UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

 

 

Commission File Number 000-27241

KEYNOTE SYSTEMS, INC.

(Exact name of Registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(650) 403-2400

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Exchange Act.  YES o      NO þ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act.  YES o      NO þ

 

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

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

 

(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

 

As of March 31, 2009, the aggregate market value of voting stock held by non-affiliates of the Registrant was $97 million, based on the closing price of a share of Registrant’s common stock on March 31, 2009, as reported by the NASDAQ Global Market.

 

The number of shares of the Registrant’s common stock outstanding as of December 4, 2009 was 14,530,686 shares.

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

Part III incorporates information by reference to portions of the Registrant’s proxy statement for its 2010 annual meeting of stockholders.

 

 

KEYNOTE SYSTEMS, INC.

 

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2009

 

TABLE OF CONTENTS

 

FORWARD-LOOKING STATEMENTS

 

Except for historical information, this annual report 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 the section entitled “Risk Factors” in Item 1A of Part I of this report, and elsewhere in this report. You should also 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 in fiscal 2010. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this annual report on Form 10-K. 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. No person is authorized to make any forward-looking statements on behalf of Keynote Systems, Inc. other than its authorized officers and then only through its external communications processes. Accordingly, you should not rely on any forward-looking statements regarding Keynote Systems, Inc. from any other sources and we undertake no obligation to correct or clarify any such forward-looking statements, except as required by federal securities law.

 

Keynote^®, DataPulse^®, CustomerScope^®, Keynote CE Rankings^®, Keynote Customer Experience Rankings^®, Perspective^®, Keynote Red Alert^®, Keynote Traffic Perspective^®, Keynote WebEffective^®, The Internet Performance Authority^®, MyKeynote^®, SIGOS^®, SITE^®, keynote^tm The Mobile & Internet Performance Authority^tm, and Keynote FlexUse^tm are trademarks or registered trademarks of Keynote Systems, Inc. in the United States and/or other countries. All other trademarks are the property of their respective owners.

 

 

Overview

 

Keynote Systems, Inc. (“Keynote” or “we”) develops and sells 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 and licensed solutions. Our Internet category includes all of our geographically distributed “on demand” Web site and transaction/application monitoring and measurement services, voice-over-IP (VoIP) and streaming measurement services, load testing services, customer experience management services, competitive research and industry scorecard services, and custom professional services. The Mobile category consists of our on-demand Mobile monitoring and testing services, our Global Roamer services and our SIGOS System Integrated Test Environment (“SITE”) systems.

 

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 September 30, 2009, we measured over 18,000 web pages each month with our Internet measurement services, and managed 210 web and mobile private agent appliances on behalf of our customers.

 

With our Internet solutions we also offer 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. Subscription fees range from monthly to annual commitments, and vary based on the type of service selected, the number of pages, transactions or devices monitored, the number of measurement locations and or appliances, the frequency of the measurements and any additional features ordered. Engagements typically involve fixed price contracts based on the complexity of the project, the size of a panel, and/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. 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. We also 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.

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

 

Revenue from our subscription services represented 57%, 59%, and 63% of our total net revenue for the fiscal years ended September 30, 2009, 2008 and 2007, respectively. Revenue from our ratable licenses represented 31%, 28% and 20% of our total net revenue for the fiscal years ended September 30, 2009, 2008 and 2007, respectively. Professional services revenue represented 12%, 13% and 17% of total net revenue for the years ended September 30, 2009, 2008 and 2007, respectively. We market our services primarily from our operations in the United States. International sales are primarily to customers in Europe. International sales were 45%, 43% and 31% of total net revenue for the years ended September 30, 2009, 2008, and 2007, respectively.

 

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.

 

Internet

 

Our Internet subscriptions and professional service engagements enable enterprises to monitor key technical performance metrics in order to benchmark and improve online application responsiveness and operational support, proactively detect problems that impact end users, and accelerate the time to respond to and repair performance issues — all from the end user perspective. Our Internet subscriptions consist of the Keynote Perspective family of services together with various solutions such as Private Agents and Adapters, and Performance Scoreboard. Private Agents are measurement agents that can be configured and deployed to measure application performance on the Internet, customer Intranets, or extranets — including Web sites hosted on private networks and behind corporate firewalls. We offer Application Perspective, Streaming and Transaction Private Agents. Our Internet professional services engagements include our custom consulting and load testing engagements, as well as Customer Experience Management engagements and competitive studies. All of our Internet services include access to the MyKeynote portal and/or various specialized monitoring and reporting consoles. In addition, we offer Red Alert and NetMechanic measurement services for small businesses or departmental Web sites on a subscription basis. The following are our Internet subscription and professional service offerings:

 

Our Keynote Perspective family includes:

 

Transaction Perspective leverages the Microsoft Internet Explorer (IE) Web browser for taking detailed performance measurements from Keynote’s worldwide infrastructure for transactions that make heavy use of Web 2.0 technologies such as Ajax and Flash and, therefore, are most accurately measured via an embedded IE browser instead of a simulated browser. It enables transaction performance problems to be quickly and accurately identified and diagnosed, enabling customers to provide an optimal quality of experience for end-users and mitigating the adverse business impact caused by performance problems. Transaction Perspective is available in multiple editions including the Standard Edition, the High Frequency Edition, and the Last Mile Editions (for DSL, Cable, Dial-Up or 3G measurements).

 

Application Perspective is a cost-effective, self-service, Web transaction monitoring service that measures the response time and success rate for performing Web transactions via a simulated web browser from multiple geographic locations worldwide. Additionally, the service provides sophisticated trending, alarms and reporting to enable the rapid assessment, diagnosis and repair of performance issues when they occur.

Streaming Perspective measures, compares and assures the performance of audio and video streams, diagnosing performance problems before they impact the end-user. Streaming Perspective supports all the latest media players, including Flash Video, Real Media, Windows Media and QuickTime players.

 

Test Perspective is a cost-effective, self-service load testing service. Customers can take advantage of Keynote’s worldwide infrastructure of load-generating computers to easily test their Web applications at varying traffic levels.

 

Web Site Perspective measures Web site performance from metropolitan areas. Web Site Perspective is designed to diagnose performance problems quickly and measure the speed and reliability of Web pages. We are and have been converting customers from using these single-page measurements to multi-page measurements such as Transaction Perspective and Application Perspective.

 

Voice Perspective offers businesses and service providers comprehensive benchmarking and monitoring of the end-to-end VoIP service quality from the end user perspective over any communication media — DSL, cable and wireless.

 

Our other Internet solutions include:

 

Keynote Diagnostic Services (“KDS”) is fee-based technical support provided on a monthly subscription basis or a per-incident basis by our technical support consultants for services such as advanced transaction scripting and proactive diagnostic assistance.

 

Enterprise Adapters can integrate with any Simple Network Management Protocol (“SNMP”) capable application, such as CA Unicenter, HP OpenView and IBM Tivoli, and securely incorporate performance alarms for external or internal Web-based events.

 

LoadPro is a consultative load testing service utilizing Keynote load testing expertise and proprietary technology. Keynote consultants help companies to accurately and dynamically test their Web-based applications by driving traffic from multiple points across the globe, thereby quantifying the opportunity cost of performance problems and avoiding over- or under-provisioning of their website hardware and software systems.

 

Performance Scoreboard is a customizable portal that allows customers to review service level objectives for multi-location online businesses. Performance Scoreboard is an effective portal for tracking performance of a company’s multiple data centers, properties, VPNs and suppliers. Performance Scoreboard enables customers to track service level objectives (“SLOs”), quickly identify application and network latency issues and analyze trends and infrastructure details using on-demand diagnostic tools.

 

Red Alert is a self-service, real-time monitoring service that tests devices connected to the Internet primarily for availability. It can measure availability of any Internet server or other Transmission Control Protocol (“TCP”) enabled Internet devices including Web servers, secure Web servers, domain name servers, mail servers, File Transfer Protocol (“FTP”) servers and network gateways. Red Alert also provides alerts when adverse conditions exceed specified thresholds.

 

WebEffective is a flexible technology platform for conducting in-depth customer experience and usability studies on individual sites or across an entire industry. WebEffective can be used by customers on an assisted self-service basis or via full service engagements delivered by Keynote consultants. Customers can undertake tests on panelist selected from the Keynote Research Panel of over 145,000 panelists, existing customer lists, or real-time interception and polling of site visitors.

 

Financial Industry Scorecards provide an expert review and heuristic approach to assessing, benchmarking and improving online customer experience on a broad array of financial services related verticals including banking, brokerage (discount and full service) and credit card. Financial Services Scorecard services are available as both custom engagements or as a subscription service.

 

Keynote Competitive Research (“KCR”) studies offer a standardized comparison of customer experience across sites in a particular industry or an understanding of how a customer’s site compares to its competitors. KCR studies usually comprise both online usability and technical performance testing of chosen web sites by our consultants.

NetMechanic is a self-service set of tools that helps businesses and individuals save time, money and improve overall Web site quality. These automated tools test site integrity, optimize page visualization, and can improve search engine rankings.

 

Other professional services may consist of custom consulting engagements that offer customer experience and technical performance research and optimization services, a combination of private and public research panels (Keynote Research Panels), and expert review of Web sites relative to best-practices in performance, usability and service level optimization.

 

Mobile

 

Mobile Device Perspective (“MDP”) measures the response time and availability of wireless data services and mobile applications from actual mobile phone handsets enabling wireless operators, mobilized enterprises and mobile content providers to improve the quality of their mobile content, applications, and services. Services currently measured include core wireless data network technologies, such as GPRS/EDGE/UMTS/HSDPA, CDMA 1xRTT/1xEV-DO, and iDEN, Web browsing, text messaging, picture messaging, streaming video, and instant messaging, as well as proprietary applications built for smart phones such as the iPhone and Blackberry. MDP provides high fidelity measurements that represent true end user experience while interacting with mobile content, applications and services.

 

Mobile Application Perspective (“MAP”) measures the response time and availability of Web sites and SMS messages on emulated handsets over mobile operators anywhere in the world. The service measures the true mobile user experience by using a real mobile browser to capture network level details to help customers understand how Web sites are downloaded on mobile devices. Along with monitoring the true mobile user performance of mobile content, MAP also benchmarks mobile quality in multiple geographic locations and against competitors.

 

SIGOS SITE is a comprehensive core network test and measurement system for all types of communication protocols and services. The SIGOS SITE system supports network operators and manufacturers as they implement new technologies such as GSM, GPRS, EDGE and UMTS with no loss of quality. It has a complete interface for protocol layer testing, performs detailed measurement activity logs for mobile quality tests, and uses SIM multiplexing to ensure the maximum selection for testing across most mobile operators around the world.

 

SIGOS Global Roamer is an on-demand service offering based on SIGOS SITE probes located in 142 cities and is designed to enable operators to test the quality of their services when accessed via various roaming arrangements involving multiple mobile operators in major geographical regions across the world.

 

Segment Financial Information and Geographic Information

 

We operate 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. For further financial information on our operating segment, as well as geographic information, refer to the information contained in Note 10 “Geographic and Segment Information,” in the notes to consolidated financial statements included in Item 8 of this report on Form 10-K.

 

Technology and Infrastructure

 

Our Internet and Mobile infrastructure consists of three key primary components: 1) measurement and data collection infrastructure, 2) our operations and data center, and 3) reporting and analysis tools. Our Internet Professional Services infrastructure for managing customer experience research projects and load testing engagements consists of the Keynote Research Panel and proprietary software.

