Keynote Systems 10Q 2011 Q1 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended December 31, 2010


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

For the transition period from to

Commission File Number: 000-27241

KEYNOTE SYSTEMS, INC.

(Exact name of registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		94-3226488 (I.R.S. Employer Identification No.)

777 Mariners Island Blvd., San Mateo, CA (Address of principal executive offices)		94404 (Zip Code)

Registrant’s telephone number, including area code: (650) 403-2400

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YESþ NOo

Indicate by check mark whether the registrant 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). Yeso Noo

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

Large accelerated filer o

Accelerated filer þ

Non-accelerated filer o
(Do not check if a smaller reporting company)

Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): YESo NOþ

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



	Class			Shares outstanding as of January 31, 2011
	Common Stock, $.001 par value			15,387,898 shares

KEYNOTE SYSTEMS, INC.


	Page
PART I—FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements		3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		24
Item 3. Quantitative and Qualitative Disclosures About Market Risk		34
Item 4. Controls and Procedures		34
PART II—OTHER INFORMATION
Item 1. Legal Proceedings		35
Item 1A. Risk Factors		36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		44
Item 3. Defaults Upon Senior Securities		44
Item 4. (Reserved)		44
Item 5. Other Information		44
Item 6. Exhibits		45
Signatures		46
EX-31.1
EX-31.2
EX-32.1
EX-32.2

PART I—FINANCIAL INFORMATION

Item 1. Unaudited Condensed Consolidated Financial Statements

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


	Page

Condensed Consolidated Balance Sheets as of December 31, 2010 and September 30, 2010		4
Condensed Consolidated Statements of Operations for the three months ended December 31, 2010 and 2009		5
Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 2010 and 2009		6
Notes to Condensed Consolidated Financial Statements		7

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
(Unaudited)


	December 31,			September 30,
	2010			2010
ASSETS
Current assets:
Cash and cash equivalents	$	25,842		$	23,241
Short-term investments		43,299			43,111

Total cash, cash equivalents and short-term investments		69,141			66,352
Accounts receivable, less allowance for doubtful accounts of $48 and $50, respectively, and less billing reserve of $260 and $150, respectively		11,537			9,094
Prepaids, deferred costs and other current assets		4,031			3,571
Inventories		1,689			1,286
Deferred tax assets		3,681			3,749

Total current assets		90,079			84,052
Deferred costs and other long-term assets		781			1,599
Property, equipment and software, net		32,958			33,432
Goodwill		62,397			63,166
Identifiable intangible assets, net		3,324			3,914
Long-term deferred tax assets		352			359

Total assets	$	189,891		$	186,522


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,084		$	1,748
Accrued expenses		8,409			7,945
Deferred revenue		17,296			19,539

Total current liabilities		27,789			29,232
Deferred rent and other long-term liabilities		3,594			3,605
Long-term deferred revenue		1,770			1,926
Long-term deferred tax liability		415			395

Total liabilities		33,568			35,158


Commitments and contingencies (see Note 15)
Stockholders’ equity:
Common stock, $0.001 par value; 100,000,000 shares authorized; 15,196,373 and 14,942,571 shares issued and outstanding, respectively		15			15
Additional paid-in capital		289,323			286,761
Accumulated deficit		(134,301	)		(137,928	)
Accumulated other comprehensive income		1,286			2,516

Total stockholders’ equity		156,323			151,364

Total liabilities and stockholders’ equity	$	189,891		$	186,522

See accompanying notes to the condensed consolidated financial statements.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)


	Three Months Ended
	December 31,
	2010			2009
Net revenue	$	24,833		$	20,709

Costs and expenses:
Costs of revenue:
Direct costs of revenue		5,843			5,403
Development		3,035			3,145
Operations		1,911			1,891
Amortization of intangible assets — software		419			298

Total costs of revenue		11,208			10,737
Sales and marketing		7,193			6,328
General and administrative		2,848			2,642
Excess occupancy income, net		(246	)		(308	)
Amortization of intangible assets — other		151			182

Total costs and expenses		21,154			19,581


Income from operations		3,679			1,128
Interest income and other, net		216			93


Income before provision for income taxes		3,895			1,221
Provision for income taxes		(268	)		(240	)


Net income	$	3,627		$	981


Net income per share:
Basic	$	0.24		$	0.07

Diluted	$	0.23		$	0.07

Shares used in computing basic and diluted net income per share:
Basic		15,006			14,514
Diluted		15,724			14,756

Cash dividends declared per common share	$	0.06		$	0.05

See accompanying notes to the condensed consolidated financial statements.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)


	Three Months Ended
	December 31,
	2010			2009
Cash flows from operating activities:
Net income	$	3,627		$	981
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization		1,006			1,197
Stock-based compensation		795			1,003
Amortization of identifiable intangible assets		570			480
Amortization of prepaid tax asset		186			201
Charges to bad debt and billing reserves		142			92
Amortization of debt investment premium		277			60
Deferred tax provision (benefit)		20			(66	)
Loss on disposal of equipment		13			7
Changes in operating assets and liabilities:
Accounts receivable		(2,682	)		(779	)
Inventories		(432	)		(52	)
Prepaids, deferred costs and other assets		121			(398	)
Accounts payable and accrued expenses		772			1,178
Deferred revenue		(2,091	)		(3,999	)

Net cash provided by (used in) operating activities		2,324			(95	)


Cash flows from investing activities:
Purchases of short-term investments		(3,217	)		(26,609	)
Maturities and sales of short-term investments		2,500			2,218
Purchases of property, equipment and software		(470	)		(775	)

Net cash used in investing activities		(1,187	)		(25,166	)


Cash flows from financing activities:
Repayment of capital lease obligation		—			(5	)
Proceeds from issuance of common stock and exercise of stock options		2,666			160
Cash dividends declared and paid		(898	)		(727	)

Net cash provided by (used in) financing activities		1,768			(572	)


Effect of exchange rate changes on cash and cash equivalents		(304	)		(324	)

Net change in cash and cash equivalents		2,601			(26,157	)
Cash and cash equivalents at beginning of the period		23,241			51,383

Cash and cash equivalents at end of the period	$	25,842		$	25,226


Supplemental cash flow disclosure:
Income taxes paid (net of refunds)	$	166		$	164
Noncash operating and investing activities:
Acquisition of property, equipment and software on account	$	188		$	190

See accompanying notes to the condensed consolidated financial statements.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(1) Summary of Significant Accounting Policies

Keynote Systems, Inc. was incorporated on June 15, 1995 in California and reincorporated in Delaware on March 31, 2000. Keynote Systems, Inc. and its subsidiaries (the “Company”) develop and sell services, hardware and software to measure, test, assure and improve Internet and mobile communications quality of service.

Basis of Presentation

The accompanying unaudited condensed consolidated balance sheets, and unaudited condensed consolidated statements of operations and cash flows reflect all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position of the Company as of December 31, 2010, and the results of operations and cash flows for the interim periods ended December 31, 2010 and 2009.

The results of operations and cash flows for any interim period are not necessarily indicative of the results to be expected for any other future interim period or for the full year. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended September 30, 2010 included in the Company’s Report on Form 10-K as filed with the SEC. The condensed consolidated financial statements include the accounts of the Company and its domestic and foreign subsidiaries. Intercompany balances have been eliminated in consolidation.

The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenue and expenses during the reporting period. Significant estimates made in preparing the condensed consolidated financial statements relate to revenue recognition, the allowance for doubtful accounts and billing reserve, inventory valuation, useful lives of property, equipment, software and identifiable intangible assets, asset impairments, the fair values of options granted under the Company’s stock-based compensation plans and valuation allowances for deferred tax assets. Actual results could differ from those estimates, and such differences may be material to the financial statements.

Recently Adopted Accounting Pronouncements

In September 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting guidance related to revenue recognition for arrangements with multiple deliverables and arrangements that include software elements. The new accounting guidance permits prospective or retrospective adoption, and the Company elected prospective adoption during the first quarter of fiscal 2011. Refer to Note 3, “Revenue Recognition” in this Form 10-Q for additional information on the impact of adoption.

(2) Net Income (Loss) Per Share

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

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

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


	Three Months Ended
	December 31,
	2010		2009
Numerator:
Net income	$	3,627	$	981

Denominator:
Weighted average shares outstanding		15,006		14,514
Effect of dilutive stock options, restricted stock units and employee stock purchase rights		718		242

Denominator for diluted net income per share		15,724		14,756


Net income per share:
Basic	$	0.24	$	0.07

Diluted	$	0.23	$	0.07

Securities representing 1.1 million and 4.1 million shares of common stock for the three months ended December 31, 2010 and 2009, respectively were excluded from the computation of diluted net income per share since their effect would be anti-dilutive, as their exercise price was greater than the average market price of the common stock during the period.

(3) Revenue Recognition

Revenue from Internet and Mobile products and services is summarized in the following table (in thousands):


	Three Months Ended
	December 31,
	2010		2009
Internet:
Web measurement subscriptions	$	7,275	$	6,170
Other subscriptions		3,448		3,665
Engagements		2,185		2,544

Internet net revenue		12,908		12,379

Mobile:
Subscriptions		3,195		2,374
Ratable licenses		4,571		5,956
System licenses		1,992		—
Maintenance and support		2,167		—

Mobile net revenue		11,925		8,330

Net revenue	$	24,833	$	20,709

In connection with the adoption of the FASB’s new accounting guidance (ASU 2009-13 and ASU 2009-14) in the first quarter of fiscal 2011, the Company is presenting the single line item “net revenue” in its condensed consolidated statement of operations and is providing additional details for its net revenue in the above table. The Company previously reported its net revenue in its condensed consolidated statement of operations under the following captions: Subscription services, Ratable licenses and Professional services.

     Subscriptions revenue consists primarily of revenue from the sale of products and services sold through a cloud-based model on a subscription basis (also referred to as Software-as-a-Service, or SaaS). Subscription arrangements with customers do not provide the customer with the right to take possession of the software supporting the on-demand application service at any time. Subscription revenue is reflected in the above table as Web measurement subscriptions (which includes Application Perspective, Transaction Perspective, Streaming Perspective and Web Site Perspective products and services), other subscriptions (which includes all other Internet subscription products and services) and Mobile subscriptions (which includes GlobalRoamer, Mobile Device Perspective, Mobile Web Perspective and Mobile Internet Testing Environment (“MITE”) products and services).

     The Company also sells monitoring systems to mobile network operators under licensing arrangements. Monitoring system arrangements with mobile customers for the sale of the Company’s automated test equipment typically includes software licenses, hardware, consulting services to configure the systems (installation services), post contract support (maintenance) services, training services and other consulting services associated with the Company’s System Integrated Test Environment (“SITE”) system. Monitoring systems revenue is reflected in the above table as ratable licenses (which includes SITE systems arrangements entered into prior to October 1, 2010), systems licenses (which includes the hardware and software elements of SITE arrangements significantly modified or entered into subsequent to September 30, 2010) and maintenance and support (which includes all other elements of SITE arrangements significantly modified or entered into subsequent to September 30, 2010 and all maintenance agreements renewals for periods subsequent to September 30, 2010).

