Document/ExhibitDescriptionPagesSize 1: 10-Q Quarterly Report HTML 835K
2: EX-31.1 Certification -- §302 - SOA'02 HTML 25K
3: EX-31.2 Certification -- §302 - SOA'02 HTML 25K
4: EX-32.1 Certification -- §906 - SOA'02 HTML 23K
11: R1 Cover Page HTML 74K
12: R2 Consolidated Balance Sheets HTML 101K
13: R3 Consolidated Balance Sheets (Parenthetical) HTML 35K
14: R4 Consolidated Income Statements HTML 76K
15: R5 Consolidated Statements Of Comprehensive Income HTML 46K
16: R6 Consolidated Statements Of Comprehensive Income HTML 25K
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17: R7 Consolidated Statements of Shareholders' Equity HTML 80K
Statement
18: R8 Consolidated Statements Of Cash Flows HTML 108K
19: R9 Summary of Significant Accounting Policies HTML 34K
20: R10 Revenue from Contracts with Customers HTML 46K
21: R11 Fair Value Measurements HTML 114K
22: R12 Short-Term and Long-Term Investments HTML 174K
23: R13 Business Combinations HTML 74K
24: R14 Balance Sheet Details HTML 85K
25: R15 Debt Facilities HTML 35K
26: R16 Leases HTML 79K
27: R17 Commitments and Contingencies HTML 29K
28: R18 Income Taxes HTML 25K
29: R19 Net Income Per Share HTML 52K
30: R20 Segment Information HTML 79K
31: R21 Restructuring Charges HTML 29K
32: R22 Summary of Significant Accounting Policies HTML 39K
(Policies)
33: R23 Revenue from Contracts with Customers (Tables) HTML 43K
34: R24 Fair Value Measurements (Tables) HTML 107K
35: R25 Short-Term and Long-Term Investments (Tables) HTML 174K
36: R26 Business Combinations (Tables) HTML 65K
37: R27 Balance Sheet Details (Tables) HTML 93K
38: R28 Debt Facilities (Tables) HTML 28K
39: R29 Leases (Tables) HTML 82K
40: R30 Net Income Per Share (Tables) HTML 52K
41: R31 Segment Information (Tables) HTML 83K
42: R32 Restructuring Charges (Tables) HTML 29K
43: R33 Revenue from Contracts with Customers - HTML 27K
Capitalized contract acquisition costs (Details)
44: R34 Revenue from Contracts with Customers - Narrative HTML 24K
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45: R35 Revenue from Contracts with Customers - Contract HTML 42K
Assets and Liabilities (Details)
46: R36 Revenue from Contracts with Customers - Remaining HTML 33K
Performance Obligations (Details)
47: R37 Fair Value Measurements - Schedule of Financial HTML 75K
Assets Measured at Fair Value on a Recurring Basis
(Details)
48: R38 Short-Term and Long-Term Investments - Schedule of HTML 70K
Short-Term and Long-Term Investments (Details)
49: R39 Short-Term and Long-Term Investments - Schedule of HTML 56K
Investments That Have Been in a Continuous
Unrealized Loss Position (Details)
50: R40 Business Combinations - Narrative (Details) HTML 53K
51: R41 Business Combinations - Purchase Price Allocation HTML 85K
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52: R42 Balance Sheet Details - Cash and Cash Equivalent HTML 29K
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54: R44 Balance Sheet Details - Other Current Assets HTML 31K
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55: R45 Balance Sheet Details - Other Assets (Details) HTML 30K
56: R46 Balance Sheet Details - Accrued Liabilities HTML 32K
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Liabilities (Details)
58: R48 Debt Facilities - Narrative (Details) HTML 65K
59: R49 Debt Facilities - Long-term Debt Maturities HTML 34K
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60: R50 Leases - Narrative (Details) HTML 37K
61: R51 Leases - Operating Lease Expense (Details) HTML 29K
62: R52 Leases - Supplemental Balance Sheet (Details) HTML 32K
63: R53 Leases - Maturities of Lease Liabilities (Details) HTML 39K
64: R54 Leases - Operating Lease Future Minimum ASC 840 HTML 68K
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65: R55 Commitments And Contingencies (Details) HTML 21K
66: R56 Income Taxes (Details) HTML 25K
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68: R58 Segment Information (Details) HTML 59K
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(Exact name of registrant as specified in its charter)
iWashington
i91-1714307
(State
or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
i801 5th Avenue
iSeattle,
iWashingtoni98104
(Address of principal executive offices and zip code)
(i206)
i272-5555
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading
Symbol(s)
Name of each exchange on which registered
iCommon stock, no par value
iFFIV
iNASDAQ
Global Select Market
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. iYes☑ No ☐
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). iYes☑ No ☐
Indicate by check mark whether the
registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,”“accelerated filer,”“smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
iLarge
Accelerated Filer
☑
Accelerated Filer
☐
Non-accelerated Filer
☐ (Do not check if a smaller reporting company)
Smaller Reporting Company
i☐
Emerging
Growth Company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check
mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐ No ☑
Unrealized gains on securities, net of taxes of $490 and $197 for the three months ended June 30, 2020 and 2019, respectively, and $146 and $940 for the nine months ended June 30, 2020 and 2019, respectively
i4,061
i918
i1,230
i3,811
Reclassification
adjustment for realized losses included in net income, net of taxes of $(47) and $(35) for the three months ended June 30, 2020 and 2019, respectively, and $(65) and $(35) for the nine months ended June 30, 2020 and 2019, respectively
i163
i112
i233
i113
Net
change in unrealized gains on available-for-sale securities, net of tax
i4,224
i1,030
i1,463
i3,924
Total
other comprehensive income
i4,408
i1,148
i695
i3,985
Comprehensive
income
$
i74,280
$
i87,053
$
i230,473
$
i336,882
The
accompanying notes are an integral part of these consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
1. iSummary
of Significant Accounting Policies
i
Description of Business
F5 Networks, Inc. (the "Company") is a leading provider of multi-cloud application services which enable its customers to develop, deploy, operate, secure, and govern applications in any architecture, from on-premises to the public cloud. The Company's cloud, software, and hardware solutions enable its customers to deliver digital experiences to their customers faster, reliably, and at scale. The
Company's 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 its high-performance appliances. In connection with its solutions, the Company offers a broad range of professional services, including consulting, training, installation, maintenance, and other technical support services. On January 24, 2020, the Company completed the acquisition of Shape Security, Inc. ("Shape"), a leader in online fraud and abuse prevention, adding protection from automated attacks, botnets, and targeted fraud to F5's world-class portfolio of application services.
i
Basis
of Presentation
The year-end consolidated balance sheet data was derived from audited financial statements but does not include all disclosures required by accounting principles generally accepted in the United States of America ("GAAP"). In the opinion of management, the unaudited consolidated financial statements reflect all adjustments, consisting only of normal recurring adjustments, necessary for their fair statement in conformity with accounting principles generally accepted in the United States of America. Certain information and footnote disclosures normally included in annual financial statements have been condensed or omitted in accordance with the rules and regulations of the Securities and Exchange Commission ("SEC"). The information included in this Form 10-Q should be read in conjunction with Management’s Discussion and Analysis of Financial Condition and Results of Operations and financial statements
and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended September 30, 2019.
