Fortinet (FTNT) Q4 Earnings Top, Revenue Growth Rate Dismal

Continuing with its upbeat performance for the sixth straight quarter, Fortinet Inc. FTNT, yesterday, reported better-than-expected results for fourth-quarter 2017, wherein revenues and earnings came ahead of the company’s expectations, and also surpassed the respective Zacks Consensus Estimate.

Fortinet’s non-GAAP earnings per share of 32 cents beat the Zacks Consensus Estimate of 29 cents. Also, earnings came in higher than management’s guidance range of 28-30 cents and marked an improvement over the year-ago quarter’s earnings of 30 cents, driven mainly by higher revenues which were partially offset by elevated operating expenses.

Quarter in Detail

Fortinet reported fourth-quarter revenues of $416.7 million, beating the Zacks Consensus Estimate of $409 million and up 14.8% year over year. Segment wise, Product revenues increased 2% year over year to $162.1 million, while Services revenues jumped 24.8% to $254.6 million. A large number of deal wins and customer additions during the reported quarter also proved conducive to top-line growth.

During the fourth quarter, the company witnessed 21% year-over-year growth in the number of deals worth more than $100,000, while the number of deals worth more than $250,000 and $500,000 climbed 31% and 24%, respectively.

Billings were up 15% on a year-over-year basis to $534 million.

Non-GAAP (excluding stock-based compensation and amortization of intangible assets) gross profit jumped 14.4% from the year-ago quarter to $313.9 million. However, gross margin contracted 40 basis points (bps) to 75.3%. It also came in below the mid-point of management’s expectation of 75-76% (mid-point 75.5%).

Furthermore, non-GAAP operating expenses jumped 21.6% year over year to $235.3 million. As a percentage of revenues, non-GAAP operating expenses advanced 320 bps year over year to 56.5%.

Non-GAAP operating profit declined 3% to $78.7 million from approximately $81.1 million recorded in the year-ago quarter. Non-GAAP operating profit margin contracted 350 bps to 18.9%, mainly due to lower gross margin and escalating operating expenses as a percentage of revenues which more than offset the benefit of higher revenues. Operating margin, however, came at the higher-end of the company’s guidance range of 18-19%.

Fortinet, Inc. Price, Consensus and EPS Surprise

Fortinet, Inc. Price, Consensus and EPS Surprise | Fortinet, Inc. Quote

Balance Sheet & Cash Flow

Fortinet exited the reported quarter with cash and cash equivalents, and short-term investments of approximately $1.25 billion, down from $1.28 billion recorded at the end of the third quarter. Accounts receivable were $346.2 million compared with $258 million witnessed at the end of the previous quarter.

During the year, the company generated operating cash flow of $594.4 million. Free cash flow for 2017 came in at $459.1 million. Fortinet bought back 11.2 million shares for $446.3 million during the year.

Guidance

Fortinet initiated outlook for first-quarter and full-year 2018.

The company’s forecasts for the first quarter are slightly lackluster. Management expects revenues in the range of $387-$393 million (mid point: $390 million), which is marginally lower than the Zacks Consensus Estimate of $390.7 million at mid-point. Billings are estimated in the range of $449-$457 million.

Non-GAAP earnings per share are anticipated to come in the band of 21-22 cents (mid point: 21.5 cents). The guidance range is much lower than the Consensus Estimate, but represents a year-over-year increase of 26.4%. Non-GAAP gross margin is estimated in the range of 75-76%, whereas non-GAAP operating margin is projected to be between 12% and 13%.

For 2018, management projects revenues in the range of $1.695-$1.715 billion (mid-point: $1.705 billion). The Zacks Consensus Estimate for revenues is currently pegged at $1.70 billion. Billings are forecast in the band of $2.030-$2.050 billion.

Nevertheless, the company anticipates that its cost-management initiatives will drive margins and earnings per share. Non-GAAP gross and operating margin projections are in the range of 75-76% and 17.7-18%, respectively.

Non-GAAP earnings per share are estimated to lie between $1.30 and $1.32 (mid-point $1.31). The Zacks Consensus Estimate is pegged at $1.19.

Our Take

Fortinet’s network security solutions include firewall, VPN, application control, antivirus, intrusion prevention, web filtering, anti-spam and WAN acceleration. The company reported better-than-expected fourth-quarter results. Nonetheless, lackluster first-quarter 2018 outlook makes us slightly cautious about its near-term performance.

Moreover, we are concerned over the company’s sluggish revenue growth rate. Notably, over the last six quarters, the company’s revenue growth rate has been around 20%, significantly lower than the previous rates of more than 30%. Additionally, Fortinet’s first-quarter revenue guidance marks an even lower growth rate of 13.8-15.6%.

In addition to this, competition from key network security players such as Cisco Systems Inc. CSCO, Check Point CHKP, Juniper Networks JNPR and Palo Alto Networks, remains another concern.

Nonetheless, we believe Fortinet’s initiative to change its business model to a subscription-based service provider will drive the company’s bottom-line results over the long run. Subscription-based service is a high gross margin business (approximately 80%) compared with the hardware-centric model.

Notably, the company generates more than 50% of the total revenues from these services, which helped it generate a 70-bps gross-margin expansion in 2017. We anticipate this strategy will continue to improve the company’s bottom-line performance in the near future as well.

Fortinet has outperformed the industry to which it belongs over the past year. The stock has gained 15.9%, while its industry registered growth of 6.5% during the same time frame.

Currently, Fortinet has a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

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