Summary of KEITHLEY INSTRUMENTS INC

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
This Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to provide investors with an understanding of the Company's operating performance and financial condition. A discussion of our business, including our strategy, products, and competition is included in Part I of our 2008 Form 10-K. Business Overview
Our business is to design, develop, manufacture and market complex electronic instruments and systems to serve the specialized needs of electronics manufacturers for high-performance production testing, process monitoring, product development and research. Our primary products are integrated systems used to source, measure, connect, control or communicate electrical direct current (DC), radio frequency (RF) or optical signals. Our customers are engineers, technicians and scientists in manufacturing, product development and research functions. During the first quarter of fiscal year 2009, semiconductor orders comprised approximately 25 percent of our total orders; wireless communications orders were about five percent; precision electronic components/subassembly manufacturers were approximately 25 percent, which includes customers in automotive, computers and peripherals, medical equipment, aerospace and defense, and manufacturers of components; and research and education orders were about 35 percent. The remainder of orders came from customers in a variety of other industries. Although our products vary in capability, sophistication, use, size and price, they generally test, measure and analyze electrical, RF, optical or physical properties. As such, we consider our business to be in a single industry segment.
The most important factors influencing our ability to grow revenue are (i) our customers' spending patterns as they invest in new capacity or upgrade manufacturing lines for new product offerings, (ii) our ability to offer interrelated products with differentiated value that solve our customers' most compelling test challenges, and (iii) our success in penetrating key accounts with our globally deployed sales and service team.
Many of the industries we serve, including but not limited to the semiconductor industry, the wireless communications industry, and precision electronic components/subassembly manufacturers, have historically been very cyclical and have experienced periodic downturns. Our customers across all industries and geographies demonstrated reduced order patterns, which began during the later part of our fourth quarter of fiscal 2008 and have continued into fiscal year 2009. In response to the order contraction we experienced, we took action during the fourth quarter of fiscal 2008 to reduce our future operating expenses. Additionally, during November and December of fiscal year 2009, we announced further cost reduction measures including a hiring freeze with the exception of a few critical replacements, a reduction in our capital expenditures, and travel and other discretionary spending, a pay reduction for the majority of U.S. exempt employees and unpaid days off for U.S. non-exempt employees, the suspension of the annual bonus program for management and lower sales commissions payments to the sales force, the suspension of the Company's 401(k) match for the remainder of fiscal year 2009, and a reduction in force that took place in January 2009.
Our focus during the past several years has been on building long-term relationships and strong collaborative partnerships with our global customers to serve their measurement needs. Toward that end, we rely primarily upon employing our own sales personnel to sell our products, and use sales representatives, to whom we pay a commission, in areas where we believe it is not cost-beneficial to employ our own people. This sales channel strategy allows us to build a sales network of focused, highly trained sales engineers who specialize in measurement expertise and problem-solving for customers and enhances our ability to sell our products to customers with worldwide operations. We believe our ability to serve our customers has been strongly enhanced by deploying our own employees throughout the United States, Europe and Asia. We expect that selling through our own sales force will be favorable to earnings during times of strong sales, but it is unfavorable during times of depressed sales, such as the current economic environment, as a substantial portion of our selling costs are fixed. Critical Accounting Policies and Estimates Management has identified the Company's "critical accounting policies." These policies have the potential to have a more significant impact on our financial statements, either because of the significance of the financial statement item to which they relate or because they require judgment and estimation due to the uncertainty involved in measuring, at a specific point in time, events which will be settled in the future. These critical accounting policies and estimates are described in Management's Discussion and Analysis included in our 2008 Form 10-K, and include use of estimates, revenue recognition, inventories, income taxes, pension plan and stock compensation plans.

