act of 1940 regarding Rule 2a-7 funds, the fair value of themoney market fund investments are classified as Level 1.
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**(6) Cash, Cash Equivalents, and Short-Term Investments**The Company considers all highly liquid investments held at major banks, commercial paper, moneymarket funds and other money market securities with original maturities of three months or less tobe cash equivalents in accordance with SFAS No. 115, “Accounting for Certain Investments in Debtand Equity Securities”.The Company classifies all of its short-term investments as available-for-sale. These investmentsmature or reset in one year or less as of the balance sheet dates, and consist of investment-gradecorporate securities. Investmentsclassified as available-for-sale are recorded at fair market value with the related unrealizedgains 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 (inthousands):                       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 recordedan 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        
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***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 loanagreement that Zandan entered into in 2007, with Oseo BDPME, a French State Bank of Innovation, toborrow approximately €182,000 or $255,000 to meet general working capital requirements. Amountsborrowed under this agreement are secured by Zandan’s 2005 research tax credit receivable in theamount of approximately €288,000 or $405,000. Amounts borrowed bear a variable interest based uponthe Euro Overnight Interest Average rate of the month plus 3.8%. Interest and principal are duewhen the research tax credit receivable is collected from the French Tax Authorities, which isexpected 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 ofDecember 31, 2008 and September 30, 2008, respectively. Inventories primarily relate to directcosts associated with finished goods hardware and are stated at the lower of cost (determined on afirst-in, first-out basis) or market. Current selling prices are primarily used for measuring anypotential declines in market value below cost. Any adjustment for market value decreases is chargedto cost of ratable licenses at the point management deems that the market value has declined. TheCompany evaluates inventories for excess quantities and obsolescence on a quarterly basis. Thisevaluation includes analysis of historical and forecasted sales of its product. Inventories on handin excess of forecasted demand or obsolete inventories are charged to cost of ratable licenses.Obsolescence is determined considering several factors, including competitiveness of productofferings, market conditions, and product life cycles.
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**(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 noimpairment existed as of September 30, 2008. The Company also evaluates goodwill for impairmentwhenever events or changes in circumstances indicate that the carrying amount may not berecoverable. These events or circumstances could include a significant change in the businessclimate, legal factors, operating performance indicators, competition, or sale or disposition of asignificant portion of a reporting unit. Recoverability of goodwill is measured at the reportingunit level by comparing the reporting unit’s carrying amount, including goodwill, to the fair valueof the reporting unit, which is measured based upon, among other factors, market multiples forcomparable companies as well as a discounted cash flow analysis. Reporting units representcomponents of the Company for which discrete financial information is available that is regularlyreviewed by management. Management has determined that the Company currently has one reportingunit. 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 comparablecompanies, during the quarter ended December 31, 2008, the Company concluded that there were notriggering events as of December 31, 2008 which would require a formal impairment analysis of thecarrying value of goodwill. Management believes that the recent decline in the Company’s marketcapitalization 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 accompanyingcondensed consolidated financial statements. The Company is continuing to monitor its economicsituation and the need to perform an impairment analysis in light of recent macro-economicindications in the equity markets as well as recent volatility and downward pressure on its marketcapitalization. To the extent the Company concludes that there are any indicators of impairmentprior to the date of the next annual goodwill impairment test on September 30, 2009, managementwill perform an impairment analysis under SFAS No. 142, “Goodwill and Other Intangible Assets,” andcould record an impairment charge to write down goodwill to its fair value. If the results of thatimpairment testing confirm that a write down of goodwill is necessary, then the Company will recordan associated charge. Any such charge could be significant and accordingly, would have a materialimpact on the Company’s financial position and results of operations, but would not be expected tohave a material adverse effect on the Company’s cash flows from operations.Identifiable intangible assets amounted to approximately $7.8 million (net of accumulatedamortization of approximately $21.7 million) and approximately $8.4 million (net of accumulatedamortization 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 developedtechnology related to software was approximately $288,000 and $205,000 for the three months endedDecember 31, 2008 and 2007, respectively. These amounts were recorded to costs of revenue.
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The estimated future amortization expense for existing identifiable intangible assets as ofDecember 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 ofDecember 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 outstandingshares of common stock, summarized below. Diluted net income (loss) per share is computed using theweighted-average number of shares of common stock outstanding and, when dilutive, potential sharesfrom 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 (inthousands, 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 fromthe 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 fromthe computation of diluted net loss per share since their effect would have been antidilutive. Theweighted-average exercise price of excluded outstanding stock options was $14.88 and $14.42 for thethree 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, theCompany assumed a liability for a legal settlement against Zandan involving a dispute alleging thatZandan had not complied with its systems support agreement. The matter was taken to court where theSwiss federal court ruled that Zandan pay €242,000 or $381,000, plus interest. Zandan was notsuccessful on appeal, and as such, accrued expenses assumed on purchase of Zandan included anaccrual of €265,000 or $417,000. However, as part of the purchase agreement, this liability is theresponsibility of Zandan’s former shareholders, and as such, the amount has been set aside inescrow.During the three months ended December 31, 2008, the former shareholders successfully reduced thislegal settlement to €229,000 or $320,000. The amount was disbursed from the escrow account sincethis legal settlement was the responsibility of Zandan’s former
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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 theplaintiff.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 taxdeclarations between late calendar year 2006 and early calendar year 2007. Since this amountrelated to pre-acquisition liability, the Company recorded the liability of $158,000 with anoffsetting 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 35percent U.S. federal statutory rate primarily due to the relative mix of foreign and domesticearnings and the fact that a portion of the earnings are being taxed in the U.S. where the Companyhas a low effective tax rate due to utilization of valuation allowance against current yearprojected income. The rate for the three months ended December 31, 2007 was higher than the 35percent U.S. federal statutory rate primarily due to the fact that the Company did not benefit fromlosses incurred in the United States.The effective tax rate is highly dependent upon the geographic distribution of the Company’sworldwide earnings or loss, tax regulations in each geographic region, the availability of taxcredits 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 andadjusts its estimates accordingly. If actual results differ from management’s estimates, futureincome tax expense could be materially affected.At September 30, 2007, the Company determined that the projected sources of future taxable incomein the United States were not sufficient to support any of the deferred tax assets located in theUnited States. Therefore, the Company established a valuation allowance against all of thedeferred tax assets related to the United States. The net deferred tax assets recorded on theCompany’s condensed consolidated balance sheets as of December 31, 2008 and September 30, 2008 areprimarily related to foreign jurisdictions. In future quarters, the projected taxable income willbe evaluated for this purpose, and it is possible that the valuation allowance would be reduced. Ifa 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 managementdetermines that the valuation allowance should be reduced, the tax effect would be recorded as adiscrete event in the quarter in which the determination was made. This analysis is applied to USdomestic taxes and to foreign, in particular German, taxes separately. SFAS No. 123R has the effectof increasing the effective tax rate due to compensation expense from incentive stock options andemployee stock purchase plan shares, which have no associated tax benefit to the Company. In afuture period, it is possible that a tax benefit would be realized on these options, at which timethe 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 onOctober 1, 2007, the Company recognized a cumulative effect adjustment of $81,000, decreasing itsincome tax liability for unrecognized tax benefits, and decreasing the September 30, 2007accumulated deficit balance. As of December 31, 2008, the total amount of gross unrecognizedbenefits was $6,406,000. Included in this balance was approximately $2,235,000 of unrecognized taxbenefits that, if recognized, would affect the effective income tax rate. There have been nosignificant changes in these amounts during the quarter ended December 31, 2008It is possible that the amount of liability for unrecognized tax benefits may change within thenext 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 togenerate an increase in liabilities for unrecognized tax benefits. In accordance with the Company’saccounting policy, it recognizes accrued interest and penalties related to unrecognized taxbenefits in the provision for income taxes. Interest and penalties were insignificant for thethree months ended December 31, 2008.Although the Company files U.S. federal, various state, and foreign tax returns, the Company’s onlymajor 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 totax loss carryovers from those years.**(13) Commitments and Contingencies***(A) Leases*
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The Company leases certain of its facilities and equipment under noncancelable capital andoperating leases, which expire on variousdates through October 2017. As of December 31, 2008, future minimum payments under the leases areas 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, tobandwidth and co-location providers amounting to $1.7 million**,**which commitments become due if theCompany 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 itsforeign subsidiaries, to customers and vendors as a form of security. The guarantees can only beexecuted upon agreement by both the customer or vendor and the Company. The guarantees are securedby 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 defendantsin two securities class-action lawsuits based on alleged errors and omissions concerningunderwriting terms in the prospectus for the Company’s initial public offering. A ConsolidatedAmended Class Action Complaint for Violation of the Federal Securities Laws (“ConsolidatedComplaint”) was filed on or about April 19, 2002, and alleged claims against the Company, certainof 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, andunder Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The lawsuitalleged that the defendants participated in a scheme to inflate the price of the Company’s stock inits initial public offering and in the aftermarket through a series of misstatements and omissionsassociated with the offering. The lawsuit is one of several hundred similar cases pending in theSouthern 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 allclaims against it with no admission of wrongdoing by the Company or any of its present or formerofficers 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 2006the Court of Appeals reversed the District Court’s determination that six focus cases could becertified as class actions. In April 2007, the Court of Appeals denied plaintiffs’ petition forrehearing, but acknowledged that the District Court might certify a more limited class. At aJune 26, 2007 status conference, the Court approved a stipulation withdrawing the proposedsettlement. On August 14, 2007, plaintiffs filed amended complaints in the focus cases, and amotion 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 statea 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 settlementagreement in principle. As part of this tentative settlement, the Company’s insurance carrier hasagreed 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 thatit will be finalized or receive approval from the District Court. The Company believes that it hasmeritorious defenses to these claims. If the tentative settlement is not implemented and thelitigation continues against the Company, the Company would continue to defend against this actionvigorously.
