Fortinet, Inc. — Q3 2022 Form 10-Q
Business context and reporting period. Fortinet sells cybersecurity hardware, software, security subscriptions and technical support primarily through channel partners. This unaudited filing covers the quarter and nine months ended September 30, 2022; comparisons are with the same 2021 periods unless noted. Amounts are in U.S. dollars.
Financial performance
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $1,149.5 million | $867.2 million | $3,134.4 million | $2,378.6 million |
| Gross profit | $866.5 million | $656.0 million | $2,346.8 million | $1,823.9 million |
| Operating income | $265.5 million | $166.4 million | $611.8 million | $435.5 million |
| Net income attributable to Fortinet | $231.6 million | $163.1 million | $543.5 million | $407.8 million |
| Diluted EPS | $0.29 | $0.19 | $0.67 | $0.49 |
- Q3 revenue rose 33%: product revenue increased 39% to $468.7 million and service revenue increased 28% to $680.8 million. Nine-month revenue rose 32%, with product revenue up 42% and service revenue up 26%.
- Q3 gross margin was 75.4%, versus 75.6%; nine-month gross margin was 74.9%, versus 76.7%. The company cited product/service mix, supply-chain and freight costs, and Alaxala consolidation as pressures; pricing and foreign-exchange effects partly offset them.
- Operating margin improved to 23% from 19% in Q3 and to 20% from 18% for the nine-month period, as operating expenses grew more slowly than revenue. Operating expenses increased in dollars, including due to hiring and higher sales, marketing and development investment.
- Q3 operating cash flow was $483.0 million and company-defined non-GAAP free cash flow was $395.2 million, compared with $398.8 million and $329.8 million, respectively. Nine-month operating cash flow was $1.20 billion, up from $1.13 billion.
- At September 30, cash and cash equivalents were $964.0 million; cash, investments and marketable equity securities totaled $1.81 billion, down from $2.99 billion at year-end 2021. Working capital was $202.6 million, versus $1.28 billion.
- Long-term debt, net, was $989.9 million; principal outstanding was $1.0 billion in senior notes due 2026 and 2031. The notes have no financial covenants. Total equity was negative $622.8 million, following substantial share repurchases.
Material changes and operating metrics
- Deferred revenue reached $4.19 billion, up 21% from December 31, 2021 and 35% from September 30, 2021. Remaining performance obligations were $4.21 billion; Fortinet expected to recognize approximately $2.15 billion over the next 12 months.
- Q3 billings, a company-defined non-GAAP measure, were $1.41 billion, up 33% year over year. Q3 product and service growth was broad across regions; EMEA had the largest dollar contribution to quarterly revenue growth.
- Fortinet repurchased 36.0 million shares for $1.99 billion during the first nine months. At quarter-end, $529.6 million remained authorized for repurchases through February 28, 2023. The repurchases were the main driver of $2.10 billion of financing cash outflows.
- Accounts receivable was $963.2 million, versus $807.7 million at year-end. Days sales outstanding rose to 75 from 63 a year earlier. Three distributors each represented at least 10% of net receivables; the largest represented 32%.
Outlook, risks and unusual items
- Management expected service revenue growth to continue increasing through the remainder of 2022, supported by business growth and prior pricing actions, while noting risks from reduced customer spending, supply constraints and slower service purchases. It expected operating expenses to increase in absolute dollars during the remainder of 2022 and estimated Q4 capital expenditures of $75–$85 million. No comprehensive numerical earnings or revenue guidance is provided in the supplied filing text.
- Management said existing cash, cash equivalents, investments and operating cash flow were sufficient for anticipated needs for at least the next 12 months. It did not currently intend to retire the senior notes early.
- Supply shortages, extended component lead times, higher freight and component costs, and insufficient inventory continued to constrain the business. Non-cancelable inventory purchase commitments were $1.46 billion, up from $1.14 billion at year-end 2021. Fortinet said it lacked enough inventory to promptly meet all demand for all products.
- Other key risks include uncertain economic conditions, inflation and higher interest rates; COVID-19 impacts; the war in Ukraine and suspension of Russian operations; intense competition; dependence on channel partners and concentrated distributors; foreign-exchange exposure; and cybersecurity, product-defect and execution risks. The company reported that the war in Ukraine had not materially adversely affected results to date but said future effects were uncertain.
- Fortinet recorded a $22.9 million equity-method investment loss for the first nine months, primarily related to Linksys. It evaluated Linksys for impairment following operating losses and concluded no other-than-temporary impairment existed as of September 30, while warning a future impairment charge remained possible.
- The nine-month effective tax rate was 4%. New U.S. foreign-tax-credit regulations increased tax expense by approximately $16.4 million. The Inflation Reduction Act’s 1% excise tax on net stock repurchases was expected to apply to repurchases after December 31, 2022, if any.
- Litigation loss-contingency accruals were not material, and management said it was not aware of existing claims likely to have a material adverse effect on financial position. On October 3, 2022, Fortinet acquired Alaxala’s remaining 25% interest for $13.5 million.
Important facts for investors to verify
- Whether supply availability, purchase commitments and higher costs affect shipments, revenue growth and gross margins in subsequent quarters.
- Whether deferred-revenue and billings growth converts into recognized revenue and cash flow as expected, and how service renewals and customer spending develop.
- Whether receivable aging, the 75-day DSO and distributor concentration create collection or credit risk.
- How continued repurchases affect liquidity, working capital and the company’s negative equity position, alongside planned capital expenditures and debt service.
- Whether Linksys performance, tax audits or other contingencies lead to impairment, tax expense or other material charges.