10-K 1 ntct-2016331x10k.htm 10-K Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended March 31, 2016
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                      to                     
Commission file number 000-26251
 
NETSCOUT SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
Delaware
04-2837575
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
310 Littleton Road, Westford, MA 01886
(978) 614-4000
 
 
Securities registered pursuant to Section 12(b) of the Act:
 
Name of each exchange on which registered: NASDAQ Global
Common Stock, $0.001 Par value
 
Select Market
Securities registered pursuant to Section 12(g) of the Act:
None
 
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES  x NO ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨ NO x
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  x    NO  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  x    Accelerated filer  ¨    Non-accelerated filer  ¨    Smaller reporting company  ¨
(Do not check if a smaller reporting company)
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES  ¨    NO  x
The aggregate market value of common stock held by non-affiliates of the registrant as of September 30, 2015 (based on the last reported sale price on the Nasdaq Global Select Market as of such date) was approximately $3,413,523,295. As of May 16, 2016, there were 93,757,507 shares of the registrant’s common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement for the fiscal year 2016 Annual Meeting of Stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K. Except as expressly incorporated by reference, the proxy statement is not deemed to be part of this report.



NETSCOUT SYSTEMS, INC.
FORM 10-K
FOR THE FISCAL YEAR ENDED MARCH 31, 2016
TABLE OF CONTENTS
 
PART I
 
 
 
 
 
Item 1.
 
 
 
Item 1A.
 
 
 
Item 1B.
 
 
 
Item 2.
 
 
 
Item 3.
 
 
 
Item 4.
 
 
 
PART II
 
 
 
 
 
Item 5.
 
 
 
Item 6.
 
 
 
Item 7.
 
 
 
Item 7A.
 
 
 
Item 8.
 
 
 
Item 9.
 
 
 
Item 9A.
 
 
 
Item 9B.
 
 
 
PART III
 
 
 
 
 
Item 10.
 
 
 
Item 11.
 
 
 
Item 12.
 
 
 
Item 13.
 
 
 
Item 14.
 
 
PART IV
 
 
 
 
Item 15.
 
 
 
 



This Annual Report on Form 10-K contains forward-looking statements under Section 21E of the Exchange Act and other federal securities laws. These statements relate to future events or our future financial performance and are identified by terminology such as "may," "will," "could," "should," "expects," "plans," "intends," "seeks," "anticipates," "believes," "estimates," "potential" or "continue," or the negative of such terms or other comparable terminology. These statements are only predictions. You should not place undue reliance on these forward-looking statements. Actual events or results may differ materially. Factors that may cause such differences include, but are not limited to, the factors discussed under the heading "Risk Factors" and in our other filings with the SEC. These factors may cause our actual results to differ materially from any forward-looking statement.

PART I
    
Item 1. Business
As used herein, references to “NetScout,” the “Company,” “we,” “us” and “our” are to NetScout Systems, Inc. and its consolidated subsidiaries or, as the context may require, NetScout Systems, Inc. only.
Overview
We are an industry leader for real-time operational intelligence and performance analytics for service assurance and cyber security solutions that are used in many of the most demanding service provider, enterprise and government networks. Our solutions, based on proprietary Adaptive Service Intelligence™ (ASI) technology, help customers continuously monitor the service delivery environment to identify performance issues and to provide insight into network-based security threats. As a result, customers can quickly resolve issues that cause business disruptions or that adversely impact the user experience. We manufacture and market these products for integrated hardware and software solutions and are also well positioned to help customers deploy our software in commercial-off-the-shelf hardware and in virtualized form factors. Regardless of the platform, customers use our solutions to help drive ROI on their network and broader IT initiatives while reducing the tangible risks associated with downtime, poor service quality and compromised security. We report revenues and income under five operating segments that aggregate under a single reportable segment.
We have been a technology innovator for three-plus decades since our founding in 1984. Our market-leading solutions change how organizations manage and optimize the delivery of business applications and services, assure user experience across global IP networks and help protect networks from unwanted security threats. Through both internal development and acquisitions, we have continually enhanced and expanded our product portfolio to meet the evolving needs of customers worldwide. Our software analytics capture and transform terabytes of network traffic data in real time into high value, actionable information that enables customers to optimize network performance, manage applications, enhance security and gain insight into the end-user experience.
Our operating results are influenced by a number of factors, including, but not limited to, the mix and quantity of products and services sold, pricing, costs of materials used in our products, growth in employee related costs, including commissions, and the expansion of our operations. Factors that affect our ability to maximize our operating results include, but are not limited to, our ability to introduce and enhance existing products, the marketplace acceptance of those new or enhanced products, continued expansion into international markets, development of strategic partnerships, competition, successful acquisition integration efforts, our ability to achieve expense reductions and make structural improvements and current economic conditions.
On July 14, 2015, which we also refer to as the Closing Date, we completed the acquisition of Danaher Corporation’s (Danaher) Communications Business (Communications Business), which included certain assets, liabilities, technology and employees within Tektronix Communications, VSS Monitoring, Arbor Networks and certain portions of the Fluke Networks Enterprise business, which excluded Danaher’s data communications cable installation business and its communication service provider business (the Transaction). The Transaction was structured as a Reverse Morris Trust transaction whereby Danaher contributed the Communications Business to a new subsidiary, Potomac Holding, LLC (Newco). The total equity consideration was approximately $2.3 billion based on issuing approximately 62.5 million new shares of NetScout common stock to the holders of common units of Newco, based on the July 13, 2015 NetScout common stock closing share price of $36.89 per share. The Transaction is expected to more than double NetScout's total addressable market to over $8 billion by extending its reach into growth-oriented adjacent markets, including cyber security, with a broader range of market-leading products and capabilities, strengthen its go-to-market resources to better support a larger, more diverse and more global customer base, and increase NetScout's scale and elevate its strategic position within key accounts. For additional information regarding the Transaction, see Note 7 of our Notes to Consolidated Financial Statements.

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Markets
Enterprise Markets
Within the enterprise market, NetScout’s nGenius® and Infinistream® technologies, along with certain product lines from the acquired businesses, enable IT organizations to improve service delivery quality, and identify and address business service performance issues and security threats before they become serious and affect large numbers of users. Some of the current enterprise IT initiatives our solutions support include:
IT Operational Excellence – We deliver real-time and historical information that provides the necessary insight to restore service, manage capacity, and understand the quality of the users’ experience.
Data Center Modernization and Cloud Computing – We enable IT organizations to manage the delivery of services across virtual and physical environments, providing a comprehensive, unified real-time view into network, application, server, and user communities' performance. We proactively detect emerging issues with the ability to help analyze both physical and virtual service delivery environments within the data center which enables organizations to optimize datacenter infrastructure investments, protect against service degradations, and simplify the operation of complex, multi-tier application environments in consolidated, state-of-the-art data centers. Our solutions are often used by enterprises to support private cloud computing environments that are aimed at enabling greater, more cost-effective accessibility to applications without compromising the reliability and security of those applications and the network. In addition, the acquisition of the assets of Fluke Networks Enterprise business provide additional capabilities to support enterprises seeking to ensure the performance of applications when utilizing public cloud environments.
Unified Communications (UC) – We deliver deep application-level unified visibility into voice, data and video services side-by-side in order to understand the interrelationships of all UC services that traverse the network infrastructure and assess quality and performance of the delivery of these services. As a result, our real-time, actionable intelligence helps customers to deliver a high-quality UC experience as users make calls, video conference and engage in instant messaging. We also help desktop, network, telecom, and application teams manage UC through a common platform across complex, geographically dispersed, and multi-vendor environments.
New Application Service Rollout We provide enterprise customers with a holistic view of the new applications and services as they are introduced into their IT environment. This view enables customers to see the relationships and interdependencies across all service delivery components including applications, network, servers, databases, and enabling protocols so they can deliver a superior user experience, achieve outstanding service quality and drive return on their application investments.
Application and Desktop Virtualization We provide clear and actionable insights that help customers fully realize the operational benefits associated with Application and Desktop Virtualization, and reduce the time it takes to identify and resolve service problems. We offer visibility across all virtual desktop infrastructure (VDI) tiers including remote access, client, virtualization, web, front-end application, and related database systems, and help customers gain actionable metrics from monitoring and analyzing the consumption and performance of VDI services.
Cybersecurity – Cyberattacks are increasing in volume complex, targeting users, applications, infrastructure, and mobile devices. We provide a range of network security solutions that enable enterprises to protect their networks from high-volume and application-specific attacks, and identify unauthorized intrusions into the network that can pose significant threats to the integrity of sensitive information and key business operations. We also provide incident response activities with deep-dive network forensics and offer contextual information surrounding a specific alert or incident to enhance investigative capabilities and avoid false positives.
Government Markets
Similar to our enterprise markets, government agencies are focused on streamlining and transforming IT into more efficient and more easily managed environments. To accomplish this, agencies are turning to IT solutions that will help simplify managing and assuring their IT environments as well as reduce costs. However, governmental markets differ from enterprise markets primarily due to their purchasing cycles being influenced by potential changes in government administrators, budgetary priorities and allocated funding for key projects.
Telecommunication Service Provider Markets
Today’s service providers are focused on delivering a compelling set of services and ensuring a high-quality user experience, while also striving to minimize operational complexity and costs. This, coupled with the challenge of Internet

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Protocol (IP) transformation activities and emerging new technologies such as LTE, virtualization, Internet Protocol Television (IP-TV), wireless network (WiFi) and cloud services drives the need for a more automated and unified approach to managing service delivery and the subscriber experience. Service providers must reduce the cost of service delivery, address increasing complexity, scale their networks cost-effectively and adapt to emerging technologies such as cloud services, virtualization and 5G while assuring high-quality user experiences to retain their revenue base. Additionally, service providers must protect their networks from high-volume, increasingly sophisticated cyberattacks that consume bandwidth and potentially create outages that impact their business customers.
For Mobile Operators – The fundamental transformation of the mobile network to all-IP enables mobile operators to build highly-scalable service delivery environments to offer new services to meet the growing subscriber demand for data, voice and video-centric services and to consolidate and simplify network operations. However, to capitalize fully on the value of IP and the significant market opportunities, mobile operators need detailed IP packet-level insight and core-to-access visibility. The addition of the Tektronix Communications assets provides a broader range of capabilities that monitor radio access networks as well as powerful analytics that provide insight into subscriber trends and their customer experience.
For Fixed-line and Cable Operators – The growing demand for high-bandwidth triple-play services, broadband connectivity, content anywhere, IP-TV, on-demand video traffic, new extended WiFi initiatives and carrier Ethernet services presents service providers with significant revenue opportunities. IP has become the de facto convergence mechanism for access, distribution and core networks, enabling new service offerings and simplifying network operations while reducing total cost of operations. For example, we are also starting to see cable operators use our solutions to monitor and manage their local area WiFi connectivity services. To realize these benefits, operators need comprehensive insight into IP services, service usage, service availability, application awareness, traffic load, network availability and network performance.
For Internet Service Providers – Over the past decade, Internet Service Providers (ISPs), including leading telecommunications providers, cable multi service operators and cloud providers, have seen significant increases in the sophistication, scale and frequency of high-volume and application-specific attacks, known as Distributed Denial of Service (DDoS) attacks, on their networks. DDoS attacks are aimed at disrupting the online services of an ISP’s business customer by overwhelming it with traffic from multiple sources. Arbor Networks provides a wide range of ISPs around the world with solutions that help them protect their networks against DDoS attacks.
Products & Technology Overview
NetScout continuously develops its solutions to meet the increasing demands and ever changing technology landscape of IP networks, service and applications. In recent years, we have delivered major product upgrades across our product lines, more tightly integrating deep packet analysis and forensics into our top-down performance management workflows, improving the flexibility of our industry-leading intelligent early warning capabilities, and adding support for new sources of user experience and performance related metrics. NetScout’s solutions are used by customers to better understand and manage network and application performance, alert themselves to problems that impact end users, validate services and network policy, plan and optimize network capacity, generate timely reports, conduct deep forensic and historical analysis, and protect their networks against security threats.
During fiscal year 2016, we continued to invest in development programs aimed at enhancing our range of offerings, including delivering new features and functionality for our nGeniusONETM Service Assurance platform that address the evolving requirements of our enterprise, service provider and government customers. The nGeniusONE platform is powered by ASI 2.0, NetScout’s next-generation Deep Packet Inspection (DPI) technology that exploits the inherent richness of packet-flow data to provide real-time, contextual analysis of service, network, and application performance. The patented ASI technology is a critical differentiating technology that enables the creation of statistical metadata, session transaction records and adaptive session traces enabling real-time, scalable monitoring of all users, all applications and all services consistently across the network. We also invested significantly in enhancing the acquired product lines within the Danaher Communications Business, and in leveraging our ASI technology to advance product integration initiatives aimed at further elevating our value proposition to customers in each of the markets we serve.
Service Assurance Solutions
nGeniusONE Management Software and Analytic Modules – NetScout’s nGeniusONE management software is used to support the Company’s enterprise, service provider and government customers enabling them to predict, preempt, and resolve network and service delivery problems while facilitating the optimization and capacity planning of their network infrastructures. Other products acquired from Danaher's Communications Business are supported by their own respective management software and related analytics. Additionally, NetScout markets a range of specialized

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platforms and analytic modules that can enable its customers to analyze and troubleshoot traffic in radio access network and WiFi networks, as well as gain timely insight into high-value services, applications and systems, and better understand the subscriber’s experience on the network. The Company expects to bring new innovations resulting from key product integration activities to the marketplace over the coming 12 to 24 months.
Intelligent Data Sources, Packet Flow Switches and Taps – NetScout’s Intelligent Data Sources, marketed under the Infinistream brand and often referred to as network probes, provide real-time collection and analysis of information-rich, high-volume packet-flow data from across the network that is displayed through the nGeniusONE Service Assurance Solution. NetScout will continue to support comparable instrumentation from the acquired product lines as the Company brings to market an integrated intelligent data source, the Infinistream NG, that powers the traditional nGeniusONE monitoring analytics and the subscriber troubleshooting analytics associated with the Iris analytics from Tektronix. NetScout also provides comprehensive network monitoring fabric switching solutions that deliver targeted network traffic access to an increasing number of monitoring systems, including the nGeniusONE Performance Management platform, as well as other monitoring and security systems. The acquired product lines from the VSS Monitoring unit further complement the Company’s family of packet flow switch offerings. Additionally, NetScout markets a suite of test access points (TAPs) that enable full, non-disruptive access to network traffic with multiple link type and speed options.
Portable Network Analysis and Troubleshooting Tools
NetScout, through the acquired Fluke Networks Enterprise assets, provides a range of portable network analysis and troubleshooting tools that help customers quickly identify key issues that can impact network and application performance. NetScout’s tools are used by IT departments to support traditional, cloud and WiFi network environments. Certain capabilities and information delivered through these tools are expected to be integrated into NetScout's nGeniusONE management solutions.
Cybersecurity Solutions
DDos Protection – NetScout provides security solutions that enable service providers and enterprises around the world to protect their networks against DDoS attacks. Our portfolio of DDoS solutions offer complete deployment flexibility spanning on-premise offerings and cloud-based capabilities to meet a broad array of customer needs.
Advanced Threat Detection – Our Spectrum offering, introduced in February 2016, combines our Internet-scale visibility with advanced threat detection, enabling enterprises to rapidly identify and investigate advanced threat campaigns that present tangible risks to the integrity of their networks.
Integration with Third-Party Solutions
To have greater operational impact on assuring performance of applications and service delivery, NetScout has integrated its technology with third-party management consoles and business service management systems. This integration allows organizations to receive alarms on impending performance problems and to link into the nGenius Service Assurance solution in order to perform detailed problem analysis and troubleshooting. Moving forward, NetScout plans to make its ASI-level data accessible to third party platforms. In addition, Arbor has embedded its DDoS mitigation capabilities on a blade within Cisco's market-leading ASR9000 router and will continue to evaluate partnership opportunities to integrate its DDOS capabilities within other network equipment platforms. By providing seamless integration into management platforms, NetScout fills a significant gap in the third-party product functionality and visibility into the interaction of applications, services and infrastructure resources from a packet-based network vantage point. NetScout collaborates with technology partners to provide integrated solutions and extend the value of the nGenius Service Assurance Solution for application and network performance management across the organization. Using packet-flow data, key performance indicators and other sources of performance information derived from the nGenius Service Assurance Solution, an organization’s ability to optimize, simplify and protect the service delivery environment is enhanced. Among the third-party solutions providers that NetScout has integrated its solutions with are Cisco Systems, Cisco Sourcefire, Citrix Systems, EMC Corporation, Hewlett-Packard Company, IBM Tivoli and VMWare.

