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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, 2000
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 0000-26251
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NETSCOUT SYSTEMS, INC.
(Exact name of registrant as specified in charter)
DELAWARE 04-2837575
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
4 TECHNOLOGY PARK DRIVE, WESTFORD, MA 01886
(978) 614-4000
------------------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT:
Common Stock, $0.001 Par Value
------------------------
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 / /
The number of shares outstanding of the registrant's common stock as of
February 9, 2001 was 29,453,602.
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NETSCOUT SYSTEMS, INC.
FORM 10Q
FOR THE QUARTER ENDED DECEMBER 31, 2000
TABLE OF CONTENTS
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements......................................................... 3
a. Consolidated Balance Sheets:
As of December 31, 2000 and March 31, 2000
b. Condensed Consolidated Statements of Income:
For the three and nine months ended December 31, 2000 and December 31, 1999
c. Consolidated Statements of Cash Flows:
For the nine months ended December 31, 2000 and December 31, 1999
d. Notes to the Consolidated Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results of
Operations......................................................................... 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk................... 23
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................................ 24
Item 2. Changes in Securities and Use of Proceeds.................................... 24
Item 6. Exhibits and Reports on Form 8-K............................................. 24
SIGNATURES........................................................................... 25
EXHIBIT INDEX
2
PART 1: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
NETSCOUT SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)
(UNAUDITED)
DECEMBER 31, MARCH 31,
2000 2000
------------ ---------
ASSETS
Current assets:
Cash and cash equivalents................................... $62,173 $48,515
Marketable securities....................................... -- 21,807
Accounts receivable, net of allowance for doubtful accounts 17,455
and returns of $935 and $754 at December 31, 2000 and
March 31, 2000, respectively.............................. 10,390
Inventories................................................. 4,824 3,131
Refundable income taxes..................................... 123 1,899
Deferred income taxes....................................... 1,304 1,022
Prepaids and other current assets........................... 2,644 3,728
---------- -------
Total current assets.................................... 88,523 90,492
Fixed assets, net........................................... 7,039 5,657
Goodwill and other intangible assets, net................... 44,074 --
Deferred income taxes....................................... 4,651 599
---------- -------
Total assets............................................ $144,287 $96,748
========== =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable............................................ $4,326 $ 2,789
Accrued compensation........................................ 5,267 3,673
Accrued other............................................... 2,120 2,448
Customer deposits........................................... -- 78
Deferred revenue............................................ 10,559 6,638
---------- -------
Total current liabilities............................... 22,272 15,626
---------- -------
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.001 par value: --
5,000,000 shares authorized, no shares issued or
outstanding at
December 31, 2000 and March 31, 2000...................... --
Common stock, $0.001 par value:
150,000,000 shares authorized, 33,399,337 shares issued 33
and 29,422,083 shares outstanding at December 31, 2000;
30,697,697 shares issued and 26,720,443 shares outstanding
March 31, 2000............................................ 31
Additional paid-in capital.................................. 105,478 67,366
Deferred compensation....................................... (4,070) (636)
Treasury stock.............................................. (25,306) (25,306)
Retained earnings........................................... 45,880 39,667
---------- -------
Total stockholders' equity.............................. 122,015 81,122
---------- -------
Total liabilities and stockholders' equity.............. $144,287 $96,748
========== =======
The accompanying notes are an integral part of these consolidated financial
statements.
3
NETSCOUT SYSTEMS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------- -------------------
2000 1999 2000 1999
-------- -------- -------- --------
Revenue:
Product................................................. $24,064 $14,584 $62,615 $40,939
Service................................................. 4,994 3,348 13,398 8,912
License and royalty..................................... 3,415 4,910 10,448 12,366
------- ------- ------- -------
Total revenue....................................... 32,473 22,842 86,461 62,217
------- ------- ------- -------
Cost of revenue:
Product (including stock-based compensation of $0, $1,
$1 and $2, respectively)............................ 7,647 5,389 21,004 15,290
Service (including stock-based compensation of $6,
$10,
$7 and $29, respectively)........................... 964 422 2,416 1,242
------- ------- ------- -------
Total cost of revenue............................... 8,611 5,811 23,420 16,532
------- ------- ------- -------
Gross margin............................................ 23,862 17,031 63,041 45,685
------- ------- ------- -------
Operating expenses:
Research and development (including stock-based
compensation of $513, $12, $1,044 and $107,
respectively)....................................... 4,125 2,322 11,036 7,022
Sales and marketing (including stock-based
compensation of $67, $66, $180 and $189,
respectively)....................................... 10,798 7,370 29,775 20,121
General and administrative (including stock-based
compensation of $5, $4, $8 and $11, respectively)... 2,558 1,334 6,500 3,421
Amortization of goodwill and other intangible
assets.............................................. 2,617 -- 5,283 --
In-process research and development................... -- -- 268 --
------- ------- ------- -------
Total operating expenses................................ 20,098 11,026 52,862 30,564
------- ------- ------- -------
Income from operations.................................. 3,764 6,005 10,179 15,121
Interest income, net.................................... 930 833 3,072 1,609
------- ------- ------- -------
Income before provision for income taxes................ 4,694 6,838 13,251 16,730
Provision for income taxes.............................. 2,024 2,467 7,038 6,031
------- ------- ------- -------
Net income.............................................. $ 2,670 $ 4,371 $ 6,213 $10,699
======= ======= ======= =======
Basic net income per share.............................. $ 0.09 $ 0.17 $ 0.22 $ 0.53
Diluted net income per share............................ $ 0.09 $ 0.16 $ 0.21 $ 0.40
Shares used in computing:
Basic net income per share............................ 29,107 25,796 28,196 20,249
Diluted net income per share.......................... 30,594 28,154 29,621 26,562
The accompanying notes are an integral part of these consolidated financial
statements.
4
NETSCOUT SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
DECEMBER 31,
-------------------
2000 1999
-------- --------
Cash flows from operating activities:
Net income................................................ $ 6,213 $10,699
Adjustments to reconcile net income to net cash provided
by operating activities, net of effects of acquisition
of NextPoint:
Depreciation and amortization........................... 2,849 2,006
Amortization of goodwill and other intangible assets.... 5,283 --
In-process research and development..................... 268 --
Loss on disposal of fixed assets........................ 84 49
Compensation expense associated with equity awards...... 1,240 339
Deferred income taxes................................... 292 --
Changes in assets and liabilities:
Accounts receivable..................................... (5,852) (2,050)
Inventories............................................. (1,693) (1,287)
Refundable income taxes................................. 1,776 (87)
Prepaids and other current assets....................... 1,201 (2,509)
Accounts payable........................................ 1,108 (1,143)
Accrued expenses........................................ 1,189 1,525
Customer deposits....................................... (78) --
Deferred revenue........................................ 3,627 2,078
-------- -------
Net cash provided by operating activities............... 17,507 9,620
-------- -------
Cash flows from investing activities:
Purchase of marketable securities......................... (18,577) (14,747)
Proceeds from maturity of marketable securities........... 40,384 2,000
Proceeds from notes receivable............................ -- 2,000
Purchase of fixed assets.................................. (3,674) (3,155)
Cash paid for acquisition of NextPoint, net of cash
received................................................ (23,164) --
-------- -------
Net cash used in investing activities................. (5,031) (13,902)
-------- -------
Cash flows from financing activities:
Proceeds from issuance of common stock.................... 2,401 30,082
Repayment of notes payable................................ (1,219) --
-------- -------
Net cash provided by financing activities............. 1,182 30,082
-------- -------
Net increase in cash and cash equivalents................. 13,658 25,800
Cash and cash equivalents, beginning of year.............. 48,515 25,477
-------- -------
Cash and cash equivalents, end of period.................. $ 62,173 $51,277
======== =======
Supplemental disclosure of cash flow information:
Cash paid for interest.................................... $ 22 $ 5
Cash paid for income taxes................................ 3,573 6,131
The accompanying notes are an integral part of these consolidated financial
statements.
