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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



(Mark
One)



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

For the quarterly period ended June 30, 2003



OR



 ̈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



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KEYNOTE SYSTEMS, INC.

(Exact name of registrant as specified in its charter)



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



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



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



Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act). YES x NO ̈



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 at July 31, 2003
|----------------------------- |  | -----------------------------------
|                             
|Common Stock, $.001 par value |  | 18,730,292                         
|                             



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##### Table of Contents

KEYNOTE SYSTEMS, INC.



TABLE OF
CONTENTS



|                             |  |                                                                                       |  | Page
|---------------------------- |  | ------------------------------------------------------------------------------------- |  | ----
|PART IFINANCIAL INFORMATION |  |                                                                                      
|                             |  |                                                                                      
|Item 1.                      |  | Financial Statements                                                                  |  | 3   
|                             |  |                                                                                      
|Item 2.                      |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 12  
|                             |  |                                                                                      
|Item 3.                      |  | Qualitative and Quantitative Disclosures about Market Risk                            |  | 26  
|                             |  |                                                                                      
|Item 4.                      |  | Controls and Procedures                                                               |  | 27  
|                             | 
|PART IIOTHER INFORMATION    |  |                                                                                      
|                             |  |                                                                                      
|Item 1.                      |  | Legal Proceedings                                                                     |  | 27  
|                             |  |                                                                                      
|Item 2.                      |  | Changes in Securities and Use of Proceeds                                             |  | 27  
|                             |  |                                                                                      
|Item 3.                      |  | Defaults Upon Senior Securities                                                       |  | 27  
|                             |  |                                                                                      
|Item 4.                      |  | Submission of Matters for a Vote of Security Holders                                  |  | 27  
|                             |  |                                                                                      
|Item 5.                      |  | Other Information                                                                     |  | 27  
|                             |  |                                                                                      
|Item 6.                      |  | Exhibits and Reports on Form 8-K                                                      |  | 27  
|                             |  |                                                                                      
|Signatures                   |  |                                                                                       |  | 28  



2



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##### Table of Contents

PART IFINANCIAL INFORMATION



Item 1.    Financial Statements.



KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES



Index to Unaudited Condensed Consolidated Financial Statements



|                                                                                                                  |  | Page
|----------------------------------------------------------------------------------------------------------------- |  | ----
|Condensed Consolidated Balance Sheets as of June 30, 2003 and September 30, 2002                                  |  | 4   
|Condensed Consolidated Statements of Operations for the three months and nine months ended June 30, 2003 and 2002 |  | 5   
|Condensed Consolidated Statements of Cash Flows for the nine months ended June 30, 2003 and 2002                  |  | 6   
|Notes to Condensed Consolidated Financial Statements                                                              |  | 7   





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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES



CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)



|                                                                                                                                      |  | June 30,2003 |          |   | September 30,2002 |  
|------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | -------- | - | ----------------- | -
|ASSETS                                                                                                                                |  |              |          |   |                   |  
|Current assets:                                                                                                                       |  |              |          |   |                   |  
|Cash and cash equivalents                                                                                                             |  | $            | 14,759   |   |                   | $
|Short-term investments                                                                                                                |  |              | 144,659  |   |                   |  
|                                                                                                                                      |  |              |          |   |                   |  
|Total cash, cash equivalents, and short-term investments                                                                              |  |              | 159,418  |   |                   |  
|Accounts receivable, less allowance for doubtful accounts of $783 and $1,238 as of June 30, 2003 and September 30, 2002,
respectively |  |              | 4,460    |   |                   |  
|Prepaid and other current assets                                                                                                      |  |              | 965      |   |                   |  
|                                                                                                                                      |  |              |          |   |                   |  
|Total current assets                                                                                                                  |  |              | 164,843  |   |                   |  
|                                                                                                                                      |  |             
|Property and equipment, net                                                                                                           |  |              | 34,590   |   |                   |  
|Identifiable intangible assets, net                                                                                                   |  |              | 2,309    |   |                   |  
|                                                                                                                                      |  |              |          |   |                   |  
|Total assets                                                                                                                          |  | $            | 201,742  |   |                   | $
|                                                                                                                                      |  |              |          |   |                   |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                  |  |              |          |   |                   |  
|Current liabilities:                                                                                                                  |  |              |          |   |                   |  
|Accounts payable                                                                                                                      |  |              | 828      |   |                   |  
|Accrued expenses                                                                                                                      |  |              | 7,594    |   |                   |  
|Deferred revenue                                                                                                                      |  |              | 4,694    |   |                   |  
|                                                                                                                                      |  |              |          |   |                   |  
|Total current liabilities                                                                                                             |  |              | 13,116   |   |                   |  
|                                                                                                                                      |  |              |          |   |                   |  
|Total liabilities                                                                                                                     |  |              | 13,116   |   |                   |  
|                                                                                                                                      |  |              |          |   |                   |  
|Stockholders equity:                                                                                                                 |  |              |          |   |                   |  
|Common stock                                                                                                                          |  |              | 23       |   |                   |  
|Treasury stock                                                                                                                        |  |              | (43,329  | ) |                   |  
|Additional paid-in capital                                                                                                            |  |              | 373,967  |   |                   |  
|Deferred compensation                                                                                                                 |  |              | (1       | ) |                   |  
|Accumulated deficit                                                                                                                   |  |              | (142,708 | ) |                   |  
|Accumulated other comprehensive income                                                                                                |  |              | 674      |   |                   |  
|                                                                                                                                      |  |              |          |   |                   |  
|Total stockholders equity                                                                                                            |  |              | 188,626  |   |                   |  
|                                                                                                                                      |  |              |          |   |                   |  
|Total liabilities and stockholders equity                                                                                            |  | $            | 201,742  |   |                   | $
|                                                                                                                                      |  |              |          |   |                   |  



See accompanying notes
to the condensed consolidated financial statements



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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES



CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)



|                                                                                    |  | Three Months EndedJune 30, |        |   | Nine Months EndedJune 30, |  
|----------------------------------------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------- | -
|                                                                                    |  | 2003                       |        |   | 2002                      |  
|Revenue:                                                                            |  |                            |        |   |                           |  
|Subscription services                                                               |  | $                          | 8,691  |   |                           | $
|Consulting and support services                                                     |  |                            | 741    |   |                           |  
|                                                                                    |  |                            |        |   |                           |  
|Total revenue                                                                       |  |                            | 9,432  |   |                           |  
|                                                                                    |  |                            |        |  
|Operating Expenses:                                                                 |  |                            |        |   |                           |  
|Costs of subscription services                                                      |  |                            | 1,873  |   |                           |  
|Costs of consulting and support services                                            |  |                            | 1,047  |   |                           |  
|Research and development                                                            |  |                            | 1,744  |   |                           |  
|Sales and marketing                                                                 |  |                            | 3,083  |   |                           |  
|Operations                                                                          |  |                            | 1,651  |   |                           |  
|General and administrative                                                          |  |                            | 1,602  |   |                           |  
|Excess occupancy costs                                                              |  |                            | 284    |   |                           |  
|Amortization of identifiable intangible assets and stock-based compensation         |  |                            | 413    |   |                           |  
|In-process research and development charge                                          |  |                            |       |   |                           |  
|                                                                                    |  |                            |        |   |                           |  
|Total operating expenses                                                            |  |                            | 11,697 |   |                           |  
|                                                                                    |  |                            |        |   |                           |  
|Loss from operations                                                                |  |                            | (2,265 | ) |                           |  
|Interest income, net                                                                |  |                            | 1,002  |   |                           |  
|                                                                                    |  |                            |        |   |                           |  
|Net loss before cumulative effect of a change in accounting principle               |  |                            | (1,263 | ) |                           |  
|Cumulative effect of a change in accounting principle                               |  |                            |       |   |                           |  
|                                                                                    |  |                            |        |   |                           |  
|Net loss                                                                            |  | $                          | (1,263 | ) |                           | $
|                                                                                    |  |                            |        |   |                           |  
|Net loss per share:                                                                 |  |                            |        |   |                           |  
|Net loss per share before the cumulative effect of a change in accounting principle |  |                            | (0.06  | ) |                           |  
|Cumulative effect per share of a change in accounting principle                     |  |                            |       |   |                           |  
|                                                                                    |  |                            |        |   |                           |  
|Basic and diluted net loss per share                                                |  | $                          | (0.06  | ) |                           | $
|                                                                                    |  |                            |        |   |                           |  
|Shares used in computing basic and diluted net loss per share                       |  |                            | 20,831 |   |                           |  
|                                                                                    |  |                            |        |   |                           |  



See accompanying notes
to the condensed consolidated financial statements



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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES



CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



|                                                                                     |  | Nine months endedJune 30, |        
|------------------------------------------------------------------------------------ |  | ------------------------- | -------
|                                                                                     |  | 2003                      |        
|Cash flows from operating activities:                                                |  |                           |        
|Net loss                                                                             |  | $                         | (5,377 
|Adjustments to reconcile net loss to net cash from operating activities:             |  |                           |        
|Depreciation and amortization                                                        |  |                           | 4,824  
|Amortization of intangible assets                                                    |  |                           | 1,210  
|Amortization of debt investment premium                                              |  |                           | 2,961  
|Cumulative effect of a change in accounting principle                                |  |                           |       
|In-process research and development charge                                           |  |                           |       
|Amortization of deferred stock-based compensation                                    |  |                           | 30     
|Changes in operating assets and liabilities, net of acquired assets and liabilities: |  |                           |        
|Accounts receivable, net                                                             |  |                           | 360    
|Prepaid and other assets                                                             |  |                           | 1,619  
|Accounts payable, accrued expenses and accrued excess facility costs                 |  |                           | (1,309 
|Deferred revenue                                                                     |  |                           | (442   
|                                                                                     |  |                           |        
|Net cash provided by operating activities                                            |  |                           | 3,876  
|                                                                                     |  |                           |        
|Cash flows from investing activities:                                                |  |                           |        
|Purchase of plant, property and equipment                                            |  |                           | (1,602 
|Proceeds from (purchase of ) businesses and assets, net                              |  |                           | 75     
|Sales of short-term investments                                                      |  |                           | 165,846
|Purchases of short-term investments                                                  |  |                           | (98,028
|                                                                                     |  |                           |        
|Net cash provided by investing activities                                            |  |                           | 66,291 
|                                                                                     |  |                           |        
|Cash flows from financing activities:                                                |  |                           |        
|Repayment of notes payable and capital lease                                         |  |                           |       
|Proceeds from issuance of common stock                                               |  |                           | 2,888  
|Repurchase of outstanding common stock                                               |  |                           | (79,170
|                                                                                     |  |                           |        
|Net cash used in financing activities                                                |  |                           | (76,282
|                                                                                     |  |                           |        
|Net (decrease) increase in cash and cash equivalents                                 |  |                           | (6,115 
|Cash and cash equivalents at beginning of the period                                 |  |                           | 20,874 
|                                                                                     |  |                           |        
|Cash and cash equivalents at end of the period (1) (2)                               |  | $                         | 14,759 
|                                                                                     |  |                           |        



|(1) |  | Excludes $144.7 million of short-term investments at June 30, 2003.
|--- |  | -------------------------------------------------------------------

|(2) |  | Excludes $279.8 million of short-term investments and restricted cash at June 30, 2002.
|--- |  | ---------------------------------------------------------------------------------------



See accompanying notes to the condensed consolidated financial statements



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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS



(1)    Basis of Presentation



The accompanying interim unaudited condensed consolidated balance sheets and
condensed consolidated statements of operations and cash flows reflect all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position of Keynote Systems, Inc. and subsidiaries
(the Company) at June 30, 2003, and the results of operations and cash flows for the interim periods ended June 30, 2003 and 2002.



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, 2002 included in the Companys Report on Form 10-K as filed with the SEC.



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.



Excess occupancy costs are fixed charges associated with the unoccupied portion of the Companys headquarters building, such as property taxes,
insurance and depreciation. These particular costs represent the fixed costs of operating the Companys headquarters building acquired in September 2002 and are based on the actual unoccupied square footage, which was determined to be 60%
during the three and nine months ended June 30, 2003.



Certain
reclassifications have been made to previously issued financial statements to conform to the current presentation.



(2)    Stock-Based Compensation Plans



The Company issues stock options to its employees and outside directors and provides employees with stock purchase rights pursuant to stockholder approved
equity incentive and employee stock purchase plans. The Company accounts for its stock-based compensation plans under the intrinsic value method of accounting as defined by Accounting Principles Board Opinion No. 25, Accounting for Stock
Issued to Employees, and related interpretations. Accordingly, no stock-based employee compensation cost is reflected in operating expenses for the three and nine months ended June 30, 2003 and 2002, as all options granted under these plans
had an exercise price equal to or in excess of the fair market value of the underlying common stock as of the grant date for each stock option, except for certain stock options granted in fiscal 1999 or earlier, prior to the Companys initial
public offering. For those option grants in fiscal 1999 or earlier, the Company recorded deferred stock compensation of $1.9 million for the difference at the grant date between the exercise price of each stock option granted and the fair value of
the underlying common stock. This amount is being amortized on a straight-line basis over the vesting period, which is generally four years. As of June 30, 2003, the unamortized deferred compensation balance was $1,000, which will be fully amortized
by the end of fiscal 2003.



The following table illustrates the
effect on net loss and basic and diluted net loss per share if the Company had accounted for its stock option and stock purchase plans under the fair value method of accounting under Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based CompensationTransition and Disclosure (in thousands):



|                                                                                                              |  | Three MonthsEnded |        |   | Nine Months Ended |  
|------------------------------------------------------------------------------------------------------------- |  | ----------------- | ------ | - | ----------------- | -
|                                                                                                              |  | June 30,2003      |        |   | June 30,2002      |  
|Net loss, as reported                                                                                         |  | $                 | (1,263 | ) |                   | $
|Add: Stock-based employee compensation included in net loss                                                   |  |                   | 3      |   |                   |  
|Less: Total stock-based employee compensation expense determined under fair value based method for all awards |  |                   | (2,127 | ) |                   |  
|                                                                                                              |  |                   |        |   |                   |  
|Pro forma net loss                                                                                            |  | $                 | (3,387 | ) |                   |  
|                                                                                                              |  |                   |        |   |                   |  
|Basic and diluted net loss per share:                                                                         |  |                   |        |   |                   |  
|As reported                                                                                                   |  | $                 | (0.06  | ) |                   | $
|Pro forma                                                                                                     |  | $                 | (0.16  | ) |                   | $



The net tax effect on
the stock-based employee compensation determined under fair value based method for all awards is zero.



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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



(3)    Revenue Recognition



Subscription services revenue consists of fees from subscriptions to the
Companys Internet measurement, monitoring, testing and diagnostic services. The Companys subscription services revenue is deferred upon invoicing and is recognized ratably over the service period, generally ranging from one to twelve
months. For some customers, subscription services revenue is invoiced monthly upon completion of the services. Deferred revenue is comprised of all unearned revenue, primarily unearned subscription services revenue, and is recorded as deferred
revenue on the balance sheet until the revenue is earned. The Company does not generally grant refunds. All discounts granted are netted against revenue. Revenue is not recognized for free trial periods. Revenue from consulting and support services,
which includes revenue from its load-testing services, is recognized as the services are performed, typically over a one to three month period. For consulting projects that span more than one month, the Company recognizes revenue as milestones or
deliverables are completed.



(4)    Cumulative Effect of
a Change in Accounting Principle



Effective October 1,
2001, the Company early adopted Statement of Financial Accounting Standard (SFAS) No. 142, Goodwill and Other Intangible Assets. On adoption of SFAS No. 142, the Company determined its market value based on the number of shares
outstanding and the stock price as of October 1, 2001, after adjusting for a 10% premium that is assumed to represent additional value that an acquirer would be required to pay for a controlling interest in the Company. This evaluation indicated
that goodwill associated with acquisitions completed prior to fiscal 2002 was impaired as of October 1, 2001. Accordingly, the Company recorded a $3.2 million non-cash impairment charge as a cumulative effect of a change in accounting principle for
the write-off of the remaining amount of goodwill as of October 1, 2001. Currently, there is no remaining goodwill on the Companys condensed consolidated balance sheet.



(5)    Comprehensive Loss



Comprehensive loss includes net loss and 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 functional currency
of the Companys foreign operations is the applicable local currency. Gains and losses from foreign currency transactions are reflected in the condensed consolidated statements of operations as incurred. The components of comprehensive loss are
as follows (in thousands):





|                                                             |  | Three Months Ended |        |   | Nine Months Ended |  
|------------------------------------------------------------ |  | ------------------ | ------ | - | ----------------- | -
|                                                             |  | June 30,2003       |        |   | June 30,2002      |  
|Net loss                                                     |  | $                  | (1,263 | ) |                   | $
|Net unrealized gain (loss) on available-for-sale investments |  |                    | (232   | ) |                   |  
|Foreign currency translation gain                            |  |                    | 78     |   |                   |  
|                                                             |  |                    |        |   |                   |  
|Comprehensive loss                                           |  | $                  | (1,417 | ) |                   | $
|                                                             |  |                    |        |   |                   |  



(6)    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, and accounts payable, approximates fair market value due to the
short-term nature of these instruments. Financial instruments that subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and trade accounts receivable.



Credit risk is concentrated in North America, but also exists in Europe. 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 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 after 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 old 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, based on historical collection trends, to the outstanding accounts receivable balance. The allowance for doubtful accounts represents
managements best current estimate, but changes in circumstances relating to accounts receivable, including unforeseen declines in market conditions and collection rates, may result in additional allowances in the future. The Company believes
that it has adequately reserved for doubtful accounts as of the date of each balance sheet presented herein. At June 30, 2003, one customer

accounted for
more than 10% of the Companys total accounts receivable, which receivable was subsequently collected in July 2003. At June 30, 2002, one customer accounted for more than 10% of the Companys total accounts receivable, which receivable was
subsequently collected in 2002. For the three and nine months ended June 30, 2003, and the nine months ended June 30, 2002, no single customer accounted for more than 10% of the Companys total revenue during each applicable period. For the
three months ended June 30, 2002, one customer accounted for 10% of the Companys total revenue.



