Form 10-Q NETSCOUT SYSTEMS INC For: Dec 31
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E-mailUNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-Q
(Mark One)
| QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the quarterly period ended December 31, 2022
OR
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |||||
For the transition period from to | |||||
Commission file number 000-26251
(Exact Name of Registrant as Specified in Its Charter)
| (State or Other Jurisdiction of Incorporation or Organization) | (IRS Employer Identification No.) | |||||||
(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: | ||||||
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):
Non-accelerated filer ☐ Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
The number of shares outstanding of the registrant's common stock, par value $0.001 per share, as of January 26, 2023 was 70,962,252 .
NETSCOUT SYSTEMS, INC.
FORM 10-Q
FOR THE QUARTER ENDED DECEMBER 31, 2022
TABLE OF CONTENTS
| CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS | ||||||||
| Item 1. | ||||||||
| Item 2. | ||||||||
| Item 3. | ||||||||
| Item 4. | ||||||||
| Item 1. | ||||||||
| Item 1A. | ||||||||
| Item 2. | ||||||||
| Item 3. | Defaults Upon Senior Securities | |||||||
| Item 4. | Mine Safety Disclosures | |||||||
| Item 5. | Other Information | |||||||
| Item 6. | ||||||||
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.
Cautionary Statement Concerning Forward-Looking Statements
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, 2022, 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.
1
PART I: FINANCIAL INFORMATION
Item 1. Unaudited Financial Statements
NetScout Systems, Inc.
Consolidated Balance Sheets
(In thousands, except share data)
| December 31, 2022 | March 31, 2022 | ||||||||||
| (Unaudited) | |||||||||||
| Assets | |||||||||||
| Current assets: | |||||||||||
| Cash and cash equivalents | $ | $ | |||||||||
| Marketable securities | |||||||||||
Accounts receivable and unbilled costs, net of allowance for doubtful accounts of $ | |||||||||||
| Inventories and deferred costs | |||||||||||
| Prepaid income taxes | |||||||||||
| Prepaid expenses and other current assets | |||||||||||
| Total current assets | |||||||||||
| Fixed assets, net | |||||||||||
| Operating lease right-of-use assets | |||||||||||
| Goodwill | |||||||||||
| Intangible assets, net | |||||||||||
| Deferred income taxes | |||||||||||
| Long-term marketable securities | |||||||||||
| Other assets | |||||||||||
| Total assets | $ | $ | |||||||||
| Liabilities and Stockholders' Equity | |||||||||||
| Current liabilities: | |||||||||||
| Accounts payable | $ | $ | |||||||||
| Accrued compensation | |||||||||||
| Accrued other | |||||||||||
| Income taxes payable | |||||||||||
| Deferred revenue and customer deposits | |||||||||||
| Current portion of operating lease liabilities | |||||||||||
| Total current liabilities | |||||||||||
| Other long-term liabilities | |||||||||||
| Deferred tax liability | |||||||||||
| Accrued long-term retirement benefits | |||||||||||
| Long-term deferred revenue and customer deposits | |||||||||||
| Operating lease liabilities, net of current portion | |||||||||||
| Long-term debt | |||||||||||
| Total liabilities | |||||||||||
| Commitments and contingencies (Note 13) | |||||||||||
| Stockholders' equity: | |||||||||||
Preferred stock, $ | |||||||||||
Common stock, $ | |||||||||||
| Additional paid-in capital | |||||||||||
| Accumulated other comprehensive income (loss) | ( | ||||||||||
Treasury stock at cost, | ( | ( | |||||||||
| Retained earnings | |||||||||||
| Total stockholders' equity | |||||||||||
| Total liabilities and stockholders' equity | $ | $ | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
2
NetScout Systems, Inc.
Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Revenue: | |||||||||||||||||||||||
| Product | $ | $ | $ | $ | |||||||||||||||||||
| Service | |||||||||||||||||||||||
| Total revenue | |||||||||||||||||||||||
| Cost of revenue: | |||||||||||||||||||||||
| Product | |||||||||||||||||||||||
| Service | |||||||||||||||||||||||
| Total cost of revenue | |||||||||||||||||||||||
| Gross profit | |||||||||||||||||||||||
| Operating expenses: | |||||||||||||||||||||||
| Research and development | |||||||||||||||||||||||
| Sales and marketing | |||||||||||||||||||||||
| General and administrative | |||||||||||||||||||||||
| Amortization of acquired intangible assets | |||||||||||||||||||||||
| Restructuring charges | |||||||||||||||||||||||
| Total operating expenses | |||||||||||||||||||||||
| Income from operations | |||||||||||||||||||||||
| Interest and other income (expense), net: | |||||||||||||||||||||||
| Interest income | |||||||||||||||||||||||
| Interest expense | ( | ( | ( | ( | |||||||||||||||||||
| Other income (expense), net | ( | ( | |||||||||||||||||||||
| Total interest and other income (expense), net | ( | ( | ( | ||||||||||||||||||||
| Income before income tax expense | |||||||||||||||||||||||
| Income tax expense | |||||||||||||||||||||||
| Net income | $ | $ | $ | $ | |||||||||||||||||||
| Basic net income per share | $ | $ | $ | $ | |||||||||||||||||||
| Diluted net income per share | $ | $ | $ | $ | |||||||||||||||||||
| Weighted average common shares outstanding used in computing: | |||||||||||||||||||||||
| Net income per share - basic | |||||||||||||||||||||||
| Net income per share - diluted | |||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
3
NetScout Systems, Inc.
Consolidated Statements of Comprehensive Income
(In thousands)
(Unaudited)
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Net income | $ | $ | $ | $ | |||||||||||||||||||
| Other comprehensive income (loss): | |||||||||||||||||||||||
| Cumulative translation adjustments | ( | ||||||||||||||||||||||
| Changes in market value of investments: | |||||||||||||||||||||||
Changes in unrealized gains (losses), net of taxes (benefit) of $ | ( | ||||||||||||||||||||||
| Total net change in market value of investments | ( | ||||||||||||||||||||||
| Changes in market value of derivatives: | |||||||||||||||||||||||
Changes in market value of derivatives, net of taxes (benefit) of $ | ( | ||||||||||||||||||||||
Reclassification adjustment for net gains (losses) included in net income, net of taxes (benefit) of $ | ( | ||||||||||||||||||||||
| Total net change in market value of derivatives | ( | ||||||||||||||||||||||
| Other comprehensive income (loss) | ( | ||||||||||||||||||||||
| Total comprehensive income | $ | $ | $ | $ | |||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
4
NetScout Systems, Inc.
Consolidated Statements of Stockholders' Equity
(In thousands, except share data)
(Unaudited)
| Three Months Ended December 31, 2022 | |||||||||||||||||||||||||||||||||||||||||||||||
| Common Stock Voting | Additional Paid In Capital | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Retained Earnings | Total Stockholders' Equity | ||||||||||||||||||||||||||||||||||||||||||
| Shares | Par Value | Shares | Stated Value | ||||||||||||||||||||||||||||||||||||||||||||
| Balance, September 30, 2022 | $ | $ | $ | ( | $ | ( | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Net income | |||||||||||||||||||||||||||||||||||||||||||||||
| Unrealized net investment gains | |||||||||||||||||||||||||||||||||||||||||||||||
| Unrealized net gains on derivative financial instruments | |||||||||||||||||||||||||||||||||||||||||||||||
| Cumulative translation adjustments | |||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock pursuant to vesting of restricted stock units | — | ||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense for restricted stock units granted to employees | |||||||||||||||||||||||||||||||||||||||||||||||
| Repurchase of treasury stock | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||
| Balance, December 31, 2022 | $ | $ | $ | ( | $ | ( | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Nine Months Ended December 31, 2022 | |||||||||||||||||||||||||||||||||||||||||||||||
| Common Stock Voting | Additional Paid In Capital | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Retained Earnings | Total Stockholders' Equity | ||||||||||||||||||||||||||||||||||||||||||
| Shares | Par Value | Shares | Stated Value | ||||||||||||||||||||||||||||||||||||||||||||
Balance, March 31, 2022 | $ | $ | $ | $ | ( | $ | $ | ||||||||||||||||||||||||||||||||||||||||
| Net income | |||||||||||||||||||||||||||||||||||||||||||||||
| Unrealized net investment gains | |||||||||||||||||||||||||||||||||||||||||||||||
| Unrealized net loss on derivative financial instruments | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||
| Cumulative translation adjustments | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock pursuant to vesting of restricted stock units | |||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense for restricted stock units granted to employees | |||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock under employee stock purchase plan | |||||||||||||||||||||||||||||||||||||||||||||||
| Repurchase of treasury stock | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||
| Balance, December 31, 2022 | $ | $ | $ | ( | $ | ( | $ | $ | |||||||||||||||||||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
5
NetScout Systems, Inc.
Consolidated Statements of Stockholders' Equity
(In thousands, except share data)
(Unaudited)
| Three Months Ended December 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||
| Common Stock Voting | Additional Paid In Capital | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Retained Earnings | Total Stockholders’ Equity | ||||||||||||||||||||||||||||||||||||||||||
| Shares | Par Value | Shares | Stated Value | ||||||||||||||||||||||||||||||||||||||||||||
| Balance, September 30, 2021 | $ | $ | $ | ( | $ | ( | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Net income | |||||||||||||||||||||||||||||||||||||||||||||||
| Unrealized net gains on derivative financial instruments | |||||||||||||||||||||||||||||||||||||||||||||||
| Cumulative translation adjustments | |||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock pursuant to vesting of restricted stock units | |||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense for restricted stock units granted to employees | |||||||||||||||||||||||||||||||||||||||||||||||
| Repurchase of treasury stock | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||
| Balance, December 31, 2021 | $ | $ | $ | ( | $ | ( | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Nine Months Ended December 31, 2021 | |||||||||||||||||||||||||||||||||||||||||||||||
| Common Stock Voting | Additional Paid In Capital | Accumulated Other Comprehensive Income (Loss) | Treasury Stock | Retained Earnings | Total Stockholders’ Equity | ||||||||||||||||||||||||||||||||||||||||||
| Shares | Par Value | Shares | Stated Value | ||||||||||||||||||||||||||||||||||||||||||||
| Balance, March 31, 2021 | $ | $ | $ | ( | $ | ( | $ | $ | |||||||||||||||||||||||||||||||||||||||
| Net income | |||||||||||||||||||||||||||||||||||||||||||||||
| Unrealized net investment losses | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||
| Unrealized net gains on derivative financial instruments | |||||||||||||||||||||||||||||||||||||||||||||||
| Cumulative translation adjustments | |||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock pursuant to vesting of restricted stock units | |||||||||||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense for restricted stock units granted to employees | |||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock under employee stock purchase plan | |||||||||||||||||||||||||||||||||||||||||||||||
| Repurchase of treasury stock | ( | ( | |||||||||||||||||||||||||||||||||||||||||||||
| Balance, December 31, 2021 | $ | $ | $ | ( | $ | ( | $ | $ | |||||||||||||||||||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
6
NetScout Systems, Inc.
Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
| Nine Months Ended | |||||||||||
| December 31, | |||||||||||
| 2022 | 2021 | ||||||||||
| Cash flows from operating activities: | |||||||||||
| Net income | $ | $ | |||||||||
| Adjustments to reconcile net income to cash provided by operating activities, net of the effects of acquisitions: | |||||||||||
| Depreciation and amortization | |||||||||||
| Loss on extinguishment of debt | |||||||||||
| Operating lease right-of-use assets | |||||||||||
| Loss on disposal of fixed assets | |||||||||||
| Share-based compensation expense | |||||||||||
| Change in fair value of contingent consideration | ( | ||||||||||
| Deferred income taxes | ( | ( | |||||||||
| Other losses (gains) | ( | ||||||||||
| Changes in assets and liabilities | |||||||||||
| Accounts receivable and unbilled costs | ( | ( | |||||||||
| Inventories | ( | ||||||||||
| Prepaid expenses and other assets | ( | ||||||||||
| Accounts payable | ( | ||||||||||
| Accrued compensation and other expenses | ( | ( | |||||||||
| Operating lease liabilities | ( | ( | |||||||||
| Income taxes payable | ( | ( | |||||||||
| Deferred revenue | ( | ||||||||||
| Net cash provided by operating activities | |||||||||||
| Cash flows from investing activities: | |||||||||||
| Purchase of marketable securities | ( | ( | |||||||||
| Proceeds from sales and maturity of marketable securities | |||||||||||
| Purchase of fixed assets | ( | ( | |||||||||
| Purchase of intangible assets | ( | ||||||||||
| Decrease in deposits | |||||||||||
| Net cash used in investing activities | ( | ( | |||||||||
| Cash flows from financing activities: | |||||||||||
| Issuance of common stock under stock plans | |||||||||||
| Treasury stock repurchases, including accelerated share repurchases | ( | ( | |||||||||
| Tax withholding on restricted stock units | ( | ( | |||||||||
| Payment of debt issuance costs | ( | ||||||||||
| Repayment of long-term debt | ( | ( | |||||||||
| Proceeds from issuance of long-term debt | |||||||||||
| Collection of contingent consideration | |||||||||||
| Net cash used in financing activities | ( | ( | |||||||||
| Effect of exchange rate changes on cash and cash equivalents | ( | ( | |||||||||
| Net (decrease) increase in cash and cash equivalents | ( | ||||||||||
| Cash and cash equivalents, beginning of period | |||||||||||
| Cash and cash equivalents, end of period | $ | $ | |||||||||
| Supplemental disclosures: | |||||||||||
| Cash paid for interest | $ | $ | |||||||||
| Cash paid for income taxes | $ | $ | |||||||||
| Non-cash transactions: | |||||||||||
| Transfers of inventory to fixed assets | $ | $ | |||||||||
| Additions to property, plant and equipment included in accounts payable | $ | $ | |||||||||
| Issuance of common stock under employee stock plans | $ | $ | |||||||||
The accompanying notes are an integral part of these consolidated financial statements.
