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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-K
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED MARCH 31, 2001
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 / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. / /
The aggregate market value of Common Stock held by non-affiliates of the
registrant as of June 8, 2001 (based on the last reported sale price on The
Nasdaq National Market as of such date) was $158,436,175.70. As of June 20,
2001, there were 29,562,633 shares of the registrant's Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None.
NETSCOUT SYSTEMS, INC.
FORM 10-K
FOR THE ANNUAL REPORT ENDED MARCH 31, 2001
TABLE OF CONTENTS
INDEX
PART I
Item 1. Business.................................................... 3
Item 2. Properties.................................................. 12
Item 3. Legal Proceedings........................................... 13
Item 4. Submission of Matters to a Vote of Security Holders......... 13
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters......................................... 14
Item 6. Selected Financial Data..................................... 15
Item 7. Management's Discussion and Analysis of Results of
Operations and Financial Condition.......................... 16
Item 7A. Quantitative and Qualitative Disclosures about Market
Risk........................................................ 28
Item 8. Financial Statements and Supplementary Data................. 28
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure.................................... 28
PART III
Item 10. Directors and Officers...................................... 29
Item 11. Executive Compensation...................................... 32
Item 12. Security Ownership of Certain Beneficial Owners and
Management.................................................. 38
Item 13. Certain Relationships and Related Transactions.............. 41
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K......................................................... 41
Index to Consolidated Financial Statements............................... F-1
2
PART I
ITEM 1. BUSINESS
GENERAL
NetScout Systems designs, develops, manufactures, markets and supports a
family of integrated products that enable optimization of the performance and
cost management of complex, high-speed networks, including their ability to
deliver critical business applications and content to end-users efficiently. We
manufacture and market these products in an integrated hardware and software
solution suite that is used by enterprise and service provider businesses
worldwide.
Businesses are increasing their reliance on software applications and
computer networks, making them strategic assets for better competitive advantage
and essential business operations. To support the growing number of users and
their demands for faster and more reliable computer network access, new network
technologies and products are continually being introduced. The result is
increasingly large, complex and geographically dispersed networks with
infrastructures that are extremely difficult to manage. Computer network
malfunctions cause performance degradations that result in significant business
interruptions, lost revenue and customer dissatisfaction. As a result,
businesses are recognizing the critical importance of addressing network
performance problems quickly and proactively.
The NGenius-TM- Performance Management System is NetScout's solution suite
of integrated hardware and software products. Our NGenius products monitor,
collect and publish information on the traffic flows of individual software
applications (ERP, CRM, Voice-over-IP, e-commerce, etc.), as well as the
performance of the underlying network (routers, switches, and communication
links) and its users' behaviors. The NGenius information is generated from
multiple sources, but principally from data collected by NetScout's line of
network monitoring appliances called probes. The hardware probes attach to the
network and collect information from the network's traffic flows in real-time.
As they record traffic, the probes generate in-depth information about network
and traffic activity that is unique to NetScout probes, as well as
industry-standard performance data. By placing probes at strategic locations
throughout a network, enterprises and service providers can understand and
optimize the network's traffic flows and application performance across the
network. In addition to probes, the NGenius system includes intelligent software
agents that simulate end-user transactions to measure and report the response
times that would be experienced by end users throughout internal networks and
across the Internet. Using probe information, active agent data, and data
collected from network devices, our analysis and presentation software tools
provide current and historical analysis in Web-accessible, easy-to-use graphical
formats.
NetScout customers use the information generated by NGenius to reduce the
severity and the frequency of network slowdowns and service interruptions, to
manage the delivery of services as denoted by service-level agreements, to
assess infrastructure capacity against future needs, and to justify needs for
additional resources. These capabilities have a high return on investment for
customers who need to maintain high levels of service while controlling growth
and costs of the infrastructure. The information generated by NGenius products
is published in both real-time displays and customizable reports that summarize
the status of network activity, service levels, application performance, device
capacity, and other critical aspects of network availability, utilization and
performance.
During the fiscal year 2001, NetScout completed the introduction of its
NGenius Performance Management System to markets worldwide, and migrated all of
NetScout's key technologies and product functionalities onto the NGenius
platform. On July 7, 2000, NetScout acquired NextPoint Networks, Inc. to
accelerate the addition of key reporting and service level management
technologies into the NGenius suite. As part of the development effort,
NetScout's unique probe information was integrated with the new reporting
capabilities brought by NextPoint technology. This integration is a significant
milestone in the Company's strategy to drive growth by introducing
first-to-market, integrated solutions. NetScout now has the first-to-market
network performance management solution that integrates the benefits of
scalable,
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industry-leading monitoring probes with broad-based reporting and service level
management technologies.
On June 12, 2001, NetScout announced a change in the terms of its strategic
relationship with Cisco Systems, Inc. where Cisco would discontinue private
labeling and reselling NetScout's probes and begin referring sales opportunities
for probes directly to NetScout. The change was precipitated by the two
companies' need to evolve their sales and support model to better meet changing
customer requirements and needs for profitability objectives. The strategic
aspect of the relationship involving the early exchange of technology plans and
the close collaboration of technology development continues. As one of the key
elements in our market strategy, we plan to continue our technology
collaboration with Cisco and to support Cisco's continued distribution of our
software products. The addition of NetScout's NGenius Real-Time Monitor software
to Cisco's CiscoWorks2000 Routed WAN and LAN Management Solutions software
bundle is the most recent step in that strategy plan. We also intend to generate
programs with Cisco to establish mechanisms for referral of probe business and
to successfully transition the responsibility for customer and reseller
relationships to NetScout. We see continued opportunity in our relationship with
Cisco, and intend to continue increasing the sale, visibility, and accelerated
market acceptance of our products via this relationship, worldwide.
Our principal executive offices are located at 4 Technology Park Drive,
Westford, MA and our telephone number is 978-614-4000.
INDUSTRY BACKGROUND
Enterprises are increasingly dependent upon their computer data networks to
manage and deliver information and business services, both for internal
operations and to serve their many constituencies: customers, suppliers,
investors and employees. Their dependence is approaching the level of reliance
which organizations have long had on the public telephone voice network for
internal communications and to reach constituents.
As they did with the voice network in the past, enterprises today are
turning to data network service providers to fulfill their need for available,
flexible, reliable network service in the face of serious internal skill and
resource constraints. Service providers and enterprises have been building
networks rapidly to be available to satisfy the anticipated growth in demand for
information and services.
The ultimate value of the data network to both enterprises and service
providers is determined not just by availability of the network, but by the
speed, flexibility, and cost with which it can deliver high quality information,
knowledge, productivity, reach and rapid execution to fulfill critical
enterprise missions. As enterprise network dependence grows and uses of the
network are increasingly business-critical, the need for network reliability,
performance and efficiency is growing even faster.
Network management tools to measure, analyze and maintain network
performance have necessarily lagged the development of the new technologies
which drive today's networks. Beyond that natural lag, however, the recent
period of rapid growth of network infrastructures has often caused network
management to be a secondary consideration for enterprises and service providers
who were striving for rapid network expansion to meet perceived market
opportunities or competitive threats. In recent years, this led to an excess
capacity, or an over-provisioning approach to managing networks, using high
redundancy and capacity to compensate for unmeasured and unmanaged network
utilization and performance.
Today, with the slowing of the e-commerce land rush, enterprises, and
consequently service providers, are focusing on obtaining productivity and
returns from their existing investments in network facilities, not just on
building them. In that environment, the appeal of network management solutions
is much greater. Solutions which can provide improved network availability,
application performance and network
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efficiency are increasingly important, even in the face of lower growth in
network infrastructure equipment purchases and communications bandwidth.
APPROACHES TO NETWORK PERFORMANCE MANAGEMENT
Network management solution providers have developed several approaches to
manage different aspects of the overall network management challenge. These
approaches can be broadly categorized as fault management, availability
management and performance management.
Fault management is the collection and analysis of data from network devices
upon the failure of network elements, principally devices such as routers and
switches. This approach uses alarms sent by the devices and analyzes them to
help network managers to determine the cause of the failure and to repair it
more quickly. It does not provide information about the utilization or
performance of the network or allow for proactive management of the network. It
only provides value after the network failure or degradation is experienced by
the end user. Enterprises and service providers who have built networks without
putting in place any network management solutions, typically find that fault
management is the initial solution they implement. This is because without good
network management available, and the visibility to impending network problems
that it provides, their network requires fixing more frequently.