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In addition, in October 2007, a lawsuit was filed in the United States District Court for theWestern District of Washington by Vanessa Simmonds, captioned *Simmonds v. JPMorgan Chase & Co.,et al.*, No. 07-1634, alleging that the underwriters violated section 16(b) of the SecuritiesExchange Act of 1934, 15 U.S.C. section 78p(b), by engaging in short-swing trades, and seeksdisgorgement to the Company of profits from the underwriters in amounts to be proven at trial. OnFebruary 28, 2008, Ms. Simmonds filed an amended complaint. The suit names the Company as a nominaldefendant, contains no claims against the Company, and seeks no relief from the Company. Thislawsuit is one of more than fifty similar actions filed in the same court. On July 25, 2008, theunderwriter defendants in the various actions filed a joint motion to dismiss the complaints forfailure 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 ahearing on the motions to dismiss on January 16, 2009, but the court has yet to rule on eithermotions. No amount has been accrued as of December 31, 2008 and September 30, 2008 since managementbelieves 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 ordinarycourse of business. While the outcome of these matters is currently not determinable, managementdoes not expect that the ultimate costs to resolve these matters will have a material adverseeffect 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 eventthere is a failure of such warranties, the Company generally is obliged to correct or replace theproduct to conform to the warranty provision. No amount has been accrued for warranty obligationsas of December 31, 2008 or September 30, 2008, as costs to replace or correct product are generallyreimbursable under the manufacturer’s warranty.*(E) Indemnification*The Company does not generally indemnify its customers against legal claims that its servicesinfringe third-party intellectual property rights. Other agreements entered into by the Company mayinclude indemnification provisions that could subject the Company to costs and/or damages in theevent of an infringement claim against the Company or an indemnified third-party. However, theCompany has never been a party to an infringement claim and its management is not aware of anyliability related to any infringement claims subject to indemnification. As such, no amount isaccrued for infringement claims as of December 31, 2008 and September 30, 2008 in the condensedconsolidated balance sheets.**(14) Geographic and Segment Information**The Company operates in a single reportable segment encompassing the development and sale ofservices, hardware and software to measure, test, assure and improve the quality of service of theInternet 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 andwhere they are recorded in the Company’s condensed consolidated statements of operations.               **Subscription** **Ratable** **Professional**  **Services** **Licenses** **Services****Internet Test and Measurement:**            Application Perspective  X         Diagnostic Services  X         Enterprise Adapters  X         LoadPro          X NetMechanic  X         Professional Services          X Red Alert  X         Streaming Perspective  X         Test Perspective  X         Transaction Perspective  X         Web Site Perspective  X         Voice Perspective  X       X 
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               **Subscription** **Ratable** **Professional**  **Services** **Licenses** **Services**Performance Scoreboard  X         WebEffective  X       X Financial Industry Scorecards  X       X **Mobile Test and Measurement:**            Mobile Device Perspective  X         Mobile Application Perspective  X         SIGOS SITE      X     SIGOS Global Roamer  X         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-livedassets are attributed to the geographic location in which they are located. The Company includes inlong-lived assets all tangible assets. Long-lived assets in Germany include tangible assets relatedto the acquisition of SIGOS.For the three months ended December 31, 2008, no single customer accounted for 10% or more of totalnet revenue. For the three months ended December 31, 2007, one customer accounted for approximately11% of total net revenue. As of December 31, 2008, one customer accounted for 10% of total accountsreceivable. As of September 30, 2008, no single customer accounted for 10% or more of totalaccounts receivable.
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**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 conjunctionwith the Condensed Consolidated Financial Statements and the Notes thereto included in this reportas well as in our Annual Report on Form 10-K for the year ended September 30, 2008, and subsequentfilings with the Securities and Exchange Commission.Except for historical information, this Form 10-Q contains forward-looking statements within themeaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Actof 1934. These forward-looking statements involve risks and uncertainties, including, among otherthings, statements regarding our anticipated costs and expenses and revenue mix. Theseforward-looking statements include, among others, statements including the words “expects,”“anticipates,” “intends,” “believes” and similar language. Our actual results may differsignificantly from those projected in the forward-looking statements. Factors that might cause orcontribute 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 reporton Form 10-K for the fiscal year ended September 30, 2008 and elsewhere in that report. You shouldcarefully review the risks described in other documents we file from time to time with theSecurities and Exchange Commission, including the quarterly reports on Form 10-Q and currentreports on Form 8-K that we may file during the current year. You are cautioned not to place unduereliance on the forward-looking statements, which speak only as of the date of this quarterlyreport on Form 10-Q. Except as required by law, we undertake no obligation to publicly release anyrevisions to the forward-looking statements or reflect events or circumstances after the date ofthis document.**Overview**We develop and sell technology solutions to measure, test, assure and improve the quality ofservice 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 ourgeographically distributed “on demand” Web site and transaction/application monitoring andmeasurement services, voice-over-IP (VOIP) and streaming measurement services, load testingservices, customer experience management services, competitive research and industry scorecardservices, and custom professional services. The Mobile category consists of our on-demand Mobilemonitoring and testing services, our Global Roamer services and our SIGOS System Integrated TestEnvironment (“SITE”) systems.We offer our Internet services either on a subscription or on an engagement basis although, in somecases, 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 serviceselected, the number of pages, transactions or devices monitored, the number of measurementlocations 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, thesize of a panel, and the type of testing to be conducted. Our Mobile solutions are offered on asubscription basis or license basis. The subscriptions typically are for a fixed period, usuallyannual, and are based on the number of locations and devices from which monitoring and testing isperformed, 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 isbundled with ongoing maintenance and support for a fixed contract period, with no vendor specificobjective evidence of fair value on the undelivered elements, the license fees are amortized overthe length of the contract and are therefore included in the ratable licenses category. The SIGOSGlobal Roamer service is offered via a subscription fee model, typically on a three to twelve monthbasis 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 asIBM Global Services and EDS, who manage e-business Web sites for other companies. We also sell tocontent distribution providers, such as Akamai, who use our services as a pre-sales tool for theirpotential customers or in service level agreements with their existing customers. We alsooccasionally 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 theUnited Kingdom, Nordic Countries and Germany and sell indirectly through reseller partnersthroughout the rest of Europe, the Middle East, Africa and Asia. Our SIGOS SITE and Global Roamersales 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 11,840Internet pages in the same quarter a year ago.For the three months ended December 31, 2008, our 10 largest customers accounted for approximately39% of total net revenue. We cannot be certain that customers that have accounted for significantrevenue in past periods, individually or in aggregate, will renew our services and continue togenerate revenue in any future period. In addition, our customers that have monthly renewalarrangements
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may terminate their services at any time with little or no penalty. If we lose a major customer ora group of significant customers, our revenue could significantly decline.We believe that the challenges for our business include 1) continuing to drive growth in ourInternet and Mobile revenue, 2) growing multiple page/broadband related revenue such as TransactionPerspective and Application Perspective, 3) continuing to control our expenses in fiscal 2009 and4) successfully navigating the global economic downturn.**Critical Accounting Policies and Estimates**Our condensed consolidated financial statements and accompanying notes included elsewhere in thisquarterly report on Form 10-Q are prepared in accordance with accounting principles generallyaccepted in the United States. Note 2, “Summary of Significant Accounting Policies,” to theconsolidated financial statements in our Annual Report on Form 10-K for the fiscal year endedSeptember 30, 2008 describes the significant accounting policies and methods used in thepreparation of our condensed consolidated financial statements. These accounting principles requireus to make estimates, judgments and assumptions that affect the reported amounts of assets andliabilities as of the date of the financial statements, as well as the reported amounts of revenueand expenses during the periods presented. We believe that the estimates, judgments and assumptionsupon which we rely are reasonable based upon information available to us at the time that theseestimates, judgments and assumptions are made. To the extent there are material differences betweenthese estimates, judgments or assumptions and actual results, our financial statements will beaffected. We believe the following critical accounting policies affect our more significantjudgments 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, “RevenueRecognition” (“SAB 104”), Emerging Issues Task Force (“EITF”) Issue 00-21 “Revenue Arrangementswith Multiple Deliverables” (“EITF 00-21”), Statement of Position (“SOP”) No. 97-2, “SoftwareRevenue Recognition” (“SOP 97-2”), and the EITF Issue 03-5, “Applicability of AICPA Statement ofPosition 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-IncidentalSoftware” (“EITF 03-5”). We generally recognize revenue when all of the following criteria havebeen 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.” Ourrecognition of revenue is based on our assessment of the probability of collecting the relatedaccounts receivable on a customer-by-customer basis. If we determine that collection is notreasonably assured, then revenue is deferred and recognized upon the receipt of cash from thatarrangement.Our revenue consists of subscription services revenue, ratable license revenue and professionalservices revenue.     ***Subscription Services Revenue:***Subscription services revenue consists of fees from sales ofsubscriptions 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 valuedoes not exist for the allocation of revenue. As a result, the elements within our subscriptionarrangements do not qualify for treatment as separate units of accounting.
