UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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 March 31, 2013

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

For the transition period from to

Commission File Number: 000-27241

KEYNOTE SYSTEMS, INC.

(Exact name of registrant as specified in its charter)

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

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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

Large accelerated filer o		Accelerated filer x

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

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

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

Class		Shares outstanding as of May 3, 2013
Common Stock, $.001 par value		18,448,775 shares

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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share amounts and par value)

(Unaudited)

	March 31, 2013			September 30, 2012
ASSETS
Current assets:
Cash and cash equivalents	$	31,110		$	28,956
Short-term investments	26,804			20,983
Total cash, cash equivalents and short-term investments	57,914			49,939
Accounts receivable, less allowance for doubtful accounts of $588 and $632, respectively, and less billing reserve of $171 and $150, respectively	15,492			17,395
Inventories	2,193			1,980
Deferred tax assets	5,287			6,076
Other current assets	3,456			2,776
Total current assets	84,342			78,166
Property, equipment and software, net	34,951			35,165
Goodwill	110,139			110,253
Identifiable intangible assets, net	7,686			9,060
Long-term deferred tax assets	32,320			33,392
Other long-term assets	998			929
Total assets	$	270,436		$	266,965

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	2,404		$	2,393
Accrued expenses	9,810			11,301
Deferred revenue	14,158			15,626
Total current liabilities	26,372			29,320
Long-term income tax payable	3,409			3,376
Long-term deferred revenue	1,716			1,093
Other long-term liabilities	468			448
Total liabilities	31,965			34,237

Commitments and contingencies (see Note 16)
Stockholders’ equity:
Common stock—$0.001 par value; 100,000,000 shares authorized; 18,448,775 and 17,936,383 shares issued and outstanding, respectively	19			18
Additional paid-in capital	319,762			316,125
Accumulated deficit	(80,092		)	(82,358		)
Accumulated other comprehensive loss	(1,218		)	(1,057		)
Total stockholders’ equity	238,471			232,728
Total liabilities and stockholders’ equity	$	270,436		$	266,965

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 Ended March 31,						Six Months Ended March 31,
	2013			2012			2013			2012

Subscriptions and services revenue	$	26,087		$	26,569		$	54,680		$	53,893
Systems licenses revenue	3,243			4,023			8,562			9,778
Net revenue (Note 4):	29,330			30,592			63,242			63,671
Costs and expenses:
Costs of revenue:
Direct costs of revenue — subscriptions and services	7,841			7,620			15,450			14,813
Direct costs of revenue — systems licenses	803			1,071			2,285			2,472
Development	4,990			4,688			9,828			9,067
Operations	2,995			2,667			5,744			5,163
Amortization of intangible assets — technology	383			525			908			990
Total costs of revenue	17,012			16,571			34,215			32,505
Sales and marketing	9,473			8,874			18,494			18,012
General and administrative	3,178			3,801			6,829			7,909
Change in estimated fair value of acquisition-related contingent consideration	—			—			—			(2,000		)
Excess occupancy income	(556		)	(388		)	(1,072		)	(738		)
Amortization of intangible assets — other	168			969			466			1,779
Total costs and expenses	29,275			29,827			58,932			57,467
Income from operations	55			765			4,310			6,204
Interest income	32			39			57			85
Other income (expense), net	31			(51		)	(133		)	(37		)
Income before benefit (provision) for income taxes	118			753			4,234			6,252
Benefit (provision) for income taxes	204			(419		)	(1,968		)	(1,797		)
Net income	$	322		$	334		$	2,266		$	4,455

Net income per share:
Basic	$	0.02		$	0.02		$	0.13		$	0.26
Diluted	$	0.02		$	0.02		$	0.12		$	0.24
Shares used in computing basic and diluted net income per share:
Basic	18,174			17,376			18,066			17,335
Diluted	18,677			18,553			18,539			18,540

Cash dividends declared and paid per common share	$	0.00		$	0.06		$	0.12		$	0.12

See accompanying notes to the condensed consolidated financial statements.

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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(In thousands)

(Unaudited)

	Three Months Ended March 31,					Six Months Ended March 31,
	2013			2012		2013			2012

Net income	$	322		$	334	$	2,266		$	4,455
Other comprehensive income (loss):
Foreign currency translation gain (loss)	(1,553		)	1,569		(170		)	(160		)
Unrealized gain on available-for-sale investments	5			67		17			119
Tax expense on unrealized gain on available-for-sale investments	(5		)	—		(8		)	—
Total other comprehensive income (loss)	(1,553		)	1,636		(161		)	(41		)
Total comprehensive income (loss)	$	(1,231	)	$	1,970	$	2,105		$	4,414

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)

	Six Months Ended March 31,
	2013			2012

Cash flows from operating activities:
Net income	$	2,266		$	4,455
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation	2,973			2,704
Stock-based compensation	2,541			2,872
Amortization of identifiable intangible assets	1,374			2,769
Deferred tax expense	1,850			1,523
Charges to bad debt and billing reserves	210			233
Amortization of debt investment premium	20			199
Change in estimated fair value of acquisition-related contingent consideration	—			(2,000		)
Amortization of prepaid tax asset	—			65
Loss on disposal of equipment	15			9
Changes in operating assets and liabilities:
Accounts receivable	1,703			(2,103		)
Inventories	(224		)	(542		)
Other assets	(756		)	(489		)
Accounts payable and accrued expenses	(1,474		)	425
Deferred revenue	(823		)	(4,004		)
Net cash provided by operating activities	9,675			6,116
Cash flows from investing activities:
Purchases of property, equipment and software	(2,723		)	(3,247		)
Acquisition of Mobile Complete, Inc. (Note 3)	—			(60,000		)
Maturities and sales of short-term investments	15,320			5,363
Purchases of short-term investments	(21,147		)	(1,649		)
Net cash used in investing activities	(8,550		)	(59,533		)
Cash flows from financing activities:
Proceeds from issuance of common stock and exercise of stock options	3,255			1,466
Cash dividends declared and paid	(2,158		)	(2,081		)
Net cash provided by (used in) financing activities	1,097			(615		)
Effect of exchange rate changes on cash and cash equivalents	(68		)	81
Net change in cash and cash equivalents	2,154			(53,951		)
Cash and cash equivalents at beginning of the period	28,956			85,573
Cash and cash equivalents at end of the period	$	31,110		$	31,622
Supplemental cash flow disclosure:
Income taxes paid (net of refunds)	$	377		$	20
Noncash operating and investing activities:
Acquisition of property, equipment and software on account	$	669		$	327

See accompanying notes to the condensed consolidated financial statements.

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(2) Net Income Per Share

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

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

	Three Months Ended March 31,				Six Months Ended March 31,
	2013		2012		2013		2012
Numerator:
Net income	$	322	$	334	$	2,266	$	4,455
Denominator:
Weighted average shares outstanding	18,174		17,376		18,066		17,335
Effect of dilutive securities	503		1,177		473		1,205
Weighted average shares—diluted	18,677		18,553		18,539		18,540
Net income per share:
Basic	$	0.02	$	0.02	$	0.13	$	0.26
Diluted	$	0.02	$	0.02	$	0.12	$	0.24

For the three months ended March 31, 2013 and 2012, there were 0.1 million and 0.3 million, respectively, shares of potentially dilutive securities excluded from the computation of diluted net income per share because their effect would be antidilutive. Potentially dilutive securities representing zero and 0.3 million shares of common stock for the six months ended March 31, 2013 and 2012, respectively, were excluded from the computation of diluted net income per share for these periods because their effect would be antidilutive.

(3) Business Combination

On October 18, 2011, the Company acquired Mobile Complete, Inc., doing business as DeviceAnywhere (“DeviceAnywhere”). DeviceAnywhere developed an enterprise-class, cloud-based mobile application lifecycle management testing and quality assurance platform. DeviceAnywhere’s products and services complement and expand the Company’s market for testing and monitoring the functionality, usability, performance and availability of mobile applications and mobile Web sites. The acquisition date fair value of consideration transferred, assets acquired and liabilities assumed are presented below and represent our best estimates.

Fair Value of Consideration Transferred

Pursuant to the merger agreement, the Company made cash payments totaling $60.0 million for all of the outstanding securities of DeviceAnywhere on October 18, 2011. Under the terms of the merger agreement, the former stockholders of DeviceAnywhere potentially could have received additional payments (“acquisition-related contingent consideration”) totaling up to $30.0 million in cash. The “2011 earnout” of up to $15.0 million in cash was based on achievement of certain DeviceAnywhere revenue and EBITDA targets for the period from January 1, 2011 through December 31, 2011. The “2012 earnout” of up to $15.0 million in cash required achievement of 1) certain booking targets for the period from September 1, 2011 through December 31, 2011 and 2) revenue and EBITDA targets for the period from January 1, 2012 through December 31, 2012. The 2011 earnout and the 2012 earnout collectively represent the acquisition-related contingent consideration. The fair value of the acquisition-related contingent consideration was based on significant inputs not observed in the market and thus represented a Level 3 measurement. Level 3 instruments are valued based on unobservable inputs that are supported by little or no market activity and reflect the Company’s own assumptions to estimate fair value.

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In preparing the preliminary purchase price allocation as of the acquisition date, management estimated the fair value of the acquisition-related contingent consideration based on the estimated level of achievement of the 2011 earnout and 2012 earnout. As a result, a $2.0 million liability was recorded at the acquisition date for the fair value of the acquisition-related contingent consideration. Any change in the fair value of the acquisition-related contingent consideration subsequent to the acquisition date, including changes from events after the acquisition date, such as changes in the estimate of revenues and EBITDA that are expected to be achieved, are recognized in earnings in the period the estimated fair value changes. In the quarter ended December 31, 2011, the Company concluded that the targets for both the 2011 earnout and the 2012 earnout would not be met and the former stockholders of DeviceAnywhere would not receive any acquisition-related contingent consideration. Accordingly, during the first quarter of fiscal 2012, the Company reversed the previously estimated liability and recorded a $2.0 million benefit in its operating results due to the change in the fair value of acquisition-related contingent consideration.

The total acquisition date fair value of the consideration transferred was $60.0 million, inclusive of $6.0 million in cash allocated to an escrow fund to satisfy indemnification obligations pursuant to the merger agreement and the settlement of various debt and transaction related liabilities of DeviceAnywhere totaling $4.5 million.

Allocation of Consideration Transferred

The identifiable assets acquired and liabilities assumed were recognized and measured as of the acquisition date based on their estimated fair values. The excess of the fair value of consideration transferred over estimated fair value of the net tangible assets and intangible assets was recorded as goodwill.

The following table summarizes the estimated fair values of the assets and liabilities assumed based on the purchase price allocation (in thousands):

Accounts receivable	$	2,758
Other assets, including deferred tax assets	1,009
Fixed assets	1,208
Identifiable intangible assets	13,170
Total identifiable assets acquired	18,145
Accounts payable and other liabilities	(2,334		)
Contingent consideration	(2,000		)
Deferred revenue	(3,126		)
Total liabilities assumed	(7,460		)
Net identifiable assets acquired	10,685
Goodwill	49,315
Amount paid	$	60,000

Identifiable Intangible Assets

Management engaged a third-party valuation firm to assist in the determination of the fair value of the identifiable intangible assets. In determining the fair value of the identifiable intangible assets, the Company considered, among other factors, the best use of acquired assets, analyses of historical financial performance and estimates of future performance of DeviceAnywhere’s products. The fair values of identifiable intangible assets were calculated considering market participant expectations and using an income approach. The rate utilized to discount estimated net cash flows to their present values were based on a weighted average cost of capital of 12.5%. This discount rate was determined after consideration of the rate of return on debt capital and equity that typical investors would require from an investment in companies similar in size and operating in similar markets as DeviceAnywhere. The following table sets forth the components of identifiable intangible assets associated with the DeviceAnywhere acquisition, as of the acquisition date, and their estimated useful lives (in thousands, except useful life):

	Useful life (Years)	Fair Value
Technology	3-6	$	6,470
Backlog	1	2,700
Customer relationships	6	2,600
Trademarks	8	1,100
Non-compete agreements	3	300
Total identifiable intangible assets		$	13,170

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The Company determined the useful lives of the identifiable intangible assets based on the expected future cash flows associated with the respective asset. Technology is comprised of products that have reached technological feasibility and are part of DeviceAnywhere’s product line. There were no in-process research and development assets as of the acquisition date. Backlog represents the fair value of firm orders for products and services to be delivered to customers. Customer relationships represent the underlying relationships and agreements with DeviceAnywhere’s installed customer base. Trademarks represent the fair value of the brand and name recognition associated with the marketing of DeviceAnywhere’s products and services. Non-compete agreements represent the fair value of employee knowledge in the development of products and services. Amortization expense for technology is included in costs of revenue, and amortization expense for backlog, customer relationships, trademarks, and non-compete agreements are included in operating expenses.