Availability management is the collection and analysis of data on network
utilization and the availability of network services. This is done at the
network infrastructure level, that is, providing data on what communications
links are up or down and how fully utilized they are. It does not provide
information on what is causing the links to be down or heavily utilized because
it does not provide visibility into the content of flow of traffic over the
network. It is often an early step for enterprises and service providers in
developing proactive network management.
Performance management is the collection and analysis of data on network
performance and activity, such as device throughput, link utilization and
traffic flows at the level of applications and users of the network. Performance
management solutions provide real-time monitoring of the utilization of network
infrastructure resources by individuals and/or groups of applications and users,
so that consumption of those resources can be proactively managed. They provide
trending of network utilization and error occurrences so that failures can be
anticipated and avoided, minimizing the need to fix network failures.
Ultimately, performance management solutions enable increases in utilization to
take place without having to invest heavily in additional network
infrastructure; additional capacity can be added only where most urgently
required. To provide full value in managing network behavior, performance
management solutions must have mechanisms for generating information directly
from the network traffic, rather than relying solely on the limited data
supplied by the network devices themselves.
NETSCOUT PRODUCTS AND TECHNOLOGY
NetScout develops, sells and supports network performance management
solutions under the NGenius-TM- brand. The NGenius Performance Management System
is a robust, broad system implementation of the performance management approach
to network management. NGenius consists of integrated hardware and software
products that monitor, measure and report on the state of the network's ability
to fulfill its performance, cost and service-level objectives. The system is
comprised of:
- PRESENTATION AND ANALYSIS SOFTWARE, which displays the network and
application performance information in real-time or historical views
through easy-to-use, graphical formats;
- REAL-TIME, APPLICATION-AWARE PROBES that generate, collect, aggregate and
analyze network and application performance information;
- ACTIVE INTELLIGENT SOFTWARE AGENTS that generate synthetic end-user
transactions, measure and report on response times of the applications
supporting those transactions; and
5
- AGGREGATING SERVERS that accelerate the distribution and consumption of
the rich performance information by aggregating, sorting, simplifying and
storing data collected at remote sites.
PRESENTATION AND ANALYSIS SOFTWARE. The NGenius system includes a suite of
presentation and analysis software applications that display all of the
real-time and historical information gathered and analyzed by NetScout's probes
and active agents, as well as information generated from network devices. All of
the presentation and analysis software products are designed for intuitiveness
and ease of use, and utilize Web-based distribution. They also are designed with
features that simplify and enable logical monitoring and management of large,
geographically dispersed networks. NGenius performance management applications
include the following:
- NGENIUS-TM- REAL-TIME MONITOR delivers continuous views of network and
application behavior and performance information generated by NetScout's
probes. It enables proactive control of communications, link utilization,
link performance, application loads, end user behavior, device loads and
more. NGenius Real-Time Monitor delivers its continuous information
securely, anytime, anywhere, via the Web.
- NGENIUS-TM- CAPACITY PLANNER helps IT professionals leverage the value of
deployed network resources and improve the effectiveness of future network
investments by profiling and predicting application, network, and device
utilization and behavior. NGenius Capacity Planner also reports on trends
in network consumption by individual software application through
utilizing data available from NetScout probes.
- NGENIUS-TM- APPLICATION SERVICE LEVEL MANAGER generates reports on
applications service levels from information gathered by NetScout's active
agent technology. Network managers use the reports to validate application
response time and to manage relationships with IT clients or service
providers. The NGenius active agent is a Java application deployed on or
near the desktop to gather application response time information from the
customer perspective. It generates synthetic transactions to "test" the
application environment and report response time. A single active agent
can represent multiple applications, providing a cost-effective approach
to tracking business transactions.
INFORMATION COLLECTION AND GENERATION. At the heart of NetScout's value to
its customers is the unique network and application behavior and performance
information generated from data collected by NetScout's real-time probes.
NetScout probes attach to the network and collect information from applications
traffic as it flows across the network, in real-time. As they record traffic
data, the probes generate unique in-depth information about network and traffic
behavior that is available only through NetScout probes, as well as
industry-standard performance data. By placing probes at strategic locations
throughout a network, network professionals can understand and optimize
performance of the network and the applications being delivered across the
network. They can also be deployed to track and report on network usage by
applications, departments, or users, which can then be used to implement usage
based billing.
NetScout continually enhances its probe technology to ensure visibility into
all types of network traffic and communications technologies. Today, NetScout's
probes monitor all business applications, as well as voice, video, and Web
applications. NetScout recently introduced support for Voice-over-IP,
Voice-over-Frame-Relay and Virtual Private Networks to its monitoring
capabilities. NetScout has probes to support the widest range of network
topologies, including Gigabit Ethernet, DS3 Asynchronous Transfer Mode, E3 ATM,
Ethernet, Fast Ethernet, Fast EtherChannel, Token Ring, Sub-rate T1/E1, T3/E3
Wide Area Network and Frame Relay, Fiber Distributed Data Interface/Copper
Distributed Data Interface and OC-3 ATM. Our track record of innovation began
with the introduction of Ethernet probes in 1992 and we have continued to
innovate probe technology with the addition of more than twenty new probes over
the past nine years. In conjunction with probe innovation, we have continually
expanded our network traffic monitoring capabilities by also innovating highly
valuable, unique applications performance information
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through new probe software extensions, including extensions for application
response time and web-application content response time. Maintenance customers
with probes installed can upgrade them by downloading new versions of the probe
software over their network, keeping their monitoring capability current with
NetScout's industry leading innovations.
NetScout also offers options for proprietary software enhancements to its
probes. Some of those options include: NetFlow Monitor, which integrates traffic
information stored in Cisco routers with other traffic information; Resource
Monitor, which collects information from network devices, including servers, to
offer a more complete, end-to-end view of the network; Application Response Time
Management Information Base, which enables monitoring of application response
time within the network; and Virtual Local Area Network Monitor, which allows
traffic monitoring of specific sets of users within a switched network for
either increased troubleshooting or traffic accounting.
STRATEGY
Our objective is to enhance shareholder value through continued growth,
profitability and market leadership. We intend to pursue growth through
expanding our worldwide presence, expanding our customer base, and increasing
our ongoing business and penetration with our established customers. We intend
to extend our market leadership by continuing to develop the market's first
strategic, integrated, network performance management platform that overlays the
network and generates the information needed to proactively avoid network faults
and performance degradations. Key elements of our strategy include:
EXTEND TECHNOLOGY LEADERSHIP. We intend to continue to devote significant
development resources to expanding and enhancing our first-to-market, integrated
platform of performance management solutions that capitalizes on our extensive
experience with global companies and their very large computer networks. Key
aspects of our technology leadership include the ability to develop new and
groundbreaking performance management techniques, the ability to deliver
solutions across a multi-vendor environment, and our vision into emerging uses
of communications technology and networked environments. As part of our
strategy, we will enter into strategic relationships with, and/or acquire other
companies to gain complementary technologies. We intend to incorporate new
technologies and provide solutions that will enable businesses, service
providers and carriers to manage and optimize the performance of their networks,
critical software applications and network-based service offerings.
EXPAND REPORTING AND ANALYSIS SOFTWARE SUITE. We plan to develop new
analysis, presentation and reporting software to capitalize on growing demands
for integrated performance management solutions and opportunities created by
changes in networking technologies and trends, such as IP telephony and storage
area networks. We also plan to leverage the unique information generated by our
probes and integrated reporting and analysis tools, through new NGenius software
products.
EXTEND PROBE SUITE. We plan to continue to expand our probe line to extend
our monitoring capabilities alongside emerging network environments with higher
speeds, new types of traffic, new communications architectures, new
communications technologies and new network topologies. To ensure that our
customers are able to achieve comprehensive oversight of their networks, we will
maintain older topologies while regularly introducing probes for newer ones. Our
probe suite covers topologies of both domestic and international markets.
