Fortinet, Inc. — Q2 2022 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2022; figures are unaudited and in U.S. dollars. Fortinet sells cybersecurity products and services, including FortiGate/Core Platform products, FortiGuard subscriptions and FortiCare support. The company completed a five-for-one stock split effective June 22, 2022; share and per-share figures were retroactively adjusted.
Financial results and liquidity
| Metric | Q2 2022 | Q2 2021 | Change |
|---|---|---|---|
| Revenue | $1,030.1 million | $801.1 million | +29% |
| Product revenue | $400.7 million | $298.3 million | +34% |
| Service revenue | $629.4 million | $502.8 million | +25% |
| Gross profit / gross margin | $779.3 million / 75.7% | $614.2 million / 76.7% | Margin down 1.0 percentage point |
| Operating income / margin | $195.3 million / 19% | $147.5 million / 18% | Income +32% |
| Net income attributable to Fortinet | $173.5 million | $137.5 million | +26% |
| Diluted earnings per share | $0.21 | $0.16 | — |
| Operating cash flow | $323.4 million | $418.2 million | Down 23% |
| Free cash flow, non-GAAP | $283.5 million | $394.7 million | Down 28% |
| Billings, non-GAAP | $1,304.2 million | $960.9 million | +36% |
For the six months ended June 30, revenue was $1.985 billion, up 31%; operating income was $346.3 million, up 29%; and net income attributable to Fortinet was $311.9 million, versus $244.7 million. Operating cash flow was $719.5 million, versus $734.1 million. Capital expenditures were $162.5 million, yielding company-defined free cash flow of $557.0 million for the six-month period.
Six-month gross margin declined to 74.6% from 77.3%, while operating margin declined to 17% from 18%. Management attributed lower gross margin to Alaxala consolidation, higher costs and a product/service mix shift toward lower-margin products; supply-chain expedite and freight costs also pressured product margins. Operating-expense leverage partly offset the gross-margin decline.
At June 30, cash and cash equivalents were $710.0 million; short- and long-term investments were $1.209 billion; and marketable equity securities were $24.3 million. Together these totaled $1.943 billion, down from $2.993 billion at year-end 2021. Working capital was $318.0 million, versus $1.283 billion. Long-term debt, net of issuance costs, was $989.4 million, comprising $1.0 billion principal of unsecured notes due 2026 and 2031. The notes have no financial covenants. Total equity was a deficit of $379.6 million, following substantial share repurchases.
Deferred revenue was $3.932 billion at quarter-end, up 14% from December 31, 2021. Remaining performance obligations were also reported at $3.93 billion; approximately $2.01 billion is expected to be recognized over the next 12 months. Q2 bookings were $1.38 billion, up 42%, and backlog was $349.9 million, up from $161.9 million at year-end.
Material changes and unusual items
- Q2 revenue growth was broad-based. Product revenue was 39% of revenue versus 37% a year earlier; service revenue remained the larger share at 61%. APAC revenue rose 42% in Q2, EMEA 28% and Americas 23%.
- Q2 operating margin improved despite lower gross margin, as operating expenses declined as a share of revenue. For the first half, however, lower gross margin outweighed expense leverage and operating margin fell.
- Q2 other expense, net, was $9.3 million, primarily reflecting an $8.1 million loss on marketable equity securities and foreign-exchange losses. A $16.6 million equity-method investment loss was recorded for the first half, including $8.1 million in Q2, relating to Linksys. Fortinet reported no other-than-temporary impairment of Linksys at June 30, but noted future impairment remains possible.
- The six-month effective tax rate was negative 2%, compared with 7% in the prior-year period. Tax benefits included stock-based compensation and the foreign-derived intangible income deduction; new foreign-tax-credit regulations increased first-half tax expense by approximately $9.3 million.
- Fortinet repurchased 25.8 million shares for $1.49 billion in the first half, including $800.0 million in Q2. Only $29.6 million remained authorized at June 30; in July, the board added $1.0 billion, leaving approximately $1.03 billion available as of August 4.
Outlook, management commentary and risks
- Management expected service revenue growth to continue increasing through the remainder of 2022, supported by business growth and prior pricing actions, while cautioning that customer spending reductions, supply constraints or delayed service purchases could affect growth.
- Fortinet expected research and development, sales and marketing, and general and administrative expenses to increase in absolute dollars during the remainder of 2022. Estimated capital expenditures for the second half were approximately $140 million to $170 million.
- Management said existing cash, cash equivalents, investments and operating cash flow should meet anticipated cash needs for at least the next 12 months, including working capital and capital expenditures.
- Supply constraints, chip and component shortages, longer lead times and higher shipping costs remained significant. The company lacked inventory to meet all product demand promptly and had $1.49 billion of non-cancelable inventory purchase commitments at June 30, up from $1.14 billion at year-end.
- Q2 days sales outstanding increased to 80 days from 66 days a year earlier, which management attributed primarily to sales linearity. Receivables were concentrated: six distributors represented 68% of net accounts receivable, and the largest accounted for 30%.
- Fortinet suspended sales, support and other operations in Russia on March 7, 2022. The war in Ukraine had not materially affected reported first-half results, but future effects were uncertain.
- Other key risks include macroeconomic weakness, inflation and reduced IT spending; reliance on channel partners and a small number of distributors; competition and margin pressure; cybersecurity vulnerabilities and potential product defects; foreign-exchange and tax uncertainty; and possible litigation or Linksys impairment. Fortinet reported ongoing tax audits in the U.K., Canada, Germany and other jurisdictions, focused on intercompany profit allocation.
- Subsequent events included a July purchase of Union City real property for $65.3 million and the additional share-repurchase authorization. The filing reported disclosure controls effective as of June 30 and no material change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether revenue, bookings, backlog and deferred-revenue growth convert into recognized revenue and cash flow, particularly given extended lead times and unfulfilled demand.
- Whether component availability, freight costs, pricing actions and product/service mix stabilize or further pressure gross margins.
- Whether higher receivables and distributor concentration lead to slower collections, credit losses or reduced channel orders.
- How the $1.49 billion first-half repurchase program and subsequent authorization affect liquidity, equity and share count relative to investment needs.
- Whether Linksys performance triggers an impairment, and whether marketable-equity valuation changes continue to add earnings volatility.
- Developments in Russia, broader economic conditions, tax audits and litigation, as well as actual results against management’s expense and capital-spending expectations.