UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

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

Commission File Number: 000-27241

KEYNOTE SYSTEMS, INC.

Delaware		94-3226488
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
777 Mariners Island Blvd., San Mateo, CA		94404
(Address of principal executive offices)		(Zip Code)

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

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

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

Large accelerated filer o		Accelerated filer 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 the Exchange Act.): YES o NO þ

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

	Class			Shares outstanding as of August 4, 2010
	Common Stock, $.001 par value			14,931,559 shares

 

 

KEYNOTE SYSTEMS, INC.

		Page
PART I—FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements			3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			24
Item 3. Quantitative and Qualitative Disclosures About Market Risk			37
Item 4. Controls and Procedures			37
PART II—OTHER INFORMATION
Item 1. Legal Proceedings			38
Item 1A. Risk Factors			39
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			48
Item 3. Defaults Upon Senior Securities			48
Item 4. (Reserved)			48
Item 5. Other Information			48
Item 6. Exhibits			48
Signatures			49
EX-10.1
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I—FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
Index to Unaudited Condensed Consolidated Financial Statements

		Page
Condensed Consolidated Balance Sheets as of June 30, 2010 and September 30, 2009			4
Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2010 and 2009			5
Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2010 and 2009			6
Notes to Condensed Consolidated Financial Statements			7

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)

		June 30,				September 30,
		2010				2009
ASSETS
Current assets:
Cash and cash equivalents		$	23,480			$	51,383
Short-term investments			36,883				6,585
Total cash, cash equivalents and short-term investments			60,363				57,968
Accounts receivable, less allowance for doubtful accounts of $5 and $112, respectively, and less billing reserve of $399 and $150, respectively			8,347				6,403
Prepaids, deferred costs and other current assets			3,625				3,517
Inventories			1,232				1,222
Deferred tax assets			2,631				2,913
Total current assets			76,198				72,023
Deferred costs and other long-term assets			1,848				3,024
Property, equipment and software, net			33,850				34,778
Goodwill			59,069				66,078
Identifiable intangible assets, net			4,356				6,255
Long-term deferred tax assets			227				61
Total assets		$	175,548			$	182,219
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	1,319			$	1,147
Accrued expenses			8,393				8,466
Deferred revenue			16,748				17,661
Total current liabilities			26,460				27,274
Deferred rent and other long-term liabilities			3,394				3,344
Long-term deferred revenue			1,712				1,167
Long-term deferred tax liability			457				414
Total liabilities			32,023				32,199
Commitments and contingencies (see Note 14)
Stockholders’ equity:
Common stock			15				14
Additional paid-in capital			286,054				282,653
Accumulated deficit			(139,092	)			(139,614	)
Accumulated other comprehensive income (loss)			(3,452	)			6,967
Total stockholders’ equity			143,525				150,020
Total liabilities and stockholders’ equity		$	175,548			$	182,219

See accompanying notes to the condensed consolidated financial statements.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)

		Three Months Ended								Nine Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Net revenue:
Subscription services		$	11,950			$	11,455			$	35,831			$	34,269
Ratable licenses			5,159				6,390				16,906				18,348
Professional services			2,164				2,324				6,601				7,753
Total net revenue			19,273				20,169				59,338				60,370
Costs and expenses:
Costs of revenue:
Direct costs of subscription services			2,109				2,098				6,446				6,673
Direct costs of ratable licenses			1,677				1,424				5,129				4,551
Direct costs of professional services			1,457				1,293				4,275				4,466
Development			2,968				2,863				9,084				9,137
Operations			1,935				1,943				5,761				6,353
Amortization of intangible assets — software			433				290				1,166				866
Total costs of revenue			10,579				9,911				31,861				32,046
Sales and marketing			6,296				5,665				19,000				18,162
General and administrative			2,652				2,346				7,830				7,717
Excess occupancy income			(323	)			(258	)			(942	)			(729	)
Amortization of intangible assets — other			146				259				484				791
Total costs and expenses			19,350				17,923				58,233				57,987
Income (loss) from operations			(77	)			2,246				1,105				2,383
Interest income			96				157				299				744
Other income (expense), net			(143	)			(53	)			(93	)			403
Income (loss) before provision for income taxes			(124	)			2,350				1,311				3,530
Provision for income taxes			(191	)			(258	)			(789	)			(810	)
Net income (loss)		$	(315	)		$	2,092			$	522			$	2,720
Net income (loss) per share:
Basic		$	(0.02	)		$	0.15			$	0.04			$	0.19
Diluted		$	(0.02	)		$	0.15			$	0.04			$	0.19
Shares used in computing basic and diluted net income (loss) per share:
Basic			14,799				14,378				14,640				14,274
Diluted			14,799				14,403				14,905				14,321
Cash dividends declared per common share		$	0.05			$	—			$	0.15			$	—

See accompanying notes to the condensed consolidated financial statements.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)

		Nine Months Ended
		June 30,
		2010				2009
Cash flows from operating activities:
Net income		$	522			$	2,720
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			3,381				3,864
Stock-based compensation			2,547				3,400
Amortization of identifiable intangible assets			1,650				1,657
Amortization of prepaid tax asset			542				326
Charges to bad debt and billing reserves			218				254
Amortization of debt investment premium			500				3
Deferred tax provision (benefit)			(313	)			40
Collection of tax credit receivable within deferred tax assets			—				489
Loss on disposal of equipment			8				—
Changes in operating assets and liabilities:
Accounts receivable			(2,827	)			907
Inventories			(252	)			198
Prepaids, deferred costs and other assets			(131	)			(1,442	)
Accounts payable and accrued expenses			481				(6,441	)
Deferred revenue			1,600				1,445
Net cash provided by operating activities			7,926				7,420
Cash flows from investing activities:
Purchases of short-term investments			(45,791	)			(15,918	)
Maturities and sales of short-term investments			14,062				12,364
Purchases of property, equipment and software			(2,389	)			(2,596	)
Payment of acquisition costs for Zandan S.A.			—				(170	)
Net cash used in investing activities			(34,118	)			(6,320	)
Cash flows from financing activities:
Repayment of capital lease obligation			(14	)			(12	)
Repayment of notes payable			—				(248	)
Proceeds from issuance of common stock and exercise of stock options			2,993				2,282
Cash dividends declared and paid			(2,201	)			—
Net cash provided by financing activities			778				2,022
Effect of exchange rate changes on cash and cash equivalents			(2,489	)			(388	)
Net change in cash and cash equivalents			(27,903	)			2,734
Cash and cash equivalents at beginning of the period			51,383				42,546
Cash and cash equivalents at end of the period		$	23,480			$	45,280
Supplemental cash flow disclosure:
Income taxes paid (net of refunds)		$	339			$	4,276
Noncash operating and investing activities:
Exercise of non-employee stock options		$	81			$	—
Acquisition of property, equipment and software on account		$	307			$	23

See accompanying notes to the condensed consolidated financial statements.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

(1) Summary of Significant Accounting Policies

Basis of Presentation

     The accompanying unaudited condensed consolidated balance sheets, and condensed consolidated statements of operations and cash flows reflect all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position of Keynote Systems, Inc. and subsidiaries (the “Company”) as of June 30, 2010, and the results of operations and cash flows for the interim periods ended June 30, 2010 and 2009.

