[May 24, 2013] NETSCOUT SYSTEMS INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations Tweet (Edgar Glimpses Via Acquire Media NewsEdge) The following information should be read in conjunction with the audited consolidated financial information and the notes thereto included in this Annual Report on Form 10-K. In addition to historical information, the following discussion and other parts of this Annual Report contain forward-looking statements that involve risks and uncertainties. You should not place undue reliance on these forward-looking statements. Actual events or results may differ materially due to competitive factors and other factors discussed in Item 1A. "Risk Factors" and elsewhere in this Annual Report. These factors may cause our actual results to differ materially from any forward-looking statement. Overview NetScout was founded in 1984 and is headquartered in Westford, Massachusetts. We design, develop, manufacture, market, sell and support market leading unified service delivery management, service assurance and application performance management solutions focused on assuring service delivery for the world's largest, most demanding and complex IP based service delivery environments. We manufacture and market these products in integrated hardware and software solutions that are used by commercial enterprises, large governmental agencies and telecommunication service providers worldwide. We have a single operating segment and substantially all of our identifiable assets are located in the United States. Our operating results are influenced by a number of factors, including, but not limited to, the mix and quantity of products and services sold, pricing, costs of materials used in our products, growth in employee related costs, including commissions, and the expansion of our operations. Factors that affect our ability to maximize our operating results include, but are not limited to, our ability to introduce and enhance existing products, the marketplace acceptance of those new or enhanced products, continued expansion into international markets, development of strategic partnerships, competition, successful acquisition integration efforts, our ability to achieve expense reductions and make structural improvements and current economic conditions. Our key objectives have been to continue to gain market share in the wireless service provider market and to accelerate our enterprise growth by extending into the application performance management segment. A key common component of both initiatives has been our aggressive acquisition of the strongly complementary packet flow or monitoring switch technology. On October 31, 2012, we completed the acquisition of ONPATH Technologies, Inc. (ONPATH), an established provider of scalable packet flow switching technology for high-performance networks for the aggregation and distribution of network traffic for data, voice, video testing, monitoring, performance 30-------------------------------------------------------------------------------- Table of Contents management and cybersecurity deployments. ONPATH's packet flow switch technology is synergistic with our network monitoring switch strategy. The acquisition of the packet flow switch technology further strengthens our Unified Service Delivery Management strategy by enabling scalable access to all relevant network traffic across highly distributed network environments for use by any network monitoring, performance management and security system. ONPATH's test automation technology is used to monitor networks in test environments which simulate existing and planned network environments. We paid $36.8 million in cash for the acquisition of ONPATH and $4.2 million of additional compensation consideration which could be paid out in the future. On July 20, 2012, we completed the acquisition of certain assets, technology and employees from Accanto Systems, S.r.l. (Accanto). Accanto provides service assurance for telecommunication service providers enabling carriers to monitor and manage the delivery of voice services over converged, next generation network architectures. This technology is synergistic with our packet flow strategy and brings voice service monitoring capabilities for legacy voice environments and for next generation network voice services, including voice over IP (VoIP) and voice over long-term evolution (VoLTE) for 4G wireless networks. We paid $15.0 million for the acquisition of Accanto. At the end of our fiscal year ended March 31, 2012, we entered the market with the packet aggregation switch we acquired from Simena. During the second half of our fiscal year ended March 31, 2013, we added a high capacity, chassis-based packet flow switch line that we acquired from ONPATH in October 2012. The combination of these two products has provided us with a wide range of price/performance and scale, well suited for both large enterprise and service provider applications. In the wireless service provider sector we continued to gain market share primarily driven by our leading 3G and LTE data service assurance solutions globally. Our strategy here has been to complement our solution portfolio with an integrated legacy and 3G/4G voice service assurance capability. A component of this strategy was the acquisition of Accanto earlier in the fiscal year ended March 31, 2013, providing us important voice service monitoring for legacy voice environments and next generation network voice services. Overall, in the service provider market we continue to capitalize on major growth drivers. We have gained market share in the Tier 1 mobile packet switched core where we are servicing 2G/3G and now 4G infrastructures that are being driven further with capacity upgrades from existing customers. We have also been gaining new Tier 2 customers as we expand our presence both in the U.S. and around the world. We have been building our product to capture the carriers' rapid expansion of IP Services where we have become a leader. A large business opportunity for us is the servicing of Diameter Routing Agents that is used in all IP networks such as Long-term Evolution (LTE) technologies and IP Multimedia Subsystem (IMS). We are playing a central role in managing the complexity of the surge of different devices from handhelds to tablets, and how those users attach to the network, in areas such as authentication, authorization, policy and charging. Another area of growth is RAN aggregation, where there is a major transformation of the access and backhaul areas of the network. Carriers are consolidating 2G, 3G, and 4G into one box, combined with new LTE rollouts. We are helping to manage the handset and cell tower issues. During our fiscal year ended March 31, 2014, we intend to work to expand our capabilities to provide end-to-end monitoring by adding significant enhancements and features to our product set. Results Overview We saw continued growth during the fiscal year ended March 31, 2013, with product revenue growth of 18% and overall revenue growth of 14% compared to the prior fiscal year. Our earnings per share for the fiscal year ended March 31, 2013 were $0.96 per share, representing a $0.20, or 26%, increase over the same period in the prior year. Our business maintained strong gross profit margins. Our gross margin for the fiscal year ended March 31, 2013 remained flat at 79% compared to the same period in the prior year. We ended fiscal year 2013 with an immaterial amount of product backlog, compared to $13.0 million as of the end of fiscal year 2012. 31-------------------------------------------------------------------------------- Table of Contents At March 31, 2013, we had cash, cash equivalents and marketable securities of $154.1 million. This represents a decrease of $59.4 million over the previous fiscal year ended March 31, 2012. During the fiscal year ended March 31, 2013, we maintained our liquidity despite acquisitions of product technology as well as cash outflows as a result of our share repurchase program and the repayment of $62.0 million of long-term debt. Use of Non-GAAP Financial Measures We supplement the generally accepted accounting principles (GAAP) financial measures we report in quarterly earnings announcements, investor presentations and other investor communications by reporting the following non-GAAP measures: non-GAAP revenue, non-GAAP net income and non-GAAP net income per diluted share. Non-GAAP revenue eliminates the GAAP effects of acquisitions by adding back revenue related to deferred revenue revaluation. Non-GAAP net income includes the foregoing adjustment and also removes inventory fair value adjustments, expenses related to the amortization of acquired intangible assets, stock-based compensation, restructuring, certain expenses relating to acquisitions including compensation for post-combination services and business development charges, as well as early extinguishment of debt, net of related income tax effects. Non-GAAP diluted net income per share also excludes these expenses as well as the related impact of all these adjustments on the provision for income taxes. These non-GAAP measures are not in accordance with GAAP, should not be considered an alternative for measures prepared in accordance with GAAP (revenue, net income and diluted net income per share), and may have limitations in that 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 enhance the reader's overall understanding of our current financial performance and its 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 our 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 provide useful information to management and investors regarding present and future business trends relating to our financial condition and results of operations. 