Fortinet, Inc. Q3 FY2023 earnings

Fortinet's fiscal 2023 third quarter shows a business shifting its center of gravity. Total revenue rose 16.1% to $1.33 billion in the quarter ended September 30, 2023, but the growth came from services while product revenue declined as lead times and backlog returned to historical levels and demand for network security hardware normalized after roughly two years of elevated growth. Billings, a non-GAAP measure, rose 5.7% to $1.49 billion, a slower pace than revenue. Management tied that result to a slowdown in secure networking growth and to challenges in sales execution and marketing programs. It plans to move its sales and marketing teams toward the faster-growing SASE and Security Operations markets over the next several quarters. The installed base remains large: more than 700,000 customers and 1,290 patents as of September 30, 2023.

Profitability leaned on the service mix. Gross margin was 76.2%, up 0.8 percentage points, and gross profit rose 17.4% to $1.02 billion. GAAP operating income climbed 14.2% to $303.2 million, yet operating margin slipped 0.4 percentage points to 22.7% because sales and marketing and general and administrative costs grew faster than revenue. Net income rose 39.4% to $322.9 million, and diluted earnings per share were $0.41, up 41.4%, on a lower diluted share count. Through the first nine months of fiscal 2023, revenue rose 24.1% to $3.89 billion and operating income rose 39.9% to $855.7 million.

Cash generation stayed strong. Operating cash flow was $551.2 million in the quarter, up 14.1%, and $1.74 billion for the nine months, up 45.0%. Capital expenditures fell 20.2% to $70.1 million in the quarter and 29.2% to $177.2 million year to date. Free cash flow, a non-GAAP measure that subtracts purchases of property and equipment from operating cash flow, was $481.1 million for the quarter. Short-term deferred revenue rose 24.3% to $2.65 billion and remaining performance obligations rose 25.9% to $5.30 billion, a sign of future service revenue. Fortinet repurchased 10.4 million shares for $605.2 million in the nine months ended September 30, 2023, then bought back another 7.7 million shares for $444.4 million between September 30 and October 31, 2023.

Guidance points to a slower finish. For the fourth quarter of fiscal 2023, management guided revenue of $1.380 billion to $1.440 billion, billings of $1.560 billion to $1.700 billion, a non-GAAP operating margin of 27.5% to 28.5%, and diluted non-GAAP net income per share of $0.42 to $0.44. For the full fiscal year 2023, the company guided revenue of $5.270 billion to $5.330 billion, service revenue of $3.355 billion to $3.375 billion, billings of $6.095 billion to $6.235 billion, a non-GAAP operating margin of 26.5% to 27.5%, and non-GAAP diluted earnings per share of $1.54 to $1.56. Both assume a non-GAAP effective tax rate of 17%.

Risks are stacking up. Management warned that limited near-term growth in secure networking and the shift in sales focus could bring go-to-market problems, higher sales turnover and other execution challenges. Purchase commitments fell to $820.6 million from $1.34 billion at December 31, 2022 as supply conditions improved, and headcount reached 13,618 employees and contractors, up 8% from 12,595 at the end of 2022. Days sales outstanding improved to 68 days from 75 days a year earlier, a sign that collections held up. The filings list longer sales cycles on large enterprise deals, competition and pricing pressure, inflation and higher interest rates, instability in the global banking system, supply chain disruption, and the wars in Ukraine and the Middle East as factors that could hurt results.