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Growth Strategy
Our key objectives have been to continue to gain market share in the service provider market and to accelerate our enterprise growth by extending into the application performance management sector. In addition, given the nature of the customers in our government sector, we believe future cybersecurity products would be effective in this market. We believe that the Transaction (see Note 7 of our Consolidated Financial Statements) will further accelerate key elements of our strategy, which include:
Driving technology innovation – NetScout will continue to invest in research and development, and leverage the strong technical and domain expertise across its organization. As a result of the acquisition of the Transaction, NetScout has a broader base of research and development talent, exceeding 1,200 professionals as of March 31, 2016. The Company’s engineering teams will be focused on advancing technical innovation across its broad product portfolio. By capitalizing on NetScout’s extensive experience with global enterprise, service provider and government organizations with IP-based networks, NetScout will be well positioned to cross-leverage its technology development across all major platforms and relevant technologies to address the evolving demands of current and prospective customers.
Continued portfolio enhancements and product integration – We plan to continue to enhance our products and solutions to address the management challenges associated with virtualization, cloud computing, service-oriented architectures, VoIP, video, telepresence technologies, and network security. In addition, we will continue to drive our solutions to help IT organizations address the challenges of complex service delivery, datacenter consolidation, branch office consolidation and optimization, increasing mobility and the move to a more process-oriented operating environment. During fiscal year 2017, additional investment will be focused on integrating key capabilities from the acquired assets to further elevate NetScout’s value proposition to both service provider and enterprise customers. For example, we plan to bring an integrated probing solution to market for service providers that will support both the high-value subscriber troubleshooting capabilities from Tektronix Communications and NetScout’s traditional proactive, continuous IP monitoring capabilities. Other examples of product integration will focus on leveraging NetScout’s ASI technology to consolidate certain troubleshooting, monitoring and security capabilities from Fluke Networks Enterprise and Arbor within the broader nGeniusONE offerings.
Future extension into adjacent markets By enhancing and expanding NetScout’s product portfolio and driving product integration, NetScout will be positioned to further build its presence in complementary adjacent markets that can drive higher spending from existing customers, help attract new customers, and increase its total addressable market. Certain product initiatives are intended to help us make progress on this element of our strategy during fiscal year 2017.
Enable pervasive visibility – We intend to continue to expand our intelligent data source family to enable our customers to achieve greater visibility into more places across their end-to-end network environment. By driving product integration and innovation, we plan to integrate various capabilities, including our Adaptive Service Intelligence software, across the combined company's product portfolio to enable wider deployment of our technology within virtual computing environments, network devices and computing platforms and to support a broader range of network and application performance management, security and business intelligence requirements.
Expand our customer base in both enterprise and service provider markets – As a result of the Transaction, NetScout has a larger direct sales force with specialized expertise in targeting the enterprise, service provider and government markets, along with a more extensive global network of value-added resellers and systems integrators. It is our intention to substantially grow our presence in both the enterprise and service provider markets. In the enterprise market, we plan to further expand our relationships with existing large and mid-sized customers, further fortify third-party distribution channels for the enterprise tools products, and help accelerate enterprise adoption of Arbor’s cybersecurity products. We will also continue to drive further penetration into our global service provider customer base.
Increase market relevance and awareness – The Transaction has substantially expanded our customer base around the world. NetScout will continue to implement marketing campaigns aimed at generating high-quality sales opportunities with both current and prospective enterprise and service provider customers, promoting thought leadership and building the NetScout brand.
Extend our technology partner alliance ecosystem – We will continue to develop and fortify alliances with complementary solutions providers that can help us support a larger, more global and more diverse customer base. We plan to continue to enhance our technology value, product capabilities and customer relevance through the continued integration of our products into technology partner products. This includes both interoperability integration efforts, as

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well as embedding our technology into alliance partner products to gain a more extensive footprint across both enterprise and service provider networks.
Pursue strategic acquisitions – We have completed many acquisitions since the Company’s inception, including the fiscal year 2016 Transaction, that have helped broaden our capabilities, enhance our products and technologies, and better position the Company to meet the needs of a larger base of customers and prospects. We plan to be opportunistic in pursuing strategic acquisitions in order to achieve key business and technology objectives.
Improve cost structure and drive efficiencies – We will continue to focus on directing prudent investment into the key technology, product development, sales and marketing, and other initiatives that will enable us to drive long-term profitable growth. We believe that the Transaction creates a range of opportunities to further improve the Company’s profitability. NetScout plans to generate gross margin synergies by driving product integration and extending its proven manufacturing techniques, and optimizing certain product lines. In addition, NetScout plans to integrate certain operations that have previously been managed separately across various business and product lines, winding down transitional support agreements, consolidating back-office systems, and by continuing to eliminate or reduce redundancies associated with pre-existing resources, programs and capabilities.
Support Services
Customer satisfaction is a key driver of NetScout’s success. NetScout’s support programs offer customers various levels of high quality support services to assist in the deployment and use of our solutions. We have support personnel strategically deployed across the globe to deliver 24/7 telephone support to our premium customers. Certain support services, such as on-site support activities, are provided by qualified third party support partners. In addition, many of our certified resellers provide Partner Enabled Support to NetScout end-users. This is especially prevalent in international locations where time zones and language, among other factors, make it more efficient for end-users to have the reseller provide initial support functions. Our support also includes updates to our software and firmware at no additional charge, if and when such updates are developed and made generally available to our commercial customer base. If ordered, support commences upon expiration of the standard warranty for software. For software, which also includes firmware, the standard warranty commences upon shipment and expires 90 days thereafter. With regard to hardware, the standard warranty commences upon shipment and expires 12 months thereafter. We believe our warranties are consistent with commonly accepted industry standards. NetScout will continue to provide support services for the acquired platforms under existing agreements and will explore opportunities to further simplify and standardize its support obligations over the coming years.
Manufacturing
Our manufacturing operations consist primarily of final product assembly, configuration and testing. We purchase components and subassemblies from suppliers and construct our hardware products in accordance with NetScout standard specifications. We inspect, test and use process control to ensure the quality and reliability of our products. We maintain an ISO 9001 quality systems registration, a certification showing that our corporate procedures and manufacturing facilities comply with standards for quality assurance and process control. We also maintain an ISO 9001:2000 quality systems registration, a certification showing that our corporate procedures comply with standards for continuous improvement and customer satisfaction. Additionally, we have outsourced the manufacturing of certain acquired products to high-quality third-party contract manufacturers.
Although we generally use standard parts and components for our products, which are available from various suppliers, each of the computer network interface cards used in our devices is currently available only from separate single source suppliers. We have generally been able to obtain adequate supplies of components in a timely manner from current suppliers. While currently we purchase from specific suppliers, we believe that, in most cases, alternate suppliers could be identified if current suppliers are unable to fulfill our needs. Our reliance on single source suppliers is further described in Item 1A “Risk Factors.”
We manufacture our products based upon near-term demand estimates resulting from sales forecasts and historical fulfillment information. Due to the fact that these forecasts have a high degree of variability because of such factors as time of year, overall economic conditions and employee incentives, we maintain inventory levels in advance of receipt of firm orders to ensure that we have sufficient stock to satisfy incoming orders.
Sales and Marketing
Sales
We sell our products, support and services through a direct sales force and an indirect reseller and distribution channel.
Our direct sales force uses a “high-touch” sales model that consists of face-to-face meetings with customers to understand and identify their unique business challenges and requirements. Our sales teams then translate those requirements

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into tailored business solutions that allow the customer to maximize the performance of its infrastructure and service delivery environment. Due to the complexity of the systems and the capital expenditure involved, our sales cycle typically takes three to twelve months. We build strategic relationships with our customers by continually enhancing our solution to help them address their evolving service delivery management challenges. In addition to providing a comprehensive solution to meet these needs, we continually provide software enhancements to our customers as part of their maintenance contracts with us. These enhancements are designed to provide additional and ongoing value to our existing customers to promote loyalty and the expansion of their deployment of our products. Existing customer growth is also driven by the expansion and changes in their networks as they add new infrastructure elements, new users, new locations, new applications and experience increasing service traffic volumes.
We also maintain an indirect reseller and distribution channel. Sales to customers outside the United States are primarily export sales through channel partners. Our channel partners assist us by improving our reach to customers, extending our presence in new markets, and marketing and selling our products to a broad array of organizations globally. We sell through a range of channel partners including value added resellers, value added distributors, resellers, and system integrators, to our enterprise, service provider and government customers. Historically and currently, we have used indirect distribution channels principally as intermediaries on contractual terms for customers with whom we have no contract. Our sales force meets with end user customers to present NetScout products and solutions, conduct demonstrations, provide evaluation equipment, recommend detailed product solutions, develop product deployment designs and timelines, and assist in establishing financial and other justification for the proposed solution. During this selling process, a channel partner, who has contracts with both the end customer and NetScout, may be brought in to facilitate the transaction and to provide fulfillment services. In the case of international channel partners, those services usually also include currency translation and support. In the U.S., fulfillment services are usually limited to invoicing and cash collection. Under this approach, we have limited dependence upon channel partners for the major elements of the selling process. In many cases, there are multiple channel partners with the required contractual relationships, so dependence on any single channel partner is not significant.
During the fiscal year ended March 31, 2016, one direct customer accounted for more than 10% of total revenue, while no indirect channel partner accounted for more than 10% of total revenue. During the fiscal year ended March 31, 2015, two direct customers accounted for more than 10% of total revenue, while no indirect channel partner accounted for more than 10% of total revenue. During the fiscal year ended March 31, 2014, one direct customer accounted for more than 10% of total revenue, while no indirect channel partner accounted for more than 10% of total revenue.
Our sales force is organized into four main geographic teams covering sales around the globe: United States, Europe, Asia and the rest of the world. Revenue from sales outside the United States represented 29%, 23% and 24% of our total revenue in the fiscal years ended March 31, 2016, 2015 and 2014, respectively. For additional information regarding our sales by geographic location, see Note 17 of our Notes to Consolidated Financial Statements.
Marketing
Our marketing organization drives our market research, strategy, product positioning and messaging and produces and manages a variety of programs such as advertising, trade shows, industry events, public and analyst relations, social media, direct mail, seminars, sales promotions, and web marketing to promote the sale and acceptance of our solutions and to build the NetScout, ASI®, nGenius® and other applicable product brand names in the marketplace. We also host an annual worldwide user conference as a way to engage with existing customers, to provide education and awareness, and to promote expanded use of our software with these customers.
Key elements of our marketing strategy focus on thought leadership, market positioning, market education, go to market strategies, reputation management, demand generation, and the acceleration of our strategic selling relationships with local and global resellers, systems integrators, and our technology alliance partners. During fiscal year 2016, NetScout invested in further fortifying and amplifying the NetScout brand, including redesigning the NetScout logo and related brand messaging. These activities are expected to continue into fiscal year 2017 as we wind down the use of certain acquired brand names.
Research and Development
Our continued success depends significantly on our ability to anticipate and create solutions that will meet emerging customer requirements. NetScout works closely with its largest enterprise and service provider customers to better understand and address their near-term and longer-term requirements. By better understanding the key, time-sensitive needs of NetScout’s global customer base, NetScout’s development programs will continue to result in enhanced products that are able to meet the increasing challenges of an increasingly complex and dynamic global network environment.

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We have invested significant financial resources and personnel into the development of our products and technology. Our continued investment in research and development is crucial to our business and our continued success in the market. We have assembled a team of highly skilled engineers with expertise in various technologies associated with our business and the technologies being deployed by our customers. We plan to continue to enhance and expand our product offerings and capabilities in the near future while integrating key capabilities from the acquired product lines as appropriate. As a result, we plan to continue to invest and dedicate significant resources to our research and development activities for both our enterprise and service provider customers.
We predominantly develop our products internally, with some limited third-party contracting. We have also acquired developed technology through business acquisitions. To promote industry standards and manifest technology leadership, we participate in and support the activities and recommendations of industry standards bodies, such as the Internet Engineering Task Force and the 3rd Generation Partnership Project and we also engage in close and regular dialogue with our key customers and alliance partners. These activities provide early insight into the direction of network and application performance requirements for current and emerging technologies.
Seasonality
We have experienced, and expect to continue to experience, quarterly variations in our order bookings as a result of a number of factors, including the length of the sales cycle, complexity of customer environments, new product introductions and their market acceptance and seasonal factors affected by customer projects and typical IT buying cycles. Due to these factors, we historically have experienced stronger bookings during our fiscal third and fourth quarters than in the first and second quarters.
Customers
We sell our products to enterprises, service providers and governmental agencies with large- and medium-sized high-speed IP computer networks. Our enterprise customers cover a wide variety of industries, such as financial services, technology, manufacturing, healthcare, utilities, education, transportation and retail. In the telecommunications service provider customer group we address mobile operators, wireline operators and cable operators. A significant number of our service provider customers are mobile operators.
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 orders with little or no penalty. We believe that our backlog at any particular time is not meaningful because it is not necessarily indicative of future sales levels. Our combined product backlog at March 31, 2016 was $125.7 million compared to an immaterial amount at March 31, 2015. A majority of the backlog relates to customization and integration projects from our recently acquired business units. In some cases, we have begun these projects but have not yet hit billable milestones. A majority of revenue for these projects is expected to be recognized into revenue throughout fiscal year 2017.
Competition
We compete with many companies in the markets we serve. The service assurance and performance management market is highly competitive, rapidly evolving, and fragmented with overlapping technologies and a wide range of competitors, both large and small, who may deliver certain elements of our solution. Consequently, there are a number of companies who have greater name recognition and substantially greater financial, management, marketing, service, support, technical, distribution and other resources than we do. Additionally, certain competitors, either due to their size and resources or due to their technological strengths, may be able to respond more effectively than we can to new or changing opportunities, technologies, standards and customer requirements.
Principal competitive factors in our service assurance market include scalability; ability to address a large number of applications, locations and users; product performance; the ability to easily deploy into existing network environments; the ability to offer virtualized solutions; and the ability to administer and manage the solution.
While NetScout faces multiple competitors within the service assurance industry, we believe that we compete favorably on the basis of these factors. We provide a comprehensive service delivery management solution that is capable of addressing the needs of both enterprise and service provider customers and can be scaled to meet the challenges of today’s dynamic service

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delivery environments. We believe that our solutions provide superior data and compete favorably on a broad range of metrics including the ability to recognize and track a large number of applications, scalability to support high and increasing levels of data and network traffic, the ability to look at both data and control plane traffic across an entire network, and the ability to provide real-time information about service performance and real-time alerts to emerging service problems.
In the enterprise market, our competitors include companies such as Avaya, AppDynamics, CA Technologies, Compuware, ExtraHop, InfoVista, Ixia, JDSU (through its Network Instruments business that was acquired in 2014), Gigamon, Lancope, New Relic, Riverbed Technology and SolarWinds. In addition, we both compete with and partner with large enterprise management vendors, such as HP and IBM, who offer performance management solutions.
In the service provider market, we compete with probe vendors, network equipment manufacturers, big data and analytics vendors, and virtualization vendors. These vendors include Alcatel-Lucent, Astellia, Anritsu, Cisco, Empirix, Ericsson, EMC, EXFO, Guavas, Huawei, IBM, JDSU, Niksun, Polystar, Radcom, SevOne, Splunk, and Zettics. We face additional competitive threats from startups and new entrants that seek to offer innovative solutions in an industry characterized by rapid technological change.
In the cybersecurity market, we face a range of competitors, including those that may have greater name recognition and substantially greater financial, management, marketing, service, support, technical, distribution and other resources than we do. We believe that our scalability of our solutions, flexible deployment, and price-performance of our cybersecurity solutions positions us well to compete against both larger network equipment and security companies and smaller niche security solutions vendors.
In the DDoS solutions market, we compete with a broad range of vendors including Radware, Akamai, F5 Networks, A10 Networks, Fortinet and Corero Network Security. In the market for traffic management and detection solutions used to identify advanced network threats, we compete with a range of vendors including Cisco, Blue Coat Systems, the RSA Security division of EMC, Damballa, Fidelis, Securlert and Savvius.
Our ability to sustain a competitive advantage depends on our ability to deliver continued technology innovation and adapt to meet the evolving needs of our customers. Competitive factors in our industry are further described in Item 1A “Risk Factors.”
Intellectual Property Rights
We rely on patent, copyright, trademark, and trade secret laws and contract rights to establish and maintain our rights in our technology and products. While our intellectual property rights are an important element in our success, our business as a whole does not depend on any one particular patent, trademark, copyright, trade secret, license, or other intellectual property right.
NetScout uses contracts, statutory laws, domestic and foreign intellectual property registration processes, and international intellectual property treaties to police and protect its intellectual property portfolio and rights from infringement. From a contractual perspective, NetScout uses license agreements and non-disclosure agreements to control the use of our intellectual property and protect NetScout trade secrets from unauthorized use and disclosure. In addition to license agreements, NetScout relies on U.S. and international copyright law to protect against unauthorized copying of software programs, in the U.S. and abroad. NetScout has obtained U.S. and foreign trademark registrations to preserve and protect certain trademarks and trade names. NetScout has also filed and obtained U.S. patents and international counterparts to protect certain unique NetScout inventions from being unlawfully exploited by other parties. However, there is no assurance that pending or future patent applications will be granted, that we will be able to obtain patents covering all of our products, or that we will be able to license, if needed, patents from other companies on favorable terms or at all. Our proprietary rights are subject to other risks and uncertainties described under Item 1A “Risk Factors.”

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Employees
At March 31, 2016, we had a total of 3,144 employees, 2,063 of whom were employed in the United States. The majority of our employees are not subject to a collective bargaining agreement. In accordance with applicable laws, employees in certain international jurisdictions are subject to collective bargaining agreements. Employees by department at March 31, 2016 were as follows:
Function
 
Number of Employees
Sales and marketing
930

Research and development
1,224

Support services
608

General and administrative
282

Manufacturing
100

 
 
3,144

 
 
 
Corporate information
Our corporate headquarters are located at 310 Littleton Road, Westford, Massachusetts, and our telephone number is (978) 614-4000. NetScout was incorporated in Delaware in 1984.
NetScout’s internet address is http://www.netscout.com. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed pursuant to Sections 13(a) and 15(d) of the Securities Exchange Act of 1934, as amended (Exchange Act), are made available free of charge on or through our website at http://ir.netscout.com/phoenix.zhtml?c=92658&p=irol-sec as soon as reasonably practicable after such reports are filed with, or furnished to, the Securities and Exchange Commission (the SEC). None of the information posted on our website is incorporated by reference into this Annual Report.
We webcast our earnings calls and certain events we participate in or host with members of the investment community are made available on our investor relations website at http://ir.netscout.com/phoenix.zhtml?c=92658&p=irol-calendar. Additionally, we provide notifications of news or announcements regarding our financial performance, including SEC filings, investor events, press and earnings releases, as part of our investor relations website. The contents of these sections of our investor relations website are not intended to be incorporated by reference into this report or in any other report or document we file.