5
NETSCOUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements as of December 31, 2000
and for the three and nine months ended December 31, 2000 and 1999 are
unaudited. In the opinion of NetScout's management, the December 31, 2000 and
1999 unaudited interim consolidated financial statements include all
adjustments, consisting of normal recurring adjustments, necessary for a fair
presentation of the financial position and results of operations for that
period. The results of operations for the three and nine month periods ended
December 31, 2000 are not necessarily indicative of the results of operations
for the year ended March 31, 2001.
The balance sheet at March 31, 2000 has been derived from the audited
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.
For further information refer to the consolidated financial statements and
footnotes thereto included in NetScout's Annual Report on Form 10-K for the year
ended March 31, 2000, as filed with the Securities and Exchange Commission on
June 23, 2000.
2. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES
NetScout considers all highly liquid investments purchased with a maturity
of three months or less to be cash equivalents and those with maturities greater
than three months are considered to be marketable securities. Cash equivalents
and marketable securities are stated at amortized cost plus accrued interest,
which approximates fair value. Cash equivalents and marketable securities
consist primarily of money market instruments and U.S. Treasury bills.
NetScout accounts for its investments in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Under the provision of SFAS
No. 115, NetScout has classified its investments as "available-for-sale" and any
associated unrealized gains or losses, if material, are recorded as a separate
component of stockholders' equity until realized. At December 31, 2000 and
March 31, 2000, any unrealized gains or losses were not significant.
3. INVENTORIES
Inventories consist of the following (in thousands):
DECEMBER 31, MARCH 31,
2000 2000
------------ ---------
Raw materials......................................... $3,024 $2,371
Work-in-process....................................... 1,387 476
Finished goods........................................ 413 284
------ ------
$4,824 $3,131
====== ======
6
NETSCOUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill and other intangible assets consist of the following (in
thousands):
DECEMBER 31, ESTIMATED
2000 LIVES
------------ ---------
Goodwill.............................................. $45,391 5
Completed technology.................................. 2,166 3
Customer base......................................... 1,100 3
Assembled workforce................................... 700 2
-------
49,357
Less accumulated amortization......................... 5,283
-------
Total................................................. $44,074
=======
Goodwill and other intangible assets will be amortized as follows (in
thousands):
Three months ending March 31, 2001.......................... $ 2,605
2002 10,517
2003 10,254
2004 9,351
2005 9,078
2006 2,269
-------
Total....................................................... $44,074
=======
5. ACQUISITION
In July 2000, NetScout acquired all of the outstanding common and preferred
stock of NextPoint Networks, Inc. ("NextPoint") in exchange for 1,831,518 shares
of NetScout common stock and $19.6 million in cash. NetScout also issued options
and warrants exercisable for 298,647 shares of NetScout common stock in exchange
for all outstanding options and warrants exercisable for NextPoint common stock.
In December 2000, the warrants were exercised in full. The value of the
acquisition was $53.3 million based on the fair value of the consideration paid
plus direct acquisition costs. The acquisition was accounted for using the
purchase method. In addition, 267,602 shares of NetScout common stock have been
reserved and are being released during a two-year period subsequent to the
acquisition to two founding shareholders of NextPoint as they continue
employment by NetScout. NetScout recorded $4.0 million as deferred compensation
related to the reserved shares, which will be amortized to stock-based
compensation expense over the two-year period of employment. Accordingly, the
results of operations of NextPoint subsequent to July 7, 2000 have been included
in NetScout's
7
NETSCOUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
statements of operations for the three and nine months ended December 31, 2000.
The purchase price allocation, determined in part by an independent valuation,
was as follows (in thousands):
Tangible net assets......................................... $ 3,709
Intangible assets acquired:
Goodwill.................................................. 45,391
Completed technology...................................... 2,166
Customer base............................................. 1,100
Assembled workforce....................................... 700
In-process research and development....................... 268
-------
Total purchase price allocation............................. $53,334
=======
Tangible net assets acquired include cash, accounts receivable, fixed
assets, prepaid expenses and other assets, accounts payable, accrued expenses,
deferred revenue and notes payable, in addition to net deferred tax assets
related to net operating losses carried forward from NextPoint, partially offset
by deferred tax liabilities created with the acquisition of intangible assets
other than goodwill, and deferred compensation related to unvested options
exchanged as part of the acquisition. Goodwill and other intangibles are being
amortized on a straight-line basis over estimated useful lives of two to five
years (Note 4).
A portion of the purchase price was allocated to acquired in-process
research and development ("IPR&D") and completed technology. Completed
technology and IPR&D were identified and valued by an independent appraisal and
through interviews and analysis of data provided by management regarding
products under development. Developmental projects that had reached
technological feasibility were classified as completed technology and will be
amortized over three years. Projects that had not reached technological
feasibility and had no future alternative uses were classified as IPR&D and
charged to expense on the day of the acquisition. The value of IPR&D was
determined considering the project's stage of completion, the time and resources
needed for completion, the contribution of core technology, and the projected
discounted cash flows of completed products. The discount rate was determined
considering weighted average cost of capital and the risk surrounding the
successful completion of the projects under development.
The summary table below, prepared on an unaudited pro forma basis, combines
NetScout's results of operations with NextPoint's results of operations as if
NextPoint had been acquired as of April 1, 2000 and April 1, 1999 for the nine
months ended December 31, 2000 and 1999, respectively (in thousands, except per
share data):
NINE MONTHS ENDED
DECEMBER 31,
-------------------
2000 1999
-------- --------
Revenue................................................... $87,485 $63,568
Net income (loss)......................................... $ 1,273 ($ 113)
Basic net income (loss)................................... $ 0.04 ($ 0.01)
Diluted net income (loss) per share....................... $ 0.04 ($ 0.01)
8
NETSCOUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The proforma results are not necessarily indicative of what would have
occurred if the acquisition had been in effect for the periods presented. In
addition, they are not intended to be a projection of future results and do not
reflect any synergies that might be achieved from combined operations.
Our effective tax rate before non-deductible costs related to the
acquisition of NextPoint and stock-based compensation expense was 35% and 36%
for the three months ended December 31, 2000 and 1999, respectively.
Prior to the acquisition of NextPoint, a reseller of NextPoint filed an
action against NextPoint alleging breach of contract. NextPoint has denied that
a breach occurred. An escrow balance was established at the time of the
acquisition to account for potential losses related to this suit in order to
limit any exposure to NetScout. NetScout plans to vigorously defend this matter.
However, since the matter is at a preliminary stage, NetScout is unable to
predict the outcome or amount of related expense, or loss, if any.
6. CONTINGENCIES
On November 5, 1999, a former employee of NetScout filed an action against
the Company and an employee stockholder of NetScout in the Massachusetts
Superior Court Department of the Trial Court, Middlesex County, alleging claims
of discrimination on the basis of sexual harassment. On December 30, 1999,
NetScout filed a Notice of Removal to the United States District Court for the
District of Massachusetts, thereby removing the action to that Court. NetScout
filed an Answer denying these allegations. On December 21, 2000, this matter was
settled.