 

Measurement and Data Collection Infrastructure

 

Our measurement computers are Windows-based computers or mobile devices that run Keynote proprietary software to replicate the experience of a user accessing Web sites or mobile content, applications, and services through a standard Web browser, mobile browser, or mobile device. We designed our software infrastructure to perform thousands of download measurements concurrently without appreciably affecting the integrity of any

single measurement. The measurement computers are co-located at the data center facilities of major telecommunication and Internet access providers with connections to internet backbone providers and mobile network operators that are selected to be statistically representative of Internet users. At some locations, we employ multiple Internet connections and install equipment racks that can accommodate multiple measurement computers. The hosting arrangements for our measurement computers typically have terms ranging from three months to one year. We typically pay a small set-up fee and monthly rental fees to locate the measurement computers at these locations. We also pay additional monthly fees for usage of communications lines.

 

These measurement computers access a Web site to download Web pages and execute single-page and multi-page transactions, while taking measurements of every component in the process. The computers take measurements continually throughout the day, at intervals as often as three minutes, depending on the customer’s requirements and subscription service level.

 

Mobile browsers and mobile devices also access mobile content, applications, and services and execute single-step or multi-step transactions, while taking measurements of every component in the process. The mobile browsers and mobile devices take measurements continually throughout the day, at intervals as often as 15 minutes, depending on the customer requirements and subscription service level.

 

As of September 30, 2009, we had deployed more than 3,000 measurement computers and mobile devices in over 240 locations around the world. We continually upgrade and balance our network capacity to meet the needs of our customers.

 

As of September 30, 2009, we had deployed SIGOS SITE probes in more than 142 cities in major geographical regions across the world to test the quality of customer services when accessed via various roaming arrangements between mobile operators.

 

Operations and Data Centers

 

Our operations centers, located in San Mateo, California, and Plano, Texas, are designed to be scalable to support large numbers of measurement computers and to store, analyze and manage large amounts of data from these computers. Our measurement computers receive instructions from, and return collected data to, our operations centers. The data is stored in large databases that incorporate a proprietary transaction-processing system that we designed to store measurement data efficiently and to deliver measurement data with fast response times. We also employ proprietary, high-performance application servers that manage the collection of measurement data, the insertion of the data into our databases and the dissemination of this data to our customers in a variety of forms and delivery methods. Our Global Roamer infrastructure is managed from Nuremberg, Germany, the headquarters of our Keynote SIGOS subsidiary.

 

Reporting and Analysis Tools

 

We offer the following tools for reporting and analysis of Internet data:

 

 

Customers

 

For the years ended September 30, 2009, 2008 and 2007, no single customer accounted for more than 10% of our total net revenue. As of September 30, 2009, 2008 and 2007, we provided services to more than 2,800, 2,800, and 2,700 customers, respectively, including over 38% of the Fortune 100 companies.

 

Our 10 largest customers based on revenue, accounted for approximately 34% of our revenue for the year ended September 30, 2009.

 

Sales, Marketing and Customer Support

 

Sales

 

We sell our internet services through our field sales and telesales organization. Our field sales teams concentrate on selling and servicing our largest customers and consist of direct sales representatives and sales engineers located in 15 metropolitan areas (11 across the United States and 4 in Europe). In addition to the field sales teams across the country, we have telesales personnel located in Plano, Texas and India. These telesales personnel focus primarily on selling our Internet subscription services and providing telephone and email sales support and customer service. We also market and sell some of our services through our self-service Web site which allows our customers to try, purchase, and use our services. Our SIGOS SITE system and Global Roamer sales are made by account management teams working for our Keynote SIGOS subsidiary located in Nuremberg, Germany. Most of these employees are located in Nuremberg, with a small number who work in various locations across Europe.

 

In addition, we domestically distribute our services through Web-hosting and Internet service providers who manage e-business Web sites for other companies. These companies sell or bundle our services to their customer base as a value-added service and as a management tool for their customers’ Web sites. We also sell to content distribution providers who use our services as a pre-sales tool for their potential customers or in service level agreements with their existing customers. We occasionally market our services through other technology companies on a “lead referred” basis. Internationally, we use both direct and indirect sales approaches in the United Kingdom, Nordic Countries, France, and Germany and sell indirectly through reseller partners throughout the rest of Europe, the Middle East, Africa and Asia.

 

Marketing

 

We maintain an active marketing program designed to demonstrate the breadth and depth of our Internet and Mobile solutions. We promote our brand through multiple means including the public availability on our Web site of top level details for our e-business performance indices (both page download and transaction), and through our regular reporting and commentary to the media regarding Internet performance-related events.

 

Our marketing programs include advertising, Internet marketing, trade events, public relations, and other events such as Executive Summits. Executive Summits provide an opportunity for us and our partners to brief chief information officers, chief technology officers, information technology executives and network administrators on emerging solutions, new methodologies and best practices to improve mobile and online business performance.

 

Professional Services

 

As of September 30, 2009, our Global Professional Services organization consisted of 22 salaried and temporary employee consultants who deliver our Internet services. Our Internet consultants have substantial experience in technical areas ranging from capacity and performance tuning to network and application diagnostics. Our Internet consultants also provide expertise in fields including market research, panel management and survey methodologies.

 

Customer Support and Maintenance

 

We provide customer support by email and telephone. Basic support for all our services is available during the business day. Advanced support is available for a fee for our internet products through Keynote Diagnostic Services

for customers who want analytical or diagnostic support, or who require access 24 hours per day, 7 days per week to Keynote experts to assist them with their questions. We also provide ongoing technical and post-contract support and maintenance for our SIGOS SITE systems either from our Keynote SIGOS location or at a customer’s designated location.

 

Development

 

The Internet and mobile networks are characterized by rapid technological developments, frequent new application or service introductions and evolving industry standards such as Internet telephony, wireless devices, wireless fidelity, and WI-FI networks. The ongoing evolution of the Internet and mobile networks requires us to continually improve the functionality, features and reliability of our Internet and Mobile services and solutions, particularly in response to competing offerings. Therefore, we believe that our future success will depend in large part on our ability to maintain and enhance our current services and to develop or acquire new services and technologies that achieve market acceptance. The success of service introductions depends on several factors, including properly defining the scope of the new services and timely completion, introduction and market acceptance of our new services. If new Internet, networking or telecommunication technologies or standards are widely adopted or if other technological changes occur, we may need to expend significant resources to adapt our services.

 

Our development expenses were $12.2 million, $12.6 million and $11.6 million for the fiscal years ended September 30, 2009, 2008 and 2007, respectively.

 

Competition

 

The market for our services is rapidly evolving. Our competitors vary in size and in the scope and breadth of the products and services that they offer. We face competition from companies that offer Internet software and services with features similar to our services such as Gomez (which was recently acquired by Compuware), HP (which acquired Mercury Interactive), Borland Software (which acquired Segue Software), Neustar (which acquired Webmetrics) and a variety of other CEM and mobile companies that offer a combination of testing, market research capabilities and data collection. While we believe these services are not as comprehensive as ours, customers could still choose to use these services or these companies could enhance their services to offer all of the features we offer. As we expand the scope of our products and services, we expect to encounter many additional market-specific competitors.

 

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

 

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

 

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

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

 

Intellectual Property

 

We are a technology company whose success depends on developing, acquiring and protecting our intellectual property assets.

 

Intellectual Property Assets

 

Our principal intellectual property assets consist of our trademarks, our trade names, our logos, our characters, our design, our trade dress, our service marks, our patents, our patent applications and the proprietary software we developed or acquired to provide our services. Trademarks are important to our business because they represent our brand name and we use them in our marketing and promotional activities as well as in the delivery of our services. Keynote^®, DataPulse^®, CustomerScope^®, Keynote CE Rankings^®, Keynote Customer Experience Rankings^®, Perspective^®, Keynote Red Alert^®, Keynote Traffic Perspective^®, Keynote WebEffective^®, The Internet Performance Authority^®, MyKeynote^®, SIGOS^®, SITE^®, keynote^tm The Mobile & Internet Performance Authority^tm, and Keynote FlexUse^tm are trademarks or registered trademarks of Keynote Systems, Inc. in the United States and/or other countries. All other trademarks are the property of their respective owners.

 

We currently have five issued U.S. patents and three U.S. patent applications related to our Internet services. We also have one issued German patent and fifteen German patent applications related to our Mobile Data Network Testing and Monitoring Solutions. It is possible that no patents will be issued from our current pending patent applications and that our issued patents or potential future patents may be found invalid or unenforceable, or otherwise be successfully challenged. It is also possible that any patent issued to us may not provide us with any competitive advantages, that we may not develop future proprietary products or technologies that can be patented, and that the patents of others may seriously limit our ability to do business. In this regard, we have not performed any comprehensive analysis of patents of others that may limit our ability to do business.

 

Our proprietary software is an integral part of our Internet services and consists of the software we developed or acquired to collect, store, and deliver our measurement data to customers. We have also developed software that we use to provision and process customer orders and billings.

 

Protection of Our Intellectual Property

 

The intellectual property we use in our business is important to us. Despite our efforts, we may be unable to prevent others from infringing upon or misappropriating our intellectual property, which could harm our business.

 

Legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in Internet-related industries are uncertain and still evolving, and the future viability or value of any of our intellectual property rights is uncertain. Effective trademark, copyright and trade secret protection may not be available in every country in which our products are distributed or made available. Furthermore, our competitors may independently develop similar technology that substantially limits the value of our intellectual property, or they may design around patents issued to us.

 

The use of our services by many of our customers is governed by a Web-based subscription agreement, while for some of our larger customers, additional terms and conditions may be added by means of a formal, written contract. Each time customers use our services, they “click” on a Web page to agree to terms and conditions that are posted on our Web site, and our relationship with these customers is then governed by these terms and conditions and any written agreements that may exist. There is a possibility that a court, arbiter or regulatory body could deem this type of agreement to be invalid or determine that the terms and conditions governing the agreement do not fully protect our intellectual property rights. If that were to occur, our business could be harmed.

 

Although we are not currently engaged in any intellectual property litigation, we may, in the future, need to initiate a lawsuit to enforce our intellectual property rights and to protect our patents, trademarks and copyrights. Any litigation could result in substantial costs and diversion of resources and could seriously harm our business. To

date, we have not been notified that our technologies infringe the proprietary rights of anyone. We cannot assure you that others will not claim that we have infringed proprietary rights with respect to past, current or future technologies. We expect that we could become subject to intellectual property infringement claims as the number of our competitors grows and our services overlap with competitive offerings. These claims, even if not meritorious, could be expensive and divert management’s attention from operating our company. If we become liable for infringing the intellectual property rights of others, we could be required to pay a substantial damage award, to develop non-infringing technology, to obtain a license to use the third-parties intellectual property rights, or to cease selling our services that contain the infringing intellectual property. We may be unable to develop non-infringing technology or to obtain a license on commercially reasonable terms, if at all.

 

Licensed Technology

 

We license certain statistical, graphical and database technologies from third parties. We cannot assure you that these technology licenses will not infringe the proprietary rights of others or will continue to be available to us on commercially reasonable terms, if at all. The loss of this technology could require us to obtain substitute technology of lower quality or performance standards or at a greater cost. If we do not obtain or develop substitute technology, we could be unable to offer all of the features or functionality that we desire to include in our services.

 

Foreign and Domestic Operations and Geographic Data

 

The United States represents our largest geographic marketplace. Approximately 55%, 57%, and 69% of our total net revenue came from customers in the United States during the years ended September 30, 2009, 2008, and 2007, respectively. Our overall operating performance in foreign countries, mainly those in Europe, can be adversely affected by foreign currency exchange rate fluctuations, primarily the Euro and to a lesser extent the British pound.

