F5, INC. Management’s Discussion and Analysis of Financial Condition and Results of Operations (Form 10-Q)
The following discussion of our financial condition and results of operations contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 and Section 27A of the Securities Act of 1933. These statements include, but are not limited to, statements about our plans, objectives, expectations, strategies, intentions or other characterizations of future events or circumstances and are generally identified by the words "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," and similar expressions. These forward-looking statements are based on current information and expectations and are subject to a number of risks and uncertainties. Our actual results could differ materially from those expressed or implied by these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in Part II, Item 1A. "Risk Factors" herein and in other documents we file from time to time with theSecurities and Exchange Commission . We assume no obligation to revise or update any such forward-looking statements. Overview F5 is a leading provider of multi-cloud application security and delivery solutions which enable our customers to develop, deploy, operate, secure, and govern applications in any architecture, from on-premises to the public cloud. Our enterprise-grade application services are available as cloud-based, software-as-a-service, and software-only solutions optimized for multi-cloud environments, with modules that can run independently, or as part of an integrated solution on our high-performance appliances. We market and sell our products primarily through multiple indirect sales channels in theAmericas (primarilythe United States );Europe , theMiddle East , andAfrica (EMEA); and theAsia Pacific region (APAC). Enterprise customers (Fortune 1000 or Business Week Global 1000 companies) in the technology, telecommunications, financial services, transportation, education, manufacturing and health care industries, along with government customers, continue to make up the largest percentage of our customer base. Our management team monitors and analyzes a number of key performance indicators in order to manage our business and evaluate our financial and operating performance on a consolidated basis. Those indicators include: •Revenues. The majority of our revenues are derived from sales of our application security and delivery products including our BIG-IP appliances and VIPRION chassis and related software modules and our software-only Virtual Editions; Local Traffic Manager (LTM), DNS Services (formerly Global Traffic Manager); Advanced Firewall Manager (AFM) and Policy Enforcement Manager (PEM), that leverage the unique performance characteristics of our hardware and software architecture; and products that incorporate acquired technology, including Application Security Manager (ASM) and Access Policy Manager (APM); NGINX Plus and NGINX Controller; Shape Defense and Enterprise Defense; and the Secure Web Gateway and Silverline DDoS and Application security offerings which are sold to customers on a subscription basis. We also derive revenues from the sales of global services including annual maintenance contracts, training and consulting services. We carefully monitor the sales mix of our revenues within each reporting period. We believe customer acceptance rates of our new products and feature enhancements are indicators of future trends. We also consider overall revenue concentration by customer and by geographic region as additional indicators of current and future trends. Near term, we expect worsening global supply chain constraints will result in a shortfall in our ability to meet customer demand for our hardware-based solutions, thereby impacting revenues from systems sales. 24 -------------------------------------------------------------------------------- Table of Contents •Cost of revenues and gross margins. We strive to control our cost of revenues and thereby maintain our gross margins. Significant items impacting cost of revenues are hardware costs paid to our contract manufacturers, third-party software license fees, software-as-a-service infrastructure costs, amortization of developed technology and personnel and overhead expenses. Our margins have remained relatively stable; however, factors such as sales price, product and services mix, inventory obsolescence, returns, component price increases, warranty costs, global supply chain constraints, and the remaining uncertainty surrounding the COVID-19 pandemic could significantly impact our gross margins from quarter to quarter and represent significant indicators we monitor on a regular basis. •Operating expenses. Operating expenses are substantially driven by personnel and related overhead expenses. Existing headcount and future hiring plans are the predominant factors in analyzing and forecasting future operating expense trends. Other significant operating expenses that we monitor include marketing and promotions, travel, professional fees, computer costs related to the development of new products and provision of services, facilities and depreciation expenses. •Liquidity and cash flows. Our financial condition remains strong with significant cash and investments. The decrease in cash and investments for the first three months of fiscal year 2022 was primarily due to$125.0 million of cash required for the repurchase of shares and$68.0 million in cash paid for the acquisition of Threat Stack in the first quarter of fiscal 2022. The decrease in cash and investments for the first quarter