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Accordingly, we account for fees received under subscription arrangements as a single unit ofaccounting and recognize the entire arrangement fee as revenue either ratably over the serviceperiod, generally over twelve months, or based upon actual monthly usage.For customers that are billed the entire amount of their subscription in advance, subscriptionservices 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. Forcustomers that are billed on a monthly basis, revenue is recognized monthly based upon actualservice usage for the month. Regardless of when billing occurs, we recognize revenue as servicesare provided and defer any revenue that is unearned. WebEffective service is sold on a subscriptionbasis or as part of a professional services engagement. We recognize revenue from the use of ourWebEffective 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 subscriptionservices revenue. We recognize revenue from the use of our WebEffective service as part of aprofessional services engagement and revenue is recorded as professional services revenue.     ***Ratable Licenses Revenue:***Ratable licenses revenue consists of fees from the sale of mobileautomated test equipment, maintenance, engineering and minor consulting services associated withSITE systems. We frequently enterinto multiple element arrangements with mobile customers for the sale of our automated testequipment, including both hardware and software licenses, consulting services to configure thehardware and software (implementation or integration services), post contract support (maintenance)services, training services and other minor consulting services. These multiple elementarrangements are within the scope of SOP 97-2, and EITF 03-5. This determination is based on thehardware component of our multiple element arrangements being deemed to be a software relatedelement. In addition, customers only purchase the software and hardware as a package, with paymentsdue upon delivery of this hardware and software package.None of the Keynote SIGOS implementation/integration services provided by us are considered to beessential to the functionality of the licensed products. This assessment is due to theimplementation/integration services being performed during a relatively short period (generallywithin two to three months) compared to the length of the arrangement which typically ranges fromtwelve to thirty-six months. Additionally, the implementation/integration services are general innature and we have a history of successfully gaining customer acceptance.We cannot allocate the arrangement consideration to the multiple elements based on the vendorspecific objective evidence (“VSOE”) of fair value since sufficient evidence of VSOE does not existfor the undelivered elements of the arrangement, typically maintenance. Therefore, we recognize theentire arrangement fee into revenue ratably over the maintenance period, historically ranging fromtwelve 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. Whereacceptance provisions exist in the arrangement, the ratable recognition of revenue begins whenevidence of customer acceptance of the software and hardware has occurred as intended under therespective arrangement’s contractual terms.**Professional Services Revenue:**Professional services revenue consists of fees generated from ourLoadPro, CEM and professional consulting services that are purchased as part of a professionalservice project. Revenue from these services is recognized as the services are performed, typicallyover a period of one to three months. For professional service projects that contain milestones, werecognize 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) thecombination of subscription and professional services or 2) multiple professional services. Forthese arrangements, we recognize revenue in accordance with EITF 00-21. We allocate and deferrevenue for the undelivered items based on objective evidence of fair value of the undeliveredelements and recognize the difference between the total arrangement fee and the amount deferred forthe undelivered items as revenue. When sufficient objective evidence of fair value does not existfor undelivered items when subscription and professional services are combined, the entirearrangement fee is recognized ratably over the applicable performance period.**Deferred Revenue:**Deferred revenue is comprised of all unearned revenue that has been collected inadvance, primarily unearned license and subscription services revenue, and is recorded as deferredrevenue on the balance sheet until the revenue is earned. The addback of unpaid deferred revenuemay change at any point in time as it is based upon the timing of when invoices are collected andwhether there is any unpaid deferred revenue associated with such accounts receivable. Short-termdeferred revenue represents the unearned revenue that has been collected in advance that will beearned 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 beearned after twelve months of the balance sheet date.We generally do not grant refunds. All discounts granted reduce revenue. Free trials areoccasionally provided to prospective customers who would like to try certain of our Perspective andother subscription services before they commit to purchasing the
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services. The services provided during the trial period are typically stand-alone transactions andare 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-termaggregated) as of December 31, 2008 and September 30, 2008. Unpaid deferred revenue that has anassociated accounts receivable balance as of the balance sheet dates is added back to net deferredrevenue, resulting in gross deferred revenue. The amount of unpaid deferred revenue may change atany point in time as it is based upon the timing of when invoices are collected and whether thereis 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 billingallowance and unpaid deferred revenue to the extent that there is any associated accountsreceivable balance.Our allowance for doubtful accounts is determined based on historical trends, experience andcurrent market and industry conditions. We regularly review the adequacy of our accounts receivableallowance after considering the age of each invoice of the accounts receivable aging, eachcustomer’s expected ability to pay and our collection history with each customer. We reviewinvoices greater than 60 days past due to determine whether an allowance is appropriate based onthe receivable balance. In addition, we maintain a reserve for all other invoices, which iscalculated by applying a percentage, based on historical collection trends, to the outstandingaccounts receivable balance as well as specifically identified accounts that are deemeduncollectible.Billing allowance represents the reserve for potential billing adjustments that are recorded as areduction of revenue and represents a percentage of revenue based on historical trends andexperience. The allowance for doubtful accounts and billing allowance represent management’s bestestimate, but changes in circumstances relating to accounts receivable and billing adjustments,including unforeseen declines in market conditions and collection rates and the number of billingadjustments, may result in additional allowances in the future or reductions in allowances due tofuture 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 thelower of cost (determined on a first-in, first-out basis) or market. Market is based on estimatedreplacement value. Determining market value of inventories involves numerous judgments, includingaverage selling prices and sales volumes of future periods. We primarily utilize current sellingprices for measuring any potential declines in market value below cost. Any adjustment for marketvalue 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 onhand in excess of forecasted demand are provided for. In addition, we write off inventories thatare considered obsolete. Obsolescence is determined from several factors, including competitivenessof product offerings, market conditions, and product life cycles.Our inventories include mainly computer hardware and mobile hardware and accessories that may besubject to technological obsolescence. Our products are sold in a competitive industry. If actualproduct demand or selling prices are less favorable than we estimate, we may be required to takeinventory write-downs. For the three months ended December 31, 2008 and 2007, we did not experienceany write-down of inventories.
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*Allocation of Purchase Price for Business Combinations*We are required to allocate the purchase price of acquired companies to the tangible and intangibleassets 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 pricerelating to acquisitions is usually determined based on management’s assessment in conjunction withvaluations performed by an independent third party. Such a valuation requires making significantestimates and assumptions, especially with respect to intangible assets. Critical estimates invaluing certain intangible assets include, but are not limited to, future expected cash flows fromcustomer contracts, customer lists and acquired developed technologies, expected costs to developIPR&D into commercially viable products and estimating cash flows from projects when completed anddiscount rates. Estimates of fair value are based upon assumptions believed to be reasonable, butwhich are inherently uncertain and unpredictable and, as a result, actual results may differ fromestimates. Other estimates such as accruals associated with the accounting for acquisitions maychange as additional information becomes available regarding the assets acquired and liabilitiesassumed.*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 assignedto identifiable assets acquired less liabilities assumed.We evaluate our identifiable goodwill for impairment on an annual basis, and whenever events orchanges in circumstances indicate that the carrying value of an asset may not be fully recoverablefor our single reporting unit. In addition we evaluate our intangible assets and other long-livedassets for impairment whenever events or changes in circumstances indicate that the carrying amountof an asset may not be recoverable. Factors we consider important which could trigger an impairmentreview include the following: **•** significant changes in the manner of our use of the acquired assets or the strategy ofour 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 thetiming of the testing, the undiscounted net cash flows used to assess recoverability of theintangible assets and the fair value of the asset group.We performed an annual goodwill and long lived assets impairment review during the fourth quarterin fiscal 2006, 2007, and 2008. We did not record an impairment charge based on our reviews. Thegoodwill recorded on the condensed consolidated balance sheet as of December 31, 2008 wasapproximately $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 triggerevents that would indicate an interim impairment analysis of our goodwill balances during the threemonths ended December 31, 2008 is necessary. Goodwill is tested for impairment on an annual basisand between annual tests if indicators of potential impairment exist. There was a decline in themarket capitalization of our company, as well as comparable companies, during the quarter endedDecember 31, 2008. We concluded that there were no triggering events as of December 31, 2008 whichwould require a formal impairment analysis of the carrying value of goodwill. We believe that therecent decline in our market capitalization is not due to any fundamental change or adverse eventsin our company’s operations. Accordingly, we have not recognized any impairment of goodwill in theaccompanying condensed consolidated financial statements. We will continue to monitor our economicsituation and the need to perform an impairment analysis in light of recent macro-economicindications in the equity markets as well as recent volatility and downward pressure on our marketcapitalization. To the extent we conclude that there are any indicators of impairment prior to thedate of the next annual goodwill impairment test on September 30, 2009, we will perform animpairment analysis under SFAS No. 142, “Goodwill and Other Intangible Assets,” and could record animpairment charge to write down goodwill to its fair value. If the results of that impairmenttesting confirm that a write down of goodwill is necessary, then we will record an associatedcharge. Any such charge could be significant and accordingly, would have a material impact on ourfinancial position and results of operations, but would not be expected to have a material adverseeffect on our cash flows from operations.If future events or circumstances indicate that an impairment assessment is required on intangibleor long-lived assets and an asset group is determined to be impaired, our financial results couldbe 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 rightto purchase common stock under employee stock purchase plans. Since October 1, 2005, we account forstock-based compensation in accordance with SFAS 123R. Under the fair value recognition provisionsof this statement, share-based compensation cost is measured at the grant date based on the
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fair value of the award and is recognized as expense over the service (vesting) period. The valueof an option is estimated using the Black-Scholes option valuation model which requires the inputof highly subjective assumptions. A change in our assumptions could materially affect the fairvalue estimate, and thus, the total calculated costs associated with the grant of stock options orthe issue of stock under employee stock purchase plans. If actual forfeiture rates differsignificantly from these estimates, stock-based compensation expense and our results of operationscould be materially impacted. See Note 1 to the Notes to Condensed Consolidated FinancialStatements 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. Thisprocess involves estimating our actual current tax liabilities, including the impact, if any, ofadditional taxes resulting from tax examinations together with assessing temporary differencesresulting from differing treatment of items, such as deferred revenue, for tax and accountingpurposes. These differences result in deferred tax assets and liabilities. We must then assess thelikelihood that our deferred tax assets will be recoverable from future taxable income and, to theextent we believe that recovery is not likely, we must establish a valuation allowance. To theextent we establish a valuation allowance or increase the valuation allowance in a period, ourdeferred tax expense increases. If a valuation allowance is decreased, deferred tax expense may bereduced, goodwill may be reduced, or paid in capital may be increased, depending on the nature andsource of the deferred tax assets. This analysis is applied on a jurisdiction by jurisdictionbasis.Significant management judgment is required in determining our provision for income taxes, ourdeferred tax assets and liabilities, and any valuation allowance recorded against our net deferredtax 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 thegeographic mix or estimated level of annual income before taxes can affect the overall effectivetax rate. We perform an analysis of our effective tax rate and we assess the need for a valuationallowance against our deferred tax assets quarterly.The uncertainties which could affect the realization of our deferred tax assets include variousfactors such as the amount of deductions for tax purposes related to our stock options, potentialsuccessful challenges to the deferred tax assets by taxing authorities, and a mismatch of theperiod during which the type of taxable income and the deferred tax assets are realized or amismatch in the tax jurisdiction in which taxable income is generated and the company with thedeferred 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 andmeasurement attribute for the financial statement recognition and measurement of a tax positiontaken or expected to be taken in a tax return. This Interpretation also provides guidance onderecognition, 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 taxposition will be sustained upon examination, including resolution of any related appeals orlitigation processes, based on the technical merits of the position. In evaluating whether a taxposition has met the “more-likely-than-not” recognition threshold, we presume that the positionwill be examined by the appropriate taxing authority that would have full knowledge of all relevantinformation. 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 financialstatements. The tax position is measured at the largest amount of benefit that is greater than50 percent likely to be realized upon ultimate settlement.We establish liabilities or reserves when we believe that certain tax positions are not probable ofbeing sustained if challenged, despite our belief that our tax returns are fully supportable. Weevaluate these tax reserves and related interest each quarter and adjust the reserves in light ofchanging facts and circumstances regarding the probability of realizing tax benefits, such as theprogress of a tax audit or the expiration of a statute of limitations. We believe that our taxpositions comply with applicable tax laws and that we have adequately provided for known materialtax 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 toestimate the range of reasonably possible losses in excess of amounts recorded.