Deferred Revenue

In connection with the allocation of consideration transferred, the Company estimated the fair value of the service obligations assumed from DeviceAnywhere as a consequence of the acquisition. The estimated fair value of the service obligations was determined using a cost build-up approach. The cost build-up approach determines fair value by estimating the costs related to fulfilling the obligations plus a normal profit margin. The sum of the costs and operating profit approximates, in theory, the amount that the Company would be required to pay a third party to assume the service obligations. The estimated costs to fulfill the service obligations were based on the historical direct costs engaged in providing service and support activities. The estimated research and development costs associated with support contracts have not been included in the fair value determination, as these costs were not deemed to represent a legal obligation at the time of acquisition. Based on this approach, the Company recorded approximately $3.1 million of deferred revenue to reflect the estimate of the fair value of DeviceAnywhere’s service obligations assumed.

(4) Revenue Recognition

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

	Three Months Ended March 31,				Six Months Ended March 31,
	2013		2012		2013		2012
Internet:
Web measurement subscriptions	$	9,489	$	8,267	$	19,007	$	16,386
Other subscriptions	2,907		3,269		7,027		7,564
Engagements	2,637		2,821		5,400		5,911
Internet net revenue	15,033		14,357		31,434		29,861
Mobile:
Subscriptions	6,145		6,206		11,791		11,799
Ratable licenses	224		980		621		2,563
Systems licenses	3,243		4,023		8,562		9,778
Maintenance and support	4,685		5,026		10,834		9,670
Mobile net revenue	14,297		16,235		31,808		33,810
Net revenue	$	29,330	$	30,592	$	63,242	$	63,671

Subscriptions revenue consists primarily of revenue from the sale of products and services sold through a cloud-based model on a subscription basis (also referred to as Software-as-a-Service, or SaaS). Subscription arrangements with customers do not provide the customer with the right to take possession of the software supporting the on-demand service at any time. Subscription revenue consists of Web Measurement Subscriptions (which consists of Application Perspective, Transaction Perspective, Streaming Perspective and Web Site Perspective products and services), Other Subscriptions (which consists of all other Internet subscription product and services) and Mobile Subscriptions (which consists of GlobalRoamer, Mobile Device Perspective, Mobile Web Perspective, Test Center Enterprise (“TCE”) Interactive and Test Center Developer products and services).

The Company also sells monitoring systems to mobile network operators and monitoring and testing systems to enterprise mobile customers under licensing arrangements. Licensing arrangements with mobile customers typically include software licenses, hardware, consulting services to configure the systems (installation), post contract support (maintenance) services, training services and other consulting services associated with the Company’s System Integrated Test Environment (“SITE”) system, TCE Automation and TCE Monitoring products and services. Licensing arrangements consist of Ratable Licenses (which consists of SITE, TCE Automation and TCE Monitoring arrangements entered into prior to fiscal 2011, which is when new accounting guidance for revenue recognition was adopted), Systems Licenses (which consists of the hardware and software elements of SITE, TCE Automation and TCE Monitoring arrangements) and Maintenance and Support (which consists of all other elements of SITE, TCE Automation and TCE Monitoring arrangements, stand-alone mobile consulting services agreements and maintenance agreement renewals).

The Company supplements its cloud-based subscriptions and licensing arrangements with professional consulting services engagements.

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

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

· Delivery of the product or service. Customers are provided with access to the subscription based services at the beginning of the arrangement term. Subscription services are generally delivered over the period of the subscription with the customer having flexibility to define and change measurements with respect to the type, frequency, location and complexity of each measurement. Engagement services are considered delivered when the services are performed or the contractual milestones are completed. System licensing arrangements, excluding maintenance, are considered delivered when all elements of the arrangement have either been delivered or accepted, if acceptance language exists.

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

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

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

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

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

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

Revenue Recognition for Arrangements with Multiple Deliverables

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

Current accounting guidance for revenue recognition excludes tangible products containing software components and non-software components that function together to deliver the product’s essential functionality from the scope of industry specific software revenue recognition guidance. Accounting guidance also requires an entity to allocate revenue in a multiple element arrangement using the relative fair value method based upon the best estimated selling prices (“BESP”) of each deliverable if a vendor does not have VSOE or third-party-evidence (“TPE”) of selling price.

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

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The following tables summarize the amortized cost, gross unrealized gains, gross unrealized losses and fair value by significant investment category for cash, cash equivalents and short-term investments (in thousands):


	March 31, 2013
			Gross		Gross			Estimated Market Value
	Amortized Cost		Unrealized Gains		Unrealized Losses			Cash and Cash Equivalents		Short-term Investments
Cash	$	18,456	$	—	$	—		$	18,456	$	—
Level 1
Corporate and municipal bonds	7,247		18		(3		)	—		7,262
Money market funds	3,816		—		—			3,816		—
Government agencies	3,696		—		—			—		3,696
	14,759		18		(3		)	3,816		10,958
Level 2
Commercial paper	18,476		3		—			8,838		9,641
Corporate and municipal bonds	3,701		2		—			—		3,703
U.S. Treasuries	2,499		3		—			—		2,502
	24,676		8		—			8,838		15,846
Total	$	57,891	$	26	$	(3	)	$	31,110	$	26,804

	September 30, 2012
			Gross		Gross			Estimated Market Value
	Amortized Cost		Unrealized Gains		Unrealized Losses			Cash and Cash Equivalents		Short-term Investments
Cash	$	18,537	$	—	$	—		$	18,537	$	—
Level 1
Corporate bonds	4,058		6		—			—		4,064
Government agencies	5,326		1		(2		)	—		5,325
Money market funds	7,544		—		—			7,544		—
	16,928		7		(2		)	7,544		9,389
Level 2
Commercial paper	11,964		2		(1		)	2,875		9,090
U.S. Treasuries	2,501		3		—			—		2,504
	14,465		5		(1		)	2,875		11,594
Total	$	49,930	$	12	$	(3	)	$	28,956	$	20,983

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

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

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

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

The Company has the intent and ability to hold securities until their value recovers.

Market values were determined for each individual security in the investment portfolio. Investments are reviewed periodically to identify possible impairment and if impairment does exist, the charge would be recorded in the condensed consolidated statement of operations. The Company considers factors such as the length of time an investment’s fair value has been below cost, the financial condition of the investee, and the Company’s ability and intent to hold the investment for a period of time which may be sufficient for anticipated recovery in market value. There were no impairment charges recorded in the three and six month periods ended March 31, 2013 and 2012.

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Contractual maturities of available-for-sale securities at March 31, 2013 were as follows (in thousands):

	Amortized Cost		Estimated Fair Value
Due in less than one year	$	12,351	$	12,355
Due in less than two years	2,312		2,312
Due in less than three years	12,118		12,137
Total	$	26,781	$	26,804

(7) Consolidated Financial Statement Details

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

Other Current Assets

	March 31, 2013		September 30, 2012
Prepaid expenses	$	2,798	$	2,231
Security deposits, advances, and interest receivable	184		247
Income tax receivable	240		152
Deferred costs of revenue	22		25
Other assets	212		121
Total	$	3,456	$	2,776

Property, Equipment and Software

	March 31, 2013			September 30, 2012
Land	$	14,150		$	14,150
Computer equipment and software	41,266			39,059
Building and building improvements	22,623			22,431
Furniture and fixtures	2,349			2,306
Leasehold improvements	1,281			1,254
Construction in progress	460			262
	82,129			79,462
Less accumulated depreciation and amortization	(47,178		)	(44,297		)
Total	$	34,951		$	35,165

Other Long-Term Assets

	March 31, 2013		September 30, 2012
Prepaid expenses	$	645	$	437
Deposits	85		160
Deferred costs of revenue	18		43
Tenant rent receivable	250		289
Total	$	998	$	929

Accrued Expenses

	March 31, 2013		September 30, 2012
Accrued employee compensation	$	5,385	$	6,460
Income and other taxes	1,055		1,379
Accrued audit and professional fees	629		934
Other accrued expenses	2,741		2,528
Total	$	9,810	$	11,301

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(8) Inventories

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

(9) Goodwill and Identifiable Intangible Assets

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

Based on the results of the first step of the Company’s impairment test performed at September 30, 2012, the fair value of its reporting unit exceeded its carrying value by more than 10% and the Company determined that its goodwill had not been impaired. The Company continuously monitors for events and circumstances that could negatively impact the key assumptions in determining fair value, including long-term revenue growth projections, discount rates, recent market valuations from transactions by comparable companies, volatility in the Company’s market capitalization and general industry, market and macro-economic conditions. It is possible that changes in such circumstances, or in the variables associated with the judgments, assumptions and estimates used in assessing the fair value of the reporting unit, would require the Company to record a non-cash impairment charge.

During the quarter ended March 31, 2013, the Company concluded that there were no triggering events which would require an impairment analysis of the carrying value of goodwill, primarily due to the Company’s market capitalization and operating cash flows during the period. The Company is continuing to monitor the need to perform an impairment analysis in light of current economic factors as well as the recent volatility of its market capitalization. To the extent the Company concludes that there are any indicators of impairment prior to the date of the next annual goodwill impairment test, management will perform an impairment analysis to determine if an impairment charge should be recorded to write down goodwill to its fair value.

The following table presents the changes in goodwill during the six months ended March 31, 2013 (in thousands):

September 30, 2012 balance	$	110,253
Translation adjustments	(114		)
March 31, 2013 balance	$	110,139

The Company assesses long-lived assets for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. The Company assesses the fair value of the assets based on the undiscounted future cash flow that the assets are expected to generate and recognizes an impairment loss when such fair value plus net proceeds expected from disposition of the asset, if any, are less than the carrying value of the asset. When the Company identifies an impairment, it reduces the carrying amount of the asset to its estimated fair value based on a discounted cash flow approach or, when available and appropriate, to comparable market values.

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

	Technology			Customer Based			Trademark			Covenant			Backlog			Total
As of March 31, 2013:
Gross carrying value	$	10,268		$	3,822		$	1,729		$	332		$	2,796		$	18,947
Accumulated amortization	(5,642		)	(1,851		)	(795		)	(177		)	(2,796		)	(11,261		)
Net carrying value	$	4,626		$	1,971		$	934		$	155		$	—		$	7,686
As of September 30, 2012:
Gross carrying value	$	10,268		$	3,822		$	1,729		$	332		$	2,796		$	18,947
Accumulated amortization	(4,734		)	(1,634		)	(726		)	(127		)	(2,666		)	(9,887		)
Net carrying value	$	5,534		$	2,188		$	1,003		$	205		$	130		$	9,060

Amortization of technology is recorded to costs of revenue. Amortization of all other identifiable intangible assets is recorded to operating expenses. The following table presents amortization of identifiable intangible assets for the three and six months ended March 31, 2013 and 2012 (in thousands):

	Three Months Ended March 31,				Six Months Ended March 31,
	2013		2012		2013		2012
Amortization of intangible assets — technology	$	383	$	525	$	908	$	990
Amortization of intangible assets — other	168		969		466		1,779
Total amortization of intangible assets	$	551	$	1,494	$	1,374	$	2,769

The estimated future amortization expense for identifiable intangible assets as of March 31, 2013 was as follows (in thousands):

Fiscal
2013 (remaining six months)	$	959
2014	1,918
2015	1,768
2016	1,761
2017	961
Thereafter	319
Total	$	7,686
Weighted average remaining useful lives as of March 31, 2013 (years)	2.6

(10) Lease Abandonment Accrual

The Company leased a facility in New York under an operating lease that originally expired in October 2015. The Company ceased using the facility in the fourth quarter of fiscal 2009 and recorded lease abandonment expense of $0.6 million related to its discontinued use of this facility. Effective October 1, 2009, the Company subleased the facility to a third party for the remainder of its original lease term.

