10-Q 1 a10-q.txt FORM 10-Q -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- 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 JUNE 30, 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 ------------------------ 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 August 7, 2000 was 29,007,173. -------------------------------------------------------------------------------- -------------------------------------------------------------------------------- NETSCOUT SYSTEMS, INC. FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2000 TABLE OF CONTENTS
ITEM NUMBER PAGE NO. --------------------- -------- PART I: FINANCIAL INFORMATION Item 1. Financial Statements a.) Consolidated Balance Sheets: As of June 30, 2000 and March 31, 2000................... 1 b.) Condensed Consolidated Statements of Income: For the three months ended June 30, 2000 and June 30, 1999........................................................ 2 c.) Consolidated Statements of Cash Flows: For the three months ended June 30, 2000 and June 30, 1999........................................................ 3 d.) Notes to the Consolidated Financial Statements.......... 4 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations................................................................. 6 Item 3. Quantitative and Qualitative Disclosures About Market Risk................. 16 PART II: OTHER INFORMATION Item 1. Legal Proceedings.......................................................... 16 Item 2. Changes in Securities and Use of Proceeds.................................. 17 Item 6. Exhibits and Reports on Form 8-K........................................... 17 SIGNATURES.......................................................................... 18 EXHIBIT INDEX....................................................................... 19
PART 1: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS NETSCOUT SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED)
JUNE 30, MARCH 31, 2000 2000 -------- --------- ASSETS Current assets: Cash and cash equivalents................................... $ 56,722 $48,515 Marketable securities....................................... 17,611 21,807 Accounts receivable, net of allowance for doubtful accounts and returns of $719 and $754 at June 30, 2000 and March 31, 2000, respectively.................................... 12,604 10,390 Inventories................................................. 4,362 3,131 Refundable income taxes..................................... -- 1,899 Deferred income taxes....................................... 1,022 1,022 Prepaids and other current assets........................... 4,306 3,728 -------- ------- Total current assets.................................... 96,627 90,492 Fixed assets, net........................................... 6,051 5,657 Deferred income taxes....................................... 599 599 -------- ------- Total assets............................................ $103,277 $96,748 ======== ======= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable............................................ $ 3,887 $ 2,789 Accrued compensation........................................ 4,221 3,673 Accrued other............................................... 1,661 2,448 Income taxes payable........................................ 290 -- Customer deposits........................................... 25 78 Deferred revenue............................................ 7,357 6,638 -------- ------- Total current liabilities............................... 17,441 15,626 -------- ------- Commitments and contingencies Stockholders' equity: Preferred stock, $0.001 par value, 5,000,000 shares authorized, no shares issued or outstanding at June 30, 2000 and March 31, 2000................................... -- -- Common stock, $0.001 par value: 150,000,000 shares authorized; 30,794,617 shares issued and 26,817,363 shares outstanding at June 30, 2000; 30,697,697 shares issued and 26,720,443 shares outstanding at March 31, 2000......................................... 31 31 Additional paid-in capital.................................. 67,658 67,366 Deferred compensation....................................... (518) (636) Treasury stock.............................................. (25,306) (25,306) Retained earnings........................................... 43,971 39,667 -------- ------- Total stockholders' equity.............................. 85,836 81,122 -------- ------- Total liabilities, and stockholders' equity............. $103,277 $96,748 ======== =======
The accompanying notes are an integral part of these consolidated financial statements. 1 NETSCOUT SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED)
THREE MONTHS ENDED JUNE 30, ------------------- 2000 1999 -------- -------- Revenue: Product................................................... $17,761 $12,814 Service................................................... 3,976 2,465 License and royalty....................................... 3,432 3,792 ------- ------- Total revenue........................................... 25,169 19,071 ------- ------- Cost of revenue: Product................................................... 6,094 4,814 Service................................................... 595 413 ------- ------- Total cost of revenue................................... 6,689 5,227 ------- ------- Gross margin................................................ 18,480 13,844 ------- ------- Operating expenses: Research and development.................................. 2,572 2,241 Sales and marketing....................................... 8,727 6,040 General and administrative................................ 1,594 937 ------- ------- Total operating expenses................................ 12,893 9,218 ------- ------- Income from operations...................................... 5,587 4,626 Interest income, net........................................ 1,034 272 ------- ------- Income before provision for income taxes.................... 6,621 4,898 Provision for income taxes.................................. 2,317 1,764 ------- ------- Net income.................................................. $ 4,304 $ 3,134 ======= ======= Basic net income per share.................................. $ 0.16 $ 0.22 Diluted net income per share................................ $ 0.15 $ 0.13 Shares used in computing: Basic net income per share................................ 26,762 14,331 Diluted net income per share.............................. 27,954 24,909