In addition to the matter noted above, from time to time NetScout is subject
to legal proceedings and claims in the ordinary course of business. In the
opinion of management, the amount of ultimate expense with respect to any other
current legal proceedings and claims will not have a material adverse effect on
NetScout's financial position or results of operations.
7. COMPUTATION OF NET INCOME PER SHARE EARNINGS
Below is a summary of the shares used in computing basic and diluted net
income per share for the periods indicated (in thousands):
THREE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
------------------- -------------------
2000 1999 2000 1999
-------- -------- -------- --------
Weighted average number of shares
outstanding............................... 29,106 25,796 28,196 20,249
Shares attributable to Class B convertible
common stock.............................. -- -- -- 3,374
Shares attributable to Series A preferred
stock..................................... -- -- -- 611
Shares attributable to unvested common
stock..................................... 206 -- 147 --
Stock options............................... 1,282 2,358 1,278 2,328
------ ------ ------ ------
Shares used in computing diluted net income
per share................................. 30,594 28,154 29,621 26,562
====== ====== ====== ======
9
NETSCOUT SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(UNAUDITED)
The following table sets forth common stock excluded from the calculation of
diluted net income per share since the inclusion would be antidilutive (in
thousands):
THREE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
------------------- -------------------
2000 1999 2000 1999
-------- -------- -------- --------
Stock options...................................... 1,060 -- 1,242 20
8. GEOGRAPHIC INFORMATION
Revenue was distributed geographically as follows (in thousands):
THREE MONTHS ENDED NINE MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------- -------------------
2000 1999 2000 1999
-------- -------- -------- --------
North America........................... $27,895 $20,881 $77,376 $54,198
Other international..................... 4,578 1,961 9,085 8,019
------- ------- ------- -------
$32,473 $22,842 $86,461 $62,217
======= ======= ======= =======
The North America revenue figures include sales made by NetScout to domestic
resellers. These domestic resellers may sell NetScout product to international
locations. NetScout still reports these shipments as North America revenue since
NetScout ships the product to a domestic location. Substantially all of
NetScout's identifiable assets are located in the United States.
9. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended by SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities--Deferral of Effective Date of
FASB Statement No. 133" and SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities--an Amendment of FASB Statement
No. 133", which establishes accounting and reporting standards for derivative
instruments and hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. NetScout, to date has not
engaged in derivative and hedging activities, and accordingly does not believe
that the adoption of SFAS No. 133 will have a material impact on the financial
reporting and related disclosures of the company. NetScout will adopt SFAS
No. 133 as required by SFAS No. 137 in fiscal year 2002.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No.101, "Revenue Recognition in Financial
Statements", as amended by SAB No.101A and 101B. SAB No.101 summarizes the SEC's
views in applying generally accepted accounting principles to selected revenue
recognition issues in financial statements. The application of the guidance of
SAB No. 101 will be required in the Company's fourth quarter of fiscal 2001. The
Company does not believe that the adoption of SAB No. 101 will have a material
impact on its financial position and results of operations.
10
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following information should be read in conjunction with the
consolidated historical financial information and the notes thereto included in
Item 1 of this Quarterly Report on Form 10-Q and Management's Discussion and
Analysis of Financial Condition and Results of Operations contained in our
Annual Report on Form 10-K for the year ended March 31, 2000 as filed with the
Securities and Exchange Commission on June 23, 2000.
In addition to the other information in this report, the following
Management Discussion and Analysis should be considered carefully in evaluating
the Company and our business. This Quarterly Report on Form 10-Q contains
forward-looking statements. These statements relate to future events or our
future financial performance and are identified by terminology such as "may",
"will", "could", "should", "expects," "plans," "intends," "seeks,"
"anticipates," "believes," "estimates," "potential," or "continue" or the
negative of such terms or other comparable terminology. These statements are
only predictions. You should not place undue reliance on these forward-looking
statements. Actual events or results may differ materially. In evaluating these
statements, you should specifically consider various important factors,
including the risks outlined under "Certain Factors Which May Affect Future
Results" in this section of this report and our other filings with the
Securities and Exchange Commission. These factors may cause our actual results
to differ materially from any forward-looking statement.
OVERVIEW
NetScout is a market leader in designing and developing integrated,
proactive network and application infrastructure performance management (IPM)
products that improve the performance and cost-efficiency of complex, high-speed
networks. We manufacture and market these products to enterprise and service
provider customers worldwide.
IPM is an architecture for measuring and reporting on the state of the
infrastructure's ability to fulfill its business, performance and service-level
objectives. IPM products work by monitoring the key components of the
infrastructure: the application environment, the computing environment, and the
network environment.
The NGenius-TM- Performance Management System is NetScout's next-generation
architecture of infrastructure performance management products. The NGenius-TM-
system includes:
1. Data collection devices consisting of probes and software agents that
collect, aggregate and perform detailed analysis of network activity, and
2. Analytical and presentation software, which generates real-time and
historical views of the performance information in easy-to-use, graphical
formats.
NetScout was incorporated in 1984 as a consulting services company. In 1992
the Company began to develop and market its first infrastructure performance
management products. Our operations have been financed principally through cash
provided by operations and we have been profitable for each of the last seven
years. On July 7, 2000, NetScout completed its acquisition of NextPoint
Networks, Inc. ("NextPoint"). The transaction was valued at approximately
$53.3 million.
Product revenue consists of sales of our hardware products and licensing of
our software products. Product revenue is recognized upon shipment, provided
that evidence of an arrangement exists, title and risk of loss have passed to
the customer, fees are fixed or determinable and collection of the related
receivable is probable. Sales to indirect channel partners that are subject to
return privileges are recognized upon shipment, net of an allowance for
estimated product returns which is based on our return policy and historical
experience. Customer payments received in advance of product shipments are
recorded as customer deposits.
11
Service revenue consists primarily of customer fees from support agreements,
consulting and training. We generally provide three months of software and
service support and 12 months of hardware support as part of our product sales.
Revenue from software and service support is deferred and recognized over the
three-month support period. Revenue from hardware support is deferred and
recognized over the 12-month support period. In addition, customers can elect to
purchase extended support agreements, typically for 12-month periods. Revenue
from these agreements is deferred and recognized ratably over the support
period. Revenue from consulting and training is recognized as the work is
performed.
For multi-element arrangements, each element of the arrangement is analyzed
and we allocate a portion of the total fee under the arrangement to the
undelivered elements, primarily support agreements and training, using vendor
specific objective evidence of fair value of the element and the remaining
portion of the fee is allocated to the delivered elements (i.e. generally
hardware products and licensing software products), regardless of any separate
prices stated within the contract for each element, under the residual method.
Vendor specific objective evidence of fair value is based on the price the
customer is required to pay when the element is sold separately.
License and royalty revenue consists primarily of royalties paid under
license agreements by original equipment manufacturers who incorporate
components of our data collection technology into their own products or who
reproduce and sell our software products. License revenue is recognized when
delivery has occurred and when we become contractually entitled to receive
license fees, provided that such fees are fixed or determinable and collection
is probable. Royalty revenue is recognized based upon product shipment by the
license holder.
12
RESULTS OF OPERATIONS
The following table sets forth for the periods indicated the percentage of
total revenue of certain line items included in our Statements of Income:
NETSCOUT SYSTEMS, INC.
