##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 Washington, D.C. 20549
 FORM 10-Q
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended December 31, 2007
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from to
 Commission File Number: 000-27241
 KEYNOTE SYSTEMS, INC.
 (Exact name of registrant as specified in its charter)
 Delaware
(State or other jurisdiction of 
incorporation or organization)
    
    94-3226488
(I.R.S. Employer
Identification No.)777 Mariners Island Blvd., San Mateo, CA
(Address of principal executive offices)
    
    94404
(Zip Code)
 Registrants telephone number, including area code: (650) 403-2400
 þ o
  o Large accelerated filer
    

þ Accelerated filer
    
    o Non-accelerated filer(Do not check if a smaller reporting company)
    
    o Smaller reporting company
 o þ
  Class
    
    Shares outstanding as of February 6, 2008Common Stock, $.001 par value
    
    18,811,866 including 1,653,164 treasury shares




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##### 



KEYNOTE SYSTEMS, INC.
 PagePART IFINANCIAL INFORMATIONItem 1.
    
    Unaudited Financial Statements
    
    
    3Item 2.
    
    Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    21Item 3.
    
    Quantitative and Qualitative Disclosures About Market Risks
    
    
    35Item 4.
    
    Controls and Procedures
    
    
    35PART IIOTHER INFORMATIONItem 1.
    
    Legal Proceedings
    
    
    36Item 1A.
    
    Risk Factors
    
    
    37Item 2.
    
    Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    44Item 3.
    
    Defaults Upon Senior Securities
    
    
    44Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    44Item 5.
    
    Other Information
    
    
    44Item 6.
    
    Exhibits
    
    
    45Signatures
    
    
    46EXHIBIT 31.1EXHIBIT 31.2EXHIBIT 32.1EXHIBIT 32.2
  2




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##### Table of Contents



PART IFINANCIAL INFORMATION
 
 Item 1. Unaudited Financial Statements.
 KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
Index to Unaudited Condensed Consolidated Financial Statements
 PageCondensed Consolidated Balance Sheets as of December 31, 2007 and September 30, 2007
    
    4Condensed Consolidated Statements of Operations for the three months ended December 31, 2007 and 2006
    
    5Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 2007 and 2006
    
    6Notes to Condensed Consolidated Financial Statements
    
    7
 3




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##### Table of Contents



KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (In thousands)
 (Unaudited)
 December 31,
    
    
    September 30,2007
    
    
    2007ASSETSCurrent assets:Cash and cash equivalents
    
    $
    41,563
    
    
    $
    42,875Short-term investments
    
    
    57,851
    
    
    
    65,060Total cash, cash equivalents, and short-term investments
    
    
    99,414
    
    
    
    107,935Accounts receivable, less allowance for doubtful
accounts and billing adjustment of $283 and $284 at of
December 31, 2007 and September 30, 2007, respectively
    
    
    7,732
    
    
    
    5,988Prepaids, deferred costs and other current assets
    
    
    3,720
    
    
    
    2,703Inventories
    
    
    1,173
    
    
    
    1,059Deferred tax assets
    
    
    3,954
    
    
    
    3,922Total current assets
    
    
    115,993
    
    
    
    121,607Deferred costs and other long-term assets
    
    
    3,105
    
    
    
    1,301Property and equipment, net
    
    
    35,724
    
    
    
    35,480Goodwill
    
    
    64,061
    
    
    
    63,129Identifiable intangible assets, net
    
    
    7,374
    
    
    
    7,963Total assets
    
    $
    226,257
    
    
    $
    229,480LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    1,959
    
    
    $
    2,285Accrued expenses
    
    
    13,277
    
    
    
    11,656Current portion of capital lease obligation
    
    
    21
    
    
    
    24Deferred revenue
    
    
    20,795
    
    
    
    19,824Total current liabilities
    
    
    36,052
    
    
    
    33,789Long-term portion of capital lease obligation
    
    
    28
    
    
    
    31Deferred rent and other long-term liabilities
    
    
    2,060
    
    
    
    292Long-term deferred revenue
    
    
    1,457
    
    
    
    2,136Long-term deferred tax liability
    
    
    2,420
    
    
    
    2,347Total liabilities
    
    
    42,017
    
    
    
    38,595Commitments and contingencies  see Note 10Stockholders equity:Common stock
    
    
    19
    
    
    
    18Treasury stock
    
    
    (10,944
    )
    
    
    (1,151
    )Additional paid-in capital
    
    
    328,098
    
    
    
    325,525Accumulated deficit
    
    
    (140,851
    )
    
    
    (140,188
    )Accumulated other comprehensive income
    
    
    7,918
    
    
    
    6,681Total stockholders equity
    
    
    184,240
    
    
    
    190,885Total liabilities and stockholders equity
    
    $
    226,257
    
    
    $
    229,480
  4




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##### Table of Contents



KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (In thousands, except per share amounts)
 (Unaudited)
 Three months ended December 31,2007
    
    
    2006Net revenue:Subscription services
    
    $
    10,872
    
    
    $
    10,507Ratable licenses
    
    
    4,002
    
    
    
    2,206Professional services
    
    
    2,846
    
    
    
    3,102Total revenue, net
    
    
    17,720
    
    
    
    15,815Costs and expensesCosts of revenueDirect costs of subscription services
    
    
    2,111
    
    
    
    2,058Direct costs of ratable licenses
    
    
    1,603
    
    
    
    1,083Direct costs of professional services
    
    
    1,805
    
    
    
    2,123Development
    
    
    3,133
    
    
    