On January 31, 2013, the Company entered into a “Termination of Lease Agreement” with the landlord of the facility in New York whereby the lease agreement terminated on January 31, 2013. In exchange for immediate release from obligations under the lease, the Company was required to pay the landlord a termination fee of $300,000 and record lease termination expenses of $53,000.

(11) Stock-Based Compensation

1999 Equity Incentive Plan

In September 1999, the Company adopted the 1999 Equity Incentive Plan (“Incentive Plan”), which as amended by shareholder approval will expire on December 31, 2015. As of March 31, 2013, the Company was authorized to issue up to approximately 3.4 million shares of common stock under its Incentive Plan. Vesting periods are determined by the Board of Directors and generally, in the case of stock options, provide for shares to vest over a period of four years with 25% of the shares vesting one year from the date of grant and the remainder vesting monthly over the next three years. Restricted Stock Units (“RSUs”) generally vest in full either three years or four years from the date of grant. Options expire ten years after the date of grant. Approximately 1.3 million shares were available for future grants under the Incentive Plan as of March 31, 2013.

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

1999 Employee Stock Purchase Plan

In September 1999, the Company adopted the 1999 Employee Stock Purchase Plan (“Purchase Plan”) which, as amended by shareholder approval, will expire on June 28, 2019. As of March 31, 2013, the Company had reserved a total of approximately 0.2 million shares of common stock for future issuance under the Purchase Plan. Under the Purchase Plan, eligible employees may defer an amount not to exceed 10% of the employee’s compensation, as defined in the Purchase Plan, to purchase common stock of the Company. The purchase price per share is 85% of the lesser of the fair market value of the common stock on the first day of the applicable offering period or the last day of each purchase period. The Purchase Plan is intended to qualify as an “employee stock purchase plan” under Section 423 of the Internal Revenue Code.

Restricted Stock Units

Stock-based compensation cost for RSUs is measured based on the value of the Company’s stock on the grant date, reduced by the present value of the dividend yield expected to be paid on the Company’s common stock. Upon vesting, the RSUs are generally net share-settled to cover the required withholding tax and the remaining amount is converted into an equivalent number of shares of common stock.

Recipients of RSU awards generally must remain employed by the Company on a continuous basis through the end of the applicable performance period in order to receive any portion of the shares subject to the award. RSUs do not have dividend equivalent rights and do not have the voting rights of common stock until earned and issued following the end of the applicable performance period. The expense for these awards, net of estimated forfeitures, is recorded over the requisite service period based on the number of awards that are expected to be earned.

The fair value of each RSU was estimated on the date of grant using the Black-Scholes option pricing model to reflect the impact of dividends on the fair value of each RSU granted. Weighted-average assumptions for each RSU granted under the Incentive Plan were as follows:

	Three Months Ended March 31,				Six Months Ended March 31,
	2013		2012		2013		2012
Volatility	43.7	%	48.3	%	45.8	%	55.1	%
Risk free interest rate	0.2	%	0.6	%	0.3	%	0.7	%
Expected life (in years)	2.2		3.0		2.4		3.5
Dividend yield	1.6	%	1.2	%	1.7	%	1.1	%

A summary of RSU activity under the Company’s Incentive Plan for the six months ended March 31, 2013 is presented below (in thousands, except per share amounts):

	Shares		Weighted Average Grant Date Fair Value
Outstanding at September 30, 2012	722		$	19.22
Granted	165		15.24
Vested	(238	)	22.25
Cancelled	(71	)	20.06
Outstanding at March 31, 2013*	578		$	16.74

* Included in the total outstanding RSU balance at March 31, 2013, are 53,000 Performance Stock Units (“PSUs”). Each PSU award reflects a target number of shares that may be issued to the award recipient before adjusting for performance conditions. The vesting period and/or the actual number of shares the PSU recipient receives is based on pre-established targets such as net revenue and operating results.

As of March 31, 2013, there was $7.8 million of total unrecognized compensation cost (net of estimated forfeitures) related to nonvested RSUs that is expected to be recognized over a weighted average period of 2.0 years.

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Stock Options

A summary of option activity under the Company’s Incentive Plan for the six months ended March 31, 2013 is presented below (in thousands, except per share and term amounts):

	Shares		Weighted Average Exercise Price		Average Remaining Contractual Term (Years)	Aggregate Intrinsic Value
Outstanding at September 30, 2012	1,698		$	12.00	3.5
Granted	—		—
Exercised	(192	)	11.96
Forfeited or canceled	—		—
Outstanding at March 31, 2013	1,506		$	12.00	3.0	$	2,719
Vested and expected to vest	1,506		$	12.00	3.0	$	2,719
Exercisable at March 31, 2013	1,506		$	12.00	3.0	$	2,719

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value that would have been received by the options holders had they exercised all their options on March 31, 2013.

Employee Stock Purchase Plan

The Purchase Plan provides for twenty-four month offering periods which consist of four six-month purchase periods. The six-month purchase periods end on the earlier of January 31st and July 31st of each year or the last business day prior to those dates. The fair value of each stock purchase right is estimated on the first day of the offering period using the Black-Scholes option pricing model.

Weighted-average assumptions for stock purchase rights under the Purchase Plan were as follows:

	Three Months Ended March 31,				Six Months Ended March 31,
	2013		2012		2013		2012
Volatility	39.2	%	50.3	%	39.2	%	50.6	%
Risk free interest rate	0.2	%	0.3	%	0.2	%	0.3	%
Expected life (in years)	1.3		1.3		1.3		1.3
Dividend yield	1.6	%	1.4	%	1.6	%	1.4	%

Restricted Stock Agreement

On December 29, 2012, the Compensation Committee approved the early settlement of 180,000 RSUs granted to the Company’s Chief Executive Officer under a restricted stock agreement. Under the restricted stock agreement, the shares will be forfeited if the original vesting terms of the RSUs are not met. Under the original terms, the RSUs would have vested in full on July 1, 2015. The unrecognized stock-based compensation expense related to this RSU will be amortized over the remaining original vesting period.

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Stock-Based Compensation Expense

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

	Three Months Ended March 31,				Six Months Ended March 31,
	2013		2012		2013		2012
Direct costs of revenue — subscriptions and services	$	165	$	203	$	241	$	369
Development	291		375		563		680
Operations	154		160		282		303
Sales and marketing	346		519		803		950
General and administrative	246		287		652		570
Total	$	1,202	$	1,544	$	2,541	$	2,872

(12) Dividends

During the six months ended March 31, 2013 and the year ended September 30, 2012, the Company declared and paid the following cash dividends (in thousands, except per share amounts):

Record Date	Payment Date	Dividend Per Share		Total Dividend Paid
Fiscal 2013
December 1, 2012	December 15, 2012	$	0.06	$	1,078
December 21, 2012	December 31, 2012	0.06		1,080

Fiscal 2012
December 1, 2011	December 15, 2011	0.06		1,038
March 1, 2012	March 15, 2012	0.06		1,043
June 1, 2012	June 15, 2012	0.06		1,050
September 1, 2012	September 15, 2012	$	0.06	$	1,076

In January 2013, the Company announced a cash dividend of $0.07 per common share payable to stockholders of record as of June 1, 2013. The cash dividend is to be paid on or about June 15, 2013. In the future, the Company intends to pay a similar dividend on a quarterly basis; however, its ability to do so will be affected by its future results of operations, financial position and various other factors that may affect its overall business.

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

The components of comprehensive income (loss) consist of net income (loss), unrealized gains and losses on available-for-sale investments and foreign currency translation. The unrealized gains and losses on available-for-sale investments and foreign currency translation are excluded from earnings and reported as a component of stockholders’ equity. The foreign currency translation adjustment results from those subsidiaries, primarily the Company’s German subsidiary, not using the United States dollar as their functional currency since the majority of their economic activities are primarily denominated in their applicable local currency. Accordingly, all assets and liabilities related to these operations are translated at the current exchange rates at the end of each period. The resulting cumulative translation adjustments are recorded directly to the accumulated other comprehensive income (loss) account in stockholders’ equity. Revenues and expenses are translated at average exchange rates in effect during the period. Gains (losses) from foreign currency transactions are reflected in other income (expense), net in the condensed consolidated statements of operations as incurred and were $31,000 and $(133,000) for the three and six months ended March 31, 2013 and were $(51,000) and $(35,000) for the three and six months ended March 31, 2012, respectively.

The components of accumulated other comprehensive income (loss) in the equity section of the balance sheets are as follows (in thousands):

	March 31, 2013			September 30, 2012
Net unrealized gain on short-term investments	$	15		$	6
Cumulative foreign currency translation loss	(1,233		)	(1,063		)
Accumulated other comprehensive loss	$	(1,218	)	$	(1,057	)

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The Company has recorded deferred taxes on the unrealized gains on its investments of $8,000 and zero at March 31, 2013 and September 30, 2012, respectively. There is no tax effect on the foreign currency translation because it is management’s intent to reinvest indefinitely the undistributed earnings of its foreign subsidiaries to which the foreign currency translation relates.

(14) Excess Occupancy Income

Excess occupancy income consists of rental income from the leasing of space not occupied by the Company in its headquarters building, net of related expenses, which consists of property taxes, insurance, building depreciation, leasing broker fees and tenant improvement amortization. Property taxes, insurance and building depreciation are based upon actual square footage available to lease to third parties, which was approximately 75% prior to January 1, 2012 and 65% subsequent to that date. Rental income was approximately $0.9 million and $0.8 million for the three months ended March 31, 2013 and 2012, respectively. Rental income was approximately $1.8 million and $1.5 million for the six months ended March 31, 2013 and 2012, respectively. As of March 31, 2013, the Company had leased space to 16 tenants, of which 15 had noncancellable operating leases, which expire on various dates through 2018. At March 31, 2013, future minimum rents receivable under the leases were as follows (in thousands):

Fiscal
2013 (remaining six months)	$	1,220
2014	2,720
2015	1,767
2016	899
2017	409
Thereafter	240
Total future minimum rents receivable	$	7,255

(15) Income Taxes

The Company’s effective tax rate for the three months ended March 31, 2013 and 2012 was (173) %, or a benefit, and 56%, respectively. The rate for the three months ended March 31, 2013 differs from the 35% United States federal statutory rate due in part to the relative mix of foreign and domestic earnings and enacted tax rates. Additionally, on January 2, 2013, The American Taxpayer Relief Act of 2012 became law and extended the research credit to December 31, 2013. The extension of the research credit is retroactive and includes amounts paid or incurred after December 31, 2011. As a result of the retroactive extension, the Company recognized a benefit of approximately $0.3 million for qualifying amounts incurred during fiscal 2012. The rate for the three months ended March 31, 2012 differs from the 35% United States federal statutory rate primarily due to the relative mix of foreign and domestic earnings and enacted tax rates.

The Company’s effective tax rate for the six months ended March 31, 2013 and 2012 was 46% and 29%, respectively. The rate for the six months ended March 31, 2013 differs from the 35% United States federal statutory rate due in part to the relative mix of foreign and domestic earnings and enacted tax rates. Additionally, the effective tax rate was 11% higher than the statutory rate due to recording the effects of Section 162(m) limitations on deferred tax assets that should have been recorded in fiscal 2011 and 2012 (see Note 1). This was partially offset by the $0.3 million benefit discussed above related to the research credit for qualifying amounts incurred during fiscal 2012. The rate for the six months ended March 31, 2012 differs from the 35% United States federal statutory rate primarily due to the relative mix of foreign and domestic earnings, enacted tax rates, and the fact that the change in estimated fair value of acquisition-related contingent consideration is a non-taxable, discrete transaction in that period.