STATEMENTS OF INCOME PERCENTAGES
THREE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, DECEMBER 31,
----------------------- -----------------------
2000 1999 2000 1999
-------- -------- -------- --------
Revenue:
Product............................................. 74.1% 63.8% 72.4% 65.8%
Service............................................. 15.4 14.7 15.5 14.3
License and royalty................................. 10.5 21.5 12.1 19.9
----- ----- ----- -----
Total revenue..................................... 100.0 100.0 100.0 100.0
----- ----- ----- -----
Cost of revenue:
Product............................................. 23.5 23.6 24.3 24.6
Service............................................. 3.0 1.8 2.8 2.0
----- ----- ----- -----
Total cost of revenue............................. 26.5 25.4 27.1 26.6
----- ----- ----- -----
Gross margin.......................................... 73.5 74.6 72.9 73.4
----- ----- ----- -----
Operating expenses:
Research and development............................ 12.7 10.2 12.8 11.3
Sales and marketing................................. 33.2 32.3 34.4 32.3
General and administrative.......................... 7.9 5.8 7.5 5.5
Amortization of intangible assets................... 8.1 0.0 6.1 0.0
In-process research and development................. 0.0 0.0 0.3 0.0
----- ----- ----- -----
Total operating expenses.......................... 61.9 48.3 61.1 49.1
----- ----- ----- -----
Income from operations................................ 11.6 26.3 11.8 24.3
Interest income, net.................................. 2.8 3.6 3.5 2.6
----- ----- ----- -----
Income before provision for income taxes.............. 14.4 29.9 15.3 26.9
Provision for income taxes............................ 6.2 10.8 8.1 9.7
----- ----- ----- -----
Net income............................................ 8.2% 19.1% 7.2% 17.2%
===== ===== ===== =====
THREE MONTHS ENDED DECEMBER 31, 2000 AND 1999
REVENUE
Total revenues were $32.5 million and $22.8 million for the three months
ended December 31, 2000 and 1999, respectively, representing an increase of 42%
from 1999 to 2000.
PRODUCT. Product revenues were $24.1 million and $14.6 million for the
three months ended December 31, 2000 and 1999, respectively, representing an
increase of 65% from 1999 to 2000. This increase was primarily due to a 13%
increase in average selling price attributable to larger volumes of higher speed
and multi-port probes and a 48% increase in unit sales.
SERVICE. Service revenues were $5.0 million and $3.3 million for the three
months ended December 31, 2000 and 1999, respectively, representing an increase
of 49% from 1999 to 2000. This
13
increase was primarily due to an increase in support agreements attributable to
new product sales and an increase in the sale of support agreements to new and
existing customers.
LICENSE AND ROYALTY. License and royalty revenues were $3.4 million and
$4.9 million for the three months ended December 31, 2000 and 1999,
respectively, representing a decrease of 30% from 1999 to 2000. The results for
the three months ended December 31, 1999 include $818,000 of royalties related
to the three months ended September 30, 1999 that one of our partners did not
report to us until the three months ended December 31, 1999. The additional
decrease was due to a transition in a specific product line by one of our
partners.
COST OF REVENUE AND GROSS MARGIN
PRODUCT. Cost of product revenue consists primarily of components,
personnel costs, media duplication, manuals, packaging materials, licensed
technology fees and overhead. Cost of product revenue was $7.6 million and
$5.4 million for the three months ended December 31, 2000 and 1999,
respectively, representing an increase of 42% from 1999 to 2000. This increase
was primarily due to higher sales volumes from 1999 to 2000. Product gross
margins were 68% and 63% for the three months ended December 31, 2000 and 1999,
respectively. This increase was primarily due to an increase in software sales
which have higher margins.
SERVICE. Cost of service revenue consists primarily of personnel costs.
Cost of service revenues were $964,000 and $422,000 for the three months ended
December 31, 2000 and 1999, respectively, representing an increase of 128% from
1999 to 2000. Service gross margins were 81% and 87% for the three months ended
December 31, 2000 and 1999, respectively. This increase in cost and decrease in
margin was primarily due to an increase in material and consulting costs to
support our increased installed customer base.
Gross margins were $23.9 million and $17.0 million for the three months
ended December 31, 2000 and 1999, respectively, representing an increase of 40%
from 1999 to 2000. Gross margin is primarily affected by the mix of product,
service, license and royalty revenue and by the proportion of sales through
direct versus indirect distribution channels. We typically realize higher gross
margins on license and royalty revenue than on product and service revenue and
on direct sales than on indirect distribution channel sales. This increase was
primarily due to an 84% increase in direct sales.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of personnel costs, fees for outside consultants and related costs
associated with the development of new products and the enhancement of existing
products. Research and development expenses were $4.1 million and $2.3 million
for the three months ended December 31, 2000 and 1999, respectively,
representing an increase of 78% from 1999 to 2000. This increase was primarily
due to a 62% increase in personnel costs from 1999 to 2000 and the addition of
stock-based compensation charges related to the NextPoint acquisition.
SALES AND MARKETING. Sales and marketing expenses consist primarily of
personnel costs and costs associated with marketing programs such as trade
shows, seminars, advertising and new product launch activities. Sales and
marketing expenses were $10.8 million and $7.4 million for the three months
ended December 31, 2000 and 1999, respectively, representing an increase of 47%
from 1999 to 2000. This increase was primarily due to a 53% increase in sales
and marketing personnel costs and certain related expenses from 1999 to 2000 and
a 32% increase in marketing program expenses from 1999 to 2000.
GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of personnel costs for executive, financial, information services and
human resource employees. General and administrative expenses were $2.6 million
and $1.3 million for the three months ended December 31,
14
2000 and 1999, respectively, representing an increase of 92% from 1999 to 2000.
This increase was primarily due to a 51% increase in personnel costs from 1999
to 2000, and an increase in legal expenses for the three months ended
December 31, 2000.
AMORTIZATION OF INTANGIBLE ASSETS. Amortization of intangible assets was
$2.6 million for the three months ended December 31, 2000 due to the acquisition
of NextPoint.
INTEREST INCOME, NET. Interest income, net of interest expense, was
$930,000 and $833,000 for the three-months ended December 31, 2000 and 1999,
respectively, representing an increase of 12% from 1999 to 2000. This increase
was primarily due to an increase in our cash balances related to cash generated
by operations offset by cash used to acquire NextPoint.
PROVISION FOR INCOME TAXES. The provision for income taxes was
$2.0 million and $2.5 million for the three months ended December 31, 2000 and
1999, respectively, representing a decrease of 18% from 1999 to 2000. NetScout's
effective tax rate increased to 43% from 36% for the three months ended
December 31, 2000 and 1999, respectively, as a result of non-deductible
amortization of intangible assets and stock-based compensation expense related
to the acquisition of NextPoint, which occurred during the second quarter of
fiscal 2001.
NET INCOME. Net income was $2.7 million and $4.4 million for the three
months ended December 31, 2000 and 1999, respectively, representing a decrease
of 39% from 1999 to 2000. This decrease was primarily the result of amortization
of intangible assets and stock-based compensation expense related to the
acquisition of NextPoint. Net income excluding non-cash amortization of
intangible assets and stock-based compensation expense and using a 35% effective
tax rate was $5.2 million and $4.5 million for the three months ended
December 31, 2000 and 1999, respectively, representing a 16% increase from 1999
to 2000. This increase was primarily due to revenue growth offset by additional
operating expenses resulting from the acquisition of NextPoint.