    2,872Operations
    
    
    2,003
    
    
    
    1,842Amortization of intangible assets  software
    
    
    205
    
    
    
    183Total costs of revenue
    
    
    10,860
    
    
    
    10,161Sales and marketing
    
    
    5,767
    
    
    
    4,629General and administrative
    
    
    2,487
    
    
    
    2,379Excess occupancy income
    
    
    (281
    )
    
    
    (27
    )Amortization of intangible assets  other
    
    
    537
    
    
    
    576Total costs and expenses
    
    
    19,370
    
    
    
    17,718Loss from operations
    
    
    (1,650
    )
    
    
    (1,903
    )Interest income
    
    
    1,285
    
    
    
    1,121Interest and other expenses
    
    
    (135
    )
    
    
    Net loss before (provision for) benefit from income taxes
    
    
    (500
    )
    
    
    (782
    )(Provision for) benefit from income taxes
    
    
    (244
    )
    
    
    1,046Net (loss) income
    
    $
    (744
    )
    
    $
    264Net (loss) income per share:Basic
    
    $
    (0.04
    )
    
    $
    0.02Diluted
    
    $
    (0.04
    )
    
    $
    0.01Shares used in computing basic and diluted net (loss)
income per share:Basic
    
    
    18,237
    
    
    
    17,116Diluted
    
    
    18,237
    
    
    
    17,686
  5




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##### Table of Contents



KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (In thousands)
 (Unaudited)
 Three Months EndedDecember 31,2007
    
    
    2006Cash flows from operating activities:Net (loss) income
    
    $
    (744
    )
    
    $
    264Adjustments to reconcile net (loss) income to net cash provided by operating activities:Depreciation and amortization
    
    
    1,287
    
    
    
    1,093Stock-based compensation
    
    
    1,100
    
    
    
    920Charges to bad debt and billing adjustment reserves
    
    
    51
    
    
    
    83Accretion of debt investment discount
    
    
    (551
    )
    
    
    (245
    )Amortization of identifiable intangible assets
    
    
    742
    
    
    
    759Deferred tax assets and liabilities, net
    
    
    
    
    
    
    525Changes in operating assets and liabilities:Accounts receivable
    
    
    (1,768
    )
    
    
    (648
    )Inventories
    
    
    (87
    )
    
    
    217Prepaids, deferred costs and other assets
    
    
    (1,159
    )
    
    
    (1,021
    )Accounts payable and accrued expenses
    
    
    1,501
    
    
    
    (1,108
    )Deferred revenue
    
    
    (42
    )
    
    
    3,841Net cash provided by operating activities
    
    
    330
    
    
    
    4,680Cash flows from investing activities:Purchases of property and equipment
    
    
    (1,351
    )
    
    
    (704
    )Purchase of businesses and assets, net
    
    
    
    
    
    
    (307
    )Maturities and sales of short-term investments
    
    
    30,699
    
    
    
    8,363Purchases of short-term investments
    
    
    (23,171
    )
    
    
    (7,330
    )Net cash provided by investing activities
    
    
    6,177
    
    
    
    22Cash flows from financing activities:Repayment of credit facilities
    
    
    (7
    )
    
    
    (15
    )Proceeds from issuance of common stock and exercise of stock options
    
    
    1,595
    
    
    
    746Repurchase of outstanding common stock
    
    
    (9,815
    )
    
    
    Net cash provided by (used in) financing activities
    
    
    (8,227
    )
    
    
    731Effect of exchange rate changes on cash and cash equivalents
    
    
    408
    
    
    
    82Net change in cash and cash equivalents
    
    
    (1,312
    )
    
    
    5,515Cash and cash equivalents at beginning of the period
    
    
    42,875
    
    
    
    45,662Cash and cash equivalents at end of the period
    
    $
    41,563
    
    
    $
    51,177Supplemental cash flow disclosure:Income taxes paid (net of refunds)
    
    $
    198
    
    
    $
    183Noncash operating and investing activities:Acquisition of property, equipment and software on account
    
    $
    206
    
    
    $
    418
  6




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##### Table of Contents



KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
 (1) Basis of Presentation
      Recently Adopted Accounting Pronouncements
   7




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##### Table of Contents



Balance at September 30, 2007, as reported
    
    $
    ( 140,188
    )FIN 48 adjustments to beginning balance
    
    
    81Net loss during the period
    
    
    ( 744
    )Balance at December 31, 2007
    
    $
    ( 140,851
    )
  Stock Based Compensation
      Three Months EndedDecember 31,2007
    
    2006Stock Option Under Equity Incentive Plan:Volatility
    
    
    30.9
    %
    
    
    29.5
    %Risk free interest rate
    
    
    3.9
    %
    
    
    4.6
    %Expected life (in years)
    
    
    4.50
    
    
    
    3.83Dividend yield
    
    
    
    
    
    
    Employee Stock Purchase Plan:Volatility
    
    
    24.4
    %
    
    
    27.0
    %Risk free interest rate
    
    
    4.8
    
    
    
    5.1
    %Expected life (in years)
    
    
    1.25
    
    
    
    1.25Dividend yield
    
    
    
    
    
    
    
 8




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##### Table of Contents



AverageWeighted
    
    Remaining
    
    AggregateAverage
    
    Contractual
    
    IntrinsicShares
    
    Exercise Price
    
    Term (years)
    
    ValueOutstanding at September 30, 2007
    
    
    5,723
    
    
    $
    14.21
    
    
    
    6.8
    
    
    $
    15,482Granted
    
    
    454
    
    
    $
    14.90Exercised
    
    
    (174
    )
    
