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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

(Mark One)

OR

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

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $0.001 Par Value Per Share, and the Associated Stock Purchase Rights

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    x

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

As of March 31, 2004, the aggregate market value of voting stock held by non-affiliates of the Registrant was $219 million.

The number of shares of the Registrant’s common stock outstanding as of March 31, 2004 was 19,455,773.

Documents incorporated by reference: Part III incorporates information by reference to portions of the Registrant’s proxy statement for its 2005 annual meeting of stockholders.

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KEYNOTE SYSTEMS, INC.

ANNUAL REPORT ON FORM 10-K

FOR THE FISCAL YEAR ENDED SEPTEMBER 30, 2004

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PART I

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FORWARD-LOOKING STATEMENTS

Except for historical information, this annual report 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 future business strategy, costs and expenses. These forward-looking statements include, among others, statements including the words “expect,” “anticipate,” “intend,” “will” 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 the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors That May Impact Future Operating Results” and elsewhere in this 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 quarterly reports on Form 10-Q and current reports on Form 8-K that we may file in fiscal 2005. You are cautioned not to place undue reliance on the forward-looking statements, which speak only as of the date of this annual report on Form 10-K. 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.

The trademarks of Keynote Systems, Inc. in the United States and other countries include Keynote^®, Perspective^®, the Internet Performance Authority^®, MyKeynote^™ and all related trademarks, trade names, logos, characters, design and trade dress are trademarks or registered trademarks of Keynote Systems, Inc. in the United States and other countries and may not be used without written permission.

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PART I

Item 1.    Business.

Overview

Keynote Systems, Inc. (“Keynote” or “we”) offers e-business performance measurement services and performance management solutions that enable corporate enterprises to improve e-business performance by reducing costs, improving customer satisfaction and increasing profitability. Our services are comprised of three broad areas: customer experience management (CEM) and service level management (SLM) which represent our performance management solutions, and web monitoring and measurement which represents our performance measurement services.

An important foundation of our e-business performance measurement services and management solutions is an extensive network of strategically located measurement computers, running our proprietary software, connected to the major Internet backbones in over 50 cities worldwide, plus a sophisticated operations center for collecting, analyzing and disseminating Web site response time and availability data. Keynote’s infrastructure, together with our services, and in some cases, with Keynote-managed appliances placed within a customer’s infrastructure, provide customers the ability to access their results in real-time over the Internet through any standard web browser.

As a result of our recent acquisition of Vividence Corporation (“Vividence”) in September 2004, Keynote now uses its “Keynote Research Panel,” consisting of over 160,000 panelists, to enhance its customer experience management services.

Our e-business performance measurement services and performance management solutions help customers manage their Web performance 24 hours a day, 7 days a week from an end-user perspective. We had over 1,600 measurement computers deployed in over 56 cities and in 123 locations as of September 30, 2004. As of September 30, 2004, our measurement computers measured the performance of 7,690 universal resource locators, or URLs, 7,528 Red Alert devices connected to the Internet, and 20,185 URLs through our NetMechanic service.

We offer our e-business performance measurement services primarily on a subscription basis and our performance management solution on a subscription or engagement basis. Subscription fees vary based on the type of service selected, the number of URLs and transactions measured, the number of measurement locations, the number of devices monitored, the frequency of the measurements and the additional features ordered. We offer consulting and support services on an incident and per engagement basis. Consulting and support services revenue represented 12% of total revenue for the year ended September 30, 2004, and 10% or less of total revenue for both the years ended 2003 and 2002. We market our products primarily from our operations in the United States. International sales are primarily to customers in Europe. International sales have not been significant.

We were incorporated in 1995. Our headquarters is located at 777 Mariners Island Blvd., San Mateo, CA and our telephone at that location is (650) 403-2400. Our company web site is www.keynote.com, although information on that web site shall not be deemed incorporated in this report. Through a link on the Investor Relations section of our web site, we make available free of charge our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports of Form 8-K, and all amendments to those reports filed with the Securities and Exchange Commission.

Performance Measurement Services

Our e-business performance measurement services includes our monitoring and measurement services. These services enable companies to monitor, measure, compare and improve Web and wireless infrastructure performance. These services also include the MyKeynote data analysis portal and flexible alerting and reporting capabilities.

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Transaction Perspective leverages the Microsoft Internet Explorer Web browser for taking the measurements from Keynote’s worldwide infrastructure to deliver full network-level and user-level statistics and error messages for every element of every page in the transaction. It enables transaction performance problems to be quickly and accurately identified and diagnosed, enabling customers to provide an optimal quality of experience for end-users and mitigating the adverse business impact caused by performance problems.

Application Perspective Outside Edition is a cost-effective, self-service, outside the firewall, Web transaction monitoring service that measures the ‘response time’ and ‘success rate’ for performing Web transactions from multiple geographic locations worldwide. Additionally, the service provides sophisticated trending, alarms and reporting to enable the rapid assessment, diagnosis and repair of performance issues when they occur.

Web Site Perspective measures Web site performance from metropolitan areas where end users are accessing the Internet, providing insight into the end-user experience on the leading global Internet backbones. Web Site Perspective is designed to diagnose performance problems quickly and measure the speed and reliability of Web sites across dial-up, DSL, cable or T-3 connections.

Streaming Perspective measures, compares and assures the performance of audio and video streams, diagnosing performance problems before they impact the end-user. Streaming Perspective supports all the latest media players, including Real Media, Windows Media and QuickTime players.

Red Alert Performance Tracker (RAPT) is a cost effective, self-service performance monitoring service. RAPT provides the basic information for understanding Web site performance and availability, at a low price. RAPT has the ability to monitor transaction performance up to every 20 seconds and offers alerts when problems occur.

Red Alert is a real-time Internet monitoring service that tests devices connected to the Internet every 5 minutes. Red Alert tests the availability of any Internet server or other TCP-enabled Internet devices including Web servers, secure Web servers, domain name servers, mail servers, FTP servers and network gateways. Red Alert also provides alerts when conditions exceed specified thresholds.

NetMechanic helps businesses save time and money and improve overall Web site quality with automated tools that test site integrity, optimize page visualization, and improve search engine rankings.

Web Performance Indices benchmark page download and transaction speed and reliability against competitors in particular vertical industries. Keynote’s various page download and transaction indices are also used for setting internal goals and metrics for performance, and for use in service level agreements (SLAs).

Performance Management Solutions

Our management solutions offerings include “service level management” and “customer experience management” services. Keynote’s service level management (SLM) services are designed to align e-business and IT goals to enhance operational performance of existing infrastructure and systems. Our SLM services help companies determine application readiness, define reasonable service level standards and deliver consistently upon them.

Service Level Planning

Service Level Planning enables e-business owners to translate their business goals to tangible service level agreements with internal or outsourced IT providers. Keynote provides the capability to develop realistic and competitive SLAs by defining service level standards within the context of historical system usage and

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competitive benchmarks, all from the end user perspective. The Service Level Planning services include the following services:

Service Level Practice involves Keynote consultants who work directly with customers to assess their business and application initiatives, develop realistic service level objectives and agreements and establish processes to continuously monitor and improve performance over time.

Competitive Analysis enables e-businesses to understand and improve performance delivered and service level compliance relative to key competitors and industry benchmarks.

E-Business Readiness

Our E-Business Readiness services combine performance testing and tuning expertise with realistic traffic simulation and intelligent root-cause detection technology enabling enterprises to eliminate application slowdowns and problems. E-Business Readiness includes the following services:

Capacity Planning is a consultative capacity planning engagement that enables enterprises to understand the business costs of not providing optimized performance to e-business visitors. Our professional services staff model actual user behavior on a Web application and then scale traffic using Keynote’s LoadPro methodology and technology to quickly identify performance problems at high traffic levels to ensure enterprises are fully prepared for increases in traffic. For customers who prefer a self-service solution, Test Perspective is a cost-effective service for testing applications and infrastructure under varied traffic loads.

PerformanceTune is a consultative auditing and tuning service. Our performance experts utilize our technology to help enterprises quickly isolate and repair performance bottlenecks in their Web infrastructure and applications.

WebIntegrity is a self-service, automated quality and compliance monitoring service that allows enterprises to streamline Web site maintenance and optimize site effectiveness. With WebIntegrity, enterprises can uncover site quality problems such as stale content, browser incompatibility, and poorly structured HTML code. In addition, WebIntegrity identifies compliance problems related to site privacy, security, and accessibility.

Service Level Delivery

Service Level Delivery Services enable enterprises to monitor key performance metrics in order to improve application support and operational responsiveness, proactively detect problems based on end user impact and accelerate the time to respond to and repair performance issues. Service Level Delivery includes the following services:

Service Level Monitoring and Reporting includes many Keynote services that provide ongoing measurement, monitoring and reporting so customers can track service level objectives, identify application and network issues and reduce the time to repair. Service Level Monitoring and Reporting includes many Keynote services:

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Service Level Management—Wireless

Wireless Perspective measures the availability and performance of wireless data services from actual end user devices enabling carriers and enterprises to improve the quality of wireless data services. The latest version (3.0) supports camera phones, push-to-talk (PTT), multimedia message services (MMS) and instant messaging.

