UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ---------------------------------- FORM 10-Q (MARK ONE) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 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 ------------------------------ NETSCOUT SYSTEMS, INC. (Exact name of registrant as specified in charter) DELAWARE 04-2837575 (State or other jurisdiction of (IRS Employer Identification No.) incorporation or organization) 4 TECHNOLOGY PARK DRIVE, WESTFORD, MA 01886 (978) 614-4000 ------------------------------ Securities registered pursuant to Section 12(b) of the Act: None SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: Common Stock, $0.001 Par Value --------------------------- Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES X NO The number of shares outstanding of the registrant's common stock as of August 9, 2001 was 29,565,827.
NETSCOUT SYSTEMS, INC. FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2001 TABLE OF CONTENTS <TABLE> <S> <C> PART I: FINANCIAL INFORMATION Item 1. Financial Statements.......................................................................... 3 a.) Consolidated Balance Sheets: As of June 30, 2001 and March 31, 2001 b.) Condensed Consolidated Statements of Operations: For the three months ended June 30, 2001 and 2000 c.) Consolidated Statements of Cash Flows: For the three months ended June 30, 2001 and 2000 d.) Notes to the Consolidated Financial Statements Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations......... 10 Item 3. Quantitative and Qualitative Disclosures About Market Risk.................................... 19 PART II: OTHER INFORMATION Item 1. Legal Proceedings............................................................................. 21 Item 2. Changes in Securities and Use of Proceeds..................................................... 21 Item 6. Exhibits and Reports on Form 8-K.............................................................. 21 SIGNATURES............................................................................................. 22 EXHIBIT INDEX.......................................................................................... 23 </TABLE> 2
PART 1: FINANCIAL INFORMATION ITEM 1: FINANCIAL STATEMENTS NETSCOUT SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED) <TABLE> <CAPTION> JUNE 30, MARCH 31, 2001 2001 -------- --------- ASSETS <S> <C> <C> Current assets: Cash and cash equivalents .......................................................................... $ 60,566 $ 61,382 Accounts receivable, net of allowance for doubtful accounts and returns of $355 and $408 at June 30, 2001 and March 31, 2001, respectively ............................................... 7,957 11,753 Inventories ........................................................................................ 8,288 8,653 Refundable income taxes ............................................................................ 2,966 2,412 Deferred income taxes .............................................................................. 1,342 1,374 Prepaids and other current assets .................................................................. 3,058 3,126 ---------- ----------- Total current assets ........................................................................ 84,177 88,700 Fixed assets, net .................................................................................. 7,408 6,937 Goodwill and other intangible assets, net .......................................................... 38,915 41,549 Deferred income taxes .............................................................................. 4,846 4,894 ---------- ----------- Total assets ................................................................................ $ 135,346 $ 142,080 ========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable ................................................................................... $ 2,177 $ 4,220 Accrued compensation ............................................................................... 3,740 5,013 Accrued other ...................................................................................... 2,035 1,749 Deferred revenue ................................................................................... 9,804 10,053 ---------- ----------- Total current liabilities ................................................................... 17,756 21,035 ---------- ----------- Contingencies (Note 5) Stockholders' equity: Preferred stock, $0.001 par value: 5,000,000 shares authorized; no shares issued or outstanding at June 30, 2001 and March 31, 2001 ................................................................................ -- -- Common stock, $0.001 par value: 150,000,000 shares authorized; 33,540,831 and 33,498,240 shares issued and 29,563,577 and 29,520,986 shares outstanding at June 30, 2001 and March 31, 2001, respectively ............... 33 33 Additional paid-in capital ......................................................................... 106,462 106,354 Deferred compensation .............................................................................. (2,834) (3,409) Treasury stock ..................................................................................... (25,306) (25,306) Retained earnings .................................................................................. 39,235 43,373 ---------- ----------- Total stockholders' equity ................................................................. 117,590 121,045 ---------- ----------- Total liabilities and stockholders' equity ................................................. $ 135,346 $ 142,080 ========== =========== </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 3
