Keynote Systems 10Q 2007 Q3 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 June 30, 2007


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


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

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

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed 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 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 filero Accelerated filerþ Non-accelerated filero

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): YES o NO þ

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


Class		Shares outstanding as of August 7, 2007

Common Stock, $.001 par value		18,019,530

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
TABLE OF CONTENTS

PART I—FINANCIAL INFORMATION

Item 1. Unaudited Financial Statements

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


		Page
Condensed Consolidated Balance Sheets as of June 30, 2007 and September 30, 2006		4
Condensed Consolidated Statements of Operations for the three and nine months ended June 30, 2007 and 2006		5
Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2007 and 2006		6
Notes to Condensed Consolidated Financial Statements		7

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)


	June 30,			September 30,
	2007			2006
ASSETS
Current assets:
Cash and cash equivalents	$	38,711		$	45,662
Short-term investments		64,378			45,089

Total cash, cash equivalents, and short-term investments		103,089			90,751

Accounts receivable, less allowance for doubtful accounts and billing adjustment of $483 and $473 as of June 30, 2007 and September 30, 2006, respectively		6,177			7,122
Prepaids, deferred costs and other current assets		2,912			2,655
Inventories		1,285			876
Deferred tax assets, net		1,469			1,389

Total current assets		114,932			102,793

Long-term deferred costs		849			—
Property and equipment, net		35,227			34,464
Goodwill		61,031			48,676
Identifiable intangible assets, net		8,339			10,105
Deferred tax assets		2,940			3,114

Total assets	$	223,318		$	199,152


LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	397		$	1,558
Accrued expenses		9,932			10,748
Current portion of capital lease obligation		25			31
Deferred revenue, net		21,886			9,691


Total current liabilities		32,240			22,028

Long-term portion of capital lease obligation		34			50
Long-term deferred revenue, net		2,262			958
Long-term deferred tax liability		2,904			2,727


Total liabilities		37,440			25,763


Commitments and contingencies — see Note 11
Stockholders’ equity:
Common stock		18			19
Treasury stock		—			(21,150	)
Additional paid-in capital		320,593			330,398
Accumulated deficit		(138,817	)		(137,578	)
Accumulated other comprehensive income		4,084			1,700


Total stockholders’ equity		185,878			173,389

Total liabilities and stockholders’ equity	$	223,318		$	199,152

See accompanying notes to the condensed consolidated financial statements.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)


	Three months ended						Nine months ended
	June 30,						June 30,
	2007			2006			2007			2006
Revenue:
Subscription services	$	14,324		$	11,448		$	40,973		$	31,215
Professional services		3,063			2,419			8,943			9,107

Total revenue		17,387			13,867			49,916			40,322


Costs and expenses:
Costs of subscription services		3,631			2,442			9,612			5,453
Costs of professional services		1,947			2,314			6,277			6,969
Research and development		2,950			2,673			8,699			6,753
Sales and marketing		5,243			4,653			14,909			12,042
Operations		1,853			1,867			5,643			5,361
General and administrative		2,490			2,443			7,247			6,354
Excess occupancy (income) cost		(33	)		38			(81	)		(12	)
Amortization of identifiable intangible assets		713			798			2,232			1,613
In-process research and development		—			840			—			840


Total costs and expenses		18,794			18,068			54,538			45,373


Loss from operations		(1,407	)		(4,201	)		(4,622	)		(5,051	)
Interest income and other, net		1,168			1,187			3,438			3,575


Loss before (provision) benefit for income taxes		(239	)		(3,014	)		(1,184	)		(1,476	)

(Provision) benefit for income taxes		(1,294	)		1,026			(55	)		(79	)


Net loss	$	(1,533	)	$	(1,988	)	$	(1,239	)	$	(1,555	)


Net loss per share:
Basic and diluted	$	(0.09	)	$	(0.11	)	$	(0.07	)	$	(0.08	)

Shares used in computing basic and diluted net loss per share:

Basic and diluted		17,662			18,384			17,353			18,670

See accompanying notes to the condensed consolidated financial statements.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)


	Nine months ended June 30,
	2007			2006
Cash flows from operating activities:
Net loss	$	(1,239	)	$	(1,555	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization of property, equipment and software		3,311			2,888
Stock-based compensation		3,051			2,629
Charges to bad debt and billing adjustment reserves		196			(246	)
(Accretion)/amortization of S/T investment (discount)/premium		(983	)		335
Amortization of identifiable intangible assets		2,232			1,613
In-process research and development		—			840
Deferred tax provision (benefit)		175			(774	)
Changes in operating assets and liabilities, net of acquired assets and liabilities:
Accounts receivable, net		826			1,681
Inventories		(349	)		(85	)
Prepaids, deferred costs and other assets		(1,049	)		450
Accounts payable and accrued expenses		(1,718	)		(243	)
Deferred revenue		12,957			1,851


Net cash provided by operating activities		17,410			9,384


Cash flows from investing activities:
Purchases of property, equipment and software		(4,160	)		(2,184	)
Purchase of businesses and assets, net		(307	)		(31,474	)
Earnout payment for acquisition of business		(10,587	)		—
Sale of short-term investments		39,226			94,589
Purchases of short-term investments		(57,323	)		(57,481	)
Issuance of note receivable to an unaffiliated third party		—			(300	)


Net cash provided by (used in) investing activities		(33,151	)		3,150


Cash flows from financing activities:
Payment of capital leases		(27	)		(34	)
Proceeds from issuance of common stock and exercise of stock options		8,497			3,190
Repurchase of outstanding common stock		—			(16,158	)


Net cash provided by (used in) financing activities		8,470			(13,002	)


Effect of exchange rate changes on cash and cash equivalents		320			78

Net change in cash and cash equivalents		(6,951	)		(390	)
Cash and cash equivalents at beginning of the period		45,662			46,934


Cash and cash equivalents at end of the period	$	38,711		$	46,544


Supplemental cash flow information:
Cash paid during the period for income taxes, net	$	518		$	148

Noncash Operating and Investing Activities:
Acquisition of property, equipment and software on account	$	13		$	—

Retirement of treasury stock	$	21,150		$	12,619

See accompanying notes to the condensed consolidated financial statements.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(1) Basis of Presentation

The accompanying interim unaudited Condensed Consolidated Balance Sheets, Condensed Consolidated Statements of Operations and Condensed Consolidated Statements of Cash Flows reflect all normal recurring adjustments that are, in the opinion of Management, necessary for a fair presentation of the financial position of Keynote Systems, Inc. and subsidiaries (the “Company”) as of June 30, 2007, and the results of operations and cash flows for the interim periods ended June 30, 2007 and 2006.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”), and therefore, do not include all information and footnotes necessary for a complete presentation of the Company’s results of operations, financial position and cash flows. This report should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended September 30, 2006 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 results of operations and cash flows for any interim period are not necessarily indicative of the Company’s results of operations and cash flows for any other future interim period or for a full fiscal year.

The preparation of financial statements in conformity with accounting principles generally 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 consolidated financial statements relate to the allowance for doubtful accounts, the billing allowance, income taxes and assumptions used to calculate stock-based compensation. Actual results could differ from those estimates, and such differences may be material to the financial statements.

Stock Based Compensation

(a) Summary of Plans

As of June 30, 2007, 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 both nonqualified and incentive stock options. Options expire ten years after the date of grant. Vesting periods are determined by the Board of Directors and generally 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. As of June 30, 2007, options to purchase approximately 6.0 million shares were outstanding under the Incentive Plan, and approximately 1.4 million shares were available for future issuance under the Incentive Plan.

As of June 30, 2007, the Company had reserved a total of approximately 1.4 million shares of common stock for issuance under its 1999 Employee Stock Purchase Plan (“Purchase Plan”). Under the Purchase Plan, eligible employees may defer an amount not to exceed 10% of the employee’s compensation, as defined in the Purchase Plan, to purchase common stock of the Company. The purchase price per share is 85% of the lesser of the fair market value of the common stock on the first day of the applicable purchase period or the last day of each purchase period. The Purchase Plan is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code. As of June 30, 2007, approximately 768,000 shares had been issued under the Purchase Plan, and approximately 655,000 shares had been reserved for future issuance.

(b) Summary of Assumptions and Activity

The fair value of each option was estimated on the date of grant using the Black-Scholes option pricing model. Weighted-average assumptions for options granted and stock purchases under the equity incentive plans are as follows:

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


	Three Months						Nine Months
	Ended June 30						Ended June 30
	2007			2006			2007			2006
Stock Options Under Equity Incentive Plan:

Volatility		29.7	%		30.0	%		29.3	%		31.2	%
Risk-free interest rates		4.7	%		4.9	%		4.7	%		4.6	%
Expected life (in years)		3.83			3.67			3.85			3.44
Dividend yield		—			—			—			—
Employee Stock Purchase Plan:
Volatility		25.0	%		30.0	%		26.0	%		29.0	%
Risk-free interest rates		5.1	%		3.7	%		5.1	%		3.7	%
Expected life (in years)		1.25			1.25			1.25			1.25
Dividend yield		—			—			—			—

A summary of option activity through June 30, 2007 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, 2006		6,754		$	13.24		7.1	$	6,146
Granted		140			10.65
Exercised		(86	)		8.70
Forfeited, canceled or expired		(155	)		12.03

Outstanding at December 31, 2006		6,653		$	13.27		7.0	$	6,167
Granted		292			12.25
Exercised		(211	)		9.93
Forfeited, canceled or expired		(108	)		11.74

Outstanding at March 31, 2007		6,626		$	13.36		6.9	$	18,824

Granted		104			14.05
Exercised		(519	)		9.59
Forfeited, canceled or expired		(162	)		11.41

Outstanding at June 30, 2007		6,049		$	13.75		6.7	$	33,288
Exercisable at June 30, 2007		3,736		$	15.09		5.5	$	22,152

The weighted average grant-date fair value of options granted during the three and nine months ended June 30, 2007 was $4.24 and $3.66 per share, respectively. The aggregate intrinsic value of options exercised during the three and nine months ended June 30, 2007 was approximately $3.0 million and $3.8 million, respectively.

As of June 30, 2007, there was approximately $7.2 million of total unrecognized compensation cost (net of estimated forfeitures) related to nonvested share-based compensation (nonvested stock options) arrangements as determined using the Black-Scholes option valuation model. That cost is expected to be recognized over the next four fiscal years (or a weighted average period of 2.5 years).

Excess Occupancy (Income) Costs

Excess occupancy costs are fixed expenses associated with the unoccupied portion of the Company’s headquarters building such as property taxes, insurance and depreciation. These particular costs are based on the actual square footage not occupied by Keynote, which was determined to be approximately 60% of the total rentable square footage of the headquarters building during the three and nine months ended June 30, 2007 and 2006, respectively. These fixed costs are reduced by the rental income from the leasing of the Company’s headquarters building. Rental income was approximately $296,000 and $240,000 for the three months ended June 30, 2007 and 2006, respectively. For the nine months ended June 30, 2007 and 2006, rental income was approximately $857,000 and $729,000, respectively. Rental income was greater than the excess occupancy costs, thus generating excess occupancy income for the three and nine months ended June 30, 2007 and nine months ended June 30, 2006. As of June 30, 2007, the Company had leased space with twelve tenants of which eleven had noncancelable operating leases, which expire on various dates through 2014. As of June 30, 2007, future minimum rents receivable under the leases, are as follows (in thousands):

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Twelve Months Ended June 30:
2008	$	1,961
2009		1,827
2010		1,313
2011		1,048
2012		1,001
Thereafter		218

Total future minimum rents receivable	$	7,368

(2) Revenue Recognition

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

	•		Evidence of an arrangement.The Company considers a customer signed quote, contract, or equivalent document to be evidence of an arrangement.

	•		Delivery. For subscription services not related to Keynote Systemintegration GmbH (“SIGOS”) delivery is considered to occur when the customer has been provided with access to the subscription services. The Company’s subscription services are generally delivered on a consistent basis over the period of the subscription. For professional services, delivery is considered to occur when the services or milestones are completed. For Keynote SIGOS services, delivery occurs when services are either delivered or accepted, if acceptance language exists.

	•		Fixed or determinable fee.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 client 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 in the period which the discount was granted. Revenue is not recognized for free trial periods.