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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



(7)    Investments



For the purposes of the condensed consolidated financial statements, the
Company considers all highly liquid investments with original maturities of three months or less when acquired to be cash equivalents. All of the Companys cash equivalents and short-term investments are classified as available-for-sale. These
securities are carried at fair market value, with unrealized gains and losses excluded from earnings and reported as a component of other comprehensive income (loss). The following table summarizes the Companys short-term investments in
investment-grade corporate and government debt securities with Moodys ratings of A2 or better as of June 30, 2003 (in thousands):



|                                        |  | AmortizedCost |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  |   | Estimated FairMarket Value
|--------------------------------------- |  | ------------- | ------- | -------------------- | - | --------------------- |  | - | --------------------------
|Obligations of U.S. government agencies |  | $             | 59,356  |                      | $ | 243                   |  | $ | (28                       
|Corporate bonds and commercial paper    |  |               | 84,757  |                      |   | 353                   |  |   | (22                       
|                                        |  |               |         |                      |   |                       |  |   |                           
|Total                                   |  | $             | 144,113 |                      | $ | 596                   |  | $ | (50                       
|                                        |  |               |         |                      |   |                       |  |   |                           



Income taxes on net
unrealized gains are expected to be immaterial.



The following
table summarizes the maturities of fixed maturity investments available for sale at June 30, 2003 (in thousands). Expected maturities will differ from contractual maturities of the debt securities because borrowers may have the right to call or
repay obligations with or without call or prepayment penalties.



|               |  | Amortized Cost |         | Estimated FairMarket Value
|-------------- |  | -------------- | ------- | --------------------------
|Due in 1 year  |  | $              | 58,711  |                           
|Due in 2 years |  |                | 85,402  |                           
|               |  |                |         |                           
|Total          |  | $              | 144,113 |                           
|               |  |                |         |                           





(8)    Identifiable Intangible Assets



As of June 30, 2003, the net carrying value of identifiable intangible assets was approximately $2.3 million. During the first quarter of fiscal 2003, the
Company acquired approximately $813,000 of technology-based and $31,000 of customer-based intangible assets related to the acquisition of the business of Enviz, Inc. (Enviz) (see Note 10). The purchase price allocation for the acquisition of the
business of Enviz, Inc. was adjusted by approximately $40,000 of cash, which was received by the Company during the second quarter of fiscal 2003 as a result of the finalization of the acquisition. This amount was allocated based on the original
purchase price allocation ratios to technology-based and customer-based intangible assets. In addition, the purchase price allocation for the acquisition of the business of Envive Corporation (Envive) was adjusted to reflect an amount of
approximately $144,000 of cash, which was received by the Company during the first quarter of fiscal 2003 as a result of the finalization of the acquisition. This amount was allocated based on the original purchase price allocation ratios to
technology-based and customer-based intangible assets. As a result, the net change in the gross carrying value of the identifiable intangible assets for the nine months ended June 30, 2003 increased by $660,000. These assets are being amortized over
a three year period, with minimal residual values. During the three and nine month periods ended June 30, 2003, the amortization expense for intangible assets was approximately $410,000 and $1.2 million, respectively. The components of identifiable
intangible assets are as follows (in thousands):



|As of June 30, 2003:                     |  | Technology Based |        |   | Customer Based |   |        | Trademark |  |   | Total |  
|---------------------------------------- |  | ---------------- | ------ | - | -------------- | - | ------ | --------- |  | - | ----- | -
|Gross carrying value                     |  | $                | 7,815  |   |                | $ | 3,678  |           |  | $ | 250   |  
|Accumulated amortization                 |  |                  | (5,590 | ) |                |   | (3,595 | )         |  |   | (249  | )
|                                         |  |                  |        |   |                |   |        |           |  |   |       |  
|Net carrying value at June 30, 2003      |  | $                | 2,225  |   |                | $ | 83     |           |  | $ | 1     |  
|                                         |  |                  |        |   |                |   |        |           |  |   |       |  
|As of September 30, 2002:                |  |                  |        |   |                |   |        |           |  |   |       |  
|Gross carrying value                     |  | $                | 7,173  |   |                | $ | 3,660  |           |  | $ | 250   |  
|Accumulated amortization                 |  |                  | (4,520 | ) |                |   | (3,465 | )         |  |   | (239  | )
|                                         |  |                  |        |   |                |   |        |           |  |   |       |  
|Net carrying value at September 30, 2002 |  | $                | 2,653  |   |                | $ | 195    |           |  | $ | 11    |  
|                                         |  |                  |        |   |                |   |        |           |  |   |       |  



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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



The amortization expense for existing intangible assets is
estimated to be approximately $379,000 for the remainder of fiscal 2003, approximately $1.35 million for fiscal 2004, and approximately $580,000 for fiscal 2005.



(9)    Net Loss Per Share



Basic net loss per share is computed using the weighted-average number of outstanding shares of common stock excluding
shares of restricted stock subject to repurchase summarized below. Diluted net loss per share is computed using the weighted-average number of shares of common stock outstanding excluding shares of restricted stock subject to repurchase summarized
below and, when dilutive, potential common shares from options and warrants to purchase common stock using the treasury stock method and from convertible securities using the as-if-converted basis.



The following potential common shares have been excluded from the computation
of diluted net loss per share because the effect would have been antidilutive (in thousands):



|                                                 |  | Three and nine months ended June 30
|------------------------------------------------ |  | -----------------------------------
|                                                 |  | 2003                               
|Shares outstanding under stock options           |  | 5,420                              
|Shares of restricted stock subject to repurchase |  | 6                                  
|                                                 |  |                                    
|Total shares excluded                            |  | 5,426                              
|                                                 |  |                                    



The weighted-average
exercise price per share of common stock subject to stock options was $12.71 as of June 30, 2003 and $13.45 as of June 30, 2002. The weighted-average repurchase price of restricted stock was $0.26 as of June 30, 2003, and $1.07 as of June 30, 2002.



(10)    Acquisitions



In October 2002, the Company acquired the business of Enviz, Inc. (Enviz), a
developer of user experience testing technology for $76,000 in cash and 111,000 shares of the Companys common stock.



The $841,000 purchase price consideration was based on estimated fair values of the assets and liabilities of Enviz at the acquisition date, and allocated
to the technology-based and customer-based intangible assets acquired. There was no goodwill arising from the acquisition. Identifiable intangible assets are being amortized on a straight-line basis over a three year period. Amortization of
identifiable intangible assets related to the acquisition of the business of Enviz was $66,000 and $209,000 for the three and nine months ended June 30, 2003. The condensed consolidated statements of operations for the three and nine months ended
June 30, 2003 include the results of operations relating to Envizs business activity subsequent to the acquisition. If the results of the two companies were combined on a pro forma basis for the three and nine months ended June 30, 2002, the
difference between pro forma results and the actual results reported herein, would be immaterial.



During the nine months ended June 30, 2003, in connection with the finalization of the acquisition of the business of Enviz, the Company received $40,000
of cash. As a result, the $841,000 purchase price allocation was reduced to reflect the Companys receipt of this amount. The remaining $801,000 was allocated based on the original purchase price allocation ratios to technology-based and
customer-based intangible assets as follows: $774,000 to technology-based intangible assets, $29,000 to customer-based intangible assets, and $2,000 to net liabilities.



During the nine months ended June 30, 2003, in connection with the finalization of the acquisition of the business of Envive
Corporation, the Company received $144,000 of cash. As a result, the original $3.4 million purchase price was adjusted to reflect the Companys receipt of this amount. The remaining $3.3 million was allocated based on the original purchase
price allocation ratios to technology-based and customer-based intangible assets.



Additionally, as of October 1, 2001, the Company recorded a charge of approximately $3.2 million as a cumulative effect of a change in accounting principle for the write-off of the remaining
goodwill associated with its acquisitions made prior to fiscal 2002.



In July 2003, the Company acquired the business of Streamcheck, a provider of quality measurement services for streaming media, for $500,000 in cash, plus up to $450,000 additional cash
payment if certain revenue and profitability targets are achieved during the period from July 22, 2003 through September 30, 2004. The Company believes this acquisition will enhance its ability to provide streaming measurement services.



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##### Table of Contents

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



(11)    Commitments and Contingencies



(A) Leases



The Company leases certain of its facilities under non-cancelable operating
leases, which expire on various dates through December 2005. At June 30, 2003, future minimum payments under the leases are as follows (in thousands):



|Twelve months ended June 30: |  | OperatingLeases
|---------------------------- |  | ---------------
|2004                         |  | $              
|2005                         |  |                
|2006                         |  |                
|Thereafter                   |  |                
|                             |  |                
|Total minimum lease payments |  | $              
|                             |  |                



(B)
Commitments



The Company has contingent commitments
to 51 bandwidth and collocation providers amounting to $962,000 for 96 locations, which commitments become due if the Company terminates any of these agreements prior to their expiration. At present, the Company does not intend to terminate any of
these agreements prior to their expiration.