     The Company supplements its cloud-based subscriptions and monitoring systems with engagement services.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

Revenue is recognized in accordance with appropriate accounting guidance when all of the following criteria have been met:

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

	•		Delivery of the product or service.Subscription based services are considered delivered when the customer has been provided with access to the subscription services. Subscription services are generally delivered on a consistent basis over the period of the subscription with the customer having flexibility to define and change the measurement with respect to the type, frequency, location and complexity of the measurement. Engagement services are considered delivered when the services are performed or the contractual milestones are completed. Monitoring systems, excluding maintenance, are considered delivered when all elements of the arrangement have either been delivered or accepted, if acceptance language exists.

	•		Fee is fixed or determinable.The Company considers the fee to be fixed or determinable if the fee is not subject to refund or adjustment and payment terms are standard.

	•		Collection is deemed reasonably assured.Collection is deemed reasonably assured if it is expected that the customer will be able to pay amounts under the arrangement as payments become due. If it is determined that collection is not reasonably assured, then revenue is deferred and recognized upon cash collection.

The Company does not generally grant refunds. All discounts granted reduce revenue. Free trials are typically stand-alone transactions occasionally provided to prospective customers, for which no revenue is recognized.

Subscription based services can either be billed in advance or in arrears. For customers that are billed in advance of providing measurements, revenue is deferred upon invoicing and is recognized over the service period, generally ranging from one to twelve months, commencing on the day service is first provided. For customers that are billed in arrears, revenue is recognized based upon actual usage of the subscription services and typically invoiced on a monthly basis. Regardless of when billing occurs, the Company recognizes revenue as services are provided and defers any revenue that is unearned.

Revenue associated with monitoring system hardware, software essential to the functionality of the monitoring system (“essential software”), installation services and training is deferred until the later of delivery of the complete monitoring system or until acceptance of the monitoring system, under the customer contractual terms. Revenue associated with the monitoring system product maintenance and support is recognized ratably over the maintenance term, usually one year. Non-essential software purchased by customers in bundled arrangements is deemed to be a software element that does not qualify for treatment as separate units of accounting as the Company does not have sufficient vendor specific objective evidence (“VSOE”) of fair value for the undelivered elements of the arrangement, typically maintenance. Accordingly, non-essential software revenue is recognized ratably over the product maintenance term.

Engagements revenue consists of fees generated from our professional consulting services and includes services such as Performance Insights and Customer Research Products. Revenue from these services is recognized as the services are performed, typically over a period of one to three months. For engagement service projects that contain project milestones, as defined in the arrangement, the Company recognizes revenue once the services or milestones have been delivered, based on input measures. Payment occurs either up-front or over time.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

Revenue Recognition for Arrangements with Multiple Deliverables

The Company enters into multiple element arrangements that generally consist of 1) monitoring systems combined with maintenance, installation and other consulting services, 2) subscription services combined with engagement services which includes LoadPro and WebEffective, and 3) multiple engagement services.

For Arrangements Entered into Prior to October 1, 2010:

Prior to the adoption of the amended accounting guidance for revenue arrangements with multiple deliverables, the Company was not able to establish VSOE for all of the undelivered elements associated with SITE systems, primarily maintenance. Therefore, the Company recognized 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. Ratable recognition of revenue began when evidence of customer acceptance of the software and hardware has occurred as intended under the respective arrangement’s contractual terms.

Subscription arrangements are treated as a single unit of accounting given that the elements within the subscription arrangements do not qualify for treatment as separate units of accounting because sufficient objective evidence of fair value did not exist for the allocation of revenue. As a result the entire arrangement fee was recognized as revenue either ratably over the service period, generally over twelve months, or based upon actual monthly usage.

Ratable licenses revenue consists of fees from the sale of mobile automated test equipment, maintenance, engineering and consulting services associated with SITE systems. The hardware component of the Company’s monitoring system arrangements is deemed to include an essential software related element. Customers do not purchase the hardware without also purchasing the software. None of the SITE services provided by the Company is considered to be essential to the functionality of the licensed products. This assessment is due to the implementation/integration services being performed during a relatively short period (generally within two to three months) compared to the length of the arrangement which typically ranges from twelve to thirty-six months. Additionally, the implementation/integration services are general in nature and the Company has a history of successfully gaining customer acceptance. SITE orders received prior to the beginning of fiscal year 2011 continue to be recognized ratably and are reported as Ratable license revenue.

For Arrangements Entered into Subsequent to September 30, 2010:

In October 2009, the FASB amended the accounting guidance for multiple-element revenue arrangements to:

	•		provide updated guidance on whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;

	•		require an entity to allocate revenue in an arrangement using best estimated selling prices (“BESP”) of each deliverable if a vendor does not have VSOE or third-party evidence of selling price (“TPE”); and

	•		eliminate the use of the residual method and require a vendor to allocate revenue using the relative selling price method.

Also in October 2009, the FASB amended the accounting guidance for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry specific software revenue recognition guidance.

The Company evaluates each deliverable in an arrangement to determine whether they represent separate units of accounting. For arrangements within the scope of the new revenue accounting guidance, a deliverable constitutes a separate unit of accounting when it has standalone value and there are no customer-negotiated refunds or return rights for the delivered elements. Allocation of the consideration is determined at arrangement inception on the basis of each unit’s relative selling price.

When applying the relative selling price method, the Company determines the selling price for each deliverable using its BESP, as the Company has determined it is unable to establish VSOE of selling price or TPE of selling price for the deliverables. BESP reflects the Company’s best estimates of what the selling prices of elements would be if they were sold regularly on a stand-alone basis. The Company determines BESP for a deliverable by considering multiple factors including, analyzing historical prices for standalone and bundled arrangements against price lists, market conditions, competitive landscape and internal costs.

Effects of Adoption:

The Company adopted the amended accounting guidance and prospectively applied its provisions to arrangements entered into or materially modified on or after October 1, 2010 (the beginning of fiscal year 2011). The adoption of the new revenue accounting guidance had the primary effect of recognizing SITE systems revenue, excluding maintenance, at the time of acceptance rather than ratably over the contract term. SITE orders received after September 30, 2010 are reported as System licenses for the hardware and essential software and as Maintenance and Support for the remaining elements. SITE orders received prior to the beginning of fiscal year 2011 continue to be recognized ratably and are reported as Ratable license revenue because VSOE does not exist for the undelivered elements of the arrangement, typically maintenance.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

As a result of adopting the new accounting guidance, the Company recognized $2.0 million of net revenue and $0.2 million of related direct costs of revenue in the first fiscal quarter of 2011 that would otherwise have been recognized in subsequent periods under the previous accounting guidance. If the new accounting guidance had not been adopted, the Company would have reported $6.7 million of ratable license revenue, no system license revenue, no maintenance and support revenue and total net revenue of $22.8 million for the three months ended December 31, 2010. Revenue recognized related to multiple-element arrangements entered into prior to October 1, 2010 was $4.5 million for the three months ended December 31, 2010.

Direct Cost of Revenue, Deferred Revenue and Deferred Direct Costs of Revenue

Direct Costs of Revenue:Direct costs of revenue is comprised of telecommunication and network fees for our measurement and data collection network, costs for employees and consultants assigned to consulting engagements, depreciation of equipment related to our measurement and data collection network, and hardware and supplies for SITE systems. Consistent with the presentation of net revenue, the Company previously presented direct costs of revenue under the following captions: Subscription Services, Ratable Licenses, and Professional Services. Beginning in the first quarter of fiscal 2011, the Company is presenting direct costs of revenue as one line item in the condensed consolidated statement of operations.

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

Deferred Costs:Deferred costs are mainly comprised of hardware costs associated with SITE system arrangements. For arrangements that were entered into prior to October 1, 2011, deferred costs were categorized as short-term for any arrangement for which the original maintenance period is one year or less in length. Correspondingly, deferred costs associated with arrangements for which the original maintenance period is greater than one year were classified as long-term deferred costs. These deferred costs were amortized to direct costs of revenue over the life of the customer contract, generally one to three years, commencing upon the later of delivery or acceptance. For arrangements entered into subsequent to September 30, 2010, deferred costs are charged to direct costs of revenue in the same period that the associated hardware revenue is recognized, usually upon the later of delivery or acceptance.

(4) Financial Instruments and Concentration of Risk

The carrying value of the Company’s financial instruments, including cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued expenses approximates fair market value due to their short-term nature. Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents, short-term investments and accounts receivable.

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

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

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

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

For the three months ended December 31, 2010 and 2009, no single customer accounted for 10% or more of total net revenue. As of December 31, 2010, no customer accounted for more than 10% of the Company’s net accounts receivable. As of December 31, 2009, one customer accounted for 12% of the Company’s net accounts receivable.

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

The Company considers all highly liquid investments held at major banks, commercial paper, money market funds and other securities with original maturities of three months or less to be cash equivalents in accordance with the FASB’s guidance on statement of cash flows.

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

The following table summarizes the Company’s cash and cash equivalents and short-term investments as of December 31, 2010 (in thousands):


			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Market Value
Cash	$	20,651	$	—	$	—		$	20,651
Money market funds		5,191		—		—			5,191

Total cash and cash equivalents	$	25,842	$	—	$	—		$	25,842

Fixed-term deposits	$	12,033	$	—	$	—		$	12,033
Treasuries and agencies		3,101		7		—			3,108
Corporate and municipal bonds		28,114		68		(24	)		28,158

Total short-term investments	$	43,248	$	75	$	(24	)	$	43,299

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


			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Market Value
Cash	$	17,732	$	—	$	—		$	17,732
Money market funds		5,509		—		—			5,509

Total cash and cash equivalents	$	23,241	$	—	$	—		$	23,241

Fixed-term deposits	$	12,271	$	—	$	—		$	12,271
Treasuries and agencies		3,101		10		—			3,111
Corporate and municipal bonds		27,674		70		(15	)		27,729

Total short-term investments	$	43,046	$	80	$	(15	)	$	43,111

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

The Company utilizes the FASB’s guidance to determine the fair value of financial instruments and to determine if the gross unrealized loss on investments represents a temporary impairment. The Company evaluates whether an impairment of a debt security is other than temporary each reporting period using the following guidance:

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

	•		If management determines that it is more likely than not that it will be required to sell the security before recovery of the amortized cost basis of the security, the impairment is considered other than temporary.

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

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

Contractual maturities of available-for-sale securities at December 31, 2010 were as follows (in thousands):


			Estimated
	Cost		Fair Value
Due in less than one year	$	33,342	$	33,396
Due in more than one year and less than two years		9,906		9,903

Total	$	43,248	$	43,299

(6) Fair Value Measurements

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

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

	•		Level 1 inputs are based on quoted prices in active markets for identical assets or liabilities.

