Fortinet, Inc. — Q1 2015 Form 10-Q
Reporting period: Three months ended March 31, 2015; compared with the three months ended March 31, 2014 unless otherwise noted. Fortinet provides cybersecurity products and services, including FortiGate appliances and FortiGuard and FortiCare subscriptions. Figures below are in U.S. dollars.
Financial results and liquidity
| Metric | Q1 2015 | Q1 2014 / comparison |
|---|---|---|
| Product revenue | $97.5 million | $76.8 million; up 27% |
| Service revenue | $115.4 million | $92.2 million; up 25% |
| Total revenue | $212.9 million | $168.9 million; up 26% |
| Gross profit / gross margin | $149.3 million / 70.1% | $118.2 million / 70.0% |
| Operating expenses | $148.4 million | $105.4 million; up 41% |
| Operating income | $0.9 million | $12.8 million |
| Net income / diluted EPS | $1.6 million / $0.01 | $8.4 million / $0.05 |
| Operating cash flow | $64.6 million | $60.9 million |
| Free cash flow (non-GAAP) | $59.7 million | $49.6 million |
| Cash, cash equivalents and investments | $1.073 billion | $991.7 million at Dec. 31, 2014 |
| Deferred revenue | $600.2 million | $558.8 million at Dec. 31, 2014 |
Product gross margin was 57.6% versus 58.1%; service gross margin was 80.7% versus 79.8%. The company reported working capital of $593.2 million at quarter-end. No borrowings or debt balance is identified in the supplied financial statements; contractual obligations include operating leases and purchase commitments.
Changes and drivers
- Revenue growth reflected higher FortiGate sales across entry-level, mid-range and high-end products, plus service revenue recognized from a larger base of subscription and support contracts. EMEA revenue rose 34%, Americas 26% and APAC 15%.
- Operating expenses grew faster than revenue, compressing operating income to $0.9 million from $12.8 million. Sales and marketing increased 49%, primarily on hiring and marketing investment; research and development rose 23%.
- Net income also reflected a much lower income-tax provision: the effective tax rate was 5%, compared with 39% a year earlier. Management cited discrete stock-compensation tax benefits and foreign-exchange effects related to uncertain tax benefits.
- Deferred revenue increased $41.4 million from year-end. Non-GAAP billings were $254.3 million, up from $187.6 million; billings equal revenue plus the increase in deferred revenue.
Outlook, risks and unusual items
- Management expects research and development expense as a percentage of revenue to remain comparable during the rest of 2015; sales and marketing expense as a percentage of revenue to decrease; and general and administrative expense as a percentage of revenue to increase. It expects to spend approximately $30–$35 million, primarily on office expansion and implementation of its ERP system. No numerical revenue or earnings guidance is provided in the filing text.
- Management said existing cash and cash equivalents should cover anticipated needs for at least 12 months. $326.2 million of cash and investments was held by international subsidiaries and would generally be subject to U.S. tax if repatriated.
- Key risks include quarterly order and shipment variability, dependence on channel partners and service renewals, competition and pricing pressure, product or security defects, and reliance on contract manufacturers and limited-source components. Exclusive Networks Group represented 17% of revenue and 19% of net accounts receivable at quarter-end.
- Contractual commitments totaled $135.7 million, including $67.7 million of inventory purchase commitments and $39.9 million of net operating lease commitments. The company reported no significant accrual for legal loss contingencies and did not identify a proceeding it believed likely to have a material adverse effect, while noting litigation outcomes remain uncertain.
- Unrecognized tax benefits were $46.6 million, with approximately $4.5 million accrued for related estimated interest. Stock-based compensation expense was $18.9 million, versus $12.9 million a year earlier.
- Prior-period comparison: Q1 2014 operating cash flow included a $20.0 million receipt under a six-year mutual covenant-not-to-sue and release agreement with Palo Alto Networks. Q1 2015 operating cash flow benefited from higher customer receipts and increased deferred revenue.
Important facts for investors to verify
- Whether sales-force and marketing investments translate into sustained billings and revenue growth while operating expenses moderate.
- Service-contract renewal trends and the composition and future recognition of the $600.2 million deferred-revenue balance.
- Customer and distributor concentration, including Exclusive Networks Group’s revenue and receivable exposure.
- Supply availability, inventory commitments, product-margin effects and progress on the ERP implementation and planned capital spending.
- Potential effects of uncertain tax positions, litigation and intellectual-property claims, and foreign-exchange movements on future results.