End-customers purchase FortiGuard security subscription services in advance, typically with terms of one to five years. We provide FortiGuard security subscription services 24 hours a day, seven days a week.
We also sell FortiGuard and FortiCare services as bundles, consolidating security services into packages that would be typicalare appropriate for certain types of end-customer.different use cases or end-customers.
We offer professional services to end-customers including technical account managers (“TAMs”), resident engineers (“REs”) and professional service consultants, and security architects for implementations.implementations and remote, cloud-based incident response (“IR”).
TAMs and REs are dedicated support engineers available to help identify and eliminate issues before problems arise. Each TAM and RE acts as a single point of contact and customer advocate within Fortinet, offering a deep understanding of our customers’ businesses and security requirements.
Our professional services consultants and security architects help to formulate customer-specific security strategies, develop roadmaps for securing digital initiatives and design product deployments. They work closely with end-customers to implement our products according to design, utilizing network analysis tools, traffic simulation software and scripts.
We offer training services to our end-customers and channel partners through our training departmentteam and authorized training partners. We have also implemented a training certification program, Network Security Expert, to help ensure an understanding of our products and services. Since 2020, Fortinet also offers a number of free online training courses to help address prevalent industry-wide cybersecurity skills gaps and shortages.
We primarily sell our products and services through a two-tier distribution model. We sell to distributors that sell to networking security and enterprise-focused resellers and to service providers and managed security service providers (“MSSPs”),MSSPs, who, in turn, sell products and/or services to our end-customers. In certain cases, we sell directly to large service providers and major systems integrators. We work with many technology distributors, including Arrow Electronics, Inc., Exclusive, Ingram Micro and TD Synnex Corporation,(formerly Tech Data Corporation and Arrow Electronics, Inc.Synnex Corporation, separately).
We outsource the manufacturing of our security appliance products to a variety of contract manufacturers and original design manufacturers. Our current manufacturing partners include ADLINK Technology, Inc. (“ADLINK”), IBASE Technology, Inc. (“IBASE”), Micro-Star International Co. (“Micro-Star”), Senao Networks, Inc. (“Senao”), Wistron Corporation (“Wistron”) and a number of other manufacturers. The majorityApproximately 88% of our hardware is manufactured in Taiwan. We submit purchase orders to our contract manufacturers that describe the type and quantities of our products to be manufactured, the delivery date and other delivery terms. Once our products are manufactured, they are sent to either our warehouse in California or to our logistics partner in Taoyuan City, Taiwan, where accessory packaging and quality-control testing are performed. We believe that outsourcing our manufacturing and a substantial portion of our logistics enables us to focus resources on our core competencies. Our proprietary SPUs,ASICs, which are key to the performance of our appliances, are built by contract manufacturers including Toshiba America Electronic Components, Inc. (“Toshiba”Toshiba America”) and Renesas Electronics America, Inc. (“Renesas”). These contract manufacturers use foundries in Taiwan and Japan operated by either Taiwan Semiconductor Manufacturing Company Limited (“TSMC”) or by the contract manufacturer itself.
The components included in our products are sourced from various suppliers by us or, more frequently, by our contract manufacturers. Some of the components important to our business, including certain CPUs from Intel Corporation (“Intel”); and Advanced Micro Devices, Inc. (“AMD”), network and wireless chips from Broadcom Inc. (“Broadcom”), Marvell Technology
Group Ltd. (“Marvell”), Qualcomm Incorporated (“Qualcomm”) and Intel and memory devices from Intel, Micron Technology (“Micron”), ADATA Technology Co., Ltd. (“ADATA”), OCZ Technology Group, Inc.Toshiba Corporation (“Toshiba”), Samsung Electronics Co., Ltd. (“Samsung”), and Western Digital Technologies, Inc. (“Western Digital”), are available from limited or sole sources of supply.
We have no long-term contracts related to the manufacturing of our ASICs or other components that guarantee any capacity or pricing terms.
We focus our research and development efforts on developing new hardware and software products and services, and adding new features to existing products and services. Our development strategy is to identify features, products and systems for both software and hardware that are, or are expected to be, important to our end-customers. Our success in designing, developing, manufacturing and selling new or enhanced products will depend on a variety of factors, including identification of market demand for new products productor new features, components selection, timely implementation of product design and development, product performance, quality, ease of use, costs of development, billsbill of materials, effective manufacturing and assembly processes and sales and marketing.
Despite our efforts to protect our rights in our technology, unauthorized parties may attempt to copy aspects of our products or obtain and use information and technology that we regard as proprietary. We generally enter into confidentiality agreements with our employees, consultants, vendors and customers, and generally limit access to and distribution of our proprietary information. However, we cannot provide assurance that the steps we take will prevent misappropriation of our technology. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as the laws of the United States, and many foreign countries do not enforce these laws as diligently as government agencies and private parties in the United States.
Our industry is characterized by the existence of a large number of patents and frequent claims and related litigation regarding patent and other intellectual propertyIP rights. Third parties have asserted, are currently asserting and may in the future assert patent, copyright, trademark or other intellectual propertyIP rights against us, our channel partners or our end-customers. Successful claims of infringement by a third partythird-party could prevent us from distributing certain products or performing certain services or require us to pay substantial damages (including treble damages if we are found to have willfully infringed patents or copyrights), royalties or other fees. Even if third parties offer a license to their technology, the terms of any offered license may not be acceptable and the failure to obtain a license or the costs associated with any license could cause our business, operating results or financial condition to be materially and adversely affected. In certain instances, we indemnify our end-customers, distributors and resellers against claims that our products infringe the intellectual propertyIP of third parties.
For information regarding seasonality in our sales, see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Quarterly Results of Operations—Seasonality, Cyclicality and Quarterly Revenue Trends” in Part II, Item 7 of this Annual Report on Form 10-K.
The markets for our products are extremely competitive and are characterized by rapid technological change. The principal competitive factors in our markets include the following:include:
None of our U.S. employees are represented by a labor union; however, ourunion. Our employees in certain European and Latin American countries, however, have the right to be represented by external labor organizations if they maintain up-to-date union membership. We have not experienced any work stoppages, and we consider our relations with our employees to be good.
Our web site is located at https://www.fortinet.com, and our investor relations web site is located at https://investor.fortinet.com. The information posted on our website is not incorporated by reference into this Annual Report on Form 10-K. Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to reports filed or furnished pursuant to Sections 13(a) and 15(d) of the Securities Act of 1933, as amended (the “Securities Act”), are available free of charge on our investor relations web site as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.Securities and Exchange Commission (the “SEC”). You may also access all of our public filings through the SEC’s website at https://www.sec.gov.
We webcast our earnings calls and certain events we participate in or host with members of the investment community on our investor relations web site.website. Additionally, we provide notifications of news or announcements regarding our financial performance, including SEC filings, investor events and press and earnings releases, as part of our investor relations web site.website. The contents of these web siteswebsites are not intended to be incorporated by reference into this report or in any other report or document we file.
ITEM 1A. Risk Factors
Investing in our common stock involves a high degree of risk. Investors should carefully consider the following risks and all other information contained in this Annual Report on Form 10-K, including our consolidated financial statements and the related notes, before investing in our common stock. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties that we are unaware of, or that we currently believe are not material, also may become important factors that affect us. If any of the following risks materialize, our business, financial condition and results of operations could be materially harmed. In that case, the trading price of our common stock could decline substantially, and investors may lose some or all of their investment.
Our operating results are likely to vary significantly and be unpredictable.
Our operating results have historically varied from period to period, and we expect that they will continue to do so as a result of a number of factors, many of which are outside of our control or may be difficult to predict, including:
Any one of the factors above or the cumulative effect of some of the factors referred to above may result in significant fluctuations in our quarterly financial and other operating results. This variability and unpredictability could result in our failing to meet our internal operating plan or the expectations of securities analysts or investors for any period. If we fail to meet or exceed such expectations for these or any other reasons, the market price of our shares could fall substantially and we could face costly lawsuits, including securities class action suits. In addition, a significant percentage of our operating expenses are fixed in nature over the near term. Accordingly, in the event of revenue shortfalls, we are generally unable to mitigate the negative impact on margins in the short term.
Our business depends on the overall demand for information technology and on the economic health of our current and prospective customers. In addition, the purchase of our products is often discretionary and may involve a significant commitment of capital and other resources. Weak global and regional economic conditions and spending environments, based on a downturn in the economy, a possible recession and the effects of ongoing or increased inflation or possible stagflation in certain geographies, rising interest rates, geopolitical instability and uncertainty, weak economic conditions in certain regions or a reduction in information technology spending regardless of macro-economicmacroeconomic conditions, the effects of the COVID-19 pandemic and the impact of the war in Ukraine each could have a material adverse impacts on our business, financial condition and results of operations, including longer sales cycles, lower prices for our products and services, increased component costs, higher default rates among our channel partners, reduced unit sales and slower or declining growth.
We may experience slowing growth or a decrease in billings, revenue, operating margin and free cash flow for a number of reasons, including as a result of the COVID-19 pandemic, a slowdown in demand for our products or services, a shift in demand from products to services, decrease in services revenue growth, increased competition, worldwide or regional economic challenges based on inflation or possible stagflation, a regional recession or a recession in the global economy, rising interest rates, the war in Ukraine, a decrease in the growth of our overall market or softness in demand in certain geographies or industry verticals, such as the service provider industry, changes in our strategic opportunities, execution risks and our failure for any reason to continue to capitalize on sales and growth opportunities due to other risks identified in the risk factors described in this periodic report. Our expenses as a percentage of total revenue may be higher than expected if our revenue is lower than expected and, ifexpected. If our investments in sales and marketing and other functional areas do not result in expected billings and revenue growth, we may experience margin declines anddeclines. In addition, we may not be able to sustain profitability in future periods if we fail to increase billings, revenue or deferred revenue, and do not appropriately manage our cost structure, and free cash flow, or encounter unanticipated liabilities. AnyAs a result, any failure by us to maintain profitability maintain ourand margins and continue our billings, revenue and free cash flow growth could cause the price of our common stock to materially decline.
Our FortiGuard security subscription and FortiCare technical support services revenue has historically accounted for a significant percentage of our total revenue. Revenue from the sale of new, or from the renewal of existing, FortiGuard security subscription and FortiCare technical support service contracts may decline and fluctuate as a result of a number of factors, including fluctuations in purchases of FortiGate appliances or our Fortinet Security Fabric platform products, changes in the sales mix between products and services, end-customers’ level of satisfaction with our products and services, the prices of our products and services, the prices of products and services offered by our competitors, reductions in our customers’ spending levels and the timing of revenue recognition with respect to these arrangements. If our sales of new, or renewals of existing, FortiGuard security subscription and FortiCare technical support service contracts decline, our revenue and revenue growth may decline and our business could suffer. In addition, in the event significant customers require payment terms for FortiGuard security subscription and FortiCare technical support services in arrears or for shorter periods of time than annually, such as monthly or quarterly, this may negatively impact our billings and revenue. Furthermore, we recognize FortiGuard security subscription and FortiCare technical support services revenue monthly over the term of the relevant service period, which is typically from one to five years. As a result, much of the FortiGuard security subscription and FortiCare technical support services revenue we report each quarter is the recognition of deferred revenue from FortiGuard security subscription and FortiCare technical support services contracts entered into during previous quarters or years. Consequently, a decline in new or renewed FortiGuard security subscription and FortiCare technical support services contracts in any one quarter will not be fully reflected in revenue in that quarter but will negatively affect our revenue in future quarters. Accordingly, the effect of significant downturns in sales of new, or renewals of existing, FortiGuard security subscription and FortiCare technical support services is not reflected in full in our statements of income until future periods. Our FortiGuard security subscription and FortiCare technical support services revenue also makes it difficult for us to rapidly increase our revenue through additional service sales in any period, as revenue from new and renewal support services contracts must be recognized over the applicable service period.
We generate a majority of revenue from sales to distributors, resellers and end-customers outside of the United States, and we are therefore subject to a number of risks associated with international sales and operations.
We market and sell our products throughout the world and have established sales offices in many parts of the world. Our international sales have represented a majority of our total revenue in recent periods. Therefore, we are subject to risks associated with having worldwide operations. We are also subject to a number of risks typically associated with international sales and operations, including:
economic or political instability in foreign markets;
greater difficulty in enforcing contracts and accounts receivable collection, including longer collection periods;
longer sales processes for larger deals, particularly during the summer months;
changes in regulatory requirements;
difficulties and costs of staffing and managing foreign operations;
the uncertainty of protection for intellectual property rights in some countries;
costs of compliance with foreign policies, laws and regulations and the risks and costs of non-compliance with such policies, laws and regulations;
any disruption in manufacturing or shipping or decreases in demand by channel partners or end-customers, including any such disruption or decreases caused by factors outside of our control such as natural disasters and health emergencies, including earthquakes, fires, power outages, typhoons, floods, pandemics or epidemics such as the coronavirus and manmade events such as civil unrest, labor disruption, international trade disputes, international conflicts, terrorism, wars and critical infrastructure attacks;
protectionist policies and penalties, and local laws, requirements, policies and perceptions that may adversely impact a U.S.-headquartered business’s sales in certain countries outside of the United States;
costs of complying with, and the risks, reputational damage and other costs of non-compliance with, U.S. or other foreign laws and regulations for foreign operations, including the U.S. Foreign Corrupt Practices Act, the United Kingdom Bribery Act 2010, the General Data Protection Regulation (the “GDPR”), import and export control laws, trade laws and regulations, tariffs and retaliatory measures, trade barriers and economic sanctions;
other regulatory or contractual limitations on our ability to sell our products in certain foreign markets, and the risks and costs of non-compliance;
heightened risks of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales or sales-related arrangements, such as sales “side agreements” to allow return rights, that could disrupt the sales team through terminations of employment or otherwise, and may adversely impact financial results as compared to those already reported or forecasted and result in restatements of financial statements and irregularities in financial statements;
our ability to effectively implement and maintain adequate internal controls to properly manage our international sales and operations;
political unrest, changes and uncertainty associated with terrorism, hostilities, war or natural disasters;
changes in foreign currency exchange rates;
management communication and integration problems resulting from cultural differences and geographic dispersion; and
changes in tax, tariff, employment and other laws.
Product and service sales and employee and contractor matters may be subject to foreign governmental regulations, which vary substantially from country to country. Further, we may be unable to keep up to date with changes in government requirements as they change over time. Failure to comply with these regulations could result in adverse effects to our business. In many foreign countries, it is common for others to engage in business practices that are prohibited by our internal policies and procedures or U.S. regulations applicable to us. Although we implemented policies and procedures designed to ensure compliance with these laws and policies, there can be no assurance that all of our employees, contractors, channel partners and agents will comply with these laws and policies. Violations of laws or key control policies by our employees, contractors, channel partners or agents could result in litigation, regulatory action, costs of investigation, delays in revenue recognition, delays in financial reporting, financial reporting misstatements, fines, penalties or the prohibition of the importation or exportation of our products and services, any of which could have a material adverse effect on our business and results of operations.
We may undertake corporate operating restructurings or transfers of assets that involve our group of foreign country subsidiaries through which we do business abroad, in order to maximize the operational and tax efficiency of our group structure. If ineffectual, such restructurings or transfers could increase our income tax liabilities, and in turn, increase our global effective tax rate. Moreover, our existing corporate structure and intercompany arrangements have been implemented in a
manner that we believe is in compliance with current prevailing tax laws. However, the tax authorities of the jurisdictions in which we operate may challenge our methodologies for valuing developed technology or intercompany arrangements, which could impact our worldwide effective tax rate and harm our financial position and operating results.
If we are not successful in continuing to execute our strategy to increase our sales to large and medium-sized end-customers, our results of operations may suffer.
An important part of our growth strategy is to increase sales of our products to large and medium-sized businesses, service providers and government organizations. While we have increased sales in recent periods to large and medium-sized businesses, our sales volume varies by quarter and there is risk as to our level of success selling to these target customers. Such sales involve unique sales skillsets, processes and structures, are often more complex and feature a longer contract term and may be at higher discount levels. We also have experienced uneven traction selling to certain government organizations and service providers and managed security service providers (“MSSPs”), and there can be no assurance that we will be successful selling to these customers. Sales to these organizations involve risks that may not be present, or that are present to a lesser extent, with sales to smaller entities. These risks include:
increased competition from competitors that traditionally target large and medium-sized businesses, service providers and government organizations and that may already have purchase commitments from those end-customers;
increased purchasing power and leverage held by large end-customers in negotiating contractual arrangements;
unanticipated changes in the capital resources or purchasing behavior of large end-customers, including changes in the volume and frequency of their purchases and changes in the mix of products and services, willingness to change to cloud delivery model and related payment terms;
more stringent support requirements in our support service contracts, including stricter support response times, more complex requirements and increased penalties for any failure to meet support requirements;
longer sales cycles and the associated risk that substantial time and resources may be spent on a potential end-customer that elects not to purchase our products and services;
uncertainty as to timing to close large deals and any delays in closing those deals; and
longer ramp-up periods for enterprise sales personnel as compared to other sales personnel.
Large and medium-sized businesses, service providers and MSSPs and government organizations often undertake a significant evaluation process that results in a lengthy sales cycle, in some cases longer than 12 months. Although we have a channel sales model, our sales representatives typically engage in direct interaction with end-customers, along with our distributors and resellers, in connection with sales to large and medium-sized end-customers. We may spend substantial time, effort and money in our sales efforts without being successful in producing any sales. In addition, purchases by large and medium-sized businesses, service providers and government organizations are frequently subject to budget constraints, multiple approvals and unplanned administrative, processing and other delays. Furthermore, service providers and MSSPs represent our largest industry vertical and consolidation or continued changes in buying behavior by larger customers within this industry could negatively impact our business. Large and medium-sized businesses, service providers and MSSPs and government organizations typically have longer implementation cycles, require greater product functionality and scalability, expect a broader range of services, including design, implementation and post go-live services, demand that vendors take on a larger share of risks, require acceptance provisions that can lead to a delay in revenue recognition and expect greater payment flexibility from vendors. In addition, large and medium-sized businesses, service providers and government organizations may require that our products and services be sold differently from how we offer our products and services, which could negatively impact our operating results. Our large business and service provider customers may also become more deliberate in their purchases as they plan their next-generation network security architecture, leading them to take more time in making purchasing decisions or to purchase based only on their immediate needs. All these factors can add further risk to business conducted with these customers. In addition, if sales expected from a large and medium-sized end-customer for a particular quarter are not realized in that quarter or at all, our business, operating results and financial condition could be materially and adversely affected.
Managing inventory of our products and product components is complex. Insufficient inventory or components may result in lost sales opportunities or delayed revenue, while excess inventory may harm our gross margins.
Managing our inventory is complex. Our channel partners may increase orders during periods of product shortages, cancel orders or not place orders commensurate with our expectations if their inventory is too high, return products or take advantage of price protection (if any is available to the particular partner) or delay orders in anticipation of new products, and accurately forecasting inventory requirements and demand can be challenging. Our channel partners also may adjust their orders in response to the supply of our products and the products of our competitors that are available to them and in response to seasonal fluctuations in end-customer demand. Furthermore, if the time required to manufacture or ship certain products increases for any reason, inventory shortfalls could result. If we cannot manufacture and ship our products due to, for example, natural disasters and health emergencies such as earthquakes, fires, power outages, typhoons, floods, pandemics and epidemics such as the coronavirus or manmade events such as civil unrest, labor disruption, international trade disputes, international conflicts, terrorism, wars and critical infrastructure attacks, our business and financial results could be materially and adversely impacted. Management of our inventory is further complicated by the significant number of different products and models that we sell which may impact our billings, revenue, margins and free cash flow. Mismanagement of our inventory, whether due to imprecise forecasting, employee errors or malfeasance, inaccurate information or otherwise, may adversely affect our results of operations.
Inventory management remains an area of focus as we balance the need to maintain inventory levels that are sufficient to ensure competitive lead times against the risk of inventory obsolescence because of rapidly changing technology, product transitions, customer requirements or excess inventory levels. If we ultimately determine that we have excess inventory, we may have to reduce our prices and write-down inventory, which in turn could result in lower gross margins. Alternatively, insufficient inventory levels may lead to shortages that result in delayed billings and revenue or loss of sales opportunities altogether as potential end-customers turn to competitors’ products that are readily available. For example, we have in the past experienced inventory shortages and excesses due to the variance in demand for certain products from forecasted amounts. In addition, for those channel partners that have rights of return, inventory held by such channel partners affects our results of operations. Our inventory management systems and related supply chain visibility tools may be inadequate to enable us to effectively manage inventory. If we are unable to effectively manage our inventory and that of our channel partners, our results of operations could be adversely affected.
Widespread health problems, such as the outbreak and spread of the coronavirus, could adversely affect our business in a material way.
While the majority of our products are manufactured outside of China, certain components for our products and certain of our products are manufactured in China and Taiwan. In addition, certain of our logistics and shipping operations are in Taiwan. We also have other operations in Asia. Pandemics and epidemics such as the current coronavirus outbreak or other widespread public health problems could negatively impact our business. If, for example, the coronavirus progresses in ways that disrupt the manufacture or shipment of our products or otherwise disrupt our operations, this may materially negatively impact our operating results for the first quarter of 2020 and subsequent periods, including billings, revenue, gross margins, operating margins, cash flows and other operating results and our overall business. If the coronavirus spreads in ways that continue to negatively impact the overall economy and buying patterns of partners or potential customers, this would negatively impact, and may materially negatively impact, our sales, operating results and business. If the spread of the coronavirus limits the manufacturing of our products, either by limiting components available or by limiting the actual manufacture and assembly, this likely would result in increased product backlog, lower billings, lower revenue and decreased profitability and would negatively impact, and may materially negatively impact, our operating results and business. In addition, the coronavirus has caused an increase in our expenses, including increased cancellation charges and reduced attendance fees due to the cancellation of our Accelerate Barcelona sales conference, and it may result in increased component and product manufacturing costs. These increases in expenses will likely negatively impact, and may materially negatively impact, our operating results for the first quarter 2020 and in subsequent periods. As a result of the foregoing, the coronavirus will likely negatively impact our operating results and may do so in a material way.
We are dependent on the continued services and performance of our senior management, the loss of any of whom could adversely affect our business, operating results and financial condition.
Our future performance depends on the continued services and continuing contributions of our senior management to execute on our business plan and to identify and pursue new opportunities and product innovations. The loss of services of members of senior management, particularly Ken Xie, our Co-Founder, Chief Executive Officer and Chairman, or Michael Xie, our Co-Founder, President and Chief Technology Officer, or of any of our senior sales leaders or functional area leaders, could significantly delay or prevent the achievement of our development and strategic objectives. The loss of the services or the
distraction of our senior management for any reason, including the COVID-19 pandemic, could adversely affect our business, financial condition and results of operations.
If we are unable to hire, retain and motivate qualified personnel, our business will suffer.
Our future success depends, in part, on our ability to continue to attract and retain highly skilled personnel. The loss of the services of any of our key personnel, the inability to attract or retain qualified personnel, any failure to have in place and execute an effective succession plan for key executives or delays in hiring required personnel, particularly in engineering, sales and marketing, may seriously harm our business, financial condition and results of operations. From time to time, we experience turnover in our management-level personnel. None of our key employees has an employment agreement for a specific term, and any of our employees may terminate their employment at any time. Our ability to continue to attract and retain highly skilled personnel will be critical to our future success.
Competition for highly skilled personnel is frequently intense, especially for qualified sales, support and engineering employees in network security and especially in the locations where we have a substantial presence and need for highly skilled personnel, such as the San Francisco Bay Area and Vancouver, Canada. We may not be successful in attracting, assimilating or retaining qualified personnel to fulfill our current or future needs. Also, to the extent we hire personnel from competitors, we may be subject to allegations that they have been improperly solicited or divulged proprietary or other confidential information. Changes in immigration laws, including changes to the rules regarding H1-B visas, may also harm our ability to attract personnel from other countries. Our inability to hire properly qualified and effective sales, support and engineering employees could harm our growth and our ability to effectively support growth.
If we do not increase the effectiveness of our sales organization, we may have difficulty adding new end-customers or increasing sales to our existing end-customers and our business may be adversely affected.
Although we have a channel sales model, sales in our industry are complex and members of our sales organization often engage in direct interaction with our prospective end-customers, particularly for larger deals involving larger end-customers. Therefore, we continue to be substantially dependent on our sales organization to obtain new end-customers and sell additional products and services to our existing end-customers. There is significant competition for sales personnel with the skills and technical knowledge that we require, including experienced enterprise sales employees and others. Our ability to grow our revenue depends, in large part, on our success in recruiting, training and retaining sufficient numbers of sales personnel to support our growth and on the effectiveness of those personnel in selling successfully in different contexts, each of which has its own different complexities, approaches and competitive landscapes, such as managing and growing the channel business for sales to small businesses and more actively selling to the end-customer for sales to larger organizations. New hires require substantial training and may take significant time before they achieve full productivity. Our recent hires and planned hires may not become productive as quickly as we expect, and we may be unable to hire or retain sufficient numbers of qualified individuals in the markets where we do business or plan to do business. Furthermore, hiring sales personnel in new countries requires additional setup and upfront costs that we may not recover if the sales personnel fail to achieve full productivity. If our sales employees do not become fully productive on the timelines that we have projected, our revenue will not increase at anticipated levels and our ability to achieve long-term projections may be negatively impacted. If we are unable to hire and train sufficient numbers of effective sales personnel, or the sales personnel are not successful in obtaining new end-customers or increasing sales to our existing customer base, our business, operating results and prospects will be adversely affected. If we do not hire properly qualified and effective sales employees and organize our sales team effectively to capture the opportunities in the various customer segments we are targeting, our growth and ability to effectively support growth would be harmed.
The sales prices of our products and services may decrease, which may reduce our gross profits and operating margin, and which may adversely impact our financial results and the trading price of our common stock.
The sales prices for our products and services may decline for a variety of reasons or our product mix may change, resulting in lower growth and margins based on a number of factors, including competitive pricing pressures, discounts or promotional programs we offer, a change in our mix of products and services and anticipation of the introduction of new products and services. Competition continues to increase in the market segments in which we participate, and we expect competition to further increase in the future, thereby leading to increased pricing pressures. Larger competitors with more diverse product offerings may reduce the price of products and services that compete with ours in order to promote the sale of other products or services or may bundle them with other products or services. Additionally, although we price our products and services worldwide in U.S. dollars, currency fluctuations in certain countries and regions have in the past, and may in the future, negatively impact actual prices that partners and customers are willing to pay in those countries and regions. Furthermore, we anticipate that the sales prices and gross profits for our products or services will decrease over product life
cycles. We cannot ensure that we will be successful in developing and introducing new offerings with enhanced functionality on a timely basis, or that our product and service offerings, if introduced, will enable us to maintain our prices, gross profits and operating margin at levels that will allow us to maintain profitability.
If our internal enterprise IT networks, on which we conduct internal business and interface externally, our operational networks, through which we connect to customer systems and provide services, or our research and development networks, our back-end labs and cloud stacks through which we research and develop products and services, are compromised, public perception of our products and services may be harmed, our customers may be breached and harmed, we may become subject to liability, and our business, operating results and stock price may be adversely impacted.
Our success depends on the market’s confidence in our ability to provide effective network security protection. Despite our efforts and processes to prevent breaches of our internal network system and website, we are still vulnerable to computer viruses, break-ins, phishing attacks, attempts to overload our servers with denial-of-service and other cyber-attacks and similar disruptions from unauthorized access to our internal network system or our website. Our security measures may also be breached due to employee error, malfeasance or otherwise, which breaches may be more difficult to detect than outsider threats, and the existing programs and trainings we have in place to prevent such insider threats may not be effective or sufficient. Third parties may also attempt to fraudulently induce our employees to transfer funds or disclose information in order to gain access to our network and confidential information. Third parties may also send our customers or others malware or malicious emails that falsely indicate that we are the source, potentially causing lost confidence in us and reputational harm. We cannot guarantee that the measures we have taken to protect our network and website will provide adequate security. Moreover, because we provide network security products, we may be a more attractive target for attacks by computer hackers and any security breaches and other security incidents involving us may result in more harm to our reputation and brand than companies that do not sell network security solutions. Hackers and malicious parties may be able to develop and deploy viruses, worms, ransomware and other malicious software programs that attack our products and customers, that impersonate our update servers in an effort to access customer networks and negatively impact customers, or otherwise exploit any security vulnerabilities of our products, or attempt to fraudulently induce our employees, customers or others to disclose passwords or other sensitive information or unwittingly provide access to our internal network system or data. For example, as we previously announced, in the second quarter of 2019 we discovered that an unauthorized party targeted us using sophisticated techniques, such as efforts to impersonate our firewall update servers, in order to try to gain access to certain of our customers’ systems. Although, based on our investigation of this incident, we do not believe that it had a material impact on our or our customers’ businesses, and in general we take numerous measures and implement multiple layers of security to protect our network and our customers’ networks, and, in this particular case, we took immediate additional action to protect our customers, we cannot guarantee that our security products and services will prevent all threats. Further, we cannot be sure that third parties have not been, or will not in the future be, successful in improperly accessing our system and our customers’ systems, which could negatively impact us and our customers. An actual or perceived breach, or any other actual or perceived data security incident, that involves our network, systems or website and/or our customers’ network, systems or websites, including the specific matter that is discussed above, could adversely affect the market perception of our products and services and investor confidence in our company. Any breach of our network system or website could impair our ability to operate our business, including our ability to provide FortiGuard security subscription and FortiCare technical support services to our end-customers, lead to interruptions or system slowdowns, cause loss of critical data or lead to the unauthorized disclosure or use of confidential, proprietary or sensitive information. We could also be subject to liability and litigation and reputational harm and our channel partners and end-customers may be harmed, lose confidence in us and decrease or cease using our products and services. Any breach of our internal network system or our website could have an adverse effect on our business, operating results and stock price.
Reliance on a concentration of shipments at the end of the quarter could cause our billings and revenue to fall below expected levels.
As a result of customer-buying patterns and the efforts of our sales force and channel partners to meet or exceed quarterly quotas, we have historically received a substantial portion of each quarter’s sales orders and generated a substantial portion of each quarter’s billings and revenue during the last two weeks of the quarter. We implemented a cloud-based quoting tool to help provide our sales team with the ability to have faster quote generation, reduce quote errors and increase sales productivity. Our ability to integrate the data from this tool into our order processing may cause order processing delays that could have an effect on our financial results.Our billings and revenue for any quarter could fall below our expectations or those of securities analysts and investors, resulting in a decline in our stock price, if expected orders at the end of any quarter are delayed for any reason or our ability to fulfill orders at the end of any quarter is hindered for any reason, including, among others:
the failure of anticipated purchase orders to materialize;
our logistics partners’ inability to ship products prior to quarter-end to fulfill purchase orders received near the end of the quarter;
disruption in manufacturing or shipping based on natural disasters or widespread public health problems including pandemics and epidemics such as the coronavirus outbreak;
our failure to accurately forecast our inventory requirements and to appropriately manage inventory to meet demand;
our inability to release new products on schedule;
any failure of our systems related to order review and processing; and
any delays in shipments due to trade compliance requirements, labor disputes or logistics changes at shipping ports, airline strikes, severe weather or otherwise.
Unless we continue to develop better market awareness of our company and our products, and to improve lead generation and sales enablement, our revenue may not continue to grow.
Increased market awareness of our capabilities and products and increased lead generation are essential to our continued growth and our success in all of our markets, particularly for the large businesses, service provider and government organization market. We have historically had relatively low spending on marketing activities. While we have increased our investments in sales and marketing, it is not clear that these investments will continue to result in increased revenue. If our investments in additional sales personnel or our marketing programs are not successful in continuing to create market awareness of our company and products or increasing lead generation, or if we experience turnover and disruption in our sales and marketing teams, we will not be able to achieve sustained growth, and our business, financial condition and results of operations will be adversely affected.
We rely on third-party channel partners for substantially all of our revenue. If our partners fail to perform, our ability to sell our products and services will be limited, and if we fail to optimize our channel partner model going forward, our operating results may be harmed. Additionally, a small number of distributors represents a large percentage of our revenue and gross accounts receivable, and one distributor accounted for 36%32% of our total net accounts receivable as of December 31, 2019.2022.
A significant portion of our sales is generated through a limited number of distributors, and substantially all of our revenue is from sales by our channel partners, including distributors and resellers. We depend on our channel partners to generate a significant portion of our sales opportunities and to manage our sales process. To the extent our channel partners are unsuccessful in selling our products, or if we are unable to enter into arrangements with and retain a sufficient number of high-quality channel partners in each of the regions in which we sell products, we are unable to keep them motivated to sell our products, or our channel partners shift focus to other vendors and/or our competitors, our ability to sell our products and operating results may be harmed. The termination of our relationship with any significant channel partner may adversely impact our sales and operating results.
We provide sales channel partners with specific programs to assist them with selling our products and incentivize them to sell our products, but there can be no assurance that these programs will be effective. In addition, our channel partners may be unsuccessful in marketing, selling and supporting our products and services and may purchase more inventory than they can sell. Our channel partners generally do not have minimum purchase requirements. Some of our channel partners may have insufficient financial resources to withstand changes and challenges in business conditions. Moreover, many of our channel partners are privately held, including our largest distributor Exclusive Networks, and we may not have sufficient information to assess their financial condition. If our channel partners’ financial condition or operations weaken, their ability to sell our product and services could be negatively impacted. Our channel partners may also market, sell and support products and services that are competitive with ours, and may devote more resources to the marketing, sales and support of such products, or may decide to cease selling our products and services altogether in favor of a competitor’s products and services. They may also have incentives to promote our competitors’ products to the detriment of our own, or they may cease selling our products altogether. We cannot ensure that we will retain these channel partners or that we will be able to secure additional or replacement partners or that existing channel partners will continue to perform. The loss of one or more of our significant channel partners or the failure to obtain and ship a number of large orders each quarter through them could harm our operating results.
In addition, a small number of channel partners represents a large percentage of our revenue and gross accounts receivable. We are exposed to the credit and liquidity risk of some of our channel partners and to credit exposure in weakened markets, which could result in material losses. Our dependence on a limited number of key channel partners means that our billings, revenue and operating results may be harmed by the inability of these key channel partners to successfully sell our products and services, or if any of these key channel partners is unable or unwilling to pay us, terminates its relationship with us or goes out of business. Although we have programs in place that are designed to monitor and mitigate credit and liquidity risks, we cannot guarantee these programs will be effective in reducing our credit risks. If we are unable to adequately control these risks, our business, operating results, and financial condition could be harmed. If channel partners fail to pay us under the terms of our agreements or we are otherwise unable to collect on our accounts receivable from these channel partners, we may be adversely affected both from the inability to collect amounts due and the cost of enforcing the terms of our contracts, including litigation. Our channel partners may seek bankruptcy protection or other similar relief and fail to pay amounts due to us, or pay those amounts more slowly, either of which could adversely affect our operating results, financial position, and cash flow. We may be further impacted by consolidation of our existing channel partners. In such instances, we may experience changes to our overall business and operational relationships due to dealing with a larger combined entity, and our ability to maintain such relationships on favorable contractual terms may be more limited. We may also become increasingly dependent on a more limited number of channel partners, as consolidation increases the relative proportion of our business for which each channel partner is responsible, which may magnify the risks described in the preceding paragraphs.
For example, in July 2017, Exclusive, which distributes our solutions to a large group of resellers and end-customers, acquired Fine Tec U.S. Since the acquisition of Fine Tec U.S., Exclusive’s business with us has increased and may continue to increase in the future.
ExclusiveSix distributor customers accounted for 36%69% and 38%68% of our total net accounts receivable in the aggregate as of December 31, 20192022 and December 31, 2018,2021, respectively. During 2017, 2018 and 2019, ExclusiveSee Note 16. Segment Information in Part II, Item 8 of this Annual Report on Form 10-K for distributor customers that accounted for 25%, 30% and 31%10% or more of our total revenue respectively. In addition to other risks associated with the concentration ofor net accounts receivable and revenue from thesereceivable. Our largest distributors Exclusive is a private entity and we may not have sufficient information to assess its financial condition and, accordingly, if Exclusive were to experience financial difficulties, we might not have advance notice. Additionally, Exclusive may face liquidity risk as a private equity-backed company,or other financial challenges, which may harm our ability to collect on our accounts receivable.
We provide sales channel partners with specific programs to assist them with selling our products and incentivize them to sell our products, but there can be no assurance that these programs will be effective. In addition, anyour channel partners may be unsuccessful in marketing, selling and supporting our products and services and may purchase more inventory than they can sell. Our channel partners generally do not have minimum purchase requirements. Some of our channel partners may have insufficient financial resources to withstand changes and challenges in business conditions. Moreover, many of our channel partners are privately held, including our largest distributor, and we may not have sufficient information to assess their financial condition. If our channel partners’ financial condition or operations weaken, their ability to sell our product and services could be negatively impacted. Our channel partners may also market, sell and support products and services that are competitive with ours, and may devote more resources to the marketing, sales and support of such products, or may decide to cease selling our products and services altogether in favor of a competitor’s products and services. They may also have incentives to promote our
competitors’ products to the detriment of our own, or they may cease selling our products altogether. We cannot ensure that we will retain these channel partners or that we will be able to secure additional or replacement partners or that existing channel partners will continue to perform. The loss of one or more of our significant channel partners or the failure to obtain and ship a number of large orders each quarter through them could harm our operating results.
Any new sales channel partner will require extensive training and may take several months or more to achieve productivity. Our channel partner sales structure could subject us to lawsuits, potential liability and reputational harm if, for example, any of our channel partners misrepresent the functionality of our products or services to end-customers, our service provider customers suffer a cyber event impacting end-users, or our channel partners violate laws or our corporate policies. We depend on our global channel partners to comply with applicable legal and regulatory requirements. To the extent that they fail to do so, that could have a material adverse effect on our business, operating results and financial condition. If we fail to optimize our channel partner model or fail to manage existing sales channels, our business will be seriously harmed.
Actual, possibleReliance on a concentration of shipments at the end of the quarter could cause our billings and revenue to fall below expected levels or perceived defects or vulnerabilitiesdelay collections and the related increase in our products or services,free cash flow.
As a result of customer buying patterns and the failureefforts of our products or services to detect or prevent a security breach or the misuse of our products could harm our reputationsales force and divert resources.
Because our products and services are complex, they have contained and may contain defects or errors that are not detected until after their commercial release and deployment by our customers. Defects or vulnerabilities may impede or block network traffic, cause our products or services to be vulnerable to electronic break-ins, cause them to fail to help secure our customers or cause our products or services to allow unauthorized access to our customers’ networks. We are also susceptible to errors, defects, vulnerabilities or attacks that may arise at, or be inserted into our products in, different stages in our supply chain, or manufacturing processes, and which are out of our control. Attacks may target specific unidentified or unresolved vulnerabilities that exist or arrive only in the supply chain, making these attacks virtually impossible to anticipate and difficult to defend against. Different customers deploy and use our products in different ways, and certain deployments and usages may subject our products to adverse conditions that may negatively impact the effectiveness and useful lifetime of our products. Our networks and products, including cloud-based technology, could be targeted by attacks specifically designed to disrupt our business and harm our reputation. We cannot ensure that our products will prevent all security threats. Because the techniques used by computer hackers to access or sabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques. In addition, defects or errors in our FortiGuard security subscription or FortiCare updates or our FortiGate appliances and operating systems could result in a failure of our FortiGuard security subscription services to effectively update end-customers’ FortiGate appliances and cloud-based products and thereby leave customers vulnerable to attacks. Furthermore, our solutions may also fail to detect or prevent viruses, worms or similar threats due to a number of reasons such as the evolving nature of such threats and the continual emergence of new threats that we may fail to add to our FortiGuard databases in time to protect our end-customers’ networks. Our FortiGuard or FortiCare data centers and networks may also experience technical failures and downtime, and may fail to distribute appropriate updates,
or failchannel partners to meet or exceed quarterly quotas, we have historically received a substantial portion of each quarter’s sales orders and generated a substantial portion of each quarter’s billings and revenue during the increased requirements of our customer base. Any such technical failure, downtime or failures in general may temporarily or permanently expose our end-customers’ networks, leaving their networks unprotected against the latest security threats.