 

Employees

 

As of September 30, 2009, we had a total of 307 employees, of which 200 were based in the United States, 93 were based in Germany and 14 were based in other international locations, primarily Europe. None of our employees are represented by a collective bargaining agreement nor have we experienced any work stoppage. In our German subsidiary, our employees are represented by a workers’ council which consists of employees who are elected onto the council by their colleagues. We believe that our relationships with our domestic and international employees are good. Our future success depends on our ability to attract, motivate and retain our key personnel. We may be unable to retain our key employees, including our management team and experienced engineers, or to attract, assimilate or retain other highly qualified employees. There is substantial competition for highly skilled employees with experience in the Internet industry.

 

 

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

 

While we were profitable in fiscal 2009, we incurred net losses on a GAAP basis in fiscal 2008, fiscal 2007 and in other prior fiscal years. As of September 30, 2009, we had an accumulated deficit of approximately $140 million. If we are not able to increase our revenues, it may be difficult to sustain profitability in light of current economic conditions. In addition, we are required under generally accepted accounting principles to review our goodwill and identifiable intangible assets for impairment when events or circumstances indicate that the carrying value may not be recoverable. As of September 30, 2009, we had approximately $6.3 million of net identifiable intangible assets and approximately $66.1 million of goodwill. We have in the past and may in the future, incur expenses in connection with a write-down of goodwill and identifiable intangible assets due to changes in market conditions. In addition, we have deferred tax assets which may not be fully realized, which may contribute to additional losses. We are also required to record as compensation expense, in accordance with Accounting Standards Codification (“ASC”) 718 (formerly referenced as SFAS No. 123R, Share-Based Payment), the cost of stock-based awards. As a result of these and other conditions, we may not be able to sustain profitability in the future.

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

 

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

 

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

 

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

 

Our operations and performance depend significantly on worldwide economic conditions. Uncertainty about current global economic conditions poses a risk as consumers and businesses have reduced and may continue to reduce spending in response to tighter credit, negative financial news and/or declines in income or asset values, which could have a material negative effect on the demand for our products and services. Other factors that could influence demand include labor and healthcare costs, access to credit, consumer confidence, and other macroeconomic factors affecting spending behavior. These and other economic factors could have a material adverse effect on demand for our products and services. The decrease in consumer demand could have a variety of negative effects on our financial results, and in certain cases, may reduce our revenue, increase our costs, and lower our gross margin percentage, or require us to recognize impairments of our assets. In addition, real estate values across the U.S. have been adversely affected by the global economic downturn and tighter credit conditions, and we cannot assure you that the value of our building will not be adversely affected by these conditions.

 

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

 

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

 

 

 

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

 

The market price of our common stock can be volatile.

 

The stock market in recent years has experienced significant price and volume fluctuations, and has recently experienced substantial declines and volatility that have affected the market prices of technology companies. These fluctuations have often been unrelated to or disproportionately impacted by the operating performance of these companies. The market for our common stock has been subject to similar fluctuations. Factors such as fluctuations in our operating results, announcements of events affecting other companies in the technology industry, currency fluctuations and general market conditions may cause the market price of our common stock to decline. In addition, because of the relatively low trading volume and the fact that we have approximately 14.5 million shares outstanding at September 30, 2009, our stock price could be more volatile than companies with higher trading volumes and larger numbers of shares available for trading in the public market.

 

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

 

We had $66.1 million of goodwill recorded on our consolidated balance sheet as of September 30, 2009. Goodwill represents the excess of cost over the fair market value of net assets acquired in business combinations. If our market capitalization drops significantly below the amount of net equity recorded on our balance sheet, it could indicate a decline in our value and would require us to further evaluate whether our goodwill has been impaired. At September 30th of each year, we perform an annual review of our goodwill to determine if it has become impaired, in which case we would write down the impaired portion of our goodwill. We also evaluate goodwill for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If we were required to write down all or a significant part of our goodwill, our operating results and net worth could be materially adversely affected.

 

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

 

Sales of our Internet subscription services, primarily our Application Perspective and Transaction Perspective services have generated a majority of our total revenue in the past. Revenue from our Web site Perspective Services,

a single page, single device measurement, has been decreasing. If revenues from our Application Perspective and Transaction Perspective Services, multi page, multi device measurements, or from other services do not continue to increase to offset the declines, we may not be able to increase our Internet revenue and our operating results could suffer. Therefore, the success of our business currently depends, and for the immediate future will continue to substantially depend, on sales and renewals of these Internet services

 

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

 

Revenue from our Mobile services has increased from approximately $28.7 million for the year ended September 30, 2008 to approximately $32.6 million for the year ended September 30, 2009. We also experienced increased bookings during the same period. We cannot assure you that we will continue to experience similar growth rates for this business in future periods. Future growth for these services could be adversely affected by a number of factors, including, but not limited to the market for mobile services is an emerging market and therefore it is difficult to predict the level of demand for the types of services we offer; currency rates; adverse global economic conditions; and our ability to successfully compete against current or new competitors in this area. Our business and our operating results could be harmed if we are not able to continue to grow revenue from our Mobile services.

 

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

 

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

 

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

 

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

 

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

 

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

 

The market for our services is rapidly evolving. Our competitors vary in size and in the scope and breadth of their products and services. We face competition from companies that offer Internet software and services with features similar to our services such as Gomez (which is being acquired by Compuware), Hewlett-Packard (which acquired Mercury Interactive), Borland Software (which acquired by Segue Software) and a variety of other Internet and mobile companies that offer a combination of testing, market research capabilities and data collection. Customers could choose to use these companies’ services or these companies could enhance their services to offer

all of the features we offer. As we expand the scope of our products and services, we expect to encounter many additional market-specific competitors.

 

In addition, Compuware’s acquisition of Gomez, Inc. could result in additional competition for us depending on which products and services the combined company offers in the future. Furthermore, Compuware may find additional uses for services provided by Gomez, Inc. which compete with our services.

 

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

 

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

 

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

 

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

 

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

 

Our ten largest customers accounted for approximately 34% of our total net revenue for the years ended September 30, 2009 and 2008. We cannot be certain that customers that have accounted for significant revenue in past periods, individually or as a group, will renew, will not cancel or will not reduce their services and, therefore, continue to generate revenue in any future period. In addition, our customers that have monthly renewal arrangements may terminate their services at any time with little or no penalty. If we lose a major customer or group of customers, our revenue could decline.

 

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

 

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

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

 

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

 

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

 

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

 

To increase sales of services worldwide, we must complement our direct sales force with relationships with companies to help market and sell our services to their customers. If we are unable to maintain our existing marketing and distribution relationships, or fail to enter into additional relationships, we may have to devote substantially more resources to the direct sale and marketing of our services. We would also lose anticipated revenue from customer referrals and other co-marketing benefits.

 

In the past, we have had to terminate relationships with some of our international resellers, and we may be required to terminate other reseller relationships in the future. As a result, we may have to commit resources to supplement our direct sales effort to find additional resellers in foreign countries.

 

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

 

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

 

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

 

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

 

Professional services revenue represented approximately 12% and 13% of total net revenue for the years ended September 30, 2009 and 2008, respectively. We will need to successfully market these services in order to increase professional services revenue. The market for these services is very competitive. Each professional services

engagement typically spans a one- to twelve-month period, and therefore, it is more difficult for us to predict the amount of professional services revenue recognized in any particular quarter. Our business and operating results could be harmed if we cannot increase our professional services revenue.

 

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

 

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

 

 

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

 

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

 

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

 

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

 

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

 

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

 

Any outage for any period of time or loss of customer data could cause us to lose customers. Our operations systems are also vulnerable to damage from break-ins, computer viruses, unauthorized access, vandalism, fire,

floods, earthquakes, power loss, telecommunications failures and similar events. Our insurance may not be adequate in any particular case.

 

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

 

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

 

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

 

Others might bring infringement claims which could harm our business.

 

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

 

Our business, which includes our operating results and financial condition, is susceptible to additional risks associated with international operations.

 

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

 

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

 

International sales in dollars were approximately 45% and 43% of our total net revenue for the year ended September 30, 2009 and 2008, respectively. We expect to continue to commit our resources to expand our

international sales and marketing activities. Conducting international operations subjects us to risks we do not face in the United States. These include:

 

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

 

 

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

 

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

 

 

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

 

If we need to raise additional capital and are unable to do so, our business could be harmed.

 

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

 

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

 

Our success is heavily dependent on our ability to create proprietary technology and to protect and enforce our intellectual property rights in that technology, as well as our ability to defend against adverse claims of third parties with respect to our technology and intellectual property. To protect our proprietary technology, we rely primarily on a combination of contractual provisions, confidentiality procedures, trade secrets, copyright and trademark laws, and patents. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects

of our products or obtain and use information that we regard as proprietary. Policing unauthorized use of our products is difficult. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Our means of protecting our proprietary rights may not be adequate and unauthorized third parties, including our competitors, may independently develop similar or superior technology, duplicate or reverse engineer aspects of our products, or design around our patented technology or other intellectual property.

 

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

 

Changes to existing accounting pronouncements or taxation rules or practices may cause adverse revenue fluctuations, affect our reported financial results or how we conduct our business.

 

Generally accepted accounting principles, or GAAP, are promulgated by, and are subject to the interpretation of the Financial Accounting Standards Board, or FASB, and the SEC. New accounting pronouncements or taxation rules and varying interpretations of accounting pronouncements or taxation practices have occurred and may occur in the future. Any future changes in accounting pronouncements or taxation rules or practices may have a significant effect on how we report our results and may even affect our reporting of transactions completed before the change is effective. In addition, a review of existing or prior accounting practices may result in a change in previously reported amounts. For example, the FASB has recently issued new accounting principles around revenue recognition and the SEC is considering adoption of international financial reporting standards. This change to existing rules, future changes, if any, or the questioning of current practices may adversely affect our reported financial results, our ability to remain listed on the Nasdaq Global Market, or the way we conduct our business and subject us to regulatory inquiries or litigation.

 

 

None.

 

 

As of September 30, 2009, our facilities primarily consisted of our headquarters building in San Mateo, California, an 188,000 square foot building which includes rentable space of approximately 181,000 square feet, which we own. We currently occupy approximately 42,000 square feet of this facility, which is our principal sales/marketing, product development, operations and administrative location and contains our data center.

 

We also lease facilities as follows:

 

 

We also lease office space in New York, New York; Seattle, Washington; Austin, Texas; Cambridge, Massachusetts; and Paris, France. The New York office space consists of 7,600 square feet that is being subleased from October 2009 to the end of the lease term in October 2015. The Washington office space is for our mobile operations and consists of 3,500 square feet that is leased through June 2013. The Massachusetts office space consists of 2,650 square feet that is leased through June 2011. The Paris office space consists of 1,485 square feet that is leased through October 2017. The Texas office space consists of 1,200 square feet that is leased through February 2012.

 

Additionally, we maintain small offices in Toronto, Canada; Reading, United Kingdom; Stockholm, Sweden; and Hamburg, Germany. We lease two corporate apartments in Alexandria, Virginia. These corporate apartments are used by our remote consultants and our operations teams who utilize these corporate apartments rather than hotels. We believe that our facilities are adequate for our current and future requirements.

 

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

 

We were a party to a global settlement with the plaintiffs that would have disposed of all claims against us with no admission of wrongdoing by us or any of our 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 in March 2008. Plaintiffs, the issuer defendants (including us), the underwriter defendants, and the insurance carriers for the defendants, have engaged in mediation and settlement negotiations. The parties have reached a settlement agreement, which the District Court preliminarily approved on June 10, 2009. Following a hearing on September 10, 2009, the District Court gave final approval to the settlement. As part of this settlement, our insurance carrier has agreed to assume our entire payment obligation under the terms of the settlement.