(C) Legal Proceedings



Beginning
on August 16, 2001, a number of 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 are 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 allege 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 alleges that the Company had a duty to disclose the activities of the underwriters in the registration statement relating to its initial public offering. The complaints have been
consolidated into a single action with cases brought against over three hundred other issuers and their underwriters that make similar allegations regarding the initial public offerings of those issuers. The plaintiffs counsel and the
individual named defendants counsel have reached an agreement whereby the individual named defendants have been dismissed from the case, without any payments by the Company. The Company has accepted a settlement proposed by the plaintiffs and
its Directors and Officers insurance carriers, which will not require any payments by the Company. The final settlement is currently awaiting approval from the United States District Court for the Southern District of New York.



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 the Companys condensed
consolidated financial position, results of operations, or cash flows.



(12)    Stockholder Rights Plan



On October 28, 2002, the Company announced that its Board of Directors adopted a stockholder rights plan. The plan is designed to protect the long-term value of the Company for its stockholders during any future unsolicited acquisition
attempt. Key features of the rights plan include:



| |  | The rights become exercisable only upon the occurrence of certain events specified in the plan, including the acquisition of 15% of the Companys outstanding common stock by a
person or group;
|- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | Each right entitles the holder, other than an acquiring person, to acquire shares of the Companys common stock at a 50% discount to the then-prevailing market
price; and
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | The Companys Board of Directors may redeem outstanding rights at any time prior to a person becoming an acquiring person, at a price of $0.001 per right and, prior
to such time, the Board may amend the terms of the rights without the approval of the holders of the rights.
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES



NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS  (Continued)



(13)    Stock Repurchase Program



The Company completed an issuer tender offer on November 26, 2002. The
Company purchased approximately 4.3 million shares at a price of $8.00 per share under the offer for approximately $34.2 million.



The Company completed an issuer tender offer on May 16, 2003. The Company purchased approximately 4.3 million shares at a price of $9.50 per share under
the tender offer for approximately $40.5 million.



The total
number of shares repurchased since January 2001, including the tender offers described above, is approximately 10.3 million shares, for an aggregate price of approximately $89.4 million.



(14)    Geographic, Segment, and Significant Customer Information



The Company has determined that it operates in a single reportable segment:
the development and sale of services to measure, test, assure and improve the quality of service of web sites.



The Company markets its products primarily from its operations in the United States. International sales are primarily to customers in Europe. These sales
and the Companys foreign-owned assets are not significant. At June 30, 2003, one customer accounted for more than 10% of the Companys total accounts receivable, which receivable was subsequently collected in July 2003. At June 30, 2002,
one customer accounted for more than 10% of the Companys total accounts receivable, which receivable was subsequently collected in 2002. For the three and nine months ended June 30, 2003, and the nine months ended June 30, 2002, no single
customer accounted for more than 10% of the Companys total revenue during each period. For the three months ended June 30, 2002, one customer accounted for 10% of the Companys total revenue.



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



The following information should be read in conjunction with the interim unaudited condensed consolidated financial statements and related notes.



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 expect, anticipate, intend, believe 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 and in
our annual report on Form 10-K for the fiscal year ended September 30, 2002, in the section Managements Discussion and Analysis of Financial Condition and Results of OperationsFactors That May Impact Future Operating Results
and elsewhere in that report. You should also carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the annual report on Form 10-K, the quarterly reports on Form 10-Q
and current reports on Form 8-K that we file in fiscal 2003. 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. 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 provide services that enable corporate enterprises to benchmark, test, and manage their electronic business, or e-business, applications, and systems,
both inside and outside the firewall. Our services are designed to provide total performance management by allowing enterprise customers to improve the quality of their e-business from the end-user perspective through cost-effective and
easy-to-use web performance management and testing solutions. We provide outsourced services and appliances, which do not require complex and costly software implementations, configuration or maintenance by our customers. We believe that enterprises
who use our services leverage their existing software and hardware, improve customer satisfaction and reduce capital expenditures.



Revenue consists of subscription services revenue and consulting and support services revenue. Subscription services revenue consists of fees from
subscriptions to our Internet measurement, monitoring, testing, and diagnostic services. Our subscription services revenue is deferred upon invoicing and is recognized ratably over the service period, generally ranging from one to twelve months. For
some customers, subscription services revenue is invoiced monthly upon completion of the services. Deferred revenue is comprised of all unearned revenue, primarily unearned subscription services revenue, and is recorded as deferred revenue on our
balance sheet until the revenue is earned. As of June 30, 2003, we had recorded $4.7 million of deferred revenue. We do not generally grant refunds. All discounts granted are netted against revenue. Revenue is not recognized during free trial
periods. Revenue from our consulting and support services, which includes revenue from our load testing services, is recognized as the services are performed, typically over a one to three month period. For longer consulting projects that span more
than one month, we recognize revenue as milestones or deliverables are completed.



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A majority of our subscription services revenue comes from our web performance benchmarking services.
Subscription services revenue also includes our Red Alert and NetMechanic monitoring and alarm services, test perspective subscription services, WebEffective subscription services, application performance management subscription services, and our
private agent application performance management services. Our customers purchase these subscription services for initial terms of three to twelve months and then may renew their subscription on an annual, semi-annual, or month-to-month basis.



Subscription services fees can vary based on the number of
URLs measured, the number of devices monitored, the number of measurement locations, the number of users, the number of hours, the frequency of the measurements, the number of private agents, the additional features ordered, and the type of
services.



We offer our consulting and support services on a
per engagement basis. Consulting and support services revenue as a percentage of total revenue amounted to 8% and 9% for the three and nine months ended June 30, 2003. We believe that consulting and support services revenue may increase in the
future as a percentage of total revenue as our existing consulting and support services become more widely used and as we introduce additional consulting and support services. However, we cannot assure you that this revenue will increase in absolute
dollars in future periods.



For the quarter ended June 30,
2003, our 10 largest customers accounted for approximately 32% of total revenue. We cannot be certain that customers that have accounted for significant revenue in past periods, individually or in aggregate, will renew our services and continue to
generate revenue in any future period. In addition, our customer agreements can generally be terminated 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.



Effective April 1, 2003, we implemented company-wide salary
reductions, reduced headcount, and amended our bonus structure to be contingent on the achievement of overall company profitability as well as individual performance targets. Accordingly, we expect that expenses for research and development, sales
and marketing, operations, general and administrative, and excess occupancy costs for the fourth quarter of fiscal 2003 will decrease compared to the third quarter of fiscal 2003.



Results of Operations



Revenue



|                                    |  | 2003           |        | 2002 |   | % Change | 
|----------------------------------- |  | -------------- | ------ | ---- | - | -------- | 
|                                    |  | (In thousands) |        |      |  
|For the three months ended June 30: |  |                |        |      |   |          | 
|Subscription services               |  | $              | 8,691  |      | $ | 8,516    | 
|Consulting and support services     |  |                | 741    |      |   | 958      | 
|                                    |  |                |        |      |   |          | 
|                                    |  | $              | 9,432  |      | $ | 9,474    | 
|For the nine months ended June 30:  |  |                |        |      |   |          | 
|Subscription services               |  | $              | 26,099 |      | $ | 25,869   | 
|Consulting and support services     |  |                | 2,649  |      |   | 2,403    | 
|                                    |  |                |        |      |   |          | 
|                                    |  | $              | 28,748 |      | $ | 28,272   | 



Subscription
Services.    Revenue from subscription services increased by $175,000 or 2% for the three months ended June 30, 2003 as compared to the same period in 2002. Revenue from subscription services increased $230,000 or 1% for the nine
months ended June 30, 2003 as compared to the same period in 2002. Subscription services represented approximately 92% and 90% of total revenue for the three months ended June 30, 2003 and 2002, respectively, and approximately 91% and 92% of total
revenue for the nine months ended June 30, 2003 and 2002, respectively. The slight increase was primarily due to increases in revenue from our application performance management services.



Consulting and Support Services.    Revenue from consulting and support services decreased $217,000 or 23% for the three
months ended June 30, 2003 as compared to the same period in 2002, however, it increased $246,000 or 10% for the nine months ended June 30, 2003 as compared to the same period in 2002. Consulting and support services represented approximately 8% and
10% of total revenue for the three months ended June 30, 2003 and 2002, respectively, and approximately 9% and 8% of total revenue for the nine months ended June 30, 2003 and 2002, respectively. The decrease for the three month period was primarily
due to fewer engagements and engagements for a lower level of services, offset by increased revenue from our new service offerings, Keynote Diagnostic Services, which were introduced in the first quarter of fiscal 2002, and WebEffective, which was
introduced in the first quarter of fiscal 2003. The increase for the nine month period was primarily due to the increased contributions from Keynote Diagnostic Services and WebEffective. Because our consulting and support services are provided on a
per engagement basis, revenue depends on the number of engagements and the size of such engagements. As such, it is difficult for us to predict our consulting and support services revenue from period to period.



At June 30, 2003, one customer accounted for more than 10% of the
Companys total accounts receivable, which receivable was

subsequently collected in July 2003. At June 30, 2002, one customer accounted for more than
10% of the Companys total accounts receivable, which receivable was subsequently collected in 2002. For the three and nine months ended June 30, 2003, and the nine months ended June 30, 2002, no single customer accounted for more than 10% of
the Companys total revenue during each period. For the three months ended June 30, 2002, one customer accounted for 10% of the Companys total revenue.



