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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 March 31, 2019
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 every Interactive Data File required to be submitted 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 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
 
 
Smaller reporting company
o
 
Emerging growth company
o


Table of Contents

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
Securities registered pursuant to Section 12(b) of the Exchange Act:
Common Stock, $0.001 Par Value
 
FTNT
 
The Nasdaq Stock Market LLC
(Title of each class)
 
(Trading Symbol)
 
(Name of exchange on which registered)
As of April 30, 2019, there were 170,760,612 shares of the registrant’s common stock outstanding.




FORTINET, INC.
QUARTERLY REPORT ON FORM 10-Q
For the Quarter Ended March 31, 2019
Table of Contents
 
 
 
 
 
 
Page
 
 
 
 
PART IFINANCIAL INFORMATION
 
 
 
 
Item 1.
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
PART II—OTHER INFORMATION
 
 
 
 
Item 1.
Item 1A.
Item 2.
Item 6.
 
 


 


Table of Contents

PART I—FINANCIAL INFORMATION

ITEM 1.
Financial Statements
FORTINET, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in millions, except per share amounts)
 
 
March 31,
2019
 
December 31,
2018
ASSETS
 
 
 
CURRENT ASSETS:
 
 
 
Cash and cash equivalents
$
1,216.9

 
$
1,112.4

Short-term investments
584.9

 
537.2

Accounts receivable—Net
381.0

 
444.5

Inventory
88.4

 
90.0

Prepaid expenses and other current assets
42.1

 
36.8

Total current assets
2,313.3

 
2,220.9

LONG-TERM INVESTMENTS
50.2

 
67.0

PROPERTY AND EQUIPMENT—NET
272.0

 
271.4

DEFERRED CONTRACT COSTS
190.5

 
182.6

DEFERRED TAX ASSETS
262.7

 
255.0

GOODWILL
38.2

 
38.2

OTHER INTANGIBLE ASSETS—NET
19.1

 
22.1

OTHER ASSETS
59.7

 
20.8

TOTAL ASSETS
$
3,205.7

 
$
3,078.0

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
CURRENT LIABILITIES:
 
 
 
Accounts payable
$
69.2

 
$
86.4

Accrued liabilities
88.7

 
77.5

Accrued payroll and compensation
81.0

 
98.4

Income taxes payable
24.3

 
28.2

Deferred revenue
991.1

 
965.9

Total current liabilities
1,254.3

 
1,256.4

DEFERRED REVENUE
774.7

 
720.9

INCOME TAX LIABILITIES
80.7

 
77.5

OTHER LIABILITIES
37.9

 
13.0

Total liabilities
2,147.6

 
2,067.8

COMMITMENTS AND CONTINGENCIES (Note 11)


 


STOCKHOLDERS’ EQUITY:
 
 
 
Common stock, $0.001 par value—300 shares authorized; 170.7 and 169.8 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively
0.2

 
0.2

Additional paid-in capital
1,108.1

 
1,068.3

Accumulated other comprehensive loss
(0.2
)
 
(0.8
)
Accumulated deficit
(50.0
)
 
(57.5
)
Total stockholders’ equity
1,058.1

 
1,010.2

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
$
3,205.7

 
$
3,078.0

See notes to condensed consolidated financial statements.


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Table of Contents

FORTINET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited, in millions, except per share amounts)
 
 
Three Months Ended
March 31,
2019
 
March 31,
2018
REVENUE:
 
 
 
Product
$
162.7

 
$
142.8

Service
309.9

 
256.2

Total revenue
472.6

 
399.0

COST OF REVENUE:
 
 
 
Product
70.2

 
58.2

Service
42.8

 
39.0

Total cost of revenue
113.0

 
97.2

GROSS PROFIT:
 
 
 
Product
92.5

 
84.6

Service
267.1

 
217.2

Total gross profit
359.6

 
301.8

OPERATING EXPENSES:
 
 
 