An actual, possible or perceived security breach or infectionlast two weeks of the network of one of our end-customers, regardless of whetherquarter. We typically arrange for a logistics partner to pick up the breach is attributable to the failure of our products or services to prevent the security breach, could adversely affect the market’s perception of our security products and services and, in some instances, subject us to potential liability that is not contractually limited. We may not be able to correct any security flaws or vulnerabilities promptly, or at all. Our products may also be misused by end-customers or third parties who obtain access to our products. For example, our products could be used to censor private access to certain information on the internet. Such use of our products for censorship could result in negative press coverage and negatively affect our reputation, even if we take reasonable measures to prevent any improperlast shipment of our products a few hours prior to the end of the quarter, and a delay in the arrival of the logistics partner or if ourother factors such as a power outage could prevent us from shipping and billing for a material amount of products are provided by an unauthorized third party. Any actual,for which we have orders. Further, it is possible or perceived defects, errors or vulnerabilities in ourthat the dollar value of these products or misuseintended to be shipped late on the last day of our products, could result in:
the expenditure of significant financial and product development resources in efforts to analyze, correct, eliminate or work around errors or defects or to address and eliminate vulnerabilities;
the loss of existing or potential end-customers or channel partners;
delayed or lost revenue;
delay or failure to attain market acceptance;
negative publicity and harm to our reputation; and
litigation, regulatory inquiries or investigations thatquarter may be costly and harmmaterial. Additionally, our reputation and, in some instances, subject us to potential liability that is not contractually limited.
If we do not appropriately manage any future growth, including throughservice billings are dependent on the expansioncompletion of our real estate facilities, or are unable to improve our systems, processes and controls, our operating results will be negatively affected.
We rely heavily on information technology to help manage critical functions such as order configuration, pricing and quoting, revenue recognition, financial forecasts, inventory and supply chain management and trade compliance reviews. In addition, we have been slow to adopt and implement certain automated functions, which could have a negative impact on our business. For example, a large part of our order processing relies on manual data entryof customer purchase orders received through email and, to a lesser extent, through electronic data interchange from our customers. Due to the use of manual processes and the fact that we may receive a large amount of our orders in the last few weeks of any given quarter, an interruption in our email service or other systems could result in delayed order fulfillment and decreased billings and revenue for that quarter.
To manage any future growth effectively, we must continue to improve and expand our information technology and financial, operating, security and administrative systems and controls, and our business continuity and disaster recovery plans and processes. We must also continue to manage headcount, capital and processes in an efficient manner. We may not be able to successfully implement requisite improvements to these systems, controls and processes, such as system capacity, access, security and change management controls, in a timely or efficient manner. Our failure to improve our systems and processes, or their failure to operate in the intended manner, whether as a result of the significant growth of our business or otherwise, may result in our inability to manage the growth of our business and to accurately forecast our revenue, expenses and earnings, or to prevent certain losses. Moreover, the failure of our systems and processes could undermine our ability to provide accurate, timely and reliable reports on our financial and operating results and could impact the effectiveness of our internal control over financial reporting.
In addition, our systems, processes and controls may not prevent or detect all errors, omissions, malfeasance or fraud, such as corruption and improper “side agreements” that may impact revenue recognition or result in financial liability. Our productivity and the quality of our products and services may also be adversely affected if we do not integrate and train our new employees quickly and effectively. Any future growth would add complexity to our organization and require effective coordination throughout our organization. Failure to ensure appropriate systems, processes and controls and to manage any future growth effectively could result in increased costs and harm our reputation and results of operations.
We have expanded our office real estate holdings to meet our projected growing need for office space. We have started construction on a second building adjacent to our headquarters as we expand our campus in Sunnyvale, California. These plans will require significant capital expenditure over the next several years and involve certain risks, including impairment charges and acceleration of depreciation, changes in future business strategy that may decrease the need for expansion (such as a decrease in headcount) and risks related to construction. Future changes in growth or fluctuations in cash flow may also negatively impact our ability to pay for these projects or free cash flow. Additionally, inaccuracies in our projected capital expenditures could negatively impact our business, operating results and financial condition.
We may experience difficulties maintaining and expanding our internal business management systems.
The maintenance ofby our internal business management systems, such assome of which cannot be performed until after the related products have been shipped. If we do not have enough time after shipping our Enterprise Resource Planning (“ERP”)products for our systems to perform these processes prior to the end of the quarter, or we have system issues that prevent processing in time to realize service billings in a quarter, we will not be able to bill and Customer Relationship Management (“CRM”) systems, has required,realize billings for those services until the following quarter, which may materially negatively impact our billings for a particular quarter. We implemented a cloud-based quoting tool to help provide our sales team with the ability to have faster quote generation, reduce quote errors and will continueincrease sales productivity. Our ability to require,integrate the investment of significant financial and human resources. In addition, wedata from this tool into our order processing may choose to upgrade or expand the functionality of our internal systems, leading to additional costs. We may also discover deficiencies in our design or maintenance of our internal systemscause order processing delays that could adversely affect our ability to forecast orders, process orders, ship products, provide services and customer support, send invoices and track payments, fulfill contractual obligations, accurately maintain books and records, provide accurate, timely and reliable reportshave an effect on our financial results. Our billings and operating results or otherwise operate our business. Additionally, ifrevenue for any of our internal systems does not operate as intended, the effectiveness of our internal control over financial reporting could be adversely affected or our ability to assess it adequately could be delayed. Further, we may expand the scope of our ERP and CRM systems. Our operating results may be adversely affected if these upgrades or expansions are delayed or if the systems do not function as intended or are not sufficient to meet our operating requirements.
If our estimates or judgments relating to our critical accounting policies are based on assumptions that change or prove to be incorrect, our operating resultsquarter could fall below our expectations or those of securities analysts and investors, resulting in a decline in our stock price.price, if expected orders at the end of any quarter are delayed for any reason or our ability to fulfill orders at the end of any quarter is hindered for any reason, including, among others:
•the failure of anticipated purchase orders to materialize;
•our logistics partners’ failure or inability to ship products prior to quarter-end to fulfill purchase orders received near the end of the quarter;
•disruption in manufacturing or shipping based on power outages, system failures, labor disputes or constraints, excessive demand, natural disasters or widespread public health problems including pandemics and epidemics such as the COVID-19 pandemic;
•our failure to accurately forecast our inventory requirements and to appropriately manage inventory to meet demand;
•our inability to release new products on schedule;
•any failure of our systems related to order review and processing; and
•any delays in shipments due to trade compliance requirements, labor disputes or logistics changes at shipping ports, airline strikes, severe weather or otherwise.
We rely significantly on revenue from FortiGuard and other security subscription and FortiCare technical support services, and revenue from these services may decline or fluctuate. Because we recognize revenue from these services over the term of the relevant service period, downturns or upturns in sales of FortiGuard and other security subscription and FortiCare technical support services are not immediately reflected in full in our operating results.
Our FortiGuard and other security subscription and FortiCare technical support services revenue has historically accounted for a significant percentage of our total revenue. Revenue from the sale of new, or from the renewal of existing,
FortiGuard and other security subscription and FortiCare technical support service contracts may decline and fluctuate as a result of a number of factors, including fluctuations in purchases of Core Platform appliances or our Enhanced Platform Technology products, changes in the sales mix between products and services, end-customers’ level of satisfaction with our products and services, the prices of our products and services, the prices of products and services offered by our competitors, reductions in our customers’ spending levels and the timing of revenue recognition with respect to these arrangements. If our sales of new, or renewals of existing, FortiGuard and other security subscription and FortiCare technical support service contracts decline, our revenue and revenue growth may decline and our business could suffer. In addition, in the event significant customers require payment terms for FortiGuard and other security subscription and FortiCare technical support services in arrears or for shorter periods of time than annually, such as monthly or quarterly, this may negatively impact our billings and revenue. Furthermore, we recognize FortiGuard and other security subscription and FortiCare technical support services revenue ratably over the term of the relevant service period, which is typically from one to five years. As a result, much of the FortiGuard and other security subscription and FortiCare technical support services revenue we report each quarter is the recognition of deferred revenue from FortiGuard and other security subscription and FortiCare technical support services contracts entered into during previous quarters or years. Consequently, a decline in new or renewed FortiGuard and other security subscription and FortiCare technical support services contracts in any one quarter will not be fully reflected in revenue in that quarter but will negatively affect our revenue in future quarters. Accordingly, the effect of significant downturns in sales of new, or renewals of existing, FortiGuard and other security subscription and FortiCare technical support services is not reflected in full in our statements of income until future periods. Our FortiGuard and other security subscription and FortiCare technical support services revenue also makes it difficult for us to rapidly increase our revenue through additional service sales in any period, as revenue from new and renewal support services contracts must be recognized over the applicable service term.
If we are unable to hire, retain and motivate qualified personnel, our business will suffer.
Our future success depends, in part, on our ability to continue to attract and retain highly skilled personnel. The loss of the services of any of our key personnel, the inability to attract or retain qualified personnel, any failure to have in place and execute an effective succession plan for key executives or delays in hiring required personnel, particularly in engineering, sales and marketing, may seriously harm our business, financial condition and results of operations. From time to time, we experience turnover in our management-level personnel. None of our key employees has an employment agreement for a specific term, and any of our employees may terminate their employment at any time. Our ability to continue to attract and retain highly skilled personnel will be critical to our future success.
Competition for highly skilled personnel is frequently intense, especially for qualified sales, support and engineering employees in network security and especially in the locations where we have a substantial presence and need for highly skilled personnel, such as the San Francisco Bay Area and the Vancouver, Canada area. We may not be successful in attracting, assimilating or retaining qualified personnel to fulfill our current or future needs. In addition, to the extent we hire personnel from competitors, we may be subject to allegations that they have been improperly solicited or divulged proprietary or other confidential information. Changes in immigration laws, including changes to the rules regarding H1-B visas, may also harm our ability to attract personnel from other countries. Our inability to hire properly qualified and effective sales, support and engineering employees could harm our growth and our ability to effectively support growth.
We have incurred indebtedness and may incur other debt in the future, which may adversely affect our financial condition and future financial results.
As of December 31, 2022, we had an aggregate of $990.4 million of indebtedness outstanding under our senior notes. Under the agreements governing our indebtedness, we are permitted to incur additional debt. This debt, and any debt that we may incur in the future, may adversely affect our financial condition and future financial results by, among other things:
•increasing our vulnerability to downturns in our business, to competitive pressures and to adverse economic and industry conditions;
•requiring the dedication of a portion of our expected cash from operations to service our indebtedness, thereby reducing the amount of expected cash flow available for other purposes, including capital expenditures, share repurchases and acquisitions; and
•limiting our flexibility in planning for, or reacting to, changes in our businesses and our industries;
If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may be required, among other things, to seek additional financing in the debt or equity markets, refinance or restructure all or a portion of our
indebtedness, sell selected assets or reduce or delay planned capital, operating or investment expenditures. Such measures may not be sufficient to enable us to service our debt.
Additionally, the agreements governing our indebtedness impose restrictions on us and require us to comply with certain covenants. If we breach any of these covenants and do not obtain a waiver from the noteholders, then, subject to applicable cure periods, any or all of our outstanding indebtedness may be declared immediately due and payable. There can be no assurance that any refinancing or additional financing would be available on terms that are favorable or acceptable to us, if at all.
Under the terms of our outstanding senior notes, we may be required to repurchase the notes for cash prior to their maturity in connection with the occurrence of certain changes of control that are accompanied by certain downgrades in the credit ratings of the notes. The repayment obligations under the notes may have the effect of discouraging, delaying or preventing a takeover of our company. If we were required to pay the notes prior to their scheduled maturity, it could have a negative impact on our cash position and liquidity and impair our ability to invest financial resources in other strategic initiatives.
In addition, changes by any rating agency to our credit rating may negatively impact the value and liquidity of both our debt and equity securities, as well as affect our ability to obtain additional financing in the future and may negatively impact the terms of any such financing.
Risks Related to Our Sales and End-Customers
We generate a majority of revenue from sales to distributors, resellers and end-customers outside of the United States, and we are therefore subject to a number of risks associated with international sales and operations.
We market and sell our products throughout the world and have established sales offices in many parts of the world. Our international sales have represented a majority of our total revenue in recent periods. Therefore, we are subject to risks associated with having worldwide operations. We are also subject to a number of risks typically associated with international sales and operations, including:
•disruption in the supply chain or in manufacturing or shipping, or decreases in demand by channel partners or end-customers, including any such disruption or decreases caused by factors outside of our control such as natural disasters and health emergencies, including earthquakes, droughts, fires, power outages, typhoons, floods, pandemics or epidemics such as the COVID-19 pandemic and manmade events such as civil unrest, labor disruption, international trade disputes, international conflicts, terrorism, wars or other foreign conflicts, such as the war in Ukraine or tensions between China and Taiwan, and critical infrastructure attacks;
•fluctuations in foreign currency exchange rates or a strengthening of the U.S. dollar, as a significant portion of our expenses is incurred and paid in currencies other than the U.S. dollar, and the impact such fluctuations may have on the actual prices that our partners and customers are willing to pay for our products and services;
•economic or political instability in foreign markets, such as any economic or political instability caused by economic downturns and wars or other foreign conflicts, such as the war in Ukraine, tensions between China and Taiwan and any expansions thereof;
•greater difficulty in enforcing contracts and accounts receivable collection, including longer collection periods;
•longer sales processes for larger deals, particularly during the summer months or as a result of the COVID-19 pandemic and related travel and gathering restrictions;
•changes in regulatory requirements;
•difficulties and costs of staffing and managing foreign operations;
•the uncertainty of protection for IP rights in some countries;
•costs of compliance with foreign policies, laws and regulations and the risks and costs of non-compliance with such policies, laws and regulations;
•protectionist policies and penalties, and local laws, requirements, policies and perceptions that may adversely impact a U.S.-headquartered business’s sales in certain countries outside of the U.S.;
•costs of complying with, and the risks, reputational damage and other costs of non-compliance with, U.S. or other foreign laws and regulations for foreign operations, including the U.S. Foreign Corrupt Practices Act, the United Kingdom Bribery Act 2010, the General Data Protection Regulation (the “GDPR”), import and export control laws, trade laws and regulations, tariffs and retaliatory measures, trade barriers and economic sanctions;
•other regulatory or contractual limitations on our ability to sell our products in certain foreign markets, and the risks and costs of non-compliance;
•heightened risks of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales or sales-related arrangements, such as sales “side agreements” to allow return rights, that could disrupt the sales team through terminations of employment or otherwise, and may adversely impact financial results as compared to those already reported or forecasted and result in restatements of financial statements and irregularities in financial statements;
•our ability to effectively implement and maintain adequate internal controls to properly manage our international sales and operations;
•political unrest, changes and uncertainty associated with terrorism, hostilities, war or natural disasters;
•management communication and integration problems resulting from cultural differences and geographic dispersion; and
•changes in tax, tariff, employment and other laws.
The preparationongoing effects of the COVID-19 pandemic may increase the severity and unpredictability of a number of the foregoing risks, and the risks to our business presented by the COVID-19 pandemic may be more significant and for a longer term in certain international geographies where we do meaningful business.
Product and service sales and employee and contractor matters may be subject to foreign governmental regulations, which vary substantially from country to country. Further, we may be unable to keep up to date with changes in government requirements as they change over time. Failure to comply with these regulations could result in adverse effects to our business. In many foreign countries, it is common for others to engage in business practices that are prohibited by our internal policies and procedures or U.S. regulations applicable to us. Although we implemented policies and procedures designed to ensure compliance with these laws and policies, there can be no assurance that all of our employees, contractors, channel partners and agents will comply with these laws and policies. Violations of laws or key control policies by our employees, contractors, channel partners or agents could result in litigation, regulatory action, costs of investigation, delays in revenue recognition, delays in financial statementsreporting, financial reporting misstatements, fines, penalties or the prohibition of the importation or exportation of our products and services, any of which could have a material adverse effect on our business and results of operations.
We may undertake corporate operating restructurings or transfers of assets that involve our group of foreign country subsidiaries through which we do business abroad, in conformityorder to maximize the operational and tax efficiency of our group structure. If ineffectual, such restructurings or transfers could increase our income tax liabilities, and in turn, increase our global effective tax rate. Moreover, our existing corporate structure and intercompany arrangements have been implemented in a manner we believe reasonably ensures that we are in compliance with generally accepted accounting principlescurrent prevailing tax laws. However, the tax authorities of the jurisdictions in which we operate may challenge our methodologies for valuing developed technology or intercompany arrangements, which could impact our worldwide effective tax rate and harm our financial position and operating results.
If we are not successful in continuing to execute our strategy to increase our sales to large and medium-sized end-customers, our results of operations may suffer.
An important part of our growth strategy is to increase sales of our products to large- and medium-sized businesses, service providers and government organizations. While we have increased sales in recent periods to large- and medium-sized businesses, our sales volume varies by quarter and there is risk as to our level of success selling to these target customers. Such
sales involve unique sales skillsets, processes and structures, are often more complex and feature a longer contract term and may be at higher discount levels. We also have experienced uneven traction selling to certain government organizations and service providers and MSSPs, and there can be no assurance that we will be successful selling to these customers. Sales to these organizations involve risks that may not be present, or that are present to a lesser extent, with sales to smaller entities. These risks include:
•increased competition from competitors that traditionally target large and medium-sized businesses, service providers and government organizations and that may already have purchase commitments from those end-customers;
•increased purchasing power and leverage held by large end-customers in negotiating contractual arrangements;
•unanticipated changes in the capital resources or purchasing behavior of large end-customers, including changes in the volume and frequency of their purchases and changes in the mix of products and services, willingness to change to cloud delivery model and related payment terms;
•more stringent support requirements in our support service contracts, including stricter support response times, more complex requirements and increased penalties for any failure to meet support requirements;
•longer sales cycles and the associated risk that substantial time and resources may be spent on a potential end-customer that elects not to purchase our products and services;
•increased requirements from these customers that we have certain third-party security or other certifications, which we may not have, the lack of which may adversely affect our ability to successfully sell to such customers;
•uncertainty as to timing to close large deals and any delays in closing those deals; and
•longer ramp-up periods for enterprise sales personnel as compared to other sales personnel.
Large and medium-sized businesses, service providers and MSSPs and government organizations often undertake a significant evaluation process that results in a lengthy sales cycle, in some cases longer than 12 months. Although we have a channel sales model, our sales representatives typically engage in direct interaction with end-customers, along with our distributors and resellers, in connection with sales to large- and medium-sized end-customers. We may spend substantial time, effort and money in our sales efforts without being successful in producing any sales. In addition, purchases by large- and medium-sized businesses, service providers and government organizations are frequently subject to budget constraints, multiple approvals and unplanned administrative, processing and other delays; in light of current economic conditions and regulations in place by various government authorities, some of these sales cycles are being further extended. Furthermore, service providers and MSSPs represent our largest industry vertical and consolidation or continued changes in buying behavior by larger customers within this industry could negatively impact our business. Large- and medium-sized businesses, service providers and MSSPs and government organizations typically have longer implementation cycles, require greater product functionality and scalability, expect a broader range of services, including design, implementation and post go-live services, demand that vendors take on a larger share of risks, require acceptance provisions that can lead to a delay in revenue recognition and expect greater payment flexibility from vendors. In addition, large- and medium-sized businesses, service providers and government organizations may require that our products and services be sold differently from how we offer our products and services, which could negatively impact our operating results. Our large business and service provider customers may also become more deliberate in their purchases as they plan their next-generation network security architecture, leading them to take more time in making purchasing decisions or to purchase based only on their immediate needs. All these factors can add further risk to business conducted with these customers. In addition, if sales expected from a large- and medium-sized end-customer for a particular quarter are not realized in that quarter or at all, our business, operating results and financial condition could be materially and adversely affected.
If we do not increase the effectiveness of our sales organization, we may have difficulty adding new end-customers or increasing sales to our existing end-customers and our business may be adversely affected.
Although we have a channel sales model, sales in our industry are complex and members of our sales organization often engage in direct interaction with our prospective end-customers, particularly for larger deals involving larger end-customers. Therefore, we continue to be substantially dependent on our sales organization to obtain new end-customers and sell additional products and services to our existing end-customers. There is significant competition for sales personnel with the
skills and technical knowledge that we require, including experienced enterprise sales employees and others. Our ability to grow our revenue depends, in large part, on our success in recruiting, training and retaining sufficient numbers of sales personnel to support our growth and on the effectiveness of those personnel in selling successfully in different contexts, each of which has its own different complexities, approaches and competitive landscapes, such as managing and growing the channel business for sales to small businesses and more actively selling to the end-customer for sales to larger organizations. New hires require substantial training and may take significant time before they achieve full productivity. Our recent hires and planned hires may not become productive as quickly as we expect, and we may be unable to hire or retain sufficient numbers of qualified individuals in the markets where we do business or plan to do business. Furthermore, hiring sales personnel in new countries requires managementadditional setup and upfront costs that we may not recover if the sales personnel fail to achieve full productivity. If our sales employees do not become fully productive on the timelines that we have projected, our revenue may not increase at anticipated levels and our ability to achieve long-term projections may be negatively impacted. If we are unable to hire and train sufficient numbers of effective sales personnel, the sales personnel are not successful in obtaining new end-customers or increasing sales to our existing customer base or sales personnel do not effectively sell our Enhanced Platform Technology products, our business, operating results and prospects may be adversely affected. If we do not hire properly qualified and effective sales employees and organize our sales team effectively to capture the opportunities in the various customer segments we are targeting, our growth and ability to effectively support growth may be harmed.
Unless we continue to develop better market awareness of our company and our products, and to improve lead generation and sales enablement, our revenue may not continue to grow.
Increased market awareness of our capabilities and products and increased lead generation are essential to our continued growth and our success in all of our markets, particularly the market for sales to large businesses, service providers and government organizations. While we have increased our investments in sales and marketing, it is not clear that these investments will continue to result in increased revenue. If our investments in additional sales personnel or our marketing programs are not successful in continuing to create market awareness of our company and products or increasing lead generation, in growing billings for our broad product suite or if we experience turnover and disruption in our sales and marketing teams, we may not be able to achieve sustained growth, and our business, financial condition and results of operations may be adversely affected.
A portion of our revenue is generated by sales to government organizations and to companies that perform on government contracts. These sales subject us to a number of regulatory requirements, challenges and risks.
We derive a portion of our revenue from sales to government organization in the US (federal, state, local and education markets) and in foreign markets. Sales to government organizations are subject to several risks. Because of public sector budgetary cycles and laws or regulations governing public procurements, such sales often require significant upfront time and expense without any assurance of winning a sale.
Government demand, sales and payment for our products and services may be negatively impacted by numerous factors and requirements unique to selling to government agencies, such as:
•policies, laws or regulations have in the past, and may in the future, require us to hold certain third-party and government security certifications in order to sell our products and services and to make estimatesorganizational and assumptionsoperational changes in order to sell into specific government agencies or programs, and such certifications may be costly to obtain and maintain;
•funding authorizations and requirements unique to government agencies, with funding or purchasing reductions or delays adversely affecting public sector demand for our products; and
•geopolitical matters, including tariff and trade disputes, government shutdowns, impact of the war in Ukraine, tensions between China and Taiwan and trade protectionism and other political dynamics that may adversely affect our ability to sell in certain locations or obtain the amounts reportedrequisite permits and clearances required for certain purchases by government organizations of our products and services.
In addition, government certifications and requirements may restrict our ability to sell to certain government customers until we have obtained certain certifications or meet other applicable requirements, which we are not guaranteed to do. For example, certain of our competitors may be certified under the U.S. Federal Risk and Authorization Management Program (“FedRAMP”) and until such a time that are also certified under FedRAMP, we risk losing sales to certain government customers to certified competitors.
The rules and regulations applicable to sales to government organizations may also negatively impact sales to other organizations. For example, government organizations may have contractual or other legal rights to terminate contracts with our
distributors and resellers for convenience or due to a default, and any such termination may adversely impact our future results of operations. If the distributor receives a significant portion of its revenue from sales to government organizations, the financial health of the distributor could be substantially harmed, which could negatively affect our future sales to such distributor. Governments routinely investigate, review and audit government vendors’ administrative and other processes, and any unfavorable investigation, audit, other review or unfavorable determination related to any government clearance or certification could result in the consolidated financial statementsgovernment’s refusing to continue buying our products and accompanying notes. We baseservices, a limitation and reduction of government purchases of our estimates on historical experienceproducts and on variousservices, a reduction of revenue or fines, or civil or criminal liability if the investigation, audit or other assumptionsreview uncovers improper, illegal or otherwise concerning activities. Any such penalties could adversely impact our results of operations in a material way. Further, any refusal to grant certain certifications or clearances by one government agency, or any decision by one government agency that we believeour products do not meet certain standards, may reduce business opportunities and cause reputational harm and cause concern with other government agencies, governments and businesses and cause them to not buy our products and services and/or lead to a decrease in demand for our products generally.
Finally, purchases by some governments, including the U.S. federal government, may require certain products to be reasonable undermanufactured in the circumstances,United States or in other high-cost manufacturing locations. We may not manufacture all products in locations that meet such requirements meaning our products will not be eligible for certain government purchases.
The war in Ukraine and any expansion thereof and our reduction of operations in Russia have affected, and may continue to affect, our business.
The war in Ukraine and resulting disruption are ongoing and likely to continue, and may also expand into other regions. Some of the impacts and potential impacts of the war in Ukraine and possible expansion thereof include, but are not limited to:
•reduction of sales and revenue based on our reduction of operations and sales in Russia;
•difficulty in business planning and forecasting due to the uncertainty of the impact of the war on aspects of our business, such as providedon our distributors, resellers and end-customers;
•uncertainty and disruption in “Management’s Discussionthe general demand environment, including Russia, Belarus and AnalysisUkraine, which could reduce demand by distributors;
•increased costs and the diversion of Financial Conditionmanagement’s attention related to oversight of our international operations;
•failure of Russian distributors to pay outstanding accounts receivables owed to us;
•retaliatory actions by Russia or other countries against us and Resultsother Western companies that chose to limit or remove business operations in the region;
•increased risk of Operations—Critical Accounting Policiesdata breach and Estimates”other threats from ransomware, destructive malware, distributed denial-of-service attacks, as well as fraud, spam and fake accounts, cyber-attacks or other illegal activity conducted generally by bad actors seeking to take advantage of us, our distributors, resellers or end-customers;
•any devaluation of local currency or other inflationary effects caused by the impact of sanctions and other macroeconomic effects of the war; and
•significant volatility and disruption of global financial markets and negative impact to global and regional economies.
Sanctions and trade control measures that have been implemented against Russia and Belarus, and others that may be implemented, are complex and still evolving. Our efforts to comply with such measures may be costly, time consuming and divert the attention of management. Any alleged or actual failure to comply with these measures as we work to reduce our business operations in Russia may subject us to government scrutiny, civil or criminal proceedings, sanctions and other liabilities, which may have a material adverse effect on our international operations, financial condition and results of operations.
Any of the above-mentioned factors could adversely affect our business, prospects, financial condition and results of operations. The extent and duration of the military action, sanctions and resulting market disruptions are impossible to predict,
but could be substantial. Any such disruptions may also magnify the impact of other risks described in this Annual Report on Form 10-K, the results of which form the basis for making judgments about the carrying values of assets10-K.
Risks Related to Our Industry, Customers, Products and liabilities that are not readily apparent from other sources. Our operating results may be adversely affected if our assumptions change or if actual circumstances differ from thoseServices
We face intense competition in our assumptions, which could causemarket and we may not maintain or improve our competitive position.
The market for network security products is intensely competitive and dynamic, and we expect competition to continue to intensify. We face many competitors across the different cybersecurity markets. Our competitors include companies such as Arista, Aruba, Barracuda, Check Point, Cisco, CrowdStrike, F5 Networks, Huawei, Juniper, Palo Alto Networks, SonicWALL, Sophos, Trend Micro, VMware and Zscaler.
Some of our existing and potential competitors enjoy competitive advantages such as:
•greater name recognition and/or longer operating resultshistories;
•larger sales and marketing budgets and resources;
•broader distribution and established relationships with distribution partners and end-customers;
•access to fall below the expectations of securities analystslarger customer bases;
•greater customer support resources;
•greater resources to make acquisitions;
•stronger U.S. government relationships;
•lower labor and investors, resulting in a decline in our stock price. Significant assumptionsdevelopment costs; and estimates used in preparing our consolidated
•substantially greater financial, statements include those related to revenue recognition, deferred contract coststechnical and commission expense, valuation of inventory, accounting for business combination, contingent liabilities and accounting for income taxes.other resources.
We offer retroactive price protection toIn addition, certain of our major distributors,larger competitors have broader product offerings, and ifleverage their relationships based on other products or incorporate functionality into existing products in a manner that discourages customers from purchasing our products. These larger competitors often have broader product lines and market focus, and are in a better position to withstand any significant reduction in capital spending by end-customers in these markets. Therefore, these competitors will not be as susceptible to downturns in a particular market. Also, many of our smaller competitors that specialize in providing protection from a single type of security threat are often able to deliver these specialized security products to the market more quickly than we failcan.
Conditions in our markets could change rapidly and significantly as a result of technological advancements or continuing market consolidation. Our competitors and potential competitors may also be able to balancedevelop products or services, and leverage new business models, that are equal or superior to ours, achieve greater market acceptance of their products and services, disrupt our markets, and increase sales by utilizing different distribution channels than we do. For example, certain of our competitors are focusing on delivering security services from the cloud which include cloud-based security providers, such as Zscaler. In addition, current or potential competitors may be acquired by third parties with greater available resources, and new competitors may arise pursuant to acquisitions of network security companies or divisions. As a result of such acquisitions, competition in our market may continue to increase and our current or potential competitors might be able to adapt more quickly to new technologies and customer needs, devote greater resources to the promotion or sale of their products and services, initiate or withstand substantial price competition, take advantage of acquisition or other opportunities more readily, or develop and expand their product and service offerings more quickly than we do. In addition, our competitors may bundle products and services competitive with ours with other products and services. Customers may accept these bundled products and services rather than separately purchasing our products and services. As our customers refresh the security products bought in prior years, they may seek to consolidate vendors, which may result in current customers choosing to purchase products from our competitors on an ongoing basis. Due to budget constraints or economic downturns, organizations may be more willing to incrementally add solutions to their existing network security infrastructure from competitors than to replace it with our solutions. These competitive pressures in our market or our failure to compete effectively may result in price reductions, fewer customer orders, reduced revenue and gross margins and loss of market share.
Managing inventory of our products and product components is complex. Insufficient inventory or components may result in lost sales opportunities or delayed revenue, while excess inventory may harm our gross margins.
Managing our inventory is complex, especially given current supply chain disruption. Our channel partners may increase orders during periods of product shortages, cancel orders or not place orders commensurate with our expectations if their inventory with end-customeris too high, return products or take advantage of price protection (if any is available to the particular partner) or delay orders in anticipation of new products, and accurately forecasting inventory requirements and demand forcan be challenging. Our channel partners also may adjust their orders in response to the supply of our products and the products of our allowancecompetitors that are available to them and in response to seasonal fluctuations in end-customer demand. Furthermore, the time required to source components including chips and other components, and manufacture or ship certain products has increased, and so we expect inventory shortfalls to continue and costs to manufacture and ship on-time to continue to increase. If we cannot manufacture and ship our products due to, for price protectionexample, global chip shortages, excessive demand on contract manufacturers capacity, natural disasters and health emergencies such as earthquakes, fires, power outages, typhoons, floods, cyber events, pandemics and epidemics such as the COVID-19 pandemic or manmade events such as civil unrest, labor disruption, international trade disputes, international conflicts, terrorism, wars or other foreign conflicts, such as the war in Ukraine or tensions between China and Taiwan, and critical infrastructure attacks, our business and financial results could be materially and adversely impacted.
The global chip shortage caused by the COVID-19 pandemic and other factors affecting manufacturing capacity is having, and we expect to continue to have, an adverse impact on our ability to manage our inventory and to meet product demand in a timely fashion. We expect this shortage will persist for an indefinite period of time. Management of our inventory is further complicated by the significant number of different products and models that we sell which may be inadequate, which couldimpact our billings, revenue, margins and free cash flow. Mismanagement of our inventory, whether due to imprecise forecasting, employee errors or malfeasance, inaccurate information or otherwise, may adversely affect our results of operations. The COVID-19 pandemic has resulted in challenges for us to obtain components and inventory, as well as increases to freight and shipping costs, and may result in a material adverse effect on our results of operations.
We provideInventory management remains an area of focus as we balance the need to maintain inventory levels that are sufficient to ensure competitive lead times against the risk of inventory obsolescence because of rapidly changing technology, product transitions, customer requirements or excess inventory levels. If we ultimately determine that we have excess inventory, we may have to reduce our prices and write-down inventory, which in turn could result in lower gross margins. Alternatively, insufficient inventory levels may lead to shortages that result in delayed billings and revenue or loss of sales opportunities altogether as potential end-customers turn to competitors’ products that are readily available. For example, we have in the past experienced inventory shortages and excesses due to the variance in demand for certain products from forecasted amounts. Our inventory management systems and related supply chain visibility tools may be inadequate to enable us to effectively manage inventory. If we are unable to effectively manage our inventory and that of our major distributors with price protection rights for inventories ofchannel partners, our products held by them. If we reduce the list price of our products, certain distributors receive refunds or credits from us that reduce the price of such products held in their inventory based upon the new list price. Future credits for price protection will depend on the percentage of our price reductions for the products in inventory and our ability to manage the levels of our major distributors’ inventories. If future price protection adjustments are higher than expected, our future results of operations could be materially and adversely affected.
If our new products and product enhancements do not achieve sufficient market acceptance, our results of operations and competitive position will suffer.
We spend substantial amounts of time and money to develop internally and acquire new products and enhanced versions of our existing products in order to incorporate additional features, improved functionality or other enhancements in order to meet our customers’ rapidly evolving demands for network security in our highly competitive industry. When we develop a new product or an enhanced version of an existing product, we typically incur expenses and expend resources upfront to market, promote and sell the new offering. Therefore, when we develop and introduce new or enhanced products, they must achieve high levels of market acceptance in order to justify the amount of our investment in developing and bringing them to market.
Our new products or product enhancements could fail to attain sufficient market acceptance for many reasons, including:
•delays in releasing our new products or enhancements to the market;
•failure to accurately predict market demand in terms of product functionality and to supply products that meet this demand in a timely fashion;
•failure to have the appropriate research and development expertise and focus to make our top strategic Enhanced Platform Technology products successful;
•failure of our sales force and partners to focus on selling new products;
•inability to interoperate effectively with the networks or applications of our prospective end-customers;
•inability to protect against new types of attacks or techniques used by hackers;
•actual or perceived defects, vulnerabilities, errors or failures;
•negative publicity about their performance or effectiveness;
•introduction or anticipated introduction of competing products by our competitors;
•poor business conditions for our end-customers, causing them to delay IT purchases;
•changes to the regulatory requirements around security; and
•reluctance of customers to purchase products incorporating open source software.
If our new products or enhancements do not achieve adequate acceptance in the market, our competitive position will be impaired, our revenue will be diminished and the effect on our operating results may be particularly acute because of the significant research, development, marketing, sales and other expenses we incurred in connection with the new product or enhancement.
Demand for our products may be limited by market perception that individual products from one vendor that provide multiple layers of security protection in one product are inferior to point solution network security solutions from multiple vendors.
Sales of many of our products depend on increased demand for incorporating broad security functionality into one appliance. If the market for these products fails to grow as we anticipate, our business will be seriously harmed. Target customers may view “all-in-one” network security solutions as inferior to security solutions from multiple vendors because of, among other things, their perception that such products of ours provide security functions from only a single vendor and do not allow users to choose “best-of-breed” defenses from among the wide range of dedicated security applications available. Target customers might also perceive that, by combining multiple security functions into a single platform, our solutions create a “single point of failure” in their networks, which means that an error, vulnerability or failure of our product may place the entire network at risk. In addition, the market perception that “all-in-one” solutions may be suitable only for small and medium-sized businesses because such solution lacks the performance capabilities and functionality of other solutions may harm our sales to large businesses, service provider and government organization end-customers. If the foregoing concerns and perceptions become prevalent, even if there is no factual basis for these concerns and perceptions, or if other issues arise with our market in general, demand for multi-security functionality products could be severely limited, which would limit our growth and harm our business, financial condition and results of operations. Further, a successful and publicized targeted attack against us, exposing a “single point of failure”, could significantly increase these concerns and perceptions and may harm our business and results of operations.
If functionality similar to that offered by our products is incorporated into existing network infrastructure products, organizations may decide against adding our appliances to their network, which would have an adverse effect on our business.
Large, well-established providers of networking equipment, such as Cisco, offer, and may continue to introduce, network security features that compete with our products, either in standalone security products or as additional features in their network infrastructure products. The inclusion of, or the announcement of an intent to include, functionality perceived to be similar to that offered by our security solutions in networking products that are already generally accepted as necessary components of network architecture may have an adverse effect on our ability to market and sell our products. Furthermore, even if the functionality offered by network infrastructure providers is more limited than our products, a significant number of customers may elect to accept such limited functionality in lieu of adding appliances from an additional vendor such as us. Many organizations have invested substantial personnel and financial resources to design and operate their networks and have established deep relationships with other providers of networking products, which may make them reluctant to add new components to their networks, particularly from other vendors such as us. In addition, an organization’s existing vendors or new vendors with a broad product offering may be able to offer concessions that we are not able to match because we currently offer
only network security products and have fewer resources than many of our competitors. If organizations are reluctant to add additional network infrastructure from new vendors or otherwise decide to work with their existing vendors, our business, financial condition and results of operations will be adversely affected.
Because we depend on several third-party manufacturers to build our products, we are susceptible to manufacturing delays that could prevent us from shipping customer orders on time, if at all, and may result in the loss of sales and customers, and third-party manufacturing cost increases could result in lower gross margins and free cash flow.
We outsource the manufacturing of our security appliance products to contract manufacturing partners and original design manufacturing partners, including manufacturers with facilities located in Taiwan China and other countries outside the United States such as ADLINK, IBASE, Micro-Star, Wistron, Senao ADLINK and IBASE.Wistron. Our reliance on our third-party manufacturers in Asia and elsewhere reduces our control over the manufacturing process, exposing us to risks, including reduced control over quality assurance, costs, supply and timing and possible tariffs. Any manufacturing disruption related to our third-party manufacturers or their component suppliers for any reason, including global chip shortages, natural disasters and health emergencies such as earthquakes, fires,
power outages, typhoons, floods, health pandemics and epidemics such as the coronavirusCOVID-19 pandemic and manmade events such as civil unrest, labor disruption, cyber events, international trade disputes, international conflicts, terrorism, wars, such as the war in Ukraine, and critical infrastructure attacks, could impair our ability to fulfill orders. If we are unable to manage our relationships with these third-party manufacturers effectively, or if these third-party manufacturers experience delays, increased manufacturing lead-times, disruptions, capacity constraints or quality control problems in their manufacturing operations, or fail to meet our future requirements for timely delivery, our ability to ship products to our customers could be impaired and our business would be seriously harmed. Further, certain components for our products come from Taiwan and approximately 88% of our hardware is manufactured in Taiwan. Any increase in tensions between China and Taiwan, including threats of military actions or escalation of military activities, could adversely affect our manufacturing operations in Taiwan.
These manufacturers fulfill our supply requirements on the basis of individual purchase orders. We have no long-term contracts or arrangements with our third-party manufacturers that guarantee capacity, the continuation of particular payment terms or the extension of credit limits. Accordingly, they are not obligated to continue to fulfill our supply requirements, and the prices we are charged for manufacturing services could be increased on short notice. If we are required to change third-party manufacturers, our ability to meet our scheduled product deliveries to our customers would be adversely affected, which could cause the loss of sales and existing or potential customers, delayed revenue or an increase in our costs, which could adversely affect our gross margins. Our individual product lines are generally manufactured by only one manufacturing partner. Any production or shipping interruptions for any reason, such as a natural disaster, epidemic, capacity shortages, quality problems or strike or other labor disruption at one of our manufacturing partners or locations or at shipping ports or locations, would severely affect sales of our product lines manufactured by that manufacturing partner. Furthermore, manufacturing cost increases for any reason could result in lower gross margins.
Our proprietary SPUs,ASICs, which are key to the performance of our appliances, are built by contract manufacturers including Renesas and Toshiba.Toshiba America. These contract manufacturers use foundries operated by TSMC or Renesas on a purchase-order basis, and these foundries do not guarantee their capacity and could delay orders or increase their pricing. Accordingly, the foundries are not obligated to continue to fulfill our supply requirements, and due to the long lead time that a new foundry would require, we could suffer inventory shortages of our SPUASIC as well as increased costs. In addition to our proprietary SPU,ASIC, we also purchase off-the-shelf ASICs or integrated circuits from vendors for which we have experienced, and may continue to experience, long lead times. Our suppliers may also prioritize orders by other companies that order higher volumes or more profitable products. If any of these manufacturers materially delays its supply of ASICs or specific product models to us, or requires us to find an alternate supplier and we are not able to do so on a timely and reasonable basis, or if these foundries materially increase their prices for fabrication of our ASICs, our business would be harmed.
In addition, our reliance on third-party manufacturers and foundries limits our control over environmental regulatory requirements such as the hazardous substance content of our products and therefore our ability to ensure compliance with the Restriction of Hazardous Substances Directive (the “EU RoHS”) adopted in the European Union (the “EU”) and other similar laws. It also exposes us to the risk that certain minerals and metals, known as “conflict minerals,”minerals”, that are contained in our products have originated in the Democratic Republic of the Congo or an adjoining country. As a result of the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (“Dodd-Frank”), the SECSecurities and Exchange Commission (the “SEC”) adopted disclosure requirements for public companies whose products contain conflict minerals that are necessary to the functionality or production of such products. Under these rules, we are required to obtain sourcing data from suppliers, perform supply chain due diligence, and file annually with the SEC a specialized disclosure report on Form SD covering the prior calendar year. We have incurred and expect to incur additional costs to comply with the rules, including costs related to efforts to determine the origin, source and chain of custody of the conflict minerals used in our products and the adoption of conflict minerals-related governance policies, processes and controls. Moreover, the implementation of these compliance measures could adversely affect the sourcing, availability and pricing of materials used in the manufacture of our
products to the extent that there may be only a limited number of suppliers that are able to meet our sourcing requirements, which would make it more difficult to obtain such materials in sufficient quantities or at competitive prices. We may also encounter customers who require that all of the components of our products be certified as conflict-free. If we are not able to meet customer requirements, such customers may choose to not purchase our products, which could impact our sales and the value of portions of our inventory.
Because some of the key components in our products come from limited sources of supply, we are susceptible to supply shortages, long lead times for components, and supply changes, each of which could disrupt or delay our scheduled product deliveries to our customers, result in inventory shortage, cause loss of sales and customers or increase component costs resulting in lower gross margins and free cash flow.
We and our contract manufacturers currently purchase several key parts and components used in the manufacture of our products from limited sources of supply. We are therefore subject to the risk of shortages and long lead times in the supply of these components and the risk that component suppliers may discontinue or modify components used in our products. We have in the past experienced, and are currently experiencing, shortages and long lead times for certain components. Our limited source components for particular appliances and suppliers of those components include specific types of CPUs from Intel and AMD, network and wireless chips from Broadcom, Marvell, Qualcomm and Intel, and memory devices from Intel, Micron, ADATA, Toshiba, Samsung and Western
Digital. We also may face shortages in the supply of the capacitors and resistors that are used in the manufacturing of our products. For example, the global chip shortage caused by the COVID-19 pandemic and other factors affecting manufacturing continues to affect the manufacturing capacity of us and our contract manufacturers. This shortage may persist for an indefinite period of time. The introduction by component suppliers of new versions of their products, particularly if not anticipated by us or our contract manufacturers, could require us to expend significant resources to incorporate these new components into our products. In addition, if these suppliers were to discontinue production of a necessary part or component, we would be required to expend significant resources and time in locating and integrating replacement parts or components from another vendor. Qualifying additional suppliers for limited source parts or components can be time-consuming and expensive.
Our manufacturing partners have experienced long lead times for the purchase of components incorporated into our products. Lead times for components may be adversely impacted by factors outside of our control such as global chip shortages, natural disasters and health emergencies such as earthquakes, fires, power outages, typhoons, floods, health pandemics and epidemics such as the coronavirus,COVID-19 pandemic, and manmade events such as civil unrest, labor disruption, international trade disputes, international conflicts, terrorism, wars, such as the war in Ukraine, critical infrastructure attacks and other factors. Our reliance on a limited number of suppliers involves several additional risks, including:
•a potential inability to obtain an adequate supply of required parts or components when required;
•financial or other difficulties faced by our suppliers;
•infringement or misappropriation of our intellectual property;IP;
•price increases;
•failure of a component to meet environmental or other regulatory requirements;
•failure to meet delivery obligations in a timely fashion;
•failure in component quality; and
•inability to ship products on a timely basis.
The occurrence of any of these events would be disruptive to us and could seriously harm our business. Any interruption or delay in the supply of any of these parts or components, or the inability to obtain these parts or components from alternate sources at acceptable prices and within a reasonable amount of time, would harm our ability to meet our scheduled product deliveries to our distributors, resellers and end-customers. This could harm our relationships with our channel partners and end-customers and could cause delays in shipment of our products and adversely affect our results of operations. In addition, increased component costs could result in lower gross margins.
We are exposedoffer retroactive price protection to fluctuations in currency exchange rates,certain of our major distributors, and if we fail to balance their inventory with end-customer demand for our products, our allowance for price protection may be inadequate, which could negativelyadversely affect our financial condition and results of operations.
A significant portionWe provide certain of our operating expenses are incurred outside the United States. These expenses are denominated in foreign currencies and are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Euro, Brazilian real, Canadian dollar and British pound. Additionally, fluctuations in the exchange ratemajor distributors with price protection rights for inventories of the Canadian dollar may negatively impact our development plans in Burnaby, Canada. While we are not currently engaged in material hedging activities, we have been hedging currency exposures relating to certain balance sheet accounts through the use of forward exchange contracts.products held by them. If we stop hedging against anyreduce the list price of these risksour products, certain distributors receive refunds or ifcredits from us that reduce the price of such products held in their inventory based upon the new list price. Future credits for price protection will depend on the percentage of our attemptsprice reductions for the products in inventory and our ability to hedge against these currency exposuresmanage the levels of our major distributors’ inventories. If future price protection adjustments are not successful,higher than expected, our financial condition andfuture results of operations could be materially and adversely affected. Our
The sales contracts are primarily denominated in U.S. dollars and therefore, while substantially all of our revenue is not subject to foreign currency risk, it does not serve as a hedge to our foreign currency-denominated operating expenses. In addition, a strengthening of the U.S. dollar may increase the real cost of our products to our customers outside of the United States, which may also adversely affect our financial condition and results of operations.
Failure to comply with laws and regulations applicable to our business could subject us to fines and penalties and could also cause us to lose end-customers in the public sector or negatively impact our ability to contract with the public sector.
Our business is subject to regulation by various federal, state, regional, local and foreign governmental agencies, including agencies responsible for monitoring and enforcing employment and labor laws, workplace safety, product safety, product labeling, environmental laws, consumer protection laws, anti-bribery laws, data privacy laws, import and export controls, federal securities laws and tax laws and regulations. In certain jurisdictions, these regulatory requirements may be
more stringent than in the United States. Non-compliance with applicable regulations or requirements could subject us to investigations, sanctions, enforcement actions, disgorgement of profits, fines, damages and civil and criminal penalties or injunctions. If any governmental sanctions are imposed, or if we do not prevail in any possible civil or criminal litigation, our business, operating results and financial condition could be adversely affected. In addition, responding to any action will likely result in a significant diversion of management’s attention and resources and an increase in professional fees. Enforcement actions and sanctions could harm our business, operating results and financial condition.
For example, the GDPR, which became effective in May 2018 and superseded current EU data protection regulations, imposes stringent data handling requirements on companies that receive or process personal data of residents of the EU. Non-compliance with the GDPR could result in significant penalties, including data protection audits and heavy fines. Compliance with, and the other burdens imposed by, the GDPR may limit our ability to operate or expand our business in Europe and could adversely impact our operating results, as could delays or shortcomings in the implementation of our GDPR compliance program.
Additionally, we may be subject to other legal regimes throughout the world governing data handling, protection and privacy. For example, in June 2018, California passed the California Consumer Privacy Act (the “CCPA”), which provides new data privacy rights for consumers and new operational requirements for companies and became effective on January 1, 2020. Fines for non-compliance may be up to $7,500 per violation. The costs of compliance with, and other burdens imposed by, the GDPR and CCPA may limit the use and adoptionprices of our products and services and could have an adverse impact onmay decrease, which may reduce our business.
Selling our solutions to the U.S. government, whether directly or through channel partners, also subjects us to certain regulatory and contractual requirements and risks. Failure to comply with these requirements by either us or our channel partners could subject us to investigations, fines, suspension or debarment from doing business with the U.S. government or one of its divisions, and other penalties and damages, which could have an adverse effect on our business, operating results, financial condition and prospects. As an example, the U.S. Department of Justice (the “DOJ”) has in the past pursued claims against, and obtained monetary settlements or damages from, companies, including us, under the False Claims Act and other statutes related to pricing, discount practices and compliance with laws related to sales to the federal government, such as the Trade Agreements Act (the “TAA”). The DOJ continues to actively pursue such claims. Any violations of regulatory and contractual requirements could result in us being suspended or debarred fromfuture government contracting. Any of these outcomes could have an adverse effect on our revenue, operating results, financial condition and prospects.
These laws and regulations impose added costs on our business, and failure to comply with these or other applicable regulations and requirements, including non-compliance in the past, could lead to claims for damages from our channel partners, penalties, termination of contracts, loss of exclusive rights in our intellectual property and temporary suspension or permanent debarment from government contracting. Any such damages, penalties, disruptions or limitations in our ability to do business with the public sector could have an adverse effect on our businessgross profits and operating results.
Global economic uncertainty and weakening product demand caused by political instability and conflict could adversely affect our business and financial performance.
Economic uncertainty in various global markets caused by political instability and conflict has resulted,margin and may continue to result, in weakened demand for our products and services and difficulty in forecastingadversely impact our financial results and managing inventory levels. Political developments impacting government spending and international trade, including potential government shutdowns and election year instability in the United States, continued uncertainty surrounding the United Kingdom’s departure from the EU and trade disputes and tariffs, may negatively impact markets and cause weaker macro-economic conditions. The effects of these events may continue due to potential additional U.S. government shutdowns and developments resulting from the 2020 presidential election, instability in the United Kingdom and the EU as negotiations for the terms of Brexit continue, with the ultimate outcome still uncertain, and the United States’ ongoing trade disputes with China and other countries. The continuing effect of any or all of these events could adversely impact demand for our products, harm our operations and weaken our financial results.
We are subject to governmental export and import controls that could subject us to liability or restrictions on sales, and that could impair our ability to compete in international markets.
Because we incorporate encryption technology into our products, certaintrading price of our products are subject to U.S. export controls and may be exported outside the United States only with the required export license or through an export license exception, or may be prohibited altogether from export to certain countries. If we were to fail to comply with U.S. export laws, U.S. Customs regulations and import regulations, U.S. economic sanctions and other countries’ import and export laws, we
could be subject to substantial civil and criminal penalties, including fines for the company and incarceration for responsible employees and managers, and the possible loss of export or import privileges. In addition, if our channel partners fail to obtain appropriate import, export or re-export licenses or permits (e.g. for stocking orders placed by our partners), we may also be adversely affected through reputational harm and penalties and we may not be able to provide support related to appliances shipped pursuant to such orders. Obtaining the necessary export license for a particular sale may be time-consuming and may result in the delay or loss of sales opportunities.
Furthermore, U.S. export control laws and economic sanctions prohibit the shipment of certain products to U.S. embargoed or sanctioned countries, governments and persons. Even though we take precautions to prevent our product from being shipped to U.S. sanctions targets, our products could be shipped to those targets by our channel partners, despite such precautions. Any such shipment could have negative consequences including government investigations and penalties and reputational harm. In addition, various countries regulate the import of certain encryption technology, including import permitting and licensing requirements, and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries. Changes in our products or changes in export and import regulations may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products globally or, in some cases, prevent the export or import of our products to certain countries, governments or persons altogether. Any change in export or import regulations, economic sanctions or related legislation, shift in the enforcement or scope of existing regulations, or change in the countries, governments, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations. Any decreased use of our products or limitation on our ability to export or sell our products would likely adversely affect our business, financial condition and results of operations.
Efforts to withdraw from or materially modify international trade agreements, to change tax provisions related to global manufacturing and sales or to impose new tariffs, economic sanctions or related legislation, any of which could adversely affect our financial condition and results of operations.
Our business benefits directly and indirectly from free trade agreements, and we also rely on various U.S. corporate tax provisions related to international commerce, as we develop, market and sell our products and services globally. Efforts to withdraw from or materially modify international trade agreements, or to change corporate tax policy related to international commerce, could adversely affect our financial condition and results of operations as could the continuing uncertainty regarding whether such actions will be taken.
Moreover, efforts to implement changes related to export or import regulations (including the imposition of new border taxes or tariffs on foreign imports), trade barriers, economic sanctions and other related policies could harm our results of operations. For example, during 2018 and 2019 the United States imposed additional import tariffs on certain goods from different countries and on most of Chinese imported goods. As a result, China and other countries imposed retaliatory tariffs on goods exported from the United States and both the United States and foreign countries have threatened to alter or leave current trade agreements. While we do not currently expect these tariffs to have a significant effect on our raw material and product import costs, if the United States expands increased tariffs, or retaliatory trade measures are taken by China or other countries in response to the tariffs, the cost of our products could increase, our operations could be disrupted or we could be required to raise our prices, which may result in the loss of customers and harm to our reputation and operating performance.
Any modification in these areas, any shift in the enforcement or scope of existing regulations or any change in the countries, governments, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential end-customers with international operations and could result in increased costs. Any decreased use of our products or limitation on our ability to export or sell our products would likely adversely affect our business, financial condition and results of operations.
If we fail to comply with environmental requirements, our business, financial condition, operating results and reputation could be adversely affected.
We are subject to various environmental laws and regulations, including laws governing the hazardous material content of our products, laws relating to our real property and future expansion plans and laws concerning the recycling of electrical and electronic equipment. The laws and regulations to which we are subject include the EU RoHS Directive, EU Registration, Evaluation, Authorization and Restriction of Chemicals and the EU Waste Electrical and Electronic Equipment Directive (the “WEEE Directive”), as well as the implementing legislation of the EU member states. Similar laws and regulations have been passed or are pending in China, South Korea, Norway and Japan and may be enacted in other regions, including in the United States, and we are, or may in the future be, subject to these laws and regulations.
The EU RoHS Directive and the similar laws of other jurisdictions ban or restrict the presence of certain hazardous substances such as lead, mercury, cadmium, hexavalent chromium and certain fire-retardant plastic additives in electrical equipment, including our products. We have incurred costs to comply with these laws, including research and development costs, costs associated with assuring the supply of compliant components and costs associated with writing off scrapped noncompliant inventory. We expect to continue to incur costs related to environmental laws and regulations in the future. With respect to the EU RoHS, we and our competitors rely on exemptions for lead and other substances in network infrastructure equipment. It is possible one or more of these use exemptions will be revoked in the future. Additionally, although some of the EU RoHS exemptions have been extended, it is possible that some of these exemptions may expire in the future without being extended. If this exemption is revoked or expires without extension, if there are other changes to these laws (or their interpretation) or if new similar laws are passed in other jurisdictions, we may be required to re-engineer our products to use components compatible with these regulations. This re-engineering and component substitution could result in additional costs to us and/or disrupt our operations or logistics.common stock.
The EU has also adopted the WEEE Directive, which requires electronic goods producers to be responsible for the collection, recycling and treatment of such products. Although currently our EU international channel partners are responsible for the requirements of this directive as the importer of record in most of the European countries in which we sell our products, changes in interpretation of the regulations may cause us to incur costs or have additional regulatory requirements in the future to meet in order to comply with this directive, or with any similar laws adopted in other jurisdictions.
Our failure to comply with these and future environmental rules and regulations could result in reduced sales of our products, increased costs, substantial product inventory write-offs, reputational damage, penalties and other sanctions.
A portion of our revenue is generated by sales to government organizations, which are subject to a number of challenges and risks.
Sales to U.S. and foreign federal, state and local governmental agency end-customers have accounted for a portion of our revenue in past periods, and we may in the future increase sales to government organizations. Sales to government organizations are subject to a number of risks. Selling to government organizations can be highly competitive, expensive and time consuming, often requiring significant upfront time and expense, with long sales cycles and without any assurance of winning a sale.
Government demand, sales and paymentprices for our products and services may be negatively impacted by numerousdecline for a variety of reasons or our product mix may change, resulting in lower growth and margins based on a number of factors, including competitive pricing pressures, discounts or promotional programs we offer, a change in our mix of products and requirements unique to selling to government agencies, such as:
public sector budgetary cycles;
funding authorizationsservices and requirements unique to government agencies, with funding or purchasing reductions or delays adversely affecting public sector demand for our products;
geopolitical matters, including tariff and trade disputes, Brexit and government shutdowns; and
rules and regulations applicable to certain government sales, including GSA regulations.
The rules and regulations applicable to sales to government organizations may also negatively impact sales to other organizations. To date, we have had limited traction in sales to U.S. federal government agencies, and any future sales to government organizations is uncertain. Government organizations may have contractual or other legal rights to terminate contracts with our distributors and resellers for convenience or due to a default, and any such termination may adversely impact our future results of operations. For example, if the distributor receives a significant portion of its revenue from sales to such government organization, the financial healthanticipation of the distributor could be substantially harmed, which could negatively affect our future salesintroduction of new products and services. Competition continues to such distributor. Governments routinely investigate, review and audit government vendors’ administrative and other processes, and any unfavorable investigation, audit or other review could resultincrease in the government’s refusingmarket segments in which we participate, and we expect competition to continue buyingfurther increase in the future, thereby leading to increased pricing pressures. Larger competitors with more diverse product offerings may reduce the price of products and services that compete with ours in order to promote the sale of other products or services or may bundle them with other products or services. Additionally, although we price our products and services a reduction of revenue or fines, or civil or criminal liability if the investigation, audit or other review uncovers improper, illegal or otherwise concerning activities. Any such penalties could adversely impact our results of operationsworldwide in a material way. Finally, purchases by the U.S. government may requiredollars, currency fluctuations in certain products to be manufacturedcountries and regions have in the United Statespast, and other high cost manufacturing locations,may in the future, negatively impact actual prices that partners and customers are willing to pay in those countries and regions. Furthermore, we may not manufacture allanticipate that the sales prices and gross profits for our products or services will decrease over product life cycles. We cannot ensure that we will be successful in locationsdeveloping and introducing new offerings with enhanced functionality on a timely basis, or that meet the requirements of the U.S. government.our product and service offerings, if introduced, will enable us to maintain our prices, gross profits and operating margin at levels that will allow us to maintain profitability.
False detection ofActual, possible or perceived defects, errors or vulnerabilities viruses or security breaches or false identification of spam or spyware could adversely affect our business.
Our FortiGuard security subscription services may falsely detect, report and act on viruses or other threats that do not actually exist. This risk is heightened by the inclusion of a “heuristics” feature in our products which attempts to identify viruses and other threats not based on any known signatures but based on characteristics or anomalies that may indicate that a particular item is a threat. When our end-customers enableservices, the heuristics feature in our products, the risk of falsely identifying viruses and other threats significantly increases. These false positives, while typical in the industry, may impair the perceived reliabilityfailure of our products and may therefore adversely impact market acceptanceor services to detect or prevent a security breach or the misuse of our products. Also, our FortiGuard security subscription services may falsely identify emails or programs as unwanted spam or potentially unwanted programs, or alternatively fail to properly identify unwanted emails or programs, particularly as spam emails or spyware are often designed to circumvent anti-spam or spyware products. Parties whose emails or programs are blocked by our products may seek redress against us for labeling them as spammers or spyware, or for interfering with their business. In addition, false identification of emails or programs as unwanted spam or potentially unwanted programs may reduce the adoption of our products. If our system restricts important files or applications based on falsely identifying them as malware or some other item that should be restricted, this could adversely affect end-customers’ systems and cause material system failures. In addition, our threat researchers periodically identify vulnerabilities in various third-party products, and, if these identifications are perceived to be incorrect or are in fact incorrect, this could harm our business. Any such false identification or perceived false identification of important files, applications or vulnerabilities could result in negative publicity, loss of end-customersoperational results and sales, increased costs to remedy any problem and costly litigation.reputation.
Our ability to sell our products is dependent on the quality of our technical support services, and our failure to offer high-quality technical support services would have a material adverse effect on our sales and results of operations.
Once our products are deployed within our end-customers’ networks, our end-customers depend on our technical support services, as well as the support of our channel partners and other third parties, to resolve any issues relating to our products. If we, our channel partners or other third parties do not effectively assist our customers in planning, deploying and operational proficiency for our products, succeed in helping our customers quickly resolve post-deployment issues and provide effective ongoing support, our ability to sell additional products and services to existing customers would be adversely affected and our reputation with potential customers could be damaged. Many large end-customers, and service provider or government organization end-customers, require higher levels of support than smaller end-customers because of their more complex deployments and more demanding environments and business models. If we, our channel partners or other third parties fail to meet the requirements of our larger end-customers, it may be more difficult to execute on our strategy to increase our penetration with large businesses, service providers and government organizations. Our failure to maintain high-quality support services would have a material adverse effect on our business, financial condition and results of operations and may subject us to litigation, reputational damage, loss of customers and additional costs.
We could be subject to changes in our tax rates, the adoption of new U.S. or international tax legislation or exposure to additional tax liabilities.
We are subject to taxes in the United States and numerous foreign jurisdictions, where a number of our subsidiaries are organized. Our provision for income taxes is subject to volatility and could be adversely affected by several factors, many of which are outside of our control. These include:
the mix of earnings in countries with differing statutory tax rates or withholding taxes;
changes in the valuation of our deferred tax assets and liabilities;
transfer pricing adjustments;
an increase in non-deductible expenses for tax purposes, including certain stock-based compensation expense;
tax costs related to intercompany realignments;
tax assessments resulting from income tax audits or any related tax interest or penalties that could significantly affect our provision for income taxes for the period in which the settlement takes place; and
changes in accounting principles, court decisions, tax rulings, and interpretations of or changes to tax laws, and regulations by international, federal or local governmental authorities.
We have open tax years that could be subject to the examination by the Internal Revenue Service (the “IRS”) and other tax authorities. We currently have ongoing tax audits in the United Kingdom, Canada and several other foreign jurisdictions. The focus of all of these audits is the allocation of profit between our legal entities. We regularly assess the likelihood of adverse outcomes resulting from such examinations to determine the adequacy of our provision for income taxes. Although we believe that our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our consolidated financial statements and may materially affect our financial results.
On June 7, 2019, the Ninth Circuit issued an opinion in Altera Corporation and Subsidiaries vs. Commissioner of Internal Revenue that reversed the Tax Court Decision in favor of the IRS. This ruling stated the IRS rule that stock compensation must be included in cost sharing was valid. Based on this decision, in second quarter of 2019, we recorded a reserve for uncertain tax positions for this potential tax liability. On February 10, 2020, the Ninth Circuit decision was appealed to the Supreme Court of the United States. We will continue to monitor and assess the impact as this case moves forward.
We may undertake corporate operating restructurings or transfers of assets that involve our group of foreign country subsidiaries through which we do business abroad, in order to maximize the operational and tax efficiency of our group structure. If ineffectual, such restructurings or transfers could increase our income tax liabilities, and in turn, increase our global effective tax rate. Moreover, our existing corporate structure and intercompany arrangements have been implemented in a manner that we believe is in compliance with current prevailing tax laws. However, the tax authorities of the jurisdictions in which we operate may challenge our methodologies for valuing developed technology or intercompany arrangements, which could impact our worldwide effective tax rate and harm our financial position and operating results.
Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable income and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.
Forecasting our estimated annual effective tax rate is complex, and subject to uncertainty, and there may be material differences between our forecasted and actual tax rates.
Forecasts of our income tax position and effective tax rate are complex, subject to uncertainty and periodic updates because our income tax position for each year combines the effects of a mix of profits earned and losses incurred by us in various tax jurisdictions with a broad range of income tax rates, as well as changes in the valuation of deferred tax assets and liabilities, the impact of various accounting rules and changes to these rules and tax laws, the results of examinations by various tax authorities, and the impact of any acquisition, business combination or other reorganization or financing transaction. To forecast our global tax rate, we estimate our pre-tax profits and losses by jurisdiction and forecast our tax expense by jurisdiction. If the mix of profits and losses, our ability to use tax credits or effective tax rates in a given jurisdiction differs from our estimate, our actual tax rate could be materially different than forecasted, which could have a material impact on our results of business, financial condition and results of operations. Additionally, our actual tax rate may be subject to further uncertainty due to potential changes in U.S. and foreign tax rules.
As a multinational corporation, we conduct our business in many countries and are subject to taxation in many jurisdictions. The taxation of our business is subject to the application of multiple and sometimes conflicting tax laws and regulations, as well as multinational tax conventions. Our effective tax rate is highly dependent upon the geographic distribution of our worldwide earnings or losses, the tax regulations and tax holidays in each geographic region, the availability of tax credits and carryforwards and the effectiveness of our tax planning strategies. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws themselves are subject to change as a result of changes in fiscal policy, changes in legislation and the evolution of regulations and court rulings. Consequently, tax authorities may impose tax assessments or judgments against us that could materially impact our tax liability and/or our effective income tax rate.
The Organisation for Economic Co-operation and Development (the “OECD”), an international association comprised of 36 countries, including the United States, has issued and continues to issue guidelines and proposals that change various aspects of the existing framework under which our tax obligations are determined in many of the countries in which we do business. Due to our extensive international business activities, any changes in the taxation of such activities could increase our tax obligations in many countries and may increase our worldwide effective tax rate.
Our inability to acquire and integrate other businesses, products or technologies could seriously harm our competitive position.
In order to remain competitive, we may seek to acquire additional businesses, products, technologies or intellectual property, such as patents. For example, we closed our acquisitions of enSilo and CyberSponse in the fourth quarter of 2019. For any possible future acquisitions, we may not be successful in negotiating the terms of the acquisition or financing the acquisition. For both our prior and future acquisitions, we may not be successful in effectively integrating the acquired business, product, technology or intellectual property and sales force into our existing business and operations. We may have difficulty incorporating acquired technologies, intellectual property or products with our existing product lines, integrating reporting systems and procedures, and maintaining uniform standards, controls, procedures and policies. For example, we may experience difficulties integrating an acquired company’s ERP or CRM systems, sales support and other processes and systems, with our current systems and processes. Our due diligence may fail to identify all of the problems, liabilities or other shortcomings or challenges of an acquired business, product or technology, including issues with intellectual property, product quality or product architecture, regulatory compliance practices, revenue recognition or other accounting practices or employee or customer issues, and we may not accurately forecast the financial impact of an acquisition. In addition, any acquisitions we are able to complete may be dilutive to revenue growth and earnings and may not result in any synergies or other benefits we had expected to achieve, which could result in impairment charges that could be substantial. We may have to pay cash, incur debt or issue equity securities to pay for any acquisition, each of which could affect our financial condition or the value of our capital stock and could result in dilution to our stockholders. Acquisitions during a quarter may result in increased operating expenses and adversely affect our results of operations for that period or future periods compared to the results that we have previously forecasted or achieved. Further, completing a potential acquisition and integrating acquired businesses, products, technologies or intellectual property could significantly divert management time and resources.
Our business is subject to the risks of warranty claims, product returns, product liability and product defects.
Our products are very complex and, despite testing prior to their release,they have contained and may contain undetected defects, errors or vulnerabilities that are not detected until after their commercial release and deployment by our customers. Defects, errors especially when first introduced or when new versionsvulnerabilities may impede or block network traffic, cause our products or services to be vulnerable to electronic break-ins, cause them to fail to help secure our customers or cause our products or services to allow unauthorized access to our customers’ networks. Our Product Security Incident Response Team publicly posts on our FortiGuard Labs website known product vulnerabilities, including critical vulnerabilities, and methods for customers to mitigate the risk of vulnerabilities. However, there can be no assurance that such posts will be sufficiently timely or complete or those customers will take steps to mitigate the risk of vulnerabilities, and certain customers may be negatively impacted.Additionally, any perception that our products have vulnerabilities, whether or not accurate, and any actual vulnerabilities may harm our operational results and reputation, more significantly as compared to certain other companies because we are released. Producta security company. Our products are also susceptible to errors, have affecteddefects, logic flaws, vulnerabilities and inserted vulnerabilities that may arise in, or be included in our products in, different stages of our supply chain, manufacturing and shipment processes, and a threat actor’s exploitation of these weaknesses may be difficult to anticipate, prevent, and detect. If we are unable to maintain an effective supply chain security risk management and products security program, then the performancesecurity and effectivenessintegrity of our products and the updates to those products that our customers receive could delaybe exploited by third parties or insiders. Different customers deploy and use our products in different ways, and certain deployments and usages may subject our products to adverse conditions that may negatively impact the developmenteffectiveness and useful lifetime of our products. Our networks and products, including cloud-based technology, could be targeted by attacks specifically designed to disrupt our business and harm our operational results and reputation. We cannot ensure that our products will prevent all adverse security events. Because the techniques used by malicious adversaries to access or releasesabotage networks change frequently and generally are not recognized until launched against a target, we may be unable to anticipate these techniques. In addition, defects or errors in our FortiGuard and other security subscription or FortiCare updates or our Fortinet appliances and operating systems could result in a failure of our FortiGuard and other security subscription services to effectively update end-customers’ Fortinet appliances and cloud-based products and thereby leave customers vulnerable to attacks. Furthermore, our solutions may also fail to detect or prevent viruses, worms, ransomware attacks or similar threats due to a number of reasons such as the evolving nature of such threats and the continual emergence of new threats that we may fail to add to our FortiGuard databases in time to protect our end-customers’ networks. Our data centers and networks and those of our hosting vendors and cloud service providers, may also experience technical failures and downtime, and may fail to distribute appropriate updates, or fail to meet the increased requirements of our customer base. Any such technical failure, downtime or failures in general may temporarily or permanently expose our end-customers’ networks, leaving their networks unprotected against the latest security threats.
An actual, possible or perceived security breach or infection of the network of one of our end-customers, regardless of whether the breach is attributable to the failure of our products or new versions of products,services to prevent the security breach, or any actual or perceived security risk in our supply chain, could adversely affect our reputation and our end-customers’ willingness to buy products from us, result in litigation and disputes with customers and adversely affect market acceptance orthe market’s perception of our products. Any such errors or delays in releasing new products or new versions of products or allegations of unsatisfactory performance could cause us to lose revenue or market share, increase our service costs, cause us to incur substantial costs in redesigning the products, cause us to lose significant end-customers, subject us to litigation, litigation costs and liability for damages and divert our resources from other tasks, any one of which could materially and adversely affect our business, results of operations and financial condition. Our products must successfully interoperate with products from other vendors. As a result, when problems occur in a network, it may be difficult to identify the sources of these problems. The occurrence of hardware and software errors, whether or not caused by our products, could delay or reduce market acceptance of oursecurity products and have an adverse effect on our businessservices, cause customers and financial performance, and any necessary revisions may causecustomer prospects not to buy from us to incur significant expenses. The occurrence of any such problems could harm our business, financial condition and results of operations.
Although we generally have limitation of liability provisions in our standard terms and conditions of sale, they may not fully or effectively protect us from claims if exceptions apply or if the provisions are deemed unenforceable, and, in some circumstances we may be required to indemnify a customer in full, without limitation, for certain liabilities, including liabilities that are not contractually limited. The sale and support of our products also entail the risk of product liability claims. We maintain insurance to protect against certain claims associated with the use of our products, but our insurance coverage may not adequately cover any claim asserted against us, if at all, and in some instances, may subject us to potential liability that is not contractually limited. In addition, even claims that ultimately are unsuccessfulWe may not be able to correct any security flaws or vulnerabilities promptly, or at all. Our products may also be misused or misconfigured by end-customers or third parties who obtain access to our products. For example, our products could be used to censor private access to certain information on the internet. Such use of our products for censorship could result in our expenditure of funds in litigationnegative press coverage and divert management’s time and other resources.
Our business is subject to the risks of earthquakes, fire, power outages, typhoon, floods, virus outbreaks and other broad health-related challenges and other catastrophic events, and to interruption by manmade problems such as civil unrest, labor disruption, critical infrastructure attack and terrorism.
A significant natural disaster, such as an earthquake, fire, power outage, flood, viral outbreak or other catastrophic event, could have a material adverse impact on our business, operating results and financial condition. Our corporate headquarters are located in the San Francisco Bay Area, a region known for seismic activity, and our research and development and data center in Burnaby, Canada, from which we deliver to customers our FortiGuard security subscription updates, is subject to the risk of flooding and is also in a region known for seismic activity. Any earthquake in the Bay Area or Burnaby, or
flooding in Burnaby, could materially negatively impact our ability to provide products and services, such as FortiCare support and FortiGuard subscription services and could otherwise materially negatively impact our business. In addition, natural disasters could affect our manufacturing vendors, suppliers or logistics providers’ abilityreputation, even if we take reasonable measures to perform services, such as obtaining product components and manufacturing products, or performing or assisting with shipments, on a timely basis, as well as our customers’ ability to order from us and our employees’ ability to perform their duties. For example, a typhoon in Taiwan could materially negatively impact our ability to ship products and could result in delays in billings and revenues, and the coronavirus outbreak could materially negatively impact our ability to manufacture and ship products. In the event our or our service providers’ information technology systems or manufacturing or logistics abilities are hindered byprevent any of the events discussed above, shipments could be delayed, resulting in our missing financial targets, such as revenue and shipment targets, for a particular quarter. In addition, regional instability, civil unrest, labor disruptions, acts of terrorism and other geo-political unrest could cause disruptions in our business or the business of our manufacturers, logistics providers, partners or end-customers, or of the economy as a whole. Given our typical concentration of sales at the end of each quarter, any disruption in the business of our manufacturers, logistics providers, partners or end-customers that impacts sales at the end of our quarter could have a significant adverse impact on our quarterly results. To the extent that any of the above results in security risks to our customers, delays or cancellations of customer orders, the delay of the manufacture, deployment orimproper shipment of our products or interruptionif our products are provided by an unauthorized third party. Any actual, possible or downtimeperceived defects, errors or vulnerabilities in our products, or misuse of our services,products, could result in:
•the expenditure of significant financial and product development resources in efforts to analyze, correct, eliminate or work around errors or defects or to address and eliminate vulnerabilities;
•the loss of existing or potential end-customers or channel partners;
•delayed or lost revenue;
•delay or failure to attain market acceptance;
•negative publicity and harm to our business, financial conditionreputation; and results of operations would
•litigation, regulatory inquiries or investigations that may be adversely affected.costly and harm our reputation and, in some instances, subject us to potential liability that is not contractually limited.
Risks Related to Our Industry
The network security market is rapidly evolving and the complex technology incorporated in our products makes them difficult to develop. If we do not accurately predict, prepare for and respond promptly to technological and market developments and changing end-customer needs, our competitive position and prospects may be harmed.
The network security market is expected to continue to evolve rapidly. Moreover, many of our end-customers operate in markets characterized by rapidly changing technologies and business plans, which require them to add numerous network access points and adapt increasingly complex networks, incorporating a variety of hardware, software applications, operating systems and networking protocols. In addition, computer hackers and others who try to attack networks employ increasingly sophisticated techniques to gain access to and attack systems and networks. The technology in our products is especially complex because it needs to effectively identify and respond to new and increasingly sophisticated methods of attack, while minimizing the impact on network performance. Additionally, some of our new products and enhancements may require us to develop new hardware architectures and ASICs that involve complex, expensive and time-consuming research and development processes. For example, we enter into development agreements with third parties. If our contract development projects are not successfully completed, or are not completed in a timely fashion, our product development could be delayed and our business generally could suffer. Costs for contract development can be substantial and our profitability may be harmed if we are unable to recover these costs. Although the market expects rapid introduction of new products or product enhancements to respond to new threats, the development of these products is difficult and the timetable for commercial release and availability is uncertain and there can be long time periods between releases and availability of new products. We have in the past and may in the future experience unanticipated delays in the availability of new products and services and fail to meet previously announced timetables for such availability. If we do not quickly respond to the rapidly changing and rigorous needs of our end-customers by developing, and releasing and making available on a timely basis new products and services or enhancements that can respond adequately to new security threats, our competitive position and business prospects may be harmed.
Moreover, business models based on a subscription SaaS, either hosted or cloud-based services, have become increasingly in-demand by our end-customers and adopted by other providers, including our competitors. While we have introduced additional cloud-based products and services and will continue to do so, most of our platform is currently deployed on premise, and therefore, if customers demand that our platform be provided through a subscription SaaS business model, we would be required to make additional investments in our infrastructure and personnel to be able to more fully provide our platform through a subscription SaaS model in order to maintain the competitiveness of our platform. Such investments may involve expanding our data centers, servers and networks, and increasing our technical operations and engineering teams. These risks are compounded by the uncertainty concerning the future viabilitysuccess of any of our particular subscription SaaS business models and the future demand for suchour subscription SaaS models by customers. Additionally, if we are unable to meet the demand to provide our services through a subscription SaaS model, we may lose customers to competitors.
Our uniform resource locator (“URL”) database for our web filtering service may fail to keep pace with the rapid growth of URLs and may not categorize websites in accordance with our end-customers’ expectations.
The success of our web filtering service depends on the breadth and accuracy of our URL database. Although our URL database currently catalogs millions of unique URLs, it contains only a portion of the URLs for all of the websites that are
available on the internet. In addition, the total number of URLs and software applications is growing rapidly, and we expect this rapid growth to continue in the future. Accordingly, we must identify and categorize content for our security risk categories at an extremely rapid rate. Our database and technologies may not be able to keep pace with the growth in the number of websites, especially the growing amount of content utilizing foreign languages and the increasing sophistication of malicious code and the delivery mechanisms associated with spyware, phishing and other hazards associated with the internet. Further, the ongoing evolution of the internet and computing environments will require us to continually improve the functionality, features and reliability of our web filtering function. Any failure of our databases to keep pace with the rapid growth and technological change of the internet could impair the market acceptance of our products, which in turn could harm our business, financial condition and results of operations.
In addition, our web filtering service may not be successful in accurately categorizing internet and application content to meet our end-customers’ expectations. We rely upon a combination of automated filtering technology and human review to categorize websites and software applications in our proprietary databases. Our end-customers may not agree with our determinations that particular URLs should be included or not included in specific categories of our databases. In addition, it is possible that our filtering processes may place material that is objectionable or that presents a security risk in categories that are generally unrestricted by our customers’ internet and computer access policies, which could result in such material not being blocked from the network. Conversely, we may miscategorize websites such that access is denied to websites containing information that is important or valuable to our customers. Any miscategorization could result in customer dissatisfaction and
harm our reputation. Any failure to effectively categorize and filter websites according to our end-customers’ and channel partners’ expectations could impair the growth of our business.
False detection of vulnerabilities, viruses or security breaches or false identification of spam or spyware could adversely affect our business.
Our FortiGuard and other security subscription services may falsely detect, report and act on viruses or other threats that do not actually exist. This risk is heightened by the inclusion of a “heuristics” feature in our products, which attempts to identify viruses and other threats not based on any known signatures but based on characteristics or anomalies that may indicate that a particular item is a threat. When our end-customers enable the heuristics feature in our products, the risk of falsely identifying viruses and other threats significantly increases. These false positives, while typical in the industry, may impair the perceived reliability of our products and may therefore adversely impact market acceptance of our products. Also, our FortiGuard and other security subscription services may falsely identify emails or programs as unwanted spam or potentially unwanted programs, or alternatively fail to properly identify unwanted emails or programs, particularly as spam emails or spyware are often designed to circumvent anti-spam or spyware products. Parties whose emails or programs are blocked by our products may seek redress against us for labeling them as spammers or spyware, or for interfering with their business. In addition, false identification of emails or programs as unwanted spam or potentially unwanted programs may reduce the adoption of our products. If our newsystem restricts important files or applications based on falsely identifying them as malware or some other item that should be restricted, this could adversely affect end-customers’ systems and cause material system failures. In addition, our threat researchers periodically identify vulnerabilities in various third-party products, and, product enhancementsif these identifications are perceived to be incorrect or are in fact incorrect, this could harm our business. Any such false identification or perceived false identification of important files, applications or vulnerabilities could result in negative publicity, loss of end-customers and sales, increased costs to remedy any problem and costly litigation.
Our ability to sell our products is dependent on our quality control processes and the quality of our technical support services, and our failure to offer high-quality technical support services would have a material adverse effect on our sales and results of operations.
Once our products are deployed within our end-customers’ networks, our end-customers depend on our technical support services, as well as the support of our channel partners and other third parties, to resolve any issues relating to our products. If we, our channel partners or other third parties do not achieve sufficient market acceptance,effectively assist our customers in planning, deploying and operational proficiency for our products, succeed in helping our customers quickly resolve post-deployment issues and provide effective ongoing support, our ability to sell additional products and services to existing customers could be adversely affected and our reputation with potential customers could be damaged. Many large end-customers, and service provider or government organization end-customers, require higher levels of support than smaller end-customers because of their more complex deployments and more demanding environments and business models. If we, our channel partners or other third parties fail to meet the requirements of our larger end-customers, it may be more difficult to execute on our strategy to increase our penetration with large businesses, service providers and government organizations. Our failure to maintain high-quality support services would have a material adverse effect on our business, financial condition and results of operations and competitive position will suffer.may subject us to litigation, reputational damage, loss of customers and additional costs.
We spend substantial amountsOur business is subject to the risks of timewarranty claims, product returns, product liability and moneyproduct defects.
Our products are very complex and, despite testing prior to acquiretheir release, have contained and develop internallymay contain undetected defects or errors, especially when first introduced or when new versions are released. Product errors have affected the performance and effectiveness of our products and enhanced versionscould delay the development or release of our existing products in order to incorporate additional features, improved functionality or other enhancements in order to meet our customers’ rapidly evolving demands for network security in our highly competitive industry. When we develop a new product or an enhanced version of an existing product, we typically incur expenses and expend resources upfront to market, promote and sell the new offering. Therefore, when we develop and introduce new or enhanced products, they must achieve high levels of market acceptance in order to justify the amount of our investment in developing and bringing them to market.
Our new products or product enhancements could failnew versions of products, adversely affect our reputation and our end-customers’ willingness to attain sufficientbuy products from us, result in litigation and disputes with customers and adversely affect market acceptance for many reasons, including:
or perception of our products. Any such errors or delays in releasing our new products or enhancementsnew versions of products or allegations of unsatisfactory performance could cause us to lose revenue or market share, increase our service costs, cause us to incur substantial costs in redesigning the market;
failureproducts, cause us to accurately predict market demand in termslose significant end-customers, subject us to litigation, litigation costs and liability for damages and divert our resources from other tasks, any one of product functionalitywhich could materially and to supplyadversely affect our business, results of operations and financial condition. Our products that meet this demandmust successfully interoperate with products from other vendors. As a result, when problems occur in a timely fashion;
failurenetwork, it may be difficult to haveidentify the appropriate researchsources of these problems. The occurrence of hardware and development expertise and focus to makesoftware errors, whether or not caused by our top strategic fabric products, successful;
failurecould delay or reduce market acceptance of our sales forceproducts and partners to focus on selling new products;
inability to interoperate effectively with the networks or applications of our prospective end-customers;
inability to protect against new types of attacks or techniques used by hackers;
actual or perceived defects, vulnerabilities, errors or failures;
negative publicity about their performance or effectiveness;
introduction or anticipated introduction of competing products by our competitors;
poor business conditions for our end-customers, causing them to delay IT purchases;
changes to the regulatory requirements around security; and
reluctance of customers to purchase products incorporating open source software.
If our new products or enhancements do not achieve adequate acceptance in the market, our competitive position will be impaired, our revenue will be diminished and thehave an adverse effect on our operating resultsbusiness and financial performance, and any necessary revisions may be particularly acute becausecause us to incur significant expenses. The occurrence of the significant research, development, marketing, sales and other expenses we incurred in connection with the new product or enhancement.
Demand for our products may be limited by market perception that individual products from one vendor that provide multiple layers of security protection in one product are inferior to point solution network security solutions from multiple vendors.
Sales of many of our products depend on increased demand for incorporating broad security functionality into one appliance. If the market for these products fails to grow as we anticipate, our business will be seriously harmed. Target customers may view “all-in-one” network security solutions as inferior to security solutions from multiple vendors because of, among other things, their perception thatany such products of ours provide security functions from only a single vendor and do not allow users to choose “best-of-breed” defenses from among the wide range of dedicated security applications available. Target customers might also perceive that, by combining multiple security functions into a single platform, our solutions create a “single point of failure” in their networks, which means that an error, vulnerability or failure of our product may place the entire network at risk. In addition, the market perception that “all-in-one” solutions may be suitable only for small and medium-sized businesses because such solution lacks the performance capabilities and functionality of other solutions may harm our sales to large businesses, service provider and government organization end-customers. If the foregoing concerns and perceptions become prevalent, even if there is no factual basis for these concerns and perceptions, or if other issues arise with our market in general, demand for multi-security functionality productsproblems could be severely limited, which would limit our growth and harm our business, financial condition and results of operations. Further,
Although we generally have limitation of liability provisions in our standard terms and conditions of sale, they may not fully or effectively protect us from claims if exceptions apply or if the provisions are deemed unenforceable, and in some circumstances we may be required to indemnify a successfulcustomer in full, without limitation, for certain liabilities, including liabilities that are not contractually limited. The sale and publicized targeted attacksupport of our products also entail the risk of product liability claims. We maintain insurance to protect against certain claims associated with the use of our products, but our insurance coverage may not adequately cover any claim asserted against us, exposing a “single pointif at all, and in some instances may subject us to potential liability that is not contractually limited. In addition, even claims that ultimately are unsuccessful could result in our expenditure of failure,” could significantly increase these concernsfunds in litigation and perceptionsdivert management’s time and other resources.
Risks Related to our Systems and Technology
If our internal enterprise IT networks, on which we conduct internal business and interface externally, our operational networks, through which we connect to customers, vendors and partners systems and provide services, or our research and development networks, our back-end labs and cloud stacks hosted in our data centers, colocation vendors or public cloud providers, through which we research, develop and host products and services, are compromised, public perception of our products and services may harmbe harmed, our customers may be breached and harmed, we may become subject to liability, and our business, operating results and results of operations.stock price may be adversely impacted.
We face intense competitionOur success depends on the market’s confidence in our marketability to provide effective network security protection. Despite our efforts and processes to prevent breaches of our internal networks, systems and websites, we are still vulnerable to computer viruses, break-ins, phishing attacks, ransomware attacks, attempts to overload our servers with denial-of-service, vulnerabilities in vendor hardware and software that we leverage, advanced persistent threats from sophisticated actors and other cyber-attacks and similar disruptions from unauthorized access to our internal networks, systems or websites. Our security measures may lack sufficient financialalso be breached due to employee error, malfeasance or other resourcesotherwise, which breaches may be more difficult to maintaindetect than outsider threats, and the existing programs and trainings we have in place to prevent such insider threats may not be effective or improvesufficient. Third parties may also attempt to fraudulently induce our competitive position.
The market foremployees to transfer funds or disclose information in order to gain access to our networks and confidential information. Third parties may also send our customers or others malware or malicious emails that falsely indicate that we are the source, potentially causing lost confidence in us and reputational harm. We cannot guarantee that the measures we have taken to protect our networks, systems and websites will provide adequate security. Moreover, because we provide network security products, is intensely competitivewe may be a more attractive target for attacks by computer hackers and we expect competition to intensify in the future. We face many competitors across the different cybersecurity markets. Our competitors include companies such as Barracuda, Check Point, Cisco, CrowdStrike, F5 Networks, FireEye, Forcepoint, Imperva, Juniper, McAfee, Palo Alto Networks, Proofpoint, SonicWALL, Sophos, Trend Micro and Zscaler.
Many of our existing and potential competitors enjoy substantial competitive advantages such as:
greater name recognition and longer operating histories;
larger sales and marketing budgets and resources;
broader distribution and established relationships with distribution partners and end-customers;
access to larger customer bases;
greater customer support resources;
greater resources to make acquisitions;
lower labor and development costs; and
substantially greater financial, technicalany security breaches and other resources.
In addition, some ofsecurity incidents involving us may result in more harm to our larger competitors have substantially broader product offerings,reputation and leverage their relationships based on other products or incorporate functionality into existing products in a mannerbrand than companies that discourages customers from purchasing our products. These larger competitors often have broader product linesdo not sell network security solutions. Hackers and market focus, and are in a better position to withstand any significant reduction in capital spending by end-customers in these markets. Therefore, these competitors will not be as susceptible to downturns in a particular market. Also, many of our smaller competitors that specialize
in providing protection from a single type of security threat are often able to deliver these specialized security products to the market more quickly than we can.
Conditions in our markets could change rapidly and significantly as a result of technological advancements or continuing market consolidation. Our competitors and potential competitorsmalicious parties may also be able to develop and deploy viruses, worms, ransomware and other malicious software programs that attack our products and customers, that impersonate our update servers in an effort to access customer networks and negatively impact customers, or otherwise exploit any security vulnerabilities of our products, or attempt to fraudulently induce our employees, customers or others to disclose passwords or other sensitive information or unwittingly provide access to our internal networks, systems or data.
For example, from time to time, we have discovered that unauthorized parties have targeted us using sophisticated techniques, including by stealing technical data and attempting to steal private encryption keys, in an effort to both impersonate our products and threat intelligence update services and leverage new business models,possibly attempt other attack methodologies. Using these techniques, these unauthorized parties have tried, and may in the future try, to gain access to certain of our and our customers’ systems. We have also, for example, discovered that are equalunauthorized parties have targeted vulnerabilities in our product software and infrastructure in an effort to gain entry into our customers’ networks. In addition, in general threat actors use dark web forums to sell organizations’ stolen credentials. If threat actors sell valid credentials used by our customers to access our services, it is possible that unauthorized third parties may use such stolen credentials to try to gain access to our services. These and other hacking efforts against us and our customers may be ongoing and may happen in the future.
Although we take numerous measures and implement multiple layers of security to protect our networks, we cannot guarantee that our security products, processes and services will secure against all threats. Further, we cannot be sure that third parties have not been, or superior to ours, achieve greaterwill not in the future be, successful in improperly accessing our systems and our customers’ systems, which could negatively impact us and our customers. An actual breach could significantly harm us and our customers, and an actual or perceived breach, or any other actual or perceived data security incident, threat or vulnerability, that involves our supply chains, networks, systems or websites and/or our customers’ supply chains, networks, systems or websites could adversely affect the market acceptanceperception of theirour products and services and increase sales by utilizing different distribution channels than we do. For example, certaininvestor confidence in our company. Any breach of our competitors are focusing on deliveringnetworks, systems or websites could impair our ability to operate our business, including our ability to provide FortiGuard and other security subscription and FortiCare technical support services fromto our end-customers, lead to interruptions or system slowdowns, cause loss of critical data or lead to the cloud. In addition, currentunauthorized disclosure or potential competitorsuse of confidential, proprietary or sensitive information. We could also be subject to liability and litigation and reputational harm and our channel partners and end-customers may be acquired by third parties with greater available resources,harmed, lose confidence in us and new competitors may arise pursuant to acquisitions of network security companiesdecrease or divisions. As a result of such acquisitions, competition in our market may continue to increase and our current or potential competitors might be able to adapt more quickly to new technologies and customer needs, devote greater resources to the promotion or sale of their products and services, initiate or withstand substantial price competition, take advantage of acquisition or other opportunities more readily, or develop and expand their product and service offerings more quickly than we do. In addition, our competitors may bundle products and services competitive with ours with other products and services. Customers may accept these bundled products and services rather than separately purchasingcease using our products and services. AsAny breach of our customers refresh the security products bought in prior years, they may seek to consolidate vendors, which may result in current customers choosing to purchase products from our competitors on an ongoing basis. Due to budget constraintsinternal networks, systems or economic downturns, organizations may be more willing to incrementally add solutions to their existing network security infrastructure from competitors than to replace it with our solutions. These competitive pressures in our market or our failure to compete effectively may result in price reductions, fewer customer orders, reduced revenue and gross margins and loss of market share.
If functionality similar to that offered by our products is incorporated into existing network infrastructure products, organizations may decide against adding our appliances to their network, which wouldwebsites could have an adverse effect on our business.business, operating results and stock price.
In addition, there has been a general increase in phishing attempts and spam emails as well as social engineering attempts from hackers, and many of our employees continue to work remotely which may pose additional data security risks in the event remote work environments are not as secure as office environments. Any security breach could negatively impact our reputation and results of operations.
If we do not appropriately manage any future growth, including through the expansion of our real estate facilities, or are unable to improve our systems, processes and controls, our operating results will be negatively affected.
Large, well-established providers of networking equipmentWe rely heavily on information technology to help manage critical functions such as Cisco, F5 Networksorder configuration, pricing and Juniper offer,quoting, revenue recognition, financial forecasts, inventory and supply chain management and trade compliance reviews. In addition, we have been slow to adopt and implement certain automated functions, which could have a negative impact on our business. For example, a large part of our order processing relies on manual data entryof customer purchase orders received through email and, to a lesser extent, through electronic data interchange from our customers. Due to the use of manual processes and the fact that we may receive a large amount of our orders in the last few weeks of any given quarter, an interruption in our email service or other systems could result in delayed order fulfillment and decreased billings and revenue for that quarter.
To manage any future growth effectively, we must continue to introduce, networkimprove and expand our information technology and financial, operating, security features that compete withand administrative systems and controls, and our products, eitherbusiness continuity and disaster recovery plans and processes. We must also continue to manage headcount, capital and processes in standalonean efficient manner. We may not be able to successfully implement requisite improvements to these systems, controls and processes, such as system capacity, access, security productsand change management controls, in a timely or efficient manner. Our failure to improve our systems and processes, or their failure to operate in the intended manner, whether as additional featuresa result of the significant growth of our business or otherwise, may result in their network infrastructure products. The inclusionour inability to manage the growth of our business and to accurately forecast our revenue, expenses and earnings, or to prevent certain losses. Moreover, the announcementfailure of an intent to include, functionality perceived to be similar to that offered by our security solutions in networking products that are already generally accepted as necessary components of network architecture may have an adverse effect onsystems and processes could undermine our ability to marketprovide accurate, timely and sellreliable reports on our products. Furthermore, even iffinancial and operating results and could impact the functionality offered by network infrastructure providers is more limited thaneffectiveness of our internal control over financial reporting.
In addition, our systems, processes and controls may not prevent or detect all errors, omissions, malfeasance or fraud, such as corruption and improper “side agreements” that may impact revenue recognition or result in financial liability. Our productivity and the quality of our products a significant number of customersand services may electalso be adversely affected if we do not integrate and train our new employees quickly and effectively. Any future growth would add complexity to accept such limited functionalityour organization and require effective coordination throughout our organization. Failure to ensure appropriate systems, processes and controls and to manage any future growth effectively could result in lieu of adding appliances from an additional vendor such as us. Many organizations have invested substantial personnelincreased costs and financial resources to design and operate their networks and have established deep relationships with other providers of networking products, which may make them reluctant to add new components to their networks, particularly from other vendors such as us. In addition, an organization’s existing vendors or new vendors with a broad product offering may be able to offer concessions that we are not able to match because we currently offer only network security products and have fewer resources than many ofharm our competitors. If organizations are reluctant to add additional network infrastructure from new vendors or otherwise decide to work with their existing vendors, our business, financial conditionreputation and results of operationsoperations.
We have expanded our office real estate holdings to meet our projected growing need for office space. These plans will require significant capital expenditure over the next several years and involve certain risks, including impairment charges and acceleration of depreciation, changes in future business strategy that may decrease the need for expansion (such as a decrease in headcount or increase in work from home) and risks related to construction. Future changes in growth or fluctuations in cash flow may also negatively impact our ability to pay for these projects or free cash flow. Additionally, inaccuracies in our projected capital expenditures could negatively impact our business, operating results and financial condition.
We may experience difficulties maintaining and expanding our internal business management systems.
The maintenance of our internal business management systems, such as our Enterprise Resource Planning (“ERP”) and Customer Relationship Management (“CRM”) systems, has required, and will continue to require, the investment of significant financial and human resources. In addition, we may choose to upgrade or expand the functionality of our internal systems, leading to additional costs. Deficiencies in our design or maintenance of our internal systems may adversely affect our ability to sell products and services, forecast orders, process orders, ship products, provide services and customer support, send invoices and track payments, fulfill contractual obligations, accurately maintain books and records, provide accurate, timely and reliable reports on our financial and operating results or otherwise operate our business. Additionally, if any of our internal systems does not operate as intended, the effectiveness of our internal control over financial reporting could be adversely affected.affected or our ability to assess it adequately could be delayed. Further, we may expand the scope of our ERP and CRM systems. Our operating results may be adversely affected if these upgrades or expansions are delayed or if the systems do not function as intended or are not sufficient to meet our operating requirements.
Risks Related to our Intellectual Property
Our proprietary rights may be difficult to enforce which could enableand we may be subject to claims by others to copy or use aspects of our products without compensating us.that we infringe their propriety technology.
We rely primarily on patent, trademark, copyright and trade secrets laws and confidentiality procedures and contractual provisions to protect our technology. Valid patents may not issue from our pending applications, and the claims eventually allowed on any patents may not be sufficiently broad to protect our technology or products. Any issued patents may be challenged, invalidated or circumvented, and any rights granted under these patents may not actually provide adequate defensive protection or competitive advantages to us. Patent applications in the United States are typically not published until at least 18 months after filing, or, in some cases, not at all, and publications of discoveries in industry-related literature lag behind actual discoveries. We cannot be certain that we were the first to make the inventions claimed in our pending patent applications or that we were the first to file for patent protection. Additionally, the process of obtaining patent protection is expensive and time-consuming, and we may not be able to prosecute all necessary or desirable patent applications at a reasonable cost or in a timely manner. In addition, recent changes to the patent laws in the United States may bring into question the validity of certain software patents and may make it more difficult and costly to prosecute patent applications. As a result, we may not be able to obtain adequate patent protection or effectively enforce our issued patents.
Despite our efforts to protect our proprietary rights, unauthorized parties may attempt to copy aspects of our products or obtain and use information that we regard as proprietary. We generally enter into confidentiality or license agreements with our employees, consultants, vendors and customers, and generally limit access to and distribution of our proprietary information. However, we cannot guarantee that the steps taken by us will prevent misappropriation of our technology. Policing unauthorized use of our technology or products is difficult. In addition, the laws of some foreign countries do not protect our proprietary rights to as great an extent as the laws of the United States, and many foreign countries do not enforce these laws as diligently as government agencies and private parties in the United States. From time to time, legal action by us may be necessary to enforce our patents and other intellectual propertyIP rights, to protect our trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement or invalidity. Such litigation could result in substantial costs and diversion of resources and could negatively affect our business, operating results and financial condition. If we are unable to protect our proprietary rights (including aspects of our software and products protected other than by patent rights), we may find ourselves at a competitive disadvantage to others who need not incur the additional expense, time and effort required to create the innovative products that have enabled us to be successful to date.
Our products contain third-party open sourceopen-source software components, and failure to comply with the terms of the underlying open sourceopen-source software licenses could restrict our ability to sell our products.
Our products contain software modules licensed to us by third-party authors under “open source” licenses, including but not limited to, the GNU Public License, the GNU Lesser Public License, the BSD License, the Apache License, the MIT X License and the Mozilla Public License. From time to time, there have been claims against companies that distribute or use open sourceopen-source software in their products and services, asserting that open sourceopen-source software infringes the claimants’ intellectual propertyIP rights. We could be subject to suits by parties claiming infringement of intellectual propertyIP rights in what we believe to be licensed open sourceopen-source software. Use and distribution of open sourceopen-source software may entail greater risks than use of third-party commercial software, as, for example, open sourceopen-source licensors generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. Some open sourceopen-source licenses contain requirements that we make available source code for modifications or derivative works we create based upon the type of open sourceopen-source software we use. If we combine our proprietary software with open sourceopen-source software in a certain manner, we could, under certain open sourceopen-source licenses, be required to release the source code of our proprietary software to the public. This would allow our competitors to create similar products with lower development effort and time and ultimately could result in a loss of product sales for us.
Although we monitor our use of open source software to avoid subjecting our products to conditions we do not intend, the terms of many open source licenses have not been interpreted by U.S. courts, and there is a risk that these licenses could be construed in a way that, for example, could impose unanticipated conditions or restrictions on our ability to commercialize our products. In this event, we could be required to seek licenses from third parties to continue offering our products, to make our proprietary code generally available in source code form, to re-engineer our products or to discontinue the sale of our products if re-engineering could not be accomplished on a timely basis, any of which requirements could adversely affect our business, operating results and financial condition.
Claims by others that we infringe their proprietary technology or other litigation matters could harm our business.
Patent and other intellectual propertyIP disputes are common in the network security industry. Third parties are currently asserting, have asserted and may in the future assert claims of infringement of intellectual propertyIP rights against us. Third parties have also asserted such claims against our end-customers or channel partners whom we may indemnify against claims that our products infringe the intellectual propertyIP rights of third parties. As the number of products and competitors in our market increases and overlaps occur, infringement claims may increase. Any claim of infringement by a third party, even those without merit, could cause us to incur substantial costs defending against the claim and could distract our management from our business. In addition, litigation may involve patent holding companies, non-practicing entities or other adverse patent owners who have no relevant product revenue and against whom our own patents may therefore provide little or no deterrence or protection.
Although third parties may offer a license to their technology, the terms of any offered license may not be acceptable, and the failure to obtain a license or the costs associated with any license could cause our business, financial condition and results of operations to be materially and adversely affected. In addition, some licenses may be non-exclusive and, therefore, our competitors may have access to the same technology licensed to us.
Alternatively, we may be required to develop non-infringing technology, which could require significant time, effort and expense, and may ultimately not be successful. Furthermore, a successful claimant could secure a judgment or we may agree to a settlement that prevents us from distributing certain products or performing certain services or that requires us to pay substantial damages (including treble damages if we are found to have willfully infringed such claimant’s patents or
copyrights), royalties or other fees. Any of these events could seriously harm our business, financial condition and results of operations.
From time to time, we are subject to lawsuits claiming patent infringement. We are also subject to other litigation in addition to patent infringement claims, such as employment-related litigation and disputes, as well as general commercial litigation, and could become subject to other forms of litigation and disputes, including stockholder litigation. If we are unsuccessful in defending any such claims, our operating results and financial condition and results may be materially and adversely affected. For example, we may be required to pay substantial damages and could be prevented from selling certain of our products. Litigation, with or without merit, could negatively impact our business, reputation and sales in a material fashion.
We have several ongoing patent lawsuits, certain companies have sent us demand letters proposing that we license certain of their patents, and organizations have sent letters demanding that we provide indemnification for patent claims. As two examples of the ongoing patent lawsuits against us, one such patent lawsuit by British Telecommunications plc was filed in federal court in Delaware in July 2018, and a second such lawsuit by Finjan, Inc. was filed in federal court in California in October 2018, and additional patent lawsuits have been filed against us since. Given this and the proliferation of lawsuits in our industry and other similar industries by both non-practicing entities and operating entities, and recent non-practicing entity and operating entity patent litigation against other companies in the security space, we expect that we will be sued for patent infringement in the future, regardless of the merits of any such lawsuits. The cost to defend such lawsuits and any settlement payment or adverse result in such lawsuits could have a material adverse effect on our results of operations and financial condition.
We rely on the availability of third-party licenses.
Many of our products include software or other intellectual propertyIP licensed from third parties. It may be necessary in the future to renew licenses relating to various aspects of these products or to seek new licenses for existing or new products. Licensors may claim we owe them additional license fees for past and future use of their software and other intellectual propertyIP or that we cannot utilize such software or intellectual propertyIP in our products going forward. There can be no assurance that the necessary licenses would be available on acceptable terms, if at all. The inability to obtain certain licenses or other rights or to obtain such licenses or rights on favorable terms or for reasonable pricing, or the need to engage in litigation regarding these matters, could result in delays in product releases until equivalent technology can be identified, licensed or developed, if at all, and integrated into our products and may result in significant license fees and have a material adverse effect on our business, operating results, and financial condition. Moreover, the inclusion in our products of software or other intellectual propertyIP licensed from third parties on a non-exclusive basis could limit our ability to differentiate our products from those of our competitors.
We also rely on technologies licensed from third parties in order to operate functions of our business. If any of these third parties allege that we have not properly paid for such licenses or that we have improperly used the technologies under such licenses, we may need to pay additional fees or obtain new licenses, and such licenses may not be available on terms acceptable to us or at all or may be costly. In any such case, or if we were required to redesign our internal operations to function with new technologies, our business, results of operations and financial condition could be harmed.
Other Risks Related to Our Business and Financial Position
Our inability to successfully acquire and integrate other businesses, products or technologies, or to successfully invest in and form successful strategic alliances with other businesses, could seriously harm our competitive position and could negatively affect our financial condition and results of operations.
In order to remain competitive, we may seek to acquire additional businesses, products, technologies or IP, such as patents, and to make equity investments in businesses coupled with strategic alliances. For any possible future acquisitions or investments, we may not be successful in negotiating the terms of the acquisition or investment or financing the acquisition or investment. For both our prior and future acquisitions, we may not be successful in effectively integrating the acquired business, product, technology, IP or sales force into our existing business and operations, and the acquisitions may negatively impact our financial results. We may have difficulty incorporating acquired technologies, IP or products with our existing product lines, integrating reporting systems and procedures, and maintaining uniform standards, controls, procedures and policies. For example, we may experience difficulties integrating an acquired company’s ERP or CRM systems, sales support and other processes and systems, with our current systems and processes. The results of certain businesses that we invest in, such as Linksys, are, or may in the future, be reflected in our operating results, and we depend on these companies to provide us financial information in a timely manner in order to meet our financial reporting requirements.We may experience difficulty in timely obtaining financial information from the companies in which we have invested in order to meet our financial reporting requirements. Our due diligence for acquisitions and investments may fail to identify all of the problems, liabilities or other shortcomings or challenges of an acquired business, product or technology, including issues with IP, product quality or product architecture, regulatory compliance practices, environmental and sustainability compliance practices, revenue recognition or other accounting practices or employee or customer issues. We also may not accurately forecast the financial impact of an acquisition or an investment and alliance. In addition, any acquisitions and significant investments we are able to complete may be dilutive to revenue growth and earnings and may not result in any synergies or other benefits we had expected to achieve, which could negatively impact our operating results and result in impairment charges that could be substantial. We may have to pay cash, incur debt or issue equity securities to pay for any acquisition, each of which could affect our financial condition or the value of our capital stock and could result in dilution to our stockholders. Acquisitions or investments during a quarter may result in increased operating expenses and adversely affect our cash flows or our results of operations for that period and future periods compared to the results that we have previously forecasted or achieved. Further, completing a potential acquisition or investment and alliance and integrating acquired businesses, products, technologies or IP are challenging to do successfully and could significantly divert management time and resources.
Linksys sells predominantly into the consumer Wi-Fi market, and its sales have declined since our investment. Because we are accounting for our Linksys investment using the equity method of accounting, we are required to assess the investment for other-than-temporary impairment (“OTTI”) when events or circumstances suggest that the carrying amount of the investment may be impaired. We have analyzed whether there should be an OTTI of the value of our investment in Linksys and during the three months ended December 31, 2022 we recorded an OTTI charge of $22.2 million. In evaluating OTTI, we considered factors such as Linksys financial results and operating history, our ability and intent to hold the investment until its fair value recovers, the implied revenue valuation multiples compared to guideline public companies, Linksys’ ability to achieve milestones and any notable operational and strategic changes. We intend to continue to analyze our investment in Linksys to determine whether any further impairment is appropriate. If any further decline in fair value is determined to be other-than-temporary, we will adjust the carrying value of the investment to its fair value and record the impairment expense in our consolidated statements of income. The cost basis of the investment is not adjusted for subsequent recoveries in fair value. We may experience additional volatility to our statements of operations due to the underlying operating results of Linksys or impairments of our Linksys investment. This volatility could be material to our results in any given quarter and may cause our stock price to decline.
Failure to comply with laws and regulations applicable to our business could subject us to fines and penalties and could also cause us to lose end-customers in the public sector or negatively impact our ability to contract with the public sector.
Our business is subject to regulation by various federal, state, regional, local and foreign governmental agencies, including agencies responsible for monitoring and enforcing employment and labor laws, workplace safety, product safety, product labeling, environmental laws, consumer protection laws, anti-bribery laws, data privacy laws, import and export controls, federal securities laws and tax laws and regulations. In certain jurisdictions, these regulatory requirements may be more stringent than in the United States. Non-compliance with applicable regulations or requirements could subject us to investigations, sanctions, enforcement actions, disgorgement of profits, fines, damages and civil and criminal penalties or injunctions. If any governmental sanctions are imposed, or if we do not prevail in any possible civil or criminal litigation, our business, operating results and financial condition could be adversely affected. In addition, responding to any action will likely result in a significant diversion of management’s attention and resources and an increase in professional fees. Enforcement actions and sanctions could harm our business, operating results and financial condition.
For example, GDPR, which became effective in May 2018 and superseded current EU data protection regulations, imposes stringent data handling requirements on companies that receive or process personal data of residents of the EU. Non-compliance with the GDPR could result in significant penalties, including data protection audits and heavy fines. Compliance with, and the other burdens imposed by, the GDPR may limit our ability to operate or expand our business in Europe and could adversely impact our operating results, as could delays or shortcomings in the implementation of our GDPR compliance program. In July 2020, the European Court of Justice issued a judgment declaring invalid the EU-U.S. Privacy Shield Framework (the “Privacy Shield”) as a mechanism for exportation of personal data from the European Economic Area to the United States. Though we are not participants of the Privacy Shield, and instead employ alternative mechanisms for personal data transfers, the ruling raises questions as to GDPR implications and adequate data protection in the United States, and may have an impact on our European customers and related business operations.
Additionally, we may be subject to other legal regimes throughout the world governing data handling, protection and privacy. For example, in June 2018, California passed the California Consumer Privacy Act (the “CCPA”), which provides new data privacy rights for consumers and new operational requirements for companies and became effective on January 1, 2020. The CCPA was expanded pursuant to the California Privacy Rights Act, which was passed in 2020 and becomes effective in 2023. Other states have since passed similar laws. The costs of compliance with and the penalties for violations of the GDPR, the CCPA and other similar state laws, along with other burdens imposed by these regulations, may limit the use and adoption of our products and services and could have an adverse impact on our business.
Selling our solutions to the U.S. government, whether directly or through channel partners, also subjects us to certain regulatory and contractual requirements, government permit and clearance requirements and other risks. Failure to comply with these requirements or to obtain and maintain government permits and clearances required to do certain business, by either us or our channel partners, could subject us to investigations, fines, suspension, limitations on business or debarment from doing business with the U.S. government or one of its divisions, as well as other penalties, damages and reputational harms, which could have an adverse effect on our business, operating results, financial condition and prospects. Any violations of regulatory and contractual requirements could result in us being suspended or debarred fromfuture government contracting. Any of these outcomes could have an adverse effect on our revenue, operating results, financial condition and prospects.
These laws, regulations and other requirementsimpose added costs on our business, and failure to comply with these or other applicable regulations and requirements, including non-compliance in the past, could lead to claims for damages from our channel partners, penalties, termination of contracts, loss of exclusive rights in our IP and temporary suspension, permanent debarment from government contracting, or other limitations on doing business. Any such damages, penalties, disruptions or limitations in our ability to do business with the public sector could have an adverse effect on our business and operating results.
We are subject to governmental export and import controls that could subject us to liability or restrictions on sales, and that could impair our ability to compete in international markets.
Because we incorporate encryption technology into our products, certain of our products are subject to U.S. export controls and may be exported outside the United States only with the required export license or through an export license exception, or may be prohibited altogether from export to certain countries. If we were to fail to comply with U.S. export laws, U.S. Customs regulations and import regulations, U.S. economic sanctions and other countries’ import and export laws, we could be subject to substantial civil and criminal penalties, including fines for the company and incarceration for responsible employees and managers, and the possible loss of export or import privileges. In addition, if our channel partners fail to obtain appropriate import, export or re-export licenses or permits (e.g., for stocking orders placed by our partners), we may also be adversely affected through reputational harm and penalties and we may not be able to provide support related to appliances shipped pursuant to such orders. Obtaining the necessary export license for a particular sale may be time-consuming and may result in the delay or loss of sales opportunities.
Furthermore, U.S. export control laws and economic sanctions prohibit the shipment of certain products to U.S. embargoed or sanctioned countries, governments and persons, such as the sanctions and trade restrictions that have been implemented against Russia and Belarus. Even though we take precautions to prevent our product from being shipped to U.S. sanctions targets, our products could be shipped to those targets by our channel partners, despite such precautions. Any such shipment could have negative consequences including government investigations and penalties and reputational harm. In addition, various countries regulate the import of certain encryption technology, including import permitting and licensing requirements, and have enacted laws that could limit our ability to distribute our products or could limit our customers’ ability to implement our products in those countries. Changes in our products or changes in export and import regulations may create delays in the introduction of our products in international markets, prevent our customers with international operations from deploying our products globally or, in some cases, prevent the export or import of our products to certain countries, governments or persons altogether. Any change in export or import regulations, economic sanctions or related legislation, shift
in the enforcement or scope of existing regulations, or change in the countries, governments, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential customers with international operations. Any decreased use of our products or limitation on our ability to export or sell our products would likely adversely affect our business, financial condition and results of operations.
Efforts to withdraw from or materially modify international trade agreements, to change tax provisions related to global manufacturing and sales or to impose new tariffs, economic sanctions or related legislation, any of which could adversely affect our financial condition and results of operations.
Our business benefits directly and indirectly from free trade agreements, and we also rely on various corporate tax provisions related to international commerce, as we develop, market and sell our products and services globally. Efforts to withdraw from or materially modify international trade agreements, or to change corporate tax policy related to international commerce, could adversely affect our financial condition and results of operations as could the continuing uncertainty regarding whether such actions will be taken.
Moreover, efforts to implement changes related to export or import regulations (including the imposition of new border taxes or tariffs on foreign imports), trade barriers, economic sanctions and other related policies could harm our results of operations. For example, in recent years, the United States has imposed additional import tariffs on certain goods from different countries and on most goods imported from China. As a result, China and other countries imposed retaliatory tariffs on goods exported from the United States and both the United States and foreign countries have threatened to alter or leave current trade agreements. While we do not currently expect these tariffs to have a significant effect on our raw material and product import costs, if the United States expands increased tariffs, or retaliatory trade measures are taken by other countries in response to the tariffs, the cost of our products could increase, our operations could be disrupted or we could be required to raise our prices, which may result in the loss of customers and harm to our reputation and operating performance.
Any modification in these areas, any shift in the enforcement or scope of existing regulations or any change in the countries, governments, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export or sell our products to, existing or potential end-customers with international operations and could result in increased costs. Any decreased use of our products or limitation on our ability to export or sell our products would likely adversely affect our business, financial condition and results of operations.
If we fail to comply with environmental requirements, our business, financial condition, operating results and reputation could be adversely affected.
We are subject to various environmental laws and regulations, including laws governing the hazardous material content of our products, laws relating to our real property and future expansion plans and laws concerning the recycling of Electrical and Electronic Equipment (“EEE”). The laws and regulations to which we are subject include the EU RoHS Directive, EU Regulation 1907/2006 – Registration, Evaluation, Authorization and Restriction of Chemicals (the “REACH” Regulation) and the EU Waste Electrical and Electronic Equipment Directive (the “WEEE Directive”), as well as the implementing legislation of the EU member states. Similar laws and regulations have been passed or are pending in China, South Korea, Norway and Japan and may be enacted in other regions, including in the United States, and we are, or may in the future be, subject to these laws and regulations. These legal and regulatory regimes, including the laws, rules and regulations thereunder, evolve frequently and may be modified, interpreted and applied in an inconsistent manner from one jurisdiction to another, and may conflict with one another. Moreover, the timing and effect of these laws and regulations on our business may be uncertain. To the extent we have not complied with such laws, rules and regulations, we could be subject to significant fines, revocation of licenses, limitations on our products and services, reputational harm and other regulatory consequences, each of which may be significant and could adversely affect our business, operating results and financial condition. These laws and regulations may also impact our suppliers which could have among other things, have an adverse impact on the costs of components in our products.
The EU RoHS Directive and the similar laws of other jurisdictions ban or restrict the presence of certain hazardous substances such as lead, mercury, cadmium, hexavalent chromium and certain fire-retardant plastic additives in electrical equipment, including our products. We have incurred costs to comply with these laws, including research and development costs and costs associated with assuring the supply of compliant components. We expect to continue to incur costs related to environmental laws and regulations in the future. With respect to the EU RoHS, we and our competitors rely on exemptions for lead and other substances in network infrastructure equipment. It is possible one or more of these use exemptions will be revoked in the future. Additionally, although some of the EU RoHS exemptions have been extended, it is possible that some of these exemptions may expire in the future without being extended. If this exemption is revoked or expires without extension, if there are other changes to these laws (or their interpretation) or if new similar laws are passed in other jurisdictions, we may be
required to re-engineer our products to use components compatible with these regulations. This re-engineering and component substitution could result in additional costs to us and/or disrupt our operations or logistics.
As part of the Circular Economy Action Plan, the European Commission amended the EU Waste Framework Directive (“WFD”) to include a number of measures related to waste prevention and recycling, whereby we are responsible for submitting product data to a Substances of Concern In articles as such or in complex objects (Products) (“SCIP”) database containing information on Substances of Very High Concern (“SVHC”) in articles and in complex objects. The SCIP database is established under the WFD and managed by the European Chemicals Agency (“ECHA”). We have incurred costs in order to comply with this new requirement. Similar laws and regulations have been passed or are pending in European Economic Area and UK.
The EU’s WEEE Directive, which requires electronic goods producers to be responsible for the collection, recycling and treatment of such products. Although currently our EU international channel partners are responsible for the requirements of this directive as the importer of record in most of the European countries in which we sell our products, changes in interpretation of the regulations may cause us to incur costs or have additional regulatory requirements in the future to meet in order to comply with this directive, or with any similar laws adopted in other jurisdictions including the United States.
Our failure to comply with these and future environmental rules and regulations could result in decreased demand for our products and services resulting in reduced sales of our products, increased demand for competitive products and services that result in lower emissions than our products, increased costs, substantial product inventory write-offs, reputational damage, penalties and other sanctions, any of which could harm our business and financial condition. To date, our expenditures for environmental compliance have not had a material impact on our operating results or cash flows, and, although we cannot predict the future impact of such laws or regulations, they will likely result in additional costs. New laws may result in increased penalties associated with violations or require us to change the content of our products or how they are manufactured, which could have a material adverse effect on our business, operating results and financial condition.
Investors’ expectations of our performance relating to environmental, social and governance factors may impose additional costs and expose us to new risks.
There is an increasing focus from certain investors, employees, customers and other stakeholders concerning corporate responsibility, specifically related to ESG matters. Some investors may use these non-financial performance factors to guide their investment strategies and, in some cases, may choose not to invest in us if they believe our policies and actions relating to corporate responsibility are inadequate. The growing investor demand for measurement of non-financial performance is addressed by third-party providers of sustainability assessment and ratings on companies. The criteria by which our corporate responsibility practices are assessed may change due to the constant evolution of the sustainability landscape, which could result in greater expectations of us and cause us to undertake costly initiatives to satisfy such new criteria. If we elect not to or are unable to satisfy such new criteria, investors may conclude that our policies and/or actions with respect to corporate social responsibility are inadequate. We may face reputational damage in the event that we do not meet the ESG standards set by various constituencies.
Furthermore, in the event that we communicate certain initiatives and goals regarding ESG matters, such as our commitment to target carbon neutrality on Scope 1 and Scope 2 emissions resulting from our owned facilities worldwide by 2030, we could fail, or be perceived to fail, in our achievement of such initiatives or goals, or we could be criticized for the scope, target and timelines of such initiatives or goals. If we fail to satisfy the expectations of investors, customers, employees, and other stakeholders or our initiatives are not executed as planned, our reputation and business, operating results and financial condition could be adversely impacted. In addition, the SEC has also proposed a draft rule that requires climate disclosures in financial filings. To the extent the SEC proposal becomes effective for our company, we will be required to establish additional internal controls, engage additional consultants and incur additional costs related to evaluating, managing and reporting on our environmental impact and climate-related risks and opportunities. If we fail to implement sufficient oversight or accurately capture and disclose on environmental matters, our reputation, business, operating results and financial condition may be materially adversely affected.
Risks Related to Finance, Accounting and Tax Matters
If our estimates or judgments relating to our critical accounting policies are based on assumptions that change or prove to be incorrect, our operating results could fall below expectations of securities analysts and investors, resulting in a decline in our stock price.
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, as provided in “Management’s Discussion and Analysis of Financial Condition and Results
of Operations—Critical Accounting Policies and Estimates” in this Annual Report on Form 10-K, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Our operating results may be adversely affected if our assumptions change or if actual circumstances differ from those in our assumptions, which could cause our operating results to fall below the expectations of securities analysts and investors, resulting in a decline in our stock price. Significant assumptions and estimates used in preparing our consolidated financial statements include those related to revenue recognition, deferred contract costs and commission expense, accounting for business combinations, contingent liabilities and accounting for income taxes.
We are exposed to fluctuations in currency exchange rates, which could negatively affect our financial condition and results of operations.
A significant portion of our operating expenses are incurred outside the United States. These expenses are denominated in foreign currencies and are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Euro, Japanese yen, Canadian dollar and British pound. A weakening of the U.S. dollar compared to foreign currencies would negatively affect our expenses and operating results, which are expressed in U.S. dollars.Additionally, fluctuations in the exchange rate of the Canadian dollar may negatively impact our development plans in Burnaby, Canada. While we are not currently engaged in material hedging activities, we have been hedging currency exposures relating to certain balance sheet accounts through the use of forward exchange contracts. If we stop hedging against any of these risks or if our attempts to hedge against these currency exposures are not successful, our financial condition and results of operations could be adversely affected. Our sales contracts are primarily denominated in U.S. dollars and therefore, while substantially all of our revenue is not subject to foreign currency risk, it does not serve as a hedge to our foreign currency-denominated operating expenses. In addition, a strengthening of the U.S. dollar may increase the real cost of our products to our customers outside of the United States, which may also adversely affect our financial condition and results of operations.
We could be subject to changes in our tax rates, the adoption of new U.S. or international tax legislation or exposure to additional tax liabilities.
We are subject to taxes in the United States and numerous foreign jurisdictions, where a number of our subsidiaries are organized. Our provision for income taxes is subject to volatility and could be adversely affected by several factors, many of which are outside of our control. These include:
•the mix of earnings in countries with differing statutory tax rates or withholding taxes;
•changes in the valuation of our deferred tax assets and liabilities;
•transfer pricing adjustments;
•increases to corporate tax rates;
•an increase in non-deductible expenses for tax purposes, including certain stock-based compensation expense;
•changes in availability of tax credits and/or tax deductions;
•tax costs related to intercompany realignments;
•tax assessments resulting from income tax audits or any related tax interest or penalties that could significantly affect our provision for income taxes for the period in which the settlement takes place; and
•changes in accounting principles, court decisions, tax rulings, and interpretations of or changes to tax laws, and regulations by international, federal or local governmental authorities.
We have open tax years that could be subject to the examination by the Internal Revenue Service (the “IRS”) and other tax authorities. We currently have ongoing tax audits in the United Kingdom, Canada, Germany and several other foreign jurisdictions. The focus of all of these audits is the allocation of profits among our legal entities. We regularly assess the likelihood of adverse outcomes resulting from such examinations to determine the adequacy of our provision for income taxes. Although we believe that our estimates are reasonable, the ultimate tax outcome may differ from the amounts recorded in our consolidated financial statements and may materially affect our financial results.
We may undertake corporate operating restructurings or transfers of assets that involve our group of foreign country subsidiaries through which we do business abroad, in order to maximize the operational and tax efficiency of our group
structure. If ineffectual, such restructurings or transfers could increase our income tax liabilities, and in turn, increase our global effective tax rate. Moreover, our existing corporate structure and intercompany arrangements have been implemented in a manner we believe reasonably ensures that we are in compliance with current prevailing tax laws. However, the tax authorities of the jurisdictions in which we operate may challenge our methodologies for valuing developed technology or intercompany arrangements, which could impact our worldwide effective tax rate and harm our financial position and operating results.
Significant judgment is required in determining any valuation allowance recorded against deferred tax assets. In assessing the need for a valuation allowance, we consider all available evidence, including past operating results, estimates of future taxable income and the feasibility of tax planning strategies. In the event that we change our determination as to the amount of deferred tax assets that can be realized, we will adjust our valuation allowance with a corresponding impact to the provision for income taxes in the period in which such determination is made.
Forecasting our estimated annual effective tax rate is complex and subject to uncertainty, and there may be material differences between our forecasted and actual tax rates.
Forecasts of our income tax position and effective tax rate are complex, subject to uncertainty and periodic updates because our income tax position for each year combines the effects of a mix of profits earned and losses incurred by us in various tax jurisdictions with a broad range of income tax rates, as well as changes in the valuation of deferred tax assets and liabilities, the impact of various accounting rules and changes to these rules and tax laws, the results of examinations by various tax authorities, and the impact of any acquisition, business combination or other reorganization or financing transaction. To forecast our global tax rate, we estimate our pre-tax profits and losses by jurisdiction and forecast our tax expense by jurisdiction. If the mix of profits and losses, our ability to use tax credits or our effective tax rate in a given jurisdiction differs from our estimate, our actual tax rate could be materially different than forecasted, which could have a material impact on our results of business, financial condition and results of operations. Additionally, our actual tax rate may be subject to further uncertainty due to potential changes in U.S. and foreign tax rules.
As a multinational corporation, we conduct our business in many countries and are subject to taxation in many jurisdictions. The taxation of our business is subject to the application of multiple and sometimes conflicting tax laws and regulations, as well as multinational tax conventions. Our effective tax rate is highly dependent upon the geographic distribution of our worldwide earnings or losses, the tax regulations in each geographic region, the availability of tax credits and carryforwards and the effectiveness of our tax planning strategies. The application of tax laws and regulations is subject to legal and factual interpretation, judgment and uncertainty. Tax laws themselves are subject to change as a result of changes in fiscal policy, changes in legislation and the evolution of regulations and court rulings. Consequently, tax authorities may impose tax assessments or judgments against us that could materially impact our tax liability and/or our effective income tax rate.
The Organisation for Economic Co-operation and Development (the “OECD”), an international association comprised of 38 countries, including the United States, has issued and continues to issue guidelines and proposals that change various aspects of the existing framework under which our tax obligations are determined in many of the countries in which we do business. Due to our extensive international business activities, any changes in the taxation of such activities could increase our tax obligations in many countries and may increase our worldwide effective tax rate.
Risks Related to Ownership of ourOur Common Stock
As a public company, we are subject to compliance initiatives that will require substantial time from our management and result in significantly increased costs that may adversely affect our operating results and financial condition.
The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”), Dodd-Frank and other rules implemented by the SEC and The Nasdaq Stock Market impose various requirements on public companies, including requiring changes in corporate governance practices. These requirements, as well as proposed corporate governance laws and regulations under consideration, may further increase our compliance costs. If compliance with these various legal and regulatory requirements diverts our management’s attention from other business concerns, it could have a material adverse effect on our business, financial condition and results of operations. Sarbanes-Oxley requires, among other things, that we assess the effectiveness of our internal control over financial reporting annually, and of our disclosure controls and procedures quarterly. Although our most recent assessment, testing and evaluation resulted in our conclusion that, as of December 31, 2019,2022, our internal controls over financial reporting were effective, we cannot predict the outcome of our testing in 20202023 or future periods.periods and there can be no assurance that, in the future, our internal controls over financial reporting will be effective or deemed effective. We may incur additional expenses and commitment of management’s time in connection with further evaluations, both of which could materially increase our operating expenses and accordingly reduce our operating results.
In September 2018, California enacted a law that requires publicly held companies headquartered in California to have at least one female director by the end of 2019 and at least three by the end of 2021, depending on the size of the board. The law would impose financial penalties for failure to comply. Though we are currently in compliance with the requirements of the law for 2019, we may incur costs associated with complying with the law in future years, including costs associated with expanding our board of directors or identifying qualified candidates for appointment to our board of directors, or financial penalties or harm to our brand and reputation if we are unable to do so.
Changes in financial accounting standards may cause adverse unexpected fluctuations and affect our reported results of operations.
A change in accounting standards or practices, and varying interpretations of existing or new accounting pronouncements, such as changes to standards related to revenue recognition (which became effective for us on January 1, 2018) and accounting for leases (which became effective for us on January 1, 2019), as well as the significant costs incurred or that may be incurred to adopt and to comply with these new pronouncements, could have a significant effect on our reported financial results or the way we conduct our business. If we do not ensure that our systems and processes are aligned with the new standards, we could encounter difficulties generating quarterly and annual financial statements in a timely manner, which could have an adverse effect on our business, our ability to meet our reporting obligations and compliance with internal control requirements.
The revenue and lease standards are principles based and interpretation of those principles may vary from company to company based on their unique circumstances. Management will continue to make judgments and assumptions based on our interpretation of the new standard. It is possible that interpretation, industry practice and guidance may evolve as we work toward implementing the new revenue recognition standard. If our circumstances change or if actual circumstances differ from our assumptions, our operating result may be adversely affected and could fall below our publicly announced guidance or the expectations of securities analysts and investors, resulting in a decline in the market price of our common stock. Further, equity investments are now required to be measured at fair value (with subsequent changes in fair value recognized in net income), which may increase the volatility of our earnings.
If securities or industry analysts stop publishing research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.
The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. If we do not maintain adequate research coverage, or if one or more of the analysts who cover us downgrades our stock or publishes inaccurate or unfavorable research about our business or if our results or forecasts fail to meet the expectations of research analysts and investors, our stock price could decline. If one or more of these analysts ceases coverage of our company or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.
The trading price of our common stock may be volatile.volatile, which may be exacerbated by share repurchases under our Share Repurchase Program.
The market price of our common stock may be subject to wide fluctuations in response to, among other things, the risk factors described in this periodic report, news about us and our financial results, the impact of the COVID-19 pandemic, news about our competitors and their results, and other factors such as rumors or fluctuations in the valuation of companies perceived by investors to be comparable to us. For example, during 2019,2022, the closing price of our common stock ranged from $66.91$45.93 to $109.53$69.50 per share.share (as adjusted for the five-for-one forward stock split of our common stock effective June 22, 2022).
Furthermore, stock markets have experienced price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These broad market and industry fluctuations, as well as general economic, political and market conditions, such as recessions, interest rate changes or international currency fluctuations, may negatively affect the market price of our common stock.
In the past, many companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. Securities litigation against us could result in substantial costs and divert our management’s attention from other business concerns, which could seriously harm our business. In addition, the market price of our common stock and the market price of the common stock of many other companies have fallen significantly since the outbreak of the COVID-19 pandemic. The extent to which the COVID-19 pandemic may impact the market price of our common stock is unclear, and the market price of our common stock may fluctuate significantly as a result of the COVID-19 pandemic.
Share repurchases under ourthe Repurchase Program (the “Repurchase Program”) could increase the volatility of the trading price of our common stock, could diminish our cash reserves, could occur at non-optimal prices and may not result in the most effective use of our capital.
In November 2019,February 2023, our board of directors approved a $1.0 billion increase in the authorized stock repurchase under the Repurchase Program and extended the terman extension of the Repurchase Program to February 28, 2021, bringing29, 2024. As of December 31, 2022, the aggregate amount authorized to be repurchased $2.5 billion. As of December 31, 2019, $1.6under the Repurchase Program was $5.25 billion and $529.6 million remained available for future share repurchases under the Repurchase Program.repurchases. Share repurchases under the Repurchase Program could affect the price of our common stock, increase stock price volatility and diminish our cash reserves. In addition, an announcement of the reduction, suspension or termination of the Repurchase Program could result in a decrease in the trading price of our common stock. Moreover, our stock price could decline, resulting in repurchases made at non-optimal prices. Our failure to repurchase our stock at optimal prices may be perceived by investors as an inefficient use of our cash and cash equivalents, which could result in litigation that may have an adverse effect on our business, operating results and financial condition. In addition, while our board of directors carefully considers various alternative uses of our cash and cash equivalents in determining whether to authorize stock repurchases, there can be no assurance that the decision by our board of directors to repurchase stock would result in the most effective uses of our cash and cash equivalents, and there may be alternative uses of our cash and cash equivalents that would be more effective, such as investing in growing our business organically or through acquisitions.
Anti-takeover provisions contained in our certificate of incorporation and bylaws, as well as provisions of Delaware law, could impair a takeover attempt.
Our certificate of incorporation, bylaws and Delaware law contain provisions that could have the effect of rendering more difficult, delaying or preventing an acquisition deemed undesirable by our board of directors. Our corporate governance documents include provisions:
•authorizing “blank check” preferred stock, which could be issued by the board without stockholder approval and may contain voting, liquidation, dividend and other rights superior to our common stock;
•limiting the liability of, and providing indemnification to, our directors and officers;
limiting the ability of our stockholders to call and bring business before special meetings;
•requiring advance notice of stockholder proposals for business to be conducted at meetings of our stockholders and for nominations of candidates for election to our board of directors;
•providing that certain litigation matters may only be brought against us in state or federal courts in the State of Delaware;
•controlling the procedures for the conduct and scheduling of board and stockholder meetings; and
•providing the board of directors with the express power to postpone previously scheduled annual meetings and to cancel previously scheduled special meetings.
These provisions, alone or together, could delay or prevent hostile takeovers and changes in control or changes in our management.
In addition, our amended and restated bylaws provide that unless we consent in writing to the selection of an alternative forum, to the fullest extent permitted by law, the federal district courts of the United States shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act. Any person or entity purchasing or otherwise acquiring any interest in any of our securities shall be deemed to have notice of and consented to this provision. This provision, as well as provisions providing that certain litigation matters may only be brought against us in state or federal courts in the State of Delaware, may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or any of our directors, officers or other employees, which may discourage lawsuits against us and our directors, officers and other employees.
As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203 of the Delaware General Corporation Law, which prevents stockholders holding more than 15% of our outstanding common stock from engaging in certain business combinations without approval of the holders of a substantial majority of all of our outstanding common stock.
Any provision of our certificate of incorporation, bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock, and could also affect the price that some investors are willing to pay for our common stock.
However, these anti-takeover provisions will not have the effect of preventing activist stockholders from seeking to increase short-term stockholder value through actions such as nominating board candidates and requesting that we pursue strategic combinations or other transactions. These actions could disrupt our operations, be costly and time-consuming and divert the attention of our management and employees. In addition, perceived uncertainties as to our future direction as a result
of activist stockholder actions could result in the loss of potential business opportunities, as well as other negative business consequences. Actions of an activist stockholder may also cause fluctuations in our stock price based on speculative market perceptions or other factors that do not necessarily reflect our business. Further, we may incur significant expenses in retaining professionals to advise and assist us on activist stockholder matters, including legal, financial, communications advisors and solicitation experts, which may negatively impact our future financial results.
General Risks
Global economic uncertainty, an economic downturn, the possibility of a recession, inflation, rising interest rates, weakening product demand caused by political instability, changes in trade agreements and conflicts such as the war in Ukraine, could adversely affect our business and financial performance.
Economic uncertainty in various global markets caused by political instability and conflict, such as the war in Ukraine, and economic challenges caused by the effects of the COVID-19 pandemic, the economic downturn, any resulting recession, inflation or rise in interest rates has resulted, and may continue to result, in weakened demand for our products and services and difficulty in forecasting our financial results and managing inventory levels. The current economic uncertainty, and possibility of a recession, has negatively impacted the stock prices of many companies in 2022, including many companies in the technology sector. Political developments impacting government spending and international trade, including potential government shutdowns and trade disputes and tariffs may negatively impact markets and cause weaker macroeconomic conditions. The effects of these events may continue due to potential U.S. government shutdowns and the transition in administrations, and the United States’ ongoing trade disputes with Russia, China and other countries. The continuing effect of any or all of these events could adversely impact demand for our products, harm our operations and weaken our financial results.
Our business is subject to the risks of earthquakes, drought, fire, power outages, typhoon, floods, virus outbreaks and other broad health-related challenges, cyber events and other catastrophic events, and to interruption by manmade problems such as civil unrest, war, labor disruption, critical infrastructure attack and terrorism.
A significant natural disaster, such as an earthquake, drought, fire, power outage, flood, viral outbreak or other catastrophic event, could have a material adverse impact on our business, operating results and financial condition. Our corporate headquarters are located in the San Francisco Bay Area, a region known for seismic activity, and our research and development and data center in Burnaby, Canada, from which we deliver to customers our FortiGuard and other security subscription updates, is subject to the risk of flooding and is also in a region known for seismic activity. Any earthquake in the Bay Area or Burnaby, or flooding in Burnaby, could materially negatively impact our ability to provide products and services, such as FortiCare support and FortiGuard subscription services and could otherwise materially negatively impact our business. In addition, natural disasters could affect our manufacturing vendors, suppliers or logistics providers’ ability to perform services, such as obtaining product components and manufacturing products, or performing or assisting with shipments, on a timely basis, as well as our customers’ ability to order from us and our employees’ ability to perform their duties. For example, a typhoon in Taiwan could materially negatively impact our ability to manufacture and ship products and could result in delays and reductions in billings and revenues, or the effects of the COVID-19 pandemic may negatively impact our ability to manufacture and ship products, possibly in a material way, and could result in delays and reductions in billings and revenues, also possibly in a material way. The impact of climate change could affect economies in ways that negatively impact us and our results of operations. In the event our or our service providers’ information technology systems or manufacturing or logistics abilities are hindered by any of the events discussed above, shipments could be delayed, resulting in our missing financial targets, such as revenue and shipment targets, for a particular quarter. In addition, regional instability, international disputes, wars, such as the war in Ukraine and any expansion thereof, and other acts of aggression, civil and political unrest, labor disruptions, rebellions, acts of terrorism and other geo-political unrest could cause disruptions in our business or the business of our manufacturers, suppliers, logistics providers, partners or end-customers, or of the economy as a whole. Given our typical concentration of sales at the end of each quarter, any disruption in the business of our manufacturers, logistics providers, partners or end-customers that impacts sales at the end of our quarter could have a significant adverse impact on our quarterly results. To the extent that any of the above results in security risks to our customers, delays or cancellations of customer orders, the delay of the manufacture, deployment or shipment of our products or interruption or downtime of our services, our business, financial condition and results of operations would be adversely affected.
Changes in financial accounting standards may cause adverse unexpected fluctuations and affect our reported results of operations.
A change in accounting standards or practices, and varying interpretations of existing or new accounting pronouncements, as well as significant costs incurred or that may be incurred to adopt and to comply with these new pronouncements, could have a significant effect on our reported financial results or the way we conduct our business. If we do not ensure that our systems and processes are aligned with the new standards, we could encounter difficulties generating quarterly and annual financial statements in a timely manner, which could have an adverse effect on our business, our ability to meet our reporting obligations and compliance with internal control requirements.
Management will continue to make judgments and assumptions based on our interpretation of new standards. If our circumstances change or if actual circumstances differ from our assumptions, our operating results may be adversely affected
and could fall below our publicly announced guidance or the expectations of securities analysts and investors, resulting in a decline in the market price of our common stock. Further, marketable equity investments are required to be measured at fair value (with subsequent changes in fair value recognized in net income), which may increase the volatility of our earnings.
ITEM 1B. Unresolved Staff Comments
Not applicable.
ITEM 2. Properties
Our corporate headquarters is located in Sunnyvale, California and comprises approximately 160,000395,000 square feet of building space on ten20 acres of land. In 2019, we began construction on a second building of approximately 170,000 square feet that will serve as the cornerstone of our headquarters campus. Along with our corporate headquarters, as of December 31, 2019,2022, we also own approximately 200,000290,000 square feet in Union City, California, used as afor manufacturing assembly and operations center;operations; approximately 375,000560,000 square feet of office and building space in Burnaby and Ottawa, Canada, used for operations, support and research and development work; approximately 100,000 square feet of office space in Chicago; approximately 100,000 square feet of office space in Florida; approximately 90,000 square feet of office space in Texas; and 40,000approximately 70,000 square feet of office space in Valbonne, France, predominantly used as afor sales and support office.support. We also own additional building space in Sunnyvale and Union City, California, for future development of approximately 470,000 square feet.
We maintain additional leased offices throughout the world, predominantly used as sales and support offices.offices, and leased data center spaces throughout the world operated under co-location arrangements. We believe that our existing properties are sufficient and suitable to meet our current needs. We intend to expand our facilities or add new facilities as we add employeesto support our future growth and enter new geographic markets, and we believe that suitable additional or alternative space will be available or can be developed as needed to accommodate ongoing operations and any such growth. However, we expect to incur additional operating expenses and capital expenditures in connection with such new or expanded facilities.
For information regarding the geographical location of our property and equipment, seerefer to Note 1516 to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K.
ITEM 3. Legal Proceedings
We are subject to various claims, complaints and legal actions that arise from time to time in the normalordinary course of business. We accrue for contingencies when we believe that a loss is probable and that we can reasonably estimate the amount of any such loss. There can be no assurance that existing or future legal proceedings arising in the ordinary course of business or otherwise will not have a material adverse effect on our business, consolidated financial position, results of operations or cash flows.
ITEM 4. Mine Safety Disclosure
Not applicable.
Part II
All share and per share amounts presented in this Part II have been retroactively adjusted to reflect the five-for-one forward stock split of our common stock effective June 22, 2022.
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ITEM 5. | Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |
ITEM 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock
Our common stock is traded on The Nasdaq Global Select Market under the symbol “FTNT.”
Holders of Record
As of February 21, 2020,17, 2023, there were 43 holders of record of our common stock. A substantially greater number of holders of our common stock are “street name” or beneficial holders, whose shares are held by banks, brokers and other financial institutions.
Dividends
We have never declared or paid cash dividends on our capital stock. We do not anticipate paying any cash dividends in the foreseeable future. Any future determination to declare cash dividends will be made at the discretion of our board of directors and will depend on our financial condition, operating results, capital requirements, general business conditions and other factors that our board of directors may deem relevant.
Securities Authorized for Issuance Under Equity Compensation Plans
Information responsive to this item is incorporated herein by reference to our definitive proxy statement with respect to our 2023 Annual Meeting of Stockholders to be filed with the Securities and Exchange Commission (the “SEC”) within 120 days after the end of the fiscal year covered by this Annual Report on Form 10-K.
Stock Performance Graph
This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities and Exchange Act of 1934 (the “Exchange Act”), or incorporated by reference into any filing of Fortinet under the Securities Act of 1933, as amended (the “Securities Act”), or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.
The following graph compares the cumulative five-year total return for our common stock, the Standard & Poor’s 500 Stock Index (the “S&P 500 Index”) and the NASDAQ Computer Index. Such returns are based on historical results and are not intended to suggest future performance. Data for the S&P 500 Index and the NASDAQ Computer Index assume reinvestment of dividends. We have never declared or paid cash dividends on our capital stock, nor do we anticipate paying any such cash dividends in the foreseeable future.
COMPARISON OF CUMULATIVE TOTAL RETURN*
Among Fortinet, Inc., the S&P 500 Index and
the NASDAQ Computer Index
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| | | | | | | | | | | | | | | | | | | | | | | | |
| | December 2014 * | | December 2015 | | December 2016 | | December 2017 | | December 2018 | | December 2019 |
Fortinet, Inc. | | $ | 100 |
| | $ | 102 |
| | $ | 98 |
| | $ | 142 |
| | $ | 230 |
| | $ | 348 |
|
S&P 500 Index | | $ | 100 |
| | $ | 99 |
| | $ | 109 |
| | $ | 130 |
| | $ | 122 |
| | $ | 157 |
|
NASDAQ Computer | | $ | 100 |
| | $ | 106 |
| | $ | 119 |
| | $ | 166 |
| | $ | 159 |
| | $ | 240 |
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | December 2017 * | | December 2018 | | December 2019 | | December 2020 | | December 2021 | | December 2022 |
Fortinet, Inc. | | $ | 100 | | | $ | 161 | | | $ | 244 | | | $ | 340 | | | $ | 823 | | | $ | 560 | |
S&P 500 Index | | $ | 100 | | | $ | 94 | | | $ | 121 | | | $ | 140 | | | $ | 178 | | | $ | 144 | |
NASDAQ Computer | | $ | 100 | | | $ | 96 | | | $ | 145 | | | $ | 217 | | | $ | 299 | | | $ | 192 | |
* Assumes that $100 was invested on December 31, 2017 in stock or index, including reinvestment of dividends. Stockholder returns over the indicated period should not be considered indicative of future stockholder returns. |
* Assumes that $100 was invested on December 31, 2014 in stock or index, including reinvestment of dividends. Stockholder returns over the indicated period should not be considered indicative of future stockholder returns.
Sales of Unregistered Securities
None.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
Share Repurchase Program
In January 2016, our board of directors approved our Share Repurchase Program (the “Repurchase Program”)., which authorized the repurchase of up to $200.0 million of our outstanding common stock through December 31, 2017. From 2016 through 2021, our board of directors approved increases to our Repurchase Program by various amounts and extended the term to February 28, 2023, bringing the aggregated amount authorized to $4.25 billion. In November 2019,July 2022, our board of directors approved a $1.0 billion increase, in the authorized stock repurchase under the Repurchase Program and extended the term of the Repurchase Program to February 28, 2021, bringing the aggregate amount authorized to be repurchased to $2.5 billion$5.25 billion. In February 2023, our board of our outstanding common stock throughdirectors approved an extension of the Repurchase Program to February 28, 2021.29, 2024. Under the Repurchase Program, share repurchases may be made by us from time to time in privately negotiated transactions or in open market transactions. The Repurchase 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. Since its inception, we have repurchased 20.8211.4 million shares of our common stock under the Repurchase Program for an aggregate purchase price of $907.2 million.$4.72 billion.
The following table provides information with respect to the sharesThere were no repurchases of common stock we repurchased during the three months ended December 31, 2019 (in millions, except per2022. As of December 31, 2022, $529.6 million remained available for future share amounts):repurchases under the Repurchase Program.
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| | | | | | | | | | | | | | |
| | Total Number of Shares Purchased | | Average Price Paid per Share | | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | | Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs |
October 1 - October 31, 2019 | | 0.3 |
| | $ | 77.39 |
| | 0.3 |
| | $ | 592.9 |
|
November 1 - November 30, 2019 | | — |
| | $ | — |
| | — |
| | $ | 1,592.9 |
|
December 1 - December 31, 2019 | | * |
| | $ | 100.01 |
| | * |
| | $ | 1,592.8 |
|
Total | | 0.3 |
| | $ | 77.40 |
| | 0.3 |
| | |
* Number rounds to zero
ITEM 6. Selected Financial Data
The following selected consolidated financial data set forth below was derived from our historical audited consolidated financial statements and should be read in conjunction with the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Financial Statements and Supplementary Data,” and other financial data included elsewhere in this Annual Report on Form 10-K. Our historical results of operations are not indicative of our future results of operations.
[Reserved]
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| | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2019 | | 2018 | | 2017 | | 2016 | | 2015 |
| (in millions, except per share amounts) |
Consolidated Statements of Income Data: | | | | | | | | | |
Total revenue | $ | 2,156.2 |
| | $ | 1,801.2 |
| | $ | 1,494.9 |
| | $ | 1,275.4 |
| | $ | 1,009.3 |
|
Total gross profit | $ | 1,650.3 |
| | $ | 1,350.8 |
| | $ | 1,109.6 |
| | $ | 937.6 |
| | $ | 722.5 |
|
Operating income | $ | 344.2 |
| | $ | 231.0 |
| | $ | 109.8 |
| | $ | 42.9 |
| | $ | 14.9 |
|
Net income | $ | 326.5 |
| | $ | 332.2 |
| | $ | 31.4 |
| | $ | 32.2 |
| | $ | 8.0 |
|
Net income per share: | | | | | | | | | |
Basic | $ | 1.91 |
| | $ | 1.96 |
| | $ | 0.18 |
| | $ | 0.19 |
| | $ | 0.05 |
|
Diluted | $ | 1.87 |
| | $ | 1.91 |
| | $ | 0.18 |
| | $ | 0.18 |
| | $ | 0.05 |
|
Weighted-average shares outstanding: | | | | | | | | | |
Basic | 171.0 |
| | 169.1 |
| | 174.3 |
| | 172.6 |
| | 170.4 |
|
Diluted | 175.0 |
| | 174.2 |
| | 178.1 |
| | 176.3 |
| | 176.1 |
|
|
| | | | | | | | | | | | | | | | | | | |
| As of December 31, |
2019 | | 2018 | | 2017 | | 2016 | | 2015 |
(in millions) |
Consolidated Balance Sheet Data: | | | | | | | | | |
Cash, cash equivalents and investments | $ | 2,209.9 |
| | $ | 1,716.6 |
| | $ | 1,349.3 |
| | $ | 1,310.5 |
| | $ | 1,164.3 |
|
Total assets | $ | 3,885.5 |
| | $ | 3,078.0 |
| | $ | 2,257.9 |
| | $ | 2,139.9 |
| | $ | 1,790.5 |
|
Total stockholders’ equity | $ | 1,321.9 |
| | $ | 1,010.2 |
| | $ | 589.4 |
| | $ | 837.7 |
| | $ | 755.4 |
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ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
In addition to historical information, this Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. These statements include, among other things, statements concerning our expectations regarding:
•supply chain constraints, the global chip and component shortages, and other factors affecting our manufacturing capacity, delivery, cost and inventory management;
•increased inflation or stagflation, and rising interest rates in many geographies and changes in currency exchange rates and currency regulations;
•the duration and impact of the COVID-19 pandemic, including various COVID-19 variants and “return to office” plans;
•continued growth and market share gains;
•variability in sales in certain product and service categories from year to year and between quarters;
•expected impact of sales of certain products and services;
the impact of macro-economic,•macroeconomic, geopolitical factors and other disruption on our manufacturing or sales, including the impact of the coronavirusCOVID-19 pandemic and other public health issues, wars and natural disasters;
the proportion of our revenue that consists of our product and service revenue, and the mix of billings between products and services, and the duration of service contracts;
the impact of our product innovation strategy;
the effects of •government regulation, tariffs and other related policies;
•drivers of long-term growth and operating leverage, such as increased sales productivity and capacity, functionality and value in our standalone and bundled subscription service offerings;
•growing our solution sales through channel partners to businesses, service providers and government organizations, our ability to execute these sales and of the complexity of sellingproviding solutions to all segments (including the increased competition and unpredictability of timing associated with sales to larger enterprises), the impact of sales to these organizations on our long-term growth, expansion and operating results, and the effectiveness of our internal sales organization;
•our ability to hire properly qualified and effective sales, support and engineering employees;
•risks and expectations related to acquisitions and equity interests in private and public companies, including integration issues related to go-to-market plans, product plans, employees of such companies, controls and processes and the acquired technology, and risks of negative impact by such acquisitions and equity investments on our financial results;
•trends in revenue, cost of revenue and gross margin;
•trends in our operating expenses, including sales and marketing expense, research and development expense, general and administrative expense, and expectations regarding these expenses;
risks and expectations related to acquisitions or sales of assets, including integration issues related to product plans and products, including the acquired technology;
continued investments in research and development, and •expectations that our research and developmentoperating expense will increase in absolute dollars during 2020;2023;
continued investments in our sales resources and infrastructure and marketing strategy, and expectations that our sales and marketing expense will increase in absolute dollars during 2020;
expectations that our general and administrative expense will increase in absolute dollars during 2020;
•expectations that proceeds from the exercise of stock options in future years will be adversely impacted by the increased mix of restricted stock units versus stock options granted;
estimates•expectations regarding uncertain tax benefits and our effective domestic and global tax rates, and the impact of a rangethe Tax Cuts and Jobs Act of 2017 (“TCJA”), the Coronavirus Aid, Relief, and Economic Security Act of 2020 spending on our headquarters expansion project;and the Inflation Reduction Act of 2022 (“IRA”);
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• | expectations regarding uncertain tax benefits and our effective domestic and global tax rates, and the impact of the Tax Cuts and Jobs Act (the “2017 Tax Act”) and the Ninth Circuit’s Altera decision regarding stock-based compensation in cost sharing arrangements;
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expectations regarding spending related to real estate acquisitions and development, data center investments, as well as other capital expenditures and to the impact on free cash flows;flow;
•estimates of a range of 2023 spending on capital expenditures;
•competition in our markets;
•statements regarding expected outcomes and liabilities in litigation;
•our intentions regarding share repurchases and the sufficiency of our existing cash, cash equivalents and investments to meet our cash needs, including our debt servicing requirements, for at least the next 12 months;
•other statements regarding our future operations, financial condition and prospects and business strategies; and
•adoption and impact of new accounting standards.
These forward-looking statements are subject to certain risks and uncertainties that could cause our actual results to differ materially from those reflected in the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in this Annual Report on Form 10-K and, in particular, the risks discussed under the heading “Risk Factors” in Part I, Item 1A of this Annual Report on Form 10-K and those discussed in other documents we file with the Securities and Exchange Commission (the “SEC”).SEC. We undertake no obligation, and specifically disclaim any obligation, to revise or publicly release the results of any revision to these and any other forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue reliance on such forward-looking statements.
Business Overview
Fortinet is a global leader in cybersecurity solutions provided to a wide variety of organizations, such asincluding enterprises, communication service providers and security service providers, government organizations and small businesses. Our cybersecurity solutions are designed to provide broad visibility and segmentation of the digital attack surface through our integrated Fortinet Security Fabriccybersecurity platform products and services providing a mesh architecture, which featuresfeature automated protection, detection and response.response along with consolidated visibility across both Fortinet-developed solutions and a broad ecosystem of third-party solutions and technologies. Our cybersecurity platform portfolio leverages a common operating system or integration to this operating system across our product offerings and helps organizations better secure their environments and reduce their security and network complexities. The Fortinet operating system has an open architecture designed to integrate Fortinet solutions with third-party solutions in a single ecosystem, enabling automated detection and response across the attack surface.
Our product offerings consist of our Core Platform (previously referred to as FortiGate network security) and our Enhanced Platform Technologies (previously referred to as Platform Extension). The Enhanced Platform includes Secure Networking (Secure Switching, Access Points, 5G and Network Access Control), Network and Security Operations (Management, Analytics, Security Information and Event Management, Security Operations, Orchestration and Response and Email Security), Endpoint Security (Enhanced Detection and Response and Identity) and Cloud Security (Web Application Firewall, Cloud Network Security and Cloud-native Application Protection).
Our cloud- and hosted- Enhanced Platform Technology products and services include sandboxing, endpoint detection and response (“EDR”), email security, web application and application programming interface (“API”) security, cloud networking security and cloud-native protection as well as management and analytics.
Our FortiGuard security subscription services are enabled by FortiGuard Labs, which provides threat research and artificial intelligence capabilities from a cloud network to deliver coordinated protection for the ever-expanding attack surface through Core Platform appliance and virtual machine as well as all Enhanced Platform Technology products that are registered by the end-customer.
Our FortiCare support services provide both technical support and professional services to help our customers deploy, maintain, and operationalize our Core Platform and Enhanced Platform Technology products and services.
Our proprietary Application-Specific Integrated Circuits (“ASIC”) are implemented in our physical Core Platform appliances and are designed to enhance the security processing capabilities implemented in software by accelerating computationally intensive tasks such as firewall policy enforcement, software-defined wide-area network (“SD-WAN”), network address translation, Intrusion Prevention Systems (“IPS”), threat detection and encryption. We also provide Fortinet
virtualized Application-Specific Integrated Circuits (“vASICs”) across our Core Platform virtual appliances to deliver similar accelerated capabilities when run in virtualized environments.
Our FortiOS operating system provides the foundation for the operation of Core Platform and Enhanced Platform Technology products, whether physical, virtual, private- or public-cloud based. FortiOS directs the operations of processors and ASICs and provides system management functions. We make regular updates to FortiOS available through our FortiCare support services.
Networking functionality and security capabilities are integrated into the FortiOS operating system to run both the Core Platform and Enhanced Platform Technology capabilities of our cybersecurity mesh architecture (“Fortinet Security Fabric”). This approach to security combines discrete security solutions together into an integrated operating system which provides centralized management, visibility, automation and intelligence sharing to simplify operations and respond rapidly to threats.
The focus areas of our business consist of:
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• | •Secure Networking—Our Security-Driven Networking solutions enables the convergence of networking and security across all edges to provide next-generation firewall (“NGFW”), SD-WAN, LAN Edge (Wi-Fi and switch) and secure access service edge (“SASE”). We derive a majority of product sales from our Core Platform network security appliances. Core Platform network security appliances include a broad set of built-in security and networking features and functionalities, including firewall, next-generation firewall, secure web gateway, secure sockets layer (“SSL”) inspection, SD-WAN, Intrusion Prevention system (“IPS”), sandboxing, data leak prevention, virtual private network (“VPN”), switch and wireless controller and wide area network (“WAN”) edge. Our network security appliances are managed by our FortiOS network operating system, which provides the foundation for Core Platform security functions.We enhance the performance of our network security appliances from branch to data center by designing and implementing ASICs technology within our appliances, enabling us to add security and network functionality with minimal impact to network throughput performance. Along with our secure Wi-Fi access points and switches, we help organizations secure their networks across campuses, branches and work from anywhere (“WFA”) deployments.For the Japanese market, we also offer high performance network switches marketed under Alaxala for data center switching. FortiOS supports many more secure networking markets and applications than just Firewall. These include:
•Network Firewall (“NFW”) •Software-Defined Wide Area Network (“SD-WAN”) •Secure LAN/WLAN (Wi-Fi and Switch) (SD-Branch/Campus) •Secure Access Service Edge (“SASE”) •Universal Zero Trust Network Access (“ZTNA”) •Encryption Applications (SSL Inspection, Virtual Private Network (“VPN”), and IPsec Connectivity)
Further each security application has number of customer use cases. For example, Network Firewall has the following use cases:
•Data Center Perimeter NGFW •North–South Internal Segmentation Firewall •Distributed Network Edge Firewall •East–West Micro Segmentation Firewall •Virtual Firewall (“VM”) •Cloud Native Firewall (“CNF”) •Firewall as a Service (“FWaaS”) •Containerized Firewall •Endpoint Firewall •SMB Firewall •Home Firewall
•Zero Trust Access—Fortinet’s Enhanced Platform Technology products and services extend beyond the network to create a cybersecurity mesh architecture to cover other attack vectors. Our Zero Trust Access solutions enable
customers to know and control who and what is on their network, in addition to providing security for WFA. Zero Trust Access solutions include FortiNAC, FortiAuthenticator, FortiClient and FortiToken. Additionally, the proliferation of OT and internet of things (“IoT”) devices has generated new opportunities for us to grow our business. Our network access control solutions provide visibility, control and automated event responses in order to secure OT and IoT devices.
•Cloud Security—We help customers connect securely to and across their individual, hybrid cloud, multi-cloud and virtualized data center environments by offering security through our virtual firewall and other software products and through integrated cloud-native capabilities with major cloud platforms. Our public and private cloud security solutions, including virtual appliances and hosted solutions, bring our Enhanced Platform Technology products and services into and across cloud environments, delivering security that follows their applications and data. Our solutions include network security, web application firewall and API protection, cloud-native security and workload protection. Our Secure SD-WAN for multi-Cloud solution automates deployment of an overlay network across different cloud networks and offers visibility, control and centralized management that integrates functionality across multiple cloud environments. Our cloud security portfolio also includes securing applications in all environments in which they can be deployed, including physical and virtual data centers, clouds, and edge compute instances. Fortinet cloud security offerings are available for deployment in major public and private cloud environments, including Amazon Web Services, Google Cloud, IBM Cloud, Microsoft Azure, Oracle Cloud and VMWare Cloud. We also offer managed web application firewall (“WAF”) rules delivered by FortiGuard Labs as an overlay service to native security offerings offered by Amazon Web Services.
•Security Operations—We derive a majority of product sales from our FortiGate network security appliances. Our FortiGate network security appliances include a broad set of built-in security and networking features and functionalities, including firewall, next-generation firewall, secure web gateway, SSL inspection, SD-WAN, intrusion prevention, SSL data leak prevention, VPN, switch and wireless controller and wide area network edge. Our network security appliances are managed by our FortiOS network operating system, which provides the foundation for FortiGate security functions. We enhance the performance of our network security appliances from branch to data center by designing and implementing SPU technology within our appliances, enabling us to add security and network functionality with minimal impact to network throughput performance. |
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• | Infrastructure Security—The Fortinet Security Fabric platform is a broad, automated and integrated security platform that extends beyond the network to cover other attack vectors. Other infrastructure solutions covered include Secure Access (Wi-Fi and switch).
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• | Cloud Security—We help customers connect securely to and across their hybrid, public and private cloud environments by offering security through our virtual firewall and other software products in public and private cloud environments. Our cloud security solutions, including virtual appliances and hosted solutions, extend the core capabilities of the Fortinet Security Fabric platform to provide businesses with the same level of cybersecurity and threat intelligence in and across cloud environments that they receive on their physical networks. Fortinet cloud security offerings are available across all major cloud providers, including Amazon Web Services, Microsoft Azure, Google Cloud, Oracle Cloud, Alibaba Cloud and IBM Cloud. Our Cloud Security portfolio also includes securing applications, including email and web.
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• | Endpoint Protection, Internet of Things and Operational Technology Security—We protect end-customers from advanced threats that target their devices and the data that reside on them through our advanced endpoint solutions that provide core endpoint protection, advanced threat protection, incident monitoring, and response. Additionally, the proliferation of IoT and the digitization of OT devices has generated new opportunities for us to grow our business. We offer network access control solutions that provide visibility, control and automated event responses in order to secure IoT devices.
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We also develop and provide AI-drivena range of products and services that enable the security operations solutions, includingcenter (“SOC”) teams to identify, investigate and remediate potential incidents in which cybercriminals bypass prevention-oriented controls. Given the breadth of the attack surface to monitor, as well as the volume and sophistication of cyber threats, artificial intelligence is a key part of these offerings, which include: FortiGuard and other security subscription services, thatmodern endpoint security with EDR, a range of breach-protection technologies plus our security information and event management (“SIEM”) and security orchestration, automation and response (“SOAR”), all of which can be applied across the entire Fortinet Security Fabric platform.set of Platform Extension products and services. These solutions help customers better secure their environments by delivering deeperautomatically deliver security intelligence and insights that enable organizations to protect against and by narrowingrespond to threats faster through integration with Fortinet and third-party controls.
•Security as a Service—Our customers purchase our natively integrated FortiGuard security subscription services as an add-on to products and solutions across many of the gaps inEnhanced Platform Technology products and services with the goal of receiving real-time threat intelligence and protection updates. The rich set of FortiGuard security skillssubscription services is built from the ground up to provide comprehensive protection for users and resources thatapplications, including market leading offerings for IPS, Web, video and DNS filtering, AV and cloud sandbox as well as OT and IoT Security. The FortiGuard security subscription services are present in many organizations.provided from our FortiGuard Labs and cloud-delivered to provide real-time unified protection across network endpoint and cloud.
•Support and Professional Services—We offer technical support, FortiOS updates and extended product warranty through our FortiCare support services. In addition to our security solutions, our customers, channel partners and end-customers may purchase FortiGuard and other security subscription services to receive threat intelligence updates, FortiCare technical support services, across allwe offer a range of our productsadvanced services, including premium support, professional services and theexpedited warranty replacement. Our advanced support service offerings include technical account managers that act as a single point of Technical Account Managers, Resident Engineerscontact and customer advocate within Fortinet. Our professional service offerings include resident engineers and professional service consultants for implementations or training services.trainings.
Financial Highlights
•Total revenue was $2.16$4.42 billion in 2019,2022, an increase of 20%32% compared to $1.80$3.34 billion in 2018. 2021.
•Product revenue was $788.5 million$1.78 billion in 2019,2022, an increase of 17%42% compared to $674.4 million$1.26 billion in 2018. 2021.
•Service revenue was $1.37$2.64 billion in 2019,2022, an increase of 21%26% compared to $1.13$2.09 billion in 2018.2021.
We generated operating•Total gross profit was $3.33 billion in 2022, an increase of 30% compared to $2.56 billion in 2021.
•Operating income of $344.2was $969.6 million in 2019,2022, an increase of 49% compared to $231.0$650.4 million in 2018.2021.
•Cash, cash equivalents, investments and investmentsmarketable equity securities were $2.21$2.26 billion as of December 31, 2019, an increase2022, a decrease of $493.3$736.0 million, or 29%25%, from December 31, 2018.2021.
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• | Deferred revenue was $2.14 billion as of December 31, 2019, an increase of $449.1 million, or 27%, from December 31, 2018.
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We generated cash flows from operating activities
•Long-term debt, net of $808.0unamortized discount and debt issuance costs, was $990.4 million in 2019, an increaseand $988.4 million as of $169.1 million, or 26%, compared to 2018.December 31, 2022 and 2021, respectively.
•In 2019,2022, we repurchased 1.936.0 million shares of common stock under the Repurchase Program for an aggregate purchase price of $140.9 million.$1.99 billion. In 2018,2021, we repurchased 3.812.9 million shares of common stock for a total purchase price of $209.1$741.8 million.
•Deferred revenue was $4.64 billion as of December 31, 2022, an increase of $1.19 billion, or 34%, from December 31, 2021. Short-term deferred revenue was $2.35 billion as of December 31, 2022, an increase of $571.9 million, or 32%, from December 31, 2021.
•Cash flows from operating activities were $1.73 billion in 2022, an increase of $230.9 million, or 15%, compared to 2021.
•In October 2022, we acquired the remaining 25% of equity interests in Alaxala for $13.5 million in cash, and Alaxala became a wholly owned subsidiary.
•Our loss related to our equity method investment in Linksys Holdings, Inc. (“Linksys”) in fiscal 2022 totaled $68.1 million, which comprised of our proportionate share of Linksys’ financial results as well as the amortization of the basis differences of $45.9 million, which included a $17.5 million charge in connection with a valuation allowance established on deferred tax assets at Linksys, and the other-than-temporary impairment (“OTTI”) charge of $22.2 million.
Our revenue growth was driven by both product and service revenue. On a geographic basis, revenue continues to be diversified globally, which remains a key strength of our business.
In 2022, the Americas region, the Europe, Middle East and Africa (“EMEA”) region and the Asia Pacific (“APAC”) region contributed 41%, 38% and 21% of our total revenue, respectively, and increased by 31%, 33% and 33% compared to 2021, respectively.
Product revenue grew 17% 42% in 2019. We experienced2022. Product revenue growth was consistent with an elevated cyber threat landscape and changes in our pricing model. The product revenue growth was primarily due to strong growth across severalmany of our hardwareEnhanced Platform Technology products, including our secure access products and software products, including FortiGate enabled with SD-WAN features.licenses. In addition, our product revenue growth was driven by a strong demand for the wide range operating system capabilities embedded in our Core Platform products.
Service revenue growth has accelerated over the past three years from 22% in 2020, to 24% in 2021, to 26% in 2022. Service revenue growth of 21%26% in 20192022 was driven by the strength of our FortiGuard and other security subscription revenue and FortiCare technical support and other service revenue, which grew 24%.27% and 26%, respectively. The increases were primarily due to the recognition of revenue from our growing deferred revenue balance related to FortiGuard and other security subscriptions delivered to on-premise and cloud-based environments, as well as FortiCare and other technical support, including our customers moving to higher-tier support offerings and the early effects of certain pricing actions.
During the second quarter of 2019, we reclassified the 100 seriesOur billings were diversified on a geographic basis. In 2022, six countries represented approximately 50% of our FortiGate product from an entry-level product to a mid-range product. Prior periods have been reclassified to conform with current period presentation. Including this reclassification, we saw a mix shift from high-end to mid-range products in 2019.
Duringbillings and the fourth quarter of 2019, we acquired enSilo Limited (“enSilo”) and CyberSponse Inc. (“CyberSponse”) to further strengthen our Fortinet Security Fabric platform by providing real-time automated endpoint detection and response capability (enSilo) and security orchestration, automation and response products and services (CyberSponse). The impact of these acquisitions, individually andremaining 50% in the aggregate were not material tofrom over 100 countries that individually contributed less than 4% of our consolidated financial statements.billings.
In 2019, our revenue growth outpaced our growth in operating expenses. As a result, operatingOperating expenses as a percentage of revenue decreased by twoapproximately 3.6 percentage points in 2022 compared to 2018.2021, which benefited from the favorable impact of foreign currency fluctuations. Headcount increased by 21%24% to 7,08212,595 employees and contractors as of December 31, 2019,2022, up from 5,84510,195 as of December 31, 2018. The acquisition2021.
Impact of enSiloMacroeconomic Developments and CyberSponse increased headcountCOVID-19 Pandemic Update
Our overall performance depends in part on worldwide economic and geopolitical conditions and their impact on customer behavior. Worsening economic conditions, including inflation, higher interest rates, slower growth, fluctuations in foreign exchange rates and other changes in economic conditions, may adversely affect our results of operations and financial performance.
We continue to monitor and respond to developments relating to the COVID-19 pandemic. In response to the COVID-19 pandemic, we undertook a number of actions to protect our employees, including restricting travel and directing
many of our employees to work from home. In certain geographies, we have transitioned back to an in-person working mode, allowing increasing numbers of employees to work from our offices with reasonable precautions and, in all cases, subject to abiding by 135 employees. Excluding these two acquisitions, headcount wouldlocal legal restrictions. We intend to continue to monitor and abide by local employee health and safety protocols and other regulations as applicable to each local office.
We have increased 19% year over year.
The impact of the coronavirus outbreakseen certain impacts on our business remains uncertain, and thoughoperations, results of operations, financial condition, cash flows, liquidity and capital and financial resources as of and during the majorityyear ended December 31, 2022. Conversely, some aspects of our products are manufactured outside of China,business do not appear to have been significantly affected. During the year ended December 31, 2022, we observed the following:
•We saw continued supply chain challenges, including chip and other component shortages and increased costs for certain chips and other components and shipping, and we did not have enough inventory to promptly meet all demand for all products.
•In many countries, our productsemployees’ ability to travel was reduced and certain of our products are manufactured in Chinain-person sales and Taiwan andmarketing events or meetings that would normally have been held were canceled, postponed or converted into virtual events. However, as certain country’s restrictions continued to ease, we have internationalstarted to see an increase in expenses related to travel and marketing events. Although we cannot predict if or when such expenses will return to pre-pandemic levels, as of December 31, 2022, we had started to see an increase in such expenses as compared to the same period last year.
•In order to mitigate supply chain disruptions and other supply chain risks and in anticipation of future demand, we increased our commitments with certain suppliers to secure capacity and are meeting regularly with our contract manufacturers and component suppliers to manage future commitments, address component shortages and monitor delivery. We have also transitioned primarily to air shipping to avoid port congestion and logistics centersextended ocean freight time.
•Our days sales outstanding increased to 89 days for the year ended December 31, 2022, compared to 75 days for the year ended December 31, 2021, primarily due to the sales linearity. The accounts receivable allowance for credit losses was $3.6 million as of December 31, 2022, an increase of $1.2 million compared to $2.4 million as of December 31, 2021, primarily due to an increase in Taiwan. While any significant impact is uncertain at this point, if the coronavirus outbreak continues to spread, the business disruption caused thereby couldpast due invoices over 60 and 90 days.
The COVID-19 pandemic may have a material negative impact on our future periods. If we experience component, shipping, inventory or customer payment challenges, it will negatively impact billings and product revenue gross margin, operating margin,in the current quarter and FortiGuard and FortiCare service revenues in subsequent quarters, as we sell annual and multi-year service contracts that are recognized ratably over the service term, generally starting on the contract registration date. In addition, the broader implications of the pandemic on our business and operations and our financial results, including the extent to which the effects of the pandemic may impact future results and growth in the cybersecurity industry, remain uncertain. The extent of the impact of the COVID-19 pandemic on our operational and financial performance will depend on ongoing developments, including the duration and spread of the virus and its variants, the impact on our end-customers’ spending, the volume of sales and length of our sales cycles, the impact on our partners, suppliers, and employees, actions that may be taken by governmental authorities and other factors identified in Part I, Item 1A “Risk Factors” in this Form 10-K. Given the dynamic nature of these circumstances, the full impact of the COVID-19 pandemic on our business and operations, results of operations, financial condition, cash flows, liquidity and othercapital and financial results for the first quarter of 2020 and certain periods thereafter.resources cannot be reasonably estimated at this time.
Business Model
We primarilytypically sell our products and services through a two-tier distribution model. We sellsecurity solutions to distributors that sell to networking security and enterprise-focusedfocused resellers and to certain service providers, and MSSPs, who, in turn, sell to end-customers or use our end-customers. In certain cases,products and services to provide hosted solutions to other enterprises. At times, we also sell directly to certain large enterprise customers, large service providers and major systems integrators. In certain cases, we sell directly toOur end-customers are located in over 100 countries and include small, medium and large service providersenterprises and major systems integrators. government organizations across a wide range of industries, including education, financial services, government, healthcare, manufacturing, retail, technology and telecommunications. An end-customer deployment may involve as few as one or as many as thousands of Core Platform products as well as Enhanced Platform Technology products, depending on the end-customer’s size and security requirements.
We also offer our products acrosshosted in our own data centers and through co-locations and major cloud providers, and have recognized on-demand revenue fromincluding Amazon Web Services, Microsoft Azure,Google Cloud, IBM Cloud, Google CloudMicrosoft Azure and Oracle Cloud. We have also recognized revenue from customers who deploy our products in a bring-your-own-license (“BYOL”) arrangementarrangements at a cloud provider such as Amazon Web Services, Microsoft Azure, Google Cloud, Oracle Cloud and Alibaba Cloud.providers or at private clouds. In a BYOL arrangement, a customer purchases a software license from us through our channel partners and deploys the software in a cloud provider’s environment. Similarly, customers may purchase such a license from us and deployenvironment in third-party clouds or in their private cloud.
Our customers purchase our hardware products and software licenses, as well as our FortiGuard and other security subscription and FortiCare technical support services. We generally invoice at the time of our sale for the total price of the products and security and technical support services. The invoice is typically payable within 30Standard payment terms are generally no more than 60 days, though we may offer extended payment terms to 45 days. We also invoice certain services on a monthly basis.distributors or related to certain transactions.
Key Metrics
We monitor a number ofseveral key metrics, including the key financial metrics set forth below, in order to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts, and assess operational efficiencies. The following table summarizes revenue, deferred revenue, billings (non-GAAP), net cash provided by operating activities, and free cash flow (non-GAAP). We discuss revenue below under “—Components of Operating Results,” and we discuss net cash provided by operating activities below under “—Liquidity and Capital Resources.” Deferred revenue, billings (non-GAAP), and free cash flow (non-GAAP) are discussed immediately below the following table.
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| Year Ended or As of December 31, |
| 2022 | | 2021 | | 2020 |
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| (in millions) |
Revenue | $ | 4,417.4 | | | $ | 3,342.2 | | | $ | 2,594.4 | |
Deferred revenue | $ | 4,640.3 | | | $ | 3,452.9 | | | $ | 2,605.3 | |
Billings (non-GAAP) | $ | 5,594.0 | | | $ | 4,181.4 | | | $ | 3,090.0 | |
Net cash provided by operating activities | $ | 1,730.6 | | | $ | 1,499.7 | | | $ | 1,083.7 | |
Free cash flow (non-GAAP) | $ | 1,449.4 | | | $ | 1,203.8 | | | $ | 907.8 | |
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| Year Ended or As of December 31, |
| 2019 | | 2018 | | 2017 |
| (in millions) |
Revenue | $ | 2,156.2 |
| | $ | 1,801.2 |
| | $ | 1,494.9 |
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Deferred revenue | $ | 2,135.9 |
| | $ | 1,686.8 |
| | $ | 1,336.3 |
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Billings (non-GAAP) | $ | 2,602.9 |
| | $ | 2,153.3 |
| | $ | 1,795.9 |
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Net cash provided by operating activities | $ | 808.0 |
| | $ | 638.9 |
| | $ | 594.4 |
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Free cash flow (non-GAAP) | $ | 715.8 |
| | $ | 585.9 |
| | $ | 459.1 |
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Deferred revenue. Our deferred revenue consists of amounts that have been invoiced but that have not yet been recognized as revenue. The majority of our deferred revenue balance consists of the unrecognized portion of service revenue from FortiGuard and other security subscription and FortiCare technical support service contracts, which is recognized as revenue ratably over the contractual service period.term. We monitor our deferred revenue balance, short term and total deferred revenue growth and the mix of short-term and long-term deferred revenue because deferred revenue represents a significant portion of free cash flow and of revenue to be recognized in future periods. Deferred revenue was $2.14$4.64 billion as of December 31, 2019,2022, an increase of $449.1 million,$1.19 billion, or 27%34%, from December 31, 2018.2021. Short term deferred revenue was $2.35 billion as of December 31, 2022, and increase of $571.9 million, or 32%, from December 31, 2021.
Billings (non-GAAP). We define billings as revenue recognized in accordance with generally accepted accounting principles in the United States (“GAAP”) plus the change in deferred revenue from the beginning to the end of the period, and adjustments to the deferred revenue balance due to adoption of Financial Accounting Standards Board (“FASB”) Topic 606, Revenue from Contracts with Customers (“Topic 606”), less any deferred revenue balances acquired from business combination(s) and adjustment due to adoption of new accounting standard during the period. We consider billings to be a useful metric for management and investors because billings
drive current and future revenue, which is an important indicator of the health and viability of our business. There are a number ofseveral limitations related to the use of billings instead of GAAP revenue. First, billings include amounts that have not yet been recognized as revenue and are impacted by the term of FortiGuard security subscription and FortiCare and other support contractual service period agreements. Second, we may calculate billings in a manner that is different from peer companies that report similar financial measures. Management accounts for these limitations by providing specific information regarding GAAP revenue and evaluating billings together with GAAP revenue. Total billings were $2.60$5.59 billion for 2019,in 2022, an increase of 21%34% compared to $2.15$4.18 billion in 2018.2021.
A reconciliation of revenue, the most directly comparable financial measure calculated and presented in accordance with GAAP, to billings is provided below:
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| Year Ended December 31, |
2022 | | 2021 | | 2020 |
| | | | |
(in millions) |
Billings: | | | | | |
Revenue | $ | 4,417.4 | | | $ | 3,342.2 | | | $ | 2,594.4 | |
Add: Change in deferred revenue | 1,187.4 | | | 847.6 | | | 496.2 | |
Less: Deferred revenue balance acquired in business combinations | (10.8) | | | (4.1) | | | (0.6) | |
Less: Adjustment due to adoption of ASU 2021-08 | — | | | (4.3) | | | — | |
Total billings (non-GAAP) | $ | 5,594.0 | | | $ | 4,181.4 | | | $ | 3,090.0 | |
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| Year Ended December 31, |
2019 | | 2018 | | 2017 |
(in millions) |
Billings: | | | | | |
Revenue | $ | 2,156.2 |
| | $ | 1,801.2 |
| | $ | 1,494.9 |
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Add: Change in deferred revenue | 449.1 |
| | 350.5 |
| | 301.0 |
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Add: Deferred revenue adjustment due to adoption of Topic 606 | — |
| | 4.1 |
| | — |
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Less: Deferred revenue balance acquired in business combinations | (2.4 | ) | | (2.5 | ) | | — |
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Total billings (non-GAAP) | $ | 2,602.9 |
| | $ | 2,153.3 |
| | $ | 1,795.9 |
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Free cash flow (non-GAAP). We define free cash flow as net cash provided by operating activities minus purchases of property and equipment.equipment and excluding any significant non-recurring items. We believe free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by the business that, after capital expenditures, can be used for strategic opportunities, including repurchasing outstanding common stock, investing in our business, making strategic acquisitions, and strengthening the balance sheet. A limitation of using free cash flow rather than the GAAP measures of cash provided by or used in operating activities, investing activities, and financing activities is that free cash flow does not represent the total increase or decrease in the cash and cash equivalents balance for the period because it excludes cash flows from investing activities other than capital expenditures and cash flows from financing activities. Management accounts for this limitation by providing information about our capital expenditures and other investing and financing activities on the face of the consolidated statements of cash flows and under “—Liquidity and Capital Resources” and by presenting cash flows from investing and financing activities in our reconciliation of free cash flow. In addition, it is important to note that other companies, including companies in our industry, may not use free cash flow, may calculate free cash flow in a different manner than we do or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of free cash flow as a comparative measure. A reconciliation of net cash provided by operating activities, the most directly comparable financial measure calculated and presented in accordance with GAAP, to free cash flow is provided below:
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| Year Ended December 31, |
2022 | | 2021 | | 2020 |
| | | | |
(in millions) |
Free Cash Flow: | | | | | |
Net cash provided by operating activities | $ | 1,730.6 | | | $ | 1,499.7 | | | $ | 1,083.7 | |
Less: Purchases of property and equipment | (281.2) | | | (295.9) | | | (125.9) | |
Less: Proceeds from intellectual property matter | — | | | — | | | (50.0) | |
Free cash flow (non-GAAP) | $ | 1,449.4 | | | $ | 1,203.8 | | | $ | 907.8 | |
Net cash provided by (used in) investing activities | $ | 763.9 | | | $ | (1,325.1) | | | $ | (72.8) | |
Net cash provided by (used in) financing activities | $ | (2,130.3) | | | $ | 82.8 | | | $ | (1,171.6) | |
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| | | | | | | | | | | |
| Year Ended December 31, |
2019 | | 2018 | | 2017 |
(in millions) |
Free Cash Flow: | | | | | |
Net cash provided by operating activities | $ | 808.0 |
| | $ | 638.9 |
| | $ | 594.4 |
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Less: Purchases of property and equipment | (92.2 | ) | | (53.0 | ) | | (135.3 | ) |
Free cash flow (non-GAAP) | $ | 715.8 |
| | $ | 585.9 |
| | $ | 459.1 |
|
Net cash used in investing activities | $ | (502.3 | ) | | $ | (134.9 | ) | | $ | (76.8 | ) |
Net cash used in financing activities | $ | (195.6 | ) | | $ | (202.6 | ) | | $ | (415.6 | ) |
Components of Operating Results
Revenue. We generate the majority of our revenue from sales of our hardware and software products and amortization of amounts included in deferred revenue related to previous sales of FortiGuard security subscription and FortiCare technical support services. We also recognize revenue from cloud security solutions, professional services, and training.
Our total revenue is comprised of:
•Product revenue. Product revenue is primarily generated from sales of our physical and virtual machine appliances. The majority of our product revenue continues to be generated by our Core Platform product line. Product revenue also includes revenue from sales of Enhanced Platform Technologies. As a percentage of total revenue, our product revenue has varied from quarter to quarter.
•Service revenue. Service revenue is generated primarily from FortiGuard security subscription services and FortiCare technical support services. We recognize revenue from FortiGuard security subscription and FortiCare technical support services ratably over the following:service term. Our typical contractual support and subscription term is one to five years. We also generate a small portion of our revenue from other services, for which we recognize revenue as the services are provided, and cloud-based services, for which we recognize revenue as the services are delivered or on a monthly usage basis. As a percentage of total revenue, we continue to expect service revenue to be higher than product revenue. Our service revenue growth rate depends significantly on the growth of our customer base, the expansion of our service bundle offerings, the mix of our product revenue, pricing actions, the expansion and introduction of new service offerings, the attach rate of service contracts to new product sales, and the renewal of service contracts by our existing customers.
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• | Product revenue. Product revenue is primarily generated from sales of our appliances. The majority of our product revenue has been generated by our FortiGate product line, and we do not expect this to change in the foreseeable future. Product revenue also includes revenue derived from sales of fabric hardware and software products, including FortiGate software licenses. As a percentage of total revenue, we expect that our product revenue may vary from quarter-to-quarter based on certain factors, as discussed below under “—Quarterly Results of Operations,” and we expect the trend to continue in 2020.
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• | Service revenue. Service revenue is generated primarily from FortiGuard security subscription services and FortiCare technical support services. We recognize revenue from FortiGuard security subscription and FortiCare technical support services over the contractual service period. Our typical contractual support and subscription term is one to three years and, to a lesser extent, five years. We also generate a small portion of our revenue from professional services and training services, for which we recognize revenue as the services are provided, and cloud-based services, for which we recognize revenue as the services are delivered or on a monthly usage basis. As a percentage of total revenue, we continue to expect service revenue to be higher than product revenue. Our service revenue growth rate depends significantly on the growth of our customer base, the expansion of our service bundle offerings, the expansion and introduction of new service offerings and the renewal of service contracts by our existing customers.
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Our total cost of revenue is comprised of:
•Cost of product revenue. The majority of the following:cost of product revenue consists of third-party contract manufacturers’ costs and the costs of materials used in production. Our cost of product revenue also includes supplies, shipping costs, personnel costs associated with logistics and quality control, facility-related costs, excess and obsolete inventory costs, warranty costs and amortization of intangible assets. Personnel costs include compensation benefits and stock-based compensation.
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• | Cost of product•Cost of service revenue. Cost of service revenue is primarily comprised of personnel costs, third-party repair and contract fulfillment, data center costs, colocation expenses and cloud hosting, supplies, facility-related costs and amortization of intangible assets.
. The majority of the cost of product revenue consists of third-party contract manufacturers’ costs and the costs of materials used in production. Our cost of product revenue also includes supplies, shipping costs, personnel costs associated with logistics and quality control, facility-related costs, excess and obsolete inventory costs, warranty costs and amortization of intangible assets. Personnel costs include direct compensation and benefits.
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• | Cost of service revenue. Cost of service revenue is primarily comprised of salaries, benefits and bonuses, as well as stock-based compensation. Cost of service revenue also includes third-party repair and contract fulfillment, data center and cloud hosting, supplies and facility-related costs.
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Gross margin. Gross profit as a percentage of revenue, or gross margin, has been and will continue to be affected by a variety of factors, including the average sales price of our products, product costs, the mix of products sold and the mix of revenue between hardware products, software licenses and services and any excess inventory write-offs.or other charges. Service revenue and software licenses have had a positive effect on our total gross margin given the higher gross margins compared to hardware product gross margins.products. During 2019, service gross margin benefited from renewals and continued sales of services and subscriptions, growing faster than related expenses. Product2022, product gross margin benefited from gains in average selling price, as well as lower directpartially offset by higher component costs due to supply chain constraints and indirect product costs as a percentagethe consolidation of product revenue.Alaxala Networks Corporation (“Alaxala”) starting from August 31, 2021. It also benefited from deal mix, software revenue growthgrowth. Service gross margin decreased due to data center expansion, increased labor cost and a stable product transition environment. Costour consolidation of product revenue was comprisedAlaxala, partially offset by favorable impact of direct product costsforeign currency exchange rates and indirect costs, including inventory reserves and other manufacturing overhead.higher average selling prices. Overall gross margin in 20202023 will be impacted by service and product revenue mix, but we expect it to be comparable to overall gross margin in 2019.mix.
Operating expenses. Our operating expenses consist of research and development, sales and marketing and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist primarily of salaries, benefits, bonuses, stock-based compensation, and sales commissions as applicable.and stock-based compensation. We expect personnel costs to continue to increase in absolute dollars as we expand our workforce.
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• | •Research and development. Research and development expense consists primarily of personnel costs. Additional research and development expenses include ASIC and system prototypes and certification-related expenses, depreciation of property and equipment and facility-related expenses. The majority of our research and development is focused on software development and the ongoing development of our hardware products. We record research and development expenses as incurred. As of December 31, 2022, approximately 89% of our research and development teams were located in Canada, the United States and India. As of December 31, 2022, approximately two-thirds of our engineers worked on software development while the remainder worked on hardware development.
•Sales and marketing. Sales and marketing expense is the largest component of our operating expenses and primarily consists of personnel costs. Additional sales and marketing expenses include product marketing, public relations, field marketing and events and channel marketing programs (e.g., partner cooperative marketing arrangements), as well as travel, depreciation of property and equipment and facility-related expenses. The majority of our research and development is focused on both software development and the ongoing development of our hardware platform. We record all research and development expenses as incurred. Our research and development teams are primarily located in Canada and the United States. |
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• | Sales and marketing. Sales and marketing expense is the largest component of our operating expenses and primarily consists of personnel costs. Additional sales and marketing expenses include product marketing, public relations, field marketing and channel marketing programs (e.g. partner cooperative marketing arrangements), as well as travel, depreciation of property and equipment and facility-related expenses. We
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intend to hire additional personnel focused on sales and marketing and expand our sales and marketing efforts worldwide in order to capture market shareshare.
•General and administrative. General and administrative expense consists of personnel costs, as well as professional fees, depreciation of property and equipment and software and facility-related expenses. General and administrative personnel include our executive, finance, human resources, information technology and legal organizations. Our professional fees principally consist of outside legal, auditing, tax, information technology and other consulting costs.
•Gain on intellectual property matter. Gain on intellectual property matter consists of the amortization of the deferred component of an agreement with a competitor in the enterprise market.network security industry, whereby, the competitor party paid us a lump sum of $50.0 million for a seven-year mutual covenant-not-to-sue for patent claims.
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• | General and administrative. General and administrative expense consists of personnel costs, as well as professional fees, depreciation of property and equipment and software and facility-related expenses. General and administrative personnel include our executive, finance, human resources, information technology and legal organizations. Our professional fees principally consist of outside legal, auditing, accounting, tax, information technology and other consulting costs.
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Interest income—net.income. Interest income—netincome consists primarily of interest earned on our cash cash equivalents and investments. We have historically investedHistorically, our cash ininvestments include corporate debt securities, certificates of deposit and term deposits, commercial paper, money market funds, and U.S. government and agency securities.securities and municipal bonds.
Interest expense. Interest expense consists primarily of interest expense due to the senior notes and other miscellaneous interest expense.
Other income (expense)expense—net. Other income (expense)—expense—net consists primarily of foreign exchange gains and losses related to foreign currency remeasurement, gains or losses due to the changes in fair value of our marketable equity securities, realized gains and losses of available-for-sale securities, net rental income from real estate, as well as the gain on the sale or the impairment charges of an investmentour investments in a privately held company andcompanies without readily determinable fair values, which are not accounted for under the impairment charge on an investment in a privately held company.equity method.
Provision for (benefit from) income taxes. We are subject to income taxes in the United States, as well as other tax jurisdictions or countries in which we conduct business. Earnings from our non-U.S. activities are subject to income taxes in local countries and may be subject to U.S. income taxes. Our effective tax rate differs from the U.S. statutory rate primarily due to foreign income subject to different tax rates than in the U.S., nondeductible stock-based compensation expense, federal research and development tax credit, state income taxes, withholding taxes, excess tax benefits related to stock-based compensation expense and the tax impacts of the 2017 Tax Act.foreign-derived intangible income (“FDII”) deduction.
Critical Accounting Policies and Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with GAAP. These principles require us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, cost of revenue and expenses, and related disclosures. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. To the extent that there are material differences between these estimates and our actual results, our future financial statements will be affected.
We believe that, of the significant accounting policies described in Note 1 to our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K, the following accounting policies involve a greater degree of judgment and complexity. Accordingly, we believe these are the most critical to fully understand and evaluate our financial condition and results of operations.
Revenue Recognition
On January 1, 2018, we adopted Topic 606, Revenue from Contracts with Customers, using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported under ASC Topic 605 (“Topic 605”), Revenue Recognition.
Beginning in 2018, revenuesRevenues are recognized when control of goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Prior to 2018, revenue was recognized under Topic 605 when all of the following criteria were met: (i) persuasive evidence of an arrangement existed, (ii) delivery has occurred or services have been rendered, (iii) sales price was fixed or determinable and (iv) collectability was reasonably assured.
Under Topic 606, weWe determine revenue recognition through the following steps:
•identification of a contract or contracts with a customer;
•identification of the performance obligations in a contract, including evaluation of performance obligations as to being distinct goods or services in a contract;
•determination of a transaction price;
•allocation of a transaction price to the performance obligations in a contract; and
•recognition of revenue when, or as, we satisfy a performance obligation.
Our sales contracts typically contain multiple deliverables, such as hardware, software license, security subscription, technical support services and other services, which are generally capable of being distinct and accounted for as separate performance obligations. We evaluated the criteria to be distinct under Topic 606Our hardware and concluded thatsoftware licenses have significant standalone functionalities and capabilities. Accordingly, the hardware and software licenses wereare distinct and distinct in the context of a contract from the security subscription and technical support services, as a customer can benefit from the hardware and software licensesproduct without the services and the services are separately identifiable within a contract. We allocate a transaction price to each performance obligation based on relative standalone selling price. We establish standalone selling price using the prices charged for a deliverable when sold separately. If not observable through past transactions, we determine standalone selling price based on the historical pricing and discounting practices for those services when sold separately. We determine standalone selling price for a product or service by considering multiple historical factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies and the term of a service contract that fall within a reasonably range as a percentage of list price.contract.
Under the previous standard, Topic 605, revenue from contracts that contain products and services is allocated to each unit of accounting based on an estimated selling price using vendor-specific objective evidence (“VSOE”) of selling price, if it existed, or third-party evidence (“TPE”) of selling price. If neither VSOE nor TPE of selling price existed for a deliverable, we used our best estimate of selling price for that deliverable. For multiple-element arrangements where software deliverables were included, revenue was allocated to the non-software deliverables and to the software deliverables as a group using the relative estimated selling prices of each of the deliverables in an arrangement based on the estimated selling price hierarchy. The amount allocated to the software deliverables was then allocated to each software deliverable using the residual method when VSOE of fair value existed. If evidence of VSOE of fair value of one or more undelivered elements did not exist, all software allocated revenue was deferred and recognized when delivery of those elements occurred or when fair value was established. When the undelivered element for which we did not have VSOE of fair value was support, revenue for the entire arrangement was recognized ratably over the support period. The same residual method and VSOE of fair value principles applied for our multiple element arrangements that contained only software elements.
Deferred Contract Costs and Commission Expense
Beginning in 2018, we recognized commission expense based on Topic 606’s guidance forWe defer contract costs. Under this new guidance, we recognizecosts that are recoverable and incremental to obtaining customer sales contracts. Contract costs, which primarily consist of sales commissions, relatedare amortized on a systematic basis that is consistent with the transfer to product sales upfront while sales commissions for service contracts are deferred as deferred contract costs in the consolidated balance sheets and amortized overcustomer of the applicable amortization period.goods or services to which the asset relates. Costs for initial contracts that are not commensurate with commissions on renewal commissionscontracts are amortized on a straight-line basis over the period of benefit which we have determined to beof five years and which is typically longer than the initial contract term. Significant estimates,years. Estimates, assumptions, and judgments in accounting for deferred contract costs include, but are not limited to, identification of contract costs, anticipated billings and the expected period of benefit.
Valuation of Inventory
Inventory is recorded at the lower of cost or net realizable value. Cost is computed using the first-in, first-out method. In assessing the ultimate recoverability of inventory, we make estimates regarding future customer demand, the timing of new product introductions, economic trends and market conditions. If the actual product demand is significantly lower than forecasted, we could be required to record inventory write-downs which would be charged to cost of product revenue. Any write-downs could have an adverse impact on our gross margins and profitability.
Business Combinations
We include the results of operations of the businesses that we acquire as of the respective dates of acquisition. We allocate the fair value of the purchase price of our business acquisitions to the tangible and intangible assets acquired and liabilities assumed based on their estimated fair values. The excess of the purchase price over the fair values of these identifiable assets and liabilities is recorded as goodwill. We often continue to gather additional information throughout the measurement period, and if we make changes to the amounts recorded, such changes are recorded in the period in which they are identified.
Contingent Liabilities
From time to time, we are involved in disputes, litigation and other legal actions. However, there are many uncertainties associated with any litigation, and these actions or other third-party claims against us may cause us to incur substantial settlement charges, which are inherently difficult to estimate and could adversely affect our results of operations. We periodically review significant new claims and litigation matters for the probability of an adverse outcome. We accrue for a loss contingency if a loss is probable and the amount of the loss can be reasonably estimated. These accruals are generally based on a range of possible outcomes that require significant judgement. Estimates can change as individual
claims develop. The actual liability in any such matters may be materially different from our estimates, which could result in the need to adjust our liability and record additional expenses.
Accounting for Income Taxes
We record income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our financial statements or tax returns. In addition, deferred tax assets are recorded for the future benefit of utilizing net operating losses and research and development credit carryforwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets and liabilities are expected to be realized or settled. Valuation allowances are provided when necessary to reduce deferred tax assets to the amount expected to be realized.
We recognize tax benefits from an uncertain tax position only if it is more likely than not, based on the technical merits of the position that the tax position will be sustained on examination by the tax authorities. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.
Effective January 1, 2018, the 2017 Tax Act reduced the federal corporate income tax rate from 35% to 21% and created a territorial tax system with a one-time transition tax on foreign earnings of U.S. subsidiaries not previously subject to U.S. income tax. Our selection of an accounting policy for 2018 with respect to the Global Intangible Low-Taxed Income (“GILTI”) tax rules was to treat GILTI tax as a current period expense under the period cost method. For 2019, we were not subject to GILTI. We will continue to monitor and assess the impact of the 2017 Tax Act and ongoing guidance and accounting interpretations issued in response to the 2017 Tax Act.
As part of the process of preparing our consolidated financial statements, we are required to estimate our taxes in each of the jurisdictions in which we operate. We estimate actual current tax exposure together with assessing temporary differences resulting from differing treatment of items, such as accruals and allowances not currently deductible for tax purposes. These differences result in deferred tax assets, which are included in our consolidated balance sheets. In general, deferred tax assets
represent future tax benefits to be received when certain expenses previously recognized in our consolidated statements of income become deductible expenses under applicable income tax laws, or loss or credit carryforwards are utilized.
In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We continue to assess the need for a valuation allowance on the deferred tax assets by evaluating both positive and negative evidence that may exist. Any adjustment to the valuation allowance on deferred tax assets would be recorded in the consolidated statements of income for the period that the adjustment is determined to be required.
We recognize tax benefits from an uncertain tax position only if it is more likely than not, based on the technical merits of the position that the tax position will be sustained on examination by the tax authorities. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.
Investments in privately held companies
Our investments in privately held companies consist of investments in common stock or in-substance common stock. One of these investments provides us with the ability to exercise significant influence over the investee, but not an absolute controlling financial interest. The investment is accounted for under the equity method of accounting. Determining that we do not control but exercise significant influence over the operating and financial policies of the investee requires significant judgement when considering many factors, including but not limited to, the ownership interest in the investee, board representation, participation in policy-making processes, and participation rights in certain significant financial and operating decisions of the investee in the ordinary course of business. Our investment in Linksys is our only equity method investment. We record our proportionate share of the net earnings or losses of Linksys based on the most recently available financial statements of Linksys, which are provided to us on a three-month lag. We evaluate if there are material transactions or events that occur during the intervening period that materially affect the financial position or results of operations. We also record our share of the amortization of any basis differences, as well as any OTTI as gain or loss from equity method investment in our consolidated statements of income and as an adjustment to the investment balance.
We evaluate our equity method investment at the end of each reporting period to determine whether events or changes in business circumstances indicate that the carrying value of the investment may not be recoverable. Evidence of a loss in value might include, but would not necessarily be limited to, series of operating losses, current expected performance relative to expected performance when we initially invested, performance relative to peers and the results of a discounted cash flow analysis. We consider various factors in determining whether an OTTI has occurred, including Linksys financial results and operating history, our ability and intent to hold the investment until its fair value recovers, the implied revenue valuation multiples compared to guideline public companies, Linksys’ ability to achieve milestones and any notable operational and strategic changes.
Results of Operations
The following tables set forth our results of operations for the periods presented and as a percentage of our total revenue for those periods. The period-to-period comparison of financial results is not necessarily indicative of financial results to be achieved in future periods.
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2022 | | 2021 | | 2020 |
| | | | | |
| (in millions) |
Consolidated Statements of Income Data: | | | | | |
Revenue: | | | | | |
Product | $ | 1,780.5 | | | $ | 1,255.0 | | | $ | 916.4 | |
Service | 2,636.9 | | | 2,087.2 | | | 1,678.0 | |
Total revenue | 4,417.4 | | | 3,342.2 | | | 2,594.4 | |
Cost of revenue: | | | | | |
Product | 691.3 | | | 487.7 | | | 352.4 | |
Service | 393.6 | | | 295.3 | | | 217.6 | |
Total cost of revenue | 1,084.9 | | | 783.0 | | | 570.0 | |
Gross profit: | | | | | |
Product | 1,089.2 | | | 767.3 | | | 564.0 | |
Service | 2,243.3 | | | 1,791.9 | | | 1,460.4 | |
Total gross profit | 3,332.5 | | | 2,559.2 | | | 2,024.4 | |
Operating expenses: | | | | | |
Research and development | 512.4 | | | 424.2 | | | 341.4 | |
Sales and marketing | 1,686.1 | | | 1,345.7 | | | 1,071.9 | |
General and administrative | 169.0 | | | 143.5 | | | 119.5 | |
Gain on intellectual property matter | (4.6) | | | (4.6) | | | (40.2) | |
Total operating expenses | 2,362.9 | | | 1,908.8 | | | 1,492.6 | |
Operating income | 969.6 | | | 650.4 | | | 531.8 | |
Interest income | 17.4 | | | 4.5 | | | 17.7 | |
Interest expense | (18.0) | | | (14.9) | | | — | |
Other expense—net | (13.5) | | | (11.6) | | | (7.8) | |
Income before income taxes and loss from equity method investment | 955.5 | | | 628.4 | | | 541.7 | |
Provision for income taxes | 30.8 | | | 14.1 | | | 53.2 | |
Loss from equity method investment | (68.1) | | | (7.6) | | | — | |
Net income including non-controlling interests | 856.6 | | | 606.7 | | | 488.5 | |
Less: net loss attributable to non-controlling interests, net of tax | (0.7) | | | (0.1) | | | — | |
Net income attributable to Fortinet, Inc. | $ | 857.3 | | | $ | 606.8 | | | $ | 488.5 | |
| | | | | | | | | | Year Ended December 31, |
| Year Ended December 31, | 2022 | | 2021 | | 2020 |
| 2019 | | 2018 | | 2017 | | | | | |
| (in millions) | (as percentage of revenue) |
Consolidated Statements of Income Data: | | | | | | |
Revenue: | | | | | | Revenue: | |
Product | $ | 788.5 |
| | $ | 674.4 |
| | $ | 577.2 |
| Product | 40 | % | | 38 | % | | 35 | % |
Service | 1,367.7 |
| | 1,126.8 |
| | 917.7 |
| Service | 60 | | | 62 | | | 65 | |
Total revenue | 2,156.2 |
| | 1,801.2 |
| | 1,494.9 |
| Total revenue | 100 | | | 100 | | | 100 | |
Cost of revenue: | | | | | | Cost of revenue: | |
Product | 324.6 |
| | 291.0 |
| | 243.8 |
| Product | 16 | | | 15 | | | 14 | |
Service | 181.3 |
| | 159.4 |
| | 141.5 |
| Service | 9 | | | 9 | | | 8 | |
Total cost of revenue | 505.9 |
| | 450.4 |
| | 385.3 |
| Total cost of revenue | 25 | | | 23 | | | 22 | |
Gross profit: | | | | | | |
Gross margin: | | Gross margin: | |
Product | 463.9 |
| | 383.4 |
| | 333.4 |
| Product | 61 | | | 61 | | | 62 | |
Service | 1,186.4 |
| | 967.4 |
| | 776.2 |
| Service | 85 | | | 86 | | | 87 | |
Total gross profit | 1,650.3 |
| | 1,350.8 |
| | 1,109.6 |
| |
Total gross margin | | Total gross margin | 75 | | | 77 | | | 78 | |
Operating expenses: | | | | | | Operating expenses: | | | | | |
Research and development | 277.1 |
| | 244.5 |
| | 210.6 |
| Research and development | 12 | | | 13 | | | 13 | |
Sales and marketing | 926.9 |
| | 782.3 |
| | 701.0 |
| Sales and marketing | 38 | | | 40 | | | 41 | |
General and administrative | 102.1 |
| | 93.0 |
| | 87.9 |
| General and administrative | 4 | | | 4 | | | 5 | |
Restructuring charges | — |
| | — |
| | 0.3 |
| |
Gain on intellectual property matter | | Gain on intellectual property matter | — | | | — | | | (2) | |
Total operating expenses | 1,306.1 |
| | 1,119.8 |
| | 999.8 |
| Total operating expenses | 53 | | | 57 | | | 58 | |
Operating income | 344.2 |
| | 231.0 |
| | 109.8 |
| |
Interest income—net | 42.5 |
| | 26.5 |
| | 13.5 |
| |
Other income (expense)—net | (7.5 | ) | | (6.6 | ) | | 0.7 |
| |
Income before income taxes | 379.2 |
| | 250.9 |
| | 124.0 |
| |
Provision for (benefit from) income taxes | 52.7 |
| | (81.3 | ) | | 92.6 |
| |
Net income | $ | 326.5 |
| | $ | 332.2 |
| | $ | 31.4 |
| |
Operating margin | | Operating margin | 22 | | | 19 | | | 20 | |
Interest income | | Interest income | — | | | — | | | 1 | |
Interest expense | | Interest expense | — | | | — | | | — | |
Other expense—net | | Other expense—net | — | | | — | | | — | |
Income before income taxes and loss from equity method investment | | Income before income taxes and loss from equity method investment | 22 | | | 19 | | | 21 | |
Provision for income taxes | | Provision for income taxes | 1 | | | — | | | 2 | |
Loss from equity method investment | | Loss from equity method investment | (2) | | | — | | | — | |
Net income including non-controlling interests | | Net income including non-controlling interests | 19 | | | 18 | | | 19 | |
Less: net loss attributable to non-controlling interests, net of tax | | Less: net loss attributable to non-controlling interests, net of tax | — | | | — | | | — | |
Net income attributable to Fortinet, Inc. | | Net income attributable to Fortinet, Inc. | 19 | % | | 18 | % | | 19 | % |
| Percentages have been rounded for presentation purposes and may differ from unrounded results. | | Percentages have been rounded for presentation purposes and may differ from unrounded results. |
|
| | | | | | | | |
| Year Ended December 31, |
2019 | | 2018 | | 2017 |
(as percentage of revenue) |
Revenue: | | | | | |
Product | 37 | % | | 37 | % | | 39 | % |
Service | 63 |
| | 63 |
| | 61 |
|
Total revenue | 100 |
| | 100 |
| | 100 |
|
Cost of revenue: | | | | | |
Product | 15 |
| | 16 |
| | 16 |
|
Service | 8 |
| | 9 |
| | 9 |
|
Total cost of revenue | 23 |
| | 25 |
| | 26 |
|
Gross margin: | | | | | |
Product | 59 |
| | 57 |
| | 58 |
|
Service | 87 |
| | 86 |
| | 85 |
|
Total gross margin | 77 |
| | 75 |
| | 74 |
|
Operating expenses: | | | | | |
Research and development | 13 |
| | 14 |
| | 14 |
|
Sales and marketing | 43 |
| | 43 |
| | 47 |
|
General and administrative | 5 |
| | 5 |
| | 6 |
|
Restructuring charges | — |
| | — |
| | — |
|
Total operating expenses | 61 |
| | 62 |
| | 67 |
|
Operating margin | 16 |
| | 13 |
| | 7 |
|
Interest income—net | 2 |
| | 1 |
| | 1 |
|
Other income (expense)—net | — |
| | — |
| | — |
|
Income before income taxes | 18 |
| | 14 |
| | 8 |
|
Provision for (benefit from) income taxes | 2 |
| | (5 | ) | | 6 |
|
Net income | 15 | % | | 18 | % | | 2 | % |
Percentages have been rounded for presentation purposes and may differ from unrounded results.
Discussion regarding our financial condition and results of operations for 20182021 as compared to 20172020 can be found in Item 7 of our Annual Report on Form 10-K for the fiscal year ended December 31, 2018,2021, filed with the SEC on February 27, 2019.
25, 2022.
2019
2022 and 20182021
Revenue
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
2022 | | 2021 | | | | |
Amount | | % of Revenue | | Amount | | % of Revenue | | Change | | % Change |
| | | | | | | | | | |
(in millions, except percentages) |
Revenue: | | | | | | | | | | | |
Product | $ | 1,780.5 | | | 40 | % | | $ | 1,255.0 | | | 38 | % | | $ | 525.5 | | | 42 | % |
Service | 2,636.9 | | | 60 | | | 2,087.2 | | | 62 | | | 549.7 | | | 26 | |
Total revenue | $ | 4,417.4 | | | 100 | % | | $ | 3,342.2 | | | 100 | % | | $ | 1,075.2 | | | 32 | % |
Revenue by geography: | | | | | | | | | | | |
Americas | $ | 1,785.0 | | | 41 | % | | $ | 1,358.8 | | | 41 | % | | $ | 426.2 | | | 31 | % |
EMEA | 1,691.8 | | | 38 | | | 1,275.9 | | | 38 | | | 415.9 | | | 33 | |
APAC | 940.6 | | | 21 | | | 707.5 | | | 21 | | | 233.1 | | | 33 | |
Total revenue | $ | 4,417.4 | | | 100 | % | | $ | 3,342.2 | | | 100 | % | | $ | 1,075.2 | | | 32 | % |
|
| | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
2019 | | 2018 | | | | |
Amount | | % of Revenue | | Amount | | % of Revenue | | Change | | % Change |
(in millions, except percentages) |
Revenue: | | | | | | | | | | | |
Product | $ | 788.5 |
| | 37 | % | | $ | 674.4 |
| | 37 | % | | $ | 114.1 |
| | 17 | % |
Service | 1,367.7 |
| | 63 |
| | 1,126.8 |
| | 63 |
| | 240.9 |
| | 21 |
|
Total revenue | $ | 2,156.2 |
| | 100 | % | | $ | 1,801.2 |
| | 100 | % | | $ | 355.0 |
| | 20 | % |
Revenue by geography: | | | | | | | | | | | |
Americas | $ | 917.3 |
| | 42 | % | | $ | 762.9 |
| | 42 | % | | $ | 154.4 |
| | 20 | % |
Europe, Middle East and Africa (“EMEA”) | 813.9 |
| | 38 |
| | 678.0 |
| | 38 |
| | 135.9 |
| | 20 |
|
Asia Pacific (“APAC”) | 425.0 |
| | 20 |
| | 360.3 |
| | 20 |
| | 64.7 |
| | 18 |
|
Total revenue | $ | 2,156.2 |
| | 100 | % | | $ | 1,801.2 |
| | 100 | % | | $ | 355.0 |
| | 20 | % |
Total revenue increased by $355.0 million,$1.08 billion, or 20%32%, in 20192022 compared to 2018.2021. We continued to experience significant organic revenue growth (i.e., revenue growth excluding attribution from recent acquisitions) with diversification of revenue globally,geographically, and across both customer and industry segments. Revenue from all regions grew, with the Americas contributing the largest portion of our revenue growththe increase on an absolute dollar basis and APAC, which included Alaxala, contributing the largest portion of the increase on a percentage basis.
Product revenue increased by $114.1$525.5 million, or 17%42%, in 20192022 compared to 2018. We experienced2021. Product revenue growth was consistent with an elevated cyber threat landscape, the convergence of security and networking and included the benefit of certain pricing actions. The product revenue growth was primarily due to strong growth across many of our hardwareEnhanced Platform Technology products, including our secure access products and software products due to an increase inlicenses. In addition, our product revenue fromgrowth was driven by a strong demand for the wide range operating system capabilities embedded in our SD-WAN FortiGate solutions and growth in sales of our Infrastructure Security solutions.Core Platform products.
Service revenue increased by $240.9$549.7 million, or 21%26%, in 20192022 compared to 2018.2021. Service revenue growth has accelerated over the past three years from 22% in 2020, to 24% in 2021 to 26% in 2022. Compared to 2021, FortiGuard security subscription revenue increased by $302.0 million, or 27% and FortiCare, other technical support and other revenues increased by $144.8$247.7 million, or 24%26%, and by $96.1 million, or 18%, respectively, in 2019 compared to 2018.2022. The increases were primarily due to the recognition of revenue from our growing deferred revenue balance related to FortiGuard and other security subscriptions delivered to on-premise and cloud-based environments as well as FortiCare technical support and other contracts. technical support. Our growing deferred revenue balance was primarily due to our growth in customer base, expansion of our service offerings, and impact of pricing actions.
Of the service revenue recognized in 2019, 68%2022, 66% was included in the deferred revenue balance as of December 31, 2018.2021. Of the service revenue recognized in 2018, 67%2021, 65% was included in the deferred revenue balance as of December 31, 2017.2020.
Of the service revenue recognized in each quarter of 2022, from 87% to 88% was included in deferred revenue as of the beginning of the respective quarter.
Cost of revenue and gross margin
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
2022 | | 2021 | | Change | | % Change |
| | | | | | |
(in millions, except percentages) |
Cost of revenue: | | | | | | | |
Product | $ | 691.3 | | | $ | 487.7 | | | $ | 203.6 | | | 42 | % |
Service | 393.6 | | | 295.3 | | | 98.3 | | | 33 | |
Total cost of revenue | $ | 1,084.9 | | | $ | 783.0 | | | $ | 301.9 | | | 39 | % |
Gross margin (%): | | | | | | | |
Product | 61.2 | % | | 61.1 | % | | | | |
Service | 85.1 | % | | 85.9 | % | | | | |
Total gross margin | 75.4 | % | | 76.6 | % | | | | |
|
| | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
2019 | | 2018 | | Change | | % Change |
(in millions, except percentages) |
Cost of revenue: | | | | | | | |
Product | $ | 324.6 |
| | $ | 291.0 |
| | $ | 33.6 |
| | 12 | % |
Service | 181.3 |
| | 159.4 |
| | 21.9 |
| | 14 |
|
Total cost of revenue | $ | 505.9 |
| | $ | 450.4 |
| | $ | 55.5 |
| | 12 | % |
Gross margin (%): | | | | | | | |
Product | 58.8 | % | | 56.9 | % | |
|
| | |
Service | 86.7 |
| | 85.9 |
| |
|
| | |
Total gross margin | 76.5 | % | | 75.0 | % | |
|
| | |
Total gross margin increaseddecreased by 1.51.2 percentage points in 20192022 compared to 2018,2021, primarily driven by improvementsa change in revenue mix to bothlower margin product revenue from higher margin service revenue and the consolidation of Alaxala starting from August 31, 2021 and partially offset by favorable impact of foreign currency fluctuations. Revenue mix shifted by 2.0 percentage points from service gross margins. revenue to product revenue, as a percentage of total revenue.
Product gross margin increased by 1.90.1 percentage points in 20192022 compared to 2018. Product gross margin benefited from gains in2021, primarily driven by higher average selling price, as well as lower directprices and indirect productpartially offset by higher expedite fees and other component costs as a percentagedue to supply chain constraints and the consolidation of product revenue. It also benefited from deal mix, software revenue growth and a stable product transition environment.Alaxala. Cost of
product revenue was comprised primarily of third-party contract manufacturers’ costs and the costs of materials used in production.
Service gross margin increaseddecreased by 0.8 percentage points in 20192022 compared to 2018, as2021, primarily driven by data center expansion, increased labor cost and our service revenue growth outpaced our growth in related personnel costs.consolidation of Alaxala and partially offset by favorable impact of foreign currency fluctuation and higher average selling prices. Cost of service revenue was comprised primarily of personnel costs, third-party repair and contract fulfillment, data center costs, colocation expenses and cloud hosting, supplies and facility-related costs.
Operating expenses
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | Change | | % Change |
2022 | | 2021 | |
Amount | | % of Revenue | | Amount | | % of Revenue | |
| | | | | | | | | | |
(in millions, except percentages) |
Operating expenses: | | | | | | | | | | | |
Research and development | $ | 512.4 | | | 12 | % | | $ | 424.2 | | | 13 | % | | $ | 88.2 | | | 21 | % |
Sales and marketing | 1,686.1 | | | 38 | | | 1,345.7 | | | 40 | | | 340.4 | | | 25 | |
General and administrative | 169.0 | | | 4 | | | 143.5 | | | 4 | | | 25.5 | | | 18 | |
Gain on intellectual property matter | (4.6) | | | — | | | (4.6) | | | — | | | — | | | — | |
Total operating expenses | $ | 2,362.9 | | | 53 | % | | $ | 1,908.8 | | | 57 | % | | $ | 454.1 | | | 24 | % |
| | | | | | | | | | | |
Percentages have been rounded for presentation purposes and may differ from unrounded results. |
|
| | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | Change | | % Change |
2019 | | 2018 | |
Amount | | % of Revenue | | Amount | | % of Revenue | |
(in millions, except percentages) |
Operating expenses: | | | | | | | | | | | |
Research and development | $ | 277.1 |
| | 13 | % | | $ | 244.5 |
| | 14 | % | | $ | 32.6 |
| | 13 | % |
Sales and marketing | 926.9 |
| | 43 |
| | 782.3 |
| | 43 |
| | 144.6 |
| | 18 |
|
General and administrative | 102.1 |
| | 5 |
| | 93.0 |
| | 5 |
| | 9.1 |
| | 10 |
|
Total operating expenses | $ | 1,306.1 |
| | 61 | % | | $ | 1,119.8 |
| | 62 | % | | $ | 186.3 |
| | 17 | % |
Research and development
Research and development expense increased by $32.6$88.2 million, or 13%21%, in 20192022 compared to 2018,2021, primarily due to an increase of $63.1 million in personnel-related costs of $29.9 million as a result of increased compensation rates and headcount to support the development of new products and continued enhancements to our existing products. In addition, we incurred increases in depreciation and other occupancy costs of $16.6 million and product development costs of $4.9 million, partially offset by the favorable impact of foreign currency fluctuations. We currently intend to continue to invest in our research and development organization, and expect research and development expense to increase in absolute dollars in 2020.2023.
Sales and marketing
Sales and marketing expense increased by $144.6$340.4 million, or 18%25%, in 20192022 compared to 2018,2021, primarily due to an increase of $208.5 million in personnel-related costs of $103.9 million as a result of increasescosts. We significantly increased our sales capacity, including newer non-tenured salespeople. The increase in headcount is expected to sales and marketing headcount in order tohelp drive global market share gains.revenue increases. In addition, marketingwe incurred increases in marketing-related expenses increasedof $52.6 million, travel expense of $38.8 million, depreciation and other occupancy-related expense of $17.8 million and supplies expense of $10.6 million, partially offset by $16.8 million.the favorable impact of foreign currency fluctuations. We currently intend to continue to make investments in our sales resources and infrastructure and marketing strategy,resources, which are critical to support our future growth, and expect sales and marketing expense to increase in absolute dollars in 2020.2023.
General and administrative
General and administrativeadministrative expense increased by $9.1$25.5 million, or 10%18%, in 20192022 compared to 2018,2021, primarily due to an increase in personnel-related costs of $17.3 million. In addition, we incurred increases in depreciation and other occupancy costs of $3.5 million, subscriptions and other expense of $3.2 million, professional services fee of $2.9 million and provision for expected credit losses of $1.4 million, partially offset by a decrease in legal-related costs of $6.1 million and an increase in litigation coststhe favorable impact of $3.1 million. Certain facilities, depreciation, and information technology costs are allocated to other organizations based on headcount.foreign currency fluctuations. We currently expect general and administrative expense to increase in absolute dollars in 2020.2023.
Operating income and margin
We generated operating income of $344.2$969.6 million in 2019,2022, an increase of $113.2$319.2 million, or 49%, compared to $231.0$650.4 million in 2018.2021. Operating income as a percentage of revenue increased to 16%22% in 20192022 compared to 13%19% in 2018.2021. The increase in our operating margin isprimarily benefits from a 2.1 percentage point decrease in sales and marketing expense as a percentage of revenue, primarily due to the favorable impact of foreign currency fluctuations, as well as improvement in gross margin by 1.5 percentage points.sales productivity compared to prior year. In addition, as a percent of total revenue, research and development expense decreased by 0.7 percentage points, sales and marketing expense decreased by 0.4 percentage points and general and administrative expense decreased 1.1 percentage points and 0.5 percentage points, respectively, as percentage of revenue. The benefit from lower operating expense as a percentage of revenue was partially offset by 0.4a 1.2 percentage points.point decrease in gross margin.
Interest income—netincome, interest expense and other expense—net
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
2022 | | 2021 | | Change | | % Change |
| | | | | | |
(in millions, except percentages) |
Interest income | $ | 17.4 | | | $ | 4.5 | | | $ | 12.9 | | | 287 | % |
Interest expense | (18.0) | | | (14.9) | | | (3.1) | | | 21 | % |
Other expense—net | (13.5) | | | (11.6) | | | (1.9) | | | 16 | % |
|
| | | | | | | | | | | | | | |
| Year Ended December 31, | | | | |
2019 | | 2018 | | Change | | % Change |
(in millions, except percentages) |
Interest income—net | $ | 42.5 |
| | $ | 26.5 |
| | $ | 16.0 |
| | 60 | % |
Other expense—net | $ | (7.5 | ) | | $ | (6.6 | ) | | $ | (0.9 | ) | | 14 | % |
Interest income—netincome increased by $12.9 million in 20192022 as compared to 2018,2021, primarily due toas a result of higher interest rates, and, to a lesser extent, higher invested balances of cash, cash equivalents and investments.partially offset by lower investment balances. Interest income—netincome varies depending on our average investment balances during the period, types and mix of investments, and market interest rates. The changeInterest expense increased by $3.1 million in other expense—net in 20192022 as compared to 2018 was2021, primarily due to our senior notes issued in the resultfirst quarter of a $3.82021. Other expense—net increased by $1.9 million impairment charge on an investment in a privately held company during 20192022 as compared to a $2.22021 due to an $8.0 million gainincrease in loss on the sale of an investment in a privately held company in the same period last year,marketable equity securities, partially offset by $3.5a $3.6 million decrease in foreign currency exchange losses.losses and a $2.5 million increase in net rental income from real estate.
Provision for (benefit from) income taxes
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | Change | | % Change |
2022 | | 2021 | |
| | | | | | |
(in millions, except percentages) |
Provision for income taxes | $ | 30.8 | | | $ | 14.1 | | | $ | 16.7 | | | 118 | % |
Effective tax rate (%) | 3 | % | | 2 | % | | | | |
|
| | | | | | | | | | | | | | |
| Year Ended December 31, | | Change | | % Change |
2019 | | 2018 | |
(in millions, except percentages) |
Provision for (benefit from) income taxes | $ | 52.7 |
| | $ | (81.3 | ) | | $ | 134.0 |
| | (165 | )% |
Effective tax rate | 14 | % | | (32 | )% | |
|
| |
|
|
Our provision for income taxes for 20192022 reflects an effective tax rate of 14%3%, compared to an effective tax rate benefit of 32%2% for 2018.2021. The provision for income taxes for 2019 was2022 was comprised primarily of an $88.8a $233.4 million tax expense related to U.S. federal and state income taxes, other foreign income taxes, and foreign withholding taxes and a $10.1 million tax expense for an unrecognized tax benefit related to the Ninth Circuit’s opinion in Altera Corporation and Subsidiaries vs. Commissioner of Internal Revenue (“Altera”).benefits. The provision was partially offset by excess tax benefits of $39.3$75.8 million from stock-based compensation expense, a tax benefit of $115.2 million from the FDII deduction, and a tax benefitsbenefit of $6.8$11.6 million from federal research and development tax credits.
Our provision for income taxes for 2021 reflects an effective tax rate benefit of 32%2%, compared to an effective tax rate of 10% for 2020. The provision for income taxes for 2021 was comprised primarily of impacts related to the 2017 Tax Act, including a benefit of $164.0$140.8 million from the realignment of our tax structure and operations that resulted in a book-to-tax basis difference from previously taxed off-shore deferred revenue. These benefits were partially offset by a $32.6 million increase in the transition tax for finalization of the provisional estimates under Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act, $20.5 million of tax expense for the impact of the GILTI and $29.6 million of tax expense related to U.S. federal and state income taxes, other foreign income taxes, foreign withholding taxes and unrecognized tax benefits. The provision was partially offset by excess tax benefits of $82.0 million from stock-based compensation expense, a decreasetax benefit of $33.6 million from the FDII deduction, and a tax benefit of $11.1 million from federal research and development tax credits.
Loss from Equity Method Investment
| | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, | | Change | | % Change |
2022 | | 2021 | |
| | | | | | |
(in millions, except percentages) |
Loss from equity method investment | $ | (68.1) | | | $ | (7.6) | | | $ | (60.5) | | | 796 | % |
Loss from equity method investment increased by $60.5 million in tax reserves.
Quarterly Results2022 as compared to 2021, due to $38.3 million increase in our proportionate share of Operations
The following table sets forth our unaudited quarterly statements of income data for the last eight quarters. The information for each of these quarters has been prepared on the same basisLinksys’ financial results as well as the audited annual financial statementsamortization of the basis differences, which included elsewherea $17.5 million charge in this Annual Reportconnection with a valuation allowance established on deferred tax assets at Linksys, and the OTTI charge of $22.2 million recorded in the opinion of management, includes all adjustments, which includes only normal recurring adjustments, necessary for the fair presentation of the results of operations for these periods. This data should be read in conjunction with our audited consolidated financial statements and related notes included elsewhere in this annual report. These quarterly operating results are not necessarily indicative of our operating results for any future period.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended |
| Dec 31, 2019 | | Sept 30, 2019 | | Jun 30, 2019 | | Mar 31, 2019 | | Dec 31, 2018 | | Sept 30, 2018 | | Jun 30, 2018 | | Mar 31, 2018 |
| (in millions, except per share amounts) |
Consolidated Statements of Income Data: | | | | | | | | | | | | | | | |
Revenue: | | | | | | | | | | | | | | | |
Product | $ | 238.8 |
| | $ | 197.1 |
| | $ | 189.9 |
| | $ | 162.7 |
| | $ | 200.8 |
| | $ | 164.5 |
| | $ | 166.3 |
| | $ | 142.8 |
|
Service | 375.6 |
| | 350.4 |
| | 331.8 |
| | 309.9 |
| | 306.2 |
| | 289.4 |
| | 275.0 |
| | 256.2 |
|
Total revenue | 614.4 |
| | 547.5 |
| | 521.7 |
| | 472.6 |
| | 507.0 |
|
| 453.9 |
|
| 441.3 |
|
| 399.0 |
|
Cost of revenue: | | | | | | | | | | | | | | | |
Product (1)(2) | 92.7 |
| | 79.0 |
| | 82.7 |
| | 70.2 |
| | 86.9 |
| | 72.0 |
| | 73.9 |
| | 58.2 |
|
Service (1)(2) | 47.8 |
| | 45.1 |
| | 45.6 |
| | 42.8 |
| | 41.6 |
| | 39.6 |
| | 39.2 |
| | 39.0 |
|
Total cost of revenue | 140.5 |
| | 124.1 |
| | 128.3 |
| | 113.0 |
| | 128.5 |
|
| 111.6 |
|
| 113.1 |
|
| 97.2 |
|
Total gross profit | 473.9 |
| | 423.4 |
| | 393.4 |
| | 359.6 |
| | 378.5 |
|
| 342.3 |
|
| 328.2 |
|
| 301.8 |
|
Operating expenses: | | | | | | | | | | | | | | | |
Research and development (1) | 71.2 |
| | 69.9 |
| | 67.4 |
| | 68.6 |
| | 65.5 |
| | 58.7 |
| | 61.2 |
| | 59.1 |
|
Sales and marketing (1)(2) | 257.1 |
| | 227.4 |
| | 226.5 |
| | 215.9 |
| | 205.9 |
| | 198.3 |
| | 192.8 |
| | 185.3 |
|
General and administrative (1) | 27.2 |
| | 26.1 |
| | 24.3 |
| | 24.5 |
| | 22.0 |
| | 22.5 |
| | 23.5 |
| | 25.0 |
|
Total operating expenses | 355.5 |
| | 323.4 |
| | 318.2 |
| | 309.0 |
| | 293.4 |
|
| 279.5 |
|
| 277.5 |
|
| 269.4 |
|
Operating income | 118.4 |
| | 100.0 |
| | 75.2 |
| | 50.6 |
| | 85.1 |
|
| 62.8 |
|
| 50.7 |
|
| 32.4 |
|
Interest income—net | 9.9 |
| | 11.4 |
| | 11.0 |
| | 10.2 |
| | 9.3 |
| | 6.9 |
| | 5.8 |
| | 4.5 |
|
Other income (expense)—net | (0.6 | ) | | (6.0 | ) | | (0.4 | ) | | (0.5 | ) | | (2.3 | ) | | 0.9 |
| | (5.0 | ) | | (0.2 | ) |
Income before income taxes | 127.7 |
| | 105.4 |
| | 85.8 |
| | 60.3 |
| | 92.1 |
|
| 70.6 |
|
| 51.5 |
|
| 36.7 |
|
Provision for (benefit from) income taxes | 12.5 |
| | 25.6 |
| | 13.1 |
| | 1.5 |
| | (90.5 | ) | | 11.9 |
| | 2.2 |
| | (4.9 | ) |
Net income | $ | 115.2 |
| | $ | 79.8 |
| | $ | 72.7 |
| | $ | 58.8 |
| | $ | 182.6 |
|
| $ | 58.7 |
|
| $ | 49.3 |
|
| $ | 41.6 |
|
Net income per share: | | | | | | | | | | | | | | | |
Basic | $ | 0.67 |
| | $ | 0.47 |
| | $ | 0.42 |
| | $ | 0.35 |
| | $ | 1.07 |
| | $ | 0.35 |
| | $ | 0.29 |
| | $ | 0.25 |
|
Diluted | $ | 0.66 |
| | $ | 0.46 |
| | $ | 0.42 |
| | $ | 0.34 |
| | $ | 1.04 |
| | $ | 0.33 |
| | $ | 0.28 |
| | $ | 0.24 |
|
three months ended December 31, 2022.
(1)
Includes stock-based compensation as follows:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended |
| Dec 31, 2019 | | Sept 30, 2019 | | Jun 30, 2019 | | Mar 31, 2019 | | Dec 31, 2018 | | Sept 30, 2018 | | Jun 30, 2018 | | Mar 31, 2018 |
| (in millions) |
Cost of product revenue | $ | 0.3 |
| | $ | 0.4 |
| | $ | 0.4 |
| | $ | 0.4 |
| | $ | 0.4 |
| | $ | 0.3 |
| | $ | 0.4 |
| | $ | 0.4 |
|
Cost of service revenue | 2.9 |
| | 2.7 |
| | 2.9 |
| | 2.8 |
| | 2.8 |
| | 2.8 |
| | 2.7 |
| | 2.5 |
|
Research and development | 10.0 |
| | 9.3 |
| | 10.0 |
| | 9.4 |
| | 9.5 |
| | 9.3 |
| | 9.2 |
| | 8.4 |
|
Sales and marketing | 25.1 |
| | 24.9 |
| | 26.3 |
| | 25.4 |
| | 25.1 |
| | 26.0 |
| | 23.6 |
| | 20.9 |
|
General and administrative | 5.4 |
| | 5.1 |
| | 5.4 |
| | 5.0 |
| | 4.8 |
| | 4.8 |
| | 4.7 |
| | 4.3 |
|
Total stock-based compensation expense | $ | 43.7 |
| | $ | 42.4 |
| | $ | 45.0 |
| | $ | 43.0 |
| | $ | 42.6 |
| | $ | 43.2 |
| | $ | 40.6 |
| | $ | 36.5 |
|
(2)Total amortization included in product costs, service costs, and sales and marketing expense are as follows:
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended |
| Dec 31, 2019 | | Sept 30, 2019 | | Jun 30, 2019 | | Mar 31, 2019 | | Dec 31, 2018 | | Sept 30, 2018 | | Jun 30, 2018 | | Mar 31, 2018 |
| (in millions) |
Amortization of intangible assets | $ | 2.8 |
| | $ | 2.2 |
| | $ | 2.9 |
| | $ | 3.0 |
| | $ | 2.9 |
| | $ | 2.5 |
| | $ | 1.8 |
| | $ | 1.8 |
|
Seasonality, Cyclicality and Quarterly Revenue Trends
Our quarterly results reflect a pattern of increased customer buying at year-end, which has positively impacted billings and product revenue activity in the fourth quarter. In the first quarter, we generally experience lower sequential customer product buying, followed by an increase in buying in the second quarter. Theand third quarter is often consistent with the second quarter.quarters. Although these seasonal factors aremay be common in the technology sector, historical patterns should not be considered a reliable indicator of our future sales activity or performance. On a quarterly basis, we have usually generated the majority of our product revenue in the final month of each quarter and a significant amount in the last two weeks of each quarter. We believe this is due to customer buying patterns typical in this industry.
Consistent with the seasonality note above, our total quarterly revenue over the past eight quarterstwo years has generally increased sequentially in each quarter, except in the first quarter of 2019 and 2018.year. Product revenue in each quarter in 2019, increased year-over-year as compared to the same quarter in 2018, which2021, as we believe was due tohave continued product innovation and launched new product models, expanded our solution sales, including SD-WAN and OT solutions and increased our investments we made in our sales and marketing organizations, continued product innovation and a robust security market. We continue to see a shift from product revenue to higher-margin, recurring service revenue.organizations.
Total gross margin has fluctuated on a quarterly basis primarily due to seasonalitythe relative product and service mix as well as the timing of product salessupplier cost increases and seasonality of costour own price increases. Product gross margin varies based on the types of products sold, their cost profile and thetheir average selling prices of our products.prices. In 2019,2022, product gross margin was impacted by new product introductions, and the mix of high-end, mid-range and entry-level products.Core Platform products and the mix of other Enhanced Platform Technologies products, software sales and the timing and impact of supplier cost increases and our own price list increases. In 2022, we experienced an unusual level of component suppliers charging new expedite fees andincreases in freight costs.Historically, we have been able to improve our direct cost of appliances and our product gross margin. Service gross margin benefited from theis impacted by revenue growth ofand our customer basepersonnel-related costs, third-party repair and renewals.contract fulfillment, data center, colocation fees, cloud hosting, supplies, facility-related costs and foreign currency fluctuations.
Liquidity and Capital Resources
| | | | | | | | | | | | | | | | | |
| As of December 31, |
| 2022 | | 2021 | | 2020 |
| | | | | |
| (in millions) |
Cash and cash equivalents | $ | 1,682.9 | | | $ | 1,319.1 | | | $ | 1,061.8 | |
Short-term and long-term investments | 548.1 | | | 1,634.8 | | | 893.8 | |
Marketable equity securities | 25.5 | | | 38.6 | | — | |
Total cash, cash equivalents, investments and marketable equity securities | $ | 2,256.5 | | | $ | 2,992.5 | | | $ | 1,955.6 | |
Working capital | $ | 732.0 | | | $ | 1,282.5 | | | $ | 910.9 | |
| | | | | |
| Year Ended December 31, |
| 2022 | | 2021 | | 2020 |
| | | | | |
| (in millions) |
Net cash provided by operating activities | $ | 1,730.6 | | | $ | 1,499.7 | | | $ | 1,083.7 | |
Net cash provided by (used in) investing activities | 763.9 | | | (1,325.1) | | | (72.8) | |
Net cash provided by (used in) financing activities | (2,130.3) | | | 82.8 | | | (1,171.6) | |
Effect of exchange rate changes on cash and cash equivalents | (0.4) | | | (0.1) | | | — | |
Net increase (decrease) in cash and cash equivalents | $ | 363.8 | | | $ | 257.3 | | | $ | (160.7) | |
|
| | | | | | | | | | | |
| As of December 31, |
| 2019 | | 2018 | | 2017 |
| (in millions) |
Cash and cash equivalents | $ | 1,222.5 |
| | $ | 1,112.4 |
| | $ | 811.0 |
|
Investments | 987.4 |
| | 604.2 |
| | 538.3 |
|
Total cash, cash equivalents and investments | $ | 2,209.9 |
| | $ | 1,716.6 |
| | $ | 1,349.3 |
|
Working capital | $ | 1,295.4 |
| | $ | 964.5 |
| | $ | 689.6 |
|
| | | | | |
| Year Ended December 31, |
| 2019 | | 2018 | | 2017 |
| (in millions) |
Net cash provided by operating activities | $ | 808.0 |
| | $ | 638.9 |
| | $ | 594.4 |
|
Net cash used in investing activities | (502.3 | ) | | (134.9 | ) | | (76.8 | ) |
Net cash used in financing activities | (195.6 | ) | | (202.6 | ) | | (415.6 | ) |
Net increase in cash and cash equivalents | $ | 110.1 |
| | $ | 301.4 |
| | $ | 102.0 |
|
Liquidity and capital resources may beare primarily impacted by our operating activities, including cash tax payments, proceeds from issuance of our investment grade debt, as well as by ourcash used on stock repurchases, proceeds associated with stock option exercises, issuances of common stock under our equity incentive plans and payment of taxes in connection with the net settlement of equity awards, real estate purchases and other capital expenditures, investments in various companies and business acquisitions.
In recent years, we have received significant capital resources from our billings to customers, issuance of investment grade debt and, to some extent, from the exercise of stock options andby our Employee Stock Purchase Plan (“ESPP”) purchases.employees. Additional increases in billings may depend on a number of factors, including demand for and availability of our products and services, competition, market or industry changes, macroeconomic events such as rising inflation and interest rates, the COVID-19 pandemic, supply chain capacity and disruptions, international conflicts, including the war in Ukraine, and our ability to execute. We expect
proceeds from the exercise of stock options in future years to be impacted by the increased mix of restricted stock units versus stock options granted to our employees and also to vary based on our share price. There will notWe expect our cash tax payments to increase as a result of a provision in the TCJA requiring taxpayers to capitalize and amortize research and development expenses for tax purposes, other tax law changes and our expected growth.
In July 2022, our board of directors authorized a $1.0 billion increase in the authorized stock repurchase under the Repurchase Program, bringing the aggregate amount of authorized to be future proceeds from purchasesrepurchased to $5.25 billion of our outstanding common stock through February 28, 2023. In 2022, we repurchased 36.0 million shares of common stock under our ESPP, which was terminated in February 2019.the Repurchase Program for an aggregate purchase price of $1.99 billion. As of December 31, 2019, $1.6 billion2022, $529.6 million remained available for future share repurchases under the Repurchase Program. In February 2023, our board of directors approved an extension of the Repurchase Program to February 29, 2024.
ConstructionIn March 2021, we issued $1.0 billion aggregate principal amount of a second building atsenior notes, consisting of $500.0 million aggregate principal amount of 1.0% notes due March 15, 2026 and $500.0 million aggregate principal amount of 2.2% notes due March 15, 2031, in an underwritten registered public offering. We do not currently intend to retire these senior notes early. Refer to Note 11. Debt in Part II, Item 8 of this Annual Report on Form 10-K for information on the senior notes.
We expect to continue to increase our headquarters campus started indata center, office and warehouse capacity to support growth and the fourth quarterexpansion of 2018 and related spendingexisting services or introduction of new services. As we purchase new properties, we will continue in 2020 and until project completion.work to incorporate these properties into the environmental goals we have established. We estimate 2020 real estate spending, including the headquarters campus project,2023 capital expenditures to be between $150.0$400.0 million and $160.0 million dollars.
$450.0 million.
Our principal commitments consist of obligations under our senior notes, inventory purchase and other contractual commitments. As of December 31, 20192022, the long-term debt, net of unamortized discount and debt issuance costs, was $990.4 million. $500.0 million in aggregate principal amount of senior notes is due on March 15, 2026 and $500.0 million in aggregate principal amount of senior notes is due on March 15, 2031. In addition, we enter into non-cancellable agreements with contract manufacturers to procure inventory based on our requirements in order to reduce manufacturing lead times, plan for adequate component supply or incentivize suppliers to deliver. In certain instances, these agreements allow us the option to reschedule and adjust our requirements based on our business needs prior to firm orders being placed. In 2022, ,we significantly increased these commitments as contract manufacturers and component suppliers significantly increased their pricing and lead times. Inventory purchase commitments as of December 31, 2022, were $1.34 billion, an increase of $194.5 million compared to $1.14 billion as of December 31, 2021. We estimate payments of $1.27 billion due on or before December 31, 2023 related to these commitments. We also have open purchase orders and contractual obligations in the ordinary course of business for which we have not received goods or services. As of December 31, 2022, we had $108.1 million in other contractual commitments having a remaining term in excess of one year that are non-cancelable.
As of December 31, 2022, our cash, cash equivalents, investments and investmentsmarketable equity securities of $2.21$2.26 billion were invested primarily in deposit accounts, money market funds,commercial paper, corporate debt securities, commercial paper,U.S. government and agency securities, certificates of deposit and term deposits, money market funds, municipal bonds and U.S. government and agencymarketable equity securities. It is our investment policy to invest excess cash in a manner that preserves capital, provides liquidity and generates return without significantly increasing risk. We do not enter into investments for trading or speculative purposes.
The amount of cash, cash equivalents and investments held by our international subsidiaries was $109.3$218.1 million and $132.4 million as of December 31, 20192022 and $956.6 million as of December 31, 2018. The decrease in cash, cash equivalents and investments held by our international subsidiaries related to changes in our international tax structure.2021, respectively.
We believe that our existing cash and cash equivalents and cash flow from operations will be sufficient to meet our anticipated cash needs for at least the next 12 months. Our futuremonths to meet our requirements and plans for cash, including meeting our working capital requirements and capital expenditure requirements. In the long term, our ability to support our requirements and plans for cash, including our working capital and capital expenditure requirements will depend on many factors, including our growth rate, the timing and amount of our share repurchases, the timing and extent of spending to support development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced products and services offerings, the continuing market acceptance of our products, the timing and extent of spending to support development efforts, our investments in purchasing or leasing real estate.estate, cash tax payments and macroeconomic impacts such as rising inflation and interest rates, the war in Ukraine and the COVID-19 pandemic. Historically, we have required capital principally
to fund our working capital needs, share repurchases, capital expenditures and acquisition activities. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at all.
Operating Activities
Cash generated by operating activities is our primary source of liquidity. It is primarily comprised of net income, as adjusted for non-cash items and changes in operating assets and liabilities. Non-cash adjustments consist primarily of stock-based compensation, amortization of deferred contract costs and depreciation and amortization. Changes in operating assets and liabilities consist primarily of changes in deferred revenue, deferred contract costs, accounts receivable and inventory.
Our operating activities during 2019 provided $808.0 million in cash as a result of the continued growth of our business and our ability to successfully manage our working capital. Changes in operating assets and liabilities primarily resulted from an increase in sales of our FortiGuard security subscription and FortiCare technical support services to new and existing customers, as reflected by an increase in our deferred revenue. Our total deferred revenue balance grew $449.1 million, or 27%, during 2019.
Our operating activities during 2018 provided $638.9 million in cash as a result of the continued growth of our business and our ability to successfully manage our working capital. Changes in operating assets and liabilities primarily resulted from an increase in sales of our FortiGuard security subscription and FortiCare technical support services to new and existing customers, as reflected by an increase in our deferred revenue. Our total deferred revenue balance as of December 31, 2018 of $1.69 billion represented a 26% increase year over year.
Investing Activities
The changes in cash flows from investing activities primarily relate to timing of purchases, maturities and sales of investments and purchases of property and equipment. Historically, in making a lease versus purchase decision related to our larger facilities, we have considered various factors including financial metrics and the impact on our employees. In certain cases, we have elected to purchase the facility if we believed that purchasing rather than leasing is more in line with our long-term strategy. We expect to make similar decisions in the future. We may also make cash payments in connection with future business combinations.
During 2019, cash used in investing activities was primarily driven by $375.5 million expended on purchases of investments, net of maturities2022, 2021 and sales of investments, $92.2 million spent on purchases of property and equipment and $34.6 million used for the acquisitions of enSilo and CyberSponse, net of cash acquired.
During 2018, cash used in investing activities was primarily due to $60.2 million spent for purchases of our investments, net of maturities and sales of investments, $53.0 million spent on capital expenditures and $21.7 million used for the acquisitions of Bradford Networks, Inc. and ZoneFox Limited, net of cash acquired.
Financing Activities
The changes in cash flows from financing activities primarily relate to repurchase and retirement of common stock, proceeds from the issuance of common stock under our equity incentive plans, taxes paid related to net share settlement of equity awards and payments of debt assumed in business combinations.
During 2019, cash used in financing activities was $195.6 million, primarily due to $145.1 million used to repurchase shares of our common stock, $46.5 million used to pay tax withholding, net of proceeds, from the issuance of common stock and $3.7 million of payments of the debt assumed in business combinations.
During 2018, cash used in financing activities was $202.6 million, primarily due to $211.8 million used to repurchase shares of our common stock and $10.1 million of payments of the debt assumed in business combinations. This was partially offset by $19.3 million of proceeds from the issuance of common stock, net of tax withholding.
Contractual Obligations and Commitments
The following summarizes our inventory purchase commitments as of December 31, 2019:
|
| | | | | | | | | | | | | | | | | | | |
| Payments Due by Period |
| Total | | Less than 1 year | | 1 - 3 years | | 3 - 5 years | | More than 5 years |
| (in millions) |
Inventory purchase commitments (1) | $ | 231.9 |
| | $ | 231.9 |
| | $ | — |
| | $ | — |
| | $ | — |
|
| |
(1) | Consists of minimum purchase commitments with independent contract manufacturers. |
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 December 31, 2019, we had $12.8 million in other contractual commitments having a remaining term in excess of one year that may not be cancelable.
As of December 31, 2019, we had $82.8 million of long-term income tax liabilities, including interest, related to uncertain tax positions. Because of the high degree of uncertainty regarding the settlement of these liabilities, we are unable to estimate the years in which future cash outflows may occur.
Off-Balance Sheet Arrangements
During 2019, 2018 and 2017,2020, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Operating Activities
Cash generated by operating activities is our primary source of liquidity. It is primarily comprised of net income, as adjusted for non-cash items and changes in operating assets and liabilities. Non-cash adjustments consist primarily of amortization of deferred contract costs, stock-based compensation and depreciation and amortization. Changes in operating assets and liabilities consist primarily of changes in deferred revenue, accounts receivable, net, deferred contract costs and deferred tax assets.
Our operating activities during 2022 provided cash flows of $1.73 billion as a result of the continued growth of our business and our ability to successfully manage our working capital. Changes in operating assets and liabilities primarily resulted from an increase in sales of our FortiGuard and other security subscription services and FortiCare technical support services to new and existing customers, as reflected by an increase of $1.18 billion in our deferred revenue during 2022.
Investing Activities
The changes in cash flows from investing activities primarily relate to timing of purchases, maturities and sales of investments, purchases of property and equipment, investments in various companies and business acquisitions. Historically, in making a lease-versus-ownership decision related to warehouse, office or data center space, we have considered various factors including financial metrics and expected long-term growth rates. In certain cases, we have elected to own the facility if we believed that purchasing or developing buildings rather than leasing is more in line with our long-term strategy. We may make similar decisions in the future. We may also make cash payments in connection with future business combinations.
During 2022, cash provided by investing activities was primarily driven by $1.08 billion cash proceeds from maturities and sales of investments, net of purchases of investments, $281.2 million of purchases of property and equipment, and $30.8 million used for the acquisitions of certain assets and liabilities in a network detection and response business and the remaining 25% equity interests in Alaxala, net of cash.
Financing Activities
The changes in cash flows from financing activities primarily relate to repurchase and retirement of common stock, and taxes paid related to net share settlement of equity awards, net of proceeds from the issuance of common stock under our Amended and Restated 2009 Equity Incentive Plan (the “2009 EIP”).
During 2022, cash used in financing activities was $2.13 billion, primarily driven by $1.99 billion used to repurchase shares of our common stock and $134.3 million used to pay tax withholding, net of proceeds from the issuance of common stock.
Recent Accounting Pronouncements
SeeRefer to Note 1 of the notes to our consolidated financial statements in Part II, Item 8 of this Annual Report on Form 10-K for a full description of recently adopted accounting pronouncements.
ITEM 7A. Quantitative and Qualitative Disclosures about Market Risk
Investment and Interest Rate Fluctuation Risk
We are exposed to interest rate risks related to our investment portfolio and outstanding debt.
The primary objectives of our investment activities are to preserve principal, provide liquidity and maximize income without significantly increasing risk. Some of the securities we invest in are subject to market risk. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. To minimize this risk, we maintain our portfolio of cash, cash equivalents, investments and investmentsmarketable equity securities in a variety of securities, including commercial paper, corporate debt securities, U.S. government and agency securities, certificates of deposit and term deposits, commercial paper, money market
funds, municipal bonds and U.S. government and agencymarketable equity securities. The risk
associated with fluctuating interest rates is limited to our investment portfolio. A 10% decrease in interest rates in 2019, 20182022, 2021 and 20172020 would have resulted in an insignificant decrease in our interest income in each of these periods.
On March 5, 2021, we issued $1.0 billion aggregate principal amount of senior notes, consisting of $500.0 million aggregate principal amount of 1.0% notes due March 15, 2026 and $500.0 million aggregate principal amount of 2.2% notes due March 15, 2031. We carry the senior notes at face value less unamortized discount on our consolidated balance sheets. As the senior notes bear interest at a fixed rate, we have no financial statement risk associated with changes in interest rates. Refer to Note 11. Debt in Part II, Item 8 of this Annual Report on Form 10-K.
Foreign Currency Exchange Risk
Our sales contracts are primarily denominated in U.S. dollars and therefore substantially all of our revenue is not subject to foreign currency translation risk. However, a substantial portion of our operating expenses incurred outside the United States are denominated in foreign currencies and are subject to fluctuations due to changes in foreign currency exchange rates, particularly changes in the Euro (“EUR”), the Japanese yen (“JPY”), the Canadian dollar (“CAD”), the Brazilian real (“BRL”), the Euro (“EUR”) and the British pound (“GBP”). To help protect against significant fluctuations in value and the volatility of future cash flows caused by changes in currency exchange rates, we engage in foreign currency risk management activities to minimize the impact of balance sheet items denominated in CAD. We do not use these contracts for speculative or trading purposes. All of the derivative instruments are with high quality financial institutions and we monitor the credit worthiness of these parties. These contracts typically have a maturity of one month and settle on the last day of each month. We record changes in the fair value of forward exchange contracts related to balance sheet accounts in Other income (expense)—other expense—net in the consolidated statements of income. We recognized an expense of $4.7$4.6 million in 20192022 due to foreign currency transaction losses.
Our use of forward exchange contracts is intended to reduce, but not eliminate, the impact of currency exchange rate movements. Our forward exchange contracts are relatively short-term in nature and are focused on the CAD. Long-term material changes in the value of the U.S. dollar against other foreign currencies, such as the EUR, BRLJPY and GBP, could adversely impact our operating expenses in the future. We assessed the risk of loss in fair values from the impact of hypothetical changes in foreign currency exchange rates. For foreign currency exchange rate risk, a 10% increase or decrease of foreign currency exchange rates against the U.S. dollar with all other variables held constant would have resulted in a $5.6$16.4 million change in the value of our foreign currency cash balances as of December 31, 2019.2022.
Inflation Risk
Our monetary assets, consisting primarily of cash, cash equivalents and short-term investments, are not affected significantly by inflation because they are predominantly short-term. We believe the impact of inflation on replacement costs of equipment, furniture and leasehold improvements will not materially affect our operations. The rate of inflation, however, affects our cost of revenue and expenses, such as those for employee compensation, which may not be readily recoverable in the price of products and services offered by us.
| |
ITEM 8. | Financial Statements and Supplementary Data |
ITEM 8. Financial Statements and Supplementary Data
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
For the years ended December 31, 2019, 2018, and 2017
The supplementary financial information required by this Item 8 is included in Part II, Item 7 of this Annual Report on Form 10-K under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Quarterly Results of Operations.”
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the stockholders and the Board of Directors of Fortinet, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Fortinet, Inc. and subsidiaries (the “Company”) as of December 31, 20192022 and 2018,2021, the related consolidated statements of income, comprehensive income, stockholders’ equity (deficit), and cash flows, for each of the three years in the period ended December 31, 2019,2022, and the related notes and the schedule listed in the Index at Item 15 (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 20192022 and 2018,2021, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019,2022, in conformity with accounting principles generally accepted in the United States of America.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2019,2022, based on criteria established in Internal Control–Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 25, 2020,23, 2023, expressed an unqualified opinion on the Company’s internal control over financial reporting.
Change in Accounting Principle
As discussed in Note 1 to the financial statements, the Company has changed its method of accounting for revenue in fiscal 2018 due to adoption of the new revenue standard.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit MatterMatters
The critical audit mattermatters communicated below is a matterare matters arising from the current-period audit of the financial statements that waswere communicated or required to be communicated to the audit committee and that (1) relatesrelate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit mattermatters below, providing a separate opinionopinions on the critical audit mattermatters or on the accounts or disclosures to which it relates.they relate.
Investments in Privately Held Companies – Refer to Notes 1 and 6 to the financial statements
Critical Audit Matter Description
In fiscal year 2021, the Company invested $160 million in cash for shares of Series A Preferred Stock of Linksys Holdings, Inc. (“Linksys”), for a 50.8% ownership interest. This investment is accounted for under the equity method of accounting and is evaluated for events or changes in business circumstances that indicate that it’s carrying value might not be recoverable and whether any estimated decline in value is considered to be other-than-temporary. Evaluating whether the investment is other-than-temporarily impaired requires management to evaluate several qualitative and quantitative factors including, among others, Linksys financial results and operating history, the Company’s ability and intent to hold the investment until its fair value recovers, the implied revenue valuation multiples compared to guideline public companies, Linksys’ ability to achieve milestones and any notable operational and strategic changes (collectively, “impairment indicators”). In the fourth quarter of fiscal year 2022, management concluded that such investment was other-than-temporarily impaired and recorded an impairment charge.
Concluding on whether the presence of impairment indicators indicates that an investment is other-than-temporarily impaired, involves significant and complex management judgment. Therefore, a high degree of auditor judgment and an increased extent
of effort was required when performing audit procedures to evaluate the appropriateness of management’s assessment of identified impairment indicators and the conclusions reached around whether these impairment indicators result in an other-than-temporary impairment.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to management’s assessment of identified impairment indicators and the conclusions reached around whether these impairment indicators result in an other-than-temporary impairment included, among others:
•We tested the effectiveness of controls over management’s assessment of identified impairment indicators and the conclusions reached around whether these impairment indicators result in an other-than-temporary impairment.
•We evaluated management’s other-than-temporary impairment analysis of its Linksys investment by assessing whether certain indicators were present and whether those indications implied an other-than-temporary loss of value. These procedures included but were not limited to:
◦We evaluated the reasonableness of the estimated cash flows by comparing such estimated cash flows to historical results and other internal and external information.
◦With the assistance of our fair value specialists, we evaluated the discount rates and revenue valuation multiples by testing the source information used in determining discount rates and revenue valuation multiples.
◦We tested the mathematical accuracy of the discounted cash flows analysis and the resulting estimated fair value of Linksys.
◦We compared Linksys’ estimated undiscounted cash flows and estimated fair value to Fortinet’s carrying amount.
◦We performed inquiries with relevant members of management to obtain an understanding of their current and expected performance for Linksys, including their understanding of any operational and strategic changes.
◦We performed a retrospective review of Linksys’ performance by comparing actual Linksys results to the performance expected by management when the Company initially invested in Linksys.
◦We evaluated the length of time Linksys has incurred losses.
◦We evaluated Linksys’ performance relative to its peers and to the economy by performing a comparison to peer company results and macro-economic trends.
•We tested the mathematical accuracy of the Linksys impairment as the excess of the investment’s carrying value over its estimated fair value.
Litigation Contingencies–– Refer to Note 11Notes 1 and 12 to the financial statements
Critical Audit Matter Description
The Company is involved in disputes, litigation and other legal actions in the normal course of business. Claims from third parties may result in a requirement to pay substantial damages and could prevent the Company from selling certain of theirits products. An estimated loss fromThe Company accrues for a loss contingency is accrued byif a charge to income if itloss is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. WhereThese accruals are generally based on a range of loss can be reasonably estimated with no best estimate in the range, management records the minimum estimated liability.
The determination of litigation contingency accruals is subject topossible outcomes that require significant management judgement in assessing the likelihood of a loss being incurred and when determining whether a reasonable estimate of the loss or range of loss can be made.
judgement.
Given the inherent uncertainty of the outcome of identified current matters, auditing the valuation assertion of litigation contingencies required a high degree of auditor judgment and an increased extent of effort when performing audit procedures.
How the Critical Audit Matter Was Addressed in the Audit
Our audit procedures related to the litigation contingencies included the following, among others:
•We tested the effectiveness of controls over management’s litigation contingency accrual analysis and assessment of matters with potential impact.
•We obtained and evaluated legal letters from internal and external legal counsel, and we discussed with internal legal counsel the pending litigation matters.
•We made inquiries with management to obtain an understanding of litigation matters that the Company is currently
undergoing.
•We read available court filings for litigation matters to search for contradictory information.
•We read Board of Directors meeting minutes to search for contradictory information.
•We evaluated the assumptions used by the Company to estimate the litigation contingency, including corroborating the assumptions with internal legal counsel.
We evaluated the Company’s litigation contingencies disclosure for consistency with our knowledge of the Company’s litigation matters.
/s/ DELOITTE & TOUCHE LLP
San Jose, California
February 25, 202023, 2023
We have served as the Company’s auditor since 2002.
FORTINET, INC.
CONSOLIDATED BALANCE SHEETS
(in millions, except per share amounts)
| | | December 31, 2019 | | December 31, 2018 | | December 31, 2022 | | December 31, 2021 |
ASSETS | | | | ASSETS | | | |
CURRENT ASSETS: | | | | CURRENT ASSETS: | |
Cash and cash equivalents | $ | 1,222.5 |
| | $ | 1,112.4 |
| Cash and cash equivalents | $ | 1,682.9 | | | $ | 1,319.1 | |
Short-term investments | 843.1 |
| | 537.2 |
| Short-term investments | 502.6 | | | 1,194.0 | |
Accounts receivable—Net of reserves for doubtful accounts of $1.2 million and $0.9 million at December 31, 2019 and 2018, respectively | 544.3 |
| | 444.5 |
| |
Marketable equity securities | | Marketable equity securities | 25.5 | | | 38.6 | |
Accounts receivable—Net of allowance for credit losses of $3.6 million and $2.4 million at December 31, 2022 and 2021, respectively | | Accounts receivable—Net of allowance for credit losses of $3.6 million and $2.4 million at December 31, 2022 and 2021, respectively | 1,261.7 | | | 807.7 | |
Inventory | 117.9 |
| | 90.0 |
| Inventory | 264.6 | | | 175.8 | |
Prepaid expenses and other current assets | 41.2 |
| | 36.8 |
| Prepaid expenses and other current assets | 73.1 | | | 65.4 | |
Total current assets | 2,769.0 |
| | 2,220.9 |
| Total current assets | 3,810.4 | | | 3,600.6 | |
LONG-TERM INVESTMENTS | 144.3 |
| | 67.0 |
| LONG-TERM INVESTMENTS | 45.5 | | | 440.8 | |
PROPERTY AND EQUIPMENT—NET | 344.3 |
| | 271.4 |
| PROPERTY AND EQUIPMENT—NET | 898.5 | | | 687.6 | |
DEFERRED CONTRACT COSTS | 237.0 |
| | 182.6 |
| DEFERRED CONTRACT COSTS | 518.2 | | | 423.3 | |
DEFERRED TAX ASSETS | 232.6 |
| | 255.0 |
| DEFERRED TAX ASSETS | 569.4 | | | 342.3 | |
GOODWILL | | GOODWILL | 128.0 | | | 125.1 | |
OTHER INTANGIBLE ASSETS—NET | 31.1 |
| | 22.1 |
| OTHER INTANGIBLE ASSETS—NET | 56.0 | | | 63.6 | |
GOODWILL | 67.2 |
| | 38.2 |
| |
OTHER ASSETS | 60.0 |
| | 20.8 |
| OTHER ASSETS | 202.0 | | | 235.8 | |
TOTAL ASSETS | $ | 3,885.5 |
| | $ | 3,078.0 |
| TOTAL ASSETS | $ | 6,228.0 | | | $ | 5,919.1 | |
| | | | | | | |
LIABILITIES AND STOCKHOLDERS’ EQUITY | | | | |
LIABILITIES AND EQUITY (DEFICIT) | | LIABILITIES AND EQUITY (DEFICIT) | |
CURRENT LIABILITIES: | | | | CURRENT LIABILITIES: | |
Accounts payable | $ | 96.4 |
| | $ | 86.4 |
| Accounts payable | $ | 243.4 | | | $ | 148.4 | |
Accrued liabilities | 97.7 |
| | 77.5 |
| Accrued liabilities | 266.3 | | | 197.3 | |
Accrued payroll and compensation | 101.8 |
| | 98.4 |
| Accrued payroll and compensation | 219.4 | | | 195.0 | |
Income taxes payable | 4.1 |
| | 28.2 |
| |
Deferred revenue | 1,173.6 |
| | 965.9 |
| Deferred revenue | 2,349.3 | | | 1,777.4 | |
Total current liabilities | 1,473.6 |
| | 1,256.4 |
| Total current liabilities | 3,078.4 | | | 2,318.1 | |
DEFERRED REVENUE | 962.3 |
| | 720.9 |
| DEFERRED REVENUE | 2,291.0 | | | 1,675.5 | |
INCOME TAX LIABILITIES | 82.8 |
| | 77.5 |
| INCOME TAX LIABILITIES | 67.8 | | | 79.5 | |
LONG-TERM DEBT | | LONG-TERM DEBT | 990.4 | | | 988.4 | |
OTHER LIABILITIES | 44.9 |
| | 13.0 |
| OTHER LIABILITIES | 82.0 | | | 59.2 | |
Total liabilities | 2,563.6 |
| | 2,067.8 |
| Total liabilities | 6,509.6 | | | 5,120.7 | |
COMMITMENTS AND CONTINGENCIES (Note 11) |
|
| |
|
| |
STOCKHOLDERS’ EQUITY: | | | | |
Common stock, $0.001 par value—300 shares authorized; 171.7 shares and 169.8 shares issued and outstanding at December 31, 2019 and 2018, respectively | 0.2 |
| | 0.2 |
| |
COMMITMENTS AND CONTINGENCIES (Note 12) | | COMMITMENTS AND CONTINGENCIES (Note 12) | | | |
EQUITY (DEFICIT): | | EQUITY (DEFICIT): | |
Common stock, $0.001 par value—1,500.0 shares authorized; 781.5 shares and 810.0 shares issued and outstanding at December 31, 2022 and 2021, respectively | | Common stock, $0.001 par value—1,500.0 shares authorized; 781.5 shares and 810.0 shares issued and outstanding at December 31, 2022 and 2021, respectively | 0.8 | | | 0.8 | |
Additional paid-in capital | 1,180.3 |
| | 1,068.3 |
| Additional paid-in capital | 1,284.2 | | | 1,253.6 | |
Accumulated other comprehensive income (loss) | 1.1 |
| | (0.8 | ) | |
Retained earnings (accumulated deficit) | 140.3 |
| | (57.5 | ) | |
Total stockholders’ equity | 1,321.9 |
| | 1,010.2 |
| |
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY | $ | 3,885.5 |
| | $ | 3,078.0 |
| |
Accumulated other comprehensive loss | | Accumulated other comprehensive loss | (20.2) | | | (4.8) | |
Accumulated deficit | | Accumulated deficit | (1,546.4) | | | (467.9) | |
Total Fortinet, Inc. stockholders’ equity (deficit) | | Total Fortinet, Inc. stockholders’ equity (deficit) | (281.6) | | | 781.7 | |
Non-controlling interests | | Non-controlling interests | — | | | 16.7 | |
Total equity (deficit) | | Total equity (deficit) | (281.6) | | | 798.4 | |
TOTAL LIABILITIES AND EQUITY (DEFICIT) | | TOTAL LIABILITIES AND EQUITY (DEFICIT) | $ | 6,228.0 | | | $ | 5,919.1 | |
See notes to consolidated financial statements.
FORTINET, INC.
CONSOLIDATED STATEMENTS OF INCOME
(in millions, except per share amounts)
| | | Year Ended December 31, | | Year Ended December 31, |
2019 | | 2018 | | 2017 | 2022 | | 2021 | | 2020 |
REVENUE: | | | | | | REVENUE: | | | | | |
Product | $ | 788.5 |
| | $ | 674.4 |
| | $ | 577.2 |
| Product | $ | 1,780.5 | | | $ | 1,255.0 | | | $ | 916.4 | |
Service | 1,367.7 |
| | 1,126.8 |
| | 917.7 |
| Service | 2,636.9 | | | 2,087.2 | | | 1,678.0 | |
Total revenue | 2,156.2 |
| | 1,801.2 |
| | 1,494.9 |
| Total revenue | 4,417.4 | | | 3,342.2 | | | 2,594.4 | |
COST OF REVENUE: | | | | | | COST OF REVENUE: | | | | | |
Product | 324.6 |
| | 291.0 |
| | 243.8 |
| Product | 691.3 | | | 487.7 | | | 352.4 | |
Service | 181.3 |
| | 159.4 |
| | 141.5 |
| Service | 393.6 | | | 295.3 | | | 217.6 | |
Total cost of revenue | 505.9 |
| | 450.4 |
| | 385.3 |
| Total cost of revenue | 1,084.9 | | | 783.0 | | | 570.0 | |
GROSS PROFIT: | | | | | | GROSS PROFIT: | | | | | |
Product | 463.9 |
| | 383.4 |
| | 333.4 |
| Product | 1,089.2 | | | 767.3 | | | 564.0 | |
Service | 1,186.4 |
| | 967.4 |
| | 776.2 |
| Service | 2,243.3 | | | 1,791.9 | | | 1,460.4 | |
Total gross profit | 1,650.3 |
| | 1,350.8 |
| | 1,109.6 |
| Total gross profit | 3,332.5 | | | 2,559.2 | | | 2,024.4 | |
OPERATING EXPENSES: | | | | | | OPERATING EXPENSES: | | | | | |
Research and development | 277.1 |
| | 244.5 |
| | 210.6 |
| Research and development | 512.4 | | | 424.2 | | | 341.4 | |
Sales and marketing | 926.9 |
| | 782.3 |
| | 701.0 |
| Sales and marketing | 1,686.1 | | | 1,345.7 | | | 1,071.9 | |
General and administrative | 102.1 |
| | 93.0 |
| | 87.9 |
| General and administrative | 169.0 | | | 143.5 | | | 119.5 | |
Restructuring charges | — |
| | — |
| | 0.3 |
| |
Gain on intellectual property matter | | Gain on intellectual property matter | (4.6) | | | (4.6) | | | (40.2) | |
Total operating expenses | 1,306.1 |
| | 1,119.8 |
| | 999.8 |
| Total operating expenses | 2,362.9 | | | 1,908.8 | | | 1,492.6 | |
OPERATING INCOME | 344.2 |
| | 231.0 |
| | 109.8 |
| OPERATING INCOME | 969.6 | | | 650.4 | | | 531.8 | |
INTEREST INCOME—NET | 42.5 |
| | 26.5 |
| | 13.5 |
| |
OTHER INCOME (EXPENSE)—NET | (7.5 | ) | | (6.6 | ) | | 0.7 |
| |
INCOME BEFORE INCOME TAXES | 379.2 |
| | 250.9 |
| | 124.0 |
| |
PROVISION FOR (BENEFIT FROM) INCOME TAXES | 52.7 |
| | (81.3 | ) | | 92.6 |
| |
NET INCOME | $ | 326.5 |
| | $ | 332.2 |
| | $ | 31.4 |
| |
Net income per share (Note 9): | | | | | | |
INTEREST INCOME | | INTEREST INCOME | 17.4 | | | 4.5 | | | 17.7 | |
INTEREST EXPENSE | | INTEREST EXPENSE | (18.0) | | | (14.9) | | | — | |
OTHER EXPENSE—NET | | OTHER EXPENSE—NET | (13.5) | | | (11.6) | | | (7.8) | |
INCOME BEFORE INCOME TAXES AND LOSS FROM EQUITY METHOD INVESTMENT | | INCOME BEFORE INCOME TAXES AND LOSS FROM EQUITY METHOD INVESTMENT | 955.5 | | | 628.4 | | | 541.7 | |
PROVISION FOR INCOME TAXES | | PROVISION FOR INCOME TAXES | 30.8 | | | 14.1 | | | 53.2 | |
LOSS FROM EQUITY METHOD INVESTMENT | | LOSS FROM EQUITY METHOD INVESTMENT | (68.1) | | | (7.6) | | | — | |
NET INCOME INCLUDING NON-CONTROLLING INTERESTS | | NET INCOME INCLUDING NON-CONTROLLING INTERESTS | 856.6 | | | 606.7 | | | 488.5 | |
LESS: NET LOSS ATTRIBUTABLE TO NON-CONTROLLING INTERESTS, NET OF TAX | | LESS: NET LOSS ATTRIBUTABLE TO NON-CONTROLLING INTERESTS, NET OF TAX | (0.7) | | | (0.1) | | | — | |
NET INCOME ATTRIBUTABLE TO FORTINET, INC. | | NET INCOME ATTRIBUTABLE TO FORTINET, INC. | $ | 857.3 | | | $ | 606.8 | | | $ | 488.5 | |
Net income per share attributable to Fortinet, Inc. (Note 9): | | Net income per share attributable to Fortinet, Inc. (Note 9): | | | | | |
Basic | $ | 1.91 |
| | $ | 1.96 |
| | $ | 0.18 |
| Basic | $ | 1.08 | | | $ | 0.74 | | | $ | 0.60 | |
Diluted | $ | 1.87 |
| | $ | 1.91 |
| | $ | 0.18 |
| Diluted | $ | 1.06 | | | $ | 0.73 | | | $ | 0.58 | |
Weighted-average shares outstanding: | | | | | | |
Weighted-average shares used to compute net income per share attributable to Fortinet, Inc.: | | Weighted-average shares used to compute net income per share attributable to Fortinet, Inc.: | | | | | |
Basic | 171.0 |
| | 169.1 |
| | 174.3 |
| Basic | 791.4 | | | 816.1 | | | 821.0 | |
Diluted | 175.0 |
| | 174.2 |
| | 178.1 |
| Diluted | 805.3 | | | 835.3 | | | 838.3 | |
See notes to consolidated financial statements.
FORTINET, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(in millions)
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2022 | | 2021 | | 2020 |
Net income including non-controlling interests | $ | 856.6 | | | $ | 606.7 | | | $ | 488.5 | |
Other comprehensive loss: | | | | | |
Change in foreign currency translation | (9.7) | | | (3.8) | | | — | |
Change in unrealized gains (losses) on investments | (6.2) | | | (3.5) | | | (0.2) | |
Less: tax provision (benefit) related to items of other comprehensive loss | (1.4) | | | (0.8) | | | 0.2 | |
Other comprehensive loss | (14.5) | | | (6.5) | | | (0.4) | |
Comprehensive income including non-controlling interests | 842.1 | | | 600.2 | | | 488.1 | |
Less: comprehensive income (loss) attributable to non-controlling interests | 0.2 | | | (1.1) | | | — | |
Comprehensive income attributable to Fortinet, Inc. | $ | 841.9 | | | $ | 601.3 | | | $ | 488.1 | |
|
| | | | | | | | | | | |
| Year Ended December 31, |
| 2019 | | 2018 | | 2017 |
Net income | $ | 326.5 |
| | $ | 332.2 |
| | $ | 31.4 |
|
Other comprehensive income (loss): | | | | | |
Change in unrealized gains (losses) on investments | 2.5 |
| | — |
| | (0.1 | ) |
Tax provision (benefit) related to change in unrealized gains (losses) on investments | 0.5 |
| | — |
| | — |
|
Other comprehensive income (loss) | 2.0 |
| | — |
| | (0.1 | ) |
Comprehensive income | $ | 328.5 |
| | $ | 332.2 |
| | $ | 31.3 |
|
See notes to consolidated financial statements.
FORTINET, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(in millions)
| | | | | | | | | | | | | | | Common Stock | | Additional Paid-In Capital | | Accumulated Other Comprehensive Income (Loss) | | Retained Earnings (Accumulated Deficit) | | Non-Controlling Interests | | Total Equity (Deficit) |
| Common Stock | | Additional Paid-In Capital | | Accumulated Other Comprehensive Income (Loss) | | Retained Earnings (Accumulated Deficit) | | Total Stockholders’ Equity | Shares | | Amount | |
Shares | | Amount | | |
BALANCE—December 31, 2016 | 173.1 |
| | $ | 0.2 |
| | $ | 800.6 |
| | $ | (0.7 | ) | | $ | 37.6 |
| | $ | 837.7 |
| |
BALANCE—December 31, 2019 | | BALANCE—December 31, 2019 | 858.7 | | | $ | 0.8 | | | $ | 1,179.7 | | | $ | 1.1 | | | $ | 160.8 | | | $ | — | | | $ | 1,342.4 | |
Issuance of common stock in connection with equity incentive plans - net of tax withholding | 6.0 |
| | — |
| | 29.5 |
| | — |
| | — |
| | 29.5 |
| Issuance of common stock in connection with equity incentive plans - net of tax withholding | 12.6 | | | — | | | (86.1) | | | — | | | — | | | — | | | (86.1) | |
Repurchase and retirement of common stock | (11.2 | ) | | — |
| | (57.7 | ) | | — |
| | (388.6 | ) | | (446.3 | ) | Repurchase and retirement of common stock | (58.6) | | | — | | | (78.7) | | | — | | | (1,001.4) | | | — | | | (1,080.1) | |
Stock-based compensation expense | — |
| | — |
| | 137.2 |
| | — |
| | — |
| | 137.2 |
| Stock-based compensation expense | — | | | — | | | 191.7 | | | — | | | — | | | — | | | 191.7 | |
Net unrealized loss on investments - net of tax | — |
| | — |
| | — |
| | (0.1 | ) | | — |
| | (0.1 | ) | Net unrealized loss on investments - net of tax | — | | | — | | | — | | | (0.4) | | | — | | | — | | | (0.4) | |
Net income | — |
| | — |
| | — |
| | — |
| | 31.4 |
| | 31.4 |
| Net income | — | | | — | | | — | | | — | | | 488.5 | | | — | | | 488.5 | |
BALANCE—December 31, 2017 | 167.9 |
| | 0.2 |
| | 909.6 |
| | (0.8 | ) | | (319.6 | ) | | 589.4 |
| |
BALANCE—December 31, 2020 | | BALANCE—December 31, 2020 | 812.7 | | | 0.8 | | | 1,206.6 | | | 0.7 | | | (352.1) | | | — | | | 856.0 | |
Issuance of common stock in connection with equity incentive plans - net of tax withholding | 5.7 |
| | — |
| | 17.5 |
| | — |
| | — |
| | 17.5 |
| Issuance of common stock in connection with equity incentive plans - net of tax withholding | 10.2 | | | — | | | (141.7) | | | — | | | — | | | — | | | (141.7) | |
Repurchase and retirement of common stock | (3.8 | ) | | — |
| | (21.7 | ) | | — |
| | (187.4 | ) | | (209.1 | ) | Repurchase and retirement of common stock | (12.9) | | | — | | | (19.2) | | | — | | | (722.6) | | | — | | | (741.8) | |
Stock-based compensation expense | — |
| | — |
| | 162.9 |
| | — |
| | — |
| | 162.9 |
| Stock-based compensation expense | — | | | — | | | 207.9 | | | — | | | — | | | — | | | 207.9 | |
Cumulative effect adjustments from adoption of Topic 606 | — |
| | — |
| | — |
| | — |
| | 117.3 |
| | 117.3 |
| |
Recognition of non-controlling interests upon business combination | | Recognition of non-controlling interests upon business combination | — | | | — | | | — | | | — | | | — | | | 17.8 | | | 17.8 | |
Net unrealized loss on investments - net of tax | | Net unrealized loss on investments - net of tax | — | | | — | | | — | | | (2.7) | | | — | | | — | | | (2.7) | |
Foreign currency translation adjustment | | Foreign currency translation adjustment | — | | | — | | | — | | | (2.8) | | | — | | | (1.0) | | | (3.8) | |
Net income | — |
| | — |
| | — |
| | — |
| | 332.2 |
| | 332.2 |
| Net income | — | | | — | | | — | | | — | | | 606.8 | | | (0.1) | | | 606.7 | |
BALANCE—December 31, 2018 | 169.8 |
| | 0.2 |
| | 1,068.3 |
| | (0.8 | ) | | (57.5 | ) | | 1,010.2 |
| |
BALANCE—December 31, 2021 | | BALANCE—December 31, 2021 | 810.0 | | | 0.8 | | | 1,253.6 | | | (4.8) | | | (467.9) | | | 16.7 | | | 798.4 | |
Issuance of common stock in connection with equity incentive plans - net of tax withholding | 3.8 |
| | — |
| | (48.9 | ) | | — |
| | — |
| | (48.9 | ) | Issuance of common stock in connection with equity incentive plans - net of tax withholding | 7.5 | | | — | | | (134.7) | | | — | | | — | | | — | | | (134.7) | |
Repurchase and retirement of common stock | (1.9 | ) | | — |
| | (12.1 | ) | | — |
| | (128.8 | ) | | (140.9 | ) | Repurchase and retirement of common stock | (36.0) | | | — | | | (55.4) | | | — | | | (1,935.8) | | | — | | | (1,991.2) | |
Stock-based compensation expense | — |
| | — |
| | 173.0 |
| | — |
| | — |
| | 173.0 |
| Stock-based compensation expense | — | | | — | | | 217.3 | | | — | | | — | | | — | | | 217.3 | |
Cumulative-effect adjustment from adoption of ASU 2018-02 | — |
| | — |
| | — |
| | (0.1 | ) | | 0.1 |
| | — |
| |
Net unrealized gain on investments - net of tax | — |
| | — |
| | — |
| | 2.0 |
| | — |
| | 2.0 |
| |
Acquisition of the non-controlling interests | | Acquisition of the non-controlling interests | — | | | — | | | 3.4 | | | — | | | — | | | (16.9) | | | (13.5) | |
Net unrealized loss on investments - net of tax | | Net unrealized loss on investments - net of tax | — | | | — | | | — | | | (4.8) | | | — | | | — | | | (4.8) | |
Foreign currency translation adjustment | | Foreign currency translation adjustment | — | | | — | | | — | | | (10.6) | | | — | | | 0.9 | | | (9.7) | |
Net income | — |
| | — |
| | — |
| | — |
| | 326.5 |
| | 326.5 |
| Net income | — | | | — | | | — | | | — | | | 857.3 | | | (0.7) | | | 856.6 | |
BALANCE—December 31, 2019 | 171.7 |
| | $ | 0.2 |
| | $ | 1,180.3 |
| | $ | 1.1 |
| | $ | 140.3 |
| | $ | 1,321.9 |
| |
BALANCE—December 31, 2022 | | BALANCE—December 31, 2022 | 781.5 | | | $ | 0.8 | | | $ | 1,284.2 | | | $ | (20.2) | | | $ | (1,546.4) | | | $ | — | | | $ | (281.6) | |
See notes to consolidated financial statements.
FORTINET, INC.