 

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 of our profits from the underwriters in amounts to be proven at trial. On February 28, 2008, Ms. Simmonds filed an amended complaint. The suit names us as a nominal defendant, contains no claims against us, and seeks no relief from us. This lawsuit is one of more than fifty similar actions filed in the same court. On July 25, 2008, the underwriter defendants in the various actions filed a joint motion to dismiss the complaints for failure to state a claim. The parties entered into a stipulation, entered as an order by the Court, that we are not required to answer or otherwise respond to the amended complaint. Accordingly, we did not join the motion to dismiss filed by certain issuers. On March 12, 2009, the court dismissed the complaint in this lawsuit with prejudice. On March 31, 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 May 22, 2009 issued an order granting the parties’ joint motion filed on May 22, 2009 to consolidate the 54 appeals and 30 cross-appeals. Under the current schedule, the briefing was completed on November 17, 2009. No date has been set for oral argument in the Ninth Circuit.

 

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

 

No matters were submitted to a vote of security holders during the fourth quarter of our fiscal year ended September 30, 2009.

 

 

The following table presents information regarding our executive officers as of December 11, 2009:

 

 

Umang Gupta has served as one of our directors since September 1997 and as our Chief Executive Officer and Chairman of the Board of Directors since December 1997. From 1984 to 1996, he was a private investor and an advisor to high-technology companies and the founder, Chairman of the Board and Chief Executive Officer of Gupta Technologies, a client/server database and tools company. Prior to that he held various positions with Oracle Corporation and IBM. Mr. Gupta holds a B.S. degree in Chemical Engineering from the Indian Institute of Technology, Kanpur, India, and an M.B.A. degree from Kent State University.

 

Adil Kaya has served as Managing Director of Keynote SIGOS since April 2008. Prior to that, Mr. Kaya served as Director of Sales and Professional Services at Keynote SIGOS since its acquisition in April 2006. From 1990 until its acquisition by Keynote, he served as Director of Sales and Professional Services at SIGOS Gmbh. Mr. Kaya has more than 20 years of broad experience in the telecommunications industry. Mr. Kaya holds a Master’s degree in electrical engineering from the University of Applied Sciences in Cologne, Germany.

 

Andrew Hamer has served as our Chief Financial Officer and Vice President of Finance since January 2006. Prior to that, he served as our Corporate Controller from June 2005 to December 2005. Previously, he held Chief Financial Officer and Vice President of Finance and Administration positions at KnowNow, IQ Labs and Intraspect software from May 2000 to June 2005. From January 1997 until May 2000, Mr. Hamer was the director of finance at Excite@Home and from April 1993 to December 1996, he held a series of financial leadership positions at Sybase culminating in his position as Group Controller overseeing a software development group at the company. Mr. Hamer holds both a B.S. degree in Accounting from the State University of New York at Binghamton, and an M.A. degree in Accounting from Florida International University.

 

Anshu Agarwal has served as Vice President of Marketing since May 2008. Mr. Agarwal served as our Executive Director of Marketing from February 2007 to April 2008 and Senior Director of Marketing from April 2006 to January 2007. Prior to joining Keynote, Mr. Agarwal served as Senior Director of Innovation and Marketing and Projects Director of Fireman’s Fund, from January 2002 to April 2006. Prior to that, Mr. Agarwal served in various marketing positions at a number of technology companies, including Foundry Networks, Shutterfly.com, Sparks.com, and Hewlett Packard Company. He holds a B.A. from Rutgers University and an M.B.A. from NYU Stern School of Business.

Donald Aoki has served as our Senior Vice President of Keynote Professional Services since July 2008. Prior to that, he served as our General Manager of Customer Experience Management group from June 2006 to September 2007, Senior Vice President of Engineering and Operations from November 2004 to June 2006 and Vice President of Engineering from May 1997 to October 2004. From December 1994 to May 1997, he served as a Business Unit General Manager of Aspect Telecommunications, a supplier of customer relational management solutions. Mr. Aoki holds a B.S. degree in Computer Science from the University of Southern California and a M.S. degree in Electrical Engineering and Computer Science from the Massachusetts Institute of Technology.

 

Eric Stokesberry has served as our Vice President of Operations since April 2006. Mr. Stokesberry joined Keynote in 1998 as a Senior Software Engineer. Since then, he has served as Manager and Director of Test Engineering as well as Director of Operations. Prior to joining Keynote, he worked at Network General, both as an engineer and as a product manager. Mr. Stokesberry holds a B.S. degree in Electrical Engineering from Stanford University.

 

Jeffrey Kraatz has served as our Senior Vice President of Worldwide Sales and Services since May 2007. Prior to that, he served as our Vice President of Sales Americas and Asia Pacific from April 2006 to April 2007. Prior to joining Keynote, from June 2004 to April 2005, Mr. Kraatz was the Vice President of Worldwide Sales for Caspian Networks, an advanced IP router company. He also founded Strategic Alliance Worldgroup, an Asian focused international sales and marketing consulting firm from September 2002 to May 2004, and was CEO of two B2B e-commerce firms, Netclerk and Fastxchange, from April 1999 to March 2002. He was Vice President of Sales and Marketing at Warpspeed Communications from March 1998 to March 1999. Mr. Kraatz held a number of senior management positions over a ten-year period with Octel Communications, prior to its acquisition by Lucent Technologies in 1997. Earlier in his career, Mr. Kraatz spent ten years working at SPRINT from 1978 to 1987. He holds a B.A. in Economics from University of California at Los Angeles.

 

Krishna Khadloya has served as our Vice President of Engineering since April 2006. Mr. Khadloya joined Keynote in September 1999 and has served as our Director and Senior Director of Engineering. Prior to that, he served as Director of Research and Development at Mentor Graphics Corporation, an electronic design automation software company. Mr. Khadloya holds a M.S. degree in Computer Science from State University of New York Albany and a B.S. degree in Electrical and Electronics Engineering from Birla Institute of Technology and Science at Pilani, India. He has attended the Executive Program at Stanford University’s Graduate School of Business.

 

Martin Löhlein has served as Managing Director of Keynote SIGOS since April 2008. Prior to that, Mr. Löhlein served as Director of Research and Development at Keynote SIGOS since its acquisition in April 2006. From 1991 until its acquisition by Keynote, he served as Director of Research and Development at SIGOS Gmbh. Mr. Löhlein has more than 20 years of management and technology experience in the telecommunications business. Mr. Löhlein holds a B.S. degree in telecommunications engineering from Georg-Simon-Ohm University of Applied Sciences in Nuremberg, Germany.

 

Vik Chaudhary has served as Vice President of Product Management and Corporate Development since June 2007. Mr. Chaudhary joined Keynote in May 2002 and has served as our Vice President of Marketing and Senior Director of Corporate Development. Before joining Keynote, Mr. Chaudhary founded Bizmetric, an online business measurements company in July 1998 and acted as Chief Executive Officer of the company until March 2002. He was Director of Product Management at Gupta Technologies from February 1993 to March 1998. Prior to that, he led software engineering teams at Oracle Corporation from September 1989 to February 1993. Mr. Chaudhary holds a B.S. degree in Computer Science and Engineering from the Massachusetts Institute of Technology.

 

 

Price Range of Common Stock

 

Our common stock has traded on the Nasdaq Global Market under the symbol “KEYN” since our initial public offering on September 24, 1999. The following table presents the high and low sales price per share of our common stock for the periods indicated, as reported on the Nasdaq Global Market:

 

 

On December 4, 2009, we had 14,530,686 shares, of our common stock outstanding held by 62 stockholders of record. Because many brokers and other institutions hold our stock on behalf of stockholders, we believe the total number of beneficial holders is greater than that represented by these record holders.

 

The market price of our common stock has fluctuated in the past and is likely to fluctuate in the future. In addition, the market prices of securities of other technology companies, particularly Internet-related companies, have been highly volatile. This volatility is often unrelated to the operating performance of these companies. Factors that may have a significant effect on the market price of our common stock include:

 

 

 

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

 

Dividend Policy

 

In the past, we have never declared or paid any cash dividends on our common stock or other securities. In November 2009, we announced a dividend of $0.05 per share payable to stockholders of record as of December 1, 2009. In the future, we intend to pay a similar dividend on a quarterly basis, however, our ability to continue to do so will be affected by our future results of operations, financial position, business and the various other factors that may affect our overall business, including those set forth in “Risk Factors.” Accordingly, we cannot assure you that in the future we will be able to continue to pay a quarterly dividend of this amount, or at all.

 

Purchases of Equity Securities

 

We did not repurchase any common stock during fiscal year 2009. If we were to make additional repurchases of shares of our common stock, we could face additional limits on our use of net operating losses.

Stock Price Performance Graph

 

The information contained in the Performance Graph shall not be deemed to be “soliciting material” or “filed” with the SEC or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), except to the extent that we specifically incorporate it by reference into a document filed under the Securities Act of 1933, as amended (the “Securities Act”) or the Exchange Act.

 

The following graph and table compares the cumulative total stockholder return on our common stock, the NASDAQ Composite Index and The Street.com Internet Sector Index. The graph and table assume that $100 was invested in our common stock, the NASDAQ Composite Index and The Street.com Internet Sector Index on September 30, 2004, and calculates the annual return through September 30, 2009. The stock price performance on the following graph and table is not necessarily indicative of future stock price performance.

 

Cumulative Total Return

 

 

 

The following selected consolidated financial data should be read in conjunction with the consolidated financial statements and related notes appearing in Item 8, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in Item 7 in this Annual Report on Form 10-K. The consolidated statement of operations data for the years ended September 30, 2009, 2008, and 2007, and the consolidated balance sheet data as of September 30, 2009 and 2008, are derived from and are qualified in their entirety by our consolidated financial statements which are included in Item 8 in this Annual Report on Form 10-K. The consolidated statement of operations data for the years ended September 30, 2006 and 2005, and the consolidated balance sheet data as of September 30, 2007, 2006, and 2005, are derived from our audited consolidated financial statements which do not appear in this report. The historical results presented below are not necessarily indicative of the results to be expected for any future fiscal year.

 

 

 

 

 

For information regarding comparability of this data as it may relate to future periods, see the discussion in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

Except for historical information, this Report 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. Forward-looking statements include, among others, those 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 such differences include, but are not limited to, those discussed in Item 1A “Risk Factors”. 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 or Current Reports on Form 8-K that we file in the current fiscal year. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. 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 offer technology-based services and systems that enable enterprises to improve their mobile and online business performance and communications technologies. We offer Internet test and measurement services (“Internet”) and mobile test and measurement services (“Mobile”). Our Internet category includes all of our geographically distributed Web site and application monitoring and measurement services, voice-over-IP and streaming measurement services, load testing services, customer experience management services, competitive research and industry scorecard services, and other professional services. The Mobile category consists of our on-demand Mobile monitoring and testing services, our Global Roamer services and our SIGOS System Integrated Test Environment (“SITE”) systems. We believe all of our services help our customers reduce costs, improve customer satisfaction and increase profitability.

 

We offer our Internet services primarily on a subscription basis and on an engagement basis although, in some cases, we offer Internet professional services on a per incident or per study basis. We also offer the self-service use of our Internet technology for a fixed period of time on a subscription basis. Subscription fees range from monthly to annual commitments, and vary based on the type of service selected, the number of pages, transactions or devices monitored, the number of measurement locations and/or appliances, the frequency of the measurements and any additional features ordered. Engagements typically involve fixed price contracts based on the complexity of the project, the size of a panel, and the type of testing to be conducted. Our Mobile solutions are offered on a subscription basis or license basis. The subscriptions typically are for a fixed period, usually annual, and are based on the number of locations and devices from which monitoring and testing is performed, and the number of mobile operators and services covered by such monitoring and testing. The SIGOS SITE system, which includes software and monitoring hardware, is usually offered via a software license fee model, but because it is bundled with ongoing maintenance and support for a fixed contract period, the license fees are amortized over the length of the contract and are therefore included in ratable license 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.

