NETSCOUT SYSTEMS INC - 10-Q Quarterly Report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

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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 SEPTEMBER 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

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NETSCOUT SYSTEMS, INC.

(Exact name of registrant as specified in charter)

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

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

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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

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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
November 7, 2002 was 29,968,671.

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NETSCOUT SYSTEMS, INC.

FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2002

TABLE OF CONTENTS

PART I: FINANCIAL INFORMATION

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

a.) Condensed Consolidated Balance Sheets:
As of September 30, 2002 and March 31, 2002............................................................ 3

b.) Condensed Consolidated Statements of Operations:
For the three and six months ended September 30, 2002 and September 30, 2001.......................... 4

c.) Condensed Consolidated Statements of Cash Flows:
For the six months ended September 30, 2002 and September 30, 2001..................................... 5

d.) Notes to the Condensed Consolidated Financial Statements............................................. 6

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................................... 27

Item 4. Controls and Procedures............................................................................. 27

PART II: OTHER INFORMATION

Item 2. Changes in Securities and Use of Proceeds........................................................... 28

Item 4. Submission of Matters to a Vote of Security Holders................................................. 28

Item 6. Exhibits and Reports on Form 8-K.................................................................... 29

SIGNATURES................................................................................................... 30

Certifications Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002..................................... 31

EXHIBIT INDEX................................................................................................ 33

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PART I: 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.

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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.

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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.

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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 September 30, 2002 and for the three and six months ended
September 30, 2002 and 2001, respectively, have been prepared by NetScout
Systems, Inc. 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 our financial
position, results of operations and cash flows. The results of operations for
the three and six month periods ended September 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

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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 September 30, 2002, an unrealized gain of $55 was recorded as
other comprehensive income (Note 8).

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 $69 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.

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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:

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 and assembled workforce
amortization:

NOTE RECEIVABLE

In accordance with Statement of Financial Accounting Standards ("SFAS")
No. 144, NetScout recorded $472 and $547 of impairment charges for the three
months ended June 30, 2002 and September 30, 2002, respectively, related to a
long-term note receivable. These impairment charges are

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NETSCOUT SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

4. LONG-LIVED ASSETS (CONTINUED)
based on management's assessments of the collectability of this note receivable.
At September 30, 2002, we concluded that this asset was fully impaired.

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 March 31, 2002, NetScout had
repurchased 124 shares under this program. No shares have been repurchased by
the Company during the six months ended September 30, 2002.

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 for the three and six months ended September 30, 2002 was
$55, related to unrealized gains on marketable securities.

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NETSCOUT SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

9. INCOME TAX BENEFIT

For the six months ended September 30, 2002, we 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. NetScout's projected annual effective tax rate increased to a benefit of
36% in fiscal 2003 from a benefit of 8% in fiscal 2002, which was primarily
impacted by the adoption of SFAS No. 142, "Goodwill and Other Intangible
Assets," effective April 1, 2002, which causes goodwill and the un-amortized
assembled workforce intangible asset to be no longer subject to amortization.

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. SUBSEQUENT EVENT

On October 28, 2002, our Board of Directors approved that an offer be made
to exchange options to purchase shares of our common stock with an exercise
price of at least $10.00 per share for new options we will grant on a date no
earlier than six months and one day after we accept the options in the exchange.
Other than the Chief Executive Officer and the Chairman of the Board of
Directors of NetScout, all employees of NetScout and its subsidiaries holding
eligible options can participate in this offer to exchange. Directors and
consultants of NetScout are also not eligible to participate in this offer to
exchange.

We will file a Schedule TO with the SEC on or about November 8, 2002 that
will contain the terms of the offer to exchange.

12. 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

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NETSCOUT SYSTEMS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)

(IN THOUSANDS, EXCEPT PER SHARE DATA)

(UNAUDITED)

12. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS (CONTINUED)
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 was adopted by us 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 currently 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." For the three and six months
ended September 30, 2002, NetScout applied the provisions of SFAS No. 144 to a
long-term note receivable balance (Note 4).

