Netscout Systems Inc: Form 10-Q for the period ended Jun 30, 2023

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, 2023, 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, 2023. 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 nearly four 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 many Fortune 500 companies 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 technology 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.

Global and Macroeconomic Conditions

We continue to closely monitor current global and macroeconomic conditions, including the impacts of the war in Ukraine and related sanctions, global geopolitical tension, stock market volatility, exchange rate fluctuations, inflation, interest rates, and the risk of a recession, 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 conditions remain uncertain. For the fiscal year ended March 31, 2023, we observed that technology and project spending normalized after observing elongated purchasing cycles resulting from the macroeconomic impacts of the COVID-19 pandemic and we focused on advancing our products, growing revenue, enhancing earnings per share, and generating free cash flow. In response to the Russian military operations in Ukraine, we ceased business operations in Russia, including sales, support on existing contracts and professional services.

Though we continue to monitor the impacts of evolving global and macroeconomic conditions on our business, 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, marketable securities and investments 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, including managing discretionary spending and hiring activities, but are continuing to invest in areas that advance our business for the future. In addition to our cash equivalents, based on covenant levels at June 30, 2023, we had an incremental $700 million available to us under our revolving credit facility.

Results Overview

Total revenue increased $2.3 million for the three months ended June 30, 2023 as compared to total revenue for the three months ended June 30, 2022 primarily due to an increase in revenue from our cybersecurity offerings, an increase in revenue from enterprise customers from service assurance offerings, and an increase in service revenue from maintenance contracts, partially offset by a decrease in revenue from service provider customers due to less radio frequency propagation modeling project revenues.

Our gross profit percentage increased by four percentage points to 76% during the three months ended June 30, 2023, as compared with the three months ended June 30, 2022 primarily due to product mix with less revenue in the three months ended June 30, 2023 from radio frequency propagation modeling projects, which have lower margins.

Net loss for the three months ended June 30, 2023 was $4.2 million, as compared with a net loss for the three months ended June 30, 2022 of $7.1 million, a decrease of $2.9 million. The decrease in net loss was primarily due to a $10.3 million decrease in costs to deliver radio frequency propagation modeling projects, a $2.3 million increase in revenue, a $2.2 million decrease in advertising expense, a $2.0 million increase in interest income, a $1.9 million decrease in amortization of intangible assets, a $1.8 million decrease in restructuring expense, a $0.8 million decrease in legal fees, and a $0.8 million decrease in expenses related to trade shows, user conferences and other events. These decreases in net loss were partially offset by an $11.2 million increase in employee-related costs, a $2.2 million decrease in income tax benefit, a $1.1 million increase in direct material costs, a $1.1 million increase in foreign exchange expense, a $1.1 million increase in other marketing related costs, a $1.0 million increase in travel expense, a $0.9 million increase in contractor fees, and a $0.6 million increase in cost of materials used to support customers under service contracts.

At June 30, 2023, we had cash, cash equivalents, marketable securities and investments (current and non-current) of $390.5 million. This represents a decrease of $37.4 million from $427.9 million at March 31, 2023. This decrease was primarily due to $22.4 million of net cash used in operations, $13.4 million used for tax withholdings on restricted stock units, and $2.0 million used for capital expenditures during the three months ended June 30, 2023.

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 removes the aforementioned adjustments and also removes legal expenses related to a civil judgment, and restructuring charges. Non-GAAP net income removes the foregoing adjustments related to non-GAAP income from operations, and also removes change in the fair value of derivative instrument, net of related income tax effects. Non-GAAP EBITDA from operations removes 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 (loss) from operations, net income (loss) and net income (loss) per share on a GAAP and non-GAAP basis for the three months ended June 30, 2023 and 2022 (in thousands, except for per share amounts):

26

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, 2023, filed with the Securities and Exchange Commission (SEC) on May 16, 2023, for a description of all of our critical accounting policies and estimates.

Three Months Ended June 30, 2023 and 2022

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 June 30, 2023, no direct customers or indirect channel partners accounted for more than 10% of our total revenue. During the three months ended June 30, 2022, two direct customers, AT&T and Verizon, accounted for more than 10% of our total revenue, while no indirect channel partners accounted for more than 10% of our total revenue.

(Dollars in Thousands)

Product. The 4%, or $3.6 million, decrease in product revenue compared with the same period last year was primarily due to a decrease in revenue from radio frequency propagation modeling projects, partially offset by an increase in revenue from cybersecurity offerings, and an increase in revenue from enterprise customers from service assurance offerings.