Research and development
68.6

 
59.1

Sales and marketing
215.9

 
185.3

General and administrative
24.5

 
25.0

Total operating expenses
309.0

 
269.4

OPERATING INCOME
50.6

 
32.4

INTEREST INCOME
10.2

 
4.5

OTHER EXPENSE—NET
(0.5
)
 
(0.2
)
INCOME BEFORE INCOME TAXES
60.3

 
36.7

PROVISION FOR (BENEFIT FROM) INCOME TAXES
1.5

 
(4.9
)
NET INCOME
$
58.8

 
$
41.6

Net income per share (Note 9):
 
 
 
Basic
$
0.35

 
$
0.25

Diluted
$
0.34

 
$
0.24

Weighted-average shares outstanding:
 
 
 
Basic
170.2

 
167.7

Diluted
174.8

 
171.8

See notes to condensed consolidated financial statements.


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Table of Contents

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

 
Three Months Ended
 
March 31,
2019
 
March 31,
2018
Net income
$
58.8

 
$
41.6

Other comprehensive income (loss):
 
 
 
Change in unrealized gains (losses) on investments
1.0

 
(1.2
)
Tax provision related to change in unrealized gains (losses) on investments
0.3

 

Other comprehensive income (loss)
0.7

 
(1.2
)
Comprehensive income
$
59.5

 
$
40.4


See notes to condensed consolidated financial statements.




3

Table of Contents

FORTINET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(unaudited, in millions)

 
Three Months Ended March 31, 2019
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive Loss
 
Accumulated Deficit
 
Total
Stockholders’
Equity
Shares
 
Amount
 
BALANCE—December 31, 2018
169.8

 
$
0.2

 
$
1,068.3

 
$
(0.8
)
 
$
(57.5
)
 
$
1,010.2

Issuance of common stock in connection with equity incentive plans - net of tax withholding
1.7

 

 
1.6

 

 

 
1.6

Repurchase and retirement of common stock
(0.8
)
 

 
(4.8
)
 

 
(51.4
)
 
(56.2
)
Stock-based compensation expense

 

 
43.0

 

 

 
43.0

Cumulative-effect adjustment from adoption of ASU 2018-02

 

 

 
(0.1
)
 
0.1

 

Net unrealized gain on investments - net of tax

 

 

 
0.7

 

 
0.7

Net income

 

 

 

 
58.8

 
58.8

BALANCE—March 31, 2019
170.7

 
$
0.2

 
$
1,108.1

 
$
(0.2
)
 
$
(50.0
)
 
$
1,058.1

 
 
Three Months Ended March 31, 2018
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive Loss
 
Accumulated Deficit
 
Total
Stockholders’
Equity
Shares
 
Amount
 
BALANCE—December 31, 2017
167.9

 
$
0.2

 
$
909.6

 
$
(0.8
)
 
$
(319.6
)
 
$
589.4

Issuance of common stock in connection with equity incentive plans - net of tax withholding
2.6

 

 
25.4

 

 

 
25.4

Repurchase and retirement of common stock
(2.5
)
 

 
(13.6
)
 

 
(101.9
)
 
(115.5
)
Stock-based compensation expense

 

 
36.5

 

 

 
36.5

Cumulative effect adjustments from adoption of Topic 606

 

 

 

 
117.3

 
117.3

Net unrealized gain on investments - net of tax

 

 

 
(1.2
)
 

 
(1.2
)
Net income

 

 

 

 
41.6

 
41.6

BALANCE—March 31, 2018
168.0

 
$
0.2

 
$
957.9

 
$
(2.0
)
 
$
(262.6
)
 
$
693.5

See notes to condensed consolidated financial statements.