The accompanying notes are an integral part of these consolidated financial statements. 2 NETSCOUT SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED)
THREE MONTHS ENDED JUNE 30, ------------------- 2000 1999 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income................................................ $ 4,304 $ 3,134 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Depreciation and amortization........................... 769 580 Loss on disposal of fixed assets........................ 11 28 Compensation expense associated with equity awards...... 58 92 Changes in assets and liabilities: Accounts receivable................................... (2,214) (1,881) Inventories........................................... (1,231) 581 Refundable income taxes............................... 1,899 217 Prepaids and other current assets..................... (578) (239) Accounts payable...................................... 1,098 (3,445) Accrued expenses...................................... (239) (1,157) Income taxes payable.................................. 290 507 Customer deposits..................................... (53) -- Deferred revenue...................................... 719 575 -------- ------- Net cash provided by (used in) operating activities... 4,833 (1,008) -------- ------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of marketable securities......................... (12,646) -- Proceeds from maturity of marketable securities........... 16,842 -- Purchase of fixed assets.................................. (1,174) (1,619) -------- ------- Net cash provided by (used in) investing activities... 3,022 (1,619) -------- ------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock.................... 352 68 -------- ------- Net cash provided by financing activities............. 352 68 -------- ------- Net increase (decrease) in cash and cash equivalents...... 8,207 (2,559) Cash and cash equivalents, beginning of the period........ 48,515 25,477 -------- ------- Cash and cash equivalents, end of the period.............. $ 56,722 $22,918 ======== ======= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest.................................... $16 $1 Cash paid for income taxes................................ 128 1,053
The accompanying notes are an integral part of these consolidated financial statements. 3 NETSCOUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UAUDITED) 1. BASIS OF PRESENTATION The accompanying consolidated financial statements as of June 30, 2000 and for the three months ended June 30, 2000 and 1999 are unaudited. In the opinion of NetScout's management, the June 30, 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 month period ended June 30, 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. 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 June 30, 2000 and March 31, 2000 any unrealized gains or losses were not significant. 3. INVENTORIES Inventories consist of the following:
JUNE 30, MARCH 31, 2000 2000 -------- --------- Raw materials............................................. $2,595 $2,371 Work-in-process........................................... 771 476 Finished goods............................................ 996 284 ------ ------ $4,362 $3,131 ====== ======
4 NETSCOUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UAUDITED) 4. GEOGRAPHIC INFORMATION Revenue was distributed geographically as follows:
JUNE 30, ------------------- 2000 1999 -------- -------- North America............................................. $23,225 $15,442 Other international....................................... 1,944 3,629 ------- ------- $25,169 $19,071 ======= =======
Substantially all of NetScout's identifiable assets are located in the United States. 5. 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 sex and 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 has filed an Answer denying these allegations and plans to vigorously defend this matter. NetScout has recorded an accrual to address 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 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. 6. ACQUISITION On July 7, 2000, NetScout Systems, Inc., a Delaware corporation, completed its 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 a wholly-owned subsidiary of NetScout, pursuant to an Agreement and Plan of Reorganization dated as of June 13, 2000. The transaction was valued at approximately $60 million in which NetScout issued approximately 2.1 million NetScout shares and approximately $19.5 million in cash at closing and reserved approximately 25,000 NetScout shares and approximately $231,000 in cash for issuance upon the exercise of warrants for NextPoint Series C preferred stock, and approximately 274,000 NetScout shares for issuance upon the exercise of NextPoint options. The acquisition has been accounted for as a purchase transaction. 