Results of Operations
First Quarter Fiscal 2009 Compared with First Quarter Fiscal 2008 Net sales of $31,070 for the first quarter of fiscal 2009 decreased $7,368, or 19 percent, compared to the prior year's first quarter sales of $38,438. Sales outside of the Americas represented approximately 75 percent of total sales for the current year's quarter. Two percentage points of the sales decrease was the result of a stronger U.S. dollar. Geographically, sales were down 15 percent in the Americas, 23 percent in Asia, and 18 percent in Europe. Sequentially, sales decreased six percent compared with the fourth quarter of fiscal year 2008, approximately half of which was the result of a stronger U.S. dollar. Orders of $27,663 for the first quarter decreased 32 percent from last year's first quarter orders of $40,593. Geographically, orders decreased 28 percent in the Americas, 41 percent in Asia, and 24 percent in Europe when compared to the prior year. Orders from the Company's semiconductor customers decreased approximately 35 percent, orders from wireless communications customers decreased approximately 80 percent, orders from both precision electronic component/subassembly manufacturers and from research and education customers each decreased approximately 15 percent compared to the prior year's first quarter. Order backlog decreased $3,371 during the quarter to $15,038 at December 31, 2008. The Company does not track net sales in the same manner as it tracks orders by major customer group. However, sales trends generally correlate to Company order trends, although they may vary between quarters depending upon the orders which remain in backlog.
Cost of goods sold as a percentage of net sales increased to 42.8 percent from 40.9 percent in the prior year's first quarter. The increase was due primarily to lower sales volume, and a three percent stronger U.S. dollar versus foreign currencies. Nearly all products the Company sells are manufactured in the United States; therefore, cost of goods sold expressed in dollars is generally not affected by changes in foreign currencies. However, as a percentage of net sales, it is affected as net sales dollars fluctuate due to currency exchange rates changes. Foreign exchange hedging decreased cost of goods sold as a percentage of net sales by 0.5 percentage points in the first quarter of fiscal 2009, and increased cost of goods sold as a percentage of net sales by 0.5 percentage points in the first quarter of fiscal 2008.
Selling, general and administrative expenses of $14,015 or 45.1 percent of net sales, decreased $2,046, or 13 percent, from $16,061, or 41.8 percent of net sales, in last year's first quarter. The decrease was due primarily to the cost-cutting actions the Company has taken. These include lower compensation expenses; including lower salaries and in-house commissions and bonuses; and lower marketing program spending. Additionally, during the current year's first quarter, we recognized a favorable adjustment for performance award units granted in fiscal years 2007 and 2008, which we currently expect to settle at zero percent and 50 percent of target, respectively. See Note E to the Company's condensed consolidated financial statements included in this Form 10-Q. Product development expenses for the quarter were $6,053, or 19.5 percent of net sales, down $110, or two percent, from last year's $6,163, or 16.0 percent of net sales. The decrease is primarily a result the favorable adjustment for performance award units granted in prior years (see Note E), and lower project consultant costs resulting from our cost-cutting actions. This was partially offset by higher development supplies and pilot production costs as we continue to expand, refresh and enhance our product offering and capabilities. The Company recognized a favorable adjustment of $3 during the first quarter for severance and related costs, which were recorded in the fourth quarter of fiscal year 2008. The severance and related costs associated with the reduction in force that took place in January 2009 will be recorded in the Company's second quarter of fiscal year 2009 and are expected to approximate $1,300.
The Company reported an operating loss of $2,290 for the first quarter of fiscal year 2009 compared to operating income of $480 for the prior year's quarter. Lower net sales accounted for the decrease, which was partially offset by lower operating costs due to the cost-cutting actions, and lower stock-based compensation expense. See Note E.
Investment income was $175 for the quarter compared to $528 in last year's first quarter. The decrease was due primarily to lower cash and short-term investment balances, lower interest rates, and a reduction to the interest rate on a long-term note receivable.

The Company recorded income tax expense for the three months ended December 31, 2008, of $30,224 on a loss before taxes of $2,135, an effective tax rate of 1,415.7 percent. The tax expense included a $29,967 non-cash expense for a valuation allowance recorded against U.S. deferred tax assets. As a result of the overall downturn in the U.S. economy, our sales and profitability have been adversely impacted resulting in a cumulative loss for the past twelve quarters. This coupled with revised downward projections led us to conclude that it is more likely than not that the deferred tax assets will not be realized; accordingly, we recorded the valuation allowance. In addition, the Company was not able to record a tax benefit on the current quarter's U.S. loss, and recorded income in certain foreign operations that resulted in tax expense for the quarter. This compares to income tax expense of $99 on income before taxes of $988, or an effective tax rate of 10.0 percent for the prior year's quarter ended December 31, 2007.
For the first three months of fiscal year 2008, the effective tax rate was less than the U.S. federal statutory tax rate due to the favorable impacts of the research tax credit and tax benefits of foreign income which are taxed at lower rates than the U.S. statutory tax rate. These benefits were partially offset by taxes paid to U.S. state and local jurisdictions and other permanent differences.
The Company reported a net loss of $32,359, or $2.07 per share, for the first quarter of fiscal 2009, compared with net income of $889, or $0.05 per diluted share, for the first quarter of fiscal 2008. Included in the current quarter's results is an unfavorable discrete tax adjustment of approximately $1.92 per share.
Financial Condition, Liquidity and Capital Resources Working Capital
The following table summarizes working capital as of December 31, 2008 and September 30, 2008:

                                               December 31       September 30
       Current assets:
       Cash and cash equivalents              $      29,160     $       22,073
       Short-term investments                             -              5,700
       Accounts receivable and other, net            14,755             17,265
       Total inventories                             18,045             19,823
       Deferred income taxes                            771              5,483
       Prepaid expenses                               2,471              2,079


       Total current assets                          65,202             72,423

       Current liabilities:
       Short-term debt                                  559                 23
       Accounts payable                               5,240              7,325
       Accrued payroll and related expenses           4,530              7,073
       Other accrued expenses                         6,114              6,142
       Income taxes payable                             813              1,174


       Total current liabilities                     17,256             21,737


       Working capital                        $      47,946     $       50,686

Working capital decreased during the quarter by $2,740. Current assets decreased during the quarter by $7,221, while current liabilities decreased $4,481. During the first quarter of fiscal year 2009, we converted $12,500 of investments, including our investments in auction rate securities, to cash. The $12,500 included $6,120 of auction rate securities (net of a valuation allowance of $680), which were classified as long-term at September 30, 2008. As of December 31, 2008, the Company no longer holds any auction rate securities. Accounts receivable and other, net decreased $2,510 during the quarter primarily due to lower net sales. Days sales outstanding were 47 at December 31, 2008 and at September 30, 2008. Inventories decreased $1,778 during the quarter primarily due to inventory management. Inventory turns were 2.7 at December 31, 2008 and at September 30, 2008. Deferred income taxes decreased $4,712 primarily due to the establishment of a valuation reserve against the U.S. deferred tax assets. See Note M. With regard to the decrease in current liabilities, accounts payable decreased $2,085 primarily due to the cost-cutting actions implemented during the quarter. Accrued payroll and related decreased $2,543 primarily due to the payment of severance charges recorded during the fourth quarter of fiscal year 2008 (see Note N), the payment of fiscal year 2008 incentive compensation that was tied to sales levels, lower incentive compensation in the first quarter of fiscal year 2009 resulting from lower sales, and lower payroll costs due to the cost-cutting actions the Company has taken.

Sources and Uses of Cash
The following table is a summary of our Condensed Consolidated Statements of
Cash Flows:

                                               For the Three Months
                                                Ended December 31,
                                                2008            2007
               Cash (used in) provided by:
               Operating activities          $    (3,645 )    $ (1,925 )
               Investing activities               11,424         3,144
               Financing activities                 (820 )      (3,283 )

Operating activities. Cash used in operating activities was $3,645 for the quarter of fiscal year 2008 compared with $1,925 in the same period last year, a decrease of $1,720. The primary cause of the decrease was lower net income, partially offset by higher non-cash charges and lower changes in working capital, which were described in Working Capital above. Adjustments to reconcile net earnings to net cash provided by operating activities are presented on the Condensed Consolidated Statements of Cash Flows.
Investing activities. Cash provided by investing activities was $11,424 during the fiscal year 2009 period compared to $3,144 in the same period last year. As described above in Working Capital, the Company converted $12,500 of investments to cash during the quarter current year's quarter. During the first quarter of fiscal year 2008, the Company had net sales of investments, including investments in auction rate securities, of $4,339. Short-term investments totaled $0 at December 31, 2008 and $28,019 at December 31, 2007. Financing activities. Cash used in financing activities was $820 in the first quarter of fiscal year 2009 as compared to $3,283 last year. During the 2009 first quarter, we repurchased 166,733 Common Shares for $787 at an average cost of $4.72 per share including commissions. This includes 11,733 Common Shares withheld for payroll taxes upon the issuance of Common Shares for vested performance award units in November 2008. During the 2008 first quarter, we repurchased 241,400 Common Shares for $2,365, or an average cost per share including commissions of $9.80. See Note F. Short-term debt at December 31, 2008 totaled $559 versus $449 at December 31, 2007, and $23 at September 30, 2008. We expect to finance capital spending and working capital requirements with cash and short-term investments and our available lines of credit. At December 31, 2008, we had available unused lines of credit with domestic and foreign banks aggregating $13,907, which was a combination of long-term and short-term depending upon the nature of the indebtedness. Outlook
The Company's customers' spending has dramatically decreased as a result of current macroeconomic conditions, and we are particularly uncertain about their future capital spending. We remain focused on executing against our business plan and on aligning our cost structure with the current economic reality. Based upon current expectations, the Company is estimating sales for the second quarter of fiscal 2009, which will end March 31, 2009, to range between $22,000 and $29,000. The Company expects a loss for the second quarter. For the remainder of fiscal year 2009, the Company expects to record tax expense as a result of taxes generated in foreign jurisdictions.
During the second quarter of fiscal 2009, the Company expects to incur approximately $1,300 for the costs associated with the reduction in its worldwide workforce that was implemented during January 2009. The actions taken were the result of the order decline realized during the latter part of fiscal 2008 and into fiscal 2009. The cost reduction actions that the Company has taken, including pay and benefit reductions, workforce reductions, and discretionary cost reductions, are expected to result in a cost savings during fiscal 2009 of approximately 20 percent of the Company's operating costs incurred during fiscal 2008.

