Netscout Systems Inc: Form 10-Q for the period ended Sep 30, 2024

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, 2024, 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, 2024. 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 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 to 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, artificial intelligence and business 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 volume, 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 and 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 ongoing war in Ukraine and the Middle East, global geopolitical tension, stock market volatility, industry-specific capital spending trends, 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 business, customers, employees, supply chain, and distribution network. The full extent of the impacts of these global and macroeconomic conditions remain uncertain. In response to the war

in Ukraine, we ceased business operations in Russia, including sales, support on existing contracts and professional services.

The macroeconomic environment remains challenging with constrained customer spending and we expect this to persist for the remainder of fiscal year 2025. As a result, we have continued our efforts to manage discretionary costs and align spending with the current environment while we continue to execute on our long-term strategic plans.

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 September 30, 2024, we had an incremental $725 million available to us under our revolving credit facility. On October 4, 2024, we amended and extended the Second Amended and Restated Credit Agreement, which decreased the revolving credit facility from $800 million to $600 million and reduced the incremental amount available to us under our revolving credit facility to $525 million. For further information, see Note 20 contained in the "Notes to Consolidated Financial Statements" included in Part 1 of this quarterly report on Form 10-Q.

Results Overview

Total revenue decreased $42.3 million, or 10%, for the six months ended September 30, 2024 as compared to total revenue for the six months ended September 30, 2023, which benefited from approximately $48 million of backlog-related revenue. Excluding this factor, revenue would have increased on a year over year basis. The decrease in total revenue for the six months ended September 30, 2024 as compared to total revenue for the six months ended September 30, 2023 was a result of lower revenue from both service provider and enterprise customers from service assurance offerings, including radio frequency propagation modeling projects, as a result of industry-specific capital spending constraints, as well as a decrease in revenue from service provider customers from cybersecurity offerings.

Our gross profit percentage decreased by one percentage point to 76% during the six months ended September 30, 2024, as compared with the six months ended September 30, 2023 primarily due to lower sales volume of higher margin products and services.

Net loss for the six months ended September 30, 2024 was $434.3 million, as compared with net income for the six months ended September 30, 2023 of $17.3 million. The increase of $451.6 million in net loss was primarily due to a $427.0 million goodwill impairment charge, a $42.3 million decrease in revenue, a $19.0 million increase from restructuring charges due to the voluntary separation program, a $2.7 million increase in expenses related to trade shows, user conferences, and other events, a $1.0 million increase from software licenses, and a $1.0 million increase in foreign exchange expense. These increases to net loss were partially offset by an $11.9 million increase in income tax benefit, a $7.6 million increase in other income from the change in fair value of a foreign equity investment, a $5.5 million decrease in employee related expenses as a result of a decrease in headcount, partially offset by an increase in variable incentive compensation, a $3.6 million decrease in commissions expense, a $3.5 million decrease in direct material costs, a $3.5 million decrease in amortization expense, a $2.3 million decrease from depreciation expense, and a $1.6 million decrease in contractor fees.

At September 30, 2024, we had cash, cash equivalents, marketable securities and investments (current and non-current) of $401.9 million. This represents a decrease of $22.2 million from $424.1 million at March 31, 2024. This decrease was primarily due to $25.3 million used to repurchase shares of our common stock, $25.0 million used to repay long-term debt, $13.5 million used for tax withholdings on restricted stock units, $2.2 million used for capital expenditures, and $1.3 million used to acquire technology licenses, partially offset by $34.7 million of net cash provided by operations, and an $8.3 million increase from the change in fair value of an equity instrument during the six months ended September 30, 2024.

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 expense, and acquisition-related depreciation expense. Non-GAAP income from operations removes the aforementioned adjustments to non-GAAP gross profit and also removes legal expenses related to civil judgments, gain on the divestiture of a business, goodwill impairment charges, 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 and six months ended September 30, 2024 and 2023, respectively (dollars in thousands, except for per share data):

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Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with GAAP consistently applied. The preparation of these consolidated financial statements requires us to make significant estimates and judgments that affect the amounts reported in our consolidated financial statements and the accompanying notes. These items are regularly monitored and analyzed by management for changes in facts and circumstances, and material changes in these estimates could occur in the future. Changes in estimates are recorded in the period in which they become known. We base our estimates on historical experience and various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from our estimates.