7
NetScout Systems, Inc.
Notes to Consolidated Financial Statements
(Unaudited)
NOTE 1 – BASIS OF PRESENTATION
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, 2022 filed with the Securities and Exchange Commission on May 19, 2022.
Global and Macroeconomic Conditions
The Company continues to closely monitor the current global and macroeconomic conditions, including the impact of the war in Ukraine, global geopolitical tension, stock market volatility, exchange rate fluctuations, rising inflation and interest rates, the risk of a recession, and the coronavirus (COVID-19) pandemic on all aspects of its business, including the manner and extent to which they have impacted and could continue to impact its customers, employees, supply chain, and distribution network. The impacts of these global and macroeconomic trends remain uncertain. It is possible that the measures taken by the governments of countries affected and the resulting economic impacts may materially and adversely affect the Company's future results of operations, cash flows and financial position as well as its customers.
The Company has the responsibility to evaluate whether conditions and/or events raise substantial doubt about its ability to meet its future financial obligations as they become due within one year after the date that the financial statements are issued. The Company has taken and continues to take precautionary actions to manage costs and spending across the organization. This includes managing discretionary spending and hiring activities. In addition, based on covenant levels, the Company had, as of December 31, 2022, an incremental $600 million available under its 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 had elected to defer the employer-paid portion of social security taxes. The Company had deferred $4.5 million of employer payroll taxes, which was included as accrued other in the Company's consolidated balance sheet at March 31, 2022. The balance was paid in December 2022.
The Company expects net cash provided by operations combined with cash, cash equivalents, and marketable securities and borrowing availability under the revolving credit facility to provide sufficient liquidity to fund current obligations, capital spending, debt service requirements and working capital requirements over at least the next twelve months.
Recent Accounting Pronouncements
In October 2021, the FASB issued ASU 2021-08, Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers, which requires companies to recognize and measure contract assets and contract liabilities acquired in a business combination as if the acquiring company originated the related revenue contracts. ASU 2021-08 is effective for fiscal years beginning after December 15, 2022, with early adoption permitted. ASU 2021-08 is effective for the Company beginning April 1, 2023. Amendments within the standard are required to be applied on a prospective basis from the date of adoption. The adoption is not expected to have a material impact on the Company's financial position, results of operations, and disclosures. We will apply the provisions of ASU 2021-08 after adoption to future acquisitions, if any.
In March 2020, the FASB issued ASU 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The amendments provide optional guidance for a limited time to ease the potential burden in accounting for reference rate reform. The new guidance provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships and other transactions affected by reference rate reform if certain
8
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 cybersecurity 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 fulfillment, 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 primarily on the performance obligation's historical pricing. The Company also considers its overall pricing objectives and practices across different sales channels and geographies, and market conditions. Generally, the Company has established SSP for a majority of its service performance obligations based on historical standalone sales. In certain instances, the Company has established SSP for services based upon an estimate of profitability and the underlying cost to fulfill those services. SSP has primarily been established for product performance obligations as the average or median selling price the performance obligation was recently sold for, whether sold alone or sold as part of a bundle transaction. The Company reviews sales of the product performance obligations on a quarterly basis and
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During the nine months ended December 31, 2022, the Company recognized revenue of $277.1 million related to the Company's deferred revenue balance reported at March 31, 2022.
Performance Obligations
Customer contracts may include promises to transfer multiple products and services to a customer. Determining whether the products and services are considered distinct performance obligations that should be accounted for separately or as one combined performance obligation may require significant judgment. The transaction price is allocated among performance obligations in bundled contracts in an amount that depicts the relative standalone selling prices of each obligation.
For contracts involving distinct hardware and software licenses, the performance obligations are satisfied at a point in time when control is transferred to the customer. For standalone maintenance and post-contract support (PCS) the performance obligation is satisfied ratably over the contract term as a stand-ready obligation. For consulting and training services, the performance obligation may be satisfied over the contract term as a stand-ready obligation, satisfied over a period of time as those services are delivered, or satisfied at the completion of the service when control has transferred, or the services have expired unused.
Payments for hardware, software licenses, one-year maintenance, PCS and consulting services, are typically due up front with payment terms of 30 to 90 days. However, the Company does have contracts pursuant to which billings occur ratably over a period of years following the transfer of control for the contracted performance obligations. Payments on multi-year maintenance, PCS and consulting services are typically due in annual installments over the contract term. The Company did not have any material variable consideration such as obligations for returns, refunds or warranties at December 31, 2022.
At December 31, 2022, the Company had total deferred revenue of $444.9 million, which represents the aggregate total contract price allocated to undelivered performance obligations. The Company expects to recognize $317.4 million, or 71 %, of this revenue during the next 12 months, and expects to recognize the remaining $127.5 million, or 29 %, 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, but the related account receivable has not been collected. While the receivable represents an enforceable obligation, the Company does not believe its right to payment is unconditional, therefore for balance sheet presentation purposes, the Company has not recognized the deferred revenue or the related account receivable and no amounts appear in the consolidated balance sheets for such transactions because control of the underlying deliverable has not transferred. The aggregate amount of unrecognized accounts receivable and deferred revenue was $3.7 million and $9.4 million at December 31, 2022 and March 31, 2022, respectively.
NetScout expects that the amount of billed and unbilled deferred revenue will change from quarter to quarter for several reasons, including the specific timing, duration and size of large customer support and service agreements, varying billing cycles of such agreements, the specific timing of customer renewals, and foreign currency fluctuations. The Company did not have material significant financing components, or variable consideration or performance obligations satisfied in a prior period recognized during the nine months ended December 31, 2022.
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 with an unconditional right to payment occur before all performance obligations are delivered or payments are received in advance of performance under the contract.
Costs to Obtain Contracts
The Company has determined that the only significant incremental costs incurred to obtain contracts with customers within the scope of Topic 606 are sales commissions paid to its employees. Sales commissions are recorded as an asset and amortized to expense ratably over the remaining performance periods of the related contracts with remaining performance
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obligations. The Company expenses costs as incurred for sales commissions when the amortization period would have been one year or less.
At December 31, 2022, the consolidated balance sheet included $9.3 million in assets related to sales commissions to be expensed in future periods. A balance of $4.7 million was included in prepaid expenses and other current assets, and a balance of $4.6 million was included in other assets in the Company's consolidated balance sheet at December 31, 2022. At March 31, 2022, the consolidated balance sheet included $8.8 million in assets related to sales commissions to be expensed in future periods. A balance of $4.6 million was included in prepaid expenses and other current assets, and a balance of $4.2 million was included in other assets in the Company's consolidated balance sheet at March 31, 2022.
During the three and nine months ended December 31, 2022 and 2021, respectively, the Company recognized $1.8 million, $1.6 million, $5.2 million and $4.7 million of amortization related to this sales commission asset, which is included in the sales and marketing expense line in the Company's consolidated statements of operations.
Allowance for Credit Losses
The Company continually monitors collections from its customers. The Company evaluates the collectability of its accounts receivable and determines the appropriate allowance for credit losses based on a combination of factors, including but not limited to, analysis of the aging schedules, past due balances, historical collection experience and prevailing economic conditions.
| Balance at March 31, 2022 | $ | ||||
| Provision for allowance for credit losses | |||||
| Recoveries and other adjustments | |||||
| Write off charged against the allowance for credit losses | ( | ||||
| Balance at December 31, 2022 | $ | ||||
NOTE 3 – CONCENTRATION OF CREDIT RISK AND SIGNIFICANT CUSTOMERS
Financial instruments that potentially subject the Company to concentration of credit risk consist primarily of investments, trade accounts receivable and accounts payable. The Company's cash, cash equivalents, and marketable securities are placed with financial institutions with high credit standings.
At December 31, 2022, 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. At March 31, 2022, the Company had no direct customers or indirect channel partners which accounted for more than 10% of the accounts receivable balance.
During the three and nine months ended December 31, 2022 and 2021, one direct customer, Verizon, accounted for more than 10% of the Company's total revenue, while no indirect channel partners accounted for more than 10% of total revenue.
NOTE 4 – SHARE-BASED COMPENSATION
On September 12, 2019, the Company's stockholders approved the 2019 Equity Incentive Plan (2019 Plan), which replaced the Company's 2007 Equity Incentive Plan, as amended (Amended 2007 Plan). The 2019 Plan permits 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 Plan (2019 Amended Plan) to increase the number of shares reserved for issuance by 4,700,000 shares, 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.
On August 24, 2022, the Company's stockholders approved an amendment to the 2019 Amended Plan (2019 Second Amended Plan). This amendment increased the number of shares reserved for issuance by 7,000,000 shares and changed the factor used to calculate the increase or reduction in the number of shares available for issuance under the 2019 Second
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Amended Plan. At August 24, 2022, there was a total of 8,764,811 shares reserved for issuance under the 2019 Second Amended Plan, which consisted of 7,000,000 new shares plus 1,764,811 shares that remained available for grant under the 2019 Amended Plan as of August 24, 2022, the effective date of the 2019 Second Amended Plan. At December 31, 2022, an aggregate of 6,235,096 shares remained available for grant under the 2019 Second Amended Plan.
Periodically, the Company grants share-based awards to employees, officers, and directors of the Company and its subsidiaries. During the fiscal years ended March 31, 2023 and 2022, the Company granted performance-based restricted stock units to certain executive officers that vest based upon the Company's total shareholder return as compared to the Russell 2000 Index over a three-year period. The performance-based restricted stock units were valued using the Monte Carlo Simulation model. The measurement and recognition of compensation expense is based on estimated fair values for all share-based payment awards made to its employees and directors. Share-based award grants are generally measured at fair value on the date of grant based on the number of shares granted and the quoted price of the Company's common stock. Such value is recognized as a cost of revenue or an operating expense over the corresponding vesting period.
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Cost of product revenue | $ | $ | $ | $ | |||||||||||||||||||
| Cost of service revenue | |||||||||||||||||||||||
| Research and development | |||||||||||||||||||||||
| Sales and marketing | |||||||||||||||||||||||
| General and administrative | |||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||
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, 2022. Under the ESPP, shares of the Company's common stock may be purchased on the last day of each bi-annual offering period at 85 % of the fair value on the last day of such offering period. The offering periods run from March 1st through August 31st and from September 1st through the last day of February each year. During the nine months ended December 31, 2022, employees purchased 206,029 shares under the ESPP and the fair value per share was $31.74 .
On August 24, 2022, the Company's stockholders approved an amendment to the ESPP that increased the number of shares available under the ESPP by an additional 2,000,000 shares.
NOTE 5 – CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES
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Marketable Securities
The following is a summary of marketable securities held by NetScout at December 31, 2022, classified as short-term and long-term (in thousands):
| Amortized Cost | Unrealized Losses | Fair Value | |||||||||||||||
| Type of security: | |||||||||||||||||
| U.S. government and municipal obligations | $ | $ | ( | $ | |||||||||||||
| Commercial paper | |||||||||||||||||
| Corporate bonds | ( | ||||||||||||||||
| Certificates of deposit | |||||||||||||||||
| Total short-term marketable securities | ( | ||||||||||||||||
| U.S. government and municipal obligations | ( | ||||||||||||||||
| Total long-term marketable securities | ( | ||||||||||||||||
| Total marketable securities | $ | $ | ( | $ | |||||||||||||
The following is a summary of marketable securities held by NetScout at March 31, 2022, classified as short-term and long-term (in thousands):
| Amortized Cost | Unrealized Losses | Fair Value | |||||||||||||||
| Type of security: | |||||||||||||||||
| U.S. government and municipal obligations | $ | $ | ( | $ | |||||||||||||
| Commercial paper | |||||||||||||||||
| Corporate bonds | ( | ||||||||||||||||
| Certificates of deposit | |||||||||||||||||
| Total short-term marketable securities | ( | ||||||||||||||||
| Total long-term marketable securities | |||||||||||||||||
| Total marketable securities | $ | $ | ( | $ | |||||||||||||
Contractual maturities of the Company's marketable securities held at December 31, 2022 and March 31, 2022 were as follows (in thousands):
| December 31, 2022 | March 31, 2022 | ||||||||||
| Available-for-sale securities: | |||||||||||
| Due in 1 year or less | $ | $ | |||||||||
| Due after 1 year through 5 years | |||||||||||
| $ | $ | ||||||||||
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NOTE 6 – FAIR VALUE MEASUREMENTS
The fair value hierarchy has three levels based on the reliability of the inputs used to determine fair value. Level 1 refers to fair values determined based on quoted prices in active markets for identical assets. Level 2 refers to fair values estimated using significant other observable inputs, and Level 3 includes fair values estimated using significant non-observable inputs. The following tables present the Company's financial assets and liabilities measured on a recurring basis using the fair value hierarchy at December 31, 2022 and March 31, 2022 (in thousands):
| Fair Value Measurements at | |||||||||||||||||||||||
| December 31, 2022 | |||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||
| ASSETS: | |||||||||||||||||||||||
| Cash and cash equivalents | $ | $ | $ | $ | |||||||||||||||||||
| U.S. government and municipal obligations | |||||||||||||||||||||||
| Commercial paper | |||||||||||||||||||||||
| Corporate bonds | |||||||||||||||||||||||
| Certificate of deposits | |||||||||||||||||||||||
| Derivative financial instruments | |||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||
| LIABILITIES: | |||||||||||||||||||||||
| Derivative financial instruments | $ | $ | ( | $ | $ | ( | |||||||||||||||||
| $ | $ | ( | $ | $ | ( | ||||||||||||||||||
| Fair Value Measurements at | |||||||||||||||||||||||
| March 31, 2022 | |||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||
| ASSETS: | |||||||||||||||||||||||
| Cash and cash equivalents | $ | $ | $ | $ | |||||||||||||||||||
| U.S. government and municipal obligations | |||||||||||||||||||||||
| Commercial paper | |||||||||||||||||||||||
| Corporate bonds | |||||||||||||||||||||||
| Certificate of deposits | |||||||||||||||||||||||
| Derivative financial instruments | |||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||
| LIABILITIES: | |||||||||||||||||||||||
| Derivative financial instruments | $ | $ | ( | $ | $ | ( | |||||||||||||||||
| $ | $ | ( | $ | $ | ( | ||||||||||||||||||
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 they are valued using observable inputs other than Level 1 quoted prices that are observable for the asset or liability, either directly or indirectly, including quoted prices for similar assets or liabilities in active markets, or quoted prices for identical or similar assets in markets that are not active.