Certain prior year amounts have been reclassified to conform to the current year presentation in the Consolidated Statements of Cash Flows. The reclassified amounts are considered immaterial and there was no change to total cash from operating, investing or financing activities as a result.
There have been no material changes to the Company's significant accounting policies as of and for the three and nine months ended June 30, 2020, except for the accounting policy for leases that was updated as
a result of adopting Accounting Standards Update 2016-02, Leases (Topic 842) (ASU 2016-02) and related standards. For more information, refer to the "Recently Adopted Accounting Standards" section of Note 1 and Note 8 - Leases.
In December 2019, a novel strain of coronavirus (“COVID-19“) was first identified, and in March 2020, the World Health Organization categorized COVID-19 as a pandemic. The Company assessed the impact that COVID-19 had on its results of operations, including, but not limited to an assessment of its allowance for doubtful accounts, the carrying value of short-term and long-term investments, the carrying value of goodwill and other long-lived assets, and the impact to revenue recognition and cost of revenues. The
Company is actively monitoring the impact to the results of its business operations, and may make decisions required by federal, state or local authorities, or that are determined to be in the best interests of its employees, customers, partners, suppliers and stockholders. As of the filing date, the extent to which the COVID-19 pandemic may impact the Company’s financial condition or results of operations remains uncertain.
i
Recently
Adopted Accounting Standards
In February 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-02, Leases (Topic 842) (ASU 2016-02), which requires lessees to recognize on the balance sheet a right-of-use asset, representing its right to use the underlying asset for the lease term, and a corresponding lease liability for all leases with terms greater than twelve months. The Company's leases consist primarily of operating leases for its offices and lab spaces. The Company does not have finance leases. The guidance also requires qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows
arising from leases. The Company adopted this standard on October 1, 2019 on a modified retrospective basis by applying the new standard to its lease portfolio as of October 1, 2019, while continuing to apply legacy guidance in the comparative periods. The adoption of this standard had no impact on the consolidated income statements and consolidated statements of cash flows. Refer to Note 8 - Leases for further discussion.
Upon adoption of the standard, the Company elected the package of three expedients for existing and expired contracts
to not reassess: the existence of additional leases, lease classification, or the treatment of initial direct costs. The Company also
applies the short-term lease exemption for leases with an original expected term of 12 months or less and expenses such leases month-to-month and does not record a right-of-use asset or lease liability. Short-term lease activity under the exception is not significant. Additionally, the Company does not separate lease and non-lease components in
the allocation of minimum lease payments for its office space and equipment leases, as such separation is not significant.
The Company includes in minimum lease payments, fixed and variable payments based on a rate or index, but excludes variable payments based on satisfying future benchmarks or actual future costs incurred; such amounts are expensed as incurred. To calculate the net present value, the Company applied an incremental borrowing rate. This incremental borrowing rate is determined using a portfolio approach based on the rate of interest the Company would pay to borrow an amount equal to the lease payments on a collateralized basis
over a similar term. Renewal options to extend lease terms are excluded from the minimum lease term at lease commencement.
Recently Issued Accounting Pronouncements
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (ASU 2016-13), which replaces the incurred loss impairment methodology in current GAAP with a methodology that reflects expected credit losses. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. The Company does not anticipate that the adoption of this standard
will have a material impact on its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40) (ASU 2018-15), which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software, and hosting arrangements that include an internal use software license. The accounting for the service element of a hosting arrangement that is a service contract is not affected by the amendments in this update. The new standard is effective for fiscal years,
and interim periods within those fiscal years, beginning after December 15, 2019. Early adoption is permitted. The Company does not anticipate that the adoption of this standard will have a material impact on its consolidated financial statements.
The table below shows significant movements in capitalized contract acquisition costs (current and noncurrent) for the nine months ended June 30, 2020 (in thousands):
Amortization
of capitalized contract acquisition costs was $i7.8 million and $i6.9 million
for the three months ended June 30, 2020 and 2019, respectively, and $i24.8 million and $i21.3 million
for the nine months ended June 30, 2020 and 2019, respectively, and is recorded in Sales and Marketing expense in the accompanying consolidated income statements. There was ino impairment of any capitalized contract acquisition costs during any period presented.
Timing may differ between the satisfaction of performance obligations and the invoicing and collection of amounts related to the Company's contracts with customers. The Company records assets for amounts related to performance obligations that are satisfied but not yet billed and/or collected, in addition to contracts that have started, but not yet been fully billed. These assets are recorded as contract assets rather than receivables when receipt of the consideration is conditional
on something other than the passage of time. Liabilities are recorded for amounts that are collected in advance of the satisfaction of performance obligations. These liabilities are classified as current and non-current deferred revenue.
As of June 30, 2020, contract
assets that are expected to be reclassified to receivables within the next 12 months are included in other current assets, with those expected to be transferred to receivables in more than 12 months included in other assets. There were no impairments of contract assets during the nine months ended June 30, 2020 and 2019.
The table below shows significant movements in the deferred revenue balances (current and noncurrent) for the nine months ended June 30, 2020 (in thousands):
The Company's contract assets and liabilities are reported in a net position on a contract
by contract basis at the end of each reporting period.
Remaining Performance Obligations
Remaining performance obligations represent the amount of the transaction price under contracts with customers that are attributable to performance obligations that are unsatisfied or partially satisfied at the reporting date. As of June 30, 2020, the total non-cancelable remaining performance obligations under the Company's contracts with customers was approximately $i1.3 billion
and the Company expects to recognize revenues on approximately i69.7% of these remaining performance obligations over the next 12 months, i18.9%
in year two, and the remaining balance thereafter.
See Note 12, Segment Information, for disaggregated revenue by significant customer and geographic region.
3. iFair Value Measurements
In accordance with the authoritative guidance on fair value measurements and disclosure under GAAP, the
Company determines fair value using a fair value hierarchy that distinguishes between market participant assumptions developed based on market data obtained from sources independent of the reporting entity, and the reporting entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances and expands disclosure about fair value measurements.
Fair value is the price that would be received to sell an asset or paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date, essentially the exit price.
The levels of fair value hierarchy are:
Level 1: Quoted prices in active markets for identical assets and liabilities at the measurement
date that the Company has the ability to access.
Level 2: Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Unobservable inputs for which there is little or no market data available. These inputs reflect management's assumptions of what market participants would use in pricing the asset or liability.