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 currently expect that the adoption of SFAS No. 146 will have a significant
impact on its consolidated financial statements.

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following information should be read in conjunction with the unaudited
condensed 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 NetScout 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, estimates of
potential future product returns related to current period revenue, current
economic trends, changes in our customer composition and historical experience.
If these accounting judgments and estimates relating to product returns prove to
be inadequate, our financial results could be materially and 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

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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 56% and 65% of total revenue for the three months ended
September 30, 2002 and 2001, respectively, and 54% and 67% of total revenue for
the six months ended September 30, 2002 and 2001, respectively, compared to 51%
and 69% of total revenue for the three months ended June 30, 2002 and 2001,
respectively. Total revenue generated from Cisco Systems, Inc. represented 11%
and 40% of our total revenue for the three months ended September 30, 2002 and
2001, respectively, and 13% and 46% of our total revenue for the six months
ended September 30, 2002 and 2001, respectively. We have completed the
transition of Cisco customers who are actively purchasing our products through
either a direct or other reseller relationships with NetScout. No other customer
or indirect channel partner accounted for 10% or more of our total revenue
during the three or six months ended September 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. On August 1, 2002, we
amended our agreement with Cisco regarding the incorporation of our software
into Cisco's products to extend the term of the agreement until November 1, 2003
with automatic renewals for 18 month periods, subject to certain conditions.

Revenue from sales outside North America represented 13% and 9% of our total
revenue for the three months ended September 30, 2002 and 2001, respectively,
and 16% and 10% of our total revenue for the six months ended September 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 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

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arise. We believe our credit policies are prudent and reflect normal industry
terms and business risk. At September 30, 2002 and 2001, no customer accounted
for 10% or more of our accounts receivable. Historically, we have not
experienced any significant nonperformance by our customers nor do we anticipate
nonperformance by our customers in the future and, accordingly, we do 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
our judgments and estimates of the uncollectability of specific accounts
receivable, 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 these accounting
judgments and estimates relating to the allowance for doubtful accounts prove to
be inadequate, our financial results could be materially and 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. We
regularly monitor our inventories for potential obsolete and excess inventory.
Our reserve for obsolete and excess inventory is based upon our estimates of
forecasts of unit sales, expected timing and impact of new product
introductions, historical product demand, current economic trends, expected
market acceptance of our products and expected customer buying patterns.
Significant judgments and estimates must be made when establishing the reserve
for obsolete and excess inventory. If these accounting judgments and estimates
relating to obsolete and excess inventory prove to be inadequate, our financial
results could be materially and adversely impacted in future periods.

VALUATION OF LONG-LIVED ASSETS

NetScout regularly performs reviews of the carrying value of our long-lived
assets, consisting of fixed assets, goodwill and other intangible assets and
other assets, to determine if any impairment is present. Items that could
trigger impairment include, but are not limited to, current economic trends,
customer buying patterns, customer credit-worthiness and expected revenue
projections, significant under performance of product demand 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. In accordance with
SFAS No. 144, we recorded $1.0 million of impairment charges during the six
months ended September 30, 2002, related to a long-term note receivable, which
was fully impaired.

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-lived assets prove to be inadequate, an
asset may be determined to be impaired and our financial results could be
materially adversely impacted. Likewise, if a future event or circumstance
indicates 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 and adversely impacted in future periods.

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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 SEPTEMBER 30, 2002 AND 2001

REVENUE

Total revenues were $17.9 million and $19.7 million for the three months
ended September 30, 2002 and 2001, respectively, representing a decrease of 9%
from 2001 to 2002.

PRODUCT. Product revenues were $10.5 million and $12.3 million for the
three months ended September 30, 2002 and 2001, respectively, representing a
decrease of 14% from 2001 to 2002. This decrease was primarily due to a 37%
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, partially offset by an increase in the average selling price
of approximately 36% attributable to the increased sales of our higher speed
probes. We expect the current challenging market as a result of network
management capital spending controls in the U.S. and abroad and the

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current economic downturn will have an impact on our future product revenue
results which can not be quantified at this time.

