Fortinet, Inc. — 2020 Form 10-K
Reporting period: Fiscal year ended December 31, 2020. Fortinet provides cybersecurity products and services, principally FortiGate appliances and recurring FortiGuard security subscriptions and FortiCare support.
Financial performance
| Metric | 2020 | 2019 | Change |
|---|---|---|---|
| Revenue | $2.594 billion | $2.163 billion | +20% |
| Product revenue | $916.4 million | $788.5 million | +16% |
| Service revenue | $1.678 billion | $1.375 billion | +22% |
| Gross profit | $2.024 billion | $1.657 billion | +22% |
| Gross margin | 78.0% | 76.6% | +1.4 percentage points |
| Operating income | $531.8 million | $351.0 million | +52% |
| Net income | $488.5 million | $331.7 million | +47% |
| Diluted EPS | $2.91 | $1.90 | +53% |
| Operating cash flow | $1.084 billion | $808.0 million | +34% |
| Free cash flow (non-GAAP) | $907.8 million | $715.8 million | +27% |
| Billings (non-GAAP) | $3.090 billion | $2.603 billion | +19% |
| Deferred revenue | $2.605 billion | $2.109 billion | +24% |
Operating margin increased to 20% from 16%; net margin was approximately 19% versus 15%. Product gross margin rose to 61.5% from 58.8%, while service gross margin was 87.0% versus 86.8%. Management attributed the product margin improvement to lower hardware costs as a share of revenue and more software sales; service revenue growth outpaced related costs.
Cash, cash equivalents and investments totaled $1.956 billion at year-end, down from $2.210 billion. Working capital was $910.9 million, compared with $1.313 billion. Financing cash outflow was $1.172 billion, primarily reflecting $1.080 billion of share repurchases. The balance sheet reports no borrowings; it includes $53.1 million of operating lease liabilities and $90.3 million of long-term income tax liabilities.
Material changes and notable items
- Revenue increased across all regions: Americas +17%, EMEA +21%, and APAC +23%. Services made up 65% of revenue, versus 64% in 2019.
- Deferred revenue rose $496.2 million. The company expects to recognize approximately $1.39 billion of remaining performance obligations over the next 12 months.
- Operating income included a $40.2 million gain from a patent covenant-not-to-sue agreement. Fortinet received $50.0 million in cash; the filing describes a further potential $50.0 million payment if the agreement is extended after its initial seven-year term. The gain is a non-recurring contributor to reported results.
- Fortinet repurchased 11.7 million shares for $1.08 billion in 2020. At year-end, $1.01 billion remained authorized under the $3.0 billion program, which runs through February 28, 2022.
- OPAQ and Panopta were acquired in 2020 for preliminary purchase prices of $8.0 million and $31.9 million, respectively. Their impact on consolidated results was not material.
- The company corrected an immaterial prior-period error in the timing of FortiCare revenue recognition. The correction increased 2019 revenue by $6.8 million and 2018 revenue by $3.4 million; it did not affect operating cash flow, billings, or free cash flow.
Outlook, risks and contingencies
- No numerical revenue or earnings guidance is provided in this filing. Management expected research and development, sales and marketing, and general and administrative expenses to increase in absolute dollars in 2021. Estimated 2021 spending on the headquarters expansion was $50–$60 million, with completion anticipated in the first half of 2021.
- Management cited the uncertain effects of COVID-19, including longer sales cycles, extended distributor payment terms, supply and component constraints, higher shipping costs, and potential changes in demand. It also reported higher stock of certain products to mitigate supply risk; excess inventory could lead to write-downs.
- Key exposures include channel and customer concentration (Exclusive accounted for 30% of 2020 revenue and 34% of year-end net receivables), reliance on third-party manufacturers and limited-source components, intense competition, cybersecurity/product-defect risks, and dependence on recurring service renewals. Approximately 85% of hardware was manufactured in Taiwan.
- Fortinet disclosed ongoing litigation, including patent matters, but stated that litigation accruals were not material at year-end and that it was unaware of claims likely to have a material adverse effect on its financial position. The auditor identified litigation contingencies as a critical audit matter. The filing also reports ongoing tax audits in the UK, Canada and other jurisdictions, with $90.3 million of long-term tax liabilities tied to uncertain tax positions.
- The company reported effective disclosure controls and internal control over financial reporting; the independent auditor issued unqualified opinions on the financial statements and internal controls.
Important facts for investors to verify
- How much of operating-income growth reflects recurring operations versus the $40.2 million IP gain, and how margins trend without that item.
- Whether deferred-revenue and billings growth translates into sustained revenue growth, including service renewal and attach rates.
- Collection performance and credit exposure to major distributors, especially Exclusive, given extended payment terms and receivables concentration.
- Whether component availability, Taiwan manufacturing concentration, and inventory buildup affect shipments, margins, or working capital.
- Cash use for repurchases and headquarters construction, and the effect on liquidity and future investment capacity.
- Outcomes of patent litigation and tax audits, and any material changes to related contingencies or liabilities.