Level 1 investments are valued based on quoted market prices in active markets and include the Company's cash equivalent investments. Level 2 investments, which include investments that are valued based on quoted prices in markets that are not active, broker or dealer quotations, actual trade data, benchmark yields or alternative pricing sources with reasonable levels of price transparency, include the Company's certificates of deposit, corporate bonds and notes, municipal bonds and notes, U.S. government securities, U.S. government agency securities and international government securities. Fair values for the Company's level 2 investments are based
on similar assets without applying significant judgments. In addition, all of the Company's level 2 investments have a sufficient level of trading volume to demonstrate that the fair values used are appropriate for these investments.
A financial instrument's level within the fair value hierarchy is based upon the lowest level of any input that is significant to the fair value measurement. However, the determination of what constitutes "observable" requires significant judgment by the Company. The Company considers observable data to be market data which is readily available, regularly distributed or updated, reliable and verifiable, not proprietary, and provided
by independent sources that are actively involved in the relevant market.
i
The Company's financial assets measured at fair value on a recurring basis subject to the disclosure requirements at June 30, 2020, were as follows (in thousands):
Fair
Value Measurements at Reporting Date Using
Quoted Prices in Active Markets for Identical Securities (Level 1)
The Company's financial assets measured at fair value on a recurring basis subject to the disclosure requirements at September 30, 2019, were as follows (in thousands):
Fair
Value Measurements at Reporting Date Using
Quoted Prices in Active Markets for Identical Securities (Level 1)
Available-for-sale securities — certificates of deposits
i—
i249
i—
i249
Available-for-sale
securities — corporate bonds and notes
i—
i259,547
i—
i259,547
Available-for-sale
securities — municipal bonds and notes
i—
i12,129
i—
i12,129
Available-for-sale
securities — U.S. government securities
i—
i78,992
i—
i78,992
Available-for-sale
securities — U.S. government agency securities
i—
i22,146
i—
i22,146
Long-term
investments
Available-for-sale securities — corporate bonds and notes
i—
i298,916
i—
i298,916
Available-for-sale
securities — municipal bonds and notes
i—
i2,524
i—
i2,524
Available-for-sale
securities — U.S. government securities
i—
i5,515
i—
i5,515
Available-for-sale
securities — U.S. government agency securities
i—
i51,447
i—
i51,447
Total
$
i140,238
$
i884,869
$
i—
$
i1,025,107
The
Company uses the fair value hierarchy for financial assets and liabilities. The fair value of the Company's borrowings under its Term Loan Facility approximate the carrying value based on the borrowing rates currently available to the Company for loans with similar terms using Level 2 inputs. The carrying amounts of other current financial assets and other current financial liabilities approximate fair value due to their short-term nature.
The Company's non-financial assets and liabilities, which include goodwill, intangible assets, and long-lived assets, are not required to be carried at fair value on a recurring basis. These non-financial assets and liabilities
are measured at fair value on a non-recurring basis when there is an indicator of impairment, and they are recorded at fair value only when impairment is recognized. The Company reviews goodwill and intangible assets for impairment annually, during the second quarter of each fiscal year, or as circumstances indicate the possibility of impairment. The Company monitors the carrying value of long-lived assets for impairment whenever events or changes in circumstances indicate its carrying amount may not be recoverable. Included in the Company’s impairment considerations for non-financial assets and liabilities in the current quarter were the potential impacts of the COVID-19 pandemic. During the three and nine months
ended June 30, 2020 and 2019, the Company did not recognize any impairment charges related to goodwill, intangible assets, or long-lived assets.
4. iShort-Term
and Long-Term Investments
i
Short-term investments consist of the following (in thousands):
Interest
income from investments was $i2.2 million and $i5.8 million for the three months ended June 30, 2020 and 2019,
respectively, and $i11.1 million and $i20.2 million for the nine months ended June 30, 2020 and 2019,
respectively. Interest income is included in other income, net on the Company's consolidated income statements.
i
The following table summarizes investments that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for more than 12 months as of June 30, 2020 (in thousands):
The following table summarizes investments that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for more than 12 months as of September 30, 2019 (in thousands):
The
Company invests in securities that are rated investment grade. The Company reviews the individual securities in its portfolio to determine whether a decline in a security's fair value below the amortized cost basis is other-than-temporary. Gross unrealized losses were not deemed material as of June 30, 2020 and were primarily caused by global market disruptions resulting from the COVID-19 pandemic rather than credit risks associated with the respective issuers of the debt securities. The Company determined that as of June 30, 2020, there were no investments in its portfolio that were other-than-temporarily impaired as a result of the COVID-19 pandemic or other market conditions.
5.
iiBusiness Combinations/
Fiscal
Year 2020 Acquisition of Shape Security, Inc.
On December 19, 2019, the Company entered into a Merger Agreement (the "Merger Agreement") with Shape Security, Inc. ("Shape"), a provider of fraud and abuse prevention solutions. The transaction closed on January 24, 2020 with Shape becoming a wholly-owned subsidiary of F5.
Pursuant to the Merger Agreement, at the effective time of the acquisition, the capital stock of Shape and the vested outstanding and unexercised stock options in Shape were cancelled and converted to the right to receive approximately $i1.0
billion in cash, subject to certain adjustments and conditions set forth in the Merger Agreement, and the unvested stock options and restricted stock units in Shape held by continuing employees of Shape were assumed by F5, on the terms and conditions set forth in the Merger Agreement. Included in cash consideration was $i23.2 million of transaction costs paid by F5 on behalf of Shape. In addition, the Company incurred $i15.3
million of transaction costs associated with the acquisition which was included in General and Administrative expenses in the first and second fiscal quarters of 2020.
Shape is a leader in online fraud and abuse prevention, adding protection from automated attacks, botnets, and targeted fraud to F5's world-class portfolio of application services. As a result of the acquisition, the Company acquired all the assets and assumed all the liabilities of Shape. The goodwill related to the Shape acquisition is comprised primarily of expected synergies from combining operations and the acquired intangible assets that do not qualify for separate recognition. Goodwill related to the Shape acquisition is not expected to be deductible for tax purposes. The results of operations of Shape have been included in the
Company's consolidated financial statements from the date of acquisition.
The preliminary purchase price allocation is as follows (in thousands):
Estimated
Useful
Life
Assets acquired
Cash, cash equivalents, and restricted cash
$
i53,934
Fair
value of tangible assets:
Accounts receivable
i21,077
Deferred
tax assets
i24,619
Operating lease right-of-use assets
i29,644
Other
tangible assets
i22,571
Identifiable intangible assets:
Developed
technologies
i120,000
i7
years
Customer relationships
i21,000
i4
years
Trade name
i9,500
i5
years
Goodwill
i799,611
Total assets acquired
$
i1,101,956
Liabilities
assumed
Deferred revenue
$
(i39,000)
Operating
lease liabilities
(i30,773)
Other assumed liabilities
(i18,571)
Total
liabilities assumed
$
(i88,344)
Net assets acquired
$
i1,013,612
/
The
initial allocation of the purchase price was based on preliminary valuations and assumptions and is subject to change within the measurement period. The Company expects to finalize the allocation of the purchase price as soon as practicable and no later than one year from the acquisition date.