SERVICE. Service revenues were $5.9 million and $5.0 million for the three
months ended September 30, 2002 and 2001, respectively, representing an increase
of 18% 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. We
anticipate that we will continue to increase our service revenue in future
quarters as our current installed base continues to expand.

LICENSE AND ROYALTY. License and royalty revenues were $1.5 million and
$2.4 million for the three months ended September 30, 2002 and 2001,
respectively, representing a decrease of 39% from 2001 to 2002. This decrease is
primarily due to a reduction in Cisco reported unit volume of Cisco products
which incorporate our software. We anticipate a continued decrease in our
license and royalty revenues due to our decreased focus on royalty partnerships
in favor of a concentration on partnerships that more closely complement our
current product strategies.

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 $3.5 million and
$4.3 million for the three months ended September 30, 2002 and 2001,
respectively, representing a decrease of 20% from 2001 to 2002. This decrease
corresponds with the 37% 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, as well as a decrease in our
fixed manufacturing costs. Product gross margins were 67% and 65% for the three
months ended September 30, 2002 and 2001, respectively. This increase in gross
margin percentage was primarily due to an increase of approximately 36% in
average selling price per unit partially offset by a 28% increase in average
cost 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 $1.2 million and
$870,000 for the three months ended September 30, 2002 and 2001, respectively,
representing an increase of 33% from 2001 to 2002. Service gross margins were
81% and 83% for the three months ended September 30, 2002 and 2001,
respectively. This increase in cost and decrease in gross margin percentage was
primarily due to increases in our personnel and related travel costs.

Gross margins were $13.3 million and $14.5 million for the three months
ended September 30, 2002 and 2001, respectively, representing a decrease of 8%
from 2001 to 2002. Gross margin percentage was 74% for the three months ended
September 30, 2002 and 2001. 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 fact that gross margin
percentage remained constant was primarily due to the increased product margin
percentage. This increased product gross margin percentage mainly resulted from
an increase of approximately 36% in average selling price per unit and an
increase in direct sales, which historically have higher gross margins,
partially offset by a 28% increase in average cost per unit and by decreased
license and royalty revenue margin contribution.

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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 $4.0 million and $5.0 million
for the three months ended September 30, 2002 and 2001, respectively,
representing a decrease of 20% from 2001 to 2002. This decrease was primarily
due to a 92% decrease in stock-based compensation charges related to the
NextPoint acquisition from 2001 to 2002, an 82% decrease in non-recurring
engineering charges due to the timing of various projects from 2001 to 2002 and
a 9% decrease in personnel costs. We anticipate that sequentially we will
increase research and development expenses in absolute dollars as we invest in
new product development.

SALES AND MARKETING. Sales and marketing expenses consist primarily of
personnel costs and other costs associated with marketing programs such as trade
shows, seminars, advertising, and new product launch activities. Sales and
marketing expenses were $8.3 million and $8.5 million for the three months ended
September 30, 2002 and 2001, respectively, representing a decrease of 2% from
2001 to 2002. This decrease was primarily due to a 37% decrease in spending on
marketing programs from 2001 to 2002 and a 5% decrease in sales travel from 2001
to 2002 both due to short term cost containment measures that we have
implemented during this current economic downturn. 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 sequentially 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
$1.9 million for the three months ended September 30, 2002 and 2001,
respectively, representing an increase of 12% from 2001 to 2002. This increase
was primarily due to an impairment charge of $547,000 on a long-term note
receivable balance offset by decreases in various general and administrative
expenses including personnel, accounting services and investor relations
expenses. We anticipate that we will decrease general and administrative
expenses in absolute dollars sequentially in the absence of the long-term note
receivable impairment charge and as we continue to maintain spending controls
during the current economic downturn. We will continue to monitor the economic
situation and re-evaluate spending once the economy improves.

