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| FTNT > SEC Filings for FTNT > Form 10-Q on 30-Oct-2012 | All Recent SEC Filings |
30-Oct-2012
Quarterly Report
In addition to historical information, this Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These statements include, among other things, statements concerning our expectations regarding:
• variability in sales in certain product categories from year to year and between quarters;
• expected impact of sales of certain products;
• continued sales into large enterprises;
• mix of billings between products and services;
•mix of service sales containing multi-year support and subscription contracts;
• the significance of stock-based compensation as an expense;
• the proportion of our revenue that consists of our product and
service revenues and future trends with respect to service revenue
as we renew existing services contracts and expand our customer
base;
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• the impact of our product innovation strategy;
• trends in revenue, costs of revenue, and gross margin;
• trends in our operating expenses, including personnel costs,
research and development expense, sales and marketing expense and
general and administrative expense;
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• our effective tax rate; and
• the sufficiency of our existing cash and investments to meet our cash needs for at least the next 12 months;
as well as other statements regarding our future operations, financial condition and prospects and business strategies. These forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Quarterly Report on Form 10-Q and, in particular, the risks discussed under the heading "Risk Factors" included elsewhere in this Quarterly Report on Form 10-Q and in our other SEC filings, including our Form 10-K. We undertake no obligation to revise or publicly release the results of any revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
Business Overview
We provide network security solutions, which enable broad, integrated and high performance protection against dynamic security threats while simplifying the IT security infrastructure for enterprises, service providers and governmental entities worldwide. As of September 30, 2012, we had shipped over 1,000,000 appliances to more than 10,000 channel partners and to more than 140,000 end-customers worldwide, including a majority of the Fortune Global 100.
Our core Unified Threat Management ("UTM") product line of FortiGate physical and virtual appliances ships with a set of security and networking capabilities, including firewall, VPN, application control, antivirus, intrusion prevention, Web filtering, antispam and WAN acceleration functionality. We derive a substantial majority of product sales from our FortiGate appliances, which range from the FortiGate-20 series, designed for small businesses, to the FortiGate-5000 series for large enterprises, telecommunications carriers, and service providers. Sales of FortiGate products are generally balanced across entry-level (FortiGate-20 to -100 series), mid-range (FortiGate-200 to -800 series) and high-end (FortiGate-1000 to -5000 series) models with each product category representing approximately one-third of FortiGate sales. Our UTM solution also includes our FortiGuard security subscription services, which end-customers can subscribe to in order to obtain access to dynamic updates to intrusion prevention, application control, antivirus, Web filtering, vulnerability management and antispam functionality included in our appliances. End-customers can also choose to purchase FortiCare technical support services for our products. End-customers also often use FortiManager and FortiAnalyzer products in conjunction with a FortiGate
deployment to provide centralized management, analysis and reporting capabilities. We complement our core FortiGate product line with other appliances and software that offer additional protection from security threats to other critical areas of the enterprise, such as messaging, Web application firewalls, databases, protection against denial of service attacks (DDoS) and endpoint security for employee computers and mobile devices. Sales of these complementary products have grown in recent quarters, although these products still represent less than 10% of our revenue.
In October 2012, we announced our new FortiOS 5.0 operating system. FortiOS 5.0 is our fifth generation security operating system, and this release brings more than 150 new features to our FortiGate product line. In addition, we announced version 5.0 operating systems for our FortiManager, FortiAnalyzer, and FortiClient products, to address the need for increasingly sophisticated management and analysis of the network infrastructure and endpoint devices in various environments.
In October 2012, we also announced our new FortiASIC-SoC2 processor. FortiASIC-SoC2 is our second-generation processor that combines general purpose processing power with Fortinet's custom technology to provide hardware-accelerated network security performance for our FortiGate appliances. It provides more than double the general processing capacity than its predecessor.
Financial Highlights
• We recorded revenue of $136.3 million and $382.5 million during the
three and nine months ended September 30, 2012, respectively. This
represents an increase of 17% and 22% during the three and nine
months ended September 30, 2012, respectively, compared to the same
periods last year. Revenue included $1.8 million and $2.6 million
from the sales of previously-acquired patents during the three
months ended September 30, 2012 and September 30, 2011,
respectively. Product revenue was $63.0 million and $177.9 million
during the three and nine months ended September 30, 2012,
respectively, an increase of 19% and 27% during the three and nine
months ended September 30, 2012, respectively, compared to the same
periods last year. Services revenue was $69.8 million and $197.3
million during the three and nine months ended September 30, 2012,
respectively, an increase of 21% and 24% during the three and nine
months ended September 30, 2012, respectively, compared to the same
periods last year.