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**Results of Operations**The following table sets forth, as a percentage of total net revenue, certain condensedconsolidated statements of operations data for the periods indicated. All information is derivedfrom our condensed consolidated financial statements included in this report. The operating resultsare 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 threemonths 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 ratablelicenses revenue as a result of our SIGOS products and services. Other factors impacting netincome include: **•** Increase of $634,000, or 3%, in total costs and expenses, from approximately $19.4million for the three months ended December 31, 2007 to approximately $20.0 million for thethree months ended December 31, 2008. Of the increase, $413,000 was attributable toincreased investment in our sales force primarily related to additional personnel from 89at the beginning of the first quarter of fiscal 2008 to 98 at the end of the first quarterof fiscal 2009. $153,000 was attributable to higher professional fees in general andadministration expenses related to the fiscal year 2008 annual audit. The remainingincrease in total costs and expenses was attributable to three additional headcount ingeneral and administration.  **•** Decrease in net interest income and other of $477,000 due to reduction in interestincome attributable to lower cash balances during the three months ended December 31, 2008as 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%           
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***Subscription Services***. Net revenue from subscription services increased by $601,000 for the threemonths ended December 31, 2008 as compared to the three months ended December 31, 2007. Theincrease in subscription services net revenue for the three months ended December 31, 2008 wasmainly attributable to increased sales of our multiple page/broadband subscription services ofapproximately $1.3 million and Global Roamer services of $427,000, offset by a decrease in oursingle-page device subscription services of approximately $1.1 million. We have reduced oursingle-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 forthe 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 wasmainly attributable to revenue growth from the sale of new SIGOS SITE systems. Net revenue fromthese sales is being recognized in revenue over the maintenance period for each contract which istypically twelve to thirty-six months. We expect revenue growth for ratable licenses will be muchless than experienced in the past. This is primarily attributable to the amount of revenue beingrecognized from prior periods normalizing with new sales contracts that will be amortized overtwelve to thirty-six months as well as the weakening of the dollar against the Euro in the futurecompared to prior quarters.***Professional Services***. Net revenue from professional services increased by $275,000 for the threemonths ended December 31, 2008 as compared to the three months ended December 31, 2007. Theincrease in professional services net revenue for the three months ended December 31, 2008 wasmainly attributable to increased contributions from our professional consulting engagements, namelyload testing engagements, related to preparing websites for the holiday shopping season.In addition to analyzing revenue for subscription services and professional services, managementalso internally analyzes revenue categorized as Internet Test and Measurement (“Internet”) andMobile Test and Measurement (“Mobile”).The following table identifies which services are categorized as Internet and Mobile services andwhere they are recorded in our condensed consolidated statements of operations.               **Subscription** **Ratable** **Professional**  **Services** **Licenses** **Services****Internet Test and Measurement:**            Application Perspective  X         Diagnostic Services  X         Enterprise Adapters  X         LoadPro          X NetMechanic  X         Professional Services          X Red Alert  X         Streaming Perspective  X         Test Perspective  X         Transaction Perspective  X         Web Site Perspective  X         Voice Perspective  X       X Performance Scoreboard  X         WebEffective  X       X Financial Industry Scorecards  X       X **Mobile Test and Measurement:**            Mobile Device Perspective  X         Mobile Application Perspective  X         SIGOS SITE      X     SIGOS Global Roamer  X         
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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 tothree months ended December 31, 2007. Internet net revenue represented 62% and 70% of total netrevenue for the three months ended December 31, 2008 and 2007, respectively. The increase inInternet net revenue in absolute dollars for the three months ended December 31, 2008 was mainlyattributable to an increased contribution of approximately $1.3 million from ourmultiple-page/broadband services and $396,000 from our professional consulting engagements whichconsist of our load testing, VoIP, enterprise solutions and customer experience engagements,primarily related to preparing websites for the holiday shopping season. The increase in totalInternet net revenue was offset by the decline of approximately $1.1 million from oursingle-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% and30% of total net revenue for the three months ended December 31, 2008 and 2007, respectively. Theincrease for the three months ended December 31, 2008 was mainly attributable to revenue growthfrom 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 ofincreased contribution from our Global Roamer subscription services.For the three months ended December 31, 2008, no single customer accounted for more than 10% oftotal net revenue. For the three months ended December 31, 2007, one customer accounted forapproximately 11% of total net revenue. As of December 31, 2008, one customer accounted for 10% oftotal accounts receivable. As of September 30, 2008, no single customer accounted for 10% or moreof total accounts receivable. International sales were approximately 42% and 36% of total netrevenue 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 Service***s. Direct costs of subscription services consist of connectionfees to major telecommunication and internet access providers for bandwidth usage of ourmeasurement computers, which are located around the world and depreciation, maintenance and otherequipment charges for our measurement and data collection infrastructure and Global Roamerservices. Direct costs of subscription services increased by $145,000 for the three months endedDecember 31, 2008 as compared to the three months ended December 31, 2007 and represented 20% and19% 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 feesrelated to our multi-page measurements. We do not anticipate that direct costs of subscriptionservices for the second quarter of fiscal 2009 will change significantly in absolute dollarscompared 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 ofour SIGOS SITE systems. Direct costs of ratable licenses decreased by $115,000 for the threemonths ended December 31, 2008 as compared to the three months ended December 31, 2007 andrepresented
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25% and 40% of ratable licenses net revenue for the three months ended December 31,2008 and 2007, respectively. The cost of thetest equipment as part of each new customer contract is expensed ratably over the same initialtwelve to thirty-six month period as the revenue to which it is associated. The decreases indirect costs of ratable licenses in absolute dollars and as a percentage of the ratable licenserevenue are due to the fact that there was a higher amount of revenue being recognized in the threemonths ended December 31, 2008 for maintenance renewals that did not have any significantassociated direct costs for test equipment.***Direct Costs of Professional Services.***Direct costs of professional services consist ofcompensation expenses and related costs for professional services personnel, external consultingexpenses to deliver our professional services revenue, panel and reward costs associated with ourcustomer experience engagements, all load-testing bandwidth costs and related networkinfrastructure costs. Direct costs of professional services decreased by $127,000 for the threemonths ended December 31, 2008 as compared to the three months ended December 31, 2007, andrepresented 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 monthsended December 31, 2008 was primarily due to lower personnel related costs associated with ourcustomer experience management services due to stringent cost containment. We do not anticipatethat direct costs of professional services for the second quarter of fiscal 2009 will changesignificantly 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 othercosts associated with the development of our products and services. Development expenses decreasedby $50,000 for the three months ended December 31, 2008 compared to the three months endedDecember 31, 2007. The decrease in development costs for the three months ended December 31, 2008was 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 thatdevelopment expenses for the second quarter of fiscal 2009 will change significantly in absolutedollars 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 andtechnical support personnel who manage and maintain our field measurement and collectioninfrastructure and headquarters data center, and provide basic and extended customer support. Ouroperations personnel also work closely with other departments to assure the reliability of ourservices. 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 expensesfor the three months ended December 31, 2008 was primarily attributable to costs associated withour new data center that was completed in the third quarter of fiscal year 2008. We do notanticipate that operations expenses for the second quarter of fiscal 2009 will change significantlyin 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 salesand marketing personnel, lead-referral fees, marketing programs and travel expenses. Our sales andmarketing expenses increased by approximately $413,000 for the three months ended December 31, 2008as compared to the three months ended December 31, 2007. The increase in sales and marketing costsfor the three months ended December 31, 2008 was mainly attributable to our continued investment inour sales and
