Fortinet, Inc. — Q1 2022 Form 10-Q
Reporting period: Three months ended March 31, 2022. Fortinet sells cybersecurity products and services, including network security products, FortiGuard subscriptions and FortiCare support. Financial statements are unaudited.
Financial performance and position
| Metric | Q1 2022 | Q1 2021 / comparison |
|---|---|---|
| Revenue | $954.8 million | $710.3 million; up 34% |
| Product revenue | $371.0 million | $240.7 million; up 54% |
| Service revenue | $583.8 million | $469.6 million; up 24% |
| Gross profit / gross margin | $701.0 million / 73.4% | $553.7 million / 78.0% |
| Operating income / margin | $151.0 million / approximately 16% | $121.6 million / approximately 17% |
| Net income attributable to Fortinet | $138.4 million | $107.2 million |
| Diluted EPS | $0.84 | $0.64 |
| Operating cash flow | $396.1 million | $315.9 million |
| Free cash flow (non-GAAP) | $273.5 million | $263.8 million |
Product gross margin fell to 56.6% from 62.1%; service gross margin fell to 84.1% from 86.1%. Management attributed lower overall gross margin to product/service mix, Alaxala consolidation, higher component and shipping costs, and data-center expansion. Higher selling prices partly offset product cost increases. Operating expenses rose 27% to $550.0 million, led by sales and marketing and R&D. Operating margin declined 1.3 percentage points year over year.
Cash, cash equivalents, short- and long-term investments, and marketable equity securities totaled $2.502 billion at quarter-end, down from $2.993 billion at December 31, 2021. Working capital was $697.8 million, versus $1.283 billion. Long-term debt, net of issuance costs and discount, was $988.9 million; it comprises $1.0 billion principal of unsecured notes due in 2026 and 2031. The notes have no financial covenants, according to the filing.
Cash used in investing activities was $45.4 million, including $122.6 million of property and equipment purchases, partly offset by net investment maturities. Cash used in financing was $746.0 million, primarily due to $691.2 million of share repurchases and $64.8 million of taxes on net share settlements. Deferred revenue was $3.658 billion, up $205.0 million, or 6%, from year-end; remaining performance obligations were $3.66 billion, with approximately $1.89 billion expected to be recognized over the next 12 months.
Changes versus the prior comparable period
- Revenue growth was broad-based: Americas revenue rose 32%, EMEA 25%, and APAC 57%. APAC included Alaxala.
- Bookings were reported at $1.28 billion, up 50% from $851.6 million. Separately, billings, a non-GAAP measure defined as revenue plus the change in deferred revenue, were $1.160 billion, up 36% from $850.6 million.
- Backlog increased to $278.3 million from $161.9 million at December 31, 2021; the reported backlog excludes $48.7 million of Alaxala-related orders.
- Marketable-equity losses and foreign-exchange losses contributed to other expense of $9.1 million, compared with $2.0 million a year earlier. Fortinet also recorded an $8.5 million equity-method loss related to Linksys.
- The income tax line was a benefit of $8.1 million, versus a provision of $12.2 million. The effective tax rate was negative 6%, compared with 10%, primarily reflecting FDII and stock-based compensation tax benefits; new foreign tax credit regulations increased Q1 2022 tax expense by approximately $4.1 million.
Outlook, commentary, risks and unusual items
- No specific quantified revenue or earnings guidance is provided in the supplied filing text. Management expected R&D, sales and marketing, and general and administrative expenses to rise in absolute dollars during the remainder of 2022. It estimated capital expenditures of $150 million to $180 million for the rest of 2022 and said existing cash, investments and operating cash flow should cover anticipated needs for at least 12 months.
- Management cited strong product demand, an elevated cyber-threat environment, growth in Core Platform and Platform Extension products, and growing subscription and support revenue. Headcount reached 10,860 employees and contractors, up 7% from year-end.
- Supply-chain constraints, chip and component shortages, longer lead times, higher component and freight costs, and limited inventory remained significant risks. Fortinet increased supplier commitments and used air freight to mitigate disruption. Inventory purchase commitments were $1.373 billion at March 31, 2022, including $1.283 billion for 2022.
- Following Russia’s invasion of Ukraine, Fortinet reported immediate order reductions from Russia and suspended sales, support and other operations there on March 7, 2022. The company said the conflict had not materially affected Q1 financial results but that future effects were uncertain.
- Fortinet repurchased 2.3 million shares for $691.2 million during the quarter at an average $304.13 per share; $829.6 million remained authorized. This materially reduced cash and equity during the period.
- Other notable items include the $8.5 million Linksys equity-method loss and a $1.1 million quarterly gain from amortization of a patent covenant agreement. A December 2021 patent-litigation settlement included $10.0 million paid, with $5.6 million expensed and $4.4 million deferred for recognition as royalty cost.
- The company disclosed ongoing litigation and tax audits but said it was unaware of existing claims likely to have a material adverse effect on its financial position; outcomes remain uncertain. Six distributor customers represented 64% of net accounts receivable, and three distributors each represented at least 10% of Q1 revenue. COVID-related disruption, economic weakness and inflation, competition, cybersecurity/product vulnerabilities, international exposure and reliance on third-party manufacturers and channel partners are among the principal risks.
- After quarter-end, the board approved a proposed five-for-one stock split, conditional on stockholder approval at the June 17, 2022 annual meeting.
Important facts for investors to verify
- Reconcile bookings of $1.28 billion with billings of $1.160 billion and understand each measure’s definition and period basis.
- Assess whether supply availability, elevated purchase commitments and shipping costs affect backlog conversion, revenue timing and gross margins.
- Monitor the sustainability of growth in product sales and deferred service revenue, alongside the lower gross-margin mix and operating-margin decline.
- Evaluate cash and liquidity after substantial repurchases, planned capital spending, inventory commitments and ongoing share-repurchase authorization.
- Review distributor concentration, especially receivables exposure, and the potential financial or operational effects of Russia-related developments, Linksys losses, tax audits and litigation.