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

The Company’s accounting for deferred taxes involves the evaluation of a number of factors concerning the realizability of the Company’s deferred tax assets. Assessing the realizability of deferred tax assets is dependent upon several factors, including the likelihood and amount, if any, of future taxable income in relevant jurisdictions during the periods in which those temporary differences become deductible. The Company forecasts taxable income by considering all available positive and negative evidence including its history of operating income or losses and its financial plans and estimates which are used to manage the business. These assumptions require significant judgment about future taxable income. The amount of deferred tax assets considered realizable is subject to adjustment in future periods if estimates of future taxable income are reduced.

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The Company’s maintains a valuation allowance on certain deferred tax assets because management does not believe that it is more likely than not that they will be realized The deferred tax assets on which a valuation allowance is maintained primarily consist of foreign net operating losses in certain jurisdictions, net operating losses resulting from windfall stock option deductions which when realized will be credited to additional paid in capital and certain state deferred tax assets. Any subsequent increases in the valuation allowance will be recognized as an increase in deferred tax expense. Any decreases in the valuation allowance will be recorded either as a reduction of the income tax provision or as a credit to paid-in-capital if the associated deferred tax asset relates to excess deductions on the exercise of stock options.

As of March 31, 2013, the total amount of gross unrecognized benefits related to uncertain tax positions was $8.3 million. Included in this balance was approximately $6.6 million of unrecognized tax benefits that, if recognized, would affect the effective income tax rate.

The Company’s 2006 through 2009 German income tax returns are being audited by the German tax authorities. The Company believes it has made adequate tax payments and accrued adequate amounts such that the outcome of this audit will have no material adverse effects on its results of operations or financial condition.

It is possible that the amount of liability for unrecognized tax benefits, including the unrecognized tax benefits related to the audit in Germany, may change within the next twelve months. However, an estimate of the range of possible changes cannot be made at this time. In addition, over the next twelve months, the Company’s existing tax positions may continue to generate an increase in liabilities for unrecognized tax benefits. In accordance with the Company’s accounting policy, it recognizes accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. Interest and penalties accrued during the six months ended March 31, 2013 was $0.1 million.

As of March 31, 2013, the fiscal tax years that remain subject to examination in the Company’s major tax jurisdictions are:

Jurisdiction		Open Tax Years
United States—Federal		1997 through 2011
United States—California		2000 through 2011
Germany		2006 through 2011

(16) Commitments and Contingencies

Leases

The Company leases certain of its facilities and equipment under noncancelable leases, which expire on various dates through March 2018. As of March 31, 2013, future minimum payments under these operating leases were as follows (in thousands):

Fiscal
2013 (remaining six months)	$	390
2014	336
2015	287
2016	233
2017	196
Thereafter	61
Total minimum lease payments	$	1,503

Rent expense was approximately $0.4 million for both the three months ended March 31, 2013 and 2012. Rent expense was approximately $0.7 million for both the six months ended March 31, 2013 and 2012.

Commitments

As of March 31, 2013, the Company had $1.0 million of contingent commitments to bandwidth and co-location providers. These contingent commitments have a remaining term of up to twenty-one months and become due if the Company terminates any of these agreements prior to their expiration.

As of March 31, 2013, the Company, through one of its foreign subsidiaries, had outstanding guarantees totaling $0.2 million to customers and vendors as a form of security. The guarantees can only be executed upon agreement by both the customer or vendor and the Company. The guarantees are secured by an unsecured line of credit in the amount of $1.3 million.

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Legal Proceedings

On December 4, 2012, Qexez, LLC, a non-practicing entity, filed a complaint against the Company in the Eastern District of Texas alleging that the Company’s technology infringes U.S. patent number 7,596,373. This entity is the assignee of this patent. The Company filed a motion to dismiss and motion to strike. In response, Plaintiff filed an amended complaint, to which the Company will respond. The amended complaint seeks an unspecified amount of damages and injunctive relief. Due to the preliminary nature of this litigation, the Company is unable to determine the likelihood of an unfavorable outcome against it and is unable to reasonably estimate a range of loss, if any.

The Company is subject to other legal proceedings, claims, and litigation arising in the ordinary course of business. While the outcome of these matters is currently not determinable, the Company does not expect that the ultimate costs to resolve these matters — consisting of the fees and costs that are required for a litigation matter from its commencement to final disposition or settlement — will have a material adverse effect on its consolidated financial position, results of operations, or cash flows. No amount has been accrued as of March 31, 2013 since the Company believes that the liability, if any, is not probable and cannot be reasonably estimated.

Warranties

The Company’s products are generally warranted to perform for a period of one year. In the event there is a failure of such products, the Company generally is obliged to correct or replace the product to conform to the warranty provision. No amount has been accrued for warranty obligations as of March 31, 2013 and September 30, 2012, as costs to replace or correct are generally reimbursable under the manufacturer’s warranty.

Indemnification

The Company does not generally indemnify its customers against legal claims that its services infringe third-party intellectual property rights. Other agreements entered into by the Company may include indemnification provisions that could subject the Company to costs and/or damages in the event of an infringement claim against the Company or an indemnified third-party. However, the Company has never been a party to an infringement claim and its management is not aware of any liability related to any infringement claims subject to indemnification. As such, no amount is accrued for infringement claims as of March 31, 2013. The Company also indemnifies its officers and directors pursuant to a standard form of indemnification agreement.

(17) Geographic and Segment Information

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

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

	Three Months Ended March 31,				Six Months Ended March 31,
	2013		2012		2013		2012
United States	$	17,202	$	16,203	$	35,460	$	33,705
Europe*	6,359		8,370		15,725		15,630
Other*	5,769		6,019		12,057		14,336
Net revenue	$	29,330	$	30,592	$	63,242	$	63,671

* No individual country represented more than 10% of net revenue for the three and six months ended March 31, 2013 and 2012.

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

	March 31, 2013		September 30, 2012
United States	$	33,314	$	33,583
Germany	1,609		1,563
Other	28		19
Total	$	34,951	$	35,165

(18) Subsequent Events

In April 2013, the Company announced that its Board of Directors authorized the repurchase of up to $10 million of the Company’s outstanding shares of common stock. The shares may be purchased from time to time for a period of twelve months. The timing, price and quantity of purchases will be at the discretion of the Company and the program may be discontinued or suspended at any time.

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

The following discussion of the financial condition and results of operations of Keynote Systems, Inc. (referred to herein as “we,” “us,” “Keynote” or “the Company”) should be read in conjunction with the unaudited condensed consolidated financial statements and the notes thereto included in this report as well as the audited financial statements and notes thereto in our Annual Report on Form 10-K for the year ended September 30, 2012, and subsequent filings with the Securities and Exchange Commission.

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 include, among others, statements including the words “expects,” “anticipates,” “intends,” “believes” and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to these differences include, but are not limited to, those discussed in this section, the section entitled “Risk Factors” in Item 1A of Part II of this report, and in our annual report on Form 10-K for the fiscal year ended September 30, 2012 and elsewhere in that report. You should carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the quarterly reports on Form 10-Q and current reports on Form 8-K that we may file during the current year. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this quarterly report on Form 10-Q. Except as required by law, we undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

Overview

Keynote is a leading global provider of mobile and Web cloud testing and monitoring services. We maintain one of the world’s largest on-demand quality testing and performance monitoring networks comprised of approximately 7,000 measurement computers and mobile devices in over 300 locations covering 180 countries. Our global network enables our customers to continuously test, monitor and assure the online and mobile experience. We offer a robust portfolio of cloud products and services to optimize the end-user customer experience to world-class telecommunications and enterprise customers, representing a broad cross-section of industries. Our cloud products and services are grouped into three categories: Internet, Enterprise Mobile and Telecommunications Mobile.

We deliver our products and services primarily through a cloud-based model on a subscription basis (also referred to as Software-as-a-Service, or SaaS). Subscription fees range from monthly to multi-year commitments and vary based on the type of service selected, the number of measurements, transactions or devices monitored, the number of measurement locations and/or appliances, the frequency of the measurements, the communication protocols or services measured, privacy settings and any additional features ordered. Our System Integrated Test Environment (“SITE”) and Test Center Enterprise (“TCE”) systems, which include software and hardware, usually are offered via a software license fee model that is bundled with ongoing maintenance and support. Our engagement services, or professional services, complement and support our cloud products and services. Our engagement services provide our customers with a deeper and qualitative perspective of their performance data.

Our net revenue decreased by $0.5 million, or 1%, from $63.7 million for the six months ended March 31, 2012 to $63.2 million for the six months ended March 31, 2013. Our net income decreased by $2.2 million from net income of $4.5 million for the six months ended March 31, 2012 to net income of $2.3 million for the six months ended March 31, 2013. The decrease in net revenue is primarily attributable to a $2.0 million decrease in Mobile net revenue, partially offset by a $1.5 million increase in Internet net revenue for the six months ended March 31, 2013 compared to the six months ended March 31, 2012. Total costs and expenses increased $1.4 million from $57.5 million for the six months ended March 31, 2012 to $58.9 million for the six months ended March 31, 2013, primarily due to the benefit recorded in the prior year’s period of $2.0 million for the change in fair value of acquisition-related contingent consideration.

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

· Continuing to drive revenue growth, especially in mobile markets served by our Enterprise Mobile products and services, which we believe is a key factor in creating stockholder value;

· Meeting challenges faced due to the current global economic environment, especially in Europe, as this affects our customers’ ability to purchase our products and services;

· Developing and marketing new products and services that respond to competitive and technological developments and changing customer needs;

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Results of Operations

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

	Three Months Ended March 31,				Six Months Ended March 31,
	2013		2012		2013		2012
Subscriptions and services revenue	88.9	%	86.8	%	86.5	%	84.6	%
Systems licenses revenue	11.1		13.2		13.5		15.4
Net revenue	100.0	%	100.0	%	100.0	%	100.0	%
Costs and expenses:
Costs of revenue:
Direct costs of revenue — subscriptions and services	26.8		24.9		24.5		23.3
Direct costs of revenue — systems licenses	2.7		3.5		3.6		3.8
Development	17.0		15.3		15.5		14.2
Operations	10.2		8.7		9.1		8.1
Amortization of intangible assets — technology	1.3		1.7		1.4		1.6
Sales and marketing	32.3		29.1		29.2		28.4
General and administrative	10.8		12.4		10.8		12.4
Change in fair value of acquisition-related contingent consideration	—		—		—		(3.1	)
Excess occupancy income	(1.9	)	(1.3	)	(1.7	)	(1.2	)
Amortization of intangible assets — other	0.6		3.2		0.8		2.8
Total costs and expenses	99.8		97.5		93.2		90.3
Income from operations	0.2		2.5		6.8		9.7
Interest income and other, net	0.2		—		(0.1	)	0.1
Income before benefit (provision) for income taxes	0.4		2.5		6.7		9.8
Benefit (provision) for income taxes	0.7		(1.4	)	(3.1	)	(2.8	)
Net income	1.1	%	1.1	%	3.6	%	7.0	%

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

Net Revenue

	For the three months ended March 31,						For the six months ended March 31,
	2013		2012		% Change		2013		2012		% Change
Internet:
Web Measurement Subscriptions	$	9,489	$	8,267	15	%	$	19,007	$	16,386	16	%
Other Subscriptions	2,907		3,269		(11	)	7,027		7,564		(7	)
Engagements	2,637		2,821		(7	)	5,400		5,911		(9	)
Total Internet net revenue	15,033		14,357		5		31,434		29,861		5
Mobile:
Subscriptions	6,145		6,206		(1	)	11,791		11,799		—
Ratable Licenses	224		980		(77	)	621		2,563		(76	)
Systems Licenses	3,243		4,023		(19	)	8,562		9,778		(12	)
Maintenance and Support	4,685		5,026		(7	)	10,834		9,670		12
Total Mobile net revenue	14,297		16,235		(12	)	31,808		33,810		(6	)
Net revenue	$	29,330	$	30,592	(4	)%	$	63,242	$	63,671	(1	)%

Mobile net revenue by customer type:
Enterprise	5,416		5,884		(8	)%	10,665		11,827		(10	)%
Telecommunications	8,881		10,351		(14	)	21,143		21,983		(4	)
Total Mobile net revenue	$	14,297	$	16,235	(12	)%	$	31,808	$	33,810	(6	)%

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Subscription revenue is reflected in the above table as Web Measurement Subscriptions (which includes Application Perspective, Transaction Perspective, Streaming Perspective and Web Site Perspective products and services), Other Subscriptions (which includes all other Internet subscription products and services) and Mobile Subscriptions (which includes GlobalRoamer, Mobile Device Perspective, Mobile Web Perspective, TCE Interactive and Test Center Developer products and services). Licensing arrangements for monitoring and testing systems are reflected in the above table as Ratable Licenses (which includes SITE, TCE Automation and TCE Monitoring arrangements entered into prior to fiscal 2011, which is when new accounting guidance for revenue recognition was adopted), Systems Licenses (which includes the hardware and software elements of SITE, TCE Automation and TCE Monitoring arrangements) and Maintenance and Support (which includes all the other elements of SITE, TCE Automation and TCE Monitoring arrangements, stand-alone consulting services agreements and maintenance agreement renewals).