     The results of operations and cash flows for any interim period are not necessarily indicative of the results to be expected for any other future interim period or for the full year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended September 30, 2009 included in the Company’s Report on Form 10-K as filed with the SEC. The condensed consolidated financial statements include the accounts of the Company and its domestic and foreign subsidiaries. Intercompany balances have been eliminated in consolidation.

     The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Significant estimates made in preparing the condensed consolidated financial statements relate to revenue recognition, the allowance for doubtful accounts and billing reserve, inventories and inventory valuation, allocation of purchase price for business combinations, useful lives of property, equipment, software and identifiable intangible assets, asset impairments, the fair values of options granted under the Company’s stock-based compensation plans and valuation allowances for deferred tax assets. Actual results could differ from those estimates, and such differences may be material to the financial statements. Certain prior year amounts in the condensed consolidated financial statements and notes thereto have been reclassified to conform to the current period’s presentation, including classifying the current portion of capital lease obligation in accrued expenses (see Note 7 and Note 15).

Recently Adopted Accounting Pronouncements

     In February 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010-09, Subsequent Events (Topic 855)—Amendments to certain Recognition and Disclosure Requirements (ASU 2010-09) to remove the requirement of disclosing the date through which subsequent events have been evaluated in order to remedy potential conflicts with other requirements. However, in accordance with ASC 855 and existing SEC rules, subsequent events are still required to be evaluated through the date the financial statements are issued.

     In January 2010, the FASB issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the transfers of assets and liabilities between Level 1 (quoted prices in active market for identical assets or liabilities) and Level 2 (significant other observable inputs) of the fair value measurement hierarchy, including the reasons and the timing of the transfers. Additionally, the guidance requires a roll-forward of activities on purchases, sales, issuance, and settlements of the assets and liabilities measured using significant unobservable inputs (Level 3 fair value measurements). The guidance became effective for the Company with the reporting period beginning January 1, 2010, except for the disclosure on the roll-forward activities for Level 3 fair value measurements, which will become effective for its reporting period beginning July 1, 2011. Adoption of this new guidance had no impact on the Company’s condensed consolidated financial position, results of operations and cash flows.

     During the first quarter of 2009, the Company adopted FASB Accounting Standards Codification (“ASC”) 820, Fair Value Measurements and Disclosures (formerly referenced as Statement of Financial Accounting Standards (“SFAS”) No. 157, Fair Value Measurements), which defines fair value, provides a framework for measuring fair value, and expands the disclosures required for fair value measurements. In February 2008, the FASB issued supplemental guidance that delays the effective date of this new fair value accounting standard to fiscal years beginning after November 15, 2008 for all non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), which the Company adopted in the first quarter of 2010. Adoption of this supplemental guidance to the accounting standard had no material impact on the Company’s condensed consolidated financial position, results of operations and cash flows.

     During the first quarter of 2010, the Company adopted FASB ASC 805, Business Combinations (formerly referenced as SFAS No. 141 (revised 2007), Business Combinations), which establishes principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree in a business combination. This new accounting standard also establishes principles regarding how goodwill acquired in a business combination or a gain from a bargain purchase should be recognized and measured, as well as provides guidelines on the disclosure requirements on the nature and financial impact of the business combination. In April 2009, the FASB amended this new accounting standard to require that assets acquired and liabilities assumed in a business combination that arise from contingencies be recognized at fair value, if the fair value can be determined during the measurement period. This new business combination accounting standard will apply prospectively to any future business combinations. The effect of adoption of this new accounting pronouncement on the Company’s financial condition or operating results will depend on the nature of acquisitions completed after the date of adoption.

Recently Issued Accounting Pronouncements

     In September 2009, the FASB amended the ASC as summarized in ASU 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements, and ASU 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements. As summarized in ASU 2009-14, ASC Topic 985 has been amended to remove from the scope of industry specific revenue accounting guidance for software and software related transactions, tangible products containing software components and non-software components that function together to deliver the product’s essential functionality. As summarized in ASU 2009-13, ASC Topic 605 has been amended (1) to provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and the consideration allocated; (2) to require an entity to allocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence (“VSOE”) or third-party evidence of selling price; and (3) to eliminate the use of the residual method and require an entity to allocate revenue using the relative selling price method. The accounting changes summarized in ASU 2009-14 and ASU 2009-13 are both effective for fiscal years beginning on or after June 15, 2010, with early adoption permitted. Adoption may either be on a prospective basis or by retrospective application. The Company is currently assessing the impact of these amendments to the ASC, which will be adopted on the first day of fiscal 2011, on its accounting and reporting systems and processes; however, at this time the Company is unable to quantify the impact on its financial statements of its adoption or determine the timing and method of its adoption.

Stock Based Compensation

     (a) Summary of Plans

     As of June 30, 2010, the Company was authorized to issue up to approximately 8.3 million shares of common stock under its 1999 Equity Incentive Plan (“Incentive Plan”) to employees, directors, and consultants, including nonqualified and incentive stock options, restricted stock units (“RSUs”), and stock bonuses. Options expire ten years after the date of grant. Vesting periods are determined by the Board of Directors and generally, in the case of stock options, provide for shares to vest over a period of four years with 25% of the shares vesting one year from the date of grant and the remainder vesting monthly over the next three years. RSUs generally vest in full three years from the date of grant. As of June 30, 2010, options to purchase approximately 4.3 million shares and approximately 430,000 RSUs were outstanding under the Incentive Plan. Approximately 1.2 million shares were available for future issuance under the Incentive Plan as of June 30, 2010.

     As of June 30, 2010, the Company had reserved a total of approximately 1.4 million shares of common stock for issuance under its 1999 Employee Stock Purchase Plan (“Purchase Plan”). Under the Purchase Plan, eligible employees may defer an amount not to exceed 10% of the employee’s compensation, as defined in the Purchase Plan, to purchase common stock of the Company. The purchase price per share is 85% of the lesser of the fair market value of the common stock on the first day of the applicable offering period or the last day of each purchase period. The Purchase Plan is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code. As of June 30, 2010, approximately 1.2 million shares had been issued under the Purchase Plan, and approximately 210,000 shares remain for future issuance.

     (b) Restricted Stock Units

     Prior to fiscal 2009, the Company used equity awards in the form of stock options as one of the means for recruiting and retaining highly skilled talent. In fiscal 2009, the Company began issuing primarily RSUs rather than stock options for eligible employees as the primary type of long-term equity-based award. Stock-based compensation cost for RSUs is measured based on the value of the Company’s stock on the grant date, reduced by the present value of the dividend yield expected to be paid on the Company’s common

stock. Upon vesting, the RSUs are generally net share-settled to cover the required withholding tax and the remaining amount is converted into an equivalent number of shares of common stock.

     There were approximately 37,000 RSUs cancelled due to departures during the nine months ended June 30, 2010. Approximately 430,000 and 470,000 RSUs were outstanding at June 30, 2010 and September 30, 2009, respectively, with a weighted average grant date fair value of $9.06 and $8.88 per unit, respectively.

     As of June 30, 2010, there was approximately $2.0 million of total unrecognized compensation cost (net of estimated forfeitures) related to nonvested RSUs that is expected to be recognized over a weighted average period of 2.0 years.