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marketing, primarily related to additional personnel from 89 at the beginning of the first quarterof fiscal 2008 to 98 at the end of the first quarter of fiscal 2009. We do not anticipate thatsales and marketing expenses for the second quarter of fiscal 2009 will change significantly inabsolute 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 othergeneral corporate expenses. General and administrative expenses increased $333,000 for the threemonths ended December 31, 2008 as compared to the three months ended December 31, 2007. Theincrease in general and administrative expenses are primarily attributable a $153,000 increase inprofessional fees related to our fiscal 2008 annual audit and a $88,000 increase related to threeadditional headcount. We believe that general and administrative expenses for the second quarterof fiscal 2009 will decrease in absolute dollars compared to the first quarter of fiscal 2009 dueto 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 inour headquarters building, net of related fixed costs, such as property taxes, insurance, buildingdepreciation, leasing broker fees and tenant improvement amortization. The costs are based on theactual square footage available for lease to third parties, which was approximately 75% and 60% forthe three months ended December 31, 2008 and 2007, respectively. The decrease in excess occupancyincome for the three months ended December 31, 2008 as compared to the three months ended December31, 2007 was primarily due to the net increase in expenses related to depreciation, property taxesand insurance. We expect the excess occupancy income will be approximately the same in thesecond 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 monthsended December 31, 2008 as compared to the three months ended December 31, 2007. The decrease intotal amortization is due to certain intangibles becoming fully amortized in the second half offiscal 2008, offset by increase in amortization associated with intangible assets purchased in theZandan acquisition that occurred in April 2008. Amortization of intangible assets — softwaremainly relates to our Keynote SIGOS developed technology related to our SIGOS SITE system and, to alesser extent, to Zandan’s developed technology related to mobile, and is reflected in direct costsof revenue in our condensed consolidated statements of operations.We review our identifiable intangible assets for impairment whenever events or changes incircumstances indicate that the carrying amount of these assets may not be recoverable. AtDecember 31, 2008, we had a remaining balance of approximately $7.8 million of identifiableintangible assets that are being amortized over a three to six and one half-year expected life. Weexpect the amortization
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of identifiable intangible assets to be approximately $702,000 for thesecond quarter of fiscal 2009, assuming no additional acquisitionsor impairment charges. We expect the remaining carrying value of the identifiable intangible assetsas 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 valueat 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 endedDecember 31, 2008 as compared to the three months ended December 31, 2007. The decrease was mainlydue to lower interest income earned on lower balance of invested cash and cash equivalents. Thedecrease in interest income was offset partially by a foreign exchange gain associated withremeasurements 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 anyadditional 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 percentU.S. federal statutory rate primarily due to the relative mix of foreign and domestic earnings andthe fact that a portion of the earnings are being taxed in the U.S. where we have a low effectivetax rate due to utilization of valuation allowance against current year projected income. The ratefor the three months ended December 31, 2007 was higher than the 35 percent U.S. federal statutoryrate primarily due to the fact that we did not benefit from losses incurred in the United States.
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***Stock-based Compensation Expense***Stock-based compensation expense, which is included in cost of revenues and operating expenses bycategory, was approximately $1.0 million and approximately $1.1 million for the three months endedDecember 31, 2008 and 2007, respectively. Stock-based compensation expense decreased by $59,000for 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 optionsand 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 expenserelated to stock options andemployee 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) multipliedby 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 cashequivalents consist of highly liquid investments held at major banks, money market mutual funds andother money market securities with original maturities of three months or less. We do not holdauction rate securities.*Cash provided by operating activities*We expect that cash provided by operating activities may fluctuate in future periods as a result ofa number of factors, including fluctuations in our operating results, accounts receivablecollections, and the timing and amount of tax and other payments.For the three months ended December 31, 2008, net cash provided by operating activities wasapproximately $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 operatingactivities and a $2.2 million net decrease in operating assets and liabilities. The non-cashadjustments primarily consist of depreciation, amortization and stock-based compensation expenseoffset by bad debt and billing adjustment reserves. The net decrease in operating assets andliabilities was primarily due to an increase in accounts receivable of $1.4 million, and a decreasein accounts payable and accrued expenses of $785,000. The increase in accounts receivable duringthe first quarter of fiscal 2009 was mainly related to higher DSO for the period as evidenced byour higher DSO of 38 days for the first quarter of fiscal 2009 as compared to 32 days for thequarter ended September 30, 2008. The change in accounts payable and accrued expenses during thefirst quarter of fiscal 2009 was mainly related to timing of payments of legal and audit servicesrelated to regulatory compliance and the timing of when payments are made.
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*Cash provided by investing activities*The changes in cash flows from investing activities primarily relate to the timing of purchases andmaturities of investments and acquisitions. We also use cash to invest in capital and other assetsto support our growth and infrastructure. For the three months ended December 31, 2008, net cashprovided by our investing activities was approximately $1.5 million. We received $2.4 million ofcash from the net sales of short-term investments. We also utilized $661,000 to purchase propertyand equipment, primarily for our production infrastructure and information systems, and tenantimprovements 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 stockrepurchases and proceeds received from the issuance of common stock associated with our employeestock 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 fromthe 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 realproperty operating leases and equipment capital and operating leases, with various lease terms, thelongest of which expires in October 2017. Additionally, we had contingent commitments ranging inlength from one to twenty-eight months to bandwidth and collocation providers amounting to $1.7million, which commitments become due if we terminate any of these agreements prior to theirexpiration. At present, we do not intend to terminate any of these agreements prior to theirexpiration. 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 foreignsubsidiaries, to customers and vendors as a form of security. The guarantees can only be executedupon agreement by both the customer or vendor and us. The guarantees are secured by a unsecuredline 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 anticipatedcash needs for working capital and capital expenditures for at least the next 12 months. Factorsthat 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-terminvestments. If, after some period of time, cash generated from operations is insufficient tosatisfy our liquidity requirements, we may seek to sell additional equity or debt securities or toobtain 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 additionalequity or convertible debt securities could result in dilution to our stockholders, and we may notbe able to obtain additional financing on acceptable terms, if at all. If we are unable to obtainthis additional financing, our business may be harmed.**Off Balance Sheet Arrangements**We did not enter into any transactions with unconsolidated entities whereby we have financialguarantees, subordinated retained interests, derivative instruments or other contingentarrangements that expose us to material continuing risks, contingent liabilities, or any otherobligation 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 andrequirements for how an acquirer recognizes and measures in its financial statements theidentifiable assets acquired, the liabilities assumed any non controlling interest in the acquireeand the goodwill acquired. The Statement also establishes disclosure requirements which will enableusers to evaluate the nature and financial effects of the business combination. SFAS No. 141R iseffective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, whichwill be our fiscal year beginning October 1, 2009. We are currently evaluating the potentialimpact, if any, of the adoption of SFAS No. 141R on our consolidated financial position, results ofoperations and cash flows.