    $
    8.59Forfeited or canceled
    
    
    (22
    )
    
    $
    13.55Expired
    
    
    (1
    )
    
    $
    10.85Outstanding at December 31, 2007
    
    
    5,980
    
    
    $
    14.42
    
    
    
    6.8
    
    
    $
    16,202Exercisable at December 31, 2007
    
    
    3,610
    
    
    $
    15.76
    
    
    
    5.6
    
    
    $
    11,800
   Excess Occupancy Income
  Fiscal years:2008 (remaining nine months)
    
    $
    1,8902009
    
    
    2,3012010
    
    
    1,8052011
    
    
    1,6862012
    
    
    1,408Thereafter
    
    
    307Total future minimum rents receivable
    
    $
    9,397
 (2) Revenue Recognition
  
    
    Persuasive evidence of an arrangement exists.The Company considers a
customer signed quote, contract, or equivalent document to be evidence
of an arrangement.
    
    Delivery of the product or service. For subscription services,
delivery is considered to occur when the customer has been provided
with access to the subscription services. The Companys subscription
services are generally delivered on a consistent basis over the period
of the subscription. For professional services, delivery is considered
to occur when the services or milestones are completed. For ratable
licenses, delivery occurs when all elements of the arrangement have
either been delivered or accepted, if acceptance language exists.
    
    Fee is fixed and determinable.The Company considers the fee to be
fixed or determinable if the fee is not subject to refund or
adjustment and payment terms are standard.
 9




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##### Table of Contents




    
    Collection is deemed reasonably assured.Collection is deemed
reasonably assured if it is expected that the client will be able to
pay amounts under the arrangement as payments become due. If it is
determined that collection is not reasonably assured, then revenue is
deferred and recognized upon cash collection.
  Subscription Services Revenue:
    Ratable Licenses Revenue:
   Professional Services Revenue:
 10




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##### Table of Contents



Deferred Revenue:
 Deferred Costs:
 (3) Accumulated Other Comprehensive Income and Foreign Currency Translation
   Three Months EndedDecember 31,2007
    
    
    2006Net (loss) income
    
    $
    (744
    )
    
    $
    264Net unrealized gain on available-for-sale investments
    
    
    10
    
    
    
    59Foreign currency translation gain
    
    
    1,227
    
    
    
    1,177Comprehensive income
    
    $
    493
    
    
    $
    1,500
  11




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##### Table of Contents



(4) Financial Instruments and Concentration of Risk
    (5) Cash, Cash Equivalents, and Short-Term Investments
    Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Market ValueCash
    
    $
    24,688
    
    
    $
    
    
    
    $
    
    
    
    $
    24,688Commercial paper
    
    
    2,831
    
    
    
    
    
    
    
    
    
    
    
    2,831Money market mutual funds
    
    
    14,044
    
    
    
    
    
    
    
    
    
    
    
    14,044Total
    
    $
    41,563
    
    
    $
    
    
    
    $
    
    
    
    $
    41,563
  Gross
    
    
    GrossAmortized
    
    
    Unrealized
    
    
    Unrealized
    
    
    EstimatedCost
    
    
    Gains
    
    
    Losses
    
    
    Market ValueState government agency securities
    
    $
    9,250
    
    
    $
    
    
    
    $
    
    
    
    $
    9,250FNMA and FHLMC securities
    
    
    12,425
    
    
    
    9
    
    
    
    
    
    
    
    12,434Corporate bonds and commercial paper
    
    
    36,166
    
    
    
    11
    
    
    
    (10
    )
    
    
    36,167Total
    
    $
    57,841
    
    
    $
    20
    
    
    $
    (10
    )
    
    $
    57,851
 12




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##### Table of Contents



EstimatedAmortized
    
    MarketCost
    
    ValueTwelve month ending December 31, 2008
    
    $
    57,841
    
    
    $
    57,851
  (6) Inventories
  (7) Goodwill and Identifiable Intangible Assets
 :
 Balance at September 30, 2007
    
    $
    63,129Translation adjustments
    
    
    932Balance at December 31, 2007
    
    $
    64,061
  Technology
    
    
    TechnologyBased-
    
    
    Based-
    
    
    CustomerSoftware
    
    
    Other
    
    
    Based
    
    
    Trademark
    
    
    Covenant
    
    
    Backlog
    
    
    TotalAs of December 31, 2007:Gross carrying value
    
    $
    3,967
    
    
    $
    11,946
    
    
    $
    9,385
    
    
    $
    1,038
    
    
    $
    76
    
    
    $
    254
    
    
    $
    26,666Accumulated amortization
    
    
    (1,305
    )
    
    
    (11,255
    )
    
    
    (7,019
    )
    
    
    (552
    )
    
    
    (30
    )
    
    
    (91
    )
    
    
    (20,252
    )Translation adjustments
    
    
    314
    
    
    
    
    
    
    
    445
    
    
    
    154
    
    
    
    18
    
    
    
    29
    
    
    
    960Net carrying value at
December 31, 2007
    
    $
    2,976
    
    
    $
    691
    
    
    $
    2,811
    
    
    $
    640
    
    
    $
    64
    
    
    $
    192
    
    
    $
    7,374As of September 30, 2007:Gross carrying value
    
    $
    3,967
    
    
    $
    11,946
    
    
    $
    9,385
    
    
    $
    1,038
    
    
    $
    76
    
    
    $
    254
    
    
    $
    26,666Accumulated amortization
    
    
    (979
    )
    
    
    (11,197
    )
    