32-------------------------------------------------------------------------------- Table of Contents The following table reconciles revenue, net income and net income per share on a GAAP and non-GAAP basis for the years ended March 31, 2013, 2012 and 2011 (in thousands): Year Ended March 31, 2013 2012 2011 GAAP revenue $ 350,550 $ 308,679 $ 290,540 Revenue impact of accounting change - - (929 ) Deferred revenue fair value adjustment 1,215 312 132 Non-GAAP revenue $ 351,765 $ 308,991 $ 289,743 GAAP net income $ 40,609 $ 32,428 $ 37,265 Revenue adjustments 1,215 312 (797 ) Inventory fair value adjustment 453 - - Share-based compensation expense 9,580 8,702 6,439 Amortization of acquired intangible assets 7,424 6,782 5,887 Business development and integration expense 1,618 4,715 755 Compensation for post combination services 2,721 438 - Restructuring charges 1,065 603 - Loss on extinguishment of debt - 690 - Income tax adjustments (8,671 ) (7,700 ) (4,668 ) Non-GAAP net income $ 56,014 $ 46,970 $ 44,881 GAAP diluted net income per share $ 0.96 $ 0.76 $ 0.87 Share impact of non-GAAP adjustments identified above 0.36 0.34 0.17 Non-GAAP diluted net income per share $ 1.32 $ 1.10 $ 1.04 Critical Accounting Policies We consider accounting policies related to marketable securities, revenue recognition, valuation of goodwill, intangible assets and other acquisition accounting items, and share based compensation to be critical in fully understanding and evaluating our financial results. The application of these policies involves significant judgments and estimates by us. Marketable Securities We measure the fair value of our marketable securities at the end of each reporting period. Fair value is defined as the exchange price that would be received for an asset in the principal or most advantageous market for the asset in an orderly transaction between market participants on the measurement date. Marketable securities are recorded at fair value and have been classified as Level 1 or 2 within the fair value hierarchy. Fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in accessible active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves. Investments and marketable securities are considered to be impaired when a decline in fair value below cost basis is determined to be other-than-temporary. We periodically evaluate whether a decline in fair value below cost basis is other-than-temporary by considering available evidence regarding these investments including, among other factors, the duration of the period that, and extent to which, the fair value is less than cost basis, the financial health of and business outlook for the issuer, including industry and sector performance and operational and financing cash flow factors, overall market conditions and trends and our intent and ability to retain our investment in the security for a period of time sufficient to allow for an anticipated recovery in market value. Once a decline in fair value is determined to be other-than-temporary, a write-down is recorded and a new cost 33-------------------------------------------------------------------------------- Table of Contents basis in the security is established. Assessing the above factors involves inherent uncertainty. Write-downs, if recorded, could be materially different from the actual market performance of investments and marketable securities in our portfolio if, among other things, relevant information related to our investments and marketable securities was not publicly available or other factors not considered by us would have been relevant to the determination of impairment. Revenue Recognition Product revenue consists of sales of our hardware products (which include required embedded software that works together with the hardware to deliver the hardware's essential functionality), licensing of our software products, and sale of hardware bundled with a software license. Product revenue is recognized upon shipment, provided that evidence of an arrangement exists, title and risk of loss have passed to the customer, fees are fixed or determinable and collection of the related receivable is probable. Because many of our solutions are comprised of both hardware and more than incidental software components, we recognize revenue in accordance with authoritative guidance on both hardware and software revenue recognition. Service revenue consists primarily of fees from customer support agreements, consulting and training. We generally provide software and hardware support as part of product sales. Revenue related to the initial bundled software and hardware support is recognized ratably over the support period. In addition, customers can elect to purchase extended support agreements for periods after the initial software warranty expiration. Support services generally include rights to unspecified upgrades (when and if available), telephone and internet-based support, updates and bug fixes. Revenue from customer support agreements is recognized ratably over the support period. 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 as the related training services are provided. Generally, our 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. Multi-element arrangements are concurrent customer purchases of a combination of our product and service offerings that may be delivered at various points in time. For multi-element arrangements comprised only of hardware products and related services, we allocate the total arrangement consideration to the multiple elements based on each element's selling price compared to the total relative selling price of all the elements. Each element's selling price is based on management's best estimate of selling price (BESP) paid by customers based on the element's historical pricing when VSOE or TPE does not exist. We have established BESP for product elements as the average selling price the element was sold for over the past six quarters, whether sold alone or sold as part of a multiple element transaction. Our internal list price for products, reviewed quarterly by senior management, with consideration in regards to changing factors in our technology and in the marketplace, is generated to target the desired gross margin from sales of product after analyzing historical discounting trends. We review sales of the product elements on a quarterly basis and update, when appropriate, BESP for such elements to ensure that it reflects recent pricing experience. We have established VSOE for services related undelivered elements. For multi-element arrangements comprised only of software products and related services, we allocate a portion of the total arrangement consideration to the undelivered elements, primarily support agreements and training, using VSOE of fair value for the undelivered elements. The remaining portion of the total arrangement consideration is allocated to the delivered software, referred to as the residual method. VSOE of fair value of the undelivered elements is based on the price customers pay when the element is sold separately. We review the separate sales of the undelivered elements on a quarterly basis and update, when appropriate, its VSOE of fair value for such elements to ensure that it reflects recent pricing experience. If we cannot objectively determine the 34-------------------------------------------------------------------------------- Table of Contents VSOE of the fair value of any undelivered software element, we defer revenue until all elements are delivered and services have been performed, or until fair value can objectively be determined for any remaining undelivered elements. For multi-element arrangements comprised of a combination of hardware and software elements, the total arrangement consideration is bifurcated between the hardware and hardware related deliverables and the software and software related deliverables based on the relative selling prices of all deliverables as a group. Then, arrangement consideration for the hardware and hardware-related services is recognized upon delivery or as the related services are provided outlined above and revenue for the software and software-related services is allocated following the residual method and recognized based upon delivery or as the related services are provided. Our product is distributed through our direct sales force and indirect distribution channels through alliances with resellers. Revenue arrangements with resellers are recognized on a sell-in basis; that is, when we deliver the product to the reseller. We record consideration given to a reseller as a reduction of revenue to the extent we have recorded revenue from the reseller. We do not offer