Wireless Perspective—Network Edition is an end-to-end monitoring and root cause diagnostics service for a wireless carrier’s core data network, focusing on the newer high-speed technologies such as EV-DO, EDGE and UMTS. Core network latency is measured via UDP protocol, and throughput, latency, availability and variability are measured via FTP and HTTP protocols. Competitive benchmarks are also available.

Customer Experience Management

Keynote’s Customer Experience Management (CEM) services provide companies a complete view of the experience of their customers as they interact with their e-business services.

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WebEffective^™ consists of both Research Tools and Custom Research services. Using these services, customers can benefit from the Keynote Research Panel of over 160,000 panelists, existing customer lists from the client or real-time polling of site visitors.

The research tools that comprise Keynote WebEffective^™ are:

Keynote’s expert Professional Services team provides custom research services to address the most critical elements of customer experience on the Web. Some of these services include:

Web Performance Indices

Keynote’s page download and transactional indices measure the responsiveness and availability of Web pages and multi-step processes on leading Web sites in a given market. Measurements are made using Keynote’s global infrastructure of over 1,600 measurement computers and taken 24 hours a day, 7 days a week. Keynote regularly publishes the results of its indices. Keynote’s current Web performance indices include the following page download indices: the Keynote Business 40 Internet Performance Index, the Keynote Consumer 40 Internet Performance Index and the Keynote Government 40 Index. Keynote’s current transaction indices include: The Keynote Broker Web Transaction Performance Index, The Keynote E-Commerce Web Transaction Performance Index, The Keynote E-Banking Web Transaction Performance Index, The Keynote E-Government Web Transaction Performance Index, The Keynote Credit Card Web Transaction Performance Index and The Keynote Travel & Hospitality Web Transaction Performance Index Suite (includes leading airlines, hotels and online travel agencies). Additionally, Keynote offers specific single page download indices for various markets including healthcare and computers.

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Keynote’s Customer Experience Research

Keynote Syndicated Research provides insights on market trends and online innovations. Keynote has two basic syndicated research offerings:

Technology and Infrastructure

Our performance measurement infrastructure consists of three key components: measurement and data collection infrastructure, our operations and data center, and reporting and analysis tools.

Measurement and Data Collection Infrastructure

Our measurement computers are Windows-based computers that run Keynote proprietary software to replicate the experience of a user accessing web sites through a standard web browser. We designed our measurement-computer software to perform thousands of download measurements concurrently without distorting or affecting the integrity of any single measurement. The measurement computers are colocated at the data center facilities of major telecommunication and internet access providers that are selected to be statistically representative of Internet users. At some locations, we employ multiple Internet connections and install equipment racks that can accommodate multiple measurement computers. The hosting arrangements for our measurement computers typically have terms ranging from three months to one year. We typically pay a small set-up fee and pay monthly fees to continue to locate the measurement computers at these locations. We also pay additional monthly fees for communications lines.

These measurement computers access a web site to download web pages and execute multi-page transactions, while taking measurements of every component in the process. The computers take measurements continually throughout the day, at intervals as short as three minutes, depending on the customer’s requirements and subscription service level.

As of September 30, 2004, we had deployed more than 1,600 measurement computers in 65 domestic and 58 international telecommunication and internet access provider locations, with most locations having multiple measurement computers in order to provide different types of measurement services or to accommodate changes in measurement volume. We continually upgrade and balance our network capacity to meet the needs of our customers.

Operations and Data Centers

Our operations centers, located in San Mateo, California, and Plano, Texas, are designed to be scalable to support large numbers of measurement computers and to store, analyze and manage large amounts of data from these computers. Our measurement computers receive instructions from, and return collected data to, our operations center. The data are stored in large databases that incorporate a proprietary transaction-processing system that we designed to be efficient in storing and delivering measurement data with fast response times. We also employ proprietary, high-performance application server computers that manage the collection of measurement data, the insertion of the data into our databases and the dissemination of this data to our customers in a variety of forms and delivery methods.

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Reporting and Analysis Tools

We offer the following tools for reporting and analysis of performance measurement data:

Customers

For the year ended September 30, 2004 and 2003, no one customer accounted for more than 10% of our total revenue. As of September 30, 2004 and 2003, we provided services to approximately 2,100 and 2,200 companies, respectively, including over half of the Fortune 100 companies.

Our 10 largest customers, based on revenue for the fiscal year ended September 30, 2004, were American Express, Cingular Wireless (formerly known as AT&T Wireless), Hewlett-Packard, IBM, JP Morgan Chase, Microsoft, Savvis (formerly known as Cable and Wireless), SBC Communications, Sprint and Veridian. These customers accounted for approximately 34% of our revenue for the year ended September 30, 2004.

Sales, Marketing and Customer Support

Sales

We sell our services through our field sales and telesales organization. Our field sales teams consist of direct sales representatives and sales engineers, located in 10 metropolitan areas across the United States, and concentrate on our e-business performance management products. In addition to the field sales teams across the country, we have telesales personnel located in Plano, Texas. These telesales personnel focus primarily on selling our e-business performance measurement services and also provide telephone and email sales support and customer service to our enterprise customers. We believe that through the combined use of our enterprise sales teams and telesales personnel, we are able to efficiently focus our sales resources on interfacing with a variety of customers, which is designed to ensure customer satisfaction. We also market and sell some of our services through our self-service web site, where customers can sign up and try, purchase, and use our services.

In addition, domestically, we distribute our services through web-hosting and Internet service providers such as IBM Global Services and EDS, who manage e-business web sites for other companies. These companies sell or bundle our services to their customer base as a value-added service and as a management tool for their customers’ web sites. We also sell to content distribution providers, such as Akamai and Savvis, who use our services as a pre-sales tool for their potential customers or in service level agreements with their existing customers. We also market our services through several other technology companies, such as VeriSign, on a “lead referred” basis. Internationally, we use both direct and indirect sales approaches in the United Kingdom and Germany and sell indirectly through reseller partners throughout the rest of Europe, the Middle East, Africa and Asia.

Marketing

We maintain an active marketing program designed to demonstrate to Fortune 1000 companies the breadth and depth of our e-business performance measurement services and performance management solutions. We promote our

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brand through multiple means including the public availability on our Web site of top level details for our e-business performance indices (both page download and transaction), and through our regular reporting and commentary to the media regarding Internet performance-related events.

Our marketing programs include advertising, Internet marketing, trade events, public relations, and our annual Global Internet Performance Conference. Our Global Internet Performance Conference event, held in New York, provides an opportunity for us and our partners to brief chief information officers, chief technology officers, information technology executives and network administrators on emerging solutions, new methodologies and best practices to help customers optimize e-business performance.

Customer Support

We provide customer support by email and telephone. Basic support for all our products is available during the business day. Advanced support is available for a fee through our Keynote Diagnostic Services, for customers who want analytical or diagnostic support, or who require access 24 hours per day, 7 days per week to Keynote expertise to assist them with their questions.

Research and Development

The Internet is characterized by rapid technological developments, frequent new application or service introductions and evolving industry standards. The ongoing evolution of the Internet requires us to continually improve the functionality, features and reliability of our e-business performance measurement services and e-business performance management solutions, particularly in response to competing offerings. Therefore, we believe that our future success will depend in large part on our ability to maintain and enhance our current services and to develop or acquire new services and technologies that achieve market acceptance. The success of service introductions depends on several factors, including properly defining the scope of the new services and timely completion, introduction and market acceptance of our new services. If new Internet, networking or telecommunication technologies or standards are widely adopted or if other technological changes occur, we may need to expend significant resources to adapt our services.

Our research and development expenses were $7.1 million for the fiscal year ended September 30, 2004, $7.4 million for the fiscal year ended September 30, 2003 and $8.9 million for the fiscal year ended September 30, 2002.

Competition

The market for e-business performance measurement services and performance management solutions is rapidly evolving. Our competitors vary in size and in the scope and breadth of the products and services that they offer. We face competition from companies that offer software and services with features similar to our services such as Mercury Interactive, Gomez Advisors, Segue Software, WatchFire, and a variety of small companies that offer a combination of testing, market research capabilities and data. While we believe these services are not as comprehensive as ours, customers could still choose to use these services or these companies could enhance their services to offer all of the features we offer. As we expand the scope of our products and services, we expect to encounter many additional market-specific competitors.

We could also face competition from other companies, which currently do not offer services similar to our services, but offer software or services related to e-business performance measurement services and e-business performance management solutions, such as Webtrends, Omniture, Webside Story and Coremetrics, and free services that measure web site availability. In addition, companies that sell systems management software, such as BMC Software, CompuWare, CA-Unicenter, HP-Openview, Quest Software, NetIQ, Veritas’ Precise Software, and IBM’s Tivoli Unit, with some of whom we have strategic relationships, could choose to offer services similar to ours.