of fiscal 2022 was partially offset by cash provided by operating activities of$90.4 million . Going forward, we believe the primary driver of cash flows will be net income from operations. We will continue to evaluate possible acquisitions of, or investments in businesses, products, or technologies that we believe are strategic, which may require the use of cash. Additionally, onJanuary 31, 2020 , we entered into a Revolving Credit Agreement (the "Revolving Credit Agreement") that provides for a senior unsecured revolving credit facility in an aggregate principal amount of$350.0 million (the "Revolving Credit Facility"). We have the option to increase commitments under the Revolving Credit Facility from time to time, subject to certain conditions, by up to$150.0 million . As ofDecember 31, 2021 , there were no outstanding borrowings under the Revolving Credit Facility, and we had available borrowing capacity of$350.0 million . •Balance sheet. We view cash, short-term and long-term investments, deferred revenue, accounts receivable balances and days sales outstanding as important indicators of our financial health. Deferred revenues continued to increase in the first quarter of fiscal year 2022 due to the growth of our subscriptions business, including the acquired deferred revenue associated with the Threat Stack acquisition. Our days sales outstanding for the first quarter of fiscal year 2022 was 55. Days sales outstanding is calculated by dividing ending accounts receivable by revenue per day for a given quarter. Summary of Critical Accounting Policies and Estimates The preparation of our financial condition and results of operations requires us to make judgments and estimates that may have a significant impact upon our financial results. We believe that, of our significant accounting policies, the following require estimates and assumptions that require complex, subjective judgments by management, which can materially impact reported results: revenue recognition, accounting for business combinations and accounting for leases. Actual results may differ from these estimates under different assumptions or conditions. There were no material changes to our critical accounting policies and estimates compared to the critical accounting policies and estimates described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Form 10-K for the fiscal year endedSeptember 30, 2021 . Refer to the "Recently Adopted Accounting Standards" section of Note 1 in this Quarterly Report on Form 10-Q for a summary of the new accounting policies. COVID-19 Update Management has prioritized a human-first approach to the COVID-19 pandemic. For F5, this means ensuring the health and safety of employees, their families and our communities. Further, this approach extends to our customers as we look for ways that we can support their operations during this crisis. Our analysis shows COVID-19 did not have a significant impact on our results of operations for the quarter endedDecember 31, 2021 . We continue to monitor the ongoing uncertainty related to the global pandemic on our business and financial outlook. Global supply chain constraints in the wake of the COVID-19 pandemic continue to reduce our visibility into component availability, and lead times are increasing for components necessary for our hardware-based solutions. We are undertaking efforts to mitigate supply chain constraints, but worsening component availability is expected to cause lengthening lead times on shipments of products to customers, delaying our ability to fulfill some hardware orders. In addition, we are conducting business with substantial modifications to employee travel, employee work locations, and virtualization or cancellation of certain sales and marketing events, among other modifications. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities, 25 -------------------------------------------------------------------------------- Table of Contents or that we determine are in the best interests of our employees, customers, partners, suppliers and stockholders. It is not clear what the potential effects any such alterations or modifications may have on our business, including the effects on our customers and prospects, or on our financial results. Results of Operations The following discussion and analysis should be read in conjunction with our consolidated financial statements, related notes and risk factors included elsewhere in this Quarterly Report on Form 10-Q. Three months ended December 31, 2021 2020 (in thousands, except percentages) Net revenues Products$ 343,149 $ 288,045 Services 343,951 336,572 Total$ 687,100 $ 624,617 Percentage of net revenues Products 49.9 % 46.1 % Services 50.1 53.9 Total 100.0 % 100.0 % Net Revenues. Total net revenues increased 10.0% for the three months endedDecember 31, 2021 , from the comparable period in the prior year. Overall revenue growth for the three months endedDecember 31, 2021 , was primarily due to the increases in both product and service revenue. The product revenue increase was driven by software revenue increases, specifically from our software-as-a-service product offerings and our subscription-based offerings, which include software sold via our flexible consumption program or multi-year subscriptions. Service revenues increased as a result of our increased installed base of products. In addition, our stand-alone security product revenue and our global services revenue associated with security continued to grow in the first quarter of fiscal 2022. Revenues outside ofthe United States represented 44.5% of total net revenues