Service. The 5%, or $5.9 million, increase in service revenue compared to the same period last year was primarily due to an increase in revenue from maintenance contracts.

Total revenue by geography was as follows:

(Dollars in Thousands)

United States revenue decreased 5%, or $6.9 million, primarily due to a decrease in revenue from radio frequency propagation modeling projects, partially offset by an increase in revenue from enterprise customers from cybersecurity offerings, and an increase in revenue from enterprise customers from service assurance offerings. The 12%, or $9.2 million, increase in international revenue compared with the same period last year was primarily driven by higher revenue from service provider and enterprise customers from service assurance offerings.

Total revenue by product line was as follows:

(Dollars in Thousands)

The 10%, or $5.9 million, increase in revenue from the cybersecurity product line was largely due to higher revenue from enterprise customers, and the 2%, or $3.5 million, decrease in the service assurance product line was largely due to a decrease in revenue from radio frequency propagation modeling projects from service provider customers.

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.

(Dollars in Thousands)

Product. The 38%, or $10.1 million, decrease in cost of product revenue for the three months ended June 30, 2023 compared to the same period last year was primarily due to a $10.3 million decrease in costs related to the delivery of radio frequency propagation modeling projects, and a $0.7 million decrease in the amortization of intangible assets. These decreases were partially offset by a $1.1 million increase in direct material costs. The product gross profit percentage increased by nine percentage points to 82% during the three months ended June 30, 2023 as compared with the three months ended June 30, 2022. The 9%, or $6.6 million, increase in product gross profit is attributable to the 38%, or $10.1 million, decrease in cost of product revenue, partially offset by the 4%, or $3.6 million, decrease in product revenue.

Service. The 9%, or $2.8 million, increase in cost of service revenue for the three months ended June 30, 2023 compared to the same period last year was primarily due to a $2.2 million increase in employee-related costs associated with an increase in variable incentive compensation, and a $0.6 million increase in cost of materials used to support customers under service contracts. The service gross profit percentage decreased by one percentage point to 71% during the three months ended June 30, 2023 as compared with the three months ended June 30, 2022. The 4%, or $3.1 million, increase in service gross profit is attributable to the 5%, or $5.9 million, increase in service revenue, partially offset by the 9%, or $2.8 million, increase in cost of service revenue.

Gross profit. Our gross profit increased 6%, or $9.6 million, during the three months ended June 30, 2023 when compared with the three months ended June 30, 2022. This increase is attributable to the 13%, or $7.3 million, decrease in cost of revenue, and the increase in revenue of 1%, or $2.3 million. As a result, the gross profit percentage increased by four percentage points to 76% for the three months ended June 30, 2023 as compared with the three months ended June 30, 2022.

Operating Expenses

(Dollars in Thousands)

Research and development. Research and development expenses consist primarily of personnel expenses, fees for outside consultants, overhead and related expenses associated with the development of new products and the enhancement of existing products.

The 5%, or $2.1 million, increase in research and development expenses for the three months ended June 30, 2023 compared to the same period last year was primarily due to a $3.1 million increase in employee-related expenses associated with an increase in variable incentive compensation, partially offset by a $0.6 million decrease in contractor fees.

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 4%, or $2.7 million, increase in total sales and marketing expenses for the three months ended June 30, 2023 compared to the same period last year was primarily due to a $3.5 million increase in employee-related expenses associated with an increase in variable incentive compensation as well as an increase in headcount, a $1.1 million increase in other marketing related expenses, and a $0.8 million increase in travel expenses. These increases were partially offset by a $2.2 million decrease in advertising expense, and a $0.8 million decrease in expenses related to trade shows, user conferences and other events.

General and administrative. General and administrative expenses consist primarily of personnel expenses for executive, financial, legal and human resource employees, overhead and other corporate expenditures.

The 14%, or $3.4 million, increase in general and administrative expenses for the three months ended June 30, 2023 compared to the same period last year was primarily due to a $2.3 million increase in employee-related expenses associated with an increase in variable incentive compensation, and a $1.3 million increase in contractor fees. These increases were partially offset by a $0.8 million decrease in legal fees.

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), Network General Corporation, Avvasi Inc. and Efflux Systems, Inc.

The 8%, or $1.2 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 and Network General Corporation.

Restructuring. During the quarter ended June 30, 2022, we restructured certain departments to better align functions. As a result of the restructuring program, we recorded $1.8 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 were paid in full during the fiscal year ended March 31, 2023.

Interest and Other Expense, Net. Interest and other expense, net includes interest earned on our cash, cash equivalents and marketable securities, interest expense and other non-operating gains or losses.

(Dollars in Thousands)

The 53%, or $0.7 million, change in interest and other expense, net for the three months ended June 30, 2023 compared to the same period last year was primarily due to a $2.0 million increase in interest income, partially offset by a $1.1 million increase in foreign exchange expense.

Income Taxes. The effective tax rates were 21.3% and 32.0% for the three months ended June 30, 2023 and 2022, respectively. The effective tax rate for the three months ended June 30, 2023 differed from the effective tax rate for the three months ended June 30, 2022, primarily due to the impact of U.S. taxation of foreign earnings and the foreign derived intangible income deduction relative to forecasted profits, which were partially offset by a discrete benefit from stock compensation.

(Dollars in Thousands)

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 June 30, 2023 was $15.6 million compared to $44.4 million at March 31, 2023. Combined product backlog included fulfillable backlog of $12.1 million and $41.1 million at June 30, 2023 and March 31, 2023, 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. At June 30, 2023 and March 31, 2023, deferred revenue and accounts receivable each contained a gross balance of $0.2 million and $8.3 million, respectively, related to these radio frequency propagation modeling project orders. 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. A majority of the revenue for these projects is expected to be recognized into revenue throughout the fiscal year ending March 31, 2024.

Liquidity and Capital Resources

Cash, cash equivalents, marketable securities and investments consisted of the following (in thousands):

31

Cash, cash equivalents, marketable securities and investments

At June 30, 2023, cash, cash equivalents, marketable securities and investments (current and non-current) totaled $390.5 million, a $37.4 million decrease from $427.9 million at March 31, 2023. This decrease was primarily due to $22.4 million of net cash used in operations, $13.4 million used for tax withholdings on restricted stock units, and $2.0 million used for capital expenditures during the three months ended June 30, 2023. Cash held outside the United States was approximately $196.4 million.

Cash and cash equivalents were impacted by the following:

(in thousands)

Net cash from operating activities

Cash used in operating activities was $22.4 million during the three months ended June 30, 2023, compared with $12.5 million of cash used in operating activities during the three months ended June 30, 2022. The $9.9 million change was due in part to a $13.9 million decrease from accrued compensation and other expenses, an $8.2 million decrease from deferred income taxes, a $5.8 million decrease from inventories, a $2.1 million decrease from depreciation and amortization, and a $1.1 million decrease from income tax payable. These decreases were partially offset by a $9.6 million increase from prepaid expenses and other assets, a $4.3 million increase from share-based compensation, a $3.4 million increase from deferred revenue, and a $2.9 million increase from the change in net income during the three months ended June 30, 2023 as compared with the three months ended June 30, 2022.

Net cash from investing activities

(in thousands)

Cash used in investing activities was $19.1 million during the three months ended June 30, 2023, compared with $22.5 million of cash provided by investing activities during the three months ended June 30, 2022. The $41.6 million increase in cash used in investing activities was due in part to a $42.1 million increase in cash outflow from marketable securities related to a decrease of $43.8 million in proceeds from the sales and maturity of marketable securities, partially offset by a $1.7 million decrease related to the purchase of marketable securities and investments during the three months ended June 30, 2023 when compared with the three months ended June 30, 2022, and a $0.2 million decrease in cash outflow related to agreements to acquire technology licenses during the three months ended June 30, 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 2024.

Net cash from financing activities

(in thousands)

Cash used in financing activities changed by $297.4 million to $13.4 million during the three months ended June 30, 2023, compared with $310.8 million of cash used in financing activities during the three months ended June 30, 2022.

During the three months ended June 30, 2022, we repurchased 3,255,814 shares for $150.0 million under our ASR program.

In connection with the delivery of our common stock upon vesting of restricted stock units, we withheld 435,172 and 309,088 shares at a cost of $13.4 million and $10.8 million related to minimum statutory tax withholding requirements on these restricted stock units during the three months ended June 30, 2023 and 2022, respectively. These withholding transactions do not fall under the repurchase program described above, and therefore do not reduce the number of shares that are available for repurchase under that program.

During the three months ended June 30, 2022, we repaid $150.0 million of borrowings under the Second Amended and Restated Credit Agreement.

Sources of Cash and Cash Requirements

Credit Facility

On July 27, 2021, we amended and extended our existing credit facility (as amended, the 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. At June 30, 2023, $100 million was outstanding under the Second Amended and Restated Credit Agreement.

