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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2003

OR

For the transition period from _____________ to ______________

COMMISSION FILE NUMBER: 000-27241

Keynote Systems, Inc.

(Exact name of registrant as specified in its charter)

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

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

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

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

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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

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PART I—FINANCIAL INFORMATION

Item 1.     Financial Statements

KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

Index to Unaudited Condensed Consolidated Financial Statements

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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands)

(Unaudited)

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)

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)

See accompanying notes to the condensed consolidated financial statements

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KEYNOTE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The accompanying interim unaudited condensed consolidated financial statements reflect all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the financial position of Keynote Systems, Inc. and subsidiaries (the Company) at March 31, 2003, and the results of operations and cash flows for the interim periods ended March 31, 2003 and 2002.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”), and therefore, do not include all information and footnotes necessary for a complete presentation of the Company’s results of operations, financial position and cash flows. This report should be read in conjunction with the consolidated financial statements and notes thereto for the fiscal year ended September 30, 2002 included in the Company’s Report on Form 10-K as filed with the SEC.

The results of operations for any interim period are not necessarily indicative of the Company’s results of operations for any other future interim period or for a full fiscal year.

Excess occupancy costs are costs related to fixed charges associated with the unoccupied portion of the Company’s headquarters’ building, such as property taxes, insurance and depreciation. These costs represent the fixed costs of operating the Company’s headquarters’ building acquired in September 2002 and are based on the actual unoccupied square footage, which was determined to be 60% during the three and six months ended March 31, 2003.

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

The Company issues stock options to its employees and outside directors and provides employees purchase rights with respect to its stock pursuant to stockholder approved stock option and employee stock purchase plans. The Company accounts for its stock-based compensation plans under the intrinsic value method of accounting as defined by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations. Accordingly, no stock-based employee compensation cost is reflected in net income for the three and six months ended March 31, 2003 and 2002, as all options granted under these plans had an exercise price equal to or in excess of the fair market value of the underlying common stock as of the grant date for each stock option, except for certain stock options granted in fiscal 1999 or earlier, prior to its initial public offering. For those option grants in fiscal 1999 or earlier, the Company recorded deferred stock compensation of $1.9 million for the difference at the grant date between the exercise price of each stock option granted and the fair value of the underlying common stock. This amount is being amortized on a straight-line basis over the vesting period, which is generally four years. As of March 31, 2003, the unamortized deferred compensation balance was $4,000.

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

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

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

Comprehensive loss includes net loss and unrealized gains and losses on short-term investments in debt securities and foreign currency translation. These items are excluded from earnings and reported as a component of stockholders’ equity. The functional currency of the Company’s foreign operations is the applicable local currency. The translation of foreign currencies into U.S. dollars is performed for balance sheet accounts using exchange rates in effect at the balance sheet date and for revenue and expense accounts using average exchange rates for each reporting period. Gains and losses from foreign currency transactions are reflected in the condensed consolidated statements of operations as incurred (in thousands):

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

Credit risk is concentrated in North America, but also exists in Europe. The Company generally requires no collateral from customers, however, throughout the collection process, it conducts an ongoing evaluation of customers’ ability to pay. The Company’s allowance for doubtful accounts is determined based on historical trends, experience and current market and industry conditions. Management regularly reviews the adequacy of the Company’s allowance for doubtful accounts after considering the aging of accounts receivable, the age of each invoice, each customer’s expected ability to pay and the Company’s collection history with each customer. Management reviews invoices greater than 60 days old to determine whether an allowance is appropriate based on the receivable balance. In addition, the Company maintains a reserve for all other invoices, which is calculated by applying a percentage to the outstanding accounts receivable balance, based on historical collection trends. The allowance for doubtful accounts represents management’s best current estimate, but changes in circumstances relating to accounts receivable, including unforeseen declines in market conditions and collection rates, may result in additional allowances in the future. The Company believes that it has adequately reserved for doubtful accounts as of the date of each balance sheet presented herein. At March 31, 2003 and 2002, no single customer accounted for more than 10% of the Company’s total accounts receivable. For the three and six months ended March 31, 2003 and 2002, no single customer accounted for more than 10% of the Company’s total revenue during each period.