• We generated cash flows from operating activities of $133.6 million
during the nine months ended September 30, 2012, an increase of 21%
compared to the same period last year.
• Cash, cash equivalents and investments were $690.3 million as of
September 30, 2012, an increase of $151.6 million from December 31,
2011.
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• Deferred revenue was $340.1 million as of September 30, 2012, an increase of $45.2 million from December 31, 2011.
During the three months ended September 30, 2012, revenues grew as a result of the successful execution of our global sales strategy and the continued product innovation that has strengthened our technology advantages and resulted in market share gains. The recent introduction of several new FortiGate entry-level appliances such as the FortiGate-20C and -40C with their WIFI counterparts and the FortiGate-100D; the FortiGate-600C and FortiGate-800C mid-range appliances; and the FortiGate-1000C, FortiGate-3240C and FortiGate-5101C for large enterprises and service providers continued to gain traction and contributed to the revenue growth.
We continue to invest in research and development to strengthen our technology leadership position, as well as sales and marketing to expand brand awareness, strengthen our value proposition, and expand our global sales team and distribution channels. We experienced healthy deal volumes driven by traction in enterprise data center deployments, large enterprise deals, with particular strength in the retail, financial and telecommunications sectors. The number of deals involving sales greater than $100,000 was 168 in the three months ended September 30, 2012, compared to 130 in the three months ended September 30, 2011. The number of deals involving sales greater than $250,000 was 61 in the three months ended September 30, 2012, compared to 39 in the three months ended September 30, 2011. The number of deals involving sales greater than $500,000 was 16 in the three months ended September 30, 2012, compared to 13 in the three months ended September 30, 2011. We expect some variability in this metric, and remain focused on investing in our sales and research and development resources in order to expand our reach into new high-growth verticals and emerging markets, and meet increasing customer expectations about the quality and functionality of our products, as we continue to sell to large customers, such as enterprise and service providers. While we have experienced some success selling into certain vertical customer segments, such as service providers and enterprise, we have experienced less traction selling into other verticals such as the U.S. federal government and there can be
no assurance we will be successful selling into certain vertical customer segments.
During the three months ended September 30, 2012, operating expenses increased
by 23% compared to the same period last year. The increase was primarily driven
by additional headcount to support our growth as we continued to invest in the
development of new products and expand our sales coverage. We also incurred $1.3
million of litigation settlement expense in the three months ended September 30,
2012. These increases were partially offset by favorable foreign currency
exchange rates compared to the same period last year. Headcount increased to
1,854 at September 30, 2012 from 1,527 at September 30, 2011. Our accelerated
pace of hiring continued this quarter, particularly in support, sales and
marketing and research and development as we increased headcount by 92 from June
30, 2012.
Key Metrics
We monitor the key financial metrics set forth below on a quarterly basis to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts and assess operational efficiencies. Our total deferred revenue increased by $8.7 million from $331.4 million at June 30, 2012 to $340.1 million at September 30, 2012. Revenue recognized plus the change in deferred revenue from the beginning to the end of the period is a useful metric that management identifies as billings. Billings for services drive deferred revenue, which is an important indicator of the health and visibility of our business, and has historically represented a majority of the quarterly revenue that we recognize. We also ended the three months ended September 30, 2012 with $690.3 million in cash, cash equivalents and investments and have had positive cash flow from operations for every fiscal year since 2005. We discuss revenue, gross margin, and the components of operating income and margin under "Results of Operations," and we discuss our cash, cash equivalents, and investments under "Liquidity and Capital Resources." Deferred revenue and cash flow from operations are discussed immediately below the following table.
For The Three Months Ended Or As Of
September 30, September 30,
2012 2011
($ amounts in 000's)
Revenue 136,268 116,426
Gross margin 72 % 73 %
Operating income(1) 25,770 26,160
Operating margin 19 % 22 %
Total deferred revenue 340,078 275,126
Increase in total deferred revenue over prior
quarter 8,710 1,927
Cash, cash equivalents and investments 690,303 502,967
Cash flows from operating activities 40,770 36,039
Free cash flow(2) 24,342 34,704
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(1) Includes:
Stock-based compensation expense 8,830 5,734
Patent settlement income 478 478
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Deferred revenue. Our deferred revenue consists of amounts that have been invoiced but that have not yet been recognized as revenue. The majority of our deferred revenue balance consists of the unamortized portion of services revenue from subscription and support service contracts. We monitor our deferred revenue balance because it represents a significant portion of revenue to be recognized in future periods. The following table reflects the calculation of billings as discussed in the paragraph above. For a discussion of the limitations of non-GAAP financial measures, see "-Other Non-GAAP Financial Measures" below.
Three Months Ended
September 30, September 30,
2012 2011
($ amounts in 000's)
Billings:
Revenue 136,268 116,426
Increase in deferred revenue 8,710 1,927
Total billings (Non-GAAP) 144,978 118,353
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Cash flow from operations. We monitor cash flow from operations as a measure of our overall business performance. Our cash flow from operations is driven in large part by advance payments for both new and renewal contracts for subscription and support services, consistent with our billings for the period. Monitoring cash flow from operations and free cash flow enables us to analyze our financial performance excluding the non-cash effects of certain items such as depreciation, amortization and stock-based compensation expenses, thereby allowing us to better understand and manage the cash needs of our business. Free cash flow, an alternative non-GAAP financial measure of liquidity, is defined as net cash provided by operating activities less capital expenditures. For a discussion of the limitations of non-GAAP financial measures, see "-Other Non-GAAP Financial Measures" below.
Three Months Ended
September 30, September 30,
2012 2011
($ amounts in 000's)
Free Cash Flow:
Net cash provided by operating activities 40,770 36,039
Less purchases of property and equipment (16,428 ) (1,335 )
Free cash flow (Non-GAAP) 24,342 34,704
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Other Non-GAAP Financial Measures
To supplement our condensed consolidated financial statements presented in accordance with U.S. GAAP, we consider certain financial measures that are not prepared in accordance with GAAP, including billings and free cash flow discussed above as well as non-GAAP gross margin, non-GAAP income from operations and non-GAAP operating margin, non-GAAP operating expenses and non-GAAP net income. These non-GAAP financial measures are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similar measures presented by other companies.
We use these non-GAAP financial measures internally in analyzing our financial results and believe they are useful to investors, as a supplement to GAAP measures, in evaluating our ongoing operational performance and enhancing an overall understanding of our past financial performance, as they help illustrate underlying trends in our business that could otherwise be masked by the effect of the expenses that we exclude in these non-GAAP financial measures. Furthermore, we use many of these measures to establish budgets and operational goals for managing our business and evaluating our performance. We also believe that the use of these non-GAAP financial measures provides an additional tool for investors to use in comparing our recurring core business operating results over multiple periods with other companies in our industry, many of which present similar non-GAAP financial measures to investors.
These non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. There are a number of limitations related to the use of these non-GAAP financial measures versus the nearest GAAP equivalent of these financial measures. First, these non-GAAP financial measures exclude certain recurring, non-cash charges such as stock-based compensation expense and a patent settlement. Stock-based compensation has been, and will continue to be for the foreseeable future, a significant recurring expense in our business and is an important part of our employees' overall compensation. Second, the expenses that we exclude in our calculation of these non-GAAP financial measures may differ from the expenses, if any, that our peer companies may exclude when they report their results of operations. We compensate for these limitations by providing the nearest GAAP equivalents of these non-GAAP financial measures and describing these GAAP equivalents in our Results of Operations below.
Non-GAAP gross margin is gross margin as reported on our condensed consolidated statements of operations, excluding the impact of stock-based compensation expense, which is a non-cash charge. Non-GAAP income from operations is operating
income, as reported on our condensed consolidated statements of operations, excluding the impact of stock-based compensation expense and the income from a patent settlement. Non-GAAP operating margin is non-GAAP income from operations divided by revenue. The following tables reconcile GAAP gross margin, income from operations, and operating margin to non-GAAP gross margin, non-GAAP income from operations, and non-GAAP operating margin for the three months ended September 30, 2012 and September 30, 2011.
Three Months Ended
September 30, September 30,
2012 2011
% of % of
Amount Revenue Amount Revenue
($ amounts in 000's)
Total revenue 136,268 116,426
GAAP gross profit and margin 98,460 72 85,287 73
Stock-based compensation expense 1,103 1 628 1
Non-GAAP gross profit and margin 99,563 73 85,915 74
GAAP income from operations and margin 25,770 19 26,160 22
Stock-based compensation expense:
Cost of revenue 1,103 1 628 1
Research and development 2,525 1 1,516 1
Sales and marketing 3,879 3 2,708 2
General and administrative 1,323 1 882 1
Total stock-based compensation 8,830 6 5,734 5
Patent settlement (478 ) - (478 ) -
Non-GAAP income from operations and margin 34,122 25 31,416 27
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Non-GAAP operating expenses exclude the impact of stock-based compensation expense and the income from a patent settlement. The following tables reconcile GAAP operating expenses to non-GAAP operating expenses for the three months ended September 30, 2012 and September 30, 2011.
Three Months Ended
September 30, September 30,
2012 2011
% of % of
Amount Revenue Amount Revenue
($ amounts in 000's)
Operating Expenses:
Research and development expenses:
GAAP research and development
expenses 20,498 15 16,834 14
Stock-based compensation (2,525 ) (1 ) (1,516 ) (1 )
Non-GAAP research and development
expenses 17,973 14 15,318 13
Sales and marketing expenses:
GAAP sales and marketing expenses 44,743 33 36,934 32
Stock-based compensation (3,879 ) (3 ) (2,708 ) (2 )
Non-GAAP sales and marketing
expenses 40,864 30 34,226 30
General and administrative expenses:
GAAP general and administrative
expenses 7,449 5 5,359 5
Stock-based compensation (1,323 ) (1 ) (882 ) (1 )
Patent settlement 478 - 478 -
Non-GAAP general and administrative
expenses 6,604 4 4,955 4
Total operating expenses:
GAAP operating expenses 72,690 53 59,127 51
Stock-based compensation (7,727 ) (5 ) (5,106 ) (4 )
Patent settlement 478 - 478 -
Non-GAAP operating expenses 65,441 48 54,499 47
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Non-GAAP net income is net income, as reported in our condensed consolidated statements of operations, excluding the impact of stock-based compensation expense and income from a patent settlement. The following tables reconcile GAAP net income as reported on our condensed consolidated statements of operations to non-GAAP net income for the three months ended September 30, 2012 and September 30, 2011.
Three Months Ended
September 30, September 30,
2012 2011
($ amounts in 000's)
Net Income:
GAAP net income 17,206 17,917
Stock-based compensation expense(1) 8,830 5,734
Patent settlement(2) (478 ) (478 )
Provision for income taxes(3) 9,565 9,207
Non-GAAP income before provision for income taxes 35,123 32,380
Tax effects related to non-GAAP adjustments(4) (11,942 ) (10,685 )
Non-GAAP net income 23,181 21,695
Non-GAAP net income per share - diluted 0.14 0.13
Shares used in per share calculation - diluted 166,791 163,869
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(2) The patent settlement income is removed from GAAP net income to reconcile to non-GAAP income before taxes.
(3) Provision for income taxes is our GAAP provision that must be added to GAAP net income to reconcile to non-GAAP
income before taxes.
(4) Tax provision related to non-GAAP income before tax reflects 34% and 33%
effective tax rates in the three months ended September 30, 2012 and
September 30, 2011, respectively. Based on the annual estimate for
geographic split of income, as well as various tax credits we expect to
achieve in various locations, we currently plan to use a 34% tax rate for
the year, subject to discrete items that may occur in a particular quarter.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with U.S. GAAP. These principles require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, cash flow and related disclosure of contingent assets and liabilities. Our estimates include those related to revenue recognition, stock-based compensation, valuation of inventory, warranty liabilities and accounting for income taxes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these estimates. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.
There have been no significant changes to our critical accounting policies and estimates since the fiscal year ended December 31, 2011.
Revenue Recognition-In October 2009, the Financial Accounting Standards Board ("FASB") amended the Accounting Standards Codification ("ASC") as summarized in ASU No. 2009-13, Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements ("ASU 2009-13"), and ASU No. 2009-14, Software (Topic 985): Certain Revenue Arrangements That Include Software Elements ("ASU 2009-14"). ASU 2009-13 amended the accounting for multiple-element arrangements to provide guidance on . . .
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