Fortinet, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; comparisons are with the three months ended March 31, 2022 unless otherwise noted. Fortinet provides cybersecurity and secure networking products and related subscription and technical support services. Figures are in U.S. dollars.
Financial performance
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Total revenue | $1,262.3 million | $954.8 million | +32% |
| Product revenue | $500.7 million | $371.0 million | +35% |
| Service revenue | $761.6 million | $583.8 million | +30% |
| Gross profit | $954.5 million | $701.0 million | +36% |
| Gross margin | 75.6% | 73.4% | +2.2 percentage points |
| Operating income | $273.5 million | $151.0 million | +81% |
| Operating margin | 21.7% | 15.8% | +5.9 percentage points |
| Net income attributable to Fortinet | $247.7 million | $138.4 million | +79% |
| Diluted earnings per share | $0.31 | $0.17 | — |
| Operating cash flow | $677.5 million | $396.1 million | +71% |
| Free cash flow, non-GAAP | $647.2 million | $273.5 million | — |
Growth was broad-based geographically: Americas revenue rose 37%, EMEA 38%, and APAC 15%. FortiGuard and other security subscription revenue increased 35%; FortiCare technical support and other services increased 25%. Management attributed product growth to demand across platform offerings, pricing actions, improved supply availability, and backlog fulfillment. Gross-margin improvement reflected higher product selling prices and lower freight and expedite costs, as well as service pricing and foreign-exchange effects.
Liquidity, debt, and balance sheet
- Cash and cash equivalents were $2.304 billion at March 31, 2023, versus $1.683 billion at year-end. Cash, investments, and marketable equity securities totaled $2.895 billion.
- Working capital was $1.097 billion, compared with $732.0 million at December 31, 2022. Deferred revenue totaled $4.881 billion, up 5% from year-end and 33% year over year. Remaining performance obligations were $4.91 billion; approximately $2.49 billion was expected to be recognized as revenue over the next 12 months.
- Long-term debt, net of discount and issuance costs, was $990.9 million. The $1.0 billion of senior notes consist of $500 million due 2026 at 1.0% and $500 million due 2031 at 2.2%; the filing says there are no financial covenants. Management believes available cash and operating cash flow will meet anticipated needs for at least 12 months.
- Investing activities used $42.4 million; financing activities used $13.7 million. Capital expenditures were $30.3 million in the quarter. Management estimated 2023 capital expenditures of $400–$450 million.
- Inventory was $302.7 million, up from $264.6 million at year-end. Non-cancelable inventory purchase commitments were $1.202 billion, including $1.136 billion due in 2023.
Material changes and notable items
- Operating margin rose as gross margin improved and operating expenses declined as a share of revenue, although operating expenses increased 24% in absolute dollars. Management expects R&D, sales and marketing, and general and administrative expenses to increase in absolute dollars during the remainder of 2023.
- Linksys equity-method investment losses increased to $22.1 million from $8.5 million. Fortinet recorded a $22.2 million impairment of the investment in Q4 2022; it found no additional other-than-temporary impairment at March 31, 2023, but further impairment remains possible.
- Net cash from operations increased partly with business growth, improved profitability, working-capital management, and a $240.7 million increase in deferred revenue. Free cash flow is a non-GAAP measure defined by Fortinet as operating cash flow less property and equipment purchases.
- No shares were repurchased in Q1. In April, the board increased the authorized repurchase amount by $1.0 billion, to $6.25 billion through February 29, 2024; approximately $1.53 billion remained available as of May 8. Fortinet also purchased Plano, Texas, real property for $19.3 million in April.
- Stock-based compensation was $57.0 million, compared with $53.9 million a year earlier. Effective tax rate was 7%, versus negative 6%, with the current-period rate affected by the FDII deduction and excess tax benefits from stock-based compensation.
Outlook, risks, and contingencies
Management cited continued growth opportunities in secure networking, cybersecurity platforms, and OT security, while cautioning that results may vary and that current-quarter revenue and billings may benefit from shipments against prior-period backlog. No specific revenue or earnings guidance is stated in the supplied filing text. Management expects operating expenses to rise in absolute dollars for the rest of 2023 and plans $400–$450 million of capital expenditures.
- Risks include macroeconomic weakness and reduced IT spending; supply constraints, component availability, and the possibility of excess inventory or purchase commitments; and reliance on third-party manufacturers and channel partners. Fortinet disclosed that approximately 89% of its hardware is manufactured in Taiwan.
- Revenue and receivables are concentrated among distributors: three distributors each represented at least 10% of Q1 revenue, and six distributors accounted for 66% of net accounts receivable. Days sales outstanding rose to 78 from 75 a year earlier; the allowance for credit losses increased to $6.7 million from $3.6 million at year-end.
- Other material risks include competition, product vulnerabilities or cyber incidents, foreign exchange and geopolitical exposure, real-estate investment execution, and potential Linksys impairment. The filing notes ongoing tax audits in the U.K., Canada, Germany, and other jurisdictions focused on intercompany profit allocation.
- Open litigation accruals were not material, and management said it was unaware of existing claims likely to have a material adverse effect on financial position. Litigation outcomes remain uncertain; IP claims could entail costs, damages, or future royalty payments.
- Management reported effective disclosure controls as of March 31, 2023 and no material change in internal control over financial reporting during the quarter.
Key facts for investors to verify
- Whether revenue, billings, deferred revenue, and backlog trends remain strong as supply conditions improve and prior-quarter backlog is fulfilled.
- Whether gross-margin gains persist amid component costs, pricing, product mix, and service infrastructure spending.
- Whether the $1.202 billion of inventory commitments align with actual demand, and whether supply exposure—particularly manufacturing concentration in Taiwan—changes.
- Whether major distributors remain financially sound and receivables collection stabilizes, given customer concentration and higher days sales outstanding.
- Whether planned capital spending and the expanded repurchase authorization are consistent with liquidity, free cash flow, and management’s stated investment priorities.
- Whether Linksys operating results or tax-audit outcomes lead to further charges or changes in Fortinet’s effective tax rate.