4

Table of Contents

FORTINET, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in millions)
 
Three Months Ended
 
March 31,
2019
 
March 31,
2018
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
Net income
$
58.8

 
$
41.6

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Stock-based compensation
43.0

 
36.5

Amortization of deferred contract costs
25.1

 
20.8

Depreciation and amortization
15.7

 
13.2

Amortization of investment premiums, net of accretion of purchase discounts
(1.1
)
 
0.1

Other
0.3

 
0.3

Changes in operating assets and liabilities:
 
 
 
Accounts receivable—net
63.6

 
48.9

Inventory
(2.6
)
 
(7.3
)
Prepaid expenses and other current assets
(5.9
)
 
1.2

Deferred contract costs
(32.9
)
 
(32.5
)
Deferred tax assets
(8.0
)
 
(9.6
)
Other assets
0.1

 
(0.9
)
Accounts payable
(18.0
)
 
(13.6
)
Accrued liabilities
3.9

 
(4.7
)
Accrued payroll and compensation
(18.1
)
 
(10.0
)
Other liabilities
(0.9
)
 
(0.6
)
Deferred revenue
79.0

 
64.1

Income taxes payable
(0.7
)
 
(7.8
)
Net cash provided by operating activities
201.3

 
139.7

CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
Purchases of investments
(264.5
)
 
(134.9
)
Sales of investments
8.1

 
16.3

Maturities of investments
227.6

 
104.7

Purchases of property and equipment
(10.2
)
 
(11.6
)
Net cash used in investing activities
(39.0
)
 
(25.5
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
Repurchase and retirement of common stock
(60.4
)
 
(115.5
)
Proceeds from issuance of common stock
34.6

 
45.1

Taxes paid related to net share settlement of equity awards
(32.0
)
 
(19.2
)
Net cash used in financing activities
(57.8
)
 
(89.6
)
NET INCREASE IN CASH AND CASH EQUIVALENTS
104.5

 
24.6

CASH AND CASH EQUIVALENTS—Beginning of period
1,112.4

 
811.0

CASH AND CASH EQUIVALENTS—End of period
$
1,216.9

 
$
835.6

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
 
 
 
Operating lease liabilities arising from obtaining right-of-use assets
$
3.5

 
$

Cash paid to settle liability incurred for repurchase of common stock
$
4.2

 
$

NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
Transfers of evaluation units from inventory to property and equipment
$
4.3

 
$
4.9

Liability for purchase of property and equipment and asset retirement obligations
$
7.6

 
$
3.6

See notes to condensed consolidated financial statements.

5

Table of Contents

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

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, 2018, contained in our Annual Report on Form 10-K filed with the SEC on February 27, 2019. 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 months ended March 31, 2019 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, 2018 is derived from the audited consolidated financial statements for the year ended December 31, 2018.

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 months ended March 31, 2019, except for the accounting policies for leases that were updated as a result of adopting Accounting Standards Update (“ASU”) 2016-02—Leases (Topic 842) (“Topic 842”). For more information, refer to the “Recently Adopted Accounting Standards” and Note 10.

Recently Adopted Accounting Standards

Leases

In February 2016, the Financial Accounting Standards Board (the “FASB”) issued Topic 842, which requires the recognition of right-of-use (“ROU”) assets and lease liabilities for operating leases on the condensed consolidated balance sheet. We adopted Topic 842 and its related amendments as of January 1, 2019 using a modified retrospective transition approach by applying the new standard to all leases existing at the date of initial application and not restating comparative periods. We elected the package of practical expedients permitted under the transition guidance, which allowed us to not reassess whether arrangements contain leases, not reassess lease classification and not reassess initial direct costs.

Under the new guidance, we determine if an arrangement contains a lease and the classification of that lease, if applicable, at inception or upon modification of a contract. We have elected to not recognize a lease liability or ROU asset for short-term leases (leases with a term of twelve months or less and does not include an option to purchase the underlying asset that the Company is reasonably certain to exercise). We have elected to not allocate the contract consideration for operating lease contracts with lease and non-lease components, and account for the lease and non-lease components as a single lease component. ROU assets represent our right to use an underlying asset for the lease term. Lease liabilities represent our obligation to make lease payments under the lease. Operating lease ROU assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. The implicit rate within our operating leases is generally not determinable and therefore we use our incremental borrowing rate at the lease commencement date to determine the present value of lease payments. The determination of our incremental borrowing rate requires judgment. We determine our incremental borrowing rate for each lease using indicative bank borrowing rates, adjusted for various factors including level of collateralization, term and currency to align with the terms of a lease. The operating lease ROU asset also includes any lease prepayments, net of lease incentives. Certain of our leases include options to extend or terminate the lease. An option to extend the lease is considered in connection with determining the ROU asset and lease liability when it is reasonably certain we will exercise that option. An option to terminate is considered unless it is reasonably certain we will not exercise the option.