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

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

Intellectual Property

We are a technology company whose success depends on developing, acquiring and protecting our intellectual property assets.

Intellectual Property Assets

Our principal intellectual property assets consist of our trademarks, our trade names, our logos, our characters, our design, our trade dress, our service marks, our patents, our patent applications and the proprietary software we developed or acquired to provide our services. Trademarks are important to our business because they represent our brand name and we use them in our marketing and promotional activities as well as in the delivery of our services. Our trademarks include our registered trademark Keynote, Perspective, Vividence and The Internet Performance Authority. Our trademark on Keynote is pending registration outside of the United States. We have other trademarks that are currently pending registration with the U.S. Patent and Trademark Office or have not been registered.

We currently have three issued U.S. patents and one foreign patent. We have seven pending U.S. patent applications and three pending foreign patent applications related to our e-business performance management, e-business performance testing services and customer experience management services. It is possible that no patents will be issued from our currently pending patent applications and that our issued patents or potential future patents may be found invalid or unenforceable, or otherwise be successfully challenged. It is also possible that any patent issued to us may not provide us with any competitive advantages, that we may not develop future proprietary products or technologies that can be patented, and that the patents of others may seriously limit our ability to do business. In this regard, we have not performed any comprehensive analysis of patents of others that may limit our ability to do business.

Our proprietary software consists of the software we developed or acquired that is an integral part of our testing and performance management services as well as that which collects, stores, and delivers our measurement data to customers. We have also developed software that we use to provision and process customer orders and billings.

Protection of Our Intellectual Property

The intellectual property we use in our business is important to us. Despite our efforts, we may be unable to prevent others from infringing upon or misappropriating our intellectual property, which could harm our business.

Legal standards relating to the validity, enforceability and scope of protection of intellectual property rights in Internet-related industries are uncertain and still evolving, and the future viability or value of any of our

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intellectual property rights is uncertain. Effective trademark, copyright and trade secret protection may not be available in every country in which our products are distributed or made available. Furthermore, our competitors may independently develop similar technology that substantially limits the value of our intellectual property, or they may design around patents issued to us.

The use of our services by many of our customers is governed by a web-based subscription agreement, but for some of our larger customers, additional terms and conditions may be added by means of a formal, written contract. Each time customers use our services, they “click” on a web page to agree to terms and conditions that are posted on our web site, and our relationship with these customers is then governed by these terms and conditions and any written agreements that may exist. There is a possibility that a court, arbiter or regulatory body could deem this type of agreement to be invalid or determine that the terms and conditions governing the agreement do not fully protect our intellectual property rights. If that were to occur, our business could be harmed.

Although we are not currently engaged in any intellectual property litigation, we may, in the future, need to initiate a lawsuit to enforce our intellectual property rights and to protect our patents, trademarks and copyrights. Any litigation could result in substantial costs and diversion of resources and could seriously harm our business. To date, we have not been notified that our technologies infringe the proprietary rights of anyone. We cannot assure you that others will not claim that we have infringed proprietary rights with respect to past, current or future technologies. We expect that we could become subject to intellectual property infringement claims as the number of our competitors grows and our services overlap with competitive offerings. These claims, even if not meritorious, could be expensive and divert management’s attention from operating our company. If we become liable for infringing the intellectual property rights of others, we would be required to pay a substantial damage award and to develop non-infringing technology, obtain a license or cease selling the services that contain the infringing intellectual property. We may be unable to develop non-infringing technology or to obtain a license on commercially reasonable terms, if at all.

Licensed Technology

We license certain statistical, graphical and database technologies from third parties. We cannot assure you that these technology licenses will not infringe the proprietary rights of others or will continue to be available to us on commercially reasonable terms, if at all. The loss of this technology could require us to obtain substitute technology of lower quality or performance standards or at greater cost. If we do not obtain or develop substitute technology, we could be unable to offer all of the features or functionality that we desire to include in our services.

Foreign and Domestic Operations and Geographic Data

The United States and Canada represents our largest geographic marketplace. Approximately 94% of our net sales during the year ended September 30, 2004 came from customers in the United States and Canada. Margins on sales of our services in foreign countries mainly those in Europe can be adversely affected by foreign currency exchange rate fluctuations.

Employees

As of September 30, 2004, we had a total of 250 employees, of which 239 were based in the United States, and 11 were based internationally. None of our employees are represented by a collective bargaining agreement nor have we experienced any work stoppage. We believe that our relationships with our employees are good. Our future success depends on our ability to attract, motivate and retain our key personnel. We may be unable to retain our key employees, including our management team, and experienced engineers, or to attract, assimilate or retain other highly qualified employees. Although a number of technology companies have implemented workforce reductions, there remains substantial competition for highly skilled employees with experience in the Internet industry. None of our key employees are bound by agreements that could prevent them from terminating their employment at any time.

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Item 2.    Properties.

As of September 30, 2004, our facilities primarily consisted of our headquarters building in San Mateo, California, a 188,000 square foot building, which we own. We currently occupy approximately 56,000 square feet of this facility, which is our principal sales/marketing, product development and administrative location and contains our operations personnel and data center. We believe that our facilities are adequate for our current and future needs. We also have a five-year lease, expiring in December 2005, for approximately 8,000 square feet of office space in Plano, Texas, for our Red Alert, NetMechanic, inside sales and support and operations. We also have a five-year lease, expiring in June 2007, for approximately 2,500 square feet of office space in New York, New York for our New York consulting operations. We also lease office space in New York, New York for approximately 1,000 square feet that expires in March 2005 for our Vividence consulting group. We also maintain offices in Seattle, Washington, for our wireless operations and in West Toronto, Ontario for our streaming operations. In addition, we have leases on three corporate apartments, of which two leases expire by June 2005, and one is a month to month lease. These corporate apartments were acquired from our Hudson Williams acquisition and are used by our out-of-town consultants who utilize these corporate apartments rather than hotels. See Note 12 of the Notes to Consolidated Financial Statements for additional information regarding our lease agreements.

Item 3.    Legal Proceedings.

Beginning on August 16, 2001, a number of class action lawsuits were filed in the United States District Court for the Southern District of New York against over 300 issuers of securities including us, certain of our officers, and the underwriters of our initial public offering. These lawsuits were essentially identical, and were brought on behalf of those investors who purchased our securities between September 24, 1999 and August 19, 2001. These complaints alleged generally that the underwriters in certain initial public offerings, including ours, allocated shares in those initial public offerings in unfair or unlawful ways, such as requiring the purchaser to agree to buy in the aftermarket at a higher price or to buy shares in other companies with higher than normal commissions. The complaint also alleged that we had a duty to disclose the activities of the underwriters in the registration statement relating to our initial public offering. The plaintiffs’ counsel and the issuer defendants’ counsel reached a preliminary agreement to settle these actions, including ours, without any payments by us. The settlement awaits approval by the Court.

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

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

No matters were submitted to a vote of security holders during the fourth quarter of our fiscal year ended September 30, 2004.

Item 4A.    Executive Officers.

The following table presents information regarding our executive officers as of December 12, 2004:

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Umang Gupta has served as one of our directors since September 1997 and as our chief executive officer and chairman of the board of directors since December 1997. Previously, he was a private investor and an advisor to high-technology companies and the founder and chairman of the board and chief executive officer of Centura Software Corporation. He previously held various positions with Oracle Corporation and IBM. Mr. Gupta holds a B.S. degree in chemical engineering from the Indian Institute of Technology, Kanpur, India, and an M.B.A. degree from Kent State University.

Peter Maloney has served as our chief financial officer since October 2003 and as our vice president of finance since January 2002. Mr. Maloney joined Keynote in October 2001 as Vice President and Controller and served in that position until January 2002. From May 1998 to September 2001, Mr. Maloney served at Adaptive Broadband Corporation, a fixed wireless broadband company, in senior management positions including Senior Vice President of Finance and Senior Vice President of Corporate Development. Prior to Adaptive, he served at Republic Industries, Inc., a diversified consumer products and services company, in senior financial positions including Vice President of Investor Relations. Prior to Republic, Mr. Maloney served in financial management positions at Dole Food Company and Arthur Andersen LLP. Mr. Maloney holds an M.B.A. degree in corporate finance from the University of Southern California and a B.B.A. in economics from Temple University.

Donald Aoki has served as our senior vice president of engineering and operations since November 2004 and as our vice president of engineering since May 1997. From December 1994 to May 1997, he served as a business unit general manager of Aspect Telecommunications, a supplier of customer relational management solutions. Mr. Aoki holds a B.S. degree in computer science from the University of Southern California and a M.S. degree in electrical engineering and computer science from the Massachusetts Institute of Technology.