NINE MONTHS ENDED DECEMBER 31, 2000 AND 1999
REVENUE
Total revenues were $86.5 million and $62.2 million for the nine months
ended December 31, 2000 and 1999, respectively, representing an increase of 39%
from 1999 to 2000.
PRODUCT. Product revenues were $62.6 million and $40.9 million for the nine
months ended December 31, 2000 and 1999, respectively, representing an increase
of 53% from 1999 to 2000. This increase was primarily due to a 26% increase in
average selling price attributable to larger volumes of higher speed and
multi-port probes and a 27% increase in unit sales.
SERVICE. Service revenues were $13.4 million and $8.9 million for the nine
months ended December 31, 2000 and 1999, respectively, representing an increase
of 50% from 1999 to 2000. This increase was primarily due to an increase in
support agreements attributable to new product sales and an increase in the sale
of support agreements to new and existing customers.
LICENSE AND ROYALTY. License and royalty revenues were $10.4 million and
$12.4 million for the nine months ended December 31, 2000 and 1999,
respectively, representing a decrease of 16% from 1999 to 2000. This decrease
was due to a transition in a specific product line from one of our partners.
COST OF REVENUE AND GROSS MARGIN
PRODUCT. Cost of product revenue was $21.0 million and $15.3 million for
the nine months ended December 31, 2000 and 1999, respectively, representing an
increase of 37% from 1999 to 2000. This increase was primarily due to higher
sales volumes from 1999 to 2000. Product gross margins were 66%
15
and 63% for the nine months ended December 31, 2000 and 1999, respectively. This
increase was primarily due to an increase in software sales which have higher
margins.
SERVICE. Cost of service revenues were $2.4 million and $1.2 million for
the nine months ended December 31, 2000 and 1999, respectively, representing an
increase of 95% from 1999 to 2000. Service gross margins were 82% and 86% for
the nine months ended December 30, 2000 and 1999, respectively. This increase in
cost and decrease in margin was primarily due to an increase in material and
consulting costs to support our increased installed customer base.
Gross margins were $63.0 million and $45.7 million for the nine months ended
December 31, 2000 and 1999, respectively, representing an increase of 38% from
1999 to 2000. This increase was primarily due to a 76% increase in direct sales.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT. Research and development expenses were
$11.0 million and $7.0 million for the nine months ended December 31, 2000 and
1999, respectively, representing an increase of 57% from 1999 to 2000. This
increase was primarily due to a 40% increase in personnel costs and a 91%
increase in contracting expenses from 1999 to 2000.
SALES AND MARKETING. Sales and marketing expenses were $29.8 million and
$20.1 million for the nine months ended December 31, 2000 and 1999,
respectively, representing an increase of 48% from 1999 to 2000. This increase
was primarily due to a 61% increase in sales and marketing personnel costs and
certain related expenses from 1999 to 2000 and a 55% increase in marketing
program expenses from 1999 to 2000.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were
$6.5 million and $3.4 million for the nine months ended December 31, 2000 and
1999, respectively, representing an increase of 90% from 1999 to 2000. This
increase was primarily due to a 46% increase in personnel costs from 1999 to
2000 and an increase in legal expenses from 1999 to 2000 for the nine months
ended December 31, 2000.
AMORTIZATION OF INTANGIBLE ASSETS. Amortization of intangible assets was
$5.3 million for the nine months ended December 31, 2000 due to the acquisition
of NextPoint.
IN-PROCESS RESEARCH AND DEVELOPMENT. In-process research and development
was $268,000 for the nine months ended December 31, 2000 due to the acquisition
of NextPoint. Completed technology and in-process research and development were
identified and valued by an independent appraisal and through interviews and
analysis of data provided by management regarding products under development.
INTEREST INCOME, NET. Interest income, net of interest expense, was
$3.1 million and $1.6 million for the nine months ended December 31, 2000 and
1999, respectively, representing an increase of 91% from 1999 to 2000. This
increase was primarily due to an increase in our cash balances related to cash
generated by operations offset by cash used to acquire NextPoint.
PROVISION FOR INCOME TAXES. The provision for income taxes was
$7.0 million and $6.0 million for the nine months ended December 31, 2000 and
1999, respectively, representing an increase of 17% from 1999 to 2000.
NetScout's effective tax rate increased to 53% from 36% for the nine months
ended December 31, 2000 and 1999, respectively, as a result of non-deductible
amortization of intangible assets, in-process research and development expense,
and stock-based compensation expense related to the acquisition of NextPoint,
which occurred during the second quarter of fiscal 2001.
16
NET INCOME. Net income was $6.2 million and $10.7 million for the nine
months ended December 31, 2000 and 1999, respectively, representing a decrease
of 42% from 1999 to 2000. This decrease was the result of amortization of
intangible assets, in-process research and development expense and stock-based
compensation expense related to the acquisition of NextPoint. Net income
excluding non-cash amortization of intangible assets, in-process research and
development expense and stock-based compensation expense and using a 35%
effective tax rate was $13.0 million and $11.0 million for the nine months ended
December 31, 2000 and 1999, respectively, representing an 18% increase from 1999
to 2000. This increase was primarily due to revenue growth offset by additional
operating expenses resulting from the acquisition of NextPoint.
LIQUIDITY AND CAPITAL RESOURCES
As of December 31, 2000, we had $62.2 million in cash and cash equivalents.
Prior to our initial public offering, we financed our operations through cash
provided by operating activities. On August 17, 1999, we completed our initial
public offering of 3,000,000 shares of common stock at a price of $11.00 per
share. We received net proceeds of approximately $29.6 million after underwriter
discounts and commissions and other offering expenses. We have a line of credit
with a bank, which allows us to borrow up to $5.0 million for working capital
purposes and to obtain letters of credit. The line of credit expires in
March 2001, and it is the intention of NetScout to renegotiate the line of
credit for an extended period of time. Amounts available under the line of
credit are a function of eligible accounts receivable and bear interest at the
bank's prime rate. At December 31, 2000, we had letters of credit outstanding
under the line aggregating $561,000. The bank line of credit is secured by our
inventory and accounts receivable.
Cash and cash equivalents were $62.2 million at December 31, 2000. Cash
provided by operating activities was $17.5 million and $9.6 million for the nine
months ended December 31, 2000 and 1999, respectively. Cash provided by
operating activities was primarily derived from net income and to a lesser
degree, increases in deferred revenue, increases in amortization of goodwill and
other intangible assets, and depreciation and amortization for the nine months
ended December 31, 2000. This was partially offset by increases in accounts
receivable and inventories for the nine months ended December 31, 2000. Cash
provided by operating activities was primarily derived from net income and to a
lesser degree, increases in deferred revenue, and depreciation and amortization
for the nine months ended December 31, 1999. This was partially offset by
increases in accounts receivable, inventories and prepaids and other current
assets for the nine months ended December 31, 1999. These changes were due to
the growth of our business and the purchase of NextPoint.
Cash used by investing activities was $5.0 million and $13.9 million for the
nine months ended December 31, 2000 and 1999, respectively. This was primarily
caused by cash paid for the acquisition of NextPoint, the purchase of marketable
securities, and the purchase of fixed assets, partially offset by proceeds from
the maturity of marketable securities for the nine months ended December 31,
2000. In 1999, cash used by investing activities reflects the purchase of
marketable securities and the purchase of fixed assets, partially offset by
proceeds from the maturity of marketable securities and notes receivable for the
nine months ended December 31, 1999.
Cash provided by financing activities was $1.2 million and $30.1 million for
the nine months ended December 31, 2000 and 1999, respectively, which was
primarily due to proceeds from the issuance of common stock for the nine months
ended December 31, 2000 and 1999, respectively, and was offset by a repayment of
notes payable related to the acquisition of NextPoint for the nine months ended
December 31, 2000.
We believe that our current cash balances and the cash flows generated by
operations will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for at least the next 12 months. Thereafter, if
cash generated from operations is insufficient to satisfy our liquidity
requirements, we may seek to sell additional equity or convertible debt
securities. The sale of
17
additional equity or debt securities could result in additional dilution to our
stockholders. A portion of our cash may be used to acquire or invest in
complementary businesses or products or to obtain the right to use complementary
technologies. From time to time, in the ordinary course of business, we evaluate
potential acquisitions of such businesses, products or technologies.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities," as amended by SFAS No. 137, "Accounting for
Derivative Instruments and Hedging Activities--Deferral of Effective Date of
FASB Statement No. 133" and SFAS No. 138, "Accounting for Certain Derivative
Instruments and Certain Hedging Activities--an Amendment of FASB Statement
No. 133", which establishes accounting and reporting standards for derivative
instruments and hedging activities. It requires that an entity recognize all
derivatives as either assets or liabilities in the statement of financial
position and measure those instruments at fair value. The company, to date has
not engaged in derivative and hedging activities, and accordingly does not
believe that the adoption of SFAS No. 133 will have a material impact on the
financial reporting and related disclosures of the company. The Company will
adopt SFAS No. 133 as required by SFAS No. 137 in fiscal year 2002.
In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No.101, "Revenue Recognition in Financial
Statements", as amended by SAB No.101A and 101B. SAB No.101 summarizes the SEC's
views in applying generally accepted accounting principles to selected revenue
recognition issues in financial statements. The application of the guidance of
SAB No. 101 will be required in the Company's fourth quarter of fiscal 2001. The
Company does not believe that the adoption of SAB No. 101 will have a material
impact on its financial position and results of operations.
CERTAIN FACTORS WHICH MAY AFFECT FUTURE RESULTS
Our operating results and financial condition have varied in the past and
may in the future vary significantly depending on a number of factors. Except
for the historical information in this report, the matters contained in this
report include forward-looking statements that involve risks and uncertainties.
The following factors, among others, could cause actual results to differ
materially from those contained in forward-looking statements made in this
report. Additional risks that are not yet identified or that we currently think
are immaterial may also impair our business operations. Such factors, among
others, may have a material adverse effect upon our business, results of
operations and financial condition.
A REDUCTION IN ORDERS FROM CISCO SYSTEMS, INC. WOULD MATERIALLY ADVERSELY
AFFECT OUR BUSINESS. Our operating results and financial condition for a
particular fiscal period would be materially adversely affected if there is a
substantial reduction in orders from Cisco Systems, Inc. or if we are unable to
complete one or more Cisco orders planned for that period. We derive a
significant portion of our revenue from Cisco, which distributes some of our
products under its private label and incorporates some of our software in its
products. Cisco accounted for 44% and 52% of our total revenue for the three and
nine months ended December 31, 2000, respectively, and 54% and 50% of our total
revenue for the three and nine months ended December 31, 1999, respectively. Our
future performance is significantly dependent upon Cisco's continued promotion
of our products. Cisco has no obligation to purchase any products from us.
Further, we do not control Cisco's distribution of our products, whether
incorporated into Cisco's products or sold under private label. Finally, Cisco
may decide to internally develop products that compete with our solution or
partner with our competitors or bundle or sell competitors' solutions, possibly
at lower prices. If our relationship with Cisco were terminated or adversely
affected for any reason, our business, operating results and financial condition
would be materially adversely affected.
18
OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE. Our quarterly revenue and
operating results are difficult to predict and may fluctuate significantly from
quarter to quarter. Most of our expenses, such as employee compensation and
rent, are relatively fixed in the short term. Moreover, our expense levels are
based, in part, on our expectations regarding future revenue levels. As a
result, if revenue for a particular quarter is below our expectations, we may
not be able to reduce operating expenses proportionately for that quarter, and
therefore this revenue shortfall would have a disproportionately negative effect
on our operating results for that quarter.
Our quarterly revenue may fluctuate as a result of a variety of factors,
many of which are outside our control, including the following:
- the market for network and application infrastructure performance
management solutions is in an early stage of development and therefore
demand for our solutions may be uneven;
- the timing and receipt of orders from customers, particularly Cisco,
especially in light of our lengthy sales cycle;
- the timing and market acceptance of new products or product enhancements
by us or our competitors;
- distribution channels through which our products are sold could change;
- the timing of hiring sales personnel and the speed at which such personnel
become productive;
- we may not be able to anticipate or adapt effectively to developing
markets and rapidly changing technologies; and
- our prices or the prices of our competitors' products may change.
We operate with minimal backlog because our products typically are shipped
shortly after orders are received. As a result, product revenue in any quarter
is substantially dependent on orders booked and shipped in that quarter and
revenue for any future quarter is not predictable to any degree of certainty.
Therefore, any significant deferral of orders for our products would cause a
shortfall in revenue for that quarter.
OUR RELIANCE ON SOLE SOURCE SUPPLIERS COULD ADVERSELY AFFECT OUR
BUSINESS. Many components that are necessary for the assembly of our probes are
obtained from separate sole source suppliers or a limited group of suppliers.
These components include some of our network interface cards, which are produced
for us solely by SBS Technologies, Inc., SysKonnect, Inc. and Adaptec, Inc. Our
reliance on sole or limited suppliers involves several risks, including a
potential inability to obtain an adequate supply of required components and
reduced control over pricing, quality and timely delivery of components. We do
not generally maintain long-term agreements with any of our suppliers or large
volumes of inventory. Our inability to obtain adequate deliveries or the
occurrence of any other circumstance that would require us to seek alternative
sources of these components would affect our ability to ship our products on a
timely basis. This could damage relationships with current and prospective
customers, cause shortfalls in expected revenue and materially adversely affect
our business, operating results and financial condition.
OUR CONTINUED GROWTH DEPENDS ON OUR ABILITY TO EXPAND OUR SALES FORCE. We
must increase the size of our sales force in order to increase our direct sales
and support our indirect sales channels. Because our products are very
technical, sales people require a long period of time to become productive,
typically three to six months. This lag in productivity, as well as the
challenge of attracting qualified candidates, may make it difficult to meet our
sales force growth targets. Further, we may not generate sufficient sales to
offset the increased expense resulting from growing our sales force. If we are
unable to successfully expand our sales capability, our business, operating
results and financial condition could be materially adversely affected.
19
OUR SUCCESS DEPENDS ON OUR ABILITY TO EXPAND AND MANAGE INDIRECT
DISTRIBUTION CHANNELS. To increase our sales, we must further expand and manage
our indirect distribution channels, including original equipment manufacturers,
distributors, resellers, systems integrators and service providers. Sales to our
indirect distribution channels accounted for 69% and 76% of our total revenue
for the three months ended December 31, 2000 and 1999, respectively, and 72% and
78% of our total revenue for the nine months ended December 31, 2000 and 1999,
respectively. Sales to Cisco accounted for 44% and 54% of our total revenue for
the three months ended December 31, 2000 and 1999, respectively, and 52% and 50%
of our total revenue for the nine months ended December 31, 2000 and 1999,
respectively. Our indirect channel partners have no obligation to purchase any
products from us. In addition, they could internally develop products, which
compete with our solutions or partner with our competitors or bundle or resell
competitors' solutions, possibly at lower prices. Our inability to expand and
manage our relationships with our partners, the inability or unwillingness of
our partners to effectively market and sell our products or the loss of existing
partnerships could have a material adverse effect on our business, operating
results and financial condition.