	•		Level 2 inputs are based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

	•		Level 3 inputs are generally unobservable and typically reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. The fair values are therefore determined using model-based techniques that include option pricing models, discounted cash flow models, and similar techniques.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

The following table presents the Company’s assets measured at fair value on a recurring basis as of December 31, 2010 (in thousands):


	Quoted Prices
	in Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
	Instruments		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Total
Cash and cash equivalents:
Money market funds	$	5,191	$	—	$	—	$	5,191
Short-term investments:
Fixed-term deposits		—		12,033		—		12,033
Municipal and corporate bonds		28,158		—		—		28,158
Treasuries and agencies		3,108		—		—		3,108

Total assets measured at fair value	$	36,457	$	12,033	$	—	$	48,490

Fixed-term deposits are valued at cost, which approximates fair value as of December 31, 2010.

(7) Consolidated Financial Statement Details

The following tables present the Company’s condensed consolidated financial statement details (in thousands):

Prepaids, Deferred Costs and Other Current Assets


	December 31, 2010		September 30, 2010
Prepaid expenses	$	1,680	$	1,591
Deferred costs of revenue		662		806
Income tax receivable		394		425
Prepaid tax asset		621		—
Security deposits, advances, and interest receivable		575		590
Other assets		99		159

Total	$	4,031	$	3,571

Property, equipment and software


	December 31, 2010			September 30, 2010
Land	$	14,150		$	14,150
Computer equipment and software		32,201			31,874
Building		21,698			21,614
Furniture and fixtures		2,160			2,151
Leasehold and building improvements		1,182			1,155
Construction in progress		255			292

		71,646			71,236
Less accumulated depreciation and amortization		(38,688	)		(37,804	)

Total	$	32,958		$	33,432

Deferred Costs and Other Long-Term Assets


	December 31, 2010		September 30, 2010
Prepaid tax asset	$	—	$	823
Deferred costs of revenue		230		209
Tenant rent receivable		140		163
Deposits		219		221
Prepaid expenses		192		183

Total	$	781	$	1,599

Accrued Expenses


	December 31, 2010		September 30, 2010
Accrued employee compensation	$	4,489	$	4,040
Accrued audit and professional fees		392		334
Income and other taxes		1,161		1,016
Other accrued expenses		2,367		2,555

Total	$	8,409	$	7,945

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

(8) Inventories

Inventories primarily relate to direct costs associated with SITE systems hardware and are stated at the lower of cost (determined on a first-in, first-out basis) or market. If the cost of the inventories exceeds their market value, provisions are made currently for the difference between the cost and the market value. The Company evaluates inventories for excess quantities and obsolescence on a quarterly basis. This evaluation includes analysis of historical and forecasted sales of our product. Obsolescence is determined considering several factors, including competitiveness of product offerings, market conditions, and product life cycles. Any adjustment for market value decreases, inventories on hand in excess of forecasted demand or obsolete inventories are charged to direct cost of revenue in the period that management identifies the adjustment.

(9) Goodwill and Identifiable Intangible Assets

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

Based on the results of the first step of the Company’s impairment test performed at September 30, 2010, the fair value of its reporting unit exceeded its carrying value by more than 20%. Accordingly, the Company determined that its goodwill had not been impaired. The Company continuously monitors for events and circumstances that could negatively impact the key assumptions in determining fair value, including long-term revenue growth projections, discount rates, recent market valuations from transactions by comparable companies, volatility in the Company’s market capitalization and general industry, market and macro-economic conditions. It is possible that changes in such circumstances, or in the variables associated with the judgments, assumptions and estimates used in assessing the fair value of the reporting unit, would require the Company to record a non-cash impairment charge.

During the quarter ended December 31, 2010, the Company concluded that there were no triggering events which would require a formal impairment analysis of the carrying value of goodwill, primarily due to the Company’s market capitalization and cash flows during the period. The Company is continuing to monitor the need to perform an impairment analysis in light of current economic factors in the equity markets as well as the recent volatility of its market capitalization. To the extent the Company concludes that there are any indicators of impairment prior to the date of the next annual goodwill impairment test, management will perform an impairment analysis to determine if an impairment charge should be recorded to write down goodwill to its fair value. If the results of any impairment testing indicate that a write down of goodwill is necessary, such charge could be significant and, accordingly, could have a material impact on the Company’s financial position and results of operations, but would not be expected to have a material adverse effect on the Company’s cash flows from operations.

The following table presents the changes in goodwill during the three months ended December 31, 2010 (in thousands):


Balance at September 30, 2010	$	63,166
Translation adjustment		(769	)

Balance at December 31, 2010	$	62,397

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

The components of identifiable intangible assets are as follows (in thousands):


	Technology			Technology
	Based-			Based-			Customer
	Software			Other			Based			Trademark			Covenant			Backlog			Total
As of December 31, 2010:
Gross carrying value	$	7,909		$	11,845		$	8,045		$	1,375		$	37		$	111		$	29,322
Accumulated amortization		(5,405	)		(11,845	)		(7,638	)		(998	)		(28	)		(84	)		(25,998	)

Net carrying value	$	2,504		$	—		$	407		$	377		$	9		$	27		$	3,324


As of September 30, 2010:
Gross carrying value	$	7,944		$	11,845		$	8,071		$	1,382		$	38		$	113		$	29,393
Accumulated amortization		(4,984	)		(11,845	)		(7,602	)		(939	)		(27	)		(82	)		(25,479	)

Net carrying value	$	2,960		$	—		$	469		$	443		$	11		$	31		$	3,914

Amortization of developed technology related to software was recorded to costs of revenue. Amortization of all other identifiable intangible assets was recorded to operating expenses. The following table presents amortization of identifiable intangible assets for the three months ended December 31, 2010 and 2009 (in thousands):


	Three Months Ended
	December 31,
	2010		2009
Amortization of intangible assets — software	$	419	$	298
Amortization of intangible assets — other		151		182

Total amortization of intangible assets	$	570	$	480

The estimated future amortization expense for existing identifiable intangible assets as of December 31, 2010 was as follows (in thousands):


Fiscal years:
2011 (remaining nine months)	$	1,671
2012		1,368
2013		285

Total	$	3,324

Weighted-average remaining useful life as of December 31, 2010 (years)		2.1

(10) Lease Abandonment Accrual

The Company leases a facility in New York under an operating lease that expires in October 2015. The Company ceased using the facility in the fourth quarter of fiscal 2009 and, effective October 1, 2009, subleased the facility to a third party for the remainder of its lease term. In the fourth quarter of fiscal 2009, the Company recorded lease abandonment expense of $0.6 million related to its discontinuance of this facility. The changes in the lease abandonment liability for the quarter ended December 31, 2010 was as follows (in thousands):


Lease abandonment liability, September 30, 2010	$	468
Lease payments to lessor		(68	)
Sublease proceeds		43

Lease abandonment liability, December 31, 2010	$	443

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

(11) Stockholders’ Equity and Stock Based Compensation

Dividends

Prior to November 2009, the Company had not declared or paid any cash dividends on its common stock or other securities. During the quarters ended December 31, 2010 and 2009, the Company declared and paid the following cash dividends (in thousands except per share amounts):


Record Date	Payment Date	Dividend Per Share		Total Dividend Paid
December 1, 2009	December 15, 2009	$	0.05	$	727
December 1, 2010	December 15, 2010	$	0.06	$	898

Stock Based Compensation

Summary of Plans

As of December 31, 2010, the Company was authorized to issue up to approximately 8.3 million shares of common stock under its 1999 Equity Incentive Plan (“Incentive Plan”) to employees, directors and consultants, including nonqualified and incentive stock options, restricted stock units (“RSUs”), and stock bonuses. Options expire ten years after the date of grant. Vesting periods are determined by the Board of Directors and generally, in the case of stock options, provide for shares to vest over a period of four years with 25% of the shares vesting one year from the date of grant and the remainder vesting monthly over the next three years. RSUs generally vest in full three years from the date of grant. As of December 31, 2010, options to purchase approximately 3.7 million shares and approximately 539,000 RSUs were outstanding under the Incentive Plan. Approximately 1.4 million shares were available for future issuance under the Incentive Plan as of December 31, 2010.

Under the Incentive Plan, the exercise price for incentive stock options is at least 100% of the stock’s fair market value on the date of the grant for employees owning less than 10% of the voting power of all classes of stock, and at least 110% of the fair market value on the date of grant for employees owning more than 10% of the voting power of all classes of stock. For nonqualified stock options, the exercise price must be at least 110% of the fair market value on the date of grant for employees owning more than 10% of the voting power of all classes of stock and no less than 85% for employees owning less than 10% of the voting power of all classes of stock.

In September 1999, the Company adopted the 1999 Employee Stock Purchase Plan (“Purchase Plan”). As of December 31, 2010, the Company had reserved a total of approximately 1.4 million shares of common stock for issuance under the Purchase Plan. Under the Purchase Plan, eligible employees may defer an amount not to exceed 10% of the employee’s compensation, as defined in the Purchase Plan, to purchase common stock of the Company. The purchase price per share is 85% of the lesser of the fair market value of the common stock on the first day of the applicable offering period or the last day of each purchase period. The Purchase Plan is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code. As of December 31, 2010, approximately 1.3 million shares had been issued under the Purchase Plan, and approximately 140,000 shares remain for future issuance.

Restricted Stock Units

Historically, the Company used equity awards in the form of stock options as one of the means for recruiting and retaining highly skilled talent. In fiscal 2009, the Company began issuing RSUs rather than stock options for eligible employees as the primary type of long-term equity-based award. Stock-based compensation cost for RSUs is measured based on the value of the Company’s stock on the grant date, reduced by the present value of the dividend yield expected to be paid on the Company’s common stock. Upon vesting, the RSUs are generally net share-settled to cover the required withholding tax and the remaining amount is converted into an equivalent number of shares of common stock. A summary of RSU activity under the Company’s Incentive Plan for the three months ended December 31, 2010 is presented below (in thousands, except per share amounts):


				Weighted
				Average
	Shares			Grant Date Fair Value
Outstanding at September 30, 2010		489		$	9.07
Granted		54			11.42
Vested		—			—
Cancelled		(4	)		7.59

Outstanding at December 31, 2010		539		$	9.26

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

As of December 31, 2010, there was $2.4 million of total unrecognized compensation cost (net of estimated forfeitures) related to nonvested RSUs that is expected to be recognized over a weighted average period of 1.7 years.

The fair value of each RSU granted in fiscal 2009 was based upon the market value of the Company’s stock on the date of grant. Beginning in the first quarter of fiscal 2010, the Company began declaring and paying dividends on its common stock. Accordingly, the fair value of each RSU granted subsequent to September 30, 2009 was estimated on the date of the grant using the Black-Scholes option pricing model to reflect the impact of dividends on the fair value of each RSU granted. There were no RSUs granted in the three months ended December 31, 2009. Weighted-average assumptions for each RSU granted in the three months ended December 31, 2010 under the Incentive Plan were as follows:


Volatility	58.1	%
Risk free interest rate	0.6	%
Expected life (in years)	3.0
Dividend yield	2.0	%

Stock Options

The fair value of each option is estimated on the date of grant using the Black-Scholes option pricing model. There were no options granted in the quarters ended December 31, 2010 and 2009.