AMORTIZATION OF OTHER INTANGIBLE ASSETS. Amortization of other intangible
assets was $272,000 and $359,000 for the three months ended September 30, 2002
and 2001, respectively, due to the acquisition of NextPoint. We anticipate that
we will continue to amortize other intangible assets at the current rate of
$272,000 per quarter until fully amortized.

AMORTIZATION OF GOODWILL. 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.
Amortization of goodwill was $2.3 million for the three months ended
September 30, 2001, due to the acquisition of NextPoint.

INTEREST INCOME AND OTHER EXPENSES, NET. Interest income, net of interest
and other expenses, was $326,000 and $499,000 for the three months ended
September 30, 2002 and 2001, respectively, representing a decrease of 35% from
2001 to 2002. This decrease was primarily due to lower market interest rates on
cash, cash equivalents and marketable securities.

INCOME TAX BENEFIT. The income tax benefit was $370,000 and $38,000 for the
three months ended September 30, 2002 and 2001, respectively. NetScout's
projected annual effective tax rate increased to a benefit of 36% in fiscal 2003
from a benefit of 8% in fiscal 2002, which was primarily impacted by the
adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," effective
April 1, 2002, which

17

causes goodwill and the un-amortized assembled workforce intangible asset to be
no longer subject to amortization.

NET LOSS. Net loss was $710,000 and $2.9 million for the three months ended
September 30, 2002 and 2001, respectively, representing a 76% improvement from
2001 to 2002. The decrease in net loss year over year was mainly attributable to
the decrease in the amortization of goodwill and other intangible assets from an
aggregate of $2.6 million to an aggregate of $272,000 for the three months ended
September 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. The pro forma net income (loss) was ($373,000) and $271,000 for
the three months ended September 30, 2002 and 2001, respectively, when excluding
the non-cash amortization of goodwill and other intangible assets of $272,000
and $2.6 million and stock-based compensation of $65,000 and $582,000 for the
three months ended September 30, 2002 and 2001, respectively. This increase in
net loss is primarily attributable to the reduction in gross margin dollars due
to decreased revenue attributable to the current economic downturn and the
impairment charge of a long-term note receivable, offset by reductions in other
operating expenses due to tight spending controls and an increased tax benefit
due to lower projected taxable income for the year ended March 31, 2003.

SIX MONTHS ENDED SEPTEMBER 30, 2002 AND 2001

REVENUE

Total revenues were $35.8 million and $37.9 million for the six months ended
September 30, 2002 and 2001, respectively, representing a decrease of 6% from
2001 to 2002.

PRODUCT. Product revenues were $20.8 million and $22.7 million for the six
months ended September 30, 2002 and 2001, respectively, representing a decrease
of 8% from 2001 to 2002. This decrease was primarily due a 35% 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 38%
attributable to the increased sale of our higher-end probes. We expect the
current challenging market as a result of network management capital spending
controls in the U.S. and abroad and the current economic downturn will have an
impact on our future product revenue results which can not be quantified at this
time.

SERVICE. Service revenues were $11.7 million and $9.7 million for the six
months ended September 30, 2002 and 2001, respectively, representing an increase
of 20% 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. We
anticipate that we will continue to increase our service revenue in future
quarters as our current installed base continues to expand.

LICENSE AND ROYALTY. License and royalty revenues were $3.3 million and
$5.5 million for the six months ended September 30, 2002 and 2001, respectively,
representing a decrease of 40% from 2001 to 2002. This decrease is primarily due
to a reduction in Cisco reported unit volume of the products which incorporate
some of our software. We anticipate a continued decrease in our license and
royalty revenues due to our decreased focus on royalty partnerships in favor of
a concentration on partnerships that more closely complement our current product
strategies.

