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Fortinet (FTNT) Q2 Earnings Top, Revenue Growth Rate Dismal

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

Fortinet’s adjusted earnings per share (including stock-based compensation but excluding amortization of intangible assets) of 14 cents beat the Zacks Consensus Estimate of 8 cents. Adjusted earnings also marked a solid improvement over the year-ago quarter’s earnings of 3 cents, driven mainly by higher revenues and efficient cost management, which were partially offset by higher share counts.

On a non-GAAP (excluding stock-based compensation and amortization of intangible assets) basis, the network security solution providing company posted earnings of 27 cents, which was higher than management’s guidance range of 19–20 cents and marked a 41.7% year-over-year improvement.

Fortinet, Inc. Price, Consensus and EPS Surprise

 

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

Revenues

Fortinet reported second-quarter revenues of $363.5 million, beating the Zacks Consensus Estimate of $361 million and up 16.7% year over year. Segment wise, Product revenues increased 4% year over year to $142.7 million, while Services revenues jumped 26% to $220.8 million.

The year-over-year improvement was primarily aided by growth in sales productivity and success in selling multiple product deployments. A large number of deal wins and customer additions during the quarter also proved conducive to top-line growth.

During the quarter, Fortinet added over 10,000 customers, bringing the total count to over 320,000.The company witnessed 21% year-over-year growth in the number of deals worth over $100,000, while the number of deals worth over $250,000 and $500,000 increased 5% and 10%, respectively.

Billings were up 14% on a year-over-year basis to $426.9 million.

Operating Results

Gross profit increased 18% from the year-ago quarter to $267.8 million. Moreover, gross margin expanded 80 basis points (bps) to 73.7%, primarily backed by sales of higher-value subscription bundles.

Furthermore, the company efficiently managed its operating expenses this quarter. As a percentage of revenues, non-GAAP operating expenses contracted 570 bps year over year to 55.6%. In dollar terms, however, the figure advanced 5.9% to $202.1 million.

Non-GAAP operating profit jumped 82.7% to $65.7 million from approximately $36 million in the year-ago quarter. Non-GAAP operating profit margin expanded 650 bps to 18.1%, mainly attributed to improved gross margin and efficient cost management.

Balance Sheet & Cash Flow

Fortinet exited the reported quarter with cash and cash equivalents, and short-term investments of approximately $1.21 billion, almost flat with $1.20 billion recorded at the end of the first quarter. Accounts receivable were $271.1million compared with $271.1 million recorded at the end of the previous quarter.

During the first half of 2017, the company generated operating cash flow of $274.5 million. Free cash flow for the first two quarters came in at $174.6 million. Fortinet bought back 849,000 shares for $33.2 million during the first half of 2017.

Guidance

Buoyed by a better-than-expected second-quarter performance, Fortinet raised its outlook for full-year 2017. For 2017, management now expects revenues in the range of $1.487–$1.495 billion (mid-point: $1.491 billion), up from the earlier guidance of $1.485–$1.495 billion (mid-point: $1.490 billion). Billings forecast has also been raised to $1.775–$1.795 billion from $1.770–$1.792 billion. The Zacks Consensus Estimate for revenues is currently pegged at $1.49 billion.

Similarly, non-GAAP earnings per share are now projected to come between 94 cents and 96 cents (mid-point 95 cents), up from of 89–91 cents (mid point: 90 cents) predicted earlier.

Non-GAAP gross margin is now anticipated to come between 74.5% and 75% compared with the earlier forecasted range of 74%–75%. Non-GAAP operating margin is projected to come at 16.2%.

However, the company’s revenue forecast for the third quarter is slightly disappointing. Management expects revenues in the range of $367–$373 million (mid point: $370 million), which is lower than the Zacks Consensus Estimate of $371.45 million at mid-point. Billings are estimated in the range of $417–$427 million.

Non-GAAP earnings per share are anticipated to come in the band of 22–23 cents (mid point: 22.5 cents). Non-GAAP gross margin is expected to be 75%, whereas non-GAAP operating margin is anticipated to be between 16% and 17%.

Our Take

Fortinet’s network security solutions include firewall, VPN, application control, antivirus, intrusion prevention, web filtering, anti-spam and WAN acceleration. The company reported better-than-expected second-quarter results. Despite persistent macro uncertainties, management seems to be optimistic on the back of a healthy network security market, solid product line-up and investment plans. Furthermore, the company’s upbeat guidance for full-year 2017 is encouraging.

Despite all these, shares of Fortinet dropped over 4% in yesterday’s after-hour trade, as investors seemed concerned over the company’s slowing revenue growth rate. Notably, over the last four quarters, the company’s revenue growth rates have been around 20%, significantly lower than its previous rates of over 30%. Additionally, Fortinet’s second-quarter revenue guidance marks an even lower growth rate of 15.9–17.8%.

Moreover, competition from key network security players such as Cisco Systems Inc. CSCO, Check Point CHKP, Juniper Networks JNPR and Palo Alto Networks, remains a concern.

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

Notably, the company generates over 50% of the total revenue from these services, which helped it generate a 80 basis points gross margin expansion in the second quarter. We believe that this strategy will continue to improve the company’s bottom-line performances as well.

Notably, the stock has returned 34.7% in the year-to-date period compared with the industry’s gain of 20.6% in the same time frame.

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

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