Richard Rudolph has served as our vice president of worldwide sale since December 2001. From February 2001 to December 2001, he served as senior vice president of global sales and business development for webHancer Corporation, a provider of web performance measurement and analysis. From April 1999 to January 2001, he served as vice president of sales at WebTrends, a web site performance measurement and analysis company. From June 1997 to April 1999, he held sales positions at Extensis Corporation, a provider of products and services for electronic publishing. Mr. Rudolph holds a B.S. degree in economics from Oregon State University.

Arnold Waldstein has served as our vice president of marketing and business development since April 2002. From May 1999 to March 2002, Mr. Waldstein served as vice president of marketing and strategic alliances for Moai Technologies, an online strategic sourcing company. From March 1998 to May 1999, he founded and served as chief executive officer of Waldstein Consulting, a boutique consulting firm. From February 1996 to February 1998, he served as vice president of marketing and business development at Electric Communities, an online services company. Mr. Waldstein holds a B.A. degree in English from Ohio University.

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PART II

Item 5.    Market for Registrant’s Common Stock and Related Stockholder Matters.

Price Range of Common Stock

Our common stock has traded on the Nasdaq National Market under the symbol “KEYN” since our initial public offering on September 24, 1999. On December 09, 2004, we had 19,924,744 shares of our common stock outstanding held by 92 stockholders of record. Because many brokers and other institutions hold our stock on behalf of stockholders, we believe the total number of beneficial holders is greater than that represented by these record holders. The following table presents the high and low sales price per share of our common stock for the period indicated, as reported on the Nasdaq National Market:

The market price of our common stock has fluctuated in the past and is likely to fluctuate in the future. In addition, the market prices of securities of other technology companies, particularly Internet-related companies, have been highly volatile. This volatility is often unrelated to the operating performance of these companies. Factors that may have a significant effect on the market price of our common stock include:

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

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Dividend Policy

We have never declared or paid any cash dividends on our common stock or other securities. We do not anticipate paying cash dividends in the foreseeable future.

Item 6.    Selected Consolidated Financial Data.

The following selected consolidated financial data should be read in conjunction with the Consolidated Financial Statements and related Notes appearing in Item 8, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in Item 7 in this Annual Report on Form 10-K. The consolidated statement of operations data for the years ended September 30, 2004, 2003, and 2002, and the consolidated balance sheet data as of September 30, 2004 and 2003, are derived from and are qualified in their entirety by our Consolidated Financial Statements, which have been audited by KPMG LLP, Independent Registered Public Accounting Firm, and which are included in Item 8 in this Annual Report on Form 10-K. The consolidated statement of operations data for the year ended September 30, 2001 and 2000, and the consolidated balance sheet data as of September 30, 2002, 2001, and 2000, are derived from our audited consolidated financial statements which do not appear in this report. The historical results presented below are not necessarily indicative of the results to be expected for any future fiscal year.

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Overview

We offer e-business performance measurement services and performance management solutions that enable corporate enterprises to measure, monitor, test and tune, diagnose and optimize their e-business systems both inside and outside the firewall. Keynote’s services provide enterprise customers with solutions enabling them to increase return on investment, save money and efficiently link information technology resources to e-business goals. Our solutions comprise of three broad areas: customer experience management (CEM), service level management (SLM) and web monitoring and measurement which include a broad portfolio of cost-effective measurement, monitoring, performance management, load testing, content quality testing and usability testing services. Our customer experience management and service level management represent our performance management solutions. Our web monitoring and measurement represents our performance measurement services. Keynote’s goal is to empower customers to deliver an optimal experience to end-users and to gain competitive advantage, while helping them reduce unnecessary capital expenditures and leverage enterprise management software they already own.

Revenue consists of subscription services revenue and consulting and support services revenue. Subscription services revenue consists of fees from subscriptions to our web monitoring and measurement, testing, customer experience, diagnostic and our WebEffective Intelligence Platform services. Subscription services revenue is deferred upon invoicing and is recognized ratably over the service period, commencing on the day service is provided, 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 that has been collected, primarily unearned subscription services revenue, and is recorded as deferred revenue on our balance sheet until the revenue is earned. Any uncollected deferred revenue reduces the balance of accounts receivable. As of September 30, 2004, we had recorded approximately $7.7 million of deferred revenue. We do not generally grant refunds. All discounts granted reduce revenue. Revenue is not recognized during free trial periods. Consulting and support services revenue, which consists of fees generated by our consulting and support services and our load testing services, is recognized as the services are performed, typically over a period of one to three months. For longer consulting projects that span more than one month, we recognize revenue as milestones or deliverables are completed.

A majority of our subscription services revenue comes from our e-business performance measurement services, which include our Perspective services. Subscription services revenue also includes our Red Alert and NetMechanic monitoring and alarm services, Test Perspective, WebEffective Intelligence Platform, performance

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management subscription services, our private agent and application performance management services. Our customers purchase these services for an initial term of three to twelve months and then may renew on an annual, semi-annual, or month-to-month basis.

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

We offer our consulting and support services on a per engagement basis. Consulting and support services revenue amounted to approximately 12% of total revenue for the year ended 2004 and approximately 10% of total revenue for both the years ended 2003 and 2002. We believe that consulting and support services revenue may increase somewhat in the future as a percentage of total revenue, as our existing consulting and support services become more widely used, as a result of acquisitions and as we introduce additional services that require consulting expertise. However, we cannot assure you that this revenue will increase in absolute dollars in future periods.

We had total revenue of $42.4 million for the year ended September 30, 2004, $38.3 million for the year ended September 30, 2003, and $37.9 million for the year ended September 30, 2002. We achieved net income of $4.6 million for the year ended September 30, 2004, a net loss of $4.7 million for the year ended September 30, 2003, and a net loss of $65.5 million for the year ended September 30, 2002.

For the year ended September 30, 2004, our 10 largest customers accounted for approximately 34% 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 customers that have monthly renewal arrangements may terminate their services at any time with little or no penalty. If we lose a major customer or a group of significant customers, our revenue could significantly decline.

During fiscal 2004, we made four acquisitions. In December 2003, we acquired the business of MatrixNet (“MatrixNet”), a division of Xaffire, Inc. for $582,000 in cash. The MatrixNet service measures performance from network agent locations to a customer’s web infrastructure or devices. With the acquisition of MatrixNet, we introduced our Network Perspective services which is a diagnostic service that provides granular reporting of Internet latency and performance metrics for quick resolution of Internet-related problems. In April 2004, we acquired NetRaker Corporation (“NetRaker”) for approximately $3.7 million in cash. NetRaker is a provider of online customer experience management solutions that help e-businesses manage, measure, evaluate and improve the design and navigability of their web sites. We believe this acquisition will enhance and broaden our customer experience management solutions for enterprise customers as well as allow us to target e-business marketing executives within Fortune 500 companies. In July 2004, we acquired Hudson Williams Corporation (“Hudson Williams”) for approximately $2.5 million in cash. Hudson Williams is a provider of performance management and load testing consulting services. In September 2004, we acquired Vividence Corporation (“Vividence”) for approximately $20.2 million in cash. Similar to NetRaker, Vividence is a provider of web—based customer experience management solutions.

We believe that the challenges for our business include 1) increasing performance management solutions revenue while continuing to stabilize performance measurement services revenue, 2) integrating our recent acquisitions and 3) controlling our expenses for the first quarter of fiscal 2005 at 15% to 17% higher than the fourth quarter of fiscal 2004, assuming no acquisitions.

Critical Accounting Policies and Estimates

In preparing our consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, our management is required to make estimates and assumptions that affect the amounts reported in our consolidated financial statements and related notes. We believe that the

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estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. These estimates, judgments and assumptions can affect the reported amounts of assets and liabilities as of the date of the financial statements, as well as the reported amounts of revenue and expenses during the periods presented. To the extent there are material differences between these estimates, judgments or assumptions and actual results, our financial statements will be affected. We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our consolidated financial statements.

Our critical accounting policies and estimates are of both a routine and non-routine nature. The recurring policies relate to revenue recognition, the allowance for doubtful accounts and billing allowance, goodwill impairments, and accounting for income taxes. The non-routine policy relates to the valuation of our long-lived assets including purchased intangibles.

Revenue Recognition

Revenue consists of subscription services revenue and consulting and support services revenue. Subscription services revenue consists of fees from subscriptions to our web monitoring and measurement services and performance management solutions. Our subscription services revenue is generally deferred upon invoicing and is recognized ratably over the service period, generally ranging from one to twelve months. For some customers, subscription services revenue is invoiced monthly upon completion of the services. We do not generally grant refunds. All discounts granted reduce revenue. Revenue is not recognized for free trial periods. Revenue from our consulting and support services other than Vividence services, which includes revenue from our load testing service, is recognized ratably as the services are performed, typically over a period of one to three months. For consulting projects that span more than one month, we generally recognize revenue as milestones or deliverables are completed. Subscription revenue related to the use of the Webeffective Intelligence Platform to conduct evaluations is recognized upon completion of each evaluation.