7
LEVERAGE INSTALLED BASE OPPORTUNITIES. More than 75,000 network segments
are monitored by the more than 3,000 customers that have deployed NetScout
products worldwide. Ongoing business with those customers represented
approximately two-thirds of our business in fiscal year 2001. During fiscal year
2001, the potential for recurring sales with existing customers increased with
the introduction of the NGenius system and the new products acquired through the
acquisition of NextPoint. We have initiated steps to target existing users of
our products with marketing and sales programs designed to promote the more
extensive use of our performance management solutions. Customers purchase
products through our top reseller partners or direct from us. In both cases, we
participate in selling to them using a "high-touch" selling model. In this
model, NetScout's worldwide field sales force maintains a very high presence
with customers and prospects, consulting direct and alongside reseller partners
to satisfy customers' needs.
TARGET MARKET OPPORTUNITIES. We target our products at markets that we
believe have the potential for growth. We have identified the following markets
as having the potential for increasingly strong demand for our integrated
products:
- Global enterprises;
- Global service providers, including carriers, ISPs, ASPs, MSPs, etc.; and
- Professional technology services organizations, such as systems
integrators.
CISCO RELATIONSHIP. Since 1994, we have had a strategic relationship with
Cisco. Over time, the relationship expanded to include exchange of technology
development plans, the private labeling and reselling of NetScout's probes and
real-time monitoring software and joint field sales and support activities.
Development activities have included the quarterly exchange of technology and
product plans between NetScout and Cisco to guide development of network
management technologies that align with the future needs of Cisco-powered
networks. Standard functionality in NetScout's solutions has grown to include
support for Cisco's switch product line, ISL, Netflow and QoS, and the resale of
NetScout's software technology in the CiscoWorks2000 Routed WAN and LAN
Management Solutions software bundle. On June 12, 2001, NetScout announced a
change in the Cisco relationship where Cisco would discontinue private labeling
and reselling NetScout's probes and begin referring sales opportunities for
probes directly to NetScout. The change was precipitated by the two companies'
need to evolve their sales and support model to better meet changing customer
requirements and needs for profitability. The strategic aspect of the
relationship involving the early exchange of technology plans continues. The two
companies' development organizations collaborate closely on product direction.
Our strategy is to continue to collaborate with Cisco on technology development
and to support Cisco's continued distribution of our software products. The
addition of NetScout's NGenius Real-Time Monitor software to Cisco's
CiscoWorks2000 Routed WAN and LAN Management Solutions software bundle is the
most recent step in that strategy. We also intend to generate programs with
Cisco to establish mechanisms for referral of probe business and to successfully
transition the responsibility for customer and reseller relationships to
NetScout. We see continued opportunity in our relationship with Cisco, and
intend to continue increasing the sale, visibility, and accelerated market
acceptance of our products via this relationship worldwide.
EXPAND DISTRIBUTION CHANNELS. We plan to continue to increase our direct
field sales presence where it is advantageous to do so during calendar year
2001. We also seek to develop additional indirect distribution channels with
computer networking equipment and software application vendors, systems
integrators, distributors, resellers and service providers. In addition to
Cisco, our channel relationships include SBC, Acterna, NEC, MCI Worldcom, Toyo,
Siemens and TGS Telonic. These and other important partners facilitate the
worldwide distribution and market acceptance of our solutions.
FACILITATE DEVELOPMENT OF COMPLEMENTARY THIRD-PARTY PRODUCTS. Our probes
generate rich performance information that can be leveraged by third-party
software products. As a means to increase demand for our products, we encourage
the development of applications that leverage our solutions. We are partnered
with Apogee Networks, for the delivery of usage-based billing solutions. Our
NGenius
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product platform also facilitates delivery of complementary performance
management and reporting applications with its open style architecture and user
interface portal.
NetScout intends to leverage the competitive advantage of its
application-and-user level network traffic information generating technology in
probes, agents and analysis software, to build the broadest, most robust network
performance management for the strategic enterprise networks of the future, a
solution on which all other network management will be based.
SALES AND MARKETING
NetScout targets corporations and service providers with large,
mission-critical networks through a combination of direct and indirect sales
channels. Our direct sales teams play an integral and influential role in
serving a large portion of our channel partner's accounts, providing the
consulting expertise needed to determine technical and practical needs of
customers and designing and presenting the solutions that best suit those needs.
We prioritize hiring practices and training programs to ensure our sales
personnel are both highly talented and well trained. We continue to provide
programs for our direct sales force, as well as channel partners, throughout the
year, for in-depth product and technical training. We encourage joint
initiatives involving our sales teams and the teams of our partners.
NetScout's sales force utilizes a "high-touch" sales model that consists of
meetings with end-users to understand and identify their individual business
requirements. Our sales teams then translate those requirements into tailored
business solutions that would maximize performance of their network. Due to the
complexity of the systems and the capital expenditure involved, our sales cycle
can extend anywhere from three to twelve months. There is significant, ongoing
revenue opportunity with customers throughout the life of their networks and our
sales model is designed to capitalize on this opportunity. The Company has
invested aggressively in its direct, quota-carrying sales force, growing it by
approximately 50% during fiscal 2001.
Over the past several years, the largest portion of our indirect sales has
channeled through our strategic partner, Cisco Systems, Inc. Revenue derived
through the Cisco channel represented 51%, 50%, and 51% of our total revenue for
the fiscal years ended March 31, 1999, 2000 and 2001, respectively.
Approximately 12%, 17% and 13% of total revenue has been derived through
royalties we receive as compensation for our core monitoring technology being
resold as part of CiscoWorks2000 Routed WAN and LAN Management Solutions
software bundle for the fiscal years ended March 31, 1999, 2000 and 2001,
respectively. The remaining 39%, 33% and 38% of total revenue has been derived
through ongoing sales and support of NetScout probes to Cisco customers
accomplished through joint selling by Cisco and NetScout sales organizations for
the fiscal years ended March 31, 1999, 2000 and 2001, respectively. Through
these joint sales and support activities, NetScout has maintained relationships
with virtually all top customers. The recent change in the selling model for
NetScout probes to Cisco customers influences only sales associated with
NetScout probes. Sales of our software on the CiscoWorks2000 software bundle are
not affected. We anticipate the recent investments in our sales infrastructure
and the high level of involvement our sales organization has held in fulfilling
sales and support with Cisco customers to be advantageous in transitioning to
direct fulfillment of probe sales. Our strategic relationship with Cisco is
governed by a project development and license agreement dated as of January 13,
1994 and private labeling agreement dated as of October 17, 1995, which terms
expire October 31, 2002.
Our other indirect channel partners include original equipment
manufacturers, distributors, resellers, service providers and system
integrators. Total revenue from indirect distribution channels represented 81%,
78% and 72% of total revenue for the fiscal years ended March 31, 1999, 2000 and
2001, respectively.
Our sales force is organized into three main regions, North America,
Europe-Middle East-Africa and Asia Pacific. Revenue from sales outside North
America represented 12%, 13% and 10% of our total revenue in the fiscal years
ended March 31, 1999, 2000 and 2001, respectively. Sales outside North America
are primarily to indirect channel partners, which are generally responsible for
importing products and
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providing consulting and technical support and service to customers within their
territory. Our reported international revenue does not include any revenue from
sales to customers outside North America made by any of our North American based
indirect channel partners. The North America revenue figures include sales made
by NetScout to these North American based indirect channel partners. These
domestic resellers may sell NetScout product to international locations,
however, NetScout still reports these shipments as North America revenue since
NetScout ships the product to a domestic location. We expect revenue from sales
outside North America to continue to account for a significant portion of our
revenue in the future.
As of March 31, 2001, our North American field sales organization consisted
of 84 employees. Our international sales organization consisted of 28 employees
with offices in the United Kingdom, France, Hong Kong, Netherlands, Germany,
Norway and Singapore. In addition, we had 28 employees responsible for providing
telesales, training and sales and administrative support.
As of March 31, 2001, our marketing organization consisted of 20 employees.
Our marketing organization produces and manages a variety of programs such as
advertising, trade shows, public relations, direct mail, seminars, sales
promotions, and web marketing to promote the sale and acceptance of our
solutions and to build the NetScout brand name in the marketplace. Key elements
of our marketing strategy focus on demand generation in new target markets,
demand generation within our installed base, and acceleration of strategic
selling relationships with local and global resellers and systems integrators.
SUPPORT SERVICES
Customer satisfaction is a key driver of NetScout's success. NetScout offers
pre and post-sales support programs to assist in the deployment and use of our
solutions. We have support personnel located in the United States and abroad
with some support provided by qualified third party support organizations.