 

The following management’s discussion and analysis gives effect to the corrections discussed in Note 1(A) to the consolidated financial statements.

 

Our net income increased by approximately $6.1 million, from a net loss of approximately $2.8 million for the year ended September 30, 2008 to net income of approximately $3.3 million for the year ended September 30, 2009. Total net revenue increased by approximately $3.2 million, or 4.2%, from approximately $76.9 million for the year ended September 30, 2008 to approximately $80.1 million for the year ended September 30, 2009. The increase in total net revenue is mainly attributable to an increase of approximately $2.8 million in our ratable licenses revenue from our SIGOS products and services. Total costs and expenses decreased approximately $3.8 million, or 4.7%, from approximately $81.0 million for the year ended September 30, 2008 to approximately $77.2 million for the year ended September 30, 2009 which was primarily due to strong cost containment efforts including salary

reductions of between 7% and 10% across our United States based workforce, lower spending on external consultants and marketing expenses, as well as lower amortization costs of $0.9 million. We anticipate that total expenses for the first quarter of fiscal 2010 will be comparable to the fourth quarter of fiscal 2009.

 

For the year ended September 30, 2009, our 10 largest customers accounted for approximately 34% of total net revenue. We cannot be certain that customers that have accounted for significant revenue in past periods, individually or in aggregate, will renew our services and continue to generate revenue in any future period. In addition, our customers that have monthly renewal arrangements may terminate their services at any time, with little or no penalty. If we lose a major customer or a group of significant customers, our revenue could significantly decline.

 

We believe that the challenges for our business include 1) continuing to drive growth in our Internet and Mobile revenue, 2) growing multiple page/broadband related revenue, such as Transaction Perspective and Application Perspective, without corresponding reductions in unit price, 3) continuing to control our expenses in fiscal 2010, and 4) the challenges faced due to the current economic global downturn.

 

Critical Accounting Policies and Estimates

 

Our consolidated financial statements and accompanying notes included elsewhere in this Annual Report on Form 10-K are prepared in accordance with accounting principles generally accepted in the United States of America. These accounting principles require us to make estimates, judgments and assumptions that have a significant effect on 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 consolidated financial statements:

 

 

Revenue Recognition

 

We recognize revenue in accordance with Staff Accounting Bulletin (“SAB”) 104, Revenue Recognition, FASB Accounting Standards Codification (“ASC”) 605-25-30 (formerly referenced as Emerging Issues Task Force (“EITF”) Issue 00-21 Revenue Arrangements with Multiple Deliverables), ASC 985-605-15 (formerly referenced as Statement of Position (“SOP”) No. 97-2, Software Revenue Recognition), and ASC 985-605-15-3 (formerly referenced as EITF Issue 03-5, Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software). We generally recognize revenue when all of the following criteria have been met:

 

 

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

 

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

 

Subscription Services Revenue:  Subscription services revenue, which is recognized in accordance with SAB 104 and ASC 605-25-30, consists of fees from sales of subscriptions to our Perspective family of services and Global Roamer.

 

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

 

For customers that are billed the entire amount of their subscription in advance, subscription services revenue is deferred upon invoicing and is recognized ratably over the service period, generally ranging from one to twelve months, commencing on the day service is first provided. For customers that are billed on a monthly basis, revenue is recognized monthly based upon actual service usage for the month. Regardless of when billing occurs, we recognize revenue as services are provided and defer any revenue that is unearned. WebEffective service is sold on a subscription basis or as part of a professional services engagement. We recognize revenue from the use of our WebEffective service that is sold on a subscription basis ratably over the subscription period, commencing on the day service is first provided, and such revenue is recorded as subscription services revenue. We recognize revenue from the use of our WebEffective service as part of a professional services engagement 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, software, maintenance, engineering and consulting services associated with Keynote SIGOS SITE systems. We frequently enter into multiple element arrangements with mobile customers for the sale of our automated test equipment, including both hardware and software licenses, consulting services to configure the hardware and software (implementation or integration services), post contract support (maintenance) services, training services and other minor consulting services. These multiple element arrangements are within the scope of ASC 985-605-15, and ASC 985-605-15-3. This determination is based on the hardware component of our multiple element arrangements being deemed to be a software related element. In addition, customers do not purchase the hardware without also purchasing the software. In other words, the software and hardware is sold as a package with payments due from customer upon delivery of this hardware and software package.

 

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

 

We cannot allocate the arrangement consideration to the multiple elements based on vendor specific objective evidence (“VSOE”) of fair value since sufficient VSOE does not exist for the undelivered elements of the arrangement, typically maintenance. Therefore, we recognize the entire arrangement fee into revenue ratably over the maintenance period, historically ranging from twelve to thirty-six months, once the implementation and integration services are completed, usually within two to three months following the delivery of the hardware and software. Where acceptance provisions exist in the arrangement the ratable recognition of revenue begins when evidence of customer acceptance of the software and hardware has occurred as intended under the respective arrangement’s contractual terms.

 

Professional Services Revenue:  Professional services revenue consists of fees generated from our LoadPro, 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 twelve months. For professional service projects that contain milestones, we recognize revenue once the services or milestones have been delivered, based on input measures. Payment occurs either up-front or over time.

 

We also enter into multiple element arrangements that generally consist of either: 1) the combination of subscription and professional services or 2) multiple professional services. For these arrangements, we recognize revenue in accordance with ASC 605-25-30. We allocate and defer revenue for the undelivered items based on objective evidence of fair value of the undelivered elements and recognize the difference between the total arrangement fee and the amount associated with the undelivered items as revenue. When sufficient objective evidence of fair value does not exist for undelivered items when subscription and professional services are combined, the entire arrangement fee is recognized ratably over the applicable performance period.

 

Deferred Revenue:  Deferred revenue is comprised of all unearned revenue that has been collected in advance, primarily unearned license and subscription services revenue, and is recorded as deferred revenue on the balance sheet until the revenue is earned. Deferred revenue is reduced to the extent that there are any accounts receivable balances associated with the deferred revenue (“unpaid deferred revenue”) at the balance sheet date and may change at any point in time based upon the timing of when invoices are collected. 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 more than twelve months from the balance sheet date and primarily consists of Keynote SIGOS SITE revenue.

 

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

 

The table below provides the details of gross deferred revenue (short-term and long-term aggregated), unpaid deferred revenue and net deferred revenue (the amount presented on the consolidated balance sheets) as of September 30, 2009 and 2008. The addback to net deferred revenue (the deferred revenue balance as recorded on the consolidated balance sheets) represents the unpaid deferred revenue that has an associated accounts receivable balance as of the balance sheet dates. The addback of unpaid deferred revenue may change at any point in time as it is based upon the timing of when invoices are collected and whether there is any deferred revenue associated with such accounts receivable.

 

 

Allowance for Doubtful Accounts and Billing Allowance

 

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

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

 

Inventories and Inventory Valuation

 

Inventories related to SIGOS SITE systems were approximately $1.2 million as of September 30, 2009, and relate to direct costs associated with finished goods hardware. Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market. Market is based on estimated replacement value. Determining market value of inventories involves numerous judgments, including average selling prices and sales volumes in future periods. We primarily utilize current selling prices for measuring any potential declines in market value below cost. Any adjustment for market value is charged to direct cost of ratable licenses at the time of the market value decline.

 

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

 

Our inventories include mainly computer hardware and mobile hardware and accessories that may be subject to technological obsolescence. Our products are sold in a competitive industry. If actual product demand or selling prices are less favorable than we estimate, we may be required to take inventory write-downs. For the years ended September 30, 2009, 2008 and 2007, we did not experience any write-down of inventories.

 

Allocation of Purchase Price for Business Combinations

 

We are required to allocate the purchase price of acquired companies to the tangible and intangible assets acquired and liabilities assumed, as well as any in-process research and development (“IPR&D”), based on their estimated fair values. Our methodology for allocating the purchase price relating to acquisitions is usually determined based on management’s assessment in conjunction with valuations performed by an independent third party. Such a valuation requires making significant estimates and assumptions, especially with respect to intangible assets. Critical estimates in valuing certain intangible assets include, but are not limited to, 1) future expected cash flows from customer contracts, customer lists and acquired developed technologies; 2) expected costs to develop IPR&D into commercially viable products and estimating cash flows from projects when completed; and 3) discount rates. Estimates of fair value are based upon assumptions believed to be reasonable, but which are inherently uncertain and unpredictable and, as a result, actual results may differ from estimates. Other estimates such as accruals associated with the accounting for acquisitions may change as additional information becomes available regarding the assets acquired and liabilities assumed.

 

Goodwill, Identifiable Intangibles Assets, and Long-Lived Assets

 

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

 

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

 

 

Management continually applies its judgment when performing these evaluations to determine the timing of the testing, the undiscounted net cash flows used to assess recoverability of the intangible assets and the fair value of the asset group. If future events or circumstances indicate that our estimates or the related assumptions change, an impairment assessment is required and/or an asset group is determined to be impaired, our financial results could be materially and adversely impacted.

 

We performed an annual goodwill review during the fourth quarter in fiscal 2007, 2008, and 2009. We did not record an impairment charge based on our reviews. The goodwill recorded on the consolidated balance sheet as of September 30, 2009 was approximately $66.1 million as compared to $64.4 million as of September 30, 2008.

 

Stock-based Compensation

 

We issue stock options and restricted stock units to our employees and outside directors and provide our employees the right to purchase common stock under our employee stock purchase plan. Since October 1, 2005, we have accounted for stock-based compensation in accordance with ASC 718. Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the service (vesting) period. The value of an option is estimated using the Black-Scholes option valuation model which requires the input of highly subjective assumptions. A change in our assumptions could materially affect the fair value estimate, and thus, the total calculated costs associated with the grant of stock options and restricted stock units or the issue of stock under the employee stock purchase plan. Additionally, if actual forfeiture rates differ significantly from our estimates, stock-based compensation expense and our results of operations could be materially impacted. See Note 6 to the notes to consolidated financial statements for more detail.

 

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

 

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

 

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

 

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

 

As of October 1, 2007, we adopted ASC 740-10 (formerly referenced as FIN 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109) to account for uncertain tax positions. ASC 740-10 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The evaluation of a tax position in accordance with ASC 740-10 is a two-step process. The first step is recognition — we

determine whether it is “more-likely-than-not” that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the “more-likely-than-not” recognition threshold, we presume that the position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information. The second step is measurement — a tax position that meets the “more-likely-than-not” recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured at the largest amount of benefit that is greater than 50 percent likely to be realized upon ultimate settlement.