Recent Accounting Pronouncements
In September 2006, the FASB issued SFAS No. 157 ("SFAS No. 157"), "Fair Value Measurements." SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. This Statement is applicable to other accounting pronouncements that require or permit fair value measurements. Accordingly, this Statement does not require any new fair value measurements. However, for some entities, the application of this Statement will change current practice. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. However, the FASB did provide a one year deferral for the implementation of SFAS No. 157 for nonfinancial assets and liabilities. The Company adopted SFAS No. 157 effective October 1, 2008, and the statement did not have a material impact on our consolidated financial statements. In September 2006, the FASB issued Statement of Financial Accounting Standard No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, ("SFAS No. 158"), an amendment of FASB Statements No. 87, 88, 106 and 132(R)." SFAS No. 158 represents the completion of the first phase in the FASB's postretirement benefits accounting project and requires an employer that is a business entity and sponsors one or more single employer benefit plans to (1) recognize the over funded or under funded status of the benefit plan in its statement of financial position, (2) recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs of credits that arise during the period but are not recognized as components of net periodic benefit cost, (3) measure defined benefit plan assets and obligations as of the end of the employer's fiscal year, and (4) disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. The provisions of SFAS No. 158 were effective as of September 30, 2007, except for the measurement date provisions, which are effective for fiscal years ending after December 15, 2008. Effective September 30, 2009, the Company will change its measurement date to September 30th and does not expect that the change in measurement date provision of this Statement will have a material impact on its consolidated financial statements.
In February 2007, the FASB issued Statement of Financial Accounting Standard No. 159, ("SFAS No. 159"), "The Fair Value Option for Financial Assets and Financial Liabilities - including an amendment of FAS 115." SFAS No. 159 allows companies to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. Unrealized gains and losses shall be reported on items for which the fair value option has been elected in earnings at each subsequent reporting date. SFAS No. 159 is effective for fiscal years beginning after November 15, 2007. The Company adopted SFAS No. 159 effective October 1, 2008, and the statement did not have a material impact on our consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, "Disclosures About Derivative Instruments and Hedging Activities - an amendment of FASB Statement No. 133" ("SFAS No. 161"). SFAS No. 161 requires, among other things, enhanced disclosure about the volume and nature of derivative and hedging activities and a tabular summary showing the fair value of derivative instruments included in the statement of financial position and statement of operations. SFAS 161 also requires expanded disclosure of contingencies included in derivative instruments related to credit risk. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008. The Company will adopt SFAS No. 161 as of our second quarter of fiscal year 2009, and does not expect the adoption to have a material impact on our consolidated financial statements. ITEM 3. Quantitative and Qualitative Disclosures About Market Risk. The Company is exposed to a variety of risks, including foreign currency fluctuations, interest rate fluctuations and changes in the market value of its short-term investments. In the normal course of business, we employ established policies and procedures to manage our exposure to fluctuations in foreign currency values and interest rates.
The Company is exposed to foreign currency exchange rate risk primarily through transactions denominated in foreign currencies. We currently utilize foreign exchange forward contracts or option contracts to sell foreign currencies to fix the exchange rates related to near-term sales and effectively fix our margins. Generally, these contracts have maturities of three months or less. Our policy is to only enter into derivative transactions when we have an identifiable exposure to risk, thus not creating additional foreign currency exchange rate risk. In our opinion, a ten percent adverse change in foreign currency exchange rates would not have a material effect on these instruments and therefore our results of operations, financial position or cash flows.

The Company maintains a short-term investment portfolio consisting of United States government backed notes and bonds, corporate notes and bonds, and mutual funds consisting primarily of government notes and bonds. An increase in interest rates would decrease the value of certain of these investments. However, in management's opinion, a ten percent increase in interest rates would not have a material impact on our results of operations, financial position or cash flows.
ITEM 4. Controls and Procedures.
The Company has evaluated, under the supervision and with the participation of the Company's Chief Executive Officer and Chief Financial Officer, the design and operation of the Company's disclosure controls and procedures as of December 31, 2008 pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective in ensuring that information required to be disclosed in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities Exchange Commission's rules and forms, and that information was accumulated and communicated to the Company's management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
There were no changes in the internal control over financial reporting that occurred during the first quarter of fiscal 2009 that have materially affected, or are reasonably likely to materially affect, the Company's internal controls over financial reporting.