NETSCOUT SYSTEMS INC - 10-Q Quarterly Report

Back to GetFilings.com

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

------------------------

FORM 10-Q

(MARK ONE)

/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2002

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 0000-26251

------------------------
NETSCOUT SYSTEMS, INC.
(Exact name of registrant as specified in charter)

DELAWARE 04-2837575
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)

310 LITTLETON ROAD, WESTFORD, MA 01886
(978) 614-4000

------------------------

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, $0.001 Par Value

------------------------

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 / /

The number of shares outstanding of the registrant's common stock as of
August 7, 2002 was 29,866,328.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------

NETSCOUT SYSTEMS, INC.
FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2002
TABLE OF CONTENTS

PART I: FINANCIAL INFORMATION

Item 1. Financial Statements................................ 3

a.) Condensed Consolidated Balance Sheets:
As of June 30, 2002 and March 31, 2002

b.) Condensed Consolidated Statements of Operations:
For the three months ended June 30, 2002 and June 30,
2001

c.) Condensed Consolidated Statements of Cash Flows:
For the three months ended June 30, 2002 and June 30,
2001

d.) Notes to the Condensed Consolidated Financial
Statements

Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 12

Item 3. Quantitative and Qualitative Disclosures About
Market Risk............................................... 24

PART II: OTHER INFORMATION

Item 1. Legal Proceedings................................... 25

Item 2. Changes in Securities and Use of Proceeds........... 25

Item 6. Exhibits and Reports on Form 8-K.................... 25

SIGNATURES.................................................. 26

EXHIBIT INDEX............................................... 27

2

PART 1: FINANCIAL INFORMATION

ITEM 1: FINANCIAL STATEMENTS

NETSCOUT SYSTEMS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(IN THOUSANDS, EXCEPT SHARE AND PER SHARE DATA)

(UNAUDITED)

The accompanying notes are an integral part of these condensed consolidated
financial statements.

3

NETSCOUT SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

The accompanying notes are an integral part of these condensed consolidated
financial statements.

4

NETSCOUT SYSTEMS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(IN THOUSANDS)

(UNAUDITED)

The accompanying notes are an integral part of these condensed consolidated
financial statements.

5

NETSCOUT SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

1. BASIS OF PRESENTATION

The accompanying unaudited interim condensed consolidated financial
statements as of June 30, 2002 and for the three months ended June 30, 2002 and
2001, respectively, have been prepared by NetScout Systems, Inc. (the "Company"
or "NetScout") in accordance with generally accepted accounting principles for
interim financial reports and the instructions for Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, certain information and footnote disclosures
normally included in financial statements prepared under generally accepted
accounting principles have been considered or omitted pursuant to such
regulations. In the opinion of NetScout's management, the unaudited interim
consolidated financial statements include all adjustments, consisting of normal
recurring adjustments, necessary for a fair presentation of the Company's
financial position, results of operations and cash flows. The results of
operations for the three month period ended June 30, 2002 are not necessarily
indicative of the results of operations for the year ending March 31, 2003. The
balance sheet at March 31, 2002 has been derived from the audited consolidated
financial statements at that date but does not include all of the information
and footnotes required by generally accepted accounting principles for complete
financial statements.

For further information refer to the consolidated financial statements and
footnotes thereto included in NetScout's Annual Report on Form 10-K for the year
ended March 31, 2002, as filed with the Securities and Exchange Commission on
June 28, 2002.

Certain reclassifications have been made to the prior year financial
statements to conform to the current presentation.

2. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES

We consider all highly liquid investments purchased with a maturity of three
months or less to be cash equivalents and those with maturities greater than
three months are considered to be marketable securities. Cash equivalents and
marketable securities are stated at amortized cost plus accrued interest, which
approximates fair value. Cash equivalents and marketable securities consist
primarily of money market instruments and U.S. Treasury bills.

Cash, cash equivalents and marketable securities consist of the following:

NetScout accounts for its investments in accordance with Statement of
Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." Under the provision of SFAS
No. 115, NetScout has classified its investments as "available-for-sale" and
associated unrealized gains or losses are recorded as a separate component of
stockholders' equity

6

NETSCOUT SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

2. CASH, CASH EQUIVALENTS AND MARKETABLE SECURITIES (CONTINUED)
until realized. At June 30, 2002 and March 31, 2002, there were no significant
unrealized gains or losses.

3. INVENTORIES

Inventories consist of the following:

4. LONG-LIVED ASSETS

GOODWILL AND OTHER INTANGIBLE ASSETS

NetScout adopted SFAS No. 142, "Goodwill and Other Intangible Assets," in
April 2002. Prior to the adoption of SFAS No. 142, the net carrying amount of
goodwill was $28,770. In accordance with the provisions of SFAS No. 142,
NetScout reclassified its assembled workforce intangible net asset of $68 to
goodwill. NetScout concluded that it had one reporting unit and assigned the
entire balance of goodwill to this reporting unit for purposes of performing a
transitional impairment test as of April 1, 2002. The fair value of the
reporting unit was determined using NetScout's market capitalization as of
April 1, 2002. As of April 1, 2002, the fair value of NetScout exceeded the
carrying value of its net assets in the reporting unit, including goodwill, and
accordingly, NetScout concluded no impairment existed as of that date. NetScout
will perform a test of impairment of goodwill annually or when changes in events
or circumstances indicate that an impairment test is required.

7

NETSCOUT SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

4. LONG-LIVED ASSETS (CONTINUED)
The following table summarizes other intangible assets by major intangible
asset class:

Estimated amortization expense for the fiscal years 2003 and 2004 is $1,088
and $272, respectively.

The following table presents a reconciliation of net loss and net loss per
share adjusted for the exclusion of goodwill amortization and assembled
workforce amortization:

NOTE RECEIVABLE

At June 30, 2002, NetScout performed a probability weighted cash flow
analysis on a long-term note receivable balance based on management's current
assessment of probable outcomes regarding future cash flows and concluded that
this asset was partially impaired. In accordance with SFAS No. 144, the Company
recorded a $472 impairment charge for the three months ended June 30, 2002.