for the three months endedDecember 31, 2021 , compared to 48.7% for the same period in the prior year. Net Product Revenues. Net product revenues increased 19.1% for the three months endedDecember 31, 2021 , from the comparable period in the prior year. The increase of$55.1 million in net product revenues for the three months endedDecember 31, 2021 was due to an increase in both software and systems revenue compared to the same period in the prior year. The following presents net product revenues by systems and software (in thousands): Three months ended December 31, 2021 2020 Net product revenues Systems revenue$ 180,157 $ 178,571 Software revenue 162,992 109,474 Total net product revenue$ 343,149 $ 288,045 Percentage of net product revenues Systems revenue 52.5 % 62.0 % Software revenue 47.5 38.0 Total net product revenue 100.0 % 100.0 % Net Service Revenues. Net service revenues increased 2.2% for the three months endedDecember 31, 2021 , from the comparable period in the prior year. The increases in service revenue were the result of increased purchases or renewals of maintenance contracts driven by additions to our installed base of products. 26 -------------------------------------------------------------------------------- Table of Contents The following distributors of our products accounted for more than 10% of total net revenue: Three months ended December 31, 2021 2020 Ingram Micro, Inc. 18.7 % 18.1 % Synnex Corporation 12.2 % 10.0 % The following distributors of our products accounted for more than 10% of total receivables: December 31, September 30, 2021 2021 Ingram Micro, Inc. 17.8 % 12.6 % Synnex Corporation 14.4 % 11.9 % Carahsoft Technology - 11.5 % No other distributors accounted for more than 10% of total net revenue or receivables. Three months ended December 31, 2021 2020 (in thousands, except percentages) Cost of net revenues and gross profit Products$ 81,662 $ 67,038 Services 53,411 47,941 Total 135,073 114,979 Gross profit$ 552,027 $ 509,638 Percentage of net revenues and gross margin (as a percentage of related net revenue) Products 23.8 % 23.3 % Services 15.5 14.2 Total 19.7 18.4 Gross margin 80.3 % 81.6 % Cost of Net Product Revenues. Cost of net product revenues consists of finished products purchased from our contract manufacturers, manufacturing overhead, freight, warranty, provisions for excess and obsolete inventory, software-as-a-service infrastructure costs and amortization expenses in connection with developed technology from acquisitions. Cost of net product revenues increased$14.6 million , or 21.8% for the three months endedDecember 31, 2021 , from the comparable period in the prior year. The increase in cost of net product revenues was primarily due to component cost increases, expedite fees, and other costs related to actions we are taking to mitigate supply chain constraints. Cost of Net Service Revenues. Cost of net service revenues consists of the salaries and related benefits of our professional services staff, travel, facilities and depreciation expenses. For the three months endedDecember 31, 2021 , cost of net service revenues as a percentage of net service revenues was 15.5%, compared to 14.2% for the comparable period in the prior year. Professional services headcount at the end ofDecember 2021 increased to 1,037 from 967 at the end ofDecember 2020 . 27
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Three months ended
December 31,
2021 2020
(in thousands, except
percentages)
Operating expenses
Sales and marketing $ 234,035 $ 214,546
Research and development 130,271 114,191
General and administrative 65,661 63,153
Restructuring charges 7,909 -
Total $ 437,876 $ 391,890
Operating expenses (as a percentage of net sales) Sales and marketing
34.1 % 34.3 % Research and development 19.0 18.3 General and administrative 9.5 10.1 Restructuring charges 1.1 - Total 63.7 % 62.7 % Sales and Marketing. Sales and marketing expenses consist of salaries, commissions and related benefits of our sales and marketing staff, the costs of our marketing programs, including public relations, advertising and trade shows, travel, facilities, and depreciation expenses. Sales and marketing expenses increased$19.5 million , or 9.1% for the three months endedDecember 31, 2021 , from the comparable period in the prior year. The increase in sales and marketing expense was primarily due to an increase of$10.9 million in personnel costs for the three months endedDecember 31, 2021 , from the comparable period in the prior year. Sales and marketing expenses for the first quarter of fiscal 2022 also included an impairment charge of$6.2 million related to the write-off of the Shape trade name intangible asset. Sales and marketing headcount at the end ofDecember 2021 increased to 2,430 from 2,398 at the end ofDecember 2020 . Sales and marketing expenses included stock-based compensation expense of$26.8 million for the three months endedDecember 31, 2021 , compared to$25.2 million for the same period in the prior year. Research and Development. Research and development expenses consist of the salaries and related benefits of our product development personnel, prototype materials and other expenses related to the development of new and improved products, facilities and depreciation expenses. Research and development expenses increased$16.1 million , or 14.1% for the three months endedDecember 31, 2021 , from the comparable period in the prior year. For the three months endedDecember 31, 2021 , personnel costs increased$14.1 million from the comparable period in the prior year due to growth in research and