Fortinet, Inc.
FORTINET INC (Form: 10-Q, Received: 08/05/2016 17:22:39)
Table of Contents

 
 
 
 
 
 
 
 
 
 
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 June 30, 2016
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, 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 July 29, 2016 , there were 172,687,823 shares of the registrant’s common stock outstanding.




FORTINET, INC.
QUARTERLY REPORT ON FORM 10-Q
For the Quarter Ended June 30, 2016
Table of Contents
 
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


 


Table of Contents

Part I

ITEM 1.
Financial Statements

FORTINET, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in thousands, except per share amounts)
 
 
June 30,
2016
 
December 31,
2015
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
596,380

 
$
543,277

Short-term investments
388,388

 
348,074

Accounts receivable—net of reserves for sales returns and doubtful accounts of $10,215 and $6,228 at June 30, 2016 and December 31, 2015, respectively
254,379

 
259,563

Inventory
81,247

 
83,868

Prepaid expenses and other current assets
33,490

 
35,761

Total current assets
1,353,884

 
1,270,543

LONG-TERM INVESTMENTS
237,223

 
272,959

DEFERRED TAX ASSETS
180,782

 
119,216

PROPERTY AND EQUIPMENT—net
125,636

 
91,067

OTHER INTANGIBLE ASSETS—net
31,488

 
17,640

GOODWILL
14,235

 
4,692

OTHER ASSETS
16,930

 
14,393

TOTAL ASSETS
$
1,960,178

 
$
1,790,510

 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
56,920

 
$
61,500

Accrued liabilities
32,901

 
33,028

Accrued payroll and compensation
70,787

 
61,111

Income taxes payable
8,161

 
8,379

Deferred revenue
563,195

 
514,652

Total current liabilities
731,964

 
678,670

DEFERRED REVENUE
340,786

 
276,651

INCOME TAX LIABILITIES
66,304

 
60,624

OTHER LIABILITIES
16,498

 
19,188

Total liabilities
1,155,552

 
1,035,133

COMMITMENTS AND CONTINGENCIES (Note 10)


 


STOCKHOLDERS’ EQUITY:
 
 
 
Common stock, $0.001 par value—300,000 shares authorized; 172,436 and 171,399 shares issued and outstanding at June 30, 2016 and December 31, 2015, respectively
172

 
171

Additional paid-in capital
744,922

 
687,658

Accumulated other comprehensive income (loss)
724

 
(933
)
Retained earnings
58,808

 
68,481

Total stockholders’ equity
804,626

 
755,377

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
1,960,178

 
$
1,790,510

See notes to condensed consolidated financial statements.


3


FORTINET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(unaudited, in thousands, except per share amounts)
 
 
Three Months Ended
 
Six Months Ended
June 30,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
REVENUE:
 
 
 
 
 
 
 
Product
$
136,641

 
$
114,777

 
$
261,213

 
$
212,286

Service
174,750

 
125,008

 
334,754

 
240,385

Total revenue
311,391

 
239,785

 
595,967

 
452,671

COST OF REVENUE:
 
 
 
 
 
 
 
Product
52,788

 
47,397

 
102,101

 
88,765

Service
31,715

 
22,101

 
60,046

 
44,335

Total cost of revenue
84,503

 
69,498

 
162,147

 
133,100

GROSS PROFIT:
 
 
 
 
 
 
 
Product
83,853

 
67,380

 
159,112

 
123,521

Service
143,035

 
102,907

 
274,708

 
196,050

Total gross profit
226,888

 
170,287

 
433,820

 
319,571

OPERATING EXPENSES:
 
 
 
 
 
 
 
Research and development
45,502

 
37,389

 
90,256

 
73,205

Sales and marketing
162,694

 
111,928

 
308,797

 
212,537

General and administrative
22,184

 
18,018

 
41,623

 
29,979

Restructuring charges
553

 

 
881

 

Total operating expenses
230,933

 
167,335

 
441,557

 
315,721

OPERATING INCOME (LOSS)
(4,045
)
 
2,952

 
(7,737
)
 
3,850

INTEREST INCOME
1,705

 
1,364

 
3,451

 
2,786

OTHER EXPENSE—net
(1,350
)
 
(830
)
 
(2,662
)
 
(1,507
)
INCOME (LOSS) BEFORE INCOME TAXES
(3,690
)
 
3,486

 
(6,948
)
 
5,129

PROVISION FOR (BENEFIT FROM) INCOME TAXES
(2,302
)
 
2,694

 
(7,678
)
 
2,777

NET INCOME (LOSS)
$
(1,388
)
 
$
792

 
$
730

 
$
2,352

Net income (loss) per share (Note 8):
 
 
 
 
 
 
 
Basic
$
(0.01
)
 
$

 
$

 
$
0.01

Diluted
$
(0.01
)
 
$

 
$

 
$
0.01

Weighted-average shares outstanding:
 
 
 
 
 
 
 
Basic
172,075

 
169,930

 
171,910

 
169,009

Diluted
172,075

 
176,234

 
175,360

 
174,983

See notes to condensed consolidated financial statements.