contractual rights of return, stock balancing, or price protection to our resellers, and actual product returns from them have been insignificant to date. In addition, we have history of successfully collecting receivables from the resellers. As a result, we do not maintain reserves for reseller product returns. Valuation of Goodwill, Intangible Assets and Other Acquisition Accounting Items The carrying value of goodwill was $202.5 million and $170.4 million as of March 31, 2013 and 2012, respectively. We have two reporting units: (1) Unified Service Delivery and (2) Test Automation. Goodwill is tested for impairment at a 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 segment below its carrying value. Because NetScout, and our two reporting units, did not experience any significant adverse changes in our business or reporting structures, we performed the qualitative Step 0 assessment. In performing the qualitative Step 0 assessment, we considered certain events and circumstances specific to the entity at the reporting unit level, such as macroeconomic conditions, industry and market considerations, overall financial performance and cost factors when evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. No indicators of impairment were noted as of January 31, 2013. Additionally, the market capitalization of NetScout as a whole significantly exceeded its carrying value. The carrying value of intangible assets was $63.8 million and $54.7 million as of March 31, 2013 and 2012, 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. We amortize intangible assets over their estimated useful lives, except for the acquired tradename which resulted from the Network General acquisition, which has an indefinite life and thus, is not amortized. The carrying value of the indefinite lived tradename is evaluated annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. During the fiscal year ended March 31, 2013, we early adopted authoritative guidance that gives entities an option to first assess qualitative factors to determine whether the existence of events and circumstances indicate that it is more likely than not that the indefinite-lived intangible asset is impaired. If based on its qualitative assessment an entity concludes that it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, quantitative impairment testing is required. However, if an entity concludes otherwise, quantitative impairment testing is not required. We completed our annual impairment test of the indefinite lived intangible as of January 31, 2013 using the qualitative Step 0 assessment described above, which largely mirrors the Unified Service Delivery analysis, as the tradenames apply to a majority of the products and branding within that reporting unit. No impairment indicators were observed as of January 31, 2013. 35 -------------------------------------------------------------------------------- Table of Contents We have acquired five companies during the three year period ended March 31, 2013. The acquisition method of accounting requires that we estimate the fair value of the assets and liabilities acquired as part of these transactions. In order to estimate the fair value of acquired intangibles we use a relief from royalty model which requires management to estimate: future revenues expected to be generated by the acquired intangibles, a royalty rate which a market participant would pay related to the projected revenue stream, a present value factor which approximates a risk adjusted rate of return for a market participant purchasing the assets, and a technology migration curve representing a period of time over which the technology assets or some portion thereof are still being used. We are also required to develop the fair value for customer relationships acquired as part of these transactions which requires that we create estimates for the following items: a projection of future revenues associated with the acquired company's existing customers, a turnover rate for those customers, a margin related to those sales, and risk adjusted rate of return for a market participant purchasing those relationships. The acquisition of Simena LLC also contained contingent features based on the ultimate settlement of assets and liabilities acquired as part of transaction, and the former owners future period of employment with the Company. Contingent consideration accounting requires the Company to estimate the probability of various settlement scenarios, the former owners expected period of employment with NetScout, and a risk adjusted interest rate to present value to the payment streams. Share-based Compensation We recognize compensation expense for all share-based payments. Under the fair value recognition provisions, we recognize share-based compensation net of an estimated forfeiture rate and only recognize compensation cost for those shares expected to vest on a straight-line basis over the requisite service period of the award. We are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the share-based compensation expense could be significantly different from what we have recorded in the current period. Based on historical experience, we assumed an annualized forfeiture rate of 0% for awards granted to our directors, and an annualized forfeiture rate of 10% for awards granted to our senior executives and remaining employees. We will record additional expense if the actual forfeitures are lower than estimated and will record a recovery of prior expense if the actual forfeitures are higher than estimated. Results of Operations Comparison of Years Ended March 31, 2013 and 2012 Revenue Product revenue consists of sales of our hardware products and licensing of our software products. Service revenue consists of customer support agreements, consulting and training. No one direct customer or indirect channel partner accounted for more than 10% of our total revenue during the fiscal years ended March 31, 2013 and 2012. Fiscal Year Ended March 31, (Dollars in Thousands) 2013 2012 Change % of % of Revenue Revenue $ % Revenue: Product $ 198,749 57 % $ 168,141 54 % $ 30,608 18 % Service 151,801 43 140,538 46 11,263 8 % Total revenue $ 350,550 100 % $ 308,679 100 % $ 41,871 14 % 36 -------------------------------------------------------------------------------- Table of Contents Product. The 18%, or $30.6 million, increase in product revenue was due to a $19.4 million increase in revenue from our general enterprise sector and an $18.8 million increase in our service provider sector. These increases were offset by a $7.6 million decrease in our government enterprise sector. Compared to the same period in the prior year, we realized a 7% increase in units shipped and a 6% increase in the average selling price per unit of our products. The increase in average selling price is due to product mix. We expect continued growth in our fiscal year ended March 31, 2014 and expect our service provider sector to continue to be a significant driver of future growth. Service. The 8%, or $11.3 million, increase in service revenue was due to a $10.8 million increase in revenue from maintenance contracts due to increased new maintenance contracts and renewals from a growing support base and a $1.7 million increase in premium support contracts. These were offset by a $1.3 million decrease in consulting revenue. We expect single digit percentage growth in our service revenues. We expect this to be generated by product revenue growth which increases our installed base and therefore our related maintenance contracts. Total product and service revenue from direct and indirect channels are as follows: Fiscal Year Ended March 31, (Dollars in Thousands) 2013 2012 Change % of % of Revenue Revenue $ % Indirect $ 172,136 49 % $ 166,483 54 % $ 5,653 3 % Direct 178,414 51 142,196 46 36,218 25 % Total revenue $ 350,550 100 % $ 308,679 100 % $ 41,871 14 % The 3%, or $5.7 million, increase in indirect channel revenue is the result of the increase in sales in Europe to our service provider customers. Sales to customers outside the United States are export sales typically through channel partners, who are generally responsible for distributing our products and providing technical support and service to customers within their territories. Our reported international revenue does not include any revenue from sales to customers outside the United States that are shipped to our United States-based indirect channel partners. These domestic resellers fulfill customer orders based upon joint selling efforts in conjunction with our direct sales force and may subsequently ship our products to international locations; however, we report these shipments as United States revenue since we ship the products to a domestic location. The 25%, or $36.2 million, increase in direct channel revenue is the result of increased domestic revenue from our service provider and domestic general enterprise customers. Total revenue by geography is as follows: Fiscal Year Ended March 31, (Dollars in Thousands) 2013 2012 Change % of % of Revenue Revenue $ % United States $ 262,020 75 % $ 230,359 75 % $ 31,661 14 % International: Europe 42,884 12 32,998 10 9,886 30 % Asia 18,107 5 17,637 6 470 3 % Rest of the world 