QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 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 July 28, 2021 was 74,085,582.
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 $407 and $416 at June 30, 2021 and March 31, 2021, respectively
146,199
197,717
Inventories and deferred costs
20,841
22,813
Prepaid income taxes
11,534
1,906
Prepaid expenses and other current assets
23,777
23,583
Total current assets
696,256
722,472
Fixed assets, net
46,973
48,474
Operating lease right-of-use assets
58,899
61,512
Goodwill
1,716,092
1,717,554
Intangible assets, net
494,412
511,866
Deferred income taxes
8,201
8,096
Other assets
12,221
15,064
Total assets
$
3,033,054
$
3,085,038
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable
$
16,961
$
17,964
Accrued compensation
53,292
83,057
Accrued other
21,726
21,127
Income taxes payable
5,492
7,025
Deferred revenue and customer deposits
257,969
269,748
Current portion of operating lease liabilities
12,125
12,354
Total current liabilities
367,565
411,275
Other long-term liabilities
22,180
21,641
Deferred tax liability
89,591
92,287
Accrued long-term retirement benefits
40,255
39,479
Long-term deferred revenue and customer deposits
101,929
103,310
Operating lease liabilities, net of current portion
58,579
61,267
Long-term debt
350,000
350,000
Total liabilities
1,030,099
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 June 30, 2021 and March 31, 2021
—
—
Common stock, $0.001 par value:
300,000,000 shares authorized; 124,694,737 and 124,197,974 shares issued and 74,084,245 and 73,751,615 shares outstanding at June 30, 2021 and March 31, 2021, respectively
124
124
Additional paid-in capital
2,968,631
2,955,400
Accumulated other comprehensive loss
(1,877)
(1,940)
Treasury stock at cost, 50,610,492 and 50,446,359 shares at June 30, 2021 and March 31, 2021, respectively
(1,327,273)
(1,322,496)
Retained earnings
363,350
374,691
Total stockholders' equity
2,002,955
2,005,779
Total liabilities and stockholders' equity
$
3,033,054
$
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 largely unknown and rapidly 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 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 is taking precautionary actions to limit costs and spending across the organization. This includes limiting discretionary spending and hiring activities. In addition, based on covenant levels at June 30, 2021, the Company had, as of June 30, 2021, an incremental $345 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 June 30, 2021, the Company had deferred $8.9 million of employer payroll taxes, of which 50% are required to be deposited by December 2021 and the remaining 50% by December 2022. The balance of $4.5 million was included as accrued other and a balance of $4.4 million was included as other long-term liabilities in the Company's consolidated balance sheet at June 30, 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 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 element’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 elements 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 multi-element arrangements of those engagements as a basis for establishing SSP. SSP has been established for product elements as the average or median selling price the element was recently sold for, whether sold alone or sold as part of a multiple element transaction. The Company reviews sales of the product elements on a quarterly basis and updates, when appropriate, its SSP for such elements 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 three months ended June 30, 2021, the Company recognized revenue of $96.0 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 June 30, 2021.
At June 30, 2021, the Company had total deferred revenue of $359.9 million, which represents the aggregate total contract price allocated to undelivered performance obligations. The Company expects to recognize $258.0 million, or 72%, of this revenue during the next 12 months, and expects to recognize the remaining $101.9 million, or 28%, of this revenue thereafter.
Because of NetScout's revenue recognition policies, 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, 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, except in the case of maintenance renewals. The aggregate amount of unrecognized accounts receivable and deferred revenue was $8.2 million and $7.1 million at June 30, 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 three months ended June 30, 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 all performance obligations are delivered or payments are received in advance of performance under the contract.
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 June 30, 2021, the consolidated balance sheet included $7.3 million in assets related to sales commissions to be expensed in future periods. A balance of $4.0 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 June 30, 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 months ended June 30, 2021 and 2020, the Company recognized $1.6 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
Recoveries and other adjustments
2
Write off charged against the allowance for credit losses
(11)
Balance at June 30, 2021
$
407
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 June 30, 2021, the Company had no direct customers or indirect channel partners which 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 months ended June 30, 2021 and 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.
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 three months ended June 30, 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 Company accounts for all share-based awards in accordance with GAAP, which requires the measurement and recognition of compensation expense 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
June 30,
2021
2020
Cost of product revenue
$
274
$
245
Cost of service revenue
1,613
1,350
Research and development
4,091
3,781
Sales and marketing
4,814
3,992
General and administrative
3,173
2,728
$
13,965
$
12,096
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.
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 June 30, 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):
June 30, 2021
March, 31, 2021
June 30, 2020
March 31, 2020
Cash and cash equivalents
$
487,168
$
467,176
$
403,306
$
338,489
Restricted cash
—
—
748
1,748
Total cash, cash equivalents and restricted cash
$
487,168
$
467,176
$
404,054
$
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 June 30, 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
$
1,039
$
—
$
1,039
Commercial paper
5,698
—
5,698
Total short-term marketable securities
6,737
—
6,737
Total long-term marketable securities
—
—
—
Total marketable securities
$
6,737
$
—
$
6,737
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 June 30, 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 June 30, 2021 and March 31, 2021 (in thousands):
Fair Value Measurements at
June 30, 2021
Level 1
Level 2
Level 3
Total
ASSETS:
Cash and cash equivalents
$
487,168
$
—
$
—
$
487,168
U.S. government and municipal obligations
1,039
—
—
1,039
Commercial paper
—
5,698
—
5,698
Derivative financial instruments
—
18
—
18
$
488,207
$
5,716
$
—
$
493,923
LIABILITIES:
Derivative financial instruments
$
—
$
(38)
$
—
$
(38)
$
—
$
(38)
$
—
$
(38)
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.
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):
June 30, 2021
March 31, 2021
Raw materials
$
15,363
$
13,189
Work in process
148
16
Finished goods
4,019
6,168
Deferred costs
1,311
3,440
$
20,841
$
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 June 30, 2021 and March 31, 2021, the carrying amount of goodwill was $1.7 billion. The change in the carrying amount of goodwill for the three months ended June 30, 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 three months ended June 30, 2021 as follows (in thousands):
Balance at March 31, 2021
$
1,717,554
Foreign currency translation impact
(1,462)
Balance at June 30, 2021
$
1,716,092
Intangible Assets
The net carrying amounts of intangible assets were $494.4 million and $511.9 million at June 30, 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 June 30, 2021 (in thousands):
Cost
Accumulated Amortization
Net
Developed technology
$
252,544
$
(216,447)
$
36,097
Customer relationships
777,583
(347,777)
429,806
Distributor relationships and technology licenses
11,498
(8,149)
3,349
Definite-lived trademark and trade name (a)
58,107
(33,213)
24,894
Core technology
7,192
(7,192)
—
Net beneficial leases
336
(336)
—
Non-compete agreements
292
(292)
—
Capitalized software
3,317
(3,292)
25
Other
1,208
(967)
241
$
1,112,077
$
(617,665)
$
494,412
(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):
Cost
Accumulated Amortization
Net
Developed technology
$
252,071
$
(212,688)
$
39,383
Customer relationships
775,898
(333,903)
441,995
Distributor relationships and technology licenses
11,469
(7,829)
3,640
Definite-lived trademark and trade name
39,434
(31,467)
7,967
Core technology
7,192
(7,192)
—
Net beneficial leases
336
(336)
—
Non-compete agreements
292
(292)
—
Capitalized software
3,317
(3,281)
36
Other
1,208
(963)
245
$
1,091,217
$
(597,951)
$
493,266
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 months ended June 30, 2021 and 2020, respectively (in thousands):
The following is the expected future amortization expense at June 30, 2021 for the fiscal years ending March 31 (in thousands):
2022 (remaining nine months)
$
55,893
2023
66,852
2024
58,592
2025
51,354
2026
46,991
Thereafter
214,730
$
494,412
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 June 30, 2021 and March 31, 2021 were as follows (in thousands):
Notional Amounts (a)
Prepaid Expenses and Other Current Assets
Accrued Other
June 30, 2021
March 31, 2021
June 30, 2021
March 31, 2021
June 30, 2021
March 31, 2021
Derivatives Designated as Hedging Instruments:
Forward contracts
$
5,048
$
11,037
18
$
57
38
152
Derivatives Not Designated as Hedging Instruments:
Forward contracts
—
6,373
—
—
—
39
$
18
$
57
$
38
$
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 (loss) (OCI) and results of operations for the three months ended June 30, 2021 and 2020 (in thousands):
Gain Recognized in OCI on Derivative (a)
Gain (Loss) Reclassified from Accumulated OCI into Income (b)
June 30, 2021
June 30, 2020
Location
June 30, 2021
June 30, 2020
Forward contracts
$
169
$
11
Research and development
$
(8)
$
8
Sales and marketing
(97)
34
$
169
$
11
$
(105)
$
42
(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 June 30, 2021 and 2020 (in thousands):
Loss Recognized in Income (a)
Location
June 30, 2021
June 30, 2020
Forward contracts
General and administrative
$
(248)
$
—
$
(248)
$
—
(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) with a syndicate of lenders by and among: the Company; JPMorgan Chase Bank, N.A. (JPMorgan), as administrative agent and collateral agent; J.P. Morgan Securities LLC, KeyBanc Capital Markets, Merrill Lynch, Pierce, Fenner & Smith Incorporated, RBC Capital Markets and Wells Fargo Securities, LLC, as joint lead arrangers and joint bookrunners; Fifth Third Bank, Santander Bank, N.A., SunTrust Bank, N.A. and U.S. Bank National Association, as co-documentation agents; and the lenders party thereto.
The Amended Credit Agreement provides 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 Company may elect to use the credit facility for general corporate purposes or to finance the repurchase of up to twenty-five million shares of the Company's common stock under the Company's common stock repurchase plan. The commitments under the Amended Credit Agreement will expire on January 16, 2023, and any outstanding loans will be due on that date. At June 30, 2021, $350 million was outstanding under the Amended Credit Agreement.
At the Company's election, revolving loans under the Amended Credit Agreement bear interest at either (a) an Alternate Base Rate per annum equal to the greatest of (1) JPMorgan's prime rate, (2) 0.50% in excess of the New York Federal Reserve Bank (NYFRB) rate, or (3) an adjusted one month LIBOR rate plus 1%; or (b) such adjusted LIBOR rate (for the interest period selected by the Company), in each case plus an applicable margin. For the period from the delivery of the Company's financial statements for the quarter ended March 31, 2021, until the Company has delivered financial statements for the quarter ended June 30, 2021, the applicable margin will be 1.25% per annum for LIBOR loans and 0.25% per annum for Alternate Base Rate loans, and thereafter the applicable margin will vary depending on the Company's leverage ratio, ranging from 0.75% per annum for Base Rate loans and 1.75% per annum for LIBOR loans if the Company's consolidated leverage ratio is less than or equal to 3.50 to 1.00, down to 0.00% per annum for Alternate Base Rate loans and 1.00% per annum for LIBOR loans if the Company's consolidated leverage ratio is equal to or less than 1.50 to 1.00. As of June 30, 2021, the Company’s maximum allowed consolidated leverage ratio is 3.50 to 1.00.
On July 27, 2017, the U.K. Financial Conduct Authority (FCA) announced that it will no longer require banks to submit rates for the calculation of LIBOR after 2021. On March 5, 2021, the Intercontinental Exchange Benchmark Administration
(IBA), the FCA-regulated and authorized administrator of LIBOR, announced, and the FCA confirmed, that one week and two-month USD LIBOR settings will cease on December 31, 2021, and that the USD LIBOR panel will cease on June 30, 2023.
IBA notes that any publication of the Overnight and 1, 3, 6 and 12 Months USD LIBOR settings based on panel bank
submissions beyond December 31, 2021 will need to comply with applicable regulations, including as to representativeness.
Based on current information from panel banks, IBA anticipates there being a representative panel for the continuation of these
USD LIBOR settings through to June 30, 2023.
The Company's Amended Credit Agreement, which matures on January 16, 2023 prior to the June 30, 2023 cessation of USD LIBOR publications, provides for the Administrative Agent to determine if (i) adequate and reasonable means do not exist for ascertaining the LIBOR rate or (ii) the FCA or Government Authority having jurisdiction over the Administrative Agent has made a public statement identifying a specific date after which the LIBOR rate shall no longer be used for determining interest rates for loans and the Administrative Agent determines that (i) and (ii) above are unlikely to be temporary, then the Administrative Agent and the Company would agree to transition to an Alternate Base Rate borrowing as described above or amend the Credit Agreement to establish an alternate rate of interest to LIBOR that gives due consideration to the then prevailing market convention for determining a rate of interest for syndicated loans in the United States at such time.
The Company's consolidated leverage ratio is the ratio of its total funded debt compared to its consolidated adjusted EBITDA. Consolidated adjusted 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 definition of consolidated adjusted EBITDA in the Amended Credit Agreement.
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 March 31, 2021 until the Company has delivered financial statements for the quarter ended June 30, 2021, the commitment fee will be 0.20% per annum, and thereafter the commitment fee will vary depending on the Company's consolidated leverage ratio, ranging from 0.30% per annum if the Company's consolidated leverage ratio is greater than 2.75 to 1.00, down to 0.15% per annum if the Company's consolidated leverage ratio is equal to or less than 1.50 to 1.00.
Letter of credit participation fees are payable to each lender on the amount of such lender’s letter of credit exposure, during the period from the closing date of the Amended 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 a rate per annum equal to the applicable margin for LIBOR loans. 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 LIBOR 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 Amended Credit Agreement at any time, without penalty, subject to certain notice requirements.
Debt is recorded at the amount drawn on the revolving credit facility plus interest based on floating rates reflective of changes in the market which approximates fair value.
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 Company 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 Amended 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 Amended Credit Agreement.
The Amended 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. In addition, the Company is required to maintain certain consolidated leverage and interest coverage ratios. These covenants and limitations are more fully described in the Amended Credit Agreement. At June 30, 2021, the Company was in compliance with all of these covenants.
The Amended 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 Amended Credit Agreement and related documents, 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 Amended Credit Agreement and the other loan documents.
The Company has capitalized debt issuance costs totaling $12.2 million at June 30, 2021, which are being amortized over the life of the revolving credit facility. The unamortized balance was $2.7 million as of June 30, 2021. The balance of $1.7 million was included as prepaid expenses and other current assets and a balance of $1.0 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 10 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 months ended June 30, 2021 and 2020 were as follows (in thousands):
Three Months Ended
June 30,
2021
2020
Lease cost under long-term operating leases
$
3,275
$
3,262
Lease cost under short-term operating leases
560
813
Variable lease cost under short-term and long-term operating leases
833
882
Total operating lease cost
$
4,668
$
4,957
The table below presents supplemental cash flow information related to leases during the three months ended June 30, 2021 and 2020 (in thousands):
June 30, 2021
June 30, 2020
Right-of-use assets obtained in exchange for new operating lease liabilities
$
—
$
1,794
At June 30, 2021 and March 31, 2021, the weighted average remaining lease term in years and weighted average discount rate were as follows:
June 30, 2021
March 31, 2021
Weighted average remaining lease term in years - operating leases
Future minimum payments under non-cancellable leases at June 30, 2021 are as follows (in thousands):
Year ending March 31:
2022 (remaining nine months)
$
10,382
2023
12,926
2024
10,309
2025
10,106
2026
9,093
Thereafter
29,298
Total lease payments
$
82,114
Less imputed interest
(11,410)
Present value of lease liabilities
$
70,704
NOTE 12 – COMMITMENTS AND CONTINGENCIES
Legal – 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 awards 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. NetScout continues to avail itself of its legal options. NetScout has concluded that the risk of loss associated with the post-suit damages award is "probable" in accounting terms, regardless of the options NetScout may pursue, and that the risk of loss associated with pre-suit damages is now remote. Accounting rules require NetScout to provide an estimate for the range of potential liability. NetScout currently estimates that the range of liability is 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 is not reasonably estimable but is likely within the range of $0 to $2,800,000.
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 months ended June 30, 2021 and 2020 (in thousands):
Three Months Ended
June 30,
2021
2020
Service cost
$
45
$
52
Interest cost
91
93
Net periodic pension cost
$
136
$
145
Expected Contributions
During the three months ended June 30, 2021, the Company made contributions of $0.1 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 June 30, 2021, the Company repurchased 17,910,840 shares for $471.9 million in the open market under the twenty-five million share repurchase program. At June 30, 2021, 7,089,160 shares of common stock remained available to be purchased under the current repurchase program. There were no share repurchases during the three months ended June 30, 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 164,133 shares and 113,163 shares at a cost of $4.8 million and $3.1 million, respectively, related to minimum statutory tax withholding requirements on these restricted stock units during the three months ended June 30, 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.
Calculations of the basic and diluted net loss per share and potential common shares are as follows (in thousands, except for per share data):
Three Months Ended
June 30,
2021
2020
Numerator:
Net loss
$
(11,341)
$
(17,420)
Denominator:
Denominator for basic net loss per share - weighted average common shares outstanding
73,859
72,303
Dilutive common equivalent shares:
Weighted average restricted stock units and performance-based restricted stock units
—
—
Denominator for diluted net loss per share - weighted average shares outstanding
73,859
72,303
Net loss per share:
Basic net loss per share
$
(0.15)
$
(0.24)
Diluted net loss per share
$
(0.15)
$
(0.24)
The following table sets forth restricted stock units excluded from the calculation of diluted net loss per share, since their inclusion would be anti-dilutive (in thousands):
Three Months Ended
June 30,
2021
2020
Restricted stock units
1,353
1,152
Basic net loss per share is calculated by dividing net loss 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 loss per share is calculated by dividing net loss 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. As the Company incurred a net loss during the three months ended June 30, 2021 and 2020, all outstanding restricted stock units and performance-based restricted stock units have an anti-dilutive effect and are therefore excluded from the computation of diluted weighted average shares outstanding.
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 represented an income tax benefit of 13.3% and an income tax benefit of 9.6% for the three months ended June 30, 2021 and 2020, respectively. The effective tax rate for the three months ended June 30, 2021 differed from the effective tax rate for the three months ended June 30, 2020, primarily due to the impact of research and development tax credits, foreign tax credits and the foreign derived intangible income deduction relative to forecasted profits, partially offset by the discrete remeasurement of certain deferred taxes due to a change in enacted tax rate in the UK during the quarter ended June 30, 2021.
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
June 30,
2021
2020
United States
$
102,893
$
107,323
Europe
38,556
34,758
Asia
17,316
13,696
Rest of the world
31,507
28,038
$
190,272
$
183,815
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.
NOTE 18 – SUBSEQUENT EVENTS
On July 27, 2021, the Company amended and extended its Amended Credit Agreement (Second Amended and Restated Credit Agreement). 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 or to repurchase shares of common stock under the Company's common stock repurchase plan. 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 all amounts outstanding under the existing credit agreement on July 27, 2021 by drawing down the same amount under the Second Amended and Restated Credit Agreement.
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 35 years 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 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 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 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 a phased reopening at some of our facilities, we remain focused on protecting the health and well-being of our employees and continue to maintain work from home policies for a vast majority of our employees where feasible.
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. For fiscal year 2022, as people in the world get immunized and return to "normal", we expect that technology and project spending will resume and we will be focused on advancing our products, growing revenue, enhancing earnings per share, and generating solid 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 crisis 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 control 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 June 30, 2021, we had, as of June 30, 2021, an incremental $345 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 June 30, 2021, we had deferred $8.9 million of employer payroll taxes, of which 50% are required to be deposited by December 2021 and the remaining 50% by December 2022.
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.
Results Overview
Total revenue for the three months ended June 30, 2021 as compared to total revenue for the three months ended June 30, 2020 increased due to an increase in revenue from the product portion of our service assurance offerings in both the service provider and enterprise verticals, as well as an increase in revenue from our DDoS offerings, partially offset by a decrease in revenue from the service portion of our service assurance offerings.
Our gross profit percentage remained flat at 71% during the three months ended June 30, 2021 as compared with the three months ended June 30, 2020.
Net loss for the three months ended June 30, 2021 was $11.3 million, as compared with a net loss for the three months ended June 30, 2020 of $17.4 million, a decrease of $6.1 million. The decrease in net loss was primarily due to a $6.5 million increase in revenue, a $4.2 million decrease in employee-related expenses associated with a reduction in headcount and a decrease in variable incentive compensation, a $2.8 million decrease in legal-related expenses, a $2.4 million decrease in other expense, and a $1.6 million decrease in amortization of intangible assets. These decreases were partially offset by a $3.1 million increase in commissions expense, a $2.0 million increase in direct material costs, a $1.5 million increase in contractor fees, a $1.2 million increase in obsolescence charges, a $1.0 million increase in travel expenses attributable to the lifting of COVID-19 related restrictions, an $0.8 million increase in advertising expense, and an $0.8 million increase in expenses related to user conferences.
At June 30, 2021, we had cash, cash equivalents and marketable securities (current and non-current) of $493.9 million. This represents an increase of $17.4 million from $476.5 million at March 31, 2021. This increase was primarily due to cash provided by operating activities of $24.1 million, partially offset by $4.8 million used for tax withholdings on restricted stock units and $2.6 million used for capital expenditures during the three months ended June 30, 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, amortization, and (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, 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 (loss) from operations, net income (loss) and net income (loss) per share on a GAAP and non-GAAP basis for the three months ended June 30, 2021 and 2020 (in thousands, except for per share amounts):
Per share impact of non-GAAP adjustments identified above
0.35
0.41
Non-GAAP diluted net income per share
$
0.20
$
0.17
GAAP loss from operations
$
(10,667)
$
(14,487)
Previous adjustments to determine non-GAAP income from operations
32,446
35,132
Non-GAAP income from operations
21,779
20,645
Depreciation excluding acquisition related
5,811
5,952
Non-GAAP EBITDA from operations
$
27,590
$
26,597
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
•marketable securities.
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.
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 June 30, 2021 and 2020, no direct customer or indirect channel partner accounted for more than 10% of our total revenue.
Three Months Ended
Change
June 30,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
Revenue:
Product
$
81,950
43
%
$
71,693
39
%
$
10,257
14
%
Service
108,322
57
112,122
61
(3,800)
(3)
%
Total revenue
$
190,272
100
%
$
183,815
100
%
$
6,457
4
%
Product.The 14%, or $10.3 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 3%, or $3.8 million, decrease in service revenue compared to the same period last year was primarily driven by non-renewals associated with service provider consolidation, discontinued product lines, and the timing of renewal bookings.
Total revenue by geography was as follows:
Three Months Ended
Change
June 30,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
United States
$
102,893
54
%
$
107,323
58
%
$
(4,430)
(4)
%
International:
Europe
38,556
20
34,758
19
3,798
11
%
Asia
17,316
9
13,696
8
3,620
26
%
Rest of the world
31,507
17
28,038
15
3,469
12
%
Subtotal international
87,379
46
76,492
42
10,887
14
%
Total revenue
$
190,272
100
%
$
183,815
100
%
$
6,457
4
%
United States revenue decreased 4%, or $4.4 million, primarily due to a decrease in revenue from network performance management offerings for enterprise and service provider customers, partially offset by an increase in revenue from DDoS offerings. The 14%, or $10.9 million, increase in international revenue compared with the same period last year was primarily driven by higher revenue from network performance management offerings.
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
June 30,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
Cost of revenue
Product
$
23,165
12
%
$
21,152
12
%
$
2,013
10
%
Service
31,245
16
31,828
17
(583)
(2)
%
Total cost of revenue
$
54,410
28
%
$
52,980
29
%
$
1,430
3
%
Gross profit:
Product $
$
58,785
31
%
$
50,541
27
%
$
8,244
16
%
Product gross profit %
72
%
70
%
Service $
$
77,077
41
%
$
80,294
44
%
$
(3,217)
(4)
%
Service gross profit %
71
%
72
%
Total gross profit $
$
135,862
$
130,835
$
5,027
4
%
Total gross profit %
71
%
71
%
Product. The 10%, or $2.0 million, increase in cost of product revenue for the three months ended June 30, 2021 compared to the same period last year was primarily due to a $2.0 million increase in direct material costs as a result of the increase in product revenue, and a $1.2 million increase in obsolescence charges. These increases were partially offset by a $1.3 million decrease in the amortization of intangible assets. The product gross profit percentage increased by two percentage points to 72% during the three months ended June 30, 2021 as compared with the three months ended June 30, 2020. The 16%, or $8.2 million, increase in product gross profit is attributable to the 14%, or $10.2 million, increase in product revenue, partially offset by the 10%, or $2.0 million, increase in cost of product revenue.
Service. The 2%, or $0.6 million, decrease in cost of service revenue for the three months ended June 30, 2021 compared to the same period last year was primarily due to a $2.1 million decrease in employee-related expenses associated with a decrease in variable incentive compensation as well as a decrease associated with the timing of certain projects. This decrease was partially offset by a $1.1 million increase in contractor fees. The service gross profit percentage decreased by one percentage point to 71% during the three months ended June 30, 2021 as compared with the three months ended June 30, 2020. The 4%, or $3.2 million decrease in service gross profit is attributable to the 3%, or $3.8 million, decrease in service revenue, partially offset by the 2%, or $0.6 million, decrease in cost of service revenue.
Gross profit. Our gross profit increased 4%, or $5.0 million, during the three months ended June 30, 2021 when compared with the three months ended June 30, 2020. This increase is attributable to the increase in revenue of 4%, or $6.5 million, partially offset by the 3%, or $1.4 million, increase in cost of revenue. The gross profit percentage remained flat at 71% for the three months ended June 30, 2021 as compared with the three months ended June 30, 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 6%, or $2.6 million, decrease in research and development expenses for the three months ended June 30, 2021 compared to the same period last year was primarily due to a $2.7 million decrease in employee-related expenses associated with a reduction in headcount and a decrease in variable incentive compensation.
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 11%, or $6.5 million, increase in total sales and marketing expenses for the three months ended June 30, 2021 compared to the same period last year was primarily due to a $3.1 million increase in commissions expense, a $1.0 million increase in travel expense primarily attributable to the lifting of COVID-19 related restrictions, an $0.8 million increase in employee-related expenses largely due to an increase in variable incentive compensation, an $0.8 million increase in expenses related to user conferences, and an $0.8 million increase in advertising and other marketing related expenses.
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 10%, or $2.4 million, decrease in general and administrative expenses for the three months ended June 30, 2021 compared to the same period last year was primarily due to a $2.8 million decrease in legal-related expenses, offset by a $0.5 million increase in allowance for credit losses.
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 $0.3 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 Expense, Net. Interest and other expense, net includes interest earned on our cash, cash equivalents and marketable securities, interest expense and other non-operating gains or losses.
The 49%, or $2.4 million, decrease in interest and other expense, net was primarily due to a $1.7 million decrease in foreign exchange expense, and a $0.9 million decrease in interest expense due to debt repayments on the credit facility, as well as a decrease in the average interest rate.
Income Taxes. Our effective tax rates represented an income tax benefit of 13.3% and an income tax benefit of 9.6% for the three months ended June 30, 2021 and 2020, respectively. The effective income tax rate for the three months ended June 30, 2021 differed from the effective income tax rate for the three months ended June 30, 2020, primarily due to the impact of research and development tax credits, foreign tax credits and the foreign derived intangible income deduction relative to forecasted profits partially offset by the discrete remeasurement of certain deferred taxes due to a change in enacted tax rate in the UK during the quarter ended June 30, 2021.
Three Months Ended
Change
June 30,
(Dollars in Thousands)
2021
2020
% of Revenue
% of Revenue
$
%
Income tax benefit
$
(1,746)
(1)
%
$
(1,847)
(1)
%
$
101
5
%
Off-Balance Sheet Arrangements
At June 30, 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.
Legal – From time to time, we are 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 our 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 awards 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, we filed our 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. NetScout continues to avail itself of its legal options. NetScout has concluded that the risk of loss associated with the post-suit damages award is "probable" in accounting terms, regardless of the options NetScout may pursue, and that the risk of loss associated with pre-suit damages is
now remote. Accounting rules require us to provide an estimate for the range of potential liability. NetScout currently estimates that the range of liability is 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 is not reasonably estimable but is likely within the range of $0 to $2,800,000.
Liquidity and Capital Resources
Cash, cash equivalents and marketable securities consisted of the following (in thousands):
June 30, 2021
March 31, 2021
Cash and cash equivalents
$
487,168
$
467,176
Short-term marketable securities
6,737
9,277
Cash, cash equivalents and marketable securities
$
493,905
$
476,453
Cash, cash equivalents and marketable securities
At June 30, 2021, cash, cash equivalents and marketable securities (current and non-current) totaled $493.9 million, a $17.4 million increase from $476.5 million at March 31, 2021. This increase was primarily due to cash provided by operating activities of $24.1 million, partially offset by $4.8 million used for tax withholdings on restricted stock units, and $2.6 million used for capital expenditures during the three months ended June 30, 2021.
At June 30, 2021, cash and short-term and long-term investments in the United States were $321.6 million, while cash held outside the United States was approximately $172.3 million.
Cash and cash equivalents were impacted by the following:
Three Months Ended
June 30,
(in thousands)
2021
2020
Net cash provided by operating activities
$
24,056
$
44,931
Net cash (used in) provided by investing activities
$
(32)
$
20,543
Net cash used in financing activities
$
(4,777)
$
(4,103)
Net cash from operating activities
Cash provided by operating activities was $24.1 million during the three months ended June 30, 2021, compared with $44.9 million of cash provided by operating activities during the three months ended June 30, 2020. The $20.8 million decrease was due in part to a $23.4 million decrease from accounts receivable, a $16.2 million decrease from accrued compensation and other expenses, a $7.2 million decrease from prepaid expenses and other assets, a $1.8 million decrease from depreciation and amortization, and a $1.1 million decrease from income taxes payable. These decreases were partially offset by a $12.1 million increase from deferred revenue, a $6.7 million increase from inventories, a $6.1 million increase from net income, a $1.9 million increase from share-based compensation, and an $0.8 million increase from deferred income taxes during the three months ended June 30, 2021 as compared with the three months ended June 30, 2020.
Cash (used in) provided by investing activities included the following:
Purchase of marketable securities
$
(5,696)
$
(5,743)
Proceeds from sales and maturity of marketable securities
8,230
33,026
Purchase of fixed assets
(2,578)
(2,605)
Purchase of intangible assets
—
(4,237)
Decrease in deposits
12
102
$
(32)
$
20,543
Cash used in investing activities was $32 thousand during the three months ended June 30, 2021, compared with $20.5 million of cash provided by investing activities during the three months ended June 30, 2020. The $20.5 million decrease in cash (used in) provided by investing activities was due in part to a $24.7 million decrease in cash inflow from marketable securities related to a $24.8 million decrease in proceeds from the sales and maturity of marketable securities during the three months ended June 30, 2021 when compared with the three months ended June 30, 2020. This decrease was partially offset by a $4.2 million cash outflow related to agreements to acquire technology licenses for $4.5 million during the three months ended June 30, 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
Three Months Ended
June 30,
(in thousands)
2021
2020
Cash used in financing activities included the following:
Payment of contingent consideration
$
—
$
(1,000)
Tax withholding on restricted stock units
(4,777)
(3,103)
$
(4,777)
$
(4,103)
Cash used in financing activities increased by $0.7 million to $4.8 million during the three months ended June 30, 2021, compared with $4.1 million of cash used in financing activities during the three months ended June 30, 2020.
During the three months ended June 30, 2021, we paid $1.0 million of contingent purchase consideration related to the Eastwind acquisition in April 2020.
In connection with the delivery of our common stock upon vesting of restricted stock units, we withheld 164,133 and 113,163 shares at a cost of $4.8 million and $3.1 million related to minimum statutory tax withholding requirements on these restricted stock units during the three months ended June 30, 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.
Credit Facility
On January 16, 2018, we amended and expanded our existing credit agreement (Amended Credit Agreement) with a syndicate of lenders by and among: NetScout; JPMorgan Chase Bank, N.A. (JPMorgan), as administrative agent and collateral agent; J.P. Morgan Securities LLC, KeyBanc Capital Markets, Merrill Lynch, Pierce, Fenner & Smith Incorporated, RBC Capital Markets and Wells Fargo Securities, LLC, as joint lead arrangers and joint bookrunners; Fifth Third Bank, Santander Bank, N.A., SunTrust Bank, N.A. and U.S. Bank National Association, as co-documentation agents; and the lenders party thereto.
The Amended Credit Agreement provides 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. We may elect to use the credit facility for general corporate purposes or to finance the repurchase of up to twenty-five million shares of our common stock under our common stock repurchase plan. The commitments under the Amended Credit Agreement will expire on January 16, 2023, and any outstanding loans will be due on that date. During the fiscal year ended March 31, 2021, we repaid $100.0 million of borrowings under the Amended Credit Agreement. At June 30, 2021, $350 million was outstanding under the Amended Credit Agreement.
At our election, revolving loans under the Amended Credit Agreement bear interest at either (a) an Alternate Base Rate per annum equal to the greatest of (1) JPMorgan's prime rate, (2) 0.50% in excess of the New York Federal Reserve Bank (NYFRB) rate, or (3) an adjusted one month LIBOR rate plus 1%; or (b) such adjusted LIBOR rate (for the interest period selected by us), in each case plus an applicable margin. For the period from the delivery of our financial statements for the quarter ended March 31, 2021, until we have delivered financial statements for the quarter ended June 30, 2021, the applicable margin will be 1.25% per annum for LIBOR loans and 0.25% per annum for Alternate Base Rate loans, and thereafter the applicable margin will vary depending on our leverage ratio, ranging from 0.75% per annum for Base Rate loans and 1.75% per annum for LIBOR loans if our consolidated leverage ratio is less than or equal to 3.50 to 1.00, down to 0.00% per annum for Alternate Base Rate loans and 1.00% per annum for LIBOR loans if our consolidated leverage ratio is equal to or less than 1.50 to 1.00. As of June 30, 2021, the Company’s maximum allowed consolidated leverage ratio is 3.50 to 1.00.
On July 27, 2017, the U.K. Financial Conduct Authority (FCA) announced that it will no longer require banks to submit rates for the calculation of LIBOR after 2021. On March 5, 2021, the Intercontinental Exchange Benchmark Administration
(IBA), the FCA-regulated and authorized administrator of LIBOR, announced, and the FCA confirmed, that one week and two-month USD LIBOR settings will cease on December 31, 2021, and that the USD LIBOR panel will cease on June 30, 2023.
IBA notes that any publication of the Overnight and 1, 3, 6 and 12 Months USD LIBOR settings based on panel bank
submissions beyond December 31, 2021 will need to comply with applicable regulations, including as to representativeness.
Based on current information from panel banks, IBA anticipates there being a representative panel for the continuation of these
USD LIBOR settings through to June 30, 2023.
Our Amended Credit Agreement, which matures on January 16, 2023 prior to the June 30, 2023 cessation of USD LIBOR publications, provides for the Administrative Agent to determine if (i) adequate and reasonable means do not exist for ascertaining the LIBOR rate or (ii) the FCA or Government Authority having jurisdiction over the Administrative Agent has made a public statement identifying a specific date after which the LIBOR rate shall no longer be used for determining interest rates for loans and the Administrative Agent determines that (i) and (ii) above are unlikely to be temporary, then the Administrative Agent and NetScout would agree to transition to an Alternate Base Rate borrowing as described above or amend the Credit Agreement to establish an alternate rate of interest to LIBOR that gives due consideration to the then prevailing market convention for determining a rate of interest for syndicated loans in the United States at such time.
Our consolidated leverage ratio is the ratio of our total funded debt compared to our consolidated adjusted EBITDA. Consolidated adjusted 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 definition of consolidated adjusted EBITDA in the Amended Credit Agreement.
Commitment fees will accrue on the daily unused amount of the credit facility. For the period from the delivery of our financial statements for the quarter ended March 31, 2021 until we have delivered financial statements for the quarter ended June 30, 2021, the commitment fee will be 0.20% per annum, and thereafter the commitment fee will vary depending on our consolidated leverage ratio, ranging from 0.30% per annum if our consolidated leverage ratio is greater than 2.75 to 1.00, down to 0.15% per annum if our consolidated leverage ratio is equal to or less than 1.50 to 1.00.
Letter of credit participation fees are payable to each lender on the amount of such lender’s letter of credit exposure, during the period from the closing date of the Amended 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 a rate per annum equal to the applicable margin for LIBOR loans. 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 LIBOR 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 Amended Credit Agreement at any time, without penalty, subject to certain notice requirements.
Debt is recorded at the amount drawn on the revolving credit facility plus interest based on floating rates reflective of changes in the market which approximates fair value.
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 us 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 Amended Credit Agreement generally prohibits any other liens on the assets of NetScout and its restricted subsidiaries, subject to certain exceptions as described in the Amended Credit Agreement.
The Amended 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. In addition, we are required to maintain certain consolidated leverage and interest coverage ratios. These covenants and limitations are more fully described in the Amended Credit Agreement. At June 30, 2021, we were in compliance with all of these covenants.
The Amended 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 Amended Credit Agreement and related documents, 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 Amended Credit Agreement and the other loan documents.
We have capitalized debt issuance costs totaling $12.2 million at June 30, 2021, which are being amortized over the life of the revolving credit facility. The unamortized balance was $2.7 million as of June 30, 2021. The balance of $1.7 million was included as prepaid expenses and other current assets and a balance of $1.0 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 currently 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 Amended Credit Agreement, or to repurchase shares of our common stock through our stock repurchase program. 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 June 30, 2021, we owed $350 million on this loan with an interest rate of 1.35%. A sensitivity analysis was performed on the outstanding portion of our debt obligation as of June 30, 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 June 30, 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 June 30, 2021, we had foreign currency forward contracts designated as hedging instruments with notional amounts totaling $5.0 million. The valuation of outstanding foreign currency forward contracts at June 30, 2021 resulted in an asset balance of $18 thousand, reflecting favorable rates in comparison to current market rates and a liability balance of $38 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 June 30, 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 June 30, 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.
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 be material to our 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 awards 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, we filed our 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. NetScout continues to avail itself of its legal options. NetScout has concluded that the risk of loss associated with the post-suit damages award is "probable" in accounting terms, regardless of the options NetScout may pursue, and that the risk of loss associated with pre-suit damages is now remote. Accounting rules require us to provide an estimate for the range of potential liability. NetScout currently estimates that the range of liability is 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 is not reasonably estimable but is likely within the range of $0 to $2,800,000.
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 June 30, 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
04/1/2021-4/30/2021
139
$
27.81
—
7,089,160
5/1/2021-5/31/2021
9,864
26.68
—
7,089,160
6/1/2021-6/30/2021
154,130
29.26
—
7,089,160
Total
164,133
$
29.10
—
7,089,160
(1)We purchased an aggregate of 164,133 shares during the three months ended June 30, 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
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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 June 30, 2021 formatted in Inline XBRL
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Filed herewith.
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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: August 5, 2021
/s/ Anil K. Singhal
Anil K. Singhal
President, Chief Executive Officer and Chairman
(Principal Executive Officer)
Date: August 5, 2021
/s/ Jean Bua
Jean Bua
Executive Vice President and Chief Financial Officer
