Fortinet, Inc. — 2015 Form 10-K Summary
Business context and reporting period. Fortinet provides network security products and related subscription, support, training and professional services, primarily through channel partners. This annual report covers the fiscal year ended December 31, 2015; it is not a standalone quarterly filing. The company reported one operating segment.
Financial results and liquidity
| Metric | FY 2015 | FY 2014 | Change |
|---|---|---|---|
| Revenue | $1,009.3 million | $770.4 million | +31% |
| Product revenue | $476.8 million | $360.6 million | +32% |
| Service revenue | $532.5 million | $409.8 million | +30% |
| Gross profit / margin | $722.5 million / 71.6% | $539.4 million / 70.0% | Margin +1.6 percentage points |
| Operating income / margin | $14.9 million / 1.5% | $59.3 million / 7.7% | Down substantially |
| Net income | $8.0 million | $25.3 million | Down 68% |
| Cash from operating activities | $282.5 million | $196.6 million | +44% |
| Free cash flow (non-GAAP) | $245.2 million | $164.4 million | +49% |
Product and service gross margins were 60.1% and 81.9%, respectively. Cash, cash equivalents and investments totaled $1.164 billion at year-end, including $543.3 million in cash and equivalents; working capital was $591.9 million. Deferred revenue was $791.3 million, up 42%. The balance sheet reports no interest-bearing debt; total liabilities were $1.035 billion, including deferred revenue and $60.6 million of income tax liabilities related to uncertain tax positions.
Billings, a non-GAAP measure, rose 37% to $1.232 billion. Capital expenditures were $37.4 million. Revenue was $435.3 million in the Americas, $366.0 million in EMEA and $208.0 million in APAC.
Material changes versus prior periods
- Revenue growth was strong, but operating expenses rose 47% to $707.6 million, led by sales and marketing, which increased 49% to $470.4 million. Operating margin fell to 1.5% from 7.7%.
- Gross margin improved, with management citing a higher mix of high-end FortiGate products, software sales, inventory efficiencies and better service margins.
- Headcount increased 41% to 4,018 employees and contractors as Fortinet expanded sales, marketing, R&D and customer support.
- Fourth-quarter revenue was $296.5 million, versus $224.0 million in Q4 2014. Fortinet recorded a $2.5 million net loss in Q4 2015, compared with $6.8 million net income a year earlier; Q4 2015 included a $15.6 million income tax provision on $13.0 million of pretax income.
Outlook, commentary, risks and unusual items
- Management said it expects product and service revenue mix, gross margin, and several operating expense ratios to remain at relatively comparable levels in 2016. It provided no specific revenue or earnings guidance in the supplied filing text.
- Management expects 2016 capital expenditures of $35 million to $45 million, principally for facilities expansion and ERP implementation, and said existing cash and equivalents should cover anticipated needs for at least 12 months.
- Fortinet acquired Meru Networks in July 2015 for total consideration of $41.8 million. Meru contributed $28.1 million of revenue and a $14.0 million net loss from acquisition through year-end. Meru-related restructuring charges were $7.6 million in 2015; the company estimated total charges of $8.0 million, with the remainder expected in 2016.
- A third-party release-of-claims agreement generated $9.0 million in December 2015. After $2.0 million of contingent legal fees, $7.0 million was deferred and is to be recognized as an offset to G&A expense through 2018. A prior $20.0 million Palo Alto Networks agreement is also being recognized over time through 2020.
- Key risks include reliance on distributors and suppliers, including one distributor responsible for 18% of 2015 revenue and 23% of year-end net receivables; component and manufacturing concentration; intense competition and pricing pressure; product defects or security failures; foreign exchange exposure; long enterprise sales cycles; and execution risks from the ERP implementation and Meru integration.
- Legal matters include ongoing patent litigation and other claims. Management stated it had not recorded a significant loss-contingency accrual and did not consider a material adverse outcome likely based on its assessment, while noting litigation outcomes remain uncertain. Legal fees paid to a law firm connected to a director’s son were $7.2 million in 2015.
- The financial statements received an unqualified audit opinion. Management and the auditor concluded internal control over financial reporting was effective at year-end, although Meru’s controls were excluded from the assessment for 2015.
Important facts for investors to verify
- Whether revenue, billings and deferred-revenue growth continue, and how much growth comes from recurring services versus product sales.
- Whether significant sales and marketing investment converts into sustained growth and operating-margin recovery.
- The sustainability of gross-margin improvements and the impact of product mix, pricing, inventory and component costs.
- Meru’s integration progress, contribution to results and remaining restructuring costs; also ERP implementation timing and costs.
- Distributor concentration, receivables exposure and supply-chain resilience, alongside patent litigation and uncertain tax liabilities.
- Post-year-end capital allocation: Fortinet repurchased $50.0 million of shares under a new $200.0 million authorization through the filing date.