Item 1A. Risk Factors.
In addition to the other information in this report, the following factors should be considered carefully in evaluating NetScout and our business.
Our operating results and financial condition have varied in the past and may in the future vary significantly depending on a number of factors. Except for the historical information in this report, the matters contained in this report include forward-looking statements that involve risk and uncertainties. The following factors are among many that could cause actual results to differ materially from those contained in or implied by forward-looking statements made in this report. These statements involve the risks and uncertainties identified below as well as additional risks and uncertainties that are not yet identified or that we currently think are immaterial but may also impact our business operations. Such factors are among many that may have a material adverse impact upon our business, results of operations and financial condition.
You should consider carefully the risks and uncertainties described below, together with the information included elsewhere in this Annual Report on Form 10-K and other documents we file with the SEC. The risk and uncertainties described below are those that we have identified as material, but are not the only risk and uncertainties facing us. Our business is also subject to general risks and uncertainties that affect many other companies. Additional risks and uncertainties not currently known to us or that we currently believe are immaterial also may impair our business, including our results of operations, liquidity and financial condition.
Because of the following factors, as well as other variables affecting our results of operations, past financial performance may not be a reliable indicator of future performance, and historical trends should not be used to anticipate results or trends in future periods.

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Risks related to the Company's Business Following the Transaction
The successful integration of the Communications Business into our business within the projected timetable is complex and could adversely affect our future results and the market price of our common stock.
The long-term success of the Transaction depends, in large part, on our ability, as a significantly more complex combined company, to realize the anticipated benefits and on the sales and profitability of the combined company. To realize these anticipated benefits, we must successfully integrate the respective businesses of the combined companies. While our integration efforts have been successful so far, any acquisition involves numerous business and strategic risks and if we fail to anticipate or deal with these properly, our reputation and business success could be adversely affected. In addition, the integration process has been complex and time-consuming. Difficulties that may be encountered in the ongoing integration process and which could affect our success include, but are not limited, to the following:
difficulties in assimilating the acquired operations, systems, technologies, personnel, cultures and products;
difficulties in managing geographically dispersed operations;
complexities associated with managing the larger, more complex, combined business;
integrating personnel of NetScout and the Communications Business while maintaining focus on providing consistent, high-quality products and service to customers;
the loss of key employees;
liabilities identified in the due diligence process for which we did not properly assess the magnitude or which could result in unexpected litigation or regulatory exposure, unfavorable accounting treatment, unexpected increases in taxes due, significant issues with product quality or development or other adverse effects on our business or consolidated financial statements;
multiple or overlapping product lines as a result of the acquisitions that are offered, priced and supported differently, which could cause customer confusion and delays;
higher than anticipated costs in continuing support and development of acquired products;
diversion of management's attention from our core business and the challenges of managing larger and more widespread operations from the Transaction;
adverse effects on existing business relationships with respective suppliers, licensors, contract manufacturers, customers, distributors, resellers and industry experts;
significant impairment, exit and/or restructuring charges if the products or technologies acquired in the acquisitions do not meet our sales expectations or are unsuccessful;
substantial accounting charges for restructuring and related expenses, write-off of in-process research and development, impairment of goodwill, amortization or impairment of intangible assets and share-based compensation expense;
insufficient revenue to offset increased expenses associated with the Transaction;
risks associated with entering markets in which we have no or limited prior experience;
difficulties in maintaining or establishing uniform standards, controls, procedures and policies;
failure to properly integrate internal controls and financial systems of the combined companies; and
potential unknown liabilities and unforeseen expenses associated with the Transaction.
If any of these events were to occur, our ability to maintain relationships with customers, channel partners, suppliers and employees or our ability to achieve the anticipated benefits of the Transaction could be adversely affected, or could reduce our sales or earnings or otherwise adversely affect our business and financial results and, as a result, adversely affect the market price of our common stock.
The Transaction may not achieve its anticipated benefits. In addition, we will continue to incur significant expenses and management will continue to devote significant time in connection with the integration of the Communications Business.
We may not be able to successfully realize anticipated growth opportunities or integrate our business and operations with the Communications Business' business and operations. Following the Transaction, we have significantly more revenue, expenses, assets and employees than we did prior to the Transaction. We will continue to incur significant expenses in connection with the integration of the Communications Business, including integrating products and technology, personnel, information technology systems, accounting systems, suppliers, and channel partners of each business and implementing consistent standards, policies, and procedures, and may possibly be subject to material write downs in assets and charges to earnings. We may not successfully or cost-effectively integrate the Communications Business' business and operations into our existing business and operations. Even if we are able to integrate the combined businesses and operations successfully, this integration may not result in the realization of the full benefits of the growth and other opportunities that we currently expect

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from the Transaction within the anticipated time frame, or at all. Further, our management team will continue to devote significant time and attention to the integration efforts which may distract us from operating our ongoing business operations.
The success of the combined company will also depend on relationships with third parties and pre-existing customers and channel partners of NetScout and the Communications Business. Any adverse changes in these relationships could adversely affect the combined company's business, financial condition or results of operations.
The combined company's success depends on our ability to maintain and renew relationships with pre-existing customers, channel partners, suppliers, and other third parties of both NetScout and the Communications Business and our ability to establish new relationships. There can be no assurance that the business of the combined company will be able to maintain and renew pre-existing contracts and other business relationships, or enter into or maintain new contracts and other business relationships, on acceptable terms, if at all. The failure to maintain important business relationships could have a material adverse effect on our business, financial condition or results of operations as a combined company.
Risks Related to the Company and its Operations
Foreign currency exchange rates may adversely affect our financial statements.
As a result of the Transaction, an increasing portion of our revenue is derived from international operations. Our consolidated financial results are reported in U.S. dollars. Most of the revenue and expenses of our foreign subsidiaries are denominated in local currencies. Given that cash is typically received over an extended period of time for many of our license agreements and given that a material portion of our revenue is generated outside of the United States, fluctuations in foreign exchange rates (such as the Euro) against the U.S. dollar could result in substantial changes in reported revenues and operating results due to the foreign exchange impact upon translation of these transactions into U.S. dollars.
In the normal course of business, we employ various hedging strategies to partially mitigate these risks, including the use of derivative instruments. These strategies may not be effective in protecting us against the effects of fluctuations from movements in foreign exchange rates. Fluctuations of the foreign exchange rates could materially adversely affect our business, financial condition, operating results and cash flow.
Additionally, sales and purchases in currencies other than the U.S. dollar expose us to fluctuations in foreign currencies relative to the U.S. dollar and may adversely affect our financial statements. Increased strength of the U.S. dollar increases the effective price of our products sold in U.S. dollars into other countries, which may require us to lower our prices or adversely affect sales to the extent we do not increase local currency prices. Decreased strength of the U.S. dollar could adversely affect the cost of materials, products and services we purchase overseas. Sales and expenses of our non-U.S. businesses are also translated into U.S. dollars for reporting purposes and the strengthening or weakening of the U.S. dollar could result in unfavorable translation effects. In addition, certain of our businesses may invoice customers in a currency other than the business' functional currency, and movements in the invoiced currency relative to the functional currency could also result in unfavorable translation effects. The Company also faces exchange rate risk from its investments in subsidiaries owned and operated in foreign countries.
Our indebtedness may limit our operations and our use of our cash flow, and any failure to comply with the covenants that apply to our indebtedness could adversely affect our liquidity and financial condition.
On July 14, 2015, we entered into a certain credit facility with a syndicate of lenders pursuant to a Credit Agreement (Credit Agreement). The Credit Agreement provides for a five-year $800 million senior secured revolving credit facility, including a letter of credit sub-facility of up to $50 million. We have used the new credit facility for working capital purposes and for a repurchase of $300.0 million of common stock as of March 31, 2016 under our previously announced 20 million share common stock repurchase plan. The commitments under the Credit Agreement will expire on July 14, 2020, and any outstanding loans will be due on that date. As of the date of this report, we had approximately $300 million in outstanding indebtedness under the Credit Agreement. Our debt level can have negative consequences, including exposing us to interest rate risk. We may incur significantly more debt in the future, and there can be no assurance that our cost of funding will not substantially increase. Our current revolving credit facility also imposes certain restrictions on us; for more information please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations." 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 Credit Agreement and the other loan documents, which would adversely affect our liquidity and financial condition. If we take on additional indebtedness, the risks described above could increase.

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Any failure to meet our debt obligations could damage our business.
Our ability to meet our obligations under the Credit Agreement will depend on market conditions and our future performance, which is subject to economic, financial, competitive and other factors beyond our control. If we are unable to remain profitable or if we use more cash than we generate in the future, our level of indebtedness at such time could adversely affect our operations by increasing our vulnerability to adverse changes in general economic and industry conditions and by limiting or prohibiting our ability to obtain additional financing for additional capital expenditures, acquisitions and general corporate and other purposes. In addition, if we are unable to make payments as required under the Credit Agreement, we would be in default under the terms of the notes, which could seriously harm our business. If we incur significantly more debt, this could intensify the risks described above.
We may fail to secure necessary additional financing.
Our future success may depend in part on our ability to obtain additional financing to support our continued growth and operations and any downgrades in our credit rating could affect our ability to obtain additional financing in the future and may affect the terms of any such financing. If our existing sources of liquidity are insufficient to satisfy our operating requirements, we may need to seek to raise capital by:
issuing additional common stock or other equity instruments;
acquiring additional bank debt;
issuing debt securities; or
obtaining lease financings.
However, we may not be able to obtain additional capital when we want or need it, or capital may not be available on satisfactory terms. Furthermore, any additional capital may have terms and conditions that adversely affect our business, such as new financial or operating covenants, or that may result in additional dilution to our stockholders.
We expect that existing cash, cash equivalents, marketable securities, cash provided from operations and our bank credit facilities will be sufficient to meet ongoing cash requirements. However, our failure to generate sufficient cash as our debt becomes due or to renew credit lines prior to their expiration could materially adversely affect our business, financial condition, operating results and cash flow.
Our effective tax rate may increase or fluctuate, which could increase our income tax expense and reduce our net income.
Our effective tax rate or the taxes we owe could be adversely affected by several factors, many of which are outside of our control, including:
changes in the relative proportions of revenues and income before taxes in the various jurisdictions in which we operate that have differing statutory tax rates;
changing tax laws, regulations, and interpretations in multiple jurisdictions in which we operate as well as the requirements of certain tax rulings;
changes in the research and development tax credit laws, earnings being lower than anticipated in jurisdictions where we have lower statutory rates and being higher than anticipated in jurisdictions where we have higher statutory rates;
changes in accounting and tax treatment of share-based compensation;
the valuation of generated and acquired deferred tax assets and the related valuation allowance on these assets;
transfer pricing adjustments;
the tax effects of purchase accounting for acquisitions and restructuring charges that may cause fluctuations between reporting periods; and
tax assessments or any related tax interest or penalties that could significantly affect our income tax expense for the period in which the settlements take place.
We are subject to income taxes in the United States and in numerous foreign jurisdictions. From time to time, we may receive notices that a tax authority in a particular jurisdiction believes that we owe a greater amount of tax than we have reported to such authority.
While we regularly assess the likelihood of adverse outcomes from such examinations and the adequacy of our provision for income taxes, there can be no assurance that such provision is sufficient and that a determination by a tax authority will not have an adverse effect on our results of operations. An adverse change in our effective tax rate could have a material and

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adverse effect on our financial condition and results of operations and the price of our common stock could decline if our financial results are materially affected by an adverse change in our effective tax rate.
Our estimates and judgments related to critical accounting policies could be inaccurate.
We consider accounting policies related to marketable securities, revenue recognition, valuation of goodwill and acquired intangible assets and share-based compensation to be critical in fully understanding and evaluating our financial results. Management makes accounting judgments and estimates related to these policies. These estimates and judgments affect, among other things, the reported amounts of our assets, liabilities, revenue and expenses, the amounts of charges accrued by us, and related disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances and at the time they are made. If our estimates or the assumptions underlying them are not correct, actual results may differ materially from our estimates and we may need to, among other things, accrue additional charges that could adversely and our business, operating results and financial condition could be materially and adversely impacted in future periods and could negatively affect our stock price.
Our quarterly revenue and operating results may fluctuate.
Our quarterly revenue and operating results are difficult to predict and may fluctuate significantly from quarter to quarter. Our quarterly revenue may fluctuate as a result of a variety of factors associated with our industry, many of which may be outside of our control, including the following:
the rate of growth of, and changes in technology trends in, our market and other industries in which we currently or may in the future operate;
technology spending by current and potential customers;
reduced demand for our products;
uneven demand for service delivery and network and application performance management solutions and network security solutions;
the timing and size of orders from customers, especially in light of our lengthy sales cycle;
the timing and market acceptance of new products or product enhancements by us or our competitors;
the timing of hiring sales personnel and the speed at which such personnel become productive;
our ability to anticipate or adapt effectively to developing markets and rapidly changing technologies and technology requirements;
our ability to develop and manufacture new products and technologies in a timely manner;
the competitive position of our products;
the continued acceptance of our products by our customers and in the industries that we serve;
changes in the number and size of our competitors, including the effects of new entrants and the effects of well-resourced competitors increasing their investment in our markets, and changes in the prices and capabilities of competitors' products;
customer ability to implement our products;
cancellation, deferral, or limitation of orders by customers;
changes in foreign currency exchange rates;
attrition of key employees and competition with other companies for employees with specific talents and experience;
the number, severity, and timing of threat outbreaks (e.g., malware, attacks, worms and viruses);
the quality and level of our execution of our business strategy and operating plan, and the effectiveness of our sales and marketing programs;
economic slowdowns and the occurrence of unforeseeable global events that contribute to such slowdowns;
our reliance on contract manufacturers for the production and shipment of our hardware products;
our contract manufacturers' ability to obtain sufficient supplies of sole or limited source components or materials;
changes in accounting rules;
costs related to acquisitions; and
our ability to manage expenses.
If our revenue or operating results fall below the expectations of investors or securities analysts or below any guidance we may provide to the market, the price of our common stock could decline substantially. Such a stock price decline could also occur even if we meet our publicly stated revenue and/or earnings guidance. Most of our expenses, such as employee compensation, benefits and rent, are relatively fixed in the short term. Moreover, our expense levels are based, in part, on our expectations regarding future revenue levels. As a result, if revenue for a particular quarter is below our expectations, we may not be able to reduce operating expenses proportionately for that quarter, and, therefore, this revenue shortfall would have a disproportionately negative impact on our operating results for that quarter.

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It may be necessary in the future to undertake cost reduction initiatives to improve profitability, which could lead to a deterioration of our competitive position. Any difficulties that we encounter as we reduce our costs could negatively impact our results of operations and cash flows.  
The effectiveness of our disclosure and internal controls may be limited.
Our disclosure controls and procedures and internal control over financial reporting may not prevent all material errors and intentional misrepresentations. Any system of internal control can only provide reasonable assurance that all control objectives are met. Some of the potential risks involved could include, but are not limited to, management judgments, simple errors or mistakes and willful misconduct regarding controls or misinterpretation. Under Section 404 of the Sarbanes-Oxley Act we are required to evaluate and determine the effectiveness of our internal control over financial reporting. Compliance with this legislation requires management's attention and expense. Management's assessment of our internal control over financial reporting may or may not identify weaknesses that need to be addressed in our internal control system. If we are unable to conclude that our internal control over financial reporting is effective, investors could lose confidence in our reported financial information which could have an adverse effect on the market price of our stock or impact our borrowing ability. In addition, changes in operating conditions and changes in compliance with policies and procedures currently in place may result in inadequate internal control over financial reporting in the future.
If our products contain errors or quality issues, they may be costly to correct, revenue may be delayed, we could be sued and our reputation could be harmed.
Our products are inherently complex and, despite testing by our customers and us, errors or quality issues may be found in our products after commencement of commercial shipments, especially when first introduced or when new versions are released. These errors may result from components supplied by third parties incorporated into our products, which makes us dependent upon the cooperation and expertise of such third parties for the diagnosis and correction of such errors. If errors are discovered, we may not be able to correct them in a timely manner or at all. In addition, we may need to make significant expenditures to eliminate errors and failures. Errors and failures in our products could result in loss of or delay in market acceptance of our products and could damage our reputation. Regardless of the source of these defects or errors, we may need to divert the attention of our engineering personnel from our product development efforts to address the detection and correction of these errors and defects. If one or more of our products fail, a customer may assert warranty and other claims for substantial damages against us. Our contracts with customers contain provisions relating to warranty disclaimers and liability limitations, which may not be upheld. Defending a lawsuit, regardless of its merit, is costly and may divert management's attention and harm the market's perception of us and our products. In addition, if our business liability insurance coverage proves inadequate or future coverage is unavailable on acceptable terms or at all, our business, operating results and financial condition could be adversely impacted.
The occurrence or discovery of these types of errors or failures could have a material and adverse impact on our business, operating results and financial condition. Any such errors, defects, or security vulnerabilities could also adversely affect the market's perception of our products and business.
If we fail to introduce new products and solutions or enhance our existing products and solutions to keep up with rapid technological change, demand for our products and solutions may decline.
The market for application and network performance management and service assurance solutions is highly competitive and characterized by rapid changes in technology, evolving industry standards, changes in customer requirements and frequent product introductions and enhancements. Such changes also affect the network security market in which we now participate. Our success is dependent upon our ability to meet our customers' needs, which are driven by changes in computer networking technologies, new application technologies and the emergence of new industry standards. In addition, new technologies may shorten the life cycle for our products and solutions or could render our existing or planned products and services obsolete. We must address demand from our customers for advancements in our products and services applications in order to support our customers' growing needs and requirements. In order to meet this challenge and remain competitive in the market, we must introduce new enhancements to our existing product lines and service offerings. If we are unable to develop and introduce new network and application performance management and service assurance products or enhancements to existing products, as well as network security products and solutions, in a timely and successful manner, this inability could have a material and adverse impact on our business, operating results and financial condition.
As our success depends in part on our ability to develop product enhancements and new products and solutions that keep pace with continuing changes in technology and customer preferences, we must devote resources to significant research and development, development and introduction of new products and enhancements on a timely basis, and obtaining market acceptance for our existing products and new products. We have introduced and intend to continue to introduce new products