Subscription Services Revenue:Subscription services revenue consists of (i) fees from sales of subscriptions and (ii) sales of mobile automated test equipment, maintenance, engineering and minor consulting services associated with Keynote SIGOS System Integrated Test Environment (“SITE”).

For customers that pay in advance, subscription services revenue is deferred upon invoicing and is recognized ratably over the service period, generally ranging from one to twelve months, commencing on the day service is first provided. For customers billed in arrears, subscription services revenue is invoiced monthly upon completion of the services. The Company’s WebEffective and WebExcellence technology is typically used in Customer Experience Management (“CEM”) professional engagements, and accordingly, such revenue is recorded as professional services revenue. However, in instances where customers solely require the use of the technology, such technology is sold on a stand-alone subscription basis. As a result, such revenue is recognized ratably over the subscription period, commencing on the day service is first provided, and recorded as subscription services revenue.

For non-Keynote SIGOS related services, revenue is recognized in accordance with Staff Accounting Bulletin (“SAB”) 104, “Revenue Recognition” (“SAB 104”) and Emerging Issues Task Force (“EITF”) Issue 00-21, “Revenue Arrangements with Multiple Deliverables” (“EITF 00-21”).

For non-Keynote SIGOS related services, the Company also enters into multiple element arrangements where sufficient objective evidence of fair value does not exist for the allocation of revenue. Therefore, the Company recognized the entire arrangement fee into revenue either ratably over the service period, generally over twelve months, or based upon actual monthly usage.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

As a result of the Company’s acquisition of SIGOS on April 3, 2006, the Company frequently enters into multiple element arrangements with mobile customers, for the sale of its automated test equipment, including both hardware and software licenses, consulting services to configure the hardware and software (implementation or integration services), post contract support (maintenance) services, training services and other minor consulting services. These multiple element arrangements are within the scope of Statement of Position No. 97-2, “Software Revenue Recognition” (“SOP 97-2”), and the Emerging Issues Task Force Issue 03-5, “Applicability of AICPA Statement of Position 97-2 to Non-Software Deliverables in an Arrangement Containing More-Than-Incidental Software”. This determination is based on the hardware component of the Company’s multiple element arrangements being deemed to be a software related element. In addition, customers do not purchase the hardware without also purchasing the software, as well as the software and hardware being sold as a package, with payments due from customer upon delivery of this hardware and software package.

None of the Keynote SIGOS services provided by the Company are considered to be essential to the functionality of the other elements. This assessment is due to the implementation services being performed during a relatively short period (generally within three months) compared to the length of the arrangement which typically ranges from twelve to thirty-six months. Additionally, the implementation /integration services are general in nature and the Company has a history of successfully gaining customer acceptance. The Company cannot allocate the arrangement consideration to the multiple elements based on the vendor specific objective evidence (“VSOE”) of fair value since sufficient VSOE does not exist for the allocation of revenue. Therefore, the Company recognizes the entire arrangement fee into revenue ratably over the service period, historically ranging from twelve to thirty-six months, once the implementation and integration services are complete, usually within two to three months following the delivery of the hardware and software. The ratable recognition of revenue begins when evidence of customer delivery or acceptance, if acceptance language exists, of the software and hardware has occurred as intended under the respective arrangement’s contractual terms.

Professional Services Revenue:Professional services revenue consists of fees generated by the Company’s professional services, and consists of WebEffective, WebExcellence, LoadPro and Testing services that are purchased as part of a professional service project, and are recognized as the services are performed, typically over a period of one to three months. For professional service projects that span one month or less, the Company recognizes revenue once the projects are completed. For professional service projects that contain substantive milestones, the Company recognizes revenue once milestones have been delivered. Payment occurs either up front or over time.

The Company also enters into multiple element arrangements, which include both subscription and professional service revenue, other than those Keynote SIGOS related arrangements involving hardware and software implementation/integration. For these arrangements, the Company recognizes revenue in accordance with EITF 00-21, and allocates and defers revenue for the undelivered items based on objective evidence of fair value of the undelivered elements, and recognizes the difference between the total arrangement fee and the amount deferred for the undelivered items as revenue. The Company determines fair value of the undelivered elements based on historical evidence of stand-alone sales of these elements to third parties. When sufficient objective evidence of fair value does not exist for undelivered items, the entire arrangement fee is recognized ratably over the remaining applicable performance period once the last element has been delivered.

Deferred Revenue:Deferred revenue is comprised of all unearned revenue that has been collected in advance, primarily unearned subscription services revenue, and is recorded as deferred revenue on the Condensed Consolidated 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 of the balance sheet date and primarily consists of Keynote SIGOS revenue.

Deferred Costs:Deferred costs are mainly comprised of hardware costs associated with Keynote SIGOS revenue arrangements involving hardware. Deferred costs are categorized as short term for any arrangement for which the original service contracts are one year or less in length. Correspondingly, deferred costs associated with arrangements for which the original service contracts are greater than one year are classified as noncurrent Deferred Costs in the Condensed Consolidated Balance Sheet. Contract lives generally range from one to three years. These deferred costs are amortized to cost of subscription services over the life of the customer contract. Amortization of these deferred costs commences when revenue recognition commences which is typically when evidence of delivery or acceptance occurs.

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

Comprehensive income (loss) includes net loss, unrealized gains and losses on short-term investments in debt securities and foreign currency translation. The unrealized gains and losses on short-term investments in debt securities 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 U.S. 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, United Kingdom, and Canada.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

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 (loss) account in stockholders’ equity. Revenue and expenses are translated at average exchange rates in effect during the period. Gains (losses) from foreign currency transactions are reflected in interest and other expenses in the Condensed Consolidated Statements of Operations as incurred.

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


	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2007			2006			2007			2006
Net loss	$	(1,533	)	$	(1,988	)	$	(1,239	)	$	(1,555	)
Net unrealized gain (loss) on available-for-sale investments		7			(13	)		120			136
Foreign currency translation gain		586			1,837			2,264			1,857

Comprehensive income (loss)	$	(940	)	$	(164	)	$	1,145		$	438

There is no tax effect on the foreign currency translation because it is Management’s intent to reinvest such foreign earnings indefinitely in its foreign subsidiaries.

(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, and capital lease obligation, 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 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 aging of accounts receivable, the age of each invoice, each customer’s expected ability to pay and the Company’s collection history with each customer. Management reviews invoices greater than 60 days past due to determine whether an allowance is appropriate based on the receivable balance. 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. In addition to the allowance for doubtful accounts, the Company maintains a billing allowance that represents the reserve for potential billing adjustments that are recorded as a reduction of revenue. The Company’s accounting for billing allowance represents a percentage of revenue based on historical trends and experience.

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

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

The Company considers all highly liquid investments held at major banks, commercial paper, money market mutual funds and other money market securities with original maturities of three months or less to be cash equivalents. The Company classifies all of its short-term investments as available-for-sale. These investments currently mature in one year or less, and consist of 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. There were no realized gains or losses during the three and nine months ended June 30, 2007.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The following table summarizes the Company’s cash and cash equivalents as of June 30, 2007 (in thousands):


			Gross		Gross
	Amortized		Unrealized		Unrealized		Estimated
	Cost		Gains		Losses		Market Value
Cash	$	17,619	$	—	$	—	$	17,619

Commercial paper		20,962		—		—		20,962
Money market mutual funds		130		—		—		130

Total	$	38,711	$	—	$	—	$	38,711

The following table summarizes the Company’s short-term investments in investment-grade debt securities as of June 30, 2007 (in thousands):


			Gross		Gross
	Amortized		Unrealized		Unrealized			Estimated
	Cost		Gains		Losses			Market Value
FNMA and FHLMC securities	$	2,037	$	—	$	(4	)	$	2,033

Other US federal and state government agencies		11,163				(9	)		11,154
Corporate bonds and commercial paper		51,219		3		(31	)		51,191

Total	$	64,419	$	3	$	(44	)	$	64,378

The following table summarizes the maturities of fixed maturity short-term investments available for sale as of June 30, 2007 (in thousands). Expected maturities of debt securities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties.


			Estimated
	Amortized		Market
	Cost		Value

Twelve months ending June 30, 2008	$	64,419	$	64,378

(6) Inventories

Inventories related to Keynote SIGOS SITE services were approximately $1.3 million and $876,000 as of June 30, 2007 and September 30, 2006, respectively. Inventories primarily relate to direct costs associated with finished goods hardware and are stated at the lower of cost (determined on a first-in, first-out basis) or market. Current selling prices are primarily used for measuring any potential declines in market value below cost. Any adjustment for market value decreases is charged to cost of subscription services at the point Management deems that the market value has declined lower than the carrying 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. Inventories on hand in excess of forecasted demand or obsolete inventories are charged to cost of subscription services. Obsolescence is determined considering several factors, including competitiveness of product offerings, market conditions, and product life cycles.

(7) Goodwill and Identifiable Intangible Assets

The following table represents the changes in goodwill during the nine months ended June 30, 2007 (in thousands):


Balance at September 30, 2006	$	48,676
Additional goodwill for payment of the SIGOS earnout (see Note 9)		10,561
Adjustment to goodwill for SIGOS (see Note 9)		(132	)
Additional goodwill for Vividence (see Note 9)		26
Translation adjustments and other		1,900

Balance at June 30, 2007	$	61,031

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Identifiable intangible assets amounted to approximately $8.3 million (net of accumulated amortization of approximately $18.8 million) at June 30, 2007, and approximately $10.1 million (net of accumulated amortization of approximately $16.6 million) at September 30, 2006. The components of identifiable intangible assets excluding goodwill are as follows (in thousands):


	Technology			Customer						Non-Compete
	Based			Based			Trademark			Covenant			Backlog			Total
As of June 30, 2007:
Gross carrying value	$	15,913		$	9,385		$	1,038		$	76		$	254		$	26,666
Accumulated amortization		(11,816	)		(6,443	)		(453	)		(20	)		(61	)		(18,793	)
Translation adjustments		101			252			91			12			10			466

Net carrying value at June 30, 2007	$	4,198		$	3,194		$	676		$	68		$	203		$	8,339


As of September 30, 2006:
Gross carrying value	$	15,913		$	9,385		$	1,038		$	76		$	254		$	26,666
Accumulated amortization		(10,571	)		(5,636	)		(323	)		(7	)		(24	)		(16,561	)

Net carrying value at September 30, 2006	$	5,342		$	3,749		$	715		$	69		$	230		$	10,105

Amortization expense for identifiable intangible assets for the three months ended June 30, 2007 and 2006 was $713,000 and $798,000, respectively. Amortization expense for identifiable intangible assets for the nine months ended June 30, 2007 and 2006 was $2.2 million and $1.6 million, respectively. Assuming no additional acquisitions or impairment charges, the amortization expense for existing identifiable intangible assets as of June 30, 2007 is estimated to be approximately $715,000 for the remainder of fiscal 2007, $2.7 million for fiscal 2008, $1.7 million for fiscal 2009, $1.3 million in fiscal 2010, $1.3 million in fiscal 2011, and approximately $580,000 in fiscal 2012.

(8) Net Loss Per Share

Basic net loss per share is computed using the weighted-average number of outstanding shares of common stock, summarized below. Diluted net income per share is computed using the weighted-average number of shares of common stock outstanding and, when dilutive, potential shares from options and employee stock plan purchases to purchase common stock using the treasury stock method.

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


	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2007			2006			2007			2006
Numerator:
Net loss	$	(1,533	)	$	(1,988	)	$	(1,239	)	$	(1,555	)

Denominator:
Denominator for basic net loss per share—weighted average shares		17,662			18,384			17,353			18,670
Incremental common shares attributable to shares issuable under stock option plans		—			—			—			—

Denominator for diluted net loss per share—weighted average shares		17,662			18,384			17,353			18,670


Basic and diluted net loss per share	$	(0.09	)	$	(0.11	)	$	(0.07	)	$	(0.08	)

Potential shares of common stock that have been excluded from the computation of diluted net loss per share because the effect would have been antidilutive were 811,000 and 6.6 million shares subject to outstanding stock options for the three months ended June 30, 2007 and 2006, respectively. Potential shares of common stock that have been excluded from the computation of diluted net loss per share because the effect would have been antidilutive were 3.4 million and 6.6 million shares subject to outstanding stock options for the nine months ended June 30, 2007 and 2006, respectively. The weighted-average exercise price of excluded outstanding stock options was $36.10 and $20.65 for the three months ended June 30, 2007 and 2006, respectively. The weighted-average exercise price of excluded outstanding stock options was $17.35 and $13.40 for the nine months ended June 30, 2007 and 2006, respectively.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(9) Acquisitions

On April 3, 2006, the Company acquired all the outstanding shares of SIGOS, a mobile data network testing and monitoring solutions provider, for approximately €25 million, or approximately $30.1 million at then current exchange rates, and incurred approximately $1.2 million of direct transaction costs.

