Fortinet, Inc. — FY 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012. This is an annual report, not a standalone fourth-quarter filing; quarterly figures below provide Q4 context. Financial statement amounts are in U.S. dollars.
Business context
Fortinet sells network security appliances and related subscription, support and other services worldwide, principally through distributors and resellers. FortiGate is its core product platform; subscriptions and support are generally recognized over their service terms. In FY 2012, services represented 51% of revenue. One distributor accounted for 11% of annual revenue.
Financial performance and liquidity
| Metric | FY 2012 | FY 2011 | Change |
|---|---|---|---|
| Total revenue | $533.6 million | $433.6 million | +23% |
| Product revenue | $248.9 million | $197.4 million | +26% |
| Services revenue | $274.0 million | $220.3 million | +24% |
| Gross profit / margin | $386.2 million / 72.4% | $320.0 million / 73.8% | Margin down 1.4 points |
| Operating income / margin | $100.5 million / 19% | $88.9 million / 21% | Income +13% |
| Net income | $66.8 million | $62.5 million | +7% |
| Diluted EPS | $0.40 | $0.38 | +$0.02 |
| Operating cash flow | $183.9 million | $132.8 million | +38% |
| Free cash flow (non-GAAP) | $161.8 million | $129.2 million | Up year over year |
| Deferred revenue | $363.2 million | $294.8 million | +$68.4 million |
Cash, cash equivalents and investments totaled $739.6 million at year-end, versus $538.7 million a year earlier. Working capital was $250.0 million. The balance sheet reports no borrowings; the filing does not present a debt balance as a key metric. Total liabilities were $464.6 million, including $363.2 million of deferred revenue. Management said existing cash and investments were expected to cover anticipated cash needs for at least 12 months. $26.6 million of cash was held by foreign subsidiaries and was not immediately available for domestic operations without repatriation and potential tax.
Q4 FY 2012 revenue was $151.2 million, compared with $120.9 million in Q4 FY 2011. Q4 operating income was $35.0 million versus $26.5 million, and net income was $21.5 million versus $16.5 million. Q4 gross margin was 73%, compared with 73% in Q4 FY 2011.
Material changes and management commentary
- Growth reflected higher FortiGate sales across product tiers and services revenue recognized from a larger deferred-revenue base. Revenue grew in all regions: Americas 26%, EMEA 21%, and APAC 22%.
- Gross margin declined as product margin was affected by a large retail customer’s lower-margin product mix and higher material costs; services margin fell as Fortinet expanded support capacity and consulting services.
- Operating expenses rose 24%, principally due to hiring and investment in research and development and global sales coverage. Headcount increased to 1,954 from 1,583.
- Management cited increased large-deal activity: deals above $100,000 rose to 718 from 560; deals above $250,000 to 241 from 167; and deals above $500,000 to 81 from 57.
- Billings, a non-GAAP measure defined as revenue plus the increase in deferred revenue, were $602.0 million, up from $475.8 million. Free cash flow is also non-GAAP; the company defines it as operating cash flow less capital expenditures.
Outlook, risks and unusual items
- No specific revenue or earnings guidance for FY 2013 is provided. Management expected overall gross margin to remain near FY 2012 levels and R&D, sales and marketing, and G&A expenses as a percentage of revenue to remain comparable.
- Key risks include intense competition and pricing pressure; reliance on channel partners; quarter-end sales concentration and seasonality; inventory and component shortages; dependence on contract manufacturers and limited-source suppliers; product defects or security failures; and foreign-currency, international, regulatory and tax exposures.
- Approximately 35% of aggregate billings, on average over the prior eight quarters, came in the final two weeks of a quarter, making results sensitive to shipment and order-processing delays. The company also cautioned that historical seasonality is not a reliable indicator of future performance.
- FY 2012 included $3.7 million from sales of previously acquired patents. A $1.5 million non-recurring stock-award forfeiture true-up in Q4 reduced stock-based compensation expense and increased reported operating and net income; management considered the adjustment immaterial to current and prior periods.
- Patent matters remained pending, including NPS litigation scheduled for trial in September 2013 and an appeal in the ESR matter. Fortinet said it did not then believe the cited cases had a reasonable possibility of loss or would materially adversely affect the business. A separate former-stockholder class action was settled for $1.0 million in November 2012.
- Unrecognized tax benefits were $27.8 million; related recorded liabilities, including interest, were $28.8 million. The filing notes a California audit of FY 2010 and FY 2011, with no material adverse impact then expected. The federal R&D tax credit was reinstated retroactively for FY 2012, with the benefit to be recorded in Q1 FY 2013.
- Fortinet 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
- Whether growth in billings and deferred revenue continues to translate into recognized revenue, renewals and operating cash flow.
- Whether gross margins stabilize after FY 2012 declines, particularly in services and lower-margin product deals.
- Whether the large-deal pipeline and enterprise expansion persist without further disproportionate expense growth.
- Exposure to the 11%-of-revenue distributor, channel concentration, and quarter-end shipment dependence.
- Progress and potential outcomes of pending patent litigation, tax matters, and supplier/component constraints.
- The effect of stock-based compensation, including dilution, and the comparability of non-GAAP measures with GAAP results.