Fortinet, Inc. — Q1 2012 Form 10-Q
Reporting period: Three months ended March 31, 2012. Financial statements are unaudited and prepared under U.S. GAAP. Fortinet provides network security products and subscription and support services.
Financial performance
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Revenue | $117.2m | $93.3m | +26% |
| Product revenue | $53.2m | $40.2m | +32% |
| Services revenue | $62.1m | $48.7m | +28% |
| Gross profit / margin | $86.2m / 73.5% | $69.9m / 74.9% | Margin down 1.4 points |
| Operating income / margin | $18.7m / 16% | $17.4m / 19% | Income +7% |
| Net income | $14.2m | $13.6m | +4% |
| Diluted EPS | $0.09 | $0.08 | +1 cent |
| Operating cash flow | $48.5m | $40.2m | +21% |
GAAP operating expenses rose 29% to $67.5m, led by higher sales and marketing and research and development spending. Stock-based compensation was $7.2m, up from $3.1m. Management’s non-GAAP measures exclude stock compensation and patent settlement income; non-GAAP diluted EPS was $0.11 versus $0.09.
Liquidity, balance sheet and cash flow
- Cash, cash equivalents and investments totaled $600.3m at March 31, 2012, up $61.6m from year-end; working capital was $280.5m.
- Current assets were $551.5m and current liabilities $271.0m. Deferred revenue was $314.6m, up $19.7m from December 31, 2011.
- Free cash flow, a non-GAAP measure defined as operating cash flow less capital expenditures, was $46.9m; capital expenditures were $1.6m. Cash and cash equivalents increased $2.8m during the quarter.
- No debt is reported on the balance sheet. The filing says $25.4m of cash was held by foreign subsidiaries and was not immediately available for domestic operations unless repatriated.
- Investing activities used $62.3m, primarily reflecting net purchases of investments. Financing activities provided $15.9m, including proceeds from stock issuance and employee-option tax benefits.
Changes, outlook and management commentary
- Revenue increased across all regions: Americas +30%, EMEA +22% and APAC +25%. Product and services growth was partly offset by a 57% decline in ratable and other revenue.
- Management attributed growth to its global sales strategy, product launches and stronger enterprise activity. Deals above $100,000 increased to 153 from 111; deals above $250,000 increased to 47 from 34.
- Gross margin declined as product mix shifted toward mid-range appliances, service costs rose to support a larger customer base, and stock-based compensation increased. Operating margin contracted as expenses grew faster than revenue.
- Management said it expected R&D and sales and marketing expense as a percentage of revenue to decline in the second half of fiscal 2012, while G&A as a percentage of revenue was expected to remain comparable. No specific revenue or earnings guidance is provided in the filing.
- Management expected existing cash and investments, together with operating cash flow, to meet anticipated cash needs for at least 12 months. It cited a planned 34% full-year tax rate, subject to quarterly discrete items; Q1’s effective rate was 28%, compared with 25% a year earlier.
- Fortinet acquired IntruGuard Devices on March 8 for stated consideration of $950,000. The allocation included $940,000 of purchased technology, to be amortized through cost of revenue over three years; $400,000 was held in escrow.
Risks, contingencies and unusual items
- Key risks include quarter-to-quarter sales variability, dependence on channel partners, competition and pricing pressure, product and security defects, supply constraints and manufacturing concentration, and execution of growth into larger enterprises and government customers. The filing notes limited traction in U.S. federal sales.
- One distributor, Exclusive Networks, represented 11% of Q1 revenue; no customer exceeded 10% in Q1 2011. Revenue is also exposed to order timing and end-of-quarter shipment concentration.
- Non-cancelable contract-manufacturer purchase orders were $29.3m; operating lease and other purchase commitments brought disclosed contractual obligations to $46.7m.
- Three lawsuits were disclosed, including two patent matters and a former-stockholder class action. Management stated it did not consider a loss reasonably possible at that time for the matters discussed in the financial-statement note; the class action had a November 2012 trial date.
- Unrecognized tax benefits were $22.4m, with approximately $0.9m accrued for estimated interest. The filing excludes uncertain-tax-position liabilities from its contractual-obligations table because timing of potential cash outflows could not be estimated.
- Management reported disclosure controls were effective as of March 31, 2012 and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether deferred revenue growth and service renewals continue to support future recognized revenue and billings.
- Whether gross and operating margins stabilize as Fortinet expands hiring and enterprise support; track stock-based compensation and its effect on reported results.
- Whether product demand, inventory availability and supplier lead times support shipments without margin-eroding discounting or inventory write-downs.
- Developments in the disclosed litigation and tax positions, and any cash or earnings impact from the IntruGuard acquisition.
- Composition, maturity, credit quality and liquidity of the $525.5m investment portfolio, including the portion of cash held overseas.