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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
________________
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 000-27241
Keynote Systems, Inc.
(Exact name of registrant as specified in its charter)
CALIFORNIA 94-3226488
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2855 Campus Drive, San Mateo, CA 94403
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (650) 522-1000
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [_]
Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date:
Class Shares outstanding at January 31, 2000
----- --------------------------------------
Common Stock, $.001 par value 23,772,285
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Keynote Systems
Table of Contents
<TABLE>
<CAPTION>
PART I - FINANCIAL INFORMATION Page
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<S> <C> <C>
Item 1. Financial Statements.......................................................................... 2
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 8
Item 3. Quantitative and Qualitative Disclosures about Market Risk ................................... 20
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................................................. 21
Item 2. Changes in Securities and Use of Proceeds..................................................... 21
Item 3. Defaults Upon Senior Securities............................................................... 21
Item 4. Submission of Matters to a Vote of Security Holders........................................... 21
Item 5. Other Information............................................................................. 21
Item 6. Exhibits and Reports on Form 8-K.............................................................. 21
Signatures................................................................................................ 22
</TABLE>
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<PAGE>
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements.
KEYNOTE SYSTEMS, INC.
Index to Condensed Consolidated Financial Statements
<TABLE>
<CAPTION>
Page
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<S> <C>
Condensed Consolidated Balance Sheets as of December 31, 1999 and September 30, 1999................................ 3
Condensed Consolidated Statements of Operations for the three months ended December 31, 1999 and 1998............... 4
Condensed Consolidated Statements of Cash Flows for the three months ended December 31, 1999 and 1998............... 5
Notes to Condensed Consolidated Financial Statements................................................................ 6
</TABLE>
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KEYNOTE SYSTEMS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands)
<TABLE>
<CAPTION>
December 31, 1999 September 30, 1999
- ------------------------------------------------------------------------------------------------------------
<S> <C> <C>
Assets
Current assets:
Cash and cash equivalents................................... $ 69,208 $ 64,647
Accounts receivable, net.................................... 4,100 2,295
Current portion of loans to related parties................. 491 -
Prepaids and other current assets........................... 831 333
-------- --------
Total current assets................................... 74,630 67,275
Property and equipment, net...................................... 3,813 3,277
Loans to related parties, less current portion................... 456 451
Other assets..................................................... 363 68
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$ 79,262 $ 71,071
======== ========
Liabilities and Shareholders' Equity
Current liabilities:
Current portion of notes payable............................ $ 1,192 $ 1,189
Current portion of capital lease obligations................ 135 133
Accounts payable and accrued expenses....................... 3,467 2,578
Deferred revenue............................................ 2,814 1,087
-------- --------
Total current liabilities.............................. 7,608 4,987
Notes payable, less current portion.............................. 2,311 2,591
Capital lease obligations, less current portion.................. 216 251
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Total liabilities...................................... 10,135 7,829
Shareholders' equity:
Common stock................................................ 24 23
Additional paid-in capital.................................. 85,249 77,430
Deferred stock-based compensation........................... (1,049) (1,135)
Shareholder notes receivable................................ (373) (388)
Accumulated deficit......................................... (14,724) (12,688)
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Total shareholders' equity.................................. 69,127 63,242
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$ 79,262 $ 71,071
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</TABLE>
See accompanying notes to the condensed consolidated financial statements
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KEYNOTE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
<TABLE>
<CAPTION>
Three Months Ended December 31,
---------------------------------
1999 1998
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<S> <C> <C>
Revenue:
Subscription services............................. $ 4,579 $ 889
Consulting services............................... 217 -
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Total revenues............................... 4,796 889
Expenses
Cost of subscription services..................... 2,066 168
Cost of consulting services....................... 254 -
Research and development.......................... 841 325
Sales and marketing............................... 2,728 627
Operations........................................ 777 229
General and administrative........................ 839 254
Amortization of stock-based compensation.......... 86 23
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Total expenses............................... 7,591 1,626
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Loss from operations......................... (2,795) (737)
Interest income (expense), net....................... 759 (61)
-------- ---------
Net loss..................................... $(2,036) $ (798)
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Loss per share:
Basic and diluted............................ $ (0.09) $ (0.27)
======== =========
Weighted average common shares outstanding:
Basic and diluted............................ 22,798 3,004
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</TABLE>
See accompanying notes to the condensed consolidated financial statements
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KEYNOTE SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
<TABLE>
<CAPTION>
Three Months Ended December 31,
--------------------------------
1999 1998
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<S> <C> <C>
Cash flows from operating activities:
Net loss ..................................................................................... $ (2,036) $ (796)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation and amortization................................................................ 440 114
Amortization of discount on notes............................................................ 8 9
Amortization of stock based compensation..................................................... 86 23
Changes in operating assets and liabilities:
Accounts receivable......................................................................... (1,805) (95)
Prepaids and other assets................................................................... (1,289) (12)
Accounts payable and accrued expenses....................................................... 889 (10)
Deferred revenue............................................................................ 1,727 248
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Net cash used for operating activities................................................... (1,980) (519)
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Cash flows used for investing activities:
Purchases of property and equipment........................................................... (976) (155)
--------- ---------
Cash flows from financing activities:
Repayments of notes payable................................................................... (318) (59)
Proceeds from issuance of notes payable....................................................... - 2,694
Proceeds from public offering, net of issuance costs.......................................... 7,811 -
Repayments of shareholder notes............................................................... 15 -
Issuance of common stock, net of issuance costs............................................... 9 13
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Net cash provided by financing activities................................................ 7,517 2,648
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Net increase in cash and cash equivalents........................................................ 4,561 1,974
Cash and cash equivalents at beginning of the period............................................. 64,647 2,293
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Cash and cash equivalents at end of the period................................................... $ 69,208 $ 4,268
========= =========
Noncash financing activities:
Issuance of common stock for shareholder notes receivable................................ $ - $ 4
========= =========
Deferred compensation related to stock option grants..................................... $ - $ 363
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</TABLE>
See accompanying notes to the condensed consolidated financial statements
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<PAGE>
KEYNOTE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF PRESENTATION
The accompanying interim unaudited condensed consolidated balance sheets
and condensed consolidated statements of operations and cash flows reflect all
normal recurring adjustments that are, in the opinion of management, necessary
for a fair presentation of the financial position of Keynote Systems, Inc. (the
Company) at December 31, 1999, and the results of operations and cash flows for
the interim periods ended December 31, 1999 and 1998.
The accompanying unaudited condensed consolidated financial statements have
been prepared in accordance with the instructions on Form 10-Q and, therefore,
do not include all information and footnotes necessary for a complete
presentation of the Company's results of operations, financial position and cash
flows. We filed audited financial statements that included all information and
footnotes necessary for a complete presentation for each of the years in the
three year period ended September 30, 1999 in Keynote's combined annual report
on Form 10-K for the fiscal year ended September 30, 1999.
The results of operations for any interim period are not necessarily
indicative of the Company's results of operations for any other future interim
period or for a full fiscal year.
(2) REVENUE RECOGNITION POLICY
Subscription services revenue consists of fees from subscriptions to the
Company's Internet measurement and diagnostic services. Subscription revenues
are deferred upon 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 recognizes revenue on a percentage of
completion basis.
Cost of subscription revenues consists of connection fees to Internet
service providers for bandwidth usage of the Company's computer measurement
agents around the world, depreciation, maintenance and other equipment charges
for the Company's 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 who manage and maintain the Company's
measurement data and headquarter infrastructure and support the Company's
customer base.
(3) COMPREHENSIVE LOSS
The Company has no components of other comprehensive loss for any period
presented.
(4) FAIR VALUES OF FINANCIAL INSTRUMENTS
The carrying amounts of cash and cash equivalents, accounts receivable and
accounts payable approximate their respective fair values.
(5) SHAREHOLDER'S EQUITY
In October 1999, the Company raised $7.8 million, net of issuance costs
from the exercise of the underwriters' over-allotment option to purchase 600,000
shares of the Company's common stock granted in connection with its initial
public offering.
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KEYNOTE SYSTEMS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(6) 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 per share is computed using the
weighted-average number of shares of common stock outstanding and, when
dilutive, potential common shares from options and warrants to purchase common
stock using the treasury stock method and from convertible securities using the
"as-if-converted" basis.
The following potential common shares have been excluded from the
computation of diluted net loss per share because the effect would have been
antidilutive (in thousands):
<TABLE>
<CAPTION>
Three Months ended
December 31,
1999 1998
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<S> <C> <C>
Shares outstanding under stock options 2,058 701
Shares of restricted stock subject to repurchase 675 1,949
Shares issuable pursuant to warrants to purchase:
Convertible preferred stock - 537
Common stock 7 110
Shares of convertible preferred stock on an
"as-if-converted" basis - 9,222
</TABLE>
The weighted-average exercise price of stock options was $6.81 and $0.21
for the three months ended December 31, 1999 and 1998, respectively. The
weighted-average purchase price of restricted stock was $0.19 and $0.14, for the
three months ended December 31, 1999 and 1998, respectively. The weighted-
average exercise price of the convertible preferred stock warrants was $1.341.26
for the three months ended December 31, 1998. The weighted average exercise
price of the common stock warrants were $1.10 and $1.34 for the three months
ended December 31, 1999 and 1998, respectively.
(7) RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) 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 the Company does not currently hold any derivative
instruments and does not engage in hedging activities, we expect that the
adoption of SFAS No. 133 will not have a material impact on the Company's
financial position, results of operations or cash flows. The Company will be
required to adopt SFAS No. 133 in fiscal 2001.
(8) SEGMENT INFORMATION
The Company has determined that it operations in a single operating
segment: developing and selling services to measure, assure and improve the
quality of service of web sites. In December 1999, the Company opened an
international office located in Paris, France. All of the Company's long-lived
assets are located in the United States. To date, there have been no
significant operating revenues or expenses from the Company's international
operations. For the three months ended December 31, 1999, one customer
accounted for approximately 12% of total revenues.
(9) SUBSEQUENT EVENTS
In January 2000, the Company filed a Registration Statement on Form S-1 in
connection with the proposed public offering of 4,750,000 shares of its common
stock. The Company is offering 1,000,000 shares and the selling shareholders
are offering an additional 3,750,000 shares. An additional 712,500 shares
would be offered if the underwriter's exercise their over allotment option.
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ITEM 2. Management Discussion and Analysis of Financial Condition and Results
of Operations
You should read the following information in conjunction with the interim
unaudited condensed consolidated financial statements and related notes.
Except for historical information, this Quarterly Report contains forward-
looking statements within the meaning of Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934, as amended. Such
forward-looking statements involve risks and uncertainties, including, among
other things, statements regarding our anticipated costs and expenses, revenue
mix and plans for addressing Year 2000 issues. Such forward-looking statements
include, among others, those statements including the words "expects,"
"anticipates," "intends," "believes" and similar language. Our actual results
may differ significantly from those projected in the forward-looking statements.
Factors that might cause or contribute to such differences include, but are not
limited to, those discussed in the section "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Factors That May Impact Future
Operating Results." You should carefully review the risks described in other
documents we file from time to time with the Securities and Exchange Commission,
including the Quarterly Reports on Form 10-Q that we will file in 2000 and our
Annual Report on Form 10-K, which was filed on December 21, 1999. You are
cautioned not to place undue reliance on the forward-looking statements, which
speak only as of the date of this Quarterly Report on Form 10-Q. We undertake
no obligation to publicly release any revisions to the forward-looking
statements or reflect events or circumstances after the date of this document.
Overview
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 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.
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. In April 1999, we released a new
version of Keynote Perspective, which included our Transaction service, 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 December 1999, we
introduced Keynote Consumer Perspective, which measures web-site performance via
Internet access methods typically used from home, such as dial-up connections,
cable modems, and digital subscriber lines. 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
Our direct sales organization also provides telephone and e-mail sales
support, telemarketing services and pre-sales technical support. We believe our
direct sales approach enables us to focus our resources on ascertaining the
needs of our customers, to devote significant attention to customer satisfaction
and to quickly offer new services to our existing customers.
We also distribute our services through web-hosting and Internet service
providers such as Digex and 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.
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 subscription-based services that our customers
purchase for at least 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 URLs measured, the number of measurement locations, the frequency of
the measurements, and the additional features ordered. 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 December 31, 1999,
we had recorded $2.8 million 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.
We have experienced substantial net losses since inception. As of December
31, 1999, we had an accumulated deficit of $14.7 million. Although our revenues
have grown significantly in recent periods, we may be unable to sustain this
growth. Therefore, you should not consider our historical growth indicative of
future revenue levels or operating results. We expect to incur significant
losses in the future.
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For the three months ended December 31, 1999, 10 customers accounted for
approximately 42% of our total quarterly revenues. 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.
Results of Operations
Revenues
<TABLE>
<CAPTION>
For the three months ended December 31: 1999 1998 % Change
------------------- ------------------- --------------------
Revenue (In thousands)
<S> <C> <C> <C>
Revenues $4,796 $ 889 439%
</TABLE>
Revenues were $4.8 million for the three months ended December 31, 1999 and
$889,000 for the three months ended December 31, 1998, representing an increase
of $3.9 million, or 439%. Subscription services represented 95% of total
revenues for the three months ended December 31, 1999 and 100% of total revenues
for the three months ended December 31, 1998. The increase in total revenues
was attributable to the increase in both the number of new customers and the
increase in revenue from existing customers. For the three months ended December
31, 1999, one customer accounted for approximately 12% of total revenues. For
the three months ended December 31, 1998, no customers accounted for more than
10% of total revenues.
Expenses
<TABLE>
<CAPTION>
For the three months ended December 31: 1999 1998 % Change
------------------- ------------------- --------------------
(In thousands)
<S> <C> <C> <C>
Cost of subscription services $2,066 $ 168 1130%
Cost of consulting services $ 254 $ --
</TABLE>
Cost of Subscription Services. Cost of subscription services consists of
connection fees to Internet service providers for bandwidth usage of our
measurement computers around the world and depreciation, maintenance and other
equipment charges for our measurement infrastructure. Cost of subscription
services was $2.1 million for the three months ended December 31, 1999 and
$168,000 for the three months ended December 31, 1998, representing an increase
of $1.9 million, or 1130%. This increase was primarily due to the greater number
of measurement computers deployed and additional bandwidth consumption,
resulting in higher connection fees and more depreciation and equipment charges.
In addition, during the three months ended December 31, 1999, we continued to
increase measurement capacity and bandwidth at our existing locations, and
expand our measurement infrastructure. Cost of subscription services was 45% of
subscription services for the three months ended December 31, 1999 and 19% of
subscription services for the three months ended December 31, 1998.
Cost of Consulting Services. Cost of consulting services consists of
compensation expenses for consulting personnel and related costs. Our cost of
consulting services was $254,000 for the three months ended December 31, 1999
and $0 for the three months ended December 31, 1998. Cost of consulting
services exceeded consulting services revenue for the three months ended
December 31, 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.
<TABLE>
<CAPTION>
For the three months ended December 31: 1999 1998 % Change
------------------- ------------------- --------------------
(In thousands)
<S> <C> <C> <C>
Research and development $ 841 $ 325 159%
</TABLE>
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
$841,000 for the three months ended December 31, 1999 and $325,000 for the three
months ended December 31, 1998, representing an increase of $516,000, or 159%.
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.
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<TABLE>
<CAPTION>
For the three months ended December 31: 1999 1998 % Change
------------------- ------------------- --------------------
(In thousands)
<S> <C> <C> <C>
Sales and marketing $2,728 $ 627 335%
</TABLE>
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 $2.7 million for the three months ended December 31, 1999 and
$627,000 for the three months ended December 31, 1998, representing an increase
of $2.1 million or 335%. 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.
<TABLE>
<CAPTION>
For the three months ended December 31: 1999 1998 % Change
------------------- ------------------- --------------------
(In thousands)
<S> <C> <C> <C>
Operations $ 777 $ 229 239%
</TABLE>
Operations. Operations expenses consist primarily of compensation and
related costs for management personnel, technical support employees and 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 $777,000 for the three months ended
December 31, 1999 and $229,000 for the three months ended December 31, 1998,
representing an increase of $548,000 or 239%. 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.
<TABLE>
<CAPTION>
For the three months ended December 31: 1999 1998 % Change
------------------- ------------------- --------------------
(In thousands)
<S> <C> <C> <C>
General and administrative $ 839 $ 254 231%
</TABLE>
General and Administrative. General and administrative expenses consist
primarily of salaries and related expenses, accounting, legal and administrative
expenses, insurance, professional service fees and other general corporate
expenses. Our general and administrative expenses were $839,000 for the three
months ended December 31, 1999 and $254,000 for the three months ended December
31, 1998, representing an increase of $585,000, or 231%. This increase was
primarily related to hiring additional employees to support the growth of our
business, as well as increases in costs associated with becoming a public
company. We believe that our general and administrative expenses will continue
to increase 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.
<TABLE>
<CAPTION>
For the three months ended December 31: 1999 1998 % Change
------------------- ------------------- --------------------
(In thousands)
<S> <C> <C> <C>
Amortization of stock-based compensation $ 86 $ 23 270%
</TABLE>
Amortization of Stock-Based Compensation. Some options granted prior to
December 31, 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
$86,000 and $23,000 in stock-based compensation expense for the three months
ended December 31, 1999 and 1998, respectively, relating to the amortization of
deferred compensation expense and had an aggregate of $1.0 million of deferred
compensation remaining to be amortized as of December 31, 1999. Deferred
compensation is amortized on a straight-line basis over the vesting period of
the options. We expect amortization of approximately $341,000 in fiscal 2000,
$341,000 in fiscal 2001, $341,000 in fiscal 2002 and $112,000 in fiscal 2003.
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<TABLE>
<CAPTION>
For the three months ended December 31: 1999 1998 % Change
------------------- -------------------- --------------------
(In thousands)
<S> <C> <C> <C>
Interest income (expense), net $ 759 ($ 61) 1344%
</TABLE>
Interest Income (Expense), Net
Net interest income (expense) was $759,000 for the three months ended
December 31, 1999 and $(61,000) for the three months ended December 31, 1998,
representing an increase of $820,000. The increase was primarily due to higher
interest income from our increase in cash and cash equivalents resulting from
the proceeds we received from our initial public offering.
Provision for Income Taxes
No provision for federal and state income taxes has been recorded because
we have experienced net losses since inception that 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 September 30, 1999, we had net operating loss carryforwards for
federal income tax reporting purposes of approximately $10.6 million available
to reduce future income subject to income taxes. As of September 30, 1999, we
had net operating loss carryforwards for state income tax purposes of
approximately $6.2 million available to reduce future income subject to income
taxes. The federal net operating loss carryforwards expire in various periods
through 2019. State net operating loss carryforwards expire in various periods
through 2004. In addition, as of September 30, 1999, we had federal research and
development tax credit carryforwards of approximately $154,000. The federal
credit carryforwards expire in various periods through 2019. As of September 30,
1999, we had California research and development tax credit carryforwards of
approximately $140,000. 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.
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.
Prior to our initial public offering, we had raised approximately $25.8 million,
net of offering costs, from the sale of common stock and preferred stock. In
our initial public offering, we raised $56.7 million, net of issuance costs,
including $7.8 million raised from the exercise of the underwriter's over-
allotment option, which occurred in October 1999. In addition, we financed our
operations through subordinated and other debt, equipment loans and a capital
lease. The principal balance outstanding at December 31, 1999 for these loans
and leases was approximately $3.9 million. At December 31, 1999, we had
approximately $69.2 million in cash and cash equivalents investments.
Net cash used in operating activities was $2.0 million in the three months
ended December 31, 1999, $519,000 in the three months ended December 31, 1998.
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, accounts payable and accrued expenses and
depreciation of property and equipment.
Since inception, our investing activities have been purchases of property
and equipment. Capital expenditures totaled $976,000 in the three months ended
December 31, 1999 and $155,000 in the three months ended December 31, 1998.
Our financing activities provided $7.5 million in the three months ended
December 31, 1999 and $2.6 million in the three months ended December 31, 1998.
In the three months ended December 31, 1999, we raised $7.8 million from the
exercise of the underwriter over-allotment option from our initial public
offering. During the three months ended December 31, 1998, we received $2.7
million in proceeds from our equipment loans.
As of December 31, 1999, our principal commitments consisted of $3.9
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 December 31, 1999, we also had commitments of
approximately $482,000 in future lease payments for our headquarters facility.
We had no material commitments for capital expenditures as of December 31, 1999.
Because we expect to continue to increase the number of our measurement
computers and increase their measurement capacity, 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 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
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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.
Nothwithstanding the passage of January 1, 2000, our business could still face
year 2000 problems.
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.
Representatives of the research and development, operations and
administrative departments were 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 were 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 dates 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, and 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.
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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 that 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 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 developed a Business Continuity and Contingency Plan to mitigate
problems that could result if our automated systems are unable to recognize year
2000 dates. The plan helps to ensure the continuity of our core business
processes by identifying, assessing, managing and mitigating year 2000 risks.
Resources critical to operating our core business processes and key support
processes have been identified so that in the event of a failure of our
services, a basic level of service can be provided to our customers until the
normal level of services can be restored. The plan identifies risks and threats,
establishes mitigation strategies for the identified risks and threats and
provides contingencies in the event risk mitigation efforts fail.
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 derivative instruments and does 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.
Factors That May Impact Future Operating Results
We are an early stage company with an unproven business model that 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 December 1999 and our Lifeline service in
July 1999, our Consumer Perspective in December 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.
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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 $2.0 million for the three months ended December 31,
1999, and as of December 31, 1999, we had an accumulated deficit of $14.7
million. We believe that our operating expenses will continue to increase as we
grow our business. As a result, although our recent initial public offering
provided 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.
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-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.
Our results of operations could vary significantly from quarter to quarter.
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
worldwide. 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 report:
. 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 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;
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. 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;
. 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 our Keynote Consumer Perspective and Keynote Lifeline
services, 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 approximately 7,000 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
15,000 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 fiscal 2000 to measure in excess of 40,000
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 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.
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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 low ranking in one of our indices has harmed their
business. 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.
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
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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.
We face growing competition that 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, a
unit of Visual Networks and Service Metrics a unit of Exodus Communications. 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.
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, HP-Openview
and IBM's Tivoli Unit, and companies that sell load-testing software such as
Mercury Interactive and Segue Software, 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 three months ended December 31, 1999, 10 customers accounted for
approximately 42% 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 be 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.
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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 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 the market does not accept our professional services, 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.
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 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.
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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 that 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.
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.
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 2% of our total revenues for the three months
ended December 31, 1999 and for 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.
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 in the
future, or the belief that these sales could occur, could cause a drop in the
market price of our common stock In January 2000, we filed a registration
statement on Form S-1 in connection with the proposed public offering of
4,750,000 shares of our common stock. Upon completion of that offering, we will
have outstanding 24,772,285 shares of common stock. Of these shares, the
4,600,000 shares sold in our initial public offering as well as the 4,750,000
shares to be sold in our secondary offering will be freely tradable without
restriction or further registration under the Securities Act, unless the shares
are purchased by our "affiliates".
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<PAGE>
The remaining 15,422,285 shares of common stock outstanding upon completion
of our secondary 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
until March 23, 2000, without the prior written approval of FleetBoston
Robertson Stephens Inc. In addition, our officers, directors, and selling
shareholders, who hold 14,360,017 shares of common stock after this offering,
have agreed not to sell or otherwise dispose of any shares of our common stock
for a period of 90 days after the date of the final prospectus for the secondary
offering. 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 December 31, 1999 there were options to purchase 2,057,862
shares of our common stock and outstanding warrants to purchase 7,273 shares of
common stock.
Assuming the cash exercise of these warrants and options outstanding as of
December 31, 1999, the remaining 17,487,420 shares of our common stock will
become eligible for public sale as follows:
. 0 shares as of the date this quarterly report;
. 3,068,994 as of March 23, 2000;
. 5,288 shares as of April 26, 2000;
. 23,224 shares as of April 30, 2000;
. 22,624 shares as of May 11, 2000;
. 14,360,017 shares 90 days after the date of the final prospectus for the
secondary offering;
. 7,273 shares one year after the date of the final prospectus for the
secondary offering.
As of September 30, 1999 there were outstanding options and warrants to
purchase 2,198,692 shares of our common stock outstanding. Sales of a
substantial number of these shares could cause our stock price to fall.
Item 3. 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 December 31, 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 December 31, 1999.
-20-
<PAGE>
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
We are not a party to any material legal proceedings.
Item 2. Changes in Securities and Use of Proceeds
The effective date of our registration statement on Form S-1 filed under
Securities Act of 1933 (No. 333-82781) relating to the initial public offering
of our common stock, was September 24, 1999. A total of 3,875,000 shares of our
common stock were sold by us and 125,000 shares of common stock were sold on
behalf of a selling shareholder at a price of $14.00 per share to an
underwriting syndicate led by FleetBoston Robertson Stephens Inc., Hambrecht &
Quist LLC and Dain Rauscher Incorporated. The offering commenced on September
24, 1999 and closed on September 29, 1999.
On October 15, 1999, we sold an additional 600,000 shares of common stock
at a price of $14.00 per share to this underwriting syndicate upon
their exercise of the over-allotment option.
As a result of the initial public offering, we received proceeds of $56.7
million, net of issuance costs, including proceeds of $7.8 million, net of
issuance costs, from the exercise of the underwriters' over-allotment option. A
portion of the proceeds was applied toward continuing operations. The remaining
proceeds are being used as working capital or are included in cash and cash
equivalents. We did not receive any proceeds from the sale of shares by the
selling stockholders.
Item 3. Defaults Upon Senior Securities
Not applicable.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
Item 5. Other Information
Not applicable.
Item 6. Exhibits and Reports on Form 8-K.
(a) Index to Exhibits
Exhibit No. 27.01 - Financial Data Schedule (Available in EDGAR format
only)
(b) Reports on Form 8-K
No reports on Form 8-K were filed in the quarter ended December 31, 1999.
-21-
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of San Mateo, State of
California, on this 14th day of February, 2000.
KEYNOTE SYSTEMS, INC.
By: /s/ Umang Gupta
------------------------------------
Umang Gupta
Chairman of the Board and Chief
Executive Officer
By: /s/ John J. Flavio
------------------------------------
John J. Flavio
Vice President of Finance and Chief
Financial Officer
(Principal Financial and Accounting
Officer)
-22-
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