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FTNT > SEC Filings for FTNT > Form 10-Q/A on 7-Aug-2013All Recent SEC Filings

Show all filings for FORTINET INC

Form 10-Q/A for FORTINET INC


7-Aug-2013

Quarterly Report


ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended ("Exchange Act"). 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 and service providers;

the significance of stock-based compensation as an expense;

            the proportion of our revenue that consists of our product and
             service revenues, and the mix of billings between products and
             services;

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, and expectations regarding these
             expenses as a percentage of revenue;

our effective tax rate;

            the sufficiency of our existing cash, cash equivalents and
             investments to meet our cash needs for at least the next 12 months;
             and

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 in Part II, Item 1A. Risk Factors and elsewhere in this Quarterly Report on Form 10-Q and in our other SEC filings, including the 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. From inception through June 30, 2013, we shipped over 1,250,000 appliances via more than 15,000 channel partners to more than 160,000 end-customers worldwide, including a majority of the 2012 Fortune Global 100.

Our core Unified Threat Management ("UTM")/Next Generation Firewall ("NGFW") product line of FortiGate physical and virtual appliances ships with a set of security and networking capabilities, including firewall, VPN, application control, anti-malware, intrusion prevention, Web filtering, anti-spam and WAN acceleration functionality. We derive a substantial majority of product sales from our FortiGate appliances, which range from the FortiGate-20, designed for small businesses, to the FortiGate-5000 series for large enterprises, telecommunications carriers, and service providers. Our UTM/NGFW 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, anti-malware, Web filtering, vulnerability management and anti-spam 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.


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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 DDoS, endpoint security for employee computers and mobile devices and wireless access point. Although sales of these complementary products have grown in recent quarters, these products still represent less than 10% of our total revenue.

Financial Highlights

            We recorded total revenue of $147.4 million and $283.2 million
             during the three and six months ended June 30, 2013, respectively.
             This represents an increase of 14% and 15% during the three and six
             months ended June 30, 2013, respectively, compared to the same
             periods last year. Product revenue was $66.5 million and $124.5
             million during the three and six months ended June 30, 2013,
             respectively, an increase of 8% during each of the periods, compared
             to the same periods last year. Services revenue was $79.7 million
             and $155.6 million during the three and six months ended June 30,
             2013, respectively, an increase of 22% during each of the periods,
             compared to the same periods last year.



            We generated cash flows from operating activities of $75.3 million
             during the six months ended June 30, 2013, a decrease of 19%
             compared to the same period last year.

Cash, cash equivalents and investments were $814.4 million as of June 30, 2013, an increase of $74.8 million from December 31, 2012.

Deferred revenue was $389.7 million as of June 30, 2013, an increase of $26.5 million from December 31, 2012.

During the three and six months ended June 30, 2013, revenue grew as a result of our sales efforts and product offerings. We also continued to gain traction with several recently introduced products, including new FortiGate entry-level appliances such as the FG-60D with its WIFI counterparts; the FG-800C mid-range appliance; and the FG-3600C and FG-5001C for large enterprises and service providers.

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. During the three and six months ended June 30, 2013, we experienced higher sales volume in our FortiGate product family, particularly entry-level products, wireless security and access point products, which contributed to the largest portion of the growth during this period. Although we experienced a decline in deals valued at greater than $500,000 during the six months ended June 30, 2013 when compared to the same period last year, during the three and six months ended June 30, 2013, we experienced an increase in the number of deals involving sales greater than $250,000 and deals greater than $100,000 when compared to the same periods last year. Specifically, the number of deals involving sales greater than $500,000 was 20 and 33 in the three and six months ended June 30, 2013, respectively, compared to 19 and 38 in the three and six months ended June 30, 2012, respectively. The number of deals involving sales greater than $250,000 was 58 and 113 in the three and six months ended June 30, 2013, respectively, compared to 55 and 102 in the three and six months ended June 30, 2012, respectively. The number of deals involving sales greater than $100,000 was 190 and 360 in the three and six months ended June 30, 2013, respectively, compared to 168 and 321 in the three and six months ended June 30, 2012, respectively. We expect some variability in this metric, and remain focused on investing in our sales and marketing and research and development resources in order to expand our reach into new high-growth verticals and emerging markets. Moreover, such investments will allow us to meet increasing customer expectations about the quality and functionality of our products, as we continue to sell to large enterprises and service providers. While we have experienced some success selling to large enterprises, across key verticals, including service provider, government, retail, financial services and education, we experienced slower sales in the U.S. service provider sector during the three and six months ended June 30, 2013, and there can be no assurance we will be successful selling into these vertical customer segments.