27,539 8 27,685 9 (146 ) (1 %) Subtotal international 88,530 25 78,320 25 10,210 13 % Total revenue $ 350,550 100 % $ 308,679 100 % $ 41,871 14 % 37 -------------------------------------------------------------------------------- Table of Contents United States revenues increased 14%, or $31.7 million, as a result of an increase in our service provider and general enterprise sectors. The 13%, or $10.2 million, increase in international revenue is primarily due to an increase in our service provider sector in Europe as well as our general enterprise sector throughout the world. We expect revenue from sales to customers outside the United States to continue to account for a significant portion of our total revenue in the future. In accordance with United States export control regulations we do not sell to, or do business with, countries subject to economic sanctions and export controls. Cost of Revenue and Gross Profit Cost of product revenue consists primarily of material components, manufacturing personnel expenses, manuals, packaging materials, overhead and amortization of capitalized software, acquired software and core technology. Cost of service revenue consists primarily of personnel, material, overhead and support costs. Fiscal Year Ended March 31, (Dollars in Thousands) 2013 2012 Change % of % of Revenue Revenue $ % Cost of revenue: Product $ 45,752 13 % $ 39,271 13 % $ 6,481 17 % Service 28,256 8 26,401 8 1,855 7 % Total cost of revenue $ 74,008 21 % $ 65,672 21 % $ 8,336 13 % Gross profit: Product $ $ 152,997 44 % $ 128,870 42 % $ 24,127 19 % Product gross profit % 77 % 77 % - % Service $ 123,545 35 % 114,137 37 % 9,408 8 % Service gross profit % 81 % 81 % - % Total gross profit $ $ 276,542 $ 243,007 $ 33,535 14 % Total gross profit % 79 % 79 % 0 % Product. The 17%, or $6.5 million, increase in cost of product revenue was primarily due to the 18%, or $30.6 million increase in product revenue for the fiscal year ended March 31, 2013 when compared to the fiscal year ended March 31, 2012. In addition, there was a $453 thousand increase due to the amortization of a fair value adjustment related to inventory recorded from the acquisition of ONPATH. The product gross profit percentage remained flat at 77% during the fiscal year ended March 31, 2013 as compared to the same period in the prior year. Average headcount in cost of product revenue was 29 and 26 for the years ended March 31, 2013 and 2012, respectively. Service. The 7%, or $1.9 million, increase in cost of service revenue was primarily due to a $1.7 million increase in employee related expenses resulting from increased headcount to support our growing installed base as well as increased incentive compensation. The 8%, or $9.4 million, increase in service gross profit corresponds with the 8%, or $11.3 million, increase in service revenue, offset by the 7%, or $1.9 million, increase in cost of services. The service gross profit percentage remained flat at 81% for the fiscal year ended March 31, 2013 when compared to the same period in the prior year. Average headcount in cost of service revenue was 139 and 125 for the years ended March 31, 2013 and 2012, respectively. Gross profit. Our gross profit increased 14%, or $33.5 million. This increase is attributable to our increase in revenue of 14%, or $41.9 million, offset by a 13%, or $8.3 million, increase in cost of revenue. The gross margin percentage remained flat at 79% during the fiscal year ended March 31, 2013 when compared to the same period in the prior year. Overall we expect our gross margin percentage to remain relatively flat in future periods with increased sales volumes offset by corresponding increases in product and service costs. 38-------------------------------------------------------------------------------- Table of Contents Operating Expenses Fiscal Year Ended March 31, (Dollars in Thousands) 2013 2012 Change % of % of Revenue Revenue $ % Research and development $ 61,546 18 % $ 49,478 16 % $ 12,068 24 % Sales and marketing 116,807 33 109,624 35 7,183 7 % General and administrative 29,718 8 27,488 9 2,230 8 % Amortization of acquired intangible assets 2,877 1 2,131 1 746 35 % Restructuring charges 1,065 - 603 - 462 77 % Total operating expenses $ 212,013 60 % $ 189,324 61 % $ 22,689 12 % 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 24%, or $12.1 million, increase in research and development expenses is due to a $9.0 million increase in employee related expenses due to increased headcount and incentive compensation, a $1.2 million increase in compensation for post combination services related to the acquisitions of Simena, Replay and ONPATH, a $536 thousand increase in consulting costs, a $495 thousand increase in travel expenses, a $443 thousand increase in allocated overhead, a $417 thousand increase in rent expense, a $333 thousand increase in depreciation and a $259 thousand increase in meeting expenses. These were offset by a $1.5 million decrease in business development expenses. Average headcount in research and development was 338 and 291 for the fiscal years ended March 31, 2013 and 2012, respectively. We expect research and development expenses to decline as a percentage of sales in future periods as revenue growth offsets additional research and development headcount associated with our recent acquisitions. Sales and marketing. Sales and marketing expenses consist primarily of personnel expenses, including commissions, overhead and other expenses associated with selling activities and marketing programs such as trade shows, seminars, advertising, and new product launch activities. The 7%, or $7.2 million, increase in total sales and marketing expenses was due to a $2.3 million increase in employee related expenses due to increased headcount, a $1.6 million increase in marketing related expenses, a $1.1 million increase in sales meeting costs, a $1.0 million increase in depreciation expense, a $891 thousand increase in expenses related to the NetScout user conference as this was not held during the fiscal year ended March 31, 2012, a $581 thousand increase in recruitment and a $534 thousand increase in employee training. Average headcount in sales and marketing was 333 and 317 for the fiscal years ended March 31, 2013 and 2012, respectively. 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 $2.2 million, increase in general and administrative expenses was due to a $1.4 million increase in employee related expenses related to an increase in incentive compensation, a $973 thousand increase in deal related compensation associated with acquisitions and a $971 thousand increase in software license expenses. These expenses were offset by an $853 thousand decrease in business development costs associated with acquisitions. Average headcount in general and administrative was 115 and 117 for the fiscal years ended March 31, 2013 and 2012, respectively. 39 -------------------------------------------------------------------------------- Table of Contents Amortization of acquired intangible assets. Amortization of acquired intangible assets consists primarily of amortization of customer relationships related to the acquisitions of ONPATH, Accanto, Simena, Replay, Psytechnics and Network General Central Corporation (Network General). The 35%, or $746 thousand, increase in amortization of acquired intangible assets is due to the increase of expense recorded related to the acquisitions of ONPATH, Accanto, Simena and Replay. The amortization related to the acquisitions ONPATH and Accanto were not recorded during the prior fiscal year ended March 31, 2012 as the acquisitions have occurred within the past twelve months. In addition, there were increases related to the acquisitions of Simena and Replay during the fiscal year ended March 31, 2013 as compared to the prior fiscal year primarily related to recording an entire year of amortization in the current year. Restructuring charges. During the fiscal year ended March 31, 2013, we restructured part of our international sales organization related to an overlap of personnel acquired as part of the Accanto acquisition. As a result, we recorded $1.2 million of restructuring charges during the fiscal year ended March 31, 2013 related to severance costs. Interest and Other Expense, Net Interest and other expense, net includes interest earned on our cash, cash equivalents, marketable securities and restricted investments, interest expense and other non-operating gains or losses. Fiscal Year Ended March 31, (Dollars in Thousands) 2013 2012 Change % of % of Revenue Revenue $ % Interest and other expense, net $ (793 ) (0 %) $ (2,765 ) (1 %) $ 1,972 71 % The 71%, or $2.0 million, decrease in interest and other income (expense), net was due to a $690 thousand decrease related to the loss on extinguishment of debt in connection with the refinancing of our previous credit facility during the fiscal year ended March 31, 2012, a $718 thousand decrease in foreign currency transaction expense, a $475 thousand decrease in interest expense due to a decrease in the interest rate as well as the payment of our outstanding debt during the fiscal year ended March 31, 2013. In addition, there was an $89 thousand increase in interest income. Income