NETSCOUT SYSTEMS, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED) <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, -------------------- 2001 2000 ---- ---- <S> <C> <C> Revenue: Product ...................................................... $ 10,425 $ 17,761 Service ...................................................... 4,699 3,976 License and royalty .......................................... 3,042 3,432 --------- --------- Total revenue ........................................... 18,166 25,169 --------- --------- Cost of revenue: Product ...................................................... 4,450 6,094 Service (including stock-based compensation of $2 and $0, respectively) ........................................... 917 595 --------- --------- Total cost of revenue .................................. 5,367 6,689 --------- --------- Gross margin ................................................... 12,799 18,480 --------- --------- Operating expenses: Research and development (including stock-based compensation of $542 and $10, respectively) ................. 4,613 2,572 Sales and marketing (including stock-based compensation of $29 and $60, respectively) ............................... 9,090 8,727 General and administrative (including stock-based compensation of $2 and $2, respectively) .................... 1,714 1,594 Amortization of goodwill and other intangible assets ......... 2,634 -- --------- --------- Total operating expenses ............................... 18,051 12,893 --------- --------- Income (loss) from operations .................................. (5,252) 5,587 Interest income, net ........................................... 687 1,034 --------- --------- Income (loss) before provision for income taxes ................ (4,565) 6,621 Provision for (benefit from) income taxes ...................... (427) 2,317 --------- --------- Net income (loss) .............................................. $ (4,138) $ 4,304 ========= ========= Basic net income (loss) per share .............................. $(0.14) $0.16 Diluted net income (loss) per share ............................ $(0.14) $0.15 Shares used in computing: Basic net income (loss) per share ........................... 29,406,508 26,762,130 Diluted net income (loss) per share ......................... 29,406,508 27,954,492 </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 4
NETSCOUT SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, ------------------- INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 2001 2000 ---- ---- <S> <C> <C> CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) .......................................................... $ (4,138) $ 4,304 Adjustments to reconcile net income (loss) to net cash provided by operating activities, net of effects of the acquisition of NextPoint: Depreciation and amortization ........................................... 1,128 769 Amortization of goodwill and other intangible assets .................... 2,634 -- Loss on disposal of fixed assets ........................................ 12 11 Compensation expense associated with equity awards ...................... 575 72 Deferred income taxes ................................................... 80 -- Changes in assets and liabilities: Accounts receivable, net ........................................... 3,796 (2,214) Inventories ........................................................ 365 (1,231) Refundable income taxes ............................................ (548) 1,899 Prepaids and other current assets .................................. 68 (578) Accounts payable ................................................... (2,043) 1,098 Accrued compensation and other expenses ............................ (987) (239) Income taxes payable ............................................... -- 290 Deferred revenue ................................................... (249) 666 --------- -------- Net cash provided by operating activities .......................... 693 4,847 --------- -------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of marketable securities ............................................ -- (12,646) Proceeds from maturity of marketable securities .............................. -- 16,842 Purchase of fixed assets ..................................................... (1,611) (1,174) --------- -------- Net cash provided by (used in) investing activities ................ (1,611) 3,022 --------- -------- CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds from issuance of common stock ....................................... 102 338 --------- -------- Net increase (decrease) in cash and cash equivalents ........................... (816) 8,207 Cash and cash equivalents, beginning of the period ............................. 61,382 48,515 --------- -------- Cash and cash equivalents, end of the period ................................... $ 60,566 $ 56,722 ========= ======== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for interest ....................................................... $1 $16 Cash paid for income taxes ................................................... $42 $128 NON-CASH FINANCING ACTIVITIES: Tax benefits of disqualifying dispositions of stock options .................. $6 $-- </TABLE> The accompanying notes are an integral part of these consolidated financial statements. 5
NETSCOUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED) 1. BASIS OF PRESENTATION The accompanying consolidated financial statements as of June 30, 2001 and for the three months ended June 30, 2001 and 2000 are unaudited. In the opinion of NetScout's management, the June 30, 2001 and 2000 unaudited interim consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair presentation of the financial position and results of operations for that period. The results of operations for the three month period ended June 30, 2001 are not necessarily indicative of the results of operations for the year ending March 31, 2002. The balance sheet at March 31, 2001 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. For further information refer to the consolidated financial statements and footnotes thereto included in NetScout's Annual Report on Form 10-K for the year ended March 31, 2001, as filed with the Securities and Exchange Commission on June 29, 2001. 2. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES NetScout considers all highly liquid investments purchased with a maturity of three months or less to be cash equivalents and those with maturities greater than three months are considered to be marketable securities. Cash equivalents and marketable securities are stated at amortized cost plus accrued interest, which approximates fair value. Cash equivalents and marketable securities consist primarily of money market instruments and U.S. Treasury bills. NetScout accounts for its investments in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in Debt and Equity Securities." Under the provision of SFAS No. 115, NetScout has classified its investments as "available-for-sale" and any associated unrealized gains or losses, if significant, are recorded as a separate component of stockholders' equity until realized. At June 30, 2001 and March 31, 2001, any unrealized gains or losses were not significant. 3. INVENTORIES Inventories consist of the following: <TABLE> <CAPTION> JUNE 30, MARCH 31, 2001 2001 ---- ---- <S> <C> <C> Raw materials................................... $6,091 $5,608 Work-in-process................................. - 10 Finished goods.................................. 2,197 3,035 ------- ------- $8,288 $8,653 ======= ======= </TABLE> 6
NETSCOUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED) 4. GOODWILL AND OTHER INTANGIBLE ASSETS Goodwill and other intangible assets consist of the following: <TABLE> <CAPTION> JUNE 30, ESTIMATED 2001 LIVES --------- --------- <S> <C> <C> Goodwill ...................... $45,475 5 Completed technology .......... 2,166 3 Customer base ................. 1,100 3 Assembled workforce ........... 700 2 ------- 49,441 Less - accumulated amortization 10,526 ------- Total ......................... $38,915 ======= </TABLE> Goodwill and other intangible assets will be amortized as follows: <TABLE> <S> <C> Nine months ended March 31, 2002.... $ 7,902 2003 ............................... 10,273 2004 ............................... 9,369 2005 ............................... 9,097 2006 ............................... 2,274 ------- Total .............................. $38,915 ======= </TABLE> Due to the recent decline in NetScout's common stock value, lower than expected first quarter results and a general decline in the market, NetScout undertook an evaluation of its goodwill and other intangible assets and determined that the carrying amounts were recoverable. Estimates and assumptions underlying the projections of gross cash flows used to determine recoverability could change in the future which could trigger a material impairment write-down. 5. CONTINGENCIES Prior to the acquisition of NextPoint Networks, Inc. ("NextPoint"), a reseller of NextPoint filed an action against NextPoint alleging breach of contract. NextPoint 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 this matter is at a preliminary stage, NetScout is unable to predict the outcome or estimate the amount of related expense, if any. In addition to the matter noted above, from time to time NetScout is subject to legal proceedings and claims in the ordinary course of business. In the opinion of management, the amount of ultimate expense with respect to any other current legal proceedings and claims will not have a significant adverse effect on NetScout's financial position or results of operations. 7
NETSCOUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED) 6. COMPUTATION OF NET INCOME (LOSS) PER SHARE Below is a summary of the shares used in computing basic and diluted net income (loss) per share for the three month periods indicated: <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, -------- 2001 2000 ---- ---- <S> <C> <C> Weighted average number of shares outstanding ............................................... 29,406,508 26,762,130 Stock options ................................................. -- 1,192,362 ---------- ---------- Shares used in computing diluted net income (loss) per share... 29,406,508 27,954,492 ========== ========== </TABLE> The following table sets forth common stock excluded from the calculation of diluted net income (loss) per share since the inclusion would be antidilutive: <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, -------- 2001 2000 ---- ---- <S> <C> <C> Stock options ............... 4,898,128 1,341,650 Reserved common stock ....... 141,830 -- --------- --------- 5,039,958 1,341,650 ========= ========= </TABLE> 7. GEOGRAPHIC INFORMATION Revenue was distributed geographically as follows: <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, -------- 2001 2000 ---- ---- <S> <C> <C> North America ...................... $16,318 $23,225 Europe - Middle East - Africa....... 1,262 847 Asia - Pacific ..................... 586 1,097 ------- ------- $18,166 $25,169 ======= ======= </TABLE> The North America revenue includes sales made by NetScout to domestic resellers. These domestic resellers may sell NetScout products to international locations. NetScout reports these shipments as North America revenue since NetScout ships the products to a domestic location. Substantially all of NetScout's identifiable assets are located in the United States. 8