Of the cash paid at closing, approximately $6 million (€5 million) was withheld in an escrow account for specified indemnity obligations. In accordance with the purchase agreement, the Company released approximately $5.6 million (€4.1 million) from escrow to the former shareholders of SIGOS in April 2007. In addition, the Company paid an additional €8 million, or approximately $10.6 million at then current exchange rates, in the second quarter of fiscal 2007. This additional purchase consideration increased goodwill and was based on revenue and profitability milestones achieved in calendar 2006. During the three months ended June 30, 2007, the Company recorded an adjustment to decrease goodwill for SIGOS in the amount of $132,000. The adjustment related to the unpaid portion of the estimated $1.2 million of direct transaction costs which Management deemed as unnecessary since the estimated transaction costs exceeded the actual costs incurred and paid.

In December 2006, pursuant to an escrow agreement, the Company paid approximately $250,000 of the purchase price, which had been held back on its acquisition of the GomezPro business of Watchfire Corporation that occurred in November 2005.

In March 2007, the Company and the shareholders’ representative of Vividence Corporation (“Vividence”) agreed upon the final escrow settlement amount to be received from the former shareholders of Vividence. The Company received the final settlement amount of $210,000 in May 2007 which was recorded as a reduction to “other assets” offsetting the associated receivable from Vividence.

(10) Income Taxes

The Company’s effective tax rate for the three months ended June 30, 2007 and 2006 was 541.4% and (34.0%), respectively. The Company’s effective tax rate for the nine months ended June 30, 2007 and 2006 was 4.6% and 5.4%, respectively. The high tax rate for the three months ended June 30, 2007 was due primarily to a change in the estimated annual tax rate for the fiscal year ending September 30, 2007. The change in estimate of the annual effective tax rate was primarily due to a revision of the forecasted income for the fiscal year. The Company calculates its income tax provisions based on the estimated annual effective tax rate for the Company. However, as required by the Financial Accounting Standards Board (“FASB”) Interpretation 18, “Accounting for Income Taxes in Interim Periods” (“FIN 18”), the impact of items of tax expense (or benefit) that do not relate to “ordinary income” in the current year generally should be accounted for discretely in the period in which it occurs and be excluded from the effective tax rate calculation. For the three months ended June 30, 2007, the Company recorded a discrete benefit of $153,000 related to the reversal of certain tax reserves for one of its European entities and a benefit of $129,000 related to the disqualified disposition of incentive stock options. The Company recorded a total of $307,000 in discrete benefits for the nine months ended June 30, 2007.

The tax provision for the first nine months of fiscal 2007 differs from U.S. statutory rate primarily due to permanent differences related mostly to book compensation expense related to the granting of Incentive Stock Options. The effective tax rate is highly dependent upon the geographic distribution of its worldwide earnings or loss, tax regulations in each geographic region, the availability of tax credits and carry-forwards, the impact of SFAS No. 123R and the effectiveness of tax planning strategies. SFAS No. 123R has the effect of increasing the effective tax rate due to the charge to earnings from incentive stock options and ESPP shares, which have no associated current tax benefit to the Company. In a future period it is possible that a tax benefit would be realized on these options, at which time the tax rate may be reduced as a result. 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 June 30, 2007, the projected sources of taxable income were considered to be sufficient to recognize a portion of the deferred tax assets. In future quarters, the projected taxable income will be evaluated for this purpose, and it is possible that the valuation allowance would be increased or reduced further, which would increase or reduce the effective tax rate and deferred tax expense, the goodwill balance, and the paid-in-capital. In the event that Management determines that the valuation allowance should be increased or 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 US domestic taxes and to foreign, in particular German, taxes separately.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(11) Commitments and Contingencies

(A) Leases

The Company leases certain of its facilities and equipment under noncancelable capital and operating leases, which expire on various dates through August 2015. As of June 30, 2007, future minimum payments under the leases are as follows (in thousands):


	Operating		Capital
	Leases		Leases
Twelve months ended June 30:
2008	$	849	$	25
2009		761		17
2010		658		16
2011		513		6
2012		365		—
Thereafter		909		—

Total minimum lease payments	$	4,055		64


Less amounts representing interest				(5	)


Present value of minimum lease payments				59

Less current portion of capital lease obligation				(25	)


Long-term portion of capital lease obligation			$	34

Rent expense for the three months ended June 30, 2007 and 2006 was approximately $253,000 and $219,000, respectively. Rent expense for the nine months ended June 30, 2007 and 2006 was approximately $688,000 and $535,000, respectively.

(B) Commitments

The Company has contingent commitments, which range in length from one to 23 months, to 114 bandwidth and collocation providers amounting to $824,000 in the aggregate for 102 locations,which commitments become due if the Company terminates any of these agreements prior to their expiration.

(C) Legal Proceedings

Beginning on August 16, 2001, several class action lawsuits were filed in the United States District Court for the Southern District of New York against the Company, certain of its officers, and the underwriters of the Company’s initial public offering. These lawsuits were essentially identical, and were brought on behalf of those who purchased the Company’s securities between September 24, 1999 and August 19, 2001. These complaints alleged generally that the underwriters in certain initial public offerings, including the Company’s, allocated shares in those initial public offerings in unfair or unlawful ways, such as requiring the purchaser to agree to buy in the aftermarket at a higher price or to buy shares in other companies with higher than normal commissions. The complaint also alleged that the Company had a duty to disclose the activities of the underwriters in the registration statement relating to its initial public offering. The plaintiffs’ counsel and the issuer defendants’ counsel have reached a preliminary settlement agreement whereby the issuers and individual defendants will be dismissed from the case, without any payments by the Company. Although, the settlement was preliminarily approved, while the parties’ awaited final court approval of the settlement, in December 2006 the Court of Appeals reversed the District Court’s finding that six focus cases could be certified as class actions. In April 2007, the Court of Appeals further denied the plaintiffs’ petition for rehearing, but acknowledged that the District Court might certify a more limited class. At a June 26, 2007 status conference, the District Court terminated the proposed settlement as stipulated among the parties, and scheduled briefing on plaintiffs’ motion to certify a different class. If a satisfactory settlement is not renegotiated in light of the new class definition, the Company intends to defend itself vigorously. No amount is accrued as of June 30, 2007.

The Company is subject to 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 its consolidated financial position, results of operations, or cash flows.

(D) Warranties

The Company’s products are generally warranted to perform for a period of one year. In the event there is a failure of such warranties, the Company would be obliged to correct or replace the product to conform to the warranty provision. As of June 30, 2007, the Company recorded no warranty liability because such liability is generally covered under the manufacturer’s warranty.

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(E) Indemnification

The Company does not generally indemnify its customers against legal claims that its services infringe on third-party intellectual property rights. Other agreements entered into by the Company may include indemnification provisions that could subject the Company to costs and/or damages in the event of an infringement claim against the Company or an indemnified third-party. However, the Company has never been a party to an infringement claim and its Management is not aware of any liability related to any infringement claims subject to indemnification. As such, no amount is accrued for infringement claims as of June 30, 2007 and September 30, 2006 in the Condensed Consolidated Balance Sheets.

(12) Stock Repurchase Program

On December 4, 2006, as part of its overall stock repurchase program, the Company entered into agreements with B. Riley & Co., Inc. (“B. Riley”) and Craig-Hallum Capital Group (“Craig-Hallum”) to establish Trading Plans intended to qualify under Rule 10b5-1 of the Securities Exchange Act of 1934 (the “Exchange Act”). Each Trading Plan instructs B. Riley and Craig-Hallum, respectively, to repurchase for the Company, in accordance with Rule 10b-18 of the Exchange Act, up to 1 million shares each, of the Company’s common stock, for an aggregate of up to 2 million shares. Repurchases under the Trading Plans are scheduled to terminate as late as December 2007.

The Company retired approximately 974,000 shares of treasury stock in fiscal 2006 and retired approximately 2.0 million shares of treasury stock during the nine months ended June 30, 2007. The Company did not retire any treasury shares during the three months ended June 30, 2007.

No repurchases occurred during the three months ended June 30, 2007. As of June 30, 2007, approximately 14.3 million shares had been repurchased for an aggregate price of approximately $135.3 million. As of June 30, 2007, the Company was authorized to repurchase up to an additional $57.8 million of its common stock pursuant to the stock repurchase program.

(13) Geographic, Customer and Segment Information

The Company operates as a single operating segment encompassing the development and sale of services, hardware and software to measure, test, assure and improve the quality of service of the Internet and of mobile communications. While the Company operates as one operating segment, Management reviews revenue under three categories – Internet, Mobile and Customer Experience Management services in addition to subscription services and professional services revenue. Management continues to allocate resources based on the one operating segment.

Information regarding geographic areas is as follows (in thousands):


	Three Months Ended				Nine Months Ended
	June 30,				June 30,
	2007		2006		2007		2006
Revenues:
United States	$	12,136	$	11,681	$	35,588	$	35,669
Europe*		4,113		1,829		10,673		4,040
Other*		1,138		357		3,655		613

	$	17,387	$	13,867	$	49,916	$	40,322


*		No individual country represents more than 10% of total revenue.


	June 30,		September 30,
	2007		2006

Long Lived Assets:
United States	$	34,506	$	33,775
Germany		696		667
Other		25		22

	$	35,227	$	34,464

Revenues are attributable to countries based on the geographic location of the customers. Long-lived assets are attributed to the

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

geographic location in which they are located. The Company includes in long-lived assets all tangible assets.

For the three and nine months ended June 30, 2007, no individual customer accounted for more than 10% of total revenue. For the three and nine months ended June 30, 2006, one customer accounted for approximately 14% and 12% of total revenue, respectively. As of June 30, 2007 no individual customer accounted for more than 10% of total accounts receivable. As of September 30, 2006, one customer accounted for 18% of total accounts receivable. For the three months ended June 30, 2007 and 2006, the ten largest customers accounted for 35% and 35% of total revenue, respectively. For the nine months ended June 30, 2007 and 2006, the ten largest customers accounted for 33% and 33% of total revenue, respectively.

The following table identifies which services are categorized as Internet, Mobile and Customer Experience Management services and where they are recorded in the Company’s Condensed Consolidated Statements of Operations (listed in alphabetical order):


	Subscription		Professional
	Services		Services
Internet Test and Measurement:
Application Perspective		X
Diagnostic Services		X
Enterprise Adapters		X
LoadPro				X
NetMechanic		X
Professional Services				X
Red Alert		X
Streaming Perspective		X
Test Perspective		X		X
Transaction Perspective		X
WebIntegrity		X
Web Site Perspective		X
Voice Perspective		X
Performance Scoreboard		X

Mobile Test and Measurement:
Mobile Application Perspective		X
Mobile Device Perspective		X
SIGOS SITE		X
SIGOS Global Roamer		X

Customer Experience Management:
WebEffective		X		X
WebExcellence		X		X

The following table summarizes Internet, Mobile, and Customer Experience Management solutions revenue (in thousands):


	2007		2006
For the three months ended June 30:
Internet	$	10,849	$	9,623
Mobile		4,601		1,949
Customer experience management		1,937		2,295

Total Revenue	$	17,387	$	13,867


For the nine months ended June 30:
Internet	$	31,603	$	29,313
Mobile		12,120		2,976
Customer experience management		6,193		8,033

Total Revenue	$	49,916	$	40,322

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(14) Recently Issued Accounting Pronouncements

In May 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections” (“FAS 154”) to replace Accounting Principles Board Opinion No. 20, “Accounting Changes” and Statement No. 3, “Reporting Accounting Changes in Interim Periods.” FAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections, and establishes retrospective application as the required method for reporting a change in accounting principle. FAS 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable, and for reporting a change when retrospective application is determined to be impracticable. FAS 154 also addresses the reporting of a correction of an error by restating previously issued financial statements. FAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company adopted this pronouncement in its fiscal year beginning October 1, 2006 and such adoption did not have an impact on its consolidated results of operations and financial condition.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006, which will be the Company’s fiscal year beginning October 1, 2007. The Company is currently evaluating the impact of FIN 48 on its consolidated results of operations and financial condition. It is possible that the tax reserves will be adjusted; however the amount cannot be determined at this time.