Tax Expense The annual effective tax rate for fiscal year 2013 is 36.3%, compared to an annual effective tax rate of 36.3% for fiscal year 2012. Generally, the annual effective tax rates differ from statutory rates primarily due to the impact of the domestic production activities deduction, the impact of state taxes, and federal, foreign and state tax credits. Fiscal Year Ended March 31, (Dollars in Thousands) 2013 2012 Change % of % of Revenue Revenue $ % Income tax expense $ 23,127 7 % $ 18,490 6 % $ 4,637 25 % 40 -------------------------------------------------------------------------------- Table of Contents Comparison of Years Ended March 31, 2012 and 2011 Revenue Product revenue consists of sales of our hardware products and licensing of our software products. Service revenue consists of customer support agreements, consulting and training. No one direct customer or indirect channel partner accounted for more than 10% of our total revenue during fiscal years ended March 31, 2012 and 2011. Fiscal Year Ended March 31, (Dollars in Thousands) 2012 2011 Change % of % of Revenue Revenue $ % Revenue: Product $ 168,141 54 % $ 159,948 55 % $ 8,193 5 % Service 140,538 46 130,592 45 9,946 8 % Total revenue $ 308,679 100 % $ 290,540 100 % $ 18,139 6 % Product. The 5%, or $8.2 million, increase in product revenue was due to a $9.1 million increase in revenue from our service provider sector and a $400 thousand increase in revenue from our enterprise sector. These increases were offset by a $1.3 million decrease in our government sector. Compared to the same period in the prior year, we realized an 11% decrease in units shipped, while the average selling price per unit of our products increased approximately 17%. The increase in average selling price per unit is due to a shift in product mix from our lower priced probes and software to our higher priced Infinistream products. Product revenue related to our acquisitions was $4.1 million during the year ended March 31, 2012. Service. The 8%, or $9.9 million, increase in service revenue was due to a $10.6 million increase in revenue from maintenance contracts due to increased new maintenance and renewals from a growing support base and an $834 thousand increase in premium support contracts. This was partially offset by a $675 thousand decrease in consulting revenue and a $937 thousand decrease in training revenue mainly due to the one-time recognition of $1.0 million in training revenue during the quarter ended June 30, 2010 from non-refundable expired contracts. Prior to the quarter ended June 30, 2010, we had not been able to demonstrate that we had fulfilled our obligations under these contracts. However, starting with the quarter ended June 30, 2010, we were able to demonstrate that our obligations had been fulfilled. While we will continue to recognize revenue from non-refundable expired contracts, revenue in future quarters from such expired contracts is not expected to be significant. Service revenue related to our acquisitions was $1.4 million during the year ended March 31, 2012. Total product and service revenue from direct and indirect channels are as follows: Fiscal Year Ended March 31, (Dollars in Thousands) 2012 2011 Change % of % of Revenue Revenue $ % Indirect $ 166,483 54 % $ 172,010 59 % $ (5,527 ) (3 %) Direct 142,196 46 118,530 41 23,666 20 % Total revenue $ 308,679 100 % $ 290,540 100 % $ 18,139 6 % The 3%, or $5.5 million, decrease in indirect channel revenue is the result of the decline in sales to government customers, as well as our European service provider and financial customers. Sales to customers outside the United States are export sales through channel partners, who are generally responsible for distributing our products and providing technical support and service to customers within their territories. Our reported 41-------------------------------------------------------------------------------- Table of Contents international revenue does not include any revenue from sales to customers outside the United States that are shipped to our United States-based indirect channel partners. These domestic resellers fulfill customer orders based upon joint selling efforts in conjunction with our direct sales force and may subsequently ship our products to international locations; however, we report these shipments as United States revenue since we ship the products to a domestic location. The 20%, or $23.7 million, increase in direct channel revenue is the result of increased domestic revenue from our service provider and financial customers. Total revenue by geography is as follows: Fiscal Year Ended March 31, (Dollars in Thousands) 2012 2011 Change % of % of Revenue Revenue $ % United States $ 230,359 75 % $ 211,711 73 % $ 18,648 9 % International: Europe 32,998 10 37,921 13 (4,923 ) (13 %) Asia 17,637 6 16,260 6 1,377 8 % Rest of the world 27,685 9 24,648 8 3,037 12 % Subtotal international 78,320 25 78,829 27 (509 ) (1 %) Total revenue $ 308,679 100 % $ 290,540 100 % $ 18,139 6 % United States revenues increased 9%, or $18.6 million, as a result of an increase in our service provider and financial sectors. The 1%, or $509 thousand, decrease in international revenue is due to decline in our financial and service provider sectors in Europe. The decline in sales from Europe reflects the impact of economic conditions in the region. In accordance with United States export control regulations we do not sell to, or do business with, countries subject to economic sanctions and export controls. Cost of Revenue and Gross Profit Cost of product revenue consists primarily of material components, manufacturing personnel expenses, manuals, packaging materials, overhead and amortization of capitalized software, acquired software and core technology. Cost of service revenue consists primarily of personnel, material, overhead and support costs. Fiscal Year Ended March 31, (Dollars in Thousands) 2012 2011 Change % of % of Revenue Revenue $ % Cost of revenue: Product $ 39,271 13 % $ 38,175 13 % $ 1,096 3 % Service 26,401 8 23,186 8 3,215 14 % Total cost of revenue $ 65,672 21 % 61,361 21 % 4,311 7 % Gross profit: Product $ $ 128,870 42 % $ 121,773 42 % 7,097 6 % Product gross profit % 77 % 76 % 1 % Service $ 114,137 37 % 107,406 37 % 6,731 6 % Service gross profit % 81 % 82 % (1 %) Total gross profit $ $ 243,007 $ 229,179 $ 13,828 6 % Total gross profit % 79 % 79 % 0 % 42 -------------------------------------------------------------------------------- Table of Contents Product. The 3%, or $1.1 million, increase in cost of product revenue was primarily due to the 5%, or $8.2 million increase in product revenue for the fiscal year ended March 31, 2012 when compared to the fiscal year ended March 31, 2011. Amortization of software and core technology included as cost of product revenue increased by $671 thousand for the fiscal year ended March 31, 2012. The product gross profit percentage increased by one point to 77% during the fiscal year ended March 31, 2012. This increase was primarily due to lower discounting, offset by the increase in amortization of software and core technology. Average headcount in cost of product revenue was 26 and 29 for the years ended March 31, 2012 and 2011, respectively. Service. The 14%, or $3.2 million, increase in cost of service revenue was primarily due to a $1.9 million increase in employee related expenses resulting from increased headcount to support our growing installed base, a $793 thousand increase in cost of materials used to support customers under service contracts and a $210 thousand increase in allocated overhead costs. The 6%, or $6.7 million, increase in service gross profit corresponds with the 8%, or $9.9 million, increase in service revenue, offset by the 14%, or $3.2 million, increase in cost of services. The service gross profit percentage decreased by one point to 81% for the fiscal year ended March 31, 2012. Average headcount in cost of service revenue was 125 and 115 for the years ended March 31, 2012 and 2011, respectively. Gross profit. Our gross profit increased 6%, or $13.8 million. This increase is attributable to our increase in revenue of 6%, or $18.1 million, offset by a 7%, or $4.3 million, increase in cost of revenue. The gross margin percentage remained flat at 79% during the fiscal year ended March 31, 2012. Operating Expenses Fiscal Year Ended March 31, (Dollars in Thousands) 2012 2011 Change % of % of Revenue Revenue $ % Research and development $ 49,478 16 % $ 40,628 14 % $ 8,850 22 % Sales and marketing 109,624 35 105,271 36 4,353 4 % General and administrative 27,488 9 23,308 8 4,180 18 % Amortization of acquired intangible assets 2,131 1 1,907 1 224 12 % Restructuring charges 603 - - - 603 100 % Total operating expenses $ 189,324 61 % $ 171,114 59 % $ 18,210 11 % 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 22%, or $8.9 million, increase in research and development expenses is due to a $4.7 million increase in employee related expenses, due to increased headcount and share-based compensation expenses, a $1.5 million increase in integration costs largely related to the acquisition of Simena, a $987 thousand increase in depreciation, a $438 thousand increase in compensation for post combination services related to the acquisition of Replay, a $404 thousand increase in overhead allocations, a $363 thousand increase in rent and office expense due to the acquisitions of Psytechnics and Replay and a $257 thousand increase in technical supplies. Average headcount in research and development was 291 and 257 for the fiscal years ended March 31, 2012 and 2011, respectively. Sales and marketing. Sales and marketing expenses consist primarily of personnel expenses, including commissions, overhead and other expenses associated with selling activities and marketing programs such as trade shows, seminars, advertising, and new product launch activities. 