development headcount, including employees from the acquisitions ofVolterra and Threat Stack. Research and development headcount at the end ofDecember 2021 increased to 1,947 from 1,801 at the end ofDecember 2020 . Research and development expenses included stock-based compensation expense of$18.6 million for the three months endedDecember 31, 2021 , compared to$15.0 million for the same period in the prior year. General and Administrative. General and administrative expenses consist of the salaries, benefits and related costs of our executive, finance, information technology, human resource and legal personnel, third-party professional service fees, facilities and depreciation expenses. General and administrative expenses increased$2.5 million , or 4.0% for the three months endedDecember 31, 2021 , from the comparable period in the prior year. For the three months endedDecember 31, 2021 , personnel costs increased$4.0 million , from the comparable period in the prior year due to growth in general and administrative headcount. The increase in general and administrative expenses for the three months endedDecember 31, 2021 were partially offset by a decrease of$1.5 million in professional fees, from the comparable period in the prior year. General and administrative headcount at the end ofDecember 2021 increased to 856 from 735 at the end ofDecember 2020 . General and administrative expenses included stock-based compensation expense of$10.9 million for the three months endedDecember 31, 2021 , compared to$10.5 million for the same period in the prior year. Restructuring Charges. In the first fiscal quarter of 2021, we completed a restructuring plan to align strategic and financial objectives and optimize resources for long term growth. As a result of these initiatives, we recorded a restructuring charge of$7.9 million related to a reduction in workforce that is reflected in our results for the three months endedDecember 31, 2021 . 28
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Three months ended
December 31,
2021 2020
(in thousands, except percentages)
Other income and income taxes
Income from operations $ 114,151 $ 117,748
Other expense, net (2,431) (683)
Income before income taxes 111,720 117,065
Provision for income taxes 18,161 29,387
Net income $ 93,559 $ 87,678
Other income and income taxes (as percentage of net revenue)
Income from operations 16.6 % 18.9 %
Other expense, net (0.3) (0.1)
Income before income taxes 16.3 18.7
Provision for income taxes 2.7 4.7
Net income 13.6 % 14.0 %
Other Expense, Net. Other expense, net consists primarily of interest income and
expense and foreign currency transaction gains and losses. The decrease in other
expense, net for the three months ended December 31, 2021 was primarily due to
an increase in foreign currency loss of $1.0 million compared to the same period
in the prior year. In addition, interest income from our investments decreased
$0.9 million for the three months ended December 31, 2021 compared to the same
period in the prior year.
Provision for income taxes. The effective tax rate was 16.3% and 25.1% for the
three months ended December 31, 2021 and 2020, respectively. The decrease in the
effective tax rate for the three months ended December 31, 2021 as compared to
the three months ended December 31, 2020 is primarily due to the tax impact of
stock-based compensation.
We record a valuation allowance to reduce our deferred tax assets to the amount
we believe is more likely than not to be realized. In making these
determinations we consider historical and projected taxable income, and ongoing
prudent and feasible tax planning strategies in assessing the appropriateness of
a valuation allowance. Our net deferred tax assets at December 31, 2021 and
September 30, 2021 were $145.6 million and $125.8 million , respectively. The net
deferred tax assets include valuation allowances of $46.6 million and $40.4
million as of December 31, 2021 and September 30, 2021 , respectively, which are
primarily related to certain state and foreign net operating losses and tax
credit carryforwards.
Our worldwide effective tax rate may fluctuate based on a number of factors,
including variations in projected taxable income in the various geographic
locations in which we operate, the impact of stock-based compensation, changes
in the valuation of our net deferred tax assets, resolution of potential
exposures, tax positions taken on tax returns filed in the various geographic
locations in which we operate, and the introduction of new accounting standards
or changes in tax laws or interpretations thereof in the various geographic
locations in which we operate. We have recorded liabilities to address potential
tax exposures related to business and income tax positions we have taken that
could be challenged by taxing authorities. The ultimate resolution of these
potential exposures may be greater or less than the liabilities recorded which
could result in an adjustment to our future tax expense.
Liquidity and Capital Resources
Cash and cash equivalents, short-term investments and long-term investments
totaled $935.9 million as of December 31, 2021 , compared to $1,043.4 million as
of September 30, 2021 , representing a decrease of $107.5 million .
The decrease was primarily due to $125.0 million of cash required for the
repurchase of outstanding common stock and $68.0 million in cash paid for the
acquisition of Threat Stack in the first quarter of fiscal 2022. The decrease
was partially offset by cash provided by operating activities of $90.4 million
for the three months ended December 31, 2021 .