4


FORTINET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(unaudited, in thousands)

 
Three Months Ended
 
Six Months Ended
 
June 30,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
Net income (loss)
$
(1,388
)
 
$
792

 
$
730

 
$
2,352

Other comprehensive income (loss):
 
 
 
 
 
 
 
Unrealized gains (losses) on investments
662

 
(822
)
 
2,549

 
63

Tax provision (benefit)
232

 
(287
)
 
892

 
23

Other comprehensive income (loss)—net of taxes
430

 
(535
)
 
1,657

 
40

Comprehensive income (loss)
$
(958
)
 
$
257

 
$
2,387

 
$
2,392


See notes to condensed consolidated financial statements.




5


FORTINET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in thousands)
 
Six Months Ended
 
June 30,
2016
 
June 30,
2015
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
730

 
$
2,352

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
21,841

 
13,382

Amortization of investment premiums
2,794

 
3,881

Stock-based compensation
59,249

 
40,525

Other non-cash items—net
1,192

 
1,891

Changes in operating assets and liabilities:
 
 
 
Accounts receivable—net
2,022

 
9,523

Inventory
(8,019
)
 
(7,917
)
Deferred tax assets
(27,120
)
 
(13,072
)
Prepaid expenses and other current assets
2,442

 
(3,492
)
Other assets
(2,409
)
 
(513
)
Accounts payable
(130
)
 
(8,383
)
Accrued liabilities
(6,426
)
 
(228
)
Accrued payroll and compensation
8,679

 
5,670

Other liabilities
(2,858
)
 
(1,884
)
Deferred revenue
111,082

 
97,156

Income taxes payable
5,463

 
10,033

Net cash provided by operating activities
168,532

 
148,924

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of investments
(230,855
)
 
(229,479
)
Sales of investments
7,366

 
22,472

Maturities of investments
219,131

 
240,625

Purchases of property and equipment
(44,399
)
 
(15,688
)
Payments made in connection with business acquisition, net of cash acquired
(20,660
)
 

Net cash provided by (used in) investing activities
(69,417
)
 
17,930

CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Proceeds from issuance of common stock
22,972

 
42,647

Taxes paid related to net share settlement of equity awards
(17,358
)
 
(11,362
)
Repurchase and retirement of common stock
(50,000
)
 

Payments of debt assumed in connection with business acquisition
(1,626
)
 

Net cash provided by (used in) financing activities
(46,012
)
 
31,285

NET INCREASE IN CASH AND CASH EQUIVALENTS
53,103

 
198,139

CASH AND CASH EQUIVALENTS—Beginning of period
543,277

 
283,254

CASH AND CASH EQUIVALENTS—End of period
$
596,380

 
$
481,393

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Cash paid for income taxes—net
$
13,673

 
$
10,077

NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Transfers of evaluation units from inventory to property and equipment
$
11,449

 
$
8,923

Liability for purchase of property and equipment and asset retirement obligations
$
7,617

 
$
1,359

Liability incurred in connection with business acquisition
$
1,513

 
$

See notes to condensed consolidated financial statements.

6


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 (“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, 2015, contained in our Annual Report on Form 10-K (the “Form 10-K”) filed with the SEC on February 26, 2016. 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 six months ended June 30, 2016 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, 2015 is derived from the audited consolidated financial statements for the year ended December 31, 2015.

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 six months ended June 30, 2016 , except for changes to our policy related to stock-based compensation expense. For more information, refer to the “Recently Adopted Accounting Standards.”

Recently Adopted Accounting Standards

In March 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-09—Compensation—Stock Compensation—Improvements to Employee Share-Based Payment Accounting (“ASU 2016-09”). The new guidance changes the accounting for certain aspects of stock-based payments to employees and requires excess tax benefits and tax deficiencies to be recorded in the income statement when the awards vest or are settled. In addition, cash flows related to excess tax benefits will no longer be separately classified as a financing activity apart from other income tax cash flows. The standard also allows us to repurchase more of an employee’s shares for tax withholding purposes without triggering liability accounting, clarifies that all cash payments made on an employee’s behalf for withheld shares should be presented as a financing activity on our cash flows statement, and provides an accounting policy election to account for forfeitures as they occur. The new standard is effective for us beginning January 1, 2017, with early adoption permitted.

We elected to early adopt the new guidance in the second quarter of 2016. The primary impact of the adoption was the recognition of excess tax benefits in our provision for income taxes rather than paid-in capital, as well as the adjustment in stock-based compensation expense as a result of our change in forfeiture policy. The new guidance eliminates the requirement to delay the recognition of excess tax benefits until it reduces current taxes payable. We adopted this change on a modified retrospective basis, and recorded unrecognized excess tax benefits amounting to $32.4 million as a cumulative-effect adjustment, which increased retained earnings on January 1, 2016. The new guidance also requires us to record, subsequent to the adoption, excess tax benefits and tax deficiencies in the period these arise. As a result, our provision for income taxes decreased by $3.6 million during the first quarter of 2016 and $2.6 million during the second quarter of 2016.

Under the new guidance, we have elected to change our policy and have started to recognize forfeitures of awards as they occur. The change in forfeiture policy was adopted using a modified retrospective transition method. We recorded a cumulative-effect adjustment to decrease retained earnings by $0.8 million upon transition on January 1, 2016 and a retrospective decrease of stock-based compensation of $2.0 million during the first quarter of 2016.