43-------------------------------------------------------------------------------- Table of Contents The 4%, or $4.4 million, increase in total sales and marketing expenses was primarily due to a $3.4 million increase in employee related expenses and share-based compensation expenses, an $840 thousand increase in commission expense, an $829 thousand increase in trade show expenses, a $787 thousand increase in travel expenses and a $405 thousand increase in sales meetings. These expenses were partially offset by a $983 thousand decrease in expenses related to the NetScout user conference as this was not held during the year ended March 31, 2012 and a $649 thousand decrease in recruiting costs. Average headcount in sales and marketing was 317 and 312 for the fiscal years ended March 31, 2012 and 2011, respectively. 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 18%, or $4.2 million, increase in general and administrative expenses was primarily due to a $2.2 million increase in employee related expenses related to stock-based compensation and incentive compensation, and, a $1.2 million increase in business development costs associated with the acquisitions, a $477 thousand increase in professional services and a $381 thousand increase in consulting fees. Average headcount in general and administrative was 117 and 113 for the fiscal years ended March 31, 2012 and 2011, respectively. Amortization of acquired intangible assets. Amortization of acquired intangible assets consists primarily of amortization of customer relationships related to the acquisitions of Simena, Replay, Psytechnics and Network General. Restructuring charges. During the fiscal year ended March 31, 2012, we implemented a plan to restructure parts of our general and administrative organization to centralize operations as well as our international sales organization to better align our resources with forecasted sales opportunities. As a result of the restructuring program, we eliminated 12 positions and recorded $603 thousand of restructuring charges related to severance costs paid to employees. Interest and Other Expense, Net Interest and other expense, net includes interest earned on our cash, cash equivalents, marketable securities and restricted investments, interest expense and other non-operating gains or losses. Fiscal Year Ended March 31, (Dollars in Thousands) 2012 2011 Change % of % of Revenue Revenue $ % Interest and other expense, net $ (2,765 ) (1 %) $ (1,772 ) (1 %) $ (993 ) 56 % The 56%, or $993 thousand, increase in interest and other expense was due to a $690 thousand loss on the extinguishment of debt in connection with the refinancing of our prior credit facility, a $369 thousand increase in a one-time foreign currency transaction expense recorded as a result of the acquisition of Replay, a $256 thousand increase in foreign currency transaction expense and a $253 thousand decrease in interest income due to lower overall market interest rates. These increases to interest and other expense were partially offset by a $686 thousand decrease in interest expense due to a decrease in the interest rate and principal amounts outstanding associated with our debt. During the fiscal years ended March 31, 2012 and 2011, the average interest rates on our term loan were 2.123% and 2.750%, respectively. 44-------------------------------------------------------------------------------- Table of Contents Income Tax Expense The annual effective tax rate for fiscal year 2012 is 36.3%, compared to an annual effective tax rate of 33.8% for fiscal year 2011. Generally, the annual effective tax rates differ from statutory rates primarily due to the impact of the domestic production activities deduction, differences in tax rates in foreign jurisdictions and federal, foreign and state tax credits. The difference in our effective tax rate compared to the prior year is primarily due to acquisition related items, a lower qualified production activity deduction, tax reserves and changes in the relative mix of income and losses across various jurisdictions. Fiscal Year Ended March 31, (Dollars in Thousands) 2012 2011 Change % of % of Revenue Revenue $ % Income tax expense $ 18,490 6 % $ 19,028 7 % $ (538 ) 3 % Contractual Obligations As of March 31, 2013, we had the following contractual obligations: Payment due by period (Dollars in thousands) Less than 1 More than Contractual Obligations Total year 1-3 years 3-5 years 5 years Unconditional purchase obligations $ 2,605 $ 2,605 $ - $ - $ - Operating lease obligations (1) 37,183 5,509 9,592 8,312 13,770 Contingent purchase consideration 5,087 840 - - 4,247 Retirement obligations 1,757 516 528 520 193 Total contractual obligations $ 46,632 $ 9,470 $ 10,120 $ 8,832 $ 18,210 As of March 31, 2013, the total amount of net unrecognized tax benefits for uncertain tax positions and the accrual for the related interest was $370 thousand. We are unable to make a reliable estimate when cash settlement, if any, will occur with a tax authority as the timing of examinations and ultimate resolution of those examinations is uncertain. We have also excluded long-term deferred revenue of $25.9 million as such amounts will be recognized as services are provided. (1) We lease facilities and certain equipment under operating lease agreements extending through September 2023 for a total of $37.2 million. Off-Balance Sheet Arrangements We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships. Commitment and Contingencies We account for claims and contingencies in accordance with authoritative guidance that requires us to record an estimated loss from a claim or loss contingency when information available prior to issuance of our consolidated financial statements indicates that it is probable that a liability has been incurred at the date of the consolidated financial statements and the amount of the loss can be reasonably estimated. If we determine that it 45-------------------------------------------------------------------------------- Table of Contents is reasonably possible but not probable that an asset has been impaired or a liability has been incurred or if the amount of a probable loss cannot be reasonably estimated, then in accordance with the authoritative guidance, we disclose the amount or range of estimated loss if the amount or range of estimated loss is material. Accounting for claims and contingencies requires us to use our judgment. We consult with legal counsel on those issues related to litigation and seek input from other experts and advisors with respect to matters in the ordinary course of business. See Note 17 for a discussion of contingencies. We recorded two contingent liabilities related to the acquisition of Simena. One relates to future consideration to be paid to the former owner which had an initial fair value of $8.0 million at the time of acquisition and another relates to contractual non-compliance liabilities incurred by Simena with an initial fair value of $1.6 million at the time of acquisition. At March 31, 2013, the present value of the future consideration was $5.1 million and the contractual non-compliance liability was $246 thousand. During the summer of 2012, we received letters from former Accanto employees reserving their rights and alleging violations of Italian Civil Code Article 2112 relating to their employment. Further, in December 2012, we received communication from an Italian law firm engaged by a subset of Accanto employees asserting violations of Italian Civil Code Article 2112 relating to their employment and requesting transfer of employment to NetScout. As of March 31, 2013, the related claims have been settled and NetScout's portion of the immaterial liability was paid. As disclosed in Item 3, in March 2012, we uncovered and investigated, and in April 2012, disclosed to the U.S. Department of Justice and the California State Attorney General potential violations of federal and California state anti-trust laws. The potential violations involve a former employee and one or more third parties in connection with sales to state governmental agencies during fiscal year 2012. We believe we did not benefit from any of the transactions uncovered and believe that the amounts involved are not material. The California State Attorney General is conducting an investigation into the matter. We are cooperating fully and are providing all requested information. In general, the federal and state agencies have the authority to seek fines and other remedies for anti-trust violations; however, no charges or proceedings