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and solutions. If the introduction of these products and solutions is significantly delayed or if we are unsuccessful in bringing these products and solutions to market, our business, operating results and financial condition could be materially and adversely impacted. We are currently developing a number of new products as well as enhancements to our existing products and offerings.
In addition, we must invest in research and development in order to remain competitive in our industry. However, there can be no assurances that continued investment and higher costs of research and development will ultimately result in us maintaining or increasing our market share, which would result in a decline to our operating results. The process of developing new solutions is complex and uncertain; we must commit significant resources to developing new services or features without knowing whether our investments will result in services the market will accept. If our research and development expenses increase without a corresponding increase in our revenues, it could have a material adverse effect on our operating results. Also, we may not be able to successfully complete the development and market introduction of new products or product enhancements in a timely manner. If we fail to develop and deploy new products and product enhancements on a timely basis, or if we fail to gain market acceptance of our new products, our revenues will decline and we may lose market share to our competitors.
We face significant competition from other technology companies.
The service assurance, performance management and network security markets are a highly competitive, rapidly evolving, and fragmented market that has overlapping technologies and competitors, both large and small, and we expect the competition on offerings and pricing to increase. We believe customers make service management system and network security purchasing decisions based primarily upon the following factors:
product and service performance, functionality and price;
timeliness of new product and service introductions;
network capacity;
ease of installation, integration, and use;
customer service and technical support;
name and reputation of vendor;
quality and value of the product and services; and
alliances with industry partners.
We compete with a growing number of providers of service assurance, application performance management solutions, network security offerings and portable network traffic analyzers and probes. In addition, leading network equipment, network security and service assurance and application technology vendors offer their own management solutions, including products which they license from other competitors. Some of our current and potential competitors have greater name recognition and substantially greater financial, management, marketing, service, support, technical, distribution and other resources than we do. In addition, some of our customers develop their own in-house solutions to meet their technological needs. Further, in recent years some of our competitors have been acquired by larger companies that are seeking to enter or expand in the markets in which we operate. We expect this trend to continue as companies attempt to strengthen or maintain their market positions in an evolving industry. Therefore, given their larger size and greater resources our competitors may be able to respond more effectively than we can to new or changing opportunities, technologies, standards and customer requirements.
As a result of the competitive factors highlighted in this section and other factors, we may not be able to compete effectively with our current or future competitors. If we are unable to anticipate or react to these competitive challenges or if existing or new competitors gain market share in any of our markets, our competitive position could weaken and we could experience a decline in our sales that could adversely affect our business and operating results. This competition could result in increased pricing pressure, reduced profit margins, increased sales and marketing expenses, and failure to increase, or the loss of, market share, any of which would likely have a material and adverse impact on our business, operating results and financial condition.
Increased customer demands on our technical support services may adversely affect our relationships with our customers and our financial results.
We offer technical support services with many of our products. We may be unable to respond quickly enough to accommodate short-term increases in customer demand for support services. We also may be unable to modify the format of our support services to compete with changes in support services provided by competitors. Our customers depend on our support organization to resolve any issues relating to our products deployed on their networks. A high level of support is critical for continued relationship with our customers. If we or our channel partners do not effectively assist our customers in deploying our products, succeed in helping our customers quickly resolve post-deployment issues, and provide effective ongoing support,

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it would adversely affect our ability to sell our products to existing customers and would harm our reputation with potential customers. In addition, as we expand our operations internationally, our support organization will face additional challenges, including those associated with delivering support, training and documentation in languages other than English. Any failure to maintain high quality support and services would harm our operating results and reputation. Further customer demand for these services, without corresponding revenues, could have a material and adverse impact on our financial condition and results of operations.
Failure to manage growth properly and to implement enhanced automated systems could adversely impact our business.
The growth in size and complexity of our business and our customer base has been and will continue to be a challenge to our management and operations. Our growth has been through acquisitions of businesses with complementary businesses and technologies, and we anticipate that further significant expansion will be required. This growth is expected to continue to place significant demands on our management, infrastructure, and other resources. To manage further growth effectively, we must hire, integrate, and retain highly skilled personnel qualified to manage our expanded operations. We will also need to continue to improve our financial and management controls, reporting systems, and procedures. If we are unable to manage our growth effectively, our costs, the quality of our products, the effectiveness of our sales organization, attraction and retention of key personnel, our business, our operating results and financial condition could be materially and adversely impacted. To manage our growth effectively, we may need to implement new or enhanced automated infrastructure technology and systems.
Any disruptions or ineffectiveness relating to our systems implementations and enhancements could adversely affect our ability to process customer orders, ship products, provide services and support to our customers, bill and track our customers, fulfill contractual obligations, and otherwise run our business.
As a result of the diversification of our business, personnel growth, acquisitions and international expansion in recent years, many of our employees are now based outside of our headquarters office. If we are unable to appropriately increase management depth and enhance succession planning, we may not be able to achieve our financial or operational goals. It is also important to our continued success that we hire qualified employees, properly train them and manage out poorly-performing personnel, all while maintaining our corporate culture and spirit of innovation. If we are not successful at these efforts, our growth and operations could be adversely affected.
As our business evolves, we must also expand and adapt our information technology (IT) and operational infrastructure. Our business relies on our data systems, billing systems and other operational and financial reporting and control systems. All of these systems have become increasingly complex due to the diversification and complexity of our business, acquisitions of new businesses with different systems and increased regulation over controls and procedures. To manage our technical support infrastructure effectively and improve our sales efficiency, we will need to continue to upgrade and improve our data systems, billing systems, ordering processes and other operational and financial systems, procedures and controls. These upgrades and improvements may be difficult and costly. If we are unable to adapt our systems and organization in a timely, efficient and cost-effective manner to accommodate changing circumstances, our business may be adversely affected. If the third parties we rely on for hosted data solutions for our internal network and information systems are subject to a security breach or otherwise suffer disruptions that impact the services we utilize, the integrity and availability of our internal information could be compromised causing the loss of confidential or proprietary information, damage to our reputation and economic loss.
We may not successfully complete acquisitions or integrate acquisitions we do make, which could impair our ability to compete and could harm our operating results.
We may need to acquire complementary businesses, products or technologies to remain competitive or expand our business. We actively investigate and evaluate potential acquisitions of complementary businesses, products and technologies in the ordinary course of business. We may compete for acquisition opportunities with entities having significantly greater resources than us. As a result, we may not succeed in acquiring some or all businesses, products or technologies that we seek to acquire. Our inability to effectively consummate acquisitions on favorable terms could significantly impact our ability to compete effectively in our targeted markets and could negatively affect our results of operations.
Acquisitions that we do complete could adversely impact our business. The potential adverse consequences from acquisitions include:
the potentially dilutive issuance of common stock or other equity instruments;
the incurrence of debt and amortization expenses related to goodwill and acquired intangible assets;
the potentially costly and disruptive impact of assuming unfavorable pre-existing contractual relationships of acquired companies that we would not have otherwise entered into and potentially exiting or modifying such relationships;

19


the potential litigation or other claims in connection with, or inheritance of claims or litigation risk as a result of, an acquisition including claims from terminated employees, customers, third parties or enforcement actions by various regulators;
the incurrence of significant costs and expenses; and
the potentially negative impact of poor performance of an acquisition on our earnings per share.
Acquisition transactions also involve numerous business risks. These risks from acquisitions include:
difficulties in assimilating the acquired operations, technologies, personnel and products;
difficulties in managing geographically dispersed operations;
difficulties in assimilating diverse financial reporting and management information systems;
difficulties in maintaining uniform standards, controls, procedures and policies;
the diversion of management's attention from other business concerns;
use of cash to pay for acquisitions that may limit other potential uses of our cash, including stock repurchases and retirement of outstanding indebtedness;
substantial accounting charges for restructuring and related expenses, write-off of in-process research and development, impairment of goodwill, amortization or impairment of intangible assets and share-based compensation expense;
the potential disruption of our business;
the potential loss of key employees, customers, distributors or suppliers;
the inability to generate sufficient revenue to offset acquisition or investment costs; and
the potential for delays in customer purchases due to uncertainty and the inability to maintain relationships with customers of the acquired businesses.
If we are not able to successfully manage these issues, the anticipated benefits and efficiencies of the acquisitions may not be realized fully or at all, or may take longer to realize than expected, and our ability to compete, our revenue and gross margins and our results of operations may be adversely affected
Our ability to quickly and successfully recover from a disaster or other business continuity event could affect our ability to deliver our products and cause reputational harm to our business.
The occurrence of a natural disaster or an act of terrorism, or a decision or need to close any of our facilities without adequate notice or time for making alternative arrangements could result in interruptions in the delivery of our products and services. Our central business functions, including administration, human resources and finance services depend on the proper functioning of our computer, telecommunication and other related systems and operations. A disruption or failure of these systems or operations because of a disaster or other business continuity event could cause data to be lost or otherwise delay our ability to complete sales and provide the highest level of service to our customers. In addition, we could have difficulty producing accurate financial statements on a timely basis, which could adversely affect the trading value of our stock. Although we endeavor to ensure there is redundancy in these systems and that they are regularly backed-up, there are no assurances that data recovery in the event of a disaster would be effective or occur in an efficient manner. Our operations are dependent upon our ability to protect our technology infrastructure against damage from business continuity events that could have a significant disruptive effect on our operations. We could experience material adverse interruptions to our operations or delivery of services to our clients in a disaster recovery scenario.
If a security breach or cyber attack of our IT networks and systems, or any of our products, occurs, our operations could be interrupted, our products and services may be perceived as vulnerable, and our brand and reputation could be damaged, which could reduce revenue, increase expenses, and expose us to legal claims or regulatory actions.
Although we have controls and security measures in place to prevent such attacks, experienced computer hackers are increasingly organized and sophisticated. Malicious attack efforts operate on a large-scale and sometimes offer targeted attacks as a paid for service. In addition, the techniques they use to access or sabotage networks change frequently and generally are not recognized until launched against a target. Use of open source code or other third-party software in our products and infrastructure could also bring increased cybersecurity risks As a result, our products may not anticipate new techniques quickly enough to protect against malicious attacks. If we fail to identify and respond to new and increasingly complex methods of attack and to update our products accordingly, we could be at risk of an attack.
Others, including employees or vendors, may also intentionally or unintentionally provide unauthorized access to our IT environments or to our customers' IT environments.

20


As such, our IT networks and systems, and our products, may still be vulnerable to data theft, computer viruses, programming errors, attacks by third parties or similar problems. If we, or our customers using our products, were to experience a security breach or cyber attack, we could incur substantial costs and liabilities, including but not limited to, expenses attributable to rectifying the security breach or cyber attack including the cost of repairing any damage to our, or our customers' systems, liability for stolen assets or information, lost revenue and income resulting from any system or product downtime, increased costs for cyber security protection, and damage to our reputation causing customers and possibly investors to lose confidence in us. Similarly, an actual or perceived breach of our customers' network security allowing access to our customers' data centers or other parts of their IT environments, regardless of whether the breach is attributable to our products, may cause contractual disputes, result in damage to our reputation and could require significant expenditures of our capital and diversion of our resources from development efforts.
Because some of our products include SaaS offerings, and our customers who purchase these hosted products and solutions depend on us for reliable access to our solution, any significant disruption in our SaaS hosting network infrastructure could harm our reputation, result in early termination of customer agreements or loss of customers, and negatively affect our business.
Additionally, efforts by hackers or others could cause interruptions, delays or cessation of our product licensing, or modification of our software, which could cause us to lose existing or potential customers. If these efforts are successful and a third party obtains unauthorized access to our or our customers' IT environments, our business operations, and those of our customers, could be adversely affected, losses or theft of data could occur, our reputation and future sales could be harmed, governmental regulatory action or private or governmental litigation could be commenced against us and our business, financial condition, operating results and cash flow could be materially adversely affected.
Our internal operations are dependent upon various information technology systems, and failures of or interruptions to those systems could harm our business.
Our business processes are dependent upon certain information technology systems, some of which are operated or hosted by third parties. In addition, in connection with integrating the acquired business units, we will undertake reconfiguring some of our IT systems or other business processes, these efforts will be time-consuming and costly.
If any of these systems fail or are interrupted, or if our ability to connect to or interact with one or more networks is interrupted, our processes may function at a diminished level or not at all. This would harm our ability to ship products, which could negatively impact our relationships with our customers and partners and our financial results would likely be harmed.
Our reliance on sole source suppliers could adversely impact our business.
Specific components that are necessary for the hardware assembly of our instruments are obtained from separate sole source suppliers or a limited group of suppliers. These components include our network interface cards and proprietary NetScout hardware. Our reliance on sole or limited suppliers involves several risks, including a lack of control over the manufacturing process, inventory management and potential inability to obtain an adequate supply of required components and the inability to exercise control over pricing, quality and timely delivery of components. For most of our products, we do not have the internal manufacturing capabilities to meet our customers' demands. It is our practice to mitigate these risks by partnering with key suppliers, including distributors, to establish a variety of supply continuity practices. These practices may include, among other approaches, establishing buffer supply requiring suppliers to maintain adequate stocks of materials, bonding agreements with distributors, and use-based and kanban programs to set supply thresholds. We also enter into escrow arrangements for certain technologies. Where possible, we use widely-available off the shelf hardware and work with large suppliers with multiple factories and other risk management practices. However, failure of supply or failure to execute effectively on any of these programs could result in our inability to obtain adequate deliveries or the occurrence of any other circumstance that would require us to seek alternative sources of these components would impact our ability to ship our products on a timely basis. Moreover, if we are unable to continue to acquire from these suppliers on acceptable terms, or should any of these suppliers cease to supply us with components for any reason, we may not be able to identify and integrate an alternative source of supply in a timely fashion or at the same costs. Any transition to one or more alternate manufacturers would likely result in delays, operational problems and increased costs, and may limit our ability to deliver our products to our customers on time for such transition period. These risks could damage relationships with our current and prospective customers, cause shortfalls in expected revenue, and could materially and adversely impact our business, operating results and financial condition.

21


If we violate the U.S. Foreign Corrupt Practices Act or applicable anti-bribery laws in other countries, or if we fail to comply with U.S. export controls and government contracting laws, our business could be harmed.
We earn a significant portion of our total revenues from international sales. As a result, we must comply with complex foreign and U.S. laws and regulations, such as the U.S. Foreign Corrupt Practices Act, the U.K. Bribery Act and other local laws prohibiting corrupt payments to government officials and others, as well as anti-competition regulations.
The U.S. Foreign Corrupt Practices Act (FCPA), which has seen increased enforcement recently, generally prohibits U.S. companies and their intermediaries from making corrupt payments to foreign officials for the purpose of obtaining or keeping business or otherwise obtaining favorable treatment and requires companies to maintain appropriate record-keeping and internal accounting practices to accurately reflect the transactions of the company. Under the FCPA, U.S. companies may be held liable for actions taken by agents or local partners or representatives. In addition, regulators may seek to hold us liable for successor liability FCPA violations committed by companies which we acquire. We are also subject to the U.K. Bribery Act and may be subject to certain anti-corruption laws of other countries in which we do business.
In addition to anti-bribery and anti-corruption laws, we are also subject to the export and re-export control laws of the U.S., including the U.S. Export Administration Regulations (EAR) and to U.S. government contracting laws, rules and regulations, and may be subject to government contracting laws of other countries in which we do business. If we or our distributors, resellers, agents, or other intermediaries fail to comply with the FCPA, the EAR or U.S. government contracting laws, or the anti-corruption, export or governmental contracting laws of other countries, governmental authorities in the U.S. or other countries could seek to impose civil and/or criminal penalties, which could have a material adverse effect on our business, results of operations, financial conditions and cash flows.
Violations of these laws and regulations could result in fines and penalties, criminal sanctions, restrictions on our business conduct and on our ability to offer our products and services in one or more countries. Such violations could also adversely affect our reputation with existing and prospective clients, which could negatively impact our operating results and growth prospects.
The failure to recruit and retain qualified personnel and plan for and manage the succession of key executives could hinder our ability to successfully manage our business, which could have a material adverse effect on our financial position and operating results.
We operate in businesses where there is intense competition for experienced personnel in all of our global markets and have, in some instances, experienced attrition of our employees to direct and indirect competitors. We depend on our ability to identify, recruit, hire, train, develop and retain qualified and effective professionals and to attract and retain talent needed to execute our business strategy. Our future success depends in large part upon our ability to attract, train, motivate and retain highly skilled employees, particularly executives, sales and marketing personnel, software engineers, and technical support personnel. The complexity of our products, processing functionality, software systems and services requires highly trained professionals. While we presently have a sophisticated, dedicated and experienced team of employees who have a deep understanding of our business lines, the labor market for these individuals has historically been very competitive due to the limited number of people available with the necessary technical skills and understanding, as well as compensation strategies, general economic conditions and various other factors. If we are unable to attract and retain the highly skilled technical personnel that are integral to our sales, marketing, product development and technical support teams, the rate at which we can generate sales and develop new products or product enhancements may be limited. This inability could have a material and adverse impact on our business, operating results and financial condition.
In addition, we must maintain and periodically increase the size of our sales force in order to increase our direct sales and support our indirect sales channels. Because our products are very technical, sales people require a comparatively long period of time to become productive, typically three to twelve months. This lag in productivity, as well as the challenge of attracting qualified candidates, may make it difficult to meet our sales force growth targets. Further, we may not generate sufficient sales to offset the increased expense resulting from growing our sales force. If we are unable to maintain and periodically expand our sales capability, our business, operating results and financial condition could be materially and adversely impacted.
Loss of key personnel could adversely impact our business. Our future success depends to a significant degree on the skills, experience and efforts of Anil Singhal, our President, Chief Executive Officer, and co-founder, and our other key executive officers and senior managers to work effectively as a team. Effective succession planning is also important for our long-term success. Failure to ensure effective transfers of knowledge and smooth transitions involving key employees could hinder our strategic planning and execution. The loss of one or more of our key personnel could have a material and adverse impact on our business, operating results and financial condition. We must, therefore, plan for and manage the succession of key executives due to retirement, illness or competitive offers elsewhere.