In June 2006, Emerging Issues Task Force (“EITF”) issue EITF 06-3 “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is Gross versus Net Presentation)” was ratified. This issue relates to any tax assessed by a governmental authority that is directly imposed on a revenue producing transaction between a seller and a customer and requires additional disclosures related to those taxes on either a gross (included in revenue) or a net (excluded from revenue) basis. This issue is effective for fiscal years beginning after December 15, 2006, which will be the Company’s fiscal year beginning October 1, 2007. The Company is currently evaluating the impact of EITF 06-3 on its consolidated results of operations and financial condition.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Current Year Misstatements.”SAB No. 108 requires analysis of misstatements using both an income statement (rollover) approach and a balance sheet (iron curtain) approach in assessing materiality and provides for a one-time cumulative effect transition adjustment. SAB No. 108 is effective for its fiscal year 2007 annual financial statements. Management is currently assessing the potential impact that adoption of SAB No. 108 will have on its financial statements. The Company currently anticipates that the aggregate amount of the uncorrected differences will be approximately $2.0 million, however, this amount could be more or less than $2.0 million pending final analysis by Management of the impact of adopting SAB No. 108.

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (“FAS 157”), which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles (“GAAP”). As a result of FAS 157, there is now a common definition of fair value to be used throughout GAAP, which is expected to make the measurement of fair value more consistent and comparable. FAS 157 is effective for the first fiscal year beginning after November 15, 2007, which will be the Company’s fiscal year beginning October 1, 2008. The Company has not yet begun to evaluate the effects, if any, of adoption on its consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. SFAS No. 159 permits companies to choose to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS No. 159 is effective for the Company beginning in the first quarter of fiscal year 2009, although earlier adoption is permitted. The Company is currently evaluating the impact of adopting SFAS No. 159 on its consolidated financial statements.

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

The followingdiscussion 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 Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and the Notes thereto included in the Company’s Annual Report on Form 10-K for the year ended September 30, 2006, and subsequent filings with the Securities and Exchange Commission (the “SEC”).

Except for historical information, this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements involve risks and uncertainties, including, among other things, statements regarding our anticipated costs and expenses and revenue mix. These forward-looking statements include, among others, statements including the words “expects,” “anticipates,” “intends,” “believes” and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to these differences include, but are not limited to, those discussed in this section, the section entitled “Risk Factors” in Item 1A of Part II of this report, and in our annual report on Form 10-K for the fiscal year ended September 30, 2006 and elsewhere in that report. You should carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the quarterly reports on Form 10-Q and current reports on Form 8-K that we may file during the current year. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this quarterly report on Form 10-Q. Except as required by law, we undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

Overview

We offer technology-based solutions that enable corporate enterprises to improve their online business performance and communications technologies. We categorize our solutions in three broad categories: Internet test and measurement (“Internet”), customer experience management (“CEM”), and mobile test and measurement (“Mobile”). Our Internet category includes all of our geographically distributed “on demand” Web site and application monitoring and measurement services, voice over IP and streaming measurement services, load testing services and professional services engagements. The CEM category consists of the WebEffective platform whether sold on a technology license basis, or as part of a competitive intelligence study or custom consulting engagement and the WebExcellence scorecard services sold on a subscription basis or as part of a custom consulting engagement. The Mobile category consists of our on-demand Mobile monitoring and testing services as well as our Keynote SIGOS SITE systems sales where we have continued to see increased revenue growth. All of these categories of services help our customers reduce costs, improve customer satisfaction and increase profitability.

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

Our net loss decreased by $455,000, from a net loss of approximately $2.0 million for the quarter ended June 30, 2006 to a net loss of $1.5 million for the quarter ended June 30, 2007. Total revenue increased approximately $3.5 million or 25%, from approximately $13.9 million for the quarter ended June 30, 2006 to approximately $17.4 million for the quarter ended June 30, 2007. The increase in revenue was primarily due to approximately $2.7 million in Mobile revenue from Keynote SIGOS services and to a lesser extent, an increase of approximately $1.2 million in our Internet revenue, offset by decreased contribution from our CEM revenue of $358,000. Total costs and expenses increased by $726,000 million from approximately $18.1 million for the quarter ended June 30, 2006 to approximately $18.8 million for the quarter ended June 30, 2007. The increase in total costs and expenses was mainly attributable to higher costs of subscription services related to growth in our Keynote SIGOS business and the cost of building out our new public infrastructure for mobile test and measurement services. Total costs and expenses were further increased by higher sales and marketing expenses related to added sales personnel driving higher compensation and travel related expenses.

Our net loss decreased by $316,000, from a net loss of approximately $1.6 million for the nine months ended June 30, 2006 to a net loss of approximately $1.2 million for the nine months ended June 30, 2007. Total revenue increased approximately $9.6 million or 24%, from approximately $40.3 million for the nine months ended June 30, 2006 to approximately $49.9 million for the nine months ended June 30, 2007. The increase in revenue was due primarily to approximately $9.1 million in Mobile revenue mainly attributable from our Keynote SIGOS services and to a lesser extent, an increase of approximately $2.3 million in our Internet revenue, offset by decreased contribution from our CEM revenue of approximately $1.8 million. Total costs and expenses increased by $9.2 million from approximately $45.4 million for the nine months ended June 30, 2006 to approximately $54.5 million for the nine months ended June 30, 2007. The increase in total costs and expenses was mainly attributable to costs associated with the Keynote SIGOS acquisition which closed on April 3, 2006. Further increases resulted from costs of subscription services related to increased depreciation, equipment charges, and connection fees, and increased sales and marketing expenses associated with additional sales personnel causing an increase in personnel and associated compensation and travel related expenses.

At June 30, 2007 and 2006, we measured for revenue over 11,100 and 9,600 Internet pages, respectively. For the three and nine months ended June 30, 2007, our 10 largest customers accounted for approximately 35% and 33% of total revenue, respectively. We cannot be certain that customers that have accounted for significant revenue in past periods, individually or in aggregate, will renew our services and continue to generate revenue in any future period. In addition, our customers that have monthly renewal arrangements may terminate their services at any time with little or no penalty. If we lose a major customer or a group of significant customers, our revenue could significantly decline.

We believe that the challenges for our business include 1) increasing our Internet, CEM and Mobile revenue by generating organic revenue growth from our existing services and by continuing to internally develop enhanced services, 2) integrating and realizing anticipated benefits from our prior acquisitions and any acquisitions that may occur in the future, 3) increasing our contribution margin for our professional services revenue, and 4) continuing to control our expenses for the remainder of fiscal 2007.

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 of America. Note 2, “Summary of Significant Accounting Policies,” to the consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended September 30, 2006 describes the significant accounting policies and methods used in the preparation of our consolidated financial statements. 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 consolidated financial statements:

	•		Revenue recognition

	•		Allowance for doubtful accounts and billing allowance

	•		Inventories and inventory valuation

	•		Allocation of purchase price for business combinations

	•		Goodwill, identifiable intangible assets, and long-lived assets

	•		Stock-based compensation

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

Revenue Recognition

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

	•		Evidence of an arrangement,

	•		Delivery,

	•		Fixed or determinable fee, and

	•		Collection is deemed reasonably assured.

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

Subscription Services Revenue:Subscription services revenue consists of (1) fees from sales of subscriptions to our Perspective family of services, various enterprise-premises based solutions such as Private Agents and Adapters, Global Roamer, Performance Scoreboard, Red Alert and NetMechanic, and 2) sales of mobile automated test equipment, maintenance, engineering and minor consulting services associated with Keynote SIGOS SITE.

For customers that pay in advance, subscription services revenue is deferred upon invoicing and is recognized ratably over the service period, generally ranging from one to twelve months, commencing on the day service is first provided. For customers billed in arrears, subscription services revenue is invoiced monthly upon completion of the services. Our WebEffective and WebExcellence technology is typically used in our CEM engagements, and accordingly, such revenue is recorded as professional services revenue. However, in instances where customers solely require the use of the technology, such technology is sold on a stand-alone subscription basis. As a result, such revenue is recognized ratably over the subscription period, commencing on the day service is first provided, and recorded as subscription services revenue.

For our non- Keynote SIGOS related services, we recognize revenue in accordance with SAB 104 and EITF 00-21.

For non- Keynote SIGOS related services, we also enter into multiple element arrangements where sufficient objective evidence of fair value also does not exist for the allocation of revenue. Therefore, we recognize the entire arrangement fee into revenue either ratably over the service period, generally over twelve month periods or based upon actual monthly usage.

As a result of the acquisition of Keynote SIGOS, we frequently enter into multiple element arrangements with mobile customers, for the sale of our automated test equipment, including hardware, software licenses, consulting services to configure the hardware and software (implementation or integration services), post contract support (maintenance) services, training services and other minor consulting services. These multiple element arrangements are within the scope of SOP No. 97-2, and EITF 03-5. This determination is based on the hardware component of our multiple element arrangements being deemed to be a software related element. In addition, customers do not purchase the hardware without also purchasing the software, as well as the software and hardware being sold as a package, with payments due from customer upon delivery of this hardware and software package.

None of the Keynote SIGOS services provided by us are considered to be essential to the functionality of the other elements. This assessment is due to the implementation services being performed during a relatively short period (generally within three months) compared to the length of the arrangement which typically range from 12 to 36 months. Additionally, the implementation and integration services are general in nature and we have a history of successfully gaining customer acceptance. We cannot allocate the arrangement consideration to the multiple elements based on the vender specific objective evidence (“VSOE”) of fair value since sufficient VSOE does not exist for the allocation of revenue. Therefore, we recognize the entire arrangement fee into revenue ratably over the service period, historically ranging from 12 to 36 months, once the implementation and integration services are complete, usually within two to three months following the delivery of the hardware and software. The ratable recognition of revenue begins when evidence of customer delivery or acceptance, if such acceptance language exists, of the software and hardware has occurred as intended under the respective arrangement’s contractual terms.

We do not generally grant refunds. All discounts granted reduce revenue in the period which the discount is granted. Revenue is not recognized for free trial periods.

Professional Services Revenue:Professional services revenue consists of fees generated by our professional services, and consists of WebEffective, WebExcellence, LoadPro and Testing services that are purchased as part of a professional service project, and are recognized as the services are performed, typically over a period of one to three months. For professional service projects that span one month or less, we recognize revenue once the projects are completed. For professional service projects that contain milestones, we recognize revenue once the services or milestones have been delivered. Payment occurs either up front or over time.

We also enter into multiple element arrangements, which include both subscription and professional service revenue, other than those Keynote SIGOS related arrangements involving hardware and software implementation/integration. For these arrangements, we recognize revenue in accordance with EITF 00-21, and allocate and defer revenue for the undelivered items based on objective evidence of fair value of the undelivered elements, and recognize the difference between the total arrangement fee and the amount deferred for the undelivered items as revenue. We would determine fair value of the undelivered elements based on historical evidence of stand-alone sales of these elements to third parties. When sufficient objective evidence of fair value does not exist for undelivered items, the entire arrangement fee is recognized ratably over the remaining subscription period once the professional services have been delivered.

Deferred Revenue:Deferred revenue is comprised of all unearned revenue that has been collected in advance, primarily unearned subscription services revenue, and is recorded as deferred revenue on the Condensed Consolidated Balance Sheet until the revenue is earned. For informational purposes, we have provided a reconciliation of the total net deferred revenue (both short-term and long-term), as reported on the Condensed Consolidated Balance Sheets as of June 30, 2007 and September 30, 2006 to total gross deferred revenue (in thousands):


	Domestic		International		Total
Net deferred revenue	$	9,609	$	14,540	$	24,149
Add: unpaid deferred revenue		799		2,933		3,732

Gross deferred revenue at June 30, 2007	$	10,408	$	17,473	$	27,881


Net deferred revenue	$	5,936	$	4,713	$	10,649
Add: unpaid deferred revenue		804		1,453		2,257

Gross deferred revenue at September 30, 2006	$	6,740	$	6,166	$	12,906

The unpaid deferred revenue may change at any point in time as it is based upon the timing of when invoices are collected and whether there is any unpaid deferred revenue associated with such accounts receivable. Short-term deferred revenue represents the unearned revenue that has been collected in advance that will be earned within 12 months of the balance sheet date. Correspondingly, long-term deferred revenue represents the unearned revenue that will be earned after 12 months of the balance sheet date and this primarily consists of Keynote SIGOS revenue.

Deferred Costs:Deferred costs are mainly comprised of hardware costs associated with Keynote SIGOS revenue arrangements involving hardware. Deferred costs are categorized as short term for any arrangement for which the original service contracts are one year or less in length. Correspondingly, deferred costs associated with arrangements for which the original service contracts are greater than one year are classified as noncurrent deferred costs on the Condensed Consolidated Balance Sheet. Contract lives generally range from one to three years. These deferred costs are amortized to cost of subscription services over the life of the customer contract. Amortization of these deferred costs commences when revenue recognition commences which is typically when evidence of delivery or acceptance occurs.

Allowance for Doubtful Accounts and Billing Allowance

Accounts receivable are recorded net of an allowance for doubtful accounts receivable and billing allowance of approximately $483,000, or 8% of total accounts receivable, and approximately $473,000, or 6% of total accounts receivable, as of June 30, 2007 and September 30, 2006, respectively.

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

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

Inventories and Inventory Valuation

Inventories related to Keynote SIGOS SITE services were approximately $1.3 million as of June 30, 2007 and relate to direct costs associated with finished goods hardware. Inventories are stated at the lower of cost (determined on a first-in, first-out basis) or market. Market is based on estimated replacement value. Determining market value of inventories involves numerous judgments, including average selling prices and sales volumes of future periods. We primarily utilize current selling prices for measuring any potential declines in market value below cost. Any adjustment for market value is charged to cost of subscription services.

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

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

Allocation of Purchase Price for Business Combinations

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

Goodwill, Identifiable Intangible Assets and Long-Lived Assets

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

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

	•		significant changes in the manner of our use of the acquired assets or the strategy of our overall business;

	•		significant negative industry or economic trends;

	•		significant decline in our stock price for a sustained period; and

	•		our market capitalization relative to net book value.

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

We performed an annual impairment review during the fourth quarter in fiscal 2004, 2005, and 2006. We did not record an impairment charge based on our reviews. The goodwill recorded on the Condensed Consolidated Balance Sheet as of June 30, 2007 was approximately $61.0 million as compared to approximately $48.7 million as of September 30, 2006. The increase to goodwill of approximately $12.4 million for the first nine months of fiscal 2007 was primarily related to the earn-out payment to the former shareholders of SIGOS as a result of their achievement of certain profitability and revenue goals in calendar 2006 and, to a lesser extent, to foreign currency exchange fluctuations. See Note 9 to the Notes to Condensed Consolidated Financial Statements for more detail.

If our estimates or the related assumptions change in the future, we may be required to record an impairment charge on goodwill to reduce its carrying amount to its estimated fair value. If future events or circumstances indicate that an impairment assessment is required on intangible or long-lived assets and an asset group is determined to be impaired, our financial results could be materially and adversely impacted in future periods.

Stock-Based Compensation

We issue stock options to our employees and outside directors and provide our employees the right to purchase common stock under employee stock purchase plans. Since October 1, 2005, we account for stock-based compensation in accordance with Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 123R “Share-Based Payment (“SFAS 123R”). Under the fair value recognition provisions of this statement, share-based compensation cost is measured at the grant date based on the value of the award and is recognized as expense over the service (vesting) period. The value of an option is estimated using the Black-Scholes option valuation model which requires the input of highly subjective assumptions. A change in our assumptions could materially affect future fair value estimates, and thus, the total calculated costs associated with the grant of stock options or issue of stock under employee stock purchase plans. See Note 1 in the Notes to Condensed Consolidated Financial Statements.

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

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

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

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

We establish liabilities or reserves when we believe that certain tax positions are not probable of being sustained if challenged, despite our belief that our tax returns are fully supportable. We evaluate these tax reserves and related interest each quarter and adjust the reserves in light of changing facts and circumstances regarding the probability of realizing tax benefits, such as the progress of a tax audit or the expiration of a statute of limitations. We believe that our tax positions comply with applicable tax laws and that we have adequately provided for known material tax contingencies; however, due to the inherent complexity and uncertainty relating to tax matters, including the likelihood and potential outcome of any tax audits, Management is not able to estimate the range of reasonably possible losses in excess of amounts recorded.

Results of Operations

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


	Three Months Ended						Nine Months Ended
	June 30,						June 30,
	2007			2006			2007			2006
Revenue:
Subscription services		82.4	%		82.6	%		82.1	%		77.4	%
Professional services		17.6			17.4			17.9			22.6


Total revenue		100.0			100.0			100.0			100.0
Costs and expenses:
Costs of subscription services		20.9			17.6			19.3			13.5
Costs of professional services		11.2			16.7			12.6			17.3
Research and development		17.0			19.3			17.4			16.7
Sales and marketing		30.2			33.6			29.9			29.9
Operations		10.7			13.5			11.3			13.3
General and administrative		14.3			17.6			14.5			15.8
Excess occupancy (income) costs		(0.2	)		0.3			(0.2	)		0.0
Amortization of identifiable intangible assets		4.1			5.8			4.5			4.0
In-process research and development		—			6.1			0.0			2.1


Total cost and expenses		108.2			130.5			109.3			112.6

Loss from operations		(8.2	)		(30.5	)		(9.3	)		(12.6	)
Interest income and other, net		6.7			8.6			6.9			8.9

Loss before provision for income taxes		(1.5	)		(21.9	)		(2.4	)		(3.7	)
(Provision) Benefit for income taxes		(7.4	)		7.4			(0.1	)		(0.2	)

Net loss		(8.9	)%		(14.5	)%		(2.5	)%		(3.9	)%

Comparison of the Three and Nine Months Ended June 30, 2007 and 2006

Revenue


	2007		2006		% Change
	(In thousands)
For the three months ended June 30:
Subscription services	$	14,324	$	11,448		25	%
Professional services		3,063		2,419		27	%

Total revenue	$	17,387	$	13,867		25	%


For the nine months ended June 30:
Subscription services	$	40,973	$	31,215		31	%
Professional services		8,943		9,107		(2	)%

Total revenue	$	49,916	$	40,322		24	%

Subscription Services. Revenue from subscription services increased approximately $2.9 million for the three months ended June 30, 2007 as compared to the three months ended June 30, 2006. The increase in subscription services revenue for the three months ended June 30, 2007, as listed in descending order of impact, was mainly attributable to incremental revenue generated from Keynote SIGOS, and increased sales of Application Perspective, Transaction Perspective, Streaming Perspective and VOIP Perspective services offset by a decrease in sales of Web Site Perspective, Consumer Perspective, and Enterprise Solutions subscription services.

Revenue from subscription services increased approximately $9.8 million for the nine months ended June 30, 2007 as compared to the nine months ended June 30, 2006. The increase in subscription services revenue for the nine months ended June 30, 2007, as listed in descending order of impact, was mainly attributable to incremental revenue generated from Keynote SIGOS, and increased sales of Application Perspective, Transaction Perspective, Voice Perspective, and Streaming Perspective services offset by a decrease in sales of Web Site Perspective, Consumer Perspective, and Enterprise Solutions subscription services.

Professional Services. Revenue from professional services increased by $644,000 for the three months ended June 30, 2007 as compared to the three months ended June 30, 2006. The increase in professional services revenue for the three months ended June 30, 2007 was primarily due to increased contributions from Enterprise Solutions and LoadPro engagements, offset by decreased professional services contribution from our CEM WebEffective engagements. Revenue from professional services decreased slightly by $164,000 for the nine months ended June 30, 2007 as compared to the nine months ended June 30, 2006. The decrease in professional services revenue for the nine months ended June 30, 2007, was primarily due to decreased contribution from our CEM WebEffective engagements, offset, by increased contributions in our LoadPro and Enterprise Solutions engagements.

In addition to analyzing revenue for subscription services and professional services, Management also internally analyzes revenue categorized as Internet, Mobile, and CEM. The following table identifies which services are categorized as Internet, Mobile and CEM revenue and where they are recorded in our Condensed Consolidated Statements of Operations listed in alphabetical order:


	Subscription	Professional
	Services	Services
Internet Test and Measurement:
Application Perspective	X
Diagnostic Services	X
Enterprise Adapters	X
LoadPro		X
NetMechanic	X
Professional Services		X
Red Alert	X
Streaming Perspective	X
Test Perspective	X	X
Transaction Perspective	X
WebIntegrity	X
Web Site Perspective	X
Voice Perspective	X
Performance Scoreboard	X

Mobile Test and Measurement:
Mobile Application Perspective	X
Mobile Device Perspective	X
SIGOS Global Roamer	X
SIGOS SITE	X

Customer Experience Management:
WebEffective	X	X
WebExcellence	X	X

The following table summarizes Internet, Mobile and CEM revenue:


					%
	2007		2006		change
	(In thousands)
For the Three Months Ended June 30:
Internet Subscriptions	$	9,129	$	8,909		2	%
Internet Engagements		1,720		714		141	%

Total Internet Revenue		10,849		9,623		13	%


Mobile Subscriptions		4,601		1,949		136	%
Mobile Engagements		—		—		—	%

Total Mobile Revenue		4,601		1,949		136	%


CEM Subscriptions		593		590		1	%
CEM Engagements		1,344		1,705		(21	)%

Total CEM Revenue		1,937		2,295		(16	)%


Total Revenue	$	17,387	$	13,867		25	%


For the Nine Months Ended June 30:
Internet Subscriptions	$	27,053	$	26,567		2	%
Internet Engagements		4,550		2,746		66	%

Total Internet Revenue		31,603		29,313		8	%


Mobile Subscriptions		12,120		2,976		307	%
Mobile Engagements		—		—		—	%

Total Mobile Revenue		12,120		2,976		307	%


CEM Subscriptions		1,799		1,672		8	%
CEM Engagements		4,394		6,361		(31	)%

Total CEM Revenue		6,193		8,033		(23	)%


Total Revenue	$	49,916	$	40,322		24	%

Internet revenue increased by approximately $1.2 million for the three months ended June 30, 2007 compared to the three months ended June 30, 2006. Internet revenue represented 62% and 69% of total revenue for the three months ended June 30, 2007 and 2006, respectively. Internet revenue increased by approximately $2.3 million for the nine months ended June 30, 2007 compared to nine months ended June 30, 2006. Internet revenue represented 63% and 73% of total revenue for the nine months ended June 30, 2007 and 2006, respectively. The increase in Internet revenue for the three and nine months ended June 30, 2007 in absolute dollars was mainly attributable to increased contributions from our Application Perspective, Enterprise Solutions engagements, and Transaction Perspective services, offset by a decrease in our Web Site Perspective, Consumer Perspective and Enterprise Solutions subscription services.

Mobile revenue increased by approximately $2.7 million for the three months ended June 30, 2007 compared to the three months ended June 30, 2006. Mobile revenue represented 26% and 14% of total revenue for the three months ended June 30, 2007 and 2006, respectively. Mobile revenue increased by approximately $9.1 million for the nine months ended June 30, 2007 compared to the nine months ended June 30, 2006. Mobile revenue represented 24% and 7% of total revenue for the nine months ended June 30, 2007 and 2006, respectively. The increase for the three and nine months ended June 30, 2007 was mainly attributable to the addition of Keynote SIGOS SITE, and to a lesser extent, revenue from our Global Roamer, each due to the acquisition of Keynote SIGOS on April 3, 2006 and to a much lesser extent, increased contribution from our Mobile Perspective services.

CEM revenue decreased by $358,000 for the three months ended June 30, 2007 compared to the three months ended June 30, 2006. CEM revenue represented 11% and 17% of total revenue for the three months ended June 30, 2007 and 2006, respectively. CEM revenue decreased by approximately $1.8 million for the nine months ended June 30, 2007 compared to the nine months ended June 30, 2006. CEM revenue represented 12% and 20% of total revenue for the nine months ended June 30, 2007 and 2006, respectively. The decrease in CEM revenue for the three and nine months ended June 30, 2007 was mainly attributable to a decrease in WebEffective engagements. CEM revenue seems to have stabilized around $2 million for each of the last three quarters of fiscal year 2007.

For the three and nine months ended June 30, 2007, no individual customer accounted for more than 10% of total revenue. For the three and nine months ended June 30, 2006, one customer accounted for more than 10% of total revenue. As of June 30, 2007, no individual customer accounted for more than 10% of our total accounts receivable. International sales were approximately 30% and 16% of our total revenue for the three months ended June 30, 2007 and 2006, respectively. International sales were approximately 29% and 12% of our total revenue for the nine months ended June 30, 2007 and 2006, respectively.

Costs and Expenses:

Costs of Subscription and Professional Services


	2007		2006		% Change
	(In thousands)
For the three months ended June 30:
Costs of subscription services	$	3,631	$	2,442		49	%
Costs of professional services	$	1,947	$	2,314		(16)	%

For the nine months ended June 30:
Costs of subscription services	$	9,612	$	5,453		76	%
Costs of professional services	$	6,277	$	6,969		(10)	%

Costs of Subscription Services. Costs of subscription services consist of connection fees to major telecommunication and internet access providers for bandwidth usage of our measurement computers, which are located around the world and depreciation, maintenance and other equipment charges for our measurement and data collection infrastructure. Cost of subscription services also includes cost of materials, personnel and consulting costs, supplies, and merchandise related to the sale and support of our Keynote SIGOS SITE systems. Costs of subscription services increased approximately $1.2 million for the three months ended June 30, 2007 as compared to the three months ended June 30, 2006 and represented 25% and 21% of subscription services revenue for the three months ended June 30, 2007 and 2006, respectively. An increase in costs of subscription services for the three months ended June 30, 2007 was primarily due to 1) increased growth within our Keynote SIGOS business and personnel costs and 2)depreciation, equipment charges, and connection fees related to building out our new public infrastructure for mobile content test and measurement.

Costs of subscription services increased approximately $4.2 million for the nine months ended June 30, 2007 as compared to the nine months ended June 30, 2006 and represented 23% and 17% of subscription services revenue for the nine months ended June 30, 2007 and 2006, respectively. An increase in cost of approximately $2.1 million for the nine months ended June 30, 2007 was due to the inclusion of cost of materials and personnel costs related to the Keynote SIGOS SITE systems as a result of the acquisition of Keynote SIGOS in April 2006. Additional increases for the nine months ended June 30, 2007, resulted from increased personnel costs, depreciation, equipment charges, and connection fees related to additional measurement computers as well as replacing existing measurement computers.

Costs of Professional Services.Costs of professional services consist primarily of salaries and related expenses for professional services personnel, external consulting costs to deliver our professional services, panel and reward costs associated with our WebEffective Intelligence Platform and WebExcellence scorecard services, all load-testing bandwidth costs and related network infrastructure costs. Costs of professional services decreased $367,000 for the three months ended June 30, 2007 as compared to the three months ended June 30, 2006, and represented 64% and 96% of professional services revenue for the three months ended June 30, 2007 and 2006. The decrease was mainly due to the reduction in consulting personnel costs due to normal attrition and a minor reduction in workforce for our CEM business.

Costs of professional services decreased $692,000 for the nine months ended June 30, 2007 as compared to the nine months ended June 30, 2006, and represented 70% and 77% of professional services revenue for the nine months ended June 30, 2007 and 2006, respectively. The decrease in costs of professional services for the nine months ended June 30, 2007 was primarily related to a reduction in panel and reward costs related to various engagements as well as lower personnel costs in CEM.

Research and Development


	2007		2006		% Change
	(In thousands)
For the three months ended June 30:
Research and development	$	2,950	$	2,673		10	%

For the nine months ended June 30:
Research and development	$	8,699	$	6,753		29	%

Research and development expenses consist primarily of salaries and related expenses for research and development personnel. Research and development expenses increased by $277,000 for the three months ended June 30, 2007 compared to the three months

ended June 30, 2006. Research and development expenses increased by approximately $1.9 million for the nine months ended June 30, 2007 compared to the nine months ended June 30, 2006. The increase in research and development costs for the three months ended June 30, 2007 was primarily due to higher consultant, temporary labor and personnel costs due to additional headcount. The increase in research and development costs for the nine months ended June 30, 2007 was primarily due to additional personnel from the acquisition of Keynote SIGOS. To date, all internal research and development expenses have been expensed as incurred. We do not anticipate that research and development expenses for the fourth quarter of fiscal 2007 will increase significantly in absolute dollars compared to the third quarter of fiscal 2007.

Sales and Marketing


	2007		2006		% Change
	(In thousands)
For the three months ended June 30:
Sales and marketing	$	5,243	$	4,653		13	%

For the nine months ended June 30:
Sales and marketing	$	14,909	$	12,042		24	%

Sales and marketing expenses consist primarily of salaries and related expenses, such as commissions and bonuses, earned by sales and marketing personnel, lead-referral fees, marketing programs and travel expenses. Our sales and marketing expenses increased by approximately $590,000 for the three months ended June 30, 2007 as compared to the three months ended June 30, 2006. The increase in sales and marketing costs for the three months ended June 30, 2007 was mainly attributable to increased personnel costs related to additional headcount in sales personnel.

Our sales and marketing expenses increased by approximately $2.9 million for the nine months ended June 30, 2007 as compared to the nine months ended June 30, 2006. The increase in sales and marketing costs for the nine months ended June 30, 2007 was mainly attributable to an increase in international growth and the additional headcount in both sales and marketing personnel. Additionally, the increase was attributable to the acquisition of Keynote SIGOS.

We anticipate that sales and marketing expenses for the fourth quarter of fiscal 2007 will increase in absolute dollars compared to the third quarter of fiscal 2007 due to additional headcount costs to reflect our continued investment in our sales and marketing operations.

Operations


	2007		2006		% Change
	(In thousands)
For the three months ended June 30:
Operations	$	1,853	$	1,867		(1	)%

For the nine months ended June 30:
Operations	$	5,643	$	5,361		5	%

Operations expenses consist primarily of salaries and related expenses for Management and technical support personnel who manage and maintain our field measurement and collection infrastructure and headquarters data center, and provide basic and extended customer support. Our operations personnel also work closely with other departments to assure the reliability of our services and to support our sales and marketing activities. Our operations expenses slightly decreased by $14,000 for the three months ended June 30, 2007 as compared to the three months ended June 30, 2006. Our operations expenses increased $282,000 for the nine months ended June 30, 2007 as compared to the nine months ended June 30, 2006. The increase in operations expenses for the nine months ended June 30, 2007 was primarily attributable to additional headcount and consulting costs to supplement our customer support team. We do not anticipate that operations expenses for the fourth quarter of fiscal 2007 will change significantly in absolute dollars compared to the third quarter of fiscal 2007.

General and Administrative


	2007		2006		% Change
	(In thousands)
For the three months ended June 30:
General and administrative	$	2,490	$	2,443		2	%

For the nine months ended June 30:
General and administrative	$	7,247	$	6,354		14	%

General and administrative expenses consist primarily of salaries and related expenses, accounting, legal and administrative expenses, insurance, professional service fees and other general corporate expenses. General and administrative expenses slightly increased by $47,000 for the three months ended June 30, 2007 as compared to the three months ended June 30, 2006. The increase was primarily attributable to higher personnel costs related to additional headcount.

General and administrative expenses increased $893,000 for the nine months ended June 30, 2007 as compared to the nine months ended June 30, 2006. The increase for the nine months ended June 30, 2007 was mainly attributable to additional personnel costs related to the Keynote SIGOS acquisition in April 2006, offset by a decrease in expenses related to a reduction in audit related fees.

We anticipate that general and administrative expenses for the fourth quarter of fiscal 2007 will increase in absolute dollars compared to the third quarter of fiscal 2007 due to higher professional services fees.

Excess Occupancy (Income) Costs


	2007			2006			% Change
	(In thousands)
For the three months ended June 30:
Excess occupancy (income) costs	$	(33	)	$	38			(187	)%

For the nine months ended June 30:
Excess occupancy (income)	$	(81	)	$	(12	)		575	%

Excess occupancy costs are fixed expenses associated with the unoccupied portion of our headquarters building such as property taxes, insurance and depreciation. These particular costs are reduced by the rental income from the leasing of our space in our headquarters building. For the three months ended June 30, 2007, we generated an income of $33,000 as compared to an expense of $38,000 for the three months ended June 30, 2006. The costs are based on the actual unoccupied square footage, which was approximately 60% of the total rentable square footage of the headquarters building for the three months ended June 30, 2007 and 2006. Excess occupancy income for the nine months ended June 30, 2007 increased $69,000 as compared to the nine months ended June 30, 2006. The increase in excess occupancy income was attributable to increases in tenant rent offset by increased insurance and depreciation expenses in fiscal 2007. We anticipate that excess occupancy income will increase in the fourth quarter of fiscal 2007 as compared to the third quarter of fiscal 2007 due to an increase in tenant rent.

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


	2007		2006		% Change
	(In thousands)
For the three months ended June 30:
Amortization of identifiable intangible assets	$	713	$	798		(11)	%
In-process research and development		—		840		(100)	%

For the nine months ended June 30:
Amortization of identifiable intangible assets	$	2,232	$	1,613		38	%
In-process research and development		—		840		(100)	%

Amortization of identifiable intangible assets decreased by approximately $85,000 for the three months ended June 30, 2007 as compared to the three months ended June 30, 2006. Amortization of identifiable intangible assets increased by approximately $619,000 for the nine months ended June 30, 2007 as compared to the nine months ended June 30, 2006. The decrease for the three months ended June 30, 2007 is attributable to certain intangibles becoming fully amortized, offset by increased amortization of identifiable intangible assets resulting primarily from our Keynote SIGOS acquisition. The increase in amortization for the nine months ended June 30, 2007 was primarily due to the acquisition of Keynote SIGOS in April 2006.

At June 30, 2007, we had a remaining balance of approximately $8.3 million of identifiable intangible assets that are being amortized over a two to five-year expected life. We expect the amortization of identifiable intangible assets to be approximately $715,000 for the remainder of fiscal 2007, assuming no additional acquisitions or impairment charges. We expect the remaining carrying value of the identifiable intangible assets as of June 30, 2007, as listed in the table below, will be fully amortized by March 2012 (in thousands):


	Technology		Customer
	Based		Based		Trademark		Covenant		Backlog		Total
Net carrying value at June 30, 2007	$	4,198	$	3,194	$	676	$	68	$	203	$	8,339

During the quarter ended June 30, 2006, we expensed $840,000 of in-process research and development in connection with the acquisition of Keynote SIGOS. There was no corresponding charge in the quarter ended June 30, 2007.

Interest Income and Interest and Other Expenses, net


	2007		2006		% Change
	(In thousands)
For the three months ended June 30:
Interest income, interest and other expenses, net	$	1,168	$	1,187		(2	)%

For the nine months ended June 30:
Interest income, interest and other expenses, net	$	3,438	$	3,575		(4	)%

Interest income and interest and other expenses, net decreased $19,000 for the three months ended June 30, 2007 as compared to the three months ended June 30, 2006. Interest income and interest and other expenses, net decreased $137,000 for the nine months ended June 30, 2007 as compared to thene months ended June 30, 2006. We expect that interest income, and interest and other expenses, net, for the fourth quarter of fiscal 2007 will be approximately $1.2 million, absent any additional cash transactions, changes in planned uses of cash and assuming no material changes in interest rates.

(Provision)Benefit for Income Taxes


	2007			2006			% Change
	(In thousands)
For the three months ended June 30:
(Provision) benefit for income taxes	$	(1,294	)	$	1,026			(226)	%

For the nine months ended June 30:
(Provision) for income taxes	$	(55	)	$	(79	)		(30)	%

Our effective tax rate for the three months ended June 30, 2007 and 2006 was approximately 541.4% and (34%), respectively. Our effective tax rate for the nine months ended June 30, 2007 and 2006 was approximately 4.6% and 5.4%, respectively. For the three months ended June 30, 2007, the Company recorded a discrete benefit of $153,000 related to the reversal of certain tax reserves for one of our European entities and a benefit of $129,000 related to the disqualified disposition of incentive stock options. The Company recorded a total of $307,000 in discrete benefits for the nine months ended June 30, 2007. The income tax provisions were calculated based on the estimated annual effective tax rate for our Company.

Stock-based Compensation Expense

On October 1, 2005, we adopted SFAS 123R, which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors including employee stock options and employee stock purchase plan purchases based on estimated fair values. The following table summarizes stock-based compensation related to employee stock options and employee stock purchase plan purchases under SFAS 123R which was allocated as follows (in thousands):


	Three Months Ended June 30,				Nine Months Ended June 30,
	2007		2006		2007		2006
Costs of subscription services	$	64	$	42	$	145	$	42
Costs of professional services		99		119		363		401
Research and development		265		226		684		627
Sales and marketing		356		266		952		767
Operations		148		151		438		484
General and administrative		195		121		469		308

Stock-based compensation expense included in operating expenses related to stock options and employee stock purchase	$	1,127	$	925	$	3,051	$	2,629

Liquidity and Capital Resources


	June 30,		September 30,
	2007		2006
	(In thousands)
Cash, cash equivalents and short-term investments	$	103,089	$	90,751
Accounts receivable, net	$	6,177	$	7,122
Working capital	$	82,692	$	80,765
Days sales in accounts receivable (DSO) (a)		32		43


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

		The DSO’s presented in the table above reflect the three months ended June 30, 2007 and September 30, 2006.


	2007			2006
	(In thousands)
For the nine months ended June 30,
Cash provided by operating activities	$	17,410		$	9,384
Cash (used in) provided by investing activities	$	(33,151	)	$	3,150
Cash provided by (used in) financing activities	$	8,470		$	(13,002	)

Cash, cash equivalents and short-term investments

As of June 30, 2007, we had approximately $38.7 million in cash and cash equivalents and approximately $64.4 million in short-term investments, for a total of approximately $103.1 million. Cash and cash equivalents consist of highly liquid investments held at major banks, commercial paper, money market mutual funds and other money market securities with original maturities of three months or less. Short-term investments consist of investment-grade corporate and government debt securities and issuances with Moody’s ratings of A2 or better.

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. For the nine months ended June 30, 2007, net cash provided by operating activities was approximately $17.4 million. Net cash provided was mainly due to net loss of approximately $1.2 million, adjusted for approximately $8.0 million of non-cash adjustments

to reconcile net loss to net cash provided by operating activities and a $10.7 million net increase in operating assets and liabilities. The non-cash adjustments primarily consist of depreciation, amortization and stock-based compensation expense. The net increase in operating assets and liabilities was primarily due to increases in deferred revenue of approximately $13.0 million and a decrease in accounts receivable of $826,000 offset by decreases in accounts payable and accrued expenses of $1.7 million and in deferred costs of approximately $1.0 million. The increase in deferred revenue during the first nine months of fiscal 2007 was mainly related to Keynote SIGOS, which recognizes revenue ratably over the service contract period. The change in deferred costs was attributable to an increase in deferred hardware costs related to Keynote SIGOS SITE which corresponds to an increase in related deferred revenue.

Cash provided by investing activities

The changes in cash flows from investing activities primarily relate to the timing of purchases and maturities of investments and acquisitions. We also use cash to invest in capital and other assets to support our growth and infrastructure. For the nine months ended June 30, 2007, net cash used by our investing activities was approximately $33.2 million. We utilized approximately $10.9 million for acquisition-related expenses. Pursuant to the purchase agreement, relating to the acquisition of Keynote SIGOS, approximately $10.6 million was paid to the former shareholders of SIGOS due to the achievement of certain revenue and profitability milestones in calendar 2006. Pursuant to an escrow agreement, approximately $250,000 of the purchase price for our acquisition of the GomezPro business of Watchfire Corporation, was released in December 2006. The remaining amount related to acquisition-related expenses for our Keynote SIGOS acquisition. We also utilized approximately $18.1 million of cash for the net purchases of short-term investments and approximately $4.2 million to purchase property and equipment, primarily for our production infrastructure and information systems, and tenant improvements associated with space that we have leased in our headquarters building.

Cash provided by financing activities

The changes in cash flows from financing activities primarily relate to payments made for stock repurchases and proceeds received from the issuance of common stock associated with our employee stock option plan and employee stock purchase plan. For the nine months ended June 30, 2007, net cash provided by financing activities was approximately $8.5 million, which was primarily due to proceeds from the issuance of common stock and the exercise of stock options.

Our Board of Directors has approved a plan to repurchase shares of our common stock. The Board has expanded the repurchase program several times by either increasing the authorized number of shares to be repurchased or by authorizing a fixed dollar amount expansion, most recently in December 2006. From the inception of the stock repurchase program in January 2001 to June 30, 2007, a total of approximately 14.3 million shares have been repurchased in the open market for approximately $135.3 million. At June 30, 2007, approximately $57.8 million was available to repurchase shares of our common stock pursuant to the stock repurchase program. There were no repurchases made during the nine months ended June 30, 2007.

Commitments

As of June 30, 2007, our principal commitments consisted of approximately $4.1 million in real property operating leases and equipment capital and operating leases, with various lease terms, the longest of which expires in August 2015. Additionally, we had contingent commitments ranging in length from one to 23 months to 114 bandwidth and collocation providers amounting to $824,000 in the aggregate for 102 locations, which commitments become due if we terminate any of these agreements prior to their expiration. At present, we do not intend to terminate any of these agreements prior to their expiration. We expect to continue to invest in capital and other assets to support our growth. We expect to make additional capital expenditures of approximately $1.0 million to $1.5 million related to our operations and headquarters building during the fourth quarter of fiscal 2007.

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

Off Balance Sheet Arrangements

We did not enter into any transactions with unconsolidated entities whereby we have financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or

any other obligation under a variable interest in a unconsolidated entity that provides financing, liquidity, market risk or credit risk support to us.

Recently Issued Accounting Pronouncements

In May 2005, the FASB issued Statement No. 154, “Accounting Changes and Error Corrections” (“FAS 154”) to replace Accounting Principles Board Opinion No. 20, “Accounting Changes” and Statement No. 3, “Reporting Accounting Changes in Interim Periods.” FAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections, and establishes retrospective application as the required method for reporting a change in accounting principle. FAS 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable, and for reporting a change when retrospective application is determined to be impracticable. FAS 154 also addresses the reporting of a correction of an error by restating previously issued financial statements. FAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We adopted this pronouncement in our fiscal year beginning October 1, 2006 and such adoption did not have an impact on our consolidated results of operations and financial condition.

In June 2006, the FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN 48”). This Interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006, which will be our fiscal year beginning October 1, 2007. We are currently evaluating the impact of FIN 48 on our consolidated results of operations and financial condition. It is possible that the tax reserves will be adjusted; however the amount cannot be determined at this time.

In June 2006, Emerging Issues Task Force (“EITF”) issue EITF 06-3 “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is Gross versus Net Presentation)” was ratified. This issue relates to any tax assessed by a governmental authority that is directly imposed on a revenue producing transaction between a seller and a customer and requires additional disclosures related to those taxes on either a gross (included in revenue) or a net (excluded from revenue) basis. This issue is effective for fiscal years beginning after December 15, 2006, which will be our fiscal year beginning October 1, 2007. We are currently evaluating the impact of EITF 06-3 on our consolidated results of operations and financial condition.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Current Year Misstatements”.SAB No. 108 requires analysis of misstatements using both an income statement (rollover) approach and a balance sheet (iron curtain) approach in assessing materiality and provides for a one-time cumulative effect transition adjustment. SAB No. 108 is effective for our fiscal year 2007 annual financial statements. We are currently assessing the potential impact that adoption of SAB No. 108 will have on our financial statements. We currently anticipates that the aggregate amount of the uncorrected differences will be approximately $2.0 million, however, this amount could be more or less than $2.0 million pending our final analysis of the impact of adopting SAB 108.

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, “Fair Value Measurements” (“FAS 157”), which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles (“GAAP”). As a result of FAS 157, there is now a common definition of fair value to be used throughout GAAP, which is expected to make the measurement of fair value more consistent and comparable. FAS 157 is effective for the first fiscal year beginning after November 15, 2007, which will be the our fiscal year beginning October 1, 2008. We have not yet begun to evaluate the effects, if any, of adoption on our consolidated financial statements.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities”. SFAS No. 159 permits companies to choose to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS No. 159 is effective beginning in the first quarter of fiscal year 2009, although earlier adoption is permitted. We are currently evaluating the impact of adopting SFAS No. 159 on our consolidated financial statements.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity.Our interest income and expense is sensitive to changes in the general level of U.S. interest rates, particularly because most of our cash, cash equivalents and short-term investments are invested in short-term debt instruments. If market interest

rates were to change immediately and uniformly by ten percent (10%) from levels as of June 30, 2007, the interest earned on those cash, cash equivalents, and short-term investments could increase or decrease by approximately $460,000 on an annualized basis.

Foreign Currency Fluctuations and Derivative Transactions.A substantial majority of our revenue and expenses are transacted in U.S. dollars. However, we do enter into transactions in other currencies, primarily the Euro. Movements in the currency exchange rate of the Euro could cause variability in our revenues, expenses or other income (expenses), net. We do not enter into derivative transactions for trading or speculative purposes.

Item 4. Controls and Procedures

(a) Changes in Internal Controls

There were no changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

(b) Evaluation of Disclosure Controls and Procedures

Regulations under the Securities Exchange Act of 1934 require public companies 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 Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms. Our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective in reaching a level of reasonable assurance in achieving our desired control objectives.

Our Management, including our chief executive officer and chief financial officer, does not expect that our disclosure controls and procedures or our internal controls will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Keynote have been detected.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

Beginning on August 16, 2001, several class action lawsuits were filed in the United States District Court for the Southern District of New York against us, certain of our officers, and the underwriters of our initial public offering. These lawsuits were essentially identical, and were brought on behalf of those who purchased our securities between September 24, 1999 and August 19, 2001. These complaints alleged generally that the underwriters in certain initial public offerings, including ours, allocated shares in those initial public offerings in unfair or unlawful ways, such as requiring the purchaser to agree to buy in the aftermarket at a higher price or to buy shares in other companies with higher than normal commissions. The complaint also alleged that we had a duty to disclose the activities of the underwriters in the registration statement relating to its initial public offering. The plaintiffs’ counsel and the issuer defendants’ counsel have reached a preliminary settlement agreement whereby the issuers and individual defendants will be dismissed from the case, without any payments by us. Although, the settlement was preliminarily approved, while the parties’ awaited final court approval of the settlement, in December 2006 the Court of Appeals reversed the District Court’s finding that six focus cases could be certified as class actions. In April 2007, the Court of Appeals further denied the plaintiffs’ petition for rehearing, but acknowledged that the District Court might certify a more limited class. At a June 26, 2007 status conference, the District Court terminated the proposed settlement as stipulated among the parties, and scheduled briefing on plaintiffs’ motion to certify a different class. If a satisfactory settlement is not renegotiated in light of the new class definition, we intend to defend itself vigorously. No amount is accrued as of June 30, 2007.

We are subject to 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

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

We incurred net losses for the three and nine months ended June 30, 2007, and we may not be able to achieve or sustain profitability in the future. As of June 30, 2007, we had an accumulated deficit of approximately $138.8 million. 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 June 30, 2007, we had approximately $8.3 million of net identifiable intangible assets and approximately $61.0 million of goodwill. We have in the past and may in the future, incur expenses in connection with a write-down of goodwill and identifiable intangible assets due to changes in market conditions. In addition, we have deferred tax assets which may not be fully realized. We are also required to record as compensation expense under FAS 123R, the cost of stock-based awards. We may never be able to regain our historic revenue growth rates.

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

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

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

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.

Results of operations could vary significantly from quarter to quarter. If revenue falls below our expectations, we may not be able to 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:

	•		The rate of new and renewed subscriptions to our services;

	•		The effect of any unforeseen or unplanned operating expenses;

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

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

	•		Our ability to attract and retain new customers in a quarter, particularly larger enterprise customers;

	•		The timing and service period of orders received during a quarter;

	•		Our ability to successfully introduce new products and services to offset any reductions in revenue from services that are not as widely used or that are experiencing decreased demand such as our Web Site Perspective and CEM services;

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

	•		Our success in obtaining additional professional services engagements;

	•		Our ability to increase sales of each of our three service lines;

	•		The timing and amount of operating costs and capital expenditures relating to changes of our domestic and international operations infrastructure; and

•

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.

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

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

Sales of our Internet subscription services, primarily our Web Site Perspective-Business Edition and Transaction Perspective services, have generated a majority of our total revenue in the past. Therefore, the success of our business currently depends, and for the immediate future will continue to substantially depend, on sales and renewals of these Internet services. Our Internet subscriptions revenue has not increased significantly from historic levels. If these revenue trends continue with respect to our Internet subscriptions services, our operating results could suffer if we are not able to increase revenue from other services.

Our mobile services may not continue to grow as rapidly, which could harm our business.

Revenue from our mobile services has increased from approximately $1.9 million for the three months ended June 30, 2006 to approximately $4.6 million for the three months ended June 30, 2007. Revenue from our mobile services has increased from approximately $2.9 million for the nine months ended June 30, 2006 to approximately $12.1 million for the nine months ended June 30, 2007. We also experienced increased bookings during the first nine months of fiscal 2007. However, we cannot assure that we will continue to experience similar growth rates for this business in future periods. Future growth for these services could be adversely affected by a number of factors, including, but not limited to: we have little experience operating in Germany, where Keynote SIGOS is located; the market for mobile services is an emerging market and therefore it is difficult to predict the level of demand for the types of services we offer; and we may not be able to successfully compete against current or new competitors in this area. Our business could be harmed if we are not able to continue to grow revenue from our mobile services.

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

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

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

The ongoing evolution of the Internet and mobile networks has led to the development of new technologies such as Internet telephony, wireless devices, wireless fidelity, and WI-FI networks. These developing technologies require us to continually improve the functionality, features and reliability of our services, particularly in response to offerings of our competitors. If we do not succeed in developing and marketing new services that respond to competitive and technological developments and changing customer needs, we may encounter difficulties retaining existing customers and attracting new customers. We must also introduce any new services as quickly as possible. The success of new services depends on several factors, including proper definition of the scope of the new services and timely completion, introduction and market acceptance of our new services. If new Internet, networking or telecommunication technologies or standards are widely adopted or if other technological changes occur, we may need to expend significant resources to adapt our services to these developments or we could lose market share or some of our services could become obsolete.

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

The market for our services is rapidly evolving. Our competitors vary in size and in the scope and breadth of the products and services that they offer. We face competition from companies that offer Internet software and services with features similar to our services such as Gomez, Mercury Interactive (recently acquired by Hewlett-Packard), Segue Software (recently acquired by Borland Software Corporation) and a variety of other CEM and mobile companies that offer a combination of testing, market research capabilities and

data. While we believe these services are not as comprehensive as ours, customers could still choose to use these services or these companies could enhance their services to offer all of the features we offer. As we expand the scope of our products and services, we expect to encounter many additional market-specific competitors.

In addition, the acquisition of Mercury Interactive by Hewlett-Packard with whom we have a relationship could result in additional competition for us depending on which products and services the combined company offers in the future. Furthermore, Hewlett-Packard may find additional uses for services of Mercury Interactive which compete with our services, and as a result of its acquisition of Mercury Interactive, it may not promote our services at the same level as it had in the past which could result in a decrease in our Internet revenue.

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

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

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

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

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

Our ten largest customers accounted for approximately 33% of our total revenue for each of the nine months ended June 30, 2007 and 2006, respectively. We cannot be certain that customers that have accounted for significant revenue in past periods, individually or as a group, will renew, will not cancel or will not reduce their services and, therefore, continue to generate revenue in any future period. In addition, our customers that do not have written contracts or that have monthly renewal arrangements may terminate their services at any time with little or no penalty. If we lose a major customer, our revenue could decline.

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

To increase sales of services worldwide, we must complement our direct sales force with relationships with companies to help market and sell our services to their customers. If we are unable to maintain our existing marketing and distribution relationships, or fail to enter into additional relationships, we may have to devote substantially more resources to the direct sale and marketing of our services. We would also lose anticipated revenue from customer referrals and other co-marketing benefits. In the past, we have had to terminate relationships with some of our international resellers, and we may be required to terminate other reseller relationships in the future. As a result, we may have to commit resources to supplement our direct sales effort in foreign countries.

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

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

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

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

Professional services revenue represented approximately 18% and 23% of total revenue for the nine months ended June 30, 2007 and 2006, respectively. Professional services revenue has decreased in absolute dollars in the past, and this trend could continue. We will need to successfully market these services in order to increase professional services revenue. The market for these services is very competitive. Each professional services engagement typically spans a one- to three-month period, and therefore, it is more difficult for us to predict the amount of professional services revenue recognized in any particular quarter. Our business could be harmed if we cannot increase our professional services revenue.

The success of our business depends on the continued use of the Internet by business and consumers for e-business and communications.

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

	•		security concerns including the potential for fraud or theft of stored data and information communicated over the 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.

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

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

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

Our network infrastructure could be disrupted by a number of different occurrences, which could impair our ability to serve and retain existing customers or attract new customers.

All data collected from our measurement computers are stored in and distributed from our operations center, which we maintain at a single location. We maintain a backup operations center in Plano, Texas. Our operations depend upon our ability to maintain and protect our computer systems, most of which are located at our corporate headquarters in San Mateo, California, which is an area susceptible to earthquakes and possible power outages. Although we have a generator to provide our own source of long-term uninterruptible power, if we experience power outages at our operations center, we might not be able to promptly receive data from our measurement computers and we might not be able to deliver our services to our customers on a timely basis. Although we believe our main operations are redundant between our San Mateo and Plano datacenters, an outage at either center could lead to service interruptions. Therefore, our operations systems are vulnerable to damage from break-ins, computer viruses, unauthorized access, vandalism, fire, floods, earthquakes, power loss, telecommunications failures and similar events.

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 center is damaged, this could disrupt our services, which could impair our ability to retain existing customers or attract new customers.

If our computer infrastructure is not functioning properly, we may not be able to deliver our services in a timely or accurate manner. We have occasionally experienced outages of our service in the past, which have typically lasted no more than a few hours. These outages have been caused by a variety of factors including electrical distribution equipment malfunctions, operator error, the failure of a back-up computer to operate when the primary computer ceased functioning and power outages due to our previous facility’s being inadequately equipped to house our operations center. Any outage for any period of time or loss of customer data could cause us to lose customers.

Individuals who attempt to breach our network security, such as hackers, could, if successful, misappropriate proprietary information or cause interruptions in our services. Although in the past we had a breach of our security through what appears to be unauthorized access to certain data belonging to one of our customers, we have not yet experienced any breaches of our network security or sabotage that has prevented us from serving our customers. We might be required to expend significant capital and resources to protect against, or to alleviate, problems caused by hackers. We may not have a timely remedy against a hacker who is able to breach our network security. In addition to intentional security breaches, the inadvertent transmission of computer viruses could expose us to litigation or to a material risk of loss.

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

Our measurement computers that we use to provide many of our services are located at facilities that are not owned by our customers or us. Instead, these devices are installed at locations near various Internet access points worldwide. Although we operate these computers remotely from our San Mateo and Nuremberg operations centers, 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 develop relationships with these companies or if these companies cease their operations as some have done due to bankruptcies or are acquired. In addition, if our measurement computers cease to function properly, we may not be able to repair or service these computers on a timely basis, as we may not have immediate access to our measurement computers. Our ability to collect data in a timely manner could be impaired if we are unable to maintain and repair our computers should performance problems arise.

Others might bring infringement claims against us, our customers or our suppliers that could harm our business.

In recent years, there has been significant litigation in the United States involving patents and other intellectual property rights. We could become subject to intellectual property infringement claims as the number of our competitors grows and our services overlap with competitive offerings. In addition, we are also 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 and to develop noninfringing technology, obtain a license or cease selling the services that contain the infringing intellectual property. We may be unable to develop non-infringing technology or to obtain a license on commercially reasonable terms, or at all.

Our business will be susceptible to additional risks associated with international operations.

We believe we must expand the sales of our services outside the United States. Although we completed our acquisition of SIGOS Systemsintegration GmbH in April 2006, to date, we have relatively little experience with operating outside the United States, and we may not succeed in these efforts. International sales were approximately 29% and 12% our total revenue for the nine months ended June 30, 2007 and 2006, respectively. We intend to expand the sales of our services by selling directly to certain customers and through resellers to other customers. Therefore, we expect to continue to commit our resources to expand our international sales and marketing activities. Conducting international operations subjects us to risks we do not face in the United States. These include:

	•		currency exchange rate fluctuations;

	•		seasonal fluctuations in purchasing patterns;

	•		unexpected changes in regulatory requirements;

	•		maintaining and servicing computer hardware 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; and

	•		reduced protection for intellectual property rights in some countries.

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

Compliance with new rules and regulations concerning corporate governance may increase our costs and could harm our results of operations.

The Sarbanes-Oxley Act of 2002, mandated, among other things, that companies adopt new corporate governance measures and imposes comprehensive reporting and disclosure requirements, thorough reviews and attestations of our internal controls and imposes increased civil and criminal penalties for companies, their chief executive officers and chief financial officers and directors for securities law violations. In addition, The Nasdaq Global Market, on which our common stock is listed, has also adopted additional comprehensive rules and regulations relating to corporate governance. These laws, rules and regulations have increased the scope, complexity and cost of our corporate governance, reporting and disclosure practices. As a result, we have experienced and expect to continue to experience increased costs of compliance which could harm our results of operations and divert Management’s attention from business operations.

We also expect these developments to make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced coverage or incur substantially higher costs to obtain coverage. Further, our board members, Chief Executive Officer and Chief Financial Officer could face an increased risk of personal liability in connection with the performance of their duties as a result of these developments. As a result, we may have difficultly attracting and retaining qualified board members and executive officers, which would adversely affect our results of operations.

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

There has been a trend toward industry consolidation in our markets for several years. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. For example, last year Hewlett-Packard acquired Mercury Interactive. 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, with the effect that loss of a major customer could harm our revenue.

If we fail to maintain the adequacy of our internal controls, our ability to provide accurate financial statements could be impaired and any failure to maintain our internal controls and provide accurate financial statements could cause our stock price to decrease substantially.

One or more material weaknesses in our internal controls over financial reporting could occur or be identified in the future. For example, as set forth in Item 9A of our Form 10-K for the fiscal year ended September 30, 2005, we had a material weakness in our internal controls over financial reporting that existed as of September 30, 2005 with respect to our accounting for income taxes. In addition, because of inherent limitations, our internal controls over financial reporting may not prevent or detect misstatements, and any projections of any evaluation of the effectiveness of internal controls to future periods are subject to the risk that controls may become inadequate because of changes in conditions or that the degree of compliance with our policies or procedures may deteriorate. If we fail to maintain the adequacy of our internal controls, including any failure to implement or difficulty in implementing required new or improved controls, our business and results of operations could be harmed, we could fail to be able to provide reasonable assurance as to our financial results or meet our reporting obligation and there could be a material adverse effect on the price of our securities.

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

We have completed several acquisitions, 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 that 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 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.

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.

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

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

EXHIBIT INDEX

Exhibit

Incorporated by Reference

Filing

Filed

Form

File No.

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 9th day of August 2007.


		KEYNOTE SYSTEMS, INC.

By:		/s/ UMANG GUPTA
		Umang Gupta
		Chairman of the Board and Chief Executive Officer
		(Principal Executive Officer)

By:		/s/ ANDREW HAMER
		Andrew Hamer
		Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)

EXHIBIT INDEX

Exhibit

Incorporated by Reference

Filing

Filed

Form

File No.

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-Q2007 Q3 Quarterly report

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