F5 10-Q 2022-12-31

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended December 31, 2022

OR

For the transition period from to

Commission File Number 000-26041

F5, INC.

(Exact name of registrant as specified in its charter)

801 5th Avenue

Seattle, Washington 98104

(Address of principal executive offices and zip code)

(206) 272-5555

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ 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). Yes ☑ 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):

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 ☐ No ☑

The number of shares outstanding of the registrant’s common stock as of January 27, 2023 was 60,120,642.

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F5, INC.

QUARTERLY REPORT ON FORM 10-Q

For the Quarter Ended December 31, 2022

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PART I. FINANCIAL INFORMATION

F5, INC.

CONSOLIDATED BALANCE SHEETS

(unaudited, in thousands)

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

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F5, INC.

CONSOLIDATED INCOME STATEMENTS

(unaudited, in thousands, except per share amounts)

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

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F5, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited, in thousands)

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

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F5, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY

(unaudited, in thousands)

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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 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 the Americas; 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 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. Our revenue is derived from the sales of both global services and products. Our global services revenue includes annual maintenance contracts, training and consulting services. The majority of our product revenues are derived from sales of our application security and delivery solutions including our BIG-IP software and systems, F5 NGINX software, and our F5 Silverline offerings. Our BIG-IP software solutions are sold both on a perpetual license and a subscription basis. We sell F5 NGINX on a subscription basis. Our Silverline solution is a managed services offering, also sold on a subscription basis. During our fiscal year 2022, we launched F5 Distributed Cloud Services. F5 Distributed Cloud Services provides security, multi-cloud networking, and edge-based computing solutions, encompassing software solutions from what were previously branded as our Shape, Volterra, and Silverline product offerings. F5 Distributed Cloud Services are offered on a subscription basis, under a unified software-as-a-service ("SaaS") platform.

We monitor the sales mix of our revenues within each reporting period. We believe customer acceptance rates of our new products, feature enhancements and consumption models are indicators of future trends. We also consider overall revenue concentration by geographic region as an additional indicator of current and future trends. Toward the end of fiscal 2022, and continuing through the first quarter of fiscal 2023, we saw changes in customer buying patterns due to the uncertain macroeconomic environment. We will continue to closely monitor the macroeconomic environment and its impacts on our business.

• 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. In addition, 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.

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• 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 2023 was primarily due to cash used for the voluntary prepayment of the Term Loan Facility, including the outstanding principal balance of $350.0 million, and all accrued, but unpaid interest outstanding of $3.0 million. In addition, $40.0 million of cash was used for the repurchase of outstanding common stock in the first quarter of fiscal 2023. The decrease in cash and investments for the first quarter of fiscal 2023 was partially offset by cash provided by operating activities of $157.6 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, 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, 2022, 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 2023 due to the growth of our subscriptions business. Our days sales outstanding for the first quarter of fiscal year 2023 was 62. 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 ended September 30, 2022. 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.

Impact of Current Macroeconomic Conditions

Our overall performance depends in part on worldwide economic and geopolitical conditions and their impacts on customer behavior. Worsening economic conditions, including inflation, higher interest rates, slower growth, fluctuations in foreign exchange rates, and developments related to the COVID-19 pandemic, and other changes in economic conditions, may adversely affect our results of operations and financial performance. For further discussion of the potential impacts of recent macroeconomic events on our business, financial condition, and operating results, see Part 1, Item 1A, "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended September 30, 2022.

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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 1.9% for the three months ended December 31, 2022, from the comparable period in the prior year. Overall revenue growth for the three months ended December 31, 2022, was primarily due to an increase in service revenue as a result of our increased installed base of products. Revenues outside of the United States represented 46.4% of total net revenues for the three months ended December 31, 2022, compared to 44.5% for the same period in the prior year.

Net Product Revenues. Net product revenues remained relatively flat for the three months ended December 31, 2022, from the comparable period in the prior year.

The following presents net product revenues by systems and software (in thousands):

Net Service Revenues. Net service revenues increased 4.6% for the three months ended December 31, 2022, from the comparable period in the prior year. The increase in service revenue was the result of increased purchases or renewals of maintenance contracts driven by additions to our installed base of products. In addition, we are starting to see the benefits of price increases put in place in fiscal 2022.

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The following distributors of our products accounted for more than 10% of total net revenue:

The following distributors of our products accounted for more than 10% of total receivables:

No other distributors accounted for more than 10% of total net revenue or receivables.