The developed technology intangible asset will be amortized on a straight-line basis over its estimated useful life of iseven years
and included in cost of net product revenues. The trade names and customer relationships intangible assets will be amortized on a straight-line basis over their estimated useful lives of ifive years and ifour
years, respectively, and included in sales and marketing expenses. The weighted average life of the amortizable intangible assets recognized from the Shape acquisition was i6.5 years as of January 24, 2020, the date the transaction closed. The estimated useful lives for the acquired intangible assets were based on the expected future cash flows associated with the respective asset.
Since the Shape acquisition was completed on January
24, 2020, the F5 and Shape teams have been executing a plan to integrate ongoing operations. The pro forma financial information, as well as the revenue and earnings generated by Shape, were not considered material to the Company's operations.
Fiscal Year 2019 Acquisition of Nginx, Inc.
On March 9, 2019, the Company entered into a Merger Agreement (the "Merger Agreement") with Nginx, Inc. ("NGINX"), a provider of open source web server software and application delivery solutions. The transaction closed on May 8, 2019 with NGINX becoming a wholly-owned subsidiary of F5.
Pursuant
to the Merger Agreement, at the effective time of the acquisition, the capital stock of NGINX and the vested outstanding and unexercised stock options in NGINX were cancelled and converted to the right to receive approximately $i643.2 million in cash, subject to certain adjustments and conditions set forth in the Merger Agreement, and the unvested stock options and restricted stock units in NGINX held by continuing employees of NGINX were assumed by F5, on the terms and conditions set forth in the Merger Agreement. Included in cash consideration was
$i19.0 million of transaction costs paid by F5 on behalf of NGINX. In addition, the Company incurred $i1.0
million of transaction costs associated with the acquisition which was included in General and Administrative expenses for fiscal 2019.
NGINX is an open source leader in application delivery. The combined company will enable multi-cloud application services across all environments, providing the ease-of-use and flexibility developers require while also delivering the scale, security, reliability and enterprise readiness network operations teams demand. As a result of the acquisition, the Company
acquired all the assets and assumed
all the liabilities of NGINX. The goodwill related to the NGINX acquisition is comprised primarily of expected synergies from combining operations and the acquired intangible assets that do not qualify for separate recognition. The results of operations of NGINX have been included in the Company's consolidated financial statements from the date of acquisition.
The purchase price allocation is as follows (in thousands):
Estimated
Useful
Life
Assets acquired
Cash and cash equivalents
$
i29,911
Fair
value of tangible assets:
Other tangible assets
i23,699
Identifiable
intangible assets:
Developed technologies
i62,500
i7
years
Customer relationships
i12,000
i15
years
Trade name
i14,500
i7
years
Non-competition agreements
i300
i2
years
Goodwill
i503,414
Total assets acquired
$
i646,324
Liabilities
assumed
Other assumed liabilities
$
(i9,116)
Total
liabilities assumed
$
(i9,116)
Net assets acquired
$
i637,208
The
measurement period for the NGINX acquisition lapsed during the third quarter of fiscal 2020. The Company reduced the carrying amount of goodwill by $i6.0 million to reflect an adjustment to consideration exchanged for the purchase of NGINX within the post-close measurement period. No other financial statement amounts were affected by this adjustment. The adjustment was not material to the current period or any of the previous period financial statements.
The
developed technology intangible asset will be amortized on a straight-line basis over its estimated useful life of iseven years and included in cost of net product revenues. The trade names and customer relationships intangible assets will be amortized on a straight-line basis over their estimated useful lives of iseven
years and ififteen years, respectively, and included in sales and marketing expenses. The weighted average life of the amortizable intangible assets recognized from the NGINX acquisition was i8.1
years as of May 8, 2019, the date the transaction closed. The estimated useful lives for the acquired intangible assets were based on the expected future cash flows associated with the respective asset. Tax deductible goodwill based on the Company's preliminary calculation is $i490.3 million.
Since
the NGINX acquisition was completed on May 8, 2019, the F5 and NGINX teams have been executing a plan to integrate ongoing operations.
6. iBalance Sheet Details
Cash, Cash Equivalents and Restricted Cash
i
The
following table provides a reconciliation of the Company's cash and cash equivalents and restricted cash reported within the consolidated balance sheets that sum to the total cash, cash equivalents and restricted cash shown in the Company's consolidated statements of cash flows for the periods presented (in thousands):
In connection with the acquisition of Shape, on January 24, 2020, the Company 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 $i400.0 million (the "Term Loan Facility"). The proceeds from the Term Loan Facility were primarily used to finance the acquisition of Shape and related expenses. In connection with the Term Loan Facility, the Company incurred $i2.2
million in debt issuance costs, which are recorded as a reduction to the carrying value of the principal amount of the debt.
Borrowings under the Term Loan Facility bear interest at a rate equal to, at the Company's option, (a) LIBOR, adjusted for customary statutory reserves, plus an applicable margin of i1.125% to i1.75%
depending on the Company's leverage ratio, or (b) an alternate base rate determined in accordance with the Term Credit Agreement, plus an applicable margin of i0.125% to i0.750%
depending on the Company's leverage ratio. Interest on the outstanding principal of borrowings is currently due quarterly in arrears. As of June 30, 2020, the margin for LIBOR-based loans was i1.125% and the margin for alternate base rate loans was i0.125%.
The
Term Loan Facility matures on January 24, 2023 with quarterly installments (commencing with the first full fiscal quarter ended after January 24, 2020) equal to i1.25% of the original principal amount of the Term Loan Facility. The remaining outstanding principal of borrowings under the Term Loan Facility is due upon maturity on January 24, 2023. Borrowings under the Term Loan Facility may be voluntarily prepaid, in whole
or in part, without penalty or premium. Borrowings repaid or prepaid under the Term Loan Facility may not be reborrowed.
Among certain affirmative and negative covenants provided in the Term Credit Agreement, there is a financial covenant that requires the Company 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 its outstanding principal borrowings on the Term Loan Facility in future periods, depending on the Company's performance. As of June 30, 2020, the Company was in
compliance with all covenants.