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NOTE 7 – INVENTORIES
| December 31, 2022 | March 31, 2022 | ||||||||||
| Raw materials | $ | $ | |||||||||
| Work in process | |||||||||||
| Finished goods | |||||||||||
| Deferred costs | |||||||||||
| $ | $ | ||||||||||
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, 2022 using the qualitative assessment as the Company concluded that it was more likely than not that the fair value of the reporting unit exceeded its carrying value.
At December 31, 2022 and March 31, 2022, the carrying amount of goodwill was $1.7
The following table summarizes the changes in the carrying amount of goodwill for the nine months ended December 31, 2022 as follows (in thousands):
| Balance at March 31, 2022 | $ | ||||
| Foreign currency translation impact | |||||
| Balance at December 31, 2022 | $ | ||||
Intangible Assets
The net carrying amounts of intangible assets were $382.3 million and $433.4 million at December 31, 2022 and March 31, 2022, 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.
Intangible assets include the following amortizable intangible assets at December 31, 2022 (in thousands):
| Estimated Useful Life in Years | Cost | Accumulated Amortization | Net | ||||||||||||||||||||
| Developed technology | $ | $ | ( | $ | |||||||||||||||||||
| Customer relationships | ( | ||||||||||||||||||||||
| Distributor relationships and technology licenses | ( | ||||||||||||||||||||||
| Definite-lived trademark and trade name | ( | ||||||||||||||||||||||
| Core technology | ( | ||||||||||||||||||||||
| Non-compete agreements | ( | ||||||||||||||||||||||
| Capitalized software | ( | ||||||||||||||||||||||
| Other | ( | ||||||||||||||||||||||
| $ | $ | ( | $ | ||||||||||||||||||||
15
Intangible assets include the following amortizable intangible assets at March 31, 2022 (in thousands):
| Estimated Useful Life in Years | Cost | Accumulated Amortization | Net | ||||||||||||||||||||
| Developed technology | $ | $ | ( | $ | |||||||||||||||||||
| Customer relationships | ( | ||||||||||||||||||||||
| Distributor relationships and technology licenses | ( | ||||||||||||||||||||||
| Definite-lived trademark and trade name | ( | ||||||||||||||||||||||
| Core technology | ( | ||||||||||||||||||||||
| Non-compete agreements | ( | ||||||||||||||||||||||
| Capitalized software | ( | ||||||||||||||||||||||
| Other | ( | ||||||||||||||||||||||
| $ | $ | ( | $ | ||||||||||||||||||||
Amortization included as cost of product revenue consists of amortization of developed technology, distributor relationships and technology licenses, core technology and software. Amortization included as operating expense consists of all other intangible assets. The following table provides a summary of amortization expense for the three and nine months ended December 31, 2022 and 2021, respectively (in thousands):
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Amortization of intangible assets included as: | |||||||||||||||||||||||
| Cost of product revenue | $ | $ | $ | $ | |||||||||||||||||||
| Operating expense | |||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||
The following is the expected future amortization expense at December 31, 2022 for the fiscal years ending March 31 (in thousands):
| 2023 (remaining three months) | $ | ||||
| 2024 | |||||
| 2025 | |||||
| 2026 | |||||
| 2027 | |||||
| Thereafter | |||||
| $ | |||||
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.
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All of the Company's derivative instruments are utilized for risk management purposes, and the Company does not use derivatives for speculative trading purposes. These contracts will mature over the next twelve months and are expected to impact earnings on or before maturity.
The notional amounts and fair values of derivative instruments in the consolidated balance sheets at December 31, 2022 and March 31, 2022 were as follows (in thousands):
| Notional Amounts (a) | Prepaid Expenses and Other Current Assets | Accrued Other | |||||||||||||||||||||||||||||||||
| December 31, 2022 | March 31, 2022 | December 31, 2022 | March 31, 2022 | December 31, 2022 | March 31, 2022 | ||||||||||||||||||||||||||||||
| Derivatives Designated as Hedging Instruments: | |||||||||||||||||||||||||||||||||||
| Forward contracts | $ | $ | $ | $ | $ | $ | |||||||||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||||||||||||||
(a) Notional amounts represent the gross contract/notional amount of the derivatives outstanding.
The following table provides the effect that foreign exchange forward contracts designated as hedging instruments had on other comprehensive income (OCI) and results of operations for the three months ended December 31, 2022 and 2021 (in thousands):
| Gain Recognized in OCI on Derivative (a) | Gain (Loss) Reclassified from Accumulated OCI into Income (b) | ||||||||||||||||||||||||||||
| December 31, 2022 | December 31, 2021 | Location | December 31, 2022 | December 31, 2021 | |||||||||||||||||||||||||
| Forward contracts | $ | $ | Research and development | $ | $ | ( | |||||||||||||||||||||||
| Sales and marketing | |||||||||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||||||||
(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 that foreign exchange forward contracts designated as hedging instruments had on other comprehensive income (OCI) and results of operations for the nine months ended December 31, 2022 and 2021 (in thousands):
| Gain (Loss) Recognized in OCI on Derivative (a) | Gain (Loss) Reclassified from Accumulated OCI into Income (b) | ||||||||||||||||||||||||||||
| December 31, 2022 | December 31, 2021 | Location | December 31, 2022 | December 31, 2021 | |||||||||||||||||||||||||
| Forward contracts | $ | ( | $ | Research and development | $ | $ | ( | ||||||||||||||||||||||
| Sales and marketing | ( | ||||||||||||||||||||||||||||
| $ | ( | $ | $ | $ | ( | ||||||||||||||||||||||||
(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 that foreign exchange forward contracts not designated as hedging instruments had on the Company's results of operations for the nine months ended December 31, 2022 and 2021 (in thousands):
| Loss Recognized in Income (a) | |||||||||||||||||||||||||||||
| Location | December 31, 2022 | December 31, 2021 | |||||||||||||||||||||||||||
| Forward contracts | General and administrative | $ | $ | ( | |||||||||||||||||||||||||
| $ | $ | ( | |||||||||||||||||||||||||||
(a)The amount represents the change in fair value of derivative contracts due to changes in spot rates.
17
NOTE 10 – LONG-TERM DEBT
On July 27, 2021, the Company amended and extended the Amended Credit Agreement (Second Amended and Restated Credit Agreement) with a syndicate of lenders by and among: the Company; JPMorgan Chase Bank, N.A. (JPMorgan), as administrative agent and collateral agent; JPMorgan, Wells Fargo Securities, LLC, BofA Securities Inc., RBC Capital Markets, PNC Capital Markets LLC and Mizuho Bank, Ltd., as joint lead arrangers and joint bookrunners; Santander Bank, N.A., U.S. Bank National Association, Fifth Third Bank National Association, Silicon Valley Bank and TD Bank, N.A., as co-documentation agents; and the lenders party thereto.
The Second Amended and Restated Credit Agreement provides for a five-year , $800.0 million senior secured revolving credit facility, including a letter of credit sub-facility of up to $75.0 million. The Company may elect to use the credit facility for general corporate purposes (including to finance the repurchase of shares of the Company's common stock). The commitments under the Second Amended and Restated Credit Agreement will expire on July 27, 2026, and any outstanding loans will be due on that date.
In connection with the Second Amended and Restated Credit Agreement, during the fiscal year ended March 31, 2022, the Company paid off the outstanding balance of $350 million under the Amended Credit Agreement by borrowing the same amount under the Second Amended and Restated Credit Agreement. Additionally, the Company recorded a loss on the extinguishment of debt of $0.6 million, representing the write off of unamortized deferred financing costs, which was included in interest expense in the consolidated statements of operations for the fiscal year ended March 31, 2022. On May 9, 2022, the Company repaid $150.0 million of borrowings under the Second Amended and Restated Credit Agreement. At December 31, 2022, $200 million was outstanding under the Second Amended and Restated Credit Agreement.
At the Company's election, revolving loans under the Second Amended and Restated Credit Agreement bear interest at either (a) an Alternate Base Rate per annum equal to the greatest of (1) the Wall Street Journal prime rate; (2) the New York Federal Reserve Bank (NYFRB) rate plus 0.50 %, or (3) an adjusted one month LIBO rate plus 1 %; or (b) a Term Benchmark Borrowing rate (for the interest period selected by the Company, subject to customary provisions regarding succession from LIBO rate to SOF rate in anticipation of the upcoming discontinuation of the LIBO rate), in each case plus an applicable margin. For the period from the delivery of the Company's financial statements for the quarter ended September 30, 2022, until the Company has delivered financial statements for the quarter ended December 31, 2022, the applicable margin will be 1.00 % per annum for Term Benchmark Revolving loans and 0 % per annum for Alternate Base Rate loans, and thereafter the applicable margin will vary depending on the Company's consolidated gross leverage ratio, ranging from 1.00 % per annum for Alternate Base Rate loans and 2.00 % per annum for Term Benchmark Revolving loans if the Company's consolidated gross leverage ratio is greater than 3.50 to 1.00, down to 0 % per annum for Alternate Base Rate loans and 1.00 % per annum for Term Benchmark Revolving loans if the Company's consolidated gross leverage ratio is equal to or less than 1.50 to 1.00.
The Company's consolidated gross leverage ratio is the ratio of its consolidated total debt compared to its consolidated EBITDA as defined in the Second Amended and Restated Credit Agreement (adjusted consolidated EBITDA). Adjusted consolidated EBITDA includes certain adjustments, including, without limitation, adjustments relating to extraordinary, unusual or non-recurring charges, certain restructuring charges, non-cash charges, certain transaction costs and expenses and certain pro forma adjustments in connection with material acquisitions and dispositions, all as set forth in detail in the Second Amended and Restated Credit Agreement.
Commitment fees will accrue on the daily unused amount of the credit facility. For the period from the delivery of the Company's financial statements for the quarter ended September 30, 2022, until the Company has delivered financial statements for the quarter ended December 31, 2022, the commitment fee will be 0.15 % per annum, and thereafter the commitment fee will vary depending on the Company's consolidated gross leverage ratio, ranging from 0.30 % per annum if the Company's consolidated gross leverage ratio is greater than 2.75 to 1.00, down to 0.15 % per annum if the Company's consolidated gross leverage ratio is equal to or less than 1.50 to 1.00.
Letter of credit participation fees are payable to each lender providing the letter of credit sub-facility on the amount of such lender's letter of credit exposure, during the period from the closing date of the Second Amended and Restated Credit Agreement to, but excluding, the date which is the later of (i) the date on which such lender's commitment terminates or (ii) the date on which such lender ceases to have any letter of credit exposure, at the applicable rate that would be used to determine the interest rate applicable to Term Benchmark Revolving loans assuming such loans were outstanding during the period. Additionally, the Company will pay a fronting fee to each issuing bank in amounts to be agreed to between the Company and the applicable issuing bank.
Interest on Alternate Base Rate loans is payable at the end of each calendar quarter. Interest on Term Benchmark Revolving loans is payable at the end of each interest rate period or at the end of each three-month interval within an interest
18
rate period if the period is longer than three months. The Company may also prepay loans under the Second Amended and Restated Credit Agreement at any time, without penalty, subject to certain notice requirements.
The loans and other obligations under the credit facility are (a) guaranteed by each of the Company’s wholly-owned material domestic restricted subsidiaries, subject to certain exceptions, and (b) are secured by substantially all of the assets of the Company and the subsidiary guarantors, including a pledge of all the capital stock of material subsidiaries held directly by the Borrower and the subsidiary guarantors (which pledge, in the case of any foreign subsidiary, is limited to 65 % of the voting stock), subject to certain customary exceptions and limitations. The Second Amended and Restated Credit Agreement generally prohibits any other liens on the assets of the Company and its restricted subsidiaries, subject to certain exceptions as described in the Second Amended and Restated Credit Agreement.