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 $17.2 million, or 21.1% for the three months ended December 31, 2022, from the comparable period in the prior year. The increase in cost of net product revenues was primarily due to software product revenue growth. In addition, cost of product revenues increased due to component cost increases, expedite fees, and other sourcing-related costs in the first quarter of fiscal 2023, from the comparable period in the prior year.

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 ended December 31, 2022, cost of net service revenues as a percentage of net service revenues was 15.6%, compared to 15.5% for the comparable period in the prior year. Professional services headcount at the end of December 2022 increased to 1,082 from 1,037 at the end of December 2021.

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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 remained relatively flat for the three months ended December 31, 2022, from the comparable period in the prior year. Sales and marketing headcount at the end of December 2022 increased to 2,490 from 2,430 at the end of December 2021. Sales and marketing expenses included stock-based compensation expense of $25.7 million for the three months ended December 31, 2022, compared to $26.8 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 $12.1 million, or 9.3% for the three months ended December 31, 2022, from the comparable period in the prior year. For the three months ended December 31, 2022, personnel costs increased $11.8 million from the comparable period in the prior year due to growth in research and development headcount. Research and development headcount at the end of December 2022 increased to 2,165 from 1,947 at the end of December 2021. Research and development expenses included stock-based compensation expense of $18.5 million for the three months ended December 31, 2022, compared to $18.6 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 $4.3 million, or 6.6% for the three months ended December 31, 2022, from the comparable period in the prior year. For the three months ended December 31, 2022, personnel costs increased $4.7 million, from the comparable period in the prior year due to growth in general and administrative headcount. General and administrative headcount at the end of December 2022 increased to 959 from 856 at the end of December 2021. General and administrative expenses included stock-based compensation expense of $11.0 million for the three months ended December 31, 2022, compared to $10.9 million for the same period in the prior year.

Restructuring Charges. In the first fiscal quarters of 2023 and 2022, we completed restructuring plans to align strategic and financial objectives and optimize resources for long term growth. As a result of these initiatives, we recorded restructuring charges of $8.7 million and $7.9 million related to a reduction in workforce that is reflected in our results for the three months ended December 31, 2022 and December 31, 2021, respectively.

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Other Income (Expense), Net. Other income (expense), net consists primarily of interest income and expense and foreign currency transaction gains and losses. The increase in other income (expense), net for the three months ended December 31, 2022 was primarily due to an increase in foreign currency gains of $5.8 million compared to the same period in the prior year. In addition, interest income from our investments increased $3.0 million for the three months ended December 31, 2022 compared to the same period in the prior year. The increase in other income (expense), net for the three months ended December 31, 2022 was partially offset by an increase in interest expense of $1.8 million, compared to the prior year.

Provision for Income Taxes. The effective tax rate was 24.5% and 16.3% for the three months ended December 31, 2022 and 2021, respectively. The increase in the effective tax rate for the three months ended December 31, 2022 as compared to the three months ended December 31, 2021 is primarily due to the tax impact of stock-based compensation and international operations.

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, 2022 and September 30, 2022 were $205.6 million and $180.6 million, respectively. The net deferred tax assets include valuation allowances of $46.1 million as of December 31, 2022 and September 30, 2022, 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 $667.6 million as of December 31, 2022, compared to $894.1 million as of September 30, 2022, representing a decrease of $226.5 million. The decrease was primarily due to cash used for the voluntary prepayment of the Term Loan Facility, including the outstanding principal balance of $350.0 million, and all accrued, but unpaid interest outstanding of $3.0 million. In addition, $40.0 million of cash was used for the repurchase of outstanding common stock in the first quarter of fiscal 2023. The decrease in cash and investments for the first quarter of fiscal 2023 was partially offset by cash provided by operating activities of $157.6 million.

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Cash provided by operating activities for the first three months of fiscal year 2023 resulted from net income of $72.4 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 2023 increased from the comparable period in the prior year primarily due to an increase in cash received from customers, which partially offset strong billings for the quarter and an increase in the balance of accounts receivable.

Cash from operations could be affected by various risks and uncertainties, including, but not limited to, the effects of the risks detailed in Part 1, Item 1A, "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended September 30, 2022. 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 provided by investing activities was $61.9 million for the three months ended December 31, 2022, compared to cash used in investing activities of $42.0 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 provided by investing activities for the three months ended December 31, 2022 was primarily the result of $63.5 million in maturities of investments and $12.2 million in sales of investments, partially offset by $13.1 million in capital expenditures related to maintaining our operations worldwide.