The amendment to the minimum statutory withholding tax requirements was adopted on a modified retrospective basis. The adoption had no impact on the January 1, 2016 retained earnings. In addition, we adopted the presentation of taxes paid related to net share settlement of equity awards as a financing activity on the statement of cash flows on a retrospective basis. Our adoption had no impact to any of the periods presented in our consolidated cash flows statements since such cash flows have historically been presented as a financing activity.


7

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



The adoption of ASU 2016-09 impacted our previously reported quarterly results for 2016, as well as our weighted average shares outstanding—diluted, as follows (in thousands, except for earnings per share):

 
Three Months Ended
 
March 31, 2016
 
As Reported
 
As Adjusted
Statements of Operations:
 
 
 
Stock-based compensation expense
$
30,881

 
$
28,901

Benefit from income taxes
$
(1,809
)
 
$
(5,376
)
Net income (loss)
$
(3,429
)
 
$
2,118

Net income (loss) per share—Basic
$
(0.02
)
 
$
0.01

Net income (loss) per share—Diluted
$
(0.02
)
 
$
0.01

Weighted-average shares outstanding—Diluted
171,745

 
174,421


 
March 31, 2016
 
As Reported
 
As Adjusted
Balance Sheets:
 
 
 
Deferred tax assets
$
131,696

 
$
167,625

Additional paid-in capital
$
718,849

 
$
717,671

Retained earnings
$
23,089

 
$
60,196


In September 2015, the FASB issued ASU 2015-16—Business Combinations—Simplifying the Accounting for Measurement-Period Adjustments, which eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. Instead, acquirers must recognize measurement-period adjustments during the period in which they determine the amounts, including the effect on earnings of any amounts they would have recorded in previous periods if the accounting had been completed at the acquisition date. We adopted ASU 2015-16 on January 1, 2016. The adoption of ASU 2015-16 did not have any impact on our consolidated financial statements.

Recent Accounting Standards Not Yet Effective

In February 2016, the FASB issued ASU 2016-02—Leases, which amends lease accounting requirements to begin recording assets and liabilities arising from leases on the balance sheet. 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. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. We expect our assets and liabilities to increase as a result of the adoption of this standard. We are currently evaluating the full impact ASU 2016-02 will have on our consolidated financial statements.

In January 2016, the FASB issued ASU 2016-01—Financial Instruments—Overall—Recognition and Measurement of Financial Assets and Financial Liabilities, which modifies how entities measure equity investments and present changes in the fair value of financial liabilities. Under the new guidance, entities will have to measure equity investments that do not result in consolidation and are not accounted under the equity method at fair value and recognize any changes in fair value in net income unless the investments qualify for the new practicality exception. The practicality exception will apply to those equity investments that do not have a readily determinable fair value and do not qualify for the practical expedient to estimate fair value, and as such these investments may be measured at cost. ASU 2016-01 will be effective for us beginning on January 1, 2018. We do not expect the impact of ASU 2016-01 on our consolidated financial statements to be significant.
   
In July 2015, the FASB issued ASU 2015-11—Inventory—Simplifying the Measurement of Inventory, which changes the measurement principle for inventory from the lower of cost or market to lower of cost and net realizable value. ASU 2015-11 applies to entities that measure inventory using a method other than last-in, first-out or the retail inventory method

8

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



(e.g., first-in, first-out or average cost). ASU 2015-11 will be effective for us beginning on January 1, 2017. We do not expect the impact of ASU 2015-11 on our consolidated financial statements to be significant.

In May 2014, the FASB issued ASU 2014-09—Revenue from Contracts with Customers, which creates a single, joint revenue standard that is consistent across all industries and markets for companies that prepare their financial statements in accordance with 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. In July 2015, the FASB decided to delay the effective date of the new revenue standard by one year. In March 2016, the FASB issued ASU 2016-08, which clarifies the implementation guidance on principal versus agent considerations. In April 2016, the FASB issued ASU 2016-10, which clarifies the implementation guidance on identifying performance obligations and licensing. In May 2016, the FASB issued ASU 2016-12—Revenue from Contracts with Customers—Narrow-scope Improvements and Practical Expedients, which amends the guidance on collectability, noncash consideration, presentation of sales tax and transition. These standards will be effective for us beginning on January 1, 2018, with the option to adopt earlier on January 1, 2017. We are currently evaluating the impact of these new standards on our consolidated financial statements.

2. FINANCIAL INSTRUMENTS AND FAIR VALUE

Our investments as of June 30, 2016 and December 31, 2015 were (in thousands):
 
 
June 30, 2016
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
Corporate debt securities
$
415,008

 
$
948

 
$
(78
)
 
$
415,878

Commercial paper
68,406

 
5

 
(3
)
 
68,408

Municipal bonds
52,531

 
81

 
(1
)
 
52,611

Certificates of deposit and term deposits (1)
19,823

 

 

 
19,823

U.S. government and agency securities
68,731

 
160

 

 
68,891

Total available-for-sale securities
$
624,499

 
$
1,194

 
$
(82
)
 
$
625,611


 
December 31, 2015
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
Corporate debt securities
$
438,533

 
$
30

 
$
(1,369
)
 
$
437,194

Commercial paper
66,263

 
3

 
(34
)
 
66,232

Municipal bonds
61,050

 
12

 
(40
)
 
61,022

Certificates of deposit and term deposits (1)
14,897

 

 