 

In December 2007, we entered into an agreement whereby we purchased certain intangible assets from our German subsidiary. This transaction was treated as an intercompany sale and, as such, tax is not recognized on the sale until we no longer benefit from the underlying asset. Therefore, during December 2007, we recorded a long-term prepaid tax asset of approximately $1.8 million which represents the tax that the German subsidiary will pay of approximately $3.0 million, offset by the elimination of the remaining carrying amount of the deferred tax liability related to these intangible assets that were established at the time of the acquisition of the German subsidiary. The deferred tax liability had a carrying amount of approximately $1.2 million at the time of the transfer. We are amortizing the net prepaid tax asset of approximately $1.8 million through tax expense over the life of the underlying asset which has been estimated to be 48 months. During the three months ended September 30, 2009, we recorded an additional prepaid tax asset of approximately $1.1 million which represents the additional tax that the German subsidiary will pay based upon an increase in the purchase price calculated in fiscal 2009. We are amortizing the additional net prepaid tax asset of approximately $1.1 million through tax expense over the remaining life of the underlying asset. As of September 30, 2009, the prepaid tax asset was approximately $1.7 million, net of amortization of $820,000 and $418,000 for the years ended September 30, 2009 and 2008, respectively. The prepaid tax asset is recorded as deferred costs and other long-term assets on the consolidated balance sheet.

Results of Operations

 

The following table sets forth selected items from our consolidated statements of operations as a percentage of total net revenue.

 

 

Net Revenue

 

 

Subscription Services.

 

Subscription services revenue consists of fees from subscriptions from our traditional Perspective measurements, monitoring, testing, diagnostic, competitive research and industry scorecard services along with Global Roamer services.

 

Net revenue from subscription services increased by $283,000 for the year ended September 30, 2009 as compared to the year ended September 30, 2008. The increase in subscription services revenue for the year ended September 30, 2009 was mainly attributable to increased sales of our multiple page/broadband subscription services of approximately $2.2 million and mobile services of approximately $1.1 million, partially offset by a decrease in

our single-page device subscription services of approximately $2.5 million and $503,000 in our WebEffective subscription services.

 

Net revenue from subscription services increased by approximately $2.7 million for the year ended September 30, 2008 as compared to the year ended September 30, 2007. The increase in subscription services revenue for the year ended September 30, 2008 over the corresponding period in fiscal 2007 was mainly attributable to increased sales of our multiple page/broadband subscription services of approximately $5.4 million and Global Roamer and other mobile subscription services of approximately $2.5 million, partially offset by a decrease in our single-page/single device subscription services of approximately $5.4 million.

 

We measured an average of over 18,000, 14,100 and 11,600 page measurements during the month of September 2009, 2008 and 2007, respectively. Subscription services fees can vary based on the number of pages measured, the number of devices monitored, the number of measurement locations, the number of users, the number of hours, the frequency of the measurements, the number of private agents, the additional features ordered, and the type of services purchased.

 

We believe that subscription services revenue may increase in the future. However, we cannot assure you that revenue from our multiple page/broadband and mobile subscription services will grow faster than any declines in our single-page/single device and WebEffective subscription services in future periods.

 

Ratable Licenses.

 

Net revenue from ratable licenses increased by approximately $2.8 million for the year ended September 30, 2009 as compared to the year ended September 30, 2008. The increases in ratable licenses revenue were mainly attributable to revenue growth from the sale of new SIGOS SITE systems and existing customers renewing maintenance agreements, offset by an unfavorable impact from foreign exchange rates. Net revenue from these sales is being recognized over the maintenance period for each contract, which is typically twelve to thirty-six months.

 

Net revenue from ratable licenses increased by approximately $8.6 million for the year ended September 30, 2008 as compared to the year ended September 30, 2007. The increase was primarily due to revenue growth from the sale of new SIGOS SITE systems.

 

We expect revenue from ratable licenses will increase in the future. However, this growth may not be as much as experienced in fiscal year 2009. This is primarily attributable to the amount of revenue being recognized from prior periods normalizing with new sales contracts that will be amortized over twelve to thirty-six months. If the dollar weakens against the Euro in the future, these revenues could also be adversely affected.

 

Professional Services.

 

Net revenue from professional services increased by $113,000 for the year ended September 30, 2009 as compared to the year ended September 30, 2008. The increase in professional services revenue for the year ended September 30, 2009 was mainly attributable to an increase of $915,000 from our load testing and enterprise solutions engagements related to preparing websites for the holiday shopping season and other events and new customers, partially offset by a decrease of $802,000 related to our CEM professional engagements.

 

Net revenue from professional services decreased by approximately $2.1 million for the year ended September 30, 2008 as compared to the year ended September 30, 2007. The decrease in revenue was primarily due to fewer CEM engagements.

 

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

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

 

 

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

 

 

The following table shows revenue as a percentage of total net revenue:

 

 

Internet net revenue decreased by $737,000 for the year ended September 30, 2009 compared to year ended September 30, 2008. Internet net revenue represented 59% and 63% of total net revenue for the year ended September 30, 2009 and 2008, respectively. The decrease in internet net revenue in absolute dollars for the year ended September 30, 2009 was mainly attributable to a decrease in our single-page device subscription services of

approximately $2.5 million, a decrease of $802,000 from our CEM engagements, and a decrease of $503,000 in our WebEffective subscription services, partially offset by an increase of our multiple page/broadband subscription services of approximately $2.2 million and $915,000 from our load testing and enterprise solutions engagements.

 

Internet net revenue decreased by approximately $2.0 million for the year ended September 30, 2008 as compared to the year ended September 30, 2007. Internet net revenue represented 63% and 74% of total net revenue for the year ended September 30, 2008 and 2007, respectively. The decrease in Internet net revenue for the year ended September 30, 2008 over the corresponding period in fiscal 2007 was primarily due to a continued decrease of approximately $5.4 million from our single-page/single device subscriptions and $2.1 million from our Internet engagements which consists of our load testing, VOIP, enterprise solutions and customer experience management services, partially offset by an increase of approximately $5.4 million from our multiple-page/broadband services.

 

Mobile revenue increased by approximately $3.9 million for the year ended September 30, 2009 compared to the year ended September 30, 2008. Mobile net revenue represented 41% and 37% of total net revenue for the year ended September 30, 2009 and 2008, respectively. The increase in absolute dollars for the year ended September 30, 2009 is mainly attributable to revenue growth from the sale of new SIGOS SITE systems and existing customers renewing maintenance agreements. The increase was also attributable to increased contribution from our mobile subscription services.

 

Mobile net revenue increased by approximately $11.1 million for the year ended September 30, 2008 as compared to the year ended September 30, 2007. Mobile net revenue represented 37% and 26% of total net revenue for the year ended September 30, 2008 and 2007, respectively. The increase in Mobile net revenue for the year ended September 30, 2008 over the corresponding period in fiscal 2007 was mainly attributable to revenue growth from new SIGOS SITE systems and existing customers renewing maintenance agreements of approximately $8.6 million. In addition, the increase in Mobile net revenue, to a lesser extent, is attributable to increased growth from our mobile subscription services.

 

For the years ended September 30, 2009, 2008 and 2007, no single customer accounted for more than 10% of total net revenue. At September 30, 2009, one customer accounted for 10% of total accounts receivable. At September 30, 2008, one customer accounted for 11% of total accounts receivable. International sales were approximately 45%, 43%, and 31% of our total net revenue for the years ended September 30, 2009, 2008, and 2007, respectively.

 

Costs and Expenses:

 

Direct Costs of Subscription Services, Ratable Licenses and Professional Services

 

 

Direct Costs of Subscription Services.

 

Direct costs of subscription services consist of connection fees to telecommunication and internet access providers for bandwidth usage of our measurement computers, which are located around the world and depreciation, maintenance and other equipment charges for our measurement and data collection infrastructure and mobile subscription services. Direct costs of subscription services increased by $331,000 for the year ended September 30, 2009 as compared to the year ended September 30, 2008, and represented 19% and 18% of subscription services revenue for the year ended September 30, 2009 and 2008, respectively. The increase in absolute dollars was mainly attributable to the increase in bandwidth and connection fees related to our multi-page measurements.

 

Direct costs of subscription services decreased by $65,000 for the year ended September 30, 2008 as compared to the year ended September 30, 2007 and represented 18% and 20% of subscription services revenue for the years ended September 30, 2008 and 2007, respectively. Total direct costs of subscription services for the year ended September 30, 2008 was comparable to the year ended September 30, 2007.

We do not anticipate that direct costs of subscription services for the first quarter of fiscal 2010 will change significantly in absolute dollars compared to the fourth quarter of fiscal 2009.

 

Direct Costs of Ratable Licenses.

 

Direct costs of ratable licenses include cost of support personnel related costs, materials, supplies, and consulting costs related to the sale of our SIGOS SITE systems. Direct costs of ratable licenses decreased by $479,000 for the year ended September 30, 2009 as compared to the year ended September 30, 2008, and represented 25% and 30% of ratable licenses revenue for the year ended September 30, 2009 and 2008, respectively. The cost of the test equipment as part of each new customer contract is expensed ratably over the same initial twelve to thirty-six month period as the ratable licenses revenue to which it is associated. The decrease in direct costs of ratable licenses is mainly attributable to a higher amount of revenue being recognized during the year for maintenance renewals and software upgrades that do not have any significant associated direct costs for test equipment.

 

Direct costs of ratable licenses increased by approximately $2.0 million for the year ended September 30, 2008 as compared to the year ended September 30, 2007, and represented 30% and 35% of ratable licenses revenue for the years ended September 30, 2008 and 2007, respectively. The increase was primarily due to test equipment sold as part of each new SITE system contract that is expensed ratably over the same initial twelve to thirty-six month period as the ratable licenses revenue to which it is associated. The decrease in direct costs of ratable licenses as a percentage of the ratable license revenue is primarily due to the fact that there was higher revenue being recognized in fiscal 2008 for maintenance renewals that do not have any significant associated direct costs.

 

We do not anticipate that direct costs of ratable licenses for the first quarter of fiscal 2010 will change significantly in absolute dollars compared to the fourth quarter of fiscal 2009.

 

Direct Costs of Professional Services.

 

Direct costs of professional services consist of compensation expenses and related costs for professional services personnel, external consulting expenses to deliver our professional services revenue, panel and reward costs associated with our CEM engagements, all load-testing bandwidth costs and related network infrastructure costs. Direct costs of professional services decreased by approximately $1.2 million for the year ended September 30, 2009 as compared to the year ended September 30, 2008, and represented 60% and 73% of professional services revenue for the year ended September 30, 2009 and 2008, respectively. The decreases in costs of professional services for the year ended September 30, 2009 is primarily due to lower personnel related costs associated with our CEM services due to continued cost containment.

 

Direct costs of professional services decreased by approximately $1.1 million for the year ended September 30, 2008 as compared to the year ended September 30, 2007, and represented 73% and 69% of professional service revenue for the years ended September 30, 2008 and 2007, respectively. The decrease in direct costs of professional services was primarily due to lower personnel related costs associated with our customer experience management services. In addition, the decrease in costs of professional services was due to consulting expenses that were incurred in fiscal 2007 that did not recur in fiscal 2008 due to a specific customer engagement. The increase in direct costs of professional services as a percentage of professional services is due to lower professional services revenue in fiscal 2008 as compared to fiscal 2007.

 

We do not anticipate that direct costs of professional services for the first quarter of fiscal 2010 will change significantly in absolute dollars compared to the fourth quarter of fiscal 2009.

 

Development

 

Development expenses consist primarily of compensation, which includes stock based compensation, and other related costs for development personnel. The decrease in development costs for the year ended September 30, 2009 was primarily due to salary reductions and lower consulting costs.

 

Development expenses increased by approximately $1.0 million for the year ended September 30, 2008 as compared to the year ended September 30, 2007. The increase is primarily attributable to an increase of 5 headcount throughout the year, which amounted to approximately $781,000, and to $178,000 in higher consulting expenses.

 

We do not anticipate that development expenses for the first quarter of fiscal 2010 will change significantly in absolute dollars compared to the fourth quarter of fiscal 2009.