On February 22, 2023, we entered into a First Amendment Agreement (First Amendment) of our Second Amended and Restated Credit Agreement with a syndicate of lenders. We entered into the First Amendment in order to remove and replace the LIBOR-based interest rate benchmark provisions for U.S. dollar-denominated loans with interest rate benchmark provisions for U.S. dollar-denominated loans based on a term secured overnight financing rate (SOFR).

The First Amendment provides that U.S. dollar-denominated advances under the Second Amended and Restated Credit Agreement will bear interest at a term SOFR rate plus a credit spread adjustment of 0.10% or an Alternate Base Rate (defined in a customary manner), at the option of NetScout, plus a margin that ranges from 1.00% per annum for Alternate Base Rate loans and 2.00% per annum for term SOFR 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 SOFR loans if our consolidated gross leverage ratio is equal to or less than 1.50 to 1.00. For the period from the delivery of our financial statements for the quarter ended March 31, 2023, until we have delivered financial statements for the quarter ended June 30, 2023, 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 our financial statements for the quarter ended March 31, 2023, until we have delivered financial statements for the quarter ended June 30, 2023, 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 a rate per annum equal to the applicable margin for term SOFR 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 SOFR 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 our previous 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. Our 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. At June 30, 2023, we were 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.

We had unamortized capitalized debt issuance costs, net of $3.4 million at June 30, 2023, 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 $2.3 million was included as other assets in our consolidated balance sheet.

Cash Requirements

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 for at least the next twelve months.

We have contractual obligations for long-term debt, operating leases, unconditional purchase obligations, pension benefits plans and certain other long-term liabilities. Our obligations related to these items are described further within Management’s Discussion and Analysis of Financial Condition and Results of Operations within our Annual Report filed on form 10-K. We expect net cash provided by operating activities combined with cash, cash equivalents, marketable securities and investments and borrowing availability under our revolving credit facility will 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.

Interest Rate Risk. We hold our cash, cash equivalents and investments for working capital purposes. Some of the securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk, we maintain our portfolio of cash, cash equivalents and investments in a variety of securities, including money market funds and government debt securities. The risk associated with fluctuating interest rates is limited to our investment portfolio. Due to the short-term nature of these instruments, we believe that we do not have any material exposure to changes in the fair value of our investment portfolio as a result of changes in interest rates. Declines in interest rates, however, would reduce future interest income. The effect of a hypothetical 10% increase or decrease in overall interest rates would not have had a material impact on our operating results or the total fair value of the portfolio.

We are exposed to market risks related to fluctuations in interest rates related to our credit facility. At June 30, 2023, we owed $100 million on this loan with an interest rate of 6.25%. A sensitivity analysis was performed on the outstanding portion of our debt obligation as of June 30, 2023. Should the current weighted-average interest rate increase or decrease by 10%, the resulting annual increase or decrease to interest expense would be approximately $625 thousand as of June 30, 2023.

Foreign Currency Exchange Risk. As a result of our foreign operations, we face exposure to movements in foreign currency exchange rates, primarily the Euro, British Pound, Canadian Dollar and Indian Rupee. The current exposures arise primarily from expenses denominated in foreign currencies. We currently engage in foreign currency hedging activities in order to limit these exposures. Periodically, we also enter into forward contracts to manage exchange risk associated with third-party transactions and for which we do not elect hedge accounting treatment. We do not use derivative financial instruments for speculative trading purposes.

At June 30, 2023, we had foreign currency forward contracts designated as hedging instruments with notional amounts totaling $8.5 million. The valuation of outstanding foreign currency forward contracts at June 30, 2023 resulted in a liability balance of $1 thousand, reflecting unfavorable contract rates in comparison to current market rates at this date and an asset balance of $167 thousand, reflecting favorable rates in comparison to current market rates at this date. At March 31, 2023, we had foreign currency forward contracts designated as hedging instruments with notional amounts totaling $10.3 million and foreign currency forward contracts not designated as hedging instruments with a notional amount of $6.0 million. The valuation of outstanding foreign currency forward contracts (both designated and not designated as hedging instruments) at March 31, 2023 resulted in a liability balance of $49 thousand, reflecting unfavorable contract rates in comparison to current market rates and an asset balance of $59 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.

At June 30, 2023, NetScout, under the supervision and with the participation of our management, including the Company's principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (Exchange Act)). Based upon that evaluation, our principal executive officer and principal financial officer concluded that, at June 30, 2023, 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.

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, 2023. 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.