    
    (6,728
    )
    
    
    (504
    )
    
    
    (25
    )
    
    
    (77
    )
    
    
    (19,510
    )Translation adjustments
    
    
    247
    
    
    
    
    
    
    
    387
    
    
    
    134
    
    
    
    16
    
    
    
    23
    
    
    
    807Net carrying value at
September 30, 2007
    
    $
    3,235
    
    
    $
    749
    
    
    $
    3,044
    
    
    $
    668
    
    
    $
    67
    
    
    $
    200
    
    
    $
    7,963
  13




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##### Table of Contents



Technology
    
    
    TechnologyBased-
    
    
    Based-
    
    
    CustomerSoftware
    
    
    Other
    
    
    Based
    
    
    Trademark
    
    
    Covenant
    
    
    Backlog
    
    
    TotalRemaining nine
months of 2008
    
    $
    621
    
    
    $
    550
    
    
    $
    709
    
    
    $
    194
    
    
    $
    22
    
    
    $
    74
    
    
    $
    2,1702009
    
    
    828
    
    
    
    78
    
    
    
    587
    
    
    
    258
    
    
    
    14
    
    
    
    83
    
    
    
    1,8482010
    
    
    828
    
    
    
    13
    
    
    
    565
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,4062011
    
    
    828
    
    
    
    
    
    
    
    561
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,3892012
    
    
    
    
    
    
    
    
    
    
    561
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    561Total
    
    $
    3,105
    
    
    $
    641
    
    
    $
    2,983
    
    
    $
    452
    
    
    $
    36
    
    
    $
    157
    
    
    $
    7,374Weighted-average
remaining useful
lives as of
December 31, 2007
(years)
    
    
    3.8
    
    
    
    1.0
    
    
    
    4.3
    
    
    
    1.8
    
    
    
    1.2
    
    
    
    1.8
    
    
    
    3.6
 (8) Net (Loss) Income Per Share
   Three Months EndedDecember 31,2007
    
    
    2006Numerator:Net (loss) income
    
    $
    (744
    )
    
    $
    264Denominator:Denominator for basic net (loss) income per shareweighted average shares
    
    
    18,237
    
    
    
    17,116Incremental common shares attributable to shares issuable under stock
option and purchase plans
    
    
    
    
    
    
    580Reduction in shares for average unrecognized compensation costs
    
    
    
    
    
    
    (10
    )Denominator for diluted net (loss) income per shareweighted average shares
    
    
    18,237
    
    
    
    17,686
  (9) Income Taxes
  14




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##### Table of Contents



15




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##### Table of Contents



(10) Commitments and Contingencies
 (A) Leases
  Operating
    
    
    CapitalLeases
    
    
    LeasesFiscal year:2008 (remaining nine months)
    
    $
    667
    
    
    $
    202009
    
    
    769
    
    
    
    172010
    
    
    711
    
    
    
    162011
    
    
    514
    
    
    
    2012
    
    
    339
    
    
    
    Thereafter
    
    
    840
    
    
    
    Total minimum lease payments
    
    $
    3,840
    
    
    
    53Less amounts representing interest
    
    
    
    
    
    
    (4
    )Present value of minimum lease payments
    
    
    
    
    
    
    49Less current portion of capital lease obligation
    
    
    
    
    
    
    (21
    )Long-term portion of capital lease obligation
    
    
    
    
    
    $
    28
  (B) Commitments
 ,
 (C) Legal Proceedings
 In re Initial Public Offering Securities Litigation
  16




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##### Table of Contents



Simmonds v. JPMorgan Chase & Co.,
et al.
  (D) Warranties
  (E) Indemnification
  (11) Stock Repurchase Program
     (12) Geographic and Segment Information
  17




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##### Table of Contents



Subscription
    
    
    Ratable
    
    
    ProfessionalServices
    
    
    Licenses
    
    
    ServicesInternet Test and Measurement:Application Perspective
    
    
    XDiagnostic Services
    
    
    XEnterprise Adapters
    
    
    XLoadPro
    
    
    
    
    
    
    
    
    
    
    XNetMechanic
    
    
    XProfessional Services
    
    
    
    
    
    
    
    
    
    
    XRed Alert
    
    
    XStreaming Perspective
    
    
    XTest Perspective
    
    
    XTransaction Perspective
    
    
    XWebIntegrity
    
    
    XWeb Site Perspective
    
    
    XVoice Perspective
    
    
    XPerformance Scoreboard
    
    
    XMobile Test and Measurement:Mobile Device Perspective
    
    
    XMobile Application Perspective
    
    
    XSIGOS SITE
    
    
    
    
    
    
    XSIGOS Global Roamer
    
    
    XCustomer Experience Management:WebEffective
    
    
    X
    
    
    
    
    
    
    
    XFinancial Services Scorecards
    
    
    X
    
    
    
    
    
    
    
    X
  Three Months Ended December 31,2007
    
    
    2006Internet Subscriptions
    
    $
    8,877
    
    
    $
    8,884Internet Engagements
    
    
    1,596
    
    
    
    1,497Total Internet net revenue
    
    
    10,473
    
    
    
    10,381Mobile Subscription
    
    
    1,340
    
    
    
    997Mobile Ratable Licenses
    
    
    4,002
    
    
    
    2,206Total Mobile Subscriptions net revenue
    
    
    5,342
    
    
    
    3,203CEM Subscriptions
    
    
    655
    
    
    
    626CEM Engagements
    
    
    1,250
    
    
    
    1,605Total CEM net revenue
    
    
    1,905
    
    
    