7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS 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 is currently determining the impact, if any, that SAB No. 101 will have on its financial position and results of operations. 5 In March 2000, the Financial Accounting Standards Board issued Interpretation ("FIN") No. 44, "Accounting for Certain Transactions Involving Stock Compensation--an interpretation of APB Opinion No. 25". FIN No. 44 clarifies the application of APB Opinion No. 25 to certain issues including: the definition of an employee for purposes of applying APB Opinion No. 25; the criteria for determining whether a plan qualifies as a non-compensatory plan; the accounting consequence of various modifications to the terms of previously fixed stock options or awards; and the accounting for the exchange of stock compensation awards in business combinations. FIN No. 44 is effective July 1, 2000, but certain conclusions in FIN No. 44 are applicable retroactively to specific events occurring after either December 15, 1998 or January 12, 2000. NetScout does not expect the application of FIN No. 44 to have a significant impact on the Company's financial position or results of operations. 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. 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. Although we believe that the expectations reflected in the forward looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. We are under no duty to update any of the forward- looking statements after the date of this Form 10-Q to conform such statements to actual results. OVERVIEW NetScout designs, develops, manufactures, markets and supports a family of products that enable businesses and network service providers to manage the performance of their computer networks and software applications. Our products include data collection devices, consisting of probes and software agents, which collect, aggregate and perform detailed analysis of computer network and application data, and analytical and presentation software, which provides current network and application performance information in an easy-to-use, graphical format. We were incorporated in 1984 and primarily provided consulting services until 1992 when we began to develop and market our first computer network 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. 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 6 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. 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 the Company allocates 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. 7 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 ENDED JUNE 30, ------------------------- 2000 1999 -------- -------- Revenue: Product................................................ 70.6% 67.2% Service................................................ 15.8 12.9 License and royalty.................................... 13.6 19.9 ----- ----- Total revenue........................................ 100.0 100.0 ----- ----- Cost of revenue: Product................................................ 24.2 25.2 Service................................................ 2.4 2.2 ----- ----- Total cost of revenue................................ 26.6 27.4 ----- ----- Gross margin............................................. 73.4 72.6 ----- ----- Operating expenses: Research and development............................... 10.2 11.8 Sales and marketing.................................... 34.7 31.7 General and administrative............................. 6.3 4.9 ----- ----- Total operating expenses............................. 51.2 48.4 ----- ----- Income from operations................................... 22.2 24.2 Interest income, net..................................... 4.1 1.4 ----- ----- Income before provision for income taxes................. 26.3 25.6 Provision for income taxes............................... 9.2 9.2 ----- ----- Net income............................................... 17.1% 16.4% ===== =====
THREE MONTHS ENDED JUNE 30, 2000 AND 1999 REVENUE Total revenues were $25.2 million and $19.1 million for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 32% from 1999 to 2000. PRODUCT. Product revenues were $17.8 million and $12.8 million for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 39% from 1999 to 2000. This increase was primarily due to a 37% increase in average selling price attributable to larger volumes of higher speed and multi-port probes. 8 SERVICE. Service revenues were $4.0 million and $2.5 million for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 61% 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 attributable to increased sales and marketing efforts. LICENSE AND ROYALTY. License and royalty revenues were $3.4 million and $3.8 million for the three months ended June 30, 2000 and 1999, respectively, representing a decrease of 9% from 1999 to 2000. For the three months ended June 30, 1999, we received a large royalty from a small partner. Thereafter, due to changing product lines at the small partner, royalty from them decreased substantially. Beyond this, license and royalty was primarily sustained by the proportionate growth in unit sales of our software and embedded software products by Cisco. 