Company Quick10K Filing
Fortinet
Price78.86 EPS1
Shares175 P/E65
MCap13,793 P/FCF22
Net Debt-1,176 EBIT252
TEV12,617 TEV/EBIT50
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

FTNT 10Q Quarterly Report

Part I
Item 1. Financial Statements
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part II
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 6. Exhibits
EX-31.1 ftnt-ex311_20170930x10q.htm
EX-31.2 ftnt-ex312_20170930x10q.htm
EX-32.1 ftnt-ex321_20170930x10q.htm

Fortinet Earnings 2017-09-30

Balance SheetIncome StatementCash Flow
3.62.92.21.40.70.02012201420172020
Assets, Equity
0.60.50.30.20.0-0.12012201420172020
Rev, G Profit, Net Income
0.30.20.0-0.1-0.3-0.42012201420172020
Ops, Inv, Fin

10-Q 1 ftnt-0930201710xq.htm 10-Q Document

 
 
 
 
 
 
 
 
 
 
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, 2017
or
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 Website, 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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth 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
 
Emerging growth company
o





If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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 27, 2017, there were 173,900,211 shares of the registrant’s common stock outstanding.




FORTINET, INC.
QUARTERLY REPORT ON FORM 10-Q
For the Quarter Ended September 30, 2017
Table of Contents
 
 
 
 
 
 
Page
 
 
 
 
Part I
 
 
 
 
Item 1.
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
Part II
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 6.
 


 



Part I

ITEM 1.
Financial Statements
FORTINET, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except per share amounts)
 
 
September 30,
2017
 
December 31,
2016
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
905,794

 
$
709,003

Short-term investments
369,961

 
376,522

Accounts receivable—Net of reserves for sales returns and doubtful accounts of $14,787 and $11,235 at September 30, 2017 and December 31, 2016, respectively
257,999

 
312,998

Inventory
73,595

 
106,887

Prepaid expenses and other current assets
43,302

 
33,306

Total current assets
1,650,651

 
1,538,716

LONG-TERM INVESTMENTS
247,875

 
224,983

DEFERRED TAX ASSETS
204,721

 
182,745

PROPERTY AND EQUIPMENT—NET
239,891

 
137,249

OTHER INTANGIBLE ASSETS—NET
18,291

 
24,828

GOODWILL
14,553

 
14,553

OTHER ASSETS
19,297

 
16,867

TOTAL ASSETS
$
2,395,279

 
$
2,139,941

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
44,543

 
$
56,732

Accrued liabilities
40,439

 
35,640

Accrued payroll and compensation
75,482

 
78,138

Income taxes payable
15,862

 
13,588

Deferred revenue
734,313

 
645,342

Total current liabilities
910,639

 
829,440

DEFERRED REVENUE
484,644

 
390,007

INCOME TAX LIABILITIES
87,993

 
68,551

OTHER LIABILITIES
9,778

 
14,262

Total liabilities
1,493,054

 
1,302,260

COMMITMENTS AND CONTINGENCIES (Note 9)


 


STOCKHOLDERS’ EQUITY:
 
 
 
Common stock, $0.001 par value—300,000 shares authorized; 174,625 and 173,078 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively
175

 
173

Additional paid-in capital
912,053

 
800,653

Accumulated other comprehensive loss
(416
)
 
(765
)
Retained earnings (deficit)
(9,587
)
 
37,620

Total stockholders’ equity
902,225

 
837,681

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
2,395,279

 
$
2,139,941

See notes to condensed consolidated financial statements.

1


FORTINET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except per share amounts)
 
Three Months Ended
 
Nine Months Ended
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
REVENUE:
 
 
 
 
 
 
 
Product
$
137,095

 
$
127,972

 
$
415,053

 
$
389,185

Service
237,122

 
188,674

 
663,209

 
523,428

Total revenue
374,217

 
316,646

 
1,078,262

 
912,613

COST OF REVENUE:
 
 
 
 
 
 
 
Product
58,106

 
50,267

 
174,190

 
152,368

Service
35,543

 
34,532

 
105,675

 
94,578

Total cost of revenue
93,649

 
84,799

 
279,865

 
246,946

GROSS PROFIT:
 
 
 
 
 
 
 
Product
78,989

 
77,705

 
240,863

 
236,817

Service
201,579

 
154,142

 
557,534

 
428,850

Total gross profit
280,568

 
231,847

 
798,397

 
665,667

OPERATING EXPENSES:
 
 
 
 
 
 
 
Research and development
53,486

 
47,239

 
155,840

 
137,495

Sales and marketing
172,361

 
154,831

 
509,098

 
463,628

General and administrative
21,025

 
22,006

 
65,513

 
63,629

Restructuring charges

 
2,283

 
340

 
3,164

Total operating expenses
246,872

 
226,359

 
730,791

 
667,916

OPERATING INCOME (LOSS)
33,696

 
5,488

 
67,606

 
(2,249
)
INTEREST INCOME
3,866

 
1,888

 
9,421

 
5,339

OTHER INCOME (EXPENSE)—NET
344

 
(787
)
 
1,889

 
(3,449
)
INCOME (LOSS) BEFORE INCOME TAXES
37,906

 
6,589

 
78,916

 
(359
)
PROVISION FOR (BENEFIT FROM) INCOME TAXES
11,296

 
298

 
18,556

 
(7,380
)
NET INCOME

$
26,610

 
$
6,291

 
$
60,360

 
$
7,021

Net income per share (Note 8):
 
 
 
 
 
 
 
Basic
$
0.15

 
$
0.04

 
$
0.34

 
$
0.04

Diluted
$
0.15

 
$
0.04

 
$
0.34

 
$
0.04

Weighted-average shares outstanding:
 
 
 
 
 
 
 
Basic
175,519

 
173,335

 
175,253

 
172,212

Diluted
178,973

 
177,938

 
178,987

 
176,046

See notes to condensed consolidated financial statements.