Internet Net Revenue. Internet net revenue increased by $0.7 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012. Internet net revenue represented 51% and 47% of net revenue for the three months ended March 31, 2013 and 2012, respectively. The increase in Internet net revenue for the three months ended March 31, 2013 was mainly attributable to an increase of $1.2 million in our Internet Web Measurement Subscriptions due primarily to an increase in the number of measurements that our customers performed to test their Web sites, partially offset by a $0.3 million decrease in our Internet Subscriptions Other due to reductions in LoadPro engagements and a $0.2 million decrease in Internet Engagements (also referred to as professional services) due to lower demand for customer experience management (“CEM”) engagements.

Internet net revenue increased by $1.6 million for the six months ended March 31, 2013 compared to the six months ended March 31, 2012. Internet net revenue represented 50% and 47% of net revenue for the six months ended March 31, 2013 and 2012, respectively. The increase in Internet net revenue for the six months ended March 31, 2013 was mainly attributable to an increase of $2.6 million in our Internet Web Measurement Subscriptions primarily due to an increase in the number of measurements that our customers are performing to test their Web sites, partially offset by a decrease of $0.5 million in our Internet Subscriptions Other due to reductions in LoadPro engagements and a decrease of $0.5 million in our Engagements due to lower demand for CEM engagements.

Mobile Net Revenue. Mobile net revenue decreased by $1.9 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012. Mobile net revenue represented 49% and 53% of net revenue for the three months ended March 31, 2013 and 2012, respectively. The decrease in Mobile net revenue for the three months ended March 31, 2013 was mainly attributable to a $0.8 million decrease in Ratable Licenses revenue due to the change in revenue recognition guidance at the beginning of fiscal 2011 and a $0.8 million decrease in Systems Licenses revenue due to four large projects that were expected to be accepted in the second quarter of fiscal 2013 that were not accepted due to customer specific issues. Additionally, Maintenance and Support decreased by $0.3 million due to a large maintenance contract that was fully recognized at the end of the maintenance term in the second quarter of fiscal 2012 and recognized ratably in fiscal 2013 due to the terms of the arrangement.

Mobile net revenue decreased by $2.0 million for the six months ended March 31, 2013 compared to the six months ended March 31, 2012. Mobile net revenue represented 50% and 53% of net revenue for the six months ended March 31, 2013 and 2012, respectively. The decrease in Mobile net revenue for the six months ended March 31, 2013 was mainly attributable to a $1.9 million decrease in Ratable License revenue due to the change in revenue recognition guidance at the beginning of fiscal 2011 and a $1.2 million decrease in System Licenses due to the large projects that were not accepted by the end of the second quarter of fiscal 2013 described above. These decreases were partially offset by a $1.2 million increase in Maintenance and Support due to an increase in systems under maintenance agreements and increased DemoAnywhere revenue.

No single customer accounted for more than 10% of net revenue in the three and six month periods ended March 31, 2013. One customer accounted for 12% of net revenue for the three months ended March 31, 2012 and no single customer accounted for more than 10% of net revenue for the six months ended March 31, 2012. No customer accounted for more than 10% of our net accounts receivable at March 31, 2013. One customer accounted for 12% of our net accounts receivable at September 30, 2012.

International sales, principally in Europe, were approximately 41% and 44% of net revenue for the three and six months ended March 31, 2013, respectively, and were approximately 47% of net revenue for both the three and six months ended March 31, 2012, respectively.

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Direct Costs of Net Revenue

	For the three months ended March 31,						For the six months ended March 31,
	2013		2012		% Change		2013		2012		% Change
Direct costs of revenue —subscriptions and services	$	7,841	$	7,620	3	%	$	15,450	$	14,813	4	%
Direct costs of revenue — systems licenses	$	803	$	1,071	(25	)%	$	2,285	$	2,472	(8	)%

Direct costs of revenue—subscriptions and services is comprised of telecommunication and network fees for our measurement and data collection network, costs for employees and consultants assigned to consulting engagements and to install monitoring and testing systems, depreciation of equipment related to our measurement and data collection network, and costs of supplies.

Direct costs of revenue — subscriptions and services increased $0.2 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 and represented 30% and 29% of subscription and services revenue for the three months ended March 31, 2013 and 2012, respectively. The increase in direct costs of revenue — subscriptions and services was mainly attributable to additional telecommunication and network fees and equipment expenses due to higher monitoring volume associated with the increased subscriptions revenue.

Direct costs of revenue — subscriptions and services increased $0.6 million for the six months ended March 31, 2013 compared to the six months ended March 31, 2012 and represented 28% and 27% of subscription and services revenue for the six months ended March 31, 2013 and 2012, respectively. The increase in direct costs of revenue — subscriptions and services was mainly attributable to $0.2 million of additional telecommunication and network fees, $0.2 million of equipment expenses due to higher monitoring volume associated with the increased subscriptions revenue and an increase of $0.2 million in personnel costs associated with additional headcount primarily focused on mobile products and services.

Direct costs of revenue — systems licenses include the material and labor costs of systems hardware to be installed as part of a systems license arrangement and related software royalty fees.

Direct costs of revenue — systems licenses decreased $0.3 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012 and represented 25% and 27% of systems licenses revenue for the three months ended March 31, 2013 and 2012, respectively. The decrease in direct costs of revenue — systems licenses was due to the lower system licenses revenue as compared to the same quarter last year.

Direct costs of revenue — systems licenses decreased $0.2 million for the six months ended March 31, 2013 compared to the six months ended March 31, 2012 and represented 27% and 25% of systems licenses revenue for the six months ended March 31, 2013 and 2012, respectively. The decrease in direct costs of revenue — systems licenses was due to the lower system licenses revenue, partially offset by a higher hardware component of the systems licenses revenue.

Development

	For the three months ended March 31,						For the six months ended March 31,
	2013		2012		% Change		2013		2012		% Change
Development	$	4,990	$	4,688	6	%	$	9,828	$	9,067	8	%

Development expenses consist primarily of employee compensation, including stock-based compensation and other benefits, and other costs incurred by our development personnel. Development costs increased $0.3 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012. The increase was mainly attributable to higher personnel costs associated with additional headcount primarily focused on mobile products and services.

Development costs increased $0.8 million for the six months ended March 31, 2013 compared to the six months ended March 31, 2012. The increase was mainly attributable to higher personnel costs associated with additional headcount primarily focused on mobile products and services.

Operations

	For the three months ended March 31,						For the six months ended March 31,
	2013		2012		% Change		2013		2012		% Change
Operations	$	2,995	$	2,667	12	%	$	5,744	$	5,163	11	%

Operations expenses consist primarily of employee compensation, including stock-based compensation and other benefits, for management and technical support personnel. Our operations personnel manage and maintain our field measurement and data collection network; provide basic and extended customer support; and ensure the reliability of our services. Operations expenses increased $0.3 million for the three months ended March 31, 2013 compared to the three months ended March 31, 2012. The increase was mainly attributable to $0.2 million of equipment expenses related to our data network to support the higher subscriptions revenue and higher personnel costs to support our data network.

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Operations expenses increased $0.6 million for the six months ended March 31, 2013 compared to the six months ended March 31, 2012. The increase was mainly attributable to $0.4 million of equipment expenses related to our data network to support the higher subscriptions revenue and $0.1million of higher personnel costs to support our data network.

Sales and Marketing

	For the three months ended March 31,						For the six months ended March 31,
	2013		2012		% Change		2013		2012		% Change
Sales and marketing	$	9,473	$	8,874	7	%	$	18,494	$	18,012	3	%

Sales and marketing expenses consist primarily of salaries, benefits, commissions and bonuses earned by sales and marketing personnel, stock-based compensation, lead-referral fees, marketing programs and travel expenses. Sales and marketing expenses increased by $0.6 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. The increase was mainly attributable to higher personnel costs resulting from additional headcount in order to grow Mobile revenues.

Sales and marketing expenses increased by $0.5 million for the six months ended March 31, 2013 as compared to the six months ended March 31, 2012. The increase was mainly attributable to higher personnel costs resulting from additional headcount in order to grow Mobile revenues.

General and Administrative

	For the three months ended March 31,						For the six months ended March 31,
	2013		2012		% Change		2013		2012		% Change
General and administrative	$	3,178	$	3,801	(16	)%	$	6,829	$	7,909	(14	)%

General and administrative expenses consist primarily of employee compensation, including stock-based compensation and other benefits; professional service fees, including accounting, auditing, legal and bank fees; insurance; and other general corporate expenses. General and administrative expenses decreased by $0.6 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. The decrease was mainly attributable to $0.3 million of transaction expenses in connection with the acquisition of DeviceAnywhere that was included in the prior year quarter that did not repeat in this quarter, lower stock-based compensation due to vesting of RSUs in July 2012, and lower rent expense due to moving the DeviceAnywhere employees into our headquarter building in January 2012.

General and administrative expenses decreased by $1.1 million for the six months ended March 31, 2013 as compared to the six months ended March 31, 2012. The decrease was mainly attributable to $0.4 million of transaction expenses in connection with the acquisition of DeviceAnywhere that was included in the prior year six months ended March 31, 2012 that did not repeat in the six months ended March 31, 2013, lower stock-based compensation due to vesting of RSUs in July 2012, and lower rent expense due to moving the DeviceAnywhere employees into our headquarter building in January 2012.

Change in estimated fair value of acquisition-related contingent consideration

At the acquisition date, a $2.0 million liability was recorded based on the estimated fair value of the acquisition-related contingent consideration to the former stockholders of DeviceAnywhere based on DeviceAnywhere achieving 2011 and 2012 revenue, bookings and EBITDA targets. During the first quarter of 2012, we concluded that DeviceAnywhere would not achieve either the 2011 or the 2012 targets. Accordingly, we reversed the liability and recorded a benefit of $2.0 million due to the change in estimate of the fair value of acquisition-related contingent consideration.

Excess Occupancy Income

	For the three months ended March 31,								For the six months ended March 31,
	2013			2012			% Change		2013			2012			% Change
Rental income	$	(891	)	$	(779	)	14	%	$	(1,765	)	$	(1,520	)	16	%
Related expenses	335			391			(14	)%	693			782			(11	)%
Excess occupancy income	$	(556	)	$	(388	)	43	%	$	(1,072	)	$	(738	)	45	%

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Excess occupancy income consists of rental income from the leasing of space not occupied by us in our headquarters building, net of related expenses, which consists of property taxes, insurance, building depreciation, leasing broker fees and tenant improvement amortization. The expenses associated with excess occupancy income are based on the actual square footage available for lease to third parties, which was 75% prior to January 1, 2012 and 65% subsequent to that date. The square footage available for lease to third parties decreased because DeviceAnywhere employees and operations moved into our headquarters building in January 2012. The increase in excess occupancy income for the three and six months ended March 31, 2013 as compared to the three and six months ended March 31, 2012 was mainly attributable to new tenants occupying space in our building and annual tenant rent increases per the lease agreements. Expenses were relatively consistent for the periods presented.