have been initiated by any governmental agency against NetScout, and we have been informed by the Department of Justice that it does not intend to take any action against NetScout. We determined that it is probable that there will be amounts due, those amounts are reasonably estimable and have been accrued as an immaterial liability as of March 31, 2013. Backlog Our combined product backlog at March 31, 2013, consisting of unshipped orders and deferred product revenue, was an immaterial amount compared to $13.0 million at March 31, 2012. Warranty and Indemnification We warrant that our software and hardware products will substantially conform to the documentation accompanying such products on their original date of shipment. For software, which also includes firmware, the standard warranty commences upon shipment and expires 90 days thereafter. With regard to hardware, the standard warranty commences upon shipment and expires 12 months thereafter. Additionally, this warranty is subject to various exclusions which include, but are not limited to, non-conformance resulting from modifications made to the software or hardware by a party other than NetScout; customers' failure to follow our installation, operation or maintenance instructions; and events outside of our reasonable control. We also warrant that all support services will be performed in a good and workmanlike manner. We believe that our product and support service warranties are consistent with commonly accepted industry standards. No warranty cost information is presented and no warranty costs are accrued since service revenue associated with warranty is deferred at the time of sale and recognized ratably over the warranty period. 46-------------------------------------------------------------------------------- Table of Contents Contracts that we enter into in the ordinary course of business may contain standard indemnification provisions. Pursuant to these agreements, we may agree to defend third party claims brought against a partner or direct customer claiming infringement of such third party's (i) U.S. patent and/or European Union (EU), or other selected countries' patents, (ii) Berne convention member country copyright, and/or (iii) U.S., EU, and/or other selected countries' trademark or intellectual property rights. Moreover, this indemnity may require us to pay any damages awarded against the partner or direct customer in such type of lawsuit as well as reimburse the partner or direct customer for reasonable attorney's fees incurred by them from the lawsuit. We may also agree from time to time to provide other forms of indemnification to partners or direct customers, such as indemnification that would obligate us to defend and pay any damages awarded to a third party against a partner or direct customer based on a lawsuit alleging that such third party has suffered personal injury or tangible property damage legally determined to have been caused by negligently designed or manufactured products. We have agreed to indemnify our directors and officers and our subsidiaries' directors and officers if they are made a party or are threatened to be made a party to any proceeding (other than an action by or in the right of NetScout) by reason of the fact that the indemnified are an agent of NetScout or by reason of anything done or not done by them in any such capacity. The indemnity is for any and all expenses and liabilities of any type (including but not limited to, judgments, fines and amounts paid in settlement) reasonably incurred by the directors or officers in connection with the investigation, defense, settlement or appeal of such proceeding, provided they acted in good faith. Liquidity and Capital Resources Substantially all of our cash, cash equivalents and marketable securities are located in the United States. Cash, cash equivalents, and marketable securities consist of the following (in thousands): As of March 31, 2013 2012 2011 Cash and cash equivalents $ 99,930 $ 117,255 $ 67,168 Short-term marketable securities 37,338 79,617 133,430 Long-term marketable securities 16,823 16,644 27,880 Cash, cash equivalents and marketable securities $ 154,091 $ 213,516 $ 228,478 Cash, cash equivalents and marketable securities At March 31, 2013 cash, cash equivalents and marketable securities totaled $154.1 million, down $59.4 million from $213.5 million at March 31, 2012 due primarily to the $62.0 million repayment of long-term debt, $51.3 million used for the acquisitions of ONPATH and Accanto, $27.4 million of cash used to repurchase shares of our common stock and $11.9 million of cash used for capital expenditures, offset by $95.4 million of cash provided by operating activities. Substantially all of our cash, cash equivalents and marketable securities are located in the United States. At March 31, 2013, cash and short-term and long-term investments in the United States was $150.5 million, while cash held offshore was approximately $3.6 million. Cash and cash equivalents were impacted by the following: Year Ending March 31, (Dollars in Thousands) 2013 2012 2011Net cash provided by operating activities $ 95,412 $ 68,307 $ 67,189 Net cash (used in ) provided by investing activities $ (21,742 ) $ 9,208 $ (59,964 ) Net cash used in financing activities $ (91,004 ) $ (27,418 ) $ (3,379 ) 47 -------------------------------------------------------------------------------- Table of Contents Net cash provided by operating activities. Fiscal year 2013 compared to fiscal year 2012 Cash provided by operating activities was $95.4 million during the fiscal year ended March 31, 2013, compared to $68.3 million of cash provided by operating activities in the fiscal year ended March 31, 2012. This $27.1 million increase was due to a $9.1 million increase from accrued compensation and other expenses during the fiscal year ended March 31, 2013 when compared to the fiscal year ended March 31, 2012 largely due to the timing of accruals for incentive compensation as a result of achieving performance-based targets during fiscal year 2013 while such targets were not achieved during fiscal year 2012, accruals for the employee stock purchase plan which began in March 2012, as well as accrued commissions. In addition, there was an $8.2 million increase in profitability, a $6.3 million favorable impact from prepaid expenses and other assets largely due $6.0 million favorable impact from a decrease in prepaid income taxes, a $4.1 million favorable impact from accounts receivable in the fiscal year ended March 31, 2013 as compared to the fiscal year ended March 31, 2012 and a $2.3 million increase as a result of a decrease in inventories. These were offset by a $2.7 million unfavorable impact from deferred revenue. Accounts receivable days sales outstanding was 68 days at March 31, 2013 compared to 70 days at March 31, 2012. Fiscal year 2012 compared to fiscal year 2011 Cash provided by operating activities was $68.3 million during the fiscal year ended March 31, 2012, compared to $67.2 million of cash provided by operating activities in the fiscal year ended March 31, 2011. This $1.1 million decrease was due to a $6.8 million unfavorable impact from accounts receivable in the fiscal year ended March 31, 2012 as compared to the fiscal year ended March 31, 2011, a $4.8 million decrease in profitability, a $4.8 million decrease from increases in accounts payable, a $1.8 million decrease from accrued compensation and other expenses during the fiscal year ended March 31, 2012 when compared to the fiscal year ended March 31, 2011 largely due to the timing of accruals for incentive compensation. These decreases were offset by a $12.4 million increase from deferred revenue as a result of an increase in deferred maintenance revenue, a $2.8 million improvement from depreciation and amortization and $2.2 million increase as a result of share-based compensation. Accounts receivable days sales outstanding was 70 days at March 31, 2012 compared to 71 days at March 31, 2011. Net cash (used in) provided by investing activities. Year Ending March 31, (Dollars in Thousands) 2013 2012 2011 Cash (used in) provided by investment activities included the following: Purchase of marketable securities $ (121,133 ) $ (117,682 ) $ (153,903 ) Proceeds from maturity of marketable securities 163,416 184,899 101,430 Purchase of fixed assets (11,948 ) (11,288 ) (7,491 ) Acquisition of businesses, net of cash acquired (51,273 ) (46,721 ) - Increase in deposits (804 ) - - $ (21,742 ) $ 9,208 $ (59,964 ) Cash (used in) provided by investing activities was down $31.0 million to $22.0 million used during the fiscal year ended March 31, 2013, compared to $9.2 million of cash provided by investing activities during the fiscal year ended March 31, 2012. Cash (used in) provided by investing activities was up $69.2 million to $9.2 million provided during the fiscal year ended March 31, 2012, compared to $60.0 million of cash used in investing activities during the fiscal year ended March 31, 2011. 