The Second Amended and Restated Credit Agreement contains certain covenants applicable to the Company and its restricted subsidiaries, including, without limitation, limitations on additional indebtedness, liens, various fundamental changes, dividends and distributions, investments (including acquisitions), transactions with affiliates, asset sales, including sale-leaseback transactions, speculative hedge agreements, payment of junior financing, changes in business and other limitations customary in senior secured credit facilities. The Second Amended and Restated Credit Agreement requires the Company to maintain a certain consolidated net leverage ratio and removes the previous requirement under the Amended Credit Agreement that the Company maintain a minimum consolidated interest coverage ratio. The Company's consolidated net leverage ratio is the ratio of its Consolidated Total Debt minus the lesser of unrestricted cash and 125 % of adjusted consolidated EBITDA compared to its adjusted consolidated EBITDA. The Company’s maximum consolidated net leverage ratio is 4.00 to 1.00. These covenants and limitations are more fully described in the Second Amended and Restated Credit Agreement. As of December 31, 2022, the Company was in compliance with all covenants, including the specified total consolidated net leverage ratio range of 4.00 to 1.00.
The Second Amended and Restated Credit Agreement provides that events of default will exist in certain circumstances, including failure to make payment of principal or interest on the loans when required, failure to perform certain obligations under the Second Amended and Restated Credit Agreement and related documents including a failure to meet the maximum total consolidated net leverage ratio covenant, defaults under certain other indebtedness, certain insolvency events, certain events arising under ERISA, a change of control and certain other events. Upon an event of default, the administrative agent with the consent of, or at the request of, the holders of more than 50 % in principal amount of the loans and commitments, may terminate the commitments and accelerate the maturity of the loans and enforce certain other remedies under the Second Amended and Restated Credit Agreement and the other loan documents.
NOTE 11 – RESTRUCTURING CHARGES
During the first quarter of fiscal year 2023, the Company restructured certain departments to better align functions resulting in the termination of eighteen employees. As a result of the workforce reduction, during the nine months ended December 31, 2022, the Company recorded a restructuring charge totaling $1.9 million related to one-time employee-related termination benefits for the employees that were notified of their termination during the period. The one-time termination benefits are expected to be paid in full during the fiscal year ending March 31, 2023.
| Q1FY23 Plan | |||||
| Balance at March 31, 2022 | $ | ||||
| Restructuring charges to operations | |||||
| Cash payments | ( | ||||
| Other adjustments | ( | ||||
| Balance at December 31, 2022 | $ | ||||
NOTE 12 - LEASES
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obligation to make lease payments over the lease term. The Company's policy is to combine lease and non-lease components and to not recognize ROU assets and lease liabilities for short-term leases. Leases with an initial term of twelve months or less are classified as short-term leases. 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 8 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.
The Company has an obligation to return certain leased facilities to their original condition at the end of the respective lease term. These obligations were not material to the Company's financial statements for all periods presented.
Most of the Company's lease agreements contain variable payments, primarily for common area maintenance (CAM), which are expensed as incurred and not included in the measurement of the ROU assets and lease liabilities.
The components of operating lease cost for the three and nine months ended December 31, 2022 and 2021, respectively, were as follows (in thousands):
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Lease cost under long-term operating leases | $ | $ | $ | $ | |||||||||||||||||||
| Lease cost under short-term operating leases | |||||||||||||||||||||||
| Variable lease cost under short-term and long-term operating leases | |||||||||||||||||||||||
| Total operating lease cost | $ | $ | $ | $ | |||||||||||||||||||
The table below presents supplemental cash flow information related to leases during the nine months ended December 31, 2022 and 2021 (in thousands):
| December 31, 2022 | December 31, 2021 | ||||||||||
| Right-of-use assets obtained in exchange for new operating lease liabilities | $ | $ | |||||||||
At December 31, 2022 and March 31, 2022, the weighted average remaining lease term in years and weighted average discount rate were as follows:
| December 31, 2022 | March 31, 2022 | ||||||||||
| Weighted average remaining lease term in years - operating leases | |||||||||||
| Weighted average discount rate - operating leases | % | % | |||||||||
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Future minimum payments under non-cancellable leases at December 31, 2022 are as follows (in thousands):
| Year ending March 31: | |||||
| 2023 (remaining three months) | $ | ||||
| 2024 | |||||
| 2025 | |||||
| 2026 | |||||
| 2027 | |||||
| Thereafter | |||||
| Total lease payments | $ | ||||
| Less imputed interest | ( | ||||
| Present value of lease liabilities | $ | ||||
NOTE 13 – COMMITMENTS AND CONTINGENCIES
From time to time, NetScout is subject to legal proceedings and claims in the ordinary course of business. In the opinion of management, the amount of ultimate expense with respect to any current legal proceedings and claims, if determined adversely, will not have a material adverse effect on the Company's financial condition, results of operations or cash flows.
As previously disclosed, in March 2016, Packet Intelligence LLC (Packet Intelligence or Plaintiff) filed a Complaint against NetScout and two subsidiary entities in the United States District Court for the Eastern District of Texas asserting infringement of five United States patents. Plaintiff's Complaint alleged that legacy Tektronix GeoProbe products, including the G10 and GeoBlade products, infringed these patents. NetScout filed an Answer denying Plaintiff's allegations and asserting that Plaintiff's patents were, among other things, invalid, not infringed, and unenforceable due to inequitable conduct. In October 2017, a jury trial was held to address the parties' claims and counterclaims regarding infringement of three patents by the G10 and GeoBlade products, invalidity of these patents, and damages. In October 2017, the jury rendered a verdict finding in favor of the Plaintiff and that Plaintiff was entitled to $3,500,000 for pre-suit damages and $2,250,000 for post-suit damages. The jury indicated that the awarded damages amounts were intended to reflect a running royalty. In September 2018, the Court entered judgment and "enhanced" the jury verdict in the amount of $2.8 million as a result of a jury finding. The judgment also awarded pre- and post-judgment interest, and a running royalty on the G10 and GeoBlade products until the expiration of the patents at issue, the last date being June 2022. Following the entry of final judgment, NetScout appealed, and in July 2020, the Court of Appeals for the Federal Circuit (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. In March 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. In addition, on September 8 and 9, 2021, in proceedings initiated by third parties that did not involve NetScout, the Patent Trial and Appeal Board (PTAB) invalidated all the patent claims that were also asserted against NetScout in this case. After the PTAB decisions were issued, NetScout moved, among other things, to dismiss the case and enter judgment in its favor on the grounds that the PTAB decisions invalidating the asserted claims precluded Plaintiff from continuing to assert its patent infringement causes of action and from seeking damages from NetScout. The District Court denied NetScout’s motion with respect to its request to dismiss the case and enter judgment in its favor, but in response to alternative requests for relief requested by NetScout, vacated $1.7 million of the "enhanced" jury verdict amount of $2.8 million and also lowered the ongoing royalty rate on the G10 and GeoBlade products. The District Court entered an amended final judgment awarding Plaintiff $2.25 million in post-suit damages, $1.1 million in enhanced damages, 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 expiration date being June 2022. On July 20, 2022, NetScout filed a notice of appeal to the Court of Appeals for the Federal Circuit from, among other things, the amended final judgment. The amended judgment is stayed pending the resolution of the appeal. In view of the current circumstances, and if the post-suit and enhanced damages award along with the associated interest and royalties survives the recent PTAB invalidation decisions and NetScout's appeal, NetScout has concluded that the risk of loss associated with such damages award remains "probable" in accounting terms, and that the risk of loss associated with pre-suit damages is remote.
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NOTE 14 – PENSION BENEFIT PLANS
Certain of the Company's non-U.S. employees participate in noncontributory defined benefit pension plans. No ne 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.
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Service cost | $ | $ | $ | $ | |||||||||||||||||||
| Interest cost | |||||||||||||||||||||||
| Net periodic pension cost | $ | $ | $ | $ | |||||||||||||||||||
Expected Contributions
During the nine months ended December 31, 2022, the Company made contributions of $0.3 million to its defined benefit pension plans. During the fiscal year ending March 31, 2023, 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 15 – TREASURY STOCK
On October 24, 2017, the Company's Board of Directors approved a share repurchase program that enabled the Company to repurchase up to twenty-five million shares of its common stock (2017 Share Repurchase Program). This program became effective when the Company's previously disclosed twenty million share repurchase program was completed. The Company was not obligated to acquire any specific amount of common stock within any particular timeframe as a result of this share repurchase program. Through December 31, 2022, the Company repurchased a total of 23,790,847 shares for $660.4 million in the open market under the 2017 Share Repurchase Program, and at December 31, 2022, 1,209,153 shares of common stock remained available to be purchased under the 2017 Share Repurchase Program. The Company repurchased 4,549,329 and 1,330,678 shares for $150.0 million and $35.7 million under the 2017 Share Repurchase Program during the nine months ended December 31, 2022 and 2021, respectively.
On May 3, 2022, the Company's Board of Directors approved a new share repurchase program that enables the Company to repurchase up to twenty-five million shares of its common stock (2022 Share Repurchase Program). The 2022 Share Repurchase Program will become effective once the 2017 Share Repurchase Program is completed. The Company is not obligated to acquire any specific amount of common stock within any particular timeframe as a result of the 2022 Share Repurchase Program.
On May 9, 2022, the Company entered into accelerated share repurchase (ASR) agreements with Mizuho Markets Americas LLC (Mizuho) and Wells Fargo Bank, National Association (Wells Fargo) (collectively, the Dealers) to repurchase an aggregate of $150 million of the Company's common stock via accelerated stock repurchase transactions under the 2017 Share Repurchase Program. Under the terms of the ASR, the Company made a $75 1,627,907 3,255,814 shares in the aggregate, which was approximately 70 percent of the total number of shares of the Company's common stock expected to be repurchased under the ASR agreements. These shares reduced the number of shares of the Company's common stock available for repurchase under the 2017 Share Repurchase Program. Final settlement of the ASR agreements was completed in November 2022. As a result, the Company received an additional 651,213 shares from Mizuho and 642,302 shares from Wells Fargo, or 1,293,515 shares in the aggregate, for $47.9 million, which reduced the number of shares of the Company's common stock available to be repurchased under the 2017 Share Repurchase Program. In total, 4,549,329 shares of the Company's common stock were repurchased under the ASR agreements at an average cost per share of $32.97 during the nine months ended December 31, 2022.
In connection with the delivery of shares of the Company's common stock upon vesting of restricted stock units, the Company withheld 555,651 shares and 531,725 shares at a cost of $19.2 million and $15.2 million, respectively, related to minimum statutory tax withholding requirements on these restricted stock units during the nine months ended December 31, 2022 and 2021, respectively. These withholding transactions do not fall under the share repurchase programs described above, and therefore do not reduce the number of shares that are available for repurchase under those programs.
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NOTE 16 – NET INCOME PER SHARE
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Numerator: | |||||||||||||||||||||||
| Net income | $ | $ | $ | $ | |||||||||||||||||||
| Denominator: | |||||||||||||||||||||||
| Denominator for basic net income per share - weighted average common shares outstanding | |||||||||||||||||||||||
| Dilutive common equivalent shares: | |||||||||||||||||||||||
| Weighted average restricted stock units and performance-based restricted stock units | |||||||||||||||||||||||
| Denominator for diluted net income per share - weighted average shares outstanding | |||||||||||||||||||||||
| Net income per share: | |||||||||||||||||||||||
| Basic net income per share | $ | $ | $ | $ | |||||||||||||||||||
| Diluted net income per share | $ | $ | $ | $ | |||||||||||||||||||
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Restricted stock units | |||||||||||||||||||||||
Basic net income per share is calculated by dividing net income by the weighted average number of shares outstanding during the period. Unvested restricted shares, although legally issued and outstanding, are not considered outstanding for purposes of calculating basic earnings per share. Diluted net income per share is calculated by dividing net income by the weighted average number of shares outstanding plus the dilutive effect, if any, of outstanding stock options, restricted shares and restricted stock units using the treasury stock method. The calculation of the dilutive effect of outstanding equity awards under the treasury stock method includes consideration of proceeds from the assumed exercise of stock options and unrecognized compensation expense as additional proceeds.
NOTE 17 – INCOME TAXES
Generally, the Company's effective tax rate differs from the U.S. federal statutory income tax rate primarily due to foreign withholding taxes and U.S. taxation on foreign earnings, partially offset by research and development tax credits, foreign tax credits, stock related compensation and the foreign derived intangible income deduction.
The Company's effective tax rates were 13.1 % and 14.2 % for the three months ended December 31, 2022 and 2021, respectively. The effective tax rate for the three months ended December 31, 2022 differed from the effective tax rate for the three months ended December 31, 2021 primarily due to research and development tax credits, foreign tax credits, the foreign derived intangible income deduction, and U.S. taxation of foreign earnings.
The Company's effective tax rates were 9.5 % and 15.5 % for the nine months ended December 31, 2022 and 2021, respectively. The effective tax rate for the nine months ended December 31, 2022 differed from the effective tax rate for the nine months ended December 31, 2021 primarily due to research and development tax credits, foreign tax credits, the foreign derived intangible income deduction, and U.S. taxation of foreign earnings, as well as a discrete benefit from stock compensation during the nine months ended December 31, 2022.
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NOTE 18 – SEGMENT AND GEOGRAPHIC INFORMATION
The Company reports revenues and income under one reportable segment.
The Company manages its business in the following geographic areas: United States, Europe, Asia and the rest of the world. The Company's policies mandate compliance with economic sanctions and the export controls.
| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| United States | $ | $ | $ | $ | |||||||||||||||||||
| Europe | |||||||||||||||||||||||
| Asia | |||||||||||||||||||||||
| Rest of the world | |||||||||||||||||||||||
| $ | $ | $ | $ | ||||||||||||||||||||
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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, 2022, 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, 2022. These risks and uncertainties could cause actual results to differ significantly from those projected in forward-looking statements contained in this report or implied by past results and trends. Forward-looking statements are statements that attempt to forecast or anticipate future developments in our business, financial condition or results of operations. See the section titled "Cautionary Statement Concerning Forward-Looking Statements" that appears at the beginning of this Quarterly Report. These statements, like all statements in this report, speak only as of the date of this Quarterly Report (unless another date is indicated), and, except as required by law, we undertake no obligation to update or revise these statements in light of future developments.
Overview
We are an industry leader with over three decades of experience in providing service assurance and cybersecurity solutions that are based on our pioneering deep packet inspection technology at scale, which is used by customers worldwide to protect their digital business services against disruption. Service providers and enterprises, including local, state and federal government agencies, rely on our solutions to achieve the visibility and protection necessary to optimize network performance, ensure the delivery of high-quality, mission-critical applications and services, gain timely insight into the end user experience and protect their networks from attack. With our offerings, customers can quickly, efficiently and effectively identify and resolve issues that result in downtime, interruptions to services, poor service quality or compromised data, thereby reducing meantime-to-resolution of issues and driving compelling returns on their investments in their networks and broader technology initiatives. Some of the more significant technology trends and catalysts for our business include the evolution of customers' digital transformation initiatives such as the migration to cloud environments, the rapidly evolving cybersecurity threat landscape, business intelligence and analytics advancements, and the 5G evolution in both the service provider and enterprise customer verticals.
Our operating results are influenced by a number of factors, including, but not limited to, the mix and quantity of products and services sold, pricing, costs and availability of materials used in our products, growth in employee-related costs, including commissions, and the expansion of our operations. Factors that affect our ability to maximize our operating results include, but are not limited to, our ability to introduce and enhance existing products, the marketplace acceptance of those new or enhanced products, continued expansion into international markets, expansion into new or adjacent markets, development of strategic partnerships, competition, successful acquisition integration efforts, and our ability to control costs and make improvements in a highly competitive industry.
In response to the Russian military operations in Ukraine, we have ceased business operations in Russia, including sales, support on existing contracts and professional services. The United States and other countries have imposed sanctions on Russia that could impact our future revenue streams. These events did not have a material impact on our financial statements for the nine months ended December 31, 2022. We will continue to monitor the impact of these events on all aspects of our business.
Global and Macroeconomic Conditions
We continue to closely monitor current global and macroeconomic conditions, including the impact of the war in Ukraine, global geopolitical tension, stock market volatility, exchange rate fluctuations, rising inflation and interest rates, the risk of a recession, and the coronavirus (COVID-19) pandemic on all aspects of our business, including the manner and extent to which they have impacted and could continue to impact our customers, employees, supply chain, and distribution network. The impacts of these global and macroeconomic trends and the COVID-19 pandemic remain uncertain. For fiscal year 2022 and the first nine months of fiscal year 2023, we observed that technology and project spending resumed and we focused on advancing our products, growing revenue, enhancing earnings per share, and generating free cash flow.
Though we continue to monitor these impacts, we believe our current cash reserves and access to capital through our revolving credit facility leave us well-positioned to manage our business in today's environment. We expect net cash provided by operations combined with cash, cash equivalents and marketable securities and borrowing availability under our revolving credit facility to provide sufficient liquidity to fund current obligations, capital spending, debt service requirements and working capital requirements over at least the next twelve months. We continue to take actions to manage costs and increase productivity throughout our company but will invest in areas that advance our business for the future, as necessary. In addition to our cash equivalents, based on covenant levels at December 31, 2022, we had, as of December 31, 2022, an incremental $600 million available to us under our revolving credit facility.
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Results Overview
Total revenue increased $42.1 million for the nine months ended December 31, 2022 as compared to total revenue for the nine months ended December 31, 2021 primarily due to an increase in revenue from our radio frequency propagation modeling projects from service provider customers.
Our gross profit percentage increased by one percentage point to 76% during the nine months ended December 31, 2022, as compared with the nine months ended December 31, 2021.
Net income for the nine months ended December 31, 2022 was $62.9 million, as compared with a net income for the nine months ended December 31, 2021 of $44.3 million, an increase of $18.6 million. The increase in net income was primarily due to a $42.1 million increase in revenue, a $6.5 million decrease in amortization of intangible assets, a $5.4 million decrease in direct material costs, a $3.0 million decrease in employee-related costs, a $2.4 million increase in interest income, a $2.3 million decrease in inventory obsolescence charges, a $1.5 million decrease in income tax expense, and a $1.5 million decrease in depreciation expense. These increases to net income were partially offset by a $15.6 million increase in costs to deliver radio frequency propagation modeling projects, an $8.1 million increase in expenses related to trade shows, user conferences and other events, a $7.6 million increase in travel expense attributable to the lifting of some COVID-19 related restrictions, a $2.7 million increase in commissions expense, a $1.8 million increase in contractor fees, a $1.8 million increase in restructuring expense, a $1.6 million increase in foreign exchange expense, a $1.1 million decrease in other income, and a $1.0 million increase in recruiting costs.
At December 31, 2022, we had cash, cash equivalents and marketable securities (current and non-current) of $416.2 million. This represents a decrease of $287.0 million from $703.2 million at March 31, 2022. This decrease was primarily due to $150.0 million used in treasury stock repurchases under an ASR program, $150.0 million used to repay long-term debt, $19.2 million used for tax withholdings on restricted stock units, and $8.4 million used for capital expenditures. These decreases were partially offset by $43.9 million of net cash provided by operations during the nine months ended December 31, 2022.
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 gross profit, non-GAAP income from operations, non-GAAP net income, non-GAAP net income per share (diluted) and non-GAAP earnings before interest and other expense, income taxes, depreciation, and amortization (EBITDA) from operations. Non-GAAP gross profit 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, restructuring charges, transitional service agreement expenses, and legal expenses related to civil judgments. Non-GAAP net income includes the foregoing adjustments related to non-GAAP income from operations, and also removes loss on extinguishment of debt and change in fair value of contingent consideration, net of related income tax effects. Non-GAAP diluted net income per share removes the share impact of non-GAAP adjustments utilized in the calculation of non-GAAP net income. 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 gross profit, income from operations, net income and net income per share on a GAAP and non-GAAP basis for the three and nine months ended December 31, 2022 and 2021, respectively (in thousands, except for per share amounts):
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| Three Months Ended | Nine Months Ended | ||||||||||||||||||||||
| December 31, | December 31, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Revenue (GAAP and non-GAAP) | $ | 269,544 | $ | 262,194 | $ | 706,437 | $ | 66,384 | |||||||||||||||
| GAAP gross profit | $ | 212,742 | $ | 201,724 | $ | 534,280 | $ | 497,860 | |||||||||||||||
| Share-based compensation expense | 2,043 | 1,516 | 6,475 | 5,631 | |||||||||||||||||||
| Amortization of acquired intangible assets | 2,315 | 3,342 | 6,955 | 10,054 | |||||||||||||||||||
| Acquisition related depreciation expense | 5 | 6 | 16 | 18 | |||||||||||||||||||
| Non-GAAP gross profit | $ | 217,105 | $ | 206,588 | $ | 547,726 | $ | 513,563 | |||||||||||||||
| GAAP income from operations | $ | 63,750 | $ | 55,455 | $ | 76,026 | $ | 56,953 | |||||||||||||||
| Share-based compensation expense | 15,143 | 12,681 | 47,225 | 43,381 | |||||||||||||||||||
| Amortization of acquired intangible assets | 16,133 | 18,261 | 48,455 | 54,949 | |||||||||||||||||||
| Business development and integration expense | — | — | — | (5) | |||||||||||||||||||
| Compensation for post-combination services | — | — | — | 2 | |||||||||||||||||||
| Restructuring charges | 89 | — | 1,803 | — | |||||||||||||||||||
| Acquisition related depreciation expense | 59 | 65 | 183 | 189 | |||||||||||||||||||
| Transitional service agreement expense | — | 697 | — | 814 | |||||||||||||||||||
| Legal expenses related to civil judgments | 426 | — | 426 | — | |||||||||||||||||||
| Non-GAAP income from operations | $ | 95,600 | $ | 87,159 | $ | 174,118 | $ | 156,283 | |||||||||||||||
| GAAP net income | $ | 52,618 | $ | 47,725 | $ | 62,869 | $ | 44,280 | |||||||||||||||
| Share-based compensation expense | 15,143 | 12,681 | 47,225 | 43,381 | |||||||||||||||||||
| Amortization of acquired intangible assets | 16,133 | 18,261 | 48,455 | 54,949 | |||||||||||||||||||
| Business development and integration expense | — | — | — | (5) | |||||||||||||||||||
| Compensation for post-combination services | — | — | — | 2 | |||||||||||||||||||
| Restructuring charges | 89 | — | 1,803 | — | |||||||||||||||||||
| Acquisition-related depreciation expense | 59 | 65 | 183 | 189 | |||||||||||||||||||
| Legal expenses related to civil judgments | 426 | — | 426 | — | |||||||||||||||||||
| Loss on extinguishment of debt | — | — | — | 596 | |||||||||||||||||||
| Change in fair value of contingent consideration | — | (837) | — | (837) | |||||||||||||||||||
| Income tax adjustments | (11,449) | (11,398) | (28,585) | (25,802) | |||||||||||||||||||
| Non-GAAP net income | $ | 73,019 | $ | 66,497 | $ | 132,376 | $ | 116,753 | |||||||||||||||
| GAAP diluted net income per share | $ | 0.72 | $ | 0.64 | $ | 0.86 | $ | 0.59 | |||||||||||||||
| Per share impact of non-GAAP adjustments identified above | 0.28 | 0.25 | 0.95 | 0.97 | |||||||||||||||||||
| Non-GAAP diluted net income per share | $ | 1.00 | $ | 0.89 | $ | 1.81 | $ | 1.56 | |||||||||||||||
| GAAP income from operations | $ | 63,750 | $ | 55,455 | $ | 76,026 | $ | 56,953 | |||||||||||||||
| Previous adjustments to determine non-GAAP income from operations | 31,850 | 31,704 | 98,092 | 99,330 | |||||||||||||||||||
| Non-GAAP income from operations | 95,600 | 87,159 | 174,118 | 156,283 | |||||||||||||||||||
| Depreciation excluding acquisition related | 5,263 | 5,475 | 15,664 | 16,909 | |||||||||||||||||||
| Non-GAAP EBITDA from operations | $ | 100,863 | $ | 92,634 | $ | 189,782 | $ | 173,192 | |||||||||||||||
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Critical Accounting Policies and Estimates
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; and
•valuation of goodwill, intangible assets and other acquisition accounting items.
Please refer to the critical accounting policies set forth in our Annual Report on Form 10-K for the fiscal year ended March 31, 2022, filed with the Securities and Exchange Commission (SEC) on May 19, 2022, for a description of all of our critical accounting policies and estimates.
Three Months Ended December 31, 2022 and 2021
Revenue
Product revenue consists of sales of our hardware products and licensing of our software products. Service revenue consists of customer support agreements, consulting, training and stand-ready software as a service offerings. During the three months ended December 31, 2022 and 2021, one direct customer, Verizon, accounted for more than 10% of our total revenue, while no indirect channel partners accounted for more than 10% of our total revenue. During the three months ended December 31, 2022 and 2021, the service assurance product line accounted for approximately 79% and 73% of total revenue, respectively, and the cybersecurity product line accounted for approximately 21% and 27% of total revenue, respectively. The service assurance and cybersecurity product line results presented as a percentage of total revenue are not necessarily indicative of future revenue mix.
| Three Months Ended | Change | ||||||||||||||||||||||||||||||||||
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| % of Revenue | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||
| Revenue: | |||||||||||||||||||||||||||||||||||
| Product | $ | 149,452 | 55 | % | $ | 144,420 | 55 | % | $ | 5,032 | 3 | % | |||||||||||||||||||||||
| Service | 120,092 | 45 | 117,774 | 45 | 2,318 | 2 | % | ||||||||||||||||||||||||||||
| Total revenue | $ | 269,544 | 100 | % | $ | 262,194 | 100 | % | $ | 7,350 | 3 | % | |||||||||||||||||||||||
Product. The 3%, or $5.0 million, increase in product revenue compared with the same period last year was primarily due to an increase in revenue from radio frequency propagation modeling projects, partially offset by a decrease in revenue from cybersecurity offerings.
Service. The 2%, or $2.3 million, increase in service revenue compared to the same period last year was primarily due to an increase in revenue from maintenance contracts.
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Total revenue by geography was as follows:
| Three Months Ended | Change | ||||||||||||||||||||||||||||||||||
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| % of Revenue | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||
| United States | $ | 181,206 | 67 | % | $ | 162,794 | 62 | % | $ | 18,412 | 11 | % | |||||||||||||||||||||||
| International: | |||||||||||||||||||||||||||||||||||
| Europe | 35,926 | 13 | 48,620 | 19 | (12,694) | (26) | % | ||||||||||||||||||||||||||||
| Asia | 15,422 | 6 | 14,519 | 5 | 903 | 6 | % | ||||||||||||||||||||||||||||
| Rest of the world | 36,990 | 14 | 36,261 | 14 | 729 | 2 | % | ||||||||||||||||||||||||||||
| Subtotal international | 88,338 | 33 | 99,400 | 38 | (11,062) | (11) | % | ||||||||||||||||||||||||||||
| Total revenue | $ | 269,544 | 100 | % | $ | 262,194 | 100 | % | $ | 7,350 | 3 | % | |||||||||||||||||||||||
United States revenue increased 11%, or $18.4 million, primarily due to an increase in revenue from service provider customers from service assurance offerings and an increase in revenue from radio frequency propagation modeling projects, partially offset by a decrease in revenue from service provider customers from cybersecurity offerings. The 11%, or $11.1 million, decrease in international revenue compared with the same period last year was primarily driven by lower revenue from service provider customers from cybersecurity offerings, as well as service assurance offerings.
Cost of Revenue and Gross Profit
Cost of product revenue consists primarily of material components, manufacturing personnel expenses, packaging materials, overhead and amortization of capitalized software, acquired developed technology and core technology. Cost of service revenue consists primarily of personnel, material, overhead and support costs.
| Three Months Ended | Change | ||||||||||||||||||||||||||||||||||
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| % of Revenue | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||
| Cost of revenue | |||||||||||||||||||||||||||||||||||
| Product | $ | 25,281 | 9 | % | $ | 30,338 | 12 | % | $ | (5,057) | (17) | % | |||||||||||||||||||||||
| Service | 31,521 | 12 | 30,132 | 11 | 1,389 | 5 | % | ||||||||||||||||||||||||||||
| Total cost of revenue | $ | 56,802 | 21 | % | $ | 60,470 | 23 | % | $ | (3,668) | (6) | % | |||||||||||||||||||||||
| Gross profit: | |||||||||||||||||||||||||||||||||||
| Product $ | $ | 124,171 | 46 | % | $ | 114,082 | 44 | % | $ | 10,089 | 9 | % | |||||||||||||||||||||||
| Product gross profit % | 83 | % | 79 | % | |||||||||||||||||||||||||||||||
| Service $ | $ | 88,571 | 33 | % | $ | 87,642 | 33 | % | $ | 929 | 1 | % | |||||||||||||||||||||||
| Service gross profit % | 74 | % | 74 | % | |||||||||||||||||||||||||||||||
| Total gross profit $ | $ | 212,742 | $ | 201,724 | $ | 11,018 | 5 | % | |||||||||||||||||||||||||||
| Total gross profit % | 79 | % | 77 | % | |||||||||||||||||||||||||||||||
Product. The 17%, or $5.1 million, decrease in cost of product revenue for the three months ended December 31, 2022 compared to the same period last year was primarily due to a $3.6 million decrease in costs related to the delivery of radio frequency propagation modeling projects, and a $1.0 million decrease in the amortization of intangible assets. The product gross profit percentage increased by four percentage points to 83% during the three months ended December 31, 2022 as compared with the three months ended December 31, 2021. The 9%, or $10.1 million, increase in product gross profit is attributable to the 3%, or $5.0 million, increase in product revenue, and the 17%, or $5.1 million, decrease in cost of product revenue.
Service. The 5%, or $1.4 million, increase in cost of service revenue for the three months ended December 31, 2022 compared to the same period last year was primarily due to a $0.6 million increase in employee-related costs associated with an
29
increase in variable incentive compensation. The service gross profit percentage remained flat at 74% during the three months ended December 31, 2022 as compared with the three months ended December 31, 2021. The 1%, or $0.9 million, increase in service gross profit is attributable to the 2%, or $2.3 million, increase in service revenue, partially offset by the 5%, or $1.4 million, increase in cost of service revenue.
Gross profit. Our gross profit increased 5%, or $11.0 million, during the three months ended December 31, 2022 when compared with the three months ended December 31, 2021. This increase is attributable to the increase in revenue of 3%, or $7.4 million, and the 6%, or $3.7 million, decrease in cost of revenue. The gross profit percentage increased by two percentage points to 79% for the three months ended December 31, 2022 as compared with the three months ended December 31, 2021.
Operating Expenses
| Three Months Ended | Change | ||||||||||||||||||||||||||||||||||
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| % of Revenue | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||
| Research and development | $ | 42,558 | 16 | % | $ | 41,637 | 16 | % | $ | 921 | 2 | % | |||||||||||||||||||||||
| Sales and marketing | 66,994 | 25 | 66,048 | 25 | 946 | 1 | % | ||||||||||||||||||||||||||||
| General and administrative | 25,533 | 9 | 23,665 | 9 | 1,868 | 8 | % | ||||||||||||||||||||||||||||
| Amortization of acquired intangible assets | 13,818 | 5 | 14,919 | 6 | (1,101) | (7) | % | ||||||||||||||||||||||||||||
| Restructuring charges | 89 | — | — | — | 89 | 100 | % | ||||||||||||||||||||||||||||
| Total operating expenses | $ | 148,992 | 55 | % | $ | 146,269 | 56 | % | $ | 2,723 | 2 | % | |||||||||||||||||||||||
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 2%, or $0.9 million, increase in research and development expenses for the three months ended December 31, 2022 compared to the same period last year was primarily due to a $0.6 million increase in employee-related expenses associated with an increase in variable incentive compensation, and a $0.5 million increase in travel expenses.
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 1%, or $0.9 million, increase in total sales and marketing expenses for the three months ended December 31, 2022 compared to the same period last year was primarily due to a $1.4 million increase in travel expenses primarily attributable to the lifting of COVID-19 related restrictions, and a $0.7 million increase related to trade shows, user conferences and other events. These increases were partially offset by an $0.8 million decrease in contractor fees, and a $0.5 million decrease in commissions expense.
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 8%, or $1.9 million, increase in general and administrative expenses for the three months ended December 31, 2022 compared to the same period last year was primarily due to a $0.9 million increase in employee-related expenses associated with an increase in variable incentive compensation.
Amortization of acquired intangible assets. Amortization of acquired intangible assets consists primarily of amortization of customer relationships, definite-lived trademarks and trade names, and leasehold interests related to our acquisitions of Danaher Corporation's communications business (Comms Transaction), Simena, LLC, Network General Corporation, Avvasi Inc. and Efflux Systems, Inc.
The 7%, or $1.1 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.
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Interest and Other Income (Expense), Net. Interest and other income (expense), net includes interest earned on our cash, cash equivalents and marketable securities, interest expense and other non-operating gains or losses.
| Three Months Ended | Change | ||||||||||||||||||||||||||||||||||
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| % of Revenue | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||
| Interest and other income (expense), net | $ | (3,172) | (1) | % | $ | 177 | — | % | $ | (3,349) | (1,892) | % | |||||||||||||||||||||||
The 1,892%, or $3.3 million, change in interest and other income (expense), net for the three months ended December 31, 2022 compared to the same period last year was primarily due to a $2.0 million increase in foreign exchange expense, a $1.2 million increase in interest expense on the credit facility due to an increase in the average interest rate, an $0.8 million decrease from the change in fair value of contingent consideration, and a $0.7 million decrease in transitional services agreement income related to the HNT tools business divestiture, partially offset by a $1.4 million increase in interest income.
Income Taxes. The effective tax rates were 13.1% and 14.2% for the three months ended December 31, 2022 and 2021, respectively. The effective tax rate for the three months ended December 31, 2022 differed from the effective tax rate for the three months ended December 31, 2021, primarily due to research and development tax credits, foreign tax credits, the foreign derived intangible income deduction, and U.S. taxation of foreign earnings.
| Three Months Ended | Change | ||||||||||||||||||||||||||||||||||
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| % of Revenue | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||
| Income tax expense | $ | 7,960 | 3 | % | $ | 7,907 | 3 | % | $ | 53 | 1 | % | |||||||||||||||||||||||
Nine Months Ended December 31, 2022 and 2021
Revenue
During the nine months ended December 31, 2022 and 2021, one direct customer, Verizon, accounted for more than 10% of our total revenue, while no indirect channel partner accounted for more than 10% of our total revenue. During the nine months ended December 31, 2022 and 2021, the service assurance product line accounted for approximately 75% and 74% of total revenue, respectively, and the cybersecurity product line accounted for approximately 25% and 26% of total revenue, respectively.
| Nine Months Ended | Change | ||||||||||||||||||||||||||||||||||
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| % of Revenue | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||
| Revenue: | |||||||||||||||||||||||||||||||||||
| Product | $ | 359,519 | 51 | % | $ | 327,989 | 49 | % | $ | 31,530 | 10 | % | |||||||||||||||||||||||
| Service | 346,918 | 49 | % | 336,395 | 51 | % | 10,523 | 3 | % | ||||||||||||||||||||||||||
| Total revenue | $ | 706,437 | 100 | % | $ | 664,384 | 100 | % | $ | 42,053 | 6 | % | |||||||||||||||||||||||
Product. The 10%, or $31.5 million, increase in product revenue compared with the same period last year was primarily due to an increase in revenue from our radio frequency propagation modeling projects from service provider customers.
Service. The 3%, or $10.5 million, increase in service revenue compared with the same period last year was primarily due to an increase in revenue from maintenance contracts.
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Total revenue by geography was as follows:
| Nine Months Ended | Change | ||||||||||||||||||||||||||||||||||
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| % of Revenue | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||
| United States | $ | 461,672 | 65 | % | $ | 399,349 | 60 | % | $ | 62,323 | 16 | % | |||||||||||||||||||||||
| International: | |||||||||||||||||||||||||||||||||||
| Europe | 105,013 | 15 | 121,712 | 18 | (16,699) | (14) | % | ||||||||||||||||||||||||||||
| Asia | 44,608 | 7 | 46,835 | 7 | (2,227) | (5) | % | ||||||||||||||||||||||||||||
| Rest of the world | 95,144 | 13 | 96,488 | 15 | (1,344) | (1) | % | ||||||||||||||||||||||||||||
| Subtotal international | 244,765 | 35 | 265,035 | 40 | (20,270) | (8) | % | ||||||||||||||||||||||||||||
| Total revenue | $ | 706,437 | 100 | % | $ | 664,384 | 100 | % | $ | 42,053 | 6 | % | |||||||||||||||||||||||
United States revenue increased 16%, or $62.3 million, primarily due to an increase in revenue from service assurance offerings, including radio frequency propagation modeling projects. The 8%, or $20.3 million, decrease in international revenue compared with the same period last year was primarily driven by lower revenue from service assurance offerings.
Cost of Revenue and Gross Profit
| Nine Months Ended | Change | ||||||||||||||||||||||||||||||||||
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| % of Revenue | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||
| Cost of revenue | |||||||||||||||||||||||||||||||||||
| Product | $ | 77,967 | 11 | % | $ | 73,843 | 11 | % | $ | 4,124 | 6 | % | |||||||||||||||||||||||
| Service | 94,190 | 13 | 92,681 | 14 | 1,509 | 2 | % | ||||||||||||||||||||||||||||
| Total cost of revenue | $ | 172,157 | 24 | % | $ | 166,524 | 25 | % | $ | 5,633 | 3 | % | |||||||||||||||||||||||
| Gross profit: | |||||||||||||||||||||||||||||||||||
| Product $ | $ | 281,552 | 40 | % | $ | 254,146 | 38 | % | $ | 27,406 | 11 | % | |||||||||||||||||||||||
| Product gross profit % | 78 | % | 77 | % | |||||||||||||||||||||||||||||||
| Service $ | $ | 252,728 | 36 | % | $ | 243,714 | 37 | % | $ | 9,014 | 4 | % | |||||||||||||||||||||||
| Service gross profit % | 73 | % | 72 | % | |||||||||||||||||||||||||||||||
| Total gross profit $ | $ | 534,280 | $ | 497,860 | $ | 36,420 | 7 | % | |||||||||||||||||||||||||||
| Total gross profit % | 76 | % | 75 | % | |||||||||||||||||||||||||||||||
Product. The 6%, or $4.1 million, increase in cost of product revenue for the nine months ended December 31, 2022 compared to the same period last year was primarily due to a $15.6 million increase in costs related to the delivery of radio frequency propagation modeling projects. This increase was partially offset by a $5.4 million decrease in direct material costs, a $3.1 million decrease in the amortization of intangible assets, a $2.3 million decrease in obsolescence charges, and a $1.1 million decrease in employee-related costs associated with the timing of certain projects. The product gross profit percentage increased by one percentage point to 78% during the nine months ended December 31, 2022 when compared to the nine months ended December 31, 2021. The 11%, or $27.4 million, increase in product gross profit is attributable to the 10%, or $31.5 million, increase in product revenue, partially offset by the 6%, or $4.1 million, increase in cost of product revenue.
Service. The 2%, or $1.5 million, increase in cost of service revenue for the nine months ended December 31, 2022 compared to the same period last year was primarily due to an $0.8 million increase in employee-related expenses largely due to cost associated with the timing of certain projects as well as an increase in variable incentive compensation, and a $0.6 million increase in travel expense primarily attributable to the lifting of COVID-19 related restrictions. These increases were partially offset by a $0.6 million decrease in cost of materials used to support customers under service contracts. The service gross profit percentage increased by one percentage point to 73% for the nine months ended December 31, 2022 when compared to the nine
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months ended December 31, 2021. The 4%, or $9.0 million, increase in service gross profit is attributable to the 3%, or $10.5 million increase in service revenue, partially offset by the 2%, or $1.5 million, increase in cost of service revenue.
Gross profit. Our gross profit for the nine months ended December 31, 2022 increased 7%, or $36.4 million, compared to the same period last year. This increase is primarily attributable to the increase in revenue of 6%, or $42.1 million, partially offset by the 3%, or $5.6 million, increase in cost of revenue. The gross profit percentage increased by one percentage point to 76% for the nine months ended December 31, 2022 when compared to the nine months ended December 31, 2021.
Operating Expenses
| Nine Months Ended | Change | ||||||||||||||||||||||||||||||||||
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| % of Revenue | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||
| Research and development | $ | 129,932 | 18 | % | $ | 128,940 | 19 | % | $ | 992 | 1 | % | |||||||||||||||||||||||
| Sales and marketing | 209,435 | 30 | 197,191 | 30 | 12,244 | 6 | % | ||||||||||||||||||||||||||||
| General and administrative | 75,584 | 11 | 69,881 | 11 | 5,703 | 8 | % | ||||||||||||||||||||||||||||
| Amortization of acquired intangible assets | 41,500 | 6 | 44,895 | 7 | (3,395) | (8) | % | ||||||||||||||||||||||||||||
| Restructuring charges | 1,803 | — | — | — | 1,803 | 100 | % | ||||||||||||||||||||||||||||
| Total operating expenses | $ | 458,254 | 65 | % | $ | 440,907 | 67 | % | $ | 17,347 | 4 | % | |||||||||||||||||||||||
Research and development. The 1%, or $1.0 million, increase in research and development expenses for the nine months ended December 31, 2022 compared to the same period last year was primarily due to a $1.1 million increase in travel expenses primarily attributable to the lifting of COVID-19 related restrictions, and a $0.5 million increase in expenses related to other events. These increases were partially offset by a $0.9 million decrease in depreciation expense.
Sales and marketing. The 6%, or $12.2 million, increase in total sales and marketing expenses for the nine months ended December 31, 2022 compared to the same period last year was primarily due to an $8.1 million increase in expenses related to trade shows, user conferences and other events, a $5.3 million increase in travel expense primarily attributable to the lifting of COVID-19 related restrictions, and a $2.7 million increase in commissions expense. These increases were partially offset by a $5.0 million decrease in employee-related expenses largely due to a decrease in variable incentive compensation.
General and administrative. The 8%, or $5.7 million, increase in general and administrative expenses for the nine months ended December 31, 2022 compared to the same period last year was primarily due to a $1.5 million increase in employee-related expenses largely due to an increase in variable incentive compensation, a $0.9 million increase in legal fees, an $0.8 million increase in the provision for allowance for credit losses, a $0.7 million increase in travel expense primarily attributable to the lifting of COVID-19 related restrictions, a $0.6 million increase in rent and other facilities-related costs, and a $0.5 million increase in contractor fees.
Amortization of acquired intangible assets. Amortization of acquired intangible assets consists primarily of amortization of customer relationships, definite-lived trademark and tradenames, and leasehold interest related to the Comms Transaction and the acquisitions of Simena LLC, Network General Corporation, Avvasi, Inc. and Efflux Systems, Inc.
The 8%, or $3.4 million, decrease in amortization of acquired intangible assets for the nine months ended December 31, 2022 compared to the same period last year was largely due to a decrease in the amortization of intangible assets related to the Comms Transaction.
Restructuring charges. During the nine months ended December 31, 2022, we restructured certain departments to better align functions. As a result of the restructuring program, we recorded $1.9 million of restructuring charges related to one-time employee-related termination benefits for the employees that were notified of their termination during the period. The one-time termination benefits are expected to be paid in full during the fiscal year ending March 31, 2023.
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Interest and Other Income (Expense), Net
| Nine Months Ended | Change | ||||||||||||||||||||||||||||||||||
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| % of Revenue | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||
| Interest and other income (expense), net | $ | (6,554) | (1) | % | $ | (4,579) | (1) | % | $ | (1,975) | (43) | % | |||||||||||||||||||||||
The 43%, or $2.0 million, change in interest and other income (expense), net was primarily due to a $1.6 million increase in foreign exchange expense, an $0.8 million decrease in transitional services agreement income related to the HNT tools business divestiture, and an $0.8 million decrease from the change in fair value of contingent consideration. In addition, there was a $0.7 million increase in interest expense on the credit facility due to an increase in the average interest rate during the nine months ended December 31, 2022 when compared to the nine months ended December 31, 2021, partially offset by a loss on the extinguishment of debt recorded during the nine months ended December 31, 2021. These changes in interest and other income (expense), net were partially offset by a $2.4 million increase in interest income.
Income Taxes. Our effective tax rates were 9.5% and 15.5% for the nine months ended December 31, 2022 and 2021, respectively. The effective tax rate for the nine months ended December 31, 2022 differed from the effective rate for the nine months ended December 31, 2021, primarily due to research and development tax credits, foreign tax credits, the foreign derived intangible income deduction, and U.S. taxation of foreign earnings, as well as a discrete benefit from stock compensation during the nine months ended December 31, 2022.
| Nine Months Ended | Change | ||||||||||||||||||||||||||||||||||
| December 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in Thousands) | |||||||||||||||||||||||||||||||||||
| 2022 | 2021 | ||||||||||||||||||||||||||||||||||
| % of Revenue | % of Revenue | $ | % | ||||||||||||||||||||||||||||||||
| Income tax expense | $ | 6,603 | 1 | % | $ | 8,094 | 1 | % | $ | (1,491) | (18) | % | |||||||||||||||||||||||
Backlog
We produce our products on the basis of our forecast of near-term demand and maintain inventory in advance of receipt of firm orders from customers. We configure our products to customer specifications and generally deliver products shortly after receipt of the purchase order. Service engagements are also included in certain orders. Customers generally may reschedule or cancel unfulfilled orders with little or no penalty. Our total backlog at any particular time is not necessarily indicative of future sales levels. Within total backlog, fulfillable backlog includes what we consider to represent orders that are generally available to be delivered to customers as of the end of the reporting period. Delivery of our fulfillable backlog typically occurs early in the subsequent quarter. However, delivery may be delayed or accelerated due to various other reasons, including but not limited to, changes in timing of customer projects and product delivery schedules, which may not be within our control. Our total combined product backlog at December 31, 2022, September 30, 2022, June 30, 2022 and March 31, 2022 was $30.9 million, $60.5 million, $64.5 million and $92.8 million, respectively. Combined product backlog included fulfillable backlog of $30.4 million, $43.6 million, $39.1 million and $51.5 million at December 31, 2022, September 30, 2022, June 30, 2022 and March 31, 2022, respectively. Total backlog includes orders that were received late in the quarter and radio frequency propagation modeling projects. In some cases, we have begun these projects but have not yet hit billable milestones. Radio frequency propagation modeling project orders received in the third quarter of fiscal year 2022 allowed NetScout to bill for the entire projects based upon partial delivery. At December 31, 2022, deferred revenue related to these radio frequency propagation modeling projects included a gross balance $22.9 million compared to a gross balance of $18.4 million, $19.9 million and $19.9 million at September 30, 2022, June 30, 2022 and March 31, 2022, respectively. A majority of the revenue for these projects is expected to be recognized into revenue throughout the fiscal year ending March 31, 2023.
34
Liquidity and Capital Resources
Cash, cash equivalents and marketable securities consisted of the following (in thousands):
| December 31, 2022 | March 31, 2022 | ||||||||||
| Cash and cash equivalents | $ | 352,044 | $ | 636,161 | |||||||
| Short-term marketable securities | 57,262 | 67,037 | |||||||||
| Long-term marketable securities | 6,906 | — | |||||||||
| Cash, cash equivalents and marketable securities | $ | 416,212 | $ | 703,198 | |||||||
Cash, cash equivalents and marketable securities
At December 31, 2022, cash, cash equivalents and marketable securities (current and non-current) totaled $416.2 million, a $287.0 million decrease from $703.2 million at March 31, 2022. This decrease was primarily due to $150.0 million used in treasury stock repurchases under an ASR program, $150.0 million used to repay long-term debt, $19.2 million used for tax withholdings on restricted stock units, and $8.4 million used for capital expenditures. These decreases were partially offset by $43.9 million of net cash provided by operations during the nine months ended December 31, 2022. Cash held outside the United States was approximately $174.0 million.
Cash and cash equivalents were impacted by the following:
| Nine Months Ended | |||||||||||
| December 31, | |||||||||||
| (in thousands) | |||||||||||
| 2022 | 2021 | ||||||||||
| Net cash provided by operating activities | $ | 43,923 | $ | 140,387 | |||||||
| Net cash used in investing activities | $ | (5,647) | $ | (3,055) | |||||||
| Net cash used in financing activities | $ | (319,224) | $ | (53,719) | |||||||
Net cash from operating activities
Cash provided by operating activities was $43.9 million during the nine months ended December 31, 2022, compared with $140.4 million of cash provided by operating activities during the nine months ended December 31, 2021. The $96.5 million decrease was due in part to a $65.2 million decrease from deferred revenue, a $30.9 million decrease from accounts receivable, a $27.3 million decrease from deferred income taxes, an $8.0 million decrease from accounts payable, a $7.7 million decrease from depreciation and amortization, an $0.8 million decrease from income tax payable, and a $0.6 million decrease from the loss on extinguishment of debt. These decreases were partially offset by an $18.6 million increase from the change in net income, a $9.6 million increase from inventories, a $5.6 million increase from accrued compensation and other expenses, a $5.3 million increase from prepaid expenses and other assets, a $3.8 million increase from share-based compensation, and an $0.8 million increase from the change in fair value of contingent consideration during the nine months ended December 31, 2022 as compared with the nine months ended December 31, 2021.
Net cash from investing activities
| Nine Months Ended | |||||||||||
| December 31, | |||||||||||
| (in thousands) | |||||||||||
| 2022 | 2021 | ||||||||||
| Cash used in investing activities included the following: | |||||||||||
| Purchase of marketable securities | $ | (100,265) | $ | (11,343) | |||||||
| Proceeds from sales and maturity of marketable securities | 103,152 | 15,264 | |||||||||
| Purchase of fixed assets | (8,381) | (7,004) | |||||||||
| Purchase of intangible assets | (161) | — | |||||||||
| Decrease in deposits | 8 | 28 | |||||||||
| $ | (5,647) | $ | (3,055) | ||||||||
35
Cash used in investing activities was $5.6 million during the nine months ended December 31, 2022, compared with $3.1 million of cash used in investing activities during the nine months ended December 31, 2021. The $2.5 million increase in cash used in investing activities was due in part to a $1.4 million increase in cash outflow for capital expenditures, a $1.0 million increase in cash outflow from marketable securities related to an increase of $88.9 million related to the purchase of marketable securities, offset by an increase of $87.9 million in proceeds from the sales and maturity of marketable securities during the nine months ended December 31, 2022 when compared with the nine months ended December 31, 2021, and a $0.2 million increase in cash outflow related to agreements to acquire technology licenses during the nine months ended December 31, 2022.
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 2023.
Net cash from financing activities
| Nine Months Ended | |||||||||||
| December 31, | |||||||||||
| (in thousands) | |||||||||||
| 2022 | 2021 | ||||||||||
| Cash used in financing activities included the following: | |||||||||||
| Issuance of common stock under stock plans | $ | 2 | $ | 2 | |||||||
| Treasury stock repurchases, including accelerated share repurchases | (150,039) | (35,652) | |||||||||
| Tax withholding on restricted stock units | (19,187) | (15,246) | |||||||||
| Payment of debt issuance costs | — | (3,660) | |||||||||
| Repayment of long-term debt | (150,000) | (350,000) | |||||||||
| Proceeds from issuance of long-term debt | — | 350,000 | |||||||||
| Collection of contingent consideration | — | 837 | |||||||||
| $ | (319,224) | $ | (53,719) | ||||||||
Cash used in financing activities increased by $265.5 million to $319.2 million during the nine months ended December 31, 2022, compared with $53.7 million of cash used in financing activities during the nine months ended December 31, 2021.
During the nine months ended December 31, 2022, we repurchased 4,549,329 shares of our common stock under an ASR program for $150.0 million. During the nine months ended December 31, 2021, we repurchased 1,330,678 shares of our common stock for $35.7 million under the twenty-five million share repurchase program.
In connection with the delivery of our common stock upon vesting of restricted stock units, we withheld 555,651 and 531,725 shares at a cost of $19.2 million and $15.2 million related to minimum statutory tax withholding requirements on these restricted stock units during the nine months ended December 31, 2022 and 2021, 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.
Sources of Cash and Cash Requirements
Credit Facility
On July 27, 2021, we amended and extended the Amended Credit Agreement (Second Amended and Restated Credit Agreement) with a syndicate of lenders by and among: the Company; JPMorgan Chase Bank, N.A. (JPMorgan), as administrative agent and collateral agent; JPMorgan, Wells Fargo Securities, LLC, BofA Securities Inc., RBC Capital Markets, PNC Capital Markets LLC and Mizuho Bank, Ltd., as joint lead arrangers and joint bookrunners; Santander Bank, N.A., U.S. Bank National Association, Fifth Third Bank National Association, Silicon Valley Bank and TD Bank, N.A., as co-documentation agents; and the lenders party thereto.
The Second Amended and Restated Credit Agreement provides for a five-year, $800.0 million senior secured revolving credit facility, including a letter of credit sub-facility of up to $75.0 million. We may elect to use the credit facility for general corporate purposes (including to finance the repurchase of shares of our common stock). The commitments under the Second Amended and Restated Credit Agreement will expire on July 27, 2026, and any outstanding loans will be due on that date.
In connection with the Second Amended and Restated Credit Agreement, during the fiscal year ended March 31, 2022, we paid off the outstanding balance of $350 million under the Amended Credit Agreement by borrowing the same amount under the Second Amended and Restated Credit Agreement. Additionally, we recorded a loss on the extinguishment of debt of $0.6 million, representing the write off of unamortized deferred financing costs, which was included in interest expense in the
36
consolidated statements of operations for the fiscal year ended March 31, 2022. On May 9, 2022, the Company repaid $150.0 million of borrowings under the Second Amended and Restated Credit Agreement. At December 31, 2022, $200 million was outstanding under the Second Amended and Restated Credit Agreement.
At our election, revolving loans under the Second Amended and Restated Credit Agreement bear interest at either (a) an Alternate Base Rate per annum equal to the greatest of (1) the Wall Street Journal prime rate; (2) the New York Federal Reserve Bank (NYFRB) rate plus 0.50%, or (3) an adjusted one month LIBO rate plus 1%; or (b) a Term Benchmark Borrowing rate (for the interest period selected by NetScout, subject to customary provisions regarding succession from LIBO rate to SOF rate in anticipation of the upcoming discontinuation of the LIBO rate), in each case plus an applicable margin. For the period from the delivery of the Company's financial statements for the quarter ended September 30, 2022, until we have delivered financial statements for the quarter ended December 31, 2022, the applicable margin will be 1.00% per annum for Term Benchmark Revolving loans and 0% per annum for Alternate Base Rate loans, and thereafter the applicable margin will vary depending on our consolidated gross leverage ratio, ranging from 1.00% per annum for Alternate Base Rate loans and 2.00% per annum for Term Benchmark Revolving loans if our consolidated gross leverage ratio is greater than 3.50 to 1.00, down to 0% per annum for Alternate Base Rate loans and 1.00% per annum for Term Benchmark Revolving loans if our consolidated gross leverage ratio is equal to or less than 1.50 to 1.00.
Our consolidated gross leverage ratio is the ratio of our consolidated total debt compared to our consolidated EBITDA as defined in the Second Amended and Restated Credit Agreement (adjusted consolidated EBITDA). Adjusted consolidated EBITDA includes certain adjustments, including, without limitation, adjustments relating to extraordinary, unusual or non-recurring charges, certain restructuring charges, non-cash charges, certain transaction costs and expenses and certain pro forma adjustments in connection with material acquisitions and dispositions, all as set forth in detail in the Second Amended and Restated Credit Agreement.
Commitment fees will accrue on the daily unused amount of the credit facility. For the period from the delivery of the Company's financial statements for the quarter ended September 30, 2022, until we have delivered financial statements for the quarter ended December 31, 2022, the commitment fee will be 0.15% per annum, and thereafter the commitment fee will vary depending on our consolidated gross leverage ratio, ranging from 0.30% per annum if our consolidated gross leverage ratio is greater than 2.75 to 1.00, down to 0.15% per annum if our consolidated gross leverage ratio is equal to or less than 1.50 to 1.00.
Letter of credit participation fees are payable to each lender providing the letter of credit sub-facility on the amount of such lender's letter of credit exposure, during the period from the closing date of the Second Amended and Restated Credit Agreement to, but excluding, the date which is the later of (i) the date on which such lender's commitment terminates or (ii) the date on which such lender ceases to have any letter of credit exposure, at the applicable rate that would be used to determine the interest rate applicable to Term Benchmark Revolving loans assuming such loans were outstanding during the period. Additionally, we will pay a fronting fee to each issuing bank in amounts to be agreed to between us and the applicable issuing bank.
Interest on Alternate Base Rate loans is payable at the end of each calendar quarter. Interest on Term Benchmark Revolving loans is payable at the end of each interest rate period or at the end of each three-month interval within an interest rate period if the period is longer than three months. We may also prepay loans under the Second Amended and Restated Credit Agreement at any time, without penalty, subject to certain notice requirements.
The loans and other obligations under the credit facility are (a) guaranteed by each of our wholly-owned material domestic restricted subsidiaries, subject to certain exceptions, and (b) are secured by substantially all of the assets of us and the subsidiary guarantors, including a pledge of all the capital stock of material subsidiaries held directly by the Borrower and the subsidiary guarantors (which pledge, in the case of any foreign subsidiary, is limited to 65% of the voting stock), subject to certain customary exceptions and limitations. The Second Amended and Restated Credit Agreement generally prohibits any other liens on the assets of NetScout and our restricted subsidiaries, subject to certain exceptions as described in the Second Amended and Restated Credit Agreement.
The Second Amended and Restated Credit Agreement contains certain covenants applicable to us and our restricted subsidiaries, including, without limitation, limitations on additional indebtedness, liens, various fundamental changes, dividends and distributions, investments (including acquisitions), transactions with affiliates, asset sales, including sale-leaseback transactions, speculative hedge agreements, payment of junior financing, changes in business and other limitations customary in senior secured credit facilities. The Second Amended and Restated Credit Agreement requires us to maintain a certain consolidated net leverage ratio and removes the previous requirement under the Amended Credit Agreement that we maintain a minimum consolidated interest coverage ratio. Our consolidated net leverage ratio is the ratio of our Consolidated Total Debt minus the lesser of unrestricted cash and 125% of adjusted consolidated EBITDA compared to our adjusted consolidated EBITDA. The Company’s maximum consolidated net leverage ratio is 4.00 to 1.00. These covenants and limitations are more fully described in the Second Amended and Restated Credit Agreement. As of December 31, 2022, we were in compliance with all covenants, including the specified total consolidated net leverage ratio range of 4.00 to 1.00.
37
The Second Amended and Restated Credit Agreement provides that events of default will exist in certain circumstances, including failure to make payment of principal or interest on the loans when required, failure to perform certain obligations under the Second Amended and Restated Credit Agreement and related documents including a failure to meet the maximum total consolidated net leverage ratio covenant, defaults under certain other indebtedness, certain insolvency events, certain events arising under ERISA, a change of control and certain other events. Upon an event of default, the administrative agent with the consent of, or at the request of, the holders of more than 50% in principal amount of the loans and commitments, may terminate the commitments and accelerate the maturity of the loans and enforce certain other remedies under the Second Amended and Restated Credit Agreement and the other loan documents.
We had unamortized capitalized debt issuance costs, net of $4.0 million at December 31, 2022, which are being amortized over the life of the revolving credit facility. The unamortized capitalized debt issuance costs balance of $1.1 million was included as prepaid expenses and other current assets and a balance of $2.9 million was included as other assets in our consolidated balance sheet.
Expectations for Fiscal Year 2023
We are actively managing the business to generate cash flow and believe that we currently have adequate liquidity. We believe that these factors will allow us to meet our anticipated funding requirements.
We expect net cash provided by operating activities combined with cash, cash equivalents, and marketable securities and borrowing availability under our revolving credit facility to provide sufficient liquidity to fund current obligations, capital spending, debt service requirements and working capital requirement over at least the next twelve months. We believe we will meet longer-term expected future cash requirements and obligations through a combination of cash flows from operating activities, available cash balances, and our revolving credit facility. However, macroeconomic conditions, including rising inflation and a potential recession, could increase our anticipated funding requirements.
A portion of our cash may be used to acquire or invest in complementary businesses or products, to obtain the right to use complementary technologies, to repay borrowings under our Second Amended and Restated Credit Agreement, or to repurchase shares of our common stock through our stock repurchase programs. From time to time, in the ordinary course of business, we evaluate potential acquisitions of such businesses, products or technologies. If our existing sources of liquidity are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities. Macroeconomic conditions, including rising interest rates and volatility in the capital markets, may make it difficult for us to secure additional financing on favorable terms or at all. Any 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.
38
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Interest Rate Risk. We hold our cash, cash equivalents and investments for working capital purposes. Some of the securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk, we maintain our portfolio of cash, cash equivalents and investments in a variety of securities, including money market funds and government debt securities. The risk associated with fluctuating interest rates is limited to our investment portfolio. Due to the short-term nature of these instruments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, would reduce future interest income. The effect of a hypothetical 10% increase or decrease in overall interest rates would not have had a material impact on our operating results or the total fair value of the portfolio.
We are exposed to market risks related to fluctuations in interest rates related to our credit facility. At December 31, 2022, we owed $200 million on this loan with an interest rate of 5.39%. A sensitivity analysis was performed on the outstanding portion of our debt obligation as of December 31, 2022. Should the current weighted-average interest rate increase or decrease by 10%, the resulting annual increase or decrease to interest expense would be approximately $1.1 million as of December 31, 2022.
Foreign Currency Exchange Risk. As a result of our foreign operations, we face exposure to movements in foreign currency exchange rates, primarily the Euro, British Pound, Canadian Dollar and Indian Rupee. The current exposures arise primarily from expenses denominated in foreign currencies. We currently engage in foreign currency hedging activities in order to limit these exposures. Periodically, we also enter into forward contracts to manage exchange risk associated with third-party transactions and for which we do not elect hedge accounting treatment. We do not use derivative financial instruments for speculative trading purposes.
At December 31, 2022, we had foreign currency forward contracts designated as hedging instruments with notional amounts totaling $12.0 million. The valuation of outstanding foreign currency forward contracts at December 31, 2022 resulted in a liability balance of $188 thousand, reflecting unfavorable contract rates in comparison to current market rates at this date and an asset balance of $40 thousand, reflecting favorable rates in comparison to current market rates at this date. At March 31, 2022, we had foreign currency forward contracts designated as hedging instruments with notional amounts totaling $5.6 million. The valuation of outstanding foreign currency forward contracts at March 31, 2022 resulted in a liability balance of $78 thousand, reflecting unfavorable contract rates in comparison to current market rates and an asset balance of $20 thousand, reflecting favorable rates in comparison to current market rates at this date. The effect of a hypothetical 10% change in foreign currency exchange rates applicable to our business would not have a material impact on our historical consolidated financial statements. As our international operations grow, we will continue to reassess our approach to manage our risk relating to fluctuations in currency rates.
Item 4. Controls and Procedures
At December 31, 2022, NetScout, under the supervision and with the participation of our management, including the Company's principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)). Based upon that evaluation, our principal executive officer and principal financial officer concluded that, at December 31, 2022, 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.
39
PART II: OTHER INFORMATION
Item 1. Legal Proceedings
For information regarding our legal proceedings, see Note 13 contained in the "Notes to Consolidated Financial Statements" included in Part I of this Quarterly Report on Form 10-Q, which is incorporated herein by reference.
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for our fiscal year ended March 31, 2022. 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.
Purchases of Equity Securities by the Issuer
The following table provides information about purchases we made during the quarter ended December 31, 2022 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 (2) | Maximum Number of Shares That May Yet be Purchased Under the Program | |||||||||||||||||||
| 10/1/2022-10/31/2022 | 940 | $ | 34.42 | — | 2,502,668 | ||||||||||||||||||
| 11/1/2022-11/30/2022 | 1,297,395 | 36.99 | 1,293,515 | 1,209,153 | |||||||||||||||||||
| 12/1/2022-12/31/2022 | 229 | 32.57 | — | 1,209,153 | |||||||||||||||||||
| Total | 1,298,564 | $ | 36.99 | 1,293,515 | 1,209,153 | ||||||||||||||||||
(1)We purchased an aggregate of 5,049 shares during the three months ended December 31, 2022 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 programs (including our previously disclosed twenty-five million share repurchase program authorized on October 24, 2017 currently in effect).
(2)On May 9, 2022, we entered into ASR agreements to repurchase an aggregate of $150 million of our common stock via accelerated stock repurchase transactions. Final settlement of the ASR agreements was completed during the third quarter of our fiscal year 2023, resulting in the receipt of an additional 651,213 shares from Mizuho and 642,302 shares from Wells Fargo, or 1,293,515 shares in the aggregate. In total, 4,549,329 shares of our common stock were repurchased under the ASR agreements at an average cost per share of $32.97.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
Not Applicable.
Item 5. Other Information
None.
40
Item 6. Exhibits
(a)Exhibits
| 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 302 of the Sarbanes-Oxley Act of 2002. | ||||||||||
| + | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||||||||||
| ++ | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||||||||||
| ++ | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | ||||||||||
| 101.INS | + | XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | |||||||||
| 101.SCH | + | Inline XBRL Taxonomy Extension Schema Document. | |||||||||
| 101.CAL | + | Inline XBRL Taxonomy Extension Calculation Linkbase document. | |||||||||
| 101.DEF | + | Inline XBRL Taxonomy Extension Definition Linkbase document. | |||||||||
| 101.LAB | + | Inline XBRL Taxonomy Extension Label Linkbase document. | |||||||||
| 101.PRE | + | Inline XBRL Taxonomy Extension Presentation Linkbase document. | |||||||||
| 104 | The cover page from the Company's Quarterly Report on Form 10-Q for the quarter ended December 31, 2022 formatted in Inline XBRL | ||||||||||
| + | Filed herewith. | ||||
| ++ | Exhibit has been furnished, is not deemed filed and is not to be incorporated by reference into any of the Company's filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, irrespective of any general incorporation language contained in any such filing. | ||||
41
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| NETSCOUT SYSTEMS, INC. | ||||||||
Date: February 2, 2023 | /s/ Anil K. Singhal | |||||||
| Anil K. Singhal | ||||||||
| President, Chief Executive Officer and Chairman | ||||||||
| (Principal Executive Officer) | ||||||||
Date: February 2, 2023 | /s/ Jean Bua | |||||||
| Jean Bua | ||||||||
| Executive Vice President and Chief Financial Officer | ||||||||
(Principal Financial Officer) | ||||||||
(Principal Accounting Officer) | ||||||||
42
ATTACHMENTS / EXHIBITS
XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT
XBRL TAXONOMY EXTENSION CALCULATION LINKBASE DOCUMENT
XBRL TAXONOMY EXTENSION DEFINITION LINKBASE DOCUMENT
XBRL TAXONOMY EXTENSION LABEL LINKBASE DOCUMENT
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