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For the purposes of the condensed consolidated financial statements, the Company considers all highly liquid investments with original maturities of three months or less when acquired to be cash equivalents. All of the Company’s cash equivalents and short-term investments are classified as available-for-sale. These securities are carried at fair market value, with unrealized gains and losses excluded from earnings and reported as a component of other comprehensive income (loss). The following table summarizes the Company’s short-term investments in investment-grade debt securities as of March 31, 2003 (in thousands):

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

The following table summarizes the contractual maturities of investments available for sale at March 31, 2003 (in thousands). Expected maturities will differ from contractual maturities because borrowers may have the right to call or repay obligations with or without call or prepayment penalties.

As of March 31, 2003, the net carrying value of identifiable intangible assets was approximately $2.7 million. During the first quarter of fiscal 2003, the Company acquired approximately $813,000 of technology-based and $31,000 of customer-based intangible assets related to the acquisition of the business of Enviz, Inc. (Enviz) (see Note 10). The purchase price allocation for the acquisition of the business of Enviz, Inc. was adjusted by approximately $40,000 of cash, which was received during the second quarter of fiscal 2003 as a result of the finalization of the acquisition. This amount was allocated based on the original purchase price allocation ratios to technology-based and customer-based intangible assets. In addition, the purchase price allocation for the acquisition of the business of Envive Corporation (Envive) was adjusted to reflect an amount of approximately $144,000 of cash, which was received during the first quarter of fiscal 2003 as a result of the finalization of the acquisition. This amount was allocated based on the original purchase price allocation ratios to technology-based and customer-based intangible assets. As a result, the net change in identifiable intangible assets for the three and six months ended March 31, 2003 was a decrease of $40,000 and an increase of $660,000, respectively. These assets are being amortized over a three year period, with minimal residual values. During the three and six month periods ended March 31, 2003, the amortization expense for intangible assets was approximately $421,000 and $800,000, respectively. The components of identifiable intangible assets are as follows (in thousands):

The amortization expense for existing intangible assets is estimated to be approximately $789,000 for the remainder of fiscal 2003, approximately $1.35 million for fiscal 2004, and approximately $580,000 for fiscal 2005, assuming that the Company is not required to write-off identifiable intangible assets in the future.

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

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

The weighted-average exercise price per share of common stock subject to stock options was $12.50 as of March 31, 2003 and $13.74 as of March 31, 2002. The weighted-average repurchase price of restricted stock was $0.26 as of March 31, 2003, and $0.90 as of March 31, 2002.

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

The $841,000 purchase price consideration was based on estimated fair values of the assets and liabilities of Enviz, Inc. at the acquisition date, and allocated to the technology-based and customer-based intangible assets acquired. There was no goodwill arising from the acquisition. Identifiable intangible assets are being amortized on a straight-line basis over a three year period. Amortization of identifiable intangible assets related to the acquisition of the business of Enviz was $73,000 and $143,000 for the three and six months ended March 31, 2003. The condensed consolidated statements of operations for the three and six months ended March 31, 2003 include the results of operations relating to Enviz’s business activity subsequent to the acquisition. If the results of the two companies were combined on a pro forma basis for the three and six months ended March 31, 2002, the difference between pro forma results and the actual results reported herein, would be immaterial.

During the three months ended March 31, 2003, the $841,000 purchase price allocation of the business of Enviz, Inc. was adjusted to reflect an amount of approximately $40,000 of cash, which was received as a result of the finalization of the acquisition. This amount was allocated based on the original purchase price allocation ratios to technology-base and customer-based intangible assets. Thus, the total purchase price of $801,000 was allocated $774,000 to technology-based intangible assets, $29,000 to customer-based intangible assets, and $2,000 to net liabilities.

During the six months ended March 31, 2003, the purchase price allocation for the acquisition of the business of Envive Corporation was adjusted to reflect an amount of approximately $144,000 of cash, which was received as a result of the finalization of the acquisition. This amount was allocated based on the original purchase price allocation ratios to technology-based and customer-based intangible assets.

