Fortinet Earnings 2013-03-31

Balance Sheet	Income Statement	Cash Flow
Assets, Equity	Rev, G Profit, Net Income	Ops, Inv, Fin

10-Q 1 fortinet2013033110-q.htm FORM 10-Q Fortinet 20130331 10-Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



T	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013



o	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 001-34511

______________________________________

FORTINET, INC.

(Exact name of registrant as specified in its charter)

______________________________________



Delaware	77-0560389
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)



1090 Kifer Road Sunnyvale, California	94086
(Address of principal executive offices)	(Zip Code)

(408) 235-7700

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	x		Accelerated filer	o
Non-accelerated filer	o	(Do not check if smaller reporting company)	Smaller reporting company	o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

As of April 30, 2013, there were 162,225,326 shares of the registrant’s common stock outstanding.

FORTINET, INC.

QUARTERLY REPORT ON FORM 10-Q

For the Quarter Ended March 31, 2013

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		Page

	Part I

Item 1.	Financial Statements	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32
Item 4.	Controls and Procedures	32

	Part II

Item 1.	Legal Proceedings	33
Item 1A.	Risk Factors	33
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	54
Item 3.	Defaults Upon Senior Securities	54
Item 4.	Mine Safety Disclosures	54
Item 5.	Other Information	54
Item 6.	Exhibits	54
	Signatures	55

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Part I

ITEM 1.
Financial Statements

FORTINET, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except per share amounts)



	March 31, 2013			December 31, 2012
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	97,384		$	122,975
Short-term investments	362,996			290,719
Accounts receivable—Net	102,359			107,642
Inventory	23,933			21,060
Prepaid expenses and other current assets	26,988			26,878
Total current assets	613,660			569,274
PROPERTY AND EQUIPMENT—Net	25,803			25,638
LONG-TERM INVESTMENTS	322,158			325,892
GOODWILL AND OTHER INTANGIBLE ASSETS—Net	9,964			2,117
OTHER ASSETS	61,144			52,576
TOTAL ASSETS	$	1,032,729		$	975,497

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	26,369		$	20,816
Accrued liabilities	21,677			22,263
Accrued payroll and compensation	26,350			28,957
Deferred revenue	257,332			247,268
Total current liabilities	331,728			319,304
DEFERRED REVENUE—Non-current	119,082			115,917
OTHER LIABILITIES	34,210			29,342
Total liabilities	485,020			464,563
COMMITMENTS AND CONTINGENCIES (Note 7)
STOCKHOLDERS’ EQUITY:
Common stock, $0.001 par value — 300,000 shares authorized; 163,550 and 161,757 shares issued and 162,141 and 160,348 shares outstanding as of March 31, 2013 and December 31, 2012, respectively	164			162
Additional paid-in capital	425,524			400,075
Treasury stock	(2,995		)	(2,995		)
Accumulated other comprehensive income	2,166			3,091
Retained earnings	122,850			110,601
Total stockholders’ equity	547,709			510,934
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	1,032,729		$	975,497

See notes to condensed consolidated financial statements.

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FORTINET, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share amounts)



	Three Months Ended
	March 31, 2013		March 31, 2012
REVENUE:
Product	$	57,950	$	53,204
Services	75,896		62,138
Ratable and other revenue	1,974		1,905
Total revenue	135,820		117,247
COST OF REVENUE:
Product	22,958		19,067
Services	15,574		11,213
Ratable and other revenue	596		763
Total cost of revenue	39,128		31,043
GROSS PROFIT:
Product	34,992		34,137
Services	60,322		50,925
Ratable and other revenue	1,378		1,142
Total gross profit	96,692		86,204
OPERATING EXPENSES:
Research and development	23,334		19,667
Sales and marketing	49,976		42,036
General and administrative	7,991		5,786
Total operating expenses	81,301		67,489
OPERATING INCOME	15,391		18,715
INTEREST INCOME	1,369		1,085
OTHER INCOME (EXPENSE)—Net	215		(71		)
INCOME BEFORE INCOME TAXES	16,975		19,729
PROVISION FOR INCOME TAXES	4,726		5,556
NET INCOME	$	12,249	$	14,173
Net income per share:
Basic	$	0.08	$	0.09
Diluted	$	0.07	$	0.09
Weighted-average shares outstanding:
Basic	161,282		156,010
Diluted	167,823		165,751

See notes to condensed consolidated financial statements.

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FORTINET, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited, in thousands)



	Three Months Ended
	March 31, 2013			March 31, 2012
Net income	$	12,249		$	14,173
Other comprehensive (loss) income, net of reclassification adjustments:
Foreign currency translation (losses) gains	(952		)	558
Unrealized gains on investments	42			1,799
Tax provision related to items of other comprehensive income or loss	(15		)	(629		)
Other comprehensive (loss) income, net of tax	(925		)	1,728
Comprehensive income	$	11,324		$	15,901

See notes to condensed consolidated financial statements.

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FORTINET, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)



	Three Months Ended
	March 31, 2013			March 31, 2012
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	12,249		$	14,173
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	3,536			2,082
Amortization of investment premiums	3,051			3,255
Stock-based compensation expense	9,299			7,246
Excess tax benefit from employee stock option plans	(1,453		)	(2,320		)
Other non-cash items, net	(540		)	19
Changes in operating assets and liabilities:
Accounts receivable—Net	5,747			10,763
Inventory	(4,520		)	(3,409		)
Prepaid expenses and other current assets	(202		)	(345		)
Other assets	(8,568		)	569
Accounts payable	4,957			(6,319		)
Accrued liabilities	(11		)	(231		)
Accrued payroll and compensation	(2,416		)	(547		)
Deferred revenue	12,677			19,696
Income taxes payable	4,305			3,886
Net cash provided by operating activities	38,111			48,518
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments	(171,506		)	(192,567		)
Sales of investments	13,823			17,416
Maturities of investments	86,018			115,026
Purchases of property and equipment	(1,534		)	(1,624		)
Payments made in connection with acquisitions, net of cash acquired	(5,979		)	(550		)
Net cash used in investing activities	(79,178		)	(62,299		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock	14,464			13,551
Excess tax benefit from employee stock option plans	1,453			2,320
Net cash provided by financing activities	15,917			15,871
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS	(441		)	703
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS	(25,591		)	2,793
CASH AND CASH EQUIVALENTS—Beginning of period	122,975			71,990
CASH AND CASH EQUIVALENTS—End of period	$	97,384		$	74,783
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for income taxes	$	8,579		$	1,010
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Purchase of property and equipment not yet paid	$	744		$	688
Liability incurred in connection with business acquisition	$	—		$	400

See notes to condensed consolidated financial statements.

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


1.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation and Preparation

The unaudited condensed consolidated financial statements of Fortinet, Inc. and its wholly owned subsidiaries (collectively, “we,” “us,” or “our”) have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information as well as the instructions to Form 10-Q and the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”). Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements, and should be read in conjunction with our audited consolidated financial statements as of and for the fiscal year ended December 31, 2012, contained in our Annual Report on Form 10-K (“Form 10-K”) filed with the SEC on February 27, 2013. In the opinion of management, all adjustments, including normal recurring accruals, considered necessary for a fair presentation have been included. The results of operations for the three months ended March 31, 2013 are not necessarily indicative of the operating results for any subsequent quarter, for the full year or any future periods.

The preparation of financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Actual results could differ materially from those estimates.

There have been no material changes in our significant accounting policies as of and for the three months ended March 31, 2013, as compared to the significant accounting policies described in the Form 10-K.

Certain prior period amounts have been combined on the condensed consolidated balance sheets.

Recently Adopted Accounting Pronouncement

In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update No. 2013-02, Comprehensive Income (Topic 220)—Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income (“ASU 2013-02”). ASU 2013-02 requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. We adopted ASU 2013-02 in the three months ended March 31, 2013. The amounts reclassified out of accumulated other comprehensive income were immaterial for the three months ended March 31, 2013 and March 31, 2012.

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

2. FINANCIAL INSTRUMENTS AND FAIR VALUE

The following table summarizes our investments ($ amounts in 000’s):



	March 31, 2013
	Amortized Cost	Unrealized Gains	Unrealized Losses		Fair Value
Corporate debt securities	559,417	1,944	(251	)	561,110
Commercial paper	76,408	23	(8	)	76,423
Municipal bonds	38,939	94	(6	)	39,027
Certificates of deposit and term deposits	8,590	5	(1	)	8,594
Total available-for-sale securities	683,354	2,066	(266	)	685,154

	December 31, 2012
	Amortized Cost	Unrealized Gains	Unrealized Losses		Fair Value
Corporate debt securities	529,738	1,814	(161	)	531,391
Commercial paper	39,229	22	(6	)	39,245
Municipal bonds	36,787	83	—		36,870
Certificates of deposit and term deposits	9,099	6	—		9,105
Total available-for-sale securities	614,853	1,925	(167	)	616,611

The following table shows the gross unrealized losses and the related fair values of our investments that have been in a continuous unrealized loss position, as of March 31, 2013 ($ amounts in 000’s):



	Less Than 12 Months			12 Months or Greater		Total
	Fair Value	Unrealized Losses		Fair Value	Unrealized Losses	Fair Value	Unrealized Losses
Corporate debt securities	168,514	(251	)	—	—	168,514	(251	)
Commercial paper	11,279	(8	)	—	—	11,279	(8	)
Municipal bonds	7,074	(6	)	—	—	7,074	(6	)
Certificates of deposit and term deposits	1,000	(1	)	—	—	1,000	(1	)
Total available-for-sale securities	187,867	(266	)	—	—	187,867	(266	)

The following table shows the gross unrealized losses and the related fair values of our investments that have been in a continuous unrealized loss position, as of December 31, 2012 ($ amounts in 000’s):



	Less Than 12 Months			12 Months or Greater			Total
	Fair Value	Unrealized Losses		Fair Value	Unrealized Losses		Fair Value	Unrealized Losses
Corporate debt securities	133,006	(156	)	5,010	(5	)	138,016	(161	)
Commercial paper	8,464	(6	)	—	—		8,464	(6	)
Total available-for-sale securities	141,470	(162	)	5,010	(5	)	146,480	(167	)

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The contractual maturities of our investments were as follows ($ amounts in 000’s)



	March 31, 2013	December 31, 2012
Due within one year	362,996	290,719
Due within one to three years	322,158	325,892
Total	685,154	616,611

Realized gains or losses from the sale of available-for-sale securities were not significant for any of the periods presented.

The following table presents the fair value of our financial assets measured at fair value on a recurring basis as of March 31, 2013 and December 31, 2012 ($ amounts in 000’s):



	March 31, 2013			December 31, 2012
	Aggregate Fair Value	Quoted Prices in Active Markets For Identical Assets	Significant Other Observable Remaining Inputs	Aggregate Fair Value	Quoted Prices in Active Markets For Identical Assets	Significant Other Observable Remaining Inputs
		(Level 1)	(Level 2)		(Level 1)	(Level 2)
Assets:
Corporate debt securities	561,110	—	561,110	531,391	—	531,391
Commercial paper	80,822	—	80,822	41,994	—	41,994
Municipal bonds	39,027	—	39,027	36,870	—	36,870
Certificates of deposit and term deposits	8,594	—	8,594	9,105	—	9,105
Money market funds	12,528	12,528	—	39,871	39,871	—
Total	702,081	12,528	689,553	659,231	39,871	619,360
Reported as:
Cash equivalents	16,927			42,620
Short-term investments	362,996			290,719
Long-term investments	322,158			325,892
Total	702,081			659,231

We did not hold financial assets or liabilities which were recorded at fair value using inputs in the Level 3 category as of March 31, 2013 or December 31, 2012. There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the three months ended March 31, 2013.

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

3. INVENTORY

Inventory consisted of the following ($ amounts in 000’s):



	March 31, 2013	December 31, 2012
Raw materials	5,226	4,958
Finished goods	18,707	16,102
Inventory	23,933	21,060

4. PROPERTY AND EQUIPMENT—Net

Property and equipment consisted of the following ($ amounts in 000’s):



	March 31, 2013		December 31, 2012
Land	13,895		13,895
Building and building improvements	610		610
Evaluation units	19,708		18,322
Computer equipment and software	18,483		17,176
Furniture and fixtures	1,637		1,501
Leasehold improvements and tooling	5,510		5,354
Total property and equipment	59,843		56,858
Less: accumulated depreciation	(34,040	)	(31,220	)
Property and equipment—net	25,803		25,638

Depreciation expense was $3.2 million and $2.1 million for the three months ended March 31, 2013 and March 31, 2012, respectively.

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

5. NET INCOME PER SHARE

Basic net income per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding during the period. Diluted net income per share is computed by dividing net income by the weighted-average number of shares of common stock outstanding, plus the dilutive effects of stock options, restricted stock units (“RSUs”), and the employee stock purchase plan (“ESPP”). Potentially dilutive shares of common stock are determined by applying the treasury stock method.

A reconciliation of the numerator and denominator used in the calculation of basic and diluted net income per share is as follows ($ and share amounts in 000’s, except per share amounts):



	Three Months Ended
	March 31, 2013	March 31, 2012
Numerator:
Net income	12,249	14,173

Denominator:
Basic shares:
Weighted-average common stock outstanding-basic	161,282	156,010
Diluted shares:
Weighted-average common stock outstanding-basic	161,282	156,010
Effect of potentially dilutive securities:
Stock options	6,457	9,699
RSUs	72	—
ESPP	12	42
Weighted-average shares used to compute diluted net income per share	167,823	165,751
Net income per share:
Basic	0.08	0.09
Diluted	0.07	0.09

The following weighted-average shares of common stock were excluded from the computation of diluted net income per share for the periods presented, as their effect would have been antidilutive (in 000’s):



	Three Months Ended
	March 31, 2013	March 31, 2012
Stock options	6,751	6,028
RSUs	1,069	—
ESPP	331	262
	8,151	6,290

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

6. DEFERRED REVENUE

Deferred revenue consisted of the following ($ amounts in 000’s):



	March 31, 2013	December 31, 2012
Product	4,823	5,411
Services	363,739	348,548
Ratable and other revenue	7,852	9,226
Total deferred revenue	376,414	363,185
Reported As:
Short-term	257,332	247,268
Long-term	119,082	115,917
Total deferred revenue	376,414	363,185

7. COMMITMENTS AND CONTINGENCIES

Leases—We lease certain facilities under various non-cancelable operating leases, which expire through 2020. In March 2013, we extended the operating lease for one of our existing facilities in Canada through 2020. The total incremental lease payments are $14.3 million. Rent expense was $2.3 million and $2.2 million during the three months ended March 31, 2013 and March 31, 2012, respectively. Rent expense is recognized using the straight-line method over the term of the lease. The aggregate future non-cancelable minimum rental payments on operating leases as of March 31, 2013 are as follows ($ amounts in 000’s):



	Rental Payment
Fiscal Years:
2013 (remainder)	6,481
2014	5,121
2015	3,630
2016	3,230
2017	2,905
Thereafter	7,254
Total	28,621

Contract Manufacturer and Other Commitments—Our independent contract manufacturers procure components and build our products based on our forecasts. These forecasts are based on estimates of future demand for our products, which are in turn based on historical trends and an analysis from our sales and marketing organizations, adjusted for overall market conditions. In order to reduce manufacturing lead times and plan for adequate component supply, we may issue purchase orders to some of our independent contract manufacturers which may not be cancellable. As of March 31, 2013, we had $36.6 million of open purchase orders with our independent contract manufacturers that may not be cancellable.

In addition to commitments with contract manufacturers, we have open purchase orders and contractual obligations in the ordinary course of business for which we have not received goods or services. As of March 31, 2013, we had $9.2 million in other purchase commitments.

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Warranties—We generally provide a 1-year warranty on hardware products and a 90-day warranty on software.

Accrued warranty activities are summarized as follows ($ amounts in 000’s):



	For The Three Months Ended And As Of		For The Year Ended And As Of
	March 31, 2013		December 31, 2012
Accrued warranty balance—beginning of the period	2,309		2,582
Warranty costs incurred	(759	)	(2,669	)
Provision for warranty	674		2,639
Changes in prior period estimates	60		(243	)
Accrued warranty balance—end of the period	2,284		2,309

Litigation—In August 2009, Enhanced Security Research, LLC and Security Research Holdings LLC (collectively “ESR”), a non-practicing entity, filed a complaint against us in the United States District Court for the District of Delaware alleging infringement by us and other defendants of two patents. The plaintiffs are claiming unspecified damages and requesting an injunction against the alleged infringement. In June 2010, the Court granted our motion to stay pending the outcome of reexamination proceedings in the U.S. Patent and Trademark Office (“PTO”) on both asserted patents. The PTO rejected all of the claims of the patents in the suit and ESR appealed this result to the Board of Patent Appeals and Interferences (“BPAI”). In August 2012, the BPAI completed its review of both reexamination proceedings, and, after the BPAI’s review, all claims of the asserted ESR patents remain rejected. In October 2012, ESR filed an additional appeal of the BPAI decision with the United States Court of Appeal for the Federal Circuit. That appeal is still pending. We have determined that, as of this time, there is not a reasonable possibility that a loss has been incurred.

In July 2010, Network Protection Sciences, LLC (“NPS”), a non-practicing entity, filed a complaint in the United States District Court for the Eastern District of Texas alleging patent infringement by us and other defendants. NPS is claiming unspecified damages, including treble damages for willful infringement, and requests an injunction against such alleged infringement. In December 2011, the United States District Court for the Eastern District of Texas ordered the case to be transferred to the Northern District of California. In June 2012, the United States District Court for the Northern District of California dismissed the other defendants for misjoinder, and the case is proceeding with Fortinet as the sole defendant. This case is currently scheduled for a jury trial starting in September 2013. We have determined that, as of this time, there is not a reasonable possibility that a loss has been incurred.

In June 2012, we received a letter from SRI International, (“SRI”) claiming that we infringed certain SRI patents. Subsequently, we filed a complaint in the United States District Court for the Northern District of California seeking declaratory relief and a judgment that the SRI patents were invalid, unenforceable and not infringed by any of our products or services. The case is proceeding in the United States District Court for the Northern District of California. The case is currently in the early stages, and we have determined that, as of this time, there is not a reasonable possibility that a loss has been incurred.

Indemnification—Under the indemnification provisions of our standard sales contracts, we agree to defend our customers against third-party claims asserting infringement of certain intellectual property rights, which may include patents, copyrights, trademarks, or trade secrets, and to pay judgments entered on such claims. Our exposure under these indemnification provisions is generally limited by the terms of our contracts to the total amount paid by our customer under the agreement. However, certain agreements include indemnification provisions that could potentially expose us to losses in excess of the amount received under the agreement. To date, there have been no claims under such indemnification provisions.

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

8. STOCKHOLDERS’ EQUITY

Employee Stock Options

The following table summarizes the weighted-average assumptions relating to our employee stock options:



	Three Months Ended
	March 31, 2012
Expected term in years	4.6
Volatility (%)	52
Risk-free interest rate (%)	0.7
Dividend rate (%)	—

There were no stock options granted during the three months ended March 31, 2013.

The following table summarizes the stock option activity and related information for the periods presented below (in 000’s, except per share amounts, exercise prices and contractual life):



	Options Outstanding
	Number of Shares		Weighted- Average Exercise Price ($)	Weighted- Average Remaining Contractual Life (Years)	Aggregate Intrinsic Value ($)
Balance—December 31, 2012	18,571		12.40
Forfeited	(325	)	21.05
Exercised	(1,464	)	5.41
Balance—March 31, 2013	16,782		12.84		189,979
Options vested and expected to vest—March 31, 2013	16,751		12.82	4.0	189,932
Options exercisable—March 31, 2013	11,157		8.63	3.3	170,182

The aggregate intrinsic value represents the pre-tax difference between the exercise price of stock options and the quoted market price of our common stock on March 31, 2013, for all in-the-money options. As of March 31, 2013, total compensation expense related to unvested stock options granted to employees but not yet recognized was $58.1 million, net of estimated forfeitures. This expense is expected to be amortized on a straight-line basis over a weighted-average period of 2.4 years.

Additional information related to our stock options is summarized below ($ amounts in 000’s, except per share amounts):



	Three Months Ended
	March 31, 2013	March 31, 2012
Weighted-average fair value per share granted	—	11.23
Intrinsic value of options exercised	26,059	38,102
Fair value of options vested	11,004	8,193

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Restricted Stock Units

The following table summarizes the activity and related information for RSUs for the period presented below (in 000’s, except per share amounts):



	Restricted Stock Units Outstanding
	Number of Shares		Weighted-Average Grant-Date-Fair Value per Share ($)
Balance—December 31, 2012	830		23.73
Granted	2,072		23.31
Forfeited	(70	)	23.64
Balance—March 31, 2013	2,832		23.44
RSUs expected to vest—March 31, 2013	2,607		23.44

As of March 31, 2013, total compensation expense related to unvested RSUs that were granted to employees and non-employees, but not yet recognized, was $64.7 million, net of estimated forfeitures. This expense is expected to be amortized on a straight-line basis over a weighted-average vesting period of 3.7 years.

Employee Stock Purchase Plan

In determining the fair value of the shares subject to our ESPP, we use the Black-Scholes option pricing model that employs the following weighted-average assumptions:



	Three Months Ended
	March 31, 2013	March 31, 2012
Expected term in years	0.5	0.5
Volatility (%)	48	58
Risk-free interest rate (%)	0.1	0.2
Dividend rate (%)	—	—

Additional information related to our ESPP is provided below (in 000’s, except per share amounts):



	Three Months Ended
	March 31, 2013	March 31, 2012
Weighted-average fair value per share granted ($)	6.83	8.08
Shares issued under the ESPP	329	288
Weighted-average price per share issued ($)	19.91	17.51

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Stock-based Compensation Expense

Stock-based compensation expense is included in costs and expenses as follows ($ amounts in 000’s):



	Three Months Ended
	March 31, 2013	March 31, 2012
Cost of product revenue	90	64
Cost of services revenue	1,020	745
Research and development	2,766	1,957
Sales and marketing	4,118	3,443
General and administrative	1,305	1,037
Total stock-based compensation expense	9,299	7,246

The following table summarizes stock-based compensation expense by award type ($ amounts in 000’s)



	Three Months Ended
	March 31, 2013	March 31, 2012
Stock options	5,486	6,316
RSUs	2,674	—
ESPP	1,139	930
Total stock-based compensation expense	9,299	7,246

Total income tax benefit from employee stock option plans that is recognized in the consolidated statements of operations is as follows ($ amounts in 000’s):



	Three Months Ended
	March 31, 2013	March 31, 2012
Income tax benefit from employee stock option plans	3,587	6,674

9. INCOME TAXES

The effective tax rate was 28% for each of the three months ended March 31, 2013 and March 31, 2012. The provision for income taxes for the periods presented is comprised of foreign income taxes, U.S. federal and state taxes, and withholding tax.

As of March 31, 2013 and December 31, 2012, unrecognized tax benefits were $30.2 million and $27.8 million, respectively. The total amount of $29.7 million in unrecognized tax benefits, if recognized, would favorably impact the effective tax rate.

It is our policy to classify accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. As of March 31, 2013, we had approximately $1.9 million accrued for estimated interest related to uncertain tax provisions. We do not expect any material unrecognized tax benefits to expire within the next twelve months.

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

10. EMPLOYEE BENEFIT PLAN

The 401(k) tax-deferred savings plan (the “401(k) Plan”) permits participants to make contributions by salary deduction pursuant to Section 401(k) of the Internal Revenue Code of 1986, as amended. Under the 401(k) Plan, participating employees may defer a portion of their pre-tax earnings, up to the annual contribution limit specified by the Internal Revenue Service (“IRS”). In Canada, we have a Group Registered Retirement Savings Plan program (the “RRSP”) which permits participants to make tax deductible contributions up to the maximum contribution limits under the Income Tax Act. Our matching contributions to the 401(k) Plans and RRSP were $0.5 million for each of the three months ended March 31, 2013 and March 31, 2012.

11. SEGMENT AND SIGNIFICANT CUSTOMER INFORMATION

The following tables set forth revenue and property and equipment by geographic region ($ amounts in 000’s):



	Three Months Ended
Revenue	March 31, 2013	March 31, 2012
Americas:
United States	34,788	31,119
Other Americas	17,839	15,312
Total Americas	52,627	46,431
Europe, Middle East and Africa (“EMEA”)	47,326	40,886
Asia Pacific and Japan (“APAC”)	35,867	29,930
Total revenue	135,820	117,247

During the three months ended March 31, 2013 and March 31, 2012, one distributor, Exclusive Networks Group, accounted for 12% and 11% of total revenue, respectively.



Property and Equipment	March 31, 2013	December 31, 2012
Americas:
United States	19,281	18,764
Canada	3,813	4,376
Other Americas	56	87
Total Americas	23,150	23,227
EMEA	1,652	1,213
APAC	1,001	1,198
Total property and equipment—net	25,803	25,638

12. FOREIGN CURRENCY DERIVATIVES

The notional amount of forward exchange contracts to hedge balance sheet accounts as of March 31, 2013 was ($ amounts in 000’s):



	Buy/Sell	Notional
Balance Sheet Contracts:
Currency
CAD	Buy	22,164

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

13. BUSINESS COMBINATIONS

On March 21, 2013, we acquired all of the outstanding equity securities of Coyote Point Systems, Inc. (“Coyote”), a provider of enterprise-class application delivery, load balancing and acceleration solutions, for $6.0 million in cash. The acquisition also includes a contingent obligation for up to $5.5 million in future earn-out payments to former stockholders of Coyote, if specified future operational objectives, service conditions and financial results are met within two years of the acquisition date. Of the maximum $5.5 million in contingent earn-out payments, up to $3.5 million will be payable after eighteen months from the acquisition date, and up to $2.0 million will be payable after two years from the acquisition date. As the future earn-out payments are also contingent upon one of Coyote’s former stockholders being in continued employment with us during the earn-out period, these contingent obligations will be recorded as compensation expense ratably over the earn-out periods for future services provided to us.

We accounted for this acquisition as a purchase of a business and, accordingly, the total purchase price was allocated to Coyote’s identifiable tangible and intangible assets acquired and liabilities assumed based on their estimated fair values as of the acquisition date. The fair value assigned to the intangible assets acquired was determined using the income approach which discounts expected cash flows to present value using our estimates and assumptions.

The following table summarizes the fair value of assets acquired and liabilities assumed as of the acquisition date ($ amounts in 000’s):



Cash and cash equivalents	206
Other current assets	501
Finite-lived intangible assets	2,800
Indefinite-lived intangible assets	2,600
Goodwill	2,766
Other assets	88
Total assets acquired	8,961
Current liabilities	1,078
Long-term liabilities	1,898
Total liabilities assumed	2,976
Total purchase price	5,985

Of the total acquired identified intangible assets, we allocated $2.3 million to developed technology, $0.5 million to customer relationships, and $2.6 million to in-process research and development. Identified finite-lived intangible assets consist of developed technology and customer relationships that will be amortized as cost of revenue and sales and marketing expense, respectively, ratably on a straight-line basis, each over an estimated useful life of 6 years. Identified indefinite-lived intangible assets consist of in-process research and development, which will be amortized upon completion of development. The goodwill of $2.8 million represents the premium we paid over the fair value of the net tangible liabilities assumed and identified intangible assets acquired. We paid this premium for a number of reasons, primarily for acquiring developed and in-process technology. None of the goodwill recognized as a result of the acquisition is deductible for income tax purposes. The financial results of this acquisition are considered immaterial for purposes of pro-forma financial disclosures.

On December 7, 2012, we completed the acquisition of XDN, Inc., a provider of cloud-based content delivery solutions, for a total consideration of $0.5 million. We accounted for this acquisition as a purchase of a business and, accordingly, the total purchase price was allocated to identifiable intangible assets acquired based on their estimated fair market value as of the acquisition date. The purchase price allocation resulted in purchased identifiable intangible assets of $0.5 million. Identifiable intangible assets consist of purchased technology. The fair value assigned to identifiable intangible assets acquired was determined using the market approach, which compares the value of the purchased assets to similar assets in similar lines of business. Purchased identifiable intangible assets are being amortized as cost of revenue ratably over three years. The financial results of this acquisition are considered immaterial for purposes of pro forma financial disclosures.

On March 8, 2012, we completed the acquisition of IntruGuard Devices, Inc. (“IntruGuard”), a supplier of Intelligent Availability Protection Systems, for a total consideration of $1.0 million. Of the total consideration, $0.4 million was withheld

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FORTINET, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

in escrow as security for IntruGuard’s indemnification obligations. We accounted for this acquisition as a purchase of a business and, accordingly, the total purchase price was allocated to tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair market values as of the acquisition date. The purchase price allocation resulted in purchased tangible assets of $53,000 and liabilities of $43,000, and purchased identifiable intangible assets of $0.9 million. Identifiable intangible assets consist of purchased technology. The fair value assigned to identifiable intangible assets acquired was determined using the income approach, which discounts expected future cash flows to present value using estimates and assumptions determined by us. Purchased identifiable intangible assets are being amortized as cost of revenue ratably over three years. Of the $0.4 million previously withheld in escrow, $0.2 million and $0.2 million were released to the selling stockholders during the three months ended September 30, 2012 and the three months ended March 31, 2013, respectively. The financial results of this acquisition are considered immaterial for purposes of pro forma financial disclosures.

14. GOODWILL AND OTHER INTANGIBLE ASSETS—NET

We acquired $2.8 million of goodwill during the three months ended March 31, 2013, which approximates the carrying value as of March 31, 2013.

The following table presents other intangible assets ($ amounts in 000’s):



	March 31, 2013
	Gross	Accumulated Amortization	Net
Finite-lived other intangible assets:
Developed technology	5,826	1,728	4,098
Customer relationships	500	—	500
	6,326	1,728	4,598
Indefinite-lived other intangible assets:
In-process research and development			2,600
Total other intangible assets			7,198



	December 31, 2012
	Gross	Accumulated Amortization	Net
Finite-lived other intangible assets:
Developed technology	3,541	1,424	2,117
Total other intangible assets	3,541	1,424	2,117

Amortization expense was $0.3 million and $0.2 million during the three months ended March 31, 2013 and March 31, 2012, respectively. The following table summarizes estimated future amortization expense of other intangible assets with finite lives for future fiscal years ($ amounts in 000’s):



	Amount
Fiscal Years:
2013 (remainder)	1,287
2014	1,168
2015	737
2016	472
2017	467
2018	467
Total	4,598

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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;


•	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 services revenue as we renew existing services contracts and expand our customer base;


•	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 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. Since inception through March 31, 2013, we shipped over 1,150,000 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

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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. 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), 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.

In March 2013, we completed the acquisition of Coyote Point Systems, Inc., a provider of application delivery controllers, as part of our strategy to expand our product portfolio.

Financial Highlights

•

We recorded total revenue of $135.8 million during the three months ended March 31, 2013. This represents an increase of 16% during the three months ended March 31, 2013, compared to the same period last year. Product revenue was $58.0 million, an increase of 9% during the three months ended March 31, 2013, compared to the same period last year. Services revenue was $75.9 million during the three months ended March 31, 2013, an increase of 22% during the three months ended March 31, 2013, compared to the same period last year.


•	We generated cash flows from operating activities of $38.1 million during the three months ended March 31, 2013, a decrease of 21% compared to the same period last year.


•	Cash, cash equivalents and investments were $782.5 million as of March 31, 2013, an increase of $43.0 million from December 31, 2012.


•	Deferred revenue was $376.4 million as of March 31, 2013, an increase of $13.2 million from December 31, 2012.

During the three months ended March 31, 2013, revenue grew as a result of our sales efforts and product offerings. We also recently introduced several new FortiGate entry-level appliances such as the FG-60D with its WIFI counterparts and the FG-100D; the FG-800C mid-range appliance; and the FG-3240C, 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. We believe that, during the three months ended March 31, 2013, our operating results were negatively impacted primarily by macroeconomic and geopolitical challenges in Latin America and EMEA, as well as a shortfall in sales to the U.S. service provider sector due to increased cautionary purchasing behavior, which resulted in fewer than expected large deals in the quarter. Although we experienced a decline in deals valued at greater than $500,000 during the three months ended March 31, 2013 when compared to the same period last year, during the three months ended March 31, 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 period last year. Specifically, the number of deals involving sales greater than $500,000 was 13 in the three months ended March 31, 2013, compared to 19 in the three months ended March 31, 2012. The number of deals involving sales greater than $250,000 was 55 in the three months ended March 31, 2013, compared to 47 in the three months ended March 31, 2012. The number of deals involving sales greater than $100,000 was 170 in the three months ended March 31, 2013, compared to 153 in the three months ended March 31, 2012. 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 into the large enterprise segment, 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 months ended March 31, 2013, and there can be no assurance we will be successful selling into these vertical customer segments.

During the three months ended March 31, 2013, operating expenses increased by 20% 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. During the three months ended March 31, 2013, headcount

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increased to 2,077 from 1,655 as of March 31, 2012. Our accelerated pace of hiring continued during the three months ended March 31, 2013, particularly in sales and marketing.

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 $13.2 million from $363.2 million as of December 31, 2012 to $376.4 million as of March 31, 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 March 31, 2013, we had $782.5 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
	March 31, 2013		March 31, 2012
	($ amounts in 000’s)
Revenue	135,820		117,247
Gross margin	71	%	74	%
Operating income ⁽¹⁾	15,391		18,715
Operating margin	11	%	16	%
Total deferred revenue	376,414		314,572
Increase in total deferred revenue	13,229		19,739
Cash, cash equivalents and investments	782,538		600,306
Cash provided by operating activities	38,111		48,518
Free cash flow (Non-GAAP)⁽²⁾	36,577		46,894
___________________
(1) Includes:
Stock-based compensation expense	9,299		7,246
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 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
	March 31, 2013		March 31, 2012
	($ amounts in 000’s)
Billings:
Revenue	135,820		117,247
Add increase in deferred revenue	13,229		19,739
Less deferred revenue balance acquired in business combination	(550	)	—
Total billings (Non-GAAP)	148,499		136,986

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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
	March 31, 2013		March 31, 2012
	($ amounts in 000’s)
Free Cash Flow:
Net cash provided by operating activities	38,111		48,518
Less purchases of property and equipment	(1,534	)	(1,624	)
Free cash flow (Non-GAAP)	36,577		46,894

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. 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 is gross margin as reported on our consolidated statements of operations, excluding the impact of stock-based compensation expense, which is a non-cash charge. Non-GAAP operating income is operating income, as reported on our consolidated statements of operations, excluding the impact of stock-based compensation expense and the income we received from a patent settlement. Non-GAAP operating margin is non-GAAP operating income divided by revenue. The following tables reconcile GAAP gross margin, operating income, and operating margin to non-GAAP gross margin, non-GAAP operating income, and non-GAAP operating margin for the three months ended March 31, 2013 and March 31, 2012.



	Three Months Ended
	March 31, 2013			March 31, 2012
	Amount ($)		% of Revenue	Amount ($)		% of Revenue
	($ amounts in 000’s)
Total revenue	135,820			117,247
GAAP gross profit and margin	96,692		71	86,204		74
Stock-based compensation expense	1,110		1	809		—
Non-GAAP gross profit and margin	97,802		72	87,013		74
GAAP operating income and margin	15,391		11	18,715		16
Stock-based compensation expense:
Cost of revenue	1,110		1	809		—
Research and development	2,766		2	1,957		2
Sales and marketing	4,118		3	3,443		3
General and administrative	1,305		1	1,037		1
Total stock-based compensation expense	9,299		7	7,246		6
Patent settlement income	(478	)	—	(478	)	—
Non-GAAP operating income and margin	24,212		18	25,483		22

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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 March 31, 2013 and March 31, 2012.



	Three Months Ended
	March 31, 2013				March 31, 2012
	Amount ($)		% of Revenue		Amount ($)		% of Revenue
	($ amounts in 000’s)
Operating Expenses:
Research and development expenses:
GAAP research and development expenses	23,334		17		19,667		17
Stock-based compensation expense	(2,766	)	(2	)	(1,957	)	(2	)
Non-GAAP research and development expenses	20,568		15		17,710		15
Sales and marketing expenses:
GAAP sales and marketing expenses	49,976		37		42,036		36
Stock-based compensation expense	(4,118	)	(3	)	(3,443	)	(3	)
Non-GAAP sales and marketing expenses	45,858		34		38,593		33
General and administrative expenses:
GAAP general and administrative expenses	7,991		6		5,786		5
Stock-based compensation expense	(1,305	)	(1	)	(1,037	)	(1	)
Patent settlement income	478		—		478		—
Non-GAAP general and administrative expenses	7,164		5		5,227		5
Total operating expenses:
GAAP operating expenses	81,301		60		67,489		58
Stock-based compensation expense	(8,189	)	(6	)	(6,437	)	(6	)
Patent settlement income	478		—		478		—
Non-GAAP operating expenses	73,590		54		61,530		52

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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 consolidated statements of operations to non-GAAP net income for the three months ended March 31, 2013 and March 31, 2012.



	Three Months Ended
	March 31, 2013		March 31, 2012
	($ and share amounts in 000’s, except per share amounts)
Net Income:
GAAP net income	12,249		14,173
Stock-based compensation expense ⁽¹⁾	9,299		7,246
Patent settlement income ⁽²⁾	(478	)	(478	)
Provision for income taxes ⁽³⁾	4,726		5,556
Non-GAAP income before provision for income taxes	25,796		26,497
Non-GAAP provision for income taxes ⁽⁴⁾	(8,513	)	(9,009	)
Non-GAAP net income	17,283		17,488
Non-GAAP net income per share—diluted	0.10		0.11
Shares used in per share calculation—diluted	167,823		165,751

____________________


(1)	Stock-based compensation expense is added back to GAAP net income to reconcile to non-GAAP income before taxes.


(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)	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 March 31, 2013 and March 31, 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.

Recently Adopted Accounting Pronouncement

In February 2013, the FASB issued ASU 2013-02, which requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. We adopted ASU 2013-02 in the three months ended March 31, 2013. The amounts reclassified out of accumulated other comprehensive income were immaterial for the three months ended March 31, 2013 and March 31, 2012.

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Results of Operations

Revenue



	Three Months Ended
	March 31, 2013		March 31, 2012
	Amount ($)	% of Total Revenue	Amount ($)	% of Total Revenue	Change	% Change
	($ amounts in 000’s)
Revenue:
Product	57,950	43	53,204	45	4,746	9
Services	75,896	56	62,138	53	13,758	22
Ratable and other revenue	1,974	1	1,905	2	69	4
Total revenue	135,820	100	117,247	100	18,573	16
Revenue by geography:
Americas	52,627	39	46,431	40	6,196	13
EMEA	47,326	35	40,886	35	6,440	16
APAC	35,867	26	29,930	25	5,937	20
Total revenue	135,820	100	117,247	100	18,573	16

Total revenue increased by $18.6 million, or 16%, in three months ended March 31, 2013 compared to the same period last year. All three regions contributed comparable growth on an absolute basis, with APAC contributing the largest percentage growth at 20%. Product revenue increased by $4.7 million, or 9%, compared to the same period last year. The increase in product revenue was primarily driven by greater sales volume in our FortiGate product family due to increased demand across all product categories with our entry-level products and wireless security and access point products contributing the largest portion of the growth. Services revenue increased by $13.8 million, or 22%, in the three months ended March 31, 2013 compared to the same period last year due to the recognition of revenue from our growing deferred revenue balance consisting of subscription and support contracts sold to a larger customer base.

Cost of revenue and gross margin



	Three Months Ended
	March 31, 2013	March 31, 2012	Change		% Change
	($ amounts in 000’s)
Cost of revenue:
Product	22,958	19,067	3,891		20
Services	15,574	11,213	4,361		39
Ratable and other revenue	596	763	(167	)	(22	)
Total cost of revenue	39,128	31,043	8,085		26
Gross margin (%):
Product	60.4	64.2	(3.8	)
Services	79.5	82.0	(2.5	)
Ratable and other revenue	69.8	59.9	9.9
Total gross margin	71.2	73.5	(2.3	)

Total gross margin decreased by 2.3 percentage points in the three months ended March 31, 2013 compared to the same period last year, as both product and services gross margins declined. Product gross margin decreased by 3.8 percentage

Table of Contents

points in the three months ended March 31, 2013 compared to the same period last year primarily as a result of the higher mix of entry-level products and higher overhead costs. From time to time, we have experienced sales of previously reserved inventory. During the three months ended March 31, 2013, we experienced a positive impact to gross margin of 0.3 percentage point due to the sale of fully reserved inventory compared to a positive impact to gross margin of 0.2 percentage point in the prior year. Services gross margin decreased by 2.5 percentage points during the three months ended March 31, 2013 primarily due to our continued investments in our technical support organization to accommodate our expanding customer base and higher service level expectations from our enterprise customers. In addition, we experienced growth in our professional consulting services which have lower gross margins than our support and subscription businesses. Cost of services revenue increased by $4.4 million primarily due to a $3.2 million increase in cash-based personnel costs related to an increase in headcount, a $0.3 million increase in stock-based compensation expense, and a combined $0.9 million increase in prof

Price	78.86	EPS	1
Shares	175	P/E	65
MCap	13,793	P/FCF	22
Net Debt	-1,176	EBIT	252
TEV	12,617	TEV/EBIT	50
TTM 2019-09-30, in MM, except price, ratios

10-Q	2020-09-30	Filed 2020-11-06
10-Q	2020-06-30	Filed 2020-08-06
10-Q	2020-03-31	Filed 2020-05-07
10-K	2019-12-31	Filed 2020-02-26
10-Q	2019-09-30	Filed 2019-10-31
10-Q	2019-06-30	Filed 2019-08-01
10-Q	2019-03-31	Filed 2019-05-08
10-K	2018-12-31	Filed 2019-02-27
10-Q	2018-09-30	Filed 2018-11-07
10-Q	2018-06-30	Filed 2018-08-07
10-Q	2018-03-31	Filed 2018-05-08
10-K	2017-12-31	Filed 2018-02-26
10-Q	2017-09-30	Filed 2017-11-02
10-Q	2017-06-30	Filed 2017-08-02
10-Q	2017-03-31	Filed 2017-05-03
10-K	2016-12-31	Filed 2017-03-01
10-Q	2016-09-30	Filed 2016-11-08
10-Q	2016-06-30	Filed 2016-08-05
10-Q	2016-03-31	Filed 2016-05-06
10-K	2015-12-31	Filed 2016-02-26
10-Q	2015-09-30	Filed 2015-11-09
10-Q	2015-06-30	Filed 2015-08-04
10-Q	2015-03-31	Filed 2015-05-01
10-K	2014-12-31	Filed 2015-03-02
10-Q	2014-09-30	Filed 2014-11-06
10-Q	2014-06-30	Filed 2014-08-05
10-Q	2014-03-31	Filed 2014-05-07
10-K	2013-12-31	Filed 2014-03-03
10-Q	2013-09-30	Filed 2013-11-05
10-Q	2013-06-30	Filed 2013-08-06
10-Q	2013-03-31	Filed 2013-05-08
10-K	2012-12-31	Filed 2013-02-27
10-Q	2012-09-30	Filed 2012-10-30
10-Q	2012-06-30	Filed 2012-08-08
10-Q	2012-03-31	Filed 2012-05-07
10-K	2011-12-31	Filed 2012-02-28
10-Q	2011-09-30	Filed 2011-11-04
10-Q	2011-06-30	Filed 2011-08-04
10-Q	2011-03-31	Filed 2011-05-05
10-K	2010-12-31	Filed 2011-02-25
10-Q	2010-09-30	Filed 2010-11-05
10-Q	2010-06-30	Filed 2010-08-06
10-Q	2010-03-31	Filed 2010-05-13
10-K	2009-12-31	Filed 2010-03-05

8-K	2020-10-29
8-K	2020-08-22
8-K	2020-08-06
8-K	2020-07-17
8-K	2020-06-19
8-K	2020-05-06
8-K	2020-04-17
8-K	2020-02-26
8-K	2020-02-06
8-K	2019-12-12
8-K	2019-10-31
8-K	2019-10-28
8-K	2019-10-18
8-K	2019-08-01
8-K	2019-06-21
8-K	2019-05-02
8-K	2019-02-06
8-K	2018-11-01
8-K	2018-10-23
8-K	2018-08-01
8-K	2018-06-22
8-K	2018-06-04
8-K	2018-05-03
8-K	2018-02-02

EX-31.1	fortinet_20130331x10-qex311.htm
EX-31.2	fortinet_20130331x10-qex312.htm
EX-32.1	fortinet_20130331x10-qex321.htm


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

FTNT 10Q Quarterly Report

Fortinet Earnings 2013-03-31