Fortinet, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unaudited interim results. Fortinet provides network security appliances and related subscription, support and other services to customers worldwide.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $103.0M | $76.3M | $196.3M | $146.1M |
| Gross profit / margin | $76.5M / 74.2% | $56.2M / 73.6% | $146.3M / 74.5% | $106.6M / 72.9% |
| Operating income / margin | $18.8M / 18.2% | $9.8M / 12.8% | $36.2M / 18.5% | $16.5M / 11.3% |
| Net income | $14.5M | $6.9M | $28.1M | $11.1M |
| Diluted EPS | $0.09 | $0.05 | $0.17 | $0.07 |
- Q2 revenue rose 35%; product revenue increased 50% to $46.7M and services revenue rose 29% to $52.7M. Product, services and ratable revenue represented 45%, 51% and 4% of Q2 revenue, respectively.
- Q2 gross margin improved 0.6 percentage points, principally from higher product margins and a richer mix of high-end sales. First-half gross margin improved 1.6 points.
- Q2 operating expenses increased 24% to $57.7M, slower than revenue growth; expenses were 56% of revenue versus 61% a year earlier. Sales and marketing remained the largest expense category.
- Q2 effective tax rate was 25.4%, versus 33.1%; first-half rate was 25.3%, versus 34.7%. Management attributed the lower rates primarily to research credits and transfer-pricing adjustments.
Cash, liquidity and balance sheet
- At June 30, cash and cash equivalents were $78.0M; investments were $390.5M; combined cash, cash equivalents and investments totaled $468.5M, versus $387.5M at December 31, 2010. Working capital was $208.1M.
- First-half operating cash flow was $74.2M, compared with $39.8M a year earlier. The increase reflected higher earnings and working-capital sources, including a $20.5M increase in deferred revenue. Q2 operating cash flow was $34.1M; reported Q2 free cash flow was $33.3M.
- Total deferred revenue was $273.2M, up from $252.6M at year-end 2010 and $225.5M at June 30, 2010. Management identifies this balance as an indicator of future revenue visibility.
- Total liabilities were $347.7M, including $273.2M of deferred revenue. The balance sheet presents no borrowings or debt.
Changes, outlook and notable items
- Revenue growth included $5.7M in Q2 and $9.0M in the first half from adoption of new revenue-recognition standards. Certain product revenue could be recognized upon shipment that otherwise would have been deferred; management said the impact will vary with future arrangements.
- Q2 billings, a company-defined non-GAAP measure of revenue plus the change in deferred revenue, were $110.2M, up 22% year over year. Management cited slower billings growth in EMEA. Revenue growth was strongest in APAC and the Americas.
- Management expects near-term overall gross margin to remain comparable to, or decrease slightly from, first-half 2011 levels. It expects research and development and sales and marketing costs to rise in dollars as hiring and investment continue. The filing does not provide specific revenue or earnings guidance.
- Fortinet acquired TalkSwitch Corp. on April 6 for $2.6M cash; acquired identifiable technology intangibles of approximately $1.8M are being amortized over three years. The company also completed a two-for-one stock split effective June 1; per-share information was retroactively adjusted.
- Trend Micro royalty litigation remains unresolved. Fortinet disputes its obligation to pay; the company had accrued $5.6M, including interest, and continued accruing royalty expense. The PTO rejected a number of asserted patent claims, but Trend Micro disputed one office action. Fortinet stated it did not believe a loss exceeding amounts recognized was reasonably possible.
- Other disclosed exposures include patent suits and tax audits. The company reported approximately $17.1M of unrecognized tax benefits and $18.3M of potentially non-cancelable contract-manufacturer purchase orders. It had $3.5M of disputed minimum royalty commitments and $18.0M of operating lease commitments.
- Management said existing cash and investments were expected to meet anticipated needs for at least 12 months. It also highlighted demand variability, competition, channel and supplier dependence, inventory management, foreign-exchange exposure, product quality and execution risks. Disclosure controls were deemed effective; no material second-quarter change in internal control over financial reporting was reported.
Key facts for investors to verify
- How much reported growth reflects underlying demand versus the $5.7M Q2 revenue-recognition benefit, and how the new rules affect future comparisons.
- Whether deferred revenue, billings and renewals continue to grow, especially given slower EMEA billings and the recurring-revenue contribution of services.
- Whether product mix, pricing and competition sustain gross margins as the company expands sales and hiring.
- The outcome and potential cash impact of the Trend Micro dispute and other patent matters, along with tax-audit exposures.
- Cash generation quality, including reliance on deferred-revenue growth and timing-related tax liabilities, and any changes to the stated 12-month liquidity outlook.