Fortinet, Inc. — FY2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. This is an annual report, not a standalone fourth-quarter filing. Fortinet sells cybersecurity products and subscriptions, primarily through distributors and resellers; recurring FortiGuard security subscriptions and FortiCare support are a major part of its business.
Financial performance and position
| Metric | FY2019 | FY2018 | Change |
|---|---|---|---|
| Revenue | $2.156 billion | $1.801 billion | +20% |
| Product revenue | $788.5 million | $674.4 million | +17% |
| Service revenue | $1.368 billion | $1.127 billion | +21% |
| Gross profit / gross margin | $1.650 billion / 76.5% | $1.351 billion / 75.0% | Margin +1.5 percentage points |
| Operating income / margin | $344.2 million / 16% | $231.0 million / 13% | Income +49% |
| Net income | $326.5 million | $332.2 million | -2% |
| Diluted EPS | $1.87 | $1.91 | -2% |
| Cash from operating activities | $808.0 million | $638.9 million | +26% |
| Free cash flow (non-GAAP) | $715.8 million | $585.9 million | +22% |
| Cash, cash equivalents and investments | $2.210 billion | $1.717 billion | +$493.3 million |
| Deferred revenue | $2.136 billion | $1.687 billion | +27% |
Service revenue was 63% of total revenue. FortiGuard security subscription revenue grew 24%. The company reported working capital of $1.295 billion. No material borrowing balance is presented in the supplied balance-sheet data; the filing does report operating lease liabilities of $46.1 million and $82.8 million of long-term income-tax liabilities. Inventory purchase commitments totaled $231.9 million, principally due within one year.
Fourth-quarter 2019 revenue was $614.4 million, operating income was $118.4 million and net income was $115.2 million. Fourth-quarter 2018 revenue was $507.0 million and net income was $182.6 million; the prior-year quarter included a substantial tax benefit.
Changes versus the prior comparable period
- Revenue growth was broad-based: Americas, EMEA and APAC revenue increased 20%, 20% and 18%, respectively.
- Both product and service gross margins improved; management attributed product margin gains to average selling prices, costs, deal mix and software growth, and service margin gains to revenue growing faster than related costs.
- Operating expenses rose 17% to $1.306 billion, but declined as a share of revenue. Sales and marketing remained the largest expense and increased 18%.
- Net income was slightly lower despite higher operating income, chiefly reflecting the change from an $81.3 million tax benefit in 2018 to a $52.7 million tax expense in 2019. The 2018 result included a $164.0 million benefit related to tax-structure realignment under the 2017 Tax Act.
- Operating cash flow and free cash flow increased. Capital expenditures rose to $92.2 million from $53.0 million.
Outlook, commentary and risks
- Management expected 2020 research and development, sales and marketing, and general and administrative expenses to increase in absolute dollars. It expected overall gross margin in 2020 to be comparable to 2019.
- Management estimated 2020 real-estate spending, including the Sunnyvale headquarters expansion, at $150 million to $160 million. The company said existing cash and investments should meet anticipated cash needs for at least 12 months.
- The coronavirus outbreak’s effects were uncertain at the filing date. Fortinet warned that disruption to Asian manufacturing, components or Taiwan logistics, as well as weaker customer demand and added costs, could materially affect 2020 results.
- Revenue and receivables are concentrated in distributors: Exclusive Networks represented 31% of 2019 revenue and 36% of year-end net accounts receivable; Ingram Micro represented 11% of revenue. Fortinet relies substantially on channel partners and a limited set of suppliers and manufacturers.
- Fortinet disclosed a second-quarter 2019 incident in which an unauthorized party targeted the company and attempted to reach certain customer systems. The company said its investigation found no material impact and that it was not aware of related claims.
- Other material exposures include intense competition and pricing pressure, component shortages and inventory forecasting, product vulnerabilities or service interruptions, international and currency risks, privacy and export regulation, and ongoing intellectual-property litigation. The auditor identified litigation contingencies as a critical audit matter; management said it was unaware of existing claims likely to materially harm its financial position.
- The company recorded a $10.1 million uncertain-tax benefit liability related to the Ninth Circuit’s Altera decision. Tax audits in the U.K., Canada and other jurisdictions include intercompany profit allocation. A February 2020 patent covenant-not-to-sue agreement generated a $50 million payment after year-end and may provide for a further $50 million payment after seven years if extended.
- Fortinet acquired endpoint-security provider enSilo and security-automation provider CyberSponse in Q4 2019; management said the acquisitions were not material to consolidated financial statements. The company repurchased $140.9 million of shares during 2019 and had $1.6 billion authorized for future repurchases at year-end.
Most important facts for investors to verify
- Whether billings, deferred revenue and subscription renewals continue to grow alongside recognized revenue; 2019 billings were $2.603 billion, up 21% (non-GAAP).
- Whether improving gross and operating margins persist as hiring, sales and marketing investment, and headquarters construction spending increase.
- How much distributor concentration—especially Exclusive Networks—and customer or channel credit exposure changes.
- The actual financial effects of coronavirus-related supply-chain and demand disruption, and the company’s ability to secure constrained components.
- Developments in patent litigation and tax uncertainties, including the Altera matter and ongoing foreign tax audits.
- The filing reported unqualified audit opinions on the financial statements and internal control over financial reporting as of December 31, 2019.