2


FORTINET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited, in thousands)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Net income
$
26,610

 
$
6,291

 
$
60,360

 
$
7,021

Other comprehensive income (loss):
 
 
 
 
 
 
 
Change in unrealized gains (losses) on investments
172

 
(879
)
 
506

 
1,670

Tax provision (benefit) related to change in unrealized gains (losses) on investments
65

 
(308
)
 
157

 
584

Other comprehensive income (loss)
107

 
(571
)
 
349

 
1,086

Comprehensive income
$
26,717

 
$
5,720

 
$
60,709

 
$
8,107


See notes to condensed consolidated financial statements.




3


FORTINET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
 
Nine Months Ended
 
September 30,
2017
 
September 30,
2016
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
60,360

 
$
7,021

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
41,208

 
34,896

Amortization of investment premiums
2,125

 
3,828

Stock-based compensation
102,729

 
90,342

Other non-cash items—net
3,179

 
4,846

Changes in operating assets and liabilities:
 
 
 
Accounts receivable—net
51,447

 
12,788

Inventory
17,687

 
(24,555
)
Deferred tax assets
(22,133
)
 
(35,005
)
Prepaid expenses and other current assets
(9,599
)
 
4,301

Other assets
(360
)
 
(2,595
)
Accounts payable
(16,537
)
 
(1,584
)
Accrued liabilities
8,052

 
598

Accrued payroll and compensation
(3,531
)
 
3,253

Other liabilities
(3,830
)
 
(3,119
)
Deferred revenue
184,350

 
142,867

Income taxes payable
21,716

 
6,789

Net cash provided by operating activities
436,863

 
244,671

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of investments
(359,569
)
 
(370,573
)
Sales of investments
9,995

 
21,805

Maturities of investments
329,132

 
344,959

Purchases of property and equipment
(121,641
)
 
(50,319
)
Payments made in connection with business acquisition, net of cash acquired

 
(22,087
)
Net cash used in investing activities
(142,083
)
 
(76,215
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of common stock
61,836

 
42,292

Taxes paid related to net share settlement of equity awards
(35,869
)
 
(29,886
)
Repurchase of common stock
(123,956
)
 
(75,000
)
Payments of debt assumed in connection with business acquisition

 
(1,626
)
Net cash used in financing activities
(97,989
)
 
(64,220
)
NET INCREASE IN CASH AND CASH EQUIVALENTS
196,791

 
104,236

CASH AND CASH EQUIVALENTS—Beginning of period
709,003

 
543,277

CASH AND CASH EQUIVALENTS—End of period
$
905,794

 
$
647,513

NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Liability for purchase of property and equipment
$
8,598

 
$
8,325

Transfers of evaluation units from inventory to property and equipment
$
16,255

 
$
15,627

See notes to condensed consolidated financial statements.

4


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 in the United States (“GAAP”) 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 (the “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 year ended December 31, 2016, contained in our Annual Report on Form 10-K filed with the SEC on March 1, 2017. 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, 2017 are not necessarily indicative of the results for the full year or for any future periods. The condensed consolidated balance sheet as of December 31, 2016 is derived from the audited consolidated financial statements for the year ended December 31, 2016.

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. Certain amounts in prior periods have been reclassified to conform with current period presentation.

There have been no material changes to our significant accounting policies as of and for the three and nine months ended September 30, 2017, except for changes to our policies related to business combinations. For more information, refer to the “Recently Adopted Accounting Standards.”

Recently Adopted Accounting Standards

Business Combinations – Definition of a Business

In January 2017, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) ASU 2017-01—Business Combinations: Clarifying the Definition of a Business, which clarifies the definition of a business to assist organizations with evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses. The definition of a business affects many areas of accounting including acquisitions, disposals, goodwill and consolidation. We elected to early adopt ASU 2017-01 on a prospective basis beginning on January 1, 2017. The adoption of ASU 2017-01 did not have a material impact on our consolidated financial statements.

Recent Accounting Standards Not Yet Effective

Share-Based Payment Accounting

In May 2017, the FASB issued ASU 2017-09—Compensation—Stock Compensation to clarify when to account for a change to the terms or conditions of a share-based payment award as a modification. Under ASU 2017-09, modification accounting is required only if the fair value, the vesting conditions or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. ASU 2017-09 is effective prospectively for us beginning on January 1, 2018. We do not believe ASU 2017-09 will have a material impact on our consolidated financial statements.


5

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



Goodwill Impairment

In January 2017, the FASB issued ASU 2017-04—Intangibles—Goodwill and Other: Simplifying the Test for Goodwill Impairment. ASU 2017-04 eliminates Step 2 from the goodwill impairment test which measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Under ASU 2017-04, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of the reporting unit with its carrying amount, and should recognize an impairment loss for the amount by which the carrying amount exceeds the reporting unit’s fair value, with the loss not exceeding the total amount of goodwill allocated to that reporting unit. ASU 2017-04 will be effective for us beginning on January 1, 2020. Early adoption is permitted for interim or annual goodwill impairment tests performed after January 1, 2017. At adoption, this update will require a prospective approach. We early adopted ASU 2017-04 on October 1, 2017. The adoption did not have a material impact on our consolidated financial statements.

Income Taxes – Intra-Entity Asset Transfers

In October 2016, the FASB issued ASU 2016-16—Income Taxes: Intra-Entity Transfer of Assets Other Than Inventory, which requires the recognition of the income tax consequences of an intra-entity transfer of an asset, other than inventory, when the transfer occurs. ASU 2016-16 will be effective for us beginning on January 1, 2018. We are currently evaluating the impact of ASU 2016-16 on our consolidated financial statements.

Financial Instruments – Credit Losses

In June 2016, the FASB issued ASU 2016-13—Financial Instruments—Credit Losses—Measurement of Credit Losses on Financial Instruments, which requires measurement and recognition of expected credit losses for financial assets held. ASU 2016-13 is effective for us beginning on January 1, 2020, with the option to adopt early on January 1, 2019. Based on our current accounts receivable portfolio, we do not believe ASU 2016-13 will have a material impact on our consolidated financial statements.

Leases

In February 2016, the FASB issued ASU 2016-02—Leases, which requires the recognition of right-of-use assets and lease liabilities on the consolidated balance sheet for substantially all leases. The new guidance includes a number of optional practical expedients that entities may elect to apply. The new guidance will also require significant additional disclosures about the amount, timing and uncertainty of cash flows from leases. This new guidance will be effective for us beginning on January 1, 2019, using a modified retrospective approach. Based on our current lease portfolio, we currently estimate that the value of leased assets and liabilities that may be recognized to be at least $40.0 million. We are continuing to evaluate the impact of ASU 2016-02 and our estimate is subject to change. We do not believe that ASU 2016-02 will have a material impact on our consolidated statements of operations. We expect to expand our disclosures in the notes to consolidated financial statements include more details on our leases, significant judgments and lease-related amounts recognized in the consolidated financial statements.

Financial Instruments – Recognition and Measurement

In January 2016, the FASB issued ASU 2016-01—Financial Instruments—Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, which requires most equity investments to be measured at fair value, with subsequent changes in fair value recognized in net income. A practicality exception will apply to those equity investments that do not have a readily determinable fair value. These investments may be measured at cost, adjusted for changes in observable prices minus impairment. ASU 2016-01 is effective for our cost-method investments beginning on January 1, 2018 on a prospective basis. The adoption of ASU 2016-01 will result in the adjustment to the carrying amount when the cost-method investees complete a financing round subsequent to adoption date.


6

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



Revenue Recognition

In May 2014, the FASB issued ASU 2014-09—Revenue from Contracts with Customers, which outlines a single, comprehensive model for entities to use in accounting for revenue arising from contracts with customers. The core principle of ASU 2014-09 is to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration that is expected to be received for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle and, accordingly, we expect more judgment and estimates may be required within the revenue recognition process than is required under existing U.S. GAAP, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. ASU 2014-09 will be effective for us beginning January 1, 2018. ASU 2014-09 permits two methods of adoption: retrospectively to each prior reporting period presented (the full retrospective method), or retrospectively with the cumulative effect of initially applying the guidance recognized at the date of initial application (the modified retrospective method). We will adopt the standard using the modified retrospective method and apply the standard to contracts that are not completed as of January 1, 2018, and recognize the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings.

We have substantially completed our analysis of historical contracts and believe that the quantitative impact on revenue in our consolidated financial statements is not material. We expect the pattern of revenue recognition from the sales of our FortiGate and other appliances and FortiGuard and FortiCare subscription services to be substantially unchanged on an ongoing basis. We believe that the acceleration of revenue and associated cost of sales to certain channel partners which are currently accounted for only once the product is sold through to the end-customer, and the allocation of revenue related to software due to the removal of the residual method will not have a significant impact on our financial statements.

Under ASU 2014-09, we will be required to capitalize and amortize incremental costs related to obtaining customer contracts, such as sales commission costs related to service contracts. Under current U.S. GAAP, we expense all sales commissions when incurred. Our quantitative analysis of the impact of the change in accounting for sales commissions, including the various components of our current and future compensation plans and the key assumptions associated with the amortization term, is in progress. We believe that the amortization of incremental commission costs of obtaining customer contracts is likely to have a material impact on our financial statements.

We expect to expand our financial statement disclosures, which may include more details on our disaggregation of revenue, performance obligations, contract balances and costs to obtain a contract, as well as any significant judgments. We are in the process of documenting process changes, implementing required changes in our systems and developing new controls to support recognition and disclosure under ASU 2014-09. Reviews are ongoing, which may alter our conclusions and the anticipated financial impact. We will continue to assess the impact of ASU 2014-09, along with industry trends until the adoption date.


7

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



2. FINANCIAL INSTRUMENTS AND FAIR VALUE

The following tables summarize our investments (in thousands):
 
September 30, 2017
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
Corporate debt securities
$
427,655

 
$
91

 
$
(619
)
 
$
427,127

Commercial paper
97,757

 
1

 
(23
)
 
97,735

U.S. government and agency securities
53,243

 
2

 
(118
)
 
53,127

Municipal bonds
39,854

 
22

 
(29
)
 
39,847

Total available-for-sale securities
$
618,509

 
$
116

 
$
(789
)
 
$
617,836

 
 
 
 
 
 
 
 
 
December 31, 2016
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
Corporate debt securities
$
379,494

 
$
43

 
$
(925
)
 
$
378,612

Commercial paper
95,110

 
23

 
(25
)
 
95,108

U.S. government and agency securities
64,604

 
16

 
(79
)
 
64,541

Municipal bonds
59,257

 
3

 
(235
)
 
59,025

Certificates of deposit and term deposits (1)
4,219

 

 

 
4,219

Total available-for-sale securities
$
602,684

 
$
85

 
$
(1,264
)
 
$
601,505

 
 
 
 
 
 
 
 
(1) The majority of our certificates of deposit and term deposits are foreign deposits.