Amortization of Identifiable Intangible Assets

	For the three months ended March 31,						For the six months ended March 31,
	2013		2012		% Change		2013		2012		% Change
Amortization of identifiable intangible assets — technology	$	383	$	525	(27	)%	$	908	$	990	(8	)%
Amortization of identifiable intangible assets — other	168		969		(83	)%	466		1,779		(74	)%
Total amortization of identifiable intangible assets	$	551	$	1,494	(63	)%	$	1,374	$	2,769	(50	)%

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

Amortization of identifiable intangible assets—technology and amortization of identifiable intangible assets—other decreased for the three and six months ended March 31, 2013 as compared to the three and six months ended March 31, 2012 as a result of the backlog component of the identifiable intangible assets recorded in connection with the acquisition of DeviceAnywhere being fully amortized over a one year period ending in October 2012 and an identifiable intangible asset related to mobile technology that is incorporated in our subscriptions products and services becoming fully amortized in January 2013.

We review our identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. No events or circumstances were identified in the period ended March 31, 2013 indicating that the carrying amount of these assets may not be recoverable.

Interest Income and Other Income (Expense), Net

	For the three months ended March 31,							For the six months ended March 31,
	2013		2012			% Change		2013			2012			% Change
Interest income	$	32	$	39		(18	)%	$	57		$	85		(33	)%
Other income (expense), net	31		(51		)	161	%	(133		)	(37		)	259	%
Total	$	63	$	(12	)	625	%	$	(76	)	$	48		(258	)%

Interest income and other income (expense), net increased $0.1 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. Interest income declined slightly due to lower interest rates on invested funds. Other income (expense), net increased primarily due to slightly more favorable foreign exchange rates in the three months ended March 31, 2013 as compared to the three months ended March 31, 2012.

Interest income and other income (expense), net decreased $0.1 million for the six months ended March 31, 2013 as compared to the six months ended March 31, 2012. Interest income declined slightly due to lower interest rates on invested funds. Other income (expense), net decreased primarily due to slightly less favorable foreign exchange rates in the six months ended March 31, 2013 as compared to the six months ended March 31, 2012.

Benefit (Provision) for Income Taxes

	For the three months ended March 31,							For the six months ended March 31,
	2013		2012			% Change		2013			2012			% Change
Benefit (provision) for income taxes	$	204	$	(419	)	(149	)%	$	(1,968	)	$	(1,797	)	10	%

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Our effective tax rate for the three months ended March 31, 2013 and 2012 was (173) %, or a benefit, and 56%, respectively. The rate for the three months ended March 31, 2013 differs from the 35% United States federal statutory rate due in part to the relative mix of foreign and domestic earnings and enacted tax rates. Additionally, on January 2, 2013, The American Taxpayer Relief Act of 2012 became law and extended the research credit to December 31, 2013. The extension of the research credit is retroactive and includes amounts paid or incurred after December 31, 2011. As a result of the retroactive extension, we recognized a benefit of approximately $0.3 million for qualifying amounts incurred during fiscal 2012. The rate for the three months ended March 31, 2012 differs from the 35% United States federal statutory rate primarily due to the relative mix of foreign and domestic earnings and enacted tax rates.

Our effective tax rate for the six months ended March 31, 2013 and 2012 was 46% and 29%, respectively. The rate for the six months ended March 31, 2013 differs from the 35% United States federal statutory rate due in part to the relative mix of foreign and domestic earnings and enacted tax rates. Additionally, the effective tax rate was 11% higher than the statutory rate due to recording the effects of Section 162(m) limitations on deferred tax assets that should have been recorded in fiscal 2011 and 2012. This was partially offset by the $0.3 million benefit discussed above related to the research credit for qualifying amounts incurred during fiscal 2012. The rate for the six months ended March 31, 2012 differs from the 35% United States federal statutory rate primarily due to the relative mix of foreign and domestic earnings, enacted tax rates, and the fact that the change in estimated fair value of acquisition-related contingent consideration is a non-taxable, discrete transaction in that period.

Stock based Compensation Expense

Stock-based compensation expense, which is included in total costs and expenses by category decreased $0.3 million for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012 and was mainly attributable to the vesting in July 2012 of the RSUs granted in 2009 and to certain executives departing the Company. Stock-based compensation expense decreased $0.3 million for the six months ended March 31, 2013 as compared to the six months ended March 31, 2012 primarily due to the vesting in July 2012 of the RSUs granted in 2009 and to certain executives departing the Company.

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

	Three Months Ended March 31,				Six Months Ended March 31,
	2013		2012		2013		2012
Direct costs of revenue —subscriptions and services	$	165	$	203	$	241	$	369
Development	291		375		563		680
Operations	154		160		282		303
Sales and marketing	346		519		803		950
General and administrative	246		287		652		570
Total	$	1,202	$	1,544	$	2,541	$	2,872

Non-GAAP Financial Measures and Other Operational Data

We also consider certain financial measures that are not prepared in accordance with accounting principles generally accepted in the United States (“GAAP”), including Non-GAAP net income, Non-GAAP net income per share, Adjusted EBITDA, and free cash flow, in managing and measuring the performance of our business. We use these non-GAAP financial measures internally in analyzing our financial results and believe they are useful to investors, as a supplement to GAAP measures, in evaluating our ongoing operational performance against other technology companies and enhancing an overall understanding of our past financial performance, as they help illustrate underlying trends in our business that could otherwise be masked by the effect of the non-cash expenses that we exclude in these non-GAAP financial measures. Furthermore, we use Adjusted EBITDA to establish budgets and bonus compensation targets for managing our business and evaluating our performance. The Non-GAAP measures are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similar measures presented by other companies. However, we believe that this non-GAAP information is useful as an additional means for investors to evaluate our operating performance, when reviewed in conjunction with our GAAP financial statements. Therefore, these measures should not be considered in isolation or as a substitute for measures prepared in accordance with GAAP, and because these amounts are not determined in accordance with GAAP, they should not be used exclusively in evaluating our business and operations.

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Non-GAAP Net Income and Non-GAAP Net Income Per Share

Non-GAAP net income is calculated by adjusting GAAP net income (loss) for the provision (benefit) for income taxes, cash taxes paid (net of refunds), stock-based compensation expense, amortization of purchased intangibles, and any unusual items. Cash taxes paid (net of refunds) consists of payments made to tax authorities less any refunds received from tax authorities related to income taxes. In the three months ended December 31, 2011, the $2.0 million change in fair value of acquisition-related contingent consideration was considered an unusual item. Non-GAAP net income per share is calculated by dividing Non-GAAP net income by the weighted average number of diluted shares outstanding for the period. The following table details our calculation (and reconciliation to GAAP) of non-GAAP net income and non-GAAP net income per share (in thousands, except per share amounts):

	Three Months Ended March 31,					Six Months Ended March 31,
	2013			2012		2013			2012
GAAP net income	$	322		$	334	$	2,266		$	4,455
Stock-based compensation	1,202			1,544		2,541			2,872
Amortization of intangible assets — technology	383			525		908			990
Amortization of intangible assets — other	168			969		466			1,779
Provision (benefit) for income taxes	(204		)	419		1,968			1,797
Change in fair value of acquisition-related contingent consideration	—			—		—			(2,000		)
Cash taxes paid (net of refunds)	(120		)	66		(377		)	(20		)
Non-GAAP net income	$	1,751		$	3,857	$	7,772		$	9,873
Weighted average diluted common shares outstanding	18,677			18,553		18,539			18,540
Non-GAAP net income per share	$	0.09		$	0.21	$	0.42		$	0.53

Adjusted EBITDA

Adjusted EBITDA is defined as earnings before interest income, provision (benefit) for income taxes, stock-based compensation, depreciation, amortization of purchased intangibles, other income (expense), net and any unusual items. In the first quarter of fiscal 2012, the change in fair value of acquisition-related contingent consideration was considered an unusual item. Adjusted EBITDA Margin is defined as Adjusted EBITDA as a percentage of net revenues. The following table details our calculation (and reconciliation to GAAP) of Adjusted EBITDA:

	Three Months Ended March 31,						Six Months Ended March 31,
	2013			2012			2013			2012
GAAP net income	$	322		$	334		$	2,266		$	4,455
Stock-based compensation	1,202			1,544			2,541			2,872
Amortization of intangible assets — technology	383			525			908			990
Amortization of intangible assets — other	168			969			466			1,779
Depreciation	1,495			1,370			2,973			2,704
Provision (benefit) for income taxes	(204		)	419			1,968			1,797
Change in fair value of acquisition-related contingent consideration	—			—			—			(2,000		)
Interest income and other income (expense), net	(63		)	12			76			(48		)
Adjusted EBITDA	$	3,303		$	5,173		$	11,198		$	12,549
Adjusted EBITDA Margin	11		%	17		%	18		%	20		%

Free Cash Flow

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

	Three Months Ended March 31,						Six Months Ended March 31,
	2013			2012			2013			2012
Cash flow provided by operations	$	5,852		$	4,606		$	9,675		$	6,116
Purchases of property, equipment and software	(1,270		)	(1,639		)	(2,723		)	(3,247		)
Free cash flow	$	4,582		$	2,967		$	6,952		$	2,869

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Liquidity and Capital Resources

	March 31, 2013		September 30, 2012
Cash, cash equivalents and short-term investments	$	57,914	$	49,939
Accounts receivable, net	$	15,492	$	17,395
Working capital	$	57,970	$	48,846
Days sales outstanding (DSO) for the three months ended (a)	48		53

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

Days sales outstanding decreased by 5 days from September 30, 2012 to March 31, 2013. The decrease is due to increased collections, primarily in Europe, and due to not being able to bill customers due to delays in obtaining customer acceptance for a few large SITE projects at the end of the second quarter of fiscal 2013. During the period, our customers’ payment history remained consistent with prior periods and contractual payment terms. During recent periods, our customers have requested longer payment terms. We expect this trend towards longer terms to continue.

	Six Months Ended March 31,
	2013			2012
Cash provided by operating activities	$	9,675		$	6,116
Cash used in investing activities	$	(8,550	)	$	(59,533	)
Cash provided by (used in) financing activities	$	1,097		$	(615	)

As of March 31, 2013, we had $31.1 million in cash and cash equivalents and $26.8 million in short-term investments, for a total of $57.9 million. Cash and cash equivalents consist of highly liquid investments held at major banks, money market funds and other investments with original maturities of three months or less. Short-term investments consist of investments with original maturities longer than three months, including commercial paper and investment-grade corporate and government debt securities with Moody’s ratings of A3 or better. As of March 31, 2013, $44.7 million of our cash, cash equivalents and short-term investments was held in the United States. The remainder of our cash, cash equivalents and short-term investments was held in foreign financial institutions, primarily in Germany, by our subsidiaries. If these foreign cash, cash equivalents and short-term investments are distributed to the United States in the form of dividends or otherwise, we may be subject to additional United States income taxes (subject to an adjustment for foreign tax credits) and foreign withholding taxes.

Cash provided by operating activities

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

Our largest source of operating cash flow is cash collections from our customers. Payments from subscription services customers are generally collected either at the beginning of the subscription period or monthly during the life of the subscription period. Payments for our systems licenses are generally collected at or after delivery of the hardware and software. Payments for our engagement services customers are generally collected at the completion of the service period or as milestones are completed. Our primary use of cash from operating activities, are for personnel related expenditures, measurement and data collection infrastructure costs, insurance, professional services, regulatory compliance and other expenses associated with operating our business.

For the six months ended March 31, 2013, net cash provided by operating activities was $9.7 million. Net cash provided was mainly due to net income of $2.3 million, adjusted for $9.0 million of non-cash adjustments to reconcile net income to net cash provided by operating activities and a $(1.6) million net change in operating assets and liabilities. The non-cash adjustments consist primarily of depreciation, amortization, stock-based compensation expense, changes in bad debt and billing reserves, deferred tax expenses, the change in the estimated fair value of acquisition-related contingent consideration and amortization of debt instruments purchase discount or premium. The net change in operating assets and liabilities was primarily due to a decrease in accounts receivable of $1.7 million as a result of increased customer cash collections and a decrease in accounts payable and accrued expenses of $1.5 million and a decrease in deferred revenue of $0.8 million.