NETSCOUT SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA) (UNAUDITED) 8. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business combinations be accounted for under the purchase method only and that certain acquired intangible assets in a business combination be recognized as assets apart from goodwill. SFAS No. 142 requires that ratable amortization of goodwill be replaced with periodic tests of the goodwill's impairment and that intangible assets other than goodwill be amortized over their useful lives. SFAS No. 141 is effective for all business combinations initiated after June 30, 2001 and for all business combinations accounted for by the purchase method for which the date of acquisition is after June 30, 2001. The provisions of SFAS No. 142 will be effective for fiscal years beginning after December 15, 2001, and will be adopted by NetScout, as required, in the first quarter of fiscal year 2003. The impact of SFAS No. 141 and SFAS No. 142 on the NetScout's financial statements has not yet been determined. 9. INCOME TAX BENEFIT For the three months ended June 30, 2001, the Company estimated the income tax benefit utilizing the actual effective tax rate for the quarter, representing the statutory tax rate adjusted primarily for non-deductible amortization of goodwill and stock-based compensation for the period. The Company's ability to make a reliable estimate of the annual effective tax rate will be dependent on its ability to estimate ordinary income (or loss) for the fiscal year ending March 31, 2002. 9 <Page> ITEM 2. 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 in Item 1 of this Quarterly Report on Form 10-Q and Management's discussion and Analysis of Financial Condition and Results of Operations contained in our Annual Report on Form 10-K for the year ended March 31, 2001 as filed with the Securities and Exchange Commission. 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 Quarterly Report on Form 10-Q contains forward-looking statements. These statements relate to future events or our future financial performance and are identified by terminology such as "may", "will", "could", "should", "expects," "plans," "intends," "seeks," "anticipates," "believes," "estimates," "potential," or "continue" or the negative of such terms or other comparable terminology. These statements are only predictions. You should not place undue reliance on these forward-looking statements. Actual events or results may differ materially. In evaluating these statements, you should specifically consider various important factors, including the risks outlined under "Certain Factors Which May Affect Future Results" in this section of this report and our other filings with the Securities and Exchange Commission. These factors may cause our actual results to differ materially from any forward-looking statement. OVERVIEW NetScout 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. 10
For multi-element arrangements, each element of the arrangement is analyzed and a portion of the total fee under the arrangement is allocated 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 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 generated from indirect distribution channels, including original equipment manufacturers, distributors, resellers, system integrators and service providers, represented 69% and 75% of total revenue for the three months ended June 30, 2001 and 2000, respectively. Total revenue generated from Cisco Systems, Inc. represented 52% and 57% of our total revenue for the three months ended June 30, 2001 and 2000, respectively. No other customer or indirect channel partner accounted for 10% or more of our total revenue during the three months ended June 30, 2001 and 2000. In the past, Cisco resold our probes to customers under its own private label. As of July 31, 2001, Cisco will no longer private label NetScout probes. However, Cisco continues to incorporate components of our software technology into its products. Our strategy is to continue to collaborate with Cisco on product 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 10% and 8% of our total revenue in the three months ended June 30, 2001 and 2000, respectively. Sales outside North America are primarily due 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. 11
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 Operations: NETSCOUT SYSTEMS, INC. STATEMENTS OF OPERATIONS PERCENTAGES <TABLE> <CAPTION> THREE MONTHS ENDED JUNE 30, 2001 2000 ---- ---- <S> <C> <C> Revenue: Product ....................................................... 57.4% 70.6% Service ....................................................... 25.9 15.8 License and royalty ........................................... 16.7 13.6 ----- ------ Total revenue ............................................. 100.0 100.0 ----- ------ Cost of revenue: Product ....................................................... 24.5 24.2 Service ....................................................... 5.0 2.4 ----- ----- Total cost of revenue ..................................... 29.5 26.6 ----- ------ Gross margin .................................................... 70.5 73.4 ----- ------ Operating expenses: Research and development ...................................... 25.4 10.2 Sales and marketing ........................................... 50.1 34.7 General and administrative .................................... 9.4 6.3 Amortization of goodwill and other intangible assets ........................................... 14.5 -- ----- ------ Total operating expenses .................................. 99.4 51.2 ----- ------ Income (loss) from operations ................................... (28.9) 22.2 Interest income, net ............................................ 