     (c) Stock Options

     The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model. Weighted-average assumptions for options granted under the Incentive Plan are as follows:

		Three Months Ended								Nine Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Volatility			—				46.8	%			—				42.9	%
Risk free interest rate			—				1.9	%			—				2.2	%
Expected life (in years)			—				4.5				—				4.5
Dividend yield			—				—				—				—

     A summary of option activity for the nine months ended June 30, 2010 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, 2009			4,802			$	11.65				5.8			$	820
Granted			—				—
Exercised			(269	)			8.96
Forfeited or canceled			(61	)			12.44
Expired			(193	)			13.70
Outstanding at June 30, 2010			4,279			$	11.72				4.9			$	376
Vested and expected to vest at June 30, 2010			4,225			$	11.72				4.9			$	373
Exercisable at June 30, 2010			3,757			$	11.68				4.6			$	355

     The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value that would have been received by the options holders had they exercised all their options on June 30, 2010. The aggregate intrinsic value of options exercised during the three and nine months ended June 30, 2010 was approximately $558,000 and $604,000, respectively.

     As of June 30, 2010, there was approximately $1.1 million of total unrecognized compensation cost (net of estimated forfeitures) related to nonvested stock options that are expected to be recognized over a weighted average period of 1.4 years.

     (d) Employee Stock Purchase Plan

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

		Three Months Ended								Nine Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Volatility			64.8	%			58.4	%			63.6	%			53.4	%
Risk free interest rate			0.5	%			0.6	%			0.6	%			1.2	%
Expected life (in years)			1.25				1.25				1.25				1.25
Dividend yield			0.1	%			—				—				—

     (e) Stock based Compensation Expense

     Stock based compensation under ASC 718, Compensation – Stock Compensation, related to employee stock options, restricted stock units and employee stock purchase rights was reflected in the condensed consolidated statements of operations as follows (in thousands):

		Three Months Ended								Nine Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Direct costs of ratable licenses		$	12			$	27			$	61			$	51
Direct costs of professional services			81				65				258				391
Development			199				171				604				745
Operations			102				91				328				424
Sales and marketing			299				285				936				1,216
General and administrative			64				123				360				573
Total		$	757			$	762			$	2,547			$	3,400

     For the nine months ended June 30, 2009, stock-based compensation expense included a $601,000 expense related to the cancellation in March 2009 of the Company’s Chief Executive Officer’s option to purchase 400,000 shares of its common stock at $14.99 per share, which was approximately 67% vested at the date of cancellation. Another option granted to the Company’s Chief Executive Officer to purchase 300,000 shares of common stock at an exercise price of $70.00 per share was also cancelled in March 2009. No expense was recorded for this cancellation given that the option was fully vested at the date of the cancellation.

Excess Occupancy Income

     Excess occupancy income consists of rental income from the leasing of space not occupied by the Company in its headquarters building, net of related fixed costs, such as property taxes, insurance, building depreciation, leasing broker fees and tenant improvement amortization. Property taxes, insurance and building depreciation are based upon actual square footage available to lease to third parties, which was approximately 75% for the three and nine months ended June 30, 2010 and 2009. Rental income was approximately $695,000 and $652,000 for the three months ended June 30, 2010 and 2009, respectively. Rental income was approximately $2.1 million and $1.9 million for the nine months ended June 30, 2010 and 2009, respectively. As of June 30, 2010, the Company had leased space to 12 tenants, of which 11 had noncancellable operating leases, which expire on various dates through 2014. At June 30, 2010 future minimum rents receivable under the leases, are as follows (in thousands):

		Total
Fiscal years:
2010 (remaining three months)		$	672
2011			2,599
2012			1,823
2013			430
2014			89
Thereafter			—
Total future minimum rents receivable		$	5,613

(2) Revenue Recognition

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

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

	•		Fee is fixed or determinable. The Company considers the fee to be fixed or determinable if the fee is not subject to refund or adjustment and payment terms are standard.
	•		Collection is deemed reasonably assured. Collection is deemed reasonably assured if it is expected that the customer will be able to pay amounts under the arrangement as payments become due. If it is determined that collection is not reasonably assured, then revenue is deferred and recognized upon cash collection.

     The Company does not generally grant refunds. All discounts granted reduce revenue. Free trials are occasionally provided to prospective customers who would like to try certain of the Company’s subscription services before they commit to purchasing the services. The services provided during the trial period are typically stand-alone transactions and are not bundled with other services. Revenue is not recognized for these free trial periods.

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

     Subscription services revenue is recognized in accordance with ASC 605-25-30 (formerly referenced as Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition) and ASC 605-25-30 (formerly referenced as Emerging Issues Task Force (“EITF”) Issue 00-21, Revenue Arrangements with Multiple Deliverables).

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

     For customers that are billed the entire amount of their subscription in advance, subscription services revenue is deferred upon invoicing and is recognized ratably over the service period, generally ranging from one to twelve months, commencing on the day service is first provided. For customers that are billed on a monthly basis, revenue is recognized monthly based upon actual service usage for the month. Regardless of when billing occurs, the Company recognizes revenue as services are provided and defers any revenue that is unearned.

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

     Ratable Licenses Revenue: Ratable licenses revenue consists of fees from the sale of mobile automated test equipment, maintenance, engineering and consulting services associated with Keynote SIGOS System Integrated Test Environment (“SITE”). The Company frequently enters into multiple element arrangements with mobile customers for the sale of its automated test equipment, including software licenses, hardware, consulting services to configure the hardware and software (implementation or integration services), post contract support (maintenance) services, training services and minor other consulting services. These multiple element arrangements are within the scope of ASC 985-605-15 and ASC 985-605-15-3 (formerly referenced as Statement of Position No. 97-2, Software Revenue Recognition and EITF Issue 03-5, Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software, respectively). This determination is based on the hardware component of the Company’s multiple element arrangements being deemed to include a software related element. In addition, customers do not purchase the hardware without also purchasing the software. In other words, the software and hardware are sold together as a package, with payments due from customers upon delivery.

     None of the Keynote SIGOS implementation/integration services provided by the Company are considered to be essential to the functionality of the licensed products. This assessment is due to the implementation/integration services being performed during a relatively short period (generally within two to three months) compared to the length of the arrangement which typically ranges from twelve to thirty-six months. Additionally, the implementation/integration services are general in nature and the Company has a history of successfully gaining customer acceptance.

     The Company cannot allocate the arrangement consideration to the multiple elements based on vendor specific objective evidence (“VSOE”) of fair value because sufficient evidence of VSOE does not exist for the undelivered elements of the arrangement, typically

maintenance. Therefore, the Company recognizes the entire arrangement fee into revenue ratably over the maintenance period, historically ranging from twelve to thirty-six months, once the implementation and integration services are completed, usually within two to three months following the delivery of the hardware and software. Where acceptance provisions exist, the ratable recognition of revenue begins when evidence of customer acceptance of the software and hardware has occurred as intended under the respective arrangement’s contractual terms.