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 $6.1 million and $4.8 million, for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 27% from 1999 to 2000. This increase was primarily due to higher sales volumes offset by a 18% decrease in the average cost per unit from 1999 to 2000. Product gross margins were 66% and 62% for the three months ended June 30, 2000 and 1999, respectively. SERVICE. Cost of service revenue consists primarily of personnel costs. Cost of service revenues were $595,000 and $413,000 for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 44% from 1999 to 2000. This increase was primarily due to the distribution of software updates and material costs to support our increased installed customer base. Service gross margins were 85% and 83% for the three months ended June 30, 2000 and 1999, respectively. Gross margins were $18.5 million and $13.8 million for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 34% 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 relative to product and service revenue and on direct sales relative to indirect distribution channel sales. This increase was primarily due to a 84% increase in direct sales and an increase in average selling price. 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 $2.6 million and $2.2 million for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 15% from 1999 to 2000. This increase was primarily due to a 17% increase in personnel costs from 1999 to 2000. 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 $8.7 million and $6.0 million for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 44% from 1999 to 2000. This increase was primarily due to a 51% increase in sales and marketing personnel costs 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 $1.6 million and $937,000 for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 70% from 1999 to 2000. This increase was primarily due to a 45% increase in 9 personnel costs from 1999 to 2000 and an increase in expenses related to our responsibilities as a public company. INTEREST INCOME, NET. Interest income, net of interest expense, was $1.0 million and $272,000, for the three months ended June 30, 2000 and 1999, respectively. This increase was primarily due to an increase in our cash balances related to the proceeds from our initial public offering. PROVISION FOR INCOME TAXES. The provision for income taxes was $2.3 million and $1.8 million, for the three months ended June 30, 2000 and 1999, respectively, representing an increase of 31% from 1999 to 2000, primarily due to higher pre-tax income. Our effective tax rate was 35% for the three months ended June 30, 2000 and 36% for the three months ended June 30, 1999. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2000, we had $56.7 million in cash and cash equivalents and $17.6 million in marketable securities. 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. Amounts available under the line of credit are a function of eligible accounts receivable and bear interest at the bank's prime rate. At June 30, 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, cash equivalents and marketable securities were $74.3 million at June 30, 2000. Cash provided by operating activities was $4.8 million for the three months ended June 30, 2000. Cash provided by operating activities was primarily derived from net income and to a lesser degree, increases in deferred revenue, accounts payable, depreciation and amortization, and decreases in refundable income taxes This was partially offset by increases in accounts receivable, inventory, and prepaids and other current assets for the three months ended June 30, 2000. These changes were due to the growth of our business. Cash used by operating activities was $1.0 million, for the three months ended June 30, 1999. This was primarily caused by a large decrease in our accounts payables. Cash provided by investing activities was $3.0 million for the three months ended June 30, 2000, which reflects the proceeds from the maturity of marketable securities, partially offset by purchases of fixed assets and other marketable securities. Cash used in investing activities was $1.6 million for the three months ended June 30, 1999, which was due to the purchase of fixed assets. Cash provided by financing activities was $352,000 and $68,000 for the three months ended June 30, 2000 and 1999, respectively, which was primarily due to proceeds from the issuance of common stock. On July 7, 2000, we completed the 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 a wholly-owned subsidiary of NetScout, pursuant to an Agreement and Plan of Reorganization dated as of June 13, 2000. The transaction was valued at approximately $60 million in which NetScout issued approximately 2.1 million NetScout shares and approximately $19.5 million in cash at closing and reserved approximately 25,000 NetScout shares and approximately $231,000 in cash for issuance upon the exercise of warrants for NextPoint Series C preferred stock, and approximately 274,000 NetScout shares for issuance upon the exercise of NextPoint options. The acquisition has been accounted for as a purchase transaction. 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 the next 12 months. Thereafter, if cash generated from operations is insufficient to satisfy our liquidity requirements, we may 10 seek to sell additional equity or convertible debt securities. The sale of 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 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 is currently determining the impact, if any, that SAB No. 101 will have on its financial position and results of operations. In March 2000, the Financial Accounting Standards Board issued Interpretation ("FIN") No. 44, "Accounting for Certain Transactions Involving Stock Compensation--an interpretation of APB Opinion No. 25". FIN No. 44 clarifies the application of APB Opinion No. 25 to certain issues including: the definition of an employee for purposes of applying APB Opinion No. 25; the criteria for determining whether a