22


We have assumed certain non-U.S. pension benefit obligations associated with the Communications Business. Future funding obligations related to these liabilities could restrict cash available for our operations, capital expenditures or other requirements, or require us to borrow additional funds.
As part of the Transaction, we assumed certain unfunded non-U.S. pension obligations related to non-U.S. employees of the Communications Business. While we intend to comply with any future funding obligations for our non-U.S. pension benefit plans through the use of cash from operations, there can be no assurance that we will generate enough cash to do so and also meet our other required or intended cash uses. Our inability to fund these obligations through cash from operations could require us to seek funding from other sources, including through additional borrowings, which could materially increase our outstanding debt or debt service requirements.
Our success depends, in part, on our ability to manage and leverage our distribution channels. Disruptions to, or our failure to effectively develop and manage, these partners and the processes and procedures that support them could adversely affect our ability to generate revenues from the sale of our products and services. Managing these distribution channels and relationships requires experienced personnel, and lack of sufficient expertise could lead to the decrease of the sales of our products and services and our operating results could suffer.
To increase our sales we need to continue to enhance our indirect sales efforts, to continue to manage and expand these existing distribution channels and to develop new indirect distribution channels. Our channel partners have no obligation to purchase any products from us. Some of our distribution and channel partners sell competitive products and services and the loss of, or reduction in sales by, these partners could materially reduce our revenues. In addition, they could internally develop products that compete with our solutions or partner with our competitors or bundle or resell competitors' solutions, possibly at lower prices. The potential inability to develop relationships with new partners in new markets, expand and manage our existing partner relationships, the unwillingness of our partners to market and sell our products effectively or the loss of existing partnerships could have a material and adverse impact on our business, operating results and financial condition. Our international operations, including our operations in the United Kingdom, mainland Europe, India, Asia-Pacific and other regions, are generally also subject to the risk of longer sales cycles through our international distribution channels. Sales to customers outside the United States accounted for 29%, 23%, and 24% of our total revenue for the fiscal years ended March 31, 2016, 2015 and 2014, respectively.
Our future success will likely require us to maintain and increase the number and depth of our relationships with distributors and channel partners and to leverage those relationships to expand our distribution channels and increase revenue. The need to develop such relationships can be particularly acute in areas outside of the U.S. Recruiting and retaining qualified channel partners and training them in the use of our technology and services and ensuring that they comply with our legal and ethical expectations requires significant time and resources.
Our failure to maintain and increase the number and quality of relationships with channel partners, and any inability to successfully execute on the partnerships we initiate, could significantly impede our revenue growth prospects in the short and long term.
Our success depends, in part, on our ability to manage our international research and development operations and related partnerships. Our international research and development efforts may achieve delayed or lower than expected benefits and involved competitive and other risks.
We must continue to enhance our existing products and introduce new products in order to keep up with rapid technological change. Our international research and development teams play a critical role in these efforts. We must attract, train, motivate and retain our international research and development team members. To maintain this stable international employee research and development talent, we believe we must provide our international engineers with compelling and strategically significant work, coupled with technical and architectural ownership of their respective development projects. We must develop the leaders of these international teams, while ensuring their frequent inclusion and participation in corporate strategic and operational planning. We are likely to recognize the costs associated with these investments earlier than some of the anticipated benefits, and the return on these investments may be lower, or may develop more slowly, than we expect. These development efforts also involve risks, including, knowledge transfer issues related to our technology and resulting exposure to misappropriation of intellectual property or information that is proprietary to us, heightened exposure to economic, security and political conditions abroad, and exchange rate and tax compliance issues. The risks related to our research and development efforts abroad could increase our expenses, impair our development efforts, harm our competitive position and/or damage our reputation. If we do not achieve the benefits anticipated from these investments, or if the achievement of these benefits is delayed, our operating results may be adversely affected.

23


Necessary licenses for third-party technology may not be available to us or may be very expensive.
We currently and will in the future license technology from third parties that we use to produce or embed in our products. While we have generally been able to license required third-party technology to date, future required third-party licenses may not be available to us on commercially reasonable terms or at all. Third parties who hold exclusive rights to technology that we seek to license may include our competitors. If we are unable to obtain any necessary third-party licenses, we would be required to redesign our product or obtain substitute technology, which may not perform as well, be of lower quality or be more costly. The loss of these licenses or the inability to maintain any of them on commercially acceptable terms could delay development of future products or the enhancement of existing products. We may also choose to pay a premium price for such a license in certain circumstances where continuity of the licensed product would outweigh the premium cost of the license. The unavailability of these licenses or the necessity of agreeing to commercially unreasonable terms for such licenses could materially adversely affect our business, financial condition, operating results and cash flow.
Our success depends on our ability to protect our intellectual property rights.
Our business is heavily dependent on our intellectual property. We rely upon a combination of patent, copyright, trademark and trade secret laws and registrations and non-disclosure and other contractual and license arrangements to protect our intellectual property rights. The reverse engineering, unauthorized copying, or other misappropriation of our intellectual property could enable third parties to benefit from our technology without compensating us. Furthermore, the laws of some foreign jurisdictions do not offer the same protections for our proprietary rights as the laws of the United States, and we may be subject to unauthorized use of our products in those countries. Legal proceedings to enforce our intellectual property rights could be burdensome and expensive and could involve a high degree of uncertainty. In addition, legal proceedings may divert management's attention from growing our business. There can be no assurance that the steps we have taken to protect our intellectual property rights will be adequate to deter misappropriation of proprietary information, or that we will be able to detect unauthorized use by third parties and take appropriate steps to enforce our intellectual property rights. The unauthorized copying or use of our products or proprietary information could result in reduced sales of our products and eventually harm our operating results.
Others may claim that we infringe on their intellectual property rights.
From time to time we may be subject to claims by others that our products infringe on their intellectual property rights, patents, copyrights or trademarks. In some cases, we may have agreed to indemnify our customers and partners if our products or technology infringe or misappropriate specified third party intellectual property rights; therefore, we could become involved in litigation or claims brought against our customers or partners if our products or technology are the subject of such allegations. These claims, whether or not valid, could require us to spend significant sums in litigation, pay damages or royalties, delay product shipments, reengineer our products, rename our products and rebuild name recognition or acquire licenses to such third-party intellectual property. We may not be able to secure any required licenses on commercially reasonable terms or secure them at all. Any of these claims or resulting events could have a material and adverse impact on our business, operating results and financial condition.
Uncertainties of regulation of the Internet and data traveling over the Internet could have a material and adverse impact on our financial condition and results of operations.
Currently, few laws or regulations apply directly to access to or commerce conducted on the Internet. We could be materially adversely affected by regulation of the Internet and Internet commerce in any country where we operate. Further, governments may regulate or restrict the sales, licensing, distribution, and export or import of certain technologies to certain countries. The adoption of regulation of the Internet and Internet commerce could decrease demand for our products and, at the same time, increase the cost of selling our products, which could have a material and adverse effect on our financial condition and results of operations.
The enactment of new privacy laws and regulations in the jurisdictions in which we do business could require significant company resources or limit the way our customers can use our products.
The enactment of new federal, state, or foreign data privacy laws and regulations could cause customers not to be able to take advantage of all the features or capabilities of our products which in turn could reduce demand for certain of our products. In addition, changes in international privacy laws have required an adjustment to some of our internal processes and significant resources in the past and future changes could require similar efforts and resources with regard to compliance. The adoption of or changes to any such data privacy laws and regulations could affect demand for our products, increase the cost of selling our products and divert time and attention of our management, all of which could have a material and adverse effect on our financial condition and results of operations.

24


We or our suppliers may be impacted by new regulations related to climate change or other environmental issues.
We or our suppliers may become subject to new laws enacted with regards to climate change or other environmental issues. In the event that new laws are enacted or current laws are modified in countries in which we or our suppliers operate, our flow of product may be impacted which could have a material and adverse effect on our financial condition and results of operations.
The current economic and geopolitical environment may impact some specific industries into which we sell and may lead our customers to delay or forgo technology investments and could have other impacts, any of which could materially adversely affect our business, financial condition, operating results and cash flow.
Many of our customers are concentrated in certain industries, including financial services, public sector, healthcare, and the service provider market segment. Certain industries may be more acutely affected by economic, geopolitical and other factors than other sectors. Our public sector customers are affected by federal, state and local budget decisions. To the extent that one or more of the sectors in which our customer base operates is adversely impacted, whether as a result of general conditions affecting all sectors or as a result of conditions affecting only those particular sectors, our business, financial condition and results of operations could be materially and adversely impacted. If companies in our target markets reduce capital expenditures, we may experience a reduction in sales, longer sales cycles, slower adoption of new technologies as well as downward pressure on the price of our products.
International economic, political, legal, compliance and business factors could negatively affect our financial statements and growth.
The Communications Business historically derived significant sales from customers outside the U.S. and certain manufacturing operations, suppliers and employees of the Communications Business are located outside the U.S. We expect to continue to increase our sales and presence outside the U.S., particularly in the high-growth markets. Our international business (and particularly our business in high-growth markets) is subject to risks that are customarily encountered in non-U.S. operations, any of which could negatively affect our business, financial condition and results of operations.
The success of our business depends, in part, on the continued growth in the market for and the continued commercial demand for service delivery service assurance and network security solutions focused on the performance monitoring and management of applications and networks.
We derive nearly all of our revenue from the sale of products and services that are designed to allow our customers to assure the delivery of services through the management of the performance and network security of applications across IP networks. We have actively expanded our operations in the past through acquisitions and organic growth and may continue to expand them in the future in order to gain share in the evolving market in which we operate. Therefore, we must be able to predict the appropriate features and prices for future products to address the market, the optimal distribution strategy and the future changes to the competitive environment. In order for us to be successful, our potential customers must recognize the value of more sophisticated application management and network security solutions, decide to invest in the management of their networked applications and, in particular, adopt our management solutions. Any failure of this market to continue to be viable would materially and adversely impact our business, operating results and financial condition. Additionally, businesses may choose to outsource the operations and management of their networks to managed service providers. Our business may depend on our ability to continue to develop relationships with these service providers and successfully market our products to them.
Changes in industry structure and market conditions could lead to charges related to discontinuances of certain of our products or businesses and asset impairments.
In response to changes in industry and market conditions, or as a result of the integration efforts related to our recent acquisitions, we may be required to strategically reallocate managerial, operational, financial and other resources. Any such efforts may result in charges related to consolidation of excess facilities or claims from third parties who were resellers or users of discontinued products.
Our growth could suffer if the markets into which we sell our products and services experience cyclicality.
Our growth will depend in part on the growth of the markets which the Company serves. The Company serves certain industries that have historically been cyclical and have experienced periodic downturns that have had a material adverse impact on demand for the products, software and services that the Company offers. Any of these factors could adversely affect the business, financial condition and results of operations of the combined company in any given period.

25


Uncertain conditions in the global economy and constraints in the global credit market may adversely affect our revenue and results of operations.
Disruptions in the global economy and constraints in the global credit market may cause some of our customers to reduce, delay, or cancel spending on capital and technology projects, resulting in reduced spending with us. While some industry sectors such as government and telecommunications may be less susceptible to the effects of an economic slowdown, our enterprise customers may be adversely affected, especially in financial services and consumer industries. Continued volatility in, or disruption of financial markets could limit customers' ability to obtain adequate financing to maintain operations and result in a decrease in sales volume that could have a negative impact on our results of operations. Further, competitors may respond to economic conditions by lowering their prices, which could put pressure on our pricing. We could also experience lower than anticipated order levels, cancellations of orders in backlog, defaults on outstanding accounts receivable and extended payment or delivery terms. Economic weakness, customer financial difficulties and constrained spending on IT initiatives have resulted, and may in the future result, in challenging and delayed sales cycles and could negatively impact our ability to forecast future periods. In addition, some of the markets we serve are emerging and the purchase of our products involves material changes to established purchasing patterns and policies. The purchase of our products is often discretionary and may involve a significant commitment of capital and other resources.
The price of our common stock may fluctuate with market volatility.
The market price of our common stock has been volatile and may continue to fluctuate in response to a number of factors, some of which are beyond our control. The stock market in general, and the market prices of stocks of technology companies in particular, have experienced extreme price volatility that has adversely affected, and may continue to adversely affect, the market price of our common stock for reasons unrelated to our business or operating results. Broad market fluctuations could adversely affect the market price of our common stock, which in turn could cause impairment of goodwill that could materially and adversely impact our financial condition and results of operations. In addition, the stock market in general, and the market prices of stock of publicly-traded technology companies in particular, have experienced significant volatility that often has been unrelated to the operating performance of such companies.
It is not uncommon when the market price of a stock has been volatile for holders of that stock to institute securities class action litigation against the company that issues that stock. If any of our stockholders brought such a lawsuit against us, even if the lawsuit is without merit, we could incur substantial costs defending the lawsuit beyond any insurance coverage which we may have for such risks. Such a lawsuit could also divert the time and attention of our management. Any of these events, as well as other circumstances discussed in these Risk Factors, may cause the price of our common stock to fall.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
We currently lease approximately 175,000 square feet of property in an office building in Westford, Massachusetts where our headquarters is located. The current lease will expire in September 2023, and we have an option to extend the lease for two additional five-year terms. We maintain offices in several other locations in the United States, including in or near each of Berkeley, Sunnyvale and San Jose, California; Colorado Springs, Colorado; Miami, Florida; Atlanta, Georgia; Saint Charles, Illinois; Rockland, Maryland; Burlington, Massachusetts; Ann Arbor, Michigan; Marlton, New Jersey; Plano, Texas; American Fork, Utah; Reston, Herndon, and Sterling, Virginia and Everett and Kirkland, Washington.
We also maintain offices in or near the following cities outside the United States: Melbourne and Sydney, Australia; Vienna, Austria; Brossard, Canada, Bangalore, Mumbai, Noida, and Pune India; Beijing, Guangzhou, Hong Kong, and Shanghai, China; Sao Paulo, Brazil; Massy and Paris, France; Berlin and Frankfurt, Germany; London, England; Jakarta, Indonesia; Dublin, Ireland; Tokyo, Japan; Seoul, Korea; Singapore; Mexico City, Mexico; Philippines; Madrid, Spain; Milan, Modena and Padova, Italy; Stockholm, Sweden; Kuala Lumpur, Malaysia; Taipei, Taiwan; Bangkok, Thailand; Amsterdam, Delft and Eindhoven, the Netherlands; Brno, Czech Republic; and Dubai, United Arab Emirates.
All of our facilities are leased. We believe our facilities are sufficient to meet our needs for the foreseeable future and, if needed, additional space will be available at a reasonable cost.

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Item 3. Legal Proceedings
From time to time, NetScout is subject to legal proceedings and claims in the ordinary course of business. In the opinion of management, the amount of ultimate expense with respect to any current legal proceedings and claims, if determined adversely, will not have a significant adverse effect on our financial condition, results of operations or cash flows.
Item 4. Mine Safety Disclosures
None.

27


PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Price Range of Common Stock
Our common stock trades on the Nasdaq Global Select Market, under the symbol NTCT. The following table sets forth, for the periods indicated, the high and low intraday sales prices for our common stock. Such information reflects inter-dealer price, without retail mark-up, markdown or commission and may not represent actual transactions.
Quarter Ended
 
High
 
Low
Fiscal Year 2015
 
 
 
June 30, 2014
$
44.54

 
$
33.30

September 30, 2014
$
48.13

 
$
41.15

December 31, 2014
$
46.17

 
$
31.59

March 31, 2015
$
44.76

 
$
33.53

Fiscal Year 2016
 
 
 
June 30, 2015
$
45.53

 
$
36.25

September 30, 2015
$
41.34

 
$
34.89

December 31, 2015
$
40.28

 
$
29.47

March 31, 2016
$
30.41

 
$
18.77

Stockholders
At May 16, 2016, we had 116 stockholders of record. We believe that the number of beneficial holders of our common stock exceeds 18,000.
Stock Performance Graph
This performance graph shall not be deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities under that Section, and shall not be deemed to be incorporated by reference into any filing of NetScout under the Exchange Act or the Securities Act of 1933, as amended.
The Stock Performance Graph set forth below compares the yearly change in the cumulative total stockholder return on our common stock during the five-year period from March 31, 2011 through March 31, 2016 with the cumulative total return of the Nasdaq Composite Index and the Nasdaq Computer & Data Processing Index. The comparison assumes $100 was invested on March 31, 2011 in our common stock or in the Nasdaq Composite Index and the Nasdaq Computer & Data Processing Index and assumes reinvestment of dividends, if any.
The stock price performance shown on the graph below is not necessarily indicative of future price performance. Information used in the graph was obtained from Zacks Investment Research, Inc.

28


COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN
Assumes Initial Investment of $100

 
3/31/2011
 
3/31/2012
 
3/31/2013
 
3/31/2014
 
3/31/2015
 
3/31/2016
NetScout Systems, Inc.
$
100.00

 
$
74.45

 
$
89.93

 
$
137.55

 
$
160.51

 
$
84.08

NASDAQ Composite – Total Returns
$
100.00

 
$
112.31

 
$
120.33

 
$
156.65

 
$
185.03

 
$
186.06

NASDAQ Computer and Data Processing
$
100.00

 
$
107.98

 
$
115.76

 
$
152.34

 
$
166.68

 
$
211.54

Dividend Policy
In fiscal years 2016 and 2015, we did not declare any cash dividends and do not anticipate declaring cash dividends in the foreseeable future. In addition, the terms of our credit facility limit our ability to pay cash dividends on our capital stock. It is our intention to retain all future earnings for reinvestment to fund our expansion and growth, as well as for our stock buyback program further described under Item 7 “Liquidity and Capital Resources.” Any future cash dividend declaration will be at the discretion of our Board of Directors and will depend upon, among other things, our future earnings, general financial conditions, capital requirements, existing bank covenants and general business conditions.