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

     The Company also enters into multiple element arrangements, which generally consist of either: 1) the combination of subscription and professional services, or 2) multiple professional services. For these arrangements, the Company recognizes revenue in accordance with ASC 605-25-30. The Company has been unable to establish objective evidence of fair value of the undelivered elements for such arrangements. Consequently, the entire arrangement fee is recognized ratably over the applicable performance period.

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

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

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

     The Company reports comprehensive income (loss) in accordance with the provisions of ASC 220 (formerly referenced as SFAS No. 130, Reporting Comprehensive Income), which establishes standards for reporting comprehensive income and its components in the financial statements. The components of comprehensive income consist of net income (loss), unrealized gains and losses on available-for-sale investments and foreign currency translation. The unrealized gains and losses on available-for-sale investments and foreign currency translation are excluded from earnings and reported as a component of stockholders’ equity. The foreign currency translation adjustment results from subsidiaries not using the United States dollar as their functional currency since the majority of their economic activities are primarily denominated in their applicable local currency. The Company’s subsidiaries located in Germany, the Netherlands and France have a functional currency other than the United States dollar. Accordingly, all assets and liabilities related to these operations are translated at the current exchange rates at the end of each period. Revenues and expenses are translated at average exchange rates in effect during the period. The resulting cumulative translation adjustments are recorded directly to the accumulated other comprehensive income (loss) account in stockholders’ equity. Gains (losses) from foreign currency transactions are reflected in other income (expense), net in the condensed consolidated statements of operations as incurred and were approximately ($143,000) and ($51,000) for the three months ended June 30, 2010 and 2009, respectively. Gains (losses) from foreign currency transactions were ($93,000) and $379,000 for the nine months ended June 30, 2010 and 2009, respectively.

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

		Three Months Ended								Nine Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Net income (loss)		$	(315	)		$	2,092			$	522			$	2,720
Net unrealized gain (loss) on available-for-sale investments			(6	)			1				(39	)			13
Foreign currency translation gain (loss)			(5,473	)			3,518				(10,379	)			(465	)
Other comprehensive income (loss)		$	(5,794	)		$	5,611			$	(9,896	)		$	2,268

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

(4) Financial Instruments and Concentration of Risk

     The carrying value of the Company’s cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximates fair market value due to their short-term nature. Under ASC 820, Fair Value Measurements and Disclosures, the Company presents its short-term investments at fair market value (see Note 6). Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments and accounts receivable.

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

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

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

     For the three and nine months ended June 30, 2010 and 2009 no single customer accounted for 10% or more of total net revenue. As of June 30, 2010, no customer accounted for more than 10% of total net accounts receivable. As of September 30, 2009, one customer accounted for more than 10% of total net accounts receivable, of which the entire amount has been collected.

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

     The Company considers all highly liquid investments held at major banks, commercial paper, money market funds and other securities with original maturities of three months or less to be cash equivalents in accordance with ASC 230-10, Statement of Cash Flows (formerly referenced as SFAS No. 95).

     The Company classifies all of its investments as available-for-sale at the time of purchase since it is management’s intent that these investments are available for current operations, and includes these investments on its balance sheet as short-term investments. These investments consist of fixed-term deposits with original maturities longer than three months and investment-grade corporate and government debt securities with Moody’s ratings of A2 or better. Investments classified as available-for-sale are recorded at fair market value with the related unrealized gains and losses included in accumulated other comprehensive income (loss), a component of stockholders’ equity. Realized gains and losses are recorded based on specific identification.

     The following table summarizes the Company’s cash and cash equivalents and short-term investments as of June 30, 2010 (in thousands):

						Gross				Gross
		Amortized				Unrealized				Unrealized				Estimated
		Cost				Gains				Losses				Market Value
Cash		$	15,470			$	—			$	—			$	15,470
Money market funds			8,010				—				—				8,010
Total cash and cash equivalents		$	23,480			$	—			$	—			$	23,480
Fixed-term deposits		$	8,560			$	—			$	—			$	8,560
Treasuries and agencies			4,604				2				—				4,606
Municipal and corporate bonds			23,758				11				(52	)			23,717
Total short-term investments		$	36,922			$	13			$	(52	)		$	36,883

     The following table summarizes the Company’s cash and cash equivalents and short-term investments as of September 30, 2009 (in thousands):

						Gross				Gross
		Amortized				Unrealized				Unrealized				Estimated
		Cost				Gains				Losses				Market Value
Cash		$	20,492			$	—			$	—			$	20,492
Money market funds			30,891				—				—				30,891
Total cash and cash equivalents		$	51,383			$	—			$	—			$	51,383
Fixed-term deposits		$	6,585			$	—			$	—			$	6,585
Total short-term investments		$	6,585			$	—			$	—			$	6,585

     The Company utilized the guidance and procedures in ASC 820-10 and ASC 820-10-15 to determine the fair value of financial instruments. The Company determined that the gross unrealized loss on investments represents a temporary impairment based on the guidance in ASC 320-10-35-18 through 35-34E, Investments—Debt and Equity Securities, Recognition and Measurement, Impairment. ASC 320-10-35-33A through 35-33I provide three conditions for evaluating whether an impairment of a debt security is other than temporary each reporting period:

	•		If management intends to sell an impaired debt security, the impairment is considered other than temporary. If the entity does not intend to sell the impaired debt security, it must still assess whether it is more likely than not that it will be required to sell the security.
	•		If management determines that it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis of the security, the impairment is considered other than temporary.

•

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

     The Company has the intent and ability to hold these securities until their value recovers, and have not sold any at a loss.

     Contractual maturities of available-for-sale securities at June 30, 2010 were as follows (in thousands):

						Estimated
		Cost				Fair Value
Due in less than one year		$	23,400			$	23,371
Due in more than one year and less than two years			13,522				13,512
Total		$	36,922			$	36,883

(6) Fair Value Measurements

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

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

	•		Level 1 inputs are based on quoted prices in active markets for identical assets or liabilities.
	•		Level 2 inputs are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
	•		Level 3 inputs are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques.

     The following table presents the Company’s assets measured at fair value on a recurring basis as of June 30, 2010 (in thousands):

		Quoted Prices
		in Active				Significant
		Markets for				Other				Significant
		Identical				Observable				Unobservable
		Instruments				Inputs				Inputs
		(Level 1)				(Level 2)				(Level 3)				Total
Cash and cash equivalents:
Money market funds		$	8,010			$	—			$	—			$	8,010
Short-term investments:
Fixed- term deposits			—				8,560				—				8,560
Municipal and corporate bonds			23,717				—				—				23,717
Treasuries and agencies			4,606				—				—				4,606
Total assets measured at fair value		$	36,333			$	8,560			$	—			$	44,893

     Fixed-term deposits are valued at cost, which approximates fair value as of June 30, 2010.