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In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated FinancialStatements — an amendment of Accounting Research Bulletin No. 51” (“SFAS No. 160”), whichestablishes accounting and reporting standards for ownership interests in subsidiaries held byparties other than the parent, the amount of consolidated net income attributable to the parent andto the noncontrolling interest, changes in a parent’s ownership interest and the valuation ofretained noncontrolling equity investments when a subsidiary is deconsolidated. The Statement alsoestablishes reporting requirements that provide sufficient disclosures that clearly identify anddistinguish 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 afterDecember 15, 2008, which will be our fiscal year beginning October 1, 2009. We are currentlyevaluating the potential impact, if any, of the adoption of SFAS No. 160 on our consolidatedfinancial position, results of operations and cash flows.In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and HedgingActivities” (“SFAS No. 161”). SFAS No. 161 enhances financial disclosure by requiring thatobjectives for using derivative instruments be described in terms of underlying risk and accountingdesignation in the form of tabular presentation, requiring transparency with respect to theentity’s liquidity from using derivatives, and cross-referencing an entity’s derivative informationwithin its financial footnotes. SFAS No. 161 is effective for financial statements issued forfiscal 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 cashflows.In April 2008, the FASB released FASB Staff Position 142-3, “Determination of the Useful Life ofIntangible Assets” (“FSP No. 142-3”), which amends the factors that should be considered indeveloping renewal or extension assumptions used to determine the useful life of a recognizedintangible asset under FASB Statement No. 142, “Goodwill and Other Intangible Assets”. The intentof the statement is to improve the consistency between the useful life of a recognized intangibleasset under Statement 142 and the period of expected cash flows used to measure the fair value ofthe asset under FASB Statement No. 141 (revised 2007) and other U.S. generally accepted accountingprinciples. FSP No. 142-3 is effective as of the beginning of an entity’s fiscal year that beginsafter December 15, 2008, which will be our fiscal year beginning October 1, 2009. We are currentlyevaluating the potential impact, if any, of the adoption of FSP No. 142-3 on our consolidatedfinancial position, results of operations and cash flows.In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted AccountingPrinciples” (“SFAS No. 162”). SFAS No. 162 is intended to improve financial reporting byidentifying a consistent framework, or hierarchy, for selecting accounting principles to be used inpreparing financial statements that are presented in conformity with accounting principlesgenerally accepted in the United States of America for nongovernmental entities. SFAS No. 162 iseffective beginning November 15, 2008. Any effect of applying the provisions of SFAS No. 162 is tobe reported as a change in accounting principle in accordance with SFAS No. 154, “AccountingChanges and Error Corrections — a replacement of APB Opinion No. 20 and FASB Statement No. 3.” Theadoption 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 generallevel of U.S. interest rates, particularly because most of our cash, cash equivalents andshort-term investments are invested in short-term debt instruments. If market interest rates wereto change immediately and uniformly by ten percent (10%) from levels at December 31, 2008, theinterest earned on those cash, cash equivalents, and short-term investments could increase ordecrease by approximately $33,000 on an annualized basis.*Foreign Currency Fluctuations.*A majority of our revenue and expenses are transacted inU.S. dollars. However, we do enter into transactions in other currencies, primarily the Euro andBritish Pound. We operate internationally and are exposed to potentially adverse movements inforeign currency rate changes. Revenue derived from customers outside of the United States, whichare billed from our headquarters, in San Mateo, CA, and have the U.S. dollar as the functionalcurrency is collected in foreign currencies. Revenue derived from customers outside of the UnitedStates, which are billed from our Nuremberg, Germany office are typically billed in Euros.Similarly, substantially all of the expenses of operating our international subsidiaries areincurred in foreign currencies. As a result, our U.S. dollar earnings and net cash flows frominternational 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 theaccompanying condensed consolidated statements of operations, primarily due to fluctuations in theEuro 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’smanagement, the Company’s principal executive officer and principal financial officer haveconcluded that the Company’s disclosure controls and procedures as defined in
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Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (“ExchangeAct”) were effective as of December 31, 2008 to ensure that information required to be disclosed bythe 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 Commissionrules and forms and (ii) accumulated and communicated to the Company’s management, including itsprincipal executive officer and principal financial officer, as appropriate to allow timelydecisions 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 firstquarter of fiscal 2009, which were identified in connection with management’s evaluation requiredby 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 financialreporting.**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 twosecurities class-action lawsuits based on alleged errors and omissions concerning underwritingterms in the prospectus for our initial public offering. A Consolidated Amended Class ActionComplaint for Violation of the Federal Securities Laws (“Consolidated Complaint”) was filed on orabout April 19, 2002, and alleged claims against us, certain of its officers, and underwriters ofour September 24, 1999 initial public offering (“underwriter defendants”), under Sections 11 and 15of the Securities Act of 1933, as amended, and under Sections 10(b) and 20(a) of the SecuritiesExchange Act of 1934, as amended. The lawsuit alleged that the defendants participated in a schemeto inflate the price of our stock in its initial public offering and in the aftermarket through aseries of misstatements and omissions associated with the offering. The lawsuit is one of severalhundred similar cases pending in the Southern District of New York that have been consolidated bythe court.We are a party to a global settlement with the plaintiffs that would have disposed of all claimsagainst it with no admission of wrongdoing by us or any of its present or former officers ordirectors. The settlement agreement had been preliminarily approved by the Court. However, whilethe settlement was awaiting final approval by the District Court, in December 2006 the Court ofAppeals reversed the District Court’s determination that six focus cases could be certified asclass actions. In April 2007, the Court of Appeals denied plaintiffs’ petition for rehearing, butacknowledged that the District Court might certify a more limited class. At a June 26, 2007 statusconference, 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 certificationin the focus cases on September 27, 2007. On November 13, 2007, defendants in the focus cases fileda motion to dismiss the amended complaints for failure to state a claim, which the District Courtdenied on March 2008. Plaintiffs, the issuer defendants (including us), the underwriter defendants,and the insurance carriers for the defendants, have engaged in mediation and settlementnegotiations. The parties have reached a settlement agreement in principle. As part of thistentative settlement, our insurance carrier has agreed to assume our entire payment obligationunder the terms of the settlement. Although the parties have reached a tentative settlementagreement, there can be no guarantee that it will be finalized or receive approval from theDistrict Court. We believe that we have meritorious defenses to these claims. If the tentativesettlement is not implemented and the litigation continues against us, we would continue to defendagainst this action vigorously.In addition, in October 2007, a lawsuit was filed in the United States District Court for theWestern District of Washington by Vanessa Simmonds, captioned *Simmonds v. JPMorgan Chase & Co.,et al.*, No. 07-1634, alleging that the underwriters violated section 16(b) of the SecuritiesExchange Act of 1934, 15 U.S.C. section 78p(b), by engaging in short-swing trades, and seeksdisgorgement to us of profits from the underwriters in amounts to be proven at trial. OnFebruary 28, 2008, Ms. Simmonds filed an amended complaint. The suit names us as a nominaldefendant, contains no claims against us, and seeks no relief from us. This lawsuit is one of morethan fifty similar actions filed in the same court. On July 25, 2008, the underwriter defendants inthe 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 requiredto answer or otherwise respond to the amended complaint. Accordingly, we did not join the motion todismiss 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 December31, 2008 and September 30, 2008 since our liability, if any, is not probable and cannot bereasonably estimated.We are subject to other legal proceedings, claims, and litigation arising in the ordinary course ofbusiness. While the outcome of these matters is currently not determinable, management does notexpect that the ultimate costs to resolve these matters will have a material adverse effect on ourconsolidated financial position, results of operations, or cash flows.
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**Item 1A.Risk Factors*****We have incurred in the past and may, in the future, incur losses, and we may not sustainprofitability.***     We may not be able to sustain GAAP profitability in the future. We have incurred net losses on aGAAP basis in each of our last three fiscal years. As of December 31, 2008, we had an accumulateddeficit of approximately $142.3 million. In addition, we are required under generally acceptedaccounting principles to review our goodwill and identifiable intangible assets for impairment whenevents 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 connectionwith a write-down of goodwill and identifiable intangible assets due to changes in marketconditions. During the three months ended December 31, 2008, we did not incur any impairmentcharges. In addition, we have deferred tax assets which may not be fully realized, which maycontribute to additional losses. We are also required to record as compensation expense inaccordance 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 andpurchasing additional services as well as obtaining new customers.***     To maintain and grow our revenue, we must achieve and maintain high customer renewal rates for ourInternet and Mobile services. Our customers have no obligation to renew our products and servicesafter the term and therefore, they could cease using our services at any time. In addition, ourcustomers may renew for fewer services or at lower prices. Further, our customers may reduce theiruse of our services during the term of their subscription. We cannot project the level of renewalrates or the prices at which customers renew subscriptions. Our customer renewal rates and renewalprices may decline as a result of a number of factors, including competition, consolidations in theInternet 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 salesof additional services to our existing customers. Renewals by existing customers or purchases ofour services by new customers may be limited as companies limit or reduce their technology spendingin 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 renewalrates 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 coulddecline unless we are able to obtain additional customers or sources of revenue, sufficient toreplace lost revenue.***Our business could be harmed by adverse economic conditions or reduced spending on informationtechnology.***     Our operations and performance depend significantly on worldwide economic conditions. Uncertaintyabout current global economic conditions poses a risk as consumers and businesses may postponespending in response to tighter credit, negative financial news and/or declines in income or assetvalues, 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 othereconomic factors could have a material adverse effect on demand for our products and services. Thedecrease in consumer demand could have a variety of negative effects on our financial results, andin certain cases, may reduce our revenue, increase our costs, and lower our gross marginpercentage, or require us to recognize impairments of our assets. Our results could also differmaterially from our expectations since our international sales and expenses will be affected by theeffects of the strength of the U.S. dollar.***Our quarterly financial results are subject to significant fluctuations, and if our future resultsare 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 otheroperating results fall below our expectations, we may not be able to reduce our spending rapidly inresponse to the shortfall. Other factors that could affect our quarterly operating results includethose described below and elsewhere in this report: **•** Fluctuations of the foreign exchange rates used to prepare our consolidated financialstatements;  **•** 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;
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 **•** 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 weoffer for our existing customers in a particular quarter;  **•** Our ability to attract and retain new customers in a quarter, particularly largerenterprise customers;  **•** The timing and service period of orders received during a quarter;  **•** Our ability to successfully introduce new products and services to offset any reductionsin revenue from services that are not as widely used or that are experiencing decreaseddemand such as some of our Internet services;  **•** The level of sales of our Mobile products and services and timing of customer acceptanceduring the period;  **•** The timing and amount of professional services revenue, which is difficult to predictbecause this is dependent on the number of professional services engagements in any givenperiod, the size of these engagements, and our ability to continue our existing engagementsand 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, andcapital expenditures;  **•** The timing and amount, if any, of impairment charges related to potential write-down ofacquired assets in acquisitions or charges related to the amortization of intangible assetsfrom acquisitions.  **•** Future accounting pronouncements and changes in accounting policies; and  **•** Future macroeconomic conditions in our domestic and international markets, as well as thelevel of discretionary IT spending generally.     Due to these and other factors, we believe that period-to-period comparisons of our results ofoperations are not meaningful and should not be relied upon as indicators of our futureperformance. It is possible that in some future periods, our results of operations may be below theexpectations of public-market analysts and investors. If this occurs, the price of our common stockmay decline.***The market price of our common stock is volatile.***     The stock market in recent years has experienced significant price and volume fluctuations, and hasrecently experienced substantial declines and volatility that have affected the market prices oftechnology companies. These fluctuations have often been unrelated to or disproportionatelyimpacted by the operating performance of these companies. The market for our common stock may besubject to similar fluctuations. Factors such as fluctuations in our operating results,announcements of events affecting other companies in the technology industry, currency fluctuationsand general market conditions may cause the market price of our common stock to decline. Inaddition, because of the relatively low trading volume and the fact that we have 14.2 millionshares outstanding at December 31, 2008, our stock price could be more volatile than companies withhigher 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 couldbe materially adversely affected.***     We had $64.2 million of goodwill recorded on our condensed consolidated balance sheet as ofDecember 31, 2008. Goodwill represents the excess of cost over the fair market value of net assetsacquired in business combinations. If our market capitalization drops significantly below theamount of net equity recorded on our balance sheet, it could indicate a decline in the fair valueof the Company and would require us to further evaluate whether our goodwill has been impaired. Wealso perform an annual review, at September 30, of our goodwill to determine if it has becomeimpaired, in which case we would write down the impaired portion of our goodwill. We also evaluategoodwill for impairment whenever events or changes in circumstances indicate that the carryingamount may not be recoverable. If we were required to write down all or a significant part of ourgoodwill, 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 TransactionPerspective services have generated a majority of our total revenue in the past. Revenue from ourWeb site Perspective Services, a single page, single device measurement, has been decreasing. Ifrevenues from our Application Perspective and Transaction Perspective Services, multi page, multidevice measurements, do not continue to increase, we may not be able to increase our Internetrevenue and our operating results could suffer
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if we are not able to increase revenue from other services. Therefore, the success of our businesscurrently depends, and for the immediate future will continue to substantially depend on sales andrenewals of these Internet services***If our Mobile services decline, we may not be able to grow our revenue and our results ofoperations will be harmed.***     Revenue from our Mobile services has increased from approximately $5.3 million for the three monthsended 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 willcontinue to experience similar growth rates for this business in future periods. Future growth forthese 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 thelevel of demand for the types of services we offer; currency rates; adverse global economicconditions; and we may not be able to successfully compete against current or new competitors inthis area. Our business and our operating results could be harmed if we are not able to continue togrow revenue from our Mobile services.***Improvements to the infrastructure of the Internet and mobile networks could reduce or eliminatedemand for our Internet and Mobile services.***     The demand for our services could be reduced or eliminated if future improvements to theinfrastructure of the Internet or mobile networks lead companies to conclude that the measurementand evaluation of the performance of their Web sites and services is no longer important to theirbusiness. We believe that the vendors and operators that supply and manage the underlyinginfrastructure still look to improve the speed, availability, reliability and consistency of theInternet. If these vendors and operators succeed in significantly improving the performance ofthese 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 ouroperating results.***If we do not continually improve our services in response to technological changes, includingchanges to the Internet and mobile networks, we may encounter difficulties retaining existingcustomers and attracting new customers.***     The ongoing evolution of the Internet and mobile networks has led to the development of newtechnologies such as Internet telephony, wireless devices, wireless fidelity, and WI-FI networks.These developing technologies require us to continually improve the functionality, features andreliability of our services, particularly in response to offerings of our competitors. If we do notsucceed in developing and marketing new services that respond to competitive and technologicaldevelopments and changing customer needs, we may encounter difficulties retaining existingcustomers and attracting new customers.     We must also introduce any new services as quickly as possible. The success of new services dependson several factors, including proper definition of the scope of the new services and timelycompletion, introduction and market acceptance of our new services. If new Internet, networking ortelecommunication technologies or standards are widely adopted or if other technological changesoccur, we may need to expend significant resources to adapt our services to these developments orwe 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 andbreadth of the products and services that they offer. We face competition from companies that offerInternet 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 andmobile 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 tooffer all of the features we offer. As we expand the scope of our products and services, we expectto encounter many additional market-specific competitors.     In addition, Hewlett-Packard’s acquisition of Mercury Interactive, whom we had a relationship inthe past, could result in additional competition for us depending on which products and servicesthe combined company offers in the future. Furthermore, Hewlett-Packard may find additional usesfor services of Mercury Interactive which compete with our services, and as a result of itsacquisition of Mercury Interactive, it may not promote our services at the same level as it had inthe 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 similarto our services, but offer software or services related to Web analytics services, such asWebtrends, Omniture and Coremetrics, and free services that measure Web site availability. Inaddition, 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.
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     In the future, we intend to expand our service offerings and continue to measure and manage theperformance of emerging technologies such as Internet telephony, wireless devices, and wirelessfidelity, or WI-FI, networks and, as a result, could face competition from other companies. Some ofour existing and future competitors have or may have longer operating histories, larger customerbases, greater brand recognition in similar businesses, and significantly greater financial,marketing, technical and other resources. In addition, some of our competitors may be able todevote greater resources to marketing and promotional campaigns, to adopt more aggressive pricingpolicies, and to devote substantially more resources to technology and systems development.     There are also many experienced firms that offer computer network and Internet-related consultingservices. These consulting services providers include consulting companies, such as Accenture, aswell as consulting divisions of large technology companies such as IBM. Because we do not have anestablished 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 inselling these services.     Increased competition may result in price reductions, increased costs of providing our services andloss of market share, any of which could seriously harm our business. We may not be able to competesuccessfully against our current and future competitors.***A limited number of customers account for a significant portion of our revenue, and the loss of amajor customer could harm our operating results.***     Our ten largest customers accounted for approximately 39% and 32% of our total net revenue for thethree months ended December 31, 2008 and 2007. We cannot be certain that customers that haveaccounted for significant revenue in past periods, individually or as a group, will renew, will notcancel or will not reduce their services and, therefore, continue to generate revenue in any futureperiod. In addition, our customers that do not have written contracts or that have monthly renewalarrangements may terminate their services at any time with little or no penalty. If we lose a majorcustomer 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 growour business, including hiring additional sales personnel. Typically, additional sales personnelcan take time before they become productive, and our additional marketing programs may also taketime before they yield additional business, if any. We cannot assure you that these efforts will besuccessful, or that these investments will yield significantly increased sales in the near or longterm.***Our cash and cash equivalents and short-term investments are managed through various banks aroundthe world and the current capital and credit market conditions are extremely volatile, puttingpressure on the ability of banks to provide service levels and in some cases to fail, both of whichwould 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 recentmonths, the volatility and disruption have reached unprecedented levels and has pressured thesolvency of some financial institutions. These financial institutions, including banks, have haddifficulty timely performing regular services and in some cases have failed or otherwise beenlargely taken over by governments. We maintain our cash, cash equivalents and short-terminvestments with a number of financial institutions around the world. Should some or all of thesefinancial institutions fail, we would likely have a limited ability to quickly access our cashdeposited with such institutions. If we are unable to quickly access such funds, we may need toincrease our use of our lines of credit or access more expensive credit, if available. If we areunable to access our cash or if we access existing or additional credit or are unable to accessadditional credit, it could have a negative impact on our operations.     The current financial turmoil affecting the banking system and financial markets and thepossibility that financial institutions may consolidate or go out of business have resulted in atightening in the credit markets, a low level of liquidity in many financial markets, and extremevolatility in fixed income, credit, currency and equity markets. Other income and expense couldalso vary materially from expectations depending on gains or losses realized on the sale orexchange of financial instruments; impairment charges related to debt securities as well as equityand other investments; interest rates; and cash balances. The current volatility in the financialmarkets and overall economic uncertainty increases the risk that the actual amounts realized in thefuture on our financial instruments could differ significantly from the fair values currentlyassigned to them. Uncertainty about current global economic conditions could also continue toincrease the volatility of our stock price.***If we do not complement our direct sales force with relationships with other companies to helpmarket our services, we may not be able to grow our business.***     To increase sales of services worldwide, we must complement our direct sales force withrelationships with companies to help market and sell our services to their customers. If we areunable to maintain our existing marketing and distribution relationships, or fail to enter intoadditional relationships, we may have to devote substantially more resources to the direct sale andmarketing of our services.
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     We would also lose anticipated revenue from customer referrals and other co-marketing benefits. Inthe past, we have had to terminate relationships with some of our international resellers, and wemay be required to terminate other reseller relationships in the future. As a result, we may haveto commit resources to supplement our direct sales effort to find additional resellers in foreigncountries.     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 exclusivemarketing or distribution rights. Therefore, they could reduce their commitment to us at any timein the future. Many of these companies have multiple relationships and they may not regard us assignificant for their business. In addition, these companies generally may terminate theirrelationships with us, pursue other relationships with our competitors or develop or acquireproducts or services that compete with our services. Even if we succeed in entering into theserelationships, 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 ourbusiness.***     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 substantialcompetition for highly skilled employees. If we fail to attract and retain key employees, ourbusiness 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 thethree months ended December 31, 2008 and 2007, respectively. Professional services revenue hasincreased in absolute dollars, but has decreased as a percentage of total net revenue. We will needto successfully market these services in order to increase professional services revenue. Themarket for these services is very competitive. Each professional services engagement typicallyspans a one- to three-month period, and therefore, it is more difficult for us to predict theamount of professional services revenue recognized in any particular quarter. Our business whichincludes our operating results could be harmed if we cannot increase our professional servicesrevenue.***The success of our business depends on the continued use of the Internet and mobile networks bybusiness 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 mobilenetworks must continue to be used as a means of electronic business, and communications. Inaddition, we believe that the use of the Internet and mobile networks for conducting business couldbe hindered for a number of reasons, including, but not limited to: **•** security concerns including the potential for fraud or theft of stored data andinformation communicated over the Internet and mobile networks;  **•** inconsistent quality of service, including outages of popular Web sites and mobilenetworks;  **•** 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 haveoccasionally given credits to customers as a result of past problems with our service. Despite ourtesting, 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 marketacceptance, diversion of development resources, injury to our reputation, increased insurance costsor 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 atthe level we or our customers expect.     These problems could also result in tort or warranty claims. Although we attempt to reduce the riskof losses resulting from any claims through warranty disclaimers and liability-limitation clausesin 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 notadequately cover us for claims. If a court refused to enforce the liability-limiting provisions ofour contracts for any reason, or if liabilities arose that were not contractually limited oradequately covered by insurance, we could be required to pay damages.
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***A disruption to our network infrastructure could impair our ability to serve and retain existingcustomers or attract new customers***     All data collected from our measurement computers are generally stored in and distributed from ouroperations center, which we maintain at a single location. Our operations depend upon our abilityto maintain and protect our computer systems, most of which are located at our corporateheadquarters in San Mateo, California, which is an area susceptible to earthquakes and possiblepower outages. We have occasionally experienced outages of our services in the past and if weexperience power outages at our operations centers, we might not be able to promptly receive datafrom our measurement computers and we might not be able to deliver our services to our customers ona timely basis.     Although we maintain insurance against fires, earthquakes and general business interruptions, theamount of coverage may not be adequate in any particular case. If our operations centers isdamaged, this could disrupt our services, which could impair our ability to retain existingcustomers or attract new customers.     Any outage for any period of time or loss of customer data could cause us to lose customers. Ouroperations systems are also vulnerable to damage from break-ins, computer viruses, unauthorizedaccess, vandalism, fire, floods, earthquakes, power loss, telecommunications failures and similarevents. 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 requiredto expend significant capital and resources to protect against, or to alleviate, problems caused byhackers. We may not have a timely remedy against a hacker who is able to breach our networksecurity. In addition to intentional security breaches, the inadvertent transmission of computerviruses 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 arelocated at facilities that are not owned by our customers or us. Instead, these devices areinstalled at locations near various Internet access points worldwide. We do not own or operate thefacilities, 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 facilitieswhere our measurement computers are located. We may have to find new locations for these computersif we are unable to develop relationships with these companies or if these companies cease theiroperations as some have done due to bankruptcies or are acquired. In addition, if our measurementcomputers and mobile devices cease to function properly, we may not be able to repair or servicethese computers on a timely basis, as we may not have immediate access to our measurement computersand measurement devices. Our ability to collect data in a timely manner could be impaired if we areunable 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 andother intellectual property rights. We could become subject to intellectual property infringementclaims 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 theordinary course of our business. Any of these claims, even if not meritorious, could be expensiveand divert management’s attention from operating our company. If we become liable to others forinfringement of their intellectual property rights, we could be required to pay a substantialdamage award and to develop noninfringing technology, obtain a license or cease selling theservices that contain the infringing intellectual property. We may be unable to developnon-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 toadditional risks associated with international operations.***     We derive a significant portion of our revenue and earnings from our international operations. As aresult, our financial condition and operating results could be significantly affected by risksassociated with international activities, including economic and labor conditions, politicalinstability, tax laws (including U.S. taxes on foreign subsidiaries and the negative taximplications related to moving cash from international locations to the U.S.), and changes in thevalue of the U.S. dollar versus local currencies. Margins on sales of our products and services inforeign countries could be materially adversely affected by foreign currency exchange ratefluctuations.
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     Our primary exposure to movements in foreign currency exchange rates relate mainly tonon-U.S. dollar denominated sales in Europe, as well as non-U.S. dollar denominated operatingexpenses incurred throughout the world. Weakening of foreign currencies relative to the U.S. dollarwill 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 foreigncurrency-denominated sales and earnings.     International sales were approximately 42% and 36% our total net revenue for the three months endedDecember 31, 2008 and 2007, respectively. We expect to continue to commit our resources to expandour international sales and marketing activities. Conducting international operations subjects usto 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 accountsreceivable;  **•** difficulties in managing and staffing international operations;  **•** potentially adverse tax consequences, including restrictions on the repatriation ofearnings;  **•** 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 doingbusiness.     The Internet may not be used as widely in other countries and the adoption of e-business may evolveslowly or may not evolve at all. As a result, we may not be successful in selling our services tocustomers 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 expectthis trend to continue as companies attempt to strengthen or hold their market positions in anevolving 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. Webelieve that industry consolidation may result in stronger competitors that are better able tocompete for customers. This could lead to more variability in operating results and could have amaterial 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 amajor customer could harm our revenue.***Failure to maintain effective internal controls may cause us to delay filing our periodic reportswith the SEC and adversely affect our stock price.***     The SEC, as directed by Section 404 of the Sarbanes-Oxley Act of 2002, adopted rules requiringpublic companies to include a report of management on internal control over financial reporting intheir annual reports on Form 10-K that contain an assessment by management of the effectiveness ofthe Company’s internal control over financial reporting. In addition, our independent registeredpublic accounting firm must attest to and report on the effectiveness of our internal control overfinancial reporting. Although we review our internal control over financial reporting in order toensure compliance with the Section 404 requirements, our failure to maintain adequate internalcontrols over financial reporting could result in an adverse reaction in the financial marketplacedue to a loss of investor confidence in the reliability of our financial statements, whichultimately could negatively impact our stock price.
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***We may face difficulties assimilating, and may incur costs associated with, any futureacquisitions.***     We have completed several acquisitions, and as a part of our business strategy we may seek toacquire or invest in additional businesses, products or technologies that we feel could complementor expand our business, augment our market coverage, enhance our technical capabilities or that mayotherwise 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 unknownliabilities;  **•** 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 orto our customer base;  **•** adverse effects on existing business relationships with resellers of our services, ourcustomers 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 usedto 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 benefitour stockholders.***     Our amended and restated certificate of incorporation and bylaws contain provisions that could makeit 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 forconsideration at annual meetings and for stockholder nominations for the election ofdirectors; and  **•** special meetings of our stockholders may be called only by our Board of Directors, theChairman of the Board, our Chief Executive Officer or our President, not by ourstockholders.     We have also adopted a stockholder rights plan that may discourage, delay or prevent a change ofcontrol and make any future unsolicited acquisition attempt more difficult. The rights will becomeexercisable only upon the occurrence of certain events specified in the rights plan, including theacquisition of 20% of our outstanding common stock by a person or group. In addition, it is thepolicy of our Board of Directors that a committee consisting solely of independent directors willreview the rights plan at least once every three years to consider whether maintaining the rightsplan continues to be in the best interests of Keynote and our stockholders. The Board may amend theterms 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 tomeet our capital requirements for at least the next 12 months. However, if cash is required forunanticipated needs, we may need additional capital during that period. If the market for ourproducts develops at a slower pace than anticipated, we could be required to raise substantialadditional capital. We cannot be certain that additional capital will be available to us onfavorable terms, or at all. If we were unable to raise additional capital when required, ourbusiness could be seriously harmed.
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***If the protection of our proprietary technology is inadequate, our competitors may gain access toour technology, and our market share could decline.***     Our success is heavily dependent on our ability to create proprietary technology and to protect andenforce our intellectual property rights in that technology, as well as our ability to defendagainst 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 contractualprovisions, confidentiality procedures, trade secrets, copyright and trademark laws, and patents.Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copyaspects of our products or obtain and use information that we regard as proprietary. Policingunauthorized use of our products is difficult. In addition, the laws of some foreign countries donot protect our proprietary rights to as great an extent as do the laws of the United States. Ourmeans of protecting our proprietary rights may not be adequate and unauthorized third parties,including our competitors, may independently develop similar or superior technology, duplicate orreverse engineer aspects of our products, or design around our patented technology or otherintellectual property.     There can be no assurance or guarantee that any products, services or technologies that we arepresently developing, or will develop in the future, will result in intellectual property that issubject to legal protection under the laws of the United States or a foreign jurisdiction and thatproduces 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.
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**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 PeriodicReport by Chief ExecutiveOfficer under Section 302 ofthe Sarbanes-Oxley Act of 2002         X           31.2 Certification of PeriodicReport by Chief FinancialOfficer under Section 302 ofthe Sarbanes-Oxley Act of 2002         X           32.1 Certification of ChiefExecutive Officer Pursuant to18 U.S.C. Section 1350 asAdopted Pursuant to Section 906of the Sarbanes-Oxley Act of2002 *         X           32.2 Certification of ChiefFinancial Officer Pursuant to18 U.S.C. Section 1350 asAdopted Pursuant to Section 906of the Sarbanes-Oxley Act of2002 *         X * As contemplated by SEC Release No. 33-8212, these exhibits arefurnished with this Quarterly Report on Form 10-Q and are not deemedfiled with the Securities and Exchange Commission and are notincorporated by reference in any filing of Keynote Systems, Inc. Underthe Securities Act of 1933 or the Securities Act of 1934, whether madebefore or after the date hereof and irrespective of any generalincorporation language in such filings.
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**SIGNATURES**Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned, thereunto duly authorized, in the Cityof San Mateo, State of California, on this 6th day of February 2009.       **KEYNOTE SYSTEMS, INC.**       By:  /s/ UMANG GUPTA