As of June 30, 2020, $i395.0 million of principal amount under the Term Loan Facility was outstanding, excluding unamortized debt issuance costs of $i1.9
million. The weighted average interest rate on the principal amount under the Term Loan Facility outstanding balance was i2.452% for the period ending June 30, 2020. iThe
following table presents the scheduled principal maturities as of June 30, 2020 (in thousands):
Fiscal Years Ending September 30:
Amount
2020 (remainder)
$
i—
2021
i20,000
2022
i20,000
2023
i355,000
Total
$
i395,000
Revolving
Credit Agreement
On January 31, 2020, the Company 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 $i350.0 million (the "Revolving Credit Facility"). The
Company has the option to increase commitments under the Revolving Credit Facility from time to time, subject to certain conditions, by up to $i150.0 million. Borrowings under the Revolving Credit Facility bear interest at a rate equal to, at the Company's option, (a) LIBOR, adjusted for customary statutory reserves, plus an applicable margin of i1.125%
to i1.75% depending on the Company's leverage ratio, or (b) an alternate base rate determined in accordance with the Revolving Credit Agreement, plus an applicable margin of i0.125%
to i0.750% depending on the Company's leverage ratio. The Revolving Credit Agreement also requires payment of a commitment fee calculated at a rate per annum of i0.125%
to i0.300% depending on the Company's leverage ratio on the undrawn portion of the Revolving Credit Facility. Amounts incurred during the three months ended June 30, 2020 were not material.
The Revolving Credit Facility matures on January 31, 2025, upon which any remaining outstanding principal of borrowings under the Revolving
Credit Facility is due. The Company has the option to request up to itwo extensions of the maturity date in each case for an additional period of ione
year. Among certain affirmative and negative covenants provided in the Revolving Credit Agreement, there is a financial covenant that requires the Company to maintain a leverage ratio, calculated as of the last day of each fiscal quarter, of consolidated total indebtedness to consolidated EBITDA. As of June 30, 2020, the Company was in compliance with all covenants. As of June 30, 2020, there were ino
outstanding borrowings under the Revolving Credit Facility, and the Company had available borrowing capacity of $i350.0 million.
During the first quarter of fiscal 2020, the Company adopted ASU 2016-02, Leases (Topic 842) (the "Leasing Standard") using the transition method provided in ASU 2018-11, Leases (Topic 842): Targeted Improvements. The impact of adopting the Leasing Standard resulted in
the recognition of right-of-use assets and lease liabilities of $i304.8 million and $i386.4 million, respectively, on October 1, 2019, the date
of adoption.
The majority of the Company's operating lease payments relate to its corporate headquarters in Seattle, Washington, which includes approximately i515,000 square feet of office space. The lease commenced in April 2019 and expires in 2033 with an option for renewal. The Company has concluded that the renewal option is not yet likely
to be exercised. The Company also leases additional office and lab space for product development and sales and support personnel in the United States and internationally. The Company's lease agreements do not contain any material residual value guarantees or material restrictive covenants.
i
The components of the Company's operating lease expenses for the
three and nine months ended June 30, 2020 were as follows (in thousands):
Variable
lease expense primarily consists of common area maintenance and parking expenses. The Company executed two sublease contracts that commenced during the first quarter of fiscal year 2020. Lease income payments commenced in the second fiscal quarter. The Company has three additional subleases through the Q2 2020 acquisition of Shape Security.
i
Supplemental
balance sheet information related to the Company's operating leases was as follows (in thousands, except lease term and discount rate):
Operating lease liabilities above do not include sublease income. As of June 30, 2020, the Company expects to receive sublease income of approximately $i11.4 million, which consists of $i1.1
million to be received for the remainder of fiscal 2020 and $i10.3 million to be received over the three fiscal years thereafter.
As of June 30, 2020, the Company had no significant operating leases that were executed but not yet commenced.
ASC 840 - Leases
As
a result of adopting the Leasing Standard, reporting periods beginning in the first quarter of fiscal 2020 are presented under the new standard while prior period amounts are not adjusted and continue to be reported in accordance with ASC 840 - Leases.
i
Prior to the adoption of the Leasing Standard, future minimum operating lease payments, net of sublease income, were as follows as of September 30, 2019 (in thousands):
Fiscal
Year
Gross Lease Payments
Sublease Income
Net Lease Payments
2020
$
i54,046
$
i683
$
i53,363
2021
i50,712
i1,051
i49,661
2022
i47,550
i1,082
i46,468
2023
i36,514
i368
i36,146
2024
i33,971
i—
i33,971
Thereafter
i242,826
i—
i242,826
$
i465,619
$
i3,184
$
i462,435
/
9.
iCommitments and Contingencies
Guarantees and Product Warranties
In the normal course of business to facilitate sales of its products, the Company indemnifies other parties, including customers, resellers, lessors, and parties to other transactions with the Company, with respect to certain
matters. The Company has agreed to hold the other party harmless against losses arising from a breach of representations or covenants, or out of intellectual property infringement or other claims made against certain parties. These agreements may limit the time within which an indemnification claim can be made and the amount of the claim. The Company has entered into indemnification agreements with its officers and directors and certain other employees, and the Company's bylaws contain similar indemnification obligations to the Company's
agents. It is not possible to determine the maximum potential amount under these indemnification agreements due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement.
The Company generally offers warranties of ione year for hardware for those customers without service contracts, with the option of purchasing additional warranty coverage in yearly increments.
The Company accrues for warranty costs as part of its cost of sales based on associated material product costs and technical support labor costs. Accrued warranty costs as of June 30, 2020 and September 30, 2019 were not material.
Commitments
As of June 30, 2020, the Company's principal commitments consisted of borrowings under the Term Loan Facility and obligations outstanding under operating leases. Refer to Note 7 for the scheduled principal maturities of the Term Loan Facility as of June 30, 2020.
The
Company leases its facilities under operating leases that expire at various dates through 2033. There have been no material changes in the Company's lease obligations compared to those discussed in Note 11 to its annual consolidated financial statements.
The Company currently has arrangements with contract manufacturers and other suppliers for the manufacturing of its products. The arrangement with the primary contract manufacturer allows them to procure component inventory on the Company's
behalf based on a rolling production forecast provided by the Company. The Company is obligated to the purchase of component inventory that the contract manufacturer procures in accordance with the forecast, unless it gives notice of order cancellation in advance of applicable lead times. There have been no material changes in the Company's inventory purchase obligations compared to those discussed in Note 11 to its annual consolidated financial statements.
On June 8, 2020, Lynwood Investment CY Limited (“Lynwood”) filed a lawsuit in the United States District Court for the Northern District of California against the Company along with several other named defendants, including NGINX, Inc. (BVI), NGINX Software, Inc., NGINX, Inc. (DE), and BV NGINX, LLC. In its complaint, Lynwood claims to be the assignee of all rights and interests of Rambler Internet Holding LLC (“Rambler”), and alleges that the intellectual property in the NGINX software originally released by the co-founder of NGINX in 2004 belongs to Rambler (and therefore Lynwood, by assignment) because the software was created and developed while the co-founder was employed by Rambler. Lynwood
asserts various causes of action, including copyright infringement, violation of trademark law, tortious interference, and fraud. The complaint seeks damages, disgorgement of profits, fees and costs, declarations of copyright and trademark ownership, trademark cancellations, and injunctive relief.