8

NETSCOUT SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

5. TREASURY STOCK

On September 17, 2001, NetScout announced an open market stock repurchase
program that enables NetScout to purchase up to one million shares of
outstanding NetScout common stock, subject to market conditions and other
factors. Any purchases under NetScout's stock repurchase program may be made
from time-to-time without prior notice. As of June 30, 2002, NetScout has
repurchased 124 shares under this program.

6. COMMITMENTS AND CONTINGENCIES

Prior to the acquisition of NextPoint Networks, Inc. ("NextPoint"), a
reseller of NextPoint filed an action against NextPoint alleging breach of
contract. NextPoint denied the claim. An escrow balance was established at the
time of the acquisition to account for potential losses related to this suit and
this escrow balance significantly limited NetScout's exposure. NetScout recorded
an accrual to account for any additional expenses. The matter was settled in
January 2002. In May 2002, escrow funds were released and NetScout received the
appropriate escrow balance to finalize this matter.

In addition to the matter noted above, 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 other
current legal proceedings and claims will not have a significant adverse impact
on NetScout's financial position or results of operations.

7. COMPUTATION OF NET LOSS PER SHARE

The following table sets forth common stock excluded from the calculation of
diluted net loss per share since the inclusion would be antidilutive:

8. OTHER COMPREHENSIVE INCOME

Other comprehensive income consists of unrealized gains and losses on
marketable securities and foreign currency translation adjustments. Other
comprehensive income does not materially impact net loss for the three months
ended June 30, 2002 and 2001.

9. INCOME TAX BENEFIT

For the three months ended June 30, 2002, the Company estimated the income
tax benefit utilizing an estimated annual effective tax rate for the fiscal year
ended March 31, 2003, representing the statutory tax rate adjusted primarily for
non-deductible stock-based compensation and amortization of other intangible
assets.

9

NETSCOUT SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

10. GEOGRAPHIC INFORMATION

Revenue was distributed geographically as follows:

The North America revenue includes sales to domestic resellers, who may sell
NetScout products to international locations. NetScout reports these shipments
as North America revenue since NetScout ships the products to a domestic
location. Revenue attributable to locations outside of North America is a result
of export sales. Substantially all of NetScout's identifiable assets are located
in the United States.

11. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Other
Intangible Assets." SFAS No. 141 requires that all business combinations be
accounted for under the purchase method only and that certain acquired
intangible assets in a business combination be recognized as assets apart from
goodwill. SFAS No. 142 requires that ratable amortization of goodwill be
replaced with periodic tests of the goodwill's impairment and that intangible
assets other than goodwill be amortized over their useful lives. SFAS No. 141 is
effective for all business combinations initiated after June 30, 2001. SFAS
No. 142 has been adopted by the Company in the first quarter of our fiscal year
ending March 31, 2003 (Note 4). On April 1, 2002, NetScout reclassified the
remaining un-amortized assembled workforce intangible asset to goodwill and
ceased amortization of goodwill.

In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which is effective in April 2003. SFAS No. 143 addresses the
financial reporting for obligations and retirement costs relating to the
retirement of tangible long-lived assets. NetScout does not at present expect
that the adoption of SFAS No. 143 will have a significant impact on its
consolidated financial statements.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," which became effective March 1, 2002. SFAS
No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" and Accounting Principles
Board Opinion No. 30, "Reporting the Results of Operations--Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." In June 2002, NetScout applied
the provisions of SFAS No. 144 to a long-term note receivable balance (Note 4).

10

NETSCOUT SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

11. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which will become effective for exit or
disposal activities initiated after December 31, 2002. SFAS No. 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities and supersedes Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." NetScout does
not at present expect that the adoption of SFAS No. 146 will have a significant
impact on its consolidated financial statements.

11

ITEM 2. 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
Quarterly Report on Form 10-Q.

In addition to the other information in this report, the following
Management's Discussion and Analysis should be considered carefully in
evaluating the Company and our business. This Quarterly Report on Form 10-Q
contains forward-looking statements. 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. In evaluating these
statements, you should specifically consider various important factors,
including the risks outlined under "Certain Factors Which May Affect Future
Results" in this section of this report and our other filings with the
Securities and Exchange Commission. These factors may cause our actual results
to differ materially from any forward-looking statement.

OVERVIEW

NetScout Systems, Inc. designs, develops, manufactures, markets, sells and
supports a family of integrated products that enable optimization of the
performance and cost management of complex, high-speed computer and
telecommunication networks, including their ability to efficiently deliver
critical business applications and content to end-users. NetScout manufactures
and markets these products in an integrated hardware and software solution suite
that is used by enterprise and service provider businesses worldwide. We manage
our business as a single operating segment.

NetScout was incorporated in 1984 as a consulting services company. In 1992,
we began to develop and market our first infrastructure performance management
products. Our operations have been financed principally through cash provided by
operations.

CRITICAL ACCOUNTING POLICIES

NetScout considers accounting policies related to revenue recognition,
accounts receivable and allowance for doubtful accounts, valuation of
inventories and valuation of long-lived assets to be critical in fully
understanding and evaluating our financial results.

REVENUE RECOGNITION

Product revenue consists of sales of our hardware products and licensing of
our software products. Product revenue is recognized upon shipment, provided
that evidence of an arrangement exists, title and risk of loss have passed to
the customer, fees are fixed or determinable and collection of the related
receivable is reasonably assured. Revenue is recorded net of estimated product
returns, which are based upon our return policy, sales agreements, management
estimates of potential future product returns related to current period revenue,
current economic trends, changes in our customer composition and historical
experience. If our judgments and estimates relating the product returns prove to
be inadequate, our financial results could be materially adversely impacted in
future periods.

Service revenue consists primarily of fees from customer support agreements,
consulting and training. NetScout generally provides three months of software
support and 12 months of hardware support as part of product sales. Revenue from
software support is deferred and recognized ratably over the three-month support
period. Revenue from hardware support is deferred and recognized ratably over
the 12-month support period. In addition, customers can elect to purchase
extended support agreements, typically for 12-month periods. Revenue from these
agreements is deferred and

12

recognized ratably over the support period. Revenue from consulting and training
is recognized as the work is performed.

