Fortinet Earnings 2014-09-30

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

10-Q 1 ftnt-2014093010q.htm FORM 10-Q FTNT - 2014.09.30.10Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)



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

For the quarterly period ended September 30, 2014



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.)



899 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 (“Exchange Act”) 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 Act). Yes o No x

As of October 31, 2014, there were 164,855,943 shares of the registrant’s common stock outstanding.

FORTINET, INC.

QUARTERLY REPORT ON FORM 10-Q

For the Quarter Ended September 30, 2014

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		Page

	Part I

Item 1.	Financial Statements	3
	Condensed Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013	3
	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2014 and 2013	4
	Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2014 and 2013	5
	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	36
Item 4.	Controls and Procedures	36

	Part II

Item 1.	Legal Proceedings	37
Item 1A.	Risk Factors	37
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	59
Item 6.	Exhibits	59
	Signatures	60

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Part I

Item 1. Financial Statements

FORTINET, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except per share amounts)



	September 30, 2014		December 31, 2013
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	258,096	$	115,873
Short-term investments	402,495		375,497
Accounts receivable—Net of allowance for doubtful accounts and sales returns of $5,537 and $4,605 as of September 30, 2014 and December 31, 2013, respectively	116,382		130,471
Inventory	51,344		48,672
Deferred tax assets	51,297		50,980
Prepaid expenses and other current assets	16,826		14,053
Total current assets	896,440		735,546
LONG-TERM INVESTMENTS	303,168		351,675
PROPERTY AND EQUIPMENT—Net	56,812		36,652
DEFERRED TAX ASSETS	42,276		30,058
GOODWILL	2,824		2,872
OTHER INTANGIBLE ASSETS—Net	3,104		6,841
OTHER ASSETS	7,977		4,820
TOTAL ASSETS	$	1,312,601	$	1,168,464

LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	36,520	$	35,599
Accrued liabilities	25,662		27,380
Accrued payroll and compensation	40,692		34,997
Income taxes payable	2,490		21,421
Deferred revenue	329,132		293,664
Total current liabilities	434,496		413,061
DEFERRED REVENUE	170,880		138,964
INCOME TAXES PAYABLE	40,532		30,208
OTHER LIABILITIES	17,467		471
Total liabilities	663,375		582,704
COMMITMENTS AND CONTINGENCIES (Note 9)
STOCKHOLDERS’ EQUITY:
Common stock, $0.001 par value — 300,000 shares authorized; 164,904 and 161,535 shares issued and outstanding as of September 30, 2014 and December 31, 2013, respectively	165		161
Additional paid-in capital	537,450		462,644
Accumulated other comprehensive income	114		1,092
Retained earnings	111,497		121,863
Total stockholders’ equity	649,226		585,760
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	1,312,601	$	1,168,464

See notes to condensed consolidated financial statements.

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FORTINET, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share amounts)



	Three Months Ended						Nine Months Ended
	September 30, 2014			September 30, 2013			September 30, 2014			September 30, 2013
REVENUE:
Product	$	87,731		$	69,687		$	249,880		$	194,162
Services and other	105,617			85,012			296,515			243,785
Total revenue	193,348			154,699			546,395			437,947
COST OF REVENUE:
Product	35,636			27,126			105,230			77,032
Services and other	21,249			16,804			60,155			49,734
Total cost of revenue	56,885			43,930			165,385			126,766
GROSS PROFIT:
Product	52,095			42,561			144,650			117,130
Services and other	84,368			68,208			236,360			194,051
Total gross profit	136,463			110,769			381,010			311,181
OPERATING EXPENSES:
Research and development	30,790			26,421			89,783			74,913
Sales and marketing	80,433			56,687			222,576			162,660
General and administrative	9,789			9,382			29,243			26,161
Total operating expenses	121,012			92,490			341,602			263,734
OPERATING INCOME	15,451			18,279			39,408			47,447
INTEREST INCOME	1,339			1,282			3,991			3,988
OTHER EXPENSE—Net	(1,005		)	(1,151		)	(1,968		)	(1,036		)
INCOME BEFORE INCOME TAXES	15,785			18,410			41,431			50,399
PROVISION FOR INCOME TAXES	11,729			7,381			22,901			18,142
NET INCOME	$	4,056		$	11,029		$	18,530		$	32,257
Net income per share (Note 7):
Basic	$	0.02		$	0.07		$	0.11		$	0.20
Diluted	$	0.02		$	0.07		$	0.11		$	0.19
Weighted-average shares outstanding:
Basic	164,294			162,906			163,289			162,150
Diluted	169,727			168,666			168,735			168,054

See notes to condensed consolidated financial statements.

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FORTINET, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited, in thousands)



	Three Months Ended						Nine Months Ended
	September 30, 2014			September 30, 2013			September 30, 2014			September 30, 2013
Net income	$	4,056		$	11,029		$	18,530		$	32,257
Other comprehensive (loss) income—net of taxes:
Foreign currency translation (losses) gains	(432		)	912			(333		)	(901		)
Unrealized (losses) gains on investments	(977		)	600			(993		)	(826		)
Tax benefit (provision) related to items of other comprehensive loss or income	342			(209		)	348			289
Other comprehensive (loss) income—net of taxes	(1,067		)	1,303			(978		)	(1,438		)
Comprehensive income	$	2,989		$	12,332		$	17,552		$	30,819

See notes to condensed consolidated financial statements.

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FORTINET, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)



	Nine Months Ended
	September 30, 2014			September 30, 2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	18,530		$	32,257
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	16,519			11,511
Amortization of investment premiums	6,680			8,900
Stock-based compensation	42,313			31,784
Excess tax benefit from stock-based compensation	(4,325		)	(2,504		)
Other non-cash items—net	3,801			520
Changes in operating assets and liabilities:
Accounts receivable—Net	13,140			589
Inventory	(11,095		)	(31,344		)
Deferred tax assets	(12,186		)	(14,806		)
Prepaid expenses and other current assets	(2,781		)	204
Other assets	(159		)	893
Accounts payable	3,806			11,054
Accrued liabilities	2,818			3,630
Other liabilities	14,350			(999		)
Accrued payroll and compensation	5,651			1,400
Deferred revenue	68,006			36,425
Income taxes payable	(3,850		)	11,202
Net cash provided by operating activities	161,218			100,716
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of investments	(388,808		)	(419,124		)
Sales of investments	27,282			25,488
Maturities of investments	371,837			303,852
Purchases of property and equipment	(26,802		)	(6,729		)
Payments made in connection with acquisitions—net of cash acquired	(17		)	(7,635		)
Net cash used in investing activities	(16,508		)	(104,148		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of common stock	40,529			24,470
Taxes paid related to net share settlement of equity awards	(8,506		)	(966		)
Excess tax benefit from stock-based compensation	4,325			2,504
Repurchase and retirement of common stock	(38,235		)	—
Net cash (used in) provided by financing activities	(1,887		)	26,008
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS	(600		)	(1,005		)
NET INCREASE IN CASH AND CASH EQUIVALENTS	142,223			21,571
CASH AND CASH EQUIVALENTS—Beginning of period	115,873			122,975
CASH AND CASH EQUIVALENTS—End of period	$	258,096		$	144,546
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for income taxes—net	$	38,755		$	19,721
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Liability for purchase of property and equipment and asset retirement obligations	$	4,710		$	1,349
Liability incurred for repurchase of common stock	$	379		$	—
Liability incurred in connection with business acquisition	$	—		$	100

See notes to condensed consolidated financial statements.

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FORTINET, INC.

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 generally accepted accounting principles (“GAAP”) in the United States (“U.S.”) for interim financial information as well as the instructions to Form 10-Q pursuant to 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, 2013, contained in our Annual Report on Form 10-K (“Form 10-K”) filed with the SEC on March 3, 2014. In the opinion of management, all adjustments, which includes normal recurring adjustments, considered necessary for a fair presentation have been included. All intercompany balances, transactions and cash flows have been eliminated. The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the operating results for the full year or for any future periods. The condensed consolidated balance sheets as of December 31, 2013 are derived from the audited consolidated financial statements for the year ended December 31, 2013.

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 to our significant accounting policies as of and for the three and nine months ended September 30, 2014. During the first quarter of fiscal 2014, we prospectively modified the expected term calculation used in accounting for stock-based compensation expense and the estimated useful lives of building improvements, and furniture and fixtures. During the third quarter of fiscal 2014, we reevaluated the functional currency selection for certain of our international subsidiaries and prospectively applied the U.S. dollar.

Stock-Based Compensation Expense—Beginning in the first quarter of fiscal 2014, we changed the methodology of calculating the expected term, which is one of the assumptions used in determining the fair value of our employee stock options under the Black Scholes option pricing model. The expected term represents the period that our stock-based awards are estimated to be outstanding. We believe that we have sufficient historical experience since becoming a publicly-traded company for estimating the expected term of the stock option awards, and therefore, we calculated our expected term based on historical experience instead of using the simplified method.

Currency Translation Adjustment—Prior to the third quarter of fiscal 2014, the assets and liabilities of our international subsidiaries were translated into U.S. dollars using the applicable exchange rates. The resulting foreign translation adjustments were included in the consolidated balance sheets as a component of accumulated other comprehensive income (loss) and in the consolidated statements of comprehensive income.

We reevaluated the selected functional currency of our international subsidiaries due to the nature of our business operations. We recorded the cumulative impact of the reevaluation of the functional currency in the condensed consolidated statement of operations for the three months ended September 30, 2014. The remeasurement of the assets and liabilities of all international subsidiaries will be recorded in the consolidated statement of operations prospectively. The impact of this reevaluation is not material for any of our previously issued financial statements.

Property and Equipment—Property and equipment—net is stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets as follows:



	Estimated Useful Lives
Building and building improvements	20 years
Evaluation units	1 year
Computer equipment and software	1-2 years
Furniture and fixtures	3 - 5 years
Leasehold improvements	Shorter of useful life or lease term

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FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

In March 2014, we moved into our new corporate headquarters and estimated the useful life of the building and related improvements to be 20 years. The useful life of furniture and fixtures placed in service in the new building is estimated to be 3 to 5 years.

Reclassification—Beginning in the first quarter of 2014, the amounts previously reported as Ratable and other revenue have been combined with the amounts previously reported as Services revenue in the condensed consolidated statements of operations. The combined amounts are now being presented as Services and other revenue in the condensed consolidated statements of operations. The related Cost of revenue and Gross profit, including prior period amounts, have also been combined to conform to the current period presentation. The Ratable and other revenue amounts, including the related Cost of revenue and Gross profit amounts, are not material, and the reclassification did not have any impact on our gross margin or net income.

Recent Accounting Pronouncement—In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update No. 2014-09 (Topic 606) - Revenue from Contracts with Customers (“ASU 2014-09”) to create a single, joint revenue standard that is consistent across all industries and markets for companies that prepare their financial statements in accordance with U.S. GAAP. Under ASU 2014-09, an entity is required to recognize revenue upon the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to be entitled to receive in exchange for those goods or services. ASU 2014-09 is effective for us beginning on January 1, 2017. We are currently evaluating the impact of ASU 2014-09 on our consolidated financial statements.

2. FINANCIAL INSTRUMENTS AND FAIR VALUE MEASUREMENTS

The following table summarizes our investments as of September 30, 2014 and December 31, 2013 (in thousands):



	September 30, 2014
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Corporate debt securities	$	587,087	$	763	$	(606	)	$	587,244
Commercial paper	58,250		4		(1		)	58,253
Municipal bonds	33,260		42		(25		)	33,277
Certificates of deposit and term deposits	21,143		1		—			21,144
U.S. government and agency securities	5,748		2		(5		)	5,745
Total available-for-sale securities	$	705,488	$	812	$	(637	)	$	705,663



	December 31, 2013
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Corporate debt securities	$	603,185	$	1,506	$	(374	)	$	604,317
Commercial paper	69,356		7		—			69,363
Municipal bonds	38,815		48		(20		)	38,843
Certificates of deposit and term deposits	12,645		3		—			12,648
U.S. government and agency securities	2,000		1		—			2,001
Total available-for-sale securities	$	726,001	$	1,565	$	(394	)	$	727,172

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 September 30, 2014 and December 31, 2013 (in thousands):

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FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



	September 30, 2014
	Less Than 12 Months					12 Months or Greater					Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Corporate debt securities	$	244,554	$	(605	)	$	1,017	$	(1	)	$	245,571	$	(606	)
Commercial paper	2,396		(1		)	—		—			2,396		(1		)
Municipal bonds	12,201		(25		)	2,000		—			14,201		(25		)
U.S. government and agency securities	4,745		(5		)	—		—			4,745		(5		)
Total available-for-sale securities	$	263,896	$	(636	)	$	3,017	$	(1	)	$	266,913	$	(637	)



	December 31, 2013
	Less Than 12 Months					12 Months or Greater				Total
	Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Corporate debt securities	$	182,795	$	(374	)	$	500	$	—	$	183,295	$	(374	)
Commercial paper	7,897		—			—		—		7,897		—
Municipal bonds	14,736		(20		)	—		—		14,736		(20		)
Total available-for-sale securities	$	205,428	$	(394	)	$	500	$	—	$	205,928	$	(394	)

The contractual maturities of our investments are as follows (in thousands):



	September 30, 2014		December 31, 2013
Due within one year	$	402,495	$	375,497
Due within one to three years	303,168		351,675
Total	$	705,663	$	727,172

Available-for-sale securities are reported at fair value, with unrealized gains and losses, net of tax, included as a separate component of stockholders’ equity and in total comprehensive income. Realized gains and losses on available-for-sale securities are included in Other expense—net in our condensed consolidated statements of operations.

The unrealized losses on our available-for-sale securities were caused by fluctuations in market value and interest rates as a result of the economic environment. As the declines in market value are attributable to changes in market conditions and not credit quality, and because we have concluded currently that we neither intend to sell nor it is more likely than not that we will be required to sell these investments prior to a recovery of par value, we do not consider these investments to be other-than temporarily impaired as of September 30, 2014.

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

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FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Fair Value of Financial Instruments

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The following table presents the fair value of our financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2014 and December 31, 2013 (in thousands):



	September 30, 2014								December 31, 2013
	Aggregate Fair Value		Quoted Prices in Active Markets For Identical Assets		Significant Other Observable Remaining Inputs		Significant Other Unobservable Remaining Inputs		Aggregate Fair Value		Quoted Prices in Active Markets For Identical Assets		Significant Other Observable Remaining Inputs		Significant Other Unobservable Remaining Inputs
			(Level 1)		(Level 2)		(Level 3)				(Level 1)		(Level 2)		(Level 3)
Assets:
Corporate debt securities	$	587,244	$	—	$	587,244	$	—	$	604,317	$	—	$	604,317	$	—
Commercial paper	58,253		—		58,253		—		71,363		—		71,363		—
Municipal bonds	33,277		—		33,277		—		38,843		—		38,843		—
Certificates of deposit and term deposits	21,144		—		21,144		—		12,648		—		12,648		—
Money market funds	20,125		20,125		—		—		5,724		5,724		—		—
U.S. government and agency securities	5,745		1,998		3,747		—		2,001		—		2,001		—
Total	$	725,788	$	22,123	$	703,665	$	—	$	734,896	$	5,724	$	729,172	$	—

Liabilities:
Contingent consideration	$	—	$	—	$	—	$	—	$	1,850	$	—	$	—	$	1,850
Total	$	—	$	—	$	—	$	—	$	1,850	$	—	$	—	$	1,850

Reported as:
Cash equivalents	$	20,125							$	7,724
Short-term investments	402,495								375,497
Long-term investments	303,168								351,675
Total	$	725,788							$	734,896

We classify investments within Level 1 if quoted prices are available in active markets for identical securities.

We classify items within Level 2 if the investments are valued using model driven valuations using observable inputs such as quoted market prices, benchmark yields, reported trades, broker/dealer quotes or alternative pricing sources with reasonable levels of price transparency. Investments are held by custodians who obtain investment prices from a third-party pricing provider that incorporates standard inputs in various asset price models.

There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the three and nine months ended September 30, 2014.

We classified the fair value of contingent consideration arising from the acquisition of Coyote Point Systems, Inc. (“Coyote”) (see Note 5), as a Level 3 liability since it is based on a probability-based income approach that includes significant unobservable inputs. The significant unobservable inputs include projected revenues and the percentage probability of occurrence to determine the fair value of the payment.

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FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The change in the fair value of our contingent consideration liability was as follows (in thousands):



As of December 31, 2013	$1,850
Less change in fair value of contingent consideration	(1,143)
As of March 31, 2014	707
Less change in fair value of contingent consideration	(707)
As of September 30, 2014	$—

Decreases in the projected revenues of Coyote following the acquisition resulted in reductions to the fair value of the contingent consideration and the changes are included in research and development expense in the condensed consolidated statements of operations.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

We measure certain assets, including Goodwill, Other intangible assets—net, and investments in privately-held companies at fair value on a nonrecurring basis when there are identifiable events or changes in circumstances that may have a significant adverse impact on the fair value of these assets.

During the nine months ended September 30, 2014, a decrease in the projected cash flow from Coyote resulted in an impairment charge of $2.4 million to adjust the total fair value of the other intangible assets acquired from Coyote to $2.0 million. The impairment charge is included within Cost of product revenue in the condensed consolidated statements of operations.

We classified the intangible assets acquired from Coyote as Level 3 assets due to the lack of observable inputs to determine fair value. Significant inputs used in the determination of fair value based on the probability-weighted income approach primarily include internal cash flow projections and discount rates.

As of December 31, 2013, we did not have any assets or liabilities measured at fair value on a nonrecurring basis.

3. INVENTORY

Inventory consisted of the following (in thousands):



	September 30, 2014		December 31, 2013
Raw materials	$	5,922	$	4,319
Finished goods	40,370		40,093
Consigned inventory	5,052		4,260
Inventory	$	51,344	$	48,672

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FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

4. PROPERTY AND EQUIPMENT—Net

Property and equipment—net consisted of the following (in thousands):



	September 30, 2014			December 31, 2013
Land	$	13,895		$	13,895
Building and building improvements	17,546			610
Evaluation units	29,181			23,442
Computer equipment and software	31,010			23,556
Furniture and fixtures	4,655			1,697
Construction-in-progress	5,326			10,947
Leasehold improvements	7,595			4,303
Total property and equipment	109,208			78,450
Less: accumulated depreciation	(52,396		)	(41,798		)
Property and equipment—net	$	56,812		$	36,652

Beginning in the first quarter of 2014, we reclassified certain fixed assets between categories in the table above to better reflect the nature of these fixed assets. Prior period amounts have also been reclassified to conform to the current period presentation. The impact of the reclassification is not material.

Depreciation expense was $5.4 million and $3.8 million during the three months ended September 30, 2014 and September 30, 2013, respectively. Depreciation expense was $15.3 million and $10.4 million during the nine months ended September 30, 2014 and September 30, 2013, respectively.

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FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

5. BUSINESS COMBINATIONS

Coyote Point Systems

On March 21, 2013, we acquired all of the outstanding equity securities of Coyote, a provider of application delivery, load balancing and acceleration solutions, for $6.0 million in cash. The acquisition also included 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. As of September 30, 2014, we have estimated that no contingent earn-out payment thresholds will be met.

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 (in thousands):



Cash and cash equivalents	$	206
Other current assets	501
Finite-lived intangible assets	2,800
Indefinite-lived intangible assets	2,600
Goodwill	2,824
Other assets	88
Total assets acquired	9,019
Current liabilities	1,030
Long-term liabilities	2,004
Total liabilities assumed	3,034
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 (“IPR&D”) as of the acquisition date. Identified finite-lived intangible assets consist of developed technology and customer relationships that are being amortized as cost of revenue and sales and marketing expense, respectively, ratably on a straight-line basis, each over an estimated useful life of six years. 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, due primarily to acquire 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 were considered immaterial for purposes of pro-forma financial disclosures. During the three months ended September 30, 2013, we completed the development of technology associated with the IPR&D projects, and started amortizing this developed technology as cost of revenue ratably on a straight-line basis over an estimated remaining useful life of approximately five years.

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FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

6. GOODWILL AND OTHER INTANGIBLE ASSETS—Net

We recorded $2.8 million of goodwill from the acquisition of Coyote. There were no impairments to goodwill during the three and nine months ended September 30, 2014.

During the nine months ended September 30, 2014, we reassessed the fair value and the remaining useful life of the developed technologies acquired from Coyote. Based on this reassessment, we recorded an impairment charge of $2.4 million to adjust the total fair value of the other intangible assets acquired from Coyote to $2.0 million. The impairment charge is included within Cost of product revenue in the condensed consolidated statements of operations. Subsequent to the impairment, the remaining carrying value of the Coyote developed technologies will be amortized on a straight-line basis over an estimated remaining useful life of approximately five years.

The following tables present other intangible assets—net (in thousands):



	September 30, 2014
	Gross		Accumulated Amortization		Net
Other intangible assets—net:
Developed technology	$	5,606	$	2,877	$	2,729
Customer relationships	500		125		375
Total other intangible assets—net	$	6,106	$	3,002	$	3,104



	December 31, 2013
	Gross		Accumulated Amortization		Net
Other intangible assets—net:
Developed technology	$	8,971	$	2,568	$	6,403
Customer relationships	500		62		438
Total other intangible assets—net	$	9,471	$	2,630	$	6,841

Amortization expense was $0.2 million and $0.4 million during the three months ended September 30, 2014 and September 30, 2013, respectively. Amortization expense was $1.2 million and $1.1 million for the nine months ended September 30, 2014 and September 30, 2013, respectively. The following table summarizes estimated future amortization expense of Other intangible assets—net (in thousands):



	Amount
Years Ending December 31:
2014 (remainder)	$	273
2015	1,091
2016	785
2017	425
2018	425
Thereafter	105
Total	$	3,104

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FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

7. 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”). 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 (in thousands, except per share amounts):



	Three Months Ended				Nine Months Ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Numerator:
Net income	$	4,056	$	11,029	$	18,530	$	32,257

Denominator:
Basic shares:
Weighted-average common stock outstanding-basic	164,294		162,906		163,289		162,150
Diluted shares:
Weighted-average common stock outstanding-basic	164,294		162,906		163,289		162,150
Effect of potentially dilutive securities:
Stock options	4,405		5,525		4,728		5,844
RSUs	993		213		692		50
ESPP	35		22		26		10
Weighted-average shares used to compute diluted net income per share	169,727		168,666		168,735		168,054
Net income per share:
Basic	$	0.02	$	0.07	$	0.11	$	0.20
Diluted	$	0.02	$	0.07	$	0.11	$	0.19

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 thousands):



	Three Months Ended		Nine Months Ended
	September 30, 2014	September 30, 2013	September 30, 2014	September 30, 2013
Stock options	3,023	6,640	4,101	7,364
RSUs	696	1,416	879	2,383
ESPP	226	407	133	399
	3,945	8,463	5,113	10,146

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FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

8. DEFERRED REVENUE

Deferred revenue consisted of the following (in thousands):



	September 30, 2014		December 31, 2013
Product	$	2,685	$	2,915
Services and other	497,327		429,713
Total deferred revenue	$	500,012	$	432,628
Reported As:
Current	$	329,132	$	293,664
Non-current	170,880		138,964
Total deferred revenue	$	500,012	$	432,628

9. COMMITMENTS AND CONTINGENCIES

The following table summarizes our future principal contractual obligations as of September 30, 2014 (in thousands):



	Total		2014 (remainder)		2015		2016		2017		2018		Thereafter
Operating lease commitments	$	39,575	$	2,495	$	9,411	$	7,590	$	6,649	$	5,467	$	7,963
Less: Sublease rental income	642		193		449		—		—		—		—
Operating lease commitments—net	38,933		2,302		8,962		7,590		6,649		5,467		7,963
Purchase commitments	76,355		53,006		23,349		—		—		—		—
Other contractual commitments	24,176		19,530		3,592		813		241		—		—
Total	$	139,464	$	74,838	$	35,903	$	8,403	$	6,890	$	5,467	$	7,963

Operating Leases—We lease certain facilities under various non-cancelable operating leases, which expire through 2024. The terms of certain operating leases provide for renewal options. Rent expense is recognized using the straight-line method over the term of the lease. Rent expense was $2.6 million and $2.4 million during the three months ended September 30, 2014 and September 30, 2013, respectively. Rent expense was $7.7 million and $7.1 million during the nine months ended September 30, 2014 and September 30, 2013, respectively.

Purchase Commitments and Other Contractual Commitments—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 cancelable. As of September 30, 2014, we had $76.4 million of open purchase orders with our independent contract manufacturers that may not be cancelable.

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 September 30, 2014, we had $24.2 million in other purchase commitments.

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FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

Warranties—Accrued warranty activities are summarized as follows (in thousands):



	Nine Months Ended
	September 30, 2014			September 30, 2013
Accrued warranty balance—beginning of the period	$	3,037		$	2,309
Warranty costs incurred	(2,597		)	(2,670		)
Provision for warranty for the period	3,786			3,134
Adjustment related to pre-existing warranties	(540		)	274
Accrued warranty balance—end of the period	$	3,686		$	3,047

Litigation—We are involved in disputes, litigation, and other legal actions. For lawsuits where we are the defendant, we are in the process of defending these litigation matters, and while there can be no assurances and the outcome of these matters is currently not determinable, we currently believe that there are no existing claims or proceedings that are likely to have a material adverse effect on our financial position. There are many uncertainties associated with any litigation and these actions or other third-party claims against us may cause us to incur costly litigation or substantial settlement charges. In addition, the resolution of any intellectual property litigation may require us to make royalty payments, which could adversely affect our gross margins in future periods. If any of those events were to occur, our business, financial condition, results of operations, and cash flows could be adversely affected. The actual liability in any such matters may be materially different from our estimates, if any, which could result in the need to adjust the liability and record additional expenses. We have not recorded any accrual for loss contingencies associated with such legal proceedings; determined that an unfavorable outcome is probable or reasonably possible; or determined that the amount or range of any possible loss is reasonably estimable.

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 beyond indemnification for third-party claims of intellectual property infringement and that could potentially expose us to losses in excess of the amount received under the agreement. To date, there have been no awards under such indemnification provisions.

10. STOCKHOLDERS’ EQUITY

Employee Stock Options

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



	Three Months Ended				Nine Months Ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Expected term in years	4.9		4.6		4.9		4.6
Volatility	40.7	%	47.8	%	43.1	%	47.8	%
Risk-free interest rate	1.6	%	1.2	%	1.7	%	1.2	%
Dividend rate	—		—		—		—

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FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following table summarizes the stock option activity and related information for the periods presented below (in thousands, except 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, 2013	15,521		$	13.18
Granted	320		22.36
Forfeited	(390	)	24.15
Exercised	(3,216	)	8.25
Balance—September 30, 2014	12,235		14.37
Options vested and expected to vest—September 30, 2014	12,205		$	14.35	2.82	$	136,230
Options exercisable—September 30, 2014	10,244		$	12.59	2.48	$	131,847

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 September 30, 2014, for all in-the-money options. As of September 30, 2014, total compensation expense related to unvested stock options granted to employees but not yet recognized was $22.9 million, net of estimated forfeitures. This expense is expected to be amortized on a straight-line basis over a weighted-average period of 1.47 years.

Additional information related to our stock options is summarized below (in thousands, except per share amounts):



	Three Months Ended				Nine Months Ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Weighted-average fair value per share granted	$	9.13	$	8.61	$	8.76	$	8.61
Intrinsic value of options exercised	$	17,728	$	7,880	$	49,490	$	36,997
Fair value of options vested	$	4,393	$	5,063	$	13,163	$	21,553

Restricted Stock Units

The following table summarizes the activity and related information for RSUs for the periods presented below (in thousands, except per share amounts):



	Restricted Stock Units Outstanding
	Number of Shares		Weighted-Average Grant-Date-Fair Value per Share
Balance—December 31, 2013	4,199		$	22.00
Granted	3,359		22.44
Forfeited	(342	)	21.85
Vested	(1,197	)	22.31
Balance—September 30, 2014	6,019		$	22.27
RSUs expected to vest—September 30, 2014	5,699		$	22.27

Table of Contents

FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

As of September 30, 2014, total compensation expense related to unvested RSUs that were granted to employees and non-employees under our 2009 Equity Incentive Plan, but not yet recognized, was $128.3 million, net of estimated forfeitures. This expense is expected to be amortized on a straight-line basis over a weighted-average vesting period of 3.02 years.

The following summarizes the number and value of the shares withheld for employee taxes (in thousands):



	Three Months Ended				Nine Months Ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Shares withheld for taxes	124		45		381		45
Amount withheld for taxes	$	2,985	$	966	$	8,506	$	966

Employee Stock Purchase Plan

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



	Three Months Ended				Nine Months Ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Expected term in years	0.5		0.5		0.5		0.5
Volatility	31.9	%	35.1	%	34.1	%	44.0	%
Risk-free interest rate	0.1	%	0.1	%	0.1	%	0.1	%
Dividend rate	—		—		—		—

Additional information related to the ESPP is provided below (in thousands, except per share amounts):



	Three Months Ended				Nine Months Ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Weighted-average fair value per share granted	$	6.03	$	5.04	$	5.91	$	6.11
Shares issued under the ESPP	346		344		770		672
Weighted-average price per share issued	$	19.38	$	17.90	$	18.17	$	18.88

Stock-based Compensation Expense

Stock-based compensation expense is included in costs and expenses as follows (in thousands):



	Three Months Ended				Nine Months Ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Cost of product revenue	$	60	$	91	$	351	$	277
Cost of services and other revenue	1,522		1,297		4,214		3,543
Research and development	4,505		3,548		12,558		9,605
Sales and marketing	7,397		5,215		18,890		13,927
General and administrative	1,183		1,627		6,300		4,432
Total stock-based compensation expense	$	14,667	$	11,778	$	42,313	$	31,784

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FORTINET, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

The following table summarizes stock-based compensation expense by award type (in thousands):



	Three Months Ended				Nine Months Ended
	September 30, 2014		September 30, 2013		September 30, 2014		September 30, 2013
Stock options	$	4,282	$	5,180	$	13,395	$	15,801
RSUs	9,275		5,408		25,886		12,439
ESPP	1,110		1,190		3,032		3,544
Total stock-based compensation expense	$	14,667	$	11,778	$	42,313	$	31,784

Total income tax benefit associated with stock-based compensation that is included as part of the provision for income taxes in the condensed consolidated statements of operations is as follows (in thousands):



	Three Months Ended				Nine Months Ended
	September 30, 2014		September 30, 2013		September 30, 2014	September 30, 2013
Income tax benefit associated with stock-based compensation	$	4,225	$	3,176	$

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-K	2020-12-31	Filed 2021-02-19
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	2021-02-04	Earnings, Exhibits
8-K	2020-12-08	Other Events
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	ftnt-ex311_20140930xq.htm
EX-31.2	ftnt-ex312_20140930xq.htm
EX-32.2	ftnt-ex321_20140930xq.htm

FTNT 10Q Quarterly Report

Fortinet Earnings 2014-09-30