While all of our accounting policies impact the consolidated financial statements, certain policies are viewed to be critical. Critical accounting policies are those that are both most important to the portrayal of our financial condition and results of operations and that require management's most subjective or complex judgments and estimates. We consider the following accounting policies to be critical in fully understanding and evaluating our financial results:

• revenue recognition; and
• valuation of goodwill, intangible assets and other acquisition accounting items.

Please refer to the critical accounting policies set forth in our Annual Report on Form 10-K for the fiscal year ended March 31, 2024, filed with the Securities and Exchange Commission (SEC) on May 16, 2024, for a description of all of our critical accounting policies and estimates.

Three Months Ended September 30, 2024 and 2023

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 September 30, 2024 and 2023, no direct customers or channel partners accounted for more than 10% of our total revenue.

(Dollars in Thousands)

Product. The 1%, or $0.5 million, increase in product revenue compared with the same period last year was primarily due to an increase in revenue from enterprise customers from both service assurance and cybersecurity offerings, partially offset by decreases from service provider customers from both service assurance and cybersecurity offerings.

Service. The 5%, or $6.2 million, decrease in service revenue compared with the same period last year was primarily due to a decrease in revenue from maintenance contracts.

Total revenue by geography was as follows:

(Dollars in Thousands)

United States revenue decreased 4%, or $4.2 million, primarily due to a decrease in revenue from service provider customers from service assurance offerings, including radio frequency propagation modeling projects. The 2%, or $1.5 million, decrease in international revenue compared with the same period last year was primarily driven by a decrease in revenue from service provider customers from service assurance offerings, as well as a decrease in revenue from service provider customers from cybersecurity offerings, partially offset by an increase in revenue from enterprise customers from cybersecurity offerings and service assurance offerings.

Total revenue by product line was as follows:

(Dollars in Thousands)

The 6%, or $7.8 million, decrease in revenue from the service assurance product line was due to a decrease in revenue from service provider customers for both product and service revenue. The 3%, or $2.1 million, increase in revenue from the cybersecurity product line was due to higher revenue from enterprise customers for both product and service revenue, partially offset by a decrease in product revenue from service provider customers.

Total revenue by customer vertical was as follows:

(Dollars in Thousands)

The 25%, or $22.3 million, decrease in revenue from the service provider customer vertical was due to a decrease in product and service revenue from both the service assurance and cybersecurity product lines. The 16%, or $16.7 million, increase in revenue from the enterprise customer vertical was due to an increase in product and service revenue from the cybersecurity product line and an increase in product revenue from enterprise customers, partially offset by a decrease in service revenue from the service assurance product line.

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 16%, or $2.7 million, decrease in cost of product revenue for the three months ended September 30, 2024 compared to the same period last year was primarily due to a $0.9 million decrease in direct material costs, and a $0.8 million decrease in the amortization of intangible assets. The product gross profit percentage increased by three percentage points to 83% during the three months ended September 30, 2024 as compared with the three months ended September 30, 2023. The 5%, or $3.1 million, increase in product gross profit is attributable to the 1%, or $0.5 million, increase in product revenue, and the 16%, or $2.7 million, decrease in cost of product revenue.

Service. The 6%, or $1.7 million, increase in cost of service revenue for the three months ended September 30, 2024 compared to the same period last year was primarily due to a $1.6 million increase in employee-related costs associated with an increase in variable incentive compensation partially offset by a decrease in cost due to a reduction in headcount. The service gross profit percentage decreased by three percentage points to 74% during the three months ended September 30, 2024 as compared with the three months ended September 30, 2023. The 9%, or $7.8 million, decrease in service gross profit is attributable to the 5%, or $6.2 million decrease in service revenue, and the 6%, or $1.7 million, increase in cost of service revenue.

Gross profit. Our gross profit decreased 3%, or $4.7 million, during the three months ended September 30, 2024 when compared with the three months ended September 30, 2023. This decrease is attributable to the decrease in revenue of 3%, or $5.7 million, partially offset by the 2%, or $1.0 million, decrease in cost of revenue. The gross profit percentage remained flat at 78% for the three months ended September 30, 2024 as compared with the three months ended September 30, 2023.

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 2%, or $0.8 million, increase in research and development expenses for the three months ended September 30, 2024 compared to the same period last year was primarily due to a $1.2 million increase in employee-related costs associated with an increase in variable incentive compensation partially offset by a decrease in cost due to a reduction in headcount, and a $0.6 million increase in allocated overhead. These increases were partially offset by a $0.6 million decrease from depreciation expense.