NetScout provides 8 a.m. to 8 p.m. Eastern time, toll-free customer support
as part of our product sales as well as fee based customer support. Depending on
the level of need, a 24x7 technical assistance plan is offered as part of our
MasterCare Platinum Plan, or for those requiring less assistance we offer
regular support from 8 a.m. to 8 p.m. Under our fee plans, our customers have
access to an exclusive customer Web site where information regarding frequently
asked questions, technical tips, and the latest patches and downloads are
available.
RESEARCH AND DEVELOPMENT
Our success depends on our ability to anticipate and innovate solutions that
will meet emerging customer demands. We have extensive experience in market
development in conjunction with pioneering next generation network performance
management technologies. Our core technology for monitoring and troubleshooting
network and applications performance remains positioned at the forefront of a
rising market. In fiscal 2001, we began new market development in conjunction
with our introduction of the market's first integrated network performance
management system. Our NGenius system leverages the two leading principal forms
of network performance management: real-time network and applications monitoring
and troubleshooting with historical-based capacity planning. Our plans are to
leverage the comprehensive benefits of this new platform into emerging,
growth-oriented markets.
As of March 31, 2001, our research and development organization consisted of
102 employees. In addition, we contract with third parties to perform specific
development projects. Research and development expenditures for the fiscal years
ended March 31, 1999, 2000 and 2001 were approximately $7.5 million,
$9.5 million and $15.4 million, respectively. To date, all research and
development expenses have been expensed as incurred.
We predominantly develop our products internally, with some third party
contracting. To promote industry standards and manifest technology leadership,
we engage actively in, contribute to, and often
10
provide a leadership role in Internet Engineering Task Force (IETF)
standards-making activities. These activities provide early insight into the
direction of the network and application performance management requirements
going forward for current and emerging technologies.
We also continue our technology collaboration within the framework of our
strategic relationship with Cisco Systems, Inc. As a part of this collaboration,
we review and address the network and application performance management needs
and plans engendered by Cisco-specific standards-implementations, extensions
thereto, technologies, and product and technology initiatives. These
collaborations, similar to the IETF activities, also provide NetScout with early
insight into Cisco-specific plans and directions, allowing NetScout quick
time-to-market of products and technologies.
MANUFACTURING
Our manufacturing operations consist primarily of final product assembly,
configuration and testing. We purchase components and subassemblies from
suppliers and construct our hardware products in accordance with individual
customer requirements. We inspect, test and use process control to ensure the
quality and reliability of our products. In February 1998, we obtained ISO 9001
quality systems registration, a certification showing that our procedures and
manufacturing facilities comply with standards for quality assurance and
manufacturing process control. As of March 31, 2001, our manufacturing
organization consisted of 25 employees.
Although we generally use standard parts and components for our products,
each of the computer network interface cards used in our probes is currently
available only from separate single source suppliers. We have generally been
able to obtain adequate supplies of components in a timely manner from current
suppliers. We have few supply commitments with our suppliers but believe that,
in most cases, alternate suppliers can be identified if current suppliers are
unable to fulfill our needs.
CUSTOMERS
We sell our products to businesses and organizations with large and
medium-sized, high-speed computer networks. We have sold a majority of our
products through indirect distribution channels to more than 3,000 customers
worldwide. Our products have been sold to customers operating in a wide variety
of industries, such as financial services, transportation, manufacturing,
insurance, retail and software development. Due to rapid order fulfillment we do
not operate with significant backlog.
We have worked closely and extensively with Cisco in joint sales and support
activities involving Cisco customers during the past several years. We have
established strong relationships with a great portion of Cisco customers during
this time and are now engaged in transferring relationships with those customers
fully over to NetScout. Other than Cisco, no other customer represented more
than 10% of our revenue for the fiscal year's ended March 31, 1999, 2000 and
2001.
COMPETITION
The market for our products is new and rapidly evolving, and is expected to
become increasingly competitive as current competitors expand their product
offerings and new companies enter the market. Our principal competitors include
a number of companies offering one or more solutions for the network and
application performance management market, some of which compete directly with
our products. For example, we compete with probe vendors such as Agilent
Technologies, providers of network performance management solutions such as
Concord Communications and Micromuse, 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. We believe that the principal
competitive factors in the network and applications performance
11
management solutions market include product performance, functionality and
price, name and reputation of vendor, distribution strength, and alliances with
industry partners.
Although we believe that we currently compete favorably with respect to
these factors, there can be no assurance that we can maintain our competitive
position against current and potential competitors, especially those with
greater financial, management, marketing, service, support, technical,
distribution or other resources.
INTELLECTUAL PROPERTY RIGHTS
Our success and competitiveness are dependent to a significant degree on the
protection of our proprietary technology. We rely primarily on a combination of
copyrights, trademarks, licenses, trade secret laws and restrictions on
disclosure to protect our intellectual property and proprietary rights. We also
enter into confidentiality agreements regarding proprietary information.
We pursue registration of some of our trademarks in the U.S. and in other
countries. We have registered the trademark NETSCOUT in the U.S., Canada and the
European Union and the NetScout Logo in the U.S., Canada and Japan. We also own
registrations in the U.S., Australia, Hong Kong, Japan, and Switzerland for
NEXTPOINT, in the U.S. and the European Union for SYNTHETIC TRANSACTIONS, the
U.S., European Union, and Japan for TRAFFIC SIGNATURES, and in the European
Union and Japan for APPSCOUT and BUSINESS-CENTRIC NETWORK MANAGEMENT.
In addition, we have applications for registration pending in the U.S. for
the following trademarks: APPSCOUT, ART MIB, NGENIUS (also in Canada and the
European Union), NGENIUS EVENT MANAGER, NGENIUS PACKET ANALYZER, NGENIUS
PERFORMANCE MONITOR, NGENIUS PROBES, NGENIUS TRAFFIC MONITOR, NGENIUS TREND
REPORTER and TRENDSMART.
We also have the following patents pending: EVALUATING COMPUTER RESOURCES
AND MANAGING COMPUTER RESOURCES. These U.S. patent applications were assigned to
us from NextPoint upon NetScout's acquisition of NextPoint.
Finally, we have resolved disputes involving the NETHOUND and NETSCOPE
trademarks in the U.S., and have resolved or are currently addressing trademark
disputes involving the LANSCOUT trademark in Canada and the European Union.
EMPLOYEES
As of March 31, 2001, we had 364 employees, 255 of whom were based at our
headquarters in Westford, Massachusetts. None of our employees are subject to a
collective bargaining agreement. We believe that our relations with our
employees are good.
ITEM 2. PROPERTIES
We currently lease approximately 97,500 square feet of space in an office
building in Westford, Massachusetts for our headquarters. We plan to move from
our existing office building and lease a new 175,000 square foot office building
also located in Westford, Massachusetts, commencing in September 2001. The new
lease will expire in August 2013 and we have an option to extend the lease for
an additional five-year term. We also lease office space in thirteen other
cities for our sales and support personnel, including 3,200 square feet of space
in the United Kingdom. We believe that these existing facilities are adequate to
meet our foreseeable requirements or that suitable additional or substitute
space will be available on commercially reasonable terms.
12
ITEM 3. LEGAL PROCEEDINGS
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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during the
fourth quarter of the fiscal year ended March 31, 2001.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
PRICE RANGE OF COMMON STOCK
The Company completed its initial public offering on August 17, 1999 at a
price of $11.00 per share. Since that time, the Company's common stock has
traded on the Nasdaq National Market under the symbol NTCT. The following table
sets forth, for the periods indicated, the high and low closing sales prices for
the common stock. Such information reflects inter-dealer price, without retail
mark-up, markdown or commission and may not represent actual transactions.
QUARTER ENDED HIGH LOW
- ------------- -------- --------
September 30, 1999.......................................... $36.50 $12.63
December 31, 1999........................................... $31.00 $20.31
March 31, 2000.............................................. $32.75 $14.88
June 30, 2000............................................... $17.00 $10.81
September 30, 2000.......................................... $23.75 $12.88
December 31, 2000........................................... $24.38 $10.00
March 31, 2001.............................................. $15.69 $ 4.66
As of June 20, 2001 there were approximately 5,110 stockholders of record of
the Company's common stock.