The following tables show the gross unrealized losses and the related fair values of our investments that have been in a continuous unrealized loss position (in thousands):
 
September 30, 2017
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Corporate debt securities
$
294,479

 
$
(482
)
 
$
35,645

 
$
(137
)
 
$
330,124

 
$
(619
)
U.S. government and agency securities
43,187

 
(66
)
 
5,446

 
(52
)
 
48,633

 
(118
)
Municipal bonds
16,868

 
(14
)
 
3,180

 
(15
)
 
20,048

 
(29
)
Commercial paper
36,844

 
(23
)
 

 

 
36,844

 
(23
)
Total available-for-sale securities
$
391,378

 
$
(585
)
 
$
44,271

 
$
(204
)
 
$
435,649

 
$
(789
)

 
December 31, 2016
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Corporate debt securities
$
311,980

 
$
(910
)
 
$
13,541

 
$
(15
)
 
$
325,521

 
$
(925
)
Municipal bonds
52,200

 
(235
)
 

 

 
52,200

 
(235
)
U.S. government and agency securities
33,430

 
(79
)
 

 

 
33,430

 
(79
)
Commercial paper
17,394

 
(25
)
 

 

 
17,394

 
(25
)
Total available-for-sale securities
$
415,004

 
$
(1,249
)
 
$
13,541

 
$
(15
)
 
$
428,545

 
$
(1,264
)

8

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)




The contractual maturities of our investments were as follows (in thousands):
 
September 30,
2017
 
December 31,
2016
Due within one year
$
369,961

 
$
376,522

Due between one and three years
247,875

 
224,983

Total
$
617,836

 
$
601,505


Available-for-sale securities are reported at fair value, with unrealized gains and losses and the related tax impact included as a separate component of stockholders’ equity and in comprehensive income. Realized gains and losses on available-for-sale securities are insignificant in the periods presented and are included in Other income (expense)—net in our condensed consolidated statements of operations. We use the specific identification method to determine the cost basis of investments sold.

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 decline 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 is it 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, 2017.

Fair Value Accounting—We apply the following fair value hierarchy for disclosure of the inputs used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows:

Level 1—Inputs are unadjusted quoted prices in active markets for identical assets or liabilities.

Level 2—Inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the assets or liabilities, either directly or indirectly through market corroboration, for substantially the full term of the financial instruments.

Level 3—Unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. The inputs require significant management judgment or estimation.

We measure the fair value of money market funds and certain U.S. government and agency securities using quoted prices in active markets for identical assets. The fair value of all other financial instruments was based on quoted prices for similar assets in active markets, or model driven valuations using significant inputs derived from or corroborated by observable market data.
 
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.


9

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



Fair Value of Financial Instruments

Assets Measured at Fair Value on a Recurring Basis

The following tables present the fair value of our financial assets measured at fair value on a recurring basis as of September 30, 2017 and December 31, 2016 (in thousands):
 
September 30, 2017
 
December 31, 2016
 
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
$
427,127

 
$

 
$
427,127

 
$

 
$
378,612

 
$

 
$
378,612

 
$

Commercial paper
111,726

 

 
111,726

 

 
105,097

 

 
105,097

 

U.S. government and agency securities
53,127

 
47,681

 
5,446

 

 
64,541

 
52,082

 
12,459

 

Municipal bonds
39,847

 

 
39,847

 

 
59,025

 

 
59,025

 

Money market funds
20,271

 
20,271

 

 

 
38,649

 
38,649

 

 

Certificates of deposit and term deposits (1)
55,424

 

 
55,424

 

 
59,479

 

 
59,479

 

Total
$
707,522

 
$
67,952

 
$
639,570

 
$

 
$
705,403

 
$
90,731

 
$
614,672

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reported as:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents
$
89,686

 
 
 
 
 
 
 
$
103,898

 
 
 
 
 
 
Short-term investments
369,961

 
 
 
 
 
 
 
376,522

 
 
 
 
 
 
Long-term investments
247,875

 
 
 
 
 
 
 
224,983

 
 
 
 
 
 
Total
$
707,522

 
 
 
 
 
 
 
$
705,403

 
 
 
 
 
 
(1) Subsequent to the issuance of our consolidated financial statements as of and for the year ended December 31, 2016, we determined that $55.3 million in 30-day term deposits, included within cash and cash equivalents in the consolidated balance sheet as of December 31, 2016, should have also been included as Level 2 investments in the fair value hierarchy table for financial assets and financial liabilities measured at fair value on a recurring basis. Accordingly, we have corrected the above table as of December 31, 2016, the effect of which is immaterial to the financial statements as a whole. 

There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the nine months ended September 30, 2017.


10

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



3. INVENTORY

Inventory consisted of the following (in thousands):
 
September 30,
2017
 
December 31,
2016
Raw materials
$
13,733

 
$
18,924

Finished goods
59,862

 
87,963

Inventory
$
73,595

 
$
106,887


Inventory includes finished goods held by distributors where revenue is recognized on a sell-through basis of $1.0 million as of September 30, 2017 and December 31, 2016. 

4. PROPERTY AND EQUIPMENT—NET

Property and equipment—net consisted of the following (in thousands):
 
September 30,
2017
 
December 31,
2016
Building and building improvements
$
131,054

 
$
49,783

Computer equipment and software
76,872

 
65,323

Land
62,226

 
35,079

Leasehold improvements
20,690

 
18,699

Evaluation units
20,169

 
20,173

Furniture and fixtures
13,892

 
13,995

Construction-in-progress
2,971

 
4,669

Total property and equipment
327,874

 
207,721

Less: accumulated depreciation
(87,983
)
 
(70,472
)
Property and equipment—net
$
239,891

 
$
137,249


In April 2017, we purchased certain real estate in Burnaby, Canada for $84.8 million. The purchase was accounted for under the asset acquisition method. The cost of the assets acquired was allocated to land and buildings based on their relative fair values. The amounts allocated to land and buildings were $12.7 million and $72.1 million, respectively.

Depreciation expense was $11.7 million and $10.2 million during the three months ended September 30, 2017 and September 30, 2016, respectively. Depreciation expense was $34.7 million and $28.6 million during the nine months ended September 30, 2017 and September 30, 2016, respectively.

5. INVESTMENTS IN PRIVATELY HELD COMPANIES

Our investments in the equity securities of privately held companies totaled $12.1 million and $10.3 million as of September 30, 2017 and December 31, 2016, respectively. These investments are accounted for as cost-basis investments, as we own less than 20% of the voting securities in each of these investments and do not have the ability to exercise significant influence over operating and financial policies of the respective entities. These investments are carried at historical cost and are recorded as other assets on our condensed consolidated balance sheets and would be measured at fair value if indicators of impairment existed. As of September 30, 2017, no events have occurred that would adversely affect the carrying value of these investments.

As of September 30, 2017, we determined that we had a variable interest in these privately held companies. However, we determined that we were not the primary beneficiary as we did not have the power to direct their activities that most significantly affect their economic performance. The variable interest entities are not required to be consolidated in our condensed consolidated financial statements.

6.     BUSINESS COMBINATION


11

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



On June 7, 2016, we completed our acquisition of AccelOps, Inc. (“AccelOps”), a provider of network security monitoring and analytics solutions, for total cash consideration of $22.1 million, net of cash received. This acquisition extended the Fortinet Security Fabric.

The acquisition of AccelOps was accounted as a business combination in accordance with ASC Topic 805 “Business Combinations” issued by the FASB, and we used our best estimates and assumptions to assign fair value to the tangible and intangible assets acquired and liabilities assumed at the acquisition date. The total purchase price was allocated to AccelOps’ identifiable tangible and intangible assets acquired and liabilities assumed based on their estimated fair values as of the acquisition date.

Total allocation of the purchase price was (in thousands):
Cash and cash equivalents
$
171

Accounts receivable
1,126

Prepaid expenses and other assets
430

Property and equipment
203

Deferred tax assets
3,435

Finite-lived intangible assets
14,900

Indefinite-lived intangible assets in process research and development
1,600

Goodwill
9,861

Total assets acquired
31,726

Deferred revenue
4,400

Accounts payable and accrued liabilities
3,348

Other liabilities
1,694

Total liabilities assumed
9,442

Total purchase price allocation
$
22,284


Finite-lived intangible assets consist of developed technology, customer relationships and other intangible assets. AccelOps’ technology provides a software solution to manage security, performance and compliance from a single platform. The acquired developed technologies include software patents, know-how, process and designs. The value of customer relationships is attributable to the generation of a consistent income source and the avoidance of costs associated with creating new customer relationships.

The estimated useful life and fair values of the acquired finite-lived intangible assets were as follows (in thousands, except for estimated useful life):
 
Estimated Useful Life (in years)
 
Fair Values
Developed technologies
4
 
$
12,400

Customer relationships
3
 
2,300

Other
2
 
200

Total
 
 
$
14,900


The developed technologies and other are amortized on a straight-line basis. The amortization expense of developed technologies and other intangibles are recorded in cost of revenue. The amortization expense of customer relationships is amortized on an accelerated basis and is recorded in sales and marketing expenses.

Indefinite-lived intangible assets consist of in-process research and development, which will begin to be amortized upon completion of development.

The goodwill of $9.9 million represents the amount of the purchase price in excess of the fair value of the net tangible liabilities assumed and intangible assets acquired, including AccelOps’ assembled workforce. The goodwill recorded as part of the AccelOps acquisition is not deductible for U.S. federal income tax purposes.


12

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



7. GOODWILL AND OTHER INTANGIBLE ASSETS—NET

Goodwill

As of September 30, 2017, we had goodwill of $14.6 million. There were no impairments to goodwill during the three and nine months ended September 30, 2017 or during prior periods.

Other Intangible Assets—net

The following tables present other intangible assets—net as of September 30, 2017 and December 31, 2016 (in thousands, except years):
 
September 30, 2017
 
Weighted-Average Useful Life (in Years)
 
Gross
 
Accumulated Amortization
 
Net
Other intangible assets—net:
 
 
 
 
 
 
 
Finite-lived intangible assets:
 
 
 
 
 
 
 
Developed technologies and other
3.8
 
$
23,984

 
$
12,501

 
$
11,483

Customer relationships
4.7
 
14,500

 
9,292

 
5,208

 
 
 
38,484

 
21,793

 
16,691

 
 
 
 
 
 
 
 
Indefinite-lived intangible assets:
 
 
 
 
 
 
 
In-process research and development
 
 
1,600

 

 
1,600

Total other intangible assets—net
 
 
$
40,084

 
$
21,793

 
$
18,291


 
December 31, 2016
 
Weighted-Average Useful Life (in Years)
 
Gross
 
Accumulated Amortization
 
Net
Other intangible assets—net:
 
 
 
 
 
 
 
Finite-lived intangible assets:
 
 
 
 
 
 
 
Developed technologies and other
3.8
 
$
23,984

 
$
8,750

 
$
15,234

Customer relationships
4.7
 
14,500

 
6,506

 
7,994

 
 
 
38,484

 
15,256

 
23,228

 
 
 
 
 
 
 
 
Indefinite-lived intangible assets:
 
 
 
 
 
 
 
In-process research and development
 
 
1,600

 

 
1,600

Total other intangible assets—net
 
 
$
40,084

 
$
15,256

 
$
24,828


The in-process research and development intangible asset of $1.6 million is expected to be completed in the fourth quarter of 2017. Upon completion, the cost will be transferred to developed technology and will be amortized over the remaining estimated useful life of the asset.


13

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



Amortization expense was $2.0 million and $2.8 million during the three months ended September 30, 2017 and September 30, 2016, respectively. Amortization expense was $6.5 million and $6.3 million during the nine months ended September 30, 2017 and September 30, 2016, respectively. The following table summarizes estimated future amortization expense of finite-lived intangible assets—net (in thousands):

 
Amount
Years:
 
2017 (remainder)
$
2,037

2018
6,885

2019
5,406

2020
2,363

Total
$
16,691


8. 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 during the period, plus the dilutive effects of restricted stock units (“RSUs”), stock options 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,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Numerator:
 
 
 
 
 
 
 
Net income
$
26,610

 
$
6,291

 
$
60,360

 
$
7,021

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Basic shares:
 
 
 
 
 
 
 
Weighted-average common stock outstanding-basic
175,519

 
173,335

 
175,253

 
172,212

Diluted shares:
 
 
 
 
 
 
 
Weighted-average common stock outstanding-basic
175,519

 
173,335

 
175,253

 
172,212

Effect of potentially dilutive securities:
 
 
 
 
 
 
 
RSUs
2,091

 
2,513

 
2,249

 
1,891

Stock options
1,327

 
2,009

 
1,446

 
1,867

ESPP
36

 
81

 
39

 
76

Weighted-average shares used to compute diluted net income per share
178,973

 
177,938

 
178,987

 
176,046

Net income per share:
 
 
 
 
 
 
 
Basic
$
0.15

 
$
0.04

 
$
0.34

 
$
0.04

Diluted
$
0.15

 
$
0.04

 
$
0.34

 
$
0.04



14

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



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,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
RSUs
1,038

 
2,409

 
1,567

 
3,946

Stock options
1,081

 
836

 
1,108

 
1,067

ESPP
363

 
353

 
208

 
211

 
2,482

 
3,598

 
2,883

 
5,224


9. COMMITMENTS AND CONTINGENCIES

The following table summarizes our future principal contractual obligations as of September 30, 2017 (in thousands):
 
Total
 
2017 (remainder)
 
2018
 
2019
 
2020
 
2021
 
Thereafter
Operating lease commitments
$
50,510

 
$
3,953

 
$
14,022

 
$
10,732

 
$
8,535

 
$
4,557

 
$
8,711

Inventory purchase commitments
93,664

 
89,417

 
4,247

 

 

 

 

Other contractual commitments and open purchase orders
67,253

 
40,854

 
19,651

 
4,311

 
2,132

 
302

 
3

Total
$
211,427

 
$
134,224

 
$
37,920


$
15,043


$
10,667


$
4,859


$
8,714


Operating Leases—We lease certain facilities under various non-cancelable operating leases, which expire through 2026. Certain leases require us to pay variable costs such as taxes, maintenance, and insurance. The terms of certain operating leases also provide for renewal options and escalation clauses. Rent expense was $4.1 million and $6.1 million during the three months ended September 30, 2017 and September 30, 2016, respectively. Rent expense was $12.5 million and $14.7 million during the nine months ended September 30, 2017 and September 30, 2016, respectively. Rent expense is recognized using the straight-line method over the term of the lease.
    
Inventory Purchase 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 cancelable. As of September 30, 2017, we had $93.7 million of open purchase orders with our independent contract manufacturers that may not be cancelable.

Other Contractual Commitments and Open Purchase Orders—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, 2017, we had $67.3 million in other contractual commitments that may not be cancelable. Included in other contractual commitments is $8.8 million related to the purchase of certain real estate adjacent to our corporate headquarters.

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 fees, including contingent legal fees with related parties, costs and substantial settlement charges, and possibly subject us to damages and other penalties. 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. As required under ASC

15

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



450, Contingencies, issued by the FASB, we accrue for contingencies when we believe that a loss is probable and that we can reasonably estimate the amount of any such loss.

In October 2016, we received a letter from the United States Attorney’s Office for the Northern District of California requesting information relating to our compliance with the Trade Agreements Act. This inquiry is ongoing and we are fully cooperating with this inquiry. 

Indemnification—Under the indemnification provisions of our standard sales contracts, we agree to defend our customers against third-party claims asserting various allegations such as product defects and infringement of certain intellectual property rights, which may include patents, copyrights, trademarks or trade secrets, and to pay judgments entered on such claims. In some contracts, our exposure under these indemnification provisions is limited by the terms of the contracts to certain defined limits, such as the total amount paid by our customer under the agreement. However, certain agreements include covenants, penalties and indemnification provisions, including and beyond indemnification for third-party claims of intellectual property infringement, that could potentially expose us to losses in excess of the amount received under the agreement, and in some instances to potential liability that is not contractually limited. To date, there have been no material awards under such indemnification provisions.

10. STOCKHOLDERS’ EQUITY

Stock-Based Compensation Plans

We have stock-based compensation plans pursuant to which we have granted stock options and RSUs. We also have an ESPP for all eligible employees. As of September 30, 2017, there were a total of 49,841,761 shares of common stock available for grant under our stock-based compensation plans.

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, 2016
9,509

 
$
31.01

Granted
3,630

 
37.29

Forfeited
(928
)
 
34.07

Vested
(3,153
)
 
29.02

Balance—September 30, 2017
9,058

 
$
34.01


As of September 30, 2017, total compensation expense related to unvested RSUs granted to employees and non-employees under the 2009 Plan, but not yet recognized, was $266.4 million. This expense is expected to be amortized on a straight-line basis over a weighted-average vesting period of 2.7 years.

RSUs settle into shares of common stock upon vesting. Upon the vesting of the RSUs, we net-settle the RSUs and withhold a portion of the shares to satisfy minimum statutory employee withholding taxes. Total payment for the employees’ tax obligations to the taxing authorities is reflected as a financing activity within the condensed consolidated statements of cash flows.


16

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



The following summarizes the number and value of the shares withheld for employee taxes (in thousands):
 
 
 
Nine Months Ended
 
 
 
 
 
September 30,
2017
 
September 30,
2016
Shares withheld for taxes
 
 
 
 
995

 
937

Amount withheld for taxes
 
 
 
 
$
35,869

 
$
29,886



Employee Stock Options

The following table summarizes the weighted-average assumptions relating to our employee stock options:
 
 
Three months Ended
 
Nine Months Ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Expected term in years
4.4

 
4.3

 
4.4

 
4.3

Volatility
33
%
 
38
%
 
36
%
 
42
%
Risk-free interest rate
1.8
%
 
1.1
%
 
1.9
%
 
1.1
%
Dividend rate
%
 
%
 
%
 
%

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, 2016
6,187

 
$
23.79

 
 
 


Granted
536

 
37.26

 
 
 
 
Forfeited
(164
)
 
30.84

 
 
 
 
Exercised
(1,569
)
 
18.04

 
 
 
 
Balance—September 30, 2017
4,990

 
$
26.82

 
 
 
 
Options vested and expected to vest—September 30, 2017
4,990

 
$
26.82

 
3.2
 
$
48,315

Options exercisable—September 30, 2017
3,418

 
$
24.74

 
2.0
 
$
39,413


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, 2017, for all in-the-money stock options. As of September 30, 2017, total compensation expense related to unvested stock options granted to employees but not yet recognized was $15.3 million. This expense is expected to be amortized on a straight-line basis over a weighted-average period of 2.6 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,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Weighted-average fair value per share granted
$
11.09

 
$
10.62

 
$
12.17

 
$
9.08

Intrinsic value of options exercised
3,432

 
9,340

 
30,333

 
35,593

Fair value of options vested
1,562

 
1,706

 
6,691

 
4,583


17

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)




Employee Stock Purchase Plan

In determining the fair value of the ESPP, we use the Black-Scholes option pricing model that employs the following weighted-average assumptions:
 
Nine Months Ended
 
September 30,
2017
 
September 30,
2016
Expected term in years
0.5

 
0.5

Volatility
29
%
 
39
%
Risk-free interest rate
0.9
%
 
0.4
%
Dividend rate
%
 
%

Additional information related to the ESPP is provided below (in thousands, except per share amounts):
 
Nine Months Ended
 
September 30,
2017
 
September 30,
2016
Weighted-average fair value per share granted
$
8.73

 
$
7.68

Shares issued under the ESPP
1,135

 
1,151

Weighted-average price per share issued
$
29.52

 
$
21.01


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,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Cost of product revenue
$
314

 
$
309

 
$
1,039

 
$
887

Cost of service revenue
2,371

 
2,238

 
7,154

 
6,495

Research and development
7,976

 
7,648

 
24,127

 
22,249

Sales and marketing
19,609

 
17,378

 
58,380

 
50,183

General and administrative
4,037

 
3,520

 
12,029

 
10,528

Total stock-based compensation expense
$
34,307

 
$
31,093

 
$
102,729

 
$
90,342


The following table summarizes stock-based compensation expense by award type (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
RSUs
$
29,904

 
$
27,342

 
$
89,807

 
$
79,244

Stock options
1,811

 
1,516

 
5,581

 
5,062

ESPP
2,592

 
2,235

 
7,341

 
6,036

Total stock-based compensation expense
$
34,307

 
$
31,093

 
$
102,729

 
$
90,342



18

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



Total income tax benefit associated with stock-based compensation that is recognized in the condensed consolidated statements of operations is as follows (in thousands):
 
Three Months Ended
 
Nine Months Ended
 
September 30,
2017
 
September 30,
2016
 
September 30,
2017
 
September 30,
2016
Income tax benefit associated with stock-based compensation
$
6,722

 
$
8,223

 
$
21,111

 
$
22,961


Share Repurchase Program

In January 2016, our board of directors approved the Share Repurchase Program (the “Repurchase Program”), which authorized the repurchase of up to $200.0 million of our outstanding common stock through December 31, 2017. In October 2016 and July 2017, our board of directors approved the increases in the aggregate authorized repurchase amount under the Repurchase Program by $100.0 million and $300.0 million, respectively. Under the Repurchase Program, share repurchases may be made by us from time to time in privately negotiated transactions or in open-market transactions. The Repurchase Program does not require us to purchase a minimum number of shares, and may be suspended, modified or discontinued at any time without prior notice.