    2,231Total net revenue
    
    $
    17,720
    
    
    $
    15,815
 18




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##### Table of Contents



Three Months EndedDecember 31,2007
    
    
    2006Revenues:United States
    
    $
    11,253
    
    
    $
    12,036Europe*
    
    
    5,222
    
    
    
    3,024Other*
    
    
    1,245
    
    
    
    755Total net revenue
    
    $
    17,720
    
    
    $
    15,815
 December 31,
    
    
    September 30,2007
    
    
    2007Long Lived Assets:United States
    
    $
    34,549
    
    
    $
    34,543Germany
    
    
    1,147
    
    
    
    905Other
    
    
    28
    
    
    
    32$
    35,724
    
    
    $
    35,480
 
 *
    
    No individual country represents more than 10% of total revenue.   (13) Recently Issued Accounting Pronouncements
    19




---



##### Table of Contents



20




---



##### Table of Contents



Item 2. Management Discussion and Analysis of Financial Condition and Results of Operations
   Overview
    21




---



##### Table of Contents



Critical Accounting Policies and Estimates
  
    
    Revenue recognition
    
    Allowance for doubtful accounts and billing allowance
    
    Inventories and inventory valuation
    
    Allocation of purchase price for business combinations
    
    Goodwill, identifiable intangible assets, and long-lived assets
    
    Stock-based compensation
    
    Income taxes, deferred income taxes and deferred income tax liabilities
 Revenue Recognition
  
    
    Persuasive evidence of an arrangement,
    
    Delivery of the product or service,
    
    Fee is fixed and determinable and
    
    Collection is deemed reasonably assured.
  22




---



##### Table of Contents



Subscription Services Revenue :
  Ratable License Revenue:
   Professional Services Revenue:
  23




---



##### Table of Contents



Deferred Revenue:
 Domestic
    
    
    International
    
    
    TotalNet deferred revenue
    
    $
    7,198
    
    
    $
    15,054
    
    
    $
    22,252Addback: unpaid deferred revenue
    
    
    1,406
    
    
    
    5,145
    
    
    
    6,551Gross deferred revenue at December 31, 2007
    
    $
    8,604
    
    
    $
    20,199
    
    
    $
    28,803Net deferred revenue
    
    $
    7,511
    
    
    $
    14,449
    
    
    $
    21,960Addback: unpaid deferred revenue
    
    
    3,085
    
    
    
    1,564
    
    
    
    4,649Gross deferred revenue at September 30, 2007
    
    $
    10,596
    
    
    $
    16,013
    
    
    $
    26,609
   Allowance for Doubtful Accounts and Billing Allowance
    Inventories and Inventory Valuation
   24




---



##### Table of Contents



Allocation of Purchase Price for Business Combinations
  Goodwill, Identifiable Intangible Assets and Long-Lived Assets
   
    
    significant changes in the manner of our use of the acquired assets or the strategy of our overall business;
    
    significant negative industry or economic trends;
    
    significant decline in our stock price for a sustained period; and
    
    our market capitalization relative to net book value.
    Stock-Based Compensation
  25




---



##### Table of Contents



Income Taxes, Deferred Income Tax Assets and Deferred Income Tax Liabilities
       26




---



##### Table of Contents



Results of Operations
  Three months ended December 31,2007
    
    
    2006Net revenue:Subscription services
    
    
    61.3
    %
    
    
    66.4
    %Ratable licenses
    
    
    22.6
    
    
    
    14.0Professional services
    
    
    16.1
    
    
    
    19.6Total revenue, net
    
    
    100.0
    
    
    
    100.0Costs and expenses:Costs of revenue:Direct costs of subscription services
    
    
    11.9
    
    
    
    13.1Direct costs of ratable licenses
    
    
    9.0
    
    
    
    6.8Direct costs of professional services
    
    
    10.2
    
    
    
    13.4Operations
    
    
    11.3
    
    
    
    11.6Development
    
    
    17.7
    
    
    
    18.2Amortization of intangible assets  software
    
    
    1.2
    
    
    
    1.2Sales and marketing
    
    
    32.6
    
    
    
    29.3General and administrative
    
    
    14.0
    
    
    
    15.0Excess occupancy income
    
    
    (1.6
    )
    
    
    (0.2
    )Amortization of intangible assets  other
    
    
    3.0
    
    
    
    3.6Total costs and expenses
    
    
    109.3
    
    
    
    112.0Loss from operations
    
    
    (9.3
    )
    
    
    (12.0
    )Interest income and other, net
    
    
    6.5
    
    
    
    7.1Net loss before (provision) benefit for income taxes
    
    
    (2.8
    )
    
    
    (4.9
    )(Provision for) benefit from income taxes
    
    
    (1.4
    )
    
    
    6.6Net (loss) income
    
    
    (4.2
    )%
    
    
    1.7
    %
 Comparison of the Quarters Ended December 31, 2007 and 2006
 Revenue
 For the three months ended December 31:
    
    2007
    
    
    2006
    
    
    % Change(In thousands)Subscription services
    
    $
    10,872
    
    
    $
    10,507
    
    
    
    3
    %Ratable licenses
    
    
    4,002
    
    
    
    2,206
    
    
    
    81
    %Professional services
    
    
    2,846
    
    
    
    3,102
    
    
    
    (8
    )%Total revenue, net
    
    $
    17,720
    
    
    $
    15,815
    
    
    