DIVIDEND POLICY
In fiscal years 2000 and 2001, we did not declare any cash dividends and do
not anticipate in the foreseeable future any dividend declaration. In addition,
the terms of our bank loan agreement prohibit the payment of cash dividends on
our capital stock. It is our intention to retain all future earnings for
reinvestment to fund our expansion and growth. Any future dividend declaration
will be at the discretion of our Board of Directors and will depend upon, among
other things, our future earnings, general financial conditions, capital
requirements, and general business conditions.
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 12, 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 $23.3 million of the proceeds from our initial public offering
were used in the acquisition of NextPoint. The balance of proceeds has been
invested primarily in U.S. Treasury obligations and other interest bearing
investment grade securities.
RECENT SALES OF UNREGISTERED SECURITIES
On July 7, 2000, NetScout issued 2,099,120 share of its common stock to
stockholders of NextPoint as part of the consideration paid by NetScout in
connection with the acquisition of NextPoint. In December 2000, NetScout issued
11,319 shares of its common stock to Silicon Valley Bank pursuant to the
exercise of warrants originally issued by NextPoint and assumed by NetScout upon
its acquisition of NextPoint.
14
ITEM 6. SELECTED FINANCIAL DATA
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in
conjunction with our consolidated financial statements and notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Annual Report on Form 10-K. The
consolidated statement of income data for the years ended March 31, 1999, 2000
and 2001, and the consolidated balance sheet data as of March 31, 2000 and 2001,
are derived from audited consolidated financial statements included elsewhere in
this Annual Report on Form 10-K. The consolidated statement of income data for
the years ended March 31, 1997 and 1998, and the consolidated balance sheet data
as of March 31, 1997, 1998 and 1999, have been derived from audited consolidated
financial statements of NetScout that do not appear in this Annual Report on
Form 10-K. On July 7, 2000, NetScout acquired all of the outstanding common and
preferred stock of NextPoint The results of operations of NextPoint subsequent
to July 7, 2000 have been included in NetScout's consolidated statement of
income and consolidated balance sheet for fiscal year 2001. The historical
results are not necessarily indicative of the operating results to be expected
in the future.
YEAR ENDED MARCH 31,
----------------------------------------------------
1997 1998 1999 2000 2001
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
STATEMENT OF INCOME DATA:
Revenue:
Product......................................... $25,159 $34,990 $50,374 $57,206 $ 75,673
Service......................................... 3,888 5,143 8,710 12,804 18,506
License and royalty............................. 1,601 2,696 8,467 16,149 13,772
------- ------- ------- ------- --------
Total revenue................................. 30,648 42,829 67,551 86,159 107,951
------- ------- ------- ------- --------
Cost of revenue:
Product......................................... 9,427 12,638 19,250 21,139 25,737
Service......................................... 528 784 1,235 1,718 3,453
------- ------- ------- ------- --------
Total cost of revenue......................... 9,955 13,422 20,485 22,857 29,190
------- ------- ------- ------- --------
Gross margin...................................... 20,693 29,407 47,066 63,302 78,761
------- ------- ------- ------- --------
Operating expenses:
Research and development........................ 3,003 5,129 7,526 9,526 15,424
Sales and marketing............................. 6,778 13,583 20,375 27,945 39,985
General and administrative...................... 1,815 2,950 4,104 4,631 8,382
Amortization of goodwill and other intangible
assets........................................ -- -- -- -- 7,892
In-process research and development............. -- -- -- -- 268
------- ------- ------- ------- --------
Total operating expenses...................... 11,596 21,662 32,005 42,102 71,951
------- ------- ------- ------- --------
Income from operations............................ 9,097 7,745 15,061 21,200 6,810
Interest income, net.............................. 461 743 926 2,551 3,923
------- ------- ------- ------- --------
Income before provision for income taxes.......... 9,558 8,488 15,987 23,751 10,733
Provision for income taxes........................ 3,640 3,056 5,715 8,539 7,027
------- ------- ------- ------- --------
Net income........................................ $ 5,918 $ 5,432 $10,272 $15,212 $ 3,706
======= ======= ======= ======= ========
Basic net income per share........................ $ 0.31 $ 0.28 $ 0.55 $ 0.70 $ 0.13
Diluted net income per share...................... $ 0.26 $ 0.23 $ 0.43 $ 0.56 $ 0.12
Shares used in computing:
Basic net income per share...................... 19,010 19,289 18,586 21,750 28,487
Diluted net income per share.................... 22,919 23,166 23,706 26,946 29,726
15
MARCH 31,
----------------------------------------------------
1997 1998 1999 2000 2001
-------- -------- -------- -------- --------
(IN THOUSANDS)
BALANCE SHEET DATA:
Cash, cash equivalents and marketable
securities...................................... $12,355 $15,175 $25,477 $70,322 $ 61,382
Working capital................................... 11,140 14,163 24,489 74,866 67,665
Total assets...................................... 21,703 31,220 43,974 96,748 142,080
Class B redeemable convertible common stock....... -- -- 44,161 -- --
Total stockholders' equity (deficit).............. 14,809 20,400 (13,124) 81,122 121,045
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
The following information should be read in conjunction with the
consolidated historical financial information and the notes thereto included
elsewhere in this Annual Report on Form 10-K.
In addition to the other information in this report, the following
Management's Discussion and Analysis should be considered carefully in
evaluating the Company and our business. This Annual Report on Form 10-K
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 Systems designs, develops, manufactures, markets and supports a
family of integrated products that enable optimization of the performance and
cost management of complex, high-speed networks, including their ability to
deliver critical business applications and content to end-users efficiently. We
manufacture and market these products in an integrated hardware and software
solution suite that is used by enterprise and service provider businesses
worldwide.
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 eight
years. On July 7, 2000, NetScout completed its acquisition of NextPoint
Networks, Inc. The transaction was valued at approximately $53.4 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. Revenue is recorded net of an allowance for estimated
product returns which is based upon our return policy and historical experience.
Service revenue consists primarily of customer fees from support agreements,
consulting and training. We generally provide three months of software support
and 12 months of hardware support as part of product sales. Revenue from
software support is deferred and recognized ratably over the three-month support
period. Revenue from hardware support is deferred and recognized ratably 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.
16
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 licensed 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.
Revenue from indirect distribution channels, including original equipment
manufacturers, distributors, resellers, system integrators and service
providers, represented 81%, 78% and 72% of total revenue for the fiscal years
ended March 31, 1999, 2000 and 2001. Our revenue from Cisco represented 51%, 50%
and 51% of our total revenue in the fiscal years ended March 31, 1999, 2000 and
2001, respectively. No other customer or indirect channel partner accounted for
10% or more of our total revenue during the fiscal years ended March 31, 1999,
2000 or 2001.
Cisco resold our probes to customers under its own private label in the
fiscal years ended March 31, 1999, 2000 and 2001. As of July 31, 2001, Cisco
will no longer private label NetScout probes. However, Cisco will continue to
incorporate components of our software technology into its products. Our
strategy is to continue to collaborate with Cisco on development and marketing
and to support Cisco's continued distribution of our software products. We also
intend to generate programs with Cisco to establish mechanisms for referrals of
NetScout probe business and to successfully transition the Cisco customer and
reseller probe relationships to NetScout. We see continued opportunity in our
relationship with this computer networking industry leader and intend to
continue increasing the sale, visibility and accelerated market acceptance of
our products via this relationship worldwide.
Revenue from sales outside North America represented 12%, 13% and 10% of our
total revenue in the fiscal years ended March 31, 1999, 2000 and 2001,
respectively. Sales outside North America are primarily to indirect channel
partners, which are generally responsible for importing products and providing
consulting and technical support and service to customers within their
territory. Our reported international revenue does not include any revenue from
sales to customers outside North America made by any of our North American based
indirect channel partners. The North America revenue figures include sales made
by NetScout to these North American based indirect channel partners. These
domestic resellers may sell NetScout product to international locations,
however, NetScout still reports these shipments as North America revenue since
NetScout ships the product to a domestic location. We expect revenue from sales
outside North America to continue to account for a significant portion of our
revenue in the future.