IF WE FAIL TO INTRODUCE NEW PRODUCTS AND ENHANCE OUR EXISTING PRODUCTS TO
KEEP UP WITH RAPID TECHNOLOGICAL CHANGE, DEMAND FOR OUR PRODUCTS MAY DECLINE.
The market for network and application infrastructure performance management
solutions is relatively new and is characterized by rapid changes in technology,
evolving industry standards, changes in customer requirements and frequent
product introductions and enhancements. Our success is dependent upon our
ability to meet our customers' needs, which are driven by changes in computer
networking technologies and the emergence of new industry standards. In
addition, new technologies may shorten the life cycle for our products or could
render our existing or planned products obsolete. If we are unable to develop
and introduce new network and application infrastructure performance management
products or enhancements to existing products in a timely and successful manner,
it would have a material adverse effect on our business, operating results and
financial condition.
WE FACE SIGNIFICANT COMPETITION FROM OTHER TECHNOLOGY COMPANIES. The market
for network and application infrastructure performance management solutions is
intensely competitive. We believe customers make network management system
purchasing decisions based primarily upon the following factors:
- product performance;
- functionality and price;
- name and reputation of vendor;
- distribution strength;
- and alliances with industry partners
We compete with probe vendors, such as Agilent Technologies, providers of
network performance management solutions, such as Concord Communications, Inc.
and Micromuse, Inc., and providers of portable network traffic analyzers, such
as Network Associates, Inc. New vendors of network performance monitoring and
enhancing equipment are emerging to compete with us including Packeteer, Inc. In
addition, leading network equipment providers could offer their own or
competitors' solutions in the future. Many of our current and potential
competitors have longer operating histories, greater name recognition and
substantially greater financial, management, marketing, service, support,
technical, distribution and other resources than we do. Therefore, they may be
able to respond more quickly than we can to new or changing opportunities,
technologies, standards or customer requirements.
As a result of these and other factors, we may not be able to compete
effectively with current or future competitors, which would have a material
adverse effect on our business, operating results and financial condition.
20
THE SUCCESS OF OUR BUSINESS DEPENDS ON THE CONTINUED GROWTH IN THE MARKET
FOR AND THE COMMERCIAL ACCEPTANCE OF NETWORK AND APPLICATION INFRASTRUCTURE
PERFORMANCE MANAGEMENT SOLUTIONS. We derive all of our revenue from the sale of
products and services that are designed to allow our customers to manage the
performance of computer networks and software applications. The market for
network and application infrastructure performance management solutions is in an
early stage of development. Therefore, we cannot accurately assess the size of
the market and may be unable to predict the appropriate features and prices for
products to address the market, the optimal distribution strategy and the
competitive environment that will develop. In order for us to be successful, our
potential customers must recognize the value of more sophisticated network and
application infrastructure performance management solutions, decide to invest in
the management of their networks and the performance of software applications
and, in particular, adopt our management solutions. Any failure of this market
to continue to develop would materially adversely affect our business, operating
results and financial condition. Businesses may choose to outsource the
management of their networks and applications to service providers. Our business
may depend on our ability to develop relationships with these service providers
and successfully market our products to them.
FAILURE TO PROPERLY MANAGE GROWTH COULD ADVERSELY AFFECT OUR BUSINESS. We
have been experiencing a period of rapid growth over the past several years. We
plan to continue to expand our business by hiring additional personnel. The
growth in size and complexity of our business and our customer base has been and
will continue to be a significant challenge to our management and operations. To
manage further growth effectively, we must enhance our financial information and
accounting systems and controls, integrate new personnel and manage expanded
operations. If we are unable to effectively manage our growth, our costs, the
quality of our products, the effectiveness of our sales organization, and our
ability to retain key personnel, our business, operating results and financial
condition could be materially adversely affected.
LOSS OF KEY PERSONNEL COULD ADVERSELY AFFECT OUR BUSINESS. Our future
success depends to a significant degree on the skills, experience and efforts of
Anil Singhal, our Chief Executive Officer, President, and co-founder, and
Narendra Popat, our Chairman of the Board and co-founder. We also depend on the
ability of our other executive officers and senior managers to work effectively
as a team. The loss of one or more of our key personnel could have a material
adverse effect on our business, operating results and financial condition.
WE MUST HIRE AND RETAIN SKILLED PERSONNEL IN A TIGHT LABOR
MARKET. Qualified personnel are in great demand throughout the computer
software, hardware and networking industries. The demand for qualified personnel
is particularly acute in the New England area due to the large number of
software and high technology companies and the low unemployment in the region.
Our success depends in large part upon our ability to attract, train, motivate
and retain highly skilled employees, particularly sales and marketing personnel,
software engineers, and technical support personnel. We have had difficulty
hiring and retaining these highly skilled employees in the past. If we are
unable to attract and retain the highly skilled technical personnel that are
integral to our sales, marketing, product development and customer support
teams, the rate at which we can generate sales and develop new products or
product enhancements may be limited. This inability could have a material
adverse effect on our business, operating results and financial condition.
OUR SUCCESS DEPENDS ON OUR ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY
RIGHTS. Our business is heavily dependent on our intellectual property. We rely
upon a combination of copyright, trademark and trade secret laws and
non-disclosure and other contractual arrangements to protect our proprietary
rights. The reverse engineering, unauthorized copying or other misappropriation
of our intellectual property could enable third parties to benefit from our
technology without compensating us. Legal proceedings to enforce our
intellectual property rights could be burdensome and expensive and could involve
a high degree of uncertainty. In addition, legal proceedings may divert
management's attention
21
from growing our business. There can be no assurance that the steps we have
taken to protect our intellectual property rights will be adequate to deter
misappropriation of proprietary information, or that we will be able to detect
unauthorized use by third parties and take appropriate steps to enforce our
intellectual property rights. Further, we also license software from third
parties for use as part of our products, and if any of these licenses were to
terminate, we may experience delays in product shipment until we develop or
license alternative software.
OTHERS MAY CLAIM THAT WE INFRINGE ON THEIR INTELLECTUAL PROPERTY RIGHTS. We
may be subject to claims by others that our products infringe on their
intellectual property rights. These claims, whether or not valid, could require
us to spend significant sums in litigation, pay damages, delay product
shipments, reengineer our products or acquire licenses to such third-party
intellectual property. We may not be able to secure any required licenses on
commercially reasonable terms or secure them at all. We expect that these claims
will become more frequent as more companies enter the market for network and
application infrastructure performance management solutions. Any of these claims
or resulting events could have a material adverse effect on our business,
operating results and financial condition.
IF OUR PRODUCTS CONTAIN ERRORS, THEY MAY BE COSTLY TO CORRECT, REVENUE MAY
BE DELAYED, WE COULD BE SUED AND OUR REPUTATION COULD BE HARMED. Despite testing
by our customers and us, errors may be found in our products after commencement
of commercial shipments. If errors are discovered, we may not be able to
successfully correct them in a timely manner or at all. In addition, we may need
to make significant expenditures of capital resources in order to eliminate
errors and failures. Errors and failures in our products could result in loss of
or delay in market acceptance of our products and could damage our reputation.