    12
    %
 Subscription Services
 27




---



##### Table of Contents



Ratable licenses.
 Professional Services
   Subscription
    
    
    Ratable
    
    
    ProfessionalServices
    
    
    Licenses
    
    
    ServicesInternet Test and Measurement:Application Perspective
    
    
    XDiagnostic Services
    
    
    XEnterprise Adapters
    
    
    XLoadPro
    
    
    
    
    
    
    
    
    
    
    XNetMechanic
    
    
    XProfessional Services
    
    
    
    
    
    
    
    
    
    
    XRed Alert
    
    
    XStreaming Perspective
    
    
    XTest Perspective
    
    
    XTransaction Perspective
    
    
    XWebIntegrity
    
    
    XWeb Site Perspective
    
    
    XVoice Perspective
    
    
    XPerformance Scoreboard
    
    
    XMobile Test and Measurement:Mobile Device Perspective
    
    
    XMobile Application Perspective
    
    
    XSIGOS SITE
    
    
    
    
    
    
    XSIGOS Global Roamer
    
    
    XCustomer Experience Management:WebEffective
    
    
    X
    
    
    
    
    
    
    
    XFinancial Services Scorecards
    
    
    X
    
    
    
    
    
    
    
    X
 28




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##### Table of Contents



%For the Three Months Ended December 31,
    
    2007
    
    
    2006
    
    
    Change(In thousands)Internet Subscriptions
    
    $
    8,877
    
    
    $
    8,884
    
    
    
    
    %Internet Engagements
    
    
    1,596
    
    
    
    1,497
    
    
    
    7
    %Total Internet net revenue
    
    
    10,473
    
    
    
    10,381
    
    
    
    1
    %Mobile Subscription
    
    
    1,340
    
    
    
    997
    
    
    
    35
    %Mobile Ratable Licenses
    
    
    4,002
    
    
    
    2,206
    
    
    
    81
    %Total Mobile net revenue
    
    
    5,342
    
    
    
    3,203
    
    
    
    67
    %CEM Subscriptions
    
    
    655
    
    
    
    626
    
    
    
    5
    %CEM Engagements
    
    
    1,250
    
    
    
    1,605
    
    
    
    (22)
    %Total CEM net revenue
    
    
    1,905
    
    
    
    2,231
    
    
    
    (15)
    %Total net revenue
    
    $
    17,720
    
    
    $
    15,815
    
    
    
    12
    %
     Expenses:
 Direct Costs of Subscription Services, Ratable Licenses and Professional Services
 For the three months ended December 31:
    
    2007
    
    2006
    
    % Change(In thousands)Direct costs of subscription services
    
    $
    2,111
    
    
    $
    2,058
    
    
    
    3
    %Direct costs of ratable licenses
    
    $
    1,603
    
    
    $
    1,083
    
    
    
    48
    %Direct costs of professional services
    
    $
    1,805
    
    
    $
    2,123
    
    
    
    (15)
    %
 29




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##### Table of Contents



Direct Costs of Subscription Service
 Direct Costs of Ratable Licenses.
 Direct Costs of Professional Services.
 Development
 For the three months ended December 31:
    
    2007
    
    2006
    
    % Change(In thousands)Development
    
    $
    3,133
    
    
    $
    2,872
    
    
    
    9
    %
  Operations
 For the three months ended December 31:
    
    2007
    
    2006
    
    % Change(In thousands)Operations
    
    $
    2,003
    
    
    $
    1,842
    
    
    
    9
    %
  30




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##### Table of Contents



Sales and Marketing
 For the three months ended December 31:
    
    2007
    
    2006
    
    % Change(In thousands)Sales and marketing
    
    $
    5,767
    
    
    $
    4,629
    
    
    
    25
    %
  General and Administrative
 For the three months ended December 31:
    
    2007
    
    2006
    
    % Change(In thousands)General and administrative
    
    $
    2,487
    
    
    $
    2,379
    
    
    
    5
    %
  Excess Occupancy Income
 For the three months ended December 31:
    
    2007
    
    
    2006
    
    
    % Change(In thousands)Rental income
    
    $
    (607
    )
    
    $
    (277
    )
    
    
    119
    %Rental and other expenses
    
    
    326
    
    
    
    250
    
    
    
    30
    %Excess occupancy income
    
    $
    (281
    )
    
    $
    (27
    )
    
    
    941
    %
  Amortization of Identifiable Intangible Assets
 For the three months ended December 31:
    
    2007
    
    
    2006
    
    
    % Change(In thousands)Amortization of identifiable intangible assets  software
    
    $
    205
    
    
    $
    183
    
    
    
    12
    %Amortization of identifiable intangible assets  other
    
    
    537
    
    
    
    576
    
    
    
    (7
    )Total amortization of identifiable intangible assets
    
    $
    742
    
    
    $
    759
    
    
    
    (2)
    %
 31




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##### Table of Contents



Technology
    
    Technology
    
    CustomerBased - Software
    
    Based - Other
    
    Based
    
    Trademark
    
    Covenant
    
    Backlog
    
    TotalNet carrying value at December 31, 2007
    
    $
    2,976
    
    
    $
    691
    
    
    $
    2,811
    
    
    $
    640
    
    
    $
    64
    
    
    $
    192
    
    
    $
    7,374
 Interest Income and Interest and Other Expenses
 For the three months ended December 31:
    
    2007
    
    
    2006
    
    
    % Change(In thousands)Interest income
    
    $
    1,285
    
    
    $
    1,121
    
    
    
    15
    %Interest and other expenses
    
    
    (135
    )
    
    
    
    
    
    
    N/AInterest income, interest and other expenses, net
    
    $
    1,150
    
    
    $
    1,121
    
    
    