The primary impact of adopting Topic 842 was the recognition of ROU assets and lease liabilities for operating leases of $39.1 million and $40.6 million, respectively, on January 1, 2019, which included reclassifying prepaid rent and deferred

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



rent as a component of the ROU asset. Topic 842 did not have a material impact on our condensed consolidated statements of income and cash flows.

The ROU assets and the short-term and long-term lease liabilities from our operating leases are included in other assets, accrued liabilities and other liabilities in our condensed consolidated balance sheets, respectively. Our accounting for finance leases (formerly referred to as capital leases prior to the adoption of Topic 842) remains substantially unchanged. Finance leases are not material to our condensed consolidated financial statements.

Lease expense for lease payments for our operating leases is recognized on a straight-line basis over the term of the lease.

Comprehensive Income

In February 2018, the FASB issued ASU 2018-02—Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income, which allows companies to reclassify stranded tax effects resulting from the Tax Cuts and Jobs Act (the “2017 Tax Act”) from accumulated other comprehensive income to retained earnings. We adopted ASU 2018-02 on January 1, 2019 and elected to reclassify $0.1 million of stranded tax effects as of that date.

Stock Compensation

In June 2018, the FASB issued ASU 2018-07—Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, which simplifies the accounting for share-based payments to nonemployees by aligning it with the accounting for share-based payments to employees subject to certain exceptions. ASU 2018-07 expands the scope of Accounting Standards Codification (“ASC”) Topic 718, Compensation—Stock Compensation (“ASC 718”), to include share-based payments granted to nonemployees in exchange for goods or services used or consumed in an entity’s own operations and supersedes the guidance in ASC 505, Equity, by moving it to ASC 718. We adopted ASU 2018-07 on January 1, 2019, ASU 2018-07 did not have a material impact to our condensed consolidated financial statements.

Recent Accounting Standards Not Yet Effective

Cloud Computing

In August 2018, the FASB issued ASU 2018-15—Intangibles-Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which requires a customer in a cloud computing arrangement that is a service contract to follow the internal-use software guidance in ASC Topic 350, Intangibles—Goodwill and Other, to determine which implementation costs to capitalize as assets or expense as incurred. ASU 2018-15 is effective for us beginning January 1, 2020, and early adoption is permitted. We are currently evaluating the impact of ASU 2018-15 to our condensed consolidated financial statements.

Fair Value Measurements

In August 2018, the FASB issued ASU 2018-13—Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement, which eliminates, adds and modifies certain disclosure requirements for fair value measurements in ASC 820, Fair Value Measurement, as part of its disclosure framework project. ASU 2018-13 is effective for us beginning January 1, 2020. The amendments in ASU 2018-13 on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments in ASU 2018-13 should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted upon issuance of ASU 2018-13. An entity is permitted to early adopt any removed or modified disclosures upon issuance of ASU 2018-13 and delay adoption of the additional disclosures until their effective date. We are currently assessing the impact the new guidance will have on our disclosures.

7

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




Financial Instruments

In June 2016, the FASB issued ASU 2016-13—Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments and in November 2018, the FASB issued ASU 2018-19—Codification Improvements to Topic 326, Financial Instruments—Credit Losses, as a subsequent amendment to the initial guidance (collectively, Topic 326). Topic 326 requires a financial asset (or a group of financial assets) to be measured at an amortized cost basis to be presented at the net amount expected to be collected. The new approach to estimating credit losses (referred to as the current expected credit losses model) applies to most financial assets measured at amortized cost and certain other instruments, including trade and other receivables, loans and held-to-maturity debt securities. Topic 326 is effective for us beginning on January 1, 2020, and early adoption is permitted. We are currently assessing the impact of Topic 326 on our condensed consolidated financial statements.

2.     REVENUE RECOGNITION

Our revenue consists of product and service revenue. Product revenue primarily consists of sales from our FortiGate products. Service revenue relates to sales of our FortiGuard security subscription, FortiCare technical support services and other services.

Disaggregation of Revenue

The following table presents our revenue disaggregated by major product and service lines (in millions):

 
Three Months Ended
 
March 31,
2019
 
March 31,
2018
Product
$
162.7

 
$
142.8

Service:
 
 
 
   Security subscription
169.6

 
136.6

   Technical support and other
140.3

 
119.6

      Total service revenue
309.9

 
256.2

Total revenue
$
472.6

 
$
399.0



Transaction Price Allocated to the Remaining Performance Obligations

As of March 31, 2019, the aggregate amount of the transaction price allocated to remaining performance obligations was $1.77 billion, which was substantially comprised of deferred security subscription and technical support services. We expect to recognize revenue on approximately 80% of these remaining performance obligations over the next one to two years, with the remaining balance to be recognized in three to five years.

Accounts Receivable

Trade accounts receivable are recorded at the invoiced amount. Trade accounts receivable is reduced by an allowance for doubtful accounts which is determined based on our assessment of the collectability of customer accounts. The allowance for doubtful accounts was $0.8 million and $0.9 million as of March 31, 2019 and December 31, 2018, respectively.

Deferred Contract Costs

Sales commissions earned by our sales force are considered incremental and recoverable costs of obtaining a contract with a customer. The amortization of deferred contract costs is included in sales and marketing expense in our condensed consolidated statements of income. Amortization of deferred contract costs during the three months ended March 31, 2019 and March 31, 2018 were $25.1 million and $20.8 million, respectively. No impairment loss was recognized during the three months ended March 31, 2019 or March 31, 2018.


8

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



Deferred Revenue

During the three months ended March 31, 2019 and March 31, 2018, we recognized $288.6 million and $239.1 million in revenue that was included in the deferred revenue balance as of December 31, 2018 and December 31,2017, respectively.

3.
FINANCIAL INSTRUMENTS AND FAIR VALUE

The following tables summarize our investments (in millions):
 
 
March 31, 2019
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
Corporate debt securities
$
348.1

 
$
0.3

 
$
(0.6
)
 
$
347.8

Commercial paper
150.6

 

 

 
150.6

Certificates of deposit and term deposits (1)
70.8

 

 

 
70.8

U.S. government and agency securities
65.9

 

 

 
65.9

Total available-for-sale securities
$
635.4

 
$
0.3

 
$
(0.6
)
 
$
635.1

 
 
 
 
 
 
 
 
 
December 31, 2018
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
Corporate debt securities
$
299.5

 
$

 
$
(1.2
)
 
$
298.3

Commercial paper
102.5

 

 

 
102.5

Certificates of deposit and term deposits (1)
145.8

 

 

 
145.8

U.S. government and agency securities
57.7

 

 
(0.1
)
 
57.6

Total available-for-sale securities
$
605.5

 
$

 
$
(1.3
)
 
$
604.2

 
 
 
 
 
 
 
 
(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 millions):

 
March 31, 2019
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Corporate debt securities
$
86.1

 
$
(0.1
)
 
$
77.5

 
$
(0.5
)
 
$
163.6

 
$
(0.6
)
Commercial paper
84.6

 

 

 

 
84.6

 

Certificates of deposit and term deposits
5.0

 

 

 

 
5.0

 

U.S. government and agency securities
21.2

 

 
3.5

 

 
24.7

 

Total available-for-sale securities
$
196.9

 
$
(0.1
)
 
$
81.0

 
$
(0.5
)
 