 
14,897

U.S. government and agency securities
41,727

 
3

 
(42
)
 
41,688

Total available-for-sale securities
$
622,470

 
$
48

 
$
(1,485
)
 
$
621,033

 
 
 
 
 
 
 
 

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

9

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



The gross unrealized losses and the related fair values of our investments that have been in a continuous unrealized loss position as of June 30, 2016 and December 31, 2015 were (in thousands):

 
June 30, 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
$
77,153

 
$
(36
)
 
$
40,207

 
$
(42
)
 
$
117,360

 
$
(78
)
Commercial paper
6,964

 
(3
)
 

 

 
6,964

 
(3
)
Municipal bonds
4,548

 
(1
)
 

 

 
4,548

 
(1
)
Total available-for-sale securities
$
88,665

 
$
(40
)
 
$
40,207

 
$
(42
)
 
$
128,872

 
$
(82
)

 
December 31, 2015
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Corporate debt securities
$
348,534

 
$
(1,187
)
 
$
42,033

 
$
(182
)
 
$
390,567

 
$
(1,369
)
Commercial paper
31,977

 
(34
)
 

 

 
31,977

 
(34
)
Municipal bonds
41,677

 
(36
)
 
1,008

 
(4
)
 
42,685

 
(40
)
U.S. government and agency securities
34,703

 
(42
)
 

 

 
34,703

 
(42
)
Total available-for-sale securities
$
456,891

 
$
(1,299
)
 
$
43,041

 
$
(186
)
 
$
499,932

 
$
(1,485
)

The contractual maturities of our investments as of June 30, 2016 and December 31, 2015 were (in thousands):
 
 
June 30,
2016
 
December 31,
2015
Due within one year
$
388,388

 
$
348,074

Due within one to three years
237,223

 
272,959

Total
$
625,611

 
$
621,033


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 insignificant in the periods presented and are included in Other 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 June 30, 2016 .

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.

10

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




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.

Fair Value of Financial Instruments

Assets Measured at Fair Value on a Recurring Basis

The fair values of our financial assets measured at fair value on a recurring basis as of June 30, 2016 and December 31, 2015 were (in thousands):
 
 
June 30, 2016
 
 
 
December 31, 2015
 
 
 
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
$
415,878

 
$

 
$
415,878

 
$

 
$
437,194

 
$

 
$
437,194

 
$

Commercial paper
78,406

 

 
78,406

 

 
69,231

 

 
69,231

 

Municipal bonds
52,611

 

 
52,611

 

 
61,022

 

 
61,022

 

Certificates of deposit and term deposits
19,823

 

 
19,823

 

 
14,897

 

 
14,897

 

Money market funds
49,231

 
49,231

 

 

 
50,030

 
50,030

 

 

U.S. government and agency securities
68,891

 
58,869

 
10,022

 

 
41,688

 
25,693

 
15,995

 

Total
$
684,840

 
$
108,100

 
$
576,740

 
$

 
$
674,062

 
$
75,723

 
$
598,339

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reported as:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents
$
59,229

 
 
 
 
 
 
 
$
53,029

 
 
 
 
 
 
Short-term investments
388,388

 
 
 
 
 
 
 
348,074

 
 
 
 
 
 
Long-term investments
237,223

 
 
 
 
 
 
 
272,959

 
 
 
 
 
 
Total
$
684,840

 
 
 
 
 
 
 
$
674,062

 
 
 
 
 
 

There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the six months ended June 30, 2016 .




11

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



3. INVENTORY

Our inventory as of June 30, 2016 and December 31, 2015 consisted of (in thousands):
 
 
June 30,
2016
 
December 31,
2015
Raw materials
$
17,042

 
$
15,425

Finished goods
64,205

 
68,443

Inventory
$
81,247

 
$
83,868


Inventory includes finished goods held by distributors where revenue is recognized on a sell-through basis of $1.7 million and $1.1 million as of June 30, 2016 and December 31, 2015 , respectively. Inventory also includes materials at contract manufacturers of $5.5 million and $4.9 million as of June 30, 2016 and December 31, 2015 , respectively.
 
4. PROPERTY AND EQUIPMENT—net
Our property and equipment—net as of June 30, 2016 and December 31, 2015 consisted of (in thousands):
 
 
June 30,
2016
 
December 31,
2015
Land
$
31,251

 
$
21,683

Building and building improvements
42,060

 
28,841

Evaluation units
18,299

 
15,784

Computer equipment and software
52,907

 
45,632

Furniture and fixtures
10,893

 
8,901

Construction-in-progress
13,681

 
8,106

Leasehold improvements
15,554

 
11,179

Total property and equipment
184,645

 
140,126

Less: accumulated depreciation
(59,009
)
 
(49,059
)
Property and equipment—net
$
125,636

 
$
91,067


Depreciation expense was $9.0 million and $6.8 million during the three months ended June 30, 2016 and June 30, 2015 , respectively. Depreciation expense was $18.4 million and $12.8 million during the six months ended June 30, 2016 and June 30, 2015 , respectively.

5. INVESTMENTS IN PRIVATELY-HELD COMPANIES

Our investments in the equity securities of three privately-held companies totaled $10.3 million as of June 30, 2016 and December 31, 2015 . Each of these investments are accounted for as cost-basis investments, as we own less than 20% of the voting securities 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 sheet and would be measured at fair value if indicators of impairment exist. As of June 30, 2016 , no events have occurred that would adversely affect the carrying value of these investments.

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 were not required to be consolidated in our condensed consolidated financial statements.


12

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



6. BUSINESS COMBINATIONS

AccelOps, Inc.

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 $22.3 million , of which $20.7 million was paid as of June 30, 2016 and the remaining balance was recorded as a current liability in the consolidated balance sheet as of June 30, 2016. We believe this acquisition will extend the Fortinet Security Fabric (as defined below) by enhancing our network security visibility, security data analytics, and threat intelligence across multi-vendor solutions.

The acquisition of AccelOps is accounted as a business combination in accordance with the Accounting Standards Codification Topic 805 “Business Combinations” (“ASC 805”) issued by the FASB. We use our best estimates and assumptions to assign fair value to the tangible and intangible assets acquired and liabilities assumed at the acquisition date. We included acquisition-related costs of $0.3 million in general and administrative expenses. 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. The total purchase price was allocated using the information currently available. As a result, we may continue to adjust the estimated purchase price allocation as and when additional information is available. The acquisition also included a contingent obligation for up to $4.0 million in future earn out payments to certain stockholders of AccelOps, if specified future financial targets are met for the three and six months period ended June 30, 2016 and December 31, 2016. The financial target for the three months period ended June 30, 2016 was not met.  As of June 30, 2016, no fair value was assigned to the contingent consideration based on the estimated probability of attainment of the remaining target. We will remeasure the contingent consideration periodically during the six-month contingency period for the remaining target, with changes in fair value to be recorded in our consolidated statements of operations.

Total preliminary 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
2,977

Finite-lived intangible assets
15,800

Indefinite-lived intangible assets in process research and development
1,500

Goodwill
9,543

Total assets acquired
31,750

Deferred revenue
4,400

Accounts payable and accrued liabilities
3,311

Other liabilities
1,694

Total liabilities assumed
9,405

Total purchase price allocation
$
22,345


Finite-lived intangible assets consist of developed technology, customer relationships, and other. 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.

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

The estimated useful life and fair values of the acquired finite-lived intangible assets were as follows (in thousands, except for estimated useful life):

13

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



 
Estimated Useful Life (in years)
 
Fair Values
Developed technologies
4
 
$
11,600

Customer relationships
3
 
4,000

Other
2
 
200

Total
 
 
$
15,800


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

The goodwill of $9.5 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. The financial results of this acquisition are considered immaterial for purposes of pro forma financial disclosures.

Meru Networks, Inc.

On July 8, 2015, we completed our acquisition of Meru Networks, Inc. (“Meru”), a provider of Wi-Fi networking products and services.

In connection with the acquisition, we paid $41.8 million , comprised of cash consideration of $40.9 million , withholding tax liability of $0.4 million and $0.5 million in estimated fair value associated with restricted stock units (“RSUs”) of Meru that were converted for 53,401 shares of our common stock.

We accounted for this transaction as a business combination. In 2015, we included acquisition-related costs of $1.7 million in general and administrative expenses. The total purchase price was allocated to Meru’s 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 as follows (in thousands):

Cash and cash equivalents
$
3,268

Accounts receivable
8,191

Inventory
11,610

Prepaid expenses and other assets
2,409

Property and equipment
920

Deferred tax assets
18,585

Finite-lived intangible assets
19,600

Goodwill
1,868

Total assets acquired
66,451

Deferred revenue
9,800

Accounts payable and accrued liabilities
14,887

Total liabilities assumed
24,687

Total purchase price allocation
$
41,764


The goodwill of $1.9 million represents the premium we paid over the fair value of the net tangible liabilities assumed and identified intangible assets acquired, due primarily to Meru’s assembled workforce. The goodwill recorded as part of the Meru acquisition is not deductible for U.S. federal income tax purposes.


14

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



Intangible assets consist primarily of customer relationships and developed technologies. Customer relationships represent Meru’s installed base and the ability to sell existing, in-process and future versions of our products and services to its existing customers. Developed technologies represent the virtualized wireless local area network solutions offering centralized coordination and control of various access points on the network. This includes patented and unpatented technology, know-how, processes, designs and computer software. The estimated useful life and fair values of the acquired identifiable intangible assets were as follows (in thousands, except for estimated useful life):

 
Estimated Useful Life (in years)
 
Fair Values
Customer relationships
5
 
$
12,200

Developed technologies
4
 
7,200

Trade name
0.5
 
200

Total
 
 
$
19,600


Customer relationships and trade name are amortized and the amortization expense is recorded in sales and marketing expenses in the condensed consolidated statement of operations. Developed technologies is amortized and the amortization expense is recorded in cost of product revenue in the condensed consolidated statement of operations.

7. GOODWILL AND OTHER INTANGIBLE ASSETS—net

Goodwill

Changes in the carrying amount of goodwill were (in thousands):

 
Amount
Balance—December 31, 2015
$
4,692

Addition due to business acquisition
9,543

Balance—June 30, 2016
$
14,235


There were no impairments to goodwill during the three and six months ended June 30, 2016 .