plan qualifies as a non-compensatory plan; the accounting consequence of various modifications to the terms of previously fixed stock options or awards; and the accounting for the exchange of stock compensation awards in business combinations. FIN No. 44 is effective July 1, 2000, but certain conclusions in FIN No. 44 are applicable retroactively to specific events occurring after either December 15, 1998 or January 12, 2000. NetScout does not expect the application of FIN No. 44 to have a significant impact on the Company's financial position or results of operations. YEAR 2000 READINESS DISCLOSURE To date, we have not incurred significant costs in connection with identifying and evaluating year 2000 issues or complying with year 2000 requirements. We have not experienced any significant year 2000 problems and have not deferred the release of any of our products or any IT projects as a result of year 2000 complications. However, we have not used any independent verification or validation processes to support our assertions regarding year 2000 risks and cost estimates. While we do not expect to incur significant costs in the foreseeable future, year 2000 complications are not fully known, therefore, there can be no assurance that year 2000 errors or defects will not be discovered in our products or internal software systems. If such errors or defects are discovered, there can be no assurance that the costs of making such systems year 2000 compliant will not have a material adverse effect on our business, operating results and financial condition. CERTAIN FACTORS WHICH MAY AFFECT FUTURE RESULTS We do not provide financial performance forecasts. 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. 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 11 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 57% of our total revenue for the three months ended June 30, 2000 and 44% of our total revenue for the three months ended June 30, 1999. 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. 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 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. Therefore, 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 SDL Communications, 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 12 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. 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 18% and 39% of our total revenue for the three months ended June 30, 2000 and 1999, respectively. Sales to Cisco accounted for 57% and 44% of our total revenue for the three months ended June 30, 2000 and 1999. 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 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 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 performance management solutions is intensely competitive. We believe customers make network management system purchasing decisions based primarily upon 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. 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. 13 THE SUCCESS OF OUR BUSINESS DEPENDS ON THE CONTINUED GROWTH IN THE MARKET FOR AND THE COMMERCIAL ACCEPTANCE OF NETWORK AND APPLICATION 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 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 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 and accounting systems and controls, integrate new personnel and manage expanded operations. Our financial and accounting systems are currently being upgraded and we anticipate the upgrade to be completed in the third calendar quarter of 2000. If we are unable to successfully integrate these systems and controls and 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 Chairman of the Board, Chief Executive Officer and co-founder, and Narendra Popat, our President, Chief Operating Officer 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 from growing our business. 14 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 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 GET 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 months ended June 30, 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, or intend to do, businesses 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. 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 that stock have occasionally instituted securities class action litigation against the company that issues the 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 Nextworks, Inc., a 15 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 adverse affect 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 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. 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 sex and 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 has filed an Answer denying these allegations and plans to vigorously defend this matter. NetScout has recorded an accrual to address 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 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. 16 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 $19.5 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. 11. Statement re Computation of Per Share Earnings 27. Financial Data Schedule (b) Reports on Form 8-K. None.
17 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. By: /s/ David Sommers ------------------------------------------------------------------------------ Name: David Sommers Title: Vice President and Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer) 18 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION ----------- ------------------------------------------------------------ 11 Statement re-Computation of Per Share Earnings 27 Financial Data Schedule
19