29


Purchases of Equity Securities by the Issuer
The following table provides information about purchases we made during the quarter ended March 31, 2016 of equity securities that are registered by us pursuant to Section 12 of the Exchange Act:
 
Total Number
of Shares
Purchased(1)
 
Average Price
Paid per Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs
 
Maximum Number of Shares That May
Yet be Purchased
Under the
Program
1/1/2016 - 1/31/2016

 
$

 

 
14,803,404

2/1/2016 - 2/28/2016
3,926,606

 
20.24

 
3,905,908

 
10,897,496

3/1/2016 - 3/31/2016
975,632

 
20.44

 
975,632

 
9,921,864

Total
4,902,238

 
$
20.28

 
4,881,540

 
9,921,864

 
(1)
We purchased an aggregate of 20,698 shares transferred to us from employees in satisfaction of minimum tax withholding obligations associated with the vesting of restricted stock units during the period. Such purchases reflected in the table do not reduce the maximum number of shares that may be purchased under our previously announced stock repurchase program (our 20 million share repurchase program authorized on May 19, 2015).


30


Item 6. Selected Financial Data
SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in conjunction with our audited consolidated financial statements and notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included under Item 7 of this Annual Report on Form 10-K. The consolidated statement of operations data for the fiscal years ended March 31, 2016, 2015 and 2014 and the consolidated balance sheet data at March 31, 2016 and 2015 are derived from audited consolidated financial statements included under Item 8 of this Annual Report on Form 10-K. The consolidated statement of operations data for the fiscal years ended March 31, 2013 and 2012 and the consolidated balance sheet data at March 31, 2014, 2013 and 2012 have been derived from audited consolidated financial statements of NetScout that do not appear in this Annual Report on Form 10-K. The historical results are not necessarily indicative of the operating results to be expected in the future.
 
Year Ended March 31,
 
2016 (1)
 
2015
 
2014
 
2013 (2)
 
2012 (3)
 
(In thousands, except per share data)
Statement of Operations Data:
 
 
 
 
 
 
 
 
 
Revenue:
 
 
 
 
 
 
 
 
 
Product
$
633,408

 
$
272,895

 
$
234,268

 
$
198,749

 
$
168,141

Service
322,011

 
180,774

 
162,379

 
151,801

 
140,538

Total revenue
955,419

 
453,669

 
396,647

 
350,550

 
308,679

Cost of revenue:
 
 
 
 
 
 
 
 
 
Product
238,037

 
59,037

 
51,219

 
45,752

 
39,271

Service
90,412

 
35,524

 
33,294

 
28,256

 
26,401

Total cost of revenue
328,449

 
94,561

 
84,513

 
74,008

 
65,672

Gross profit
626,970

 
359,108

 
312,134

 
276,542

 
243,007

Operating expenses:
 
 
 
 
 
 
 
 
 
Research and development
208,630

 
75,242

 
70,454

 
61,546

 
49,478

Sales and marketing
293,335

 
136,446

 
129,611

 
116,807

 
109,624

General and administrative
117,714

 
47,296

 
30,623

 
29,718

 
27,488

Amortization of acquired intangible assets
32,373

 
3,351

 
3,432

 
2,877

 
2,131

Restructuring charges
468

 

 

 
1,065

 
603

Total operating expenses
652,520

 
262,335

 
234,120

 
212,013

 
189,324

Income (loss) from operations
(25,550
)
 
96,773

 
78,014

 
64,529

 
53,683

Interest and other expense, net
(6,889
)
 
(1,808
)
 
(158
)
 
(793
)
 
(2,765
)
Income (loss) before income tax expense (benefit)
(32,439
)
 
94,965

 
77,856

 
63,736

 
50,918

Income tax expense (benefit)
(4,070
)
 
33,773

 
28,750

 
23,127

 
18,490

Net income (loss)
$
(28,369
)
 
$
61,192

 
$
49,106

 
$
40,609

 
$
32,428

Basic net income (loss) per share
$
(0.35
)
 
$
1.49

 
$
1.19

 
$
0.97

 
$
0.77

Diluted net income (loss) per share
$
(0.35
)
 
$
1.47

 
$
1.17

 
$
0.96

 
$
0.76

Weighted average common shares outstanding used in computing:
 
 
 
 
 
 
 
 
 
Net income (loss) per share—basic
81,927

 
41,105

 
41,366

 
41,665

 
42,035

Net income (loss) per share—diluted
81,927

 
41,637

 
41,955

 
42,322

 
42,750

 
(1)
During the fiscal year ended March 31, 2016, NetScout completed the Transaction. The total equity consideration was approximately $2.3 billion based on issuing approximately 62.5 million new shares of NetScout common stock.
(2)
During the fiscal year ended March 31, 2013, NetScout completed the acquisitions of ONPATH Technologies, Inc. and Accanto Systems, S.r.l. for approximately $51.8 million.
(3)
During the fiscal year ended March 31, 2012, NetScout completed the acquisitions of Psytechnics, Ltd., Fox Replay BV and Simena LLC for approximately $47.3 million collectively.

31


 
March 31,
 
2016 (1)
 
2015
 
2014
 
2013 (2)
 
2012 (3)
 
(In thousands)
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Cash, cash equivalents and short- and long-term marketable securities
$
352,075

 
$
264,857

 
$
218,794

 
$
154,091

 
$
213,516

Working capital
$
283,422

 
$
149,651

 
$
115,798

 
$
92,141

 
$
155,596

Total assets
$
3,592,843

 
$
669,049

 
$
607,763

 
$
552,176

 
$
567,757

Debt
$
300,000

 
$

 
$

 
$

 
$
62,000

Total stockholders’ equity
$
2,443,382

 
$
435,750

 
$
409,161

 
$
371,903

 
$
342,369

 
(1)
During the fiscal year ended March 31, 2016, NetScout completed the Transaction. The total equity consideration was approximately $2.3 billion based on issuing approximately 62.5 million new shares of NetScout common stock.
(2)
During the fiscal year ended March 31, 2013, NetScout completed the acquisitions of ONPATH Technologies, Inc. and Accanto Systems S.r.l. for approximately $51.8 million, including $527 thousand in cash.
(3)
During the fiscal year ended March 31, 2012, NetScout completed the acquisitions of Psytechnics, Ltd., Fox Replay BV and Simena LLC for approximately $47.3 million, including $616 thousand in cash.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following information should be read in conjunction with the audited consolidated financial information and the notes thereto included in this Annual Report on Form 10-K. In addition to historical information, the following discussion and other parts of this Annual Report contain forward-looking statements that involve risks and uncertainties. You should not place undue reliance on these forward-looking statements. Actual events or results may differ materially due to competitive factors and other factors discussed in Item 1A. “Risk Factors and elsewhere in this Annual Report. These factors may cause our actual results to differ materially from any forward-looking statement.
Overview
We are an industry leader for real-time operational intelligence and performance analytics for service assurance and cyber security solutions that are used in many of the most demanding service provider, enterprise and government networks. Our solutions, based on proprietary Adaptive Service Intelligence (ASI) technology, help customers continuously monitor the service delivery environment to identify performance issues and to provide insight into network-based security threats. As a result, customers can quickly resolve issues that cause business disruptions or that adversely impact the user experience. We manufacture and market these products for integrated hardware and software solutions and are also well positioned to help customers deploy our software in commercial-off-the-shelf hardware and in virtualized form factors. Regardless of the platform, customers use our solutions to help drive ROI on their network and broader IT initiatives while reducing the tangible risks associated with downtime, poor service quality and compromised security. We report revenues and income under five operating segments that aggregate under a single reportable segment.
We have been a technology innovator for three-plus decades since our founding in 1984. Our market-leading solutions change how organizations manage and optimize the delivery of business applications and services, assure user experience across global IP networks and help protect networks from unwanted security threats. Through both internal development and acquisitions, we have continually enhanced and expanded our product portfolio to meet the evolving needs of customers worldwide. Our software analytics capture and transform terabytes of network traffic data in real time into high value, actionable information that enables customers to optimize network performance, manage applications, enhance security and gain insight into the end-user experience.
Our mission is to enable enterprise and service providers to realize maximum benefit with minimal risk from technology advances, like IP convergence, network function virtualization (NFV), software defined networking (SDN), virtualization, cloud, mobility, bring your own device (BYOD), web, and the evolving Internet by managing the inherent complexity in a cost-effective manner.  Our ASI technology, which we have developed in support of this mission, has the potential of not only expanding our leadership in our core markets, but can also serve as the underlying technology platform that can extend use of our solutions across our global customer base.
Our operating results are influenced by a number of factors, including, but not limited to, the mix and quantity of products and services sold, pricing, costs of materials used in our products, growth in employee related costs, including commissions, and the expansion of our operations. Factors that affect our ability to maximize our operating results include, but

32


are not limited to, our ability to introduce and enhance existing products, the marketplace acceptance of those new or enhanced products, continued expansion into international markets, development of strategic partnerships, competition, successful acquisition integration efforts, our ability to achieve expense reductions and make structural improvements in the current economic conditions.
On July 14, 2015, we completed the Transaction, which was structured as a Reverse Morris Trust transaction whereby Danaher contributed the Communications Business to Newco. The total equity consideration was approximately $2.3 billion based on issuing approximately 62.5 million new shares of NetScout common stock to the existing holders of common units of Newco, based on the July 13, 2015 NetScout common stock closing share price of $36.89 per share.  The Transaction is expected to more than double NetScout's total addressable market to over $8 billion by extending its reach into growth-oriented adjacent markets, including cyber security, with a broader range of market-leading products and capabilities, strengthen its go-to-market resources to better support a larger, more diverse and more global customer base, and increase NetScout's scale and elevate its strategic position within key accounts. For additional information regarding the Transaction, see Note 7 of our Notes to Consolidated Financial Statements.
Results Overview
NetScout's financial results for the fiscal year ended March 31, 2016 include approximately eight and one-half months of contribution from the Communications Business.
We continue to maintain strong liquidity. At March 31, 2016, we had cash, cash equivalents and marketable securities of $352.1 million. This represents an increase of $87.2 million over the previous fiscal year ended March 31, 2015.
Use of Non-GAAP Financial Measures
We supplement the United States generally accepted accounting principles (GAAP) financial measures we report in quarterly and annual earnings announcements, investor presentations and other investor communications by reporting the following non-GAAP measures: non-GAAP revenue, non-GAAP net income and non-GAAP diluted net income per share. Non-GAAP revenue eliminates the GAAP effects of acquisitions by adding back revenue related to deferred revenue revaluation, an adjustment for a delayed transfer entity, and the amortization of acquired intangible assets. Non-GAAP net income includes the foregoing adjustments and also removes expenses related to share-based compensation and certain expenses relating to acquisitions including: compensation for post-combination services, business development charges, and depreciation expenses, net of related income tax effects. Non-GAAP diluted net income per share also excludes these expenses as well as the related impact of all these adjustments on the provision for income taxes.
These non-GAAP measures are not in accordance with GAAP, should not be considered an alternative for measures prepared in accordance with GAAP (revenue, net income (loss) and diluted net income (loss) per share), and may have limitations in that they do not reflect all our results of operations as determined in accordance with GAAP. These non-GAAP measures should only be used to evaluate our results of operations in conjunction with the corresponding GAAP measures. The presentation of non-GAAP information is not meant to be considered superior to, in isolation from, or as a substitute for results prepared in accordance with GAAP.
Management believes these non-GAAP financial measures enhance the reader's overall understanding of our current financial performance and its prospects for the future by providing a higher degree of transparency for certain financial measures and providing a level of disclosure that helps investors understand how we plan and measure our business. We believe that providing these non-GAAP measures affords investors a view of our operating results that may be more easily compared to our peer companies and also enables investors to consider our operating results on both a GAAP and non-GAAP basis during and following the integration period of our acquisitions. Presenting the GAAP measures on their own may not be indicative of our core operating results. Furthermore, management believes that the presentation of non-GAAP measures when shown in conjunction with the corresponding GAAP measures provide useful information to management and investors regarding present and future business trends relating to our financial condition and results of operations.

33


The following table reconciles revenue, net income (loss) and diluted net income (loss) per share on a GAAP and non-GAAP basis for the years ended March 31, 2016, 2015 and 2014:
 
Fiscal Year Ended March 31,
(Dollars in Thousands, Except per Share Data)
 
2016
 
2015
 
2014
GAAP revenue
$
955,419

 
$
453,669

 
$
396,647

Product deferred revenue fair value adjustment
10,166

 
18

 
558

       Service deferred revenue fair value adjustment
51,625

 

 

       Delayed transfer entity adjustment
633

 

 

       Amortization of acquired intangible assets
6,746

 

 

Non-GAAP revenue
$
1,024,589

 
$
453,687

 
$
397,205

GAAP net income (loss)
$
(28,369
)
 
$
61,192

 
$
49,106

Product deferred revenue fair value adjustments
10,166

 
18

 
558

Service deferred revenue fair value adjustments
51,625

 

 

Inventory fair value amortization
28,638

 

 

Share-based compensation expense
28,351

 
16,580

 
12,930

Amortization of acquired intangible assets
84,246

 
6,990

 
6,765

Business development and integration expense
29,434

 
11,956

 
523

Compensation for post-combination services
35,118

 
1,414

 
2,215

Restructuring charges
468

 

 

Loss on extinguishment of debt
55

 

 

Acquisition related depreciation expense
3,898

 

 

Income tax adjustments
(86,263
)
 
(13,810
)
 
(7,879
)
Non-GAAP net income
$
157,367

 
$
84,340

 
$
64,218

GAAP diluted net income (loss) per share
$
(0.35
)
 
$
1.47

 
$
1.17

Per share impact of non-GAAP adjustments identified above
2.26

 
0.56

 
0.36

Non-GAAP diluted net income per share
$
1.91

 
$
2.03

 
$
1.53


Critical Accounting Policies
We consider accounting policies related to marketable securities, revenue recognition, valuation of goodwill, intangible assets and other acquisition accounting items, and share based compensation to be critical in fully understanding and evaluating our financial results. We apply significant judgment and create estimates when applying these policies.
Revenue Recognition
We exercise judgment and use estimates in connection with determining the amounts of product and services revenues to be recognized in each accounting period.
We derive revenues primarily from the sale of network management tools and security solutions for service provider and enterprise customers, which include hardware, software and service offerings. The majority of our product sales consist of hardware products with embedded software that are essential to providing customers the intended functionality of the solutions. We also sell stand-alone software solutions to provide customers with enhanced functionality. In addition, we sell hardware bundled with a software license. Product revenue is recognized upon shipment, provided that evidence of an arrangement exists, title and risk of loss have passed to the customer, and in the case of software products, when the customer has the rights and ability to access the software, fees are fixed or determinable and collection of the related receivable is reasonably assured. If any significant obligations to the customer remain post-delivery, typically involving obligations relating to installation and acceptance by the customer, revenue recognition is deferred until such obligations have been fulfilled. Because many of our solutions are comprised of both hardware and more than incidental software components, we recognize revenue in accordance with authoritative guidance on both hardware and software revenue recognition.

34


Our service offerings include installation, integration, extended warranty and maintenance services, post-contract customer support (PCS), and other professional services including consulting and training. We generally provide software and/or hardware support as part of product sales. Revenue related to the initial bundled software and hardware support is recognized ratably over the support period. In addition, customers can elect to purchase extended support agreements for periods after the initial software/hardware warranty expiration. Support services generally include rights to unspecified upgrades (when and if available), telephone and internet-based support, updates and bug fixes. Consulting services are recognized upon delivery or completion of performance. Reimbursements of out-of-pocket expenditures incurred in connection with providing consulting services are included in services revenue, with the offsetting expense recorded in cost of service revenue. Training services include on-site and classroom training. Training revenues are recognized upon delivery of the training.
Generally, our contracts are accounted for individually. However, when contracts are closely interrelated and dependent on each other, it may be necessary to account for two or more contracts as one to reflect the substance of the group of contracts.
Multi-element arrangements are concurrent customer purchases of a combination of our product and service offerings that may be delivered at various points in time. For multi-element arrangements comprised only of hardware products and related services, we allocate the total arrangement consideration to the multiple elements based on each element’s fair value compared to the total relative selling price of all the elements. Each element’s selling price is based on management’s best estimate of selling price (BESP) paid by customers based on the element’s historical pricing when vendor-specific objective evidence (VSOE) or third-party evidence (TPE) does not exist. We have established BESP for product elements as the average or median selling price the element was recently sold for, whether sold alone or sold as part of a multiple element transaction. We also consider our overall pricing objectives and practices across different sales channels and geographies, and market conditions. We review sales of the product elements on a quarterly basis and update, when appropriate, our BESP for such elements to ensure that it reflects recent pricing experience. We have established VSOE for a majority of our service elements based on historical stand-alone sales or by the renewal rate offered to the customer. However certain business units we acquired as part of the Transaction are unable to establish VSOE for undelivered elements. This occurs because the pricing for standalone sales does not occur in tight bands around a midpoint, and they are not contractually fixed. In these scenarios we have typically established BESP by creating wider bands around a midpoint for stand alone transactions or in some cases using cost plus a margin for the underlying services and products. If VSOE of fair value does not exist for a deliverable, we use our BESP for that deliverable.
For multi-element arrangements comprised only of software products and related services, we allocate a portion of the total arrangement consideration to the undelivered elements, primarily support agreements and professional services, using VSOE of fair value for the undelivered elements. The remaining portion of the total arrangement consideration is allocated to the delivered software, referred to as the residual method. VSOE of fair value of the undelivered elements is based on the price customers pay when the element is sold separately. We review the separate sales of the undelivered elements on a regular basis and update when appropriate, our VSOE of fair value for such elements to ensure that it reflects recent pricing experience. If we cannot objectively determine the VSOE of the fair value of any undelivered software element, revenue is deferred until all elements are delivered and services have been performed, or until fair value can objectively be determined for any remaining undelivered elements. However, if the only undelivered element is maintenance and support, the entire arrangement fee is recognized over the service period.
For multi-element arrangements comprised of a combination of hardware and software elements, the total arrangement consideration is bifurcated between the hardware and hardware related deliverables and the software and software related deliverables based on the relative selling prices of all deliverables as a group. Then, arrangement consideration for the hardware and hardware-related services is recognized upon delivery or as the related services are provided outlined above and revenue for the software and software-related services is allocated following the residual method and recognized based upon delivery or as the related services are provided.
Our products are distributed through our direct sales force and indirect distribution channels through alliances with resellers. Revenue arrangements with resellers are recognized on a sell-in basis; that is, when we deliver the product to the reseller. We record consideration given to a reseller as a reduction of revenue to the extent we have recorded revenue from the reseller. With limited exceptions, our return policy does not allow product returns for a refund. Returns have been insignificant to date. In addition, we have a history of successfully collecting receivables from the resellers.

35


Marketable Securities
We measure the fair value of our marketable securities at the end of each reporting period. Fair value is defined as the exchange price that would be received for an asset in the principal or most advantageous market for the asset in an orderly transaction between market participants on the measurement date. Marketable securities are recorded at fair value and have been classified as Level 1 or 2 within the fair value hierarchy. Fair values determined by Level 1 inputs utilize quoted prices (unadjusted) in accessible active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize data points that are observable such as quoted prices, interest rates and yield curves.
Valuation of Goodwill, Intangible Assets and Other Acquisition Accounting Items
We amortize acquired definite-lived intangible assets over their estimated useful lives. Goodwill and other indefinite-lived intangible assets are not amortized but subject to annual impairment tests; more frequently if events or circumstances occur that would indicate a potential decline in their fair value.  We perform the assessment annually during the fourth quarter and on an interim basis if potential impairment indicators arise.  We have identified five reporting units: (1) NetScout, (2) Arbor Networks, (3) Tektronix Communications, (4) VSS and (5) FNET and an indefinite-lived trade name. To test impairment, we first assess qualitative factors to determine whether the existence of events and circumstances indicate that it is more likely than not that the intangible asset is impaired. If based on our qualitative assessment, it is more likely than not that the fair value of the intangible asset is less than its carrying amount, quantitative impairment testing is required. However, if we conclude otherwise, quantitative impairment testing is not required. During fiscal year 2016, we performed a quantitative analysis for goodwill and our non-amortizing intangible asset. We determined the fair value of the reporting unit's goodwill using established income and market valuation approaches and the fair value of its trade names using a forward-looking relief from royalty model. All goodwill and indefinite-lived intangible assets were estimated to be recoverable as of January 31, 2016.
We completed one acquisition (the Transaction) during the three year period ended March 31, 2016. The acquisition method of accounting requires an estimate of the fair value of the assets and liabilities acquired as part of these transactions. In order to estimate the fair value of acquired intangible assets we use a relief from royalty model which requires management to estimate: future revenues expected to be generated by the acquired intangible assets, a royalty rate which a market participant would pay related to the projected revenue stream, a present value factor which approximates a risk adjusted rate of return for a market participant purchasing the assets, and a technology migration curve representing a period of time over which the technology assets or some portion thereof are still being used. We are also required to develop the fair value for customer relationships acquired as part of these transactions which requires that we create estimates for the following items: a projection of future revenues associated with the acquired company’s existing customers, a turnover rate for those customers, a margin related to those sales, and risk adjusted rate of return for a market participant purchasing those relationships.
The Transaction contained both contingently returnable consideration and contingent purchase consideration. The contingently returnable consideration represents a contingent right of return from Danaher to reimburse NetScout for certain cash awards to be paid by NetScout to employees of the Communications Business transferred to Newco for post-combination services on various dates through August 4, 2016. The contingently returnable consideration was $16.1 million, net of taxes at March 31, 2016. During the fiscal year ended March 31, 2016, certain post-combination cash retention payments have been disbursed. Danaher will reimburse NetScout for those costs and NetScout will reimburse Danaher for the tax benefit. Because the right of offset has not been met, we recorded the gross amount of compensation as contingently returnable consideration and the tax benefit of $2.7 million as contingent purchase consideration. For additional information, see Note 7 of the Notes to Consolidated Financial Statements.
The acquisition of Simena LLC on November 18, 2011 also contained contingent consideration based on the ultimate settlement of assets and liabilities acquired as part of the transaction, and the former owners' future period of employment with NetScout. Contingent consideration accounting requires us to estimate the probability of various settlement scenarios, the former owners' expected period of employment with NetScout, and a risk adjusted interest rate to present value to the payment streams.
Share-Based Compensation
We recognize compensation expense for all share-based payments. Under the fair value recognition provisions, we recognize share-based compensation net of an estimated forfeiture rate and only recognize compensation cost for those shares expected to vest on a straight-line basis over the requisite service period of the award.
We are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate, the share-based compensation expense could be significantly different from what we have recorded in the current period.
Based on historical experience, we assumed an annualized forfeiture rate of 0% for awards granted to our directors, an annualized forfeiture rate of 2% for awards granted to our senior executives, and an annualized forfeiture rate of 5% for all

36


remaining employees. We will record additional expense if the actual forfeitures are lower than estimated and will record a recovery of prior expense if the actual forfeitures are higher than estimated.
Results of Operations
Comparison of Years Ended March 31, 2016 and 2015
Revenue
Product revenue consists of sales of our hardware products and licensing of our software products. Service revenue consists of customer support agreements, consulting and training. During the fiscal year ended March 31, 2016, one direct customer accounted for more than 10% of total revenue, while no indirect channel partner accounted for more than 10% of total revenue. During the fiscal year ended March 31, 2015, two direct customers accounted for more than 10% of our total revenue, while no indirect channel partner accounted for more than 10% of total revenue.
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
 
 
 
 
2016
 
2015
 
Change
 
 
 
% of
Revenue
 
 
 
% of
Revenue
 
$
 
%
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
633,408

 
66
%
 
$
272,895

 
60
%
 
$
360,513

 
132
%
Service
322,011

 
34

 
180,774

 
40

 
141,237

 
78
%
Total revenue
$
955,419

 
100
%
 
$
453,669

 
100
%
 
$
501,750

 
111
%
Product. The 132%, or $360.5 million, increase in product revenue compared to the same period last year was primarily due to $378.8 million in additional revenue resulting from the Transaction. This increase was partially offset by an $11.4 million decrease in revenue from our legacy service provider sector and a $6.9 million decrease in revenue from our legacy general enterprise sector.
Going forward, we expect that the revenue mix in future quarters will likely be oriented toward service provider customers, consistent with recent quarterly trends.  However, the timing and magnitude of certain projects will impact the quarterly revenue mix in any given quarter.
Service. The 78%, or $141.2 million, increase in service revenue compared to the same period last year was primarily due to a $128.7 million increase from the expansion of our customer base due to the Transaction and a $12.7 million increase in revenue from maintenance contracts in our legacy NetScout business due to new maintenance contracts and renewals from a growing support base.
Total revenue by geography is as follows:
 
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
 
 
 
  
2016
 
2015
 
Change
 
 
 
% of
Revenue
 
 
 
% of
Revenue
 
$
 
%
United States
$
681,569

 
71
%
 
$
348,354

 
77
%
 
$
333,215

 
96
%
International:
 
 
 
 
 
 
 
 
 
 
 
Europe
137,411

 
14

 
46,253

 
10

 
91,158

 
197
%
Asia
61,566

 
7

 
27,685

 
6

 
33,881

 
122
%
Rest of the world
74,873

 
8

 
31,377

 
7

 
43,496

 
139
%
Subtotal international
273,850

 
29

 
105,315

 
23

 
168,535

 
160
%
Total revenue
$
955,419

 
100
%
 
$
453,669

 
100
%
 
$
501,750

 
111
%
United States revenues increased 96%, or $333.2 million, primarily due to a $334.1 million increase from entities acquired as part of the Transaction. The 160%, or $168.5 million, increase in international revenue was primarily due to a $173.4 million increase from entities acquired as part of the Transaction, partially offset by a decrease across the legacy general enterprise sector.

37


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 software and core technology. Cost of service revenue consists primarily of personnel, material, overhead and support costs.
 
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
Change
  
2016
 
2015
 
 
 
 
% of
Revenue
 
 
 
% of
Revenue
 
$
 
%
Cost of revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
238,037

 
25
%
 
$
59,037

 
13
%
 
$
179,000

 
303
%
Service
90,412

 
9

 
35,524

 
8

 
54,888

 
155
%
Total cost of revenue
$
328,449

 
34
%
 
$
94,561

 
21
%
 
$
233,888

 
247
%
Gross profit:
 
 
 
 
 
 
 
 
 
 
 
Product $
$
395,371

 
41
%
 
$
213,858

 
47
%
 
$
181,513

 
85
%
Product gross profit %
62
%
 
 
 
78
%
 
 
 
(16
)%
 
 
Service $
231,599

 
24
%
 
145,250

 
32
%
 
86,349

 
59
%
Service gross profit %
72
%
 
 
 
80
%
 
 
 
(8
)%
 
 
Total gross profit $
$
626,970

 
 
 
$
359,108

 
 
 
$
267,862

 
75
%
Total gross profit %
66
%
 
 
 
79
%
 
 
 
(13
)%
 
 
Product. The 303%, or $179.0 million, increase in cost of product revenue was primarily due to the 132%, or $360.5 million increase in product revenue for the fiscal year ended March 31, 2016 when compared to the fiscal year ended March 31, 2015. A majority of the increase in cost of product revenue was primarily due to a $181.7 million increase as a result of the incremental costs from the operations related to the Transaction, as well as an $886 thousand increase in amortization of intangibles primarily due to the acceleration of intangibles in the legacy NetScout business. These increases were offset by a $3.3 million decrease in cost of goods sold for the legacy NetScout business as well as a $1.2 million decrease in obsolescence charges. The product gross profit percentage decreased by sixteen percentage points to 62% during the fiscal year ended March 31, 2016 as compared to the same period in the prior year. Average headcount in cost of product revenue was 100 and 32 for the fiscal years ended March 31, 2016 and 2015, respectively.
Service. The 155%, or $54.9 million, increase in cost of service revenue was primarily due to a $52.2 million increase as a result of the incremental costs from the operations related to the Transaction, a $1.2 million increase in compensation related expenses in the legacy NetScout business and a $959 thousand increase in cost of contracts. The service gross profit percentage decreased by eight percentage points to 72% for the fiscal year ended March 31, 2016 when compared to the fiscal year ended March 31, 2015. The 59%, or $86.3 million, increase in service gross profit corresponds with the 78%, or $141.2 million, increase in service revenue, partially offset by the 155%, or $54.9 million, increase in cost of services. Average headcount in cost of service revenue was 608 and 168 for the fiscal years ended March 31, 2016 and 2015, respectively.
Gross profit. Our gross profit increased 75%, or $267.9 million. This increase is attributable to our increase in revenue of 111%, or $501.8 million, partially offset by a $233.9 million, or 247%, increase in cost of revenue. The gross margin percentage decreased thirteen percentage points to 66% during the fiscal year ended March 31, 2016 when compared to the same period in the prior year.

38


Operating Expenses
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
Change
 
2016
 
2015
 
 
 
 
% of
Revenue
 
 
 
% of
Revenue
 
$
 
%
Research and development
$
208,630

 
22
%
 
$
75,242

 
17
%
 
$
133,388

 
177
%
Sales and marketing
293,335

 
31

 
136,446

 
30

 
156,889

 
115
%
General and administrative
117,714

 
12

 
47,296

 
10

 
70,418

 
149
%
Amortization of acquired intangible assets
32,373

 
3

 
3,351

 
1

 
29,022

 
866
%
Restructuring charges
468

 

 

 

 
468

 


Total operating expenses
$
652,520

 
68
%
 
$
262,335

 
58
%
 
$
390,185

 
149
%
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 177%, or $133.4 million, increase in research and development expenses was due to a $133.5 million increase as a result of the incremental costs from the operations related to the Transaction. Average headcount in research and development was 1,224 and 358 for the fiscal years ended March 31, 2016 and 2015, respectively.
Sales and marketing. Sales and marketing expenses consist primarily of personnel expenses, including commissions, overhead and other expenses associated with selling activities and marketing programs such as trade shows, seminars, advertising, and new product launch activities.
The 115%, or $156.9 million, increase in total sales and marketing expenses was primarily due to a $146.2 million increase as a result of the incremental costs from the operations related to the Transaction. In addition, in the legacy NetScout business there was a $3.8 million increase in commission expense, a $2.5 million increase in deal related compensation expense, a $2.0 million increase in events, $1.8 million increase for the NetScout User Conference, a $1.5 million increase in employee related expense items resulting in part from increased headcount as well as increase compensation related items and a $1.3 million increase in advertising expenses. These expenses were partially offset by a $1.2 million decrease in recruiting expenses and an $863 thousand decrease in travel expenses for the fiscal year ended March 31, 2016 as compared to the fiscal year ended March 31, 2015. Average headcount in sales and marketing was 930 and 374 for the fiscal years ended March 31, 2016 and 2015, respectively.
General and administrative. General and administrative expenses consist primarily of personnel expenses for executive, financial, legal and human resource employees, overhead and other corporate expenditures.
The 149%, or $70.4 million, increase in general and administrative expenses was primarily due to a $48.8 million increase as a result of the incremental costs from the operations related to the Transaction, a $14.8 million increase in business development expenses, a $2.5 million increase in legal expenses, a $1.9 million increase in accounting services, a $1.8 million thousand increase in employee related expenses as a result of increased compensation related expenses. Average headcount in general and administrative was 282 and 123 for the fiscal years ended March 31, 2016 and 2015, respectively.
Amortization of acquired intangible assets. Amortization of acquired intangible assets consists primarily of amortization of customer relationships, trademark and tradenames, and leasehold interest related to the acquisitions of the Communications Business, ONPATH Technologies, Inc. (ONPATH), Accanto, Simena, LLC (Simena), Fox Replay BV (Replay), Psytechnics, Ltd (Psytechnics) and Network General.
The 866%, or $29.0 million, increase in amortization of acquired intangible assets was due to a $27.9 million increase in amortization associated with the Transaction, as well as a $1.2 million increase in the legacy NetScout business related to acceleration of the amortization of certain intangibles.
Overall, we believe there is the potential to improve operating margin modestly in the fiscal year ending March 31, 2017 above reported levels for fiscal year 2016.

39


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.
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
Change
  
2016
 
2015
 
 
 
 
% of
Revenue
 
 
 
% of
Revenue
 
$
 
%
Interest and other expense, net
$
(6,889
)
 
(1
)%
 
$
(1,808
)
 
 %
 
$
(5,081
)
 
(281
)%
The 281%, or $5.1 million, increase in interest and other expense, net was due to a $5.5 million increase in interest expense due to amounts drawn down on the credit facility entered into on July 14, 2015, as well as a $1.0 million increase as a result of the incremental costs from operations related to the Transaction. These were partially offset by a $1.2 million decrease in foreign currency expense and a $246 thousand increased interest income received on investments.
Income Tax Expense
The annual effective tax rate for fiscal year 2016 is 12.5%, compared to an annual effective tax rate of 35.6% for fiscal year 2015. Generally, the effective tax rate differs from statutory tax rate due to the impact of the domestic production activities deduction, research and development credit, the impact of state taxes and income generated in jurisdictions that have a different tax rate than the U.S. statutory rate. The effective tax rate for the fiscal year ended March 31, 2016 is lower than the comparable prior year period primarily related to a decrease in profit before taxes due to Transaction related expenses recorded in the year, an increase in research and development credits attributable to acquired companies and a change in the jurisdictional mix of earnings.
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
Change
  
2016
 
2015
 
 
 
 
% of
Revenue
 
 
 
% of
Revenue
 
$
 
%
Income tax expense (benefit)
$
(4,070
)
 
 %
 
$
33,773

 
7
%
 
$
(37,843
)
 
(112
)%


40


Comparison of Years Ended March 31, 2015 and 2014
Revenue

During the fiscal year ended March 31, 2015, two direct customers accounted for more than 10% of total revenue, while no indirect channel partner accounted for more than 10% of total revenue. During the fiscal year ended March 31, 2014, one direct customer accounted for more than 10% of our total revenue, while no indirect channel partner accounted for more than 10% of total revenue.

 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
Change
  
2015
 
2014
 
 
 
 
% of
Revenue
 
 
 
% of
Revenue
 
$
 
%
Revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
272,895

 
60
%
 
$
234,268

 
59
%
 
$
38,627

 
16
%
Service
180,774

 
40

 
162,379

 
41

 
18,395

 
11
%
Total revenue
$
453,669

 
100
%
 
$
396,647

 
100
%
 
$
57,022

 
14
%
Product. The 16%, or $38.6 million, increase in product revenue was primarily due to a $26.8 million increase in revenue from our service provider sector, an $7.5 million increase in revenue from our general enterprise sector and a $4.3 million increase in revenue from our government enterprise sector.
Service. The 11%, or $18.4 million, increase in service revenue was primarily due to a $13.4 million increase in revenue from new maintenance contracts and renewals from a growing support base, a $4.6 million increase in premium support contracts and a $328 thousand increase in revenue from training.
Total revenue by geography is as follows:
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
Change
  
2015
 
2014
 
 
 
 
% of
Revenue
 
 
 
% of
Revenue
 
$
 
%
United States
$
348,354

 
77
%
 
$
303,364

 
76
%
 
$
44,990

 
15
%
International:
 
 
 
 
 
 
 
 
 
 
 
Europe
46,253

 
10

 
45,837

 
12

 
416

 
1
%
Asia
27,685

 
6

 
20,646

 
5

 
7,039

 
34
%
Rest of the world
31,377

 
7

 
26,800

 
7

 
4,577

 
17
%
Subtotal international
105,315

 
23

 
93,283

 
24

 
12,032

 
13
%
Total revenue
$
453,669

 
100
%
 
$
396,647

 
100
%
 
$
57,022

 
14
%
United States revenues increased 15%, or $45.0 million, primarily as a result of an increase in our service provider sector. The 13%, or $12.0 million, increase in international revenue is primarily due to an increase in revenue from our service provider sector across international geographies.

41


Cost of Revenue and Gross Profit
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
 
 
 
 
2015
 
2014
 
Change
 
 
 
% of
Revenue
 
 
 
% of
Revenue
 
$
 
%
Cost of revenue:
 
 
 
 
 
 
 
 
 
 
 
Product
$
59,037

 
13
%
 
$
51,219

 
13
%
 
$
7,818

 
15
%
Service
35,524

 
8

 
33,294

 
8

 
2,230

 
7
%
Total cost of revenue
$
94,561

 
21
%
 
84,513

 
21
%
 
10,048

 
12
%
Gross profit:
 
 
 
 
 
 
 
 
 
 
 
Product $
$
213,858

 
47
%
 
$
183,049

 
46
%
 
30,809

 
17
%
Product gross profit %
78
%
 
 
 
78
%
 
 
 
%
 
 
Service $
145,250

 
32
%
 
129,085

 
33
%
 
16,165

 
13
%
Service gross profit %
80
%
 
 
 
79
%
 
 
 
1
%
 
 
Total gross profit $
$
359,108

 
 
 
$
312,134

 
 
 
$
46,974

 
15
%
Total gross profit %
79
%
 
 
 
79
%
 
 
 
%
 
 
Product. The 15%, or $7.8 million, increase in cost of product revenue was primarily due to the 16%, or $38.6 million increase in product revenue for the fiscal year ended March 31, 2015 when compared to the fiscal year ended March 31, 2014. In addition, there was a $2.0 million increase in inventory obsolescence charges and a $300 thousand increase in amortization of intangible assets.  The product gross profit percentage remained flat at 78% during the fiscal year ended March 31, 2015 as compared to the same period in the prior year. Average headcount in cost of product revenue was 32 for the years ended March 31, 2015 and 2014.
Service. The 7%, or $2.2 million, increase in cost of service revenue was primarily due to a  $3.6 million increase in employee related expenses resulting in part from increased headcount to support our growing installed base, as well as from increased compensation related items for the fiscal year ended March 31, 2015 when compared to the fiscal year ended March 31, 2014. This increase was partially offset by a $1.4 million decrease in allocated overhead. The service gross profit percentage decreased by one percentage point to 80% for the fiscal year ended March 31, 2015 when compared to the fiscal year ended March 31, 2014. The 13%, or $16.2 million, increase in service gross profit corresponds with the 11%, or $18.4 million, increase in service revenue, partially offset by the 7%, or $2.2 million, increase in cost of services. Average headcount in cost of service revenue was 168 and 146 for the years ended March 31, 2015 and 2014, respectively.
Gross profit. Our gross profit increased 15%, or $47.0 million. This increase is attributable to our increase in revenue of 14%, or $57.0 million, partially offset by a $10.0 million, or 12%, increase in cost of revenue. The gross margin percentage remained flat at 79% during the fiscal year ended March 31, 2015 when compared to the same period in the prior year.
Operating Expenses
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
 
 
 
 
2015
 
2014
 
Change
 
 
 
% of
Revenue
 
 
 
% of
Revenue
 
$
 
%
Research and development
$
75,242

 
17
%
 
$
70,454

 
18
%
 
$
4,788

 
7
 %
Sales and marketing
136,446

 
29

 
129,611

 
33

 
6,835

 
5
 %
General and administrative
47,296

 
10

 
30,623

 
8

 
16,673

 
54
 %
Amortization of acquired intangible assets
3,351

 
1

 
3,432

 
1

 
(81
)
 
(2
)%
Total operating expenses
$
262,335

 
57
%
 
$
234,120

 
60
%

$
28,215

 
12
 %
Research and development. The 7%, or $4.8 million, increase in research and development expenses is due to a $3.6 million increase in employee related expenses resulting in part from increased headcount as well as from increased compensation related items, a $1.3 million increase in depreciation expense, a $945 thousand increase in consulting expenses,

42


and a $320 thousand increase in allocated overhead. These expenses were partially offset by a $952 thousand decrease in non-recurring engineering expenses, and a $253 thousand decrease in deal related compensation. Average headcount in research and development was 358 and 352 for the fiscal years ended March 31, 2015 and 2014, respectively.
Sales and marketing. The 5%, or $6.8 million, increase in total sales and marketing expenses was due to $6.1 million increase in employee related expenses resulting in part from increased headcount as well as from increased compensation related items. In addition, there was a $1.4 million increase in advertising and marketing related expenses, a $927 thousand increase related to the NetScout user conference, an $877 thousand increase in trade show expenses, a $780 thousand increase in allocated overhead, a $531 thousand increase in consulting expenses, and a $479 thousand increase in travel expenses. These expenses were partially offset by a $4.9 million decrease in commission expense for the fiscal year ended March 31, 2015 as compared to the fiscal year ended March 31, 2014. Average headcount in sales and marketing was 374 and 358 for the fiscal years ended March 31, 2015 and 2014, respectively.
General and administrative. The 54%, or $16.7 million, increase in general and administrative expenses was due to a $10.8 million increase in business development expenses, a $3.2 million increase in employee related expenses as a result of increased incentive related items as well as increased headcount, a $1.6 million increase in legal expenses, a $653 thousand increase in software licenses, and a $388 thousand increase in outside services. Average headcount in general and administrative was 123 and 118 for the fiscal years ended March 31, 2015 and 2014, respectively.
Amortization of acquired intangible assets. The 2%, or $81 thousand, decrease in amortization of acquired intangible assets is due to the decrease of expense recorded related to the acquisitions of Accanto and Replay.
Interest and Other Expense, Net
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
 
 
 
 
2015
 
2014
 
Change
 
 
 
% of
Revenue
 
 
 
% of
Revenue
 
$
 
%
Interest and other expense, net
$
(1,808
)
 
 %
 
$
(158
)
 
 %
 
$
(1,650
)
 
(1,044
)%
The 1,044%, or $1.7 million, increase in interest and other expense, net was primarily due to a $1.7 million increase in foreign currency exchange expense as well as a $172 thousand increase in expense due to loss on sale of equipment. These increases to interest and other expense, net were partially offset by a $136 thousand increase in interest income received on investments and a $105 thousand increase in other income.
Income Tax Expense
The annual effective tax rate for fiscal year 2015 was 35.6%, compared to an annual effective tax rate of 36.9% for fiscal year 2014. Generally, the annual effective tax rates differ from statutory rates primarily due to the impact of the domestic production activities deduction, the impact of state taxes, and federal, foreign and state tax credits. Our effective tax rate for the fiscal year ended March 31, 2015 was lower than the comparable prior year period primarily due to generation of taxable income in the fiscal year ended March 31, 2015 within a foreign subsidiary which generated losses in the fiscal year ended March 31, 2014; and whose fiscal year 2014 losses were not benefited.
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
 
 
 
 
2015
 
2014
 
Change
 
 
 
% of
Revenue
 
 
 
% of
Revenue
 
$
 
%
Income tax expense
$
33,773

 
7
%
 
$
28,750

 
7
%
 
$
5,023

 
17
%

43


Contractual Obligations
At March 31, 2016, we had the following contractual obligations:
Payment due by period (Dollars in thousands)
Contractual Obligations
Total
 
Less than 1
year
 
1-3 years
 
3-5 years
 
More than
5 years
Long-term debt obligations (1)
$
328,606

 
$
6,661

 
$
13,323

 
$
308,622

 
$

Unconditional purchase obligations (2)
54,112

 
49,878

 
4,234

 

 

Operating lease obligations (3)
61,857

 
21,448

 
25,814

 
8,262

 
6,333

Pension benefit plan
29,188

 
275

 
688

 
903

 
27,322

Contingent purchase consideration
7,293

 
2,657

 
4,636

 

 

Total contractual obligations
$
481,056

 
$
80,919

 
$
48,695

 
$
317,787

 
$
33,655

At March 31, 2016, the total amount of net unrecognized tax benefits for uncertain tax positions and the accrual for the related interest was $1.8 million. We are unable to make a reliable estimate when cash settlement, if any, will occur with a tax authority as the timing of examinations and ultimate resolution of those examinations is uncertain. We have also excluded long-term deferred revenue of $68.1 million as such amounts will be recognized as services are provided.
At March 31, 2016, the total accrual of our retirement obligation for our chairman and CEO was $1.6 million. The payment stream for this retirement obligation is based upon the retirement date which is currently not determinable.
 
(1)
Includes estimated future interest at an interest rate of 2.19% for our outstanding term loan at March 31, 2016.
(2)
Represents estimated open purchase orders to purchase inventory as well as commitments for products and services used in the normal course of business.
(3)
We lease facilities and certain equipment under operating lease agreements extending through March 2024 for a total of $61.9 million.
Off-Balance Sheet Arrangements
We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.
Commitment and Contingencies
We account for claims and contingencies in accordance with authoritative guidance that requires us to record an estimated loss from a claim or loss contingency when information available prior to issuance of our consolidated financial statements indicates that it is probable that a liability has been incurred at the date of the consolidated financial statements and the amount of the loss can be reasonably estimated. If we determine that it is reasonably possible but not probable that an asset has been impaired or a liability has been incurred or if the amount of a probable loss cannot be reasonably estimated, then in accordance with the authoritative guidance, we disclose the amount or range of estimated loss if the amount or range of estimated loss is material. Accounting for claims and contingencies requires us to use our judgment. We consult with legal counsel on those issues related to litigation and seek input from other experts and advisors with respect to matters in the ordinary course of business. See Note 16 for a discussion of contingencies.
We have a contingent liability related to the Transaction which represents the tax effected portion of the contingently returnable consideration. At March 31, 2016, the fair value of the future consideration to be paid to Danaher was $2.7 million.
We have one contingent liability related to the acquisition of Simena in November 2011 for future consideration to be paid to the former seller which had an initial fair value of $8.0 million at the time of acquisition. At March 31, 2016, the fair value of the future consideration was $4.6 million.

44


Warranty and Indemnification
We warrant that our software and hardware products will substantially conform to the documentation accompanying such products on their original date of shipment. For software, which also includes firmware, the standard warranty commences upon shipment and expires 90 days thereafter. With regard to hardware, the standard warranty commences upon shipment and expires 12 months thereafter. Additionally, this warranty is subject to various exclusions which include, but are not limited to, non-conformance resulting from modifications made to the software or hardware by a party other than NetScout; customers’ failure to follow our installation, operation or maintenance instructions; and events outside of our reasonable control. We also warrant that all support services will be performed in a good and workmanlike manner. We believe that our product and support service warranties are consistent with commonly accepted industry standards. Warranty cost information is presented and no material warranty costs are accrued since service revenue associated with warranty is deferred at the time of sale and recognized ratably over the warranty period.
Contracts that we enter into in the ordinary course of business may contain standard indemnification provisions. Pursuant to these agreements, we may agree to defend third party claims brought against a partner or direct customer claiming infringement of such third party’s (i) U.S. patent and/or European Union (EU), or other selected countries’ patents, (ii) Berne convention member country copyright, and/or (iii) U.S., EU, and/or other selected countries’ trademark or intellectual property rights. Moreover, this indemnity may require us to pay any damages awarded against the partner or direct customer in such type of lawsuit as well as reimburse the partner or direct customer for reasonable attorney’s fees incurred by them from the lawsuit.
We may also agree from time to time to provide other forms of indemnification to partners or direct customers, such as indemnification that would obligate us to defend and pay any damages awarded to a third party against a partner or direct customer based on a lawsuit alleging that such third party has suffered personal injury or tangible property damage legally determined to have been caused by negligently designed or manufactured products.
We have agreed to indemnify our directors and officers and our subsidiaries’ directors and officers if they are made a party or are threatened to be made a party to any proceeding (other than an action by or in the right of NetScout) by reason of the fact that the indemnified are an agent of NetScout or by reason of anything done or not done by them in any such capacity. The indemnity is for any and all expenses and liabilities of any type (including but not limited to, judgments, fines and amounts paid in settlement) reasonably incurred by the directors or officers in connection with the investigation, defense, settlement or appeal of such proceeding, provided they acted in good faith.
Liquidity and Capital Resources
Cash, cash equivalents, and marketable securities consist of the following:
 
At March 31,
(Dollars in Thousands)
 
2016
 
2015
 
2014
Cash and cash equivalents
$
210,711

 
$
104,893

 
$
102,076

Short-term marketable securities
128,003

 
101,392

 
75,234

Long-term marketable securities
13,361

 
58,572

 
41,484

Cash, cash equivalents and marketable securities
$
352,075

 
$
264,857

 
$
218,794

Cash, Cash Equivalents and Marketable Securities
At March 31, 2016 cash, cash equivalents and marketable securities totaled $352.1 million, up $87.2 million from $264.9 million at March 31, 2015 due primarily to proceeds from the issuance of debt in the amount of $294.6 million, cash provided by operations of $95.3 million, cash acquired as part of the Transaction in the amount of $27.7 million, partially offset by $311.9 million used to repurchase shares of our common stock and $24.8 million of cash used for capital expenditures.
At March 31, 2016, cash, short-term and long-term investments in the United States were $289.2 million, while cash held offshore was approximately $62.9 million.

45


Cash and cash equivalents were impacted by the following:
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
2016
 
2015
 
2014
Net cash provided by operating activities
$
95,285

 
$
106,933

 
$
110,946

Net cash provided by (used in) investing activities
$
25,089

 
$
(56,185
)
 
$
(76,581
)
Net cash used in financing activities
$
(15,300
)
 
$
(48,760
)
 
$
(31,963
)
Net Cash Provided by Operating Activities.
Fiscal year 2016 compared to fiscal year 2015
Cash provided by operating activities was $95.3 million during the fiscal year ended March 31, 2016, compared to $106.9 million of cash provided by operating activities in the fiscal year ended March 31, 2015. This $11.6 million decrease was due in part to an $89.5 million decrease from net income, a $44.9 million decrease in deferred income taxes, $27.3 million decrease from prepaid expenses and other assets, an $18.5 million decrease from amounts owed from a related party as a result of the Transaction, a $6.7 million decrease from amounts that are due to a related party as a result of the Transaction and a $1.5 million unfavorable impact from accounts receivable. Accounts receivable days sales outstanding was 80 days at March 31, 2016 compared to 61 days at March 31, 2015. These decreases were offset by a $120.4 million increase in depreciation and amortization and a $20.0 million increase from accrued compensation and other expenses. This increase from accrued compensation and other expenses was due largely to the timing of accruals and payments for compensation related items and legal and accounting related fees. In addition, there was an $11.8 million increase in share-based compensation, a $9.0 million increase from deferred revenue, a $6.6 million increase in deal related compensation and a $6.0 million increase from inventories.
Fiscal year 2015 compared to fiscal year 2014
Cash provided by operating activities was $106.9 million during the fiscal year ended March 31, 2015, compared to $110.9 million of cash provided by operating activities in the fiscal year ended March 31, 2014. This $4.0 million decrease was due in part to accounts receivable, which had a $35.3 million unfavorable impact in the fiscal year ended March 31, 2015 as compared to the fiscal year ended March 31, 2014. Accounts receivable days sales outstanding was 61 days at March 31, 2015 compared to 47 days at March 31, 2014. In addition, there was a $2.5 million decrease from deferred income taxes, and a $1.4 million decrease from income taxes payable. These decreases were offset by a $12.1 million increase in profitability. In addition, there was a $6.5 million increase from accrued compensation and other expenses during the fiscal year ended March 31, 2015 when compared to the fiscal year ended March 31, 2014 largely due to the timing of accruals and payments for accruals related to legal and accounting related expenses at March 31, 2015. The increase in cash provided by operating activities was also due to a $6.3 million decrease from a change in inventory balances, a $3.8 million favorable impact from deferred revenue due to increased sales of maintenance and services delivered over time, a $3.7 million increase from share-based compensation, a $1.4 million increase from depreciation and amortization, and a $672 thousand increase from prepaid expenses and other assets.

46


Net Cash Provided by (Used in) Investing Activities.
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
2016
 
2015
 
2014
Cash provided by (used in) investment activities included the following:
 
 
 
 
 
Purchase of marketable securities
$
(100,278
)
 
$
(133,212
)
 
$
(128,122
)
Proceeds from maturity of marketable securities
118,881

 
89,954

 
65,570

Purchase of fixed assets
(24,783
)
 
(12,808
)
 
(13,066
)
Purchase of intangible assets
(3,962
)
 
(174
)
 
(1,086
)
Collection of contingently returnable consideration
9,306

 

 

Acquisition of businesses, net of cash acquired
27,700

 

 

Increase in deposits
(150
)
 
55

 
123

       Capitalized software development costs
(1,625
)
 
$

 
$

 
$
25,089

 
$
(56,185
)
 
$
(76,581
)
Cash provided by investing activities increased by $81.3 million to $25.1 million during the fiscal year ended March 31, 2016, compared to $56.2 million of cash used in investing activities during the fiscal year ended March 31, 2015. Cash used for investing activities was $56.2 million during the fiscal year ended March 31, 2015, compared to $76.6 million of cash used for investing activities during the fiscal year ended March 31, 2014.
There was a $27.7 million increase in cash inflow related to cash acquired as part of the acquisition of the Communication Business.
Net cash inflows relating to the purchase and sales of marketable securities was up $61.9 million during the fiscal year ended March 31, 2016 relating to the amount of investments held at each respective balance sheet date, from an outflow of $43.3 million during the fiscal year ended March 31, 2015 to an inflow of $18.6 million during the fiscal year ended March 31, 2016. Net cash outflows relating to the purchase and sales of marketable securities was down $19.3 million during the fiscal year ended March 31, 2015 when compared to fiscal year ended March 31, 2014 relating to the amount of investments held at each respective balance sheet date, from an outflow of $62.6 million during the fiscal year ended March 31, 2014 to an outflow of $43.3 million during the fiscal year ended March 31, 2015.
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 in our fiscal year 2017.
Purchases of intangible assets increased by $3.8 million during the fiscal year ended March 31, 2016 as compared to the fiscal year ended March 31, 2015. During fiscal year ended March 31, 2016, we made an agreement to acquire a technology license for $3.7 million.
Net Cash Used in Financing Activities.
 
Fiscal Year Ended March 31,
(Dollars in Thousands)
 
2016
 
2015
 
2014
Cash used in financing activities included the following:
 
 
 
 
 
Issuance of common stock under stock plans
$
1

 
$
140

 
$
812

Payment of contingent consideration