Other Intangible Assets—net

Other intangible assets—net as of June 30, 2016 and December 31, 2015 were (in thousands):

 
June 30, 2016
 
Weighted-Average Useful Life (in Years)
 
Gross
 
Accumulated Amortization
 
Net
Other intangible assets—net:
 
 
 
 
 
 
 
Finite-lived intangible assets:
 
 
 
 
 
 
 
Customer relationships
4.5
 
$
16,200

 
$
3,257

 
$
12,943

Developed technologies and other
3.8
 
23,184

 
6,139

 
17,045

 
 
 
39,384

 
9,396

 
29,988

Indefinite-lived intangible assets:
 
 
 
 
 
 
 
In-process research and development
 
 
1,500

 

 
1,500

Total other intangible assets—net
 
 
$
40,884

 
$
9,396

 
$
31,488



15

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



 
December 31, 2015
 
Weighted-Average Useful Life (in Years)
 
Gross
 
Accumulated Amortization
 
Net
Other intangible assets—net:
 
 
 
 
 
 
 
Customer relationships
5.0
 
$
12,200

 
$
1,220

 
$
10,980

Developed technologies and other
3.6
 
11,384

 
4,724

 
6,660

Total other intangible assets—net
 
 
$
23,584

 
$
5,944

 
$
17,640


Amortization expense was $2.3 million and $0.3 million during the three months ended June 30, 2016 and June 30, 2015 , respectively. Amortization expense was $3.5 million and $0.5 million during the six months ended June 30, 2016 and June 30, 2015 , respectively. The following table summarizes estimated future amortization expense of Other intangible assets—net with finite lives (in thousands):

 
Amount
Years:
 
2016 (remainder)
$
6,032

2017
8,878

2018
7,281

2019
5,517

2020
2,280

Total
$
29,988


8. NET INCOME (LOSS) PER SHARE

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


16

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



A reconciliation of the numerator and denominator used in the calculation of basic and diluted net income (loss) per share is as follows (in thousands, except per share amounts):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
Numerator:
 
 
 
 
 
 
 
Net income (loss)
$
(1,388
)
 
$
792

 
$
730

 
$
2,352

 
 
 
 
 
 
 
 
Denominator:
 
 
 
 
 
 
 
Basic shares:
 
 
 
 
 
 
 
Weighted-average common stock outstanding-basic
172,075

 
169,930

 
171,910

 
169,009

Diluted shares:
 
 
 
 
 
 
 
Weighted-average common stock outstanding-basic
172,075

 
169,930

 
171,910

 
169,009

Effect of potentially dilutive securities:
 
 
 
 
 
 
 
Stock options

 
3,720

 
1,796

 
3,779

RSUs (including PSUs)

 
2,521

 
1,580

 
2,131

ESPP

 
63

 
74

 
64

Weighted-average shares used to compute diluted net income per share
172,075

 
176,234

 
175,360

 
174,983

Net income (loss) per share:
 
 
 
 
 
 
 
Basic
$
(0.01
)
 
$

 
$

 
$
0.01

Diluted
$
(0.01
)
 
$

 
$

 
$
0.01


The following potentially dilutive shares of common stock were excluded from the computation of diluted net income (loss) per share for the periods presented, as their effect would have been antidilutive (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
Stock options
7,058

 
299

 
1,182

 
274

RSUs (including PSUs)
10,577

 
414

 
4,715

 
873

ESPP
554

 

 
141

 
84

 
18,189

 
713

 
6,038

 
1,231



17

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



9. RESTRUCTURING CHARGES

The following table provides a summary of restructuring activity as of June 30, 2016 (in thousands):

 
Employee Severance and Other Benefits
 
Contract Terminations and Other Charges
 
Total
Balance as of December 31, 2015
$
3,689

 
$
229

 
$
3,918

Costs incurred
837

 
44

 
881

Less cash payments
(2,757
)
 
(171
)
 
(2,928
)
Less non-cash charges
(89
)
 

 
(89
)
Balance as of June 30, 2016
$
1,680

 
$
102

 
$
1,782


2015 Meru Restructuring

In connection with the acquisition of Meru, we initiated planned cost reduction and restructuring activities to improve our cost structure and operational efficiencies starting in the third quarter of 2015. We estimate that we will incur approximately $8.0 million of restructuring charges, consisting of severance and other benefits, contract terminations and other charges. We did not incur any material restructuring charges during the three and six months ended June 30, 2016 . To date, we have incurred $7.8 million of charges related to this restructuring. These charges are primarily related to severance payments to be paid in cash and are included in operating expense in the condensed consolidated statements of operations of the period when incurred.

Cash payments for the restructuring activities are expected to be paid through 2017, primarily relating to severance payments. The remaining restructuring reserve balance of $1.5 million is included in accrued liabilities on the condensed consolidated balance sheet as of June 30, 2016 .

2016 AccelOps Restructuring

In connection with the acquisition of AccelOps, we initiated alignment activities in the second quarter of 2016. We estimate that we will incur approximately $0.7 million of restructuring charges, primarily consisting of severance and other benefits, all of which were incurred during the three and six months ended June 30, 2016 , which are included in operating expense in the condensed consolidated statements of operations.

Cash payments for the restructuring activities are expected to be made in 2016, primarily relating to severance payments. The remaining restructuring reserve accrual of $0.2 million is included in accrued liabilities on the condensed consolidated balance sheet as of June 30, 2016 .