 

Operations

 

 

Operations expenses consist primarily of compensation and related expenses for management and technical support personnel who manage and maintain our field measurement and collection infrastructure and headquarters data center, and provide basic and extended customer support. Our operations personnel also work closely with other departments to assure the reliability of our services. Our operations expenses decreased by $312,000 for the year ended September 30, 2009 as compared to the year ended September 30, 2008, primarily due to strong cost containment through salary reductions.

 

Our operations expenses increased by $903,000 for the year ended September 30, 2008 as compared to the year ended September 30, 2007. The increase was primarily due to $584,000 of compensation-related costs due to an increase in personnel from 48 in the fourth quarter of fiscal 2007 to 51 in the fourth quarter of fiscal 2008, along with higher consulting expenses of $199,000.

 

We do not anticipate that operations expenses for the first quarter of fiscal 2010 will change significantly in absolute dollars compared to the fourth quarter of fiscal 2009.

 

Sales and Marketing

 

 

Sales and marketing expenses consist primarily of salaries, commissions and bonuses earned by sales and marketing personnel, lead-referral fees, marketing programs and travel expenses. Sales and marketing expenses decreased by approximately $1.8 million for the year ended September 30, 2009 as compared to the year ended September 30, 2008. The decreases in sales and marketing expenses for the year ended September 30, 2009 were primarily attributable to strong cost containment that resulted in lower spending on marketing programs and tradeshow events.

 

Our sales and marketing expenses increased by approximately $5.6 million for the year ended September 30, 2008 as compared to the year ended September 30, 2007. Approximately $4.6 million of the increase was primarily related to our continued investment in sales and marketing, including an increase in personnel from 89 in the fourth quarter of fiscal 2007 to 96 in the fourth quarter of fiscal 2008. In addition, the increase, to a lesser extent, was attributable to higher spending on marketing programs and events in fiscal 2008 of $332,000 and higher travel and related expenses of $372,000 due to the number of sales and marketing events.

 

We believe that sales and marketing expenses for the first quarter of fiscal 2010 will increase in absolute dollars compared to the fourth quarter of fiscal 2009 due to incremental spending on new sales personnel and seasonal spending on marketing programs.

General and Administrative

 

 

General and administrative expenses consist primarily of compensation and related costs, professional service fees, including accounting, auditing and legal fees, insurance, and other general corporate expenses. General and administrative expenses increased by $190,000 for the year ended September 30, 2009 as compared to the year ended September 30, 2008. The increase in expenses was mainly attributable to additional personnel costs associated with additional headcount and higher consulting and professional services fees, partially offset by salary reductions.

 

Our general and administrative expenses increased by $286,000 for the year ended September 30, 2008 as compared to the year ended September 30, 2007. General and administrative expenses increased by $423,000 primarily attributable to increased headcount and personnel related costs. The increase was offset by decreased spending in professional fees in fiscal 2008 as compared to fiscal 2007.

 

We do not anticipate that general and administrative expenses for the first quarter of fiscal 2010 will change significantly in absolute dollars compared to the fourth quarter of fiscal 2009.

 

Excess Occupancy Income

 

 

Excess occupancy income consists of rental income from the leasing of space not occupied by us in our headquarters building, net of related fixed costs, such as property taxes, insurance, building depreciation, leasing broker fees and tenant improvement amortization. The costs associated with excess occupancy income are based on the actual square footage available for lease to third parties, which was approximately 75% for each of the years ended September 30, 2009 and 2008. The decrease in excess occupancy income for the year ended September 30, 2009 as compared to the year ended September 30, 2008 was primarily due to increased amounts of net expenses related to depreciation, property taxes and insurance.

 

The increase in excess occupancy income in fiscal 2008 as compared to fiscal 2007 was primarily due to an increase in tenant income of approximately $1.2 million due to the leasing of additional space, offset by a net increase in expenses of $286,000.

 

We expect the excess occupancy income in the first quarter of fiscal 2010 will be comparable to the fourth quarter of fiscal 2009.

 

Amortization of Identifiable Intangible Assets and In-process Research and Development

 

Amortization of intangible assets — software mainly relates to developed technology related to our SIGOS SITE system and is reflected in direct costs of revenue in our consolidated statements of operations. All other intangibles, including customer lists, are included in amortization of intangible assets — other and is reflected in operating expenses in our consolidated statement of operations.

 

Total amortization of identifiable intangible assets decreased by $938,000 for the year ended September 30, 2009 as compared to the year ended September 30, 2008. The decrease in total amortization is due to certain intangibles becoming fully amortized in fiscal 2008, partially offset by an increase in amortization associated with intangible assets purchased in the Zandan acquisition that occurred in April 2008.

 

Total amortization of identifiable intangible assets increased by $199,000 for the year ended September 30, 2008 as compared to fiscal 2007 primarily due to intangible assets purchased in the Zandan acquisition.

 

We review our identifiable intangible assets for impairment annually or whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. At September 30, 2009, we had a remaining balance of approximately $6.3 million of identifiable intangible assets that are being amortized over a three to six and one half-year expected life. We expect the amortization of identifiable intangible assets to be approximately $619,000 for the first quarter of fiscal 2010, assuming no additional acquisitions or impairment charges. We expect the remaining carrying value of the identifiable intangible assets as of September 30, 2009, as listed in the table below, will be fully amortized by December 2012 (in thousands):

 

 

Lease abandonment expense

 

During the fourth quarter of fiscal 2009, we committed to an exit plan to cease using our New York facility. Commencing October 1, 2009, we have subleased the facility to a third party through October 2015, the remainder of the lease term. The lease abandonment expense of $635,000 is included in income from operations in the consolidated statement of operations.

 

Interest Income and Other Income (Expenses)

 

 

Subsequent to the issuance of our consolidated financial statements for the year ended September 30, 2008, management determined that foreign exchange losses previously presented in the consolidated statement of operations should have been classified in accumulated other comprehensive income. Consequently, corrections have been made to reduce other income (expenses) in the consolidated statements of operations by $336,000 to a corrected balance of $(699,000), from the balance of approximately $(1.0) million previously reported.

 

Interest income and other income (expenses), net decreased $995,000 for the year ended September 30, 2009 as compared to the year ended September 30, 2008. Interest income decreased for the year ended September 30, 2009 in comparison to fiscal 2008 primarily due to lower interest rates on invested cash balances. Other income (expenses) for the year ended September 30, 2009 increased in comparison to fiscal 2008 primarily due to more favorable foreign exchange rates in 2009 compared to 2008.

 

Interest income and other income (expenses), net, decreased by approximately $2.4 million for the year ended September 30, 2008 as compared to the year ended September 30, 2007. The decrease in interest income and other

income (expenses), net, was primarily attributable to lower interest income from lower balance of invested cash, cash equivalents, and short-term investments.

 

We believe that interest income and other income (expenses), net, for the first quarter of fiscal 2010 will be approximately $150,000, absent any additional transactions, and assuming no material changes in interest rates, foreign exchange rates, and currently planned uses of cash.

 

Provision for Income Taxes

 

 

For the year ended September 30, 2009, we recorded a net tax expense of $1.0 million.

 

Although we had a loss before income taxes for the year ended September 30, 2008, we recorded a net tax expense of approximately $1.0 million.

 

For the year ended September 30, 2007, we recorded a net tax expense of approximately $4.1 million. Our effective tax rate for the year ended September 30, 2007 was approximately 759% including the effect of the adjustment of the valuation allowance. In the fourth quarter of fiscal 2007, we recorded deferred income tax expense of approximately $3.3 million associated with an increase in the valuation allowance against our net deferred tax assets. This increase was primarily due to the net loss incurred in fiscal 2007 and our recent history of losses.

 

The tax rate differed from the statutory rate in each of the years primarily due to nondeductible stock based compensation charges, foreign tax differential, amortization on prepaid tax asset and the change in our valuation allowance.

 

We had net operating loss carryforwards at September 30, 2009 for federal income tax purposes of approximately $61.3 million, available to reduce future income subject to income taxes. The federal net operating loss carryforwards will expire, if not utilized, in the tax years 2011 through 2027. In addition, we had approximately $25.7 million of net operating loss carryforwards at September 30, 2009 available to reduce future taxable income for state income tax purposes. The state net operating loss carryforwards will expire, if not utilized, in the tax years 2011 through 2018.

 

California has enacted legislation that suspends the utilization of net operating loss carry forwards for tax years 2008 and 2009. It also limits the use of business credits to 50% of a taxpayer’s tax liability for tax years 2008 and 2009. This legislation increased our tax liability for tax year 2008 and will likely increase our tax liability for tax year 2009.

 

As of September 30, 2009, we had research credit carryforwards of approximately $2.5 million for federal and $2.3 million for state income tax purposes individually available to reduce future income taxes. The federal research credit carryforwards begin to expire in the tax year 2010. The California research credit can be carried forward indefinitely.

 

Deferred tax liabilities have not been recognized for undistributed earnings of foreign subsidiaries because it is management’s intention to reinvest such undistributed earnings indefinitely in those foreign subsidiaries. Undistributed earnings of our foreign subsidiaries amounted to approximately $4.1 million at September 30, 2009. If we distribute these earnings, in the form of dividends and otherwise, we would be subject to both U.S. income taxes (net of applicable foreign tax credits) and withholding taxes payable to the foreign jurisdiction.

 

Federal and state tax laws impose substantial restrictions on the utilization of net operating loss and credit carryforwards in the event of an “ownership change” for tax purposes, as defined in Section 382 of the Internal Revenue Code. We have determined that the net operating losses and research and development credits acquired through the acquisition of two of our subsidiaries are subject to section 382 limitations, and the effects of the limitations have been included in the loss and credit carryforwards. If an additional ownership change occurs, the utilization of net operating loss and credit carryforwards could be significantly reduced. If we were to make additional repurchases of shares of our common stock, we could face additional limits on our use of net operating losses.

Liquidity and Capital Resources

 

 

 

 

 

Cash, cash equivalents and short-term investments and working capital

 

At September 30, 2009, we had approximately $51.4 million in cash and cash equivalents and approximately $6.6 million in short-term investments, for a total of approximately $58.0 million. Cash and cash equivalents consist of highly liquid investments held at major banks, money market funds and fixed term deposits with original maturities of three months or less. As of September 30, 2009, approximately $35.5 million of our cash and cash equivalents and investments was held in the United States. The remainder of our cash and cash equivalents and short-term investments were held in foreign subsidiaries. If these cash and cash equivalents and short-term investments are distributed to the United States in the form of dividends or otherwise, we may be subject to additional U.S. income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes.

 

Cash flows from operating activities

 

We expect that cash provided by operating activities may fluctuate in future periods as a result of a number of factors, including fluctuations in our operating results, accounts receivable collections, and the timing and amount of tax and other payments.

 

Our largest source of operating cash flow is cash collections from our customers. Payments from subscription services customers are generally collected either at the beginning of the subscription period, ranging from one to twelve months, or monthly during the life of the subscription period. Payments for our ratable licenses are generally collected at delivery of the SIGOS SITE system. Payments from some of our professional services customers are collected at the end of the monthly service period or as milestones are completed. Our primary use of cash from operating activities, are for personnel related expenditures, measurement and data collection infrastructure costs, insurance, regulatory compliance and other expenses associated with operating our business.