    3
    %
  (Provision) Benefit for Income Taxes
 For the three months ended December 31:
    
    2007
    
    2006
    
    % Change(In thousands)Benefit (provision) for income taxes
    
    $
    (244
    )
    
    $
    1,046
    
    
    
    (123)
    %
  Stock-based Compensation Expense
  32




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##### Table of Contents



Three months ended December 31,2007
    
    
    2006(in thousands)Direct costs of ratable licenses
    
    $
    49
    
    
    $
    36Direct costs of professional services
    
    
    115
    
    
    
    140Development
    
    
    230
    
    
    
    209Operations
    
    
    145
    
    
    
    147Sales and marketing
    
    
    327
    
    
    
    281General and administrative
    
    
    234
    
    
    
    107Stock-based compensation expense
related to stock options and
employee stock purchase plan
    
    $
    1,100
    
    
    $
    920
 Liquidity and Capital Resources
 December 31,
    
    September 30,2007
    
    2007(In thousands)Cash, cash equivalents and short-term investments
    
    $
    99,414
    
    
    $
    107,935Accounts receivable, net
    
    $
    7,732
    
    
    $
    5,988Working capital
    
    $
    79,941
    
    
    $
    87,818Days sales in accounts receivable (DSO) (a)
    
    
    40
    
    
    
    35
 
 (a)
    
    DSO is calculated as: ((ending net accounts receivable) / net sales for the three months period) multiplied by
number of days in the periodThe DSOs presented in the table above reflect the three months ended December 31, 2007 and September 30, 2007.
 2007
    
    2006(In thousands)For the three months ended December 31Cash provided by operating activities
    
    $
    330
    
    
    $
    4,680Cash provided by investing activities
    
    $
    6,177
    
    
    $
    22Cash provided by (used in) financing activities
    
    $
    (8,227
    )
    
    $
    731
 Cash, cash equivalents and short-term investments
  Cash provided by operating activities
   33




---



##### Table of Contents



Cash provided by investing activities
  Cash provided by financing activities
   Commitments
   Off Balance Sheet Arrangements
  Recently Issued Accounting Pronouncements
  34




---



##### Table of Contents



Item 3. Quantitative and Qualitative Disclosures About Market Risks.
 Interest Rate Sensitivity.
 Foreign Currency Fluctuations and Derivative Transactions.
 
 Item 4. Controls and Procedures
 (a) Changes in Internal Controls
  35




---



##### Table of Contents



(b) Evaluation of Disclosure Controls and Procedures
   
 PART IIOTHER INFORMATION
 
 Item 1. Legal Proceedings
 In re Initial Public Offering Securities Litigation
  36




---



##### Table of Contents



Simmonds v. JPMorgan Chase & Co.,
et al.
  
 Item 1A.Risk Factors
 We have incurred in the past and may in the future continue to incur losses, and we may not achieve
and thereafter sustain profitability.
  The success of our business depends on customers renewing their subscriptions for our services and
purchasing additional services as well as obtaining new customers.
   Our quarterly financial results are subject to significant fluctuations, and if our future results
are below the expectations of investors, the price of our common stock may decline.
  
    
    The rate of new and renewed subscriptions to our services;
    
    The effect of any unforeseen or unplanned operating expenses;
    
    The amount and timing of any reductions by our customers in their usage of our services;
    
    Our ability to increase the number of Web sites we measure and the scope of services we
offer for our existing customers in a particular quarter;
    
    Our ability to attract and retain new customers in a quarter, particularly larger
enterprise customers;
    
    The timing and service period of orders received during a quarter;
 37




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##### Table of Contents




    
    Our ability to successfully introduce new products and services to offset any
reductions in revenue from services that are not as widely used or that are
experiencing decreased demand such as our CEM services;
    
    The level of sales of our MTM products and services and timing of customer acceptance
during the period;
    
    The timing and amount of professional services revenue, which is difficult to predict
because this is dependent on the number of professional services engagements in any
given period, the size of these engagements, and our ability to continue our existing
engagements and secure new engagements from customers;
    
    Our ability to increase sales of each of our three service lines;
    
    The timing and amount of operating costs, including sales and marketing, investments
and capital expenditures relating to changes of our domestic and international
operations infrastructure; and
    
    The timing and amount, if any, of impairment charges related to potential write-down of
acquired assets in acquisitions or charges related to the amortization of intangible
assets from acquisitions.
  Our operating results could be harmed if sales of ITM subscriptions decline.
  If our MTM services do not continue to grow as rapidly, we may not be able to grow our revenue and
our profitability could be harmed.
  Improvements to the infrastructure of the Internet and mobile networks could reduce or eliminate
demand for our ITM and MTM services.
  38




---



##### Table of Contents



If we do not continually improve our services in response to technological changes, including
changes to the Internet and mobile networks, we may encounter difficulties retaining existing
customers and attracting new customers.
   We face competition that could make it difficult for us to acquire and retain customers.
       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.
  39




---



##### Table of Contents



Our investment in sales and marketing may not yield increased customers or revenues.
  Our business could be harmed by adverse economic conditions or reduced spending on information
technology.
  If we do not complement our direct sales force with relationships with other companies to help
market our services, we may not be able to grow our business.
   We must retain qualified personnel in a competitive marketplace, or we may not be able to grow our
business.
  If the market does not accept our professional services, our results of operations could be harmed.
  The success of our business depends on the continued use of the Internet and mobile networks by
business and consumers for e-business and communications and if usage of these networks declines,
our operating results and working capital would be harmed.
  
    
    security concerns including the potential for fraud or theft of stored data and information
communicated over the Internet and mobile networks;
    
    inconsistent quality of service, including outages of popular Web sites and mobile networks;
 40




---



##### Table of Contents




    
    delay in the development or adoption of new standards;
    
    inability to integrate business applications with the Internet; and
    
    the need to operate with multiple and frequently incompatible products.
 The inability of our services to perform properly could result in loss of or delay in revenue,
injury to our reputation or other harm to our business.
   A disruption to our network infrastructure could impair our ability to serve and retain existing
customers or attract new customers
     Our measurement computers and mobile devices are located at sites that we do not own or operate,
and it could be difficult for us to maintain or repair them if they do not function properly.
  41




---



##### Table of Contents



Others might bring infringement claims which could harm our business.
  Our business which includes our operating results and financial conditions will be susceptible to
additional risks associated with international operations.
  
    
    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.
  Industry consolidation may lead to stronger competition and may harm our operating results.
  We failed to maintain the adequacy of our internal controls, consequently, our ability to provide
accurate financial statements could be impaired and any failure to maintain our internal controls
and provide accurate financial statements could cause our stock price to decrease substantially.
  42




---



##### Table of Contents



We may face difficulties assimilating, and may incur costs associated with, any future
acquisitions.
  
    
    difficulties in assimilating acquired personnel, operations and technologies;
    
    difficulties in managing a larger organization with geographically dispersed operations;
    
    unanticipated costs associated with the acquisition or incurring of additional unknown
liabilities;
    
    diversion of managements attention from other business concerns;
    
    entry in new businesses in which we have little direct experience;
    
    difficulties in marketing additional services to the acquired companies customer base
or to our customer base;
    
    adverse effects on existing business relationships with resellers of our services, our
customers and other business partners;
    
    the need to integrate or enhance the systems of an acquired business;
    
    impairment charges related to potential write-down of acquired assets in acquisitions;
    
    failure to realize any of the anticipated benefits of the acquisition; and
    
    use of substantial portions of our available cash or dilution in equity if stock is
used to consummate the acquisition and/or operate the acquired business.
 The market price of our common stock is volatile.
  We are exposed to fluctuations in the market values of our money market funds and investments; impairment of our money market funds or investments could harm our earnings
  We have anti-takeover protections that may delay or prevent a change in control that could benefit
our stockholders.
  
    
    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.
  43




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##### Table of Contents



Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
  Dollar Value ofTotal
    
    Shares ThatTotal
    
    
    
    
    
    Number of Shares
    
    May Yet beNumber of
    
    Average
    
    Purchased as Part of
    
    PurchasedShares
    
    Price Paid
    
    Publicly Announced
    
    Under the PlansPeriod
    
    Purchased
    
    per Share
    
    Plans or Programs(1)
    
    or Programs(1)(In thousands)October 1, 2007 to
October 31, 2007
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    56,610November 1, 2007 to
November 30, 2007
    
    
    95,976
    
    
    $
    13.94
    
    
    
    
    
    
    $
    55,272December 1, 2007 to
December 31, 2007
    
    
    611,244
    
    
    $
    13.83
    
    
    
    486,107
    
    
    $
    46,817Balance as of
December 31, 2007
    
    
    707,220
    
    
    $
    13.85
    
    
    
    486,107
    
    
    $
    46,817
 
 Item 3. Defaults Upon Senior Securities
  
 Item 4. Submission of Matters to a Vote of Security Holders
  
 Item 5. Other Information
  44




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##### Table of Contents



Item 6. Exhibits
 EXHIBIT INDEX
 Exhibit
    
    
    
    Incorporated by ReferenceFiledForm
    
    File No.
    
    Filing Date
    
    Exhibit No.
    
    Herewith31.1
    
    Certification
of Periodic Report
by Chief Executive
Officer under
Section 302 of the
Sarbanes-Oxley Act
of 2002
    
    
    
    
    
    
    
    
    
    X31.2
    
    Certification
of Periodic Report
by Chief Financial
Officer under
Section 302 of the
Sarbanes-Oxley Act
of 2002
    
    
    
    
    
    
    
    
    
X32.1
    
    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 *
    
    
    
    
    
    
    
    
    
    X32.2
    
    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 *
    
    
    
    
    
    
    
    
    
    X
 
 *
    
    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. 45




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##### Table of Contents



SIGNATURES
  KEYNOTE SYSTEMS, INC.By:
    
    /s/ UMANG GUPTAUmang GuptaChairman of the Board and Chief Executive Officer(Principal Executive Officer)By:
    
    /s/ ANDREW HAMERAndrew HamerVice President and Chief Financial Officer(Principal Financial and Accounting Officer)
 46




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##### Table of Contents



EXHIBIT INDEX
 Exhibit
    
    
    
    Incorporated by ReferenceFiledForm
    
    File No.
    
    Filing Date
    
    Exhibit No.
    
    Herewith31.1
    
    Certification
of Periodic Report
by Chief Executive
Officer under
Section 302 of the
Sarbanes-Oxley Act
of 2002
    
    
    
    
    
    
    
    
    
    X31.2
    
    Certification
of Periodic Report
by Chief Financial
Officer under
Section 302 of the
Sarbanes-Oxley Act
of 2002
    
    
    
    
    
    
    
    
    
    X32.1
    
    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 *
    
    
    
    
    
    
    
    
    
    X32.2
    
    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 *
    
    
    
    
    
    
    
    
    
    X
 
 *
    
    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.