10. COMMITMENTS AND CONTINGENCIES

Our future principal contractual obligations as of June 30, 2016 were (in thousands):

 
Total
 
2016 (remainder)
 
2017
 
2018
 
2019
 
2020
 
Thereafter
Operating lease commitments
$
75,975

 
$
10,984

 
$
17,146

 
$
15,004

 
$
12,595

 
$
9,598

 
$
10,648

Inventory purchase commitments
86,448

 
86,448

 

 

 

 

 

Other contractual commitments and open purchase orders
52,085

 
44,522

 
3,509

 
1,273

 
927

 
927

 
927

Total
$
214,508

 
$
141,954

 
$
20,655


$
16,277


$
13,522


$
10,525


$
11,575



18

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



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 $4.6 million and $2.9 million during the three months ended June 30, 2016 and June 30, 2015 , respectively. Rent expense was $8.5 million and $6.0 million during the six months ended June 30, 2016 and June 30, 2015 , 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 June 30, 2016 , we had $86.4 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 June 30, 2016 , we had $52.1 million in other contractual commitments that may not be cancelable.

Warranties —Accrued warranty activities are summarized as follows (in thousands):
 
Six Months Ended
 
June 30,
2016
 
June 30,
2015
Accrued warranty balance—beginning of the period
$
3,144

 
$
4,269

Warranty costs incurred
(1,481
)
 
(2,059
)
Provision for warranty for the period
718

 
2,294

Adjustment related to pre-existing warranties
(225
)
 
171

Accrued warranty balance—end of the period
$
2,156

 
$
4,675


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. We have not recorded any significant accrual for loss contingencies associated with such legal proceedings; determined that a significant unfavorable outcome is probable or reasonably possible; or determined that the amount or range of any possible significant 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 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 and 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 awards under such indemnification provisions.


19

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



11. STOCKHOLDERS’ EQUITY

Stock-Based Compensation Plans

We have stock-based compensation plans pursuant to which we have granted stock options and RSUs and PSUs. We also have an ESPP for all eligible employees. As of June 30, 2016 , there were a total of 45,162,348 shares of common stock available for grant under our stock-based compensation plans.

Restricted Stock Units

The activity and related information for RSUs, including PSUs, was (in thousands, except per share amounts):

 
Restricted Stock Units Outstanding
 
Number of Shares
 
Weighted-Average Grant Date Fair Value per Share
Balance—December 31, 2015
9,257

 
$
32.97

Granted
3,698

 
25.92

Forfeited
(707
)
 
32.24

Vested
(1,752
)
 
27.87

Balance—June 30, 2016
10,496

 
$
31.22


As of June 30, 2016 , total compensation expense related to unvested RSUs, including PSUs, that were granted to employees and non-employees, but not yet recognized, was $279.3 million . This expense is expected to be amortized on a straight-line basis over a weighted-average vesting period of 2.94 years. We did not grant any PSUs during the three and six months ended June 30, 2016 . The stock-based compensation expense related to PSU awards is not material. 

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.

The number of shares and amount withheld for employee taxes were (in thousands):

 
Three Months Ended
 
Six Months Ended
 
June 30,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
Shares withheld for taxes
247

 
124

 
590

 
345

Amount withheld for taxes
$
8,051

 
$
4,762

 
$
17,358

 
$
11,362




20

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



Employee Stock Options

The weighted-average assumptions relating to our employee stock options were:

 
Three Months Ended
 
Six Months Ended
 
June 30,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
Expected term in years
4.3

 
4.3

 
4.3

 
4.3

Volatility
39
%
 
38
%
 
39% - 43%

 
38% - 40%

Risk-free interest rate
1.2
%
 
1.5
%
 
1.0% - 1.2%

 
1.5
%
Dividend rate
%
 
%
 
%
 
%

The stock option activity and related information was (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, 2015
6,968

 
$
20.03

 
 
 
 
Granted
1,298

 
$
24.77

 
 
 
 
Forfeited
(102
)
 
$
37.49

 
 
 
 
Exercised
(1,263
)
 
$
8.18

 
 
 
 
Balance—June 30, 2016
6,901

 
$
22.83

 
3.33
 
65,715

Options exercisable—June 30, 2016
4,821

 
$
20.30

 
2.09
 
$
54,924


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 June 30, 2016 , for all in-the-money options. As of June 30, 2016 , total compensation expense related to unvested stock options granted to employees but not yet recognized was $18.0 million . This expense is expected to be amortized on a straight-line basis over a weighted-average period of 3.2 years.  

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

 
Three Months Ended
 
Six Months Ended
 
June 30, 2016
 
June 30, 2015
 
June 30, 2016
 
June 30, 2015
Weighted-average fair value per share granted
$
10.92

 
$
12.75

 
$
8.90

 
$
11.54

Intrinsic value of options exercised
$
6,829

 
$
22,034

 
$
26,253

 
$
63,038

Fair value of options vested
$
793

 
$
2,718

 
$
2,876

 
$
6,510




21

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



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:

 
Six Months Ended
 
June 30,
2016
 
June 30,
2015
Expected term in years
0.5

 
0.5

Volatility
48
%
 
28
%
Risk-free interest rate
0.4
%
 
0.1
%
Dividend rate
%
 
%

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

 
Six Months Ended
 
June 30,
2016
 
June 30,
2015
Weighted-average fair value per share granted
$
7.19

 
$
7.56

Shares issued under the ESPP
614

 
427

Weighted-average price per share issued
$
20.49

 
$
21.34


There were no shares granted or issued under the ESPP during the three month ended June 30, 2016 and June 30, 2015.