A summary of option activity under the Company’s Incentive Plan for the three months ended December 31, 2010 is presented below (in thousands, except per share and term amounts):


						Average
				Weighted		Remaining		Aggregate
				Average		Contractual		Intrinsic
	Shares			Exercise Price		Term (years)		Value
Outstanding at September 30, 2010		4,039		$	11.51		4.9	$	2,647
Granted		—			—
Exercised		(254	)		10.50
Forfeited or canceled		(6	)		10.70
Expired		(34	)		14.73

Outstanding at December 31, 2010		3,745		$	11.55		4.8	$	11,520

Vested and expected to vest at December 31, 2010		3,725		$	11.55		4.8	$	11,467
Exercisable at December 31, 2010		3,421		$	11.50		4.6	$	10,699

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value that would have been received by the options holders had they exercised all their options on December 31, 2010. The aggregate intrinsic value of options exercised during the three months ended December 31, 2010 was $0.9 million.

As of December 31, 2010, there was $0.6 million of total unrecognized compensation cost (net of estimated forfeitures) related to nonvested stock options that are expected to be recognized over a weighted average period of one year.

Employee Stock Purchase Plan

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


	Three Months Ended
	December 31,
	2010			2009
Volatility		61.3	%		61.3	%
Risk free interest rate		0.6	%		0.7	%
Expected life (in years)		1.25			1.25
Dividend yield		0.2	%		—

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

Stock based Compensation Expense

The following table provides a summary of the stock based compensation expense included in the condensed consolidated statements of operations as follows (in thousands):


	Three Months Ended
	December 31,
	2010		2009
Direct costs of revenue	$	96	$	137
Development		177		229
Operations		107		134
Sales and marketing		291		364
General and administrative		124		139

Total	$	795	$	1,003

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

The components of other comprehensive income (loss) consist of net income (loss), unrealized gains and losses on available-for-sale investments and foreign currency translation. The unrealized gains and losses on available-for-sale investments and foreign currency translation are excluded from earnings and reported as a component of stockholders’ equity. The foreign currency translation adjustment results from those subsidiaries not using the United States dollar as their functional currency since the majority of their economic activities are primarily denominated in their applicable local currency. The Company has subsidiaries located in Germany, the United Kingdom, the Netherlands, France and Canada. Accordingly, all assets and liabilities related to these operations are translated at the current exchange rates at the end of each period. The resulting cumulative translation adjustments are recorded directly to the accumulated other comprehensive income account in stockholders’ equity. Revenues and expenses are translated at average exchange rates in effect during the period. Gains (losses) from foreign currency transactions are reflected in other income (expense), net in the consolidated statements of operations as incurred and were approximately $83,000 and $7,000 for the three months ended December 31, 2010 and 2009, respectively.

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


	Three Months Ended
	December 31,
	2010			2009
Net income	$	3,627		$	981
Net unrealized loss on available-for-sale investments		(14	)		(131	)
Foreign currency translation loss		(1,216	)		(1,401	)

Other comprehensive income (loss)	$	2,397		$	(551	)

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

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

(13) Excess Occupancy Income

Excess occupancy income consists of rental income from the leasing of space not occupied by the Company in its headquarters building, net of related fixed costs, which consists of property taxes, insurance, building depreciation, leasing broker fees and tenant improvement amortization. Property taxes, insurance and building depreciation are based upon actual square footage available to lease to third parties, which was approximately 75% for the three months ended December 31, 2010 and 2009. Rental income was approximately $0.6 million and $0.7 million for the three months ended December 31, 2010 and 2009, respectively. As of December 31, 2010, the Company had leased space to 13 tenants, of which 12 had noncancellable operating leases, which expire on various dates through 2016. At December 31, 2010, future minimum rents receivable under the leases were as follows (in thousands):


Fiscal years:
2011 (remaining nine months)	$	1,929
2012		2,182
2013		921
2014		610
2015		491
Thereafter		161

Total future minimum rents receivable	$	6,294

(14) Income Taxes

The Company’s effective tax rate for the three months ended December 31, 2010 and 2009 was 7% and 20%, respectively. The rate for the three months ended December 31, 2010 and 2009 differs from the 35% United States federal statutory rate primarily due to the relative mix of foreign and domestic earnings, enacted tax rates, and the fact that a portion of the earnings are being taxed in the United States where the Company has a low effective tax rate due to utilization of net operating loss carryforwards. Through October 2011, the Company is also amortizing prepaid tax recorded in connection with the 2008 sale of intangible assets from its German entity to the United States entity at approximately $190,000 per quarter. Excluding the amortization of prepaid tax, the Company’s effective tax rate would have been 2% and 3% for the three months ended December 31, 2010 and 2009, respectively.

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

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

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

The Company has adopted the provisions of ASC 740-10 (formerly referenced as FASB’s Financial Interpretation No. 48,Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109). As of December 31, 2010, the total amount of gross unrecognized benefits was $7.0 million. Included in this balance was approximately $2.8 million of unrecognized tax benefits that, if recognized, would affect the effective income tax rate. The gross unrecognized tax benefits decreased by $42,000 during the three months ended December 31, 2010.

It is possible that the amount of liability for unrecognized tax benefits may change within the next three months. However, an estimate of the range of possible changes cannot be made at this time. In addition, over the next three months, the Company’s existing tax positions may continue to generate an increase in liabilities for unrecognized tax benefits. In accordance with the Company’s accounting policy, it recognizes accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. Interest and penalties were insignificant for the three months ended December 31, 2010 and 2009.

Although the Company files United States federal, various state, and foreign tax returns, the Company’s only major tax jurisdictions are the United States, Canada, the United Kingdom, the Netherlands and Germany. Tax years 1997 through 2009 remain subject to examination by the appropriate governmental agencies due to tax loss carryovers from those years.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

(15) Commitments and Contingencies

Leases

The Company leases certain of its facilities and equipment under noncancelable leases, which expire on various dates through October 2017. As of December 31, 2010, future minimum payments under these operating leases were as follows (in thousands):


	Operating
	Leases
Fiscal year:
2011 (remaining nine months)	$	694
2012		580
2013		462
2014		343
2015		350
Thereafter		138

Total minimum lease payments*	$	2,567


*		Future minimum lease payments exclude sublease proceeds of approximately $1.0 million.

Rent expense was $0.2 million for each of the three months ended December 31, 2010 and 2009.

Commitments

The Company had, as of December 31, 2010, $1.3 million of contingent commitments to bandwidth and co-location providers. These contingent commitments have a remaining term of between one to twenty-two months and become due if the Company terminates any of these agreements prior to their expiration.

As of December 31, 2010, the Company, through one of its foreign subsidiaries, had outstanding guarantees totaling $0.1 million to customers and vendors as a form of security. The guarantees can only be executed upon agreement by both the customer or vendor and the Company. The guarantees are secured by an unsecured line of credit of $1.3 million as of December 31, 2010.

Legal Proceedings

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

The Company was a party to a global settlement with the plaintiffs that would have disposed of all claims against it with no admission of wrongdoing by the Company or any of its present or former officers or directors. The settlement agreement had been preliminarily approved by the Court. However, while the settlement was awaiting final approval by the District Court, in December 2006 the Court of Appeals reversed the District Court’s determination that six focus cases could be certified as class actions. In April 2007, the Court of Appeals denied plaintiffs’ petition for rehearing, but acknowledged that the District Court might certify a more limited class. At a June 26, 2007 status conference, the Court approved a stipulation withdrawing the proposed settlement. On August 14, 2007, plaintiffs filed amended complaints in the focus cases, and a motion for class certification in the focus cases on September 27, 2007. On November 13, 2007, defendants in the focus cases filed a motion to dismiss the amended complaints for failure to state a claim, which the District Court denied on March 2008. Plaintiffs, the issuer defendants (including the Company), the underwriter defendants, and the insurance carriers for the defendants, have engaged in mediation and settlement negotiations. The parties reached a settlement agreement, which was submitted to the District Court for preliminary approval on April 2, 2009. As part of this settlement, the Company’s insurance carrier has agreed to assume the Company’s entire payment obligation under the terms of the

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

settlement. On June 10, 2009, the District Court granted preliminary approval of the proposed settlement. After a September 10, 2009 hearing, the District Court gave final approval to the settlement on October 5, 2009. Several objectors have filed notices of appeal to the United States Court of Appeals for the Second Circuit from the District Court’s October 5, 2009 order approving the settlement. Although the District Court has granted final approval of the settlement, there can be no guarantee that it will not be reversed on appeal. The Company believes that it has meritorious defenses to these claims. If the settlement is not implemented and the litigation continues against the Company, the Company would continue to defend against this action vigorously.

In addition, in October 2007, a lawsuit was filed in the United States District Court for the Western District of Washington by Vanessa Simmonds, captionedSimmonds v. JPMorgan Chase & Co., et al., No. 07-1634, alleging that the underwriters violated section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. section 78p(b), by engaging in short-swing trades, and seeks disgorgement to the Company of profits from the underwriters in amounts to be proven at trial. On February 28, 2008, Ms. Simmonds filed an amended complaint. The suit names the Company as a nominal defendant, contains no claims against the Company, and seeks no relief from the Company. This lawsuit is one of more than fifty similar actions filed in the same court. On July 25, 2008, the underwriter defendants in the various actions filed a joint motion to dismiss the complaints for failure to state a claim. The parties entered into a stipulation, entered as an order by the Court, that the Company is not required to answer or otherwise respond to the amended complaint. Accordingly, the Company did not join the motion to dismiss filed by certain issuers. On March 12, 2009, the Court dismissed the complaint in this lawsuit with prejudice. On April 10, 2009, the plaintiff filed a notice of appeal of the District Court’s order, and thereafter the underwriter defendants’ filed a cross appeal to a portion of the District Court’s order that dismissed thirty (30) of the cases without prejudice following the moving issuers’ motion to dismiss. On June 22, 2009 the Ninth Circuit issued an order granting the parties’ joint motion to consolidate the 54 appeals and 30 cross-appeals. Oral argument in the Ninth Circuit was heard on October 5, 2010, and the Court issued is written opinion on December 2, 2010. The Ninth Circuit affirmed the District Court’s decision that the demand letters that plaintiff had submitted to the 30 moving issuers were inadequate and directed the District Court to dismiss those actions with prejudice. The Ninth Circuit further directed the District Court to consider in the first instance whether the demand letters submitted to the other 24 issuers (including the Company) were sufficiently similar as also to require dismissal with prejudice. The Ninth Circuit reversed the District Court’s decision in favor of the underwriter defendants on statute of limitations grounds. On December 16, 2010, plaintiff and the underwriter defendants separately petitioned for a rehearing by the original three-judge panel of the court and a rehearing by the entire court, which petitions were denied on January 18, 2011. On January 25 and 26, 2011, the Ninth Circuit granted the motions of the underwriter defendants and of the plaintiff to stay the issuance of the court’s mandate pending those parties’ respective petitions for review by the United States Supreme Court. No amount has been accrued as of December 31, 2010 since management believes that the Company’s liability, if any, is not probable and cannot be reasonably estimated.