3.8 4.1 ----- ------ Income (loss) before provision for income taxes ........................................................... (25.1) 26.3 Provision for (benefit from) income taxes ....................... (2.3) 9.2 ----- ------ Net income (loss) ............................................... (22.8)% 17.1% ====== ====== </TABLE> THREE MONTHS ENDED JUNE 30, 2001 AND 2000 REVENUE Total revenues were $18.2 million and $25.2 million for the three months ended June 30, 2001 and 2000, respectively, representing a decrease of 28% from 2000 to 2001. PRODUCT. Product revenues were $10.4 million and $17.8 million for the three months ended June 30, 2001 and 2000, respectively, representing a decrease of 41% from 2000 to 2001. This decrease was primarily due to a 49% decrease in unit sales, which was attributable to the overall current slowdown in network management spending in many large enterprises as a result of the economic downturn. SERVICE. Service revenues were $4.7 million and $4.0 million for the three months ended June 30, 2001 and 2000, respectively, representing an increase of 18% from 2000 to 2001. This increase was primarily due to an increase in the number of support agreements attributable to product sales generated in recent reporting periods. 12
LICENSE AND ROYALTY. License and royalty revenues were $3.0 million and $3.4 million for the three months ended June 30, 2001 and 2000, respectively, representing a decrease of 11% from 2000 to 2001. This decrease corresponded with the overall current slowdown in network management spending as a result of the economic downturn. 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 $4.5 million and $6.1 million for the three months ended June 30, 2001 and 2000, respectively, representing a decrease of 27% from 2000 to 2001. Product gross margins were 57% and 66% for the three months ended June 30, 2001 and 2000, respectively. This decrease was primarily due to a 49% decrease in unit sales attributable to the overall current slowdown in network management spending in many large enterprises as a result of the economic downturn while fixed costs and overhead remained relatively constant. SERVICE. Cost of service revenue consists primarily of personnel costs, material and consulting costs. Cost of service revenues were $917,000 and $595,000 for the three months ended June 30, 2001 and 2000, respectively, representing an increase of 54% from 2000 to 2001. Service gross margins were 80% and 85% for the three months ended June 30, 2001 and 2000, respectively. This was primarily due to an 83% increase in personnel costs. Gross margins were $12.8 million and $18.5 million for the three months ended June 30, 2001 and 2000, respectively, representing a decrease of 31% from 2000 to 2001. Gross margin percentage was 71% and 73% for the three months ended June 30, 2001 and 2000, respectively. This decrease was primarily due to the decrease in unit sales attributable to the overall current slowdown in network management spending in many large enterprises as a result of the economic downturn while fixed costs and overhead remained relatively constant. 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. OPERATING EXPENSES RESEARCH AND DEVELOPMENT. Research and development expenses consist primarily of personnel costs, fees for outside consultants and related costs associated with the development of new products and the enhancement of existing products. Research and development expenses were $4.6 million and $2.6 million for the three months ended June 30, 2001 and 2000, respectively, representing an increase of 79% from 2000 to 2001. This increase was primarily due to a 67% increase in personnel costs from 2000 to 2001 and, to a lesser degree, 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 $9.1 million and $8.7 million for the three months ended June 30, 2001 and 2000, respectively, representing an increase of 4% from 2000 to 2001. This increase was primarily due to a 11% increase in personnel costs from 2000 to 2001, offset by a 27% decrease in marketing spending 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 $1.7 million and $1.6 million for the three months ended June 30, 2001 and 2000, respectively, representing an increase of 8% from 2000 to 2001. This increase was primarily due to increases in expenses for ongoing operations from 2000 to 2001. AMORTIZATION OF GOODWILL AND OTHER INTANGIBLE ASSETS. Amortization of goodwill and other intangible assets was $2.6 million for the three months ended June 30, 2001 due to the acquisition of NextPoint. INTEREST INCOME, NET. Interest income, net of interest expense, was $687,000 and $1.0 million for the three months ended June 30, 2001 and 2000, respectively, representing a decrease of 34% from 2000 to 2001. This decrease was primarily due to a decrease of investment returns on cash equivalents and marketable securities due to lower market interest rates. 13