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

The Company leases certain of its facilities under non-cancelable operating leases, which expire on various dates through December 2005. At March 31, 2003, future minimum payments under the leases are as follows (in thousands):

Beginning on August 16, 2001, a number of class action lawsuits were filed in the United States District Court for the Southern District of New York against the Company, certain of its officers, and the underwriters of the Company’s initial public offering. These lawsuits are essentially identical, and were brought on behalf of those who purchased the Company’s securities between September 24, 1999 and August 19, 2001. These complaints allege generally that the underwriters in certain initial public offerings, including the Company’s, allocated shares in those initial public offerings in unfair or unlawful ways, such as requiring the purchaser to agree to buy in the aftermarket at a higher price or to buy shares in other companies with higher than normal commissions. The complaint also alleges that the Company had a duty to disclose the activities of the underwriters in the registration statement relating to its initial public offering. The complaints have been consolidated into a single action with cases brought against over three hundred other issuers and their underwriters that make similar allegations regarding the initial public offerings of those issuers. The plaintiffs’ counsel and the individual named defendants’ counsel have reached an agreement whereby the individual named defendants have been dismissed from the case, without any payments by the Company. The case against the underwriters and the Company continues, however, plaintiffs’ counsel and the underwriters have each offered revised settlement proposals to the issuers, but various terms and conditions are being negotiated. The Company is still evaluating each proposal. The Company believes the claims are without merit and intends to defend the actions vigorously should settlement not be reached. However, these claims, even if not meritorious, could be expensive to defend and divert management’s attention from operating the Company.

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

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

On October 28, 2002, the Company announced that it had commenced an issuer tender offer for 10 million shares or approximately 36.9% of its outstanding common stock as of September 30, 2002, at a purchase price between $7.00 and $8.00 per share, net to the seller in cash. The offer expired on November 26, 2002. The Company repurchased approximately 4.3 million shares under the offer for approximately $34.2 million. On January 17, 2003, the Company retired its treasury shares of approximately 5.3 million shares, which was mainly related to the shares repurchased under the 2002 tender offer.

The total number of shares repurchased since January 2001, including the 2002 issuer tender offer, is approximately 6.1 million shares, for an aggregate price of approximately $48.7 million.

On March 24, 2003, the Company announced that it had commenced an issuer tender offer for 7.5 million shares, or approximately 33.0% of its outstanding common stock as of February 28, 2003, at a purchase price of $9.50 per share, net to the seller in cash. The tender offer was scheduled to expire on May 9, 2003, however, on May 12, 2003, the tender offer was extended five business days to May 16, 2003.

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

The Company markets its products primarily from its operations in the United States. International sales are primarily to customers in Europe. These sales and the Company’s foreign-owned assets are not significant. For the three and six months ended March 31, 2003, and March 31, 2002, respectively, no single customer accounted for more than 10% of the Company’s total revenue. At March 31, 2003, and March 31, 2002, respectively no single customer accounted for more than 10% of the Company’s total receivable.

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

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

Except for historical information, this Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements involve risks and uncertainties, including, among other things, statements regarding our anticipated costs and expenses and revenue mix. These forward-looking statements include, among others, statements including the words “expect,” “anticipate,” “intend,” “believe” and similar language. Our actual results may differ significantly from those projected in the forward-looking statements. Factors that might cause or contribute to these differences include, but are not limited to, those discussed in this section and in our annual report on Form 10-K for the fiscal year ended September 30, 2002, in the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors That May Impact Future Operating Results” and elsewhere in that report. You should also carefully review the risks described in other documents we file from time to time with the Securities and Exchange Commission, including the annual report on Form 10-K, the quarterly reports on Form 10-Q and current reports on Form 8-K that we file in fiscal 2003. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this quarterly report on Form 10-Q. We undertake no obligation to publicly release any revisions to the forward-looking statements or reflect events or circumstances after the date of this document.

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Overview

We provide services that enable corporate enterprises to benchmark, test, and manage their electronic business, or e-business, applications, and systems, both inside and outside the firewall. Our services are designed to provide “total performance management” by allowing enterprise customers to improve the quality of their e-business from the end-user perspective through cost-effective and easy-to-use web performance management and testing solutions. We provide outsourced services and appliances, which do not require complex and costly software implementations, configuration or maintenance by our customers. We believe that enterprises who use our services leverage their existing software and hardware, improve customer satisfaction and reduce capital expenditures.

Revenue consists of subscription services revenue and consulting and support services revenue. Subscription services revenue consists of fees from subscriptions to our Internet measurement, monitoring, testing, and diagnostic services. Our subscription services revenue is deferred upon invoicing and is recognized ratably over the service period, generally ranging from one to twelve months. For some customers, subscription service revenue is invoiced monthly upon completion of the services. Deferred revenue is comprised of all unearned revenue, primarily unearned subscription revenue, and is recorded as deferred revenue on our balance sheet until the revenue is earned. As of March 31, 2003, we had recorded $5.2 million of deferred revenue. We do not generally grant refunds during the initial subscription term. All discounts granted during the initial term are netted against revenue. Revenue is not recognized during free trial periods. Revenue from our consulting and support services, which includes revenue from our load testing services, is recognized as the services are performed, typically over a one to three month period. For longer consulting projects that span more than one month, we recognize revenue as milestones or deliverables are completed.

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

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

We offer our consulting and support services on a per engagement basis. Consulting and support services revenue increased as a percentage of total revenue from 7% to 8% for the three and six months ended March 31, 2002, and amounted to 10% of total revenue for both the three months and six months ended March 31, 2003, respectively. We believe that consulting and support services revenue may continue to increase in the future as a percentage of total revenue as we introduce additional services that require consulting expertise and if our Keynote Diagnostic and WebEffective services become more widely used. However, we cannot assure you that this revenue will increase in absolute dollars in future periods.

For the quarter ended March 31, 2003, our 10 largest customers accounted for approximately 30% of total revenue. We cannot be certain that customers that have accounted for significant revenue in past periods, individually or in aggregate, will renew our services and continue to generate revenue in any future period. In addition, our customer agreements can generally be terminated at any time with little or no penalty. If we lose a major customer or a group of significant customers, our revenue could significantly decline.

Effective April 1, 2003, we implemented company-wide salary reductions, reduced headcount, and amended our bonus structure to be dependent on the achievement of overall company profitability as well as individual performance targets. Accordingly, we expect that total expenses for the third quarter of fiscal 2003 will decrease compared to the second quarter of fiscal 2003.

Results of Operations

Revenue

Subscription Services.    Revenue from subscription services increased $10,000 or 0.1% for the three months ended March 31, 2003 as compared to the corresponding period in 2002. Revenue from subscription services increased $55,000 or 0.3% for the six months ended March 31, 2003 as compared to the same period in 2002. Subscription services represented 90% and 93% of total revenue for the three months ended March 31, 2003 and March 31, 2002, respectively, and approximately 90% and 92% of total revenue for the six months ended March 31, 2003 and 2002, respectively. The slight revenue increase was mainly due to services introduced in the last two years, offset by decreases in benchmarking services.

Consulting and Support Services.    Revenue from consulting and support services increased $339,000 or 52% for the three months ended March 31, 2003 as compared to the corresponding period in 2002. Revenue from consulting and support services increased $463,000 or 32% for the six months ended March 31, 2003 as compared to the same period in 2002. Consulting and support services have increased to approximately 10% from 7% of total revenue for the three months ended March 31, 2003, and March 31, 2002, respectively, and have also increased to approximately 10% from 8% of total revenue for the six months ended March 31, 2003 and 2002. The revenue increase was primarily due to increased contributions from our new service offerings, Keynote Diagnostic Services, which was introduced in the first quarter of fiscal 2002, and Web Effective, which was introduced in the first quarter of fiscal 2003. The increase was due, to a lesser extent, to our completing a larger number of testing engagements, which were generally higher in value.

For the three months and six months ended March 31, 2003 and 2002, respectively, no single customer accounted for more than 10% of total revenue. At March 31, 2003 and 2002, no single customer accounted for more than 10% of our total accounts receivable.

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Expenses:

Costs of Subscription and Consulting and Support Services

Costs of Subscription Services.    Costs of subscription services consist of connection fees to Internet service providers for bandwidth usage of our measurement computers, which are located around the world, and depreciation, maintenance and other equipment charges for our measurement and data collection infrastructure. Costs of subscription services declined 21% for the three months ended March 31, 2003 as compared to the corresponding period in 2002, and were 26% and 33% of subscription services revenue for the three months ending March 31, 2003 and 2002, respectively. Costs of subscription services declined 24% for the six months ended March 31, 2003 as compared to the corresponding period in 2002, and were 27% and 36% of subscription services revenue for the six months ended March 31, 2003 and 2002, respectively. In absolute dollars, costs of subscription services decreased $595,000 during the quarter ended March 31, 2003 as compared to the corresponding period in 2002 and $1.5 million during the six months ended March 31, 2003 as compared to the corresponding period in 2002. The decreases were primarily due to reduced costs for bandwidth and, to a lesser extent, lower bandwidth and depreciation expenses. We believe that costs of subscription services in absolute dollars for the third quarter of fiscal 2003 will decrease compared to the second quarter of fiscal 2003 due to lower depreciation expenses.

Costs of Consulting and Support Services.    Costs of consulting and support services consist of compensation expenses and related costs for consulting and support services personnel, all load-testing bandwidth costs and related network infrastructure costs. On a quarterly basis, costs of consulting and support services have increased 4% for the three months ended March 31, 2003 as compared to the corresponding period in 2002, and were 98% and 144% of consulting and support services revenue for the three months ended March 31, 2003 and 2002, respectively. Costs of consulting and support services have declined 1% for the six months ended March 31, 2003 as compared to the corresponding period in 2002, and were 98% and 131% of consulting and support services for the six months ending March 31, 2003 and 2002, respectively. Costs of consulting and support services increased $34,000 or 4% during the quarter ended March 31, 2003 compared to the corresponding period in 2002 and decreased $19,000 or 1% for the six months ended March 31, 2003 compared to the corresponding period in 2002. The increase in costs of consulting and support services for the three months ended March 31, 2003 as compared to the corresponding period in 2002 was primarily attributable to costs associated with WebEffective which we had acquired in October 2002. We expect that the costs of consulting and support services as a percentage of consulting and support services revenue will continue to be greater than the costs of subscription services as a percentage of subscription services revenue. We expect that costs of consulting and support services in absolute dollars for the third quarter of fiscal 2003 will decrease slightly from the second quarter of fiscal 2003.

Research and Development

Research and development expenses consist primarily of compensation and related costs for research and development personnel. Research and development expenses decreased $185,000 or 8% for the three months ended March 31, 2003 as compared to the corresponding period in 2002 and $316,000 or 7% for the six months ended March 31, 2003 as compared to the corresponding period in 2002. The decrease was primarily attributable to lower costs resulting from a reduced number of research and development personnel, offset, in part, by additional costs related to acquisitions. To date, all research and development expenses have been expensed as incurred. We believe that research and development expenses in absolute dollars for the third quarter of fiscal 2003 will decrease compared to the second quarter of fiscal 2003 due to reductions in personnel costs as a result of reduced salaries and lower headcount.

Sales and Marketing

Sales and marketing expenses consist primarily of salaries, commissions and bonuses earned by sales and marketing personnel, lead-referral fees, marketing programs and travel expenses. Our sales and marketing expenses decreased $935,000 or 19% for the three months ended March 31, 2003 as compared to the corresponding period in 2002 and approximately $1.6 million or 16% for the six months ended March 31, 2003 as compared to the corresponding period in 2002. The decrease primarily resulted from the restructuring of our sales organization to focus more resources on our large corporate customers and, to a lesser extent, from reduced spending on certain marketing programs. We believe that sales and marketing expenses in absolute dollars for the third quarter of fiscal 2003 will decrease compared to the second quarter of fiscal 2003 due to reductions in personnel costs as a result of reduced salaries and lower headcount and fewer marketing programs.

Operations

Operations expenses consist primarily of compensation and related costs for management and technical support personnel who manage and maintain our field measurement and collection infrastructure and headquarters data center and provide twenty-four by seven basic customer support. Our operations personnel also work closely with other departments to assure the reliability of our services and to support our sales and marketing activities. Our operations expenses decreased $281,000 or 14% for the three months ended March 31, 2003 as compared to the corresponding period in 2002 and $571,000 or 14% for the six months ended March 31, 2003 as compared to the corresponding period in 2002. The decrease in operations expenses was primarily the result of increasing operating efficiencies and reducing the number of personnel in the operations group. We believe that operations expenses in absolute dollars for the third quarter of fiscal 2003 will decrease compared to the second quarter of fiscal 2003 due to continued increases in operating efficiencies and reduction in personnel costs as a result of reduced salaries and lower headcount.

General and Administrative

General and administrative expenses consist primarily of salaries and related expenses, accounting, legal and administrative expenses, insurance, professional service fees and other general corporate expenses. General and administrative expenses decreased $154,000 or 9% for the three months ended March 31, 2003 as compared to the corresponding period in 2002 and $483,000 or 13% for the six months ended March 31, 2003 as compared to the corresponding period in 2002. The decrease in our general and administrative expenses was primarily due to lower bad debt provisions due to improved collection efforts. The decrease was due, to a lesser extent, to lower spending on professional service fees. We believe that general and administrative expenses in absolute dollars for the third quarter of fiscal 2003 will be slightly lower than the second quarter of fiscal 2003 due to reductions in personnel costs as a result of reduced salaries, offset in part by an increase related to recent changes in securities laws.

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Excess Occupancy Costs

Excess occupancy costs are costs related to fixed charges associated with the unoccupied portion of our headquarters’ building, such as property taxes, insurance and depreciation. These particular costs represent the fixed costs of operating our headquarters’ building acquired in September 2002 and are based on the actual unoccupied square footage, which was determined to be 60% during the three and six months ended March 31, 2003.

Amortization of Identifiable Intangible Assets and Stock-Based Compensation

As of March 31, 2003 and 2002, we had identifiable intangible assets with a gross carrying value of approximately $11.7 million and $9.4 million, respectively. For the three months ended March 31, 2003 and 2002, we recorded expenses of $421,000 and $222,000, respectively, in amortization of identifiable intangible assets. For the six months ended March 31, 2003 and 2002, we recorded expenses of $800,000 and $436,000, respectively, in amortization of identifiable intangible assets. As of March 31, 2003 and 2002, the net carrying value of identifiable intangible assets was approximately $2.7 million and $1.9 million, respectively.

Certain options granted prior to June 30, 1999, have been considered to be compensatory, as the estimated fair value for accounting purposes was greater than the stock price as determined by the board of directors on the date of grant. As a result, we recorded amortization of deferred compensation expense of $3,000 and $85,000 for the three months ended March 31, 2003 and 2002, respectively and $27,000 and $170,000 for the six months ended March 31, 2003 and 2002, respectively. The decrease in the amortization of deferred compensation for the three months ended March 31, 2003 as compared to the corresponding period in fiscal 2002 was a result of our discontinuing to amortize costs associated with former employees that have been terminated. As of March 31, 2003, we had a remaining balance of $4,000 included in deferred compensation remaining to be amortized during fiscal 2003. Deferred compensation is amortized on a straight-line basis over the vesting period of the options, and will be fully amortized by the end of fiscal 2003.

We expect the amortization of intangible assets and stock-based compensation to be approximately $430,000 for the third quarter of fiscal 2003, assuming no additional acquisitions or impairment charges. We expect the remaining carrying value of the identifiable intangible assets as of March 31, 2003, as listed in the table below, will be fully amortized by October 2005 (in thousands).

Interest Income, Net