18

COST OF REVENUE AND GROSS MARGIN

PRODUCT. Cost of product revenue was $6.8 million and $8.8 million for the
six months ended September 30, 2002 and 2001, respectively, representing a
decrease of 22% from 2001 to 2002. This decrease corresponds with the 35%
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, as well as decreases in fixed manufacturing costs. Product
gross margins were 67% and 61% for the six months ended September 30, 2002 and
2001, respectively. The increase in gross margin percentage was primarily due to
an increase of approximately 38% in average selling price per unit, partially
offset by a 21% increase in average cost per unit relating to the sale of higher
speed probes and an increase in direct sales, which traditionally have higher
margins.

SERVICE. Cost of service revenues were $2.1 million and $1.8 million for
the six months ended September 30, 2002 and 2001, respectively, representing an
increase of 19% from 2001 to 2002. Service gross margins were 82% for the six
months ended September 30, 2002 and 2001. This increase in cost was primarily
due to an increase in our personnel costs. While cost of service revenue
increased by 19%, service revenue increased by 20%, thereby resulting in an
unchanged service gross margin percentage.

Gross margins were $26.8 million and $27.3 million for the six months ended
September 30, 2002 and 2001, respectively, representing a decrease of 2% from
2001 to 2002. Gross margin percentage was 75% and 72% for the six months ended
September 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
margin percentage was primarily due to the increased product margin percentage.
The increased product margin percentage mainly resulted from an increase of
approximately 38% in the average selling price per unit partially offset by a
28% increase in average cost per unit and an increase in direct sales which
traditionally have higher margins. This was offset by decreased license and
royalty revenue margin contribution.

OPERATING EXPENSES

RESEARCH AND DEVELOPMENT. Research and development expenses were
$8.8 million and $9.6 million for the six months ended September 30, 2002 and
2001, respectively, representing a decrease of 8% from 2001 to 2002. This
decrease was primarily due to a 33% decrease in stock-based compensation charges
related to the NextPoint acquisition from 2001 to 2002, a 5% decrease in
personnel costs from 2001 to 2002, and a significant decrease in non-recurring
engineering charges. We anticipate that sequentially we will increase research
and development expenses in absolute dollars as we invest in new product
development.

SALES AND MARKETING. Sales and marketing expenses were $16.8 million and
$17.6 million for the six months ended September 30, 2002 and 2001,
respectively, representing a decrease of 4% from 2001 to 2002. This decrease was
primarily due to a 68% decrease in marketing programs spending and a 9% decrease
in sales travel, office and meeting expenses due to cost containment measures
that we have implemented during this current economic downturn, from 2001 to
2002, offset by a 6% increase in personnel expense. 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 sequentially as we
continue our effort to promote revenue growth and NetScout name recognition.

GENERAL AND ADMINISTRATIVE. General and administrative expenses were
$4.2 million and $3.6 million for the six months ended September 30, 2002 and
2001, respectively, representing an

19

increase of 17% from 2001 to 2002. This increase was primarily due to an
impairment of $1.0 million on a long-term note receivable partially offset by
decreased spending for investor relations and accounting services. We anticipate
that we will decrease general and administrative expenses in absolute dollars
sequentially in the absence of the long-term note receivable impairment charge
and as we continue to maintain spending controls during the current economic
downturn. We will continue to monitor the economic situation and re-evaluate
spending once the economy improves.

AMORTIZATION OF OTHER INTANGIBLE ASSETS. Amortization of other intangible
assets was $544,000 and $718,000 for the six months ended September 30, 2002 and
2001, respectively, due to the acquisition of NextPoint. We anticipate that we
will continue to amortize other intangible assets at the current rate of
$272,000 per quarter until fully amortized.

AMORTIZATION OF GOODWILL. Amortization of goodwill was $4.6 million for the
six months ended September 30, 2001. 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.