Deferred revenue is comprised of all unearned revenue that has been collected in advance, primarily unearned subscription services revenue and is recorded as deferred revenue on our balance sheet until the revenue is earned. Any uncollected deferred revenue reduces the balance of accounts receivable.

Allowance for Doubtful Accounts and Billing Allowance

Accounts receivable is recorded net of an allowance for doubtful accounts receivable and billing allowance of approximately $758,000, or 11% of total accounts receivable, and $1.0 million, or 19% of total accounts receivable as of September 30, 2004 and 2003, respectively. The decrease in our allowance for doubtful accounts and billing allowance is due to improved collection efforts as well as a reduction in loss experience.

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

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

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Impairment Assessments of Goodwill and Identifiable Purchased Intangibles

Our methodology for allocating the purchase price relating to acquisitions is usually determined based on valuations performed by an independent third party. Goodwill is measured as the excess of the cost of acquisition over the sum of the amounts assigned to identifiable assets acquired less liabilities assumed.

We perform goodwill impairment tests on an annual basis and between annual tests in certain circumstances for our single reporting unit. The goodwill recorded on the Consolidated Balance Sheets as of September 30, 2004 was approximately $24.4 million as compared to $195,000 as of September 30, 2003.

Valuation of Long Lived Assets

We evaluate the recoverability of fixed assets and identifiable purchased intangible assets other than goodwill whenever events or changes in circumstances indicate the carrying amount of any such asset group may not be fully recoverable. Changes in circumstances include economic conditions or operating performance. Our evaluation is based upon assumptions about the estimated future undiscounted net cash flows from such asset groups. Management continually applies its judgment when performing these evaluations to determine the timing of the testing, the undiscounted net cash flows used to assess recoverability and the fair value of the asset group. If future events or circumstances indicate that an impairment assessment is required and an asset group is determined to be impaired, our financial results could be materially and adversely impacted in future periods.

Accounting for Income Taxes

We are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves estimating our actual current tax liabilities, including the impact, if any, of additional taxes resulting from tax examinations together with assessing temporary differences resulting from differing treatment of items, such as deferred revenue, for tax and accounting purposes. These differences result in deferred tax assets and liabilities. We must then assess the likelihood that our deferred tax assets will be recovered from future taxable income and to the extent we believe that recovery is not likely, we must establish a valuation allowance. To the extent we establish a valuation allowance or increase this allowance in a period, we must include an expense within the tax provision in the statement of operations.

Significant management judgment is required in determining our provision for income taxes, our deferred tax assets and liabilities, and any valuation allowance recorded against our net deferred tax assets. At present, our deferred tax assets have been offset by a full valuation allowance because of our history of losses. If we subsequently determine that some or all deferred tax assets that were previously offset by a valuation allowance are realizable, the result would be a positive adjustment to earnings in the period such determination is made.

We establish liabilities or reserves when we believe that certain tax positions are likely to be challenged and we may not succeed, despite our belief that our tax returns are fully supportable. We adjust these reserves, as well as related interest, in light of changing circumstances such as the progress of tax exams. During the twelve months ended September 30, 2004, we recorded net income tax benefits totaling $218,000 associated with the resolution of tax matters relating to a foreign subsidiary and U.S. state income taxes.

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Results of Operations

The following table sets forth selected items from our consolidated statements of operations as a percentage of total revenue for each of the three years ended September 30, 2004:

Our net income improved by approximately $9.4 million, from a net loss of approximately $4.7 million for the twelve months ended September 30, 2003 to net income of approximately $4.6 million for the twelve months ended September 30, 2004. Total revenue increased by approximately $4.1 million or 11%, from approximately $38.3 million for the twelve months ended September 30, 2003 to approximately $42.4 million for the twelve months ended September 30, 2004. Total expenses decreased by approximately $8.1 million or 17%, from approximately $48.5 million for the twelve months ended September 30, 2003 to approximately $40.4 million for the twelve months ended September 30, 2004.

Our results improved by approximately $60.8 million, from a net loss of approximately $65.5 million for the twelve months ended September 30, 2002 to a net loss of approximately $4.7 million for the twelve months ended September 30, 2003. Total revenue increased by approximately $322,000 or 1%, from approximately $37.9 million for the twelve months ended September 30, 2002 to approximately $38.3 million for the twelve months ended September 30, 2003. Total expenses decreased by approximately $63.8 million or 57%, from approximately $112.3 million for the twelve months ended September 30, 2002 to approximately $48.5 million for the twelve months ended September 30, 2003.

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Our results of operations included the two weeks activity for Vividence subsequent to the date of our acquisition for the period from September 15, 2004 through September 30, 2004. Our results of operations included approximately $500,000 of revenue and a net loss of approximately $523,000 for Vividence from the date of acquisition to September 30, 2004.

Our results of operations also included activities for NetRaker and Hudson Williams. For our Netraker acquisition, our results of operations reflect activities subsequent to the date of our acquisition for the period from April 2, 2004 through September 30, 2004. For our Hudson Williams acquisition, our results of operations reflect activities for the period from July 7, 2004 through September 30, 2004. Our results of operations included approximately $1.2 million and $450,000 of revenue and a net income of $400,000 and $25,000 for NetRaker and Hudson Williams, respectively.

We anticipate that total expenses for the first quarter of fiscal 2005 will increase by approximately 15% to 17% as compared to the fourth quarter of fiscal 2004, which were approximately $11.7 million, primarily due to our recent acquisition of Vividence in September 2004, expenses associated with our 2004 Global Internet Performance Conference held in October 2004, additional personnel costs related to the acquisition of Vividence completed in September 2004, increasing cost of compliance requirements, and additional investment in our sales and marketing efforts.

In addition to analyzing revenue for subscription services and consulting and support services, management also internally analyzes revenue categorized as performance measurement services and performance management solutions.

The following table identifies which services are categorized as performance measurement services and performance management solutions and where they are recorded in our condensed consolidated statements of operations (listed in alphabetical order):

The following table summarizes performance measurement services and performance management solutions revenue (in thousands):

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Performance Measurement services revenue decreased by $806,000 for the twelve months ended September 30, 2004 as compared to the corresponding period in fiscal 2003. Performance measurement services revenue represented 66% and 76% of total revenue for the twelve months ended September 30, 2004 and 2003, respectively. Performance measurement services revenue decreased by approximately $2.7 million for the twelve months ended September 30, 2003 as compared to the corresponding period in fiscal 2002. Performance Measurement services revenue represented 76% and 83% of total revenue for the twelve months ended September 30, 2003 and 2002, respectively. The decrease in performance measurement services revenue was mainly attributable to reduced subscriptions for our Website Perspective service, resulting in fewer measurements, partially offset by increases in our Transaction Perspective and Red Alert monitoring services as well as revenue from our Streaming Perspective and Application Perspective services which were newly introduced in fiscal 2004.

Performance management solutions revenue increased by approximately $4.9 million for the twelve months ended September 30, 2004 as compared to the corresponding period in fiscal 2003. Performance Management solutions revenue represented 34% and 24% of total revenue for the twelve months ended September 30, 2004 and 2003, respectively. Performance management solutions revenue increased by approximately $3.0 million for the twelve months ended September 30, 2003 as compared to the corresponding period in fiscal 2002. Performance management solutions revenue represented 24% and 17% of total revenue for the twelve months ended September 30, 2003 and 2002, respectively. The increase in performance management solutions revenue was mainly attributable to increased contribution from our Enterprise Solutions, WebEffective Intelligence Platform services as a result of our acquisition of NetRaker in April 2004 and Vividence in September 2004, Wireless Perspective, Testing and Tuning solutions, as well as Network Perspective, which was newly introduced in December 2003 as a result of our acquisition of the business of MatrixNet division of Xaffire, Inc. (“MatrixNet”).

Comparison of Fiscal Years Ended September 30, 2004 and 2003

Revenue

Subscription Services.    Revenue from subscription services increased $2.7 million for the twelve months ended September 30, 2004 as compared to the twelve months ended September 30, 2003. Subscription services represented 88% and 90% of total revenue for the twelve months ended September 30, 2004 and September 30, 2003, respectively. The increase in revenue in absolute dollars, as listed in descending order of impact, was primarily attributable to increased revenue from our wireless perspective, WebEffective Intelligence Platform, Network perspective, streaming, and private agent services, offset by a decrease in our benchmarking revenue.

Consulting and Support Services.    Revenue from consulting and support services increased by approximately $1.5 million for the twelve months ended September 30, 2004 as compared to the twelve months ended September 30, 2003. Revenue from consulting and support services represented approximately 12% and 10% of total revenue for the twelve months ended September 30, 2004 and 2003, respectively. The increase in revenue in absolute dollars, as listed in descending order of impact, resulted primarily due to the increased contribution from WebEffective Intelligence Platform as a result of our recent acquisitions of NetRaker and

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Vividence, and from our Enterprise Solutions, and LoadPro services. Because our consulting and support services are provided on a per engagement basis, revenue depends on the number of engagements and the size of such engagements. As a result, consulting and support services revenue are less predictable than subscription services revenue and may vary from period to period.

