QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2021
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period fromto
Commission file number 000-26251
NETSCOUT SYSTEMS, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware
04-2837575
(State or Other Jurisdiction of Incorporation or Organization)
(IRS Employer Identification No.)
310 Littleton Road, Westford, MA01886
(978) 614-4000
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered:
Common Stock, $0.001 par value per share
NTCT
Nasdaq Global Select Market
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☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer☒ Accelerated filer ☐
Non-accelerated filer ☐ Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of shares outstanding of the registrant's common stock, par value $0.001 per share, as of January 27, 2022 was 73,830,308.
Unless the context suggests otherwise, references in this Quarterly Report on Form 10-Q, or Quarterly Report, to "NetScout," the "Company," "we," "us," and "our" refer to NetScout Systems, Inc. and, where appropriate, our consolidated subsidiaries.
NetScout, the NetScout logo, Adaptive Service Intelligence and other trademarks or service marks of NetScout appearing in this Quarterly Report are the property of NetScout Systems, Inc. and/or its subsidiaries and/or affiliates in the United States and/or other countries. Any third-party trade names, trademarks and service marks appearing in this Quarterly Report are the property of their respective holders.
In addition to historical information, the following discussion and other parts of this Quarterly Report contain forward-looking statements under Section 21E of the Securities Exchange Act of 1934, as amended, and other federal securities laws. These forward-looking statements involve risks and uncertainties. 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. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and other factors, including those described in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for our fiscal year ended March 31, 2021, filed with the Securities and Exchange Commission, and elsewhere in this Quarterly Report. These factors may cause our actual results to differ materially from any forward-looking statement. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements.
The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.
Accounts receivable and unbilled costs, net of allowance for doubtful accounts of $220 and $416 at December 31, 2021 and March 31, 2021, respectively
233,854
197,717
Inventories and deferred costs
21,500
22,813
Prepaid income taxes
4,355
1,906
Prepaid expenses and other current assets
26,425
23,583
Total current assets
839,588
722,472
Fixed assets, net
42,723
48,474
Operating lease right-of-use assets
56,268
61,512
Goodwill
1,720,713
1,717,554
Intangible assets, net
453,719
511,866
Deferred income taxes
7,817
8,096
Other assets
12,721
15,064
Total assets
$
3,133,549
$
3,085,038
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable
$
18,436
$
17,964
Accrued compensation
67,332
83,057
Accrued other
31,821
21,127
Income taxes payable
5,382
7,025
Deferred revenue and customer deposits
296,814
269,748
Current portion of operating lease liabilities
11,441
12,354
Total current liabilities
431,226
411,275
Other long-term liabilities
7,499
21,641
Deferred tax liability
80,763
92,287
Accrued long-term retirement benefits
38,576
39,479
Long-term deferred revenue and customer deposits
122,227
103,310
Operating lease liabilities, net of current portion
55,671
61,267
Long-term debt
350,000
350,000
Total liabilities
1,085,962
1,079,259
Commitments and contingencies (Note 12)
Stockholders' equity:
Preferred stock, $0.001 par value:
5,000,000 shares authorized; no shares issued or outstanding at December 31, 2021 and March 31, 2021
—
—
Common stock, $0.001 par value:
300,000,000 shares authorized; 126,137,308 and 124,197,974 shares issued and 73,828,546 and 73,751,615 shares outstanding at December 31, 2021 and March 31, 2021, respectively
126
124
Additional paid-in capital
3,003,679
2,955,400
Accumulated other comprehensive loss
(1,795)
(1,940)
Treasury stock at cost, 52,308,762 and 50,446,359 shares at December 31, 2021 and March 31, 2021, respectively
(1,373,394)
(1,322,496)
Retained earnings
418,971
374,691
Total stockholders' equity
2,047,587
2,005,779
Total liabilities and stockholders' equity
$
3,133,549
$
3,085,038
The accompanying notes are an integral part of these consolidated financial statements.
The accompanying unaudited interim consolidated financial statements have been prepared by NetScout Systems, Inc. (NetScout or the Company). Certain information and footnote disclosures normally included in financial statements prepared under United States generally accepted accounting principles (GAAP) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (SEC). In the opinion of management, the unaudited interim consolidated financial statements include all adjustments, consisting of normal recurring adjustments, necessary for a fair statement of the Company's financial position and stockholders' equity, results of operations and cash flows. The year-end consolidated balance sheet data and statement of stockholders' equity were derived from the Company's audited financial statements, but do not include all disclosures required by GAAP. The results reported in these unaudited interim consolidated financial statements are not necessarily indicative of results that may be expected for the entire year. All significant intercompany accounts and transactions are eliminated in consolidation.
These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements, including the notes thereto, included in the Company's Annual Report on Form 10-K for the fiscal year ended March 31, 2021 filed with the Securities and Exchange Commission on May 20, 2021.
COVID-19 Risks and Uncertainties
The Company is closely monitoring the impact of the COVID-19 pandemic on all aspects of its business. The future impacts of the pandemic and any resulting economic impact on the Company's operations are evolving. It is possible that the COVID-19 pandemic, the measures taken by the governments of countries affected and the resulting economic impact may materially and adversely affect the Company's future results of operations, cash flows and financial position as well as its customers.
Under Accounting Standards Update (ASU) 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40), or ASC 205-40, the Company has the responsibility to evaluate whether conditions and/or events raise substantial doubt about its ability to meet its future financial obligations as they become due within one year after the date that the financial statements are issued. The Company has and continues to take precautionary actions to manage costs and spending across the organization. This includes managing discretionary spending and hiring activities. In addition, based on covenant levels at December 31, 2021, the Company had, as of December 31, 2021, 2021, an incremental $450 million available under the revolving credit facility.
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (the CARES Act) was enacted. The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. The Company has elected to defer the employer-paid portion of social security taxes. As of December 31, 2021, the Company had deferred $4.5 million of employer payroll taxes, which is required to be deposited by December 2022. The balance of $4.5 million was included as accrued other liabilities in the Company's consolidated balance sheet at December 31, 2021.
The Company expects net cash provided by operations combined with cash, cash equivalents, and marketable securities and borrowing availability under the revolving credit facility to provide sufficient liquidity to fund current obligations, capital spending, debt service requirements and working capital requirements over at least the next twelve months.
Recent Accounting Pronouncements
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, which requires companies to recognize and measure contract assets and contract liabilities acquired in a business combination as if the acquiring company originated the related revenue contracts. ASU 2021-08 is effective for fiscal years beginning after December 15, 2022, with early adoption permitted. ASU 2021-08 is effective for the Company beginning April 1, 2023. Amendments within the standard are required to be applied on a prospective basis from the date of adoption. The adoption is not expected to have a material impact on the Company's financial position, results of operations, and disclosures. We will apply the provisions of ASU 2021-08 after adoption to future acquisitions, if any.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The amendments provide optional guidance for a limited time to ease the potential burden in accounting for reference rate reform. The new guidance provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships and other transactions affected by reference rate reform if certain
criteria are met. The amendments apply only to contracts and hedging relationships that reference LIBOR or another reference rate expected to be discontinued due to reference rate reform. In January 2021, the FASB issued ASU 2021-01, Reference Rate Reform, which clarifies the scope and application of certain optional expedients and exceptions regarding the original guidance. ASU 2021-01 may be applied prospectively through December 31, 2022. The expedients and exceptions provided by the amendments do not apply to contract modifications made and hedging relationships entered into or evaluated after December 31, 2022, that an entity has elected certain optional expedients for and that are retained through the end of the hedging relationship. The adoption is not expected to have a material impact on the Company's financial position, results of operations, and disclosures.
In January 2020, the FASB issued ASU 2020-01, Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) - Clarifying the Interactions between Topic 321, Topic 323, and Topic 815. This guidance addresses accounting for the transition into and out of the equity method and provides clarification of the interaction of rules for equity securities, the equity method of accounting, and forward contracts and purchase options on certain types of securities. This standard is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2020. The Company adopted the guidance as of April 1, 2021. The adoption did not have a material impact on the Company's consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Simplifying the Accounting for Income Taxes. ASU 2019-12 simplifies the accounting for income taxes, eliminates certain exceptions within ASC 740, Income Taxes, and clarifies certain aspects of the current guidance to promote consistency among reporting entities. ASU 2019-12 is effective for fiscal years beginning after December 15, 2020. The Company adopted the guidance as of April 1, 2021. The adoption did not have a material impact on the Company's consolidated financial statements.
NOTE 2 – REVENUE
Revenue Recognition Policy
The Company exercises judgment and uses estimates in connection with determining the amounts of product and service revenues to be recognized in each accounting period.
The Company derives revenues primarily from the sale of network management tools and security solutions for service provider and enterprise customers, which include hardware, software and service offerings. The Company's product sales consist of software only offerings and offerings which include hardware appliances with embedded software that are essential to providing customers the intended functionality of the solutions.
The Company accounts for revenue once a legally enforceable contract with a customer has been approved by the parties and the related promises to transfer products or services have been identified. A contract is defined by the Company as an arrangement with commercial substance identifying payment terms, each party’s rights and obligations regarding the products or services to be transferred and the amount the Company deems probable of collection. Customer contracts may include promises to transfer multiple products and services to a customer. Determining whether the products and services are considered distinct performance obligations that should be accounted for separately or as one combined performance obligation may require significant judgment. Revenue is recognized when control of the products or services are transferred to the Company's customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for products and services.
Product revenue is typically recognized upon shipment, provided a legally enforceable contract exists, control has passed to the customer, and in the case of software products, when the customer has the rights and ability to access the software, and collection of the related receivable is probable. If any significant obligations to the customer remain post-delivery, typically involving obligations relating to installation and acceptance by the customer, revenue recognition is deferred until such obligations have been fulfilled. The Company's service offerings include installation, integration, extended warranty and maintenance services, post-contract customer support, stand-ready software-as-a-service (SAAS) and other professional services including consulting and training. The Company generally provides software and/or 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/hardware warranty expiration. Support services generally include rights to unspecified upgrades (when and if available), telephone and internet-based support, updates, bug fixes and hardware repair and replacement. Consulting services are recognized upon delivery or completion of performance depending on the terms of the underlying contract. Reimbursements of out-of-pocket expenditures incurred in connection with providing consulting services are included in services revenue, with the offsetting expense recorded in cost of service revenue. Training services include on-site and classroom training. Training revenues are recognized upon delivery of the training.
Generally, the Company's contracts are accounted for individually. However, when contracts are closely interrelated and dependent on each other, it may be necessary to account for two or more contracts as one to reflect the substance of the group of contracts.
Bundled arrangements are concurrent customer purchases of a combination of the Company's product and service offerings that may be delivered at various points in time. The Company allocates the transaction price among the performance obligations in an amount that depicts the relative standalone selling prices (SSP) of each obligation. Judgment is required to determine the SSP for each distinct performance obligation. The Company uses a range of amounts to estimate SSP when it sells each of the products and services separately based on the performance obligation's historical pricing. The Company also considers its overall pricing objectives and practices across different sales channels and geographies, and market conditions. Generally, the Company has established SSP for a majority of its service performance obligations based on historical standalone sales. In certain instances, the Company has established SSP for services based upon an estimate of profitability and the underlying cost to fulfill those services. Further, for certain service engagements, the Company considers quoted prices as part of bundled arrangements of those engagements as a basis for establishing SSP. SSP has been established for product performance obligations as the average or median selling price the performance obligation was recently sold for, whether sold alone or sold as part of a bundle transaction. The Company reviews sales of the product performance obligations on a quarterly basis and updates, when appropriate, its SSP for such performance obligations to ensure that it reflects recent pricing experience. The Company's products are distributed through its direct sales force and indirect distribution channels through alliances with resellers and distributors. Revenue arrangements with resellers and distributors are recognized on a sell-in basis; that is, when control of the product transfers to the reseller or distributor. The Company records consideration given to a customer as a reduction of revenue to the extent they have recorded revenue from the customer. With limited exceptions, the Company's return policy does not allow product returns for a refund. Returns have been insignificant to date. In addition, the Company has a history of successfully collecting receivables from its resellers and distributors.
During the nine months ended December 31, 2021, the Company recognized revenue of $234.8 million related to the Company's deferred revenue balance reported at March 31, 2021.
Performance Obligations
Customer contracts may include promises to transfer multiple products and services to a customer. Determining whether the products and services are considered distinct performance obligations that should be accounted for separately or as one combined performance obligation may require significant judgment. The transaction price is allocated among performance obligations in bundled contracts in an amount that depicts the relative standalone selling prices of each obligation.
For contracts involving distinct hardware and software licenses, the performance obligations are satisfied at a point in time when control is transferred to the customer. For standalone maintenance and post-contract support (PCS) the performance obligation is satisfied ratably over the contract term as a stand-ready obligation. For consulting and training services, the performance obligation may be satisfied over the contract term as a stand-ready obligation, satisfied over a period of time as those services are delivered, or satisfied at the completion of the service when control has transferred, or the services have expired unused.
Payments for hardware, software licenses, one-year maintenance, PCS and consulting services, are typically due up front with payment terms of 30 to 90 days. However, the Company does have contracts pursuant to which billings occur ratably over a period of years following the transfer of control for the contracted performance obligations. Payments on multi-year maintenance, PCS and consulting services are typically due in annual installments over the contract term. The Company did not have any material variable consideration such as obligations for returns, refunds or warranties at December 31, 2021.
At December 31, 2021, the Company had total deferred revenue of $419.0 million, which represents the aggregate total contract price allocated to undelivered performance obligations. The Company expects to recognize $296.8 million, or 71%, of this revenue during the next 12 months, and expects to recognize the remaining $122.2 million, or 29%, of this revenue thereafter.
There are circumstances for which the Company does not recognize revenue relating to sales transactions that have been billed, and the related account receivable has not been collected. While the receivable represents an enforceable obligation, the Company does not believe its right to payment is unconditional; therefore, for balance sheet presentation purposes, the Company has not recognized the deferred revenue or the related account receivable and no amounts appear in the consolidated balance sheets for such transactions because control of the underlying deliverable has not transferred. The aggregate amount of unrecognized accounts receivable and deferred revenue was $5.5 million and $7.1 million at December 31, 2021 and March 31, 2021, respectively.
NetScout expects that the amount of billed and unbilled deferred revenue will change from quarter to quarter for several reasons, including the specific timing, duration and size of large customer support and service agreements, varying billing cycles of such agreements, the specific timing of customer renewals, and foreign currency fluctuations. The Company did not
have material significant financing components, or variable consideration or performance obligations satisfied in a prior period recognized during the nine months ended December 31, 2021.
Contract Balances
The Company may receive payments from customers based on billing schedules as established by the Company's contracts. Contract assets relate to performance obligations where control has transferred to the customer in advance of scheduled billings. The Company records unbilled accounts receivable representing the right to consideration in exchange for goods or services that have been transferred to a customer conditional on the passage of time. Deferred revenue relates to scenarios where billings occur before control has transferred for a performance obligation or payments are received in advance of performance under the contract.
Costs to Obtain Contracts
The Company has determined that the only significant incremental costs incurred to obtain contracts with customers within the scope of Topic 606 are sales commissions paid to its employees. Sales commissions are recorded as an asset and amortized to expense ratably over the remaining performance periods of the related contracts with remaining performance obligations. The Company expenses costs as incurred for sales commissions when the amortization period would have been one year or less.
At December 31, 2021, the consolidated balance sheet included $8.1 million in assets related to sales commissions to be expensed in future periods. A balance of $4.4 million was included in prepaid expenses and other current assets, and a balance of $3.7 million was included in other assets in the Company's consolidated balance sheet at December 31, 2021. At March 31, 2021, the consolidated balance sheet included $7.4 million in assets related to sales commissions to be expensed in future periods. A balance of $4.1 million was included in prepaid expenses and other current assets, and a balance of $3.3 million was included in other assets in the Company's consolidated balance sheet at March 31, 2021.
During the three and nine months ended December 31, 2021 and 2020, respectively, the Company recognized $1.6 million, $1.6 million, $4.7 million and $4.7 million of amortization related to this sales commission asset, which is included in the sales and marketing expense line in the Company's consolidated statements of operations.
Allowance for Credit Losses
The Company continually monitors collections from its customers. The Company evaluates the collectability of its accounts receivable and determines the appropriate allowance for credit losses based on a combination of factors, including but not limited to, analysis of the aging schedules, past due balances, historical collection experience and prevailing economic conditions.
The following table summarizes the activity in the allowance for credit losses (in thousands):
Balance at March 31, 2021
$
416
Provision for allowance for credit losses
49
Recoveries and other adjustments
(1)
Write off charged against the allowance for credit losses
(244)
Balance at December 31, 2021
$
220
NOTE 3 – CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
Financial instruments that potentially subject the Company to concentration of credit risk consist primarily of investments, trade accounts receivable and accounts payable. The Company's cash, cash equivalents, and marketable securities are placed with financial institutions with high credit standings.
At December 31, 2021, the Company had two direct customers which accounted for more than 10% of the accounts receivable balance, while no indirect channel partners accounted for more than 10% of the accounts receivable balance. At March 31, 2021, the Company had one direct customer which accounted for more than 10% of the accounts receivable balance, while no indirect channel partners accounted for more than 10% of the accounts receivable balance.
During the three and nine months ended December 31, 2021, one direct customer, Verizon, accounted for more than 10% of the Company's total revenue, while no indirect channel partners accounted for more than 10% of total revenue. During the three and nine months ended December 31, 2020, no direct customers or indirect channel partners accounted for more than 10% of the Company's total revenue.
Historically, the Company has not experienced any significant failure of its customers' ability to meet their payment obligations nor does the Company anticipate material non-performance by its customers in the future; accordingly, the Company does not require collateral from its customers. However, if the Company's assumptions are incorrect, there could be an adverse impact on its allowance for doubtful accounts.
NOTE 4 – SHARE-BASED COMPENSATION
On September 12, 2019, the Company's stockholders approved the 2019 Equity Incentive Plan (2019 Plan), which replaced the Company's 2007 Equity Incentive Plan, as amended (Amended 2007 Plan). The 2019 Plan permitted the granting of incentive and nonstatutory stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards, and other stock awards, collectively referred to as "share-based awards." On September 10, 2020, the Company's stockholders approved an amendment and restatement of the 2019 Equity Incentive Plan (the 2019 Amended Plan) to increase the number of shares authorized for issuance by 4,700,000, established a one-year minimum vesting requirement for awards granted on or after September 10, 2020, and changed the factor used to calculate the increase or reduction in the number of shares available for issuance under the 2019 Amended Plan.
Periodically, the Company grants share-based awards to employees, officers, and directors of the Company and its subsidiaries. During the nine months ended December 31, 2021, the Company granted performance-based restricted stock units to certain executive officers that vest based upon the Company's total shareholder return as compared to the Russell 2000 Index over a three-year period. The performance-based restricted stock units were valued using the Monte Carlo Simulation model. The measurement and recognition of compensation expense is based on estimated fair values for all share-based payment awards made to its employees and directors. Share-based award grants are generally measured at fair value on the date of grant based on the number of shares granted and the quoted price of the Company's common stock. Such value is recognized as a cost of revenue or an operating expense over the corresponding vesting period.
The following is a summary of share-based compensation expense including restricted stock units and performance-based restricted stock units granted pursuant to the Company's Amended 2007 Plan, the 2019 Plan, and the 2019 Amended Plan and employee stock purchases made under the Company's 2011 Employee Stock Purchase Plan, as amended, (ESPP), based on estimated fair values within the applicable cost and expense lines identified below (in thousands):
Three Months Ended
Nine Months Ended
December 31,
December 31,
2021
2020
2021
2020
Cost of product revenue
$
214
$
248
$
809
$
837
Cost of service revenue
1,302
1,371
4,822
4,531
Research and development
3,297
3,862
12,290
12,578
Sales and marketing
4,727
4,253
15,383
13,602
General and administrative
3,141
2,783
10,077
8,801
$
12,681
$
12,517
$
43,381
$
40,349
Employee Stock Purchase Plan – The Company maintains the ESPP for all eligible employees as described in the Company's Annual Report on Form 10-K for the year ended March 31, 2021. Under the ESPP, shares of the Company's common stock may be purchased on the last day of each bi-annual offering period at 85% of the fair value on the last day of such offering period. The offering periods run from March 1st through August 31st and from September 1st through the last day of February each year. During the nine months ended December 31, 2021, employees purchased 251,308 shares under the ESPP and the value per share was $23.31.
The Company considers all highly liquid investments purchased with an original maturity of three months or less to be cash equivalents and those investments with original maturities greater than three months to be marketable securities. Cash and cash equivalents mainly consisted of U.S. government and municipal obligations, commercial paper, money market instruments and cash maintained with various financial institutions at December 31, 2021 and March 31, 2021.
The following table provides a reconciliation of cash, cash equivalents and restricted cash reported within the consolidated balance sheets that sum to the total of the same such amounts shown in the consolidated statements of cash flows (in thousands):
December 31, 2021
March, 31, 2021
December 31, 2020
March 31, 2020
Cash and cash equivalents
$
548,105
$
467,176
$
477,755
$
338,489
Restricted cash
—
—
748
1,748
Total cash, cash equivalents and restricted cash
$
548,105
$
467,176
$
478,503
$
340,237
The Company's restricted cash includes cash balances which are legally or contractually restricted. The Company's restricted cash is included within prepaid and other current assets and consists of amounts related to holdbacks associated with prior acquisitions.
Marketable Securities
The following is a summary of marketable securities held by NetScout at December 31, 2021, classified as short-term and long-term (in thousands):
Amortized Cost
Unrealized Gains
Fair Value
Type of security:
Commercial paper
$
5,349
$
—
$
5,349
Total short-term marketable securities
5,349
—
5,349
Total long-term marketable securities
—
—
—
Total marketable securities
$
5,349
$
—
$
5,349
The following is a summary of marketable securities held by NetScout at March 31, 2021, classified as short-term and long-term (in thousands):
Amortized Cost
Unrealized Gains
Fair Value
Type of security:
U.S. government and municipal obligations
$
3,571
$
7
$
3,578
Commercial paper
5,699
—
5,699
Total short-term marketable securities
9,270
7
9,277
Total long-term marketable securities
—
—
—
Total marketable securities
$
9,270
$
7
$
9,277
Contractual maturities of the Company's marketable securities held at December 31, 2021 and March 31, 2021 were as follows (in thousands):
The fair value hierarchy has three levels based on the reliability of the inputs used to determine fair value. Level 1 refers to fair values determined based on quoted prices in active markets for identical assets. Level 2 refers to fair values estimated using significant other observable inputs, and Level 3 includes fair values estimated using significant non-observable inputs. The following tables present the Company's financial assets and liabilities measured on a recurring basis using the fair value hierarchy at December 31, 2021 and March 31, 2021 (in thousands):
Fair Value Measurements at
December 31, 2021
Level 1
Level 2
Level 3
Total
ASSETS:
Cash and cash equivalents
$
548,105
$
—
$
—
$
548,105
Commercial paper
—
5,349
—
5,349
Derivative financial instruments
—
69
—
69
$
548,105
$
5,418
$
—
$
553,523
LIABILITIES:
Derivative financial instruments
$
—
$
(13)
$
—
$
(13)
$
—
$
(13)
$
—
$
(13)
Fair Value Measurements at
March 31, 2021
Level 1
Level 2
Level 3
Total
ASSETS:
Cash and cash equivalents
$
467,176
$
—
$
—
$
467,176
U.S. government and municipal obligations
2,539
1,039
—
3,578
Commercial paper
—
5,699
—
5,699
Derivative financial instruments
—
57
—
57
$
469,715
$
6,795
$
—
$
476,510
LIABILITIES:
Derivative financial instruments
$
—
$
(191)
$
—
$
(191)
$
—
$
(191)
$
—
$
(191)
This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. On a recurring basis, the Company measures certain financial assets and liabilities at fair value, including marketable securities and derivative financial instruments.
The Company's Level 1 investments are classified as such because they are valued using quoted market prices or alternative pricing sources with reasonable levels of price transparency.
The Company's Level 2 investments are classified as such because fair value is calculated using market observable data for similar but not identical instruments, or a discounted cash flow model using the contractual interest rate as compared to the underlying interest yield curve. The Company classifies municipal obligations as Level 2 because the fair values are determined using quoted prices from markets the Company considers to be inactive. Commercial paper is classified as Level 2 because the Company uses market information from similar but not identical instruments and discounted cash flow models based on interest rate yield curves to determine fair value. The Company's derivative financial instruments consist of forward foreign exchange contracts and are classified as Level 2 because the fair values of these derivatives are determined using models based on market observable inputs, including spot prices for foreign currencies and credit derivatives, as well as an interest rate factor.
The Company's Level 3 assets consisted of contingent consideration related to the divestiture of the Company's handheld network test (HNT) tools business in September 2018. The contingent consideration represented potential future earnout payments to the Company of up to $4.0 million over two years that were contingent on the HNT tools business achieving certain milestones. During the nine months ended December 31, 2021, the Company recorded an $0.8 million increase in the fair value of the contingent consideration, which is included in other income (expense), net within the Company's consolidated statement of operations. The $0.8 million of contingent consideration was paid to the Company as the final earnout during the nine months ended December 31, 2021.
The following table sets forth a reconciliation of changes in the fair value of the Company's Level 3 financial asset for the nine months ended December 31, 2021 (in thousands):
Contingent Consideration
Balance at March 31, 2021
$
—
Change in fair value of contingent consideration
837
Collection of contingent consideration
(837)
Balance at December 31, 2021
$
—
NOTE 7 – INVENTORIES
Inventories are stated at the lower of actual cost or net realizable value. Cost is determined by using the first in, first out (FIFO) method. Inventories consist of the following (in thousands):
December 31, 2021
March 31, 2021
Raw materials
$
13,221
$
13,189
Work in process
152
16
Finished goods
4,362
6,168
Deferred costs
3,765
3,440
$
21,500
$
22,813
NOTE 8 – GOODWILL AND INTANGIBLE ASSETS
Goodwill
The Company has one reporting unit. The Company assesses goodwill for impairment at the reporting unit level at least annually, or on an interim basis if an event occurs or circumstances change that would, more likely than not, reduce the fair value of the reporting unit below its carrying value. The Company completed its annual impairment test on January 31, 2021 using the qualitative Step 0 assessment as the Company concluded that it was more likely than not that the fair value of the reporting unit exceeded its carrying value.
At December 31, 2021 and March 31, 2021, the carrying amount of goodwill was $1.7 billion. The change in the carrying amount of goodwill for the nine months ended December 31, 2021 was due to the impact of foreign currency translation adjustments related to asset balances that are recorded in currencies other than the U.S. Dollar.
The following table summarizes the changes in the carrying amount of goodwill for the nine months ended December 31, 2021 as follows (in thousands):
Balance at March 31, 2021
$
1,717,554
Foreign currency translation impact
3,159
Balance at December 31, 2021
$
1,720,713
Intangible Assets
The net carrying amounts of intangible assets were$453.7 million and $511.9 million at December 31, 2021 and March 31, 2021, respectively. Intangible assets acquired in a business combination are recorded under the acquisition method of accounting at their estimated fair values at the date of acquisition. The Company amortizes acquired intangible assets over their estimated useful lives. During the first quarter of fiscal year 2022, in conjunction with the renewal process of the Company's acquired indefinite-lived trade name and the Company's focus on advancing new product lines, the Company reassessed the estimated economic life of the acquired indefinite-lived trade name. As a result, the Company began amortizing the acquired trade name over 8 years. Prior to reclassifying the acquired trade name to a finite-lived intangible asset, the Company tested the acquired trade name for impairment and determined the fair value of the asset exceeded the carrying value. This change in estimate does not materially impact the Company's income statement.
Intangible assets include the following amortizable intangible assets at December 31, 2021 (in thousands):
Cost
Accumulated Amortization
Net
Developed technology
$
251,072
$
(221,842)
$
29,230
Customer relationships
772,339
(372,349)
399,990
Distributor relationships and technology licenses
11,408
(8,639)
2,769
Definite-lived trademark and trade name (a)
57,877
(36,380)
21,497
Core technology
7,192
(7,192)
—
Non-compete agreements
292
(292)
—
Capitalized software
3,317
(3,314)
3
Other
1,208
(978)
230
$
1,104,705
$
(650,986)
$
453,719
(a) The Company's $18.6 million acquired trade name changed from indefinite-lived during the first quarter of fiscal year 2022.
Intangible assets include the indefinite-lived trade name with a carrying value of $18.6 million and the following amortizable intangible assets at March 31, 2021 (in thousands):
Amortization included as cost of product revenue consists of amortization of developed technology, distributor relationships and technology licenses, core technology and software. Amortization included as operating expense consists of all other intangible assets. The following table provides a summary of amortization expense for the three and nine months ended December 31, 2021 and 2020, respectively (in thousands):
Three Months Ended
Nine Months Ended
December 31,
December 31,
2021
2020
2021
2020
Amortization of intangible assets included as:
Cost of product revenue
$
3,643
$
5,177
$
10,959
$
15,510
Operating expense
14,924
15,278
44,910
45,912
$
18,567
$
20,455
$
55,869
$
61,422
The following is the expected future amortization expense at December 31, 2021 for the fiscal years ending March 31 (in thousands):
2022 (remaining three months)
$
18,491
2023
66,446
2024
58,225
2025
51,025
2026
46,687
Thereafter
212,845
$
453,719
The weighted-average amortization period of developed technology and core technology is 11.2 years. The weighted-average amortization period for customer and distributor relationships is 15.9 years. The weighted-average amortization period for trademarks and trade names is 8.4 years. The weighted-average amortization period for capitalized software is 3.0 years. The weighted-average amortization period for amortizing all intangible assets is 14.6 years.
NOTE 9 – DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
NetScout operates internationally and, in the normal course of business, is exposed to fluctuations in foreign currency exchange rates. The exposures result from costs that are denominated in currencies other than the U.S. Dollar, primarily the Euro, British Pound, Canadian Dollar, and Indian Rupee. The Company manages its foreign cash flow risk by hedging forecasted cash flows for operating expenses denominated in foreign currencies for up to twelve months, within specified guidelines through the use of forward contracts. The Company enters into foreign currency exchange contracts to hedge cash flow exposures from costs that are denominated in currencies other than the U.S. Dollar. These hedges are designated as cash flow hedges at inception.
NetScout also periodically enters into forward contracts to manage exchange rate risks associated with certain third-party transactions and for which the Company does not elect hedge accounting treatment as there is no difference in the timing of gain or loss recognition on the hedging instrument and the hedged item.
All of the Company's derivative instruments are utilized for risk management purposes, and the Company does not use derivatives for speculative trading purposes. These contracts will mature over the next twelve months and are expected to impact earnings on or before maturity.
The notional amounts and fair values of derivative instruments in the consolidated balance sheets at December 31, 2021 and March 31, 2021 were as follows (in thousands):
Notional Amounts (a)
Prepaid Expenses and Other Current Assets
Accrued Other
December 31, 2021
March 31, 2021
December 31, 2021
March 31, 2021
December 31, 2021
March 31, 2021
Derivatives Designated as Hedging Instruments:
Forward contracts
$
12,772
$
11,037
$
69
$
57
$
13
$
152
Derivatives Not Designated as Hedging Instruments:
Forward contracts
—
6,373
—
—
—
39
$
69
$
57
$
13
$
191
(a) Notional amounts represent the gross contract/notional amount of the derivatives outstanding.
The following table provides the effect foreign exchange forward contracts designated as hedging instruments had on other comprehensive income (OCI) and results of operations for the three months ended December 31, 2021 and 2020 (in thousands):
Gain Recognized in OCI on Derivative (a)
Gain (Loss) Reclassified from Accumulated OCI into Income (b)
December 31, 2021
December 31, 2020
Location
December 31, 2021
December 31, 2020
Forward contracts
$
30
$
172
Research and development
$
(2)
$
(21)
Sales and marketing
40
(82)
$
30
$
172
$
38
$
(103)
(a)The amount represents the change in fair value of derivative contracts due to changes in spot rates.
(b)The amount represents reclassification from other comprehensive income to earnings that occurs when the hedged item affects earnings.
The following table provides the effect foreign exchange forward contracts not designated as hedging instruments had on the Company's results of operations for the three months ended December 31, 2021 and 2020 (in thousands):
Gain Recognized in Income (a)
Location
December 31, 2021
December 31, 2020
Forward contracts
General and administrative
$
—
$
30
$
—
$
30
(a)The amount represents the change in fair value of derivative contracts due to changes in spot rates.
The following table provides the effect foreign exchange forward contracts designated as hedging instruments had on other comprehensive income (OCI) and results of operations for the nine months ended December 31, 2021 and 2020 (in thousands):
Gain Recognized in OCI on Derivative (a)
Loss Reclassified from Accumulated OCI into Income (b)
December 31, 2021
December 31, 2020
Location
December 31, 2021
December 31, 2020
Forward contracts
$
158
$
420
Research and development
$
(17)
$
(34)
Sales and marketing
(11)
(163)
$
158
$
420
$
(28)
$
(197)
(a)The amount represents the change in fair value of derivative contracts due to changes in spot rates.
(b)The amount represents reclassification from other comprehensive income to earnings that occurs when the hedged item affects earnings.
The following table provides the effect foreign exchange forward contracts not designated as hedging instruments had on the Company's results of operations for the nine months ended December 31, 2021 and 2020 (in thousands):
Gain Recognized in Income (a)
Location
December 31, 2021
December 31, 2020
Forward contracts
General and administrative
$
—
$
76
$
—
$
76
(a)The amount represents the change in fair value of derivative contracts due to changes in spot rates.
NOTE 10 – LONG-TERM DEBT
On January 16, 2018, the Company amended and expanded its existing credit agreement (Amended Credit Agreement), which provided for a five-year, $1.0 billion senior secured revolving credit facility, including a letter of credit sub-facility of up to $75.0 million. The commitments under the Amended Credit Agreement were set to expire on January 16, 2023, and any outstanding loans were due on that date.
On July 27, 2021, the Company amended and extended the Amended Credit Agreement (Second Amended and Restated Credit Agreement) with a syndicate of lenders by and among: the Company; JPMorgan Chase Bank, N.A. (JPMorgan), as administrative agent and collateral agent; JPMorgan, Wells Fargo Securities, LLC, BofA Securities Inc., RBC Capital Markets, PNC Capital Markets LLC and Mizuho Bank, Ltd., as joint lead arrangers and joint bookrunners; Santander Bank, N.A., U.S. Bank National Association, Fifth Third Bank National Association, Silicon Valley Bank and TD Bank, N.A., as co-documentation agents; and the lenders party thereto.
The Second Amended and Restated Credit Agreement provides for a five-year, $800.0 million senior secured revolving credit facility, including a letter of credit sub-facility of up to $75.0 million. The Company may elect to use the credit facility for general corporate purposes (including to finance the repurchase of shares of the Company's common stock). The commitments under the Second Amended and Restated Credit Agreement will expire on July 27, 2026, and any outstanding loans will be due on that date.
In connection with the Second Amended and Restated Credit Agreement, the Company paid off the outstanding balance of $350 million under the Amended Credit Agreement on July 27, 2021 by borrowing the same amount under the Second Amended and Restated Credit Agreement. Additionally, the Company recorded a loss on the extinguishment of debt of $0.6 million, representing the write off of unamortized deferred financing costs, which was included in interest expense in the consolidated statements of operations for the nine months ended December 31, 2021. At December 31, 2021, $350 million was outstanding under the Second Amended and Restated Credit Agreement.
At the Company's election, revolving loans under the Second Amended and Restated Credit Agreement bear interest at either (a) an Alternate Base Rate per annum equal to the greatest of (1) the Wall Street Journal prime rate; (2) the New York Federal Reserve Bank (NYFRB) rate plus 0.50%, or (3) an adjusted one month LIBO rate plus 1%; or (b) a Term Benchmark Borrowing rate (for the interest period selected by the Company, subject to customary provisions regarding succession from LIBO rate to SOF rate in anticipation of the upcoming discontinuation of the LIBO rate), in each case plus an applicable margin. For the period from the delivery of the Company's financial statements for the quarter ended September 30, 2021, until the Company has delivered financial statements for the quarter ended December 31, 2021, the applicable margin will be 1.25% per annum for Term Benchmark Revolving loans and 0.25% per annum for Alternate Base Rate loans, and thereafter the applicable margin will vary depending on the Company's consolidated gross leverage ratio, ranging from 1.00% per annum for Alternate Base Rate loans and 2.00% per annum for Term Benchmark Revolving loans if the Company's consolidated gross leverage ratio is greater than 3.50 to 1.00, down to 0.00% per annum for Alternate Base Rate loans and 1.00% per annum for Term Benchmark Revolving loans if the Company's consolidated gross leverage ratio is equal to or less than 1.50 to 1.00.
The Company's consolidated gross leverage ratio is the ratio of its total funded debt compared to its consolidated EBITDA as defined in the Second Amended and Restated Credit Agreement (adjusted consolidated EBITDA). Adjusted consolidated EBITDA includes certain adjustments, including, without limitation, adjustments relating to extraordinary, unusual or non-recurring charges, certain restructuring charges, non-cash charges, certain transaction costs and expenses and certain pro forma adjustments in connection with material acquisitions and dispositions, all as set forth in detail in the Second Amended and Restated Credit Agreement. The Company's secured net leverage ratio is the ratio of its Consolidated Total Debt minus the lesser of unrestricted cash and 125% of adjusted consolidated EBITDA compared to its adjusted consolidated EBITDA.
Commitment fees will accrue on the daily unused amount of the credit facility. For the period from the delivery of the Company's financial statements for the quarter ended September 30, 2021, until the Company has delivered financial statements
for the quarter ended December 31, 2021, the commitment fee will be 0.20% per annum, and thereafter the commitment fee will vary depending on the Company's consolidated gross leverage ratio, ranging from 0.30% per annum if the Company's consolidated gross leverage ratio is greater than 2.75 to 1.00, down to 0.15% per annum if the Company's consolidated gross leverage ratio is equal to or less than 1.50 to 1.00.
Letter of credit participation fees are payable to each lender providing the letter of credit sub-facility on the amount of such lender's letter of credit exposure, during the period from the closing date of the Second Amended and Restated Credit Agreement to, but excluding, the date which is the later of (i) the date on which such lender's commitment terminates or (ii) the date on which such lender ceases to have any letter of credit exposure, at the applicable rate that would be used to determine the interest rate applicable to Term Benchmark Revolving loans assuming such loans were outstanding during the period. Additionally, the Company will pay a fronting fee to each issuing bank in amounts to be agreed to between the Company and the applicable issuing bank.
Interest on Alternate Base Rate loans is payable at the end of each calendar quarter. Interest on Term Benchmark Revolving loans is payable at the end of each interest rate period or at the end of each three-month interval within an interest rate period if the period is longer than three months. The Company may also prepay loans under the Second Amended and Restated Credit Agreement at any time, without penalty, subject to certain notice requirements.
The loans and other obligations under the credit facility are (a) guaranteed by each of the Company’s wholly-owned material domestic restricted subsidiaries, subject to certain exceptions, and (b) are secured by substantially all of the assets of the Company and the subsidiary guarantors, including a pledge of all the capital stock of material subsidiaries held directly by the Borrower and the subsidiary guarantors (which pledge, in the case of any foreign subsidiary, is limited to 65% of the voting stock), subject to certain customary exceptions and limitations. The Second Amended and Restated Credit Agreement generally prohibits any other liens on the assets of the Company and its restricted subsidiaries, subject to certain exceptions as described in the Second Amended and Restated Credit Agreement.
The Second Amended and Restated Credit Agreement contains certain covenants applicable to the Company and its restricted subsidiaries, including, without limitation, limitations on additional indebtedness, liens, various fundamental changes, dividends and distributions, investments (including acquisitions), transactions with affiliates, asset sales, including sale-leaseback transactions, speculative hedge agreements, payment of junior financing, changes in business and other limitations customary in senior secured credit facilities. The Second Amended and Restated Credit Agreement requires the Company to maintain a certain consolidated net leverage ratio and removes the previous requirement under the Amended Credit Agreement that the Company maintain a minimum consolidated interest coverage ratio. These covenants and limitations are more fully described in the Second Amended and Restated Credit Agreement. As of December 31, 2021, the Company was in compliance with the specified total consolidated net leverage ratio range of 4.00 to 1.00.
The Second Amended and Restated Credit Agreement provides that events of default will exist in certain circumstances, including failure to make payment of principal or interest on the loans when required, failure to perform certain obligations under the Second Amended and Restated Credit Agreement and related documents including a failure to meet the maximum total consolidated net leverage ratio covenant, defaults under certain other indebtedness, certain insolvency events, certain events arising under ERISA, a change of control and certain other events. Upon an event of default, the administrative agent with the consent of, or at the request of, the holders of more than 50% in principal amount of the loans and commitments, may terminate the commitments and accelerate the maturity of the loans and enforce certain other remedies under the Second Amended and Restated Credit Agreement and the other loan documents.
The Company had unamortized capitalized debt issuance costs, net of $5.1 million at December 31, 2021, which are being amortized over the life of the revolving credit facility. The unamortized capitalized debt issuance costs balance of $1.1 million was included as prepaid expenses and other current assets and a balance of $4.0 million was included as other assets in the Company's consolidated balance sheet.
NOTE 11 - LEASES
The Company determines if an arrangement is a lease at inception. Right-of-use (ROU) assets represent the Company's right to use an underlying asset for the duration of the lease term. Lease liabilities represent the Company's contractual obligation to make lease payments over the lease term. ROU assets are recorded and recognized at commencement for the lease liability amount, plus initial direct costs incurred less lease incentives received. Lease liabilities are recorded at the present value of future lease payments over the lease term at commencement. The discount rate used is generally the Company's estimated incremental borrowing rate unless the lessor's implicit rate is readily determinable. Incremental borrowing rates are calculated periodically to estimate the rate the Company would pay to borrow the funds necessary to obtain an asset of similar value over a similar term. Lease expenses relating to operating leases are recognized on a straight-line basis over the lease term.
The Company has operating leases for administrative, research and development, sales and marketing and manufacturing facilities and equipment under various non-cancelable lease agreements. The Company's leases have remaining lease terms
ranging from 1 year to 9 years. The Company's lease terms may include options to extend or terminate the lease where it is reasonably certain that the Company will exercise those options. The Company considers several economic factors when making this determination, including but not limited to, the significance of leasehold improvements incurred in the office space, the difficulty in replacing the asset, underlying contractual obligations, or specific characteristics unique to a particular lease. The Company’s lease agreements do not contain any material residual value guarantees or material restrictive covenants.
Most of the Company's lease agreements contain variable payments, primarily for common area maintenance (CAM), which are expensed as incurred and not included in the measurement of the ROU assets and lease liabilities.
The components of operating lease cost for the three and nine months ended December 31, 2021 and 2020 were as follows (in thousands):
Three Months Ended
Nine Months Ended
December 31,
December 31,
2021
2020
2021
2020
Lease cost under long-term operating leases
$
3,187
$
3,277
$
9,659
$
9,803
Lease cost under short-term operating leases
1,247
804
2,990
3,184
Variable lease cost under short-term and long-term operating leases
925
895
2,508
2,845
Total operating lease cost
$
5,359
$
4,976
$
15,157
$
15,832
The table below presents supplemental cash flow information related to leases during the nine months ended December 31, 2021 and 2020 (in thousands):
December 31, 2021
December 31, 2020
Right-of-use assets obtained in exchange for new operating lease liabilities
$
2,461
$
1,902
At December 31, 2021 and March 31, 2021, the weighted average remaining lease term in years and weighted average discount rate were as follows:
December 31, 2021
March 31, 2021
Weighted average remaining lease term in years - operating leases
7.20
7.70
Weighted average discount rate - operating leases
4.0
%
4.1
%
Future minimum payments under non-cancellable leases at December 31, 2021 are as follows (in thousands):
Year ending March 31:
2022 (remaining three months)
$
2,704
2023
13,316
2024
11,047
2025
10,737
2026
9,685
Thereafter
29,841
Total lease payments
$
77,330
Less imputed interest
(10,218)
Present value of lease liabilities
$
67,112
NOTE 12 – COMMITMENTS AND CONTINGENCIES
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 current legal proceedings and claims, if determined adversely, will not have a material adverse effect on the Company's financial condition, results of operations or cash flows.
As previously disclosed, in March 2016, Packet Intelligence LLC (Packet Intelligence or Plaintiff) filed a Complaint against NetScout and two subsidiary entities in the United States District Court for the Eastern District of Texas asserting infringement of five United States patents. Plaintiff's Complaint alleged that legacy Tektronix GeoProbe products, including the
G10 and GeoBlade products, infringed these patents. NetScout filed an Answer denying Plaintiff's allegations and asserting that Plaintiff's patents were, among other things, invalid, not infringed, and unenforceable due to inequitable conduct. In October 2017, a jury trial was held to address the parties' claims and counterclaims regarding infringement of three patents by the G10 and GeoBlade products, invalidity of these patents, and damages. On October 13, 2017, the jury rendered a verdict finding in favor of the Plaintiff and that Plaintiff was entitled to $3,500,000 for pre-suit damages and $2,250,000 for post-suit damages. The jury indicated that the awarded damages amounts were intended to reflect a running royalty. In September 2018, the Court entered judgment and "enhanced" the jury verdict in the amount of $2.8 million as a result of a jury finding. The judgment also awarded pre- and post-judgment interest, and a running royalty on the G10 and GeoBlade products until the expiration of the patents at issue, the last date being June 2022. Following the entry of final judgment, on June 12, 2019, NetScout filed its Notice of Appeal. On July 14, 2020, the Court of Appeals for the Federal Circuit issued a decision vacating the $3,500,000 pre-suit damages award, affirming the $2,250,000 post-suit damages award, and remanding to the district court to determine what, if any, enhancement should be awarded. On March 15, 2021, NetScout filed a petition for a writ of certiorari to the United States Supreme Court, which was subsequently denied, challenging, among other issues, the basis for enhanced damages and the patentability of the claimed technology. The case is currently on remand at the District Court for additional proceedings, including pending motions relating to whether enhanced damages should be awarded and the ongoing royalty rate. In addition, on September 8 and 9, 2021, in proceedings initiated by third parties that did not involve NetScout, the Patent Trial and Appeal Board (PTAB) invalidated all the patent claims that were also asserted against NetScout in this case. After the PTAB decisions were issued, NetScout moved to dismiss the case and enter judgment in its favor on the grounds that the PTAB decisions invalidating the asserted claims precluded Plaintiff from continuing to assert its patent infringement causes of action and from seeking damages from NetScout. Plaintiff has opposed the requested relief and has reported that appeals of the PTAB decisions with the Federal Circuit are already underway. In view of the current circumstances, NetScout has concluded that the risk of loss associated with the post-suit damages award remains "probable" in accounting terms, regardless of the options NetScout may pursue, and that the risk of loss associated with pre-suit damages is remote. Accounting rules require NetScout to provide an estimate for the range of potential liability. If the post-suit damages award survives the recent PTAB invalidation decisions, NetScout currently estimates that the range of liability would be the sum of post-suit damages, plus pre- and post-judgment interest amounts and royalties owed on post-trial sales of the accused G10 and GeoBlade products. Any potential enhancement of any such surviving post-suit damages award is not reasonably estimable but is likely within the range of $0 to $2,800,000.
NOTE 13 – PENSION BENEFIT PLANS
Certain of the Company's non-U.S. employees participate in noncontributory defined benefit pension plans. None of the Company's employees in the U.S. participate in any noncontributory defined benefit pension plans. In general, these plans are funded based on considerations relating to legal requirements, underlying asset returns, the plan's funded status, the anticipated deductibility of the contribution, local practices, market conditions, interest rates and other factors.
The following sets forth the components of the Company's net periodic pension cost of the noncontributory defined benefit pension plans for the three and nine months ended December 31, 2021 and 2020 (in thousands):
Three Months Ended
Nine Months Ended
December 31,
December 31,
2021
2020
2021
2020
Service cost
$
41
$
55
$
129
$
159
Interest cost
83
97
263
283
Net periodic pension cost
$
124
$
152
$
392
$
442
Expected Contributions
During the nine months ended December 31, 2021, the Company made contributions of $0.3 million to its defined benefit pension plans. During the fiscal year ending March 31, 2022, the Company's cash contribution requirements for its defined benefit pension plans are expected to be less than $1.0 million. As a majority of the participants within the Company's plans are all active employees, the benefit payments are not expected to be material in the foreseeable future.
NOTE 14 – TREASURY STOCK
On October 24, 2017, the Company's Board of Directors approved a share repurchase program that enables the Company to repurchase up to twenty-five million shares of its common stock. This program became effective when the Company's previously disclosed twenty million share repurchase program was completed. The Company is not obligated to acquire any specific amount of common stock within any particular timeframe as a result of this share repurchase program.
Through December 31, 2021, the Company repurchased 19,241,518 shares for $507.6 million in the open market under the twenty-five million share repurchase program. At December 31, 2021, 5,758,482 shares of common stock remained available to be purchased under the current repurchase program. The Company repurchased 1,330,678 and 154,271 shares for $35.7 million and $3.3 million, respectively, under the twenty-five million share repurchase program during the nine months ended December 31, 2021 and 2020, respectively.
In connection with the delivery of shares of the Company's common stock upon vesting of restricted stock units, the Company withheld 531,725 shares and 489,907 shares at a cost of $15.2 million and $12.8 million, respectively, related to minimum statutory tax withholding requirements on these restricted stock units during the nine months ended December 31, 2021 and 2020, respectively. These withholding transactions do not fall under the repurchase program described above, and therefore do not reduce the number of shares that are available for repurchase under that program.
NOTE 15 – NET INCOME PER SHARE
Calculations of the basic and diluted net income per share and potential common shares are as follows (in thousands, except for per share data):
Three Months Ended
Nine Months Ended
December 31,
December 31,
2021
2020
2021
2020
Numerator:
Net income
$
47,725
$
29,021
$
44,280
$
7,915
Denominator:
Denominator for basic net income per share - weighted average common shares outstanding
73,898
73,492
74,048
72,953
Dilutive common equivalent shares:
Weighted average restricted stock units and performance-based restricted stock units
1,001
386
928
665
Denominator for diluted net income per share - weighted average shares outstanding
74,899
73,878
74,976
73,618
Net income per share:
Basic net income per share
$
0.65
$
0.39
$
0.60
$
0.11
Diluted net income per share
$
0.64
$
0.39
$
0.59
$
0.11
The following table sets forth restricted stock units excluded from the calculation of diluted net income per share, since their inclusion would be anti-dilutive (in thousands):
Three Months Ended
Nine Months Ended
December 31,
December 31,
2021
2020
2021
2020
Restricted stock units
26
3,169
1,166
3,249
Basic net income per share is calculated by dividing net income by the weighted average number of shares outstanding during the period. Unvested restricted shares, although legally issued and outstanding, are not considered outstanding for purposes of calculating basic earnings per share. Diluted net income per share is calculated by dividing net income by the weighted average number of shares outstanding plus the dilutive effect, if any, of outstanding stock options, restricted shares and restricted stock units using the treasury stock method. The calculation of the dilutive effect of outstanding equity awards under the treasury stock method includes consideration of proceeds from the assumed exercise of stock options and unrecognized compensation expense as additional proceeds.
NOTE 16 – INCOME TAXES
Generally, the Company's effective tax rate differs from the statutory tax rate primarily due to foreign withholding taxes, valuation allowances and US taxation on foreign earnings, which are partially offset by research and development tax credits, foreign tax credits and the foreign derived intangible income deduction.
The Company's effective tax rates were 14.2% and 3.0% for the three months ended December 31, 2021 and 2020, respectively, and 15.5% and 14.9% for the nine months ended December 31, 2021 and 2020, respectively. The effective tax rate for the three and nine months ended December 31, 2021 differed from the effective tax rate for the three and nine months ended December 31, 2020, primarily due to the impact of research and development tax credits, foreign tax credits, the foreign derived
intangible income deduction, foreign withholding taxes, and U.S. taxation on foreign earnings relative to forecasted profits, and discrete income tax benefits related to the finalization of tax returns and a tax restructuring that occurred during the quarter ended December 31, 2021.
NOTE 17 – SEGMENT AND GEOGRAPHIC INFORMATION
The Company reports revenues and income under one reportable segment.
The Company manages its business in the following geographic areas: United States, Europe, Asia and the rest of the world. The Company's policies mandate compliance with economic sanctions and the export controls.
Total revenue by geography is as follows (in thousands):
Three Months Ended
Nine Months Ended
December 31,
December 31,
2021
2020
2021
2020
United States
$
162,794
$
137,199
$
399,349
$
364,549
Europe
48,620
44,137
121,712
116,885
Asia
14,519
15,593
46,835
43,167
Rest of the world
36,261
31,810
96,488
93,292
$
262,194
$
228,739
$
664,384
$
617,893
The United States revenue includes sales to resellers in the United States. These resellers fulfill customer orders and may subsequently ship the Company's products to international locations. Further, the Company determines the geography of its sales after considering where the contract originated. A majority of revenue attributable to locations outside of the United States is a result of export sales. Substantially all of the Company's identifiable assets are located in the United States.
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
You should read the following discussion and analysis of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and notes thereto included elsewhere in this Quarterly Report and in our Annual Report on Form 10-K for the fiscal year ended March 31, 2021, filed with the Securities and Exchange Commission. This discussion contains forward-looking statements that involve risks and uncertainties. When reviewing the discussion below, you should keep in mind the substantial risks and uncertainties that could impact our business. In particular, we encourage you to review the risks and uncertainties described in Part I, Item 1A "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended March 31, 2021. These risks and uncertainties could cause actual results to differ significantly from those projected in forward-looking statements contained in this report or implied by past results and trends. Forward-looking statements are statements that attempt to forecast or anticipate future developments in our business, financial condition or results of operations. See the section titled "Cautionary Statement Concerning Forward-Looking Statements" that appears at the beginning of this Quarterly Report. These statements, like all statements in this report, speak only as of the date of this Quarterly Report (unless another date is indicated), and, except as required by law, we undertake no obligation to update or revise these statements in light of future developments.
Overview
We are an industry leader with over three decades of experience in providing service assurance and cybersecurity solutions that are used by customers worldwide to protect their digital business services against disruption. Service providers and enterprises, including local, state and federal government agencies, rely on our solutions to achieve the visibility and protection necessary to optimize network performance, ensure the delivery of high-quality, mission-critical applications and services, gain timely insight into the end user experience and protect their networks from attack. With our offerings, customers can quickly, efficiently and effectively identify and resolve issues that result in downtime, interruptions to services, poor service quality or compromised data, thereby reducing meantime-to-resolution of issues and driving compelling returns on their investments in their networks and broader technology initiatives. Some of the more significant technology trends and catalysts for our business include the evolution of customers' digital transformation initiatives such as the migration to cloud environments, the rapidly expanding cybersecurity threat landscape, business intelligence and analytics advancements, and the 5G evolution in both the service provider and enterprise customer verticals.
Our operating results are influenced by a number of factors, including, but not limited to, the mix and quantity of products and services sold, pricing, costs and availability of materials used in our products, growth in employee-related costs, including commissions, 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 acquisition integration efforts, and our ability to control costs and make improvements in a highly competitive industry.
COVID-19 Impact
In March 2020, the World Health Organization declared the novel strain of coronavirus (COVID-19) a global pandemic and recommended containment and mitigation measures worldwide. The pandemic and these containment and mitigation measures have led to adverse impacts on the U.S. and global economies. While we have begun the process of reopening at some of our facilities, we remain focused on protecting the health and well-being of our employees and continue to support work from home flexibility where necessary and feasible.
The extent of the impact of the COVID-19 pandemic on our operational and financial performance will depend on certain developments, including the duration of the pandemic, its impact on our customers and suppliers and the range of governmental and community reactions to the pandemic, which continue to evolve and cannot be fully predicted at this time. We will continue to proactively respond to the situation and may take further actions that could alter our business operations if required by governmental authorities, or that we determine are in the best interests of our stakeholders.
We continue to closely monitor the impact of the COVID-19 pandemic on all aspects of our business, including how it has impacted and could continue to impact our customers, employees, supply chain, and distribution network. During fiscal year 2021, the COVID-19 pandemic and resulting challenging macro-economic environment caused elongated purchasing cycles that impacted our revenue. However, the revenue impact in fiscal year 2021 was offset by a reduction in our operating expenses as a result of our cost control measures and COVID-19 related restrictions on travel and events. For fiscal year 2022, as people in the world have begun to get immunized and have started to adapt to a "new normal", we have observed that technology and project spending has resumed and we are focused on advancing our products, growing revenue, enhancing earnings per share, and generating free cash flow.
We believe our current cash reserves and access to capital through our revolving credit facility leaves us well-positioned to manage our business as the pandemic continues and as a recovery eventually occurs. We expect net cash provided by
operations combined with cash, cash equivalents and marketable securities and borrowing availability under our revolving credit facility to provide sufficient liquidity to fund current obligations, capital spending, debt service requirements and working capital requirements over at least the next twelve months. We continue to take actions to manage costs and increase productivity throughout our company but will invest in areas that advance our business for the future, as necessary. In addition to our cash equivalents, based on covenant levels at December 31, 2021, we had, as of December 31, 2021, an incremental $450 million available to us under our revolving credit facility.
On March 27, 2020, the Coronavirus Aid, Relief and Economic Security Act (the CARES Act) was enacted. The CARES Act, among other things, includes provisions relating to refundable payroll tax credits, deferment of employer social security payments, net operating loss carryback periods, alternative minimum tax credit refunds, modifications to the net interest deduction limitations and technical corrections to tax depreciation methods for qualified improvement property. We have elected to defer the employer-paid portion of social security taxes. As of December 31, 2021, we had deferred $4.5 million of employer payroll taxes which is required to be deposited by December 2022.
Results Overview
Total revenue increased $46.5 million for the nine months ended December 31, 2021 as compared to total revenue for the nine months ended December 31, 2020 due to an increase in revenue from the product portion of our network performance management offerings from both service provider and enterprise customers, and an increase in revenue from the service portion from our DDoS offerings.
Our gross profit percentage increased by two percentage points to 75% during the nine months ended December 31, 2021 as compared with the nine months ended December 31, 2020.
Net income for the nine months ended December 31, 2021 was $44.3 million, as compared with net income for the nine months ended December 31, 2020 of $7.9 million, an increase of $36.4 million. The increase in net income was primarily due to a $46.5 million increase in revenue, a $5.5 million decrease in amortization of intangible assets, a $4.2 million decrease in foreign exchange expense, a $2.2 million decrease in interest expense, a $1.8 million decrease in depreciation expense, a $1.4 million decrease in costs to deliver radio frequency propagation modeling projects, a $1.3 million decrease in employee-related expenses, and a $1.3 million decrease in cost of materials used to support customers under service contracts. These increases in net income were partially offset by a $6.7 million increase in income tax expense, a $5.0 million increase in contractor fees, a $4.3 million increase in advertising and other marketing related costs, a $3.8 million increase in direct material costs, a $3.4 million increase in obsolescence charges, a $2.1 million increase in commissions expense, a $1.7 million increase in travel expenses attributable to the lifting of some COVID-19 related restrictions, and a $1.4 million increase in expenses related to trade shows, user conferences and other events.
At December 31, 2021, we had cash, cash equivalents and marketable securities of $553.5 million. This represents an increase of $77.0 million from $476.5 million at March 31, 2021. This increase was primarily due to $140.4 million in cash provided by operating activities. During the nine months ended December 31, 2021, we collected $0.8 million of contingent consideration which represented earnout payments that were contingent upon achieving of certain milestones related to the HNT tools business divestiture in September 2018. These increases were partially offset by $35.7 million used in treasury stock repurchases, $15.2 million used for tax withholdings on restricted stock units, $7.0 million used for capital expenditures, and $3.7 million used for the payment of debt issuance costs during the nine months ended December 31, 2021.
Use of Non-GAAP Financial Measures
We supplement the United States generally accepted accounting principles (GAAP) financial measures we report in quarterly and annual earnings announcements, investor presentations and other investor communications by reporting the following non-GAAP measures: non-GAAP revenue, non-GAAP gross profit, non-GAAP income from operations, non-GAAP net income, non-GAAP net income per share (diluted) and non-GAAP earnings before interest and other expense, income taxes, depreciation, and amortization (EBITDA) from operations. Non-GAAP revenue eliminates the GAAP effects of acquisitions by adding back revenue related to deferred revenue revaluation. Non-GAAP gross profit includes the aforementioned revenue adjustments and also removes expenses related to the amortization of acquired intangible assets, share-based compensation, and acquisition-related depreciation. Non-GAAP income from operations includes the aforementioned adjustments and also removes business development and integration expense, compensation for post-combination services, legal expenses related to a civil judgment, restructuring charges, and transitional service agreement expenses. Non-GAAP net income includes the foregoing adjustments related to non-GAAP income from operations, and also removes loss on extinguishment of debt and change in fair value of contingent consideration, net of related income tax effects. Non-GAAP EBITDA from operations includes the aforementioned items related to non-GAAP income from operations and also removes non-acquisition related depreciation expense.
These non-GAAP measures are not in accordance with GAAP, should not be considered an alternative for measures prepared in accordance with GAAP (revenue, gross profit, operating margin, net income and diluted net income per share), and may have limitations because they do not reflect all our results of operations as determined in accordance with GAAP. These non-GAAP measures should only be used to evaluate our results of operations in conjunction with the corresponding GAAP measures. The presentation of non-GAAP information is not meant to be considered superior to, in isolation from, or as a substitute for results prepared in accordance with GAAP.
Management believes these non-GAAP financial measures will enhance the reader's overall understanding of our current financial performance and our prospects for the future by providing a higher degree of transparency for certain financial measures and providing a level of disclosure that helps investors understand how we plan and measure our business. We believe that providing these non-GAAP measures affords investors a view of our operating results that may be more easily compared to peer companies and also enables investors to consider our operating results on both a GAAP and non-GAAP basis during and following the integration period of our acquisitions. Presenting the GAAP measures on their own may not be indicative of our core operating results. Furthermore, management believes that the presentation of non-GAAP measures when shown in conjunction with the corresponding GAAP measures provides useful information to management and investors regarding present and future business trends relating to our financial condition and results of operations.
The following table reconciles revenue, gross profit, income from operations, net income and net income per share on a GAAP and non-GAAP basis for the three and nine months ended December 31, 2021 and 2020 (in thousands, except for per share amounts):
Per share impact of non-GAAP adjustments identified above
0.25
0.27
0.97
1.10
Non-GAAP diluted net income per share
$
0.89
$
0.66
$
1.56
$
1.21
GAAP income from operations
$
55,455
$
31,770
$
56,953
$
21,062
Previous adjustments to determine non-GAAP income from operations
31,704
32,749
99,330
103,939
Non-GAAP income from operations
87,159
64,519
156,283
125,001
Depreciation excluding acquisition related
5,475
6,376
16,909
19,283
Non-GAAP EBITDA from operations
$
92,634
$
70,895
$
173,192
$
144,284
Critical Accounting Policies
Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP consistently applied. The preparation of these consolidated financial statements requires us to make significant estimates and judgments that affect the amounts reported in our consolidated financial statements and the accompanying notes. These items are regularly monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates.
While all of our accounting policies impact the consolidated financial statements, certain policies are viewed to be critical. Critical accounting policies are those that are both most important to the portrayal of our financial condition and results of operations and that require management's most subjective or complex judgments and estimates. We consider the following accounting policies to be critical in fully understanding and evaluating our financial results:
•revenue recognition;
•share-based compensation;
•valuation of goodwill, intangible assets and other acquisition accounting items; and
Please refer to the critical accounting policies set forth in our Annual Report on Form 10-K for the fiscal year ended March 31, 2021, filed with the Securities and Exchange Commission (SEC) on May 20, 2021, for a description of all of our critical accounting policies.
Three Months Ended December 31, 2021 and 2020
Revenue
Product revenue consists of sales of our hardware products and licensing of our software products. Service revenue consists of customer support agreements, consulting, training and stand-ready software as a service offering. During the three months ended December 31, 2021, one direct customer, Verizon, accounted for more than 10% of revenue, while no indirect channel partners accounted for more than 10% of our total revenue. During the three months ended December 31, 2020, no direct customer or indirect channel partner accounted for more than 10% of our total revenue.
Three Months Ended
Change
December 31,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
Revenue:
Product
$
144,420
55
%
$
114,965
50
%
$
29,455
26
%
Service
117,774
45
113,774
50
4,000
4
%
Total revenue
$
262,194
100
%
$
228,739
100
%
$
33,455
15
%
Product.The 26%, or $29.5 million, increase in product revenue compared with the same period last year was primarily due to an increase in revenue from network performance management offerings for enterprise and service provider customers, as well as an increase in revenue from distributed denial of service (DDoS) offerings.
Service.The 4%, or $4.0 million, increase in service revenue compared to the same period last year was primarily driven by timing of renewal bookings.
Total revenue by geography was as follows:
Three Months Ended
Change
December 31,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
United States
$
162,794
62
%
$
137,199
60
%
$
25,595
19
%
International:
Europe
48,620
19
44,137
19
4,483
10
%
Asia
14,519
5
15,593
7
(1,074)
(7)
%
Rest of the world
36,261
14
31,810
14
4,451
14
%
Subtotal international
99,400
38
91,540
40
7,860
9
%
Total revenue
$
262,194
100
%
$
228,739
100
%
$
33,455
15
%
United States revenue increased 19%, or $25.6 million, primarily due to an increase in revenue from network performance management offerings for enterprise and service provider customers, as well as an increase in revenue from DDoS offerings. The 9%, or $7.9 million, increase in international revenue compared with the same period last year was primarily driven by higher revenue from DDoS offerings for service provider customers.
Cost of product revenue consists primarily of material components, manufacturing personnel expenses, packaging materials, overhead and amortization of capitalized software, acquired developed technology and core technology. Cost of service revenue consists primarily of personnel, material, overhead and support costs.
Three Months Ended
Change
December 31,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
Cost of revenue
Product
$
30,338
12
%
$
24,263
11
%
$
6,075
25
%
Service
30,132
11
31,012
14
(880)
(3)
%
Total cost of revenue
$
60,470
23
%
$
55,275
25
%
$
5,195
9
%
Gross profit:
Product $
$
114,082
44
%
$
90,702
40
%
$
23,380
26
%
Product gross profit %
79
%
79
%
Service $
$
87,642
33
%
$
82,762
36
%
$
4,880
6
%
Service gross profit %
74
%
73
%
Total gross profit $
$
201,724
$
173,464
$
28,260
16
%
Total gross profit %
77
%
76
%
Product. The 25%, or $6.1 million, increase in cost of product revenue for the three months ended December 31, 2021 compared to the same period last year was primarily due to a $5.0 million increase in costs related to the delivery of radio frequency propagation modeling projects, and a $2.3 million increase in direct material costs as a result of the increase in product revenue. These increases were partially offset by a $1.4 million decrease in the amortization of intangible assets. The product gross profit percentage remained flat at 79% during the three months ended December 31, 2021 as compared with the three months ended December 31, 2020. The 26%, or $23.4 million, increase in product gross profit is attributable to the 26%, or $29.5 million, increase in product revenue, partially offset by the 25%, or $6.1 million, increase in cost of product revenue.
Service. The 3%, or $0.9 million, decrease in cost of service revenue for the three months ended December 31, 2021 compared to the same period last year was primarily due to a $1.0 million decrease in employee-related expenses associated with a reduction in headcount as well as a decrease associated with the timing of certain projects. The service gross profit percentage increased by one percentage point to 74% during the three months ended December 31, 2021 as compared with the three months ended December 31, 2020. The 6%, or $4.9 million increase in service gross profit is attributable to the 4%, or $4.0 million, increase in service revenue, and the 3%, or $0.9 million, decrease in cost of service revenue.
Gross profit. Our gross profit increased 16%, or $28.3 million, during the three months ended December 31, 2021 when compared with the three months ended December 31, 2020. This increase is attributable to the increase in revenue of 15%, or $33.5 million, partially offset by the 9%, or $5.2 million, increase in cost of revenue. The gross profit percentage increased by one percentage point to 77% for the three months ended December 31, 2021 as compared with the three months ended December 31, 2020.
Research and development. Research and development expenses consist primarily of personnel expenses, fees for outside consultants, overhead and related expenses associated with the development of new products and the enhancement of existing products.
The 5%, or $2.1 million, decrease in research and development expenses for the three months ended December 31, 2021 compared to the same period last year was primarily due to a $1.9 million decrease in employee-related expenses associated with a reduction in headcount.
Sales and marketing. Sales and marketing expenses consist primarily of personnel expenses and commissions, overhead and other expenses associated with selling activities and marketing programs such as trade shows, seminars, advertising and new product launch activities.
The 8%, or $5.1 million, increase in total sales and marketing expenses for the three months ended December 31, 2021 compared to the same period last year was primarily due to a $2.2 million increase in advertising and other marketing related expenses, a $1.4 million increase in commissions expense, an $0.8 million increase in contractor expense, a $0.7 million increase in employee-related expenses associated with an increase in variable incentive compensation, a $0.7 million increase in travel expenses primarily attributable to the lifting of COVID-19 related restrictions, partially offset by a $0.7 million decrease related to trade shows, user conferences and other events.
General and administrative. General and administrative expenses consist primarily of personnel expenses for executive, financial, legal and human resource employees, overhead and other corporate expenditures.
The 9%, or $1.9 million, increase in general and administrative expenses for the three months ended December 31, 2021 compared to the same period last year was primarily due to an $0.8 million increase in legal-related expenses, and a $0.7 million increase in employee-related expenses associated with an increase in variable incentive compensation.
Amortization of acquired intangible assets. Amortization of acquired intangible assets consists primarily of amortization of customer relationships, definite-lived trademarks and trade names, and leasehold interests related to our acquisitions of Danaher Corporation's communications business (Comms Transaction), Simena, LLC, Network General Corporation, Avvasi Inc. and Efflux Systems, Inc.
The 2%, or $0.4 million, decrease in amortization of acquired intangible assets was largely due to a decrease in the amortization of intangible assets related to the Comms Transaction, offset by an increase in the amortization of the definite-lived trade name.
Interest and Other Income (Expense), Net. Interest and other income (expense), net includes interest earned on our cash, cash equivalents and marketable securities, interest expense and other non-operating gains or losses.
Three Months Ended
Change
December 31,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
Interest and other income (expense), net
$
177
—
%
$
(3,583)
(2)
%
$
3,760
105
%
The 105%, or $3.8 million, increase in interest and other income (expense), net was primarily due to a $1.7 million decrease in foreign exchange expense, a $1.0 million decrease in interest expense due to debt repayments on the credit facility
as well as a decrease in the average interest rate, an $0.8 million increase from the change in fair value of contingent consideration, and a $0.6 million increase in transitional services agreement income related to the HNT tools business divestiture.
Income Taxes. Our effective tax rates were 14.2% and 3.0% for the three months ended December 31, 2021 and 2020, respectively. The effective income tax rate for the three months ended December 31, 2021 differed from the effective income tax rate for the three months ended December 31, 2020, primarily due to the impact of research and development tax credits, foreign tax credits, the foreign derived intangible income deduction, foreign withholding taxes, and U.S. taxation on foreign earnings relative to forecasted profits, and discrete income tax benefits related to the finalization of tax returns and a tax restructuring that occurred during the quarter ended December 31, 2021.
Three Months Ended
Change
December 31,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
Income tax expense (benefit)
$
7,907
3
%
$
(834)
—
%
$
8,741
1,048
%
Nine Months Ended December 31, 2021 and 2020
Revenue
During the nine months ended December 31, 2021, one direct customer, Verizon, accounted for more than 10% of our total revenue, while no indirect channel partner accounted for more than 10% of our total revenue. During the nine months ended December 31, 2020, no direct customer or indirect channel partner accounted for more than 10% of our total revenue.
Nine Months Ended
Change
December 31,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
Revenue:
Product
$
327,989
49
%
$
278,637
45
%
$
49,352
18
%
Service
336,395
51
%
339,256
55
%
(2,861)
(1)
%
Total revenue
$
664,384
100
%
$
617,893
100
%
$
46,491
8
%
Product.The 18%, or $49.4 million, increase in product revenue compared with the same period last year was primarily due to an increase in revenue from network performance management offerings from both service provider and enterprise customers.
Service.The 1%, or $2.9 million, decrease in service revenue compared with the same period last year was primarily driven by non-renewals associated with service provider consolidation, and discontinued product lines.
United States revenue increased 10%, or $34.8 million, primarily due to an increase in revenue from network performance management offerings for enterprise and service provider customers, offset by a decrease in revenue from DDoS offerings. The 5%, or $11.7 million increase in international revenue compared with the same period last year was primarily driven by higher revenue from network performance management offerings in Europe and Asia as well as DDoS offerings in Europe and Rest of the world.
Cost of Revenue and Gross Profit
Nine Months Ended
Change
December 31,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
Cost of revenue
Product
$
73,843
11
%
$
72,392
12
%
$
1,451
2
%
Service
92,681
14
94,763
15
(2,082)
(2)
%
Total cost of revenue
$
166,524
25
%
$
167,155
27
%
$
(631)
—
%
Gross profit:
Product $
$
254,146
38
%
$
206,245
33
%
$
47,901
23
%
Product gross profit %
77
%
74
%
Service $
$
243,714
37
%
$
244,493
40
%
$
(779)
—
%
Service gross profit %
72
%
72
%
Total gross profit $
$
497,860
$
450,738
$
47,122
10
%
Total gross profit %
75
%
73
%
Product. The 2%, or $1.5 million, increase in cost of product revenue for the nine months ended December 31, 2021 compared to the same period last year was primarily due to a $3.8 million increase in direct material costs due to an increase in product revenue, a $3.4 million increase in obsolescence charges, partially offset by a $4.5 million decrease in the amortization of intangible assets, and a $1.4 million decrease in costs related to the delivery of radio frequency propagation modeling projects. The product gross profit percentage increased by three percentage points to 77% during the nine months ended December 31, 2021 when compared to the nine months ended December 31, 2020. The 23%, or $47.9 million, increase in product gross profit is attributable to the 18%, or $49.4 million, increase in product revenue, partially offset by the 2%, or $1.5 million, increase in cost of product revenue.
Service. The 2%, or $2.1 million, decrease in cost of service revenue nine months ended December 31, 2021 compared to the same period last year was primarily due to a $3.9 million decrease in employee-related expenses associated with a reduction in headcount as well as a decrease associated with the timing of certain projects, and a $1.3 million decrease in cost of materials used to support customers under service contracts. These decreases were partially offset by a $2.5 million increase in contractor
fees. The service gross profit percentage remained flat at 72% for the nine months ended December 31, 2021 when compared to the nine months ended December 31, 2020. The $0.8 million decrease in service gross profit is attributable to the 1%, or $2.9 million decrease in service revenue, partially offset by the 2%, or $2.1 million, decrease in cost of service revenue.
Gross profit. Our gross profit for the nine months ended December 31, 2021 increased 10%, or $47.1 million, compared to the same period last year. This increase is primarily attributable to the increase in revenue of 8%, or $46.5 million and the decrease in cost of revenue of $0.6 million. The gross profit percentage increased by two percentage points to 75% for the nine months ended December 31, 2021 when compared to the nine months ended December 31, 2020.
Operating Expenses
Nine Months Ended
Change
December 31,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
Research and development
$
128,940
19
%
$
135,605
22
%
$
(6,665)
(5)
%
Sales and marketing
197,191
30
180,668
29
16,523
9
%
General and administrative
69,881
11
67,444
11
2,437
4
%
Amortization of acquired intangible assets
44,895
7
45,897
7
(1,002)
(2)
%
Restructuring charges
—
—
62
—
(62)
(100)
%
Total operating expenses
$
440,907
67
%
$
429,676
69
%
$
11,231
3
%
Research and development. The 5%, or $6.7 million, decrease in research and development expenses for the nine months ended December 31, 2021 compared to the same period last year was primarily due to a $5.8 million decrease in employee-related expenses associated with a reduction in headcount and a decrease in variable incentive compensation, and an $0.8 million decrease in depreciation expense.
Sales and marketing. The 9%, or $16.5 million, increase in total sales and marketing expenses for the nine months ended December 31, 2021 compared to the same period last year was primarily due to a $6.5 million increase in employee-related expenses largely due to an increase in variable incentive compensation, a $4.3 million increase in advertising and other marketing related expenses, a $2.1 million increase in commissions expense, a $1.5 million increase in expenses related to trade shows, user conferences and other events, a $1.4 million increase in travel expense primarily attributable to the lifting of COVID-19 related restrictions, and a $1.2 million increase in contractor fees, partially offset by an $0.8 million decrease in depreciation expense.
General and administrative. The 4%, or $2.4 million, increase in general and administrative expenses for the nine months ended December 31, 2021 compared to the same period last year was primarily due to a $1.6 million increase in employee-related expenses largely due to an increase in variable incentive compensation, a $0.6 million increase in legal-related expenses and penalties, and a $0.6 million increase in the provision for allowance in credit losses.
Amortization of acquired intangible assets. Amortization of acquired intangible assets consists primarily of amortization of customer relationships, definite-lived trademark and tradenames, and leasehold interest related to the Comms Transaction and the acquisitions of ONPATH, Simena, Psytechnics, Network General, Avvasi and Efflux.
The 2%, or $1.0 million, decrease in amortization of acquired intangible assets for the nine months ended December 31, 2021 compared to the same period last year was largely due to a decrease in the amortization of intangible assets related to the Comms Transaction, offset by an increase in the amortization of the definite-lived trade name.
The 61%, or $7.2 million, decrease in interest and other expense, net was primarily due to a $4.2 million decrease in foreign exchange expense, a $2.2 million decrease in interest expense due to debt repayments on the credit facility as well as a decrease in the average interest rate partially offset by a loss on the extinguishment of debt, and a $0.7 million increase in transitional services agreement income related to the HNT tools business divestiture.
Income Taxes. Our effective income tax rates were 15.5% and 14.9% for the nine months ended December 31, 2021 and 2020, respectively. The effective income tax rate for the nine months ended December 31, 2021 differed from the effective rate for the nine months ended December 31, 2020, primarily due to the impact of research and development tax credits, foreign tax credits, the foreign derived intangible income deduction, foreign withholding taxes, and U.S. taxation on foreign earnings relative to forecasted profits, and discrete income tax benefits related to the finalization of tax returns and a tax restructuring that occurred during the nine months ended December 31, 2021.
Nine Months Ended
Change
December 31,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
Income tax expense
$
8,094
1
%
$
1,390
—
%
$
6,704
482
%
Off-Balance Sheet Arrangements
At December 31, 2021 and 2020, we did not have any off-balance sheet arrangements as defined in Regulation S-K, Item 303(a)(4)(ii).
Commitments and Contingencies
We account for claims and contingencies in accordance with authoritative guidance that requires us to record an estimated loss from a claim or loss contingency when information available prior to issuance of our consolidated financial statements indicates that it is probable that a liability has been incurred at the date of the consolidated financial statements and the amount of the loss can be reasonably estimated. If we determine that it is reasonably possible, but not probable, that an asset has been impaired or a liability has been incurred, or if the amount of a probable loss cannot be reasonably estimated, then, in accordance with the authoritative guidance, we disclose the amount or range of estimated loss if the amount or range of estimated loss is material. Accounting for claims and contingencies requires us to use our judgment. We consult with legal counsel on those issues related to litigation and seek input from other experts and advisors with respect to matters in the ordinary course of business.
For information regarding our legal proceedings, see Note 12 contained in the "Notes to Consolidated Financial Statements" included in Part I of this Quarterly Report on Form 10-Q.
Backlog
We produce our products on the basis of our forecast of near-term demand and maintain inventory in advance of receipt of firm orders from customers. We configure our products to customer specifications and generally deliver products shortly after receipt of the purchase order. Service engagements are also included in certain orders. Customers generally may reschedule or cancel orders with little or no penalty. We believe that our backlog at any particular time is usually not meaningful because it is not necessarily indicative of future sales levels. Our combined product backlog at December 31, 2021 increased by $27.3 million since March 31, 2021 to $55.2 million. A majority of the backlog relates to orders that were received late in the quarter and radio frequency propagation modeling projects. In some cases, we have begun these projects but have not yet hit billable milestones. A propagation modeling project order received in the third quarter of fiscal year 2022 allowed NetScout to bill for the entire project based upon partial delivery. At December 31, 2021, deferred revenue and accounts receivable each contained a gross balance of $19.6 million related to this propagation modeling project. At March 31, 2021 any propagation modeling billings ahead of delivery were immaterial. A majority of the revenue for these projects is expected to be recognized into revenue within the next twelve months.
Cash, cash equivalents and marketable securities consisted of the following (in thousands):
December 31, 2021
March 31, 2021
Cash and cash equivalents
$
548,105
$
467,176
Short-term marketable securities
5,349
9,277
Cash, cash equivalents and marketable securities
$
553,454
$
476,453
Cash, cash equivalents and marketable securities
At December 31, 2021, cash, cash equivalents and marketable securities (current and non-current) totaled $553.5 million, a $77.0 million increase from $476.5 million at March 31, 2021. This increase was primarily due to $140.4 million in cash provided by operating activities, partially offset by $35.7 million used in treasury stock repurchases, $15.2 million used for tax withholdings on restricted stock units, $7.0 million used for capital expenditures, and $3.7 million used for the payment of debt issuance costs during the nine months ended December 31, 2021. Cash held outside the United States was approximately $179.0 million.
Cash and cash equivalents were impacted by the following:
Nine Months Ended
December 31,
(in thousands)
2021
2020
Net cash provided by operating activities
$
140,387
$
121,903
Net cash (used in) provided by investing activities
$
(3,055)
$
24,190
Net cash used in financing activities
$
(53,719)
$
(17,041)
Net cash from operating activities
Cash provided by operating activities was $140.4 million during the nine months ended December 31, 2021, compared with $121.9 million of cash provided by operating activities during the nine months ended December 31, 2020. The $18.5 million increase was due in part to a $68.0 million increase in deferred revenue, a $36.4 million increase from net income, a $3.8 million increase from inventories, a $3.0 million increase from share-based compensation, a $1.4 million increase from accounts payable, and a $0.6 million increase from the loss on extinguishment of debt. These increases were partially offset by a $42.9 million decrease from accounts receivable, a $36.1 million decrease from accrued compensation and other expenses, a $7.6 million decrease from depreciation and amortization, a $3.4 million decrease from prepaid expenses and other assets, a $2.1 million decrease from income taxes payable, a $0.9 million decrease from operating lease liabilities, an $0.8 million decrease from the change in fair value of contingent consideration, and a $0.7 million decrease from deferred income taxes during the nine months ended December 31, 2021 as compared with the nine months ended December 31, 2020.
Net cash from investing activities
Nine Months Ended
December 31,
(in thousands)
2021
2020
Cash (used in) provided by investing activities included the following:
Purchase of marketable securities
$
(11,343)
$
(13,974)
Proceeds from sales and maturity of marketable securities
Cash used in investing activities was $3.1 million during the nine months ended December 31, 2021, compared with $24.2 million of cash provided by investing activities during the nine months ended December 31, 2020. The $27.3 million decrease in cash (used in) provided by investing activities was due in part to a $33.8 million decrease in cash inflow from marketable securities related to a decrease of $36.4 million in proceeds from the sales and maturity of marketable securities, offset by a $2.6 million decrease related to the purchase of marketable securities during the nine months ended December 31, 2021 when compared with the nine months ended December 31, 2020. This decrease was partially offset by a $4.5 million cash outflow related to agreements to acquire technology licenses during the nine months ended December 31, 2020, and a $2.1 million decrease in cash used for capital expenditures during the nine months ended December 31, 2021 when compared to the nine months ended December 31, 2020.
Our investments in property and equipment consist primarily of computer equipment, demonstration units, office equipment and facility improvements. We plan to continue to invest in capital expenditures to support our infrastructure through the remainder of fiscal year 2022.
Net cash from financing activities
Nine Months Ended
December 31,
(in thousands)
2021
2020
Cash used in financing activities included the following:
Issuance of common stock under stock plans
$
2
$
2
Payment of contingent consideration
—
(1,000)
Treasury stock repurchases
(35,652)
(3,275)
Tax withholding on restricted stock units
(15,246)
(12,768)
Payment of debt issuance costs
(3,660)
—
Repayment of long-term debt
(350,000)
—
Proceeds from issuance of long-term debt
350,000
—
Collection of contingent consideration
837
—
$
(53,719)
$
(17,041)
Cash used in financing activities increased by $36.7 million to $53.7 million during the nine months ended December 31, 2021, compared with $17.0 million of cash used in financing activities during the nine months ended December 31, 2020.
During the nine months ended December 31, 2020, we paid $1.0 million of contingent purchase consideration related to the Eastwind acquisition in April 2020.
During the nine months ended December 31, 2021 and 2020, we repurchased 1,330,678 shares and 154,271 shares of our common stock for $35.7 million and $3.3 million, respectively, under the twenty-five million share repurchase program.
In connection with the delivery of our common stock upon vesting of restricted stock units, we withheld 531,725 and 489,907 shares at a cost of $15.2 million and $12.8 million related to minimum statutory tax withholding requirements on these restricted stock units during the nine months ended December 31, 2021 and 2020, respectively. These withholding transactions do not fall under the repurchase program described above, and therefore do not reduce the number of shares that are available for repurchase under that program.
During the nine months ended December 31, 2021, we paid $3.7 million in debt issuance costs related to the execution of our Second Amended and Restated Credit Agreement.
During the nine months ended December 31, 2021, we collected $0.8 million of contingent consideration which represented earnout payments that were contingent upon achievement of certain milestones related to the HNT tools business divestiture in September 2018.
Credit Facility
On January 16, 2018, we amended and expanded our existing credit agreement (Amended Credit Agreement), which provided for a five-year, $1.0 billion senior secured revolving credit facility, including a letter of credit sub-facility of up to $75.0 million. The commitments under the Amended Credit Agreement were set to expire on January 16, 2023, and any outstanding loans were due on that date.
On July 27, 2021, we amended and extended the Amended Credit Agreement (Second Amended and Restated Credit Agreement) with a syndicate of lenders by and among: the Company; JPMorgan Chase Bank, N.A. (JPMorgan), as administrative agent and collateral agent; JPMorgan, Wells Fargo Securities, LLC, BofA Securities Inc., RBC Capital Markets, PNC Capital Markets LLC and Mizuho Bank, Ltd., as joint lead arrangers and joint bookrunners; Santander Bank, N.A., U.S. Bank National Association, Fifth Third Bank National Association, Silicon Valley Bank and TD Bank, N.A., as co-documentation agents; and the lenders party thereto.
The Second Amended and Restated Credit Agreement provides for a five-year, $800.0 million senior secured revolving credit facility, including a letter of credit sub-facility of up to $75.0 million. We may elect to use the credit facility for general corporate purposes (including to finance the repurchase of shares of our common stock). The commitments under the Second Amended and Restated Credit Agreement will expire on July 27, 2026, and any outstanding loans will be due on that date.
In connection with the Second Amended and Restated Credit Agreement, we paid off the outstanding balance of $350 million under the Amended Credit Agreement on July 27, 2021 by borrowing the same amount under the Second Amended and Restated Credit Agreement. Additionally, we recorded a loss on the extinguishment of debt of $0.6 million, representing the write off of unamortized deferred financing costs, which was included in interest expense in the consolidated statements of operations for the nine months ended December 31, 2021. At December 31, 2021, $350 million was outstanding under the Second Amended and Restated Credit Agreement.
At our election, revolving loans under the Second Amended and Restated Credit Agreement bear interest at either (a) an Alternate Base Rate per annum equal to the greatest of (1) the Wall Street Journal prime rate; (2) the New York Federal Reserve Bank (NYFRB) rate plus 0.50%, or (3) an adjusted one month LIBO rate plus 1%; or (b) a Term Benchmark Borrowing rate (for the interest period selected by NetScout, subject to customary provisions regarding succession from LIBO rate to SOF rate in anticipation of the upcoming discontinuation of the LIBO rate), in each case plus an applicable margin. For the period from the delivery of the Company's financial statements for the quarter ended September 30, 2021, until we have delivered financial statements for the quarter ended December 31, 2021, the applicable margin will be 1.25% per annum for Term Benchmark Revolving loans and 0.25% per annum for Alternate Base Rate loans, and thereafter the applicable margin will vary depending on our consolidated gross leverage ratio, ranging from 1.00% per annum for Alternate Base Rate loans and 2.00% per annum for Term Benchmark Revolving loans if our consolidated gross leverage ratio is greater than 3.50 to 1.00, down to 0.00% per annum for Alternate Base Rate loans and 1.00% per annum for Term Benchmark Revolving loans if our consolidated gross leverage ratio is equal to or less than 1.50 to 1.00.
Our consolidated gross leverage ratio is the ratio of our total funded debt compared to our consolidated EBITDA as defined in the Second Amended and Restated Credit Agreement (adjusted consolidated EBITDA). Adjusted consolidated EBITDA includes certain adjustments, including, without limitation, adjustments relating to extraordinary, unusual or non-recurring charges, certain restructuring charges, non-cash charges, certain transaction costs and expenses and certain pro forma adjustments in connection with material acquisitions and dispositions, all as set forth in detail in the Second Amended and Restated Credit Agreement. Our secured net leverage ratio is the ratio of our Consolidated Total Debt minus the lesser of unrestricted cash and 125% of adjusted consolidated EBITDA compared to our adjusted consolidated EBITDA.
Commitment fees will accrue on the daily unused amount of the credit facility. For the period from the delivery of the Company's financial statements for the quarter ended September 30, 2021, until we have delivered financial statements for the quarter ended December 31, 2021, the commitment fee will be 0.20% per annum, and thereafter the commitment fee will vary depending on our consolidated gross leverage ratio, ranging from 0.30% per annum if our consolidated gross leverage ratio is greater than 2.75 to 1.00, down to 0.15% per annum if our consolidated gross leverage ratio is equal to or less than 1.50 to 1.00.
Letter of credit participation fees are payable to each lender providing the letter of credit sub-facility on the amount of such lender's letter of credit exposure, during the period from the closing date of the Second Amended and Restated Credit Agreement to, but excluding, the date which is the later of (i) the date on which such lender's commitment terminates or (ii) the date on which such lender ceases to have any letter of credit exposure, at the applicable rate that would be used to determine the interest rate applicable to Term Benchmark Revolving loans assuming such loans were outstanding during the period. Additionally, we will pay a fronting fee to each issuing bank in amounts to be agreed to between us and the applicable issuing bank.
Interest on Alternate Base Rate loans is payable at the end of each calendar quarter. Interest on Term Benchmark Revolving loans is payable at the end of each interest rate period or at the end of each three-month interval within an interest rate period if the period is longer than three months. We may also prepay loans under the Second Amended and Restated Credit Agreement at any time, without penalty, subject to certain notice requirements.
The loans and other obligations under the credit facility are (a) guaranteed by each of our wholly-owned material domestic restricted subsidiaries, subject to certain exceptions, and (b) are secured by substantially all of the assets of us and the subsidiary guarantors, including a pledge of all the capital stock of material subsidiaries held directly by the Borrower and the subsidiary guarantors (which pledge, in the case of any foreign subsidiary, is limited to 65% of the voting stock), subject to
certain customary exceptions and limitations. The Second Amended and Restated Credit Agreement generally prohibits any other liens on the assets of NetScout and our restricted subsidiaries, subject to certain exceptions as described in the Second Amended and Restated Credit Agreement.
The Second Amended and Restated Credit Agreement contains certain covenants applicable to us and our restricted subsidiaries, including, without limitation, limitations on additional indebtedness, liens, various fundamental changes, dividends and distributions, investments (including acquisitions), transactions with affiliates, asset sales, including sale-leaseback transactions, speculative hedge agreements, payment of junior financing, changes in business and other limitations customary in senior secured credit facilities. The Second Amended and Restated Credit Agreement requires us to maintain a certain consolidated net leverage ratio and removes the previous requirement under the Amended Credit Agreement that we maintain a minimum consolidated interest coverage ratio. These covenants and limitations are more fully described in the Second Amended and Restated Credit Agreement. As of December 31, 2021, we were in compliance with the specified total consolidated net leverage ratio range of 4.00 to 1.00.
The Second Amended and Restated Credit Agreement provides that events of default will exist in certain circumstances, including failure to make payment of principal or interest on the loans when required, failure to perform certain obligations under the Second Amended and Restated Credit Agreement and related documents including a failure to meet the maximum total consolidated net leverage ratio covenant, defaults under certain other indebtedness, certain insolvency events, certain events arising under ERISA, a change of control and certain other events. Upon an event of default, the administrative agent with the consent of, or at the request of, the holders of more than 50% in principal amount of the loans and commitments, may terminate the commitments and accelerate the maturity of the loans and enforce certain other remedies under the Second Amended and Restated Credit Agreement and the other loan documents.
We had unamortized capitalized debt issuance costs, net of $5.1 million at December 31, 2021, which are being amortized over the life of the revolving credit facility. The unamortized capitalized debt issuance costs balance of $1.1 million was included as prepaid expenses and other current assets and a balance of $4.0 million was included as other assets in our consolidated balance sheet.
Expectations for Fiscal Year 2022
We are actively managing the business to generate cash flow and believe that we currently have adequate liquidity. We believe that these factors will allow us to meet our anticipated funding requirements.
We expect net cash provided by operating activities combined with cash, cash equivalents, and marketable securities and borrowing availability under our revolving credit facility to provide sufficient liquidity to fund current obligations, capital spending, debt service requirements and working capital requirement over at least the next twelve months.
Additionally, a portion of our cash may be used to acquire or invest in complementary businesses or products, to obtain the right to use complementary technologies, to repay borrowings under our Second Amended and Restated Credit Agreement, or to repurchase shares of our common stock through our stock repurchase programs. From time to time, in the ordinary course of business, we evaluate potential acquisitions of such businesses, products or technologies. If our existing sources of liquidity are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities. The sale of additional equity or debt securities could result in additional dilution to our stockholders.
Recent Accounting Pronouncements
For information with respect to recent accounting pronouncements on our consolidated financial statements, see Note 1 contained in the "Notes to Consolidated Financial Statements" included in Part I of this Quarterly Report on Form 10-Q.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk. We hold our cash, cash equivalents and investments for working capital purposes. Some of the securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk, we maintain our portfolio of cash, cash equivalents and investments in a variety of securities, including money market funds and government debt securities. The risk associated with fluctuating interest rates is limited to our investment portfolio. Due to the short-term nature of these instruments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, would reduce future interest income. The effect of a hypothetical 10% increase or decrease in overall interest rates would not have had a material impact on our operating results or the total fair value of the portfolio.
We are exposed to market risks related to fluctuations in interest rates related to our credit facility. At December 31, 2021, we owed $350 million on this loan with an interest rate of 1.36%. A sensitivity analysis was performed on the outstanding portion of our debt obligation as of December 31, 2021. Should the current weighted-average interest rate increase or decrease by 10%, the resulting annual increase or decrease to interest expense would be approximately $0.5 million as of December 31, 2021.
Foreign Currency Exchange Risk. As a result of our foreign operations, we face exposure to movements in foreign currency exchange rates, primarily the Euro, British Pound, Canadian Dollar and Indian Rupee. The current exposures arise primarily from expenses denominated in foreign currencies. We currently engage in foreign currency hedging activities in order to limit these exposures. Periodically, we also enter into forward contracts to manage exchange risk associated with third-party transactions and for which we do not elect hedge accounting treatment. We do not use derivative financial instruments for speculative trading purposes.
At December 31, 2021, we had foreign currency forward contracts designated as hedging instruments with notional amounts totaling $12.8 million. The valuation of outstanding foreign currency forward contracts at December 31, 2021 resulted in an asset balance of $69 thousand, reflecting favorable rates in comparison to current market rates and a liability balance of $13 thousand, reflecting unfavorable contract rates in comparison to current market rates at this date. At March 31, 2021, we had foreign currency forward contracts designated as hedging instruments with notional amounts totaling $11.0 million and foreign currency forward contracts not designated as hedging instruments with a notional amount of $6.4 million. The valuation of outstanding foreign currency forward contracts (both designated and not designated as hedging instruments) at March 31, 2021 resulted in a liability balance of $191 thousand, reflecting unfavorable contract rates in comparison to current market rates and an asset balance of $57 thousand, reflecting favorable rates in comparison to current market rates at this date. The effect of a hypothetical 10% change in foreign currency exchange rates applicable to our business would not have a material impact on our historical consolidated financial statements. As our international operations grow, we will continue to reassess our approach to manage our risk relating to fluctuations in currency rates.
Item 4. Controls and Procedures
At December 31, 2021, NetScout, under the supervision and with the participation of our management, including the Company's principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)). Based upon that evaluation, our principal executive officer and principal financial officer concluded that, at December 31, 2021, our disclosure controls and procedures were effective at the reasonable assurance level in ensuring that material information relating to NetScout, including its consolidated subsidiaries, required to be disclosed by NetScout in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, including ensuring that such material information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
There were no changes in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) occurred during the period covered by this quarterly report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
For information regarding our legal proceedings, see Note 12 contained in the "Notes to Consolidated Financial Statements" included in Part I of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for our fiscal year ended March 31, 2021. The risks discussed in our Annual Report on Form 10-K could materially affect our business, financial condition and future results. There have been no material changes to those risk factors since we filed our Annual Report on Form 10-K. The risks described in our Annual Report on Form 10-K are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business, financial condition or operating results.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Sales of Unregistered Securities
None.
Issuer Purchase of Equity Securities
The following table provides information about purchases we made during the quarter ended December 31, 2021 of equity securities that are registered by us pursuant to Section 12 of the Exchange Act:
Period
Total Number of Shares Purchased (1)
Average Price Paid per Share
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
Maximum Number of Shares That May Yet be Purchased Under the Program
10/1/2021-10/31/2021
410,564
$
26.88
409,379
5,758,482
11/1/2021-11/30/2021
2,661
33.07
—
5,758,482
12/1/2021-12/31/2021
4,340
29.63
—
5,758,482
Total
417,565
$
26.95
409,379
5,758,482
(1)We purchased an aggregate of 8,186 shares during the three months ended December 31, 2021 transferred to us from employees in satisfaction of minimum tax withholding obligations associated with the vesting of restricted stock units during the period. Such purchases reflected in the table do not reduce the maximum number of shares that may be purchased under our previously announced stock repurchase program (our previously disclosed twenty-five million share repurchase program).
Composite conformed copy of Third Amended and Restated Certificate of Incorporation of NetScout (as amended) (filed as Exhibit 3.2 to NetScout's current report on Form 8-K, SEC File No. 000-26251, filed on September 21, 2016, and incorporated herein by reference).
Amended and Restated By-laws of NetScout (filed as Exhibit 3.1 to NetScout's current report on Form 8-K, SEC File No. 000-26251, filed on May 11, 2020 and incorporated herein by reference).
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101.INS
+
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
The cover page from the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2021 formatted in Inline XBRL
+
Filed herewith.
++
Exhibit has been furnished, is not deemed filed and is not to be incorporated by reference into any of the Company's filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, irrespective of any general incorporation language contained in any such filing.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
NETSCOUT SYSTEMS, INC.
Date: February 3, 2022
/s/ Anil K. Singhal
Anil K. Singhal
President, Chief Executive Officer and Chairman
(Principal Executive Officer)
Date: February 3, 2022
/s/ Jean Bua
Jean Bua
Executive Vice President and Chief Financial Officer