INTEREST INCOME AND OTHER EXPENSES, NET. Interest income, net of interest
and other expenses, was $639,000 and $1.2 million for the six months ended
September 30, 2002 and 2001, respectively, representing a decrease of 46% from
2001 to 2002. This decrease was primarily due to lower market interest rates on
cash and cash equivalents and marketable securities.

INCOME TAX BENEFIT. The income tax benefit was $1.1 million and $465,000
for the six months ended September 30, 2002 and 2001, respectively. NetScout's
projected annual effective tax rate increased to a benefit of 36% in fiscal 2003
from a benefit of 8% in fiscal 2002, which was primarily impacted by the
adoption of SFAS No. 142, "Goodwill and Other Intangible Assets," effective
April 1, 2002, which cause goodwill and the un-amortized assembled workforce
intangible asset to be no longer subject to amortization.

NET LOSS. Net loss was $1.9 million and $7.1 million for the six months
ended September 30, 2002 and 2001, respectively, representing a 74% improvement.
The decrease in net loss year over year was mainly attributable to the decrease
in the amortization of goodwill and other intangible assets from $5.3 million to
$544,000 for the six months ended September 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. The pro forma net loss
was $536,000 and $658,000 for the six months ended September 30, 2002 and 2001,
respectively, when excluding the non-cash amortization of goodwill and other
intangible assets of $544,000 and $5.3 million and stock-based compensation of
$777,000 and $1.2 million for the six months ended September 30, 2002 and 2001,
respectively. This decrease in net loss is primarily attributable to reductions
in operating expenses due to tight spending controls and an increased tax
benefit due to lower projected taxable income for the year ended March 31, 2003
offset by the decrease in gross margin dollars due to the decreased revenue
attributable to the current economic downturn and the impairment charge of a
long-term note receivable.

LIQUIDITY AND CAPITAL RESOURCES

As of September 30, 2002, we had $26.9 million in cash and cash equivalents,
$38.0 million in short-term marketable securities and $5.1 million in long-term
marketable securities, together totaling to $70.0 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 and we intend to renew upon its expiration. 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 September 30, 2002, we

20

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 $1.1 million and $2.5 million for
the six months ended September 30, 2002 and 2001, respectively. In the six
months ended September 30, 2002, cash provided by operating activities was
primarily derived from decreases in accounts receivable, prepaid and other
current assets, and inventories, and increases in depreciation and amortization,
compensation expense associated with equity awards, and the impairment of a
long-term note receivable. This was partially offset by a net loss, decreases in
accounts payable and accrued compensation and other expenses and an increase in
deferred income taxes. In the six months ended September 30, 2001, cash provided
by operating activities was primarily derived from a decrease in inventories and
accounts receivable, and an increase in depreciation and amortization and
amortization of goodwill and other intangible assets and stock-based
compensation expense associated with equity awards. This was partially offset by
a net loss, decreases in accounts payable, accrued compensation and other
expenses and an increase in prepaid and other current assets.

Cash provided by (used in) investing activities was $5.9 million and ($18.9)
million for the six months ended September 30, 2002 and 2001, respectively. For
the six months ended September 30, 2002, 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 six
months ended September 30, 2001, net cash used was primarily due to the purchase
of marketable securities and fixed assets offset by the proceeds from the
maturity of marketable securities.

Cash provided by (used in) financing activities was $637,000 and ($315,000)
for the six months ended September 30, 2002 and 2001, respectively. For the six
months ended September 30, 2002, 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 six months ended
September 30, 2001, cash used in financing activities was primarily due to a
stock repurchase program, slightly offset by proceeds from the issuance of
common stock in connection with the exercise of stock options. On September 17,
2001, NetScout announced an open market stock repurchase program that enables
NetScout to purchase up to 1 million shares of its outstanding common stock,
subject to market conditions and other factors. NetScout purchased 124,000
shares as of September 30, 2002. Cash to be used under this program is
undeterminable at this point in time.