Cash provided by operating activities for the first three months of fiscal year
2022 resulted from net income of $93.6 million combined with changes in
operating assets and liabilities, as adjusted for various non-cash items
including stock-based compensation, deferred revenue, depreciation, impairment
and amortization charges. Cash provided by operating activities for the first
quarter of fiscal 2022 decreased from the comparable period in the prior year
for two primary reasons. First, we had strong multi-year subscription sales in
the first quarter of fiscal year 2022, which are generally sold on three-year
terms. Multi-year subscriptions are billed on an annual basis with the remainder
recognized on the balance sheet as unbilled assets. Second, during the quarter
we had significant prepayments with our contract manufacturer associated with
components for future hardware-based solution builds.
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Cash from operations could be affected by various risks and uncertainties,
including, but not limited to, the effects of the COVID-19 pandemic and other
risks detailed in Part 1, Item 1A, "Risk Factors" of our Annual Report on Form
10-K for the fiscal year ended September 30, 2021 . However, we anticipate our
current cash, cash equivalents and investment balances, anticipated cash flows
generated from operations, and available borrowing capacity on the Revolver
Credit Facility will be sufficient to meet our liquidity needs.
Cash used in investing activities was $42.0 million for the three months ended
December 31, 2021 , compared to cash provided by investing activities of $20.6
million for the same period in the prior year. Investing activities include
purchases, sales and maturities of available-for-sale securities, business
acquisitions and capital expenditures. The amount of cash used in investing
activities for the three months ended December 31, 2021 was primarily the result
of $68.0 million in cash paid for the acquisition of Threat Stack in the first
quarter of fiscal 2022, along with capital expenditures related to maintaining
our operations worldwide and the purchase of investments, partially offset by
the maturity and sale of investments.
Cash used in financing activities was $116.0 million for the three months ended
December 31, 2021 , compared to cash provided by financing activities of $17.7
million for the same period in the prior year. Our financing activities for the
three months ended December 31, 2021 primarily consisted of $125.0 million of
cash used to repurchase shares, as well as $13.6 million in cash used for taxes
related to net share settlement of equity awards, and $5.0 million in cash used
to make principal payments on our term loan. Cash used in financing activities
was partially offset by cash received from the exercise of employee stock
options and stock purchases under our employee stock purchase plan of
$27.6 million .
On January 31, 2020 , we entered into a Revolving Credit Agreement (the
"Revolving Credit Agreement") that provides for a senior unsecured revolving
credit facility in an aggregate principal amount of $350.0 million (the
"Revolving Credit Facility"). We have the option to increase commitments under
the Revolving Credit Facility from time to time, subject to certain conditions,
by up to $150.0 million . As of December 31, 2021 , there were no outstanding
borrowings under the Revolving Credit Facility, and we had available borrowing
capacity of $350.0 million .
Obligations and Commitments
As of December 31, 2021 , our principal commitments consisted of borrowings under
the Term Loan Facility and obligations outstanding under operating leases.
In connection with the acquisition of Shape, on January 24, 2020 , we entered
into a Term Credit Agreement ("Term Credit Agreement") with certain
institutional lenders that provides for a senior unsecured term loan facility in
an aggregate principal amount of $400.0 million (the "Term Loan Facility"). The
proceeds from the Term Loan Facility were primarily used to finance the
acquisition of Shape and related expenses. As of December 31, 2021 , $365.0
million of principal amount under the Term Loan Facility was outstanding. There
is a financial covenant that requires us to maintain a leverage ratio,
calculated as of the last day of each fiscal quarter, of consolidated total
indebtedness to consolidated EBITDA. This covenant may result in a higher
interest rate on our outstanding principal borrowings on the Term Loan Facility
in future periods, depending on the Company's performance. We will monitor the
effect that the COVID-19 pandemic may have on our leverage ratio calculation but
do not believe there will be a material impact to the interest payable on our
borrowings under the Term Loan Facility. Refer to Note 7 of our Consolidated
Financial Statements for the scheduled principal maturities of the Term Loan
Facility as of December 31, 2021 .
We lease our facilities under operating leases that expire at various dates
through 2033. There have been no material changes in our principal lease
commitments compared to those discussed in Management's Discussion and Analysis
of Financial Condition and Results of Operations included in our Annual Report
on Form 10-K for the fiscal year ended September 30, 2021 .
We have a contractual obligation to purchase inventory components procured by
our primary contract manufacturer in accordance with our annual build forecast.
The contractual terms of the obligation contain cancellation provisions, which
reduce our liability to purchase inventory components for periods greater than
one year. In order to support our build forecast, we will, from time-to-time
prepay our primary contract manufacturer for inventory purchases.
Recent Accounting Pronouncements
The anticipated impact of recent accounting pronouncements is discussed in Note
1 to the accompanying Notes to Consolidated Financial Statements of this
Quarterly Report on Form 10-Q.
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