For the years ended September 30, 2004 and 2003, no single customer accounted for more than 10% of total revenue. At September 30, 2004 and 2003, no single customer accounted for more than 10% of total accounts receivable. International sales were approximately 6% of our total revenue for each of the twelve months ended September 30, 2004 and 2003, respectively.

Expenses:

Costs of Subscription Services 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 decreased by approximately $2.8 million for the twelve months ended September 30, 2004 as compared to the twelve months ended September 30, 2003 and represented 15% and 24% of subscription services revenue for the twelve months ended September 30, 2004 and 2003, respectively. This decrease was primarily due to reduced costs for bandwidth and, to a lesser extent, lower depreciation expenses. We intend to continue our efforts to reduce costs of subscription services in future periods. We believe that costs of subscription services in absolute dollars for the first quarter of fiscal 2005 will remain comparable to the fourth quarter of fiscal 2004.

Costs of Consulting and Support Services.    Costs of consulting and support services consist of compensation expenses and related costs for consulting and support service personnel, all load-testing bandwidth costs and related network infrastructure costs. Costs of consulting and support services also include costs of retaining and rewarding panel participants for our WebEffective Intelligence Platform engagements. Costs of consulting and support services increased by $743,000 for the twelve months ended September 30, 2004 as compared to the year ended September 30, 2003 and represented 85% and 98% of consulting and support service revenue for the years ended September 30, 2004 and 2003, respectively. The increase was primarily due to costs associated with our WebEffective Intelligence Platform services, which we acquired in April 2004 related to our NetRaker acquisition and September 2004 related to our Vividence acquisition and additional personnel costs as a result of our acquisition of Hudson Williams in July 2004, offset, in part, by a decrease in bandwidth costs. 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 and as a percentage of revenue for the first quarter of fiscal 2005 will be higher than the fourth quarter of fiscal 2004 due to the acquisition of Vividence completed in September 2004.

Research and Development

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Research and development expenses consist primarily of compensation and related costs for research and development personnel. Research and development expenses decreased by $380,000 for the twelve months ended September 30, 2004 as compared to the twelve months ended September 30, 2003. This decrease was primarily attributable to lower costs resulting from a reduced number of research and development personnel and reduced salaries. To date, all research and development expenses have been expensed as incurred. We anticipate that research and development expenses in absolute dollars for the first quarter of fiscal 2005 will increase from the fourth quarter of fiscal 2004 due to additional personnel costs related to the acquisition of Vividence completed in September 2004.

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 by $3.1 million for the twelve months ended September 30, 2004 as compared to the twelve months ended September 30, 2003. The decrease primarily resulted from a reduced number of sales and marketing personnel, and to a lesser extent, from reduced spending on certain marketing programs. We believe that continued investments in our sales and marketing efforts are essential for us to maintain our market position and to further increase acceptance of our services. We anticipate that sales and marketing expenses in absolute dollars for the first quarter of fiscal 2005 will increase compared to the fourth quarter of fiscal 2004 due to expenses associated with our 2004 Global Internet Performance Conference held in October 2004.

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 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 by $1.3 million for the twelve months ended September 30, 2004 as compared to the twelve months ended September 30, 2003. The decrease in operations expenses was primarily the result of improving operating efficiencies and to lower personnel costs from reducing the number of personnel in the operations group, and, to a lesser extent, to reduced salaries, offset partially by increased spending in communication services. We anticipate that operations expenses in absolute dollars for the first quarter of fiscal 2005 will increase compared to the fourth quarter of fiscal 2004 due to additional personnel costs related to the acquisition of Vividence completed in September 2004.

General and Administrative

General and administrative expenses consist primarily of salaries and related expenses, accounting, legal and administrative expenses, insurance, professional services fees and other general corporate expenses. Our general and administrative expenses decreased by $1.3 million for the twelve months ended September 30, 2004

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as compared to the twelve months ended September 30, 2003. The decrease in our general and administrative expenses was primarily attributable to reduced personnel costs, lower spending on professional service fees such as legal and consulting, offset by an increase in spending on accounting and audit fees mainly attributable to the increasing cost of compliance requirements and audit work associated with our acquisitions. We anticipate that general and administrative expenses in absolute dollars for the first quarter of fiscal 2005 will increase compared to the fourth quarter of fiscal 2004 due to increased personnel costs related to the acquisition of Vividence completed in September 2004 and increased regulatory services and audit fees.

Excess Occupancy Costs

Excess occupancy costs are fixed expenses associated with the unoccupied portion of our headquarters’ building, acquired in September 2002, such as property taxes, insurance, and depreciation. The costs are based on the actual unoccupied square footage, which was 60% for the first nine months and 70% for the last three months for the year ended September 30, 2003 and the twelve months ended September 30, 2004. The decrease in expenses was primarily due to an increase in tenant income and a one-time property tax refund of $63,000. We expect the unoccupied portion of our headquarters building to reduce in the first quarter of fiscal 2005 as personnel from Vividence are relocated to our headquarters building.

Amortization of Identifiable Intangible Assets, Amortization of Stock-Based Compensation and In-process Research and Development

For the twelve months ended September 30, 2004, we recorded approximately $1.7 million for the amortization of identifiable intangible assets and for the year ended September 30, 2003, we recorded approximately $1.6 million for the amortization of identifiable intangible assets. Amortization of identifiable intangible assets increased by approximately $116,000 for the twelve months ended September 30, 2004 due to increased amortization of identifiable intangible assets resulting from our acquisitions of MatrixNet in December 2003, NetRaker in April 2004, Hudson Williams in July 2004, and Vividence in September 2004.

At September 30, 2004, we had a remaining balance of approximately $6.1 million of identifiable intangible assets that are being amortized over a three or four-year expected life.

The in-process research and development expense of $241,000 for the year ended September 30, 2004 relates to the estimated fair value of an acquired in-process research and development project in connection with our acquisition of Vividence. This project, related to Vividence’s technology for its web-based customer research, had not yet reached technological feasibility and had no alternative future use. The estimated fair value of this project was determined based on the avoided costs approach as of the acquisition date where the fair value of the acquired technology is equal to the costs, which an acquirer will avoid spending in developing a similar functional technology. This amount was immediately expensed as of the acquisition date. We expect to complete the research and development on this project in the first quarter of fiscal 2005.

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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.

We expect the amortization of identifiable intangible assets to be approximately $600,000 for the first quarter of fiscal 2005, assuming no additional acquisitions or impairment charges. We expect the remaining carrying value of the identifiable intangible assets as of September 30, 2004, as listed in the table below, will be fully amortized by September 2008 (in thousands):

Interest Income, and Interest and other Expenses

Interest income, and interest and other expenses, net, decreased by $2.8 million for the twelve months ended September 30, 2004 as compared to the twelve months ended September 30, 2003. The decrease in interest income, and interest and other expenses, net, was primarily attributable to a lower level of invested cash due to the use of approximately $79.2 million of cash to repurchase our common stock primarily in our two issuer tender offers in November 2002 and May 2003, the use of approximately $25.7 million of cash for our acquisitions of MatrixNet, NetRaker, Hudson Williams, and Vividence in December 2003, April 2004, July 2004, and September 2004, respectively, and lower average interest rates. Substantially all of the interest income represents interest earned from our cash, cash equivalents, and short-term investments. We expect that interest income, and interest and other expense, net, for the first quarter of fiscal 2005 will be approximately $700,000, absent any additional transactions, and assuming no material changes in interest rates

Provision for Income Taxes

Provision for income taxes for the twelve months ended September 30, 2004 was $59,000. Our effective tax rate for the twelve months ended September 30, 2004 was approximately 6%, before recording in the fourth quarter of the year ended September 30, 2004, a net income tax benefit totaling $218,000 associated with resolution of tax matters relating to a foreign subsidiary and U.S. state income taxes, which reduced the effective tax rate to approximately 1%. We establish liabilities or reserves when we believe that certain tax positions are likely to be challenged and we may not succeed, despite our belief that our tax returns are fully supportable. We adjust these reserves, as well as related interest, in light of changing circumstances such as the progress of tax examinations and the expiration of the statute of limitations. No benefit for federal, state, and foreign income taxes was recorded for the year ended September 30, 2003 because we provided a valuation allowance against the deferred tax assets generated from the operating loss. As of September 30, 2004, we had net operating loss carryforwards for U.S. and foreign income tax reporting purposes of approximately $59 million, and $2.1 million, respectively, available to reduce future income subject to income taxes. As of September 30, 2004, we had net operating loss carryforwards for state income tax purposes of approximately $25.5 million available to

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reduce future income subject to income taxes. The U.S. net operating loss carryforwards will begin to expire, if not utilized in the year 2011. The foreign net operating loss carryforwards will begin to expire in the year 2005. State net operating loss carryforwards will begin to expire if not utilized in 2005. In addition, as of September 30, 2004, we had research credit carryforwards for both federal and California income tax purposes of approximately $1.5 million and $2.2 million, respectively, available to reduce future income taxes. The federal research credit carryforwards begin to expire in the year 2010. The California research credit carryforwards are available indefinitely.

Deferred tax liabilities have not been recognized for undistributed earnings of foreign subsidiaries because it is management’s intention to reinvest such undistributed earnings outside the United States.

Federal and California tax laws impose substantial restrictions on the utilization of net operating loss and credit carryforwards in the event of an “ownership change” for tax purposes, as defined in Section 382 of the Internal Revenue Code. We are currently in the process of determining whether ownership changes have occurred due to significant historical stock transactions in prior years. If an ownership change has occurred, the utilization of net operating loss and credit carryforwards could be reduced significantly.

Comparison of Fiscal Years Ended September 30, 2003 and 2002

Revenue

Subscription Services.    Revenue from subscription services increased slightly by $147,000, during the year ended September 30, 2003 as compared to the year ended September 30, 2002. Subscription services represented 90% and 91% of total revenue for the years ended September 30, 2003 and September 30, 2002, respectively. The increase in revenue in absolute dollars was primarily attributable to increased revenue from our Wireless Perspective, NetMechanic, WebEffective, and private agent services, offset by a decrease in our benchmarking revenue.

Consulting and Support Services.    Revenue from consulting and support services increased by $175,000, or 5%, during the year ended September 30, 2003 as compared to the year ended September 30, 2002. Revenue from consulting and support services represented approximately 10% and 9% of total revenue for the years ended September 30, 2003 and 2002, respectively. The increase in revenue in absolute dollars resulted primarily due to the increased contribution from Keynote Diagnostic Services and the additional product offering of WebEffective, which was introduced in the first quarter of fiscal 2003.

For the years ended September 30, 2003 and 2002, no single customer accounted for more than 10% of total revenue. At September 30, 2003, no customer accounted for more than 10% of total accounts receivable. At September 30, 2002, one customer accounted for more than 10% of total accounts receivable, which receivable was collected subsequent to September 30, 2002.

Expenses:

Costs of Subscription Services and Consulting and Support Services

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Costs of Subscription Services.    Costs of subscription services decreased by approximately $3.3 million, or 29%, during the year ended September 30, 2003 as compared to the year ended September 30, 2002 and represented 24% and 34% of subscription services revenue for the year ended September 30, 2003 and 2002, respectively. This decrease was primarily due to reduced costs for bandwidth and, to a lesser extent, lower depreciation expenses.

Costs of Consulting and Support Services.    Costs of consulting and support services increased by $302,000, or 9%, during the year ended September 30, 2003 as compared to the year ended September 30, 2002 and represented 98% and 95% of consulting and support service revenue for the years ended September 30, 2003 and 2002, respectively. The increase was primarily due to costs associated with our WebEffective service, which we acquired in October 2002, offset, in part, by a decrease in bandwidth costs.

Research and Development

Research and development expenses decreased by $1.5 million, or 17%, during the year ended September 30, 2003 as compared to the year ended September 30, 2002. This decrease was primarily attributable to lower costs resulting from a reduced number of research and development personnel and reduced salaries, offset, in part, by additional personnel costs related to acquisitions.

Sales and Marketing

Our sales and marketing expenses decreased by $6.2 million, or 31%, during the year ended September 30, 2003 as compared to the year ended September 30, 2002. The decrease primarily resulted from a reduced number of sales and marketing personnel, and to a lesser extent, from reduced spending on certain marketing programs.

Operations

Our operations expenses decreased by $1.2 million, or 16%, during the year ended September 30, 2003 as compared to the year ended September 30, 2002. The decrease in operations expenses was primarily the result of improving operating efficiencies and to lower personnel costs from reducing the number of personnel in the operations group, and, to a lesser extent, to reduced salaries.

General and Administrative

Our general and administrative expenses decreased by $903,000, or 13%, during the year ended September 30, 2003 as compared to the year ended September 30, 2002. The decrease in our general and administrative expenses was primarily attributable to a reduced number of general and administrative personnel, reduced salaries, and lower bad debt provisions, and, to a lesser extent, to lower spending on professional services.

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Excess Occupancy Costs

Excess occupancy costs are fixed expenses associated with the unoccupied portion of our headquarters’ building, acquired in September 2002, such as property taxes, insurance, and depreciation. The costs are based on the actual unoccupied square footage, which was 60% for the first nine months and 70% for the last three months for the year ended September 30, 2003.

Lease Termination Charge

In July 2000, we entered into a five-year synthetic lease agreement for our corporate headquarters building in San Mateo, California. On September 30, 2002, we terminated the lease and purchased the property for a total of $85.7 million. The lease, which was due to expire in 2005, provided for a residual guarantee of a total of $85.0 million due at the end of the lease term or upon lease termination. Our obligation was fully collateralized with restricted cash of $85.0 million.

After we entered into the lease in July 2000, real estate market conditions worsened, including a significant increase in available space for lease and significant declines in corresponding lease rates for commercial property. Accordingly, a loss on termination of this lease was recognized in connection with the purchase of the building in September 2002. The loss was calculated by comparing the purchase price of the building to its fair value. To determine the fair value of the building, we had an independent real estate appraisal conducted, which indicated that the fair value of the property was approximately $25.0 million. The calculated loss of approximately $60.7 million was recorded in the fourth quarter of fiscal 2002. The $60.7 million loss on termination was adjusted for the reversal of the remaining excess facility charge accrual and costs associated with the acquisition of the building, resulting in a net charge to the consolidated statements of operations of approximately $52.0 million for the year ended September 30, 2002.

Amortization of Identifiable Intangible Assets, Amortization of Stock-Based Compensation and In-process Research and Development

For the year ended September 30, 2003, we recorded approximately $1.6 million for the amortization of identifiable intangible assets and for the year ended September 30, 2002, we recorded approximately $1.1 million for the amortization of identifiable intangible assets. Amortization of identifiable intangible assets increased by approximately $474,000 for the year ended September 30, 2003 in connection with our acquisitions of NetMechanic in May 2002, Enviz in October 2002, and Streamcheck in July 2003.

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At September 30, 2003, we had a remaining balance of approximately $2.2 million of identifiable intangible assets that are being amortized over a three-year period from the date of acquisition.

Certain stock 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 $31,000 during the year ended September 30, 2003, compared to $421,000 for the year ended September 30, 2002. The decrease in the amortization of deferred compensation from fiscal 2002 to fiscal 2003 was a result of our discontinuing to amortize costs associated with former employees that had been terminated. Deferred compensation was amortized on a straight line basis over the vesting period of the options and was fully amortized as of September 30, 2003.

The in-process research and development charge of $200,000 for the year ended September 30, 2002 related to the estimated fair value of an acquired in-process research and development project, which we acquired in connection with our acquisition of NetMechanic, that had not yet reached technological feasibility and had no alternative future use, related to NetMechanic’s technology for web site testing. The estimated fair value of this project was determined based on the actual costs incurred as of the acquisition date. This amount was immediately expensed as of the acquisition date.

Interest Income, Interest and other Expenses

Interest income, and interest and other expenses, net, decreased by $6.5 million, or 54%, during the year ended September 30, 2003 as compared to the year ended September 30, 2002. The majority of the interest income was earned on our invested cash. The decrease in interest income was primarily attributable to a lower level of invested cash due to the use of $85.0 million of restricted cash to purchase our headquarters’ building in September 2002, the use of approximately $79.2 million of cash to repurchase our common stock primarily in our two issuer tender offers in November 2002 and May 2003, and the continued decline in interest rates. Substantially all of the interest income represents interest earned from our cash, short-term investments and restricted cash.

Provision for Income Taxes

No benefit for federal, state, and foreign income taxes was recorded for the years ended September 30, 2003 and 2002, because we provided a valuation allowance against the deferred tax assets generated from the operating loss.

Cumulative Effect of a Change in Accounting Principle

As discussed in Note 3 of the Notes to the Consolidated Financial Statements, “Cumulative Effect of a Change in Accounting Principle”, as a result of the implementation of Statement of Financial Accounting Standard No. 142, for fiscal 2002, we recorded a charge of approximately $3.2 million as a cumulative effect of a

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change in accounting principle for the write-off of all the remaining goodwill associated with acquisitions prior to September 30, 2002. In the year ended September 30, 2003, there was no charge for the cumulative effect of a change in accounting principle.

Liquidity and Capital Resources

Cash, cash equivalents and short-term investments

At September 30, 2004, we had approximately $19.3 million in cash and cash equivalents and approximately $128.8 million in short-term investments, for a total of approximately $148.1 million. Cash and cash equivalents consist of highly liquid investments held at major banks, commercial paper, United States government agency discount notes, money market mutual funds and other money market securities with original maturities of three months or less. Short-term investments consist of investment-grade corporate and government debt securities and issuances with Moody’s ratings of A2 or better. The increase in cash, cash equivalents and short-term investments for the year ended September 30, 2004 was primarily due to approximately $15.2 million from cash flow from operating activities, and approximately $7.1 million from cash flow from financing activities. The largest uses of cash from investing activities during the year ended September 2004 were the net purchases of property, equipment and software for approximately $4.0 million and approximately $25.7 million for the purchases of MatrixNet in December 2003, NetRaker in April 2004, Hudson Williams in July 2004, and Vividence in September 2004.