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

Warranties

The Company’s products are generally warranted to perform for a period of one year. In the event there is a failure of such products, the Company generally is obliged to correct or replace the product to conform to the warranty provision. No amount has been accrued for warranty obligations as of December 31, 2010 or September 30, 2010, as costs to replace or correct are generally reimbursable under the manufacturer’s warranty.

Indemnification

The Company does not generally indemnify its customers against legal claims that its services infringe third-party intellectual property rights. Other agreements entered into by the Company may include indemnification provisions that could subject the Company to costs and/or damages in the event of an infringement claim against the Company or an indemnified third-party. However, the Company has never been a party to an infringement claim and its management is not aware of any liability related to any infringement claims subject to indemnification. As such, no amount is accrued for infringement claims as of December 31, 2010 and September 30, 2010.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)—(CONTINUED)

(16) Geographic and Segment Information

The Company operates in a single reportable segment encompassing the development and sale of services, hardware and software to measure, test, assure and improve the service quality of Internet and mobile communications.

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


	Three Months Ended
	December 31,
	2010		2009
United States	$	12,244	$	11,308
Europe*		8,341		6,652
Other**		4,248		2,749

Net revenue	$	24,833	$	20,709


*		No individual country represents more than 10% of net revenue for the three months ended December 31, 2009. One individual country represents more than 10% of net revenue for the three months ended December 31, 2010.

**		No individual country represents more than 10% of net revenue for the three months ended December 31, 2010 and 2009.

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



	December 31, 2010		September 30, 2010
United States	$	31,768	$	32,213
Germany		1,184		1,212
Other		6		7

Total	$	32,958	$	33,432



(17)		Subsequent Events

In January 2011, the Board of Directors approved the payment of a quarterly dividend of $0.06 per share to stockholders of record as of March 1, 2011. In the future, the Company intends to pay a similar dividend on a quarterly basis; however, its ability to continue to do so will be affected by its future results of operations, financial position, business and the various other factors that may affect its overall business.

In January 2011, the Board of Directors approved an amendment to the Incentive Plan to extend the termination date from December 31, 2011 to December 31, 2014 and an amendment to the Purchase Plan to increase the number of authorized shares by 400,000. The other terms of these plans were not changed. These amendments are subject to stockholder approval.


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

The following discussion of the financial condition and results of operations of Keynote Systems, Inc. (referred to herein as “we,” “us,” “Keynote” or “the Company”) should be read in conjunction with the unaudited Condensed Consolidated Financial Statements and the Notes thereto included in this report as well as the audited financial statements and notes thereto in our Annual Report onForm 10-K for the year ended September 30, 2010, and subsequent filings with the Securities and Exchange Commission.

Except for historical information, thisForm 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements involve risks and uncertainties, including, among other things, statements regarding our anticipated costs and expenses and revenue mix. These forward-looking statements include, among others, statements including the words “expects,” “anticipates,” “intends,” “believes” and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to these differences include, but are not limited to, those discussed in this section, the section entitled “Risk Factors” in Item 1A of Part II of this report, and in our annual report onForm 10-K for the fiscal year ended September 30, 2010 and elsewhere in that report. You should carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the quarterly reports onForm 10-Q and current reports onForm 8-K that we may file during the current year. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this quarterly report onForm 10-Q. Except as required by law, we undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

Overview

Keynote is a leading global provider of Internet and mobile cloud monitoring solutions. We provide cloud-based testing, monitoring and measurement products and services that enable our customers to know how their Web sites, content, and applications perform on virtually any combination of actual browsers, networks and mobile devices. Since our founding in 1995, we have built and optimized a global monitoring network comprised of over 3,000 measurement computers and mobile devices in over 275 locations and 180 metropolitan areas worldwide and execute more than 450 million performance measurements every day. We offer a robust portfolio of Internet and mobile products and services to optimize the end-user customer experience in two broad categories: Internet Cloud (“Internet Cloud”) and Mobile Cloud (“Mobile Cloud”). We combine our Internet and Mobile Cloud products and services with our Real User Experience Testing to offer our customers a unique value proposition.

We deliver our products and services primarily through a cloud-based model on a subscriptions basis (also referred to as Software-as-a-Service, or SaaS). Subscription fees range from monthly to multi-year commitments and vary based on the type of service selected, the number of measurements, transactions or devices monitored, the number of measurement locations and/or appliances, the frequency of the measurements, the communication protocols or services measured and any additional features ordered. Our System Integrated Test Environment (“SITE”) systems, which include monitoring software and hardware, usually are offered via a software license fee model that is bundled with ongoing maintenance and support. Our Real User Experience Testing services, which we also refer to as our professional services or engagement services, primarily are offered on an engagement, per incident or per study basis. Engagements typically involve fixed price contracts based on the complexity of the project, the size of a panel, and the type of testing to be conducted.

Our net revenue increased by $4.1 million, or 20%, from $20.7 million for the three months ended December 31, 2009 to $24.8 million for the three months ended December 31, 2010. Our net income increased by $2.6 million, or 270%, from $1.0 million for the three months ended December 31, 2009 to $3.6 million for the three months ended December 31, 2010. The increase in net income is primarily attributable to a $3.6 million increase in Mobile net revenue and $0.5 million increase to Internet net revenue for the three months ended December 31, 2010 compared to the three months ended December 31, 2009. A portion of this increase was due to the adoption of the new accounting guidance described below. Total costs and expenses increased $1.6 million from $19.6 million for the three months ended December 31, 2009 to $21.2 million for the three months ended December 31, 2010.

Effective with fiscal year 2011, we adopted new revenue accounting guidance that had the primary effect of recognizing SITE systems revenue, excluding maintenance, at the time of acceptance rather than ratably over the contract term. SITE orders received after September 30, 2010 are reported as System licenses for the hardware and software elements of those contracts and as Maintenance and Support for the remaining elements. SITE orders received prior to October 1, 2010 (the beginning of fiscal year 2011) continue to be recognized ratably and are reported as Ratable license revenue. We adopted this accounting guidance and

prospectively applied its provisions to arrangements entered into or materially modified after October 1, 2010. As a result of adopting the new accounting guidance, we recognized $2.0 million of net revenue and $0.2 million of related direct costs of revenue in the first fiscal quarter of 2011 that would otherwise have been recognized in subsequent periods under the previous guidance.

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

	•		continuing to drive growth in our Internet and Mobile Cloud products and services, as we believe that revenue growth is the primary factor in creating stockholder value;

	•		growing Web measurement revenue (such as Transaction Perspective and Application Perspective which have increased over the past two quarters) in order to increase Internet revenues;

	•		growing our overall customer base to support the growth of our Internet and Mobile revenue;

	•		continuing to control our expenses in fiscal 2011 to maintain and improve profitability, particularly because of the economic uncertainties that continue to exist; and

	•		challenges faced due to the current economic environment as this affects our customers’ ability to purchase our products and services.

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

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

Critical Accounting Policies and Estimates

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

	•		Revenue recognition

	•		Allowance for doubtful accounts and billing allowance

	•		Goodwill, identifiable intangible assets and long-lived assets

	•		Stock-based compensation

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

Except for the adoption of new accounting guidance related to revenue recognition, Management believes that there have been no significant changes during the three months ended December 31, 2010 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operation in our 2010 Annual Report

on Form 10-K filed with the Securities and Exchange Commission. For a description of those critical accounting policies and estimates, please refer to our 2010 Annual Report on Form 10-K. For a description of our revenue recognition accounting policy and the effect of the adoption of the new accounting guidance on our financial statements, refer to Note 3 to our condensed consolidated financial statements in Part 1, Item 1 of this Form 10-Q.

Results of Operations

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


	Three Months Ended
	December 31,
	2010			2009
Total net revenue		100.0	%		100.0	%
Costs and expenses:
Costs of revenue:
Direct costs of revenue		23.5			26.1
Operations		7.7			9.1
Development		12.2			15.2
Amortization of intangible assets — software		1.7			1.4
Sales and marketing		29.0			30.6
General and administrative		11.5			12.8
Excess occupancy income		(1.0	)		(1.5	)
Amortization of intangible assets — other		0.6			0.9

Total costs and expenses		85.2			94.6

Income from operations		14.8			5.4
Interest income and other, net		0.9			0.5

Income before provision for income taxes		15.7			5.9
Provision for income taxes		(1.1	)		(1.2	)

Net income		14.6	%		4.7	%

The dollar amounts in the tables in this and the following sections are in thousands unless otherwise indicated.

Net Revenue


	For the Three Months Ended December 31,
	2010		2009		% Change
Internet
Web Measurement Subscriptions	$	7,275	$	6,170		18	%
Other Subscriptions		3,448		3,665		(6	)
Engagements		2,185		2,544		(14	)

Total Internet net revenue		12,908		12,379		4

Mobile
Subscriptions		3,195		2,374		35
Ratable Licenses		4,571		5,956		(23	)
System Licenses		1,992		—		—
Maintenance and Support		2,167		—		—

Total Mobile net revenue		11,925		8,330		43

Total net revenue	$	24,833	$	20,709		20	%

We previously reported net revenue in our condensed consolidated statement of operations under the following captions: Subscription Services, Ratable Licenses and Professional Services. Beginning in the first quarter of fiscal 2011, we are presenting the single line item “net revenue” in our condensed consolidated statement of operations and providing the detail table for net revenue above. Subscription revenue is reflected in the above table as web measurement subscriptions (which include Application Perspective, Transaction Perspective, Streaming Perspective and Web Site Perspective products and services), other subscriptions (which include all other Internet subscription product and services) and Mobile subscriptions (which include GlobalRoamer, Mobile Device Perspective and Mobile Web Perspective products and services). Monitoring systems revenue is reflected in the above table as ratable licenses (which includes SITE systems arrangements entered into prior to October 1, 2010), systems licenses (which includes the hardware and software elements of SITE arrangements significantly modified or entered into subsequent to September 30, 2010) and maintenance and support (which includes all other elements of SITE arrangements significantly modified or entered into subsequent to September 30, 2010 and all maintenance agreements renewals for periods subsequent to September 30, 2010).

Internet Net Revenue.Internet net revenue increased by $0.5 million for the three months ended December 31, 2010 compared to the three months ended December 31, 2009. Internet net revenue represented 52% and 60% of total net revenue for the three months ended December 31, 2010 and 2009, respectively. The increase in Internet net revenue for the three months ended December 31, 2010 was mainly attributable to an increase of $1.1 million in our Internet Web Measurement Subscriptions due primarily to an increase in the number of measurements that our customers are performing to test their Web sites, offset by a decrease of $0.2 million in our Internet Subscriptions Other and a decrease of $0.4 million from our engagements (also referred to as professional services) due primarily to a large Loadpro engagement in the first fiscal quarter of 2010 that did not recur in the first fiscal quarter of 2011.

Mobile Net Revenue.Mobile net revenue increased by $3.6 million for the three months ended December 31, 2010 compared to the three months ended December 31, 2009. Mobile net revenue represented 48% and 40% of total net revenue for the three months ended December 31, 2010 and 2009, respectively. The increase in Mobile net revenue for the three months ended December 31, 2010 was attributable mainly to an increase of $2.8 million in SITE systems, of which $2.0 million was due to the adoption of new revenue accounting guidance discussed below, and an increase of $0.8 million due to increased demand for mobile subscriptions.

In October 2009, the Financial Accounting Standards Board (“FASB”) amended the accounting guidance for revenue recognition to remove tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry specific software revenue recognition guidance. We adopted this accounting guidance and prospectively applied its provisions to arrangements entered into or materially modified on or after October 1, 2010 (the beginning of our fiscal year). The adoption of the new revenue accounting guidance had the primary effect of recognizing SITE systems revenue, excluding maintenance, at the time of acceptance rather than ratably over the contract term. SITE orders received after fiscal year 2010 are reported as System licenses for the hardware and software that works with the hardware to deliver the essential functionality of the hardware (“essential software”), and as Maintenance and Support for the remaining elements. SITE orders received prior to the beginning of fiscal year 2011 continue to be recognized ratably and are reported as Ratable license revenue because vendor specific objective evidence of fair value, or VSOE, does not exist for the undelivered elements of the arrangement, typically maintenance. As a result of adopting the new accounting guidance, we recognized $2.0 million of net revenue and $0.2 million of related direct costs of revenue in the first fiscal quarter of 2011 that would have been recognized in subsequent periods under the previous guidance. If the new accounting guidance had not been adopted, we would have reported $6.7 million of ratable license revenue, no system license revenue, no maintenance and support revenue and total net revenue of $22.8 million for the three months ended December 31, 2010. See Note 3 to condensed consolidated financial statements.

For the three months ended December 31, 2010 and 2009, no customer accounted for more than 10% of total net revenue. As of December 31, 2010, no customer accounted for more than 10% of net accounts receivable. As of September 30, 2010, one customer accounted for 10% of net accounts receivable. International sales were approximately 51% and 45% of total net revenue for the three months ended December 31, 2010 and 2009, respectively. International sales increased primarily due to the adoption of the new accounting guidance discussed in the previous paragraph.

Direct Costs of Net Revenue


	For the Three Months Ended December 31,
	2010		2009		%Change
Direct costs of net revenue	$	5,843	$	5,403		8	%

Direct costs of net revenue is comprised of telecommunication and network fees for our measurement and data collection network, costs for employees and consultants assigned to consulting engagements, depreciation of equipment related to our measurement and data collection network, and hardware and supplies for SITE systems. Consistent with the presentation of net revenue, we previously presented direct costs of revenue under the following captions: Subscription Services, Ratable Licenses, and Professional Services. Beginning in the first quarter of fiscal 2011, we are presenting direct costs of revenue as one line item in the condensed consolidated statement of operations. Direct costs of net revenue increased $0.4 million for the three months ended December 31, 2010 compared to the three months ended December 31, 2009 and represented 24% and 26% of total net revenue for the three months ended December 31, 2010 and 2009, respectively. The increase in direct costs of net revenue is mainly attributable to costs recognized as a result of the increase in revenue and the adoption of the new accounting guidance for revenue recognition (see discussion above).

Development


	For the Three Months Ended December 31,
	2010		2009		%Change
Development	$	3,035	$	3,145		(3	)%

Development expenses consist primarily of compensation, including stock-based compensation and other benefits, and other costs incurred by our development personnel. Our operations expenses remained relatively consistent for the quarter ended December 31, 2010 as compared to the quarter ended December 31, 2009.

Operations


	For the Three Months Ended December 31,
	2010		2009		%Change
Operations	$	1,911	$	1,891		1	%

Operations expenses consist primarily of compensation, including stock-based compensation and other benefits, 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 ensure the reliability of our services. Our operations expenses remained relatively consistent for the quarter ended December 31, 2010 as compared to the quarter ended December 31, 2009.

Sales and Marketing


	For the Three Months Ended December 31,
	2010		2009		%Change
Sales and marketing	$	7,193	$	6,328		14	%

Sales and marketing expenses consist primarily of salaries, benefits, commissions and bonuses earned by sales and marketing personnel, stock-based compensation, lead-referral fees, marketing programs and travel expenses. Sales and marketing expenses increased by $0.9 million for the quarter ended December 31, 2010 as compared to the quarter ended December 31, 2009. The increase was primarily attributable to an increase of $0.5 million for external marketing expenses partially related to our Mobile User Conference in Beijing and a $0.3 million increased in personnel costs to grow Mobile revenues.

General and Administrative


	For the Three Months Ended December 31,
	2010		2009		%Change
General and administrative	$	2,848	$	2,642		8	%

General and administrative expenses consist primarily of compensation, including stock-based compensation and other benefits; professional service fees, including accounting, auditing, legal and bank fees; insurance; and other general corporate expenses. General and administrative expenses increased by $0.2 million for the quarter ended December 31, 2010 as compared to the quarter ended December 31, 2009. The increase was primarily attributable to additional personnel costs associated with additional headcount.

Excess Occupancy Income


	For the Three Months Ended December 31,
	2010			2009			%Change
Rental income	$	(610	)	$	(690	)		(12	)%
Rental and other expenses		364			382			(5	)%

Excess occupancy income	$	(246	)	$	(308	)		(20	)%

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, which consists of 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 quarters ended December 31, 2010 and 2009. The decrease in excess occupancy income for the quarter ended December 31, 2010 as compared to the quarter ended December 31, 2009 was primarily due to a reduction of space rented by one tenant in the first fiscal quarter of 2011 and an early termination of a lease during the fourth fiscal quarter of 2010.

Amortization of Identifiable Intangible Assets


	For the Three Months Ended December 31,
	2010		2009		%Change
Amortization of identifiable intangible assets — software	$	419	$	298		41	%
Amortization of identifiable intangible assets — other		151		182		(17	)%

Total amortization of identifiable intangible assets	$	570	$	480		19	%

Amortization of intangible assets — software mainly relates to developed and purchased technology related to our mobile products and is reflected in direct costs of revenue in our condensed consolidated statements of operations. Amortization of intangible assets — other relates to all other intangibles, including customer lists, and is reflected in operating expenses in our condensed consolidated statement of operations.

Amortization of identifiable intangible assets — software increased by $0.1 million for the quarter ended December 31, 2010 as compared to the quarter ended December 31, 2009 due to the amortization of an intangible asset purchased from Fonjax in fiscal 2008, which was placed in service in fiscal 2010. Amortization of identifiable intangible assets — other remained relatively consistent for the quarter ended December 31, 2010 as compared to the quarter ended December 31, 2009.

We annually review our goodwill and non-amortizing intangible assets for impairment, or whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. The identifiable intangible assets will be fully amortized by fiscal 2013. See Note 9 to our consolidated financial statements for the schedule of future amortization charges. At December 31, 2010, the type and net carrying amount of the identifiable intangible assets was as follows:


Technology	Technology
Based-	Based-	Customer
Software	Other	Based		Trademark		Covenant		Backlog		Total
$2,504	$ —	$	407	$	377	$	9	$	27	$	3,324

Interest Income and Other Income (Expense), Net


	For the Three Months Ended December 31,
	2010		2009		% Change
Interest income	$	134	$	86		56	%
Other income (expense), net		82		7		1,071	%

Interest income and other income (expense), net	$	216	$	93		132	%

Other income (expense), net primarily consists of foreign currency transaction gains and losses and interest expense. Interest income and other income (expense), net increased $0.1 million for the quarter ended December 31, 2010 as compared to the quarter

ended December 31, 2009. Interest income increased primarily due to higher invested cash balances. Other income (expense), net increased primarily due to more favorable foreign exchange rates in the quarter ended December 31, 2010 as compared to the quarter ended December 31, 2009.

Provision for Income Taxes


	For the Three Months Ended December 31,
	2010		2009		%Change
Provision for income taxes	$	268	$	240		12	%

Our effective tax rate for the three months ended December 31, 2010 and 2009 was 7% and 20%, respectively. The rate for the three months ended December 31, 2010 and 2009 differs from the 35% United States federal statutory rate primarily due to the relative mix of foreign and domestic earnings, enacted tax rates, and the fact that a portion of the earnings are being taxed in the United States where we have a low effective tax rate due to utilization of net operating loss carryforwards. Through October 2011, we are also amortizing prepaid tax recorded in connection with the 2008 sale of intangible assets from our German subsidiary to the United States entity at approximately $190,000 per quarter. Excluding the amortization of this prepaid tax, our effective tax rate would have been 2% and 3% for the three months ended December 31, 2010 and 2009, respectively.

Stock based Compensation Expense

Stock-based compensation expense, which is included in total costs and expenses by category, was $0.8 million and $1.0 million for the three months ended December 31, 2010 and 2009, respectively. The decrease in stock compensation expense was due to our beginning to grant RSUs in fiscal 2009 rather than stock options and the lower number of RSUs granted as compared to the number of stock options granted in periods prior to fiscal 2009.

Stock-based compensation related to employee stock options, restricted stock units and employee stock purchase rights was reflected in the condensed consolidated statements of operations as follows:


	Three Months Ended
	December 31,
	2010		2009
Direct costs of net revenue	$	96	$	137
Development		177		229
Operations		107		134
Sales and marketing		291		364
General and administrative		124		139

Total	$	795	$	1,003

Non-GAAP Financial Measures and Other Operational Data

We also consider certain financial measures that are not prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), including Non-GAAP net income, Non-GAAP net income per share, Adjusted EBITDA, free cash flow and gross deferred revenues, and other operational data in managing and measuring the performance of our business. The Non-GAAP measures are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similar measures presented by other companies. However, we believe that this non-GAAP information is useful as an additional means for investors to evaluate our operating performance, when reviewed in conjunction with our GAAP financial statements. Therefore, these measures should not be considered in isolation or as a substitute for measures prepared in accordance with GAAP, and because these amounts are not determined in accordance with GAAP, they should not be used exclusively in evaluating our business and operations.