 

Comparison of Years Ended September 30, 2009 and 2008

 

For the year ended September 30, 2009, net cash provided by operating activities was approximately $8.8 million. Net cash provided was mainly due to net income of $3.3 million adjusted for $13.1 million of non-cash adjustments to reconcile net income to net cash provided by operating activities and a $7.6 million net decrease in operating assets and liabilities. The non-cash adjustments consist primarily of depreciation, amortization, stock-based compensation expenses and bad debt and billing adjustment reserves. The net decrease in operating assets and liabilities was primarily due to a decrease in accounts payable and accrued expenses of $4.7 million, a decrease in deferred revenue of approximately $1.7 million, and an increase in prepaid and other assets, including prepaid tax assets, of $1.8 million, partially offset by a decrease in account receivable of $0.6 million. The change in accounts payable and accrued expenses during the year ended September 30, 2009 was

mainly attributed to tax payments to the German authorities for taxes associated with prior operations and an IP migration strategy that occurred in 2008.

 

Comparison of Years Ended September 30, 2008 and 2007

 

For the year ended September 30, 2008, net cash provided by operating activities was approximately $5.3 million which was primarily due to a net loss of $2.8 million, adjusted for all non-cash amortization, depreciation and stock-based compensation. Net cash provided by operating activities for fiscal 2008 was offset by cash used in operating activities due to an increase of approximately $1.6 million in accounts receivable and a decrease of approximately $2.1 million in deferred revenue. The increase in accounts receivable was mainly attributable to higher DSO in fiscal 2008 as compared to fiscal 2007. The decrease in deferred revenue is mainly attributable to increased number of ITM customers that are now being billed on a month-to-month basis in arrears rather than being billed in advance.

 

Cash flows from investing activities

 

The changes in cash flows from investing activities primarily relates to acquisitions and the timing of purchases and maturities of investments. We also use cash to invest in equipment and other assets to support our growth and infrastructure.

 

Comparison of Years Ended September 30, 2009 and 2008

 

For the year ended September 30, 2009, net cash used by our investing activities was approximately $2.7 million. We paid approximately $15.9 million for the purchase of short-term investments, and received approximately $16.8 million from maturities and sales of short-term investments. We also utilized $3.4 million to purchase property, equipment, and software primarily for our production infrastructure, information systems, and tenant improvements associated with space that we have leased in our headquarters building.

 

Comparison of Years Ended September 30, 2008 and 2007

 

Cash flows from investing activities increased for the year ended September 30, 2008 compared to the prior year primarily due to the net sales of short-term investments of $58.3 million, offset by $10.1 million of purchases of property and equipment, acquired technology, and the purchase of businesses and assets, net.

 

Cash flows from financing activities

 

The changes in cash flows from financing activities primarily relate to payments made for stock repurchases and proceeds received from the issuance of common stock associated with our employee stock option plan and employee stock purchase plan.

 

Comparison of Years Ended September 30, 2009 and 2008

 

Cash flows from financing activities increased for the year ended September 30, 2009 compared to the prior year primarily due to proceeds from the issuance of common stock associated with our employee stock option plan and employee stock purchase plan of approximately $3.0 million.

 

Comparison of Years Ended September 30, 2008 and 2007

 

Cash flows from financing activities decreased for the year ended September 30, 2008 compared to the prior year primarily due to repurchases of our common stock in fiscal 2008. We utilized approximately $60.1 million and $1.2 million to repurchase shares of our common stock in the open market during the years ended September 30, 2008 and 2007, respectively. We received approximately $6.5 million and $12.2 million from the issuance of common stock associated with our employee stock option plan and employee stock purchase plan for the years ended September 30, 2008 and 2007, respectively.

Commitments and Contractual Obligations

 

As of September 30, 2009, our principal commitments consisted of approximately $2.5 million in real property operating leases and equipment capital and operating leases, with various lease terms, the longest of which expires in October 2017. Additionally, we had contingent commitments, ranging in length from one to twenty-nine months, to bandwidth and collocation providers amounting to approximately $1.8 million, which commitments become due if we terminate any of these agreements prior to their expiration. At present, we do not intend to terminate any of these agreements prior to their expiration. We expect to continue to invest in equipment and other assets to support our growth.

 

The following table summarizes our minimum contractual obligations and commercial commitments as of September 30, 2009 (in thousands):

 

 

The above amounts exclude liabilities under ASC 740-10, as we are unable to reasonably estimate the ultimate amount or timing of settlement.

 

As of September 30, 2009, we have outstanding guarantees to customers and vendors totaling $148,000 in one of our foreign subsidiaries. The guarantees can only be executed upon agreement by both the customer or vendor and us. The guarantees are secured by an unsecured line of credit of approximately $1.5 million that has not been drawn upon as of September 30, 2009.

 

We generally do not indemnify customers for our measuring, monitoring and testing Web-based applications against legal claims that our products and services infringe on third-party intellectual property rights. Other agreements entered into by us may include indemnification provisions that we could be subject to costs and/or damages in the event of an infringement claim against us or an indemnified third-party. However, we have never been a party to an infringement claim and in the opinion of management, we do not have a liability related to any infringement claims subject to indemnification and as such, there is no material adverse affect on our financial condition, liquidity or results of operations.

 

We believe that our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. Factors that could affect our cash position include potential acquisitions, decreases in customers or renewals, decreases in revenue or changes in the value of our short-term investments. If, after some period of time, cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or to obtain a credit facility. If additional funds are raised through the issuance of debt securities, these securities could have rights, preferences and privileges senior to holders of common stock, and the term of this debt could impose restrictions on our operations. The sale of additional equity or convertible debt securities could result in dilution to our stockholders, and we may not be able to obtain additional financing on acceptable terms, if at all. If we are unable to obtain this additional financing, our business may be harmed.

 

Off Balance Sheet Arrangements

 

We did not enter into any transactions with unconsolidated entities whereby we have financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in a unconsolidated entity that provides financing, liquidity, market risk or credit risk support to us.

Recent Accounting Pronouncements

 

In September 2009, the Financial Accounting Standards Boards (“FASB”) amended the Accounting Standards Codification (“ASC”) as summarized in Accounting Standards Update (“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. We are currently assessing the impact of these amendments to the ASC on our accounting and reporting systems and processes; however, at this time we are unable to quantify the impact on our financial statements of our adoption or determine the timing and method of our adoption.

 

During the first quarter of 2009, we adopted FASB 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) and will be adopted by the us beginning in the first quarter of 2010. Although we will continue to evaluate the application of this accounting standard, management does not currently believe adoption of this accounting pronouncement will have a material impact on our financial condition or operating results.

 

In December 2007, the FASB issued 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 is effective for fiscal years beginning on or after December 15, 2008 and will be adopted by us beginning in the first quarter of 2010 and will apply prospectively to any business combinations completed on or after that date. The effect of adoption of this new accounting pronouncement on our financial condition or operating results will depend on the nature of acquisitions completed after the date of adoption.

 

In December 2007, the FASB issued ASC 810-10-65-1, Noncontrolling Interests in Consolidated Financial Statements — an amendment of Accounting Research Bulletin No. 51 (formerly referenced as SFAS No. 160), which establishes accounting and reporting standards for ownership interests in subsidiaries held by parties other than the parent, the amount of consolidated net income attributable to the parent and to the noncontrolling interest, changes in a parent’s ownership interest and the valuation of retained noncontrolling equity investments when a subsidiary is deconsolidated. The Statement also establishes reporting requirements that provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. ASC 810-10-65-1 is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, which will be our fiscal year beginning October 1, 2009. Although we will continue to evaluate

the application of this accounting standard, management does not currently believe adoption of this accounting pronouncement will have a material impact on our consolidated financial position, results of operations and cash flows.

 

In March 2008, the FASB issued ASC 815-10, Disclosures about Derivative Instruments and Hedging Activities (formerly referenced as SFAS No. 161). ASC 815-10 enhances financial disclosure by requiring that objectives for using derivative instruments be described in terms of underlying risk and accounting designation in the form of tabular presentation, requiring transparency with respect to the entity’s liquidity from using derivatives, and cross-referencing an entity’s derivative information within its financial footnotes. ASC 815-10 is effective for financial statements issued for fiscal years beginning after November 15, 2008, which will be our fiscal year beginning October 1, 2009. We are currently evaluating the impact, if any, that ASC 815-10 may have on our consolidated financial position, results of operations and cash flows.

 

In April 2008, the FASB released ASC 350, Determination of the Useful Life of Intangible Assets (formerly referenced as FASB Staff Position 142-3), which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under ASC 350-20, Goodwill and Other Intangible Assets (formerly referenced as SFAS No. 142). The intent of the statement is to improve the consistency between the useful life of a recognized intangible asset under ASC 350-20 and the period of expected cash flows used to measure the fair value of the asset under ASC 805 and other U.S. generally accepted accounting principles. ASC 350 is effective as of the beginning of an entity’s fiscal year that begins after December 15, 2008, which will be our fiscal year beginning October 1, 2009. We are currently evaluating the potential impact, if any, of the adoption of ASC 350 on our consolidated financial position, results of operations and cash flows.

 

 

We are exposed to financial market risks, including changes in interest rates and foreign currency exchange rates. To mitigate these risks we may use derivative financial instruments in accordance with our investment and foreign exchange policies. We have not and currently do not use derivatives or other financial instruments for trading or speculative purposes.

 

Interest Rate Sensitivity.  Our interest income and expense is sensitive to changes in the general level of U.S. interest rates, particularly because most of our cash, cash equivalents and short-term investments are invested in short-term debt instruments. If market interest rates were to change immediately and uniformly by ten percent (10%) from levels at September 30, 2009, the interest earned on those cash, cash equivalents and short-term investments could increase or decrease by approximately $85,000 on an annualized basis.

 

Foreign Currency Fluctuations.  A substantial majority of our revenue and expenses are transacted in U.S. dollars. However, we do enter into transactions in other currencies, primarily the Euro and British Pound. We operate internationally and are exposed to potentially adverse movements in foreign currency rate changes. Revenues derived from customers outside of the United States, which are billed from our headquarters, in San Mateo, CA, and have the U.S. dollar as the functional currency, are collected in foreign currencies. Revenues derived from customers outside of the United States, which are billed from our Nuremberg, Germany office, are typically billed in Euros. Similarly, substantially all of the expenses of operating our international subsidiaries are incurred in foreign currencies. As a result, our U.S. dollar earnings and net cash flows from international operations may be adversely affected by changes in foreign currency exchange rates. Net foreign exchange transaction gains (losses) included in “Interest and Other Expenses” in the accompanying Consolidated Statements of Operations, primarily due to fluctuations in the Euro and the British Pound, totaled $455,000, $(610,000), and $3,000 for the years ended September 30, 2009, 2008, 2007, respectively.

 

Keynote Systems, Inc. and Subsidiaries

 

Index to Consolidated Financial Statements

 

 

To the Board of Directors and Stockholders of

Keynote Systems, Inc.

San Mateo, California

 

We have audited the accompanying consolidated balance sheets of Keynote Systems, Inc. and subsidiaries (the “Company”) as of September 30, 2009 and 2008, and the related consolidated statements of operations, stockholders’ equity and comprehensive income (loss), and cash flows for each of the three years in the period ended September 30, 2009. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Keynote Systems, Inc. and subsidiaries as of September 30, 2009 and 2008, and the results of their operations and their cash flows for each of the three years in the period ended September 30, 2009, in conformity with accounting principles generally accepted in the United States of America.

 

As discussed in Note 1(M) to the consolidated financial statements, effective October 1, 2007, the Company adopted the provisions of ASC 740-10 (“Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109.”)

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of September 30, 2009, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated December 11, 2009 expressed an unqualified opinion on the Company’s internal control over financial reporting.

 

 

San Jose, California

December 11, 2009

Keynote Systems, Inc. and Subsidiaries

Consolidated Balance Sheets

 

 

See accompanying notes to the consolidated financial statements

Keynote Systems, Inc. and Subsidiaries

 

Consolidated Statements of Operations