In addition to the above matter, the Company is subject to a variety of legal proceedings, claims, investigations, and litigation arising in the ordinary course of business, including intellectual property litigation. Management believes that the Company has meritorious defenses to the allegations made in its pending cases and intends to vigorously defend these lawsuits; however, the
Company is unable currently to determine the ultimate outcome of these or similar matters or the potential exposure to loss, if any. There are many uncertainties associated with any litigation and these actions or other third-party claims against the Company may cause it to incur costly litigation and/or substantial settlement charges that could have a material adverse effect on the Company's business, financial condition, results of operations, and cash flows.
The Company records an accrual for loss contingencies for legal proceedings when it believes that an unfavorable outcome is both (a) probable and (b) the amount or range of any possible loss is reasonably
estimable. The Company has not recorded any accrual for loss contingencies associated with such legal proceedings or the investigations discussed above.
10. iIncome Taxes
The Company's tax provision for interim
periods is determined using an estimated annual effective tax rate, adjusted for discrete items in the related period.
The effective tax rate was i20.4% and i23.1%
for the three and nine months ended June 30, 2020, respectively, compared to i20.1% and i21.3% for the
three and nine months ended June 30, 2019, respectively. The increase in the effective tax rate for the three and nine months ended June 30, 2020 as compared to the three and nine months ended June 30, 2019 is primarily due to the tax impact from stock-based compensation and other non-deductible expenses related to the acquisition of Shape Security, Inc., partially offset by a change in unrecognized tax benefits.
At June 30, 2020, the Company had $i41.1
million of unrecognized tax benefits that, if recognized, would affect the effective tax rate. It is anticipated that the Company’s existing liabilities for unrecognized tax benefits will change within the next twelve months due to audit settlements or the expiration of statutes of limitations. The Company does not expect these changes to be material to the consolidated financial statements. The Company recognizes interest and, if applicable, penalties for any uncertain tax positions as a component of income tax expense.
The Company and its subsidiaries
are subject to U.S. federal income tax as well as the income tax of multiple state and foreign jurisdictions. The Company has concluded all U.S. federal income tax matters for fiscal years through September 30, 2016. Major jurisdictions where there are wholly owned subsidiaries of F5 Networks, Inc. which require income tax filings include the United Kingdom, Japan, Singapore, Australia, and Israel. The earliest periods open for review by local taxing authorities are fiscal years 2018 for the United Kingdom, 2014 for Japan, 2015 for Singapore, 2016 for Australia, and 2013 for Israel. The Company is currently under audit by various states for fiscal years 2015
through 2018 and by Israel for fiscal years 2013 to 2017. Within the next four fiscal quarters, the statute of limitations will begin to close on fiscal years 2015 and 2016 state income tax returns and fiscal years 2014 to 2018 foreign income tax returns.
Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted average number of common and dilutive common stock equivalent shares outstanding during the period. The Company's nonvested restricted units do not have nonforfeitable rights to dividends or dividend equivalents and are not considered participating securities that should be included in the computation of earnings per share under the two-class method.
i
The
following table sets forth the computation of basic and diluted net income per share (in thousands, except per share data):
Dilutive
effect of common shares from stock options and restricted stock units
i437
i215
i351
i409
Weighted
average shares outstanding — diluted
i61,415
i60,196
i61,182
i60,372
Basic
net income per share
$
i1.15
$
i1.43
$
i3.78
$
i5.55
Diluted
net income per share
$
i1.14
$
i1.43
$
i3.76
$
i5.51
/
Anti-dilutive stock-based
awards excluded from the calculations of diluted earnings per share were immaterial for the three and nine months ended June 30, 2020 and 2019.
12. iSegment Information
Operating segments are defined as components of an enterprise for which separate financial information
is available and evaluated regularly by the chief operating decision-maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Management has determined that the Company is organized as, and operates in, ione reportable operating segment: the development, marketing and sale of application services that optimize the security, performance and availability of network applications, servers and storage systems.
Revenues
by Geographic Location and Other Information
The Company does business in ithree main geographic regions: the Americas (primarily the United States); Europe, the Middle East, and Africa (EMEA); and the Asia Pacific region (APAC). The Company's chief operating decision-maker reviews financial information presented on a consolidated basis accompanied
by information about revenues by geographic region. The Company's foreign offices conduct sales, marketing and support activities. Revenues are attributed by geographic location based on the location of the customer.
In December 2019, the Company initiated a restructuring plan to match strategic and financial objectives and optimize resources for long term growth, including a reduction in force program affecting approximately i75 employees.
The Company recorded a restructuring charge of $i7.8 million in the first quarter of fiscal 2020. The Company does not expect to record any significant future charges related to the restructuring plan.
i
During
the nine months ended June 30, 2020, the following activity was recorded (in thousands):
Item 2.Management's Discussion and Analysis of Financial Condition and Results of Operations
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 the Securities 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 services 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 the Americas (primarily the United States); Europe, the Middle East, and Africa (EMEA); and the Asia Pacific region (APAC). Enterprise customers (Fortune 1000 or Business Week Global 1000 companies) in the technology, telecommunications, financial services, transportation, education, manufacturing and healthcare 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 delivery controller (ADC) 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 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. We are also monitoring the uncertainty related to the impacts that the COVID-19 pandemic has on the global economy and our customer base.
•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,
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, and the uncertainty surrounding the COVID-19 pandemic and its potential impacts to our supply chain 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 nine months of fiscal year 2020 was primarily due to $955.6 million in cash paid for the acquisition of Shape in the second quarter of fiscal 2020, partially offset by cash provided by operating activities of $485.0 million. Going forward, we believe the primary driver of cash flows will be net income from operations. Capital expenditures of $47.9 million for the first nine months of fiscal year 2020 were primarily related to the expansion of our facilities to support our operations worldwide as well as investments in information technology
infrastructure and equipment purchases to support our core business activities. 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, 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 June 30, 2020, 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 remained relatively flat in the third quarter of fiscal year 2020 from the prior quarter. Our days sales outstanding at the end of the third quarter of fiscal year 2020 was 47. 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.
Except for the accounting policies for leases that were updated as a result of adopting ASC Topic 842, 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 ended September 30, 2019. Refer to the
"Recently Adopted Accounting Standards" section of Note 1 and Note 8 - Leases in this Quarterly Report on Form 10-Q for a summary of the new accounting policies under ASC Topic 842.
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.
While our analysis shows COVID-19 did not have a significant impact on our results of operations for the quarter ended June 30, 2020, the impacts of the global
pandemic on our business and financial outlook are currently unknown. 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, 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.
Net
revenues. Total net revenues increased 3.5% and 5.1% for the three and nine months ended June 30, 2020, respectively, from the comparable periods in the prior year. Overall revenue growth for the three and nine months ended June 30, 2020, was primarily due to increased software product revenue including our subscription-based software products and increased service revenues as a result of our increased installed base of products. International revenues represented 46.9% and 48.9% of total net revenues for the three and nine months ended June 30, 2020, respectively, compared to 51.5% and 50.4% for the same periods in the prior year, respectively.