Non-GAAP Net Income and Non-GAAP Net Income Per Share.Non-GAAP net income is calculated by adjusting GAAP net income (loss) for the provision for income taxes less cash taxes paid from on-going operations, stock-based compensation expense and amortization of purchased intangibles. Non-GAAP net income per share is calculated by dividing Non-GAAP net income by the weighted average number of diluted shares outstanding for the period. The following table details our calculation (and reconciliation to GAAP) of non-GAAP net income and non-GAAP net income per share (in thousands, except per share amounts):


	Three Months Ended
	December 31,
	2010			2009
GAAP net income	$	3,627		$	981
Stock based compensation		795			1,003
Amortization of intangible assets—software		419			298
Amortization of intangible assets—other		151			182
Provision for income taxes		268			240
Cash taxes from on-going operations		(166	)		(164	)

Non-GAAP net income	$	5,094		$	2,540

Weighted average diluted common shares outstanding:		15,724			14,756
Non-GAAP net income per share	$	0.32		$	0.17

Adjusted EBITDA.Adjusted EBITDA is defined as earnings before interest income, taxes, stock-based compensation, depreciation, amortization and other income (expense), net. The following table details our calculation (and reconciliation to GAAP) of Adjusted EBITDA:


	Three Months Ended
	December 31,
	2010			2009
GAAP net income	$	3,627		$	981
Stock based compensation		795			1,003
Amortization of intangible assets—software		419			298
Amortization of intangible assets—other		151			182
Depreciation		1,006			1,197
Provision for income taxes		268			240
Interest income and other income (expense), net		(216	)		(93	)

Adjusted EBITDA	$	6,050		$	3,808

Free Cash Flow.Free cash flow is defined as cash flow from operations less cash used for purchases of property, equipment, and software. The following table details our calculation (and reconciliation to GAAP) of free cash flow:


	Three Months Ended
	December 31,
	2010			2009
Cash flow provided by (used in) operations	$	2,324		$	(95	)
Purchases of property, equipment and software		(470	)		(775	)

Free cash flow	$	1,854		$	(870	)

Gross Deferred Revenue.Net deferred revenue is comprised of all unearned revenue that has been collected in advance, primarily unearned Ratable license and subscription services revenue, and is recorded as deferred revenue on the balance sheet until the revenue is earned. Net 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. Gross deferred revenue is defined as the sum of net deferred revenue and unpaid deferred revenue. As a result of the adoption of new accounting guidance related to revenue recognition, SITE revenue, excluding maintenance, is recognized upon the later of delivery or customer acceptance rather than ratably over the maintenance period. Accordingly, deferred revenue will decrease over the time as all of these arrangements are accounted for under the new accounting guidance. The following table details our calculation of gross deferred revenue:


	December 31, 2010		September 30, 2010
Net deferred revenue	$	19,066	$	21,465
Unpaid deferred revenue		8,187		5,775

Gross deferred revenue	$	27,253	$	27,240

Liquidity and Capital Resources


	December 31, 2010		September 30, 2010
Cash, cash equivalents and short-term investments	$	69,141	$	66,352
Accounts receivable, net	$	11,537	$	9,094
Working capital	$	62,290	$	54,820
Days sales outstanding (DSO) for the three months ended (a)		43		41


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

Days sales outstanding increased by two days, from September 30, 2010 to December 31, 2010, primarily due to increased payment terms given to customers, primarily in Europe. Management does not believe the payment terms will have an effect on future collectability.


	Three Months Ended
	December 31,
	2010			2009
Cash provided by (used in) operating activities	$	2,324		$	(95	)
Cash used in investing activities	$	(1,187	)	$	(25,166	)
Cash provided by (used in) financing activities	$	1,768		$	(572	)

Cash, cash equivalents and short-term investments

At December 31, 2010, we had $25.8 million in cash and cash equivalents and $43.3 million in short-term investments, for a total of $69.1 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. Short-term investments consist of fixed-term deposits with original maturities longer than three months and investment-grade corporate and government debt securities with Moody’s ratings of A2 or better. As of December 31, 2010, $45.2 million of our cash, cash equivalents and short-term investments was held in the United States. The remainder of our cash, cash equivalents and short-term investments were held in foreign subsidiaries. If these foreign 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 provided by operating activities

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

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 systems licenses are generally collected at delivery of the SITE system. Payments for our engagement services customers are generally collected at the completion of the 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.

For the quarter ended December 31, 2010, net cash provided by operating activities was $2.3 million. Net cash provided was mainly due to net income of $3.6 million, adjusted for $3.0 million of non-cash adjustments to reconcile net income to net cash provided by operating activities and a $(4.3) million net change in operating assets and liabilities. The non-cash adjustments consist primarily of depreciation, amortization, stock-based compensation expenses and amortization of debt instruments purchase discount or premium. The net change in operating assets and liabilities was primarily due to an increase in accounts receivable of $2.7 million, and a decrease in deferred revenue of $2.1 million, partially offset by an increase in accounts payable and accrued expenses of $0.8 million.

Cash used in investing activities

The changes in cash flows from investing activities primarily relates to the timing of purchases and maturities of investments. We also use cash to purchase property, equipment and software to support our growth and infrastructure and to make tenant improvements associated with space we lease in our headquarters building.

For the quarter ended December 31, 2010, net cash used by our investing activities was $1.2 million. We paid $3.2 million for the purchase of short-term investments, and received $2.5 million from maturities and sales of short-term investments. We also purchased $0.5 million of property, equipment, and software.

Cash provided by financing activities

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

For the quarter ended December 31, 2010, net cash from financing activities was $1.8 million. We received $2.7 million from the issuance of common stock associated with our employee stock option plan, partially offset by common stock dividends of $0.9 million.

Commitments

As of December 31, 2010, our principal commitments consisted of $2.6 million in real property and equipment operating leases. These leases expire at various times through October 2017. Additionally, we had $1.3 million of contingent commitments to bandwidth and co-location providers. These contingent commitments have a remaining term of between one to twenty-two months and 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.

As of December 31, 2010, we had outstanding guarantees totaling $0.1 million to customers and vendors of one of our foreign subsidiaries. These guarantees can only be executed upon agreement by both the customer or vendor and us. At December 31, 2010, these guarantees were secured by a $1.3 million unsecured line of credit.

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity.Our interest income is sensitive to changes in the general level of interest rates, particularly because most of our short-term investments are invested in debt instruments. If market interest rates were to change immediately and uniformly by ten percent (10%) from their current levels, the interest earned on those cash, cash equivalents, and short-term investments could increase or decrease by approximately $0.1 million on an annualized basis.

Foreign Currency Fluctuations.We operate internationally and are exposed to potentially adverse movements in foreign currency rate changes. A majority of our revenue and expenses are transacted in United States dollars. However, we do enter into transactions in other currencies, primarily the Euro and British Pound. As a result, our United States 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 “Other income (expense), net” in the accompanying condensed consolidated statements of operations, primarily due to fluctuations in the Euro and the British Pound, totaled $83,000 and $7,000 for the quarter ended December 31, 2010 and 2009, respectively. We currently do not hedge or enter into currency exchange contracts against foreign currency exposures.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Regulations under the Securities Exchange Act of 1934 (the “Exchange Act”) require public companies, including our Company, to maintain “disclosure controls and procedures,” which are defined to mean a company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that it files or submits under the Exchange Act is accumulated and timely communicated to management, including our Chief Executive Officer and Chief Financial Officer, recorded, processed, summarized, and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Our Chief Executive Officer and Chief Financial Officer, based on their evaluation of our disclosure controls and procedures as of the end of the period covered by this report, concluded that our disclosure controls and procedures were effective for this purpose.

Changes in Internal Control Over Financial Reporting

Regulations under the Exchange Act require public companies, including our company, to evaluate any change in our “internal control over financial reporting,” which is defined as a process to provide reasonable assurance regarding the reliability of financial reporting and preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States. In connection with their evaluation of our disclosure controls and procedures as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer did not identify any change in our internal control over financial reporting during the three months ended December 31, 2010, that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II-OTHER INFORMATION

Item 1. Legal Proceedings

In August 2001, we and certain of our current and former officers were named as defendants in two securities class-action lawsuits based on alleged errors and omissions concerning underwriting terms in the prospectus for our initial public offering. A Consolidated Amended Class Action Complaint for Violation of the Federal Securities Laws (“Consolidated Complaint”) was filed on or about April 19, 2002, and alleged claims against us, certain of 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 on March 2008. Plaintiffs, the issuer defendants (including us), the underwriter defendants, and the insurance carriers for the defendants, have engaged in mediation and settlement negotiations. The parties reached a settlement agreement, which was submitted to the District Court for preliminary approval on April 2, 2009. As part of this settlement, our insurance carrier has agreed to assume our entire payment obligation under the terms of the settlement. On June 10, 2009, the District Court granted preliminary approval of the proposed settlement. After a September 10, 2009 hearing, the District Court gave final approval to the settlement on October 5, 2009. Several objectors have filed notices of appeal to the United States Court of Appeals for the Second Circuit from the District Court’s October 5, 2009 order approving the settlement. Although the District Court has granted final approval of the settlement, there can be no guarantee that it will not be reversed on appeal. We believe that we have meritorious defenses to these claims. If the settlement is not implemented and the litigation continues against us, we would continue to defend against this action vigorously.

In addition, in October 2007, a lawsuit was filed in the United States District Court for the Western District of Washington by Vanessa Simmonds, captionedSimmonds v. JPMorgan Chase & Co., et al., No. 07-1634, alleging that the underwriters violated section 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. section 78p(b), by engaging in short-swing trades, and seeks disgorgement to us of profits from the underwriters in amounts to be proven at trial. On February 28, 2008, Ms. Simmonds filed an amended complaint. The suit names us as a nominal defendant, contains no claims against us, and seeks no relief from us. This lawsuit is one of more than fifty similar actions filed in the same court. On July 25, 2008, the underwriter defendants in the various actions filed a joint motion to dismiss the complaints for failure to state a claim. The parties entered into a stipulation, entered as an order by the Court, that we are not required to answer or otherwise respond to the amended complaint. Accordingly, we did not join the motion to dismiss filed by certain issuers. On March 12, 2009, the Court dismissed the complaint in this lawsuit with prejudice. On April 10, 2009, the plaintiff filed a notice of appeal of the District Court’s order, and thereafter the underwriter defendants’ filed a cross appeal to a portion of the District Court’s order that dismissed thirty (30) of the cases without prejudice following the moving issuers’ motion to dismiss. On June 22, 2009 the Ninth Circuit issued an order granting the parties’ joint motion to consolidate the 54 appeals and 30 cross-appeals. Oral argument in the Ninth Circuit was heard on October 5, 2010, and the Court issued is written opinion on December 2, 2010. The Ninth Circuit affirmed the District Court’s decision that the demand letters that plaintiff had submitted to the 30 moving issuers were inadequate and directed the District Court to dismiss those actions with prejudice. The Ninth Circuit further directed the District Court to consider in the first instance whether the demand letters submitted to the other 24 issuers (including us) were sufficiently similar as also to require dismissal with prejudice. The Ninth Circuit reversed the District Court’s decision in favor of the underwriter defendants on statute of limitations grounds. On December 16, 2010, plaintiff and the underwriter defendants separately petitioned for a rehearing by the original three-judge panel of the court and a rehearing by the entire court, which petitions were denied on January 18, 2011. On January 25 and 26, 2011, the Ninth Circuit granted the motions of the underwriter defendants and of the plaintiff to stay the issuance of the court’s mandate pending those parties’ respective petitions for review by the United States Supreme Court. No amount has been accrued as of December 31, 2010 since management believes that our liability, if any, is not probable and cannot be reasonably estimated.