(7) Consolidated Financial Statement Details

Prepaids, Deferred Costs and Other Current Assets

		June 30, 2010				September 30, 2009
Prepaid expenses		$	1,621			$	1,554
Deferred costs of revenue			838				580
Income tax receivable			695				971
Security deposits, advances, and interest receivable			361				43
Other assets			110				369
Total		$	3,625			$	3,517

Property, equipment and software

		June 30, 2010				September 30, 2009
Land		$	14,150			$	14,150
Computer equipment and software			31,239				29,551
Building			21,908				21,875
Furniture and fixtures			2,105				2,169
Leasehold and building improvements			1,110				1,179
Construction in progress			630				383
			71,142				69,307
Less accumulated depreciation and amortization			(37,292	)			(34,529	)
Total		$	33,850			$	34,778

Deferred Costs and Other Long-Term Assets

		June 30, 2010				September 30, 2009
Prepaid tax asset		$	944			$	1,710
Deferred costs of revenue			251				421
Tenant rent receivable			197				280
Deposits			235				264
Prepaid expenses			221				349
Total		$	1,848			$	3,024

Accrued Expenses

		June 30, 2010				September 30, 2009
Accrued employee compensation		$	3,828			$	4,417
Accrued audit and professional fees			1,000				429
Income and other taxes			864				844
Other accrued expenses*			2,701				2,776
Total		$	8,393			$	8,466

(8) Inventories

     Inventories primarily relate to direct costs associated with SIGOS SITE systems hardware and are stated at the lower of cost (determined on a first-in, first-out basis) or market. If the cost of the inventories exceeds their market value, provisions are made currently for the difference between the cost and the market value. The Company evaluates inventories for excess quantities and obsolescence on a quarterly basis. This evaluation includes analysis of historical and forecasted sales of the Company’s products, competitiveness of product offerings, market conditions, and product life cycles. Any adjustment for market value decreases, inventories on hand in excess of forecasted demand or obsolete inventories are charged to cost of ratable licenses in the period that management identifies the adjustment. Inventories related to SIGOS SITE systems were approximately $1.2 million as of June 30, 2010 and September 30, 2009.

(9) Goodwill and Identifiable Intangible Assets

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

     Based on the results of the first step of the Company’s impairment test performed at September 30, 2009, the fair value of its reporting unit exceeded its carrying value by approximately 2.2% and the Company passed Step 1 of the goodwill impairment test. Accordingly, the Company did not recognize any impairment of its goodwill in the September 30, 2009 consolidated financial statements. The Company continuously monitors for events and circumstances that could negatively impact the key assumptions in determining fair value, including long-term revenue growth projections, discount rates, recent market valuations from transactions by comparable companies, volatility in the Company’s market capitalization and general industry, market and macro-economic conditions. It is possible that changes in such circumstances, or in the variables associated with the judgments, assumptions and estimates used in assessing the fair value of the reporting unit, would require the Company to record a non-cash impairment charge.

     During the quarter ended June 30, 2010, the Company concluded that there were no triggering events which would require a formal impairment analysis of the carrying value of goodwill, primarily due to the Company’s market capitalization and cash flows during the period. The Company is continuing to monitor its economic situation and the need to perform an impairment analysis in light of recent macro-economic indications in the equity markets as well as recent volatility of its market capitalization. To the extent the Company concludes that there are any indicators of impairment prior to the date of the next annual goodwill impairment test, management will perform an impairment analysis under ASC 350-20, Goodwill and Other Intangible Assets, (formerly referenced as SFAS No. 142), to determine if an impairment charge should be recorded to write down goodwill to its fair value. If the results of any impairment testing indicate that a write down of goodwill is necessary, such charge could be significant and, accordingly, could have a material impact on the Company’s financial position and results of operations, but would not be expected to have a material adverse effect on the Company’s cash flows from operations.

     The following table presents the changes in goodwill during the nine months ended June 30, 2010 (in thousands):

Balance at September 30, 2009		$	66,078
Translation adjustments			(7,009	)
Balance at June 30, 2010		$	59,069

     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 June 30, 2010:
Gross carrying value		$	7,756			$	11,845			$	7,930			$	1,347			$	34			$	103			$	29,015
Accumulated amortization			(4,413	)			(11,845	)			(7,454	)			(853	)			(23	)			(71	)			(24,659	)
Net carrying value		$	3,343			$	—			$	476			$	494			$	11			$	32			$	4,356
As of September 30, 2009:
Gross carrying value		$	8,125			$	11,845			$	8,190			$	1,407			$	40			$	121			$	29,728
Accumulated amortization			(3,422	)			(11,834	)			(7,391	)			(733	)			(23	)			(70	)			(23,473	)
Net carrying value		$	4,703			$	11			$	799			$	674			$	17			$	51			$	6,255

     Amortization of developed technology related to software was recorded to costs of revenue. Amortization of all other identifiable intangible assets was recorded to operating expenses. The following table presents amortization of identifiable intangible assets for the three and nine months ended June 30, 2010 and 2009 (in thousands):

		Three Months Ended								Nine Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Amortization of intangible assets — software		$	433			$	290			$	1,166			$	866
Amortization of intangible assets — other			146				259				484				791
Total amortization of intangible assets		$	579			$	549			$	1,650			$	1,657

     The estimated future amortization expense for existing identifiable intangible assets as of June 30, 2010 is as follows (in thousands):

		Total
Fiscal years:
2010 (remaining three months)		$	555
2011			2,192
2012			1,324
2013			285
Total		$	4,356
Weighted-average remaining useful life as of June 30, 2010 (years)			2.5

     The Company leases a facility in New York under an operating lease that expires in October 2015. The Company ceased using the facility in the fourth quarter of fiscal 2009 and, effective October 1, 2009, subleased the facility to a third party for the remainder of its lease term. In the fourth quarter of fiscal 2009, the Company recorded lease abandonment expense of $635,000 related to its discontinuance of this facility. The changes in the lease abandonment liability, for the nine months ended June 30, 2010, are as follows (in thousands):

Lease abandonment liability, September 30, 2009		$	696
Lease payments to lessor			(200	)
Sublease proceeds			58
Payment of lease termination costs			(63	)
Lease abandonment liability, June 30, 2010		$	491

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

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

		Three Months Ended								Nine Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Numerator:
Net income (loss)		$	(315	)		$	2,092			$	522			$	2,720
Denominator:
Weighted average shares outstanding			14,799				14,378				14,640				14,274
Effect of dilutive stock options, RSUs and employee stock purchase rights			—				25				265				47
Denominator for diluted net income (loss) per share			14,799				14,403				14,905				14,321
Basic and diluted net income (loss) per share		$	(0.02	)		$	0.15			$	0.04			$	0.19

     Potentially dilutive securities representing 3.8 million shares of common stock for the three months ended June 30, 2010 were excluded from the computation of diluted net loss per share since they were considered antidilutive due to the net loss the Company experienced during the period. Potentially dilutive securities representing 4.6 million shares of common stock for the three months ended June 30, 2009 were excluded from the computation of diluted net income per share since their effect would be anti-dilutive, as their exercise price was greater than the average market price of the common stock. Potentially dilutive securities representing 4.0 million and 5.0 million shares of common stock for the nine months ended June 30, 2010 and 2009, respectively, were excluded from the computation of diluted net income per share since their effect would be anti-dilutive, as their exercise price was greater in each of those periods than the average market price of the common stock.

(12) Stockholders’ Equity

Dividends

     During the nine months ended June 30, 2010, the Company paid the following cash dividends:

Record Date		Payment Date		Dividend Per Share				Total Dividend Paid
December 1, 2009		December 15, 2009		$	0.05			$	727,000
March 1, 2010		March 15, 2010		$	0.05			$	731,000
June 1, 2010		June 15, 2010		$	0.05			$	743,000

(13) Income Taxes

     The Company’s effective tax rate for the three months ended June 30, 2010 and 2009 was (154)% and 11%, respectively. The Company’s effective tax rate for the nine months ended June 30, 2010 and 2009 was 60% and 23%, respectively. The rate for the three and nine months ended June 30, 2010 and 2009 differs from the 35% United States federal statutory rate primarily due to the relative mix of foreign and domestic earnings, enacted tax rates, and the fact that a portion of the earnings are being taxed in the United States where the Company has a low effective tax rate due to utilization of net operating loss carryforwards. Through October 2011, the Company is also amortizing approximately $200,000 of prepaid tax per quarter recorded on the sale of intangible assets from its German entity to the United States entity. Excluding the amortization of prepaid tax, the Company’s effective tax rate would have been (34)% and 6% for the three months ended June 30, 2010 and 2009, respectively. Excluding the amortization of this prepaid tax, the Company’s effective tax rate would have been 20% and 13% for the nine months ended June 30, 2010 and 2009, respectively.

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

     At September 30, 2007, the Company determined that the projected sources of future taxable income in the United States were not considered to be sufficient to support any of the deferred tax assets located in the United States. Therefore, the Company established a valuation allowance against all of the deferred tax assets related to the United States. In future quarters, the projected taxable income will be evaluated for this purpose, and it is possible that the valuation allowance would be reduced, which would affect the effective tax rate, deferred tax expense, and additional paid-in-capital. In the event that management determines that the valuation allowance should be reduced, the tax effect would be recorded as a discrete event in the quarter in which the determination was made. This analysis is applied to United States domestic taxes and to foreign, in particular German, taxes separately.

     ASC 718 has the effect of increasing the effective tax rate due to the charge to earnings from incentive stock options and shares purchased from the employee stock purchase plan, which have no associated tax benefit to the Company. In a future period it is possible that a tax benefit would be realized on these options and employee stock purchase rights, at which time the tax rate may be reduced as a result.

     The Company has adopted the provisions of ASC 740-10 (formerly referenced as FASB’s Financial Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109). As of June 30, 2010, the total amount of gross unrecognized benefits was $7.1 million. Included in this balance was approximately $2.6 million of unrecognized tax benefits that, if recognized, would affect the effective income tax rate. The gross unrecognized tax benefits increased by $34,000 during the three months ended June 30, 2010.

     It is possible that the amount of liability for unrecognized tax benefits may change within the next three months. However, an estimate of the range of possible changes cannot be made at this time. In addition, over the next three months, the Company’s existing tax positions will continue to generate an increase in liabilities for unrecognized tax benefits. In accordance with the Company’s accounting policy, it recognizes accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. Interest and penalties were insignificant for the three and nine months ended June 30, 2010 and 2009.

     Although the Company files United States federal, various state, and foreign tax returns, the Company’s only major tax jurisdictions are the United States, Canada, the United Kingdom, the Netherlands and Germany. Tax years 1994 through 2008 remain subject to examination by the appropriate governmental agencies due to tax loss carryovers from those years.

(14) Commitments and Contingencies

Leases

     The Company leases certain of its facilities and equipment under noncancelable leases, which expire on various dates through October 2017. As of June 30, 2010, future minimum payments under these operating and capital leases are as follows (in thousands):

		Operating				Capital
		Leases				Leases
Fiscal year:
2010 (remaining three months)		$	242			$	2
2011			761				—
2012			548				—
2013			450				—
2014			338				—
Thereafter			473				—
Total minimum lease payments (a)		$	2,812				2
Less amounts representing interest							—
Present value of minimum lease payments							2
Less current portion of capital lease obligation							(2	)
Long-term portion of capital lease obligation						$	—

     Rent expense for the three months ended June 30, 2010 and 2009 was approximately $236,000 and $303,000, respectively. Rent expense for the nine months ended June 30, 2010 and 2009 was approximately $723,000 and $937,000, respectively.

Commitments

     The Company had, as of June 30, 2010, $1.6 million of contingent commitments, which have a remaining term of between one to twenty-three months, to bandwidth and co-location providers, which commitments become due if the Company terminates any of these agreements prior to their expiration.

     As of June 30, 2010, the Company, through one of its foreign subsidiaries, has outstanding guarantees totaling $121,000 to customers and vendors as a form of security. The guarantees can only be executed upon agreement by both the customer or vendor and the Company. The guarantees are secured by an unsecured line of credit of $1.2 million as of June 30, 2010.

Legal Proceedings

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

aftermarket through a series of misstatements and omissions associated with the offering. The lawsuit is one of several hundred similar cases pending in the Southern District of New York that have been consolidated by the court.

     The Company was a party to a global settlement with the plaintiffs that would have disposed of all claims against it with no admission of wrongdoing by the Company or any of its present or former officers or directors. The settlement agreement had been preliminarily approved by the Court. However, while the settlement was awaiting final approval by the District Court, in December 2006 the Court of Appeals reversed the District Court’s determination that six focus cases could be certified as class actions. In April 2007, the Court of Appeals denied plaintiffs’ petition for rehearing, but acknowledged that the District Court might certify a more limited class. At a June 26, 2007 status conference, the Court approved a stipulation withdrawing the proposed settlement. On August 14, 2007, plaintiffs filed amended complaints in the focus cases, and a motion for class certification in the focus cases on September 27, 2007. On November 13, 2007, defendants in the focus cases filed a motion to dismiss the amended complaints for failure to state a claim, which the District Court denied on March 2008. Plaintiffs, the issuer defendants (including the Company), the underwriter defendants, and the insurance carriers for the defendants, have engaged in mediation and settlement negotiations. The parties reached a settlement agreement, which was submitted to the District Court for preliminary approval on April 2, 2009. As part of this settlement, the Company’s insurance carrier has agreed to assume the Company’s entire payment obligation under the terms of the settlement. On June 10, 2009, the District Court granted preliminary approval of the proposed settlement. After a September 10, 2009 hearing, the District Court gave final approval to the settlement on October 5, 2009. Several objectors have filed notices of appeal to the United States Court of Appeals for the Second Circuit from the District Court’s October 5, 2009 order approving the settlement. Although the District Court has granted final approval of the settlement, there can be no guarantee that it will not be reversed on appeal. The Company believes that it has meritorious defenses to these claims. If the settlement is not implemented and the litigation continues against the Company, the Company would continue to defend against this action vigorously.