For multi-element arrangements, each element of the arrangement is analyzed
and a portion of the total fee under the arrangement is allocated to the
undelivered elements, primarily support agreements and training, using vendor
objective evidence of fair value of the element and the remaining portion of the
fee is allocated to the delivered elements (i.e., generally, hardware products
and licensed software products), regardless of any separate prices stated within
the contract for each element, under the residual method. Vendor objective
evidence of fair value is based on the price customers pay when the element is
sold separately.

License and royalty revenue consists primarily of royalties under license
agreements by original equipment manufacturers who incorporate components of our
data collection technology into their own products or who reproduce and sell our
software products. License revenue is recognized when delivery has occurred and
when we become contractually entitled to receive license fees, provided that
such fees are fixed or determinable and collection is probable. Royalty revenue
is recognized based upon reported product shipment by the license holder.

Revenue generated from indirect distribution channels, including original
equipment manufacturers, distributors, resellers, system integrators and service
providers, represented 53% and 69% of total revenue for the three months ended
June 30, 2002 and 2001, respectively. Total revenue generated from Cisco
Systems, Inc. represented 14% and 52% of our total revenue for the three months
ended June 30, 2002 and 2001, respectively. No other customer or indirect
channel partner accounted for 10% or more of our total revenue during the three
months ended June 30, 2002 and 2001.

In the past, Cisco resold our probes to customers under their private label.
As of July 28, 2001, Cisco no longer marketed or sold NetScout probes under
their private label, however, they continued to place their backlog orders with
us through December 31, 2001. Additionally, Cisco continues to incorporate
components of our software technology into their products. We have completed the
transition of those Cisco customers who are actively purchasing our products to
a direct or reseller relationship with NetScout and our strategy is to continue
to collaborate with Cisco on technology development and to support Cisco's
continued distribution of our software products.

Revenue from sales outside North America represented 18% and 10% of our
total revenue for the three months ended June 30, 2002 and 2001, respectively.
Sales outside North America are primarily due to indirect channel partners, who
are generally responsible for importing products and providing consulting and
technical support and service to customers within their territory. Our reported
international revenue does not include any revenue from sales to customers
outside North America made by any of our North American-based indirect channel
partners. These domestic resellers may sell NetScout products to international
locations, however, NetScout still reports these shipments as North America
revenue since NetScout ships the products to a domestic location. NetScout
expects revenue from sales outside North America to continue to account for a
significant portion of our revenue in the future.

ACCOUNTS RECEIVABLE AND ALLOWANCE FOR DOUBTFUL ACCOUNTS

Accounts receivable is reduced by an allowance for doubtful accounts. Our
normal payment terms are net 30 days. We monitor all payments from our customers
and assess any collection issues as they arise. Management believes its credit
policies are prudent and reflect normal industry terms and business risk. At
June 30, 2002, one customer accounted for approximately 8% of our accounts
receivable, and at June 30, 2001, a different customer accounted for
approximately 17% of our accounts receivable. Historically, we have not
experienced any significant non-performance by our customers nor do we
anticipate non-performance by our customers in the future and, accordingly, do

13

not require collateral from our customers. We perform credit checks on all
potential new customers prior to acceptance of an order. We maintain allowances
for doubtful accounts for possible losses resulting from the failure of our
customers to make their required payments and any losses are recorded as general
and administrative expenses. The allowance for doubtful accounts is based upon
management estimates of the un-collectability of our accounts receivable.
Management specifically analyzes accounts receivable and historical bad debts,
customer credit-worthiness, current economic trends and customer concentrations
when evaluating the adequacy of the allowance for doubtful accounts. Significant
management judgments and estimates are made when establishing the allowance for
doubtful accounts. If our judgments and estimates relating to the allowance for
doubtful accounts prove to be inadequate, our financial results could be
materially adversely impacted in future periods.

VALUATION OF INVENTORIES

Inventories are stated at actual cost. Inventories consist primarily of raw
materials and finished goods. Many components that are necessary for the
assembly of our probes are obtained from separate sole source suppliers or a
limited group of suppliers. Our reliance on sole or limited suppliers involves
several risks; including a potential inability to obtain an adequate supply of
required components and reduced control over pricing, quality and timely
delivery of components. Generally, we do not maintain long-term agreements with
any of our suppliers or large volumes of inventory. 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. This could damage relationships
with current and prospective customers, cause shortfalls in expected revenue and
could materially adversely impact our business, operating results and financial
condition.

Inventories are reduced by a reserve for obsolete and excess inventory.
Management regularly monitors our inventories for potential obsolete and excess
inventory. Our reserve for obsolete and excess inventory is based upon
management's estimated forecasts of unit sales and estimated timing and impact
of new product introductions. Management considers historical product demand,
current economic trends, expected market acceptance of our products and expected
customer buying patterns when evaluating the adequacy of the reserve for
obsolete and excess inventory. Significant management judgments and estimates
must be made when establishing the reserve for obsolete and excess inventory. If
our judgments and estimates relating to obsolete and excess inventory prove to
be inadequate, our financial results could be materially adversely impacted in
future periods.

VALUATION OF LONG-LIVED ASSETS

NetScout regularly performs reviews on the carrying value of our long-term
assets to determine if any impairment is present. Items which could trigger
impairment include, but are not limited to, significant under-performance
relative to historical product demand, significant negative industry or economic
trends, significant decline in our stock price for a sustained period and
significant decline in our technological value compared to the market.
Management considers our stock price, historical product demand, current
economic trends, customer buying patterns, customer credit-worthiness and
expected revenue projections when assessing impairment and estimating expected
future cash flows of our long-term assets. At June 30, 2002, NetScout performed
a probability weighted cash flow analysis on a long-term note receivable balance
based on management's current assessment of probable outcomes regarding future
cash flows and concluded that this asset was partially impaired. In accordance
with SFAS No. 144, the Company recorded a $472,000 impairment charge for the
three months ended June 30, 2002.