During the three months ended September 30, 2017, we repurchased 2.4 million shares of common stock under the Repurchase Program in open market transactions at an average price of $37.19 per share, for an aggregate purchase price of $90.8 million. During the nine months ended September 30, 2017, we repurchased 3.3 million shares of common stock under the Repurchase Program in open market transactions at an average price of $37.67 per share, for an aggregate purchase price of $124.0 million. As of September 30, 2017, $365.2 million remained available for future share repurchases under the Repurchase Program. See Note 17 to the notes to the condensed consolidated financial statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for information regarding the Repurchase Program.
 
11. INCOME TAXES

Our effective tax rate was 30% for the three months ended September 30, 2017, compared to an effective tax rate of 5% for the same period last year. Our effective tax rate was 24% for the nine months ended September 30, 2017, compared to an effective tax rate of 2,053% for the same period last year. The effective tax rates for the periods presented are comprised of U.S. federal and state taxes, excess tax benefits from stock-based compensation, withholding taxes and foreign income taxes. The tax rates for the three months ended September 30, 2017 and September 30, 2016 were impacted by excess tax benefits of $1.8 million and $2.5 million, respectively, from stock-based compensation. The tax rates for the nine months ended September 30, 2017 and September 30, 2016 were impacted by excess tax benefits of $11.4 million and $8.7 million, respectively, from stock-based compensation. Our effective tax rates fluctuate based on the amount of pre-tax income or loss. The impact of discrete items, such as excess tax benefits from stock-based compensation, on our effective tax rate is greater when our pre-tax income is lower.

As of September 30, 2017 and December 31, 2016, unrecognized tax benefits were $82.1 million and $65.5 million, respectively. The total amount of $80.4 million in unrecognized tax benefits, if recognized, would favorably affect our effective tax rate. It is our policy to classify accrued interest and penalties related to uncertain tax benefits in the provision for income taxes. As of September 30, 2017 and December 31, 2016, accrued interest and penalties were $12.9 million and $9.5 million, respectively. It is reasonably possible that our gross unrecognized tax benefits will decrease by up to $9.0 million in the next twelve months, primarily due to the lapse of the statute of limitations. These adjustments, if recognized, would positively impact our effective tax rate, and would be recognized as additional tax benefits.

We file income tax returns in the U.S. federal jurisdiction and in various U.S. state and foreign jurisdictions. Generally, we are no longer subject to U.S. state and non-U.S. income tax examinations by tax authorities for tax years prior to 2009. We are no longer subject to examination by U.S federal income tax authorities for tax years prior to 2012. We are currently under examination by U.S federal income tax authorities for tax years 2012, 2013 and 2014. We have filed a waiver extending the statute of limitations to November 30, 2018 for U.S. federal income tax returns for tax years 2012, 2013 and 2014. In addition, the tax authorities in France are examining the inter-company relationship between Fortinet, Inc., Fortinet France and Fortinet Singapore. In May 2017, we received a notice from the French tax authorities that an audit was officially opened for tax years from 2007 to 2015.


19

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)



12. DEFINED CONTRIBUTION PLANS

Our tax-deferred savings plan under our 401(k) Plan, permits participating employees to defer a portion of their pre-tax earnings. In Canada, we have a Group Registered Retirement Savings Plan Program (the “RRSP”), which permits participants to make tax deductible contributions. Our board of directors approved 50% matching contributions on employee contributions up to 4% of each employee’s eligible earnings. Our matching contributions to our 401(k) Plan and the RRSP for the three months ended September 30, 2017 and September 30, 2016 were $1.2 million and $1.2 million, respectively. Our matching contributions to our 401(k) Plan and the RRSP for the nine months ended September 30, 2017 and September 30, 2016 were $3.8 million and $3.4 million, respectively.

13. SEGMENT AND SIGNIFICANT CUSTOMER INFORMATION

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Our chief operating decision maker is our chief executive officer. Our chief executive officer reviews financial information presented on a consolidated basis, accompanied by information about revenue by geographic region for purposes of allocating resources and evaluating financial performance. We have one business activity, and there are no segment managers who are held accountable for operations, operating results and plans for levels or components below the consolidated unit level. Accordingly, we have determined that we have one operating segment, and therefore, one reportable segment.
Revenue by geographic region is based on the billing address of the customer. The following tables set forth revenue and property and equipment—net by geographic region (in thousands):
 
Three Months Ended
 
Nine Months Ended
Revenue
September 30, 2017
 
September 30, 2016
 
September 30, 2017
 
September 30, 2016
Americas:
 
 
 
 
 
 
 
United States
$
123,646

 
$
108,142

 
$
367,124

 
$
309,041

Latin America (“LATAM”)
24,372

 
15,614

 
64,567

 
46,850

Canada (1)
13,135

 
10,118

 
36,539

 
30,675

Total Americas
161,153

 
133,874

 
468,230

 
386,566

Europe, Middle East and Africa (“EMEA”)
138,335

 
116,967

 
394,214

 
336,911

Asia Pacific (“APAC”)
74,729

 
65,805

 
215,818

 
189,136

Total revenue
$
374,217

 
$
316,646

 
$
1,078,262

 
$
912,613

(1) Certain amounts in the prior periods in Canada were reclassified to the United States to conform with the 2017 presentation as a result of a change in the bill-to address of a customer.


20

FORTINET, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)