Stock-based Compensation Expense

Stock-based compensation expense is included in costs and expenses as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
Cost of product revenue
$
298

 
$
210

 
$
578

 
$
350

Cost of service revenue
2,123

 
1,660

 
4,257

 
3,292

Research and development
7,458

 
5,541

 
14,601

 
10,698

Sales and marketing
16,990

 
11,271

 
32,805

 
20,578

General and administrative
3,478

 
3,078

 
7,008

 
5,764

Total stock-based compensation expense
$
30,347

 
$
21,760

 
$
59,249

 
$
40,682


The stock-based compensation expense by award type was (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
RSUs
$
26,799

 
$
17,386

 
$
51,902

 
$
31,678

Stock options
1,592

 
3,017

 
3,546

 
6,472

ESPP
1,956

 
1,357

 
3,801

 
2,532

Total stock-based compensation expense
$
30,347

 
$
21,760

 
$
59,249

 
$
40,682



22

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



Total income tax benefit associated with stock-based compensation that is recognized in the consolidated statements of operations is as follows (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
Income tax benefit associated with stock-based compensation
$
7,416

 
$
4,266

 
$
14,737

 
$
7,643


Share Repurchase Program

In January 2016, our board of directors approved a new Share Repurchase Program (the “Program”), which authorizes the repurchase of up to $200.0 million of our outstanding common stock through December 31, 2017. Under the Program, share repurchases may be made by us from time to time in privately negotiated transactions or in open market transactions. The 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. There were no shares repurchased under the Program during the three months ended June 30, 2016 . During the six months ended  June 30, 2016 , we repurchased  2.0 million  shares of common stock under the Program in open market transactions at an average price of  $24.97  per share, for an aggregate purchase price of  $50.0 million . As of June 30, 2016 , $150.0 million remained available for future share repurchases under the Program.

12. INCOME TAXES

Our effective tax rate was 62% for the three months ended June 30, 2016 , compared to an effective tax rate of 77% for the same period last year. The effective tax rate was 111% for the six months ended June 30, 2016 , compared to an effective tax rate of 54% for the same period last year. The effective tax rate for the periods presented was comprised of U.S. federal and state taxes, foreign withholding taxes and foreign income taxes. The changes in the tax provision and effective tax rate were primarily due to the tax benefit from the adoption of the new accounting guidance relating to stock-based compensation and the tax benefit from the U.S. federal research and development credit (the “U.S. federal R&D credit”). The tax rate for the three and six months ended June 30, 2015 did not include a benefit from the U.S. federal R&D credit, as the credit had expired in December 2014. In December 2015, the U.S. federal R&D credit was made permanent and the tax benefit was reflected on the income tax provision for the three and six months ended June 30, 2016. There was a pretax loss for the three and six months ended June 30, 2016 , as compared to having a pretax income for the same periods last year.

As of June 30, 2016 and December 31, 2015, unrecognized tax benefits were $63.7 million and $59.7 million , respectively. The total amount of $62.4 million in unrecognized tax benefits, if recognized, would favorably impact the effective tax rate. It is our policy to classify accrued interest and penalties related to unrecognized tax benefits in the provision for income taxes. As of June 30, 2016 , we had accrued $7.9 million for estimated interest related to uncertain tax positions.

We file income tax returns in the U.S. federal jurisdiction, and various U.S. state and foreign jurisdictions. The statute of limitations is open for years that generated state net operating loss carryforwards and after 2009 for state jurisdictions. Additionally, we have foreign net operating losses that have an indefinite life. Generally, we are no longer subject to 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 tax authorities for tax years prior to 2012. We are currently under examination by U.S federal income tax authorities for the 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. We are in the early stages of this inquiry and as of yet no official audit has been opened.


23

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



13. 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 the 401(k) Plan and RRSP for the three months ended June 30, 2016 and June 30, 2015 were $1.2 million and $0.9 million , respectively. Our matching contributions to the 401(k) Plan and RRSP during the six months ended June 30, 2016 and June 30, 2015 were $2.2 million and $1.8 million , respectively.

14. 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
 
Six Months Ended
Revenue
June 30,
2016
 
June 30,
2015
 
June 30,
2016
 
June 30,
2015
Americas:
 
 
 
 
 
 
 
United States
$
80,811

 
$
71,224

 
$
156,369

 
$
129,725

Canada
33,782

 
26,191

 
65,087

 
46,649

Other Americas
18,053

 
11,178

 
31,236

 
23,779

Total Americas
132,646

 
108,593

 
252,692

 
200,153

Europe, Middle East, and Africa (“EMEA”)
114,453

 
83,404

 
219,944

 
159,068

Asia Pacific (“APAC”)
64,292

 
47,788

 
123,331

 
93,450

Total revenue
$
311,391

 
$
239,785

 
$
595,967

 
$
452,671


Property and Equipment net
June 30,
2016
 
December 31,
2015
Americas:
 
 
 
United States
$
90,457

 
$
61,064

Other Americas
10,123

 
8,972

Total Americas
100,580

 
70,036

EMEA: