<PAGE>
Filed pursuant to Rule 424(b)(3)
Registration Statement 333-82781
[KEYNOTE LOGO]
4,000,000 SHARES
COMMON STOCK
--------------
Keynote is offering 3,875,000 shares of its common stock and Umang Gupta,
our chief executive officer, is offering an additional 125,000 shares. This is
our initial public offering, and no public market currently exists for our
shares. Our common stock has been approved for quotation on the Nasdaq National
Market under the symbol "KEYN."
-------------------
INVESTING IN OUR COMMON STOCK INVOLVES RISKS.
SEE "RISK FACTORS" BEGINNING ON PAGE 7.
-----------------
<TABLE>
<CAPTION>
PER SHARE TOTAL
<S> <C> <C>
Public Offering Price...................................................... $ 14.00 $ 56,000,000.00
Underwriting Discounts and Commissions..................................... $ 0.98 $ 3,920,000.00
Proceeds to Keynote........................................................ $ 13.02 $ 50,452,500.00
Proceeds to Mr. Gupta...................................................... $ 13.02 $ 1,627,500.00
</TABLE>
THE SECURITIES AND EXCHANGE COMMISSION AND STATE SECURITIES REGULATORS HAVE
NOT APPROVED OR DISAPPROVED THESE SECURITIES, OR DETERMINED IF THIS PROSPECTUS
IS TRUTHFUL OR COMPLETE. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
Keynote has granted the underwriters a 30-day option to purchase up to an
additional 600,000 shares of common stock to cover any over-allotments.
BancBoston Robertson Stephens Inc. expects to deliver the shares of common stock
to purchasers on September 29, 1999.
-------------------
BANCBOSTON ROBERTSON STEPHENS
HAMBRECHT & QUIST
DAIN RAUSCHER WESSELS
A DIVISION OF DAIN RAUSCHER INCORPORATED
THE DATE OF THIS PROSPECTUS IS SEPTEMBER 24, 1999.
<PAGE>
EXPLANATORY NOTE
The purpose of this Post-Effective Amendment No.1 is to file a certain
exhibit to the Registration Statement as set forth below in Item 16(a) of Part
II.
<PAGE>
COVER ARTWORK
INSIDE FRONT COVER OF PROSPECTUS:
OVERLEAF PAGE
CAPTION AT TOP OF PAGE: "Keynote enables companies to measure, assure and
improve their quality of service, allowing them to increase competitiveness and
customer satisfaction."
CAPTION AT UPPER MIDDLE OF PAGE: "Keynote Enables E-Commerce Sites to:"
TWO CAPTIONS IN BOXES AT LOWER MIDDLE OF PAGE: "Measure site performance
from numerous locations worldwide" and "Compare site performance to competitors'
and industry benchmarks."
THREE CAPTIONS IN BOXES AT BOTTOM OF PAGE: "Assure customers reach their
site all the time and quality of service benchmarks are achieved," "Diagnose and
pinpoint the source of problems: content, server, web site, internet
infrastructure" and "Improve site performance by implementing changes to content
or network infrastructure."
Keynote logo in extreme bottom right corner.
All text overlays a graphic of a globe.
GATE FOLD PAGES
In the background there is a globe.
Diagram on the globe shows how our computer measurement agents connect with
the data collection center to the customer.
CAPTIONS IN DIAGRAM: Performance Measurement, Data Collection, Storage and
Dissemination, Easy-to-Use Reporting & Analysis
The left side of the diagram shows four icons of our computer measurement
agents with www.yoursite.com written under one of the measurement agents. The
caption under the measurement agents is "Keynote's worldwide network of software
agents connected to the Internet from major cities across the globe continuously
measure web-site performance. More than 12 million measurements are taken each
day of thousands of e-commerce web sites."
In the center of the diagram under the Data Collection caption is a diagram
of our Operation Center. The caption under the box is "Complete data about
web-site quality of service, including content download and e-commerce
transaction performance and availability, is collected in real time and analyzed
at our central operations center in San Mateo, California."
The right side of the diagram under the Reporting & Analysis caption has
four diagrams. One is a pager with the caption to the right saying "Pager
alerts." One is an envelope with the caption "E-mail notifications." To the
right is a picture of a chart with the caption reading "web based analysis." The
last picture is of a folder with the caption "FTP updates."
The caption under the pictures reads "Performance data is delivered
automatically to customers via alarms and daily summary reports. Detailed
graphical analysis and diagnostics enable customers to pinpoint and solve
problems right from their web browser."
<PAGE>
YOU SHOULD RELY ONLY ON THE INFORMATION CONTAINED IN THIS PROSPECTUS. WE
HAVE NOT AUTHORIZED ANYONE TO PROVIDE YOU WITH INFORMATION DIFFERENT FROM THAT
CONTAINED IN THIS PROSPECTUS. WE ARE OFFERING TO SELL, AND SEEKING OFFERS TO
BUY, SHARES OF COMMON STOCK ONLY IN JURISDICTIONS WHERE OFFERS AND SALES ARE
PERMITTED. THE INFORMATION CONTAINED IN THIS PROSPECTUS IS ACCURATE ONLY AS OF
THE DATE OF THIS PROSPECTUS, REGARDLESS OF THE TIME OF DELIVERY OF THIS
PROSPECTUS OR OF ANY SALE OF OUR COMMON STOCK. IN THIS PROSPECTUS, "KEYNOTE,"
"WE," "US" AND "OUR" REFER TO KEYNOTE SYSTEMS, INC.
UNTIL OCTOBER 19, 1999, ALL DEALERS THAT BUY, SELL OR TRADE OUR COMMON
STOCK, WHETHER OR NOT PARTICIPATING IN THIS OFFERING, MAY BE REQUIRED TO DELIVER
A PROSPECTUS. THIS REQUIREMENT IS IN ADDITION TO THE DEALER'S OBLIGATION TO
DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO UNSOLD
ALLOTMENTS OR SUBSCRIPTIONS.
------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
---
<S> <C>
Prospectus Summary.......................................................................................... 4
Risk Factors................................................................................................ 7
Special Note Regarding Forward-Looking Statements........................................................... 20
Use of Proceeds............................................................................................. 21
Dividend Policy............................................................................................. 21
Capitalization.............................................................................................. 22
Dilution.................................................................................................... 23
Selected Financial Data..................................................................................... 24
Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 25
Business.................................................................................................... 35
Management.................................................................................................. 50
Certain Transactions........................................................................................ 60
Principal and Selling Shareholders.......................................................................... 63
Description of Capital Stock................................................................................ 65
Shares Eligible for Future Sale............................................................................. 68
Underwriting................................................................................................ 70
Legal Matters............................................................................................... 73
Experts..................................................................................................... 73
Where You Can Find Additional Information................................................................... 73
Index to Financial Statements............................................................................... F-1
</TABLE>
------------------------
Keynote-Registered Trademark- is our registered trademark and
Perspective-TM-, Lifeline-TM-, The Internet Performance Authority-TM- and
AccuStat-TM- are our trademarks or service marks. This prospectus also contains
trademarks of other companies and organizations.
3
<PAGE>
PROSPECTUS SUMMARY
YOU SHOULD READ THIS SUMMARY TOGETHER WITH THE ENTIRE PROSPECTUS, INCLUDING
THE MORE DETAILED INFORMATION IN OUR FINANCIAL STATEMENTS AND ACCOMPANYING NOTES
APPEARING ELSEWHERE IN THIS PROSPECTUS.
KEYNOTE SYSTEMS, INC.
Keynote provides Internet performance measurement and diagnostic services
that enable electronic commerce, or e-commerce, companies to measure, assure and
improve the quality of service of their web sites. E-commerce web sites face a
different set of competitive challenges than those faced by conventional "bricks
and mortar" stores. In order to discourage customers from "clicking away" to
competing web sites, e-commerce web sites must deliver fast page downloads,
efficient transactions and high reliability of access. According to a 1999 study
by Zona Research, approximately $4.4 billion per year in e-commerce sales in the
United States may be lost due to unacceptable download speeds and the resulting
user abandonment of online transactions.
OUR SERVICES
We currently offer two primary services, Keynote PERSPECTIVE and Keynote
LIFELINE. Both of these services measure web-site performance and availability,
including the time it takes for a user to download web pages. Keynote
PERSPECTIVE is targeted for e-commerce web sites with heavy levels of traffic.
Keynote PERSPECTIVE measures the performance and availability of web sites by
measuring the time it takes for pages and page components to be downloaded to a
user's personal computer. Keynote PERSPECTIVE also measures the time it takes to
complete a customer transaction on an e-commerce web site. With this service,
measurements can be taken from multiple geographic locations and from
three-minute to four-hour intervals.
Our Keynote LIFELINE service, which was introduced in July 1999, is targeted
for regionally oriented web sites and web sites with lower traffic levels. This
lower-priced service measures the time it takes to download web pages to one or
two locations in the United States. Measurements can be taken every 10 minutes
or once per hour.
In January 1999, we introduced our COMPETITIVE AUDIT and DIAGNOSTIC AUDIT
professional services offerings. With COMPETITIVE AUDIT, we measure the
performance of a customer's web site and evaluate its performance against other
web sites in the customer's industry. We also identify any bottlenecks or stress
points in the customer's web site or its connections to the Internet. In our
DIAGNOSTIC AUDIT, our consultants work with our customers to further evaluate
quality of service issues and provide specific recommendations to them as to how
they can improve their web site's quality of service.
The foundation of our services is an extensive network of strategically
located measurement computers connected to the major Internet backbones in
dozens of metropolitan areas worldwide. We also have an operations center for
collecting, analyzing and disseminating Internet performance and availability
data. We believe our customers can use our services to measure the performance
of their web sites and to ensure that their e-commerce web sites are not
experiencing performance problems such as outages, slow web page download speeds
or slow transaction processing times. With this information, we believe the web
sites can improve their customer satisfaction and reduce support costs. In
addition, it is easy for customers to begin using our services. With only a web
browser, customers can try, purchase and immediately use our services.
We market and sell our services primarily through a direct telesales force
in the United States. We also market our services through Network Solutions and
VeriSign, which are companies that provide services complementary to ours. Our
customers include over 400 leading e-commerce companies. Our 10 largest
customers, based on revenues for the nine months ended June 30, 1999, consist of
Akamai, C--NET, Digex, DoubleClick, Exodus Communications, Hewlett-Packard,
Intel, Microsoft, Nasdaq-AMEX and Sandpiper Networks.
4
<PAGE>
OUR STRATEGY
Our growth strategy is to expand our leadership in providing Internet
performance measurement and diagnostic services to e-commerce web sites.
To achieve this goal we intend to:
- extend our market penetration by promoting our LIFELINE service and
marketing additional services to LIFELINE customers as their e-commerce
web sites grow;
- increase awareness of Keynote as "THE INTERNET PERFORMANCE AUTHORITY-TM-"
through marketing programs;
- pursue marketing relationships with companies that sell products or
services complementary to our services;
- offer new features and services in order make our customers continually
aware of the importance of Keynote's services for measuring and ensuring
the quality of service of their web sites;
- expand our operations internationally; and
- expand our services to measure other aspects of quality of service other
Internet access methods and other new Internet technologies.
WE HAVE INCURRED SIGNIFICANT LOSSES AND WE MAY NOT BECOME PROFITABLE
We have incurred losses of $9.2 million since we were formed in June 1995.
In addition, we had a net loss of $3.7 million for the nine months ended June
30, 1999 and a net loss of $2.9 million for the 1998 fiscal year. We expect to
incur net losses for the foreseeable future. The market for Internet-related
products and services is highly competitive and we could face intense
competition in the future. Therefore, we may not achieve or sustain
profitability.
UNLESS OTHERWISE INDICATED, ALL INFORMATION CONTAINED IN THIS PROSPECTUS
ASSUMES:
- NO EXERCISE OF THE UNDERWRITERS' OVER-ALLOTMENT OPTION;
- THE COMPLETION OF A 1-FOR-2 REVERSE STOCK SPLIT TO BE COMPLETED
IMMEDIATELY PRIOR TO THIS OFFERING;
- THE CONVERSION OF EACH OUTSTANDING SHARE OF SERIES A PREFERRED STOCK,
SERIES B PREFERRED STOCK AND SERIES D PREFERRED STOCK INTO 1 SHARE OF
COMMON STOCK AND OF EACH SHARE OF SERIES C PREFERRED STOCK INTO 1.06 OF A
SHARE OF COMMON STOCK;
- THE EXERCISE OF A WARRANT TO PURCHASE 265,000 SHARES OF OUR COMMON STOCK
BY UMANG GUPTA, OUR CHIEF EXECUTIVE OFFICER, PRIOR TO THE CLOSING OF THIS
OFFERING; AND
- NO EXERCISE OF WARRANTS TO PURCHASE 378,478 SHARES OF OUR COMMON STOCK
PRIOR TO THE CLOSING OF THIS OFFERING.
5
<PAGE>
THE OFFERING
<TABLE>
<S> <C>
Common stock offered by Keynote.............. 3,875,000 shares
Common stock offered by Mr. Gupta............ 125,000 shares
Common stock to be outstanding after the 22,788,667 shares
offering...................................
Use of proceeds.............................. For general corporate purposes, capital
expenditures and working capital. See "Use of
Proceeds."
Nasdaq National Market symbol................ KEYN
</TABLE>
The number of shares of our common stock to be outstanding immediately after
the offering is based on the number of shares outstanding as of June 30, 1999.
- This number does not include 1,445,915 shares of our common stock subject
to options and warrants outstanding as of June 30, 1999.
- This number includes all of our outstanding shares of preferred stock that
will be converted into an aggregate of 12,588,898 shares of common stock
upon the completion of this offering.
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FISCAL YEAR ENDED NINE MONTHS
SEPTEMBER 30, ENDED JUNE 30,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues.......................................................... $ 30 $ 81 $ 1,539 $ 948 $ 4,109
Loss from operations.............................................. (628) (2,018) (2,957) (1,902) (3,513)
Net loss.......................................................... (622) (2,049) (2,918) (1,878) (3,659)
NET LOSS PER SHARE:
Basic and diluted................................................. $ (0.23) $ (0.84) $ (1.10) $ (0.72) $ (0.91)
Weighted average shares--basic and diluted........................ 2,733 2,434 2,661 2,594 4,032
Pro forma basic and diluted....................................... (0.28) (0.26)
Pro forma weighted average shares--basic and diluted.............. 10,376 14,133
</TABLE>
<TABLE>
<CAPTION>
JUNE 30, 1999
-------------------------------------
ACTUAL PRO FORMA AS ADJUSTED
--------- ----------- -------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents...................................................... $ 17,152 $ 17,497 $ 67,200
Working capital................................................................ 16,698 17,043 66,746
Total assets................................................................... 22,862 23,207 72,910
Notes payable, less current portion............................................ 2,853 2,853 2,853
Redeemable convertible preferred stock......................................... 23,381 -- --
Total shareholders' equity (deficit)........................................... (6,620) 17,106 66,809
</TABLE>
See note 2 to our financial statements for a description of the method that
we used to compute our basic and diluted net loss per share.
The pro forma balance sheet data give effect to the conversion of all of our
outstanding shares of preferred stock into common stock upon the closing of this
offering. It also gives effect to the exercise of a warrant to purchase 265,000
shares of our common stock by Umang Gupta, our chief executive officer, prior to
the closing of this offering.
The as adjusted balance sheet data give effect to the sale of the 3,875,000
shares of common stock that we are offering under this prospectus after
deducting the underwriting discounts and commissions and estimated offering
expenses. See "Capitalization."
Keynote Systems, Inc. was incorporated in California in June 1995. Our
principal offices are located at 2855 Campus Drive, San Mateo, California 94403.
Our telephone numbers at this location are (650) 522-1000 and 1-800-KEYNOTE. The
information on our web site does not constitute a part of this prospectus.
6
<PAGE>
RISK FACTORS
YOU SHOULD CAREFULLY CONSIDER THE RISKS DESCRIBED BELOW BEFORE BUYING SHARES
IN THIS OFFERING. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, OUR BUSINESS,
RESULTS OF OPERATIONS AND FINANCIAL CONDITION COULD BE SERIOUSLY HARMED, THE
TRADING PRICE OF OUR COMMON STOCK COULD DECLINE AND YOU MAY LOSE ALL OR PART OF
YOUR INVESTMENT.
THIS PROSPECTUS INCLUDES STATISTICAL DATA REGARDING THE INTERNET INDUSTRY.
THESE DATA ARE TAKEN OR DERIVED FROM INFORMATION PUBLISHED BY SOURCES INCLUDING
ZONA RESEARCH AND INTERNATIONAL DATA CORPORATION. ALTHOUGH WE BELIEVE THAT THESE
DATA ARE GENERALLY INDICATIVE OF THE MATTERS REFLECTED IN THOSE REPORTS, THESE
DATA ARE INHERENTLY IMPRECISE, AND WE CAUTION YOU TO READ THESE DATA IN
CONNECTION WITH THE REST OF THE DISCLOSURE IN THIS DOCUMENT, PARTICULARLY THIS
"RISK FACTORS" SECTION.
RISKS RELATED TO OUR BUSINESS
WE ARE AN EARLY STAGE COMPANY WITH AN UNPROVEN BUSINESS MODEL WHICH MAKES IT
DIFFICULT TO EVALUATE OUR CURRENT BUSINESS AND FUTURE PROSPECTS.
We have only a limited operating history upon which to base an evaluation of
our current business and future prospects. We began offering our Internet
performance measurement services in May 1997, we introduced the most recent
version of our PERSPECTIVE service in April 1999 and our LIFELINE service in
July 1999, and we formed our professional services organization in January 1999.
The revenue and income potential of our business and the related market are
unproven. In addition, because of our limited operating history and because the
market for Internet performance measurement and diagnostic services is
relatively new and rapidly evolving, we have limited insight into trends that
may emerge and affect our business. Before investing, you should evaluate the
risks, expenses and problems frequently encountered by companies such as ours
that are in the early stages of development and that are entering new and
rapidly changing markets such as Internet performance measurement.
WE HAVE INCURRED LOSSES, WE EXPECT TO INCUR FUTURE LOSSES AND WE MAY NEVER
ACHIEVE PROFITABILITY.
We have experienced operating losses in each quarterly and annual period
since inception and we expect to incur significant losses in the future. We
incurred net losses of $3.7 million for the nine months ended June 30, 1999, and
as of June 30, 1999, we had an accumulated deficit of $9.2 million. We believe
that our operating expenses will continue to increase as we grow our business.
As a result, although this offering will provide us with cash for our working
capital, we will need to significantly increase our revenues to achieve and
maintain profitability, as reflected in our financial statements. We may not be
able to sustain our recent revenue growth rates. In fact, we may not have any
revenue growth, and our revenues could decline. For a more detailed description
of our operating results, please see "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
THE SUCCESS OF OUR BUSINESS DEPENDS ON CUSTOMERS RENEWING THEIR SUBSCRIPTIONS
FOR OUR SERVICES AND PURCHASING ADDITIONAL SERVICES.
We depend on achieving high customer renewal rates for our revenues. Our
customers have no obligation to renew our services and therefore, they could
cease using our services at any time. We cannot assure you that we will continue
to experience high renewal rates. Our customer renewal rates may decline as a
result of a number of factors, including consolidations in the Internet industry
or if a significant number of our customers cease operations. Further, because
of the relatively small size of initial orders, we depend on sales to new
customers and sales of additional services to our existing customers.
In addition, initial sales of our services and subsequent customer follow-up
are conducted almost exclusively by telephone. A few customers have, in the
past, expressed a preference for more personal, face-
7
<PAGE>
to-face customer service. Dissatisfaction by a customer with the nature or
quality of our services could lead that customer to elect not to renew its
subscription to our services. If our renewal-rate percentage declines, our
revenues could decline unless we are able to obtain additional customers or
sources of revenues.
OUR QUARTERLY FINANCIAL RESULTS ARE SUBJECT TO SIGNIFICANT FLUCTUATIONS, AND IF
OUR FUTURE RESULTS ARE BELOW THE EXPECTATIONS OF PUBLIC-MARKET ANALYSTS AND
INVESTORS, THE PRICE OF OUR COMMON STOCK MAY DECLINE.
As indicated in our "Quarterly Results of Operations" on page 30, our
results of operations could vary significantly from quarter to quarter. For
example, our operating loss decreased to $798,000 for the quarter ended December
31, 1998 from $1.0 million for the quarter ended September 30, 1998 and then
increased to $1.1 million for the quarter ended March 31, 1999 and to $1.8
million for the quarter ended June 30, 1999. We expect to incur significant
sales and marketing expenses to promote our brand and our services, as well as
additional expenses to expand our presence world wide. If revenues fall below
our expectations, we will not be able to reduce our spending rapidly in response
to the shortfall.
Other factors that could affect our quarterly operating results include
those described below and elsewhere in this prospectus:
- the renewal rate of subscriptions to our Internet performance measurement
services;
- our ability to increase the number of web sites we measure for our
existing customers in a particular quarter;
- our ability to attract new customers in a particular quarter;
- the number of our customers who elect to purchase our entry-level Keynote
LIFELINE service as compared with our more comprehensive Keynote
PERSPECTIVE service in a particular quarter;
- the amount and timing of operating costs and capital expenditures relating
to expansion of our operations infrastructure, including our planned
international expansion; and
- the amount and timing of professional services revenues.
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.
THE SUCCESS OF OUR BUSINESS DEPENDS ON THE WIDESPREAD ADOPTION OF THE INTERNET
BY BUSINESS AND CONSUMERS FOR E-COMMERCE AND COMMUNICATIONS.
Because our business is based on providing performance measurement and
diagnostic services for web sites, the Internet must be widely adopted, in a
timely manner, as a means of electronic commerce, or e-commerce, and
communications. Because e-commerce and communications over the Internet are new
and evolving, it is difficult to predict the size of this market and its
sustainable growth rate. In addition, we believe that the use of the Internet
for conducting business transactions could be hindered for a number of reasons,
including, but not limited to:
- security concerns including the potential for fraud or theft of stored
data and information communicated over the Internet;
- inconsistent quality of service, including well-publicized outages of
popular web sites;
- lack of availability of cost-effective, high-speed service;
- limited numbers of local access points for corporate users;
- delay in the development of enabling technologies or adoption of new
standards;
8
<PAGE>
- inability to integrate business applications with the Internet;
- the need to operate with multiple and frequently incompatible products;
and
- a lack of tools to simplify access to and use of the Internet.
OUR OPERATING RESULTS DEPEND ON SALES OF OUR KEYNOTE PERSPECTIVE SERVICE.
Because we have only recently begun to offer professional services and we
only recently introduced Keynote LIFELINE, the success of our business currently
depends, and for the immediate future will continue to substantially depend, on
the sale of our Keynote PERSPECTIVE service. Therefore, we believe that initial
sales and renewals of our Keynote PERSPECTIVE service will account for
substantially all of our revenues for the immediate future. A decline in the
price of, or fluctuation in the demand for, Keynote PERSPECTIVE, or our
inability to maintain or increase sales, would cause our revenues to decline.
IF ONE OF OUR COMPETITORS' INTERNET PERFORMANCE MEASUREMENT SERVICE IS ADOPTED
AS THE INDUSTRY STANDARD FOR MEASURING THE SPEED AND RELIABILITY OF WEB SITES,
WE MAY LOSE EXISTING CUSTOMERS OR ENCOUNTER DIFFICULTIES IN ATTRACTING NEW
CUSTOMERS.
To date, no Internet performance measurement service has been adopted as an
accepted industry standard for measuring the speed and reliability of web sites.
As a result, if one of our current or potential competitors develops an Internet
performance measurement service that is adopted as the industry standard, our
customers may turn to the services provided by these competitors. In addition,
it would be more difficult for us to attract the additional customers for our
Internet performance measurement services that are necessary for our business to
grow. If this were to occur, our business would be harmed.
IMPROVEMENTS TO THE INFRASTRUCTURE OF THE INTERNET COULD REDUCE OR ELIMINATE
DEMAND FOR OUR INTERNET PERFORMANCE MEASUREMENT SERVICES.
The demand for our Internet performance measurement services could be
reduced or eliminated if future improvements to the infrastructure of the
Internet lead companies to conclude that measuring and evaluating the
performance of their web sites is no longer important to their business. The
Internet is a complex, heterogeneous network of communications networks with
multiple operators and vendors supplying and managing the underlying
infrastructure as well as connections to this infrastructure. Because the
inherent complexity of the Internet currently causes significant e-commerce
quality of service problems for companies, the vendors and operators that supply
and manage the underlying infrastructure are continuously seeking to improve the
speed, availability, reliability and consistency of the Internet. If these
vendors and operators succeed in significantly improving the performance of the
Internet, which would result in corresponding improvements in the performance of
companies' web sites, demand for our services would likely decline.
IT WOULD BE MORE DIFFICULT FOR US TO DELIVER OUR SERVICES AND THEREFORE EARN
REVENUES IF WE CANNOT EXPAND AND MANAGE OUR COMPUTER INFRASTRUCTURE
SUCCESSFULLY.
We will need to deploy a large number of measurement computers if we
experience an increase in our customer base or if we expand our operations and
measurement capabilities on a worldwide basis. These computers are responsible
for measuring the performance of web sites and collecting performance data and
it is critical to our ability to deliver our services that they operate
effectively. We currently measure the performance of between 5,000 and 6,000
web-site addresses for our customers. Based on the number of measurement
computers we currently have deployed and the communications capacity available
to these computers, we believe we are able to measure the performance of
approximately 7,000 web-site addresses. We are in the process of deploying
additional measurement computers and upgrading the underlying infrastructure so
that we will have the ability by the end of the year to measure in excess of
10,000 web-site addresses. With more measurement computers deployed, we will
need to monitor and maintain a larger and more geographically dispersed computer
network, which would require us to devote significant additional resources
9
<PAGE>
for these tasks. In addition, if we experience increases in the number of our
customers prior to deploying additional measurement computers, our existing
infrastructure may not have the capacity to accommodate the additional
customers. This could result in outages, interruptions or slower response times,
any of which could impair our ability to retain and attract customers.
WE MAY FACE LIABILITY FOR SUPPLYING INACCURATE INFORMATION TO OUR CUSTOMERS OR
FROM OUR CUSTOMERS' USE OF THE DATA THAT WE PROVIDE.
We may face liability if the information that we supply to our customers is
inaccurate. The data that we collect and store in our measurement database,
although reported to customers at over a 99% level of accuracy, may contain
inaccuracies due to distortions and bottlenecks caused by inadequate network
capacity preventing our measurement computers from gaining access to all
requested measurements. Any dissatisfaction by our customers with our
measurement data would impair our credibility in the marketplace and
significantly harm our ability to attract new customers and retain existing
customers. In addition, if we were to supply customers with inaccurate
information, these customers might initiate litigation against us on such
theories as breach of contract, breach of warranty or negligence. Our general
insurance policy does not specifically cover liability for providing inaccurate
data.
Our customers are responsible for the manner in which they use the data that
we provide to them, and our customer contracts provide that each customer must
indemnify us for any damages arising from their use of the data, reports or
analyses. However, we cannot be certain that these contract provisions provide
us with sufficient legal protection. For example, a company could use our
comparative performance data, which evaluates the relative performance of the
company's web site against web sites in an industry, and make claims to assert
that their service is superior to those of their competitors or that their
competitors' services are inferior. As a result, a third party might initiate
litigation against one of our customers on such theories as defamation, trade
libel or unfair competition relating to the customer's use of the information
that we provided to them. Even if the information that we provided were
accurate, we could be named as a defendant in any resulting litigation. Any
litigation could be expensive and could divert management's attention from
operating our company.
WE MAY FACE LIABILITY FOR PUBLISHING INDICES THAT EVALUATE AND RANK THE RELATIVE
INTERNET PERFORMANCE OF WEB SITES.
We periodically publish indices that evaluate and rate the relative
performance of various e-commerce web sites in a particular market segment. Some
companies whose web sites have performed poorly in our published indices have
asserted that our indices are not indicative of the overall consumer experience
because the indices do not measure qualitative factors such as web-site content,
navigability and appearance. Companies could potentially bring a claim against
us if they believe that their business has been harmed by their low ranking in
one of our indices. In addition, if the information published in one of our
performance indices is inaccurate, we could lose credibility in the marketplace.
This could harm our ability to attract new customers and retain existing
customers, and could result in potentially expensive litigation against us on
such theories as defamation, trade libel or unfair competition.
THE INABILITY OF OUR SERVICES TO PERFORM PROPERLY COULD RESULT IN LOSS OF OR
DELAY IN REVENUES, INJURY TO OUR REPUTATION OR OTHER HARM TO OUR BUSINESS.
Services as complex as those we offer may not perform as we expect. We have
given credits to a limited number of customers as a result of past problems with
our service, though we do not believe that any customers failed to renew their
subscription to our services due to these problems. Despite our testing, our
existing or future services may not perform as expected due to unforeseen
problems, including those related to the year 2000, which could result in loss
of or delay in revenues, loss of market share, failure to achieve market
acceptance, diversion of development resources, injury to our reputation,
increased insurance costs or increased service costs.
10
<PAGE>
These problems could also result in tort or warranty claims. Although we
attempt to reduce the risk of losses resulting from any claims through warranty
disclaimers and liability-limitation clauses in our customer agreements, these
contractual provisions may not be enforceable in every instance. Furthermore,
although we maintain errors and omissions insurance, this insurance coverage may
not adequately cover us for claims. If a court refused to enforce the
liability-limiting provisions of our contracts for any reason, or if liabilities
arose that were not contractually limited or adequately covered by insurance, we
could be required to pay damages.
IF WE DO NOT CONTINUALLY IMPROVE OUR SERVICES IN RESPONSE TO TECHNOLOGICAL
CHANGES, INCLUDING CHANGES TO THE INTERNET, WE MAY ENCOUNTER DIFFICULTIES
RETAINING EXISTING CUSTOMERS AND ATTRACTING NEW CUSTOMERS.
The ongoing evolution of the Internet requires us to continually improve the
functionality, features and reliability of our Internet performance measurement
and diagnostic services, particularly in response to competitive offerings. If
we do not succeed in developing and marketing new services that respond to
competitive and technological developments and changing customer needs, we may
encounter difficulties retaining existing customers and attracting new
customers. We must also introduce any new Internet services as quickly as
possible. The success of new services 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 SERVICES AND BRAND NAME MIGHT NOT ATTAIN THE BRAND AWARENESS NECESSARY FOR
OUR BUSINESS TO SUCCEED.
We believe that maintaining and strengthening the Keynote brand is an
important aspect of our business and an important element in attracting new
customers. Our efforts to build our brand will involve significant expense. To
promote our brand, we may increase our marketing budget or increase our
financial commitment to building our brand. If our brand-building strategy is
unsuccessful, we may fail to attract enough new customers or retain our existing
customers to the extent necessary to realize a sufficient return on our
brand-building efforts.
IF WE ARE NOT SUCCESSFUL IN SELLING OUR NEW KEYNOTE LIFELINE SERVICE, OUR
REVENUES MAY FALL SHORT OF OUR EXPECTATIONS.
We introduced our Keynote LIFELINE service in July 1999, and we have
currently sold this service to 12 customers. We cannot be certain that there
will be customer demand for these services or that we will be successful in
penetrating this market. In addition, because our Keynote LIFELINE service is
sold at a lower price than our Keynote PERSPECTIVE service, we will need to sell
our Keynote LIFELINE service to a large volume of customers in order to
significantly grow our revenues. We may not succeed in selling our Keynote
LIFELINE service.
WE FACE GROWING COMPETITION WHICH COULD MAKE IT DIFFICULT FOR US TO ACQUIRE AND
RETAIN CUSTOMERS.
The market for Internet performance measurement and diagnostic services is
new and rapidly evolving. We expect competition in this market to intensify in
the future. Our competitors vary in size and in the scope and breadth of the
products and services that they offer. Our principal competitors today include
Freshwater Software, Internet Resources Group, Inverse Network Technology and
Service Metrics. We also indirectly compete with WebCriteria, MIDS Matrix IQ
Service, and INS INSoft Division, and free services such as the WebSite Garage
unit of Netscape, NetMechanic and Internet Weather Report. While the free
services are not as comprehensive as ours, as they only take measurements from
one location, they do not measure the speed of transactions and they only
measure simple download time, customers could still choose to use these less
comprehensive services.
11
<PAGE>
If we expand the scope of our products and services, we may encounter many
additional, market-specific competitors. These potential competitors include
companies that sell network management software such as CompuWare and IBM's
Tivoli Unit, and companies that sell load-testing software such as Mercury
Interactive, each of which has announced products that could potentially compete
with us in the future. Some of our competitors have, and our future competitors
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;
- adopt more aggressive pricing policies; and
- 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 shares, any of which could seriously
harm our business. We may not be able to compete successfully against our
current and future competitors.
A LIMITED NUMBER OF CUSTOMERS ACCOUNT FOR A SIGNIFICANT PORTION OF OUR REVENUES,
AND THE LOSS OF A MAJOR CUSTOMER COULD HARM OUR OPERATING RESULTS.
For the nine months ended June 30, 1999, 10 customers accounted for
approximately 32% of our total revenues, with two of those customers, Microsoft
Corporation and Digex Incorporated, accounting for 16% of our total revenues,
and this trend may continue in the future. We cannot be certain that customers
that have accounted for significant revenues in past periods, individually or as
a group, will renew our services and continue to generate revenue in any future
period. In addition, our customer agreements can generally be terminated at any
time with little or no penalty. If we lose a major customer, our revenues could
decline.
IN ORDER TO GROW OUR BUSINESS, WE NEED TO ESTABLISH AND MAINTAIN RELATIONSHIPS
WITH OTHER COMPANIES TO HELP MARKET OUR INTERNET PERFORMANCE MEASUREMENT AND
DIAGNOSTIC SERVICES.
In order to increase sales of our Internet performance measurement and
diagnostic services worldwide, we must complement our direct sales force with
relationships with companies to market and sell our services to their customers.
If we are unable to maintain our existing contractual marketing and distribution
relationships, or fail to enter into additional relationships, we will have to
devote substantially more resources to the direct sale and marketing of our
services. We would also lose anticipated revenues from customer referrals and
other co-marketing benefits. Our success depends in part on the ultimate success
of these relationships and the ability of these companies to market and sell our
services. Our existing relationships do not, and any future relationships may
not, afford us any exclusive marketing or distribution rights. Therefore, they
could reduce their commitment to us at any time in the future. Many of these
companies have multiple relationships and they may not regard us as significant
for their business. In addition, these companies may terminate their
relationships with us, pursue other relationships with our competitors or
develop or acquire products or services that compete with our services. Even if
we succeed in entering into these relationships, they may not result in
additional customers or revenues.
In addition, growth in the sales of our services depends on our ability to
obtain domestic and international resellers, distributors and integrators who
will market and sell our services on our behalf. In the
12
<PAGE>
future, we intend to increase our indirect distribution channels through
distribution arrangements. We may not be successful in establishing
relationships with these companies, and any of these relationships, if
established, may not increase our revenue.
IN ORDER TO GROW OUR BUSINESS, WE MUST ATTRACT AND RETAIN QUALIFIED PERSONNEL
WHILE COMPETITION FOR PERSONNEL IN OUR INDUSTRY IS INTENSE.
We may be unable to retain our key employees, namely our management team and
experienced engineers, or to attract, assimilate or retain other highly
qualified employees. We have from time to time in the past experienced, and we
expect in the future to continue to experience, difficulty in hiring and
retaining highly skilled employees with experience in the Internet industry, a
complex industry that requires a unique knowledge base. In addition, there is
significant competition for qualified employees in the Internet industry. Umang
Gupta, our chief executive officer, is our only key employee with whom we have
entered into an employment agreement. Our other key employees are not bound by
employment agreements that could prevent them from terminating their employment
at any time.
In addition, because we sell our Internet performance measurement and
diagnostic services primarily through our telesales force, we believe that we
will need to attract additional sales personnel to grow our revenues. Our
ability to deliver our services also depends on our ability to attract and
retain operations personnel. There is a shortage of qualified sales and
operations personnel and competition for personnel in our industry is intense.
If we are unable to hire, train, motivate or retain qualified employees,
including sales and operations personnel, our business could be harmed.
IF OUR PROFESSIONAL SERVICES ARE NOT ACCEPTED BY THE MARKET, OUR RESULTS OF
OPERATIONS COULD BE HARMED.
We formed our professional services organization in January 1999. As a
result, we have little experience in delivering consulting services and we may
not be able to successfully introduce additional consulting services. We will
also need to successfully market these services to potential customers. There
are many experienced firms which offer computer network and Internet-related
consulting services. These consulting services providers include the consulting
groups of "Big Five" accounting firms, such as Andersen Consulting and Ernst &
Young, as well as consulting divisions of large technology companies such as
IBM. Because we do not have an established reputation for delivering consulting
services, because this area is very competitive, and due to our general
inexperience in delivering consulting services, we may not succeed in selling
these services.
IF WE ARE UNABLE TO ATTRACT, EDUCATE AND RETAIN QUALIFIED PROFESSIONAL SERVICE
PERSONNEL, WE MAY NOT BE ABLE TO SUCCESSFULLY EXPAND OUR PROFESSIONAL SERVICES
ORGANIZATION.
We plan to increase the number of our professional services personnel. If we
hire additional services personnel prior to securing a large customer base our
operating results would be adversely affected as we would incur expenses for
these personnel without commensurate revenue increases. This was the reason that
our cost of consulting services revenues exceeded our consulting services
revenues for each of the first two quarters of 1999. Competition for highly
qualified professional services personnel with knowledge of our industry is
intense. We cannot be certain that we can attract or retain a sufficient number
of professional services personnel that our business requires. In addition, new
employees will require training and education, and consequently, they will take
time to reach full productivity.
THE GROWTH OF OUR BUSINESS DEPENDS ON THE CONTINUED PERFORMANCE OF AND FUTURE
IMPROVEMENTS TO THE INTERNET.
The growth in Internet traffic has caused frequent periods of decreased
performance, requiring Internet service providers and web sites on the Internet
to upgrade their infrastructures. Our ability to increase the speed with which
we provide services to our customers and to increase the scope of these services
is limited
13
<PAGE>
by and depends upon the speed and reliability of the Internet. Consequently, the
emergence and growth of the market for our services and, consequently our
revenues, depends on the performance of and future improvements to the Internet.
BECAUSE WE HAVE EXPANDED OUR OPERATIONS, OUR SUCCESS WILL DEPEND ON OUR ABILITY
TO MANAGE OUR GROWTH, IMPROVE OUR EXISTING SYSTEMS AND IMPLEMENT NEW SYSTEMS,
PROCEDURES AND CONTROLS.
We are expanding, and we intend to continue to expand, our operations by
deploying additional measurement computers, both domestically and
internationally, hiring new personnel and implementing and integrating new
accounting and control systems to manage this expansion. We may encounter
difficulties in managing this growth. Our ability to compete effectively and to
manage any future expansion of our operations will require us to continue to
improve our financial and management controls, reporting systems and procedures
on a timely basis. We may not succeed in these efforts and a disruption could
impair our ability to retain existing customers or attract new customers.
OUR NETWORK INFRASTRUCTURE COULD BE DISRUPTED BY A NUMBER OF DIFFERENT
OCCURRENCES, WHICH COULD IMPAIR OUR ABILITY TO RETAIN EXISTING CUSTOMERS OR
ATTRACT NEW CUSTOMERS.
All data collected from our measurement computers are stored in and
distributed from our operations center. Therefore, our operations depend upon
our ability to maintain and protect our computer systems, most of which are
located at our corporate headquarters in San Mateo, California which is an area
susceptible to earthquakes. If we experience outages at our operations center,
we would not be able to receive data from our measurement computers and we would
not be able to deliver our services to our customers. We currently do not have a
redundant system for computer-network and other services at an alternate site.
Therefore, our operations systems are vulnerable to damage from break-ins,
computer viruses, unauthorized access, vandalism, fire, floods, earthquakes,
power loss, telecommunications failures and similar events. Although we maintain
insurance against fires, floods, earthquakes and general business interruptions,
the amount of coverage may not be adequate in any particular case. If our
operations center is damaged, causing a disruption in our services, this could
impair our ability to retain existing customers or attract new customers.
If our computer infrastructure is not functioning properly, we may not be
able to deliver our services in a timely or accurate manner. We have
occasionally experienced outages of our service in the past, the last of which
occurred approximately two months ago. The outages that we have experienced have
lasted no more than a few hours, with the longest outage that occurred in the
fall of 1998 having lasted approximately 12 hours. These outages have been
caused by a variety of factors including operator error, the failure of a
back-up computer to operate when the primary computer ceased functioning and
power outages due to our previous facility's being inadequately equipped to
house our operations center. Although we do not believe we have lost any
customers due to these prior outages, any outage for any period of time could
cause us to lose customers.
Hackers, or individuals who attempt to breach our network security, could,
if successful, misappropriate proprietary information or cause interruptions in
our services. Although we have not yet experienced any breaches of our network
security or sabotage, we might be required to expend significant capital and
resources to protect against, or to alleviate, problems caused by hackers. We
may not have a timely remedy against a hacker who is able to breach our network
security. In addition to purposeful security breaches, the inadvertent
transmission of computer viruses could expose us to litigation or to a material
risk of loss.
OUR MEASUREMENT COMPUTERS ARE LOCATED AT SITES WHICH WE DO NOT OWN OR OPERATE
AND IT COULD BE DIFFICULT FOR US TO MAINTAIN OR REPAIR THEM IF THEY DO NOT
FUNCTION PROPERLY.
Our measurement computers are located at facilities that are not owned by us
or our customers. Instead, these computers are installed at locations near
various Internet access points worldwide. Because we do not own or operate these
facilities, we have little control over how these computers are maintained on a
day-to-
14
<PAGE>
day basis. We do not have long-term contractual relationships with the companies
that operate the facilities where our measurement computers are located. We may
have to find new locations for these computers if we are unable to maintain or
develop relationships with these companies. In addition, if our measurement
computers were not functioning properly, we may not be immediately aware of
these difficulties or we may not be able to repair or service these computers on
a timely basis as we may not have immediate access to our measurement computers.
Our ability to collect data in a timely manner could be impaired if we are
unable to maintain and repair our computers should performance problems arise.
THE SUCCESS OF OUR BUSINESS DEPENDS ON OUR ABILITY TO PROTECT AND ENFORCE OUR
INTELLECTUAL PROPERTY RIGHTS.
The intellectual property we use in our business is important to us. We have
trademarks, service marks and two patent applications with respect to our
Internet performance measurement technology, and we have also developed
proprietary software that we use to deliver our services to our customers.
Despite our efforts, we may be unable to prevent others from infringing upon or
misappropriating our intellectual property, which could harm our business.
It is possible that no patents will issue from our currently pending patent
applications. Moreover, new patent applications may not result in issued patents
and may not provide us with any competitive advantages over, or may be
challenged by, others. 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 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.
Most of our customers' use of our services is governed by web-based license
agreements, rather than 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. 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 litigation,
we may in the future need to initiate a lawsuit to enforce our intellectual
property rights and to protect our patents, if issued, trademarks and
copyrights. Any litigation could result in substantial costs and diversion of
resources and could seriously harm our business. For a description of our
intellectual property, see "Business--Intellectual Property."
OTHERS MIGHT BRING INFRINGEMENT CLAIMS AGAINST US OR OUR SUPPLIERS THAT COULD
HARM OUR BUSINESS.
In recent years, there has been significant litigation in the United States
involving patents and other intellectual property rights. We 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 to others
for infringing their intellectual property rights, we would be required to pay a
substantial damage award and to develop noninfringing technology, obtain a
license or cease selling the services that contain the infringing intellectual
property. We may be unable to develop noninfringing technology or to obtain a
license on commercially reasonable terms, if at all.
WE DEPEND ON TECHNOLOGIES LICENSED FROM OTHER COMPANIES FOR PORTIONS OF OUR
SERVICES.
We cannot assure you that our 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. We license statistical, graphical,
database and other technologies from third parties to operate our services. The
loss of this
15
<PAGE>
technology could require us to obtain or develop 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.
IF WE EXPAND OUR INTERNATIONAL ACTIVITIES, OUR BUSINESS WILL BE SUSCEPTIBLE TO
ADDITIONAL RISKS ASSOCIATED WITH INTERNATIONAL OPERATIONS.
We believe we must expand the sales of our services outside the United
States and hire additional international personnel. Therefore, we expect to
commit significant resources to expand our international sales and marketing
activities, which were less than 10% of our total revenues for the nine months
ended June 30, 1999 and our prior periods. In addition, we intend to deploy
additional measurement computers worldwide, which would require us to maintain
and service computers over larger distances.
Conducting international operations would subject us to risks we do not face
in the United States. These include:
- currency exchange rate fluctuations;
- seasonal fluctuations in purchasing patterns;
- unexpected changes in regulatory requirements;
- maintaining and servicing computer hardware in distant locations;
- longer accounts receivable payment cycles and difficulties in collecting
accounts receivable;
- difficulties in managing and staffing international operations;
- potentially adverse tax consequences, including restrictions on the
repatriation of earnings;
- the burdens complying with a wide variety of foreign laws; and
- and reduced protection for intellectual property rights in some countries.
The Internet may not be used as widely in other countries and the adoption
of e-commerce may evolve slowly or may not evolve at all. As a result, we may
not be successful in selling our services to customers in markets outside the
United States.
OUR BUSINESS MIGHT BE HARMED IF THE SYSTEMS WE USE ARE NOT YEAR 2000 COMPLIANT
OR IF OUR CUSTOMERS OR POTENTIAL CUSTOMERS ALTER THEIR PURCHASING PATTERNS AS A
RESULT OF THE YEAR 2000 PROBLEM.
Our information technology systems could be impaired or cease to operate due
to computer systems or software products being unable to distinguish between
20th and 21st century dates, which is known as the year 2000 problem. If our
Keynote PERSPECTIVE and LIFELINE services and our network of measurement
computers fail to accurately measure, process and assess web-site performance
data due to the year 2000 problem, we could lose customers. We also rely on
technology supplied by other companies. These companies may experience year 2000
related problems. Any year 2000 problems experienced by us or any of these
companies could harm our business. Additionally, because the Internet is
comprised of numerous computers and communications lines, it may fail to
function properly or at all, causing unavailability or disruption of Internet
services. If either of these occurred, we may be unable to measure Internet
performance which would cause our revenues to decline.
Customers', or potential customers', purchasing plans could be affected by
year 2000 issues if they need to expend significant resources to correct their
existing systems. This situation could result in reduced funds available for
these customers to purchase our services. As a result, some customers may defer
the purchase of our services until after the year 2000. A decrease in the demand
for our services due to customers' year 2000 issues could harm our business.
16
<PAGE>
A previous version of our Keynote PERSPECTIVE service which we no longer
sell was not year 2000 compliant. Despite our testing and remediating, our
services may contain errors or faults with respect to the year 2000. Although
there are no users of non-year 2000 compliant versions of our services, we may
face liability in the future for any unknown or unforeseen errors or faults
relating to the year 2000. Although our directors' and officers' liability
insurance will cover liability arising from year 2000 claims, this insurance
policy has a low coverage limit, has a deductible of $250,000 and will only
cover at most an amount equal to 25% of the final claim. Therefore, we could
incur significant expenses if we were subject to one of these types of claims.
We currently have limited contingency plans with respect to the year 2000
problem, and these consist of our having established connections with other
Internet service providers to provide service if our primary Internet service
provider fails. If we experience other year 2000 issues, we may not be able to
react quickly.
WE MAY FACE DIFFICULTIES ASSIMILATING AND MAY INCUR COSTS ASSOCIATED WITH ANY
FUTURE ACQUISITIONS.
As part of our business strategy, we may seek to acquire or invest in
businesses, products or technologies that we feel could complement or expand our
business, augment our market coverage, enhance our technical capabilities or
that may otherwise offer growth opportunities. Acquisitions could create risks
for us, including:
- difficulties in assimilation of acquired personnel, operations and
technologies;
- unanticipated costs associated with the acquisition;
- diversion of management's attention from other business concerns;
- adverse effects on existing business relationships with resellers of our
service and our customers; and
- use of substantial portions of our available cash, including the proceeds
of this offering, to consummate the acquisition.
RISK RELATED TO THIS OFFERING
OUR OFFICERS, DIRECTORS AND OTHER EXISTING SHAREHOLDERS WILL OWN A LARGE
PERCENTAGE OF OUR VOTING STOCK AND WILL BE ABLE TO CONTROL US.
After this offering and assuming no additional issuances of common stock,
our officers, directors and 5% or greater shareholders will beneficially own or
control, directly or indirectly, 14,539,091 shares of our common stock, which in
the aggregate will represent approximately 63.8% of the outstanding shares of
our common stock. As a result, if these persons act together, they will have the
ability to influence all matters submitted to our shareholders for approval,
including
- the election and removal of directors and
- any merger, consolidation or sale of all or substantially all of our
assets.
This ability to exercise influence over all matters requiring shareholder
approval could prevent or significantly delay another company or person from
acquiring or merging with us. For a further discussion of the stock ownership of
our officers, directors and 5% or greater shareholders, please see "Principal
and Selling Shareholders."
THE LIQUIDITY OF OUR STOCK IS UNCERTAIN AND INVESTORS MUST BE ABLE TO WITHSTAND
A POSSIBLE LOSS OF THEIR INVESTMENT.
A public market for the trading of our common stock has not existed prior to
this offering. Although this offering will result in a trading market for our
common stock, we do not know how liquid that market might be. The initial public
offering price for our common stock will be determined through negotiations
between the underwriters and us. If you purchase shares of our common stock, you
may not be able to resell those shares at or above the initial public offering
price.
17
<PAGE>
THE MARKET PRICE FOR OUR COMMON STOCK, LIKE OTHER TECHNOLOGY STOCKS, MIGHT BE
VOLATILE AND COULD RESULT IN CLASS-ACTION SECURITIES LITIGATION AGAINST US.
The market prices of the securities of Internet-related companies have been
especially volatile. The value of your investment in our common stock could
decline due to the impact of any of the following factors upon the market price
of our common stock:
- actual or anticipated variations in our quarterly operating results;
- announcements of new Internet performance measurement service offerings by
us or our competitors;
- announcements of technological innovations;
- competitive developments;
- changes in financial estimates by securities analysts;
- failure in one or more future quarters of our operating results to meet
the expectations of securities analysts or investors;
- changes in market valuations of Internet-related companies;
- additions or departures of key personnel, notably our management team and
experienced engineers;
- conditions and trends in the Internet and e-commerce industries; and
- general economic conditions.
Further, the stock markets, particularly the Nasdaq National Market on which
we have applied to have our common stock listed, have experienced substantial
price and volume fluctuations. These fluctuations have particularly affected the
market prices of equity securities of many technology and Internet-related
companies and have often been unrelated or disproportionate to the operating
performance of those companies. The trading prices of many technology companies'
stocks are at or near historical highs. These high trading prices may not be
sustained. In the past, following periods of volatility in the market price of a
company's securities, securities class action litigation has often been
instituted against that company. Litigation, if instituted, could result in
substantial costs and a diversion of management's attention and resources.
FUTURE SALES OF OUR COMMON STOCK MAY CAUSE OUR STOCK PRICE TO DECLINE.
Sales of a large number of shares of our common stock in the market after
this offering, or the belief that these sales could occur, could cause a drop in
the market price of our common stock. Upon completion of our initial public
offering, we will have outstanding 22,788,667 shares of common stock. Of these
shares, the 4,000,000 shares sold in this offering will be freely tradable
without restriction or further registration under the Securities Act, unless the
shares are purchased by our "affiliates."
The remaining 18,788,667 shares of common stock outstanding upon completion
of this offering will be "restricted securities," as that term is defined under
Rule 144 of the Securities Act. Our directors, executive officers and other
shareholders who hold a total of 18,392,332 shares, or over 95%, of the total
outstanding shares of our common stock have executed lock-up agreements that
limit their ability to sell common stock. These shareholders have agreed not to
sell or otherwise dispose of any shares of our common stock for a period of at
least 180 days after the date of this prospectus without the prior written
approval of BancBoston Robertson Stephens Inc. When the lock-up agreements
expire, these shares and shares underlying outstanding stock options and
warrants will become eligible for sale, in some cases only subject to the
volume, manner of sale and notice requirements of Rule 144. As of June 30, 1999
there were outstanding options and warrants to purchase 1,445,915 shares of our
common stock.
18
<PAGE>
Assuming the cash exercise of these warrants and options outstanding as of
June 30, 1999, the remaining 20,234,582 shares of our common stock will become
eligible for public sale as follows:
- 0 shares as of the date of this prospectus;
- 15,785,352 shares as of 181 days after the date of this prospectus;
- 4,449,230 shares as of one year after the date of this prospectus; and
- 0 shares as of two years after the date of this prospectus.
WE ARE UNCERTAIN OF OUR ABILITY TO OBTAIN ADDITIONAL FINANCING FOR OUR FUTURE
CAPITAL NEEDS.
We may need to raise funds in the future to meet our working capital and
capital expenditure needs. However, we may not be successful in raising
additional funds at all or on terms that are favorable to us. We expect the net
proceeds from this offering will be sufficient to meet our working capital and
capital expenditure needs for at least the next twelve months. After that, we
may need additional funds to fund more rapid expansion, to expand our marketing
activities, to develop new or enhance existing services or products, to respond
to competitive pressures or to acquire complementary services, businesses or
technologies.
NEW INVESTORS WILL EXPERIENCE IMMEDIATE AND SUBSTANTIAL DILUTION FROM THIS
OFFERING.
We expect that the initial public offering price of our common stock will be
substantially higher that the book value per share of the outstanding common
stock. As a result, investors purchasing stock in this offering will experience
an immediate dilution in the net tangible book value of the common stock of
$11.07 per share, based on the number of outstanding shares as of June 30, 1999.
In the past, we issued options to acquire our common stock at prices
significantly below the initial public offering price. To the extent these
outstanding options are ultimately exercised, there will be further dilution to
investors in this offering.
MANAGEMENT MIGHT APPLY THE NET PROCEEDS FROM THIS OFFERING TO USES THAT DO NOT
IMPROVE OUR OPERATING RESULTS OR MARKET VALUE.
The net proceeds from the sale of our common stock in this offering will be
added to our general working capital. We have not reserved or allocated the net
proceeds for any specific purpose, and we cannot specify with certainty how we
will use these proceeds. Consequently, our management will have broad discretion
with respect to the application of proceeds from this offering, and you will not
have the opportunity, as part of your investment in our common stock, to assess
whether the proceeds are being used appropriately. The net proceeds may be used
for corporate purposes that do not improve our operating results or market
value. Pending application of the proceeds, they might be placed in investments
that do not produce income or that lose value.
19
<PAGE>
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
Some of the statements under "Prospectus Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business" and elsewhere in this prospectus constitute
forward-looking statements. In some cases, you can identify forward-looking
statements by terms such as "may," "might," "could," "will," "should," "expect,"
"plan," "intend," "forecast," "anticipate," "believe," "estimate," "predict,"
"foreseeable," "potential," "continue" or the negative of these terms or other
comparable terminology. The forward-looking statements contained in this
prospectus involve known and unknown risks, uncertainties and other factors that
may cause our or our industry's actual results, level of activity, performance
or achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by these statements.
These factors include, among others, those listed under "Risk Factors" and
elsewhere in this prospectus.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. You should not place undue reliance on
these forward-looking statements.
20
<PAGE>
USE OF PROCEEDS
We estimate that our net proceeds from the sale of the 3,875,000 shares of
common stock that we are offering will be approximately $49.7 million, after
deducting the underwriting discounts and commissions and estimated offering
expenses. If the underwriters' over-allotment option is exercised in full, we
estimate that our net proceeds will be approximately $57.5 million. We will not
receive any proceeds from the sale of shares of common stock by Umang Gupta, our
chief executive officer.
The principal purposes of this offering are to obtain additional capital, to
create a public market for our common stock and to facilitate future access to
public equity markets. We intend to use the proceeds for working capital,
capital expenditures and other general corporate purposes. In addition, we may
use a portion of the net proceeds from this offering to acquire or invest in
businesses, technologies or products that are complementary to our business. We
currently have no commitments or agreements with respect to any acquisitions.
Pending our use of the net proceeds, we intend to invest them in short-term,
interest-bearing, investment-grade securities.
DIVIDEND POLICY
We have never declared or paid any cash dividends on our capital stock and
do not anticipate paying any cash dividends in the foreseeable future. In
addition, the terms of our loan agreements prevent us from paying cash
dividends.
21
<PAGE>
CAPITALIZATION
The following table sets forth our capitalization as of June 30, 1999. The
pro forma information reflects the conversion of all outstanding shares of
preferred stock into shares of common stock upon the closing of this offering.
It also reflects the exercise of a warrant to purchase 265,000 shares of our
common stock by Umang Gupta, our chief executive officer, prior to the closing
of this offering at an exercise price of $1.30 per share. The pro forma as
adjusted information reflects the sale of the 3,875,000 shares of common stock
that we are offering after deducting underwriting discounts and commissions and
our estimated offering expenses.
<TABLE>
<CAPTION>
AS OF JUNE 30, 1999
---------------------------------
PRO
ACTUAL FORMA AS ADJUSTED
--------- --------- -----------
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C>
Notes payable, less current portion............................................ $ 2,853 $ 2,853 $ 2,853
--------- --------- -----------
Redeemable convertible preferred stock, $0.001 par value; 50,000,000 shares
authorized, 12,588,898 shares issued and outstanding, actual; 50,000,000
shares authorized, no shares issued and outstanding, pro forma and as
adjusted..................................................................... 23,381 -- --
Shareholders' equity (deficit):
Preferred stock, $0.001 par value; no shares authorized, issued or
outstanding, actual and pro forma; 5,000,000 shares authorized, no shares
issued and outstanding, as adjusted......................................... -- -- --
Common stock, $0.001 par value; 50,000,000 shares authorized, 6,059,769
shares issued and outstanding, actual; 50,000,000 shares authorized,
18,913,667 shares issued and outstanding, pro forma; 50,000,000 shares
authorized, 22,788,667 shares issued and outstanding, as adjusted........... 6 19 23
Additional paid-in capital................................................... 3,920 27,633 77,332
Deferred stock-based compensation............................................ (906) (906) (906)
Notes receivable from shareholders........................................... (403) (403) (403)
Accumulated deficit.......................................................... (9,237) (9,237) (9,237)
--------- --------- -----------
Total shareholders' equity (deficit)....................................... (6,620) 17,106 66,809
--------- --------- -----------
Total capitalization..................................................... $ 19,614 $ 19,959 $ 69,662
--------- --------- -----------
--------- --------- -----------
</TABLE>
The share numbers above exclude:
- 1,067,437 shares issuable upon the exercise of outstanding stock options
as of June 30, 1999, at a weighted average exercise price of $3.20 per
share;
- 410,379 shares available as of June 30, 1999, for future grant under our
current stock plans described in this prospectus; and
- 378,478 shares issuable upon the exercise of warrants outstanding as of
June 30, 1999, at a weighted average exercise price of $1.10 per share.
You should read this table together with "Management--Director
Compensation," "Management-- Employee Benefit Plans," "Description of Capital
Stock" and notes 5, 6, 7 and 8 of the notes to our financial statements.
22
<PAGE>
DILUTION
Our pro forma net tangible book value as of June 30, 1999 was $17.1 million
or $0.90 per share, assuming the conversion of all outstanding shares of
preferred stock into shares of common stock and the exercise of a warrant to
purchase 265,000 shares of our common stock by Umang Gupta, our chief executive
officer, prior to the closing of this offering at an exercise price of $1.30 per
share. Pro forma net tangible book value per share is determined by dividing the
pro forma number of outstanding shares of common stock into our net tangible
book value, which is our total tangible assets less total liabilities. After
giving effect to the receipt of the estimated net proceeds from this offering,
after deducting the underwriting discounts and commissions and estimated
offering expenses, our pro forma net tangible book value as of June 30, 1999
would have been approximately $66.8 million, or $2.93 per share. This represents
an immediate increase in pro forma net tangible book value of $2.03 per share to
existing shareholders and an immediate dilution of $11.07 per share to new
investors purchasing shares at the initial public offering price. The following
table illustrates the per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share.............................. $ 14.00
Pro forma net tangible book value per share as of June 30, 1999.... $ 0.90
Increase per share attributable to new investors................... 2.03
---------
Pro forma net tangible book value per share after offering........... 2.93
---------
Dilution per share to new investors.................................. $ 11.07
---------
---------
</TABLE>
The following table summarizes as of June 30, 1999, on the pro forma basis
described above, the number of shares of common stock purchased from us, the
total consideration paid and the average price per share paid by existing
shareholders and by investors purchasing shares of common stock in this
offering, before deducting the underwriting discounts and commissions and
estimated offering expenses:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION AVERAGE
------------------------- -------------------------- PRICE PER
NUMBER PERCENT AMOUNT PERCENT SHARE
------------ ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Existing shareholders................................. 18,913,667 83.0% $ 26,497,000 32.8% $ 1.40
New investors......................................... 3,875,000 17.0 54,250,000 67.2 14.00
------------ ----- ------------- -----
Total................................................. 22,788,667 100% $ 80,747,000 100%
------------ ----- ------------- -----
------------ ----- ------------- -----
</TABLE>
The sale of 125,000 shares by Mr. Gupta in this offering will reduce the
number of shares held by existing shareholders to 18,788,667 shares, or 82.4% of
the total number of shares of common stock to be outstanding after this
offering, and will increase the number of shares held by new investors to
4,000,000 shares, or 17.6% of the total number of shares of common stock to be
outstanding after this offering.
As of June 30, 1999, there were options and warrants outstanding to purchase
a total of 1,445,915 shares of common stock. To the extent that any of these
options or warrants are exercised, there will be further dilution to new public
investors. See "Capitalization," "Management--Employee Benefit Plans,"
"Description of Capital Stock" and notes 5, 6 and 8 to our financial statements.
23
<PAGE>
SELECTED FINANCIAL DATA
The tables that follow present portions of our financial statements and are
not complete. You should read the following selected financial data together
with our financial statements and related notes to our financial statements and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations." The selected statement of operations data for the years ended
September 30, 1996, 1997 and 1998 and for the nine months ended June 30, 1999
and the balance sheet data as of September 30, 1997 and 1998 and June 30, 1999
are derived from our financial statements that have been audited by KPMG LLP,
independent certified public accountants, included elsewhere in this prospectus.
The statement of operations data for the period from June 15, 1995 (inception)
to September 30, 1995 and the balance sheet data as of September 30, 1995 and
1996 are derived from audited financial statements that are not included in this
prospectus. The statement of operations data for the nine months ended June 30,
1998 is derived from our unaudited financial statements included elsewhere in
this prospectus and include, in the opinion of management, all adjustments,
consisting only of normal recurring adjustments, that we consider necessary for
the fair presentation of our financial position and results of operations for
those periods. The historical results presented below are not necessarily
indicative of the results to be expected for any future fiscal period. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
<TABLE>
<CAPTION>
PERIOD FROM
JUNE 15, 1995 NINE MONTHS ENDED
(INCEPTION) TO YEARS ENDED SEPTEMBER 30, JUNE 30,
SEPTEMBER 30, ------------------------------- --------------------
1995 1996 1997 1998 1998 1999
--------------- --------- --------- --------- --------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Subscription services............................ $ -- $ -- $ 81 $ 1,539 $ 948 $ 4,026
Consulting services.............................. 28 30 -- -- -- 83
----- --------- --------- --------- --------- ---------
Total revenues................................. 28 30 81 1,539 948 4,109
----- --------- --------- --------- --------- ---------
Expenses:
Cost of subscription services.................... -- -- 209 580 330 975
Cost of consulting services...................... -- -- -- -- -- 254
Research and development......................... -- 392 732 1,226 838 1,297
Sales and marketing.............................. -- 186 817 1,529 931 2,989
Operations....................................... -- -- 63 514 292 1,024
General and administrative....................... 16 80 278 647 459 849
Amortization of stock-based compensation......... -- -- -- -- -- 234
----- --------- --------- --------- --------- ---------
Total expenses................................. 16 658 2,099 4,496 2,850 7,622
----- --------- --------- --------- --------- ---------
Income (loss) from operations.................. 12 (628) (2,018) (2,957) (1,902) (3,513)
Interest income (expense), net..................... (1) 6 (31) 39 24 (146)
----- --------- --------- --------- --------- ---------
Net income (loss).............................. $ 11 $ (622) $ (2,049) $ (2,918) $ (1,878) $ (3,659)
----- --------- --------- --------- --------- ---------
----- --------- --------- --------- --------- ---------
Net income (loss) per share:
Basic and diluted................................ $ 0.03 $ (0.23) $ (0.84) $ (1.10) $ (0.72) $ (0.91)
----- --------- --------- --------- --------- ---------
----- --------- --------- --------- --------- ---------
Pro forma net loss per share..................... (0.28) (0.26)
--------- ---------
--------- ---------
Weighted average shares--basic and diluted....... 322 2,733 2,434 2,661 2,594 4,032
----- --------- --------- --------- --------- ---------
----- --------- --------- --------- --------- ---------
Pro forma weighted average shares--basic and
diluted......................................... 10,376 14,133
--------- ---------
--------- ---------
</TABLE>
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30,
------------------------------------------ AS OF JUNE
1995 1996 1997 1998 30, 1999
--------- --------- --------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Cash and cash equivalents......................................... $ 10 $ 545 $ 1,150 $ 2,293 $ 17,152
Working capital................................................... 22 551 1,007 2,164 16,698
Total assets...................................................... 39 711 1,670 3,918 22,862
Notes payable, less current portion............................... -- -- 199 303 2,853
Redeemable convertible preferred stock............................ -- 1,262 3,828 8,529 23,381
Total shareholders' equity (deficit).............................. 35 (567) (2,588) (5,552) (6,620)
</TABLE>
24
<PAGE>
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
YOU SHOULD READ THE FOLLOWING MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS TOGETHER WITH THE FINANCIAL
STATEMENTS AND RELATED NOTES INCLUDED ELSEWHERE IN THIS PROSPECTUS. THIS
DISCUSSION CONTAINS FORWARD-LOOKING STATEMENTS THAT INVOLVE RISKS AND
UNCERTAINTIES. OUR ACTUAL RESULTS COULD DIFFER MATERIALLY FROM THOSE ANTICIPATED
IN THESE FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS, INCLUDING
THOSE SET FORTH UNDER "RISK FACTORS" AND ELSEWHERE IN THIS PROSPECTUS.
OVERVIEW
Keynote was founded in June 1995 to measure Internet performance and to
market and sell the information derived from our measurement results. In April
1997, we began to sell Keynote PERSPECTIVE, a service that measures the
performance and availability of web file downloads. In September 1997, we
released and updated all existing customers to a new version of Keynote
PERSPECTIVE, which allowed our customers to view the performance data online
without installing any software. Our next release of Keynote PERSPECTIVE, in
July 1998, allowed our customers to download and analyze the performance of
entire web pages, including text and graphics. Our most recent release of
Keynote PERSPECTIVE, in April 1999, included our TRANSACTION feature, which
measures the time it takes to execute an interactive transaction that involves
the display of multiple web pages, such as placing an online stock trade order.
In July 1999, we introduced our Keynote LIFELINE service. In January 1999, we
began offering consulting services, which are designed to assist our customers
in evaluating, interpreting and improving their performance measurement and
diagnostic results.
We sell our services primarily through our telesales organization located in
San Mateo, California. We also market our services through our web site. We
derive revenues from direct sales to customers as well as from web-hosting and
Internet service providers, who, in addition to using our service as a
diagnostic tool in their own operations, also sell or bundle our services to
part of their customer base as a value-added service to these customers. We have
begun to market our products through, VeriSign and Network Solutions, which are
companies that provide services complementary to ours.
We derive and expect to continue to derive all of our subscription revenues
from the sale of our Internet performance measurement, consulting and diagnostic
services. Keynote PERSPECTIVE is a subscription-based service which our
customers purchase for an initial three-month term and then may renew their
subscription on a month-to-month basis. Subscription fees vary based on the
number of web-site addresses measured, the number of measurement locations, the
frequency of the measurements, the additional features ordered and the amount of
consulting services. Although consulting revenues have not been significant to
date, we believe that consulting revenues may become more important in the
future as we pursue additional consulting opportunities. Our international
revenues to date have not been significant.
We recognize revenues ratably as services are performed. We typically
invoice our customers monthly in advance for our services. Any unearned revenue
is recorded as deferred revenue on our balance sheet. As of June 30, 1999, we
had recorded $935,000 of deferred revenue. Revenues from our consulting services
are recognized as the services are performed; a typical project lasts one month.
For longer consulting projects, we anticipate recognizing revenue on a
percentage-of-completion basis.
Our business has grown since inception, with total revenues of $30,000 for
the fiscal year ended September 30, 1996, $81,000 for the fiscal year ended
September 30, 1997, $1.5 million for the fiscal year ended September 30, 1998
and $4.1 million for the nine months ended June 30, 1999. We incurred net losses
of $622,000 for the fiscal year ended September 30, 1996, $2.0 million for the
fiscal year ended September 30, 1997, $2.9 million for the fiscal year ended
September 30, 1998 and $3.7 million for the nine months ended June 30, 1999. We
expect to incur significant losses in the future.
25
<PAGE>
RESULTS OF OPERATIONS
NINE MONTHS ENDED JUNE 30, 1998 AND 1999
REVENUES
Our revenues were $948,000 for the nine months ended June 30, 1998 and $4.1
million for the nine months ended June 30, 1999, representing an increase of
$3.2 million, or 338%. Subscription services represented 100% of total revenues
for the nine months ended June 30, 1998 and 98% of total revenues for the nine
months ended June 30, 1999. The increase in total revenues was attributable to
the increase in both the number of customers and the revenue per customer. For
the nine months ended June 30, 1998, one customer, Digex, accounted for
approximately 18% of total revenues. For the nine months ended June 30, 1999, no
single customer accounted for more than 10% of total revenues.
EXPENSES
COST OF SUBSCRIPTION SERVICES. Cost of subscription services consists of
connection fees to Internet service providers for deployment of our measurement
computers around the world and depreciation, maintenance and other equipment
charges for our measurement infrastructure. Our cost of subscription services
was $330,000 for the nine months ended June 30, 1998 and $975,000 for the nine
months ended June 30, 1999, representing an increase of $645,000, or 195%. This
increase was primarily due to the greater number of measurement computers
deployed, resulting in higher connection fees and more depreciation and
equipment charges. Cost of subscription services was 35% of subscription
services for the nine months ended June 30, 1998 and 24% of subscription
services for the nine months ended June 30, 1999.
COST OF CONSULTING SERVICES. Cost of consulting services consists of
compensation expenses for consulting personnel and related costs. Our cost of
consulting services was $0 for the nine months ended June 30, 1998 and $254,000
for the nine months ended June 30, 1999. Cost of consulting services exceeded
consulting services revenue for the nine months ended June 30, 1999 because our
consulting division was formed in January 1999. We expect that the cost of
consulting services as a percentage of consulting-services revenue will be
greater than the cost of subscription services as a percentage of subscription
services revenues.
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of compensation and related costs for research and development
personnel and outside contractors. Our research and development expenses were
$838,000 for the nine months ended June 30, 1998 and $1.3 million for the nine
months ended June 30, 1999, representing an increase of $462,000, or 55%. This
increase was primarily related to the increase in software engineers, project
management and quality assurance personnel and outside consultants. To date, all
research and development expenses have been expensed as incurred. We believe
that a significant increase in our research and development investment is
essential for us to maintain our market position and to continue to enhance and
expand our services. Accordingly, we anticipate research and development
expenses are likely to increase in the foreseeable future.
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 were $931,000 for the nine months ended June 30, 1998 and
$3.0 million for the nine months ended June 30, 1999, representing an increase
of $2.1 million or 226%. This increase reflects our investment in additional
personnel in our sales and marketing organization and marketing programs. It
also includes salaries and referral fees to recruit and hire sales management,
sales representatives and sales engineers. We believe that a significant
increase in our sales and marketing efforts is essential for us to maintain our
market position and to further increase acceptance of our services. Accordingly,
we anticipate sales and marketing expenses will increase in the foreseeable
future.
26
<PAGE>
OPERATIONS. Operations expenses consist primarily of compensation and
related costs for management personnel, technical support employees and
consultants who manage and maintain our measurement and headquarters
infrastructure and support our customers. Our operations personnel also work
closely with other departments to assure the reliability of our services and to
support our sales and marketing activities. Operations expenses were $292,000
for the nine months ended June 30, 1998 and $1.0 million for the nine months
ended June 30, 1999, representing an increase of $708,000, or 242%. This
increase was primarily related to the hiring of personnel to manage and support
our growing customer base. We believe that continued investment is necessary to
support our ability to successfully develop, deploy and operate our growing
Internet measurement infrastructure, as well as to successfully support our
customer base. Accordingly, we anticipate that operations costs will increase in
the foreseeable future.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of salaries and related expenses, accounting, legal and administrative
expenses, professional service fees and other general corporate expenses. Our
general and administrative expenses were $459,000 for the nine months ended June
30, 1998 and $849,000 for the nine months ended June 30, 1999, representing an
increase of $390,000, or 85%. This increase was primarily related to hiring
additional employees to support the growth of our business and to an increase in
outside contractors expense.
AMORTIZATION OF STOCK-BASED COMPENSATION. Some options granted during the
fiscal year ending September 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 have recorded in general and administrative, expenses of $153,000 for the
nine months ended June 30, 1999 relating to the amortization of deferred
compensation expense and had an aggregate of $906,000 of deferred compensation
remaining to be amortized as of that date. Deferred compensation is amortized on
a straight-line basis over the vesting period of the options. We expect
amortization of approximately $66,000 in the three months ending September 30,
1999, and $265,000 in fiscal 2000, $265,000 in fiscal 2001, $265,000 in fiscal
2002 and $45,000 in fiscal 2003. In addition, we recorded a compensation charge
of $81,000 during the nine months ended June 30, 1999 as a result of our
granting of approximately 85,000 performance-based stock options to various
employees.
We believe that our general and administrative expenses will continue to
increase in absolute dollars as a result of the continued expansion of our
administrative staff and expenses associated with being a public company,
including annual and other public reporting costs, directors' and officers'
liability insurance and investor relations programs.
INTEREST INCOME (EXPENSE), NET
Net interest income (expense) was $24,000 for the nine months ended June 30,
1998 and $(146,000) for the nine months ended March 31, 1999, representing a
decrease of $170,000. This decrease was primarily due to higher interest expense
related to obligations under equipment loans and notes payable, partially offset
by higher interest income from cash and cash equivalents.
PROVISION FOR INCOME TAXES
No provision for federal and state income taxes has been recorded because we
have experienced net losses since inception which has resulted in deferred tax
assets. In light of our recent history of operating losses, we have provided a
valuation allowance for all of our deferred tax assets as we are presently
unable to conclude that it is more likely than not that the deferred tax asset
will be realized.
As of June 30, 1999, we had net operating loss carryforwards for federal
income tax reporting purposes of approximately $8,193,000 available to reduce
future income subject to income taxes. As of June 30, 1999, we had net operating
loss carryforwards for state income tax purposes of approximately $4,941,000
available to reduce future income subject to income taxes. The federal net
operating loss carryforwards expire in various periods through 2019. State net
loss carryforwards expire in various periods through 2004. In
27
<PAGE>
addition, as of June 30, 1999, we had federal research and development tax
credit carryforwards of approximately $148,000. The federal credit carryforwards
expire in various periods through 2019. As of June 30, 1999, we had California
research and development tax credit carryforwards of approximately $110,000. The
California credit may be carried over indefinitely. The U.S. Tax Reform Act of
1986 contains provisions that limit the net operating loss carryforwards and
research and development credits available to be used in any given year upon the
occurrence of certain events, including a significant change to ownership.
FISCAL YEARS ENDED SEPTEMBER 30, 1996, 1997 AND 1998
REVENUES
Revenues were $30,000 in fiscal 1996, $81,000 in fiscal 1997 and $1.5
million in fiscal 1998, representing increases of $51,000, or 170%, from fiscal
1996 to fiscal 1997 and $1.4 million from fiscal 1997 to fiscal 1998. One
customer, MCI, accounted for 11% of total revenues for fiscal 1997, and one
customer, Digex, accounted for 15% of total revenues for fiscal 1998. For fiscal
1996, no single customer accounted for more than 10% of total revenues.
Revenues for fiscal 1996 consisted of consulting revenue from a consulting
project. Commercial release of our measurement services commenced in May 1997.
The increase in revenues from fiscal 1997 to fiscal 1998 primarily reflects our
increased customer base and the commercial acceptance of our Internet
measurement services.
EXPENSES
COST OF SUBSCRIPTION SERVICES. Cost of subscription services was $0 in
fiscal 1996, $209,000 in fiscal 1997 and $580,000 in fiscal 1998, representing
increases of $209,000, from fiscal 1996 to fiscal 1997 and $371,000, or 178%,
from fiscal 1997 to fiscal 1998. The increases from fiscal 1996 to fiscal 1998
resulted from the payment of connection fees to Internet service providers for
our measurement computers around the world and depreciation, maintenance and
other equipment charges for our measurement infrastructure. As a percentage of
subscription services revenues, cost of subscription services was 258% in fiscal
1997 and 38% in fiscal 1998.
COST OF CONSULTING SERVICES. Cost of consulting services was $0 in fiscal
1996, 1997 and 1998. Our consulting division was formed in January 1999.
RESEARCH AND DEVELOPMENT. Research and development expenses were $392,000
in fiscal 1996, $732,000 in fiscal 1997 and $1.2 million in fiscal 1998,
representing increases of $340,000, or 87%, from fiscal 1996 to fiscal 1997 and
$468,000, or 64% from fiscal 1997 to fiscal 1998. The increases from fiscal 1996
through fiscal 1998 were primarily related to the increase in the number of
software engineers, project management and quality assurance personnel and
outside contractors to support our development and testing activities.
SALES AND MARKETING. Sales and marketing expenses were $186,000 in fiscal
1996, $817,000 in fiscal 1997 and $1.5 million in fiscal 1998, representing
increases of $631,000 or 339%, from fiscal 1996 to fiscal 1997 and $683,000, or
84%, from fiscal 1997 to fiscal 1998. The increases from fiscal 1996 through
fiscal 1998 reflected the addition of personnel in our sales and marketing
organizations, as well as costs associated with increased selling efforts to
develop market awareness of our services.
OPERATIONS. Operations expenses were $0 in fiscal 1996, $63,000 in fiscal
1997 and $514,000 in fiscal 1998, representing increases of $451,000 or 716%
from fiscal 1997 to fiscal 1998. The increases from fiscal 1996 through fiscal
1998 were primarily related to the increase in the number of personnel to manage
and support our growing customer base.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were
$80,000 in fiscal 1996, $278,000 in fiscal 1997 and $647,000 in fiscal 1998,
representing increases of $198,000, or 248%, from
28
<PAGE>
fiscal 1996 to fiscal 1997 and $369,000, or 133%, from fiscal 1997 to fiscal
1998. The increases from fiscal 1996 through fiscal 1998 were primarily the
result of increased compensation and related employee expenses for additional
finance and administrative personnel to support the growth of our business
during these periods.
INTEREST INCOME (EXPENSE), NET
Net interest income (expense) was $6,000 in fiscal 1996, $(31,000) in fiscal
1997 and $39,000 in fiscal 1998, reflecting interest earned on cash in
interest-bearing accounts during the respective periods in fiscal 1996 and 1998.
The interest expense in fiscal 1997 was related to obligations under equipment
loans and notes payable.
PROVISION FOR INCOME TAXES
No provision for federal and state income taxes has been recorded because we
have experienced net losses since inception which has resulted in deferred tax
assets. In light of our recent history of operating losses, we have provided a
valuation allowance for all of our deferred tax assets as we are presently
unable to conclude that it is more likely than not that the deferred tax asset
will be realized.
29
<PAGE>
QUARTERLY RESULTS OF OPERATIONS
The following table sets forth unaudited statement of operations data for
the eight quarters ended June 30, 1999. The data have been derived from
unaudited condensed financial statements not included in this prospectus that
have been prepared on the same basis as the audited financial statements and, in
the opinion of our management, include all adjustments, consisting of normal
recurring adjustments, necessary for a fair presentation of the information when
read in conjunction with the audited financial statements and related notes.
These operating results are not necessarily indicative of results of any future
period.
<TABLE>
<CAPTION>
QUARTER ENDED
-------------------------------------------------------------------------------
SEPT. DEC. 31, MARCH 31, JUNE 30, SEPT. DEC. 31, MARCH JUNE 30,
30, 1997 1997 1998 1998 30, 1998 1998 31, 1999 1999
-------- -------- --------- -------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Revenues:
Subscription services............ $ 65 $ 208 $ 337 $ 403 $ 591 $ 889 $ 1,275 1,862
Consulting services.............. -- -- -- -- -- -- 26 57
-------- -------- --------- -------- -------- -------- -------- --------
Total revenues................. 65 208 337 403 591 889 1,301 1,919
-------- -------- --------- -------- -------- -------- -------- --------
Expenses:
Cost of subscription services.... 72 86 89 155 250 168 285 522
Cost of consulting services...... -- -- -- -- -- -- 87 167
Research and development......... 189 262 237 339 388 325 338 634
Sales and marketing.............. 226 292 285 354 598 627 936 1,426
Operations....................... 38 41 80 171 222 229 320 475
General and administrative....... 100 154 154 151 188 254 189 406
Amortization of stock-based
compensation.................... -- -- -- -- -- 23 123 88
-------- -------- --------- -------- -------- -------- -------- --------
Total expenses................. 625 835 845 1,170 1,646 1,626 2,278 3,718
-------- -------- --------- -------- -------- -------- -------- --------
Loss from operations........... (560) (627) (508) (767) (1,055) (737) (977) (1,799)
Interest income (expense), net..... (8) (7) (1) 32 15 (61) (88) 3
-------- -------- --------- -------- -------- -------- -------- --------
Net loss....................... $ (568) $ (634) $ (509) $ (735) $(1,040) $ (798) $(1,065) $(1,796)
-------- -------- --------- -------- -------- -------- -------- --------
-------- -------- --------- -------- -------- -------- -------- --------
AS A PERCENTAGE OF TOTAL REVENUES:
Revenues:
Subscription services............ 100% 100% 100% 100% 100% 100% 98% 97%
Consulting services.............. -- -- -- -- -- -- 2 3
-------- -------- --------- -------- -------- -------- -------- --------
Total revenues................. 100 100 100 100 100 100 100 100
-------- -------- --------- -------- -------- -------- -------- --------
Expenses:
Cost of subscription services.... 111 41 26 38 42 19 22 27
Cost of consulting services...... -- -- -- -- -- -- 7 9
Research and development......... 291 126 70 84 66 37 26 33
Sales and marketing.............. 348 140 85 88 101 70 72 74
Operations....................... 58 20 24 42 38 26 25 25
General and administrative....... 154 74 46 38 32 29 15 21
Amortization of stock-based
compensation.................... -- -- -- -- -- 3 9 5
-------- -------- --------- -------- -------- -------- -------- --------
Total expenses................. 962 401 251 290 279 183 176 194
-------- -------- --------- -------- -------- -------- -------- --------
Loss from operations........... (862) (301) (151) (190) (179) (83) (75) (94)
Interest income (expense), net..... (12) (3) (0) 8 3 (7) (7) (0)
-------- -------- --------- -------- -------- -------- -------- --------
Net loss....................... (874)% (305)% (151)% (182)% (176)% (90)% (82)% (94)%
-------- -------- --------- -------- -------- -------- -------- --------
-------- -------- --------- -------- -------- -------- -------- --------
</TABLE>
30
<PAGE>
During the eight quarters ended June 30, 1999, our subscription revenues
consistently grew as a result of increased demand for Internet performance
measurement and diagnostic services. In addition, beginning in the first quarter
of fiscal 1999, we created a new consulting services organization to help
customers to maximize the value of the information they receive to improve their
web-site performance.
The trends discussed in the annual comparisons of operating results from
fiscal 1996 to fiscal 1998 apply generally to the comparison of results of
operations for the eight quarters ended June 30, 1999. In general, expenses
increased significantly as a result of:
- increased personnel;
- increased depreciation and other equipment costs for our expanding
measurement computers infrastructure;
- increased spending for marketing and promotional activities;
- higher recruiting and related hiring expenses for additional senior
management and other personnel;
- increased co-location fees for our measurement computers; and
- increased use of independent contractors and other outside services for
continued research and development activities.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have funded our operations primarily through private
placements of our common stock and convertible redeemable preferred stock with
strategic investors, venture capital firms and private investors. We have raised
approximately $25.8 million, net of offering costs, from the sale of common
stock and preferred stock. In addition, we financed our operations through
subordinated and other debt, equipment loans and a capital lease. The principal
balance outstanding at June 30, 1999 for these loans and leases was
approximately $4.4 million. At June 30, 1999, we had approximately $17.2 million
in cash and cash equivalents.
Net cash used in operating activities was $591,000 in fiscal 1996, $1.8
million in fiscal 1997, $2.7 million in fiscal 1998, $1.8 million in the nine
months ended June 30, 1998 and $4.1 million in the nine months ended June 30,
1999. For all of these periods, net cash used in operating activities was
primarily the result of net operating losses and changes in accounts receivable
and prepaid expenses, partially offset by changes in deferred revenues and
depreciation of property and equipment.
Since inception, our investing activities have been purchases of property
and equipment. Capital expenditures totaled $157,000 in fiscal 1996, $423,000 in
fiscal 1997 and $1.0 million in fiscal 1998, and $718,000 for the nine months
ended June 30, 1998 and $1.7 million for the nine months ended June 30, 1999.
Our financing activities provided $1.3 million in fiscal 1996, $2.9 million
in fiscal 1997 and $4.9 million in fiscal 1998, and $4.9 million in the nine
months ended June 30, 1998 and $20.6 million in the nine months ended June 30,
1999. In fiscal 1996, the $1.3 million consisted of the net proceeds received in
connection with the private placement of our Series A redeemable convertible
preferred stock. In fiscal 1997, we sold $2.6 million of our Series B redeemable
convertible preferred stock, which amount included $900,000 in principal amount
of bridge loans from earlier that year. In addition, we received approximately
$300,000 from our equipment loans. In fiscal 1998 and the nine months ended June
30, 1998, we received $4.7 million in net proceeds in connection with the sale
of our Series C redeemable convertible preferred stock. During the nine months
ended June 30, 1999, we received $17.2 million in net proceeds in connection
with the sale of stock. Of these proceeds, we received $14.8 million from the
sale of Series D redeemable convertible preferred stock and $877,000 from the
sale of common stock. The balance of these proceeds was due to option and
warrant exercises. In addition, we received $3.6 million in proceeds from
equipment and other loans which was slightly offset by $227,000 in loan
repayments.
31
<PAGE>
As of June 30, 1999, our principal commitments consisted of $4.4 million in
loans and capital leases. We have granted a security interest in substantially
all of our assets to secure these loans. The interest rate on our loans in the
form of equipment notes ranged from 5.60% to 10.25% per year and the interest
rate on the loans in the form of a promissory note bore interest at a rate of
8.25% per year. As of June 30, 1999, we also had commitments of $1.0 million in
future lease payments for our headquarters facility. We had no material
commitments for capital expenditures as of June 30, 1999. Because we expect to
increase the number of our measurement computers and increase their measurement
capacity over the remainder of fiscal 1999, we expect that we will make
additional capital expenditures to purchase this equipment. We anticipate that
we will also experience an increase in our capital expenditures and lease
commitments consistent with our anticipated growth in operations, infrastructure
and personnel.
We believe the net proceeds of this offering, together with 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.
After that time, if cash generated from operations is insufficient to satisfy
our liquidity requirements, we may seek to sell additional equity or debt
securities or to obtain a credit facility. If additional funds are raised
through the issuance of debt securities, these securities could have rights,
preferences and privileges senior to holders of common stock, and the term of
this debt could impose restrictions on our operations. The sale of additional
equity or convertible debt securities could result in additional dilution to our
shareholders, 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.
YEAR 2000 COMPLIANCE
BACKGROUND OF YEAR 2000 ISSUES
Many currently installed computer systems and software products are unable
to distinguish between twentieth-century dates and twenty-first century dates
because these systems were developed using two digits rather than four to
determine the applicable year. For example, computer programs that have
date-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This error could result in system failures or
miscalculations causing disruptions of operations, including, among other
things, a temporary inability to process transactions, send invoices or engage
in similar normal business activities. As a result, many companies' software and
computer systems may need to be upgraded or replaced to comply with these year
2000 requirements.
STATE OF READINESS
Our business depends on the operation of many systems that could potentially
be affected by year 2000-related problems. Those systems include, among others:
- hardware and software systems used by us to deliver services to customers,
including our proprietary software systems as well as software supplied by
other companies;
- communications networks such as the Internet and private Intranets;
- the internal systems of our customers and suppliers;
- the hardware and software systems used internally by us in the management
of our business; and
- non-information technology systems and services, such as power, telephone
systems and building systems.
32
<PAGE>
Representatives of the research and development, operations and
administrative departments have been charged with the responsibility of
formulating and implementing our year 2000 readiness and have completed a phased
approach to analyzing our operations and relationships as they relate to the
year 2000 problem. The phases of our year 2000 program are as follows:
- assignment of responsibility for external issues, such as products
licensed by us from third parties, internal issues, such as systems,
facilities, equipment and software;
- inventory of our operations and relationships subject to the year 2000
problem;
- comprehensive analysis, including impact analysis and cost analysis, of
our year 2000 readiness; and
- remediation and testing.
Our services rely on a combination of our proprietary software and
commercial software distributed by vendors such as Microsoft, Oracle and Sun
Microsystems. We tested our service infrastructure in September 1998 and August
1999 and found no unremediated year 2000-related problems. The service
infrastructure consists of software needed to provide service, measure
performance, store measurement data and report results. All the dates and the
date datatype used in these systems are year 2000 compliant.
Since our customers do not download any of our software on their computer
systems, we believe that our services should not create additional year 2000
problems for our customers' computer systems.
We have reviewed our important internal management information, software and
other systems in order to identify any products, services or systems that are
not year 2000 compliant. We have received written year 2000 representations from
all significant vendors and third parties. Nineteen vendors represented that
their products are year 2000 compliant; one is still testing and has indicated
that it will certify compliance before the end of 1999. We have not contacted
our web hosting and backbone providers, such as Digex, UUNET and Cable &
Wireless, which provide Internet connectivity to our remote measurement
computers.
To date, we have not encountered any material year 2000 problems with our
computer systems or any other equipment that might be subject to these problems.
We have not incurred material costs in connection with our year 2000 efforts to
date and do not expect to do so in the future, other than diversion of employee
time from other projects.
We could also experience serious harm to our business if we fail to identify
all year 2000 dependencies in our systems and in the systems of our suppliers,
customers and financial institutions. We cannot assure you that the total cost
of year 2000 compliance will not be material to our business. We may not
identify and remediate all significant year 2000 problems on a timely basis,
remediation efforts may involve significant time and expense, and unremediated
problems may seriously harm our business.
RISKS
Extended power outages or widespread failures across the Internet would
create disruptions that would take time to repair. The amount of time required
for repairs would depend on the severity of the power outages or widespread
failures.
Users of our services generally rely on sophisticated hardware and complex
software products used by our customers which may not be year 2000 compliant.
Success of our year 2000 compliance efforts may depend on the success of our
customers in dealing with their year 2000 issues. We sell our services to
companies in a variety of industries, each of which may be experiencing
different year 2000 compliance issues. Customer difficulties with year 2000
issues might require us to devote additional resources to resolve underlying
problems.
Although we have not been a party to any litigation or arbitration
proceeding to date about our services and year 2000 compliance issues, we cannot
assure you that we will not in the future be required to defend our services in
these proceedings, or to negotiate resolutions of claims based on year 2000
issues. The costs
33
<PAGE>
of defending and resolving year 2000-related disputes, regardless of the merits
of these disputes, and any liability for year 2000-related damages, including
consequential damages, would seriously harm our business, results of operations
and financial condition. In addition, we believe that purchasing patterns of
customers and potential customers may be affected by year 2000 issues as
companies expend significant resources to correct or upgrade their current
software systems for year 2000 compliance or defer additional software purchases
until after 2000. As a result, some customers and potential customers may have
more-limited budgets available to purchase services such as those offered by us,
and others may choose to refrain from changes in their information technology
environment until after 2000. To the extent year 2000 issues cause significant
delay in, or cancellation of, decisions to purchase our services, our business
would be seriously harmed.
If we experience year 2000 issues with our services or network
infrastructure, we could be unable to perform measurements or analyze and
deliver data to our customers. This could result in loss of customers and
revenues as well as the potential for litigation. This could also require us to
devote significant resources to remediating our services or network
infrastructure, which would divert our personnel from other important business
activities. If we experience year 2000 issues with respect to our other systems,
we could be unable to process orders or bill our customers. It could also
require us to devote significant resources to correct problems with these
systems.
CONTINGENCY PLAN
We have acquired connections with additional Internet service providers in
the event that our primary Internet service provider fails. We are in the
process of developing a formal year 2000 contingency plan for the remainder of
our business, which we expect to complete by September 1999.
QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKS
INTEREST RATE SENSITIVITY. Our interest income and expense could be
sensitive to changes in the general level of U.S. interest rates, particularly
because most of our cash equivalents are invested in short-term debt
instruments. If market interest rates were to change immediately and uniformly
by ten percent from levels at June 30, 1999, the fair value of our cash
equivalents and the interest earned on those cash equivalents would change by an
insignificant amount.
FOREIGN CURRENCY FLUCTUATIONS. We have not had any significant transactions
in foreign currencies, nor do we have any significant balances that are due or
payable in foreign currencies at June 30, 1999.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards, or SFAS, No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 133 establishes accounting and
reporting standards for derivative financial instruments and hedging activities
related to those instruments, as well as other hedging activities. Because we do
not currently hold any derivative instruments and do not engage in hedging
activities, we expect that the adoption of SFAS No. 133 will not have a material
impact on our financial position, results of operations or cash flows. We will
be required to adopt SFAS No. 133 in fiscal 2001.
34
<PAGE>
BUSINESS
OVERVIEW
Keynote provides Internet performance measurement and diagnostic services to
companies that operate e-commerce web sites. We market Keynote PERSPECTIVE and
Keynote LIFELINE, global services that measure and assure the quality of service
of e-commerce web sites around the world. The foundation of these services is an
extensive network of strategically located measurement computers connected to
the major Internet backbones in dozens of metropolitan areas worldwide, plus a
sophisticated operations center for collecting, analyzing and disseminating
Internet performance and availability data. We believe that companies who use
our services can increase revenues, improve customer satisfaction and retention,
reduce support costs and gain a competitive advantage. We have designed our
services to be easy for customers to try, purchase and use on a subscription
basis. Our customers include over 400 leading e-commerce companies, with our 10
largest customers based on revenues for the nine months ended June 30, 1999
consisting of Akamai, C--NET, Digex, DoubleClick, Exodus Communications,
Hewlett-Packard, Intel, Microsoft, Nasdaq-AMEX and Sandpiper Networks.
INDUSTRY BACKGROUND
The Internet has emerged as a global medium for communication, content
delivery and electronic commerce, or e-commerce, and Internet use continues to
increase rapidly. E-commerce is evolving into a mission-critical component of
many companies' operations, and is dramatically changing how businesses interact
with their customers, suppliers and partners. Many large companies such as
FedEx, General Motors, Merrill Lynch and Pfizer now use their web sites as a
fundamental, cost-effective way of communicating product and shipment
information and conducting business transactions. At the same time, the Internet
has spawned new businesses such as Amazon.com and Yahoo!, whose success is tied
exclusively to their online offerings. International Data Corporation forecasts
that the number of Internet users will grow from approximately 142 million in
1998 to 502 million by 2003, with commensurate growth in e-commerce from $50
billion to $1.3 trillion over the same period.
The competitive e-commerce environment has created a different set of
challenges than those faced by conventional "bricks and mortar" stores. These
challenges include price standardization, product commoditization, constant
change in the competitive landscape, decreased customer loyalty and low
switching costs, plus the need for consistent high quality of service and
end-user satisfaction with the online experience. As a result, a key
differentiator for many businesses with online offerings can be their quality of
service. In e-commerce, quality of service encompasses all aspects of a
customer's interactions with a web site that affect the customer's satisfaction
with the experience and the desire to repeat it. Quality of service can
generally be measured, analyzed and improved along the dimensions of speed,
availability and consistency across time and geography. To attract and retain
customers, e-commerce web sites must offer fast page downloads, efficient
transactions and high reliability all the time or customers may "click away" to
a competitor who offers comparable products and services. According to a 1999
study by Zona Research, approximately $4.4 billion per year in e-commerce sales
in the United States may be lost due to unacceptable download speeds and the
resulting abandonment of online transactions by users.
Despite substantial investments in e-commerce, building and maintaining a
high performance e-commerce site remains a significant challenge. The Internet
is a complex, heterogeneous network of communications networks with multiple
operators and vendors supplying and managing the underlying infrastructure. To
reach customers through the Internet, a company must transmit information from
its web site through an Internet service provider, which then passes the data to
an Internet backbone provider. Web pages are transmitted to the customer across
multiple Internet backbones and service providers along an often indirect path
that is determined as the information passes between backbones. There are over
40 major backbone providers in the United States, such as Sprint and UUNET, and
thousands of different Internet access providers, such as America Online and
EarthLink. In addition to the inherent complexity of the
35
<PAGE>
Internet, many internal and external factors contribute to the e-commerce
quality of service problem. These factors include inadequate networking
hardware, servers and server software, poorly constructed applications,
inadequate communications capacity and poor interconnections between Internet
backbone providers. Compounding the quality of service problem, e-commerce
companies are inherently global in nature with a geographically dispersed
customer base and around-the-clock operations.
Despite improvements in many underlying Internet technologies, the quality
of service problem is increasing. Due to the heterogeneous nature of the
Internet, no single vendor of these Internet technologies has the perspective or
the incentive to help companies identify and remedy the causes of the problem.
As a result, companies have been forced to rely upon anecdotal customer
complaints and limited data to respond to problems after they have already
occurred and customers and revenues have already been lost. The challenge of
assuring performance for e-commerce sites is only increasing as their offerings
expand into additional web-site addresses, also known as uniform resource
locators, or URLs, and as they become increasingly feature-rich and complex.
International Data Corporation forecasts that the number of URLs on the Internet
will grow from approximately 925 million in 1998 to 13.1 billion in 2003.
Given the global, around-the-clock nature of e-commerce, there is a demand
today for an independent Internet performance solution that provides companies
objective information from around the world all the time to enable e-commerce
sites to measure, assure and improve e-commerce quality of service from the
perspective of their customers.
THE KEYNOTE SOLUTION
We provide Internet performance measurement and diagnostic services that
enable e-commerce companies to measure, assure and improve quality of service of
their web sites. Key features of our solution include:
INDEPENDENT THIRD PARTY. We do not sell web servers, web software,
networking equipment or web hosting services. Therefore, customers can be
assured that we do not have any incentive to report performance problems with
respect to particular types of equipment or service providers and that we
deliver unbiased Internet performance measurement and diagnostic services. Our
Internet performance indices of business and consumer web sites are regularly
published in leading publications such as BUSINESS WEEK, COMPUTERWORLD, SMART
MONEY, THE INDUSTRY STANDARD and USA TODAY. We believe that having our indices
appear in these national publications provides us with additional credibility as
an independent provider of performance measurement and diagnostic services.
COMPREHENSIVE GLOBAL MEASUREMENT INFRASTRUCTURE. Because performance
problems can occur at many different locations throughout the Internet, we have
deployed an extensive network of measurement computers and an operations center
for collecting and disseminating performance data. Our computers are deployed in
60 U.S. and 24 international locations and currently execute over 12 million
performance measurements per day. This extensive infrastructure enables us to
provide our customers with comprehensive, up-to-the-minute performance data that
can be used to assure and improve their quality of service.
SUBSCRIPTION SERVICE. Our customers purchase our Internet performance
measurement and diagnostic services on a subscription basis with an initial
three-month term. With only a web browser, customers can try, purchase and
immediately use our services without the need to develop an internal computer
infrastructure or install any software. In addition, as changes occur in the
Internet or our services, our customers do not need to update their systems or
change the way they receive information from us.
EASY-TO-USE VIEWING AND ANALYSIS. Our automated service continually
collects and delivers quality-of-service data around the clock to our customers
and enables them to conveniently view, analyze and act on the performance
measurements. Our proprietary statistical software filters, sorts, summarizes
and presents the
36
<PAGE>
large volume of complex performance measurement data in easy-to-understand
charts, graphs and tables. Customers can view performance and diagnostic reports
through any web browser, and can be notified by email or pager when performance
thresholds are reached.
COMPREHENSIVE RANGE OF SERVICE OFFERINGS. In order to extend the reach of
our services to a broad cross-section of e-commerce web sites, we offer our
entry-level Keynote LIFELINE service which measures a web site from one or two
geographic locations. LIFELINE customers can later upgrade to our Keynote
PERSPECTIVE service, which is a comprehensive offering that features
measurements of benchmark pages, full pages, secure pages and multi-page
transactions from multiple locations and Internet backbones.
FOCUSED CONSULTING SERVICES. Consulting enhances our subscription services
by helping our customers to evaluate and respond to their
performance-measurement and diagnostic results. We provide our customers with
performance audits producing a detailed report on their e-commerce web-site
performance. Our customers often use these audits as formal, disinterested
performance reports to their own management and customers. To help our customers
to architect new web-site offerings, we also plan to provide in-depth
performance consulting along with live testing of prototype designs, based on
our experiences with major e-commerce sites.
STRATEGY
Our objective is to maintain and expand our leadership in providing Internet
performance measurement and diagnostic services to e-commerce web sites. Key
elements of our strategy are:
EXTEND MARKET PENETRATION. We plan to continue to build our internal sales
and marketing capabilities by increasing the size of our direct sales force and
the number of our telesales call centers. We plan to promote our entry-level
service, LIFELINE, as an easy-to-try, easy-to-buy Internet performance solution.
We will then seek to sell additional services to these entry-level customers,
such as our flagship Keynote PERSPECTIVE service. We also plan to continue to
promote, and seek to have published, our performance indices. We believe that if
these indices become well-publicized in the market, potential customers will be
more interested in measuring the performance of their web sites against these
indices and will therefore increase demand for our services. In addition, we
will continue to actively develop co-marketing relationships with Internet
service providers and other suppliers of complementary products and services to
our target customers.
INCREASE CUSTOMER RELIANCE ON OUR SERVICES. We intend to introduce new
features for our services so that our customers remain focused on their web
site's performance and our services in particular as their e-commerce web sites
grow. We currently offer daily performance reporting via email and intend to
offer additional reporting methods designed to keep our customers constantly
aware of their web site's performance. We also recently introduced bi-weekly
online training programs for our customers. We intend to develop and market
additional service components to add value to our customers' attempts to improve
the quality of service of their e-commerce web sites, similar to our recent
introduction of a service to measure the efficiency and success rates in
initiating and completing multi-page electronic transactions.
EXPAND OUR BRAND AWARENESS AS "THE INTERNET PERFORMANCE AUTHORITY-TM-." We
intend to expand our traditional and online marketing strategies to increase
customer awareness and brand recognition, including advertisements in the trade
and business press, direct email and other targeted marketing campaigns. For
example, we are planning to host an annual Internet performance conference to
serve as an important branding and customer-recruitment event. In addition, we
intend to expand our roster of published web performance indices to include
major e-commerce segments such as banking, shopping and portals, and we intend
to publish these indices in relevant industry publications.
ESTABLISH RELATIONSHIPS WITH COMPLEMENTARY VENDORS. We believe that a
significant market opportunity exists to sell our services to companies with
high-volume or mission-critical web sites. Therefore, we believe that we can
benefit from co-marketing relationships with other companies that sell
complementary products
37
<PAGE>
and services to our target customers. We have important contractual
relationships with VeriSign and Network Solutions to co-market our services to
their own customers on a co-branded basis bundled with their own services, and
we will seek to increase the number of these relationships. In addition, we
intend to pursue relationships with major consulting firms in order to encourage
them to recommend and specify our services to their Fortune 500 customers.
INCREASE OUR INTERNATIONAL PRESENCE. We believe that the international
expansion of e-commerce provides us with significant opportunities to offer our
services globally. We plan to increase both the number of international
locations where we provide services and the number of measurement computers
deployed internationally. We currently sell our services directly to
international customers, which include BBC, Dell (Japan), ANZ Bank and TNT
Express, and we intend to build call centers in Europe and Australia in order to
increase our international presence. To date, revenues from our international
customers have constituted less than 10% of our total revenues for each of our
fiscal years as well as the nine months ended June 30, 1999. We also intend to
pursue relationships with providers of complementary products and services in
Europe, Asia and Australia. We do not anticipate that we will incur a material
increase in our total expenses due to our proposed international expansion.
EXPAND OUR SERVICE OFFERINGS INTO ALL ASPECTS OF QUALITY OF SERVICE FOR
E-COMMERCE. We intend to broaden our measurement services to include a variety
of Internet access methods, such as dial-up modem, digital subscriber lines,
cable modem and other broadband access technologies, from either stationary or
mobile computing devices. We also intend to expand our service offerings by
measuring the speed with which a web site can be navigated and desired content
located. Finally, we intend to measure the impact of new Internet technologies,
such as streaming audio and video, multi-casting and Internet telephony.
38
<PAGE>
KEYNOTE SERVICES
Our services enable customers to measure, assure and improve their
e-commerce quality of service from multiple vantage points around the world.
These services are summarized in the following table:
<TABLE>
<S> <C> <C>
- ------------------------------------------------------------------------------------------
SERVICE OFFERINGS FEATURES PRICES
Keynote PERSPECTIVE. - measures performance and From $295 per month per URL
Targets e-commerce web availability of web-page measured, with higher prices
sites with a national or downloads depending on frequency and
worldwide customer base as - measures transaction geographic coverage of
well as heavy traffic execution time measurements
levels. - measurements taken from
multiple locations around
the world
- measurements taken around
the clock at each location at
customer-specified
intervals of 3 minutes to 4
hours
- can measure and compare
performance and
availability of any
publicly accessible web
pages on the Internet
Keynote LIFELINE. Targets - measures performance and $695 per year per URL
regionally oriented web availability of web page measured
sites and web sites with downloads
lower traffic levels. - measurements taken from one
or two locations in the
United States selected by
the customer
- measurements taken around
the clock at intervals of 10
minutes or 1 hour
Professional Services - COMPETITIVE AUDIT to From $5,000 per engagement,
compare web-site performance depending on size and
and availability against complexity
multiple competitive web
sites
- ADVANCED DIAGNOSTIC AUDIT
to make specific
recommendations to improve
quality of service
- custom consulting
engagements
</TABLE>
Keynote PERSPECTIVE is sold on a monthly subscription basis and Keynote
LIFELINE is sold only on an annual subscription basis.
We were founded in June 1995 and until we released our Keynote PERSPECTIVE
service in April 1997, we were engaged in market research and the design and
engineering of our services. We have introduced additional versions of this
service, most recently in April 1999, so that PERSPECTIVE now includes the
ability to measure web page download times, secure web page downloads and
multi-page transactions. In July 1999, we introduced our Keynote LIFELINE
service. Also, in January 1999, we formed our professional services
organization. In April 1997, we had deployed measurement computers in 18
locations, and the number of
39
<PAGE>
locations increased to 84 at June 30, 1999. Our measurement computers currently
measure the performance of between approximately 5,000 and 6,000 web sites. We
intend to deploy additional measurement computers in order to measure in excess
of 10,000 web site addresses by the end of the year.
KEYNOTE PERSPECTIVE AND KEYNOTE LIFELINE
The foundation of our services is a worldwide network of measurement
computers that run our proprietary measurement and data-collection software,
plus an operations center for storing and disseminating performance data. Our
measurement computers measure and analyze performance data around the clock from
an end-user perspective, from Internet connection points in over 35 large
metropolitan areas on a variety of Internet backbones. Keynote PERSPECTIVE and
Keynote LIFELINE require no installation, configuration or update maintenance by
customers because all software runs on our computers and produces results that
can be accessed over the Internet through any web browser.
Our services measure the most common forms of end-user interaction with a
web site--downloading simple, complex or secure web pages and completing
multi-page transactions over the Internet.
BENCHMARK PAGE. This portion of Keynote PERSPECTIVE and Keynote LIFELINE
measures and compares the download time of a single web object such as a text
file or graphic element. With this data, web-site managers can measure and
manage the effect of user geography and Internet backbones on the end user's
perceived performance of their web site.
FULL PAGE COMPONENTS. This portion of Keynote PERSPECTIVE and Keynote
LIFELINE measures the time it takes to access and download all of the elements
of a web page, including the text file and any graphic images and complex page
structures. FULL PAGE COMPONENTS is targeted at fast-changing web sites,
enabling them to measure the effects of web-page design on end users' experience
with the web site over time and geography.
SECURE PAGE. This portion of Keynote PERSPECTIVE measures the time it takes
to access a secure, encrypted page or execute a single-page transaction through
a secure page. This enables web sites to manage the effect of content and
security applications on end users' experience with web pages containing
sensitive information such as account balances or credit-card numbers.
TRANSACTION. This portion of Keynote PERSPECTIVE measures the time it takes
to execute an interactive transaction that involves the display of multiple web
pages. This enables web sites to optimize the performance of e-commerce
transactions by tracking the effects of web-page content and back-end processing
on end users' experience. A brokerage transaction, for example, might include a
series of interactions with a login page, a balance-inquiry page, a stock-quote
page, a buy-order page, a confirm-order page and a logout page.
Key features of our Keynote PERSPECTIVE and Keynote LIFELINE services
include:
STANDARD AND CUSTOM REPORTING. Measurements are delivered to our customers
through threshold-based alarms by email or pagers as well as online through a
web-browser-based interface. Summary reports that are delivered to customers by
email on a daily basis provide quick access to hourly, daily and weekly
performance data. Our customers can configure performance alarms based on
thresholds such as time-interval and city parameters to automatically notify
them when performance problems occur.
COMPREHENSIVE DIAGNOSTICS. A "drill down" feature allows our customers to
specify a time period and metropolitan area and then to search specific data to
localize, analyze and diagnose problems. We also maintain automated diagnostic
centers at all measurement locations which allow our customers to investigate
performance bottlenecks and delays by tracing a URL request from that location,
performing error analysis and pinpointing which Internet service provider,
backbone provider or other source is responsible for the performance delay.
40
<PAGE>
Our customers can also analyze full-page measurement data to pinpoint and
address the cause of a performance delay. A full-page download consists of a
hypertext markup language page along with all associated images and complex page
structures. The full-page download time can be further dissected into as many as
six constituent elements, such as domain name service lookup time or redirect
time. This level of detail allows network engineers and web-site managers to
precisely pinpoint the cause of any performance delay and quickly resolve it. As
changes are made to web-site content, connectivity or architecture, the
resulting effect on performance can also be precisely measured and compared.
COMPARATIVE ANALYSIS. In addition to delivering consistent performance,
e-commerce sites must ensure that they can perform more quickly and reliably
than competing web sites. Our customers can compare their performance against
competing sites selected by the customer and also against our performance
indices--the KEYNOTE BUSINESS 40 INDEX and the KEYNOTE WEB BROKER TRADING INDEX.
MULTIPLE VIEWS OF WEB SITE PERFORMANCE. From any web browser, our customers
can easily access historical web-site performance data over any time range
within the previous six weeks. This data can be displayed in summary form as
well as in customizable graphs that depict performance and types of error over
time, metropolitan area or Internet backbone provider. This data can also be
easily downloaded, archived and used in our customers' other applications.
CUSTOM MEASUREMENT COMPUTERS. For companies that implement extranets or
other private computer networks, we can deploy custom measurement computers to
measure the performance of these networks from specified locations and at
specified times. These measurement computers can be deployed near the company's
own web site, at key Internet access points used by the company, or at the other
business offices of the company or its suppliers and customers. Measurements are
delivered to our operations center where they are integrated with and compared
to other public web-site measurement data.
PROFESSIONAL SERVICES
In order to help our customers maximize the benefits of our services, we
offer two audits: the COMPETITIVE AUDIT and the DIAGNOSTIC AUDIT.
COMPETITIVE AUDIT. Our COMPETITIVE AUDIT is designed to provide an
unbiased, comprehensive report on a customer's web-site performance and
availability as compared to their competitors, as determined by the customer,
and industry benchmarks. The COMPETITIVE AUDIT typically requires four weeks to
complete and comprises the following phases:
- MEASUREMENT. We measure the quality of service that a customer's web site
provides to its users over differing geographies and times;
- EVALUATION. We analyze these measurements to evaluate the performance and
reliability of a customer's web site compared to both the customer's
competitors and to industry benchmarks;
- DIAGNOSIS. We identify bottlenecks and stress points in a customer's web
site and in the web site's connection to the Internet. We do this by
looking at download and transaction times, and by examining the types of
errors encountered and their patterns over geography and time; and
- IMPROVEMENT. We recommend practical changes the customer can implement to
improve quality of service.
DIAGNOSTIC AUDIT. Our DIAGNOSTIC AUDIT is a follow-on service that
complements our COMPETITIVE AUDIT to more closely analyze the e-commerce quality
of service problems that were highlighted by the COMPETITIVE AUDIT. These
consulting engagements can be individually structured and may vary both in the
length of the audit and in the nature of the services we provide. For example,
we can work with the customer's staff to provide recommendations in the areas of
Internet connectivity, multiple hosting sites and the impact of caching and
other content-distribution strategies.
41
<PAGE>
TECHNOLOGY AND ARCHITECTURE
We designed our Internet performance measurement infrastructure to allow us
to implement a flexible, scalable solution to e-commerce quality of service
problems. Our architecture consists of three key components: measurement
computers, our operations center and reporting and analysis tools.
KEYNOTE GLOBAL INFRASTRUCTURE GRAPHIC
[The captions in the diagram are "Performance Measurement," "Data
Collection, Storage and Dissemination" and "Easy-to-Use Reporting and Analysis."
The left side of the diagram under the Performance Measurement caption has
the caption "Measurement Computers." Beneath this caption are two icons with the
caption "Customer Web Sites." From these icons are four two-way arrows pointing
at four icons representing our measurement computers.
In the center of the diagram under the Data Collection, Storage and
Dissemination caption is the caption "Scalable Operations Center." Below the
caption is an icon representing our operations center. The caption under the
icon reads "Multiple database and applications servers.
In the right side of the diagram under the Easy-to-Use Reporting and
Analysis" caption are four icons. One is a pager with a caption beneath it which
reads "Pager and email alerts." Below that is a computer with a caption which
reads "Daily email reports." Below that is a computer with a caption below it
which reads "Web-based analysis." The last picture is a computer with a caption
below it which reads "Data Feed (API/ FTP)."]
MEASUREMENT COMPUTERS. Our measurement computers are Windows-based
computers that run our 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 located at the facilities of Internet
service providers that are selected to be statistically representative of
Internet users in that geographic location. At some locations, we employ
multiple Internet connections and install equipment racks that can accommodate
multiple measurement computers, allowing for large-scale, rapid deployment of
additional measurement computers. The hosting arrangements typically have terms
ranging from three months to one year, although our more recent agreements have
typically had a one-year term. We typically pay a small set-up fee and pay
monthly fees to continue to locate the measurement computers at these locations.
These fees typically are less than $1,000 per computer. We also pay additional
fees for communications lines. For the nine months ended June 30, 1999, fees
related to operating our measurement computer network infrastructure, without
taking into account non-cash expenses related to the depreciation of computer
hardware, represented less than 10% of our total expenses for that period.
42
<PAGE>
These computers access a web site to download web pages and execute
multi-page transactions, just like end users do, 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 June 30, 1999, we had deployed more than 200 measurement computers in
60 domestic and 24 international locations, with some locations having multiple
measurement computers in order to provide different types of measurements or to
accommodate higher measurement volume. Our measurement computers currently
execute more than 12 million performance measurements each day.
We intend to continue to expand the number of measurement computers so that
we can measure in excess of 10,000 web site address by the end of this calendar
year, as compared to the approximately 5,000 to 6,000 web site addresses we
currently measure. We also intend to upgrade our communications lines to our
existing and new measurement computers. Therefore, we expect that our cost of
subscription services will increase substantially over our next fiscal year. We
intend to fund the cash portion of these expenses from our available cash, which
was $17.2 million as of June 30, 1999, and customer revenue. If these sources
are insufficient, we could use a portion of the net proceeds from this offering
to fund these expenses.
SCALABLE OPERATIONS CENTER. Our operations center is 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 a large database under a proprietary
transaction-processing system that we designed to be efficient in storing and
delivering measurement data with sub-second response times that are independent
of increases in capacity. We also employ many proprietary, high-performance
application server computers that manage the collection of measurement data, the
insertion of the data into our database and the dissemination of this data to
our customers in a variety of forms and delivery methods. We have automated this
process with proprietary system-administration tools that link our sales
order-entry and billing systems.
EASY-TO-USE REPORTING AND ANALYSIS TOOLS
- PAGER AND EMAIL ALERTS. Our customers are notified by email or pager when
download times exceed a particular value in specific cities or error
counts indicate that a web site is unresponsive.
- DAILY EMAIL REPORTS. Our customers can receive a daily or weekly email
that summarizes the performance and availability of measured web sites and
compares them to industry averages for the same time period.
- WEB-BASED ANALYSIS. Through their web browsers, our customers can login to
our operations center with a password to retrieve, view and analyze
measurement data in multiple formats.
- DATA FEED. Our customers may also retrieve measurement data through an
application program interface, or API, or through bulk file transfers
using an industry-standard file-transfer protocol called FTP. This allows
our customers to embed our measurement data in their own software to
create custom data-analysis applications.
We have occasionally experienced outages of our service in the past caused
by a variety of factors, including operator error, the failure of a back-up
computer to operate when the primary computer ceased functioning and power
outages due to our previous facilities being inadequately equipped to house our
operations center. We have addressed this problem by moving to a new facility
which is designed to more easily support a larger number of computers. We also
have meetings subsequent to each outage to identify the cause of the outage to
ensure that the same problem does not occur in the future. Other than power
outages in our previous facilities, we have not experienced multiple outages
caused by the same problem.
43
<PAGE>
CUSTOMERS
We sell our PERSPECTIVE and LIFELINE services to our customers on a
subscription basis. As of June 30, 1999, we were providing our services to over
400 companies. The following is a list of each of our customers that purchased
$1,000 or more of our services in June 1999:
ONLINE RETAILERS
Amazon.com
Artist Direct
Barnes & Noble
BestBuy Online
BT Office Products
Columbia House
eToys
Fisher Scientific
Internet Shopping Network
Micro Warehouse
Motorola
N2K
Office Depot
Onsale
Shopnow.com
Value America
Virtual Vineyards
COMPUTER PRODUCTS
Advantis
CDS
Comet Systems
Compaq
Dell Computer
EMC
Hewlett-Packard
IBM
Ingram Micro
Intraware
Lotus
Navisite
Newbridge Networks
Novell
Oracle
Philips
Silicon Graphics
Storage Tek
Sybase
TechData
Telecordia Technologies
ADVERTISING SERVICES
AdForce
Adknowledge
Avenue A Media
Bell South Intelliventures
Cobalt Group
DoubleClick
Flycast
MediaPlex
NetGravity
FORTUNE 500
Eastman Kodak
FedEx
Ford Motor
General Motors
Pfizer
CONTENT SITES
Adam.com
All Apartments
American Express Travel
Services
American School
Autoweb.com
Babycenter.com
Bamboo.com
Citysearch.com
C--NET
CoolSavings.com
Dr. Koop
Egreetings Network
Garden.com
Homestore.com
Interactive Telecom
Looksmart
Microsoft
One & Only Network
PC World
QuestLink Technology
Sabre Inc./Travelocity
Southwestern Bell
Sportsline
Starwave
Trip Online
US WEST Dex
Voice Media
VR Services
Weather Channel
Web Connection
WebGenesis
FINANCIAL SERVICES
BFC Getsmart
Charles Schwab
Disclosure
Dun & Bradstreet
First USA
Intuit
Motley Fool
Nasdaq
NextCard
VISA International
Wells Fargo
INTERNET INFRASTRUCTURE
AboveNet
Akamai
Cisco
Concentric
Data Return
Digital Island
Digex
Earthweb
Exodus Communications
Interliant
InterNAP
iXL Memphis
NetMind
Nextel
Sandpiper
Sprint Consumer Division
US West
USA.Net
US Internetworking
UUNET
Verio
VeriSign
MEDIA AND INFORMATION
British Broadcasting Corporation
Big Star Entertainment
EBSCO
Encyclopedia Britannica
Forrester Research
Harris-Black
Nando Media
Time Warner
Tribune Media Services
USA Today
PORTALS
About.com
AskJeeves
eBay
Geocities
Infoseek
Netscape
Northern Light Technology
Remarq Communities
Snap
Yahoo!
44
<PAGE>
Our customers typically enter into an initial three month subscription
agreement to purchase our services and then may choose to renew these services
on a monthly basis after the initial term.
The following are examples of how some of our customers use our services.
These are current customers of the Keynote PERSPECTIVE service and were selected
because we believe they provide representative examples of how our customers use
our services.
AKAMAI TECHNOLOGIES. Akamai operates a global network for Internet content
delivery that is designed to accelerate web-site performance for e-commerce
companies and content providers. Promising 100% Internet content delivery,
Akamai is keenly focused on providing a superior level of performance that is
better than any of their competitors'. Akamai uses Keynote PERSPECTIVE to take
before and after measurements that demonstrate and quantify the performance
improvement delivered by their fault-tolerant content distribution network.
Using Keynote, Akamai can provide an objective and real-world comparison of
end-user performance from multiple user locations across the world. Akamai
accounted for approximately 2% of our revenues for the nine months ended June
30, 1999.
CISCO SYSTEMS, INC. With 1998 revenues of $8.5 billion, Cisco is a worldwide
leader in networking hardware and software solutions for the Internet. Cisco's
web site is one of the largest e-commerce sites in the world, and Cisco reports
that 85% of their software is currently being delivered and 75% of their
technical support is currently occurring over the web. Cisco has a
corporate-wide commitment to customer satisfaction, and maintaining high
web-site performance is a critical component of their customer-satisfaction
strategy. Keynote plays a key role in Cisco's performance-enhancement strategy,
helping them continually measure and assure the performance and availability of
their geographically distributed corporate web servers. Cisco accounted for less
than 1% of our revenues for the nine months ended June 30, 1999.
FLYCAST COMMUNICATIONS CORPORATION. Flycast is a leading provider of
response-oriented online advertising. In order to provide high value to its
customers, Flycast needs to deliver banner ads quickly and efficiently from its
ad servers. Flycast uses Keynote PERSPECTIVE to measure and help assure the
availability and performance of its web servers for receipt, request and
delivery of ads. Flycast also continually measures the performance of key
competitors' web-sites, and top management regularly reviews Keynote data to
ensure that Flycast achieves its goal of being the performance leader in its
industry. Flycast accounted for approximately 1% of our revenues for the nine
months ended June 30, 1999.
MICROSOFT CORPORATION.-REGISTERED TRADEMARK- MSN-TM- is the network of
Internet services from Microsoft that helps people better organize the web
around what's important to them. MSN properties include CarPoint, Expedia,
MoneyCentral and Sidewalk. MSN uses Keynote PERSPECTIVE to continually measure
the performance and availability of the MSN network from over 90 global user
locations in order to optimize consumers' experience and level of satisfaction
worldwide. Keynote PERSPECTIVE helps Microsoft establish internal benchmarks for
web-site performance and availability, determine the effects of these elements
on consumer satisfaction and enhance performance to continually meet consumers'
expectations. Microsoft accounted for approximately 9% of our revenues for the
nine months ended June 30, 1999.
WELLS FARGO BANK. San Francisco-based Wells Fargo is the 7th largest bank
holding company in the U.S. and one of the world's largest Internet banking
providers. With 900,000 customers nationwide doing their banking over the
Internet, the Wells Fargo web site must be available and deliver acceptable
access times to customers 24-hours a day, 7-days a week. Wells Fargo uses data
from Keynote's comprehensive network of software measurement computers to
provide statistically valid and customer-relevant information on how customers
are actually experiencing performance on its web site. Wells Fargo uses Keynote
PERSPECTIVE to analyze performance on multiple distributed web-page servers and
several competitors' sites. By enabling the bank to regularly measure
competitive performance levels, Keynote enables Wells Fargo to ensure that it
delivers an online banking service with performance equal or superior to the
competition. Wells Fargo accounted for less than 1% of our revenues for the nine
months ended June 30, 1999.
SALES, MARKETING AND CUSTOMER SUPPORT
SALES
We sell our services primarily through our direct sales organization in San
Mateo, California. Our direct sales organization also provides telephone and
email sales support, telemarketing services and pre-sales technical support. We
believe our direct sales approach enables us to focus our resources on
ascertaining the
45
<PAGE>
needs of our customers, to devote significant attention to customer satisfaction
and to quickly offer new services to our existing customers. We also market our
services through our web site where customers can sign up to try, purchase and
use our services.
We also distribute our services through web-hosting and Internet service
providers such as Digex and Frontier GlobalCenter, which manage e-commerce web
sites for other companies. These companies sell or bundle our services to part
of their customer base as a value-added service to these customers and as a
management tool for themselves. We also market our services through VeriSign and
Network Solutions, which are companies that sell services complementary to ours.
MARKETING
We maintain an active marketing program designed to create brand awareness
through industry-standard benchmark indices that evaluate and rank the relative
performance of various web sites. Keynote indices include:
- KEYNOTE BUSINESS 40 INDEX of 40 selected business web sites, published
regularly in leading newspapers and trade publications;
- KEYNOTE/INTERNET WORLD WEB PERFORMANCE INDEX of 20 leading consumer web
sites, published in each edition of INTERNET WORLD magazine;
- BOARDWATCH/KEYNOTE BACKBONE WEB HOSTING INDEX of major U.S. Internet
backbone providers, published regularly in BOARDWATCH magazine; and
- KEYNOTE WEB BROKER TRADING INDEX of leading online stock brokers, based on
performance and success rates of actual stock buy-order transactions
submitted on their web sites, published weekly by us and available on the
web site of SMART MONEY.
Our SITE OF THE WEEK highlights the performance and availability results of
a different e-commerce web site each week. We also publish a free weekly
electronic newsletter on Internet performance that is transmitted to thousands
of subscribers. Our key personnel have been featured in leading financial
programs on both television and radio and have been quoted extensively in
leading trade publications and newspapers.
In all of our advertising and promotional materials, we offer e-commerce web
sites the opportunity to try our PERSPECTIVE service on a trial basis with a
Free Performance Appraisal. This no-charge trial exposes potential customers to
all aspects of our service with real performance data collected for a URL of the
customer's choice and typically a competitor's URL.
CUSTOMER SUPPORT
We believe that a high level of customer support is integral to our success
in creating solutions that our customers will view as indispensable to their
ability to provide high quality of service in all aspects of their e-commerce
business. Therefore, we provide customer support around the clock by email and
telephone. We have developed and expanded our customer support services based on
feedback received from our existing customers. This feedback is supplemented by
formal customer satisfaction surveys conducted by an independent third party. In
addition, a strategic accounts team manages our relationships with our largest
customers.
RESEARCH AND DEVELOPMENT
We believe that our future success will depend in large part on our ability
to maintain and enhance our current services and to develop new services that
achieve market acceptance. For example, we have developed and are deploying
automated measurement computers around the world to measure quality of service
over dial-up connections to Internet service providers in these locations.
Our research and development expenses for the nine months ended June 30,
1999 were $1.3 million, for fiscal 1998 were $1.2 million, for fiscal 1997 were
$732,000 and for fiscal 1996 were $392,000.
The Internet is characterized by rapid technological developments, frequent
new application introductions and evolving industry standards. The emerging
nature of this market and its rapid evolution will require that we continually
improve our services, particularly in response to competing offerings. We must
also introduce new services or enhancements as quickly as possible. The success
of a service introduction depends on
46
<PAGE>
several factors, including proper definition of new services, timely completion
and introduction of new services, differentiation of new services from those of
our competitors and market acceptance. We may not be successful in developing
and marketing new services that respond to competitive and technological
developments and changing customer needs. In addition, other technological
changes could render our existing services obsolete or require us to make
substantial expenditures to adapt our services.
COMPETITION
The market for Internet performance measurement and diagnostic services is
new and rapidly evolving. We expect competition in this market to intensify in
the future. Our current competitors vary in size and in the scope and breadth of
the products and services that they offer. In the future, new competitors could
enter our market. These competitors could include large companies with longer
operating histories as well as new companies. Our principal competitors today
include Freshwater Software, Inverse Network Technology and Service Metrics. We
also indirectly compete with WebCriteria, Internet Resources Group, MIDS Matrix
IQ Service, and INS INSoft Division, and free services such as the WebSite
Garage unit of Netscape, NetMechanic and Internet Weather Report. These free
services are not as comprehensive as ours because they only measure simple
download time, not the speed of transactions, and they only take measurements
from one location.
We expect that if we are successful in our strategy to expand the scope of
our services, we may encounter many additional, market-specific competitors.
These potential competitors include companies that sell network management
software such as CompuWare and IBM's Tivoli Unit, and companies that sell load-
testing software such as Mercury Interactive, each of which has announced
products that could potentially compete with us in the future.
We believe that the principal competitive factors affecting our market are:
- product features;
- product performance, including scalability, flexibility, availability and
cost-effectiveness;
- quality of support and service; and
- company reputation.
Although we believe that our services currently compete favorably with
respect to these factors, our market is relatively new and is rapidly evolving.
We may not be able to maintain our competitive position against current and
potential competitors, especially those with significantly greater financial,
marketing, service, support, technical and other resources.
Some of our competitors have, and our future competitors 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;
- adopt more aggressive pricing policies; and
- devote substantially more resources to technology and systems development.
We may not be able to compete successfully against our current and future
competitors. See "Risk Factors--We face growing competition which could make it
difficult for us to acquire and retain customers."
INTELLECTUAL PROPERTY
We are a technology company whose success depends on developing and
protecting our intellectual property assets.
47
<PAGE>
OUR INTELLECTUAL PROPERTY ASSETS
Our principal intellectual property assets consist of our trademarks, our
patent applications and the software we developed 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 with
delivering our services. Our trademarks include our registered trademark
Keynote-Registered Trademark-. This trademark has not been registered as a
trademark outside of the United States. We have other trademarks which have not
been registered with the U.S. Patent and Trademark Office. These include
PERSPECTIVE,-TM- LIFELINE-TM-, THE INTERNET PERFORMANCE AUTHORITY-TM- and
ACCUSTAT-TM-.
We currently have no issued U.S. or foreign patents, we have applied for two
U.S. patents and we have no pending foreign patent applications. The two U.S.
patent applications relate to our technology that measures the speed of Internet
transactions. It is possible that no patents will be issued from our currently
pending patent applications and that our 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 are patentable, 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 to store and
deliver our measurement data to customers. We also have developed software that
we use to process customer orders and billings.
HOW WE PROTECT OUR INTELLECTUAL PROPERTY
To protect our proprietary technology, we rely primarily on patent,
trademark, service mark, trade dress, copyright and trade secret laws and
restrictions, as well as confidentiality procedures and contractual provisions.
Despite our efforts to protect our proprietary rights, we may be unable to
prevent others from infringing upon or misappropriating our intellectual
property. Any steps we take to protect our intellectual property may be
inadequate, time consuming and expensive. In addition, the laws of some
countries do not protect our proprietary rights to as great an extent as do the
laws of the United States.
Most of our customers' use of our services is governed by web-based license
agreements, rather than by means of a formal, written contract. Each time
customers use our service, they "click" on a web page to agree to certain terms
and conditions that are posted on our web site, which terms and conditions
impose restrictions on the customer's use of our services and our measurement
data. In addition, we seek to avoid disclosure of our trade secrets by requiring
each of our employees and others with access to our proprietary information to
execute confidentiality agreements with us. We protect our software,
documentation and other written materials under trade secret and copyright laws,
which afford only limited protection.
IT IS POSSIBLE THAT WE COULD BECOME SUBJECT TO LITIGATION
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 without
merit, could be expensive and divert management's attention from operating our
company. If we become liable for infringing intellectual property rights, we
would be required to pay a substantial damage award and to develop
non-infringing technology, obtain a license or cease selling the products 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.
WE LICENSE TECHNOLOGY USED IN PROVIDING OUR SERVICES
We license certain statistical, graphical and database technologies from
others. 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. Please see "Risk Factors-- The success of our
business depends on our ability to protect and enforce our intellectual property
rights" and "--Others may bring infringement claims against us or our suppliers
that could harm our business."
48
<PAGE>
EMPLOYEES
As of June 30, 1999, we had a total of 76 employees, including 31 in sales
and marketing, 21 in operations, 12 in engineering, 9 in administration and 3 in
consulting. None of our employees is subject to a collective bargaining
agreement, and we believe that our relations with our employees are good. Our
future success depends on our ability to attract, motivate and retain our key
personnel. Competition for employees in our industry is intense. Please see
"Risk Factors--In order to grow our business, we must attract and retain
personnel while competition in our industry is intense."
FACILITIES
Our principal offices are located in San Mateo, California, where we occupy
approximately 25,000 square feet under a sublease that expires in June, 2000. We
believe that our existing facilities are adequate for our current needs and that
suitable additional or alternative space will be available in the future on
commercially reasonable terms. Our operations center is located at our facility
in San Mateo, California and we do not have a redundant center as backup. Our
business could be adversely affected if we experience any outages or system
disruptions at this location. Please see "Risk Factors--Our network
infrastructure could be disrupted by a number of different occurrences."
LEGAL PROCEEDINGS
From time to time, we could become involved in litigation relating to claims
arising out of our ordinary course of business. We are not presently involved in
any material legal proceedings.
49
<PAGE>
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The following table presents information regarding our executive officers
and directors as of August 15, 1999:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------- --- --------------------------------------------------------------------------
<S> <C> <C>
Umang Gupta.................... 50 Chairman of the Board and Chief Executive Officer
Eugene Shklar.................. 49 Vice President of Public Services and Director
Roger Higgins.................. 56 Vice President of Worldwide Sales
Donald Aoki.................... 42 Vice President of Engineering
Lloyd Taylor................... 41 Vice President of Operations
James Salazar.................. 39 Vice President of Professional Services
John Flavio.................... 51 Vice President of Finance, Chief Financial Officer and Secretary
Marlene Williamson............. 44 Vice President of Marketing
David Cowan.................... 33 Director
Mark Leslie.................... 53 Director
Stratton Sclavos............... 37 Director
</TABLE>
UMANG GUPTA has served as a director since September 1997 and as our chief
executive officer and chairman of the board of directors since December 1997.
From January 1996 to December 1997, he was a private investor and an advisor to
high-technology companies. From October 1984 to January 1996, he was the founder
and chairman of the board and chief executive officer of Centura Software
Corporation, formerly known as Gupta Corporation, a client/server tools and
database company. Prior to founding Gupta Corporation, from 1980 to 1984, he was
with Oracle Corporation, a database company, where his last position held was
vice president and general manager of its Microcomputer Products Division. From
1973 to 1980, he held various sales and marketing positions at 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.
EUGENE SHKLAR has served as our vice president of public services since
August 1999 and as one of our directors since September 1997. From August 1996
to August 1999, Mr. Shklar served as our vice president of marketing. From May
1994 to July 1996, he was a private investor and self-employed consultant to
several high-technology start-up companies in Silicon Valley. From July 1993 to
April 1994, he was a founding employee and served as executive director of
product marketing of Siebel Systems, Inc., a supplier of web-based front-office
software systems. From April 1992 to April 1993, Mr. Shklar was vice president
of marketing of Gupta Corporation. Before that, he served for five years at
Oracle Corporation as director of marketing for both the PC Products Division
and the Networked Products Division, for two years at 3Com Corporation, a
networking company, as director of product marketing, and for seven years as
vice president of marketing and sales of Software House, Inc., a supplier of
relational database software. Mr. Shklar studied applied mathematics and
computer science at Harvard University.
ROGER HIGGINS has served as our vice president of worldwide sales since
February 1997. From March 1996 to December 1996, he served as vice president of
sales, marketing and services with Decisive Technology, an Internet survey
software company. From September 1992 to December 1995, he held several offices
at Make Systems, a network management and simulation software company, including
vice president of field operations from January 1995 to December 1995, as vice
president of marketing from September 1993 to December 1994 and as vice
president of strategic accounts and international from September 1992 to August
1993. Before this, Mr. Higgins was a vice president at Clarity Software, a Unix
software company, and Agilis Corporation, a manufacturer of hand-held computers,
and was a director with Russell Reynolds Associates, an executive recruitment
company. Mr. Higgins was the founding international vice president for 3Com
Corporation, a networking company, between 1985 and 1988 and for GriD Systems,
50
<PAGE>
a portable computer company, between 1983 and 1985. Before this, Mr. Higgins
spent 10 years with Xerox in international sales and marketing roles, after an
initial career with IBM UK. He holds a B.Sc. degree from London University.
DONALD AOKI has served as our vice president of engineering since May 1997.
From December 1994 to May 1997, he served as a business unit general manager and
from March 1994 to December 1994 as a director of software development at Aspect
Telecommunications, a supplier of customer relationship management solutions.
From 1992 to 1994, Mr. Aoki served as director of development of TIBCO, a
financial information systems company, and from 1985 to 1992 as senior director
of development for Oracle Corporation. Mr. Aoki holds a B.S. degree in computer
science from the University of Southern California and a S.M. degree in
electrical engineering and computer science from the Massachusetts Institute of
Technology.
LLOYD TAYLOR has served as our vice president of operations since January
1999. From January 1997 to December 1998, he served as vice president of
technical operations of the Web Site Management Group of Digex, Inc., a web-site
management services company. From May 1981 to January 1997, he served in various
positions at the Applied Physics Laboratory at Johns Hopkins University, most
recently as corporate telecommunications manager, where he designed and
implemented computer systems for several NASA space shuttle missions and highly
secure encryption systems for military applications. Mr. Taylor holds an
M.S.E.E. degree in electrical engineering from Johns Hopkins University and a
B.S.E.E. degree in electrical engineering and a B.S.C.S. degree in computer
science from Washington University.
JAMES SALAZAR has served as our vice president of professional services
since March 1999. From October 1994 to March 1999, he served as president of the
San Mateo Division of Cohesive Technology Solutions, a network consulting
company recently acquired by Exodus Communications. Before this, Mr. Salazar
spent two years at Tandem Computers Inc. managing network support activities. He
began his career at Ungermann-Bass, Inc. in the consulting support organization.
Mr. Salazar holds a B.S. degree in business administration and an M.B.A. degree,
each from San Jose State University.
JOHN FLAVIO has served as our vice president of finance, chief financial
officer and secretary since July 1999. From July 1993 to July 1999, he served as
chief financial officer, senior vice president, administration and finance,
secretary and treasurer of Mosaix Inc., a provider of call management systems
and customer relationship management applications, which was recently acquired
by Lucent Technologies. Prior to joining Mosaix, Mr. Flavio worked for a number
of high-technology companies, including serving as chief financial officer for
Lumisys Inc., a manufacturer of digital cameras used for medical x-ray scanning,
and Ministor Peripherals, a manufacturer of sub-miniature disk drives used in
portable computers. Mr. Flavio holds a B.S. degree in finance from Santa Clara
University and is a certified public accountant.
MARLENE WILLIAMSON has served as our vice president of marketing since
August 1999. From August 1997 to May 1999, she served as director of
communications for IBM, a personal computer manufacturer. From October 1994 to
August 1997, she served as vice president of marketing for Acer Inc., a personal
computer manufacturer. From 1987 to 1994, she held a variety of positions at
Apple Computer, Inc., a personal computer manufacturer, most recently as manager
of worldwide consumer marketing. Prior to this, Ms. Williamson was the director
of marketing communications and sales promotions at Zenith Data Systems, a
manufacturer of personal computers, from 1984 to 1987. Ms. Williamson holds a
B.S. degree in journalism from Ohio University and an M.B.A. degree from DePaul
University.
DAVID COWAN has been one of our directors since March 1998. Since August
1996, Mr. Cowan has been a general partner of Bessemer Venture Partners, a
venture capital investment firm, where he now serves as the managing general
partner. Mr. Cowan was an associate at Bessemer Venture Partners from July 1992
to July 1996. From August 1996 to April 1997, he served as chief executive
officer of Visto Corporation, an Internet services company. From January to June
1995, he served as chief financial officer, and from January 1995 to June 1996
as chairman of the board, of VeriSign, Inc., a provider of digital certificates
and related Internet trust services. Mr. Cowan also serves as a director on the
boards of VeriSign, Worldtalk
51
<PAGE>
Communications Corporation and Flycast Communications Corporation as well as the
boards of several private companies. Mr. Cowan holds an A.B. degree in
mathematics and computer science and an M.B.A. degree from Harvard University.
MARK LESLIE has been one of our directors since June 1999. He has served as
chairman and chief executive officer of VERITAS Software Corporation, a storage
management software company, since 1990, and as a director since 1988. He also
serves on the boards of Brocade Communications Systems, Inc. and Versant Object
Technology Corporation. Mr. Leslie holds a B.A. degree in physics and math from
New York University, and he completed Harvard Business School's program for
management development.
STRATTON SCLAVOS has been one of our directors since April 1999. Since July
1995, Mr. Sclavos has been the president, chief executive officer and a director
of VeriSign, Inc. From October 1993 to June 1995, he served as vice president of
worldwide marketing and sales of Taligent, Inc., a business development software
company that was a joint venture between Apple Computer, IBM and
Hewlett-Packard. Mr. Sclavos is also a director of Network Solutions, Inc.,
Visto Corporation and Marimba, Inc. Mr. Sclavos holds a B.S. degree in
electrical and computer engineering from the University of California, Davis.
BOARD COMPOSITION
We currently have five directors. Mr. Cowan was appointed to our board under
the provisions of a stock purchase agreement among us, Bessemer Venture Partners
and investors in our Series C preferred stock. Mr. Sclavos was appointed to our
board under the terms of a stock purchase agreement among us, VeriSign and
investors in our Series D preferred stock. These provisions will terminate upon
completion of this offering.
Directors are elected by the shareholders at each annual meeting of
shareholders to serve until the next annual meeting of shareholders or until
their successors are duly elected and qualified. There are no family
relationships among any of our directors, officers or key employees.
BOARD COMMITTEES
Our board of directors has a compensation committee and an audit committee.
COMPENSATION COMMITTEE. The current members of our compensation committee
are Messrs. Cowan and Leslie. The compensation committee reviews and makes
recommendations to our board concerning salaries and incentive compensation for
our officers and employees. The compensation committee also administers our 1999
Equity Incentive Plan and 1999 Employee Stock Purchase Plan.
AUDIT COMMITTEE. The current members of our audit committee are Messrs.
Sclavos and Leslie. Our audit committee reviews and monitors our financial
statements and accounting practices, makes recommendations to our board
regarding the selection of independent auditors and reviews the results and
scope of audits and other services provided by our independent auditors.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
None of the members of the compensation committee has at any time since our
formation been one of our officers or employees. None of our executive officers
currently serves or in the past has served as a member of the board of directors
or compensation committee of any entity that has one or more executive officers
serving on our board or compensation committee. Prior to the creation of our
compensation committee, all compensation decisions were made by our full board.
Neither Mr. Gupta nor Mr. Shklar participated in discussions by our board with
respect to each of his own compensation.
52
<PAGE>
DIRECTOR COMPENSATION
CASH COMPENSATION. Our directors do not receive cash compensation for their
services as directors, but are reimbursed for their reasonable expenses in
attending board and board committee meetings.
OPTION GRANTS. Each eligible director who is not our employee and who is or
becomes a member of our board on or after the effective date of the registration
statement, of which this prospectus forms a part, will be granted an option to
purchase 50,000 shares of common stock under our 1999 Equity Incentive Plan, at
an exercise price to be equal to the fair market value of our common stock on
the date of grant, unless that director has previously received an option grant
before the effective date. The options will have 10-year terms and will
terminate three months following the date the director ceases to be one of our
directors or consultants or 12 months if the termination is due to death or
disability. All options granted under the plan will vest over three years.
One-third of the shares subject to these options will become exercisable on the
earlier of one year following the director's appointment to our board of
directors or the first annual meeting of our shareholders following the grant of
the option. The remaining shares subject to this option will vest ratably over
the two years from the date on which shares first become exercisable. Any
unvested shares subject to these options will become immediately exercisable
upon a transaction which results in a change in our control.
EXECUTIVE COMPENSATION
The following table presents compensation information for fiscal 1998 paid
or accrued by our chief executive officer, each of our three other most highly
compensated executive officers whose salary and bonus for fiscal 1998 was more
than $100,000 and one other executive officer.
SUMMARY COMPENSATION TABLE
<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
AWARDS
ANNUAL -------------
COMPENSATION SECURITIES
---------------------- UNDERLYING
NAME SALARY BONUS OPTIONS
- ------------------------------------------------------ ---------- ---------- -------------
<S> <C> <C> <C>
Umang Gupta........................................... $ 119,704 -- 1,750,000
Roger Higgins......................................... 181,466 $ 61,034 --
Donald Aoki........................................... 144,748 -- --
Douglas Finlay........................................ 110,640 -- --
Eugene Shklar......................................... 58,184 -- --
</TABLE>
Mr. Gupta, our chief executive officer, joined us in December 1997 and is
currently compensated at an annual salary of $200,000. Mr. Shklar, our vice
president of public services, is currently compensated at an annual salary of
$125,000. Mr. Finlay was serving as our chief financial officer as of September
30, 1998. Mr. Flavio is compensated at an annual salary of $170,000 as our vice
president of finance and chief financial officer.
OPTION GRANTS IN FISCAL 1998
The following table presents the grants of stock options under our 1996
Stock Option Plan during fiscal 1998 to our chief executive officer, each of our
three other most highly compensated executive officers and one other executive
officer.
All options granted under the 1996 plan are immediately exercisable and are
either incentive stock options or nonqualified stock options. We have a right to
repurchase these shares upon termination of the
53
<PAGE>
optionee's employment with us. This right generally lapses as to 25% of the
shares subject to the option one year from the date of grant and as to 2.083% of
the shares each succeeding month. Options expire 10 years from the date of
grant.
Options were granted at an exercise price equal to the fair market value of
our common stock, as determined by our board on the date of grant. In fiscal
1998, we granted to our employees options to purchase a total of 2,346,400
shares of our common stock.
Potential realizable values are computed by
- multiplying the number of shares of common stock subject to a given option
by the exercise price per share,
- assuming that the aggregate option exercise price derived from that
calculation compounds at the annual 5% or 10% rates shown in the table for
the entire 10 year term of the option, and
- subtracting from that result the aggregate option exercise price.
The 5% and 10% assumed annual rates of stock price appreciation are required
by the rules of the Securities and Exchange Commission and do not represent our
estimate or projection of future common stock prices.
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS POTENTIAL REALIZABLE
-------------------------------------------------------------- VALUE AT ASSUMED
NUMBER OF PERCENT OF ANNUAL RATES OF STOCK
SECURITIES TOTAL OPTIONS EXERCISE PRICE APPRECIATION
UNDERLYING GRANTED TO PRICE FOR OPTION TERM
OPTIONS EMPLOYEES PER SHARE EXPIRATION ----------------------
NAME GRANTED (#) IN FISCAL 1998 ($/SHARE) DATE 5% ($) 10% ($)
- ------------------------------- ----------- --------------- ------------------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
Umang Gupta.................... 1,750,000 74.6% $ 0.20 12/9/2007 $ 220,113 $ 557,810
Roger Higgins.................. -- -- -- -- -- --
Donald Aoki.................... -- -- -- -- -- --
Douglas Finlay................. -- -- -- -- -- --
Eugene Shklar.................. -- -- -- -- -- --
</TABLE>
AGGREGATED OPTION EXERCISES IN FISCAL 1998 AND OPTION VALUES AT SEPTEMBER 30,
1998
The following table presents the number of shares acquired and the value
realized upon exercise of stock options during fiscal 1998 and the number of
shares of common stock subject to "vested" and "unvested" stock options held as
of September 30, 1998 by our chief executive officer, each of our three other
most highly compensated executive officers and one other executive officer. Also
presented are values of "in-the-money" options, which represent the positive
difference between the exercise price of each outstanding stock option and the
initial public offering price of $14.00 per share.
54
<PAGE>
Each of the options granted to the optionees listed in the table below was
immediately exercisable upon grant, subject to our right to repurchase the
option shares upon termination of the optionee's employment. Our right to
repurchase the shares lapses as to 25% of the shares subject to the option one
year from the date of grant and as to 2.083% of the shares each succeeding
month. Mr. Gupta's shares are no longer subject to our right of repurchase. In
the table below, the heading "vested" refers to shares as to which our right of
repurchase has lapsed. The heading "unvested" refers to shares that we have the
right to repurchase upon termination of the optionee's employment.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES
UNDERLYING UNEXERCISED VALUE OF UNEXERCISED
IN-THE-MONEY OPTIONS
NUMBER OF OPTIONS AT AT
SHARES SEPTEMBER 30, 1998 SEPTEMBER 30, 1998
ACQUIRED ON VALUE ---------------------- --------------------
NAME EXERCISE REALIZED VESTED UNVESTED VESTED UNVESTED
- ------------------------------------ ----------- --------- --------- ----------- --------- ---------
<S> <C> <C> <C> <C> <C> <C>
Umang Gupta......................... 1,797,989 $ 71,920 -- -- $ -- $ --
Roger Higgins....................... -- -- -- -- -- --
Donald Aoki......................... -- -- 5,000 15,000 69,750 209,250
Douglas Finlay...................... -- -- 10,000 10,000 138,000 138,000
Eugene Shklar....................... -- -- 25,000 20,000 345,000 286,000
</TABLE>
EMPLOYEE BENEFIT PLANS
1996 STOCK OPTION PLAN
As of June 30, 1999, options to purchase 361,529 shares of common stock were
outstanding under the 1996 Stock Option Plan and 43,994 shares of common stock
remained available for issuance upon the exercise of options that may be granted
in the future. The 1996 plan will terminate upon the completion of this offering
and no options will be granted under the plan after this offering. However,
termination will not affect any outstanding options, all of which will remain
outstanding until exercised or until they terminate or expire by their terms.
Options granted under the plan are subject to terms substantially similar to
those described below with respect to options granted under the 1999 Equity
Incentive Plan.
1999 STOCK OPTION PLAN
As of June 30, 1999, options to purchase 705,908 shares of common stock were
outstanding under the 1999 Stock Option Plan and 366,385 shares of common stock
remained available for issuance upon the exercise of options that may be granted
in the future. The plan will terminate upon the completion of this offering, at
which time our 1999 Equity Incentive Plan will become effective. As a result, no
options will be granted under the plan after this offering. However, termination
will not affect any outstanding options, all of which will remain outstanding
until exercised or until they terminate or expire by their terms. Options
granted under the plan are subject to terms substantially similar to those
described below with respect to options granted under the 1999 Equity Incentive
Plan.
1999 EQUITY INCENTIVE PLAN
SHARES RESERVED UNDER THE PLAN. The board of directors has adopted the 1999
Equity Incentive Plan and has reserved 5,000,000 shares of common stock
available for grant under this plan. In addition to the shares reserved by the
board, shares under the 1996 Stock Option Plan and the 1999 Stock Option Plan
not issued or subject to outstanding grants on the date of this prospectus and
any shares issued under these plans
55
<PAGE>
that are forfeited or repurchased by us or that are issuable upon exercise of
options that expire or become unexercisable for any reason without having been
exercised in full will be available for grant and issuance under the equity
incentive plan. Shares will again be available for grant and issuance under the
plan that:
- are subject to issuance upon exercise of an option granted under the plan
that cease to be subject to the option for any reason other than exercise
of the option;
- have been issued upon the exercise of an option granted under the plan
that are subsequently forfeited or repurchased by us at the original
purchase price; or
- are subject to an award granted pursuant to a restricted stock purchase
agreement under the plan that are subsequently forfeited or repurchased by
us at the original issue price.
In addition, on January 1, 2000 and on December 31 of each following year, the
total number of shares reserved for issuance under the plan will increase
automatically by a number of shares equal to 5% of our outstanding shares on
December 31 of the preceding year.
TERM OF THE PLAN. The plan will become effective immediately prior to the
date of this prospectus.
The plan will terminate after 10 years, unless it is terminated earlier by
our board. The plan authorizes the award of options, restricted stock awards and
stock bonuses.
If we are dissolved, liquidated or have a "change in control" transaction,
outstanding awards may be assumed or substituted by the successor corporation,
if any. In the discretion of the compensation committee, the vesting of these
awards may accelerate upon one of these transactions.
ADMINISTRATION OF THE PLAN. The plan will be administered by our
compensation committee, all of the members of which are "non-employee directors"
under applicable federal securities laws and "outside directors" as defined
under applicable federal tax laws. The compensation committee will have the
authority to construe and interpret the plan, grant awards and make all other
determinations necessary or advisable for the administration of the plan.
TYPES OF AWARDS UNDER THE PLAN. The plan provides for the grant of both
incentive stock options that qualify under Section 422 of the Internal Revenue
Code and nonqualified stock options. Incentive stock options may be granted only
to our employees or employees of a parent or subsidiary of us. All other awards,
other than incentive stock options, may be granted to our employees, officers,
directors, consultants, independent contractors and advisors or those of any
parent or subsidiary of us, provided the consultants, independent contractors
and advisors render bona fide services not in connection with the offer and sale
of securities in a capital-raising transaction. The exercise price of incentive
stock options must be at least equal to the fair market value of our common
stock on the date of grant. The exercise price of incentive stock options
granted to 10% shareholders must be at least equal to 110% of the fair market
value of our common stock on the date of grant. The exercise price of
non-qualified stock options must be at least equal to 85% of the fair market
value of our common stock on the date of grant.
Our nonemployee directors are entitled to receive automatic annual grants of
fully vested options to purchase 50,000 shares of our common stock, as described
under "Management--Director Compensation."
Options granted under the plan will either be exercisable as they vest or
will be immediately exercisable subject to our right of repurchase that lapses
as the shares vest. In general, options will vest over a four-year period.
The maximum term of options granted under the plan is 10 years.
Awards, other than nonqualified stock options, granted under the plan may
not be transferred in any manner other than by will or by the laws of descent
and distribution. The plan allows exceptions to this restriction with respect to
awards that are nonqualified stock options. They may be exercised during the
lifetime of the optionee only by the optionee. The compensation committee could
provide for differing
56
<PAGE>
provisions in individual award agreements, but only with respect to awards that
are not incentive stock options. Options granted under the plan generally may be
exercised for a period of time after the termination of the optionee's service
to us or a parent or subsidiary of us. Options will generally terminate three
months after the termination of employment or twelve months if the termination
is due to death or disability.
The purchase price for restricted stock will be determined by our
compensation committee. Stock bonuses may be issued for past services or may be
awarded upon the completion of certain services or performance goals.
1999 EMPLOYEE STOCK PURCHASE PLAN
The board has adopted the 1999 Employee Stock Purchase Plan. The plan is
intended to qualify as an "employee stock purchase plan" under Section 423 of
the Internal Revenue Code. Rights granted under the plan will not be
transferable by a participant other than by will or the laws of descent and
distribution.
SHARES RESERVED UNDER THE PLAN. The board of directors has reserved 400,000
shares of common stock under this plan. On each January 1, the aggregate number
of shares reserved for issuance under this plan will increase automatically by a
number of shares equal to 1% of our outstanding shares on December 31 of the
preceding year. The aggregate number of shares reserved for issuance under the
plan may not exceed a specified number of shares, which the board will determine
when adopting this plan.
ADMINISTRATION OF THE PLAN. The plan will be administered by our
compensation committee. Our compensation committee will have the authority to
construe and interpret the plan, and its decisions will be final and binding.
ELIGIBILITY TO PARTICIPATE. Employees generally will be eligible to
participate in the plan if they are employed 10 days before the beginning of the
applicable offering period and they are customarily employed by us, or our
parent or any subsidiaries that we designate, for more than 20 hours per week
and more than five months in a calendar year and are not, and would not become
as a result of being granted an option under the plan, 5% shareholders of us or
our designated parent or subsidiaries. Participation in the plan will end
automatically upon termination of employment for any reason.
HOW PURCHASES ARE MADE. Under the plan, eligible employees will be
permitted to acquire shares of our common stock through payroll deductions.
Eligible employees may select a rate of payroll deduction between 2% and 10% of
their compensation and are subject to maximum purchase limitations.
Each offering period under the plan will be for two years and consist of
four six-month purchase periods. The first offering period is expected to begin
on the first business day on which price quotations for our common stock are
available on the Nasdaq National Market. Offering periods and purchase periods
will begin on February 1 and August 1 of each year. However, because the first
day on which price quotations for our common stock will be available on the
Nasdaq National Market may not be February 1 or August 1, the length of the
first offering period may be more or less than two years, and the length of the
first purchase period may be more or less than six months.
The plan provides that, in the event of our proposed dissolution or
liquidation, each offering period that commenced prior to the closing of the
proposed event shall continue for the duration of the offering period, provided
that the compensation committee may fix a different date for termination of the
plan. The purchase price for our common stock purchased under the plan is 85% of
the lesser of the fair market value of our common stock on the first or last day
of the applicable offering period. The compensation committee will have the
power to change the duration of offering periods without shareholder approval,
if the change is announced at least 15 days prior to the beginning of the
affected offering period.
TERM OF THE PLAN. The plan will become effective on the first business day
on which price quotations for the common stock are available on the Nasdaq
National Market. The plan will terminate 10 years from
57
<PAGE>
the date the plan was adopted by our board, unless it is terminated earlier
under the terms of the plan. The board will have the authority to amend,
terminate or extend the term of the plan, except that no action may adversely
affect any outstanding options previously granted under the plan.
AMENDMENTS TO THE PLAN. Except for the automatic annual increase of shares
described above, shareholder approval is required to increase the number of
shares that may be issued or to change the terms of eligibility under the plan.
The board may make amendments to the plan as it determines to be advisable if
the financial accounting treatment for the plan is different from the financial
accounting treatment in effect on the date the plan was adopted by the board.
401(k) PLAN
We sponsor a defined contribution plan intended to qualify under Section 401
of the Internal Revenue Code, or a 401(k) plan. Employees who are at least 21
years old and who have been employed with us for at least 90 days are generally
eligible to participate and may enter the plan as of the first day of any
calendar quarter. Participants may make pre-tax contributions to the plan of up
to 15% of their eligible earnings, subject to a statutorily prescribed annual
limit. Each participant is fully vested in his or her contributions and the
investment earnings. We may make matching contributions on a discretionary basis
to the plan, but we have not previously done so. Contributions by the
participants or us to the plan, and the income earned on these contributions,
are generally not taxable to the participants until withdrawn. Contributions by
us, if any, are generally deductible by us when made. Participant and company
contributions are held in trust as required by law. Individual participants may
direct the trustee to invest their accounts in authorized investment
alternatives.
EMPLOYMENT CONTRACT AND TERMINATION OF EMPLOYMENT AND CHANGE IN CONTROL
ARRANGEMENTS
EMPLOYMENT CONTRACT AND TERMINATION OF EMPLOYMENT ARRANGEMENT
In December 1997, we entered into an employment agreement with Umang Gupta,
our chief executive officer. This agreement establishes Mr. Gupta's annual base
salary and eligibility for benefits and bonuses.
OPTION. Under this agreement, Mr. Gupta was granted an option to purchase
1,750,000 shares of common stock at an exercise price of $0.20 per share. This
option was immediately exercisable, subject to our right to repurchase the
shares of common stock upon termination of his employment. Mr. Gupta exercised
this option in April 1998. Our right of repurchase has now lapsed as to all of
these shares.
WARRANT. Under this agreement, Mr. Gupta was granted a warrant to purchase
265,000 shares of common stock at a purchase price of $1.30 per share. This
warrant will expire upon the earlier of the closing of this offering or December
9, 2000. Mr. Gupta is selling 125,000 shares of common stock in this offering
and using the proceeds from the sale to exercise this warrant and pay any income
tax liability resulting from the sale of the shares.
TERMINATION. This agreement continues until it is terminated upon written
notice by Mr. Gupta or us. If his employment is terminated by us for cause or if
he voluntarily elects to terminate his employment, we must pay his salary and
other benefits through the date of his termination. If his employment is
terminated by us without cause or if he terminates his employment due to a
material reduction in his salary or benefits, a material change in his
responsibilities or a sale of us, we must pay his salary and benefits through
the date of his termination and his salary for six additional months after this
date.
In connection with a loan agreement, dated as of May 1999, Mr. Gupta agreed
that, except in the case of a sale of us, he will not voluntarily elect to
terminate his employment before the earlier of December 31, 2001 or the date on
which a successor chief executive officer commences employment with us.
58
<PAGE>
CHANGE IN CONTROL ARRANGEMENTS
Our right to repurchase any unvested shares held by our executive officers
will expire upon:
- that officer's termination of employment with us without cause; or
- any sale of all or substantially all of our assets, any merger of us with
another company or any other corporate reorganization in which more than
50% of our voting power is transferred.
INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS AND LIMITATION OF LIABILITY
Our articles of incorporation includes a provision that eliminates the
personal liability of our directors for monetary damages resulting from a breach
of their fiduciary duty as one of our directors, except for liability:
- for any breach of the director's duty of loyalty to us or our
stockholders;
- for acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law;
- for any transaction from which the director derived an improper personal
benefit;
- for acts or omissions that a director believes to be contrary to the best
interests of us or our shareholders or that involve the absence of good
faith on the part of the director;
- for acts or omissions that show a reckless disregard for the director's
duty to us or our shareholders in circumstances in which the director was
aware, or should have been aware, in the ordinary course of performing a
director's duties, of a risk of a serious injury to us or our
shareholders;
- under Section 310 of the California Corporations Code regarding contracts
in which a director has a material or financial interest; or
- under Section 316 of the California Code regarding improper dividends,
loans and guarantees.
These provisions are permitted under California law.
Our bylaws provide that we:
- must indemnify our directors, officers and employees to the fullest extent
permitted by California law, subject to very limited exceptions;
- must advance expenses, as incurred, to our directors and executive
officers in connection with a legal proceeding to the fullest extent
permitted by California law, subject to very limited exceptions; and
- may enter into agreements with any of our directors, officers, employees
or agents that provide for indemnification of expenses incurred to the
fullest extent permitted by our articles of incorporation and California
law.
Prior to the completion of this offering, we intend to enter into
indemnification agreements with each of our current directors and executive
officers to give them additional contractual assurances regarding the scope of
the indemnification provided in our articles of incorporation and bylaws and to
provide additional procedural protections in the event of litigation. Presently,
there is no pending litigation or proceeding involving any of our directors,
executive officers or employees for which indemnification is sought. We are not
aware of any threatened litigation that may result in claims for
indemnification.
We intend to obtain liability insurance for our directors and officers and
intend to obtain a rider to extend that coverage for public securities matters.
59
<PAGE>
CERTAIN TRANSACTIONS
Other than Mr. Gupta's employment agreement, described in "Management" and
the transactions described below, since we were formed there has not been, nor
is there currently proposed, any transaction or series of similar transactions
to which we were or will be a party:
- in which the amount involved exceeds $60,000; and
- in which any director, executive officer, holder of more than 5% of our
common stock or any member of their immediate family had or will have a
direct or indirect material interest.
PREFERRED STOCK FINANCINGS
In May and June 1996, we sold a total of 3,039,222 shares of Series A
preferred stock at a purchase price of $0.42 per share. In July 1997, Eugene
Shklar purchased 74,937 shares of Series A preferred stock from a purchaser of
the Series A preferred stock at a purchase price of $1.10 per share. In July
1997, we sold a total of 2,333,420 shares of Series B preferred stock at a
purchase price of $1.10 per share. In March 1998, we sold a total of 3,848,986
shares of Series C preferred stock at a purchase price of $1.30 per share. In
April and May 1999, we sold a total of 3,367,272 shares of Series D preferred
stock at a purchase price of $4.42 per share and a total of 438,480 shares of
common stock at a purchase price of $4.42 per share.
Purchasers of our preferred and common stock include, among others, the
following of our executive officers, directors and holders of more than 5% of
our outstanding stock:
<TABLE>
<CAPTION>
SERIES A SERIES B SERIES C SERIES D AGGREGATE
PREFERRED PREFERRED PREFERRED PREFERRED COMMON CONSIDERATION
SHAREHOLDER STOCK STOCK STOCK STOCK STOCK PAID
- -------------------------------------- --------- --------- ---------- ---------- --------- ---------------
<S> <C> <C> <C> <C> <C> <C>
VeriSign, Inc......................... -- -- -- 1,263,200 438,480 $ 7,521,427.81
GE Capital Equity Investments, Inc.... -- -- -- 1,583,710 -- 7,000,000.41
Entities associated with Bessemer
Venture Partners, L.P............... -- -- 2,446,153 226,244 -- 4,000,000.94
Entities and individuals associated
with Applewood Associates, L.P...... 595,238 715,532 407,692 -- -- 1,537,085.86
Umang Gupta........................... -- 90,909 -- -- -- 100,000.45
Eugene Shklar......................... 74,937 565,773 611,538 113,122 -- 1,948,823.24
</TABLE>
All of the share numbers described above reflect the conversion of each
outstanding share of Series A preferred stock, Series B preferred stock and
Series D preferred stock into one share of common stock and the conversion of
each outstanding share of Series C preferred stock into 1.06 shares of common
stock.
WARRANTS
In January 1997, in connection with a bridge loan financing, we issued
warrants to purchase a total of 81,092 shares of common stock at a purchase
price of $0.05 per share to Applewood Associates, L.P., a holder of more than 5%
of our outstanding common stock, and entities associated with Applewood
Associates, including warrants to purchase 12,816 shares of common stock issued
to each of Woodland Partners, L.P. and Irwin Lieber. These warrants expire on
January 2002. We also issued a warrant to purchase a total of 70,000 shares of
common stock at a purchase price of $0.05 per share to Eugene Shklar. In July
1997, Mr. Shklar exercised this warrant.
In connection with the employment agreement we entered into in December 1997
with Umang Gupta, we issued Mr. Gupta a warrant to purchase a total of 265,000
shares of common stock at a purchase price of $1.30 per share. This warrant will
expire upon the earlier of the closing of this offering or December 9, 2000. Mr.
Gupta is selling 125,000 shares of common stock in this offering and using the
proceeds from the sale to exercise this warrant and to pay any income tax
liability resulting from the sale of the shares.
60
<PAGE>
LOANS TO EXECUTIVE OFFICERS
UMANG GUPTA. In April 1998, we loaned $280,000 to Umang Gupta, secured by a
loan and pledge agreement, in connection with his exercise of options to
purchase shares of our common stock. In May 1999, we loaned $300,000 to Mr.
Gupta, evidenced by a full recourse promissory note and secured by a stock
pledge agreement, in connection with the acceleration of the lapse of our
repurchase right with respect to the shares of our common stock owned by him. In
June 1999, these loans were consolidated into a single loan. This loan accrues
interest at a rate of 6% per year and is due and payable on or before December
31, 2001.
LLOYD TAYLOR. In January 1999, we loaned $150,000 to Lloyd Taylor, our vice
president of operations, secured by a loan and security agreement, in connection
with his relocation to California. The loan accrues interest at a rate of 9% and
is due and payable on or before January 2002.
In January 1999, we loaned an additional $75,000 to Mr. Taylor, secured by a
loan and pledge agreement, in connection with his exercise of his option to
purchase 300,000 shares of our common stock. The loan accrues interest at a rate
of 7% and is payable on or before January 2004.
OPTION GRANTS TO EXECUTIVE OFFICERS AND DIRECTORS
UMANG GUPTA. In September and December 1997, we granted to Umang Gupta
options to purchase a total of 1,797,989 shares of common stock at an exercise
price of $0.20 per share. Mr. Gupta exercised these options in April 1998.
EUGENE SHKLAR. In August 1996 and June 1997, we granted to Eugene Shklar
options to purchase a total of 431,100 shares of common stock at an exercise
price of $0.05 per share. In July 1997, 25,000 of these 431,100 shares were
canceled. In July 1997, we granted Mr. Shklar an option to purchase a total of
45,000 shares of common stock at an exercise price of $0.20 per share. In
February 1999, a total of 2,500 of these 45,000 shares were canceled. Mr. Shklar
exercised his options as to the remaining 448,600 shares in September 1996, June
1997 and January 1999.
ROGER HIGGINS. In February and June 1997, we granted to Roger Higgins
options to purchase a total of 207,859 shares of common stock at an exercise
price of $0.05 per share. Mr. Higgins exercised these options in February and
June 1997.
DONALD AOKI. In May and June 1997, we granted to Donald Aoki options to
purchase a total of 193,513 shares of common stock at an exercise price of $0.05
per share. Mr. Aoki exercised these options in June 1997 and December 1998. In
June 1999, we granted Mr. Aoki options to purchase 50,000 shares of common stock
at an exercise price of $8.00 per share.
LLOYD TAYLOR. In January 1999, we granted to Lloyd Taylor an option to
purchase 150,000 shares of common stock at an exercise price of $0.50 per share.
Mr. Taylor immediately exercised this option. In June 1999, Mr. Taylor was
granted an option to purchase 50,000 shares of common stock at an exercise price
of $8.00 per share.
JAMES SALAZAR. In March 1999, we granted James Salazar an option to
purchase 112,500 shares of common stock at an exercise price of $1.60 per share.
JOHN FLAVIO. In June 1999, we granted John Flavio an option to purchase
205,000 shares of common stock at an exercise price of $8.00 per share.
MARLENE WILLIAMSON. In August 1999, we granted Marlene Williamson an option
to purchase 150,000 shares of common stock at an exercise price of $9.00 per
share.
MARK LESLIE. In June 1999, we granted Mark Leslie an option to purchase
50,000 shares of common stock at an exercise price of $8.00 per share. Mr.
Leslie exercised this option with respect to 30,000 shares in June 1999.
61
<PAGE>
MEMORANDUM OF UNDERSTANDING WITH VERISIGN, INC.
In February 1999, we entered into a memorandum of understanding with
VeriSign, Inc. Mr. Stratton Sclavos, a member of our board of directors, is the
chief executive officer and a director of VeriSign. Under the agreement, Keynote
granted VeriSign a non-exclusive license to sell two different customized
versions of Keynote PERSPECTIVE and a one-year subscription to Keynote LIFELINE
to VeriSign's customers as an integrated part of VeriSign's product offerings.
In order to implement the product offerings subject to the agreement, Keynote
agreed to construct a network of 50 measurement computers in 25 domestic and
international cities. To help cover the costs of Keynote's initial expenditures,
VeriSign made a $250,000 advance available to Keynote prior to the commencement
of the joint marketing and distribution program. VeriSign also agreed to promote
Keynote's services as part of its regular communications with customers, such as
quarterly newsletters, and through a VeriSign web site that focuses on
security-related issues.
The customized versions of PERSPECTIVE that VeriSign may sell under the
agreement are each one month in duration and offer measurements from either:
- 10 different cities of the customer's choice, including up to two
international locations, or
- 25 different cities of the customer's choice, including up to four
international locations.
The agreement provides that if VeriSign is generating at least 500
introductory PERSPECTIVE sales per month within six months from the beginning of
the program, then VeriSign will make available to Keynote an additional $250,000
advance. If the program is not generating 500 of these sales per month within
six months from the beginning of the program, then Keynote may reduce the number
of measurement computers deployed under the agreement. If the program is not
generating 100 introductory PERSPECTIVE sales per month within six months from
the beginning of the program, then either Keynote or VeriSign may terminate the
agreement by providing 60 days' advance written notice to the other party, with
VeriSign entitled to recover the balance of the money it advanced to Keynote
ratably over the remainder of the term of the agreement.
The memorandum of understanding provides that VeriSign is entitled to offer
the 10-city and 25-city versions of the introductory PERSPECTIVE service as an
integrated part of its product offerings. VeriSign will pay Keynote $50 for each
10-city version and $100 for each 25-city version of the introductory
PERSPECTIVE service. All of the fees that VeriSign pays to Keynote for the
subscriptions VeriSign sells to its customers are deducted from the funds that
it advanced to Keynote until such advance is repaid, with a maximum of $10,417
in fees per month to be deducted from the advance. Any fees per month in excess
of $10,417 are retained by Keynote. In the event that Keynote converts the
introductory PERSPECTIVE customer into a paying PERSPECTIVE customer during the
life of the VeriSign-bundled introductory PERSPECTIVE subscription or within 30
days after this period, Keynote will pay VeriSign a one-time conversion bounty
of $1,400.
VeriSign also has the right to sell a one-year subscription to LIFELINE, and
VeriSign will receive a 50% discount to this service. This discount will
increase to 57% if, after the agreement has been in effect for six months,
VeriSign is paying Keynote more than $100,000 per month for the LIFELINE
service. However, if after the agreement has been in effect for six months,
VeriSign is paying Keynote less than $34,750 per month for the LIFELINE service,
the parties can renegotiate the discount and/or volume commitments. If Keynote
converts the LIFELINE customer into a paying PERSPECTIVE customer during the
life of the VeriSign-bundled LIFELINE subscription or within 30 days after this
period, Keynote will pay VeriSign a one-time conversion bounty of $1,400. In
addition, if a program generates leads for PERSPECTIVE, Keynote will pay
VeriSign $150 for each lead which turns into a paying customer within 90 days of
receipt of the lead.
The agreement provides that if Keynote makes available a similar service
with better terms to any customer, Keynote will provide VeriSign with the same
superior terms for the remainder of the term of the agreement. Keynote also
agreed not to enter into a similar agreement involving the bundling of its
services with certain competitors of VeriSign.
The initial term of the memorandum of understanding is two years, unless the
parties enter into a formal marketing and services agreement prior to that time
which supersedes the agreement. The agreement will continue for a series of
one-year extensions subsequent to the initial two-year term unless either party
provides written notice to the other of its intent not to renew the agreement.
Through August 31, 1999, Keynote has received from VeriSign approximately
$83,000 in revenue from this agreement.
Keynote believes that the terms of the memorandum of understanding, taken as
a whole, were no less favorable to Keynote than Keynote could have obtained from
unaffiliated third parties.
62
<PAGE>
PRINCIPAL AND SELLING SHAREHOLDERS
The following table presents information as to the beneficial ownership of
our common stock as of June 30, 1999 and as adjusted to reflect the sale of the
common stock in this offering by:
- each shareholder known by us to be the beneficial owner of more than 5% of
our common stock;
- each of our directors;
- each executive officer listed in the summary compensation table above; and
- all directors and executive officers as a group.
Beneficial ownership is determined under the rules of the Securities and
Exchange Commission and generally includes voting or investment power with
respect to securities. Unless indicated below, to our knowledge, the persons and
entities named in the table have sole voting and sole investment power with
respect to all shares beneficially owned, subject to community property laws
where applicable. Shares of common stock subject to options that are currently
exercisable or exercisable within 60 days of June 30, 1999 are deemed to be
outstanding and to be beneficially owned by the person holding the options for
the purpose of computing the percentage ownership of that person but are not
treated as outstanding for the purpose of computing the percentage ownership of
any other person. Unless indicated below, the address for each listed 5%
shareholder is c/o Keynote Systems Incorporated, 2855 Campus Drive, San Mateo,
California 94403.
The percentage of common stock outstanding as of June 30, 1999 is based on
18,913,667 shares of common stock outstanding on that date, assuming that all
outstanding preferred stock has been converted into common stock and the
exercise of a warrant to purchase 265,000 shares of our common stock by Umang
Gupta, our chief executive officer, prior to the closing of this offering.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED SHARES BENEFICIALLY OWNED
PRIOR TO THE OFFERING AFTER THE OFFERING
------------------------- NUMBER OF -------------------------
NAME OF BENEFICIAL OWNER NUMBER PERCENT SHARES OFFERED NUMBER PERCENT
- --------------------------------------------------- ------------ ----------- -------------- ------------ -----------
<S> <C> <C> <C> <C> <C>
Entities and individuals associated
with Applewood Associates, L.P. (1)
68 Wheatley Road
Brookville, New York 11545....................... 2,821,381 14.9% -- 2,821,381 12.4%
Entities associated with Bessemer
Venture Partners, L.P. (2)
535 Middlefield Road
Menlo Park, California 94025..................... 2,672,397 14.1 -- 2,672,397 11.7
VeriSign, Inc.
1350 Charleston Road
Mountain View, California 94043.................. 1,701,680 9.0 -- 1,701,680 7.5
GE Capital Equity Investments, Inc. (3)
120 Long Ridge Road
Stamford, Connecticut 06927...................... 1,583,710 8.4 -- 1,583,710 6.9
Umang Gupta (4).................................... 2,667,231 14.1 125,000 2,542,231 11.2
Eugene Shklar (5).................................. 2,023,139 10.7 -- 2,023,139 8.9
Douglas Finlay (6)................................. 343,181 1.8 -- 343,181 1.5
Roger Higgins (7).................................. 332,859 1.8 -- 332,859 1.5
Donald Aoki (8).................................... 318,513 1.7 -- 318,513 1.4
David Cowan (9).................................... 2,672,397 14.1 -- 2,672,397 11.7
Mark Leslie (10)................................... 50,000 0.3 -- 50,000 0.2
Stratton Sclavos (11).............................. 1,701,680 9.0 -- 1,701,680 7.5
All 11 directors and executive officers as a group
(12)............................................. 10,259,000 54.2 125,000 10,134,000 44.4
</TABLE>
- ------------------------
(1) Includes 150,000 shares held by Brookwood Partners, L.P., 349,601 shares
held by Woodland Partners, L.P., 499,601 shares held by Irwin Lieber and
22,624 shares held by Barry Fingerhut. Includes 81,092 shares issuable upon
exercise of warrants held by some of the entities and individuals
exercisable within 60 days of June 30, 1999.
63
<PAGE>
(2) Includes 995,048 shares held by Bessec Ventures IV L.P. and 244,615 shares
held by Bessemer Venture Investors IV L.P.
(3) GE Capital Equity Investments, Inc., a wholly-owned subsidiary of General
Electric Capital Corporation, shares beneficial ownership with General
Electrical Capital Corporation with respect to all of the shares held of
record by GE Capital Equity Investments, Inc.
(4) Includes 80,000 shares held by the Gupta Family 1999 Irrevocable Trust. Mr.
Gupta disclaims beneficial ownership of the shares held by this entity
except to the extent of his pecuniary interest in it. Includes 265,000
shares issuable upon exercise of a warrant that he will exercise prior to
the closing of this offering, as this warrant will otherwise expire.
Therefore, Mr. Gupta will sell the 125,000 shares of common stock and use
the proceeds to exercise this warrant and to pay any income tax liability
resulting from the sale of the shares.
(5) Of the shares held by Mr. Shklar, 143,891 remained subject to our right of
repurchase as of June 30, 1999.
(6) Of the shares held by Mr. Finlay, 82,256 remained subject to our right of
repurchase as of June 30, 1999.
(7) Includes 125,000 shares held by the Roger W. Higgins and Priscilla Higgins
Revocable Trust. Mr. Higgins disclaims beneficial ownership of the shares
held by this entity except to the extent of his pecuniary interest in it. Of
the shares held by Mr. Higgins, 82,821 remained subject to our right of
repurchase as of June 30, 1999.
(8) Of the shares held by Mr. Aoki, 90,529 remained subject to our right of
repurchase as of June 30, 1999.
(9) Represents 995,048 shares held by Bessec Ventures IV L.P., 244,615 shares
held by Bessemer Venture Investors IV L.P. and 1,432,734 shares held by
Bessemer Venture Partners, L.P. Mr. Cowan, one of our directors, is a
general partner of the general partner of these entities. Mr. Cowan
disclaims beneficial ownership of shares held by these entities except to
the extent of his pecuniary interest in them.
(10) Includes 20,000 shares issuable upon exercise of an immediately exercisable
option, none of which are subject to our right of repurchase.
(11) Represents 1,701,680 shares held by VeriSign, Inc. Mr. Sclavos, one of our
directors, is president and chief executive officer of VeriSign. Mr. Sclavos
disclaims beneficial ownership of shares held by VeriSign except to the
extent of his pecuniary interest in it.
(12) Includes 549,497 shares subject to our right of repurchase as of June 30,
1999; 265,000 shares issuable upon exercise of a warrant exercisable within
sixty days of June 30, 1999, which warrant will be exercised prior to the
closing of this offering; and 20,000 shares issuable upon exercise of an
immediately exercisable option, none of which are subject to our right of
repurchase.
64
<PAGE>
DESCRIPTION OF CAPITAL STOCK
Immediately following the closing of this offering, our authorized capital
stock will consist of 50,000,000 shares of common stock, $0.001 par value per
share, and 5,000,000 shares of preferred stock, $0.001 par value per share. As
of June 30, 1999, assuming the conversion of all outstanding preferred stock
into common stock and the exercise of a warrant to purchase 265,000 shares of
our common stock by Umang Gupta, our chief executive officer, upon the closing
of this offering, there were outstanding 18,913,667 shares of common stock held
of record by approximately 108 shareholders, options to purchase 1,067,437
shares of common stock and warrants to purchase 378,478 shares of common stock.
Following the closing of this offering, we intend to amend and restate our
articles of incorporation. Our articles of incorporation, bylaws and third
amended and restated investors' rights agreement, described below, are included
as exhibits to the registration statement of which this prospectus forms a part.
COMMON STOCK
DIVIDEND RIGHTS. Subject to preferences that may apply to shares of
preferred stock outstanding at the time, the holders of outstanding shares of
common stock are entitled to receive dividends out of assets legally available
at the times and in the amounts as our board may from time to time determine.
VOTING RIGHTS. Each common shareholder is entitled to one vote for each
share of common stock held on all matters submitted to a vote of shareholders.
Cumulative voting for the election of directors is not provided for in our
articles of incorporation, which means that the holders of a majority of the
shares voted can elect all of the directors then standing for election.
NO PREEMPTIVE OR SIMILAR RIGHTS. The common stock is not entitled to
preemptive rights and is not subject to conversion or redemption.
RIGHT TO RECEIVE LIQUIDATION DISTRIBUTIONS. Upon our liquidation,
dissolution or winding-up, the assets legally available for distribution to our
shareholders are distributable ratably among the holders of our common stock and
any participating preferred stock outstanding at that time after payment of
liquidation preferences, if any, on any outstanding preferred stock and payment
of other claims of creditors. Each outstanding share of common stock is, and all
shares of common stock to be outstanding upon completion of this offering will
be, fully paid and nonassessable.
PREFERRED STOCK
Upon the closing of this offering, each outstanding share of Series A
preferred stock, Series B preferred stock and Series D preferred stock will be
converted into one share of common stock and each outstanding share of Series C
preferred stock will be converted into 1.06 shares of common stock. See note 7
to our financial statements for a description of this preferred stock.
We are authorized to issue preferred stock in one or more series. We can
also establish the number of shares to be included in each series, to fix the
rights, preferences and privileges of the shares of each series and any of its
qualifications, limitations or restrictions. Our board can also increase or
decrease the number of shares of any series, but not below the number of shares
of that series then outstanding, without any further vote or action by the
shareholders.
The board may authorize the issuance of preferred stock with voting or
conversion rights that could adversely affect the voting power or other rights
of the holders of the common stock. The issuance of preferred stock, while
providing flexibility in connection with possible acquisitions and other
corporate purposes, could, among other things:
- have the effect of delaying, deferring or preventing a change in our
control; or
- may cause the market price of our common stock to decline; or
- impair the voting and other rights of the holders of our common stock.
We have no current plans to issue any shares of preferred stock.
65
<PAGE>
WARRANTS
As of June 30, 1999, we had outstanding the following warrants to purchase
our common stock:
<TABLE>
<CAPTION>
TOTAL NUMBER OF
SHARES SUBJECT EXERCISE PRICE
TO WARRANTS PER SHARE EXPIRATION DATE
- --------------- --------------- --------------------------------------------------
<C> <C> <S>
106,346 $ 0.05 January 21, 2002
36,363 1.10 December 31, 2002
36,363 1.10 June 30, 2003
35,876 1.30 June 30, 2004
16,307 1.30 3 years after this offering
147,221 1.80 3 years after this offering
</TABLE>
REGISTRATION RIGHTS
The holders of approximately 13,027,378 shares of common stock have the
right to require us to register their shares with the Securities and Exchange
Commission so that those shares may be publicly resold. They also have the right
to include their shares in any registration statement we file.
DEMAND REGISTRATION RIGHTS
At any time six months after this offering, shareholders with registration
rights can request that we file a registration statement so that they can
publicly sell their shares. The underwriters of any underwritten offering will
have the right to limit the number of shares to be included in the filed
registration statement.
WHO MAY MAKE A DEMAND. At any time six months after the closing of this
offering, GE Capital Equity Investments, Inc., VeriSign, Inc. or the holders of
at least 50% of the shares having registration rights have the right to demand
that we file a registration statement. The aggregate amount of securities to be
sold under the registration statement must exceed $7.5 million. If we are
eligible to file a registration statement on Form S-3, any holder of shares
having registration rights has the right to demand that we file a registration
statement on Form S-3, as long as the amount of securities to be sold under the
registration statement exceed $750,000.
NUMBER OF TIMES HOLDERS CAN MAKE DEMANDS. We will be required to file one
registration statement for each of GE Capital, VeriSign and the holders of at
least 50% of shares having registration rights. If we are eligible to file a
registration statement on Form S-3, we are not required to file more than one
registration statement during any 12 month period.
POSTPONEMENT. We may postpone the filing of a registration statement for up
to 90 days once in a 12-month period if we determine that the filing would be
seriously detrimental to us or our shareholders.
PIGGYBACK REGISTRATION RIGHTS
If we register any securities for public sale, shareholders with
registration rights will have the right to include their shares in that
registration statement. The underwriters of any underwritten offering will have
the right to limit the number of shares to be included in the registration
statement.
EXPENSES OF REGISTRATION
We will pay all expenses relating to any demand or piggyback registration.
However, we will not pay for any expenses of any demand registration if the
request is subsequently withdrawn by the holders of a majority of the shares
having registration rights, subject to very limited exceptions.
66
<PAGE>
EXPIRATION OF REGISTRATION RIGHTS
The registration rights described above will expire five years after this
offering is completed. The registration rights will terminate earlier with
respect to a particular shareholder if:
- that holder owns less than 1% of our outstanding securities;
- that holder can resell all of its securities in a three month period under
Rule 144 of the Securities Act; and
- we are subject to the reporting requirements of the Securities Exchange
Act.
ANTI-TAKEOVER PROVISIONS
Our articles of incorporation provides that our board of directors may issue
preferred stock with voting or other rights without shareholder action. Our
bylaws also provide that we will indemnify officers and directors against losses
that they may incur in investigations and legal proceedings resulting from their
services to us, which may include services in connection with takeover defense
measures. These provisions may have the effect of delaying, discouraging or
preventing changes in our management.
INDEMNIFICATION OF DIRECTORS AND EXECUTIVE OFFICERS AND LIMITATION OF LIABILITY
Our articles of incorporation limits the liability of directors to the
fullest extent permitted by California law. In addition, our articles of
incorporation and bylaws provide that we will indemnify our directors and
officers to the fullest extent permitted by California law. We intend to enter
into separate indemnification agreements with our directors and executive
officers that provide them indemnification protection in the event our articles
of incorporation is subsequently amended. For more information, please see
"Management-- Indemnification of Directors and Executive Officers and Limitation
of Liability."
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for our common stock is American Stock
Transfer and Trust Company. The address of our transfer agent and registrar is
40 Wall Street, New York, New York 10005, and its telephone number at this
location is (212) 936-5100.
LISTING
Our common stock will be quoted on the Nasdaq National Market under the
trading symbol "KEYN."
67
<PAGE>
SHARES ELIGIBLE FOR FUTURE SALE
Sales of substantial amounts of our common stock, including shares issued
upon exercise of outstanding warrants or options, in the public market after
this offering could adversely affect market prices prevailing from time to time
and could impair our ability to raise capital through the sale of our equity
securities. Furthermore, as described below, no shares currently outstanding
will be available for sale immediately after this offering due to contractual
restrictions on resale. Sales of substantial amounts of our common stock in the
public market after these restrictions lapse could adversely affect the
prevailing market price and our ability to raise equity capital in the future.
Upon completion of this offering, we will have outstanding 24,234,582 shares
of common stock, assuming the cash exercise of outstanding warrants to purchase
643,478 shares of common stock and the exercise of options to purchase 1,067,437
shares of common stock, as of June 30, 1999, and assuming no exercise of the
underwriters' over-allotment option. Of these shares, the 4,000,000 shares sold
in this offering will be freely tradable without restriction under the
Securities Act unless purchased by our "affiliates."
The remaining shares will become eligible for public sale as follows:
<TABLE>
<CAPTION>
APPROXIMATE NUMBER OF
ADDITIONAL SHARES THAT
DATE MAY BE SOLD COMMENT
- ------------------------------- -------------------------- ----------------------------------------------------
<S> <C> <C>
Date of this prospectus 0 Freely tradable shares
181 days after the date of this 15,785,352 Underwriter's lock-up released. These shares may be
prospectus sold under Rule 144, 144(k) or 701
April 26, 2000 3,403,791 Restricted securities held for at least one year may
be sold under Rule 144
April 30, 2000 322,413 Restricted securities held for at least one year may
be sold under Rule 144
May 11, 2000 79,548 Restricted securities held for at least one year may
be sold under Rule 144
One year after the date of this 643,478 Restricted securities held for at least one year may
prospectus be sold under Rule 144
</TABLE>
LOCK-UP AGREEMENTS
All of our officers and directors and substantially all of our shareholders
have signed lock-up agreements under which they agreed not to sell, dispose of,
loan, pledge or grant any rights with respect to any shares of common stock or
any securities convertible into or exercisable or exchangeable for shares of
common stock without the prior written consent of BancBoston Robertson Stephens
Inc. for a period of 180 days after the date of this prospectus.
BancBoston Robertson Stephens may choose to release some of these shares
from these restrictions prior to the expiration of this 180-day period, although
it has no current intention to do so.
RULE 144
In general, under Rule 144 as currently in effect, beginning 90 days after
the date of this prospectus, a person who has beneficially owned shares of our
common stock for at least one year would be entitled to sell within any
three-month period a number of shares that does not exceed the greater of:
- 1% of the number of shares of common stock then outstanding, which will
equal approximately 242,346 shares immediately after this offering; or
- the average weekly trading volume of the common stock on the Nasdaq
National Market during the four calendar weeks preceding the filing of a
notice on Form 144 with respect to the sale.
68
<PAGE>
Sales under Rule 144 are also subject to manner of sale provisions and
notice requirements and to the availability of current public information about
us.
RULE 144(k)
Under Rule 144(k), a person who has not been one of our affiliates at any
time during the 90 days preceding a sale, and who has beneficially owned the
shares proposed to be sold for at least two years, is entitled to sell those
shares without complying with the manner of sale, public information, volume
limitation or notice provisions of Rule 144. Therefore, unless otherwise
restricted, shares that have been held by a non-affiliate for at least two years
may be sold in the open market immediately after the lock-up agreements expire.
RULE 701
Any employee, officer or director of, or consultant to, us who purchased his
or her shares under a written compensatory plan or contract may be entitled to
sell his or her shares in reliance on Rule 701. Rule 701 permits affiliates to
sell their Rule 701 shares under Rule 144 without complying with the holding
period requirements of Rule 144. Rule 701 further provides that non-affiliates
may sell these shares in reliance on Rule 144 without having to comply with the
holding period, public information, volume limitation or notice provisions of
Rule 144. All holders of Rule 701 shares are required to wait until 90 days
after the date of this prospectus before selling those shares. However, all
shares issued under Rule 701 are subject to lock-up agreements and will only
become eligible for sale when the 180-day lock-up agreements expire.
REGISTRATION RIGHTS
Upon completion of this offering, the holders of 13,027,378 shares of common
stock, or their transferees, will be entitled to certain rights with respect to
the registration of those shares under the Securities Act. For a discussion of
these rights please see "Description of Capital Stock--Registration Rights."
After these shares are registered, they will be freely tradable without
restriction under the Securities Act.
STOCK OPTIONS
Immediately after this offering, we intend to file a registration statement
on Form S-8 under the Securities Act covering shares of common stock reserved
for issuance under our stock option and employee stock purchase plans. As of
June 30, 1999, options to purchase 1,067,437 shares of common stock were issued
and outstanding.
Because these options are immediately exercisable, upon the expiration of
the lock-up agreements described above, options to purchase at least 1,067,437
shares of common stock will be immediately exercisable, based on options
outstanding as of June 30, 1999. This registration statement on Form S-8 is
expected to be filed and become effective as soon as practicable after the
effective date of this offering. Accordingly, shares registered under this
registration statement will, subject to Rule 144 volume limitations applicable
to our affiliates, be available for sale in the open market immediately after
the lock-up agreements expire.
WARRANTS
As of June 30, 1999, we had outstanding warrants to purchase 378,478 shares
of common stock. When these warrants are exercised and the exercise price is
paid in cash, the shares must be held for one year before they can be sold under
Rule 144. Warrants to purchase up to 272,132 shares of common stock contain "net
exercise provisions." These provisions allow a holder to exercise the warrant
for a lesser number of shares of common stock instead of paying cash. The number
of shares which would be issued in this case would be based upon the market
price of the common stock at the time of the net exercise. If the warrant had
been held for at least one year at the time of the net exercise, the shares of
common stock could be publicly sold under Rule 144. After the lock-up agreements
described above expire, each of the outstanding warrants will have been
outstanding for at least one year.
69
<PAGE>
UNDERWRITING
The underwriters named below, acting through their representatives,
BancBoston Robertson Stephens Inc. ("Robertson Stephens"), Hambrecht & Quist LLC
and Dain Rauscher Wessels, a division of Dain Rauscher Incorporated, have
entered into an underwriting agreement with us and Umang Gupta, our chief
executive officer, to purchase the number of shares of common stock set forth
opposite their names below. The underwriters are committed to purchase and pay
for all of the shares listed below if any shares are purchased.
<TABLE>
<CAPTION>
NUMBER OF
UNDERWRITER SHARES
- ---------------------------------------------------------------------------- ----------------
<S> <C>
BancBoston Robertson Stephens Inc........................................... 1,620,000
Hambrecht & Quist LLC....................................................... 1,080,000
Dain Rauscher Wessels....................................................... 900,000
E*TRADE Securities, Inc..................................................... 200,000
Suretrade................................................................... 200,000
----------------
Total................................................................... 4,000,000
----------------
----------------
</TABLE>
Generally, we and Mr. Gupta have agreed to indemnify each underwriter
against liability arising out of any untrue statement contained in the
registration statement, any preliminary prospectus or the final prospectus, or
the omission of a material fact required to be stated in the registration
statement or such prospectus necessary to make the statements in the
registration statement or such prospectus not misleading. In addition, we and
Mr. Gupta have agreed to indemnify each underwriter against liability arising
out of violations of laws or regulations of foreign jurisdictions where reserved
shares have been offered. The underwriters have agreed to indemnify us and Mr.
Gupta against liability with respect to untrue statements or omissions, or
alleged untrue statements or omissions, made in the registration statement, any
preliminary prospectus or the final prospectus in reliance upon and in
conformity with written information furnished to us by that underwriter through
Robertson Stephens expressly for use in the registration statement, such
preliminary prospectus or the prospectus. For more detailed information on the
terms of indemnification contained in the underwriting agreement, please see
Exhibit 1.01 to the registration statement.
The shares of common stock are being offered by the several underwriters,
subject to prior sale, when, as and if issued to and accepted by them, subject
to approval of various legal matters by counsel for the underwriters and other
conditions. The underwriters reserve the right to withdraw, cancel or modify
this offer and to reject orders in whole or in part.
OVER-ALLOTMENT OPTION. We have granted to the underwriters an option,
exercisable during the 30-day period after the date of this prospectus, to
purchase up to 600,000 additional shares of common stock at the same price per
share as we and Mr. Gupta will receive for the 4,000,000 shares that the
underwriters have agreed to purchase. To the extent that the underwriters
exercise this option, each of the underwriters will have a firm commitment, to
purchase approximately the same percentage of these additional shares that the
number of shares of common stock to be purchased by it shown in the above table
represents as a percentage of the 4,000,000 shares in this offering. If
purchased, these additional shares will be sold by the underwriters on the same
terms as those on which the 4,000,000 shares are being sold.
LOCK-UP AGREEMENT. Each of our officers, directors and securityholders
agreed with the representatives or us for a period of 180 days after the
effective date of this prospectus, not to dispose of or hedge any shares of
common stock, or securities convertible into or exchangeable for shares of
common stock, now owned or later acquired by them without the prior written
consent of BancBoston Robertson Stephens Inc. However, BancBoston Robertson
Stephens Inc. may, in its sole discretion and at any time without notice,
release all or any portion of the securities subject to lock-up agreements. All
of the shares of common stock subject to the lock-up agreements will be eligible
for sale in the public market upon the expiration of the lock-up agreements,
subject to holding period, volume limitations and other conditions of Rule 144.
70
<PAGE>
FUTURE SALES. In addition, we have agreed that during the period of 180
days following the effective date of this prospectus, we will not, without the
prior written consent of BancBoston Robertson Stephens Inc., subject to limited
exceptions, including in connection with acquisitions, dispose of or hedge any
shares of common stock, or any securities convertible into, exercisable for or
exchangeable for shares of common stock, other than our sales of shares in this
offering, the issuance of common stock upon the exercise of outstanding options
or warrants or our issuance of options or shares under existing stock option or
stock purchase plans. See "Shares Eligible for Future Sales."
The underwriters do not intend to confirm sales to any accounts over which
they exercise discretionary authority.
DETERMINATION OF OFFERING PRICE. Prior to this offering, there has been no
public market for our common stock. Consequently, the initial public offering
price for the common stock in this offering will be determined through
negotiations among us and the representatives of the underwriters. The primary
considerations in determining the offering price are expected to be prevailing
market conditions, our financial information, the market valuation of other
companies that we and the representatives believe to be comparable to us,
estimates of our business potential and the business potential of the industry
in which we compete, an assessment of our management, our past and present
operation, the prospects for our future revenues and other factors deemed
relevant.
STABILIZATION. The representatives have advised us that, pursuant to
Regulation M under the Securities Act, some persons participating in the
offering may engage in transactions, including stabilizing bids, syndicate
covering transactions or the imposition of penalty bids that may have the effect
of stabilizing or maintaining the market price of the common stock at a level
above that which might otherwise prevail in the open market. A "stabilizing bid"
is a bid for or the purchase of the common stock on behalf of the underwriters
for the purpose of fixing or maintaining the price of the common stock. A
"syndicate covering transaction" is the bid for the purchase of the common stock
on behalf of the underwriters to reduce a short position incurred by the
underwriters in connection with the offering. A "penalty bid" is an arrangement
permitting the representatives to reclaim the selling concession otherwise
accruing to an underwriter or syndicate member in connection with the offering
if the common stock originally sold by this underwriter or syndicate member is
purchased by the representatives in a syndicate covering transaction and has
therefore not been effectively placed by this underwriter or syndicate member.
These transactions may be effected on the Nasdaq National Market or otherwise
and, if commenced, may be discontinued at any time.
COMMISSIONS AND DISCOUNTS. The representatives of the underwriters have
advised us that the underwriters propose initially to offer the shares of common
stock to the public at the initial public offering price set forth on the cover
page of this prospectus, and to certain dealers at that price less a concession
not in excess of $0.60 per share of common stock. The underwriters may allow,
and such dealers may reallow, a discount not in excess of $0.10 per share of
common stock to certain other dealers. After the initial public offering, the
public offering price, concession and discount may change.
The following table shows the per share and total underwriting discount to
be paid by us to the underwriters and the proceeds before expenses to us. This
information is presented assuming either no exercise or full exercise by the
underwriters of their over-allotment option.
<TABLE>
<CAPTION>
WITHOUT WITH
PER SHARE OPTION OPTION
--------- ------------- -------------
<S> <C> <C> <C>
Public offering price................................................... $ 14.00 $ 54,250,000 $ 62,650,000
Underwriting discount................................................... $ 0.98 $ 3,675,000 $ 4,263,000
Proceeds, before expenses, to Keynote................................... $ 13.02 $ 50,452,500 $ 58,264,500
</TABLE>
The underwriting fee will be an amount equal to the offering price per share
to the public of the common stock, less the amount paid by the underwriters to
Keynote per share of common stock. The underwriting fee is currently expected to
be approximately 7% of the initial public offering price. The
71
<PAGE>
expenses of the offering, exclusive of the underwriting discount, are estimated
at $750,000 and are payable entirely by us. These expenses include: filing fees
of approximately $27,403; legal, accounting and other professional services fees
of approximately $645,000; road show related expenses of approximately $30,000;
and approximately $47,597 in miscellaneous expenses.
INTERNET DISTRIBUTION. A limited number of shares will be made available to
the customers of E*TRADE Securities. E*TRADE will make a copy of the prospectus
in electronic format available on its web site located at www.etrade.com.
E*TRADE will accept conditional offers to purchase shares from all of its
customers that complete and pass an online eligibility profile. In the event
that the demand for shares from the customers of E*TRADE exceeds the amount of
shares allocated to it, E*TRADE will use a random allocation methodology to
distribute shares in even lots of 100 shares per customer. These are no plans to
direct shares to particular internet purchasers.
RESERVED SHARES. At our request, the underwriters have reserved for sale,
at the initial public offering price, up to nine percent of the shares offered
hereby to be sold to people associated with us, such as employees, vendors,
suppliers, existing shareholders and other persons that have relationships with
or are interested in us. No shares have been reserved for our directors or
officers. Indications of interest will be sought by means of a written notice,
which conforms to Rule 134, accompanied by a copy of this prospectus. The number
of shares of our common stock available for sale to the general public will be
reduced to the extent that those persons purchase the reserved shares. Any
reserved shares which are not confirmed for purchase will be offered by the
underwriters to the general public on the same terms as the other shares offered
by this prospectus.
72
<PAGE>
LEGAL MATTERS
Fenwick & West LLP, Palo Alto, California, will pass upon the validity of
the issuance of the shares of common stock offered by this prospectus. Brobeck,
Phleger & Harrison LLP, Palo Alto, California, will pass upon certain legal
matters in connection with this offering for the underwriters. As of June 30,
1999, an investment partnership and a partner of Fenwick & West LLP beneficially
owned an aggregate of 63,461 shares of our common stock.
EXPERTS
The financial statements of Keynote as of September 30, 1997 and 1998 and
June 30, 1999, and for each of the years in the three-year period ended
September 30, 1998 and for the nine months ended June 30, 1999, have been
included in this prospectus in reliance upon the report of KPMG LLP, independent
certified public accountants, appearing elsewhere in this prospectus, and upon
the authority of KPMG as experts in accounting and auditing.
Effective February 1999, our board of directors engaged KPMG as our
principal accountants to audit our financial statements. Keynote did not consult
with KPMG on any accounting or financial reporting matters in the periods before
their appointment. The change in accountants was approved by the board. Arthur
Andersen LLP served as our independent auditors from inception until the
dismissal of Arthur Andersen effective February 1999, which was approved by our
board. Arthur Andersen performed the first full fiscal year audit of our
financial statements for the then fiscal year ended December 31, 1996, as well
as the audit for the fiscal year ended December 31, 1997. The report of Arthur
Andersen on our financial statements prepared in connection with the December
31, 1996 and 1997 audits was unqualified. Furthermore, in connection with the
December 31, 1997 and 1996 audits and during the subsequent interim period prior
to the dismissal of Arthur Andersen, there were no disagreements between Arthur
Andersen and us on any matters of accounting principles or practices, financial
statement disclosure or auditing scope or procedure which, if not resolved to
the satisfaction of Arthur Andersen, would have caused Arthur Andersen to make
reference to the subject matter of such disagreements in connection with its
report.
Subsequent to KPMG's completion of the audit for the fiscal year ended
December 31, 1998, we changed our fiscal year end from December 31 to September
30. As the prior year audits performed by Arthur Andersen were as of December
31, KPMG audited the prior periods ended September 30 for the purposes of
inclusion in this prospectus.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed with the Securities and Exchange Commission, a registration
statement on Form S-1 under the Securities Act with respect to the shares of
common stock offered by this prospectus. This prospectus does not contain all of
the information set forth in the registration statement and related exhibits and
schedules. For further information with respect to us and our common stock being
offered, see the registration statement and the related exhibits and schedules.
Statements contained in this prospectus concerning the contents of any contract
or any other document are not necessarily complete. If a contract or document
has been filed as an exhibit to the registration statement, please see the copy
of the contract or document that has been filed. Each statement in this
prospectus relating to a contract or document filed as an exhibit is qualified
in all respects by the filed exhibit. The registration statement and the related
exhibits and schedules, may be inspected without charge at the principal office
of the Securities and Exchange Commission located at Room 1024, 450 Fifth
Street, Washington, D.C., 20549. Copies of all or any part of the registration
statement may be obtained from that office after payment of fees prescribed by
the Securities and Exchange Commission. The Securities and Exchange Commission
maintains a web site that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Securities and Exchange Commission at http://www.sec.gov.
We intend to provide our shareholders with annual reports containing
financial statements audited by an independent public accounting firm and
quarterly reports containing unaudited financial data for the first three
quarters of each year.
73
<PAGE>
KEYNOTE SYSTEMS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
Independent Auditors' Report............................................................................... F-2
Balance Sheets as of September 30, 1997 and 1998, and June 30, 1999........................................ F-3
Statements of Operations for the years ended September 30, 1996, 1997 and 1998, and for the nine months
ended June 30, 1998 (unaudited) and June 30, 1999........................................................ F-4
Statements of Shareholders' Equity (Deficit) for the years ended September 30, 1996, 1997 and 1998, and for
the nine months ended June 30, 1999...................................................................... F-5
Statements of Cash Flows for the years ended September 30, 1996, 1997 and 1998, and for the nine months
ended June 30, 1998 (unaudited) and June 30, 1999........................................................ F-6
Notes to Financial Statements.............................................................................. F-7
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors
Keynote Systems, Inc.:
We have audited the accompanying balance sheets of Keynote Systems, Inc.
(the Company) as of September 30, 1997 and 1998, and June 30, 1999, and the
related statements of operations, shareholders' equity (deficit), and cash flows
for each of the years in the three-year period ended September 30, 1998 and the
nine-month period ended June 30, 1999. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Keynote Systems, Inc. as of
September 30, 1997 and 1998, and June 30, 1999, and the results of its
operations and its cash flows for each of the years in the three-year period
ended September 30, 1998 and the nine-month period ended June 30, 1999, in
conformity with generally accepted accounting principles.
/s/ KPMG LLP
Mountain View, California
August 6, 1999 except as to note 12(c),
which is as of September 20, 1999
F-2
<PAGE>
KEYNOTE SYSTEMS, INC.
BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30, 1999
-------------------- ----------------------
1997 1998 ACTUAL PRO FORMA
--------- --------- --------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................ $ 1,150 $ 2,293 $ 17,152 $ 17,497
Accounts receivable, less allowance for doubtful
accounts of $10, $22, and $76, as of September 30,
1997 and 1998 and June 30, 1999..................... 55 454 1,691 1,691
Prepaids and other current assets.................... 32 55 816 816
--------- --------- --------- -----------
Total current assets............................... 1,237 2,802 19,659 20,004
Property and equipment, net............................ 431 1,105 2,709 2,709
Loans to related parties............................... -- -- 450 450
Other assets........................................... 2 11 44 44
--------- --------- --------- -----------
$ 1,670 $ 3,918 $ 22,862 $ 23,207
--------- --------- --------- -----------
--------- --------- --------- -----------
LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of notes payable..................... $ 83 $ 194 $ 1,097 $ 1,097
Current portion of capital lease obligation.......... -- -- 131 131
Accounts payable and accrued expenses................ 79 206 798 798
Deferred revenue..................................... 69 238 935 935
--------- --------- --------- -----------
Total current liabilities.......................... 231 638 2,961 2,961
Notes payable, less current portion.................... 199 303 2,853 2,853
Capital lease obligation, less current portion......... -- -- 287 287
--------- --------- --------- -----------
Total liabilities.................................. 430 941 6,101 6,101
--------- --------- --------- -----------
Commitments
Redeemable convertible preferred stock, $0.001 par
value; actual--21,781,478, 39,781,478 and 50,000,000
shares authorized as of September 30, 1997 and 1998,
and June 30, 1999, respectively; 10,745,285,
18,007,523, and 24,742,068 shares issued and
outstanding as September 30, 1997 and 1998, and June
30, 1999 respectively; aggregate liquidation
preference of $3,843, $8,564 and $23,447 as of
September 30, 1997 and 1998, and June 30, 1999,
respectively; pro forma-- 50,000,000 shares
authorized; no shares issued and outstanding......... 3,828 8,529 23,381 --
Shareholders' equity (deficit):
Common stock, $0.001 par value; 50,000,000 shares
authorized; actual--3,595,498, 4,927,301 and
6,059,769 shares issued and outstanding as of
September 30, 1997 and 1998, and June 30, 1999,
respectively; pro forma--50,000,000 shares
authorized; 18,913,667 shares issued and
outstanding......................................... 4 5 6 19
Additional paid-in capital........................... 102 347 3,920 27,288
Deferred stock-based compensation.................... -- -- (906) (906)
Shareholder notes receivable......................... (34) (326) (403) (403)
Accumulated deficit.................................. (2,660) (5,578) (9,237) (9,237)
--------- --------- --------- -----------
Total shareholders' equity (deficit)............. (2,588) (5,552) (6,620) 17,106
--------- --------- --------- -----------
$ 1,670 $ 3,918 $ 22,862 $ 23,207
--------- --------- --------- -----------
--------- --------- --------- -----------
</TABLE>
See accompanying notes to financial statements.
F-3
<PAGE>
KEYNOTE SYSTEMS, INC.
STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED SEPTEMBER 30, JUNE 30,
------------------------------- ----------------------
1996 1997 1998 1998 1999
--------- --------- --------- ----------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Revenues:
Subscription services.................................... $ -- $ 81 $ 1,539 $ 948 $ 4,026
Consulting services...................................... 30 -- -- -- 83
--------- --------- --------- ----------- ---------
Total revenues......................................... 30 81 1,539 948 4,109
--------- --------- --------- ----------- ---------
Expenses:
Cost of subscription services............................ -- 209 580 330 975
Cost of consulting services.............................. -- -- -- -- 254
Research and development................................. 392 732 1,226 838 1,297
Sales and marketing...................................... 186 817 1,529 931 2,989
Operations............................................... -- 63 514 292 1,024
General and administrative............................... 80 278 647 459 849
Amortization of stock-based compensation................. -- -- -- -- 234
--------- --------- --------- ----------- ---------
Total expenses......................................... 658 2,099 4,496 2,850 7,622
--------- --------- --------- ----------- ---------
Loss from operations................................... (628) (2,018) (2,957) (1,902) (3,513)
Interest income (expense), net............................. 6 (31) 39 24 (146)
--------- --------- --------- ----------- ---------
Net loss............................................... $ (622) $ (2,049) $ (2,918) $ (1,878) $ (3,659)
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
Basic and diluted net loss per share....................... $ (0.23) $ (0.84) $ (1.10) $ (0.72) $ (0.91)
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
Pro forma basic and diluted net loss per share............. $ (0.28) $ (0.26)
--------- ---------
--------- ---------
Shares used in computing basic and diluted net loss per
share.................................................... 2,733 2,434 2,661 2,594 4,032
--------- --------- --------- ----------- ---------
--------- --------- --------- ----------- ---------
Shares used in computing pro forma basic and diluted net
loss per share........................................... 10,376 14,133
--------- ---------
--------- ---------
</TABLE>
See accompanying notes to financial statements.
F-4
<PAGE>
KEYNOTE SYSTEMS, INC.
STATEMENTS OF SHAREHOLDERS' EQUITY (DEFICIT)
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL DEFERRED SHAREHOLDER TOTAL
------------------- PAID-IN STOCK-BASED NOTES ACCUMULATED SHAREHOLDERS'
SHARES AMOUNT CAPITAL COMPENSATION RECEIVABLE DEFICIT EQUITY (DEFICIT)
---------- ------- ---------- ------------ ----------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balances as of September 30,
1995........................ 1,929,048 $ 2 $ 21 $ -- $ -- $ 11 $ 34
Issuance of common stock
pursuant to exercise of
stock options for cash and
notes and purchase of
restricted shares with
notes....................... 1,440,952 1 69 -- (16) -- 54
Repurchase of common stock.... (666,667) -- (33) -- -- -- (33)
Net loss...................... -- -- -- -- -- (622) (622)
---------- ------- ---------- ------ ----- ----------- -------
Balances as of September 30,
1996........................ 2,703,333 3 57 -- (16) (611) (567)
Issuance of common stock
pursuant to exercise of
stock options and warrants
for cash and notes and
purchase of restricted
shares with notes........... 902,165 1 46 -- (32) -- 15
Repurchase of common stock.... (10,000) -- (1) -- -- -- (1)
Repayment of shareholder note
receivable.................. -- -- -- -- 14 -- 14
Net loss...................... -- -- -- -- -- (2,049) (2,049)
---------- ------- ---------- ------ ----- ----------- -------
Balances as of September 30,
1997........................ 3,595,498 4 102 -- (34) (2,660) (2,588)
Issuance of common stock
pursuant to exercise of
stock options for cash and
notes and purchase of
restricted shares with
notes....................... 1,845,116 2 365 -- (294) -- 73
Repurchase of common stock.... (513,313) (1) (120) -- -- -- (121)
Repayment of shareholder note
receivable.................. -- -- -- -- 2 -- 2
Net loss...................... -- -- -- -- -- (2,918) (2,918)
---------- ------- ---------- ------ ----- ----------- -------
Balances as of September 30,
1998........................ 4,927,301 5 347 -- (326) (5,578) (5,552)
Issuance of common stock
pursuant to exercise of
stock options for cash and
notes and purchase of
restricted shares with
notes....................... 1,153,249 1 2,434 -- (79) -- 2,356
Deferred compensation related
to stock option grants...... -- -- 1,059 (1,059) -- -- --
Amortization of stock-based
compensation................ -- -- -- 153 -- -- 153
Compensation related to
performance based stock
options..................... -- -- 81 -- -- -- 81
Repurchase of common stock.... (20,781) -- (1) -- -- -- (1)
Repayment of shareholder
note........................ -- -- -- -- 2 -- 2
Net loss...................... -- -- -- -- -- (3,659) (3,659)
---------- ------- ---------- ------ ----- ----------- -------
Balances as of June 30,
1999........................ 6,059,769 $ 6 $3,920 $(906) $(403) $(9,237) $(6,620)
---------- ------- ---------- ------ ----- ----------- -------
---------- ------- ---------- ------ ----- ----------- -------
</TABLE>
See accompanying notes to financial statements
F-5
<PAGE>
KEYNOTE SYSTEMS, INC.
STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED SEPTEMBER 30, JUNE 30,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Cash flows from operating activities:
Net loss........................................ $ (622) $ (2,049) $ (2,918) $ (1,878) $ (3,659)
Adjustments to reconcile net loss to net cash
used for operating activities:
Depreciation and amortization................. 27 133 336 210 523
Amortization of discount on notes............. -- 2 10 6 35
Amortization of stock-based compensation...... -- -- -- -- 153
Compensation related to performance based
stock options................................ -- -- -- -- 81
Changes in operating assets and liabilities:
Accounts receivable......................... 14 (55) (399) (217) (1,237)
Prepaids and other assets................... (23) (9) (32) (25) (1,244)
Accounts payable and accrued expenses....... 13 61 128 53 592
Deferred revenue............................ -- 69 169 18 696
--------- --------- --------- --------- ---------
Net cash used for operating activities.... (591) (1,848) (2,706) (1,833) (4,060)
--------- --------- --------- --------- ---------
Cash flows used for investing activities--
Purchases of property and equipment............. (157) (423) (1,011) (718) (1,708)
--------- --------- --------- --------- ---------
Cash flows from financing activities:
Repayments of notes payable................... -- (38) (134) (95) (227)
Proceeds from issuance of notes payable....... -- 320 338 346 3,646
Issuance of warrants to purchase preferred
stock in connection with notes............... -- 16 41 33 50
Net proceeds from issuance of preferred
stock........................................ 1,262 1,650 4,661 4,661 14,801
Proceeds from bridge financing................ -- 900 -- -- --
Proceeds from issuance of common stock........ 54 15 73 71 2,356
Repurchase of common stock.................... (33) (1) (121) (120) (1)
Repayments of shareholder notes............... -- 14 2 -- 2
--------- --------- --------- --------- ---------
Net cash provided by financing activities... 1,283 2,876 4,860 4,896 20,627
--------- --------- --------- --------- ---------
Net increase in cash and cash equivalents......... 535 605 1,143 2,345 14,859
Cash and cash equivalents at beginning of
period.......................................... 10 545 1,150 1,150 2,293
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of period........ $ 545 $ 1,150 $ 2,293 $ 3,495 $ 17,152
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Noncash financing activities:
Conversion of bridge financing to preferred
stock........................................ $ -- $ 900 $ -- $ -- $ --
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Issuance of common stock for shareholder notes
receivable................................... $ 16 $ 32 $ 294 $ 294 $ 79
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Deferred compensation related to stock option
grants....................................... $ -- $ -- $ -- $ -- $ 1,059
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
Purchase of property and equipment through
capital leases............................... $ -- $ -- $ -- $ -- $ 418
--------- --------- --------- --------- ---------
--------- --------- --------- --------- ---------
</TABLE>
See accompanying notes to financial statements.
F-6
<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS
SEPTEMBER 30, 1996, 1997 AND 1998, AND JUNE 30, 1998 AND 1999
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JUNE 30, 1998 IS UNAUDITED)
(1) THE COMPANY
Keynote Systems, Inc. (the Company) was incorporated on June 15, 1995, for
the purpose of developing and licensing new technologies to measure and manage
the responsiveness of Web-based business applications on the Internet,
intranets, and extranets.
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) REVENUE RECOGNITION
Subscription services revenue consists of fees from subscriptions to the
Company's Internet measurement and diagnostic services. Subscription revenues
are deferred upon the customer's invoicing and are recognized ratably over the
service period, generally ranging from one to twelve months. Deferred revenue is
comprised entirely of deferred subscription revenue. Revenue from consulting
services is recognized as the services are performed, typically a period of one
month. For longer consulting projects, the Company anticipates recognizing
revenue on a percentage of completion basis.
Cost of subscription revenues consists of connection fees to Internet
service providers for deployment of our computer measurement agents around the
world, depreciation, maintenance and other equipment charges for our measurement
infrastructure. Cost of consulting services consists of compensation for
consulting personnel and related costs. Operations expenses consist primarily of
compensation and related costs for management personnel, technical support
employees and consultants who manage and maintain our measurements and
headquarter infrastructure and support our customer base.
(b) USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
(c) INITIAL PUBLIC OFFERING AND UNAUDITED PRO FORMA BALANCE SHEET
In June 1999, the Board of Directors authorized the filing of a registration
statement with the Securities and Exchange Commission (SEC) that would permit
the Company to sell shares of the Company's common stock in connection with a
proposed initial public offering (IPO). If the offering is consummated under the
terms presently anticipated, all the then outstanding shares of the Company's
Series A, Series B and Series D redeemable convertible preferred stock will
automatically convert into 0.50 of a share of common stock and each outstanding
share of Series C redeemable convertible preferred stock will convert into 0.53
of a share of common stock upon the closing of the proposed IPO. The conversion
of all of the redeemable convertible preferred stock, and the exercise of a
warrant to purchase 500,000 shares of Series C redeemable convertible preferred
stock at $0.65 per share, which will convert into 265,000 shares of common stock
upon the closing of the offering, have been reflected in the accompanying
unaudited pro forma balance sheet as if it had occurred on June 30, 1999.
F-7
<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997 AND 1998, AND JUNE 30, 1998 AND 1999
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JUNE 30, 1998 IS UNAUDITED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(d) CASH AND CASH EQUIVALENTS
The Company considers all cash and highly liquid investments with an
original maturity of three months or less to be cash equivalents. As of
September 30, 1997 and 1998 and June 30, 1999, cash and cash equivalents consist
of checking and money market accounts. The Company is exposed to credit risk in
the event of default of the financial institutions to the extent of the amounts
recorded on the balance sheet.
(e) PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost less accumulated depreciation
and amortization. Depreciation is calculated using the straight-line method over
the estimated useful lives of the respective assets, generally three years.
Equipment under capital leases is amortized over the shorter of the useful life
of the equipment or the lease term. Leasehold improvements are amortized over
the shorter of the estimated useful lives of the assets or the lease term.
(f) COMPREHENSIVE INCOME (LOSS)
The Company has no components of other comprehensive loss for any period
presented.
(g) FINANCIAL INSTRUMENTS AND CONCENTRATION OF CREDIT RISK
The carrying value of the Company's financial instruments, including cash
and cash equivalents, accounts receivable and equipment notes payable
approximates fair market value. Cash and cash equivalents and accounts
receivable approximate fair market value due to their short term nature.
Equipment notes approximate fair market value as interest rates on these notes
approximate market rates. Financial instruments that subject the Company to
concentrations of credit risk consist primarily of cash and cash equivalents and
trade accounts receivable.
Credit risk is concentrated in North America. The Company performs ongoing
credit evaluations of its customers' financial condition and, generally,
requires no collateral from its customers. The Company has had immaterial
write-offs of accounts receivable to date. Based on its ongoing credit
evaluations, the Company has adequately reserved for doubtful accounts as of the
date of each balance sheet presented herein.
(h) PREPAIDS AND OTHER ASSETS
Prepaids and other assets consist principally of deposits under operating
leases, advances to employees and prepayments.
(i) STOCK-BASED COMPENSATION
The Company accounts for stock option grants under SFAS No. 123, ACCOUNTING
FOR STOCK-BASED COMPENSATION, which permits the use of the intrinsic-value
method in accordance with Accounting Principles Board (APB) Opinion No. 25,
ACCOUNTING FOR STOCK ISSUED TO EMPLOYEES, and related interpretations. Expense
associated with stock-based compensation is being amortized ratably over the
vesting period of the individual award.
F-8
<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997 AND 1998, AND JUNE 30, 1998 AND 1999
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JUNE 30, 1998 IS UNAUDITED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
(j) INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases and operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. A valuation allowance is established when necessary to reduce
deferred tax assets to the amounts expected to be realized.
(k) IMPAIRMENT OF LONG-LIVED ASSETS
The Company evaluates its long-lived assets for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Recoverability of assets to be held and used is measured by
a comparison of the carrying amount of an asset to future net cash flows
expected to be generated by the asset. If such assets are considered to be
impaired, the impairment to be recognized is measured by the amount by which the
carrying amount of the assets exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or fair value less
costs to sell.
(l) RESEARCH AND DEVELOPMENT
Research and development costs are expensed as incurred until technological
feasibility has been established. To date, the Company's service offerings have
been available for general release concurrent with the establishment of
technological feasibility and, accordingly, no development costs have been
capitalized.
(m) ACCOUNTING FOR CERTAIN INVESTMENTS IN DEBT AND EQUITY SECURITIES
The Company classifies its investments in debt and equity securities as
available-for-sale. Available-for-sale securities are carried at fair market
value, which approximates amortized cost. As of September 30, 1997 and 1998 and
June 30, 1999, the Company had no investments in debt or equity securities.
(n) UNAUDITED INTERIM FINANCIAL STATEMENTS
The accompanying unaudited interim financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information. In the opinion of management, the accompanying unaudited
financial statements have been prepared on the same basis as the audited
financial statements and include all adjustments, consisting only of normal
recurring adjustments, for the fair presentation of the Company's results of
operations and its cash flows for the nine months ended June 30, 1998. The
results reported for the interim period are not indicative of the results for
the year.
(o) NET LOSS PER SHARE
Basic net loss per share is computed using the weighted-average number of
outstanding shares of common stock excluding shares of restricted stock subject
to repurchase summarized below. Diluted net loss
F-9
<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997 AND 1998, AND JUNE 30, 1998 AND 1999
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JUNE 30, 1998 IS UNAUDITED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
per share is computed using the weighted-average number of shares of common
stock outstanding and, when dilutive, potential common shares from options and
warrants to purchase common stock using the treasury stock method and from
convertible securities using the "if-converted" basis.
The following potential common shares have been excluded from the
computation of diluted net loss per share for all periods presented because the
effect would have been antidilutive (in thousands):
<TABLE>
<CAPTION>
NINE MONTHS ENDED
YEARS ENDED SEPTEMBER 30, JUNE 30,
------------------------------- --------------------
1996 1997 1998 1998 1999
--------- --------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
Shares issuable under stock
options............................ 75 297 742 570 1,067
Shares of restricted stock subject to
repurchase......................... 370 1,028 2,036 2,222 912
Shares issuable pursuant to warrants
to purchase:
convertible preferred stock........ -- 36 390 374 537
common stock....................... -- 110 110 110 106
Shares of convertible preferred stock
on an "as-if" converted basis...... 3,039 5,373 9,222 9,222 12,589
</TABLE>
The weighted-average exercise price of outstanding stock options was $0.05
$0.13, $0.21, $0.18, and $3.20 for the years ended September 30, 1996, 1997 and
1998, and for the nine months ended June 30, 1998 and 1999, respectively. The
weighted-average purchase price of restricted stock was $0.06, $0.06, $0.16,
$0.16, and $0.26 for the years ended September 30, 1996, 1997 and 1998, and for
the nine months ended June 30, 1998 and 1999, respectively. The weighted-average
exercise price of the convertible preferred stock warrants was $1.10, $1.26,
$1.26, and $1.40 for the years ended September 30, 1997 and 1998, and for the
nine months ended June 30, 1998 and 1999, respectively. The weighted average
exercise price of common stock warrants was $0.05 for all periods presented.
Pro forma basic and diluted net loss per share is presented for the year
ended September 31, 1998 and for the nine months ended June 30, 1999 to reflect
per share data assuming the conversion of each outstanding share of Series A
preferred stock, Series B preferred stock and Series D preferred stock into 0.50
of a share of common stock and of each share of Series C preferred stock into
0.53 of a share of common stock, and the exercise of a warrant to purchase
265,000 shares of common stock by Umang Gupta, the Company's chief executive
officer, prior to the closing of the proposed IPO, as if the conversion of the
preferred stock and the exercise of the warrant had taken place at the beginning
of fiscal 1998 or at the date of issuance, if later. This data is unaudited.
(p) RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards, or SFAS, No. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES. SFAS No. 133 establishes accounting and
reporting standards for derivative financial instruments and hedging activities
related to those instruments, as well as other hedging activities. Because we do
not currently hold any
F-10
<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997 AND 1998, AND JUNE 30, 1998 AND 1999
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JUNE 30, 1998 IS UNAUDITED)
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
derivative instruments and do not engage in hedging activities, we expect that
the adoption of SFAS No. 133 will not have a material impact on our financial
position, results of operations or cash flows. We will be required to adopt SFAS
No. 133 in fiscal 2001.
(3) SHAREHOLDER NOTES RECEIVABLE AND LOANS TO RELATED PARTIES
In April 1998, the Company issued a shareholder note to an officer for
$280,000 for the purchase of common stock. In May 1998, the Company issued a
shareholder note to this officer for $300,000, in connection with the
acceleration of the lapse of the Company's repurchase right with respect to the
shares of common stock owned by him. In June 1999, these loans were consolidated
into a single loan that accrues interest at a rate of 6% and is due and payable
on or before December 31, 2001. The loan is with full recourse and secured by a
stock pledge agreement.
In January 1999, the Company issued a full recourse shareholder note to an
officer, secured by a stock pledge agreement for $75,000 related to the purchase
of common stock. The note accrues interest at a rate of 7% and is payable on or
before January 2004. Additionally, the Company loaned the officer $150,000 in
connection with a relocation he made on joining the Company. The loan is secured
by a security agreement, accrues interest at a rate of 9% and is due and payable
on or before January 2002.
(4) PROPERTY AND EQUIPMENT
A summary of property and equipment consisted of the following (in
thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
-------------------- JUNE 30,
1997 1998 1999
--------- --------- -----------
<S> <C> <C> <C>
Computer equipment and software............................... $ 553 $ 1,536 $ 3,574
Furniture and fixtures........................................ 24 52 140
Leasehold improvements........................................ 16 16 16
--------- --------- -----------
593 1,604 3,730
Less accumulated depreciation and amortization................ (162) (499) (1,021)
--------- --------- -----------
$ 431 $ 1,105 $ 2,709
--------- --------- -----------
--------- --------- -----------
</TABLE>
(5) NOTES PAYABLE
Notes payable comprised the following (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1998 1999
--------------- -----------
<S> <C> <C>
Equipment notes at an annual interest rate of between 5.60% and
10.25% payable in monthly installments, aggregating approximately
$123,000 monthly through April 2002.............................. $ 542 $ 3,270
Promissory note at an annual interest rate of 8.25% payable in
February 2002.................................................... -- 750
Discount........................................................... (45) (70)
----- -----------
497 3,950
Less current portion............................................... 194 1,097
----- -----------
$ 303 $ 2,853
----- -----------
----- -----------
</TABLE>
F-11
<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997 AND 1998, AND JUNE 30, 1998 AND 1999
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JUNE 30, 1998 IS UNAUDITED)
(5) NOTES PAYABLE (CONTINUED)
As of June 30, 1999, the aggregate maturities of notes payable for the years
ending June 30, 2000, 2001 and 2002 are as follows: $1,097,000, $1,394,000 and
$1,529,000, respectively. The Company has granted a security interest in
substantially all of its assets to secure the equipment and promissory notes.
In connection with certain of the equipment notes, the Company issued
warrants for the purchase of 145,454 shares of Series B redeemable convertible
preferred stock at $0.55 per share and warrants for the purchase of 376,238
shares of Series C redeemable convertible preferred stock at $0.65 and $0.90 per
share. Of the 145,454 Series B warrants issued, 72,727 expire on December 31,
2002, and 72,727 expire on June 30, 2003. The Series C warrants expire by June
30, 2004. As of June 30, 1999, the lender had not exercised the warrants. The
fair value of the warrants on the dates of issuance determined using the Black-
Scholes option pricing model has been recorded in Preferred Stock and as a
discount on the notes payable. The value of the warrants recorded in each of the
years ended September 30, 1997 and 1998 and the nine months ended June 30, 1999
were $16,000, $41,000 and $50,000, respectively. The fair value of each warrant
was estimated using the following assumptions: no dividends, risk free interest
rate of between 5.5% and 6.7%, volatility of 50% and a contractual life of five
years. The note discount is being amortized to interest expense using the
interest method over the term of the related notes payable.
(6) WARRANTS
In connection with a $900,000 1997 bridge financing to a related party which
later converted to shares of Series B preferred stock, the Company issued
warrants to purchase 180,000 common shares. The warrants are exercisable at
$0.05 per share and expire on the earlier of January 21, 2002, or the closing of
an underwritten initial public offering of the Company's common stock. To date,
warrants to purchase 73,654 shares of common stock were exercised and warrants
to purchase 106,346 shares of common stock remain outstanding. The fair value of
each warrant was estimated on the date of grant using the Black-Scholes option
pricing model with the following assumptions: no dividends, risk free interest
rate of 6.32%, volatility of 50% and contractual life of 5 years. The fair value
of the warrants at the date of grant was not material. In December 1997, the
Company issued a warrant to an officer to purchase 500,000 shares of Series C
redeemable convertible preferred stock at a price of $0.65 per share,
representing the fair value of a Series C redeemable convertible preferred
share. This warrant, which is now convertible into an aggregate of 265,000
shares of common stock, expires on the earlier of December 9, 2000 or the
closing of an underwritten initial public offering. In January 1997, the Company
issued a warrant to an officer to purchase 70,000 shares of common stock at a
purchase price of $0.05 per share, representing the fair value of a common
share. In July 1997, these warrants were exercised.
F-12
<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997 AND 1998, AND JUNE 30, 1998 AND 1999
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JUNE 30, 1998 IS UNAUDITED)
(7) REDEEMABLE CONVERTIBLE PREFERRED STOCK
Redeemable convertible preferred stock outstanding as of June 30, 1999, is
as follows:
<TABLE>
<CAPTION>
SHARES ISSUED AND
DESIGNATED OUTSTANDING CARRYING VALUE
------------ ------------ --------------
<S> <C> <C> <C>
Series:
Series A........................................ 6,078,444 6,078,444 $ 1,261,790
Series A1....................................... 6,078,444 -- --
Series B........................................ 4,812,295 4,666,841 2,582,371
Series B1....................................... 4,812,295 -- --
Series C........................................ 8,138,476 7,262,238 4,735,923
Series C1....................................... 8,138,476 -- --
Series D........................................ 8,000,000 6,734,545 14,801,013
------------ ------------ --------------
46,058,430 24,742,068 $ 23,381,097
------------ ------------ --------------
------------ ------------ --------------
</TABLE>
The issuance costs associated with the issuance of Series A, B, C and D
redeemable convertible preferred stock was approximately $15,000, $16,000,
$60,000 and $82,000, respectively.
The rights and preferences of Series A, B, C and D redeemable convertible
preferred stock are as follows:
- Each share of preferred stock is convertible into 0.5 of a share of common
stock at the option of the shareholder, subject to adjustments to prevent
dilution in the event of a stock split, stock dividend, combination, or
recapitalization, except for Series C which is convertible into 0.53 of a
share of common stock.
- Each share will automatically convert into common stock in the event of
the closing of an underwritten public offering of the Company's common
stock resulting in proceeds of more than $20,000,000 for an offering price
not less than $10.00 per share.
- In the event of any liquidation, dissolution, or winding up of the
Company, holders of Series A, B, C and D preferred stock are entitled to
receive, in preference to holders of common stock, the amount of $0.21,
$0.55, $0.65 and $2.21 per share, respectively, plus all declared but
unpaid dividends prior to any distribution to the holders of common stock.
In the event funds are not available to sufficiently satisfy the full
preferential amount, the entire assets of the Company will be distributed
to the holders of preferred stock ratably based on the total preferential
amount of preferred stock held.
- The holders of Series A, B, C and D preferred stock are entitled to
receive noncumulative dividends at an annual rate of $0.02, $0.06, $0.07
and $0.22 per share, respectively, as and if declared by the Board of
Directors. Dividends declared are prior and in preference to the payment
of dividends on common stock. To date, no dividends have been declared.
- Each share of preferred stock is entitled to voting rights equal to the
number of shares of common stock into which such preferred stock is
convertible.
F-13
<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997 AND 1998, AND JUNE 30, 1998 AND 1999
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JUNE 30, 1998 IS UNAUDITED)
(7) REDEEMABLE CONVERTIBLE PREFERRED STOCK (CONTINUED)
- At the election of at least a majority of the holders of preferred stock,
the Company shall be required to redeem the outstanding Series A, B, C and
D preferred stock in three equal annual installments beginning on April
15, 2002. Such redemptions shall be at a purchase price equal to the
original purchase price per share plus any declared and unpaid dividends.
(8) SHAREHOLDERS' EQUITY (DEFICIT)
(a) STOCK OPTION PLANS
As of June 30, 1999, the Company is authorized to issue up to 5.1 million
shares of common stock in connection with its 1996 and 1999 stock option plans
(the Plans) to employees, directors, and consultants. The Plans provide for the
issuance of incentive stock options or nonqualified stock options.
The stock options are generally immediately exercisable subject to a
restricted stock purchase agreement whereby the Company has the right to
repurchase the unvested portion of the shares upon the voluntary or involuntary
termination of the purchaser's employment with the Company at the original
issuance cost. The Company's right of repurchase lapses with respect to 25% of
the shares after one year, and ratably on a monthly basis over the following
three years. Through June 30, 1999, the Company has issued shares under the
Plans, of which 912,000 million are subject to repurchase at a weighted-average
price of $0.26 per share. Certain of these restricted shares were issued to
officers and employees of the Company for full recourse promissory notes with
interest rates ranging from 6% to 7% and terms of 5 years.
Under the Plans, the exercise price for incentive stock options is at least
100% of the stock's fair market value on the date of the grant for employees
owning less than 10% of the voting power of all classes of stock, and at least
110% of the fair market value on the date of grant for employees owning more
than 10% of the voting power of all classes of stock. For nonqualified stock
options, the exercise price is also at least 110% of the fair market value on
the date of grant for employees owning more than 10% of the voting power of all
classes of stock and no less than 85% for employees owning less than 10% of the
voting power of all classes of stock. Options expire 10 years after the date of
grant.
(b) STOCK-BASED COMPENSATION
The Company uses the intrinsic-value method in accounting for its employee
stock-based compensation plans. Accordingly, no compensation cost has been
recognized for any of its stock options granted because the exercise price of
each option equaled or exceeded the fair value of the underlying common stock as
of the grant date for each stock option, except for stock options granted from
October 1998 to April 1999. With respect to the stock options granted from
October 1998 to April 1999, the Company recorded deferred stock compensation of
$1,059,000 for the difference at the grant date between the exercise price of
each stock option granted and the fair value of the underlying common stock.
This amount is being amortized on a straight line basis over the vesting period,
generally four years. Had the Company determined compensation
F-14
<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997 AND 1998, AND JUNE 30, 1998 AND 1999
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JUNE 30, 1998 IS UNAUDITED)
(8) SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
costs based on the fair value at the grant date for its stock options under SFAS
No. 123 for all of the Company's stock-based compensation plans, net loss and
basic and diluted net loss per share would have been as follows:
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30, NINE MONTHS
------------------------------- ENDED JUNE 30,
1996 1997 1998 1999
--------- --------- --------- --------------
<S> <C> <C> <C> <C>
Net loss (in thouands):
As reported................................... $ (622) $ (2,049) $ (2,918) $ (3,659)
--------- --------- --------- -------
--------- --------- --------- -------
Pro forma..................................... $ (622) $ (2,051) $ (2,934) $ (4,167)
--------- --------- --------- -------
--------- --------- --------- -------
Basic and diluted net loss per share:
As reported................................... $ (0.23) $ (0.84) $ (1.10) $ (0.91)
--------- --------- --------- -------
--------- --------- --------- -------
Pro forma..................................... $ (0.23) $ (0.84) $ (1.10) $ (1.03)
--------- --------- --------- -------
--------- --------- --------- -------
</TABLE>
The fair value of each option was estimated on the date of grant using the
minimum value method with the following weighted-average assumptions: no
dividends, risk free interest rate of 6.60%, 6.22%, 5.55% and 5.16% for fiscal
1996, 1997 and 1998 and for the nine months ended June 30, 1999, respectively,
and expected life of 3.77, 3.17, 2.84 and 2.51 years for fiscal 1996, 1997 and
1998 and for the nine months ended June 30, 1999, respectively.
A summary of activity under the Company's option plans is as follows (in
thousands, except per share data):
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30,
----------------------------------------------------------
NINE MONTHS ENDED
1996 1997 1998 JUNE 30, 1999
------------------ ----------------- ----------------- -----------------
WEIGHTED- WEIGHTED- WEIGHTED- WEIGHTED-
AVERAGE AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE SHARES PRICE
------ --------- ------ --------- ------ --------- ------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Outstanding at beginning of
period........................... -- $ -- 75 $ 0.05 297 $ 0.14 742 $ 0.21
Granted............................ 370 0.05 1,106 0.07 2,346 0.21 1,132 3.34
Exercised.......................... (290) 0.05 (832) 0.05 (1,845) 0.20 (711) 0.70
Canceled........................... (5) 0.05 (52) 0.05 (56) 0.13 (96) 0.35
------ ------ ------ ------
Outstanding at end of period....... 75 0.05 297 0.14 742 0.21 1,067 3.20
------ ------ ------ ------
------ ------ ------ ------
Options exercisable at end of
period........................... 30 0.05 185 0.13 642 0.21 654 1.32
------ ------ ------ ------
------ ------ ------ ------
Weighted-average fair value of
options granted during the period
with exercise prices equal to
fair value at date of grant...... 0.01 0.01 0.03 0.91
Weighted-average fair value of
options granted during the period
with exercise prices less than
fair value at date of grant...... -- -- -- 1.65
</TABLE>
F-15
<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997 AND 1998, AND JUNE 30, 1998 AND 1999
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JUNE 30, 1998 IS UNAUDITED)
(8) SHAREHOLDERS' EQUITY (DEFICIT) (CONTINUED)
The following table summarizes information about stock options outstanding
as of June 30, 1999 (in thousands, except per share data):
<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
----------------------------------------------- ----------------------------
NUMBER WEIGHTED-AVG. NUMBER
OUTSTANDING REMAINING WEIGHTED-AVG. OUTSTANDING WEIGHTED-AVG.
EXERCISE PRICES AT 6/30/99 CONTRACTUAL LIFE EXERCISE PRICE AT 6/30/99 EXERCISE PRICE
- --------------------------------------- ----------- ----------------- --------------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
$0.03 43,353 7.78 $ 0.03 43,103 $ 0.03
From $0.10 to $0.12 187,677 8.89 0.12 182,677 0.12
From $0.25 to $0.30 132,500 9.49 0.26 112,500 0.25
$0.80 275,384 10.00 0.80 250,384 0.80
$1.60 56,400 10.00 1.60 1,250 1.60
$2.21 84,000 10.00 2.21 42,500 2.21
$4.00 288,125 10.00 4.00 21,250 4.00
----------- ----- ----- ----------- -----
From $0.03 to $4.00 1,067,439 9.65 $ 1.60 653,664 $ 0.66
----------- ----- ----- ----------- -----
----------- ----- ----- ----------- -----
</TABLE>
The Company has granted approximately 85,000 performance-based stock options
to various employees. The Company has accounted for the options in accordance
with APB 25. As a result, the Company recorded a compensation charge of $81,000
during the nine-month period ended June 30, 1999.
(9) INCOME TAXES
The differences between the income tax benefit computed at the federal
statutory rate and the Company's tax provision for all periods presented
primarily relate to net operating losses not benefited. The components of net
deferred tax are as follows (in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
-------------------- JUNE 30,
1997 1998 1999
--------- --------- -----------
<S> <C> <C> <C>
Deferred start-up costs...................................... $ 300 $ 235 $ 186
Net operating loss carryforwards............................. 710 1,832 3,075
Tax credit carryforwards..................................... 56 141 221
Other........................................................ 11 21 180
--------- --------- -----------
Total deferred tax assets.................................... 1,077 2,229 3,662
Valuation allowance.......................................... (1,077) (2,229) (3,662)
--------- --------- -----------
Net deferred tax assets...................................... $ -- $ -- $ --
--------- --------- -----------
--------- --------- -----------
</TABLE>
In light of the Company's recent history of operating losses, the Company
has provided a valuation allowance for all of its deferred tax assets as it is
presently unable to conclude that it is more likely than not that the deferred
tax assets will be realized.
As of June 30, 1999 the Company had net operating loss carryforwards for
federal income tax reporting purposes of approximately $8,193,000 available to
reduce future income subject to income taxes. As of June 30, 1999, the Company
had net operating loss carryforwards for state income tax purposes of
F-16
<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997 AND 1998, AND JUNE 30, 1998 AND 1999
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JUNE 30, 1998 IS UNAUDITED)
(9) INCOME TAXES (CONTINUED)
approximately $4,941,000 available to reduce future income subject to income
taxes. The federal net operating loss carryforwards expire in various periods
through 2019. State net loss carryforwards expire in various periods through
2004. In addition, as of June 30, 1999, the Company had federal research and
development tax credit carryforwards of approximately $148,000. The federal
credit carryforwards expire in various periods through 2019. As of June 30,
1999, the Company had California research and development tax credit
carryforwards of approximately $110,000. The California credit may be carried
over indefinitely. The U.S. Tax Reform Act of 1986 contains provisions that
limit the net operating loss carryforwards and research and development credits
available to be used in any given year upon the occurrence of certain events,
including a significant change to ownership.
(10) LEASES
The Company leases its facilities and certain equipment under noncancelable
operating leases, which expire on various dates through December 2000.
Additionally, the Company has recorded equipment under capital lease. At June
30, 1999, future minimum payments under the leases are as follows (in
thousands):
<TABLE>
<CAPTION>
YEARS ENDED SEPTEMBER 30, OPERATING CAPITAL
- ------------------------------------------------------------------------- ----------- ---------
<S> <C> <C>
1999..................................................................... $ 241 $ 39
2000..................................................................... 726 154
2001..................................................................... - 154
2002..................................................................... - 116
----------- ---------
$ 967 463
-----------
-----------
Less amount representing interest........................................ 45
---------
Present value of minimum lease payments.................................. 418
Current portion of capital lease obligation.............................. 131
---------
Capital lease obligation, less current portion........................... $ 287
---------
---------
</TABLE>
Rent expense for the years ended September 30, 1996, 1997 and 1998 and for
the nine months ended June 30, 1998 and 1999 was approximately $21,000, $84,000,
$115,000, $86,000 and $310,000, respectively.
(11) GEOGRAPHIC, SEGMENT, AND SIGNIFICANT CUSTOMER INFORMATION
In fiscal 1999, the Company adopted SFAS No. 131, DISCLOSURES ABOUT SEGMENTS
OF AN ENTERPRISE AND RELATED INFORMATION. SFAS No. 131 establishes standards for
the manner in which public companies report information about operating segments
in annual and interim financial statements. It also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. The method for determining what information to report is based on the
way management organizes the operating segments within the Company for making
operating decisions and assessing financial performance. The Company's chief
operating decision-maker is considered to be the chief executive officer (CEO).
The financial information that the CEO reviews is identical to the information
presented in the accompanying statements of operations. Therefore, the Company
has determined that it operates in a single operating segment: developing and
selling services to measure, assure and improve the quality of service of web
sites.
F-17
<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO FINANCIAL STATEMENTS (CONTINUED)
SEPTEMBER 30, 1996, 1997 AND 1998, AND JUNE 30, 1998 AND 1999
(INFORMATION AS OF AND FOR THE NINE MONTHS ENDED JUNE 30, 1998 IS UNAUDITED)
(11) GEOGRAPHIC, SEGMENT, AND SIGNIFICANT CUSTOMER INFORMATION
The Company markets its products from its operations in the United States.
International sales are primarily to customers in Europe. These sales and
foreign-owned assets are not significant.
Significant customer information is as follows:
<TABLE>
<CAPTION>
PERCENT OF TOTAL REVENUE
------------------------------------------
NINE MONTHS PERCENT OF
YEARS ENDED SEPTEMBER TOTAL ACCOUNTS RECEIVABLE
30, ENDED JUNE 30, ----------------------------
------------------------ --------------- SEPTEMBER 30, JUNE 30,
1996 1997 1998 1998 1999 1998 1999
------ ------ ------ ------ ------ --------------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
Customer A.................... -- 11% 1% 1% -- -- --
Customer B.................... -- 1% 15% 18% 7% 10% 10%
</TABLE>
(12) SUBSEQUENT EVENTS
(a) 1999 EQUITY INCENTIVE PLAN
In September 1999, the Company adopted the 1999 Equity Incentive Plan
(Incentive Plan). The Incentive Plan provides for the award of incentive stock
options, nonqualified stock options, restricted stock awards and stock bonuses.
Options may be exercisable only as they vest or may be immediately exercisable
with the shares issued subject to the Company's right of repurchase that lapses
as the shares vest. In general, options will vest over a four-year period.
(b) 1999 EMPLOYEE STOCK PURCHASE PLAN
In September 1999, the Company adopted the 1999 Employee Stock Purchase Plan
(Purchase Plan) and reserved 400,000 shares of common stock for issuance under
this plan. The number of shares reserved under the Purchase Plan will increase
automatically on January 1 of each calendar year by a number of shares equal to
1% of the Company's outstanding shares on the preceding December 31. Under the
Purchase Plan, eligible employees may defer an amount not to exceed 10% of the
employee's compensation, as defined in the Purchase Plan, to purchase common
stock of the Company. The purchase price per share will be 85% of the lesser of
the fair market value of the common stock on the first day of the applicable
offering period and the last day of each purchase period. The Purchase Plan will
be intended to qualify as an "employee stock purchase plan" under Section 423 of
the Internal Revenue Code.
(c) STOCK SPLIT
On September 20, 1999, the Company effected a 1-for-2 reverse stock split of
its common stock. The accompanying financial statements have been retroactively
restated to give effect to the 1-for-2 reverse stock split.
F-18
<PAGE>
[KEYNOTE LOGO]