We believe that our current cash balances and any future cash flows
generated by operations will be sufficient to meet our anticipated cash needs
for working capital and capital expenditures for at least the next 12 months. 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 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

21

goodwill be amortized over their useful lives. SFAS No. 141 is effective for all
business combinations initiated after June 30, 2001. SFAS No. 142 was adopted by
us 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 currently 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." For the three and six months
ended September 30, 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 currently 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 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 22% of our total revenue
for the three months ended September 30, 2001 and 26% of our total revenue for
the six months ended September 30, 2001. We now sell to those Cisco customers
who are actively purchasing our product, 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. 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 11% and 18% of our
total revenue for the three months ended September 30, 2002 and 2001,
respectively and 13% and 20% of our total revenue for the six months ended
September 30, 2002 and 2001,

22

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 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

- continuation or worsening of the current economic slowdown 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.

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 56% and 65%
of our total revenue for the three months ended September 30, 2002 and 2001,
respectively and 54% and 67% of our total revenue for the six months ended
September 30, 2002 and 2001, respectively, compared to 51% and 69% of 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 they continue to
incorporate some of our software in their products. Cisco accounted for 11%

23

and 40% of our total revenue for the three months ended September 30, 2002 and
2001, respectively and 13% and 46% of our total revenue for the six months ended
September 30, 2002 and 2001, respectively. During the past 15 months we have
worked to transition a large portion of our sales efforts from support of the
Cisco distribution channel to the development of more of our own direct sales
and other indirect distribution channels. To increase our sales going forward,
we need to continue to grow our direct sales efforts and to continue to 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 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 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.

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,

24

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 continue 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.

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

25

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, patents, copyrights or trademarks. These claims,
whether or not valid, could require us to spend significant sums in litigation,
pay damages, 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. 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 13% and 9% of our total
revenue for the three months ended September 30, 2002 and 2001, respectively,
and 16% and 10% of our total revenue for the six months ended September 30, 2002
and 2001, respectively. 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.

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.

26

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. Trading activity of our stock tends to be minimal as a result of
officers and directors and their affiliates holding a significant percentage of
our stock. 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, which in turn could cause impairment of goodwill that
could materially and adversely impact our financial condition and results of
operations.

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. NetScout'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.
NetScout'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 we currently
have a $10.0 million line of credit with $3.2 million of letters of credit
secured against it, we have no amounts outstanding under the line and no other
outstanding interest-bearing debt.

NetScout's exposure to currency exchange rate fluctuations has been limited.
All revenue transactions are completed in U.S. dollars. NetScout does pay for
certain operating expenses such as foreign payroll, rent and office expense in
foreign currency and, therefore currency exchange rate fluctuations could have a
material adverse impact on our operating results and financial condition.
Currently, NetScout does not engage in foreign currency hedging activities. The
impact of currency exchange rate fluctuations is recorded in the period
incurred.

ITEM 4. CONTROLS AND PROCEDURES

(a) Evaluation of disclosure controls and procedures.

The principal executive officer and principal financial officer have
evaluated the disclosure controls and procedures as of a date within 90 days
before the filing date of this quarterly report. Based on this evaluation, they
conclude that the disclosure controls and procedures effectively ensure that
information required to be disclosed in our filings and submissions under the
Exchange Act is recorded, processed, summarized, and reported within the time
periods specified in the Securities and Exchange Commission's rules and forms.

27

(b) Changes in internal controls.

There have been no significant changes in our internal controls or in other
factors that could significantly affect these controls subsequent to the
evaluation of the internal controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.

PART II--OTHER INFORMATION

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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At NetScout's annual meeting of stockholders held September 20, 2002,
NetScout's stockholders took the following actions:

(1) NetScout stockholders elected Narendra V. Popat and Joseph G. Hadzima, Jr.,
both Class III directors, to a three-year term expiring at NetScout's annual
meeting of stockholders in 2005 or until each director's respective
successor has been duly elected and qualified or until each director's early
resignation or removal. Election of the directors was determined by a
plurality of the votes cast at the 2002 annual meeting. With respect to
Mr. Popat, the votes were cast as follows: 26,716,660 shares of common stock
voted for the election of Mr. Popat; and 1,270,702 shares of common stock
were withheld as to the election of Mr. Popat. With respect to the election
of Mr. Hadzima, the votes were cast as follows: 27,772,513 shares of common
stock voted for the election of Mr. Hadzima; and 214,849 shares of common
stock were withheld as to the election of Mr. Hadzima.

(2) NetScout's stockholders ratified the selection of the firm of
PricewaterhouseCoopers LLP, independent public accountants, as auditors for
the fiscal year ending March 31, 2003. With respect to such matter, the
votes were cast as follows: 25,986,736 shares of common stock voted for the
proposal; 1,995,826 shares of common stock voted against the proposal; and
4,800 shares of common stock abstained.

28

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) EXHIBITS

The following exhibits are filed as part of this report:

10 Amendment No. 7 effective as of August 1, 2002 to Private
Label Agreement and Project Development and License
Agreement between Cisco Systems, Inc. and NetScout (filed as
Exhibit 10 to NetScout's Current Report on Form 8-K dated
August 1, 2002 and incorporated herein by reference)*
99.1 Certification Pursuant to Section 906 of the SARBANES-OXLEY
ACT of 2002
99.2 Certification Pursuant to Section 906 of the SARBANES-OXLEY
ACT of 2002

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

* Confidential treatment requested pursuant to Rule 24b-2 of the
Securities and Exchange Act of 1934.

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

29

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: November 8, 2002 By: /s/ ANIL K. SINGHAL
------------------------------------------------
Anil K. Singhal
PRESIDENT, CHIEF EXECUTIVE OFFICER, TREASURER AND
DIRECTOR (PRINCIPAL EXECUTIVE OFFICER)

Date: November 8, 2002 By: /s/ DAVID P. SOMMERS
------------------------------------------------
David P. Sommers
SENIOR VICE PRESIDENT, GENERAL OPERATIONS AND
CHIEF FINANCIAL OFFICER (PRINCIPAL FINANCIAL
OFFICER)

Date: November 8, 2002 By: /s/ LISA A. FIORENTINO
------------------------------------------------
Lisa A. Fiorentino
VICE PRESIDENT, FINANCE AND ADMINISTRATION AND
CHIEF ACCOUNTING OFFICER (PRINCIPAL ACCOUNTING
OFFICER)

30

I, Anil K. Singhal, certify that:

1. I have reviewed this quarterly report on Form 10-Q of NetScout
Systems, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.

Date: November 8, 2002 By: /s/ ANIL K. SINGHAL
------------------------------------------------
Anil K. Singhal
PRESIDENT, CHIEF EXECUTIVE OFFICER, TREASURER AND
DIRECTOR (PRINCIPAL EXECUTIVE OFFICER)

31

I, David P. Sommers, certify that:

1. I have reviewed this quarterly report on Form 10-Q of NetScout
Systems, Inc.;

2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;

3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;

4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a) designed such disclosure controls and procedures to ensure that material
information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this quarterly report is being
prepared;

b) evaluated the effectiveness of the registrant's disclosure controls and
procedures as of a date within 90 days prior to the filing date of this
quarterly report (the "Evaluation Date"); and

c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;

5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent function):

a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to record,
process, summarize and report financial data and have identified for the
registrant's auditors any material weaknesses in internal controls; and

b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and

6. The registrant's other certifying officers and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.

Date: November 8, 2002 By: /s/ DAVID P. SOMMERS
------------------------------------------------
David P. Sommers
SENIOR VICE PRESIDENT, GENERAL OPERATIONS AND
CHIEF FINANCIAL OFFICER (PRINCIPAL FINANCIAL
OFFICER)

32

EXHIBIT INDEX

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

* Confidential treatment requested pursuant to Rule 24b-2 of the Securities
and Exchange Act of 1934.

33