PROVISION FOR (BENEFIT FROM) INCOME TAXES. The provision for (benefit from) income taxes was ($427,000) and $2.3 million for the three months ended June 30, 2001 and 2000, respectively, representing a decrease of 118% from 2000 to 2001. For the three months ended June 30, 2001, the Company estimated the income tax benefit utilizing the actual effective tax rate for the quarter, representing the statutory tax rate adjusted primarily for non-deductible amortization of goodwill and stock-based compensation for the period. The Company's ability to make a reliable estimate of the annual effective tax rate will be dependent on its ability to estimate ordinary income (or loss) for the fiscal year ending March 31, 2002. As a result, the effective tax rate may change significantly during the fiscal year. NET INCOME (LOSS). Net income (loss) was ($4.1) million and $4.3 million for the three months ended June 30, 2001 and 2000, respectively, representing a decrease of 196% from 2000 to 2001. This decrease was primarily the result of lower product revenues attributable to the overall slowdown in network management spending in many large enterprises as a result of the economic downturn, amortization of goodwill and other intangible assets and stock-based compensation expense related to the acquisition of NextPoint. Proforma net income (loss) excluding non-cash amortization of goodwill and other intangible assets and stock-based compensation expense for the three months ended June 30, 2001 and 2000, respectively, was ($929,000) and $4.4 million for the three months ended June 30, 2001 and 2000, respectively, representing a 121% decrease from 2000 to 2001. LIQUIDITY AND CAPITAL RESOURCES As of June 30, 2001, we had $60.6 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. The Company has 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 June 30, 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 $693,000 and $4.8 million for the three months ended June 30, 2001 and 2000, respectively. In the three months ended June 30, 2001, cash provided by operating activities was primarily derived from a decrease in accounts receivable, an increase in depreciation and amortization and amortization of goodwill and other intangible assets and an increase in stock-based compensation expense associated with equity awards. This was partially offset by a net loss and a decrease in accounts payable and accrued compensation. In the three months ended June 30, 2000, cash provided by operating activities was primarily derived from net income and to a lesser degree increases in deferred revenue, accounts payable, depreciation and amortization and decreases in refundable income taxes. This was partially offset by increases in accounts receivable, inventories and prepaid and other current assets. Cash used in investing activities was $1.6 million for the three months ended June 30, 2001, which was due to the purchase of fixed assets. Cash provided by investing activities was $3.0 million for the three months ended June 30, 2000, which reflected the proceeds from the maturity of marketable securities partially offset by the purchase of marketable securities and, to a lesser degree, the purchase of fixed assets. Cash provided by financing activities was $102,000 and $338,000 for the three months ended June 30, 2001 and 2000, respectively, which was due to the proceeds from the issuance of common stock. 14
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. 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 July 2001, the Financial Accounting Standards Board issued SFAS No. 141, "Business Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS No. 141 requires that all business combinations be accounted for under the purchase method only and that certain acquired intangible assets in a business combination be recognized as assets apart from goodwill. SFAS No. 142 requires that ratable amortization of goodwill be replaced with periodic tests of the goodwill's impairment and that intangible assets other than goodwill be amortized over their useful lives. SFAS No. 141 is effective for all business combinations initiated after June 30, 2001 and for all business combinations accounted for by the purchase method for which the date of acquisition is after June 30, 2001. The provisions of SFAS No. 142 will be effective for fiscal years beginning after December 15, 2001, and will be adopted by the Company, as required, in the first quarter of fiscal year 2003. The impact of SFAS No. 141 and SFAS No. 142 on the Company's financial statements has not yet been determined. 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 no longer sells our probes to third parties under its private label, although it continues to incorporate some of our software into its 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 34% and 43% of our total revenue for the three months ended June 30, 2001 and 2000, 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 and other revenue from software sales to Cisco accounted for 18% and 14% of our total revenue for the three months ended June 30, 2001 and 2000, 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. 15
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: o current technology spending by actual and potential customers; o 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; o the timing and receipt of orders from customers, especially in light of our lengthy sales cycle; o the timing and market acceptance of new products or product enhancements by us or our competitors; o distribution channels through which our products are sold could change; o the timing of hiring sales personnel and the speed at which such personnel become productive; o we may not be able to anticipate or adapt effectively to developing markets and rapidly changing technologies; and o 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 69% and 75% of our total revenue for the three months ended June 30, 2001 and 2000, respectively. Sales to Cisco, who as of July 31, 2001 no longer resells our probes, accounted for 52% and 57% of our total revenue for the three months ended June 30, 2001 and 2000, respectively. Our indirect channel partners have no obligation to purchase any products from us. In addition, they could internally develop products, which compete with our solutions or partner with our competitors or bundle or resell competitors' solutions, possibly at lower prices. Our inability to 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. 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. 16
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: o product performance, functionality and price; o name and reputation of vendor; o distribution strength; and o 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 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. 17
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 President , Chief Executive Officer 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, 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. 18
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 three months ended June 30, 2001 and 2000. 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: o expand international indirect distribution channels; o hire additional sales personnel; o adapt products for local markets; and o 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: o failure of local laws to provide the same degree of protection against infringement of our intellectual property; o protectionist laws and business practices that favor local competitors; o dependence on local indirect channel partners; o multiple conflicting and changing governmental laws and regulations; o longer sales cycles; o greater difficulty in collecting accounts receivable; and o 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. 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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We consider all highly liquid marketable securities purchased with a maturity of three months or less to be cash equivalents and those with maturities greater than three months are considered to be marketable securities. Cash equivalents and marketable securities are stated at amortized cost plus accrued interest, which approximates fair value. Cash equivalents and marketable securities consist primarily of money market instruments and U.S. Treasury bills. We currently do not hedge interest rate exposure, but do not believe that a fluctuation in interest rates would have a material effect on the value of our cash equivalents. 19
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 the three months ended June 30, 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. 20
PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Prior to the acquisition of NextPoint Networks, Inc. ("NextPoint"), a reseller of NextPoint filed an action against NextPoint alleging breach of contract. NextPoint 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 this matter is at a preliminary stage, NetScout is unable to predict the outcome or estimate the amount of related expense, if any. In addition to the matter noted above, from time to time NetScout is subject to legal proceedings and claims in the ordinary course of business. In the opinion of management, the amount of ultimate expense with respect to any other current legal proceedings and claims will not have a significant adverse effect on NetScout's financial position or results of operations. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On August 17, 1999, we completed our initial public offering of 3,000,000 shares of common stock at a price of $11.00 per share. The principal underwriters for the transaction were Deutsche Banc Alex. Brown, Bear, Stearns & Co. Inc. and Dain Rauscher Wessels, a division of Dain Rauscher Incorporated. The registration statement relating to this offering was declared effective by the Securities and Exchange Commission (SEC File Number 333-76843) on August 11, 1999. We received net proceeds of $29.6 million after deducting $2.3 million in underwriting discounts and commissions and $1.1 million in other offering expenses. Upon the exercise of the over allotment option by the underwriters, certain selling security holders sold 450,000 shares of common stock for net proceeds of approximately $4.6 million after deducting underwriting discounts and commissions. Approximately $23.3 million of the proceeds from our initial public offering were used in the acquisition of NextPoint. The balance of proceeds have been invested primarily in U.S. Treasury obligations and other interest bearing investment grade securities. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits The following exhibits are filed or incorporated by reference as part of this Report. 10. Amendment No. 6 effective as of April 13, 2001 to Private Label Agreement and Project Development and License Agreement between Cisco Systems, Inc. and NetScout Systems, Inc.* (b) Reports on Form 8-K -- A report on Form 8-K was filed with the Securities and Exchange Commission on June 19, 2001 with respect to: Item 5 -- Other Events. To disclose that the Company issued a press release announcing that it will offer its Probes directly or through channel partners to Cisco Systems, Inc. customers, in lieu of a previous private label arrangement. *Confidential treatment requested pursuant to rule 24b-2 of the Securities Exchange Act of 1934. 21
SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. NETSCOUT SYSTEMS, INC. Date: August 14, 2001 /S/ ANIL K. SINGHAL ------------------------------------------------ Name: Anil K. Singhal Title: President, Chief Executive Officer, Treasurer and Director (Principal Executive Officer) Date: August 14, 2001 /S/ DAVID P. SOMMERS -------------------------------------- Name: David P. Sommers Title: Senior Vice President, General Operations and Chief Financial Officer (Principal Financial Officer and Accounting Officer) 22
EXHIBIT INDEX EXHIBIT NO. DESCRIPTION - ------------ ----------------------------------------------------------------- 10 Amendment No. 6 effective as of April 13, 2001 to Private Label Agreement and Project Development and License Agreement between Cisco Systems, Inc. and NetScout Systems, Inc.* - ------------------------- * Confidential treatment requested pursuant to rule 24b-2 of the Securities and Exchange Act of 1934. 23