Significant management judgments and estimates must be made when
establishing criteria for future cash flows and assessing impairment. If our
judgments and estimates relating to long-term assets prove to be inadequate, an
asset may be determined to be impaired and our financial results could be
materially adversely impacted in future periods. Likewise, if a future event or
circumstance indicates

14

that an impairment assessment is required and, through the performance of that
assessment, an asset is determined to be impaired, our financial results could
be materially adversely impacted in future periods.

RESULTS OF OPERATIONS

The following table sets forth for the periods indicated the percentage of
total revenue of certain line items included in our Statements of Operations:

NETSCOUT SYSTEMS, INC.
STATEMENTS OF OPERATIONS
PERCENTAGES OF TOTAL REVENUE

THREE MONTHS ENDED JUNE 30, 2002 AND 2001

REVENUE

Total revenues were $17.8 million and $18.2 million for the three months
ended June 30, 2002 and 2001, respectively, representing a decrease of 2% from
2001 to 2002.

PRODUCT. Product revenues were $10.3 million and $10.4 million for the
three months ended June 30, 2002 and 2001, respectively, representing a decrease
of 1% from 2001 to 2002. This decrease

15

was primarily due a 39% decrease in unit sales, which was attributable to the
continued slowdown in network management capital spending in many large
enterprises as a result of the economic downturn, offset by an increase in the
average selling price of approximately 50% attributable to the increased sale of
our higher-end probes. It is unknown what impact the network management capital
spending controls in the U.S. and abroad and the economic downturn will have on
our future product revenue results.

SERVICE. Service revenues were $5.7 million and $4.7 million for the three
months ended June 30, 2002 and 2001, respectively, representing an increase of
22% from 2001 to 2002. This increase was primarily due to an increase in the
number of customer support agreements attributable to new product sales
generated in recent reporting periods combined with continued renewals of
customer support agreements from our continually expanding installed base.

LICENSE AND ROYALTY. License and royalty revenues were $1.8 million and
$3.0 million for the three months ended June 30, 2002 and 2001, respectively,
representing a decrease of 41% from 2001 to 2002. This decrease corresponded
with the continued slowdown in network management capital spending as a result
of the economic downturn. It is unknown what impact the network management
capital spending controls in the U.S. and abroad and the economic downturn will
have on our future license and royalty results.

COST OF REVENUE AND GROSS MARGIN

PRODUCT. Cost of product revenue consists primarily of components,
personnel costs, media duplication, manuals, packaging materials, licensed
technology fees and overhead. Cost of product revenue was $3.4 million and
$4.5 million for the three months ended June 30, 2002 and 2001, respectively,
representing a decrease of 24% from 2001 to 2002. This decrease corresponds with
the 39% decrease in unit sales attributable to the overall current slowdown in
network management capital spending in many large enterprises as a result of the
economic downturn and a decrease in fixed manufacturing costs. Product gross
margins were 67% and 57% for the three months ended June 30, 2002 and 2001,
respectively. The increase in gross margins was primarily due to an increase of
approximately 50% in average selling price per unit and an increase in direct
sales which traditionally have higher margins.

SERVICE. Cost of service revenue consists primarily of personnel costs,
material and consulting costs. Cost of service revenues were $974,000 and
$917,000 for the three months ended June 30, 2002 and 2001, respectively,
representing an increase of 6% from 2001 to 2002. Service gross margins were 83%
and 80% for the three months ended June 30, 2002 and 2001, respectively. This
increase in cost was primarily due to an increase in our personnel costs,
partially offset by a decrease in consulting costs. While cost of service
revenue increased by 6%, service revenue itself increased by 22%, thereby
improving our gross margin.

Gross margins were $13.5 million and $12.8 million for the three months
ended June 30, 2002 and 2001, respectively, representing an increase of 5% from
2001 to 2002. Gross margin percentage was 76% and 71% for the three months ended
June 30, 2002 and 2001, respectively. Gross margin is primarily impacted by the
mix of product, service, license and royalty revenue and by the proportion of
sales through direct versus indirect distribution channels. We realize
significantly higher gross margins on license and royalty revenue relative to
product and service revenue. We typically realize higher gross margins on direct
sales relative to indirect distribution channel sales. The increase in gross
margins was primarily due to an increase of approximately 50% in average selling
price per unit, an increase in direct sales, along with a decrease in fixed
manufacturing costs.

16

OPERATING EXPENSES

RESEARCH AND DEVELOPMENT. Research and development expenses consist
primarily of personnel costs, fees for outside consultants and related costs
associated with the development of new products and the enhancement of existing
products. Research and development expenses were $4.8 million and $4.6 million
for the three months ended June 30, 2002 and 2001, respectively, representing an
increase of 4% from 2001 to 2002. This increase was primarily due to a 27%
increase in stock-based compensation charges related to the NextPoint
acquisition from 2001 to 2002 and a 61% increase in technical supplies from 2001
to 2002, attributable to increased usage of supplies for internal development
projects. We anticipate that we will decrease research and development expenses
in absolute dollars in future quarters as stock-based compensation declines and
as we continue to maintain spending controls during the current economic
downturn. We will continue to monitor the economic situation and will resume
growth of our investment in development once we again achieve revenue and profit
growth.

SALES AND MARKETING. Sales and marketing expenses consist primarily of
personnel costs and costs associated with marketing programs such as trade
shows, seminars, advertising, and new product launch activities. Sales and
marketing expenses were $8.5 million and $9.1 million for the three months ended
June 30, 2002 and 2001, respectively, representing a decrease of 7% from 2001 to
2002. This decrease was primarily due to a 78% decrease in marketing programs
spending from 2001 to 2002. We anticipate that we will commit additional
resources to sales and marketing in the future and that sales and marketing
expenses will increase in absolute dollars in future quarters as we continue our
effort to promote revenue growth and NetScout name recognition.

GENERAL AND ADMINISTRATIVE. General and administrative expenses consist
primarily of personnel costs for executive, financial and human resource
employees. General and administrative expenses were $2.1 million and
$1.7 million for the three months ended June 30, 2002 and 2001, respectively,
representing an increase of 23% from 2001 to 2002. This increase was primarily
due to an impairment of $472,000 on a long-term note receivable balance. In
accordance with SFAS No. 144, NetScout performed a probability weighted cash
flow analysis on this long-term note receivable balance based on management's
current assessment of probable outcomes regarding future cash flows and
concluded that the asset was partially impaired at June 30, 2002. We anticipate
that we will decrease general and administrative expenses in absolute dollars in
future quarters as we continue to maintain spending controls during the current
economic downturn. We will continue to monitor the economic situation and
reevaluate spending once the economy improves.

AMORTIZATION OF GOODWILL AND OTHER INTANGIBLE ASSETS. Amortization of
goodwill and other intangible assets was $272,000 and $2.6 million for the three
months ended June 30, 2002 and 2001, respectively, due to the acquisition of
NextPoint. With the adoption of SFAS No. 142, "Goodwill and Other Intangible
Assets," effective April 1, 2002, goodwill and the un-amortized assembled
workforce intangible asset are no longer subject to amortization. We anticipate
that we will, however, continue to amortize other intangible assets at the
current rate of $272,000 per quarter until fully amortized.

INTEREST INCOME AND OTHER EXPENSES, NET. Interest income, net of interest
and other expenses, was $313,000 and $687,000 for the three months ended
June 30, 2002 and 2001, respectively, representing a decrease of 54% from 2001
to 2002. This decrease was primarily due to lower market interest rates on cash
equivalents and marketable securities.

INCOME TAX BENEFIT. The income tax benefit was $691,000 and $427,000 for
the three months ended June 30, 2002 and 2001, respectively. NetScout's
projected annual effective tax rate increased to a benefit of 38% from a benefit
of 9% for the three months ended June 30, 2002 and 2001, respectively, as a
result of lower projected taxable income for the year ended March 31, 2003.

17

NET LOSS. Net loss was $1.1 million and $4.1 million for the three months
ended June 30, 2002 and 2001, respectively. The decrease in net loss year over
year was mainly attributable to the decrease in amortization of goodwill and
other intangible assets from $2.6 million to $272,000 for the three months ended
June 30, 2001 and 2002, respectively. With the adoption of SFAS No. 142,
"Goodwill and Other Intangible Assets," effective April 1, 2002, goodwill and
the un-amortized assembled workforce intangible asset are no longer subject to
amortization. Pro-forma net loss was $163,000 and $929,000 for the three months
ended June 30, 2002 and 2001, respectively, which excludes the non-cash
amortization of goodwill and other intangible assets of $272,000 and
$2.6 million and stock-based compensation of $712,000 and $575,000 for the three
months ended June 30, 2002 and 2001, respectively. This decrease in net loss is
primarily attributable to an increase of approximately 50% in average selling
price per unit, an increase in direct sales, along with a decrease in fixed
manufacturing costs.

LIQUIDITY AND CAPITAL RESOURCES

As of June 30, 2002, we had $32.8 million in cash and cash equivalents,
$31.9 million in short-term marketable securities and $5.0 million in long-term
marketable securities, together totaling to $69.7 million. We have a line of
credit with a bank, which allows us to borrow up to $10.0 million for working
capital purposes and to obtain letters of credit. The line of credit expires in
March 2003. Amounts available under the line of credit are a function of
eligible accounts receivable and bear interest at the bank's prime rate. As of
June 30, 2002, we had letters of credit outstanding under the line aggregating
$3.2 million. The bank line of credit is secured by our inventory and accounts
receivable.

Cash provided by operating activities was $494,000 and $693,000 for the
three months ended June 30, 2002 and 2001, respectively. In the first quarter of
fiscal year 2003, cash provided by operating activities was primarily derived
from decreases in accounts receivable and prepaid and other current assets and
increases in depreciation and amortization and compensation expense associated
with equity awards. This was partially offset by a net loss and a decrease in
accounts payable and accrued compensation. In the first quarter of fiscal year
2002, cash provided by operating activities was primarily derived from a
decrease in accounts receivable, an increase in depreciation and amortization
and amortization of goodwill and other intangible assets and an increase in
compensation expense associated with equity awards. This was partially offset by
a net loss and a decrease in accounts payable and accrued compensation.

Cash provided by (used in) investing activities was $12.4 million and ($6.7)
million for the three months ended June 30, 2002 and 2001, respectively. For the
first quarter of fiscal year 2003, cash provided by investing activities
reflects the proceeds from the maturity of marketable securities offset by the
purchase of marketable securities and the purchase of fixed assets. For the
first quarter of fiscal year 2002, cash used in investing activities reflects
the purchase of marketable securities and fixed assets.

Cash provided by financing activities was $564,000 and $102,000 for the
three months ended June 30, 2002 and 2001, respectively. For the first quarter
of fiscal years 2003, cash provided by financing activities was due to proceeds
from the issuance of common stock in connection with the exercise of stock
options and the employee stock purchase plan. For the first quarter of fiscal
year 2002, cash provided by financing activities was due to proceeds from the
issuance of common stock in connection with the exercise of stock options.

We believe that our current cash balances and the cash flows generated by
operations will be sufficient to meet our anticipated cash needs for working
capital and capital expenditures for at least the next 12 months. If demand for
our product were to decrease substantially there could be a material impact on
our ability to generate cash flow sufficient for our short-term working capital
and expenditure needs. If cash generated from operations is insufficient to
satisfy our liquidity

18

requirements, we may seek to sell additional equity or convertible debt
securities. The sale of additional equity or debt securities could result in
additional dilution to our stockholders. A portion of our cash may be used to
acquire or invest in complementary businesses or products or to obtain the right
to use complementary technologies. From time to time, in the ordinary course of
business, we evaluate potential acquisitions of such businesses, products or
technologies.

RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations," and SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS
No. 141 requires that all business combinations be accounted for under the
purchase method only and that certain acquired intangible assets in a business
combination be recognized as assets apart from goodwill. SFAS No. 142 requires
that ratable amortization of goodwill be replaced with periodic tests of the
goodwill's impairment and that intangible assets other than goodwill be
amortized over their useful lives. SFAS No. 141 is effective for all business
combinations initiated after June 30, 2001. SFAS No. 142 has been adopted by the
Company in the first quarter of our fiscal year ending March 31, 2003. On
April 1, 2002, NetScout reclassified the remaining un-amortized assembled
workforce intangible asset to goodwill and ceased amortization of goodwill.

In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement
Obligations," which is effective in April 2003. SFAS No. 143 addresses the
financial reporting for obligations and retirement costs relating to the
retirement of tangible long-lived assets. NetScout does not at present expect
that the adoption of SFAS No. 143 will have a significant impact on its
consolidated financial statements.

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets," which became effective March 1, 2002. SFAS
No. 144 supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of" and Accounting Principles
Board Opinion No. 30, "Reporting the Results of Operations--Reporting the
Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and
Infrequently Occurring Events and Transactions." In June 2002, NetScout applied
the provisions of SFAS No. 144 to a long-term note receivable balance.

In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities," which will become effective for exit or
disposal activities initiated after December 31, 2002. SFAS No. 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities and supersedes Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." NetScout does
not at present expect that the adoption of SFAS No. 146 will have a significant
impact on its consolidated financial statements.

CERTAIN FACTORS WHICH MAY IMPACT FUTURE RESULTS

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 risks and uncertainties.
The following factors, among others, could cause actual results to differ
materially from those contained in forward-looking statements made in this
report. Additional risks that are not yet identified or that we currently think
are immaterial may also impact our business operations. Such factors, among
others, may have a material adverse impact upon our business, results of
operations and financial condition.

A REDUCTION IN ORDERS FROM CUSTOMERS OF CISCO SYSTEMS, INC. COULD MATERIALLY
ADVERSELY IMPACT OUR BUSINESS. Although Cisco continues to incorporate some of
our software into their products, as of

19

July 28, 2001, Cisco no longer sold our probes to third parties under its
private label. Cisco did, however, continue to place their backlog orders with
us through December 31, 2001. By selling our probes under their private label,
Cisco accounted for 30% of our total revenue for the three months ended
June 30, 2001. We now sell to those Cisco customers who are actively purchasing
our products, both directly or through indirect channel partners, but if we are
unable to continue to sell our products directly or through indirect channel
partners to customers of Cisco in the future, our business, operating results
and financial condition could be materially adversely impacted.

A TERMINATION OF OUR STRATEGIC RELATIONSHIP WITH CISCO MAY MATERIALLY
ADVERSELY IMPACT OUR BUSINESS. Our strategic relationship with Cisco provides
us with early insight into the development of new technologies. Additionally,
Cisco incorporates some of our software in their products and provides license
and royalty revenue to NetScout. License and royalty revenue and service revenue
from Cisco accounted for 14% and 22% of our total revenue for the three months
ended June 30, 2002 and 2001, respectively. Cisco may decide to cease purchasing
our software and/or to internally develop products that compete with our
solutions or partner with our competitors or bundle or sell competitors'
solutions, possibly at lower prices. If our strategic relationship with Cisco
were terminated or further adversely impacted for any reason, our business,
operating results and financial condition could be materially adversely
impacted.

OUR QUARTERLY OPERATING RESULTS MAY FLUCTUATE. Our quarterly revenue and
operating results are difficult to predict and may fluctuate significantly from
quarter to quarter. Most of our expenses, such as employee compensation 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.

Our quarterly revenue may fluctuate as a result of a variety of factors,
many of which are outside of our control, including the following:

- current technology spending by actual and potential customers;

- the market for network management solutions is in an early stage of
development and therefore, demand for our solutions may be uneven;

- the timing and receipt 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;

- distribution channels through which our products are sold could change;

- the timing of hiring sales personnel and the speed at which such personnel
become productive;

- we may not be able to anticipate or adapt effectively to developing
markets and rapidly changing technologies;

- our prices or the prices of our competitors' products may change; and

- economic slowdowns and the occurrence of unforeseeable events, such as the
tragic events of September 11, 2001, which contribute to such slowdowns.

We operate with minimal backlog because our products typically are shipped
shortly after orders are received. As a result, product revenue in any quarter
is substantially dependent upon orders booked and shipped in that quarter and
revenue for any future quarter is not predictable to any degree of certainty.
Therefore, any significant deferral of orders for our products would cause a
shortfall in revenue for that quarter.

20

OUR CONTINUED GROWTH DEPENDS ON OUR ABILITY TO EXPAND OUR SALES FORCE. We
must 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 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 successfully expand our sales capability, our business, operating
results and financial condition could be materially adversely impacted.

OUR SUCCESS DEPENDS ON OUR ABILITY TO MANAGE INDIRECT DISTRIBUTION
CHANNELS. Sales to our indirect distribution channels accounted for 53% and 69%
of our total revenue for the three months ended June 30, 2002 and 2001,
respectively. While Cisco no longer resold our probes as of July 28, 2001, they
did continue to place backlog orders with us through December 31, 2001 and
continue to incorporate some of our software in their products. Cisco accounted
for 14% and 52% of our total revenue for the three months ended June 30, 2002
and 2001, respectively. To increase our sales, in addition to growing our direct
sales model, we must develop new and further expand and manage existing indirect
distribution channels, including original equipment manufacturers, distributors,
resellers, systems integrators and service providers. Our indirect channel
partners have no obligation to purchase any products from us. In addition, they
could internally develop products which compete with our solutions or partner
with our competitors or bundle or resell competitors' solutions, possibly at
lower prices. The potential inability to develop new relationships and to expand
and manage our existing relationships with partners, the potential inability or
unwillingness of our partners to effectively market and sell our products or the
loss of existing partnerships could have a material adverse impact on our
business, operating results and financial condition.

IF WE FAIL TO INTRODUCE NEW PRODUCTS AND ENHANCE OUR EXISTING PRODUCTS TO
KEEP UP WITH RAPID TECHNOLOGICAL CHANGE, DEMAND FOR OUR PRODUCTS MAY
DECLINE. The market for network management solutions is relatively new and is
characterized by rapid changes in technology, evolving industry standards,
changes in customer requirements and frequent product introductions and
enhancements. Our success is dependent upon our ability to meet our customers'
needs, which are driven by changes in computer networking technologies and the
emergence of new industry standards. In addition, new technologies may shorten
the life cycle for our products or could render our existing or planned products
obsolete. If we are unable to develop and introduce new network and application
infrastructure performance management products or enhancements to existing
products in a timely and successful manner, it could have a material adverse
impact on our business, operating results and financial condition.

OUR RELIANCE ON SOLE SOURCE SUPPLIERS COULD ADVERSELY IMPACT OUR
BUSINESS. Many components that are necessary for the assembly of our probes are
obtained from separate sole source suppliers or a limited group of suppliers.
These components include some of our network interface cards, which are produced
for us solely by SBS Technologies, Inc., SysKonnect, Inc., Adaptec, Inc, and
JNI. Our reliance on sole or limited suppliers involves several risks, including
a potential inability to obtain an adequate supply of required components and
reduced control over pricing, quality and timely delivery of components. We do
not generally maintain long-term agreements with any of our suppliers or large
volumes of inventory. 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. This could damage relationships with current and prospective
customers, cause shortfalls in expected revenue and could materially adversely
impact our business, operating results and financial condition.

21

WE FACE SIGNIFICANT COMPETITION FROM OTHER TECHNOLOGY COMPANIES. The market
for network management solutions is intensely competitive. We believe customers
make network management system purchasing decisions based primarily upon the
following factors:

- product performance, functionality and price;

- name and reputation of vendor;

- distribution strength; and

- alliances with industry partners.

We compete with providers of network performance management solutions, such
as Concord Communications, Inc. and providers of portable network traffic
analyzers and probes, such as Network Associates, Inc. In addition, leading
network equipment providers could offer their own or competitors' solutions in
the future. Many of our current and potential competitors have longer operating
histories, greater name recognition and substantially greater financial,
management, marketing, service, support, technical, distribution and other
resources than we do. Therefore, they may be able to respond more quickly than
we can to new or changing opportunities, technologies, standards or customer
requirements.

As a result of these and other factors, we may not be able to compete
effectively with current or future competitors, which could have a material
adverse impact on our business, operating results and financial condition.

THE SUCCESS OF OUR BUSINESS DEPENDS ON THE CONTINUED GROWTH IN THE MARKET
FOR AND THE COMMERCIAL ACCEPTANCE OF NETWORK MANAGEMENT SOLUTIONS. We derive
all of our revenue from the sale of products and services that are designed to
allow our customers to manage the performance of computer networks. The market
for network management solutions is in an early stage of development. Therefore,
we cannot accurately assess the size of the market and may be unable to predict
the appropriate features and prices for products to address the market, the
optimal distribution strategy and the competitive environment that will develop.
In order for us to be successful, our potential customers must recognize the
value of more sophisticated network management solutions, decide to invest in
the management of their networks and, in particular, adopt our management
solutions. Any failure of this market to continue to develop would materially
adversely impact our business, operating results and financial condition.
Businesses may choose to outsource the management of their networks to service
providers. Our business may depend on our ability to develop relationships with
these service providers and successfully market our products to them.

FAILURE TO PROPERLY MANAGE GROWTH 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. To manage
further growth effectively, we must enhance our financial information and
accounting systems and controls, integrate new personnel and manage expanded
operations. If we are unable to effectively manage our growth, our costs, the
quality of our products, the effectiveness of our sales organization, and our
ability to retain key personnel, our business, operating results and financial
condition could be materially 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
Narendra Popat, our Chairman of the Board and co-founder. We also depend on the
ability of our other executive officers and senior managers to work effectively
as a team. The loss of one or more of our key personnel could have a material
adverse impact on our business, operating results and financial condition.

22

WE MUST HIRE AND RETAIN SKILLED PERSONNEL. Our success depends in large
part upon our ability to attract, train, motivate and retain highly skilled
employees, particularly sales and marketing personnel, software engineers, and
technical support personnel. We have had difficulty hiring and retaining these
highly skilled employees in the past. 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 adverse impact on our business, operating
results and financial condition.

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
non-disclosure and other contractual arrangements to protect our proprietary
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. 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. Further, we also license software
from third parties for use as part of our products, and if any of these licenses
were to terminate, we may experience delays in product shipment until we develop
or license alternative software.

OTHERS MAY CLAIM THAT WE INFRINGE ON THEIR INTELLECTUAL PROPERTY RIGHTS. We
may be subject to claims by others that our products infringe on their
intellectual property rights. These claims, whether or not valid, could require
us to spend significant sums in litigation, pay damages, delay product
shipments, reengineer our products 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. We expect that these claims
could become more frequent as more companies enter the market for network and
application infrastructure performance management solutions. Any of these claims
or resulting events could have a material adverse impact on our business,
operating results and financial condition.

IF OUR PRODUCTS CONTAIN ERRORS, THEY MAY BE COSTLY TO CORRECT, REVENUE MAY
BE DELAYED, WE COULD BE SUED AND OUR REPUTATION COULD BE HARMED. Despite
testing by our customers and us, errors may be found in our products after
commencement of commercial shipments. If errors are discovered, we may not be
able to successfully correct them in a timely manner or at all. In addition, we
may need to make significant expenditures of capital resources in order 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. If one or more of our products fail, a customer may assert warranty
and other claims for substantial damages against us. The occurrence or discovery
of these types of errors or failures could have a material adverse impact on our
business, operating results and financial condition.

OUR SUCCESS DEPENDS ON OUR ABILITY TO EXPAND AND MANAGE OUR INTERNATIONAL
OPERATIONS. Sales outside North America accounted for a significant percentage
of our total revenue for the three months ended June 30, 2002 and 2001. We
currently expect international revenue to continue to account for a significant
percentage of total revenue in the future. We believe that we must continue to
expand our international sales activities in order to be successful. Our
international sales growth will be limited if we are unable to:

- expand international indirect distribution channels;

- hire additional sales personnel;

- adapt products for local markets; and

- manage geographically dispersed operations.

23

The major countries outside of North America, in which we do, or intend to
do business, are the United Kingdom, Germany, Japan and China. Our international
operations, including our operations in the United Kingdom, Germany, Japan and
China, are generally subject to a number of risks, including:

- failure of local laws to provide the same degree of protection as the laws
in the United States provide against infringement of our intellectual
property;

- protectionist laws and business practices that favor local competitors;

- dependence on local indirect channel partners;

- multiple conflicting and changing governmental laws and regulations;

- longer sales cycles;

- greater difficulty in collecting accounts receivable; and

- foreign currency exchange rate fluctuations and political and economic
instability.

THE PRICE OF OUR COMMON STOCK MAY DECREASE DUE TO MARKET VOLATILITY. The
market price of our common stock has been highly volatile and has fluctuated
significantly since the initial public offering of our common stock on
August 12, 1999. The market price of our common stock may continue to fluctuate
significantly in response to a number of factors, some of which are beyond our
control. In addition, the market prices of securities of technology companies
have been extremely volatile and have experienced fluctuations that often have
been unrelated or disproportionate to the operating performance of these
companies. Also, broad market fluctuations could adversely impact the market
price of our common stock.

Recently, when the market price of a stock has been volatile, holders of
that stock have occasionally instituted 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. The lawsuit could also divert the time
and attention of our management.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We consider all highly liquid marketable securities purchased with a
maturity of three months or less to be cash equivalents and those with
maturities greater than three months are considered to be marketable securities.
Cash equivalents and short-term marketable securities are stated at cost plus
accrued interest, which approximates fair value. Long-term marketable securities
are stated at fair value based on quoted market prices. Cash equivalents and
marketable securities consist primarily of money market instruments and U.S.
Treasury bills. The Company's primary market risk exposures are in the areas of
interest rate risk and foreign currency exchange rate risk. We currently do not
hedge interest rate exposure, but do not believe that a fluctuation in interest
rates would have a material impact on the value of our cash equivalents.

The Company's exposure to interest rates based on outstanding debt has been
and is expected to continue to be modest due to the fact that although the
Company currently has a $10.0 million line of credit with $3.2 million of
letters of credit secured against it, it has no amounts outstanding under the
line and no other outstanding interest-bearing debt. The Company's exposure to
currency exchange rate fluctuations has been and is expected to continue to be
modest. The impact of currency exchange rate movements on inter-company
transactions was immaterial for the three months ended June 30, 2002. Currently,
the Company does not engage in foreign currency hedging activities.

Effective January 1, 2002 there is a single currency within certain
countries of the European Union, known as the Euro, and one organization, the
European Central Bank, responsible for setting European monetary policy. We have
reviewed the impact the Euro has on our business and whether

24

this gives rise to a need for significant changes in our commercial operations
or treasury management functions. Because our transactions are largely
denominated in U.S. dollars, we do not believe that the Euro conversion or any
other currency exchange will have any material impact on our business, financial
condition or results of operations.

PART II--OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Prior to the acquisition of NextPoint Networks, Inc. ("NextPoint"), a
reseller of NextPoint filed an action against NextPoint alleging breach of
contract. NextPoint denied the claim. An escrow balance was established at the
time of the acquisition to account for potential losses related to this suit and
this escrow balance significantly limited NetScout's exposure. NetScout recorded
an accrual to account for any additional expenses. The matter was settled in
January 2002. In May 2002, escrow funds were released and NetScout received the
appropriate escrow balance to finalize this matter.

In addition to the matter noted above, 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
other current legal proceedings and claims will not have a significant adverse
impact on NetScout's financial position or results of operations.

ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On August 17, 1999, we completed our initial public offering of 3,000,000
shares of common stock at a price of $11.00 per share. The principal
underwriters for the transaction were Deutsche Banc Alex Brown, Bear, Stearns &
Co. Inc. and Dain Rauscher Wessels, a division of Dain Rauscher Incorporated.
The registration statement relating to this offering was declared effective by
the Securities and Exchange Commission (SEC File Number 333-76843) on
August 11, 1999. We received net proceeds of $29.6 million after deducting
$2.3 million in underwriting discounts and commissions and $1.1 million in other
offering expenses.

Upon the exercise of the over allotment option by the underwriters, certain
selling security holders sold 450,000 shares of common stock for net proceeds of
approximately $4.6 million after deducting underwriting discounts and
commissions.

Approximately $23.3 million of the proceeds from our initial public offering
were used in the acquisition of NextPoint. The balance of proceeds has been
invested primarily in U.S. Treasury obligations and other interest bearing
investment grade securities.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS

The following exhibits are filed as part of this report.

Certification Pursuant to Section 906 of the SARBANES-OXLEY
99.1 ACT of 2002
Certification Pursuant to Section 906 of the SARBANES-OXLEY
99.2 ACT of 2002

(b) The Company did not file any reports on Form 8-K during the quarterly period
ended June 30, 2002.

25

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.

NETSCOUT SYSTEMS, INC.

Date: August 14, 2002 /s/ ANIL K. SINGHAL
---------------------------------------------
Anil K. Singhal
President, Chief Executive Officer,
Treasurer and Director
(Principal Executive Officer)

Date: August 14, 2002 /s/ DAVID P. SOMMERS
---------------------------------------------
David P. Sommers
Senior Vice President, General Operations and
Chief Financial Officer
(Principal Financial Officer)

Date: August 14, 2002 /s/ LISA A. FIORENTINO
---------------------------------------------
Lisa A. Fiorentino
Vice President, Finance and Administration and
Chief Accounting Officer
(Principal Accounting Officer)