Strong Growth and Weak Guidance for Fortinet

Cybersecurity company Fortinet (FTNT +1.26%) reported its third-quarter results after the market closed on Oct. 26. Both revenue and profits surged, driven by strong double-digit growth in service revenue, and free cash flow generation doubled. The company's guidance was a touch on the light side, though, with revenue growth expected to slow down during the fourth quarter. Here's what investors need to know about Fortinet's third-quarter results.

Fortinet results: The raw numbers

Data source: Fortinet.

Image source: Fortinet.

What happened with Fortinet this quarter?

• Fortinet's service revenue grew by 26% year over year to $237.1 million. Product revenue grew by 7% year over year to $137.1 million.
• Total billings rose 24% year over year to $431.7 million.
• Total deferred revenue was $1.22 billion at the end of the quarter, up from $1.16 billion at the end of the second quarter, and up from $935 million one year ago.
• Fortinet produced $162.3 million of cash from operations and $140.6 million of free cash flow, with free cash flow doubling compared to the third quarter of 2016.
• Fortinet's cash, cash equivalents, and investments reached $1.52 billion, up from $1.46 billion at the end of the second quarter.
• The company bought back 2.4 million shares during the quarter, spending a total of $90.8 million. The board of directors approved a $400 million increase to the buyback program in October, bringing the total authorization to $1 billion.

Fortinet provided the following guidance for the fourth quarter and the full year:

• Fourth-quarter revenue is expected to be between $404 million and $412 million, representing 12.5% year-over-year growth at the midpoint. Billings are expected to be between $510 million and $525 million.
• Fourth-quarter non-GAAP EPS is expected to be between $0.28 and $0.30, compared to $0.30 in the prior-year period.
• Full-year revenue is expected to be between $1.482 billion and $1.490 billion, up 16.1% at the midpoint. Billings are expected to be between $1.772 billion and $1.787 billion.
• Full-year non-GAAP EPS is expected to be between $1.00 and $1.02, compared to $0.73 in 2016.

What management had to say

Fortinet CEO Ken Xie discussed the company's main competitive advantage: "Our large installed base of network security customers offers us a foundation from which to sell our Fortinet Security Fabric, which is the broadest and most integrated security architecture in the industry. We expect that the expanding cloud security market, and the future of securing critical infrastructure and IoT technologies, will enable Fortinet to continue to grow at multiples of the market over the coming years."

During the company's conference call, Xie discussed the company's most promising growth opportunity:

Finally, critical infrastructure and IoT present the fourth and perhaps the most exciting engine for the future growth of Fortinet. Smart cities and connected homes coexisting with local, national and global infrastructures are creating new hyperconnected environment. This environment need an architecture that scales the entire infrastructure for complete visibility, segmentation and end-to-end protection. Fortinet is uniquely positioned to capture this market opportunity.

Looking forward

Double-digit revenue growth continued for Fortinet in the third quarter, although its fourth-quarter guidance calls for a meaningful slowdown. Fortinet CFO Andrew Del Matto pointed to a tough comparison with the fourth quarter of last year, geopolitical issues in North Asia, natural disasters in Central America and the Caribbean, and general uncertainty around the company's telecom customers as reasons behind the weak guidance.

Many of these issues are short-term and shouldn't have any lasting effect on Fortinet's business. But with the stock trading for nearly 40 times adjusted earnings guidance for 2017, any slowdown in revenue growth is something to be concerned about.