Cash used in investing activities

Cash flows related to investing activities consist primarily of purchases, sales and maturities of investments and purchases of property, equipment and software to support our growth, to expand and improve our monitoring infrastructure and to make tenant improvements associated with space we lease in our headquarters building.

Net cash used in investing activities was $8.6 million for the six months ended March 31, 2013 consisting of purchases of property, equipment and software of $2.7 million, and $21.1 million short-term investments purchases, offset by $15.3 million of proceeds from the sale and maturity of short-term investments.

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Cash provided by (used in) financing activities

Cash flows from financing activities primarily relate to payments of common stock dividends and proceeds received from the issuance of common stock under our employee stock option plan and employee stock purchase plan.

For the six months ended March 31, 2013, net cash provided by financing activities was $1.1 million primarily due to $3.3 million of proceeds from the issuance of common stock, offset by the payment of common stock dividends in the amount of $2.2 million.

Commitments

As of March 31, 2013, our principal commitments consisted of $1.5 million in real property and equipment operating leases. These leases expire at various times through March 2018. Additionally, we had $1.0 million of contingent commitments to bandwidth and co-location providers. These contingent commitments have a remaining term of up to twenty-one months and become due if we terminate any of these agreements prior to their expiration. At present, we do not intend to terminate any of these agreements prior to their expiration. We expect to continue to purchase equipment and other assets to support our growth.

As of March 31, 2013, we have outstanding guarantees totaling $0.2 million to customers and vendors of one of our foreign subsidiaries. These guarantees can only be executed upon agreement by both the customer or vendor and us. These guarantees were secured by a $1.3 million unsecured line of credit.

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

Off Balance Sheet Arrangements

We did not enter into any transactions with unconsolidated entities whereby we have financial guarantees, subordinated retained interests, derivative instruments or other contingent arrangements that expose us to material continuing risks, contingent liabilities, or any other obligation under a variable interest in a unconsolidated entity that provides financing, liquidity, market or credit risk support to us.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Sensitivity. Our interest income is sensitive to changes in the general level of interest rates, particularly since most of our short-term investments are invested in debt instruments and money market funds. If market interest rates were to change immediately and uniformly by ten percent (10%) from their current levels, the interest earned on our cash, cash equivalents, and short-term investments would increase or decrease by less than $0.1 million on an annualized basis. Our investment policy’s primary objective is to preserve principal balances rather than to maximize returns.

Foreign Currency Fluctuations. While a significant portion of our revenue and a majority of our expenses are transacted in United States dollars, we operate internationally and are exposed to potentially adverse movements in foreign currency rate changes. Specifically, we enter into revenue and expense transactions denominated in other currencies, primarily the Euro and the British Pound. As a result, our United States dollar earnings and net cash flows from international operations may be adversely affected by changes in foreign currency exchange rates. Net foreign exchange transaction gains (losses), included in “Other income (expense), net” in the accompanying condensed consolidated statements of operations, are primarily due to fluctuations in the Euro and the British Pound and are a loss of $133,000 and of $35,000 in the six months ended March 31, 2013 and 2012, respectively. We currently do not hedge or enter into currency exchange contracts against foreign currency exposures.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

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Item 1A. Risk Factors

Our quarterly financial results are subject to significant fluctuations, and if our future results are below the expectations of investors, the price of our common stock may decline.

Our results of operations could vary significantly from quarter to quarter. If revenue or other financial results fall below ours or investor expectations, we may not be able to increase our revenue or reduce our spending rapidly in response to the shortfall. Other factors that could affect our quarterly operating results include those described below and elsewhere in this report:

· The level of sales of our mobile cloud products and services;

· The volatility of customer acceptance for mobile systems;

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

· The effect of global economic conditions, particularly in the United States and Europe, on customers and partners, including the level of discretionary technology spending;

· The seasonality of our revenues, especially our LoadPro and SITE products and services;

· Fluctuations in foreign currency exchange rates;

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

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

· Our ability to successfully develop and introduce new products and services;

· The timing and amount of engagement services revenue, which is difficult to predict because of its dependence on the number of engagements in any given period, the non-recurring nature of these engagements, the size of these engagements, and the seasonal nature of these engagements;

· Disruptions to our global monitoring network infrastructure;

· The timing, nature and amount of operating costs, including unforeseen or unplanned operating expenses, sales and marketing investments, changes in headcount and capital expenditures;

· Future accounting pronouncements and changes in accounting and tax policies;

· The timing and amount, if any, of impairment charges related to goodwill and acquired tangible and intangible assets; and

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

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

Our business, operating results and financial condition are susceptible to additional risks associated with international operations.

Our business, financial condition and operating results could be significantly affected by risks associated with international activities, including economic and labor conditions, the European economic downturn, political instability, tax laws (including United States taxes on foreign subsidiaries and the negative tax implications related to moving cash from international locations to the United States), and changes in the value of the United States dollar versus foreign currencies, particularly the Euro.

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Our primary exposure to movements in foreign currency exchange rates relate mainly to non-United States dollar denominated sales and cash balances in Europe, as well as non-United States dollar denominated operating expenses incurred throughout the world. As was the case in fiscal 2012, volatility of foreign currencies relative to the United States dollar may adversely affect the United States dollar value of our foreign currency-denominated cash, sales and earnings.

International sales were approximately 44% and 47% of our net revenue for the six months ended March 31, 2013 and 2012, respectively. We expect to continue to commit significant resources to our international activities. Economic conditions in Europe are currently challenging and it is possible that revenues from European customers could be adversely affected in future periods. Conducting international operations also subjects us to risks we do not face in the United States, including:

· Foreign currency exchange rate fluctuations, primarily the Euro;

· Longer accounts receivable payment cycles and difficulties in collecting accounts receivable;

· Seasonal fluctuations in purchasing patterns;

· The burdens of complying with a wide variety of foreign laws, the Foreign Corrupt Practices Act, and other similar laws;

· Unexpected changes in regulatory requirements;

· Installing, maintaining and servicing measurement computers in distant locations;

· Difficulties in managing and staffing international operations;

· Potentially adverse tax consequences, including restrictions on the repatriation of earnings;

· Difficulties in establishing and enforcing our intellectual property rights in some countries; and

· Political or economic instability, war or terrorism in some of the countries where we do business.

The success of our business depends on maintaining a large customer base, either by customers renewing their subscriptions for our products and services and purchasing additional products and services or by obtaining new customers.

To maintain and grow our revenue, we must maintain or increase the overall size of our customer base, through maintaining high customer renewal rates, obtaining new customers for our products and services, and selling additional products and services to existing customers. Our customers have no obligation to renew our products and services after their contract term and, therefore, they could cease using our products and services at any time. In addition, customers that renew may contract for fewer products and services or at lower prices. Further, our customers may reduce their usage levels of our products and services during the term of their subscription. The size of our customer base, usage and prices may decline as a result of a number of factors, including competition, consolidations in the Internet or mobile industries or if a significant number of our customers cease operations.

Additionally, sales of our products and services may decline as companies evaluate their technology spending in response to the global economic environment. We have experienced in the past, and may experience in the future, reduced spending, cancellations, and non-renewals by our customers. If we experience reduced renewal rates or if customers renew for a lesser amount of our products and services, or if customers, at any time, reduce the amount of products or services they purchase from us for any reason, our revenue could decline unless we are able to obtain additional customers or sources of revenue, sufficient to replace lost revenue.

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

Revenue from our mobile cloud products and services was $31.8 million, or 50% of total revenue, for the six months ended March 31, 2013. Future growth for these products and services could be adversely affected by a number of factors, including, but not limited to, the difficulty in predicting demand; customer acceptance of installed systems licenses; the variability of timing and amount of systems licenses arrangements; developing products responsive to the rapidly changing technology in the mobile market; currency rate fluctuations; global economic conditions; and our ability to successfully compete against current or new competitors in this market. These products and services are typically purchased by large telecommunication network providers and enterprise customers that can have longer sales and acceptance cycles. Our business and our operating results could be harmed if we experience delays in acceptance of systems or declines in revenue from our mobile cloud products and services.

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A disruption to our global monitoring network infrastructure could impair our ability to serve and retain existing customers or attract new customers.

Our operations depend upon our ability to maintain and protect our data centers, which store and distribute all data collected from our global monitoring network. We currently serve our customers from facilities located in San Mateo, California; Plano, Texas; Nuremburg, Germany; and London, the United Kingdom. Our facilities are generally susceptible to natural disasters. Specifically, our primary operations centers, located in San Mateo, California, are susceptible to earthquakes, other natural disasters and possible power outages. Natural disasters affecting large geographic areas or that cause severe damage could also negatively impact demand for our products and services from customers. We have occasionally experienced outages in the past and, if we experience outages at our operations centers in the future, we might not be able to promptly receive data from our measurement computers and we might not be able to deliver our products and services to our customers on a timely basis.

Although we maintain insurance against fires, earthquakes and general business interruptions, the amount of coverage may not be adequate in any particular case. If our operations centers are damaged, this could disrupt our products and services, which could impair our ability to retain existing customers or attract new customers.

Our operations systems are also vulnerable to damage from break-ins, computer viruses, unauthorized access, vandalism, fire, floods, earthquakes, power loss, telecommunications failures and similar events. Any outage for any period of time or loss of customer data could cause us to lose customers.

Individuals who attempt to breach our network security, such as hackers, could, if successful, misappropriate proprietary information or cause interruptions in our products and services. We might be required to expend significant capital and resources to protect against, or to alleviate, problems caused by hackers. We may not have a timely remedy against a hacker who is able to breach our network security. In addition to intentional security breaches, the inadvertent transmission of computer viruses could expose us to litigation or to a material risk of loss.

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

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

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

Our business could be harmed by adverse economic conditions or reduced spending on technology.

Our operations and performance depend significantly on global economic conditions, especially in the United States and Europe. Uncertainty about current global economic conditions poses a risk as consumers and businesses have reduced and may continue to reduce spending in response to negative financial news, legislative issues such as the debt ceiling and income tax rates, a decline in consumer confidence, quantitative easing of the monetary supply, and/or declines in income or asset values, which could have a material negative effect on the demand for our products and services. A decrease in consumer and mobile demand also could have a variety of negative effects on our customers’ demand for our products and services. Other factors that could influence demand include labor and healthcare costs, access to credit, the housing markets effect on consumer confidence, and other macroeconomic factors affecting spending behavior. These and other economic factors could have a material adverse effect on our financial results, and in certain cases, may reduce our revenue, increase our costs, and lower our gross margin percentage, or require us to recognize impairment charges against our assets. In addition, real estate values across the United States have been adversely affected by the global economic downturn and tighter credit conditions, and we cannot assure you that the value of our building will not be affected by these or future conditions.

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

We have completed several acquisitions in the past, and as part of our business strategy, we may seek to acquire or invest in additional businesses, products or technologies that we believe could complement or expand our business, augment our market coverage, enhance our technical capabilities, or may otherwise offer growth opportunities. The recent and future acquisitions could create risks for us, including:

· Difficulties in assimilating acquired personnel, operations, and technologies;

· Maintaining existing and obtaining new customers for the acquired products and services;

· Unanticipated costs associated with the acquisition or incurring of additional unknown liabilities;

· Diversion of management’s attention from other business concerns;

· 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 products and services, customers and other business partners;

· The need to integrate or enhance the internal controls and systems of an acquired business;

· Potential impairment charges related to acquired assets;

· Entry in new businesses in which we have little direct experience;

· Difficulties in managing a larger organization with geographically dispersed operations;

· 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.

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

Our ten largest customers accounted for approximately 31% of our net revenue for the six months ended March 31, 2013. 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 the usage of our products and services and, therefore, continue to generate revenue in any future period. In addition, our customers may generally terminate their contract at any time with little or no penalty. If we lose a major customer or group of customers, our revenue could decline.