Net product revenues increased 1.8% and 3.7% for the three and nine months ended June 30,
2020, respectively, from the comparable periods on the prior year. The increase in net product revenues for the three and nine months ended June 30, 2020 was primarily due to an increase in software product sales compared to the same periods in the prior year.
Net service revenues increased 4.9% and 6.1% for the three and nine months ended June 30, 2020, respectively, from the comparable periods in the prior year. The increase in net service revenues was primarily due to increases in the purchase or renewal of maintenance contracts driven by additions to our installed base of products.
The following distributors of our products accounted for more than 10% of total net revenue:
Percentage of net revenues and gross profit (as a percentage of related net revenue)
Products
22.7
%
17.8
%
20.4
%
18.1
%
Services
14.7
14.8
14.5
14.5
Total
18.2
16.1
17.0
16.1
Gross
profit
81.8
%
83.9
%
83.0
%
83.9
%
Cost of net product revenues. Cost of net product revenues consist of finished products purchased from our contract manufacturers, manufacturing overhead, freight, warranty, provisions for excess and obsolete inventory and amortization expenses in connection
with developed technology from acquisitions. Cost of net product revenues increased $13.1 million and $22.3 million, or 29.5% and 17.2% for the three and nine months ended June 30, 2020, respectively, from the comparable periods in the prior year. The increase in cost of net product revenues was primarily due to software product revenue growth for the three and nine months ended June 30, 2020 from the comparable periods in the prior year.
Cost of net service revenues. Cost of net service revenues consist of the salaries and related benefits of our professional services staff, travel, facilities and depreciation expenses. For the three and nine months ended June 30, 2020, cost of net service revenues as a percentage of net service revenues was 14.7% and
14.5%, respectively, compared to 14.8% and 14.5% for the comparable periods in the prior year, respectively. Professional services headcount at the end of June 2020 increased to 950 from 926 at the end of June 2019.
Operating
expenses (as a percentage of net revenue)
Sales and marketing
36.3
%
34.8
%
35.9
%
32.1
%
Research and development
19.9
20.7
18.5
18.5
General
and administrative
10.6
10.2
11.2
8.9
Restructuring charges
—
—
0.4
—
Total
66.8
%
65.7
%
66.0
%
59.5
%
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 $16.0 million and $91.7 million, or 8.1% and 17.3% for the three and nine months ended June 30, 2020, respectively, from the comparable periods in the prior year. The increase in sales and marketing expense was primarily due to an increase of $15.8 million and $53.5 million in personnel costs for the three and nine months ended June 30, 2020, respectively, from the comparable periods in the prior year. Sales and marketing for the nine months ended June 30, 2020 also included an increase in
commissions of $11.6 million from the comparable period in the prior year. The increase in sales and marketing expenses for the three and nine months ended June 30, 2020 was partially offset by a decrease in travel and entertainment expenses primarily due to company-wide travel restrictions as a result of the COVID-19 pandemic. Sales and marketing headcount at the end of June 2020 increased to 2,386 from 2,092 at the end of June 2019. Sales and marketing expenses included stock-based compensation expense of $21.8 million and $66.2 million for the three and nine
months ended June 30,
2020, respectively, compared to $17.8 million and $49.6 million for the same periods in the prior year, respectively.
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 decreased $0.9 million and increased $15.8 million, or decreased 0.8% and increased 5.2% for the three and nine months ended June 30, 2020, respectively, from the comparable periods in the prior year. The change in research and development expense was primarily due to a decrease of $5.3 million and an increase of $6.3 million in personnel costs for the three and nine months ended June 30,
2020, respectively, from the comparable periods in the prior year. Research and development expenses for the nine months ended June 30, 2020 also included an increase of $3.4 million in facilities costs from the comparable period in the prior year, primarily due to the move of our corporate headquarters which began in April 2019. Research and development headcount at the end of June 2020 increased to 1,771 from 1,492 at the end of June 2019. Research and development expenses included stock-based compensation expense of $13.1 million and $36.9 million for the three and nine months ended June 30, 2020, respectively, compared to $10.0 million and $30.6 million for the same periods in the prior year, respectively.
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 $4.7 million and $48.5 million, or 8.1% and 33.1% for the three and nine months ended June 30, 2020, respectively, from the comparable periods in the prior year. The increase in general and administrative expenses for the nine months ended June 30, 2020 was primarily due to an increase of $19.7 million in fees paid to outside consultants for legal, accounting and tax services, from the comparable period in the prior year. For the three and nine months ended June 30, 2020, personnel costs increased $3.4 million and $13.7 million, respectively, from the comparable periods in the prior year
due to growth in general and administrative headcount, including employees from the acquisitions of NGINX and Shape. General and administrative expenses for the nine months ended June 30, 2020 also included an increase in facilities cost of $3.0 million from the comparable period in the prior year, primarily due to the move of our corporate headquarters which began in April 2019. General and administrative headcount at the end of June 2020 increased to 679 from 581 at the end of June 2019. General and administrative expenses included stock-based compensation expense of $9.2 million and $28.0 million for the three and nine months ended June 30, 2020, respectively, compared to $8.1 million and $23.8 million for the same periods in the prior year, respectively.
Restructuring charges. In the first fiscal
quarter of 2020, 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 $7.8 million related to a reduction in workforce that is reflected in our results for the nine months ended June 30, 2020. There were no restructuring expenses recorded in fiscal 2019.
Other
income and income taxes (as percentage of net revenue)
Income from operations
15.0
%
18.2
%
16.9
%
24.4
%
Other
income, net
—
0.8
0.3
1.2
Income before income taxes
15.0
19.0
17.2
25.6
Provision
for income taxes
3.0
3.8
4.0
5.5
Net income
12.0
%
15.2
%
13.2
%
20.1
%
Other
income, net. Other income, net consists primarily of interest income and expense and foreign currency transaction gains and losses. The decrease in other income, net for the three and nine months ended June 30, 2020 was primarily due to a decrease in interest income of $3.6 million and $9.1 million, respectively, from our investments compared to the same periods in the prior year. In addition, interest expense increased $2.6 million and $4.9 million for the three and nine months ended June 30, 2020 compared to the same periods in the prior year.
Provision
for income taxes. The effective tax rate was 20.4% and 23.1% for the three and nine months ended June 30, 2020, respectively, compared to 20.1% and 21.3% for the three and nine months ended June 30, 2019, respectively. The increase in the effective tax rate for the three and nine months ended June 30, 2020 as compared to the three and nine months ended June 30, 2019 is primarily due to the tax impact from stock-based compensation and other non-deductible expenses related to the acquisition of Shape Security, Inc., partially offset by a change in unrecognized tax benefits.