     In addition, in October 2007, a lawsuit was filed in the United States District Court for the Western District of Washington by Vanessa Simmonds, captioned Simmonds v. JPMorgan Chase & Co., et al., No. 07-1634, alleging that the underwriters violated section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. section 78p(b), by engaging in short-swing trades, and seeks disgorgement to the Company of profits from the underwriters in amounts to be proven at trial. On February 28, 2008, Ms. Simmonds filed an amended complaint. The suit names the Company as a nominal defendant, contains no claims against the Company, and seeks no relief from the Company. This lawsuit is one of more than fifty similar actions filed in the same court. On July 25, 2008, the underwriter defendants in the various actions filed a joint motion to dismiss the complaints for failure to state a claim. The parties entered into a stipulation, entered as an order by the Court, that the Company is not required to answer or otherwise respond to the amended complaint. Accordingly, the Company did not join the motion to dismiss filed by certain issuers. On March 12, 2009, the Court dismissed the complaint in this lawsuit with prejudice. On April 10, 2009, the plaintiff filed a notice of appeal of the District Court’s order, and thereafter the underwriter defendants’ filed a cross appeal to a portion of the District Court’s order that dismissed thirty (30) of the cases without prejudice following the moving issuers’ motion to dismiss. On May 27, 2009, the Ninth Circuit issued an order stating that the cases were not selected for inclusion in the mediation program, and on June 22, 2009 issued an order granting the parties’ joint motion filed on May 22, 2009 to consolidate the 54 appeals and 30 cross-appeals. Briefing on the appeal was completed on November 17, 2009. No date has been set for oral argument in the Ninth Circuit. No amount has been accrued as of June 30, 2010 and September 30, 2009 since management believes that the Company’s liability, if any, is not probable and cannot be reasonably estimated.

     The Company is subject to other legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on the Company’s consolidated financial position, results of operations, or cash flows.

Warranties

     The Company’s products are generally warranted to perform for a period of one year. In the event there is a failure of such warranties, the Company generally is obliged to correct or replace the product to conform to the warranty provision. No amount has been accrued for warranty obligations as of June 30, 2010 or September 30, 2009, as costs to replace or correct are generally reimbursable under the manufacturer’s warranty.

Indemnification

     The Company does not generally indemnify its customers against legal claims that its services infringe third-party intellectual property rights. Other agreements entered into by the Company may include indemnification provisions that could subject the Company to costs and/or damages in the event of an infringement claim against the Company or an indemnified third-party. However,

the Company has never been a party to an infringement claim and its management is not aware of any liability related to any infringement claims subject to indemnification. As such, no amount is accrued for infringement claims as of June 30, 2010 and September 30, 2009 in the condensed consolidated balance sheets.

(15) Geographic and Segment Information

     The Company operates in a single reportable segment encompassing the development and sale of services, hardware and software to measure, test, assure and improve the quality of service for Internet and mobile communications. While the Company operates under one operating segment, management reviews revenue under two categories — Internet and Mobile services.

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

		Subscription		Ratable		Professional
		Services		Licenses		Services
Internet Test and Measurement:
Internet Subscriptions — Web Measurement
Application Perspective		X
Streaming Perspective		X
Transaction Perspective		X
Web Site Perspective		X
Internet Subscriptions — Other
Diagnostic Services		X
Enterprise Adapters		X
NetMechanic		X
Performance Scoreboard		X
Red Alert		X
Test Perspective		X
Financial Industry Scorecards		X
LoadPro		X
Voice Perspective		X
WebEffective		X
Internet Engagements
Professional Services						X
Financial Industry Scorecards						X
LoadPro						X
Voice Perspective						X
WebEffective						X
Mobile Test and Measurement:
Mobile Subscription
Mobile Device Perspective		X
Mobile Application Perspective		X
SIGOS Global Roamer		X
Mobile Ratable Licences
SIGOS SITE				X

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

		Three Months Ended								Nine Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Internet Subscriptions — Web Measurement		$	6,584			$	6,621			$	19,347			$	20,402
Internet Subscriptions — Other			2,648				2,782				8,882				7,998
Internet Engagements			2,164				2,324				6,601				7,753
Total Internet net revenue			11,396				11,727				34,830				36,153
Mobile Subscription			2,718				2,052				7,602				5,869
Mobile Ratable Licenses			5,159				6,390				16,906				18,348
Total Mobile net revenue			7,877				8,442				24,508				24,217
Total net revenue		$	19,273			$	20,169			$	59,338			$	60,370

     Internet Subscriptions – Web Measurement and Internet Subscriptions – Other were previously presented as one category, Internet Subscriptions.

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

		Three Months Ended								Nine Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
United States		$	10,818			$	10,969			$	32,386			$	33,949
Europe*			5,401				6,623				17,995				18,962
Other**			3,054				2,577				8,957				7,459
Total net revenue		$	19,273			$	20,169			$	59,338			$	60,370

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

		June 30,				September 30,
		2010				2009
United States		$	32,734			$	33,685
Europe			1,116				1,093
Total		$	33,850			$	34,778

(16) Subsequent Events

     In July 2010, the Board of Directors approved the payment of a quarterly dividend of $0.05 per share to stockholders of record as of September 1, 2010. In the future, the Company intends to pay a similar dividend on a quarterly basis; however, its ability to continue to do so will be affected by its future results of operations, financial position, business and the various other factors that may affect its overall business.

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

     The following discussion of the financial condition and results of operations of Keynote Systems, Inc. (referred to herein as “we,” “us,” “Keynote” or “the Company”) should be read in conjunction with the Condensed Consolidated Financial Statements and the Notes thereto included in this report as well as in our Annual Report on Form 10-K for the year ended September 30, 2009, and subsequent filings with the Securities and Exchange Commission.

     Except for historical information, this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements involve risks and uncertainties, including, among other things, statements regarding our anticipated costs and expenses and revenue mix. These forward-looking statements include, among others, statements including the words “expects,” “anticipates,” “intends,” “believes” and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to these differences include, but are not limited to, those discussed in this section, the section entitled “Risk Factors” in Item 1A of Part II of this report, and in our annual report on Form 10-K for the fiscal year ended September 30, 2009 and elsewhere in that report. You should carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the quarterly reports on Form 10-Q and current reports on Form 8-K that we may file during the current year. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this quarterly report on Form 10-Q. Except as required by law, we undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

Overview

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

     Our Internet solutions consist primarily of measurement services that are based on an extensive network of strategically-located measurement and testing computers running our proprietary software that measure online business performance from the viewpoint of a geographically dispersed user base. Our over 3,000 measurement computers and mobile devices are connected to over 240 major Internet backbone and last mile locations around the world via a sophisticated operations center for collecting, analyzing and disseminating web application response time and availability data, along with diagnostic tools to uncover the source of performance problems. Keynote’s “on demand” network infrastructure together with our consulting services, and in some cases, with Keynote-managed “private agent” appliances placed on a customer’s premises, provide our customers the ability to manage the technical performance of their online and mobile systems in real-time — 24 hours a day, 7 days a week. As of June 30, 2010, we had approximately 2,800 customers in over 80 countries for which we measured approximately 22,900 Internet pages, and managed 210 web and mobile private agent appliances. Subscription fees range from monthly to annual commitments, and vary based on the type of service selected, the number of pages, transactions or devices monitored, the number of measurement locations and/or appliances, the frequency of the measurements and any additional features ordered.

     We also offer Internet solutions consisting of custom engagements that combine our proprietary software technology with our consulting expertise to provide online businesses with research and actionable insight about their websites with respect to load and capacity problems, online customer satisfaction and usability issues, and industry/competitive comparisons and trends. We conduct load and capacity tests on our customer’s websites by driving web traffic generated by our load testing agent infrastructure, measuring performance under load and diagnosing capacity bottlenecks. We conduct online customer satisfaction and usability research using “private panels” recruited for specific customer projects. Through task-based testing, observation of natural customer behavior, online surveys and remote usability testing, Keynote consultants enable our customers to answer important questions regarding customer behavior. We perform online tests on multiple web sites within an industry and we create proprietary competitive studies that we market to our customers to help them improve their competitive position.