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

While we have been profitable in recent years, we have incurred losses in prior fiscal years. As of March 31, 2013, we had an accumulated deficit of $80.1 million. If we are not able to maintain or increase our revenue, it may be difficult to sustain profitability. As of March 31, 2013, we had $7.7 million of net identifiable intangible assets and $110.1 million of goodwill. Annually we test our goodwill for impairment. Identifiable intangible assets are tested for impairment when events or circumstances indicate that the carrying value may not be recoverable. If our market capitalization drops significantly below the amount of net equity recorded on our balance sheet, it could indicate a decline in our value and could require us to record impairment charges against our goodwill and identifiable intangible assets. In addition, we have deferred tax assets which may not be fully realized, which may contribute to additional losses. As a result of these and other conditions, we may not be able to sustain profitability in the future.

Our investment in sales and marketing may not yield increased customers or revenue.

We have invested and may continue to invest in our sales and marketing activities to help grow our business, including hiring additional domestic and international sales personnel. Typically, additional sales personnel can take time before they become productive, and our marketing programs may also take time before they yield additional business, if any. We cannot assure you that these efforts will be successful, or that these investments will yield significantly increased revenue in the near or long-term.

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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. Despite the current unemployment rate, there is substantial competition for highly skilled employees, especially in the San Francisco Bay area. If we fail to attract and retain key employees, our business could be harmed.

The market for our engagement services is very competitive and we may not succeed in selling and delivering these services.

Engagement services revenue represented approximately 8.5% of net revenue for the six months ended March 31, 2013. The market for these professional services is very competitive, and we have experienced a decline in this revenue in recent periods. Each engagement typically spans a short period of time and, therefore, it is more difficult for us to predict the amount of engagement services revenue that will be recognized in any particular quarter. We will need to successfully market these services in order to maintain or increase engagement services revenue. There are many experienced firms that offer computer network and Internet-related consulting services. These consulting services providers include consulting companies, such as Accenture, as well as consulting divisions of large technology companies, such as IBM. Because this area is very competitive, and we have limited resources dedicated to delivering engagement services, we may not succeed in selling and delivering these services.

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

The market for our products and services is rapidly evolving. Our competitors vary in size and in the scope and breadth of their products and services. We face competition from companies that offer Internet and mobile software and services with features similar to our products and services such as Compuware, Hewlett-Packard, Neustar, Perfecto Mobile, SmartBear and a variety of other Internet and mobile companies that offer a combination of testing, quality assurance, market research and data collection services. We face competition for our Telecommunications Mobile products and services from companies such as ADECEF, Ascom (which acquired Argogroup), Datamat, and JDS Uniphase (which acquired Casabyte). Customers could choose to use these companies’ products and services or these companies could enhance their products and services to offer all of the features we offer. As we expand the scope of our products and services, we expect to encounter additional market-specific competitors.

In addition, there has been a trend toward industry consolidation in our markets for several years. We expect this trend to continue as companies attempt to strengthen or hold their market positions in an evolving industry and as companies are acquired or are unable to continue operations. We believe that industry consolidation may result in stronger competitors that are better able to compete for customers. This could lead to more variability in operating results and could have a material adverse effect on our business, operating results, and financial condition. Furthermore, rapid consolidation could also lead to fewer customers and partners, with the effect that the loss of a major customer could harm our revenue.

We could also face competition from other companies which currently do not offer products and services similar to ours, but offer software or services related to Web analytics services, such as Webtrends, Adobe Systems (which acquired Omniture) and IBM (which acquired Coremetrics), and free services that measure Web site availability. In addition, companies that sell systems management software, such as BMC Software, Compuware, CA NSM, HP Software, Dell (which acquired Quest Software), Attachmate, Precise Software, and IBM’s Tivoli Unit, may decide to offer products and services similar to ours. While we have relationships with some of these companies, they could choose to develop products and services similar to ours or to offer our competitors’ services. 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 products and services and loss of market share, any of which could seriously harm our business. We may not be able to compete successfully against our current and future competitors.

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

The ongoing evolution of Internet and mobile networks has led to the development of new technologies and communications protocols, such as Internet telephony, wireless devices, Wi-Fi networks, HSDPA and LTE, as well as increased use of various applications, such as VoIP, mobile applications and video. These developing technologies require us to continually improve the functionality, features and reliability of our products and services, particularly in response to offerings by our competitors. If we do not succeed in developing and marketing new products and services that respond to competitive and technological developments and changing customer needs, we may encounter difficulties retaining existing customers and attracting new customers.

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The success of new products and services depends on several factors, including proper definition of the scope and timely completion, introduction and market acceptance. For example, we recently committed resources to add a Web privacy monitoring feature to our products and services in response to tracking by third-party advertising networks. If new Internet, mobile, networking or telecommunication technologies or standards are widely adopted or if other technological changes occur, we may need to expend significant resources to adapt to these developments or we could lose market share or some of our products and services could become obsolete.

The market price of our common stock can be volatile.

The stock market in recent years has experienced significant price and volume fluctuations, and has recently experienced substantial volatility that has affected the market prices of technology companies. These fluctuations have often been unrelated to or disproportionately impacted by the operating performance of public companies. The market for our common stock has been subject to similar fluctuations. Factors such as fluctuations in our operating results, analyst expectations and recommendations, announcements of events affecting other companies in the technology industry, currency fluctuations and general market events and conditions may cause the market price of our common stock to decline. In addition, because of our relatively low trading volume, and the fact that we only have 18.4 million shares outstanding at March 31, 2013, our stock price could be more volatile than companies with higher trading volumes and larger numbers of shares available for trading in the public market.

Our cash, cash equivalents and short-term investments are managed through various banks around the world and we may realize losses on these.

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

If the protection of our proprietary technology is inadequate, our competitors may gain access to our technology, and our market share could decline.

Our success is heavily dependent on our ability to create proprietary technology and to protect and enforce our intellectual property rights in that technology, as well as our ability to defend against adverse claims by third parties with respect to our technology and intellectual property. To protect our proprietary technology, we rely primarily on a combination of contractual provisions, confidentiality procedures, trade secrets, copyright and trademark laws, and patents. Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products and services or obtain and use information that we regard as proprietary.

The laws of some foreign countries do not protect our proprietary rights to as great an extent as do the laws of the United States. Our means of protecting our proprietary rights may not be adequate and unauthorized third parties, including our competitors, may independently develop similar or superior technology, duplicate or reverse engineer aspects of our products and services, or design around our patented technology or other intellectual property.

There can be no assurance or guarantee that any products, services or technologies that we are presently developing, or will develop in the future, will produce a competitive advantage for us or will result in intellectual property that is subject to legal protection under the laws of the United States or a foreign jurisdiction.

Others might bring infringement claims which could harm our business.

There is significant litigation involving patents and other intellectual property rights, especially in the technology and software industry. We could become subject to intellectual property infringement claims as our products and services overlap with competitive offerings. We have recently been named in a complaint brought by a non-practicing entity, as described in “Item 1 - Legal Proceedings.” In addition, we are, or could be, subject to other legal proceedings, claims, and litigation arising in the ordinary course of our business. Any of these claims, even if not meritorious, could be expensive and divert management’s attention from operating our company. If we become liable to others for infringement of their intellectual property rights, we could be required to pay a substantial damage award, to develop non-infringing technology, obtain a license to use the infringed intellectual property, or cease selling the products and services that contain the infringing intellectual property. We may be unable to develop non-infringing technology or to obtain a license on commercially reasonable terms, or at all.

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

Our measurement computers and mobile devices that we use to provide many of our products and services are located at facilities that are not owned by us. Instead, these devices are installed at various worldwide locations near Internet and mobile access points. Since we do not own or operate these facilities, we have little control over how these devices are maintained on a day-to-day basis. We do not have long-term contractual relationships with the companies that operate the facilities where our measurement computers are located. We may have to find new locations for these computers if we are unable to maintain relationships with these companies or if these companies cease their operations as some have done due to bankruptcies or being acquired. In addition, if our measurement computers and mobile devices cease to function properly, we may not be able to repair or service them on a timely basis, as we may not have immediate access to our measurement computers and measurement devices. Should performance problems arise and we are unable to quickly maintain and repair our computers and devices, our ability to collect data in a timely manner could be impaired.

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

To increase sales worldwide, we must complement our direct sales force with relationships with other companies to help market and sell our products and services. We currently have relationships with several Open Application Performance Monitoring (“Open APM”) partners and SITE system resellers. Additionally, we have partner relationships to resell our Internet and mobile products. In the past, we have had to terminate relationships with some of our international resellers, and we may be required to terminate other reseller relationships in the future. If we are unable to maintain our existing marketing, reseller and distribution relationships, or fail to enter into additional relationships, we may have to devote substantially more resources to direct sales and marketing efforts, especially in foreign countries.

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

The success of our business depends on the continued use of Internet and mobile networks by businesses and consumers for e-business and communications and, if usage of these networks declines, our operating results and working capital would be harmed.

Because our business is based on providing Internet and mobile cloud products and services, Internet and mobile networks must continue to be used as a means of business and communications. We believe that the use of Internet and mobile networks for conducting business could be hindered for a number of reasons, including, but not limited to:

· Security concerns related to information communicated over Internet and mobile networks, including the potential for fraud or theft of stored data and tracking of personal data;

· Inconsistent quality of service, including outages of popular Web sites, the Internet and mobile networks;

· Delay in the development or adoption of new standards;

· Inability to integrate business applications with Internet and mobile devices;

· The need to operate with multiple and frequently incompatible products and operating systems; and

· Potential regulation or operation of aspects of the Internet by entities such as the International Telecommunication Union.

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

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

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

As a public company, we incur significant legal, accounting and other expenses. In addition, the Sarbanes-Oxley Act, the Dodd-Frank Consumer Protection Act and rules implemented by the Securities and Exchange Commission (“SEC”) and The Nasdaq Stock Market have imposed and will impose a variety of requirements and restrictions on public companies, including requiring changes in corporate governance practices. Our management and other personnel will need to devote a substantial amount of time to these compliance initiatives, including evaluation of internal controls, stockholder advisory votes, establishment of an internal audit department and XBRL reporting. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly.

Moreover, generally accepted accounting principles (“GAAP”) are promulgated by, and are subject to the interpretations of the Financial Accounting Standards Board (“FASB”) and the SEC. New accounting guidance or taxation rules and varying interpretations of accounting guidance or taxation practices have occurred and may occur in the future. Any future changes in accounting guidance or taxation rules or practices may have a significant effect on how we report our results and may even affect our reporting of transactions completed before the change is effective. In addition, a review of existing or prior accounting practices may result in a change in previously reported amounts. The change to existing rules, future changes, if any, or the questioning of current practices may adversely affect our reported financial results, our ability to remain listed on the Nasdaq Global Market, the way we conduct our business or subject us to regulatory inquiries or litigation.

If we need to raise additional capital and are unable to do so, our business could be harmed.

We believe that our available cash, cash equivalents and short-term investments will enable us to meet our capital and operating requirements for at least the next twelve months. However, if cash is required for unanticipated operating requirements or to fund an acquisition, we may need additional capital during that period. We cannot be certain that additional capital will be available to us on favorable terms, or at all. If we were unable to raise additional capital when required, our business could be seriously harmed.

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

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

· Our stockholders may take action only at a meeting and not by written consent;

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

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

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

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits

EXHIBIT INDEX

Exhibit

Incorporated by Reference

Filed

No.

Exhibit

Form

File No.

Filing Date

Exhibit No.

Herewith

31.1

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

31.2

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

32.1*

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

32.2*

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

101*

The following materials from Keynote’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, formatted in XBRL (Extensible Business Reporting Language): (i) the unaudited Condensed Consolidated Balance Sheets, (ii) the unaudited Condensed Consolidated Statements of Operations, (iii) the unaudited Condensed Consolidated Statements of Comprehensive Income, (iv) the unaudited Condensed Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements.

* 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.

	Page
Condensed Consolidated Balance Sheets as of March 31, 2013 and September 30, 2012	4
Condensed Consolidated Statements of Operations for the three and six months ended March 31, 2013 and 2012	5
Condensed Consolidated Statements of Comprehensive Income for the three and six months ended March 31, 2013 and 2012	6
Condensed Consolidated Statements of Cash Flows for the six months ended March 31, 2013 and 2012	7
Notes to Condensed Consolidated Financial Statements	8

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

	KEYNOTE SYSTEMS, INC.


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


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


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