Fortinet's (FTNT) Q3 Earnings & Revenues Beat Estimates

Shareholders of Fortinet Inc. FTNT breathed a sigh of relief yesterday after the company declared its third-quarter 2016 results, which were better than its recently lowered revenue and earnings guidance. Moreover, Fortinet’s top and bottom line results also came ahead of the Zacks Consensus Estimate and improved year over year.

Notably, the network security solution provider had lowered its revenue and earnings guidance range on Oct 12. Fortinet had cited a longer sales cycle and weakness in North America as the major reasons for the outlook cut. It should be noted that challenges highlighted by the company were very similar to the ones that surfaced during the second quarter.

The company is witnessing slower sales completion in the enterprise and service provider markets. Ken Xie, Fortinet’s Chief Executive Officer (CEO) stated that "Enterprises are becoming more strategic with their purchasing decisions and buying with less urgency than last year”, which is resulting in lengthening of deal cycles.

Fortinet also blamed poor sales execution issues in North America as a result of the newness of its sales organization in the region for the downbeat guidance. Apart from this, it cited macro-economic issues in Latin America and the U.K. for the dismal outlook.

The aforementioned challenges had impacted the company’s overall third-quarter performances. Now let’s discuss the latest quarterly results in detail –

Revenues

Fortinet reported third-quarter revenues of $316.6 million, up 21.8% year over year. Revenues also beat the Zacks Consensus Estimate of $304 million and exceeded the company’s recently revised guidance range of $311–$316 million. Segment-wise, Product revenues jumped 7% year over year to $128 million, while Services revenues surged 34% to $188.7 million.

The year-over-year improvement was primarily aided by strength in the network security market. A large number of deal wins and customer additions during the quarter further contributed to top–line growth. During the quarter, Fortinet added approximately 9,000 customers, bringing the total count to over 289,000.

Billings were up 16% on a year-over-year basis to $347.5 million.

However, though the company registered double-digit growth in revenues and billings, the year-over-year growth rate was the slowest it had witnessed in several quarters. The reasons for this have already been mentioned before.

Operating Results

Gross profit increased 23.1% from the year-ago quarter to $231.8 million. Moreover, gross margin expanded 80 basis points (bps) to 73.2%, primarily backed by sales of higher-value subscription bundles.

Furthermore, the company has efficiently managed its operating expenses this quarter. As a percentage of revenues, adjusted operating expenses (excluding one-time items but including stock-based compensation) almost remained flat year over year at 68.5%. In dollar terms, however, it increased 21.7% to $217 million.

Adjusted operating profit came at $14.8 million, up 47.4% from the year-ago quarter. Adjusted operating profit margin expanded 80 basis points (bps) to 4.7% mainly due to improved gross margin and also supported by efficient cost management.

Adjusted net income came at $12.3 million, up 72.5% from the year-ago quarter level of $7.1 million. On a per share basis, adjusted earnings for the quarter were 7 cents compared with the prior-year period earnings of 4 cents. Quarterly earnings also came ahead of the Zacks Consensus Estimate of 3 cents per share.

FORTINET INC Price, Consensus and EPS Surprise

FORTINET INC Price, Consensus and EPS Surprise | FORTINET INC Quote

However, on GAAP basis, the company reported third-quarter 2016 earnings of 4 cents per share, a penny less than the yea- ago quarter.

Balance Sheet & Cash Flow

Fortinet exited the quarter with cash and cash equivalents, and short-term investments of approximately $1.03 billion, up from $984.8 million at the end of the previous quarter. Accounts receivable were $239 million compared with $254.4 million at the end of the second quarter.

During the quarter, the company generated cash flow of $76.1 million. Free cash flow for the quarter came in at $70.2 million. In the first three quarters of 2016, the company generated operating cash flow of $244.7 million.

During the first nine months of 2016, Fortinet repurchased shares worth $75 million. During the third quarter, the company repurchased shares worth $25 million.

Our Take

Fortinet’s network security solutions include firewall, VPN, application control, antivirus, intrusion prevention, web filtering, anti-spam and WAN acceleration. Although, the company managed to report better-than-expected third quarter results, we are skeptical about its future performance due to the challenges highlighted by the company.

The heightened worries over increasing price competition in the cybersecurity space due to issues highlighted by Fortinet have been swept away by better-than-expected results delivered by Proofpoint PFPT last week. This signifies that the challenges raised by Fortinet are company specific and are unlikely to impact the industry.

We believe that the industry has huge growth potential. Note that the financial well-being, brand image and reputation of enterprises and governments are always exposed to the risk of cyber threats. Consequently, cybersecurity has become a mission-critical, high-profile requirement.

With rapid technological advancement, organizations are increasingly adopting the “bring your own device” (BYOD) policy to enhance employee productivity with anytime/anywhere access. This trend, in turn, calls for stricter data security measures.

Moreover, various independent research firms forecast strong demand ahead. According to a Markets and Markets report, worldwide cyber security spending will reach $101 billion in 2018 and $170 billion by 2020. Gartner had earlier revealed that IT security spending peaked to $75 billion in 2015.

Therefore, in our opinion, Fortinet has to solve its challenges as soon as possible to capitalize on the huge opportunity available in the space. Otherwise players such as Juniper Networks JNPR, Cisco Systems and Check Point Software will grab the majority of market share.

Currently, Fortinet has a Zacks Rank #4 (Sell).

A better-ranked network security solution providing company is Palo Alto Networks PANW, which carries a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Palo Alto Networks has a long-term EPS growth rate of 30.3%, which is significantly higher than the industry average of 18.7%.

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