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

Item 1A. Risk Factors

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 investor 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:

	•		Fluctuations in foreign exchange rates;

	•		The effect of global economic conditions on customers and partners, including the level of discretionary IT spending;

	•		The rate of new and renewed subscriptions for our services, particularly large customers;

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

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

	•		The timing and service period of orders received during a quarter, especially from new customers;

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

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

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

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

	•		Seasonal factors, such as our LoadPro services which are typically higher in our first fiscal quarter due to customers preparing their Web sites for the holiday buying season;

	•		Future accounting pronouncements and changes in accounting policies;

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

	•		The cost associated with and the integration of future acquisitions or divestures.

Due to these and other factors, we believe that period-to-period comparisons of our results of operations may not be 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.

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 United States taxes on foreign subsidiaries and the negative tax implications related to moving cash from international locations to the United States), and changes in the value of the United States 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, particularly the Euro as a significant portion of our revenues are denominated in Euros.

Our primary exposure to movements in foreign currency exchange rates relate mainly to non-United States dollar denominated sales in Europe, as well as non-United States dollar denominated operating expenses incurred throughout the world. As was the case in recent years, volatility of foreign currencies relative to the United States dollar adversely affected the United States dollar value of our foreign currency-denominated sales and earnings.

International sales in dollars were approximately 51% and 45% of our total net revenue for the quarters ended December 31, 2010 and 2009, respectively. We expect to continue to commit significant resources to our international activities. Conducting international operations subjects us to risks we do not face in the United States. These include:

	•		currency exchange rate fluctuations, primarily the Euro;

	•		seasonal fluctuations in purchasing patterns;

	•		unexpected changes in regulatory requirements;

	•		maintaining and servicing computer systems in distant locations;

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

	•		difficulties in managing and staffing international operations;

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

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

	•		difficulties in establishing and enforcing our intellectual property rights in some countries; and

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

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 2010 and 2009, we incurred net losses in fiscal 2008 and in other prior fiscal years. As of December 31, 2010, we had an accumulated deficit of $134.3 million. If we are not able to increase our revenues, it may be difficult to sustain profitability. In addition, we are required under generally accepted accounting principles to review our goodwill and identifiable intangible assets for impairment when events or circumstances indicate that the carrying value may not be recoverable. As of December 31, 2010, we had $3.3 million of net identifiable intangible assets and $62.4 million of goodwill. We may in the future incur impairment charges 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 the FASB’s guidance on stock compensation, the cost of stock-based compensation 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 maintaining a large customer base, either by customers renewing their subscriptions for our products and services and purchasing additional products and services or by obtaining new customers.

To maintain and grow our revenue, we must maintain or increase the overall size of our customer base, either through maintaining high customer renewal rates, obtaining new customers for our products and services, and/or selling additional products and services to existing customers. Our customers have no obligation to renew our products and services after the contract term and, therefore, they could cease using our products and services at any time. In addition, customers that renew may contract for fewer product and services or at lower prices. Further, our customers may reduce their use of our products and services during the term of their subscription or purchase lower levels of our products and service. We cannot project the level of renewal rates or the prices at which customers renew subscriptions. The size of our customer base and 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, sales of our products and services may decline as companies evaluate their technology spending in response to the global economic environment. We have experienced in the past, and may experience in the future, reduced spending, cancellations, and non-renewals by our customers. If we experience reduced renewal rates or if customers renew for a lesser amount of our products and 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.

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

Revenue from our Mobile Cloud products and services was $11.9 million for the quarter ended December 31, 2010. Future growth for these products and services could be adversely affected by a number of factors, including, but not limited to, the difficulty in predicting demand; currency rate fluctuations; global economic conditions; and our ability to successfully compete against current or new competitors in this market. Our business and our operating results could be harmed if we are not able to continue to grow revenue from our Mobile Cloud products and services.

The inability of our products and 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 products and services, which may not perform at the level our customers expect. Despite our testing, upgrades to our existing or future products and 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 products and services.

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 be adequate in any particular case. 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 global monitoring network infrastructure could impair our ability to serve and retain existing customers or attract new customers.

Our operations depend upon our ability to maintain and protect our data centers, which store and distribute all data collected from our global monitoring network. We currently serve our customers from facilities located in San Mateo, California; Plano, Texas; and Nuremburg, Germany. Our primary operations center is located at our corporate headquarters in San Mateo, California, which is susceptible to earthquakes and possible power outages. We have occasionally experienced outages in the past and, if we experience 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 products and 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 products and 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 products and 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.

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 quarters ended December 31, 2010 and 2009. 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 products and services and, therefore, continue to generate revenue in any future period. In addition, our customers that have monthly renewal arrangements may terminate their contract 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 revenue in the near or long-term.

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. A decrease in consumer demand also could have a variety of negative effects on our customers’ 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 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 United States 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 further affected by these conditions.

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

To increase sales worldwide, we must complement our direct sales force with relationships with companies to help market and sell our products and 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 direct sales and marketing efforts. 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 products and 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.

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

Engagement services revenue represented approximately 9% and 12% of total net revenue for the quarters ended December 31, 2010 and 2009, respectively. We will need to successfully market these services in order to maintain or increase engagement services revenue. The market for these services is very competitive. Each engagement typically spans a one month to twelve month period and, therefore, it is more difficult for us to predict the amount of engagement services revenue recognized in any particular quarter. Our business and operating results could be harmed if we cannot maintain or increase our engagement services revenue.

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

The market for our products and 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 and mobile software and services with features similar to our products and services such as Compuware, Hewlett-Packard, Neustar and a variety of other Internet and mobile companies that offer a combination of testing, market research and data collection services. Customers could choose to use these companies’ products and services or these companies could enhance their products and 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, 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. In prior years, Compuware acquired Gomez, Hewlett-Packard acquired Mercury Interactive, and Neustar acquired Webmetrics. 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.

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

In the future, we intend to expand our product and service offerings and continue to measure and manage the performance of emerging technologies which 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 this area is very competitive, and we have limited resources dedicated to delivering engagement services, we may not succeed in selling these services.

Increased competition may result in price reductions, increased costs of providing our products and 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.

If we do not continually improve our products and 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 and communications protocols such as Internet telephony, wireless devices, Wi-Fi networks, HSDPA and LTE, 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 products and services, particularly in response to offerings by our competitors. If we do not succeed in developing and marketing new products and services that respond to competitive and technological developments and changing customer needs, we may encounter difficulties retaining existing customers and attracting new customers.

The success of new products and services depends on several factors, including proper definition of the scope and timely completion, introduction and market acceptance. 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 to these developments or we could lose market share or some of our products and services could become obsolete.

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 volatility that has 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 only have approximately 15.2 million shares outstanding at December 31, 2010, 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 $62.4 million of goodwill recorded on our consolidated balance sheet as of December 31, 2010. 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 cash, cash equivalents and short-term investments are managed through various banks around the world and we may realize losses on these.

We maintain our cash, cash equivalents and short-term investments with a number of financial institutions around the world, and our results could vary materially from expectations depending on gains or losses realized on the sale or exchange of investments; impairment charges related to debt securities as well as other investments; and interest rates. The volatility in the financial markets and overall economic conditions increases the risk that the actual amounts realized in the future on our investments could differ significantly from the fair values currently assigned to them.

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 and services or obtain and use information that we regard as proprietary.

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 and services, 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.

Others might bring infringement claims which could harm our business.

There is significant litigation in the United States involving patents and other intellectual property rights. We could become subject to intellectual property infringement claims as our products and 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 products and 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 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 products and services are located at facilities that are not owned by our customers or us. Instead, these devices are installed at locations near various worldwide Internet and mobile access points. 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 them on a timely basis, as we may not have immediate access to our measurement computers and measurement devices. Should performance problems arise, our ability to collect data in a timely manner could be impaired if we are unable to quickly maintain and repair our computers and devices.

The success of our business depends on the continued use of 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 Cloud products and services, 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 Internet and mobile networks for conducting business could be hindered for a number of reasons, including, but not limited to:

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

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

	•		delay in the development or adoption of new standards;

	•		inability to integrate business applications with the Internet; and

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

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

The demand for our products and services could be reduced or eliminated if future improvements to the infrastructure of 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 Internet and mobile networks. 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 products and services would likely decline, which would harm our operating results.

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.

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

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

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

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

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

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

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:

	•		difficulties in assimilating acquired personnel, operations and technologies;

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

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

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

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

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

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

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

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

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

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

Failure to maintain effective internal controls and changes to existing regulations may increase our costs and risk of noncompliance as well as adversely affect our stock price, revenue, and reported financial results.

As a public company, we incur significant legal, accounting and other expenses. In addition, the Sarbanes-Oxley Act, the recently-enacted Dodd-Frank Consumer Protection Act and rules subsequently implemented by the SEC and The Nasdaq Stock Market, have imposed and will impose a variety of requirements and restrictions on public companies, including requiring changes in corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these compliance

initiatives. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly.

Moreover, generally accepted accounting principles, or GAAP, are promulgated by, and are subject to the interpretation of the FASB and the SEC. New accounting guidance or taxation rules and varying interpretations of accounting guidance or taxation practices have occurred and may occur in the future. Any future changes in accounting guidance 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 guidance related to 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.

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

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. (Reserved)

Item 5. Other Information

Not applicable.

Item 6. Exhibits

EXHIBIT INDEX

Exhibit

Incorporated by Reference

Filed

No.

Exhibit

Form

File No.

Filing Date

Exhibit No.

Herewith

31.1

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

31.2

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

32.1

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

32.2

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


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

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of San Mateo, State of California, on this 4th day of February 2011.


	KEYNOTE SYSTEMS, INC.
	By:	/s/ UMANG GUPTA
		Umang Gupta
		Chairman of the Board and Chief Executive Officer (Principal Executive Officer)


	By:	/s/ CURTIS H. SMITH
		Curtis H. Smith
		Chief Financial Officer (Principal Financial Officer)


	By:	/s/ DAVID F. PETERSON
		David F. Peterson
		Chief Accounting Officer (Principal Accounting Officer)

EXHIBIT INDEX

Exhibit

Incorporated by Reference

Filed

No.

Exhibit

Form

File No.

Filing Date

Exhibit No.

Herewith

31.1

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

��

31.2

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

32.1

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

32.2

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


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

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Keynote Systems (KEYN) Inactive 10-Q2011 Q1 Quarterly report

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