17
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
YEAR ENDED MARCH 31,
------------------------------------
1999 2000 2001
-------- -------- --------
Revenue:
Product.................................................. 74.6% 66.4% 70.1%
Service.................................................. 12.9 14.9 17.1
License and royalty...................................... 12.5 18.7 12.8
----- ----- -----
Total revenue.......................................... 100.0 100.0 100.0
----- ----- -----
Cost of revenue:
Product.................................................. 28.5 24.5 23.8
Service.................................................. 1.8 2.0 3.2
----- ----- -----
Total cost of revenue.................................. 30.3 26.5 27.0
----- ----- -----
Gross margin............................................... 69.7 73.5 73.0
----- ----- -----
Operating expenses:
Research and development................................. 11.1 11.1 14.3
Sales and marketing...................................... 30.2 32.4 37.0
General and administrative............................... 6.1 5.4 7.8
Amortization of goodwill and other intangible assets..... -- -- 7.3
In-process research and development...................... -- -- 0.3
----- ----- -----
Total operating expenses............................... 47.4 48.9 66.7
----- ----- -----
Income from operations..................................... 22.3 24.6 6.3
Interest income, net....................................... 1.4 3.0 3.6
----- ----- -----
Income before provision for income taxes................... 23.7 27.6 9.9
Provision for income taxes................................. 8.5 9.9 6.5
----- ----- -----
Net income................................................. 15.2% 17.7% 3.4%
===== ===== =====
YEARS ENDED MARCH 31, 2001 AND 2000
REVENUE
Total revenues were $108.0 million and $86.2 million for the fiscal years
ended March 31, 2001 and 2000, respectively, representing an increase of 25%
from 2000 to 2001.
PRODUCT. Product revenues were $75.7 million and $57.2 million for the
fiscal years ended March 31, 2001 and 2000, respectively, representing an
increase of 32% from 2000 to 2001. This increase was primarily due to a 26%
increase in average selling price attributable to the sale of our higher end
probes.
SERVICE. Service revenues were $18.5 million and $12.8 million for the
fiscal years ended March 31, 2001 and 2000, respectively, representing an
increase of 45% from 2000 to 2001. This increase was primarily due to an
increase in the number of support agreements attributable to new product sales.
18
LICENSE AND ROYALTY. License and royalty revenues were $13.8 million and
$16.2 million for the fiscal years ended March 31, 2001 and 2000, respectively,
representing a decrease of 15% from 2000 to 2001. 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 consists primarily of components,
personnel costs, media duplication, manuals, packaging materials, licensed
technology fees and overhead. Cost of product revenue was $25.7 million and
$21.1 million for the fiscal years ended March 31, 2001 and 2000, respectively,
representing an increase of 22% from 2000 to 2001. This increase was primarily
due to a 12% increase in the average cost per unit attributable to the sale of
our higher end probes. Product gross margins were 66% and 63% for the fiscal
years ended March 31, 2001 and 2000, 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,
material and consulting costs. Cost of service revenues were $3.5 million and
$1.7 million for the fiscal years ended March 31, 2001 and 2000, respectively,
representing an increase of 101% from 2000 to 2001. Service gross margins were
81% and 87% for the fiscal years ended March 31, 2001 and 2000, respectively.
This increase in cost and decrease in margins was primarily due to an increase
in material and consulting costs to support our increased installed customer
base.
Gross margins were $78.8 million and $63.3 million for the fiscal years
ended March 31, 2001 and 2000, respectively, representing an increase of 24%
from 2000 to 2001. Gross margin percentage was 73% for each of the fiscal years
ended March 31, 2001 and 2000, respectively. 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 an increase in
the sale of our higher end probes.
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 $15.4 million and $9.5 million
for the fiscal years ended March 31, 2001 and 2000, respectively, representing
an increase of 62% from 2000 to 2001. This increase was primarily due to a 47%
increase in personnel costs from 2000 to 2001 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 $40.0 million and $27.9 million for the fiscal years
ended March 31, 2001 and 2000, respectively, representing an increase of 43%
from 2000 to 2001. This increase was primarily due to a 51% increase in sales
and marketing personnel costs from 2000 to 2001, an increase in certain
personnel related expenses and to a lesser degree a 21% increase in marketing
programs from 2000 to 2001.
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 $8.4 million
and $4.6 million for the fiscal years ended March 31, 2001 and 2000,
respectively, representing an increase of 81% from 2000 to 2001. This increase
was primarily due to a 51% increase in personnel costs from 2000 to 2001 and to
a lesser degree an increase in expenses for ongoing operations from 2000 to
2001.
19
AMORTIZATION OF GOODWILL AND OTHER INTANGIBLE ASSETS. Amortization of
goodwill and other intangible assets was $7.9 million for the fiscal year ended
March 31, 2001 due to the acquisition of NextPoint.
IN-PROCESS RESEARCH AND DEVELOPMENT. In-process research and development
was $268,000 for the fiscal year ended March 31, 2001 due to the acquisition of
NextPoint. 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 through interviews and analysis
of data regarding products under development. Developmental projects that had
reached technological feasibility were classified as completed technology.
Projects that had not reached technological feasibility and had no future
alternative uses were classified as IPR&D and charged as an 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.
INTEREST INCOME, NET. Interest income, net of interest expense, was
$3.9 million and $2.6 million for the fiscal years ended March 31, 2001 and
2000, respectively, representing an increase of 54% from 2000 to 2001. 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 $8.5 million for the fiscal years ended March 31, 2001 and
2000, respectively, representing a decrease of 18% from 2000 to 2001. NetScout's
effective tax rate increased to 65% for the fiscal year ended March 31, 2001
from 36% for the fiscal year ended March 31, 2000 as a result of non-deductible
amortization of goodwill and stock-based compensation expense related to the
acquisition of NextPoint.
NET INCOME. Net income was $3.7 million and $15.2 million for the fiscal
years ended March 31, 2001 and 2000, respectively, representing a decrease of
76% from 2000 to 2001. This decrease was primarily the result of amortization of
goodwill and other intangible assets and stock-based compensation expense
related to the acquisition of NextPoint. Net income excluding non-cash
amortization of goodwill and other intangible assets and stock-based
compensation expense and using a 34% effective tax rate was $13.7 million and
$15.7 million for the fiscal years ended March 31, 2001 and 2000, respectively,
representing a 13% decrease from 2000 to 2001. This was primarily due to revenue
growth offset by additional operating expenses resulting from the acquisition of
NextPoint.
YEARS ENDED MARCH 31, 2000 AND 1999
REVENUE
Total revenues were $86.2 million and $67.6 million for the fiscal years
ended March 31, 2000 and 1999, respectively, representing an increase of 28%
from 1999 to 2000.
PRODUCT. Product revenues were $57.2 million and $50.4 million for the
fiscal years ended March 31, 2000 and 1999, respectively, representing an
increase of 14% from 1999 to 2000. This increase was primarily due to a 30%
increase in average selling price attributable to larger volumes of higher speed
and multi-port probes.
SERVICE. Service revenues were $12.8 million and $8.7 million for the
fiscal years ended March 31, 2000 and 1999, respectively, representing an
increase of 47% from 1999 to 2000. This increase was primarily due to an
increase in the number of 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.
20
LICENSE AND ROYALTY. License and royalty revenues were $16.2 million and
$8.5 million for the fiscal years ended March 31, 2000 and 1999, respectively,
representing an increase of 91% from 1999 to 2000. This increase was primarily
due to a proportionate growth in unit sales of our software and embedded
software products by Cisco.
COST OF REVENUE AND GROSS MARGIN
PRODUCT. Cost of product revenues were $21.1 million and $19.3 million for
the fiscal years ended March 31, 2000 and 1999, respectively, representing an
increase of 10% from 1999 to 2000. This increase was primarily due to higher
sales volumes offset by a 30% decrease in the average cost per unit from 1999 to
2000. Product gross margins were 63% and 62% for the fiscal years ended
March 31, 2000 and 1999, respectively.
SERVICE. Cost of service revenues were $1.7 million and $1.2 million for
the fiscal years ended March 31, 2000 and 1999, respectively, representing an
increase of 39% from 1999 to 2000. This increase was primarily due to a 29%
increase in service personnel costs to support the increase in our installed
customer base. Service gross margins were 87% and 86% for the fiscal years ended
March 31, 2000 and 1999. This increase was primarily due to the timing of
personnel replacements and additions as well as economies of scale.
Gross margins were $63.3 million and $47.1 million for the fiscal years
ended March 31, 2000 and 1999, respectively, representing an increase of 35%
from 1999 to 2000. This increase was primarily due to an increase in license and
royalty revenue as a percentage of total revenue.
OPERATING EXPENSES
RESEARCH AND DEVELOPMENT. Research and development expenses were
$9.5 million and $7.5 million for the fiscal years ended March 31, 2000 and
1999, respectively, representing an increase of 27% from 1999 to 2000. This
increase was primarily due to a 33% increase in personnel costs from 1999 to
2000.
SALES AND MARKETING. Sales and marketing expenses were $27.9 million and
$20.4 million for the fiscal years ended March 31, 2000 and 1999, respectively,
representing an increase of 37% from 1999 to 2000. This increase was primarily
due to a 77% increase in sales and marketing personnel costs from 1999 to 2000.
GENERAL AND ADMINISTRATIVE. General and administrative expenses were
$4.6 million and $4.1 million for the fiscal years ended March 31, 2000 and
1999, respectively, representing an increase of 13% from 1999 to 2000. This
increase was primarily due to a 22% increase in personnel costs from 1999 to
2000.
INTEREST INCOME, NET. Interest income, net of interest expense, was
$2.6 million and $926,000 for the fiscal years ended March 31, 2000 and 1999,
respectively, representing an increase of 176% from 1999 to 2000. 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
$8.5 million and $5.7 million for the fiscal years ended March 31, 2000 and
1999, respectively, representing an increase of 49% from 1999 to 2000, primarily
due to higher pre-tax income. Our effective tax rate remained constant at 36%
for the fiscal years ended March 31, 2000 and 1999.
NET INCOME. Net income was $15.2 million and $10.3 million for the fiscal
years ended March 31, 2000 and 1999, respectively, representing a 48% increase
from 1999 to 2000. This increase was primarily due to revenue growth offset by
increases in operating expenses necessary to manage our expanding business from
1999 to 2000.
21
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2001, we had $61.4 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 $10.0 million for working capital
purposes and to obtain letters of credit. The line of credit expires in
March 2002. Amounts available under the line of credit are a function of
eligible accounts receivable and bear interest at the bank's prime rate. As of
March 31, 2001, 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 provided by operating activities was $12.8 million, $15.3 million, and
$17.7 million for the fiscal years ended March 31, 1999, 2000 and 2001,
respectively. In fiscal 1999, cash provided by operating activities was
primarily derived from net income and to a lesser degree an increase in
depreciation and amortization. This was partially offset by an increase in
accounts receivable. In fiscal year 2000, cash provided by operating activities
was primarily derived from net income and to a lesser degree an increase in
depreciation and amortization, accrued compensation and other expenses and
deferred revenue. This was partially offset by increases in accounts receivable,
prepaids and other current assets, and refundable income taxes and a decrease in
accounts payable. In fiscal year 2001, cash provided by operating activities was
primarily derived by net income and increases in depreciation and amortization,
deferred revenue and compensation expense associated with equity awards. This
was partially offset by an increase in inventories.
Cash provided by investing activities was $6.3 million for the fiscal year
ended March 31, 1999, which was primarily due to the maturity of marketable
securities, partially offset by the purchase of fixed assets. Cash used in
investing activities was $24.2 million for the fiscal year ended March 31, 2000,
which reflects the purchase of marketable securities and, to a lesser degree,
the purchase of fixed assets. Cash used in investing activities was
$6.3 million for the fiscal year ended March 31, 2001, which reflects cash paid
for the acquisition of NextPoint, the purchase of marketable securities and the
purchase of fixed assets largely offset by the proceeds from the maturity of
marketable securities.
Cash provided by financing activities was $22,000 for the fiscal year ended
March 31, 1999, which was due to the proceeds from the issuance of common stock,
less the purchase of treasury stock. Cash provided by financing activities was
$32.0 million for the fiscal year ended March 31, 2000, which was due to the
initial public offering proceeds. Cash provided by financing activities was
$1.5 million for the fiscal year ended March 31, 2001, which was due to proceeds
from the issuance of common stock partially offset by the repayment of notes
payables assumed with the acquisition of NextPoint.
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 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 June 1998, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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
22
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 has not engaged in derivative hedging
activities and, accordingly, does not believe that the adoption of SFAS No. 133
will have a material impact on its financial reporting and related disclosures.
NetScout will adopt SFAS No. 133, as required by SFAS No. 137, in fiscal year
2002.
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 CUSTOMERS OF CISCO SYSTEMS, INC. COULD MATERIALLY
ADVERSELY AFFECT OUR BUSINESS. Our operating results and financial condition for
a particular fiscal period could be materially adversely affected if we are
unable to sell our products directly or through channel partners to customers of
Cisco Systems, Inc. As of July 31, 2001, Cisco will no longer sell our probes to
third parties under its private label, although they will continue to
incorporate some of our software into their products. In the past, we have
derived a significant portion of our revenue from Cisco. By selling our probes
under its private label, Cisco accounted for 39%, 33% and 38% of our total
revenue for the fiscal years ended March 31, 1999, 2000 and 2001, respectively.
If, as a result of our new arrangement with Cisco, we are unable to sell our
products directly or through channel partners to customers of Cisco, our
business, operating results and financial condition could be materially
adversely affected.
A TERMINATION OF OUR STRATEGIC RELATIONSHIP WITH CISCO MAY MATERIALLY
ADVERSELY AFFECT OUR BUSINESS. Our strategic relationship with Cisco provides
us with early insight into the development of new technologies. Additionally,
Cisco incorporates some of our software in their products and provides royalty
revenue to NetScout. Royalty revenue from software sales to Cisco accounted for
12%, 17% and 13% of our total revenue for the fiscal years ended March 31, 1999,
2000 and 2001, respectively. Cisco may decide to cease purchasing our software
and/or to internally develop products that compete with our solutions or partner
with our competitors or bundle or sell competitors' solutions, possibly at lower
prices. If our strategic relationship with Cisco were terminated or further
adversely affected for any reason, our business, operating results and financial
conditions could be materially adversely affected.
23
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 of our control, including the following:
- current technology spending by actual and potential customers;
- 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, 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 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 twelve 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 develop new and further
expand and manage existing indirect distribution channels, including original
equipment manufacturers, distributors, resellers, systems integrators and
service providers. Sales to our indirect distribution channels accounted for
81%, 78% and 72% of our total revenue for the fiscal years ended March 31, 1999,
2000 and 2001, respectively. Sales to Cisco, who will no longer resell our
probes as of July 31, 2001, accounted for 51%, 50% and 51% of our total revenue
for the fiscal years ended March 31, 1999, 2000 and 2001. 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 develop new relationships and to expand and
manage our existing relationships with 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.
24
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 could have a material adverse effect on our business, operating results and
financial condition.
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 could materially adversely
affect 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 could have a material
adverse effect on our business, operating results and financial condition.
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
25
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. 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. 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 patent, 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. 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,
26
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 fail, 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 fiscal years ended March 31, 1999, 2000 and 2001.
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; and
- manage geographically dispersed operations.
The major countries outside of North America, in which we do, 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; and
- foreign currency exchange rate fluctuations and political and economic
instability.
THE PRICE OF OUR COMMON STOCK MAY DECREASE DUE TO MARKET VOLATILITY. The
market price of our common stock has been highly volatile and has fluctuated
significantly since the initial public offering of our common stock on
August 12, 1999. The market price of our common stock may continue to fluctuate
significantly in response to a number of factors, some of which are beyond our
control. 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. Also, broad market fluctuations could adversely affect the market
price of our common stock.
27
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 that stock. If any of our stockholders brought
such a 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.
ITEM 7A. 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.
The Company's primary market risk exposures are in the areas of interest
rate risk and foreign currency exchange rate risk. The Company's exposure to
interest rates has been and is expected to continue to be modest due to the fact
that the Company currently has no outstanding amounts on its $10 million line of
credit. The Company's exposure to currency exchange rate fluctuations has been
and is expected to continue to be modest due to the fact that we conduct all
company business in U.S. dollars. The impact of currency exchange rate movements
on intercompany transactions was immaterial for fiscal year 2001. Currently, the
Company does not engage in foreign currency hedging activities.