$
277.9

 
$
(0.6
)



9

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



 
December 31, 2018
 
Less Than 12 Months
 
12 Months or Greater
 
Total
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
 
Fair
Value
 
Unrealized
Losses
Corporate debt securities
$
150.1

 
$
(0.2
)
 
$
93.5

 
$
(1.0
)
 
$
243.6

 
$
(1.2
)
Commercial paper
75.6

 
(0.1
)
 

 

 
75.6

 
(0.1
)
Certificates of deposit and term deposits
51.7

 

 

 

 
51.7

 

U.S. government and agency securities
39.0

 

 
3.5

 

 
42.5

 

Total available-for-sale securities
$
316.4

 
$
(0.3
)
 
$
97.0

 
$
(1.0
)
 
$
413.4

 
$
(1.3
)


The contractual maturities of our investments were as follows (in millions):
 
 
March 31,
2019
 
December 31,
2018
Due within one year
$
584.9

 
$
537.2

Due within one to three years
50.2

 
67.0

Total
$
635.1

 
$
604.2



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 were insignificant in the periods presented and are included in other expense—net in our condensed consolidated statements of income. 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 March 31, 2019.

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.


10

Table of Contents
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 March 31, 2019 and December 31, 2018 (in millions):
 
 
March 31, 2019
 
December 31, 2018
 
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
$
349.9

 
$

 
$
349.9

 
$

 
$
299.3

 
$

 
$
299.3

 
$

Commercial paper
201.0

 

 
201.0

 

 
184.7

 

 
184.7

 

Certificates of deposit and term deposits
70.8

 

 
70.8

 

 
217.4

 

 
217.4

 

U.S. government and agency securities
65.9

 
53.5

 
12.4

 

 
57.6

 
45.3

 
12.3

 

Money market funds
14.0

 
14.0

 

 

 
58.6

 
58.6

 

 

Total
$
701.6

 
$
67.5

 
$
634.1

 
$

 
$
817.6

 
$
103.9

 
$
713.7

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reported as:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cash equivalents
$
66.5

 
 
 
 
 
 
 
$
213.4

 
 
 
 
 
 
Short-term investments
584.9

 
 
 
 
 
 
 
537.2

 
 
 
 
 
 
Long-term investments
50.2

 
 
 
 
 
 
 
67.0

 
 
 
 
 
 
Total
$
701.6

 
 
 
 
 
 
 
$
817.6

 
 
 
 
 
 


There were no transfers between Level 1 and Level 2 of the fair value hierarchy during the three months ended March 31, 2019 and year ended December 31, 2018.

4.     INVENTORY

Inventory consisted of the following (in millions):
 
 
March 31,
2019
 
December 31,
2018
Raw materials
$
10.7

 
$
13.3

Finished goods
77.7

 
76.7

Inventory
$
88.4

 
$
90.0




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



5.     PROPERTY AND EQUIPMENT—Net

Property and equipment—net consisted of the following (in millions):
 
 
March 31,
2019
 
December 31,
2018
Land
$
75.7

 
$
75.7

Building and building improvements
144.5

 
144.2

Computer equipment and software
98.7

 
95.9

Leasehold improvements
19.0

 
17.9

Evaluation units
20.1

 
20.5

Furniture and fixtures
16.2

 
15.7

Construction-in-progress
16.8

 
12.3

Total property and equipment
391.0

 
382.2

Less: accumulated depreciation
(119.0
)
 
(110.8
)
Property and equipment—net
$
272.0

 
$
271.4



Depreciation expense was $12.7 million and $11.4 million during the three months ended March 31, 2019 and March 31, 2018, respectively.

6.     INVESTMENTS IN PRIVATELY HELD COMPANIES

Our investments in the equity securities of privately held companies totaled $9.1 million as of March 31, 2019 and December 31, 2018. These investments are accounted for at cost, adjusted for changes in observable prices minus impairment. 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 recorded as other assets in our condensed consolidated balance sheets and would be measured at fair value if indicators of an increase in value or impairment existed. As of March 31, 2019, no events have occurred that would affect the carrying value of these investments.

7.     BUSINESS COMBINATIONS

ZoneFox Holdings Limited

On October 22, 2018, we acquired all outstanding shares of ZoneFox Holdings Limited (“ZoneFox”), a privately held cloud-based company providing insider threat detection and response. ZoneFox is headquartered in Edinburgh, Scotland. We expect the ZoneFox acquisition will allow us to provide additional user and entity behavior analytics features.

Under the business combination method of accounting in accordance with ASC Topic 805, Business Combinations (“ASC 805”), the total purchase price was allocated to ZoneFox’s identifiable tangible and intangible assets acquired and liabilities assumed based on their estimated fair values using management’s best estimates and assumptions to assign fair value as of the acquisition date. The purchase price for ZoneFox was $16.1 million, of which $12.5 million was allocated to goodwill that was non-deductible for tax purposes, and $6.8 million was allocated to identifiable intangible assets the majority of which was developed technology offset by $3.2 million of net liabilities assumed. Acquisition-related costs related to the ZoneFox acquisition were not material. Goodwill recorded in connection with this acquisition represents the value we expect to be created through expansion into markets within our existing business, and potential cost savings and synergies.

We may pay an additional $2.0 million in cash consideration as an earn-out that is subject in full to satisfaction of certain performance conditions. As of March 31, 2019, no fair value was assigned to the contingent consideration based on the estimated probability of attainment of the performance conditions.


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



Bradford Networks, Inc.

On June 4, 2018, we acquired all outstanding shares of Bradford Networks, Inc. (“Bradford”), a provider of network access control security products and services. We believe that this acquisition will extend the Fortinet Security Fabric to include network access control that helps with a security assessment related to devices accessing the network, including Internet of Things devices.

Under the business combination method of accounting in accordance with ASC 805, the total purchase price was allocated to Bradford’s identifiable tangible and intangible assets acquired and liabilities assumed based on their estimated fair values using management's best estimates and assumptions to assign fair value as of the acquisition date. The purchase price for Bradford was $6.8 million, of which $11.1 million was allocated to goodwill that was non-deductible for tax purposes, and $8.0 million was allocated to identifiable intangible assets the majority of which was developed technology offset by $12.3 million of net liabilities assumed. Acquisition-related costs related to the Bradford acquisition were not material. Goodwill recorded in connection with this acquisition represents the value we expect to be created through expansion into markets within our existing business, and potential cost savings and synergies.

We may pay an additional $2.0 million in cash consideration as an earn-out that is subject in full to satisfaction of certain performance conditions. As of March 31, 2019, no fair value was assigned to the contingent consideration based on the estimated probability of attainment of the performance conditions.

Pro forma information has not been presented for these acquisitions as the impact to our condensed consolidated financial statements was not material.

8.     GOODWILL AND OTHER INTANGIBLE ASSETS—Net

Goodwill

As of March 31, 2019 and December 31, 2018, we had goodwill of $38.2 million. There were no impairments to goodwill during the three months ended March 31, 2019 or during prior periods.

Other Intangible Assets—net

The following tables present other intangible assets—net as of March 31, 2019 and December 31, 2018 (in millions, except years):

 
March 31, 2019
 
Weighted-Average Useful Life (in Years)
 
Gross
 
Accumulated Amortization
 
Net
Other intangible assets—net:
 
 
 
 
 
 
 
Finite-lived intangible assets:
 
 
 
 
 
 
 
Developed technologies
4.0
 
$
34.4

 
$
19.1

 
$
15.3

Customer relationships
4.4
 
17.5

 
13.7

 
3.8

Total other intangible assets—net
 
 
$
51.9

 
$
32.8

 
$
19.1



 
December 31, 2018
 
Weighted-Average Useful Life (in Years)
 
Gross
 
Accumulated Amortization
 
Net
Other intangible assets—net:
 
 
 
 
 
 
 
Finite-lived intangible assets:
 
 
 
 
 
 
 
Developed technologies
4.0
 
$
34.4

 
$
17.0

 
$
17.4

Customer relationships
4.4
 
17.5

 
12.8

 
4.7

Total other intangible assets—net
 
 
$
51.9

 
$
29.8

 
$
22.1




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



Amortization expense was $3.0 million and $1.8 million during the three months ended March 31, 2019 and March 31, 2018, respectively.

The following table summarizes estimated future amortization expense of finite-lived intangible assets—net (in millions):
 
Amount
Years:
 
2019 (the remainder of 2019)
$
7.3

2020
6.2

2021
3.5

2022
2.1

Total
$
19.1



9.     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 our Employee Stock Purchase Plan (the “ESPP”), which was terminated in February 2019 at the completion of the prior offering period. 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 millions, except per share amounts):
 
 
Three Months Ended
 
March 31,
2019
 
March 31,
2018
Numerator:
 
 
 
Net income
$
58.8

 
$
41.6

 
 
 
 
Denominator:
 
 
 
Basic shares:
 
 
 
Weighted-average common stock outstanding-basic
170.2

 
167.7

Diluted shares:
 
 
 
Weighted-average common stock outstanding-basic
170.2

 
167.7

Effect of potentially dilutive securities:
 
 
 
RSUs
3.3

 
2.7

Stock options
1.3

 
1.3

ESPP

 
0.1

Weighted-average shares used to compute diluted net income per share
174.8

 
171.8

Net income per share:
 
 
 
Basic
$
0.35

 
$
0.25

Diluted
$
0.34

 
$
0.24




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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 millions):
 
 
Three Months Ended
 
March 31,
2019
 
March 31,
2018
RSUs
0.7

 
1.1

Stock options
0.3

 
0.5

ESPP

 
0.2

Total
1.0

 
1.8



10.     LEASES

We have operating leases for offices, research and development facilities and data centers. Our leases have remaining terms of less than one year to approximately eight years, some of which include one or more options to renew, with renewal terms of up to five years. We do not include any of our renewal options in our lease terms for calculating our lease liability, as the renewal options allow us to maintain operational flexibility and we are not reasonably certain we will exercise these renewal options at the time of the lease commencement. Our finance leases are not material to our financial statements.

The components of lease expense were as follows (in millions):

 
Three Months Ended
 
March 31,
2019
Operating lease expense
$
3.6

Variable lease expense (1)
0.6

Short-term lease expense
0.7

Total lease expense
$
4.9


(1) Variable lease expense for the three months ended March 31, 2019 predominantly included common area maintenance charges and parking expense.

Rent expense was $4.1 million during the three months ended March 31, 2018. Rent expense was recognized in accordance with ASC 840, Leases, using the straight-line method over the term of a lease.

Supplemental balance sheet information related to our operating leases was as follows (in millions, except lease term and discount rate):

 
 
Three Months Ended
 
Classification
March 31,
2019
Operating lease ROU assets - non-current
Other assets
$
39.2

 
 
 
Operating lease liabilities - current
Accrued liabilities
$
11.9

Operating lease liabilities - non-current
Other liabilities
27.5

Total operating lease liabilities
 
$
39.4

 
 
 
Weighted average remaining lease term in years - operating leases
 
4.1

Weighted average discount rate - operating leases
 
3.1
%



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



Supplemental cash flow information related to leases was as follows (in millions):

 
Three Months Ended
 
March 31,
2019
Cash paid for amounts included in the measurement of lease liabilities
 
Operating cash flows used for operating leases
$
4.6

 
 
Lease liabilities arising from obtaining right-of-use assets
 
Operating leases
$
3.5



Maturities of operating lease liabilities as of March 31, 2019 were as follows (in millions):

Year ending December 31,
Amount
2019 (the remainder of 2019)
$
9.7

2020
11.6

2021
8.2

2022
5.0

2023
3.7

Thereafter
3.8

Total lease payments
$
42.0