During the three and six months ended June 30, 2013, operating expenses increased by 27% and 24% compared to the same periods last year. The increase was primarily driven by additional headcount as we continued to invest in the development of new products and expand our sales coverage. Headcount increased to 2,182 as of June 30, 2013 from 1,762 as of June 30, 2012. Our accelerated pace of hiring continued during the three and six months ended June 30, 2013, particularly in sales and marketing, research and development, and technical support.


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Key Metrics

We monitor the key financial metrics set forth below 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 $13.3 million from $376.4 million as of March 31, 2013 to $389.7 million as of June 30, 2013. Revenue recognized plus the change in deferred revenue from the beginning to the end of the period less any deferred revenue balances acquired from business combination(s) 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 revenue that we recognize in a typical quarter. As of June 30, 2013, we had $814.4 million in cash, cash equivalents and investments and have had positive cash flow from operations every fiscal year since 2005. We discuss revenue, gross margin, and the components of operating income and margin below 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.

                                                   Three Months Ended Or As Of
                                                   June 30,             June 30,
                                                     2013                 2012
                                                      ($ amounts in 000's)
Revenue                                              147,428              128,962
Gross margin                                              70 %                 71 %
Operating income (1)                                  13,777               20,950
Operating margin                                           9 %                 16 %
Total deferred revenue                               389,682              331,368
Increase in total deferred revenue                    13,268               16,796
Cash, cash equivalents and investments               814,410              644,398
Cash provided by operating activities                 37,221               44,285
Free cash flow (Non-GAAP)(2)                          35,186               42,054
___________________
(1) Includes:
Stock-based compensation expense                      10,707                7,852
Patent settlement income                                 478                  478

(2) See "-Cash flow from operations" below for a definition of free cash flow.

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. We define billings as revenue recognized during a period plus the change in deferred revenue from the beginning to the end of the period less any deferred revenue balances acquired from business combination(s) during the period. The following table reflects the reconciliation of billings to revenue. For a discussion of the limitations of non-GAAP financial measures, see "-Other Non-GAAP Financial Measures" below.

                                    Three Months Ended
                                   June 30,      June 30,
                                     2013          2012
                                   ($ amounts in 000's)
Billings:
Revenue                            147,428        128,962
Add increase in deferred revenue    13,268         16,796
Total billings (Non-GAAP)          160,696        145,758


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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 our billings growth, profitability, and our ability to successfully manage our working capital. 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. The following table provides a reconciliation of free cash flow to cash provided by operating activities. For a discussion of the limitations of non-GAAP financial measures, see "-Other Non-GAAP Financial Measures" below.

                                             Three Months Ended
                                            June 30,     June 30,
                                              2013         2012
                                            ($ amounts in 000's)
Free Cash Flow:
Net cash provided by operating activities    37,221       44,285
Less purchases of property and equipment     (2,035 )     (2,231 )
Free cash flow (Non-GAAP)                    35,186       42,054

Other Non-GAAP Financial Measures

To supplement our consolidated financial statements presented in accordance with 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 operating income, 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, offset by patent settlement income. Effective second quarter of fiscal 2013, our non-GAAP financial measures will include amortization expense of certain intangible assets. Prior period amounts have been adjusted to conform to current period presentation. Stock-based compensation expense 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 the section entitled "-Results of Operations" below.


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Non-GAAP gross margin represents gross margin as reported in our consolidated statements of operations, excluding the impact of stock-based compensation expense and amortization expense of certain intangible assets, both of which are non-cash charges. Non-GAAP operating income is operating income, as reported on our consolidated statements of operations, excluding the impact of stock-based compensation expense, amortization expense of certain intangible assets, and the income we received from a patent settlement. Non-GAAP operating margin is non-GAAP operating income divided by revenue. The following table reconciles GAAP gross profit, GAAP gross margin, GAAP operating income, and GAAP operating margin to non-GAAP gross margin, non-GAAP operating income, and non-GAAP operating margin for the three months ended June 30, 2013 and June 30, 2012.

                                                            Three Months Ended
                                                     June 30,                 June 30,
                                                       2013                     2012
                                                              % of                     % of
                                              Amount ($)    Revenue    Amount ($)    Revenue
                                                           ($ amounts in 000's)
Total revenue                                   147,428                  128,962
GAAP gross profit and margin                    103,720           70      91,835           71
Stock-based compensation expense                  1,322            1       1,029            1
Amortization expense of certain intangible
assets (1)                                          354            -         226            -
Non-GAAP gross profit and margin                105,396           71      93,090           72
GAAP operating income and margin                 13,777            9      20,950           16
Stock-based compensation expense:
Cost of revenue                                   1,322            1       1,029            1
Research and development                          3,291            2       2,292            2
Sales and marketing                               4,594            3       3,475            2
General and administrative                        1,500            1       1,056            1
Total stock-based compensation expense           10,707            7       7,852            6
Amortization expense of certain intangible
assets (1)                                          354            -         226            -
Patent settlement income                           (478 )          -        (478 )          -
Non-GAAP operating income and margin             24,360           16      28,550           22

(1) Effective second quarter of fiscal 2013, amortization expense of certain intangible assets is excluded from GAAP gross profit and margin, and GAAP operating income and margin to reconcile to non-GAAP financial metrics. Prior period amounts have been adjusted to conform to current period presentation.


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Non-GAAP operating expenses represent operating expenses, as reported in our condensed consolidated statements of operations, excluding the impact of stock-based compensation expense and the income from a patent settlement. The following table reconciles GAAP operating expenses to non-GAAP operating expenses for the three months ended June 30, 2013 and June 30, 2012.

                                                               Three Months Ended
                                                      June 30,                    June 30,
                                                        2013                        2012
                                                               % of                        % of
                                              Amount ($)      Revenue     Amount ($)      Revenue
                                                              ($ amounts in 000's)
Operating Expenses:
Research and development expenses:
GAAP research and development expenses           25,158          17          20,388          16
Stock-based compensation expense                 (3,291 )        (2 )        (2,292 )        (2 )
Non-GAAP research and development expenses       21,867          15          18,096          14
Sales and marketing expenses:
GAAP sales and marketing expenses                55,997          38          44,259          34
Stock-based compensation expense                 (4,594 )        (3 )        (3,475 )        (2 )
Non-GAAP sales and marketing expenses            51,403          35          40,784          32
General and administrative expenses:
GAAP general and administrative expenses          8,788           6           6,238           5
Stock-based compensation expense                 (1,500 )        (1 )        (1,056 )        (1 )
Patent settlement income                            478           -             478           -
Non-GAAP general and administrative expenses      7,766           5           5,660           4
Total operating expenses:
GAAP operating expenses                          89,943          61          70,885          55
Stock-based compensation expense                 (9,385 )        (6 )        (6,823 )        (5 )
Patent settlement income                            478           -             478           -
Non-GAAP operating expenses                      81,036          55          64,540          50


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Non-GAAP net income represents net income, as reported in our condensed consolidated statements of operations, excluding the impact of stock-based compensation expense, amortization expense of certain intangible assets, and income from a patent settlement. The following table reconciles GAAP net income to non-GAAP net income for the three months ended June 30, 2013 and June 30, 2012.

                                                                Three Months Ended
                                                              June 30,          June 30,
                                                                2013              2012
                                                          ($ and share amounts in 000's,
                                                             except per share amounts)
Net Income:
GAAP net income                                               8,979                13,950
Stock-based compensation expense (1)                         10,707                 7,852
Amortization expense of certain intangible assets (2)           354                   226
Patent settlement income (3)                                   (478 )                (478 )
Provision for income taxes (4)                                6,035                 8,276
Non-GAAP income before provision for income taxes            25,597                29,826
Non-GAAP provision for income taxes (5)                      (8,447 )             (10,141 )
Non-GAAP net income                                          17,150                19,685
Non-GAAP net income per share-diluted                          0.10                  0.12
Shares used in per share calculation-diluted                168,042               166,061


____________________


(1) Stock-based compensation expense is excluded from GAAP net income to reconcile to non-GAAP income before provision for income taxes.

(2) Effective second quarter of fiscal 2013, amortization expense of certain intangible assets is excluded from GAAP net income to reconcile to non-GAAP income before provision for income taxes. Prior period amounts have been adjusted to conform to current period presentation.

(3) The patent settlement income is excluded from GAAP net income to reconcile to non-GAAP income before provision for income taxes.

(4) Provision for income taxes is our GAAP tax provision that must included in GAAP net income to reconcile to non-GAAP income before provision for income taxes.

(5) We used non-GAAP effective tax rates of 33% and 34%, which could differ from the GAAP tax rates, to calculate non-GAAP net income for the three months ended June 30, 2013 and June 30, 2012, respectively.

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 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 expense, 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 material changes in our significant accounting policies since the fiscal year ended December 31, 2012, except for the inclusion of policies related to goodwill and other indefinite-lived intangible assets.

Goodwill and other indefinite-lived intangible assets Goodwill represents the excess of purchase consideration over the estimated fair value of net assets of businesses acquired in a business combination. Goodwill . . .

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