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 or any other currency exchange will have any
material effect on our business, financial condition or results of operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
NetScout's Consolidated Financial Statements and Schedules and the Report of
the Independent Accountants appear beginning on page F-1 attached to this
report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants on
accounting or financial disclosure matters in the past.
28
PART III
ITEM 10. DIRECTORS AND OFFICERS
The directors and officers of NetScout are as follows:
NAME AGE POSITION
- ---- -------- ------------------------------------------
Anil K. Singhal........................... 47 President, Chief Executive Officer,
Treasurer and Director
Narendra Popat............................ 52 Chairman of the Board and Secretary
David P. Sommers.......................... 54 Senior Vice President, General Operations
and Chief Financial Officer
John Downing.............................. 43 Vice President, Sales Operations
Lisa Fiorentino........................... 35 Vice President, Finance and Administration
Michelle Flaherty......................... 50 Vice President, Human Resources
Daniel Gingras............................ 50 Chief Information Officer
Bruce Kelley, Jr.......................... 38 Chief Technology Officer
Ashwani Singhal........................... 40 Vice President, Engineering and Product
Development
Tracy Steele.............................. 41 Vice President, Manufacturing and Business
Operations
Bruce Sweet............................... 40 Vice President, Engineering Services and
Customer Satisfaction
Michael Szabados.......................... 49 Senior Vice President, Product Operations
John R. Egan.............................. 43 Director
Joseph G. Hadzima, Jr..................... 49 Director
Vincent J. Mullarkey...................... 53 Director
Kenneth T. Schiciano...................... 38 Director
- ------------------------
ANIL K. SINGHAL co-founded NetScout in June 1984 and has served as
NetScout's President, Chief Executive Officer, Treasurer and Director since
January 2001. Prior to this, Mr. Singhal had served as Chairman of the Board,
Chief Executive Officer and Treasurer from July 1993 to December 2000. From
NetScout's inception until July 1993, Mr. Singhal was President of NetScout.
Mr. Singhal has served as a director of NetScout since its inception. Prior to
founding NetScout, he was a Senior Architect and Project Manager at Wang
Laboratories, a provider of computer systems, from 1979 until June 1984.
Mr. Singhal is the brother of Ashwani Singhal, NetScout's Vice President,
Engineering and Product Development.
NARENDRA POPAT co-founded NetScout in June 1984 and has served as NetScout's
Chairman of the Board and Secretary since January 2001. Prior to that,
Mr. Popat had served as President, Chief Operating Officer and Secretary from
July 1993 to December 2000. From NetScout's inception until July 1993,
Mr. Popat was Chairman of the Board and Treasurer of NetScout. Mr. Popat has
served as a director of NetScout since its inception. Prior to founding
NetScout, Mr. Popat was a Senior Software Engineer at Wang Laboratories from
1980 until June 1984.
DAVID P. SOMMERS has served as NetScout's Senior Vice President, General
Operations and Chief Financial Officer since January 2001. Prior to this,
Mr. Sommers served as NetScout's Vice President and Chief Financial Officer from
April 2000 to December 2000. From November 1998 until January 2000, Mr. Sommers
was Senior Vice President and Chief Financial Officer of FlexiInternational
Software, Inc., a publicly-held developer and marketer of financial accounting
software. During 1998, Mr. Sommers was a consultant on mergers and acquisitions
to the Senior Vice President and Chief Financial Officer of Lotus Development
Corporation, an IBM subsidiary, which develops group collaboration software.
From January 1996 through August 1997, he was Chief Financial Officer of
SystemSoft Corporation, a
29
publicly-held developer and marketer of system level firmware. He also served as
Vice President and Chief Financial Officer of Advanced Media, Inc., a
publicly-held developer and marketer of interactive multimedia systems, from
September 1993 through December 1996.
JOHN DOWNING has served as NetScout's Vice President, Sales Operations since
September 2000, when he joined the company. Prior to joining NetScout, he was
Vice President of Sales at Genrad Corporation, a manufacturer of electronic
testing equipment and production solutions, from April 1998 until
September 2000 and was Vice President of North American Sales from January 1996
until March 1998.
LISA FIORENTINO has served as NetScout's Vice President, Finance and
Administration since January 2001. Ms. Fiorentino joined NetScout in
August 1995 and served as Vice President, Finance from January 2000 until
December 2000, as Director of Finance from May 1997 until January, 2000 and as
Controller from August 1995 until April 1997. Prior to joining NetScout, she
served as Finance Manager and held various other financial management positions
for Orbotech, Inc., a manufacturer of automated optical inspection equipment for
the printed circuit board industry, from January 1989 until August 1995.
MICHELLE FLAHERTY has served as NetScout's Vice President, Human Resources
since September 2000, when she joined the company. Prior to joining NetScout,
she was Vice President of Business Development for Lee Hecht Harrison, Inc. from
November 1997 to September 2000. Prior to that, she operated her own business,
M & M Solutions, an Executive Search and Recruitment firm from January 1990 to
January 2000. Also, she served as President of the Metrowest Chamber of Commerce
from June 1979 to December 1990.
DANIEL GINGRAS joined the company in April 2001 as NetScout's Chief
Information Officer. Prior to joining NetScout he was Chief Executive Officer of
iDolls.com, a venture backed internet retailer from July 1999 to April 2001.
Prior to that, he served as Vice President and Chief Information Officer at
Polymedica, a national medical products and services company, from March 1998 to
March 1999. Prior to that, he served as Vice President and Chief Information
Officer at Watts Industries, a manufacturer of water quality, safety and
conservation product, from July 1996 to March 1998.
BRUCE KELLEY, JR. co-founded NextPoint Networks, Inc. in November 1996 and
served as a Director and as Vice President and Chief Technology Officer. Since
the acquisition of NextPoint by NetScout in July 2000, Mr. Kelley had served as
Vice President, Engineering, Service Level Management of NetScout from
July 2000 to December 2000. In January 2001, Mr. Kelley assumed the position of
NetScout's Chief Technology Officer. Prior to founding NextPoint, he held
various engineering positions at Digital Equipment Corporation from 1982 to
1996, including Consultant Software Engineer and Network Management Technical
Director within Digital's Network Management Engineering Group.
ASHWANI SINGHAL has served as Vice President, Engineering and Product
Development since January 2001. Mr. Singhal joined NetScout in 1987 and served
as a Senior Software Engineer and Project Manager from 1987 until
February 1997, as Director of Engineering from February 1997 until October 1998
and as Vice President, Engineering from October 1998 through December 2000.
Prior to joining NetScout, he was a Senior Software Engineer at Symmetrix, an
artificial intelligence systems company, from 1982 until 1987. Mr. Singhal is
the brother of Anil Singhal, NetScout's President, Chief Executive Officer,
Treasurer and Director.
TRACY STEELE has served as Vice President, Manufacturing and Business
Operations since January 2001. Mr. Steele joined NetScout in November 1995 and
served as Director of Manufacturing from November 1995 until May 1997, and as
Vice President, Manufacturing from May 1997 to December 2000. Prior to joining
NetScout, he served as Director of Manufacturing for Scope Communications, a
developer of hand-held network tools from 1993 to November 1995. He also served
in various manufacturing and management positions at NBase-Xyplex, Inc., a
computer networking company, from 1985 to February 1993.
BRUCE SWEET co-founded NextPoint Networks, Inc. in December 1996 and served
as a Director and as Vice President of Engineering and Product Development.
Since the acquisition of NextPoint by NetScout
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in July 2000, Mr. Sweet had served as Vice President, Engineering, Capacity
Management, from July 2000 to December 2000. In January 2001, Mr. Sweet assumed
the position of Vice President, Engineering Services and Customer Satisfaction.
Prior to founding NextPoint, he was the Director of Network Management within
Digital Equipment Corporation's Network Business Unit from 1995 to 1996.
Mr. Sweet held various engineering positions of increasing responsibility within
Digital Equipment Corporation beginning in 1983.
MICHAEL SZABADOS has served as NetScout's Senior Vice President, Product
Operations since January 2001. Mr. Szabados joined NetScout in August 1997 and
served as Vice President, Marketing from August 1997 to December 2000. Prior to
joining NetScout, he served as Chief Executive Officer of Jupiter
Technology, Inc., a developer of frame relay access drives, from March 1997 to
August 1997. He also served as Vice President, Product Management