     We offer our Internet professional services either on a subscription or on an engagement basis although, in some cases, we also offer Internet professional services on a per incident or per study basis. Engagements typically involve fixed price contracts based on the complexity of the project, the size of a panel, and/or the type of testing to be conducted.

     Our Mobile services are based on a worldwide infrastructure of distributed mobile devices, both simulated and real, placed on behalf of key mobile service providers and content companies that benchmark, monitor and test the performance and quality of those services from multiple regional markets. We license the SIGOS SITE system, which consists of hardware “probes” built by us along with our proprietary testing and monitoring software, to major mobile providers and telecommunications carriers for the purpose of testing the end-to-end quality of a mobile network, content and services, and for diagnosing problems that need to be fixed by our customers or their partners in order to ensure a satisfactory user experience for their mobile users. In addition, we offer the SIGOS Global Roamer “on demand” solution of our SIGOS SITE system to major mobile providers and telecommunications carriers to actively test and monitor the quality of their mobile roaming partners’ voice and data networks.

     Our Mobile solutions are offered on both a subscription basis and a license basis. The subscriptions typically are for a fixed period, usually annually, and are based on the number of locations and devices from which monitoring and testing is performed, and the number of mobile operators and services covered by such monitoring and testing. The SIGOS SITE system is usually offered via a software license fee model, but because it is bundled with ongoing maintenance and support for a fixed contract period, with no vendor specific objective evidence of fair value on this undelivered element, the license fees are amortized over the length of the contract and included in ratable licenses revenue. The SIGOS Global Roamer service is offered via a subscription fee model, typically for a three to twelve month period, and is included in subscription services revenue.

     For the three months ended June 30, 2010 and 2009, our 10 largest customers accounted for approximately 32% and 34% of total net revenue, respectively. For the nine months ended June 30, 2010 and 2009, our 10 largest customers accounted for approximately 33% of total net revenue. We cannot be certain that customers that have accounted for significant revenue in past periods, individually or in aggregate, will renew our services and continue to generate revenue in any future period. In addition, our customers that have monthly renewal arrangements may terminate their services at any time with little or no penalty. If we lose a major customer or a group of significant customers, our revenue could significantly decline if we are not able to otherwise replace their revenues either from selling additional services to or increased usage by existing customers or from obtaining new customers.

     Approximately 40% of our net revenue is invoiced in currencies other than the U.S. Dollar, primarily the Euro. Our results of operations are influenced by changes in foreign currency exchange rates. Increases or decreases in the value of the U.S. Dollar, compared to other currencies, will directly affect our reported results as we translate those currencies into U.S. Dollars at the end of each fiscal period.

     Our net income (loss) decreased from net income of $2.1 million for the three months ended June 30, 2009 to net loss of $315,000 for the three months ended June 30, 2010. The change was primarily attributable to lower ratable license revenue as a result of the weakening of the Euro and an increase in customers renewing maintenance on existing systems rather than purchasing new systems, higher sales and marketing expenses due to increased external marketing expenses to grow mobile revenues and higher general and administrative expenses due to increased professional fees.

     Our net income decreased by $2.2 million, or 81%, from net income of $2.7 million for the nine months June 30, 2009 to net income of $522,000 for the nine months ended June 30, 2010. The decrease was primarily attributable to increased sales and marketing expenses of $838,000 to grow mobile revenues and a decrease in interest and other income (expense), net of $941,000 due to the weakening of the Euro.

     Our gross deferred revenue, which is primarily unearned license and subscription services revenue, was $25.2 million at June 30, 2010, which increased by $2.9 million from September 30, 2009 primarily due to the timing of payments from Mobile license customers.

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

	•		continuing to drive growth in our Internet and Mobile revenue, as we believe that these areas represent the greatest growth opportunities for our business in light of the decline in revenues from our legacy single page measurement services;
	•		growing multiple page/broadband related revenue (such as Transaction Perspective and Application Perspective which remained stable after increasing in the second fiscal quarter) without corresponding reductions in unit price (which has showed signs of stabilizing in recent quarters) in order to increase Internet revenues and margins, as growth in these services will be important to growing our Internet revenue;

	•		maintaining and growing the overall size of our customer base to support the growth of our Internet and Mobile revenue;
	•		continuing to control our expenses in fiscal 2010 to maintain and improve profitability, particularly because of the economic uncertainties that continue to exist in the current fiscal year; and
	•		the challenges faced due to the current economic global downturn as this affects our customers’ ability to purchase our services.

     Refer to “Results of Operations,” “Non-GAAP Financial Measures and Other Operational Data,” “Liquidity and Capital Resources,” and “Commitments” elsewhere in this section for a further discussion of the risks, uncertainties and trends in our business.

     We were incorporated in 1995. Our headquarters is located at 777 Mariners Island Blvd., San Mateo, CA and our telephone at that location is (650) 403-2400. Our company Web site is www.keynote.com although information on that Web site shall not be deemed incorporated in this report. Through a link on the Investor Relations section of our Web site, we make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports of Form 8-K, and all amendments to those reports filed with the Securities and Exchange Commission.

Critical Accounting Policies and Estimates

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

	•		Revenue recognition
	•		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
	•		Stock-based compensation
	•		Income taxes, deferred income taxes and deferred income tax liabilities

     Management believes that there have been no significant changes during the nine months ended June 30, 2010 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operation in our 2009 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For a description of those critical accounting policies and estimates, please refer to our 2009 Annual Report on Form 10-K.

Results of Operations

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

		Three Months Ended								Nine Months Ended
		June 30,								June 30,
		2010				2009				2010				2009
Net revenue:
Subscription services			62.0	%			56.8	%			60.4	%			56.8	%
Ratable licenses			26.8				31.7				28.5				30.4
Professional services			11.2				11.5				11.1				12.8
Total net revenue			100.0				100.0				100.0				100.0
Costs and expenses:
Costs of revenue:
Direct costs of subscription services			10.9				10.4				10.9				11.1
Direct costs of ratable licenses			8.7				7.1				8.6				7.5
Direct costs of professional services			7.6				6.4				7.2				7.4
Operations			10.0				9.6				9.7				10.6
Development			15.4				14.2				15.3				15.1
Amortization of intangible assets — software			2.2				1.4				2.0				1.4
Sales and marketing			32.7				28.1				32.0				30.1
General and administrative			13.8				11.6				13.2				12.8
Excess occupancy income			(1.7	)			(1.3	)			(1.6	)			(1.2	)
Amortization of intangible assets — other			0.8				1.3				0.8				1.3
Total costs and expenses			100.4				88.8				98.1				96.1
Income (loss) from operations			(0.4	)			11.2				1.9				3.9
Interest income and other, net			(0.2	)			0.5				0.3				1.9
Income (loss) before provision for income taxes			(0.6	)			11.7				2.2				5.8
Provision for income taxes			(1.0	)			(1.3	)			(1.3	)			(1.3	)
Net income (loss)			(1.6	)%			10.4	%			0.9	%			4.5	%