Cash used in financing activities was $374.9 million for the three months ended December 31, 2022, compared to cash used in financing activities of $116.0 million for the same period in the prior year. Our financing activities for the three months ended December 31, 2022 primarily consisted of $350.0 million of cash used for the voluntary prepayment of the Term Loan Facility, as well as $40.0 million of cash used to repurchase shares. In addition, $7.0 million in cash was used for taxes related to net share settlement of equity awards. 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 $22.2 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, 2022, 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, 2022, our principal commitments consisted of obligations outstanding under operating leases and purchase obligations with one of the Company's component suppliers.

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, 2022.

In October 2022, the Company entered into an unconditional purchase commitment with one of its suppliers for the delivery of systems components. Under the terms of the agreement, the Company is obligated to purchase $10 million of component inventory annually, with a total committed amount of $40 million over a four-year term. As of December 31, 2022, the Company has $1.8 million of remaining purchases under the first year of its commitment. Our total non-cancelable long-term purchase commitments outstanding as of December 31, 2022 was $31.8 million.

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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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 December 31, 2022. We monitor our interest rate and credit risks, including our credit exposures to specific rating categories and to individual issuers. As of December 31, 2022, 9% 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.

Inflation Risk. We are actively monitoring the current inflationary environment, but we do not believe that inflation has had a material effect on our business, financial condition or results of operations. If our costs were to become subject to significant inflationary pressures, we may not be able to fully offset such higher costs through price increases. Our inability or failure to do so could harm our business, financial condition and results of operations. If the current inflationary environment constrains our customers’ ability to procure goods and services from us, we may see customers reprioritize these investment decisions. These macroeconomic conditions could harm our business, financial condition and results of operations.

Foreign Currency Risk. The majority of our sales, cost of net revenues, and operating expenses are denominated in U.S. dollars and as a result, we have not experienced significant foreign currency transaction gains and losses to date. While we conduct transactions in foreign currencies and expect to continue to do so, we do not anticipate that foreign currency transaction gains or losses will be significant at our current level of operations. However, as we continue to expand our operations internationally, transaction gains or losses may become significant in the future.

Management believes there have been no material changes to our quantitative and qualitative disclosures about market risk during the three month period ended December 31, 2022, compared to those discussed in our Annual Report on Form 10-K for the year ended September 30, 2022.

The Company maintains 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")) which are designed to ensure that required information is recorded, processed, summarized and reported within the required timeframe, as specified in the rules set forth by the Securities Exchange Commission. Our disclosure controls and procedures are also designed to ensure that information required to be disclosed is accumulated and communicated to management, including the 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 December 31, 2022 and, based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of December 31, 2022.

Changes in Internal Control over Financial Reporting

During the first fiscal quarter, there were no changes to our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

**Item 1.**Legal Proceedings

See Note 8 - 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.

There have been no material changes to our risk factors from those described in Part 1, Item 1A, "Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended September 30, 2022, which was filed with the Securities and Exchange Commission on November 15, 2022.

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**Item 2.**Unregistered Sales of Equity Securities and Use of Proceeds

On July 25, 2022, the Company announced that its Board of Directors authorized an additional $1.0 billion for its common stock share repurchase program. This authorization is incremental to the existing $5.4 billion program, initially approved in October 2010 and expanded in subsequent fiscal years. Acquisitions for the share repurchase programs will be made from time to time in private transactions, accelerated share repurchase programs, or open market purchases as permitted by securities laws and other legal requirements. The programs can be terminated at any time. As of December 31, 2022, the Company had $1.2 billion remaining authorized to purchase shares under its share repurchase program.

Shares repurchased and retired for the three months ended December 31, 2022 are as follows (in thousands, except shares and per share data):

(1)Includes 48,629 shares withheld from restricted stock units that vested in the first quarter of fiscal 2023 to satisfy minimum tax withholding obligations that arose on the vesting of restricted stock units.

(2)Shares withheld from restricted stock units that vested to satisfy minimum tax withholding obligations that arose on the vesting of such awards do not deplete the dollar amount available for purchases under the repurchase program.

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**Item 4.**Mine Safety Disclosures

Not applicable.

None.

• Filed herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized on this 3rd day of February, 2023.