If one or more of our products fails, a customer may assert warranty and other
claims for substantial damages against us. The occurrence or discovery of these
types of errors or failures could have a material adverse effect on our
business, operating results and financial condition.
OUR SUCCESS DEPENDS ON OUR ABILITY TO EXPAND AND MANAGE OUR INTERNATIONAL
OPERATIONS. Sales outside North America accounted for a significant percentage
of our total revenue for the three and nine months ended December 31, 2000 and
1999, respectively. We currently expect international revenue to continue to
account for a significant percentage of total revenue in the future. We believe
that we must continue to expand our international sales activities in order to
be successful. Our international sales growth will be limited if we are unable
to:
- expand international indirect distribution channels;
- hire additional sales personnel;
- adapt products for local markets:
- or manage geographically dispersed operations.
The major countries outside of North America in which we do business, or
intend to do business, are the United Kingdom, Germany and Japan. Our
international operations, including our operations in the United Kingdom,
Germany and Japan, are generally subject to a number of risks, including:
- failure of local laws to provide the same degree of protection against
infringement of our intellectual property;
- protectionist laws and business practices that favor local competitors;
- dependence on local indirect channel partners;
- multiple conflicting and changing governmental laws and regulations;
- longer sales cycles;
- greater difficulty in collecting accounts receivable;
- foreign currency exchange rate fluctuations and political and economic
instability.
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THE PRICE OF OUR COMMON STOCK MAY DECREASE DUE TO MARKET VOLATILITY. The
stock market in general has recently experienced extreme price and volume
fluctuations. In addition, the market prices of securities of technology
companies have been extremely volatile and have experienced fluctuations that
often have been unrelated or disproportionate to the operating performance of
these companies. These broad market fluctuations could adversely affect the
market price of our common stock.
Recently, when the market price of a stock has been volatile, holders of a
company's stock have occasionally instituted securities class action litigation
against such company that issues that stock. If any of our stockholders brought
such lawsuit against us, even if the lawsuit is without merit, we could incur
substantial costs defending the lawsuit. The lawsuit could also divert the time
and attention of our management.
OUR BUSINESS MAY BE NEGATIVELY AFFECTED BY OUR FAILURE TO SUCCESSFULLY
INTEGRATE WITH NEXTPOINT OR TO RETAIN NEXTPOINT EMPLOYEES. On July 7, 2000, we
completed our acquisition of NextPoint Networks, Inc., a Delaware corporation,
by means of a merger of NextPoint with and into NetScout Service Level
Corporation, a Delaware corporation and one of our wholly-owned subsidiaries
pursuant to an Agreement and Plan of Reorganization dated as of June 13, 2000.
The anticipated benefits of the merger may not be achieved unless, among other
things, the operations, products, services and personnel of NextPoint are
successfully combined with ours in a timely and efficient manner. If the
anticipated benefits of the business combination are not achieved or are not
achieved in a timely fashion, then the merger could have an adverse effect on
our operating results for a significant period of time that cannot now be
determined. Furthermore, the diversion of the attention of management, and any
difficulties encountered in the transition process, could have an adverse impact
on our revenues and operating results.
Despite NetScout's efforts to retain key employees, NetScout may lose some
of NextPoint's key employees following the merger. Competition for qualified
management, engineering and technical employees in the computer software,
hardware and networking industries is intense. NextPoint employees may decide
that they do not want to work for a larger, publicly-traded company instead of a
smaller, private company. In addition, competitors may recruit NextPoint
employees during the integration of NextPoint and us. We cannot provide any
assurance that the combined enterprise will be able to attract, retain and
integrate key employees following the merger.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We consider all highly liquid marketable securities purchased with a
maturity of three months or less to be cash equivalents and those with
maturities greater than three months are considered to be marketable securities.
Cash equivalents and marketable securities are stated at amortized cost plus
accrued interest, which approximates fair value. Cash equivalents and marketable
securities consist primarily of money market instruments and U.S. Treasury
bills. We currently do not hedge interest rate exposure, but do not believe that
an increase in interest rates would have a material effect on the value of our
marketable securities.
On January 1, 1999, eleven of the existing members of the European Union
joined the European Monetary Union. Ultimately there will be a single currency
within certain countries of the European Union, known as the Euro, and one
organization, the European Central Bank, responsible for setting European
monetary policy. We have reviewed the impact the Euro will have on our business
and whether this will give rise to a need for significant changes in our
commercial operations or treasury management functions. Because our transactions
are denominated in U.S. dollars, we do not believe that the Euro conversion will
have any material effect on our business, financial condition or results of
operations.
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PART II--OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On November 5, 1999, a former employee of NetScout filed an action against
the Company and an employee stockholder of NetScout in the Massachusetts
Superior Court Department of the Trial Court, Middlesex County, alleging claims
of discrimination on the basis of sexual harassment. On December 30, 1999,
NetScout filed a Notice of Removal to the United States District Court for the
District of Massachusetts, thereby removing the action to that Court. NetScout
filed an Answer denying these allegations. On December 21, 2000, this matter was
settled.
Prior to the acquisition of NextPoint, a reseller of NextPoint filed an
action against NextPoint alleging breach of contract. NextPoint has denied that
a breach occurred. An escrow balance was established at the time of the
acquisition to account for potential losses related to this suit in order to
limit any exposure to NetScout. NetScout plans to vigorously defend this matter.
However, since the matter is at a preliminary stage, NetScout is unable to
predict the outcome or amount of related expense, or loss, if any.
In addition to the matters noted above, from time to time NetScout is
subject to legal proceedings and claims in the ordinary course of business. In
the opinion of management, the amount of ultimate expense with respect to any
other current legal proceedings and claims will not have a material adverse
effect on NetScout's financial position or results of operations.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On August 17, 1999, we completed our initial public offering of three
million shares of common stock at a price of $11.00 per share. The principal
underwriters for the transaction were Deutsche Banc Alex. Brown, Bear,
Stearns & Co. Inc. and Dain Rauscher Wessels, a division of Dain Rauscher
Incorporated. The registration statement relating to this offering was declared
effective by the Securities and Exchange Commission (SEC File Number 333-76843)
on August 11, 1999. We received net proceeds of $29.6 million after deducting
$2.3 million in underwriting discounts and commissions and $1.1 million in other
offering expenses.
Upon the exercise of the over allotment option by the underwriters, certain
selling security holders sold 450,000 shares of common stock for net proceeds of
approximately $4.6 million after deducting underwriting discounts and
commissions.
Approximately $23.2 million of the proceeds from our initial public offering
were used in the acquisition of NextPoint. The balance of proceeds have been
invested primarily in U.S. Treasury obligations and other interest bearing
investment grade securities.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
The following exhibits are filed or incorporated by reference as part of
this Report.
10. 1999 Employee Stock Purchase Plan, as amended
(b) Reports on Form 8-K--A report on Form 8-K was filed with the Securities and
Exchange Commission on January 2, 2001 with respect to:
July 7, 2000 (as amended). Item 5--Other Events--Pro Forma Combined
Statement of Operations and Notes--to disclose certain financial information
relating to the acquisition of NextPoint.
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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.
NETSCOUT SYSTEMS, INC.
Date: February 14, 2001 /s/ Anil K. Singhal
---------------------------------------------
Name: Anil K. Singhal
Title: Chief Executive Officer and President
(Principal Executive Officer)
Date: February 14, 2001 /s/ David P. Sommers
---------------------------------------------
Title: Chief Financial Officer and
Senior Vice President, General Operations
(Principal Financial Officer)
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