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 $0.3 million increase in total sales and marketing expenses for the three months ended September 30, 2024 compared to the same period last year was primarily due to a $3.6 million increase related to trade shows and other events. This increase was partially offset by a $3.5 million decrease in employee-related costs associated with a decrease in variable incentive compensation as well as a decrease in cost due to a reduction in headcount, and a $0.6 million decrease in commissions expense.

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

The 5%, or $1.1 million, increase in general and administrative expenses for the three months ended September 30, 2024 compared to the same period last year was primarily due to a $1.6 million increase in employee-related costs associated with an increase in variable incentive compensation.

Amortization of acquired intangible assets. Amortization of acquired intangible assets consists primarily of amortization of customer relationships, definite-lived trademarks and trade names, and developed technology related to our acquisitions of Danaher Corporation's communications business (Comms Transaction), Network General Corporation, Avvasi Inc. and Efflux Systems, Inc.

The 7%, or $0.9 million, decrease in amortization of acquired intangible assets was largely due to a decrease in the amortization of intangible assets acquired as part of the Comms Transaction and the Network General Corporation transaction.

Restructuring charges. During the first quarter of fiscal year 2025, we implemented a voluntary separation program (VSP) for employees who met certain age and service requirements to reduce overall headcount. As a result of the related workforce reduction, during the three months ended September 30, 2024, we recorded additional restructuring charges totaling $2.4 million related to one-time termination benefits for twenty-three employees who voluntarily terminated their employment with us during the three months ended September 30, 2024.

Gain on Divestiture of Business. During the three months ended September 30, 2023, we recorded a $3.8 million gain on the divestiture of the Test Optimization business.

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

(Dollars in Thousands)

The 252%, or $3.0 million, change in interest and other income (expense), net for the three months ended September 30, 2024 compared to the same period last year was primarily due to a $2.1 million increase in foreign exchange expense, and a $0.9 million decrease from the change in fair value of the equity investment in Napatech.

Income Tax Expense. The effective tax rates were 26.8% and 21.9% for the three months ended September 30, 2024 and 2023, respectively. The effective tax rate for the three months ended September 30, 2024 differed from the effective tax rate for the three months ended September 30, 2023, primarily related to an increase in the forecasted benefit of the foreign derived intangible deduction, offset by an increase in foreign withholding taxes.

(Dollars in Thousands)

Six Months Ended September 30, 2024 and 2023

Revenue

During the six months ended September 30, 2024, and 2023, no direct customer or channel partner accounted for more than 10% of our total revenue.

(Dollars in Thousands)

Product. The 19%, or $33.0 million, decrease in product revenue compared with the same period last year was due to a decrease in revenue from both service provider and enterprise customers from service assurance offerings, including radio frequency propagation modeling projects, as a result of industry-specific capital spending constraints, as well as a decrease in revenue from service provider customers from cybersecurity offerings. The results for the six months ended September 30, 2023 benefited from approximately $48 million of backlog-related revenue. Excluding backlog-related revenue, total revenue for the six months ended September 30, 2024 compared with the same period last year would have increased year over year.

Service. The 4%, or $9.3 million, decrease in service revenue compared with the same period last year was primarily due to a decrease in revenue from maintenance contracts as well as professional service contracts.

Total revenue by geography was as follows:

(Dollars in Thousands)

United States revenue decreased 13%, or $32.2 million, primarily due to a decrease in revenue from service assurance offerings from service provider customers, including radio frequency propagation modeling projects. The 6%, or $10.1 million, decrease in international revenue compared with the same period last year was primarily driven by lower revenue from service provider customers from both service assurance and cybersecurity offerings.

Total revenue by product line was as follows:

(Dollars in Thousands)

The 13%, or $37.1 million, decrease in revenue from the service assurance product line was due to a decrease in revenue from both enterprise and service provider customers, including radio frequency propagation modeling projects, and the 4%, or $5.2 million, decrease in revenue from the cybersecurity product line was due to a decrease in revenue from service provider customers, partially offset by an increase in revenue from enterprise customers.

Total revenue by customer vertical was as follows:

(Dollars in Thousands)

The 22%, or $42.2 million, decrease in revenue from the service provider customer vertical was due to a decrease in product and service revenue from both the service assurance and cybersecurity product lines.

Cost of Revenue and Gross Profit

(Dollars in Thousands)

Product. The 22%, or $7.3 million, decrease in cost of product revenue for the six months ended September 30, 2024 compared to the same period last year was primarily due to a $3.5 million decrease in direct material costs, a $1.5 million decrease in the amortization of intangible assets, a $0.9 million decrease in costs related to the delivery of radio frequency propagation modeling projects, a $0.8 million decrease in inventory related expenses, and a $0.6 million decrease in employee-related costs associated with the timing of certain projects. The product gross profit percentage increased by one percentage point to 82% during the six months ended September 30, 2024 when compared to the six months ended September 30, 2023. The 18%, or $25.7 million, decrease in product gross profit is attributable to the 19%, or $33.0 million, decrease in product revenue, partially offset by the 22%, or $7.3 million, decrease in cost of product revenue.

Service. The $0.3 million increase in cost of service revenue for the six months ended September 30, 2024 compared to the same period last year was primarily due to a $0.9 million increase in employee-related expenses largely due to an increase in variable incentive compensation partially offset by a decrease in costs due to a reduction in headcount, and a $0.5 million increase in contractor fees. These increases were partially offset by a $0.6 million decrease in cost of materials used to support customers under service contracts. The service gross profit percentage decreased by one percentage point to 73% for the six months ended September 30, 2024 when compared to the six months ended September 30, 2023. The 6%, or $9.6 million, decrease in service gross profit is attributable to the 4%, or $9.3 million decrease in service revenue, and the $0.3 million increase in cost of service revenue.

Gross profit. Our gross profit for the six months ended September 30, 2024 decreased 11%, or $35.2 million, compared to the same period last year. This decrease is primarily attributable to the decrease in revenue of 10%, or $42.3 million, partially offset by the 8%, or $7.0 million, decrease in cost of revenue. The gross profit percentage decreased by one percentage point to 76% for the six months ended September 30, 2024 when compared to the six months ended September 30, 2023.

Operating Expenses

(Dollars in Thousands)

Research and development. The 3%, or $2.3 million, decrease in research and development expenses for the six months ended September 30, 2024 compared to the same period last year was primarily due to a $1.2 million decrease in employee-related expenses largely due to a decrease in headcount partially offset by an increase in variable incentive compensation, a $1.2 million decrease from depreciation expense, and a $0.5 million decrease in contractor fees. These decreases were offset by a $0.9 million increase in allocated overhead.

Sales and marketing. The 6%, or $8.4 million, decrease in sales and marketing expenses for the six months ended September 30, 2024 compared to the same period last year was primarily due to a $6.5 million decrease in employee-related expenses largely due to a decrease in headcount, a $3.6 million decrease in commissions expense, and a $0.7 million decrease in advertising expense. These decreases were partially offset by a $2.7 million increase related to trade shows and other events.

General and administrative. The 3%, or $1.5 million, decrease in general and administrative expenses for the six months ended September 30, 2024 compared to the same period last year was primarily due to a $1.4 million decrease in contractor fees, a $0.7 million decrease from depreciation expense, a $0.6 million decrease in business taxes, and a $0.5 million decrease in allocated overhead. These decreases were partially offset by a $1.2 million increase in employee-related expenses largely due to an increase in variable incentive compensation, a $0.5 million increase in legal fees, and a $0.5 million increase in accounting related expenses.

Amortization of acquired intangible assets. Amortization of acquired intangible assets consists primarily of amortization of customer relationships, definite-lived trademark and tradenames, and developed technology related to our acquisitions of the Comms Transact, Network General Corporation, Avvasi, Inc. and Efflux Systems, Inc.

The 8%, or $2.0 million, decrease in amortization of acquired intangible assets for the six months ended September 30, 2024 compared to the same period last year was largely due to a decrease in the amortization of intangible assets related to the Comms Transaction and Network General Corporation.

Restructuring charges. During the first quarter of fiscal year 2025, we implemented a voluntary separation program (VSP) for employees who met certain age and service requirements to reduce overall headcount. As a result of the related workforce reduction, during the six months ended September 30, 2024, we recorded restructuring charges totaling $19.0 million related to one-time termination benefits for one hundred thirty-nine employees who voluntarily terminated their employment with us during that period.

Goodwill impairment. During fiscal year 2024, we recorded $217.3 million in goodwill impairment charges as a result of the sustained decline in our stock price and overall market capitalization. During the first quarter of fiscal year 2025, due to the continued decrease in our stock price and overall market capitalization, along with other qualitative considerations including the continued impact from the conditions in the macroeconomic environment, it was determined a Triggering Event occurred, indicating goodwill may be impaired. Accordingly, we conducted a quantitative impairment test of our goodwill at June 30, 2024. We estimated the implied fair value of our goodwill using a market approach. As a result of the quantitative impairment test performed during the first quarter of fiscal year 2025, we determined goodwill was impaired and recorded a goodwill impairment charge of $427.0 million during the three months ended June 30, 2024. The additional impairment charge recorded in the first quarter of fiscal year 2025 was primarily due to the continued decrease in our stock price from March 31, 2024 to June 30, 2024, an increase in our weighted-average cost of capital, and the refinement to the expected cost synergies that could be realized by a hypothetical buyer as a result of the VSP we implemented in the first quarter of fiscal year 2025, which impacted the company-specific control premium used to determine the fair value of the reporting unit under the market approach. We expect that these restructuring efforts will generate net annual run-rate savings of approximately $25 million to $27 million, of which we expect that approximately $18 million to $19 million will be realized in the remainder of fiscal year 2025. At September 30, 2024, the Company performed a Triggering Event assessment and concluded no event or circumstances occurred that indicated goodwill was further impaired.

The key assumption in the market approach was the company-specific control premium, which was estimated using expected synergies that would be realized by a hypothetical buyer. We also compared its implied control premium to recent control premiums paid in the industry, as evidenced by guideline public company comparable transactions. This information corroborated that the company-specific control premium was within the range of premiums for other companies operating in the industry. Changes in the estimates or assumptions used in its quantitative impairment test could materially affect the determination of fair value and the associated goodwill impairment assessment. Potential events and circumstances that could have an adverse impact on our estimates and assumptions include, but are not limited to, continued increases in costs, and high interest rates and other macroeconomic factors. An increase or decrease of 1% in the company-specific control premium used in the determination of the fair value of the reporting unit under the market approach would have resulted in an increase or decrease in the goodwill impairment recorded during the six months ended September 30, 2024 of approximately $13.0 million.

Gain on Divestiture of Business. During the six months ended September 30, 2023, we recorded a $3.8 million gain on the divestiture of the Test Optimization business.

Interest and Other Income (Expense), Net

(Dollars in Thousands)

The 1,342%, or $7.3 million, increase in interest and other income (expense), net was primarily due to a $7.6 million increase from the change in fair value of the equity investment in Napatech, a $0.8 million increase in interest income, and a $0.5 million decrease in interest expense due to debt repayments on the credit facility in May 2024, partially offset by an increase in the average interest rate on the credit facility. These increases were partially offset by a $1.0 million increase in foreign exchange expense during the six months ended September 30, 2024, when compared to the six months ended September 30, 2023, and a $0.5 million decrease in other income.

Income Tax Expense (Benefit). Our effective tax rates were 1.6% and 22.0% for the six months ended September 30, 2024 and 2023, respectively. The effective tax rate for the six months ended September 30, 2024 differed from the effective rate for the six months ended September 30, 2023, primarily related to an increase in the forecasted benefit of the foreign derived intangible income deduction offset by an increase in foreign withholding taxes and goodwill impairment incurred during the six months ended September 30, 2024, which was not deductible for tax purposes.

(Dollars in Thousands)

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Liquidity and Capital Resources

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

Cash, cash equivalents, marketable securities and investments

At September 30, 2024, cash, cash equivalents, marketable securities and investments (current and non-current) totaled $401.9 million, a $22.2 million decrease from $424.1 million at March 31, 2024. This decrease was primarily due to $25.3 million used to repurchase shares of our common stock, $25.0 million used to repay long-term debt, $13.5 million used for tax withholdings on restricted stock units, $2.2 million used for capital expenditures, and $1.3 million used to acquire technology licenses, partially offset by $34.7 million of net cash provided by operations, and an $8.3 million increase from the change in fair value of an equity instrument during the six months ended September 30, 2024. Cash and short-term investments held outside of the United States was approximately $181.1 million.

Cash and cash equivalents were impacted by the following:

(in thousands)

Net cash from operating activities

Cash provided by operating activities was $34.7 million during the six months ended September 30, 2024, compared with $48.7 million of cash used in operating activities during the six months ended September 30, 2023. The $83.4 million change was due in part to a $427.0 million goodwill impairment charge recorded during the six months ended September 30, 2024, an $82.6 million increase from accounts receivable, a $43.6 million increase from accrued compensation and other expenses, a $3.8 million increase related to the gain recorded in the six months ended September 30, 2023 for the divestiture of a business, a $3.1 million increase from income taxes payable, a $3.0 million increase from prepaid expenses and other assets, and a $0.6 million increase from accounts payable. These increases were partially offset by a $451.6 million decrease from the change in net income (loss), a $7.8 million decrease from deferred revenue, a $7.6 million decrease from the change in the fair value of an equity investment, a $5.9 million decrease from depreciation and amortization expense, a $3.4 million decrease in deferred income taxes, a $2.2 million decrease from share-based compensation, and a $2.0 million decrease from inventories during the six months ended September 30, 2024 as compared with the six months ended September 30, 2023.

Net cash from investing activities

(in thousands)

Cash provided by investing activities was $0.9 million during the six months ended September 30, 2024, compared with $7.0 million of cash used in investing activities during the six months ended September 30, 2023. The $7.9 million change was due in part to a $16.0 million increase in cash inflow from marketable securities related to a $20.9 million decrease in the purchase of marketable securities and investments, partially offset by a decrease of $4.9 million in proceeds from the sales and maturity of marketable securities during the six months ended September 30, 2024 when compared with the six months ended September 30, 2023. In addition, cash used to purchase fixed assets decreased $1.3 million during the six months ended September 30, 2024, compared with the six months ended September 30, 2023. These increases to cash inflow were partially offset by an $8.3 million decrease in proceeds from the divestiture of the Test Optimization business during the six months ended September 30, 2023, and a $1.3 million increase in cash used to acquire technology licenses during the six months ended September 30, 2024.

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 2025.

Net cash from financing activities

(in thousands)

Cash used in financing activities changed by $13.9 million to $63.8 million during the six months ended September 30, 2024, compared with $49.9 million of cash used in financing activities during the six months ended September 30, 2023.

During the six months ended September 30, 2024, we repurchased a total of 1,362,205 shares for $25.3 million in the open market under the 2022 Share Repurchase Program.

In connection with the delivery of our common stock upon vesting of restricted stock units, we withheld 681,963 and 624,941 shares at a cost of $13.5 million and $18.7 million related to minimum statutory tax withholding requirements on these restricted stock units during the six months ended September 30, 2024 and 2023, 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 six months ended September 30, 2024, we repaid $25.0 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. During the six months ended September 30, 2024, we repaid $25.0 million of borrowings under the Second Amended and Restated Credit Agreement. At September 30, 2024, $75.0 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 June 30, 2024, until we have delivered financial statements for the quarter ended September 30, 2024, 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 June 30, 2024, until we have delivered financial statements for the quarter ended September 30, 2024, 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 us and the subsidiary guarantors (which pledge, in the case of any foreign subsidiary, is limited to 65% of the voting stock), subject to certain customary exceptions and limitations. The 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 September 30, 2024, 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 $2.0 million at September 30, 2024, 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 $0.9 million was included as other assets in our consolidated balance sheet at September 30, 2024. On October 4, 2024, we amended and extended the Second Amended and Restated Credit Agreement (as amended and restated, the Third Amended and Restated Credit Agreement), which decreased the incremental amount available to us under our revolving credit facility to $525 million. For further information, see Note 20 contained in the "Notes to Consolidated Financial Statements" included in Part 1 of this quarterly report on Form 10-Q.

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 requirements 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 high inflation and interest rates, and a potential recession, could increase our anticipated funding requirements or make it more difficult for us to access capital.

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 Third 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 high 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 September 30, 2024, we owed $75.0 million on this loan with an interest rate of 5.95%. A sensitivity analysis was performed on the outstanding portion of our debt obligation as of September 30, 2024. Should the current weighted-average interest rate increase or decrease by 10%, the resulting annual increase or decrease to interest expense would be approximately $446 thousand as of September 30, 2024.

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 September 30, 2024, we had foreign currency forward contracts designated as hedging instruments with notional amounts totaling $10.2 million. The valuation of outstanding foreign currency forward contracts at September 30, 2024 resulted in a liability balance of $6 thousand, reflecting unfavorable contract rates in comparison to current market rates at this date and an asset balance of $132 thousand, reflecting favorable rates in comparison to current market rates at this date. At March 31, 2024, we had foreign currency forward contracts designated as hedging instruments with notional amounts totaling $11.7 million. The valuation of outstanding foreign currency forward contracts at March 31, 2024 resulted in a liability balance of $74 thousand, reflecting unfavorable contract rates in comparison to current market rates and an asset balance of $11 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 September 30, 2024, 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 September 30, 2024, 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, 2024. 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.