48 -------------------------------------------------------------------------------- Table of Contents During the fiscal years ended March 31, 2013 and 2012, we paid $51.3 million and $46.7 million for acquisitions. Net inflow relating to the purchase and sales of marketable securities was down $24.9 million during the fiscal year ended March 31, 2013 when compared to the fiscal year ended March 31, 2012 relating to the impact of our investments mix. In addition, during the fiscal year ended March 31, 2013, redemptions by the issuers for our remaining auction rate securities totaling $19.3 million were settled. As a result of the settlements, we reversed the remaining valuation reserve of $190 thousand. We held no investments in auction rate securities at March 31, 2013. Net inflow relating to the purchase and sales of marketable securities was up $119.7 million during the fiscal year ended March 31, 2012 when compared to the fiscal year ended March 31, 2011 relating to the impact of our investments mix. Our expenditures for 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 in our fiscal year 2014. Net cash used in financing activities. Year Ending March 31, (Dollars in Thousands) 2013 2012 2011 Cash used in financing activities included the following: Issuance of common stock under stock plans $ 575 $ 473 $ (367 ) Payment of contingent consideration (4,038 ) (846 ) - Treasury stock repurchases (27,448 ) (20,595 ) - Proceeds from issuance of long-term debt, net of issuance costs - 60,691 - Repayment of long-term debt (62,000 ) (68,106 ) (11,250 ) Excess tax benefit from share-based compensation awards 1,907 965 8,238 $ (91,004 ) $ (27,418 ) $ (3,379 ) Cash used in financing activities was up $63.6 million to $91.0 million during the fiscal year ended March 31, 2013, compared to $27.4 million of cash used in financing activities during the fiscal year ended March 31, 2012. On October 29, 2012, we paid down our outstanding credit facility in the amount of $62.0 million. As of the date of this filing there are no amounts outstanding under this credit facility. During the fiscal years ended March 31, 2012 and 2011, we repaid $7.4 million and $11.3 million, respectively, under the terms of our previous credit facility. During the fiscal years ended March 31, 2013 and 2012, we paid $4.0 million and $846 thousand, respectively, related to the contingent purchase consideration related to the acquisition of Simena. Our Board of Directors has periodically authorized us to repurchase shares of our common stock. We are currently authorized to repurchase up to four million shares with cash from operations. We repurchased 999,499 shares at a cost of $23.5 million under this program during the fiscal year ended March 31, 2013. In addition, during the fiscal year ended March 31, 2013, we had 169,531 shares transferred to us from employees for tax withholding at a cost of $3.9 million. During the fiscal year ended March 31, 2012, we repurchased 1,270,000 shares for $16.2 million. In addition, during the fiscal year ended March 31, 2012, we had 216,882 shares transferred to us from employees for tax withholding at a cost of $4.4 million. Future repurchases of shares will reduce our cash balances. 49-------------------------------------------------------------------------------- Table of Contents We generated $1.9 million, $965 thousand and $8.2 million during the fiscal years ended March 31, 2013, 2012 and 2011, respectively, of excess tax benefits from share-based compensation awards. Credit Facility On November 22, 2011, we entered into a credit facility with a syndicate of lenders led by KeyBank National Association (KeyBank) which provides us with a $250 million revolving credit facility, which may be increased to $300 million at any time up to 90 days before maturity. The revolving credit facility includes a swing line loan sub-facility of up to $10 million and a letter of credit sub-facility of up to $10 million. The credit facility matures on November 21, 2016. At March 31, 2013 there were no amounts outstanding under the credit facility. Expectations for Fiscal Year 2014 We believe that our cash balances, short-term marketable securities classified as available-for-sale and future cash flows generated by operations will be sufficient to meet our anticipated cash needs for working capital and capital expenditures for at least the next 12 months. In addition, we expect that cash provided by operating activities will continue to increase due to an expected increase in cash collections related to anticipated higher revenues, partially offset by an anticipated increase in operating expenses that require cash outlays such as salaries and commissions. Capital expenditures in our fiscal year 2014 are currently anticipated to be in line with previous years' trend. Additionally, a portion of our cash may be used to acquire or invest in complementary businesses or products or to obtain the right to use complementary technologies. From time to time, in the ordinary course of business, we evaluate potential acquisitions of such businesses, products or technologies such as our acquisitions of Psytechnics on April 1, 2011, Replay on October 3, 2011, Simena on November 18, 2011, certain assets, technology and employees of Accanto on July 20, 2012 and ONPATH on October 31, 2012. If our existing sources of liquidity are insufficient to satisfy our liquidity requirements, we may seek to sell additional equity or debt securities. The sale of additional equity or debt securities could result in additional dilution to our stockholders. Recent Accounting Standards In March 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2013-05 Foreign Currency Matters (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity (ASU 2013-05). ASU 2013-05 provides guidance on releasing cumulative translation adjustments when a reporting entity (parent) ceases to have a controlling financial interest in a subsidiary or a business within a foreign entity. ASU 2013-05 is effective on a prospective basis for fiscal years and interim reporting periods within those years, beginning after December 15, 2013 (the fourth quarter of fiscal year 2014 for the NetScout). Early adoption is permitted. This standard is not expected to have a material impact on our financial condition, results of operations, or cash flows. In February 2013, the FASB issued Accounting Standards Update No. 2013-04 "Liabilities (Topic 405): Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date" (ASU 2013-04). This guidance requires an entity to measure obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this guidance is fixed at the reporting date. This stipulates that (1) it will include the amount the entity agreed to pay for the arrangement between them and the other entities that are also obligated to the liability and (2) any additional amount the entity expects to pay on behalf of the other entities. The objective of this update is to provide guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements. The amendments in this update are effective for fiscal periods (and 50-------------------------------------------------------------------------------- Table of Contents interim reporting periods within those years) beginning after December 15, 2013 (the fourth quarter of fiscal year 2014 for NetScout). This standard is not expected to have a material impact on our financial condition, results of operations, or cash flows. In February 2013, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update 2013-02: Other Comprehensive Income (ASU 2013-02). ASU 2013-02 provides additional guidance regarding reclassifications out of Accumulated Other Comprehensive Income (AOCI). The new guidance requires entities to report the effect of significant reclassifications out of AOCI on the respective line items in net income unless the amounts are not reclassified in their entirety to net income. For amounts that are not required to be reclassified in their entirety to net income in the same reporting period, entities are required to cross-reference other disclosures that provide additional detail about those amounts. The new guidance is effective prospectively for all interim and annual periods beginning April 1, 2013 with early adoption permitted. The adoption of ASU 2013-02 will impact financial statement presentation only; accordingly, it will have no impact on our financial condition, results of operations, or cash flows. In July 2012, the FASB issued Accounting Standards Update 2012-02: Testing Indefinite-Lived Intangible Assets for Impairment (ASU 2012-02). ASU 2012-02 gives entities an option to first assess qualitative factors to determine whether the existence of events and circumstances indicate that it is more likely than not that the indefinite-lived intangible asset is impaired. If based on its qualitative assessment an entity concludes that it is more likely than not that the fair value of an indefinite-lived intangible asset is less than its carrying amount, quantitative impairment testing is required. However, if an entity concludes otherwise, quantitative impairment testing is not required. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012 (the first quarter of fiscal year 2014 for NetScout), with early adoption permitted. We adopted this standard during the fourth quarter of our fiscal year ending March 31, 2013 for our annual impairment test. [ Back To TMCnet.com's Homepage ]