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| NTCT > SEC Filings for NTCT > Form 10-K on 1-Jun-2009 | All Recent SEC Filings |
1-Jun-2009
Annual Report
The following information should be read in conjunction with the audited consolidated financial information and the notes thereto included in this Annual Report on Form 10-K. In addition to historical information, the following discussion and other parts of this Annual Report contain forward-looking statements that involve risks and uncertainties. You should not place undue reliance on these forward-looking statements. Actual events or results may differ materially due to competitive factors and other factors discussed in Item 1A. Risk Factors and elsewhere in this Annual Report. These factors may cause our actual results to differ materially from any forward-looking statement.
Overview
NetScout designs, develops, manufactures, markets, sells and supports a family of integrated management products that enable unified service delivery management capabilities, performance management and optimization of complex, high-speed networks, that assure the delivery of critical business applications, services and content efficiently to customers and end-users. These solutions enable the world's largest IT organizations to optimize, protect and simplify their IT infrastructure and operational environments while bringing enhanced operational efficiencies and helping to reduce the total overall cost of IT operations. We manufacture and market these products in integrated hardware and software solutions that have been used by commercial enterprises, large governmental agencies and telecommunication service providers worldwide. We have a single operating segment and substantially all of our identifiable assets are located in the United States.
NetScout was incorporated in 1984 as a consulting services company. In 1992, we began to develop, manufacture and market our first infrastructure performance management products. Our operations have been financed principally through cash provided by operations and through the sale of NetScout securities in conjunction with our initial public offering in August 1999.
On November 1, 2007, we completed the acquisition of Network General and embarked upon an extensive integration program to combine our respective organizations, operations and customer bases, and to merge our largely complementary products and technologies into a unified service assurance platform. NetScout publicly announced the integration of product technology from Network General into a unified product in October, 2008 resulting in a powerful, unified solution that advances service assurance and performance management by combining extensive early-warning capabilities, real-time and historical application flow analysis, and deep-packet forensics.
The acquisition of Network General was valued at $212 million for purchase accounting purposes. The acquisition was financed with a combination of six million shares of our common stock, $100 million of senior secured floating rate notes, and $53 million in cash. Included in the $212 million is $3 million in transaction costs. The integration of our back office systems was completed at April 1, 2008. The integration of the sales forces took place in the fiscal first quarter of 2009 and the product line and technology integration occurred throughout fiscal year 2009.
In the comparative financial results, a full twelve months of the Network General business is included in the consolidated results for the fiscal year ended March 31, 2009 compared to only five months for the prior year and none in fiscal year 2007. This differential has a significant impact on understanding the financial statements and related year over year explanations.
Our operating results are influenced by a number of factors, including, but not limited to, the mix of products and services sold, pricing, costs of materials used in our products and the expansion of our operations. Factors that affect our ability to maximize our operating results include, but are not limited to, our ability to introduce and enhance existing products, the marketplace acceptance of those new or enhanced products, continued expansion into international markets, development of strategic partnerships, competition, successful integration efforts and current economic conditions.
In fiscal year 2009, our total revenue increased $98.6 million, or 58%, to $267.6 million compared to $169.0 million in fiscal year 2008. This increase is primarily attributable to the acquisition of Network General on November 1, 2007. Our cost of revenue increased by $16.5 million, or 35%, to $64.1 million compared to $47.7 million in fiscal year 2008. This increase is primarily due to the increased revenue associated with the acquisition of Network General. Gross profit of $203.5 million, or 76% of revenue, in fiscal year 2009 increased from $121.3 million, or 72% of revenue, in fiscal year 2008. This increase in gross margin percentage is attributable to product mix and synergies with the combined businesses. Our gross margin is primarily affected by the mix and volume of our product and service revenue. Product revenue in fiscal year 2009 increased $48.0 million, or 45%, to $154.2 million from $106.2 million in fiscal year 2008. Service revenue in fiscal year 2009 increased $50.7 million, or 81%, to $113.4 million from $62.8 million in fiscal year 2008. We realize significantly higher gross margins on service revenue than on product revenue.
Our operating expenses, which include research and development, sales and marketing, general and administrative expenses, and amortization of intangible assets increased in fiscal year 2009 by $40.5 million, or 32%, to $167.1 million, compared to $126.6 million in fiscal year 2008. The primary contributor to this increase in operating expenses was higher employee related expenses due to increased headcount as a result of the Network General acquisition in November 2007 as well as higher sales and marketing expenses including sales commissions commensurate with the higher sales volume.
Net income for fiscal year 2009 increased by $22.1 million, to net income of $20.0 million compared to a net loss of $2.1 million for fiscal year 2008. This increase was primarily attributable to the contribution of the acquired Network General business and growth in the NetScout business, as well as non-recurring integration costs in the prior year, partially offset by an increase of $2.3 million in interest expense associated with debt entered into as a result of the acquisition of Network General.
We have continued to see significant benefit from operating leverage and remain focused on increasing our operating margin by growing revenue while containing expenses. For fiscal year 2009, our income from operations was $36.4 million, increasing by $41.7 million compared to a loss from operations of $5.3 million in fiscal year 2008. We continue to see increased interest from our customers in the importance of managing and assuring the delivery of services from within the network with packet-flow technology through a unified service delivery management platform. As networks continue to expand, bandwidth continues to increase, applications become more complex, converged networks become more prevalent, and virtualization, web services and service oriented architectures become more pervasive, our products are ideally positioned to enable IT organizations to optimize, protect and simplify their modern IP network and the services delivered to their users. During fiscal year 2009, we released several new products and enhancements that will help our IT organizations meet the challenges of managing service delivery and application and network performance issues across large, globally distributed enterprise, service provider, and government networks:
• We introduced nGenius K2, the industry's first packet-flow-based intelligent early warning service performance management dashboard that enables IT organizations to predict and prevent service
• We launched Sniffer Global, the industry's first enterprise-class portable network analyzer solution that brings much needed security, control, user activity reporting and enhanced manageability capabilities. Sniffer Global addresses a widely overlooked security risk by integrating the portable protocol analyzer into a policy-based, secure operating environment that is governed and controlled from a central authentication server. Sniffer Global controls what network data a portable analyzer user has access to, and how deeply they can access and analyze network traffic or data, helping to protect and mitigate risks from potential unauthorized use or activities;
• We announced two new key releases within the Sniffer Intelligence line of advanced, service-aware expert troubleshooting solutions. Sniffer Financial Intelligence provides intelligent analysis enabling optimizations for capital markets and financial trading environments. Sniffer Mobile Intelligence provides intelligent analysis capabilities specifically for 3G mobile networks targeting Mobile Service Providers;
• We released significant upgrades for both nGenius Performance Manager and nGenius InfiniStream products that significantly enhanced the functionality and value of our products and delivered on our promise to deliver a single unified hardware and software solution that leverages and integrates the underlying technology from NetScout and Network General. Our integration of Sniffer portfolio into the nGenius portfolio enables our customers to efficiently leverage their existing investments and benefit from the combined technical capabilities of two market-leading platforms. As a result of the product unification, elements from both product lines have come together under the nGenius Performance Management umbrella. NetScout has also unified its family of continuous capture DPC devices, formerly known as nGenius AFMon and Sniffer InfiniStream, as nGeniusInfiniStream. The new nGenius InfiniStream DPC devices retain important elements from both product lines delivering operational consistency with a flexible range of interface options and storage capacities to meet our customers most demanding high-performance requirements;
• In December 2008, we announced the mNOC mobility extension for our nGenius K2 product. mNOC mobility extends the physical boundaries of the traditional NOC, by enabling delivery of real-time performance and service delivery management metrics to web-based mobile devices enabling IT staff and business managers to have anyplace, anytime visibility into the health of their network, applications and service delivery environment. This enhancement enables mobile IT staff access to a wide range of comprehensive performance intelligence, predictive early warning alerts and definitive problem identification in rich graphic detail providing a collaborative environment with consistent workflows from which to manage the service delivery environment.
Backed by orders coming from the government and wireless telecommunications markets, we are entering fiscal year 2010 with combined product backlog, consisting of unshipped orders, and deferred product revenue of $10.0 million. We believe that this product backlog is firm and both our unshipped orders and deferred product revenue to be material to an understanding of our financial results. However, due to the fact that most of our customers have the contractual ability to cancel unshipped orders prior to shipment we cannot provide assurance that our product backlog at any point in time will ultimately become revenue.
Critical Accounting Policies
We consider accounting policies related to cash, cash equivalents and marketable securities, revenue recognition, valuation of inventories, assumptions related to purchase accounting, valuation of goodwill and acquired intangible assets, capitalization of software development costs, share based compensation, and income taxes to be critical in fully understanding and evaluating our financial results. The application of these policies involves significant judgments and estimates by us.
Cash and Cash Equivalents and Marketable Securities
We account for our investments in accordance with Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities," or SFAS 115. Under the provisions of SFAS 115, we have classified our investments as "available-for-sale" which are carried at fair value based on quoted market prices and associated unrealized gains or losses are recorded as a separate component of stockholders' equity until realized. We consider 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 consist primarily of money market instruments, U.S. Treasury bills, auction rate securities and municipal bonds. Cash equivalents and short-term marketable securities are stated at cost plus accrued interest, which approximates fair value. Long-term marketable securities, which consist of auction rate securities, typically were stated at par value prior to February 2008 due to the frequent resets through the auction process. While we continue to earn interest on auction rate securities at the maximum contractual rate, these investments are not currently trading and therefore do not currently have a readily determinable market value. Accordingly, par value no longer approximates the estimated fair value of auction rate securities. A discounted cash flow model was used to determine the estimated fair value of our investment in auction rate securities as of March 31, 2009. The assumptions used in preparing the discounted cash flow model include estimates for interest rates, timing and amount of cash flows and expected holding periods of the investments. Based on this assessment of fair value, as of March 31, 2009 we have recorded a cumulative decline in the fair value of auction rate securities of $3.6 million, which was deemed temporary. Assumptions used require significant judgments by management. Changes in the assumptions could result in materially different estimates of fair values, resulting in additional credits and charges presented in the consolidated financial statements.
Revenue Recognition
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. Because we have determined that the software components of our products are essential to the functionality and value of these products, we recognize our revenue in accordance with AICPA Statement of Position 97-2 "Software Revenue Recognition."
Service revenue consists primarily of fees from customer support agreements, consulting and training. We generally provide software and hardware support as part of product sales. Revenue related to the initial bundled software and hardware support is recognized ratably over the support period. In addition, customers can elect to purchase extended support agreements for periods after the initial software warranty expiration, typically for 12-month periods. Revenue from customer support agreements is recognized ratably over the support period. Revenue from consulting and training services is recognized as the work is performed.
Multi-element arrangements are concurrent customer purchases of a combination of our product and service offerings that may be delivered at various points in time. For multi-element arrangements, each element of the purchase is analyzed and a portion of the total purchase price is allocated to the undelivered elements, primarily support agreements and training, using vendor-specific objective evidence of fair value of the undelivered elements. Under the residual method, the remaining portion of the total purchase price is allocated to the
delivered elements, generally hardware and licensed software products, regardless of any separate prices stated within the contract for each element. Vendor-specific objective evidence of fair value of the undelivered elements is based on the price customers pay when the element is sold separately. We review the separate sales of the undelivered elements on a semi-annual basis and update, when appropriate, our vendor-specific objective evidence of fair value for such elements to ensure that it reflects our recent pricing experience.
Uncollected Deferred Revenue
Because of our revenue recognition policies, there are circumstances for which we are unable to recognize revenue relating to sales transactions that have been billed, but the related account receivable has not been collected. While the receivable represents an enforceable obligation, for balance sheet presentation purposes we have not recognized the deferred revenue or the related account receivable and no amounts appear in our consolidated balance sheets for such transactions. The aggregate amount of unrecognized accounts receivable and deferred revenue was $1.2 million and $3.3 million at March 31, 2009 and 2008, respectively.
Valuation of Inventories
Inventories are stated at the lower of actual cost or their net realizable value. Cost is determined by using the first-in, first-out, or FIFO method. Inventories consist primarily of raw materials and finished goods. Inventory carrying values are reduced to our estimate of net realizable value. We regularly monitor our inventories for potential obsolete and excess inventory. Our net realizable value adjustment is based upon our estimates of forecasts of unit sales, expected timing and impact of new product introductions, historical product demand, current economic trends, expected market acceptance of our products and expected customer buying patterns. We adjust the cost basis of inventory that has been written down to reflect its net realizable value. As of March 31, 2009 and 2008, net realizable value adjustments included within inventory on the balance sheet totaled $986 thousand and $762 thousand, respectively. Significant judgments and estimates are made when establishing the net realizable value adjustment. If these accounting judgments and estimates prove to be materially inaccurate, our financial results could be materially and adversely impacted in future periods.
Assumptions Related to Purchase Accounting and the Valuation of Goodwill and Acquired Intangible Assets
We account for our acquisitions using the purchase method of accounting in accordance with SFAS No. 141, "Business Combinations," or SFAS 141. This method requires estimates to determine the fair values of assets and liabilities acquired, including judgments to determine any acquired intangible assets such as customer relationships and developed product technology, as well as assessments of the fair value of existing assets such as property and equipment. Liabilities acquired can include balances for planned integration liabilities as well as litigation and other contingency reserves established prior to or at the time of acquisition, and require judgment in ascertaining a reasonable value. Independent appraisals may be used to assist in the determination of the fair value of certain assets and liabilities, but even those determinations would be based on significant estimates provided by us, such as forecasted revenues or profits on contract-related intangibles. Numerous factors are typically considered in the purchase accounting assessments, which are conducted by NetScout professionals from legal, finance, human resources, information systems, research and development, sales and executive management. Significant changes in assumptions and estimates subsequent to completing the allocation of purchase price to the assets and liabilities acquired, as well as differences in actual results versus estimates, could result in material impacts to earnings.
The carrying value of goodwill was $128.2 million and $131.8 million as of March 31, 2009 and 2008, respectively. Goodwill is reviewed for impairment at the enterprise-level at least annually or more frequently when events and circumstances occur indicating that the recorded goodwill may be impaired. If the book value of our enterprise exceeds its fair value, the implied fair value of goodwill is compared with the carrying value of goodwill. If the carrying value of goodwill exceeds the implied fair value, an impairment loss is recognized in income equal to that excess. During the year ended March 31, 2009, a decrease of $3.6 million was made to
adjust tax attributes and deferred tax assets related to the Network General acquisition including the release of the valuation allowance established on state tax attributes as part of the Network General acquisition.
We consider the market capitalization of our outstanding common stock versus our stockholders' equity as one indicator that may potentially trigger an impairment of goodwill analysis. Significant judgments and estimates are made when assessing impairment. If these accounting judgments and estimates prove to be materially inaccurate, an asset may be determined to be impaired and our financial results could be materially and adversely impacted in future periods. Likewise, if a future event or circumstance indicates that an impairment assessment is required and an asset is determined to be impaired, our financial results could be materially and adversely impacted in future periods. As of March 31, 2009, based upon our review, we determined that there has been no goodwill impairment.
The carrying value of acquired intangible assets was $59.6 million and $65.6 million as of March 31, 2009 and 2008, respectively. The carrying value of acquired intangible assets is recorded under the purchase method of accounting at their estimated fair values at the date of acquisition. Our acquired intangible assets include developed product technology; customer relationships and an indefinite lived tradename resulting from the acquisition of Network General on November 1, 2007 (see Note 7 and Note 8 to our consolidated financial statements). We amortize acquired intangible assets over their estimated useful lives on a straight-line basis, except for the acquired tradename which has an indefinite life and thus, is not amortized. The carrying value of the indefinite lived tradename is evaluated for potential impairment on an annual basis. At March 31, 2009 we determined that there had been no impairment of acquired intangible assets, or indefinite lived assets. Significant judgment and estimates are made when estimating fair value and useful lives for acquired intangible assets. If these accounting judgments and estimates prove to be materially inaccurate, the value of these assets and our financial results could be materially and adversely impacted. In accordance with SFAS 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", we periodically review long-lived assets for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate.
Capitalization of Software Development Costs
Costs incurred in the research and development of our products are expensed as incurred, except for certain software development costs. Costs associated with the development of computer software are expensed prior to establishment of technological feasibility (as defined by SFAS No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased or Otherwise Marketed", or SFAS 86) and capitalized thereafter, until the related software products are available for first customer shipment. Judgment is required in determining the point at which technological feasibility has been met. Amortization of capitalized software development costs are charged to cost of revenue on a straight-line basis over two years. We also capitalize acquired software in accordance with SFAS 86.
Share-based Compensation
Effective April 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123 (revised 2004), "Share Based Payment", or SFAS 123R, using the modified prospective application transition method, and therefore have not restated prior periods' results. Under this method we recognize compensation expense for all share-based payments granted after April 1, 2006 and those shares granted in prior periods but not yet vested as of April 1, 2006, in accordance with SFAS 123R. Under the fair value recognition provisions of SFAS 123R, we recognize share-based compensation net of an estimated forfeiture rate and only recognize compensation cost for those shares expected to vest on a straight-line basis over the requisite service period of the award. Prior to SFAS 123R's adoption, we accounted for share-based payments under Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", and accordingly, compensation expense was recognized only when we granted options with a discounted exercise price, granted restricted stock units, or granted options to non-employees.
Based on historical experience, we assumed an annualized forfeiture rate of 0% for awards granted to our directors during fiscal years 2009, 2008, and 2007, and an annualized forfeiture rate of 10%, 10%, and 12% for awards granted to our senior executives and remaining employees during fiscal years 2009, 2008, and 2007. We will record additional expense if the actual forfeitures are lower than estimated and will record a recovery of prior expense if the actual forfeitures are higher than estimated. The cumulative effect of the accounting change resulted in pre-tax income of $111 thousand and was recognized in the statement of operations for the year ended March 31, 2007.
Determining the appropriate fair value model and calculating the fair value of share-based payment awards requires the input of highly subjective assumptions, including the expected life of the share-based payment awards and stock price volatility. Management estimated the volatility based on historical volatility of our stock. The assumptions used in calculating the fair value of share-based payment awards represent management's best estimates, but these estimates involve inherent uncertainties and the application of management's judgment. As a result, if circumstances change and we use different assumptions, our share-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the share-based compensation expense could be significantly different from what we have recorded in the current period.
Income Taxes
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