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 June 30, 2020 and September 30, 2019 were $47.5 million and $27.4 million, respectively. The net deferred tax assets include valuation allowances of $31.0 million and $23.5 million as of June 30, 2020 and September 30, 2019, 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, 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 $1,206.5 million as of June 30, 2020, compared to $1,330.7 million as of September 30, 2019, representing a decrease of $124.2 million. The decrease was primarily due to $955.6 million in cash paid for the acquisition of Shape in the second quarter of fiscal 2020, partially offset by cash provided by operating activities of $485.0 million for the nine months ended June 30, 2020. Cash provided by operating activities for the first nine months of fiscal year 2020 resulted from net income of $229.8 million combined with changes in operating assets and liabilities, as adjusted for various non-cash items including stock-based compensation, deferred revenue, depreciation and amortization charges.
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 II, Item 1A titled “Risk Factors”. 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 $762.8 million for the nine months ended June 30, 2020, compared to cash used in investing activities of $120.6 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 nine months ended June 30,
2020 was primarily the result of $955.6 million in cash paid for the acquisition of Shape, along with capital expenditures related to the build-out of our new corporate headquarters and the purchase of investments, partially offset by the maturity and sale of investments.
Cash provided by financing activities was $394.0 million for the nine months ended June 30, 2020, compared to cash used in financing activities of $155.6 million for the same period in the prior year. Our financing activities for the nine months ended June 30, 2020 primarily consisted of $400.0 million in cash proceeds from a term loan as well as cash received from the exercise of employee stock options and stock purchases under our employee stock purchase plan of $52.0 million, partially offset by $50.0 million in cash used to repurchase common stock under
our share repurchase program and $5.0 million in cash used to make a principal payment on our term loan.
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 June 30, 2020, 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 June 30, 2020, 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 June 30, 2020, $395.0 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 for the scheduled principal maturities of the Term Loan Facility
as of June 30, 2020.
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, 2019.
We outsource the manufacturing of our pre-configured hardware platforms to contract manufacturers who assemble each product to our specifications. Our agreement with our largest contract manufacturer allows them to procure
component inventory on our behalf based upon a rolling production forecast. We are contractually obligated to purchase the component inventory in accordance with the forecast, unless we give notice of order cancellation in advance of applicable lead times.
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.
Item 3.Quantitative and Qualitative Disclosures About Market Risk
Interest
Rate Risk. We maintain an investment portfolio of various holdings, types, and maturities. Our primary objective for holding fixed income securities is to achieve an appropriate investment return consistent with preserving principal and managing risk. At any time, a sharp rise in market interest rates could have a material adverse impact on the fair value of our fixed income investment portfolio. Conversely, declines in interest rates, including the impact from lower credit spreads, could have a material adverse impact on interest income for our investment portfolio. Our fixed income investments are held for purposes other than trading. Our fixed income investments were not leveraged as of June 30, 2020. We monitor our interest rate and credit risks, including our credit exposures to specific rating categories and to individual issuers. As of June 30,
2020, 37.3% of our fixed income securities balance consisted of U.S. government and U.S. government agency securities. We believe the overall credit quality of our portfolio is strong.
Refer to Note 7 for information on our recent borrowings under the Term Loan Facility. Borrowings under the Term Loan Facility bear interest at a rate equal to, at our option, (a) LIBOR, adjusted for customary statutory reserves, plus an applicable margin of 1.125% to 1.75% depending on our leverage ratio, or (b) an alternate base rate determined in accordance with the Term Credit Agreement, plus an applicable margin of 0.125% to 0.750% depending on our leverage ratio.
The Term Loan Facility requires us to maintain a leverage ratio financial covenant, 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. At any time, a sharp rise in market interest rates could have a material adverse impact on the interest payable on outstanding principal borrowings on our Term Loan Facility. We monitor our interest rate and credit risks, which include the effect that the COVID-19 pandemic may have on interest rates on principal borrowings under the Term Loan Facility. As of June 30, 2020, we have not noted any adverse impacts to interest rates that would have a material impact to interest owed on principal borrowings.
Foreign Currency Risk. The majority of our sales and expenses are denominated in U.S. dollars and as a result, we have not experienced
significant foreign currency transaction gains and losses to date.
Management believes there have been no material changes to our quantitative and qualitative disclosures about market risk during the nine month period ended June 30, 2020, compared to those discussed in our Annual Report on Form 10-K for the year ended September 30, 2019, other than market risk that is created by the global market disruptions and uncertainties resulting from the COVID-19 pandemic. See the section “Risk Factors” for further discussion of the possible impact to our business.
Our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")) are designed to ensure that required information is properly recorded, processed, summarized and reported within the required timeframe, as specified in the rules set forth by the SEC. Our disclosure controls and procedures are also designed to ensure that information required to be disclosed is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure
controls and procedures as of June 30, 2020. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of June 30, 2020.
Changes in Internal Control over Financial Reporting
During the third quarter of fiscal 2020, there were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) or 15d-15(f) of the Exchange Act) that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Although the entire global F5 workforce is working remotely as a result of the COVID-19 pandemic, there were no material changes to our existing internal controls over
financial reporting as a result of this.
PART II — OTHER INFORMATION
Item 1.Legal Proceedings
See Note 9 - Commitments and Contingencies of the Notes to Financial Statements (Part I, Item 1 of this Form 10-Q) for information regarding legal proceedings in which we are involved.
Item 1A.Risk Factors
The following information updates, and should be
read in conjunction with, the information discussed in Part I, Item 1A. "Risk Factors" in our Annual Report on Form 10-K for the fiscal year ended September 30, 2019. The risks discussed below and in our Annual Report on Form 10-K could materially affect our business, financial condition and future results. These are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be insignificant also may materially and adversely affect our business, financial condition or operating results in the future.
The effects of a pandemic or widespread health epidemic such as the coronavirus outbreak could have a material adverse effect on our business and results of operations
In March 2020, the World Health Organization declared COVID-19 a global pandemic. The impact on the
global population and the duration of the COVID-19 pandemic is difficult to assess or predict and depends on numerous evolving factors that we may not be able to accurately predict or effectively respond to, including, without limitation: the duration and scope of the outbreak; actions taken by governments, businesses, and individuals in response to the outbreak; the effect on economic activity and actions taken in response.
The impact of the COVID-19 pandemic on our operations is not yet certain, which may or may not adversely disrupt or impact, and is not limited to the following areas: customer demand for our products and services, reductions in customer spend, delayed or the inability to collect from our customers, disruptions to our supply chain that could result in delays, shortages or increased costs of our products, disruptions to our operations in servicing our customers as a result of working remotely or business
location closures, which all may adversely impact our business, results of operations and overall financial performance in future periods.
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds
On October 31, 2018, the Company announced that its Board of Directors authorized an additional $1.0 billion for its common stock share repurchase program. This new authorization is incremental to the existing $4.4 billion program, initially approved in October 2010 and expanded in each fiscal year. Acquisitions for the share repurchase programs will be made from time to time in private transactions or
open market purchases as permitted by securities laws and other legal requirements. The Company did not repurchase and retire any shares during the three months ended June 30, 2020.
XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
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 on this 5th day of August, 2020.