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Expenses:



Costs of Subscription and Consulting and Support Services



|                                         |  | 2003           |       | 2002 |   | % Change | 
|---------------------------------------- |  | -------------- | ----- | ---- | - | -------- | 
|                                         |  | (In thousands) |       |      |  
|For the three months ended June 30:      |  |                |       |      |   |          | 
|Costs of subscription services           |  | $              | 1,873 |      | $ | 2,721    | 
|Costs of consulting and support services |  | $              | 1,047 |      | $ | 742      | 
|For the nine months ended June 30:       |  |                |       |      |   |          | 
|Costs of subscription services           |  | $              | 6,618 |      | $ | 8,970    | 
|Costs of consulting and support services |  | $              | 2,917 |      | $ | 2,631    | 



Costs of Subscription
Services.    Costs of subscription services consist of connection fees to Internet service providers for bandwidth usage of our measurement computers, which are located around the world, depreciation, maintenance and other
equipment charges for our measurement and data collection infrastructure. Costs of subscription services decreased $848,000 or 31% for the three months ended June 30, 2003 as compared to the same period in 2002 and represented 22% and 32% of
subscription services revenue for the three months ending June 30, 2003 and 2002, respectively. Costs of subscription services decreased $2.4 million or 26% for the nine months ended June 30, 2003 as compared to the same period in 2002 and
represented 25% and 35% of subscription services revenue for the nine months ending June 30, 2003 and 2002, respectively. The decreases were primarily due to reduced costs for bandwidth and, to a lesser extent, lower bandwidth usage, hardware and
depreciation expenses. We believe that costs of subscription services in absolute dollars for the fourth quarter of fiscal 2003 will decrease slightly compared to the third quarter of fiscal 2003 due to lower bandwidth and depreciation expenses.



Costs of Consulting and Support Services.    Costs of
consulting and support services consist of compensation expenses and related costs for consulting and support services personnel, all load-testing bandwidth costs and related network infrastructure costs. Costs of consulting and support services
increased $305,000 or 41% for the three months ended June 30, 2003 as compared to the corresponding period in 2002, and represented 141% and 77% of consulting and support services revenue for the three months ended June 30, 2003 and 2002,
respectively. Costs of consulting and support services increased $286,000 or 11% for the nine months ended June 30, 2003 as compared to the corresponding period in 2002, and represented 110% and 109% of consulting and support services revenue for
the nine months ending June 30, 2003 and 2002, respectively. The increase in costs of consulting and support services was primarily attributable to costs associated with our WebEffective service, which we acquired in October 2002 and, to a lesser
extent, to an increase in the number of personnel. We expect that costs of consulting and support services in absolute dollars for the fourth quarter of fiscal 2003 will increase slightly from the third quarter of fiscal 2003, but will be slightly
lower as a percentage of revenue.



Research and
Development



|                                    |  | 2003           |       | 2002 |   | % Change | 
|----------------------------------- |  | -------------- | ----- | ---- | - | -------- | 
|                                    |  | (In thousands) |       |      |  
|For the three months ended June 30: |  |                |       |      |   |          | 
|Research and development            |  | $              | 1,744 |      | $ | 2,258    | 
|For the nine months ended June 30:  |  |                |       |      |   |          | 
|Research and development            |  | $              | 5,979 |      | $ | 6,809    | 



Research and
development expenses consist primarily of compensation and related costs for research and development personnel. Research and development expenses decreased $514,000 or 23% for the three months ended June 30, 2003 as compared to the corresponding
period in 2002, and $830,000 or 12% for the nine months ended June 30, 2003 as compared to the corresponding period in 2002. The decrease was primarily attributable to lower costs resulting from a reduced number of research and development personnel
and reduced salaries, offset, in part, by additional costs related to acquisitions. To date, all research and development expenses have been expensed as incurred. We believe that research and development expenses in absolute dollars for the fourth
quarter of fiscal 2003 will decrease compared to the third quarter of fiscal 2003 due to reductions in personnel costs associated with lower headcount.



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Sales and Marketing



|                                    |  | 2003           |        | 2002 |   | % Change | 
|----------------------------------- |  | -------------- | ------ | ---- | - | -------- | 
|                                    |  | (In thousands) |        |      |  
|For the three months ended June 30: |  |                |        |      |   |          | 
|Sales and marketing                 |  | $              | 3,083  |      | $ | 4,902    | 
|For the nine months ended June 30:  |  |                |        |      |   |          | 
|Sales and marketing                 |  | $              | 11,561 |      | $ | 14,968   | 



Sales and marketing
expenses consist primarily of salaries, commissions and bonuses earned by sales and marketing personnel, lead-referral fees, marketing programs and travel expenses. Our sales and marketing expenses decreased $1.8 million or 37% for the three months
ended June 30, 2003 as compared to the corresponding period in 2002 and approximately $3.4 million or 23% for the nine months ended June 30, 2003 as compared to the corresponding period in 2002. The decrease primarily resulted from a reduced number
of sales and marketing personnel and, to a lesser extent, from reduced spending on certain marketing programs. We believe that sales and marketing expenses in absolute dollars for the fourth quarter of fiscal 2003 will decrease compared to the third
quarter of fiscal 2003 due to fewer marketing programs and to reductions in personnel costs associated with lower headcount.



Operations



|                                    |  | 2003           |       | 2002 |   | % Change | 
|----------------------------------- |  | -------------- | ----- | ---- | - | -------- | 
|                                    |  | (In thousands) |       |      |  
|For the three months ended June 30: |  |                |       |      |   |          | 
|Operations                          |  | $              | 1,651 |      | $ | 1,824    | 
|For the nine months ended June 30:  |  |                |       |      |   |          | 
|Operations                          |  | $              | 5,057 |      | $ | 5,801    | 



Operations expenses
consist primarily of compensation and related costs for management and technical support personnel who manage and maintain our field measurement and collection infrastructure and our headquarters data center, and provide twenty-four by seven basic
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 decreased $173,000 or 9% for the three months
ended June 30, 2003 as compared to the corresponding period in 2002, and $744,000 or 13% for the nine months ended June 30, 2003 as compared to the corresponding period in 2002. The decrease in operations expenses was primarily the result of
increasing operating efficiencies and reducing the number of personnel in the operations group, and to a lesser extent, to lower personnel costs associated with reduced salaries. We believe that operations expenses in absolute dollars for the fourth
quarter of fiscal 2003 will decrease compared to the third quarter of fiscal 2003 due to continued increases in operating efficiencies and reduction in personnel costs associated with lower headcount.



General and Administrative



|                                    |  | 2003           |       | 2002 |   | % Change | 
|----------------------------------- |  | -------------- | ----- | ---- | - | -------- | 
|                                    |  | (In thousands) |       |      |  
|For the three months ended June 30: |  |                |       |      |   |          | 
|General and administrative          |  | $              | 1,602 |      | $ | 1,845    | 
|For the nine months ended June 30:  |  |                |       |      |   |          | 
|General and administrative          |  | $              | 4,718 |      | $ | 5,444    | 



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 decreased
$243,000 or 13% for the three months ended June 30, 2003 as compared to the same period in 2002 and $726,000 or 13% for the nine months ended June 30, 2003 as compared to the same period in 2002. The decrease was primarily attributable to a reduced
number of general and administrative personnel, reduced salaries and lower bad debt provisions, and, to a lesser extent, to lower spending on professional service fees. We believe that general and administrative expenses in absolute dollars for the
fourth quarter of fiscal 2003 will be slightly lower than the third quarter of fiscal 2003 due to reductions in personnel costs associated with lower headcount, offset in part by an increase in costs related to complying with changes in securities
laws.



Excess Occupancy Costs



|                                    |  | 2003           |     | 2002 |   | % Change
|----------------------------------- |  | -------------- | --- | ---- | - | --------
|                                    |  | (In thousands) |     |     
|For the three months ended June 30: |  |                |     |      |   |         
|Excess occupancy costs              |  | $              | 284 |      | $ |        
|For the nine months ended June 30:  |  |                |     |      |   |         
|Excess occupancy costs              |  | $              | 862 |      | $ |        





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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 represent the fixed costs of operating our headquarters building, acquired in September 2002 and are based on the actual unoccupied square
footage, which was determined to be 60% during the three and nine months ended June 30, 2003.



Amortization of Identifiable Intangible Assets and Stock-Based Compensation



|                                                                            |  | 2003           |       | 2002 |   | % Change | 
|--------------------------------------------------------------------------- |  | -------------- | ----- | ---- | - | -------- | 
|                                                                            |  | (In thousands) |       |      |  
|For the three months ended June 30:                                         |  |                |       |      |   |          | 
|Amortization of identifiable intangible assets                              |  | $              | 410   |      | $ | 312      | 
|Amortization of stock-based compensation                                    |  |                | 3     |      |   | 85       | 
|                                                                            |  |                |       |      |   |          | 
|                                                                            |  |                |       |      |   |          | 
|Amortization of identifiable intangible assets and stock-based compensation |  | $              | 413   |      | $ | 397      | 
|                                                                            |  |                |       |      |   |          | 
|For the nine months ended June 30:                                          |  |                |       |      |   |          | 
|Amortization of identifiable intangible assets                              |  |                | 1,210 |      |   | 748      | 
|Amortization of stock-based compensation                                    |  |                | 30    |      |   | 255      | 
|                                                                            |  |                |       |      |   |          | 
|                                                                            |  |                |       |      |   |          | 
|Amortization of identifiable intangible assets and stock-based compensation |  | $              | 1,240 |      | $ | 1,003    | 
|                                                                            |  |                |       |      |   |          | 



As of June 30, 2003
and 2002, we had identifiable intangible assets with a gross carrying value of approximately $11.7 million and $11.1 million, respectively. For the three months ended June 30, 2003 and 2002, we recorded expenses of $410,000 and $312,000,
respectively, of amortization related to these identifiable intangible assets. For the nine months ended June 30, 2003 and 2002, we recorded expenses of approximately $1.2 million and $748,000, respectively, of amortization related to these
identifiable intangible assets. As of June 30, 2003 and 2002, the net carrying value of identifiable intangible assets was approximately $2.3 million and $3.2 million, respectively.



Certain options granted prior to June 30, 1999, have been considered to be compensatory, as the estimated fair value for
accounting purposes was greater than the stock price as determined by the board of directors on the date of grant. As a result, we recorded amortization of deferred compensation expense of $3,000 and $85,000 for the three months ended June 30, 2003
and 2002, respectively and $30,000 and $255,000 for the nine months ended June 30, 2003 and 2002, respectively. The decrease in the amortization of deferred compensation for the three months ended June 30, 2003 as compared to the corresponding
period in fiscal 2002 was a result of our discontinuing to amortize costs associated with former employees that have been terminated. As of June 30, 2003, we had a remaining balance of $1,000 included in deferred compensation. Deferred compensation
is amortized on a straight-line basis over the vesting period of the options and will be fully amortized by the end of fiscal 2003.



We expect the amortization of intangible assets and stock-based compensation to be approximately $400,000 for the fourth quarter of fiscal 2003, assuming
no additional acquisitions or impairment charges. We expect the remaining carrying value of the identifiable intangible assets as of June 30, 2003, as listed in the table below, will be fully amortized by October 2005 (in thousands).



|                                    |  | TechnologyBased |       | CustomerBased |   | Trademark |  | Total
|----------------------------------- |  | --------------- | ----- | ------------- | - | --------- |  | -----
|Net carrying value at June 30, 2003 |  | $               | 2,225 |               | $ | 83        |  | $    
|                                    |  |                 |       |               |   |           |  |      



In-process
Research and Development Charge



|                                    |  | 2003           |  | 2002 |     | % Change
|----------------------------------- |  | -------------- |  | ---- | --- | --------
|                                    |  | (In thousands) |  |     
|For the three months ended June 30: |  |                |  |      |     |         
|In-process research and development |  | $             |  | $    | 200 |         
|For the nine months ended June 30:  |  |                |  |      |     |         
|In-process research and development |  | $             |  | $    | 200 |         





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The charge for the three and nine months ended June 30, 2002, related to the estimated fair value of an
in-process research and development project acquired in connection with our acquisition of NetMechanic in May 2002, which had not yet reached technological feasability and had no alternative future use. The value assigned to in-process research and
development related to NetMechanics technology for web page testing. The estimated fair value of this project was determined based on actual costs incurred as of the acquisition date. This amount was immediately expensed upon the acquisition
date.



Interest Income, Net



|                                    |  | 2003           |       | 2002 |   | % Change | 
|----------------------------------- |  | -------------- | ----- | ---- | - | -------- | 
|                                    |  | (In thousands) |       |      |  
|For the three months ended June 30: |  |                |       |      |   |          | 
|Interest income, net                |  | $              | 1,002 |      | $ | 2,916    | 
|For the nine months ended June 30:  |  |                |       |      |   |          | 
|Interest income, net                |  | $              | 4,827 |      | $ | 9,063    | 



Net interest income
decreased approximately $1.9 million or 66% for the three months ended June 30, 2003 as compared to the corresponding period in 2002, and decreased approximately $4.2 million or 47% for the nine months ended June 30, 2003 as compared to the
corresponding period in 2002. The majority of the net interest income was earned on our investments. The decrease in net interest income for the three and nine months ended June 30, 2003 as compared to the corresponding period in fiscal 2002 was
primarily due to a lower level of invested cash due to the use of $85.0 million of restricted cash to purchase our headquarters building in September 2002, the two issuer tender offers that we completed in November 2002 and May 2003, open market
repurchases of our common stock in fiscal 2003 and the continued decline in interest rates. During the three and nine months ended June 30, 2003, we utilized approximately $40.7 million to repurchase approximately 4.3 million shares, primarily
pursuant to our May 2003 tender offer, and approximately $79.2 million to repurchase 8.9 million shares, pursuant to the two issuer tender offers.



Provision for Income Taxes



No provision for federal and state income taxes was recorded for the three and nine months ended June 30, 2003 and June 30, 2002, due to our operating
losses, net operating loss carryforwards, and tax credits.



Cumulative Effect of a Change in Accounting Principle





|                                                      |  | 2003           |   | 2002 |   | % Change
|----------------------------------------------------- |  | -------------- | - | ---- | - | --------
|                                                      |  | (In thousands) |   |     
|For the three months ended June 30:                   |  |                |   |      |   |         
|Cumulative effect of a change in accounting principle |  | $              |  |      | $ |        
|For the nine months ended June 30:                    |  |                |   |      |   |         
|Cumulative effect of a change in accounting principle |  | $              |  |      | $ | 3,160   



As discussed in Note 4
of the Notes to the Condensed Consolidated Financial Statements, Cumulative Effect of a Change in Accounting Principle, as a result of the implementation of Statement of Financial Accounting Standard No. 142, Goodwill and Other
Intangible Assets, we recorded a charge of approximately $3.2 million as a cumulative effect of a change in accounting principle for the write-off of all the remaining goodwill associated with acquisitions prior to fiscal 2002, in the nine
months ended June 30, 2002.



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Liquidity and Capital Resources



At June 30, 2003, we had approximately $14.8 million in cash and cash equivalents and approximately $144.7 million in
short-term investments, for a total of approximately $159.4 million in cash, cash-equivalents, and short-term investments. Our short-term investments consist of investment-grade corporate and government debt securities with Moodys ratings of
A2 or better.



Net cash provided by operating activities was
approximately $3.9 million for the nine months ended June 30, 2003. Net cash provided by operating activities was primarily the result of net income excluding all non-cash amortization and depreciation charges, a decrease in accounts receivable and
prepaid and other assets, offset by a decrease in accounts payable, accrued expenses, and deferred revenue. Accounts receivable declined mainly due to improved collections. Prepaid and other assets declined mainly due to the receipt of accrued
interest generated from our cash and short-term investments. Accounts payable and accrued expenses declined mainly due to the timing of certain payments associated with our headquarters building and periodic insurance renewals. Net cash provided by
operating activities was $575,000 for the nine months ended June 30, 2002 and resulted from net income excluding all non-cash amortization and depreciation charges and the cumulative effect of a change in accounting principle, a decrease in accounts
receivable and prepaid and other assets, offset by a decrease in accounts payable and accrued expenses and deferred revenue. The decrease in accounts receivable was due to successful collection efforts and a decrease in prepaid and other assets due
to the receipt of accrued interest generated from our cash and short-term investments. Accounts payable and accrued expenses declined mainly due to payments associated with our headquarters building and periodic insurance renewals.



Cash provided by our investing activities was approximately $66.3 million for
the nine months ended June 30, 2003. We generated a net amount of approximately $67.8 million from the net sale of short-term investments and $75,000 in net receipts associated with the finalization of the acquisitions of the businesses of Enviz,
Inc. (Enviz) and Envive Corporation (Envive). We utilized approximately $1.6 million for capital expenditures during this period. Cash provided by our investing activities was approximately $7.6 million for the nine months ended June 30, 2002.
During the nine months ended June 30, 2002, we generated a net amount of approximately $12.8 million from the net sale of short-term investments. We utilized approximately $3.0 million for property and equipment and approximately $2.2 million for
our acquisitions of the businesses of onDevice Corporation and Envive.



We used approximately $76.3 million for our financing activities for the nine months ended June 30, 2003. During the nine months ended June 30, 2003, we repurchased approximately 8.9 million shares for approximately $79.2 million, primarily
pursuant to the two issuer tender offers completed in November 2002 and May 2003. This was offset by approximately $2.9 million from the issuance of common stock associated with our employee stock option and stock purchase plans. As of June 30,
2003, the total number of shares repurchased since the initial repurchase program was authorized by our Board of Directors in January 2001 was approximately 10.3 million shares at an aggregate cost of approximately $89.4 million. We currently have
authorization to repurchase additional shares of our common stock for up to approximately $130.0 million, less common stock already repurchased. We used approximately $1.3 million for our financing activities for the nine months ended June 30, 2002.
We received $1.4 million from the issuance of common stock associated with our employee stock option and stock purchase plans, offset by $793,000 used for the repayment of notes payable for capital equipment leases, and $2.0 million used to
repurchase 249,000 shares of our common stock under our open market repurchase program.



As of June 30, 2003, our principal commitments consisted of $275,000 in real property operating leases, with various lease terms, the longest of which expires in December 2005. Additionally, we have contingent
commitments to 51 bandwidth and collocation providers amounting to $962,000 for 96 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 that we will make additional capital expenditures of approximately $600,000 related to our operations and headquarters building for the fourth quarter of fiscal 2003, excluding costs associated with
our acquisition of Streamcheck, completed in July 2003, and any other acquisitions or extraordinary transactions.



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, 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.



Critical Accounting Policies and Judgments



In preparing our condensed consolidated financial statements in accordance
with accounting principles generally accepted in the United States for interim financial statements, our management is required to make estimates and assumptions that affect the amounts reported in our condensed consolidated financial statements and
related notes. Actual results could differ from those estimates. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements.



Our critical accounting policies and judgments are of both a
routine and non-routine nature. The recurring policies relate to revenue recognition and the allowance for doubtful accounts receivable. The non-routine policy relates to the valuation of long-lived assets.



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Revenue Recognition



Subscription services revenue consists of fees from subscriptions to our Internet measurement, monitoring, testing and diagnostic services. Our
subscription services revenue is generally deferred upon invoicing and is recognized ratably over the service period, generally ranging from one to twelve months. For some customers, subscription services revenue is invoiced monthly upon completion
of the services. We do not generally grant refunds. All discounts granted are netted against revenue. Revenue is not recognized for free trial periods. Revenue from our consulting and support services, which includes revenue from our load testing
service, is recognized as the services are performed, typically over one to three month period. For consulting projects that span more than one month, we recognize revenue as milestones or deliverables are completed.



Allowance for Doubtful Accounts Receivable



Accounts receivable is recorded net of an allowance for doubtful account of
approximately $783,000, or 15%, of total accounts receivable and approximately $1.2 million, or 20%, of total accounts receivable as of June 30, 2003 and September 30, 2002, respectively. The decrease in our allowance for doubtful accounts is due to
improved collection experience as well as a reduction in loss experience. Our accounting policy for 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 aging of accounts receivable, the age of each invoice, 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. The allowance for doubtful accounts represents managements best current estimate, but changes in circumstances relating to accounts receivable may result in a requirement for additional
allowances in the future or reductions in allowances due to future recoveries.



Valuation of Long-Lived Assets



We evaluate
the recoverability of fixed assets and intangible assets other than goodwill whenever events or changes in circumstances indicate the carrying amount of any such asset group may not be fully recoverable. Changes in circumstances include economic
conditions or operating performance. Our evaluation is based upon assumptions about the estimated future undiscounted net cash flows from such asset groups. Management continually applies its best judgment when performing these evaluations to
determine the timing of the testing, the undiscounted net cash flows used to assess recoverability and the fair value of the asset group. If a future event or circumstance indicates 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.



Recent Accounting Pronouncements



In May 2003, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 150, Accounting for Certain Financial Instruments with Characteristics of both
Liabilities and Equity. SFAS No. 150 requires that certain financial instruments, which under previous guidance were accounted for as equity, must not be accounted for as liabilities. The financial instruments affected include mandatory
redeemable stock, certain financial instruments that require or may require the issuer to buy back some of its shares in exchange for cash or other assets and certain obligations that can be settled with shares of stock. SFAS No. 150 is effective
for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. We do not expect the adoption of SFAS No. 150 to have a material impact
on our consolidated financial position, results of operations or cash flows.



In November 2002, the Emerging Issues Task Force (EITF) reached a consensus on Issue No. 00-21, Revenue Arrangements with Multiple Deliverables. Issue 00-21 provides guidance on how to account for
arrangements that involve the delivery or performance of multiple products, services, and/or rights to use assets. The provisions of Issue 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We do
not believe that the adoption of Issue 00-21 will have a material effect on our consolidated financial position, results of operations or cash flows.



Factors That May Impact Future Operating Results



We have introduced new products and services, and we have an unproven business model, which makes it difficult to evaluate our current business and future prospects.



We have recently introduced many new products, including:



| |  |  | In January 2003, we released an updated version of our Wireless Perspective.
| | - |  | ----------------------------------------------------------------------------



| |  |  | In May 2003, we introduced two new Web transaction performance benchmarking indices, The Keynote Consumer E-Commerce Transaction Index and The Keynote e-Banking Transaction
Index.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In June 2003, we introduced our Best Practices for Total Performance Management for E-Government that are targeted at operations, application development and testing personnel
within federal, state and local government agencies. We also introduced an updated version of our WebIntegrity service.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | In July 2003, we introduced an updated version of our Transaction Perspective and Red Alert Performance Tracker services, and we acquired the business of Streamcheck.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



The revenue and income potential of our current
business and services and the related markets are unproven over the long term. In addition, because some of our products and services are new and because the market for web performance management and web performance testing services is evolving, we
have limited insight into trends that may emerge and affect our business.



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We have incurred losses and may, in the future, continue to incur losses, and we may never achieve profitability.



We have experienced operating losses in each quarterly
and annual period since inception. We incurred net losses of $1.3 million and $5.4 million for the three and nine months ended June 30, 2003, and as of June 30, 2003, we had an accumulated deficit of $142.7 million. In addition, we are required
under accounting principles generally accepted in the United States to review our identifiable intangible assets for impairment when events or circumstances indicate that the carrying value may not be recoverable. As of June 30, 2003, we had
approximately $2.3 million of identifiable intangible assets. If we complete acquisitions in the future, we may have additional goodwill and/or identifiable intangibles and, accordingly, may incur expenses in connection with a write-down of goodwill
and identifiable intangible assets due to changes in market conditions, as we did in fiscal 2002 when we recorded an impairment charge for goodwill of approximately $3.2 million in connection with acquisitions made prior to fiscal 2002. We must
continue to lower our operating expenses and generate sufficient revenue to achieve and sustain profitability.



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 and therefore, they could cease using our services at any time. In addition, our customers may renew for fewer services. Further, our customers may reduce their use of our services during the term of their
subscription. We cannot project the level of renewal rates. Our customer renewal rates may decline as a result of a number of factors, including consolidations in the Internet industry 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 an increase in cancellations and non-renewals in the past and may continue to experience an increased amount of cancellations and/or non-renewals.



We have experienced, and may in the future experience, cancellations and/or reduction in service. 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, our revenue could continue to decline unless we are able to obtain additional customers or sources of revenue,
sufficient to replace lost revenue. Continued reductions and/or cancellations could also result in our inability to collect amounts due.



Our quarterly financial results are subject to 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 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 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 new customers in a quarter, particularly larger customers;
|- |  | ---------------------------------------------------------------------------------



| |  | our ability to successfully introduce new products and services;
|- |  | ----------------------------------------------------------------



| |  | the timing and amount of consulting and support services revenue, which is difficult to predict in any given quarter due to the short-term nature of these engagements;
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  | the timing and amount of operating costs and capital expenditures relating to expansion or contraction of our domestic and international operations infrastructure;
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | the timing and amount, if any, of impairment charges related to potential write-downs of assets acquired in acquisitions; and
|- |  | -----------------------------------------------------------------------------------------------------------------------------



| |  | the timing and amount, if any, of restructuring costs if we are required to further restructure our operations.
|- |  | ---------------------------------------------------------------------------------------------------------------



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 our web performance benchmarking services decline.



Sales of our web performance benchmarking services, primarily our Web Site PerspectiveBusiness Edition services, and, to a lesser degree, our
Transaction Perspective services, have generated a majority of our total revenue. Therefore, the success of our business currently depends, and for the immediate future will continue to substantially depend, on sales and renewals of our benchmarking
services. We have, from time to time, increased the prices of all of our Perspective services, which could reduce demand for these services. This could result in decreased sales, which would cause our revenue to decline.



Improvements to the infrastructure of the Internet could reduce or eliminate demand for
our Internet performance measurement services.



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



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, in the past, 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 have acquired,
rather than developed internally, some of our services in connection with our acquisitions of companies and businesses. 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.



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



The ongoing evolution of the Internet requires us to
continually improve the functionality, features and reliability of our web performance management and web performance testing 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.



Our services and brand name might not attain the brand awareness necessary for our business to succeed.



We believe that maintaining and strengthening the Keynote brand in a
cost-effective manner is an important aspect of our business and an important element in attracting new customers. We may not be successful in building our brand in a cost-effective manner. If our brand-building strategy is unsuccessful, we may fail
to attract enough new customers or retain our existing customers to the extent necessary to realize a sufficient return on our brand-building efforts.



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



The market for web performance benchmarking, testing, and application
performance management 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 software and services with features similar to
our services such as Mercury Interactive, Gomez Advisors, Segue Software, WatchFire and a variety of small 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.



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 performance benchmarking, testing, and application performance management, such as WebCriteria, MIDS Matrix IQ
Service, and INS INSoft Division, an unit of Lucent Technologies, and free services that measure web site availability, including Internet Weather Report, a unit of MIDS Matrix IQ Service. In addition, companies that sell systems management
software, such as BMC Software, CompuWare, CA-Unicenter, HP-Openview, Quest Software, NetIQ, Precise Software (now part of Veritas Software), and IBMs Tivoli Unit, with some of whom we have strategic relationships, could choose to offer
services similar to ours.



In the future, we intend to expand
our service offerings and to continue to measure the impact of new technologies. These could include areas such as Internet telephony, and Web Services, 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.



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.



Ten customers accounted for approximately 32% of
our total revenue for the three months ended June 30, 2003. No single customer accounted for 10% or more of our total revenue for the three or nine months ended June 30, 2003. 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 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 web performance management and web performance testing
services, we may not be able to grow our business.



To
increase sales of our web performance management and web performance testing 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 fiscal 2002, we terminated relationships with two of our international resellers and may be required to terminate other reseller relationships in 2003. As a result, we are investing
time and resources in evaluating replacements for these resellers and are committing resources to modify our direct sales effort in the United Kingdom.



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. Although we, and a number of other technology companies, have implemented workforce reductions, there remains substantial competition for highly skilled employees. Our key employees are not bound by agreements that could prevent
them from terminating their employment at any time. 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.



Consulting and support services revenue represented approximately 8% and 9% of total revenue for the three and nine months
ended June 30, 2003, respectively. The cost of consulting and support services has, at times, exceeded our consulting revenue. We expect that the costs of consulting and support services as a percentage of consulting and support services revenue
will be greater than the costs of subscription services as a percentage of subscription services revenue. We will also need to successfully market these services to potential customers in order to increase revenue. Each consulting engagement
typically spans a one to three month period, and therefore, it is more difficult for us to predict the amount of consulting and support services revenue recognized in any particular quarter. There are many experienced firms that offer computer
network and Internet-related consulting services. These consulting services providers include consulting companies, such as Accenture and Ernst & Young, as well as consulting divisions of large technology companies such as IBM. Because we do not
have an established reputation for delivering consulting services, because this area is very competitive, and due to our limited experience in delivering consulting services, we may not succeed in selling these services.



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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 web performance management and web performance testing services, the Internet 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 for
conducting business transactions 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;
| | - |  | ---------------------------------------------------------------------------------------------------------------------------



| |  |  | inconsistent quality of service, including well-publicized outages of popular web sites;
| | - |  | ----------------------------------------------------------------------------------------



| |  |  | lack of availability of cost-effective, high-speed services;
| | - |  | ------------------------------------------------------------



| |  |  | limited numbers of local access points for corporate users;
| | - |  | -----------------------------------------------------------



| |  |  | delay in the development of enabling technologies or adoption of new standards;
| | - |  | -------------------------------------------------------------------------------



| |  |  | inability to integrate business applications with the Internet;
| | - |  | ---------------------------------------------------------------



| |  |  | the need to operate with multiple and frequently incompatible products; and
| | - |  | ---------------------------------------------------------------------------



| |  |  | a lack of tools to simplify access to and use of the Internet.
| | - |  | --------------------------------------------------------------



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. Therefore, our operations depend upon our ability to maintain and protect our computer systems, most of which are located at our corporate
headquarters in San Mateo, California, which is an area susceptible to earthquakes and possible power outages. We recently completed a generator project to provide our own source of long-term uninterruptible power. If, however, we experience regular
long-term power outages at our operations center, we might not be able to receive data from our measurement computers and we might not be able to deliver our services to our customers on a timely basis. We are currently developing a redundant system
for computer-network and other services at an alternate site. Various factors could cause us to not be able to ever complete such systems. 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, causing a disruption in our services, this 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, with the last one of significance occurring in October 2002. The outages that we have experienced have 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.





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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 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 are located at facilities that are not owned by our customers or us. Instead, these computers are installed at locations near
various Internet access points worldwide. Although we operate these computers remotely from our San Mateo, California operations center, we do not own or operate the facilities, and we have little control over how these computers 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 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. To date, we have little experience with direct sales outside the United States, and we may not succeed in these efforts. International sales were approximately 6% and 7% of our total revenue for the three and nine
months ended June 30, 2003, 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.
| | - |  | ----------------------------------------------------------------------







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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.



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;
| | - |  | -----------------------------------------------------------------------------



| |  |  | unanticipated costs associated with the acquisition;
| | - |  | ----------------------------------------------------



| |  |  | diversion of managements attention from other business concerns;
| | - |  | -----------------------------------------------------------------



| |  |  | adverse effects on existing business relationships with resellers of our service and our customers;
| | - |  | ---------------------------------------------------------------------------------------------------



| |  |  | difficulties in managing geographically-dispersed businesses;
| | - |  | -------------------------------------------------------------



| |  |  | 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.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------





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Our future operating results could be harmed if we are unable to lease a major portion of the space in our corporate
headquarters building or if the fair value of this property decreases further.



We estimate that we will need to lease the unoccupied portion, or approximately 60%, of our headquarters building in San Mateo, California. We may be unable to lease all or a part of the available space, and if it is
leased, we may not receive sufficiently high rental rates to cover our building operating costs. In addition, we have previously incurred a charge for the write-down of the building, and, if the real estate market continues to deteriorate, we may
incur charges for future write-downs. Any such charge could harm our results of operations.



Compliance with new rules and regulations concerning corporate governance may be costly and could harm our business.



The Sarbanes-Oxley Act, which was signed into law in July 2002, mandates, among other things, that companies adopt new corporate governance measures and
imposes comprehensive reporting and disclosure requirements, sets stricter independence and financial expertise standards for audit committee members 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 Stock Market, on which our common stock is listed, is also considering the adoption of additional comprehensive rules and regulations relating to
corporate governance. These laws, rules and regulations will increase the scope, complexity and cost of our corporate governance, reporting and disclosure practices, 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, we may have difficultly
attracting and retaining qualified board members and executive officers, which would adversely affect our 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. Key features of the rights plan include:



| |  |  | the rights will become exercisable only upon the occurrence of certain events specified in the rights plan, including the acquisition of 15% of our outstanding common stock by a
person or group;
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | each right entitles the holder, other than an acquiring person, to acquire shares of our common stock at a 50% discount to the then-prevailing market price; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | our Board of Directors may redeem outstanding rights at any time prior to a person becoming an acquiring person, at a price of $0.001 per right and, prior to such time,
the Board may amend the terms of the rights without the approval of the holders of the rights.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Item 3.    Qualitative and Quantitative Disclosures about Market Risks



Interest Rate Sensitivity.    Our interest income and expense is sensitive to changes in the general level of U.S. interest
rates, particularly because most of our cash, cash equivalents and short-term investments are invested in short-term debt instruments. If market interest rates were to change immediately and uniformly by ten percent (10%) from levels at June 30,
2003, the interest earned on those cash, cash equivalents, and short-term investments could increase or decrease by approximately $667,000 on an annualized basis.





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Foreign Currency Fluctuations and Derivative Transactions.    We have not had any significant
transactions in foreign currencies, nor do we have any significant balances that are due or payable in foreign currencies at June 30, 2003. We do not enter into derivative transactions for trading or speculative purposes.



Item 4.    Controls and Procedures



|(a) |  | Evaluation of Disclosure Controls and Procedures.
|--- |  | -------------------------------------------------



Within the 90 days prior to the date of this report, our Chief Executive Officer and our Chief Financial Officer performed an evaluation, with the participation of our
Disclosure Committee and other members of our management, of the effectiveness of the design and operation of our disclosure controls and procedures, which are defined under SEC rules as controls and other procedures of a company that
are designed to ensure that information required to be disclosed by a company in the reports that it files under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within required time periods. Based upon that
evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.



|(b) |  | Changes in Internal Controls
|--- |  | ----------------------------



There were no significant changes in our internal controls or other factors that could significantly affect these controls subsequent to the date of the evaluation
described in paragraph (a) above.



PART IIOTHER INFORMATION



Item 1.    Legal Proceedings



Beginning on August 16, 2001, a number of 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 are essentially identical, and were brought on behalf of those who purchased our securities between September 24, 1999 and August 19, 2001. These complaints allege 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 alleges that we had a duty to disclose the activities of the underwriters in the registration statement relating to our initial public offering. The complaints have been consolidated into a single action with cases
brought against over three hundred other issuers and their underwriters that make similar allegations regarding the initial public offerings of those issuers. The plaintiffs counsel and the individual named defendants counsel have
reached an agreement whereby the individual named defendants have been dismissed from the case, without any payments by us. We have accepted a settlement proposed by the plaintiffs and our Directors and Officers insurance carriers, which will not
require any payments by us. The final settlement is currently awaiting approval from the United States District Court for the Southern District of New York.



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 condensed consolidated financial position, results of operations, or cash flows.



Item 2.    Changes in 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 and Reports on Form 8-K



|(A) |  | Exhibits
|--- |  | --------



The following documents are filed as Exhibits to this Report:



|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.



|(b) |  | Reports on Form 8-K
|--- |  | -------------------



Not applicable.





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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 14th day of August 2003.





|KEYNOTE SYSTEMS, INC.
|---------------------
|                     
|By:                  
|                     
|                     
|By:                  
|                     
|                     
|By:                  
|                     







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EXHIBIT INDEX



|EXHIBIT NO. |  |                                                                                                                                                   
|----------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------
|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.