Cash provided by operating activities

For the twelve months ended September 30, 2004, net cash provided by operating activities was approximately $15.2 million which was mainly due to net income, excluding all non-cash amortization and depreciation charges, an increase of accounts payable and accrued liabilities of approximately $1.1 million, and an increase in deferred revenue of $956,000, partially offset by an increase in accounts receivable of $802,000 and an increase of prepaids and other assets of $125,000. The increase in deferred revenue was mainly attributable to an increase in the value of prepaid invoices and deferred revenue arising from the Vividence acquisition in September 2004. Net accounts receivable increased primarily due to the increase in revenue for fiscal 2004 as compared to the corresponding period in 2003. The decrease in prepaids and other assets was mainly attributable to normal monthly amortization, as well as lower spending and renegotiation of maintenance and support contracts at lower rates. The increase in accounts payable and accrued liabilities was mainly attributable to an increase in personnel costs related accruals such as vacation associated with our recent acquisitions and withheld our Employee Stock Purchase Plan contributions and increased spending in legal and audit services related to regulatory compliance and acquisitions.

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Cash used in investing activities

For the twelve months ended September 30, 2004, net cash used in our investing activities was approximately $26.2 million. We utilized approximately $25.7 million, including direct costs of the acquisitions, for the acquisitions of the business of the MatrixNet in December 2003, NetRaker in April 2004, Hudson Williams in July 2004, and Vividence in September 2004. We utilized approximately $4.0 million to purchase property and equipment, primarily for our production infrastructure, information systems, and tenant improvements associated with space that we have rented in our headquarters building. We generated approximately $3.5 million from the net sales and maturities of our short-term investments.

Cash provided by financing activities

For the twelve months ended September 30, 2004, net cash provided by our financing activities was approximately $7.1 million. We received approximately $7.8 million from the issuance of common stock associated with our employee stock option plan and employee stock purchase plan. We utilized $723,000 to repay two lines of credit that were assumed as a result of our recent acquisitions of NetRaker and Vividence. Our board of directors has approved a program to repurchase shares of our common stock, and pursuant to the stock repurchase program, a total of 10.4 million shares were repurchased between January 2001 and September 2004 for an aggregate price of approximately $90.1 million. At September 30, 2004, approximately $39.9 million was available to repurchase shares of our common stock pursuant to this stock repurchase program. No repurchases occurred during the twelve months ended September 30, 2004.

Commitments and Contractual Obligations

As of September 30, 2004, our principal commitments consisted of $506,000 in real property operating leases and equipment capital and operating leases, with various lease terms, the longest of which expires in June 2007. Additionally, we had contingent commitments to 126 bandwidth and collocation providers amounting to $912,000 for 101 locations ranging from one to fifteen months, which commitments become due if we terminate any of these agreements prior to their expiration. At present, we do not intend to terminate any of these agreements prior to their expiration. We expect to continue to invest in capital and other assets to support our growth. We expect to make additional capital expenditures of approximately $1.0 million related to our operations and headquarters building for the first quarter of fiscal 2005, absent any other acquisitions or extraordinary transactions.

The following table summarizes our minimum contractual obligations and commercial commitments as of September 30, 2004 (in thousands), and the effect we expect them to have on our liquidity and cash flow in future periods:

We believe that our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. Factors that could affect our cash position include potential acquisitions, additional stock repurchases, decreases in customers or renewals, decreases in revenue or changes in the value of our short-term investments. If, after some period of time, cash generated from operations is insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities or to obtain a credit facility. If additional funds are raised through the issuance of debt

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securities, these securities could have rights, preferences and privileges senior to holders of common stock, and the term of this debt could impose restrictions on our operations. The sale of additional equity or convertible debt securities could result in dilution to our stockholders, and we may not be able to obtain additional financing on acceptable terms, if at all. If we are unable to obtain this additional financing, our business may be harmed.

We also have earn out obligations associated with some of our acquisitions. For our Streamcheck acquisition, we are expected to pay out a cash payment of approximately $129,000 in January 2005. For our NetRaker and Vividence acquisitions, there are additional contingent consideration cash payments of up to $8.9 million and $6 million, respectively, that could be made if certain revenue and profitability targets are achieved by the acquired businesses during the year ended September 30, 2005. For more details, see Note 9 to the Consolidated Financial Statements.

Off Balance Sheet Arrangements

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

Indemnifications

We do not generally indemnify customers for our measuring, monitoring and testing Web-based applications against legal claims that our products and services infringe on third-party intellectual property rights. Other agreements entered into by us may include indemnification provisions under which we could be subject to costs and/or damages in the event of an infringement claim against us or an indemnified third-party. However, we have never been a party to an infringement claim and in the opinion of management, we do not have a liability related to any infringement claims subject to indemnification and as such, there is no material adverse affect on our financial condition, liquidity or results of operations.

Recent Accounting Pronouncements

In March 2004, the Emerging Issues Task Force reached consensus on Issue No. 03-01 (“EITF 03-01”), “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments.” EITF 03-01 includes new guidance for evaluating and recording impairment losses on debt and equity investments, as well as new disclosure requirements for investments that are deemed to be temporarily impaired. In September 2004, the FASB issued FASB Staff Position EITF 03-1-1, which delays the effective date until additional guidance is issued for the application of the recognition and measurement provisions of EITF 03-01 to investments in securities that are impaired; however, the disclosure requirements are effective for annual periods ending after June 15, 2004. Although we will continue to monitor the application of EITF 03-01, we do not currently believe adoption will have a material impact on our financial position or results of operations.

In December 2003, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition”, which supersedes SAB No. 101, “Revenue Recognition in Financial Statements.” The primary purpose of SAB No. 104 is to rescind accounting guidance contained in SAB No. 101 related to multiple element revenue arrangements, superseded as a result of the issuance of EITF Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables”. Additionally, SAB No. 104 rescinds the SEC’s “Revenue Recognition in Financial Statements Frequently Asked Questions and Answers” (“the FAQ”) issued with SAB No. 104 that had been codified in SEC Topic 13, “Revenue Recognition”. Selected portions of the FAQ have been incorporated into SAB No. 104. While the wording of SAB No. 104 has changed to reflect the issuance of EITF Issue No. 00-21, the revenue recognition principles of SAB No. 101 remain largely unchanged by the issuance of SAB No. 104. The adoption of SAB No. 104 did not have a material impact on our reported results.

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Accounting for Stock-Based Compensation

We currently measure compensation expense for our employee stock-based compensation plans using the intrinsic value method prescribed by Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees” and provide pro forma disclosures of the effect on net income (loss) and earnings (loss) per share as if the fair value-based method had been applied in measuring compensation expense. We have elected to follow APB Opinion No. 25 because, as further discussed in Part II, Item 8 of this Form 10-K at Note 2 of the Notes to Consolidated Financial Statements, the alternative fair value accounting provided for under Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation”, requires use of option valuation models that were not developed for use in valuing employee stock options and employee stock purchase plan shares. Under APB Opinion No. 25, when the exercise price of our employee stock options equals the market price of the underlying stock on the date of the grant, no compensation expense is recognized.

On March 31, 2004, the Financial Accounting Standards Board (“FASB”) issued a proposed Statement, “Share-based Payment,” that addresses the accounting for share-based payment transactions in which an enterprise receives employee services in exchange for (a) equity instruments of the enterprise or (b) liabilities that are based on the fair value of the enterprise’s equity instruments or that may be settled by the issuance of such equity instruments. The proposed Statement would eliminate the ability to account for share-based compensation transactions using APB Opinion No. 25 and generally would require instead that such transactions be accounted for using a fair-value-based method. If adopted, it is currently anticipated that the proposed Statement would be effective for us beginning our fourth fiscal quarter of 2005. We have not elected to expense the value of employee stock options until the FASB finalizes its new accounting standard on the matter, which may play a significant role in determining the fair value of and accounting for employee stock options. We will monitor the progress at the FASB and other developments with respect to the general issue of employee stock compensation. We are currently reviewing the potential impact from the guidance of the proposed statement, which may require that we recognize substantially more compensation expense in future periods that could have a material adverse impact on our future results of operations. The accounting impact had we chosen to apply the fair-value recognition provisions of SFAS No. 123, instead of the recognition provisions under APB Opinion No. 25, is described in Part II, Item 8 of this Form 10-K at Note 2 of the Notes to the Consolidated Financial Statements.

Factors That May Impact Future Operating Results

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

We have introduced many new services during the past fiscal year, including: