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Fortinet Inc. (FTNT - Snapshot Report) reported third-quarter 2013 earnings per share of 7 cents, which was in line with the Zacks Consensus Estimate. The quarter’s earnings, which exclude the effect of a patent settlement and amortization of intangibles but include stock-based compensation expenses, were 30.0% lower than 10 cents reported in the year-ago quarter.

Revenues

Fortinet reported third-quarter revenues of $154.7 million, up 13.5% from the year-ago quarter. The quarter’s results were above the Zacks Consensus Estimate of $151.0 million and the company guided range.

The year-over-year improvement was aided by 20.2% growth in Services revenues and 10.6% increase in Product revenues. However, this was partially offset by a 67.4% decline in Ratable and other revenues.

Geographically, Americas contributed 42% of total revenue; EMEA contributed 33.0% while Asia Pacific constituted the remaining 25.0% of revenues. All the three segments posted flat revenues on a year-over-year basis.

Billings

Billings during the quarter grew 13.9% on a year-over-year basis to $165.2 million. Number of deals worth over $100K was 187, up from 168 in the year-ago quarter. Deals over $500K increased to 19 from 16 in the year-ago period while deals over $250K were 61, flat year-over year.

Operating Results

Gross profit increased 12.5% from the year-ago quarter to $110.8 million. However, gross margin contracted 65 basis points year over year to 71.6%, primarily due to higher mix of low-margin entry-level products and lower service margin.

Adjusted total operating expenses surged 27.2% year over year. Adjusted operating margin was 11.8% compared with 18.7% in the year-ago period.

Fortinet posted adjusted net income of $10.9 million or 7 cents per share compared with $16.9 million or 10 cents in the year-ago quarter.

Balance Sheet & Cash Flow

Fortinet exited the third-quarter with cash and cash equivalents and short-term investments of $513.0 million, up from $502.7 million in the previous quarter. Accounts receivable were $107.8 compared to $108.9 million in the year-ago quarter.

Cash from operating activities was $25.4 million, down from $37.6 million in the previous quarter. Free cash flow in the third-quarter was $22.2 million.
 
Guidance

Despite the continuing macro uncertainty, Fortinet seems positive on a healthy network security market, its product lineup and investment plans.

For fourth-quarter of 2013, management expects revenues in the range of $162.0–$167.0 million, reflecting 9.0% year-over-year growth at the mid-point. Billings are expected in the range of $186.0 million to $196.0 million, up approximately 10% year over year.

Gross margin is expected in the range of 71.0%-72.0%. The company also expects operating margin to be approximately 19.0%, diluted share count of approximately 169 million to 171 million and earnings per share between 13 cents to 14 cents.

For fiscal 2013, revenues are expected to be in the range of $600.0 million to $605.0 million, up approximately 13% year over year at the midpoint. Billings are expected in the range of $660.0-$670.0 million.

For fiscal 2013, the company expects gross margin between 71.0% and 72.0%, operating margin between 18.0% and 19.0%, diluted share count of approximately 168 million to 170 million and earnings per share within 46 cents to 47 cents.

Conclusion

Fortinet provides network security solutions, which include firewall, VPN, application control, antivirus, intrusion prevention, web filtering, anti-spam, and WAN acceleration. Fortinet’s third-quarter results were modest with the top line beating the Zacks Consensus Estimate, while the bottom line matched the Zacks Consensus Estimate.

Margin contraction due to continuous investments and 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 #3 (Hold).

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