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Fortinet Inc. (FTNT - Snapshot Report) reported second-quarter 2013 earnings per share of 5 cents, which missed the Zacks Consensus Estimate by a penny. The quarter’s earnings, which exclude the effect of a patent settlement and amortization of intangibles but include stock-based compensation expenses, were 36.2% lower than 8 cents reported in the year-earlier quarter.

Revenues

Fortinet’s second quarter revenues of $147.4 million increased 14.3% from $129.0 million in the year-ago quarter. The quarter’s results were above the Zacks Consensus Estimate of $143.0 million and the company guided range. The year-over-year improvement was aided by 21.8% growth in Services revenues and 7.8% in Product revenues. However, this was partially offset by a 33.5% decline in Ratable and other revenues.

Region wise, Fortinet’s performance was solid across all Americas, Europe, Middle East & Africa (EMEA) and the Asia-Pacific. The company was successful in up-selling its new products across its client base. However, macroeconomic and geopolitical challenges in Latin America and Europe continued to be a challenge.

Billings

Billings during the quarter grew 10.0% year over year to $161.0 million. Geographically, billings from Americas grew 3.0% reflecting continuing macro uncertainty. Billing growth in EMEA was 22.0%, which was in line with Fortinet’s expectations. Asia Pacific witnessed billings growth of 9.0% despite weakness in Japan.

Number of deals worth over $100,000 was 190, up from 168 in the year-ago quarter. Deals over $500,000 and $250,000 increased to 20 and 58 from 19 and 55, respectively in the year-ago period.

Operating Results

Gross profit increased 12.9% from the year-ago quarter to $103.7 million. However, gross margin dropped 80 basis points year over year to 70.4%. The margin contraction was due to higher mix of low-margin entry-level products and lower service margin.

Total operating expenses surged 26.9% year over year. Operating margin was 9.3% compared with 16.2% in the year-ago period. Continued investments resulted in operating margin decline.

Fortinet reported net income of $9.0 million or 5 cents per share compared with $14.0 million or 8 cents in the year-ago quarter. One-time items, though present, were negligible.

Balance Sheet & Cash Flow

Fortinet exited the second quarter with cash and marketable securities of $502.7 million, up from $460.4 million in the previous quarter. Accounts receivable increased 6.4% sequentially to $108.9 million.

Cash from operating activities was $37.6 million, roughly flat with $37.7 million in the prior quarter. Capital expenditure in the second quarter was $2.1 million versus $1.5 million in the prior quarter.

Guidance

Despite the continuing macro uncertainty, Fortinet seems positive on healthy network security market, its product line-ups and agile investment plans.

For third quarter of 2013, Fortinet expects revenues in the range of $149.0–$152.0 million, reflecting 10.0% year-over-year growth at mid-point. Billing is expected in the range of $158.0 million to $162.0 million, up approximately 10% year over year. Gross margin is expected in the range of 71.0%-72.0%. The company also expects non-GAAP operating margin between 17.0% and 18.0%, share count in the range of 168 million to 170 million and non-GAAP earnings per share between 10-11 cents.

For fiscal 2013, total revenue is expected in the range of $595 million to $605 million, up approximately 12% year over year at the midpoint. Billing is expected in the range of $660.0-$670.0 million. The company also expects gross margin between 71.0% and 72.0%, non-GAAP operating margin between 18.0% and 19.0%, diluted share count of approximately 168 million to 170 million and earnings per share within 46-47 cents range.

Conclusion

Fortinet provides network security solutions, which include firewall, VPN, application control, antivirus, intrusion prevention, Web filtering, anti-spam, and WAN acceleration. Fortinet’s second-quarter results were modest with the top line missing the Zacks Consensus Estimate by a penny, while the bottom line surpassed the same. Though third quarter guidance was a bit cautious, we are encouraged by a better visibility into fiscal 2013.

Margin contraction due to continuous investments and stiff competition from key network security players such as Cisco Systems Inc. (CSCO - Analyst Report), Check Point (CHKP - Analyst Report), Juniper Networks (JNPR - Analyst Report) and Palo Alto Networks are concerns. But we think that product ramps, deal momentum, share gains from competitors, continuous growth of the network security market and expected benefits arising out of ongoing investments are catalysts.

Currently, Fortinet has a Zacks Rank #2 (Buy).

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