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(Mark One)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010
Or
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
For the transition period from to
Commission file number: 001-34511
______________________________________
FORTINET, INC.
(Exact name of registrant as specified in its charter)
______________________________________
Delaware
(State or other jurisdiction of
incorporation or organization)
1090 Kifer Road
Sunnyvale, California
(Address of principal executive offices)
77-0560389
(I.R.S. Employer
Identification No.)
94086
(Zip Code)
(408) 235-7700
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, $0.001 Par Value
(Title of each class)
The NASDAQ Stock Market LLC
NASDAQ Global Select Market
(Name of exchange on which registered)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes
No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the
Act. Yes
No
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Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes
No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any,
every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§229.405 of this
chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such
files). Yes
No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (section 229.405 of this
chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a
smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company”
in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Non-accelerated filer
(Do not check if smaller
reporting company)
Accelerated filer
Smaller reporting company
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes
No
The aggregate market value of voting stock held by non-affiliates of the registrant, as of June 30, 2010, the last business day
of the registrant’s most recently completed second quarter, was $590,897,232 (based on the closing price for shares of the
registrant's common stock as reported by The NASDAQ Global Select Market for the last business day prior to that date).
Shares of common stock held by each executive officers, director, and holder of 5% or more of the outstanding common stock
have been excluded in that such persons may be deemed to be affiliates. This determination of affiliate status is not necessarily
a conclusive determination for other purposes.
As of February 17, 2011, there were 75,231,493 shares of the registrant’s common stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement relating to its 2011 Annual Meeting of Stockholders are incorporated
by reference into Part III of this Annual Report on Form 10-K where indicated. Such Proxy Statement will be filed with the
U.S. Securities and Exchange Commission within 120 days after the end of the fiscal year to which this report relates.
FORTINET, INC.
ANNUAL REPORT ON FORM 10-K
For the Fiscal Year Ended December 31, 2010
Table of Contents
Item 1.
Business
Item 1A.
Risk Factors
Item 1B.
Unresolved Staff Comments
Item 2.
Properties
Item 3.
Legal Proceedings
Item 4.
Removed and Reserved
Part I
Part II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
Item 6.
Selected Financial Data
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk
Item 8.
Financial Statements and Supplementary Data
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A.
Controls and Procedures
Item 9B.
Other Information
Part III
Item 10.
Directors, Executive Officers and Corporate Governance
Item 11.
Executive Compensation
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13.
Certain Relationships and Related Transactions, and Director Independence
Item 14.
Principal Accounting Fees and Services
Item 15.
Exhibits and Financial Statement Schedules
Part IV
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ITEM 1.
Business
Overview
Part I
We provide network security solutions that are designed to address the fundamental problems of an increasingly
bandwidth-intensive network environment and a more sophisticated information technology (“IT”) threat landscape. Through our
products and subscription services, we provide broad, integrated and high performance protection against dynamic security threats
while simplifying the IT security infrastructure for enterprises, service providers and government entities worldwide. Our flagship
Unified Threat Management ("UTM") solution consists of our FortiGate appliance products that provide a broad array of security
and networking functions, including firewall, VPN, antivirus, intrusion prevention, application control, Web filtering, antispam,
wireless controller, and WAN acceleration. Our FortiGate appliances, from the FortiGate-50 for small businesses and branch
offices to the FortiGate-5000 series for large enterprises and service providers, are based on our proprietary technology platform.
This platform includes our FortiASICs, which are specifically designed for accelerated processing of security and networking
functions, and our FortiOS operating system, which provides the foundation for all of our security functions. Our FortiGuard
security subscription services provide end-customers with access to dynamic updates to our antivirus, application control, intrusion
prevention, Web filtering and antispam functionality based on intelligence gathered by our dedicated FortiGuard Labs team. By
combining multiple proprietary security and networking functions with our purpose-built FortiASIC and FortiOS, our FortiGate
UTM solution delivers broad protection against dynamic security threats while reducing the operational burden and costs
associated with managing multiple point products.
We complement our FortiGate product line with a family of FortiManager appliances, which enable end-customers to
manage the system configuration and security functions of multiple FortiGate appliances from a centralized console, as well as
FortiAnalyzer appliances, which enable collection, analysis and archiving of content and log data generated by our products. We
also offer other appliances and software that provide additional protection, such as: (i) FortiMail, a family of multi-featured, high
performance messaging security appliances, (ii) FortiDB, a family of appliances that provide centrally managed database-specific
security, (iii) FortiClient, a software product that provides endpoint security for desktops, laptops and mobile devices and that is
primarily used in conjunction with our FortiGate appliances, (iv) FortiWeb, a family of appliances that provide security for Web-
based applications, (v) FortiAP, a family of secure wireless access points, (vi) FortiScan, an appliance designed to provide endpoint
vulnerability assessment and remediation, (vii) FortiSwitch, a family of Ethernet switches, and (viii) FortiBridge, a family of
bypass appliances to help ensure network availability.
In October 2010 we began shipping virtual appliances for the FortiGate and FortiManager product lines. The new virtual
appliances help secure network infrastructures with the same functionality as the traditional physical appliances in their respective
product lines. They can be used in conjunction with traditional Fortinet appliances (such as FortiGate, FortiManager, and
FortiAnalyzer) to help ensure the visibility, management, and protection of physical and virtual environments.
As of December 31, 2010, we had shipped over 675,000 appliances to more than 5,000 channel partners and 100,000 end-
customers worldwide, including a majority of the 2010 Fortune Global 100.
We were incorporated in Delaware in November 2000. Our principal executive office is located at 1090 Kifer Road,
Sunnyvale, California 94086 and our telephone number at that location is (408) 235-7700.
Technology and Architecture
Our proprietary FortiASIC, hardware architecture, FortiOS operating system and associated security and networking
functions combine to form a platform that integrates security features and enables our products to perform sophisticated security
processing for networks with high throughput requirements.
FortiASIC
Our FortiASIC family of ASICs is comprised of three lines of processors: FortiASIC content processor, or CP, the
FortiASIC network processor, or NP, and the FortiASIC system-on-a-chip, or SOC. These custom ASICs are designed to enhance
the sophisticated security processing capabilities implemented in software by accelerating the computation-intensive tasks such as
firewall policy enforcement or IPS anomaly detection. This architecture provides the flexibility of implementing accelerated
processing of new threat detection without requiring a new ASIC release. The FortiASIC CP is currently included in most of our
entry-level and all of our mid-range and high-end FortiGate appliances. The FortiASIC NP is currently included in some of our
mid-range and high-end FortiGate appliances, delivering further accelerated firewall and VPN performance. The FortiASIC SOC
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is currently included in our entry-level FortiGate-60C and FortiWiFi-60C appliances.
FortiOS
FortiOS provides the foundation for the operation of all FortiGate appliances, from the core kernel functions to the
security processing feature sets. FortiOS provides multiple layers of security including a hardened kernel layer providing
protection for the FortiGate system, a network security layer providing security for end-customers’ network infrastructures, and
application content protection providing security for end-customers’ workstations and applications. FortiOS directs the operations
of processors and ASICs as well as providing system management functions such as command-line and graphical user interfaces.
We make available updates to the FortiOS through our FortiCare support services. FortiOS also enables advanced, integrated
routing and switching, allowing end-customers to deploy FortiGate devices within a wide variety of networks, as well as providing
a direct replacement solution option for legacy switching and routing equipment. The FortiOS implements a suite of commonly
used routing protocols as well as address translation technologies allowing the FortiGate appliance to integrate and operate in a
wide variety of network environments. Additional features include Virtual Domain, or VDOM, capabilities and traffic queuing and
shaping enabling administrators to set the appropriate configurations and policies that meet their infrastructure needs. FortiOS also
provides capabilities for logging of traffic for forensic analysis purposes which are particularly important for regulatory
compliance initiatives like PCI DSS. FortiOS’s packet classification, queue disciplines, policy enforcement, congestion
management, and other traffic optimization functionality are designed to help control network traffic in order to optimize
performance.
Our FortiOS incorporates the following seven core security and networking technologies:
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Firewall. Our firewall technology delivers high performance network and application firewalling, including the
ability to enforce policies based on application behavior and content. Our technology identifies traffic patterns
independent of port or protocol used, and links them to the use of specific applications, enabling visibility and
control over application behavior (explained in more detail below). By coupling application intelligence with
firewall technology, the FortiGate platform is able to deliver real-time security with integrated application
content level inspection, thereby simplifying security deployments.
Virtual Private Network. Our advanced VPN technology provides secure communications between multiple
networks and hosts, through both secure socket layer, or SSL, and IPsec VPN technologies, leveraging our
custom FortiASIC to provide hardware acceleration for high-performance communications and data privacy.
Antivirus. Our antivirus technology provides protection against malware, including viruses, spyware and trojans.
Intrusion Prevention System. Our IPS technology provides protection against current and emerging network level
threats.
Web Filtering. Our Web filtering automation technology works in concert with our research team to collect,
analyze and categorize websites to provide real-time protection through website ratings and categorization. Our
Web filtering technology is a pro-active defense feature that identifies known locations of malware and blocks
access to these malicious sources.
Antispam. We employ a variety of antispam techniques to detect and block spam. These techniques include a
hosted service performing algorithmic validations of messages against known spam messages, sophisticated
reputation service designed to evaluate and track valid email sources and destinations, intelligent image scanning
to evaluate the validity of images and dynamic heuristic rules to allow messages to be evaluated based on content
within each message.
WAN Acceleration. Our storage-enabled and storage-ready FortiGate appliances provide the ability to accelerate
network traffic across the wide area network by implementing a combination of application content caching and
protocol optimization techniques.
In addition to the seven core security and networking functions mentioned above, we also incorporate additional
technologies within FortiGate appliances that differentiate our UTM solution, including:
•
Application Control. Our application control technology provides the ability to define granular network-based
application policies giving end-customers additional control over application access.
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Data Leakage Prevention (DLP). Our DLP technology provides the ability to define rules based on corporate
policies, and consequently detect and prevent confidential data from being distributed outside of the corporate
network.
Traffic optimization. Our traffic optimization technology combines quality of service techniques with traffic
shaping to provide better service to selected network traffic based on customer policies without causing
interruptions to other traffic.
SSL inspection. Our SSL inspection technology provides the ability to decrypt SSL application content for
processing by the FortiOS. The ability to inspect encrypted SSL content enables our customers to ensure
protection from malware that would be otherwise hidden from traditional security products, and enforce the full
complement of security and networking features available within FortiOS.
Vulnerability Management. Our vulnerability management technology enables the FortiGate platform to perform
network scans to discover systems on a network, identity vulnerabilities and recommend steps for remediation.
The FortiGate devices can store the results of the scans locally, or send the results from multiple FortiGate
devices to a central FortiAnalyzer for aggregation and analysis.
Wireless Controller. Our wireless controller technology provides the ability to deploy FortiAP wireless access
points to create a secure wireless network. FortiAP access points tunnel all wireless traffic to FortiGate or
FortiWiFi platforms, enabling end-customers to use a single security platform to manage all wired and wireless
network traffic.
Products
Our core product offerings consist of our FortiGate UTM appliance family, along with our FortiManager central
management appliance and FortiAnalyzer central logging and reporting appliance, both of which are typically purchased to
complement a large FortiGate deployment.
FortiGate
Our flagship FortiGate appliances offer a set of security and networking functions, including firewall, VPN, antivirus,
intrusion prevention, application controls, Web filtering, antispam and WAN acceleration. All FortiGate appliances are based on
our proprietary operating system, FortiOS, and substantially all FortiGate models include our proprietary FortiASICs to accelerate
content and network security features implemented within FortiOS. FortiGate appliances can be centrally managed through both
embedded Web-based and command line interfaces, as well as through FortiManager which provides a central management
architecture for thousands of FortiGate appliances.
By combining multiple network security functions in our purpose-built security platform, the FortiGate provides high
quality protection capabilities and deployment flexibility while reducing the operational burden and costs associated with
managing multiple point products. Through FortiGuard security subscription services, our products enable end-customers to add
security functionality as required by their evolving business needs and the changing threat landscape. By purchasing FortiGuard
security subscription services, end-customers obtain coverage and access to regular updates for antivirus, application control, IPS,
Web filtering and antispam functions for their FortiGate appliances. With over 30 models in the FortiGate product line, FortiGate is
designed to address security requirements for small-to-mid sized businesses, remote offices, large enterprises, and service
providers.
Each FortiGate appliance runs our FortiOS operating system, and substantially all include our FortiASIC CP. The
significant differences between each model are the performance and scalability targets each model is designed to meet, while the
security features and associated services offered are common throughout all models.
The FortiGate-30 through -100 series models are designed for perimeter protection for small- to mid-sized businesses,
remote offices of large distributed organizations and as customer premises equipment for service providers. Optional wireless
LAN, or WLAN, integration is available for the FortiGate-50, -60 and -80 models, marketed as FortiWiFi, delivering additional
network access and security for wireless environments.
The FortiGate-200 through -800 series models are designed for perimeter deployment in mid-sized to large enterprise
networks. These products offer increased capacity and scalability designed to provide high network performance while delivering
the same broad security suite as all FortiGate models. Additionally, the FortiGate-310 and -620 models provide hardware
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modularity, allowing end-customers the flexibility to customize solutions to their requirements.
The FortiGate-1000 through -5000 series models deliver high performance and scalable network security functionality for
perimeter, data center and core deployment in large enterprise and service provider networks. Additionally, most of these products
provide hardware modularity, allowing end-customers the flexibility to customize solutions to their requirements. Products within
the FortiGate-3000 and -5000 series leverage Advanced Mezzanine Card, or AMC, industry standards for hardware modularization
to support the advanced networking requirements of large enterprises and service providers, including high-speed networking,
WAN connectivity, and network attached storage connectivity. The FortiGate-3950B series also leverages our proprietary Fortinet
Mezzanine Card, or FMC, that provides hardware modularity to give end-customers the ability to add additional firewall and/or
intrusion prevention performance as their network security needs evolve. The FortiGate-5000 series is also compatible with the
Advanced Telecommunications Computing Architecture, or ATCA, standard, resulting in a flexible hardware platform for system
modularity. This modularization gives end-customers the ability to deploy an initial FortiGate configuration with room to grow as
their network security needs evolve. The inclusion of network load balancing and advanced switching functionality provides
additional flexibility in how end-customers utilize the FortiGate modules within the FortiGate chassis. In addition, our
FortiGate-5000 series ATCA blades can be utilized in other third-party vendors’ industry standard ATCA chassis, allowing
FortiGate platforms to be deployed into a much wider range of network solutions. Our FortiGate-5000 series appliances offer
modular, chassis-based architecture based on the ATCA and AMC industry standards. We brand a subset of our FortiGate-3000 and
-5000 series products as FortiCarrier to reflect products specifically targeting a subset of service providers. These products add
incremental security, networking and management functionality often utilized in service provider deployments.
FortiGate System Virtualization (VDOM)
In addition to providing network and content level security, FortiOS also offers system virtualization capabilities—the
ability to “divide” a security appliance into multiple separately provisioned and managed instances. This capability is currently
deployed in substantially all of our FortiGate products as our virtual domain, or VDOM, feature, where administrators have the
ability to segment a single FortiGate appliance platform into multiple FortiGate instances. Network security system virtualization,
using our VDOM feature, provides isolation between each virtual system, giving administrators flexibility in configuration and
traffic management capabilities for each virtual instance.
Fortinet Management and Analysis Appliances
Our FortiManager and FortiAnalyzer appliances are typically sold in conjunction with a large FortiGate deployment.
FortiManager
Our FortiManager appliances provide a central management solution for our FortiGate appliances, including the wide
variety of network and security features offered within FortiOS. One FortiManager appliance is capable of effectively managing
thousands of FortiGate units, and also provides central management for FortiClient software. FortiManager facilitates the
coordination of policy-based provisioning, device configuration and operating system revision management, as well as network
security monitoring and device control.
FortiAnalyzer
Our FortiAnalyzer appliances are network logging, analyzing, and reporting appliances that securely aggregate content
and log data from our FortiGate devices and other Fortinet products as well as third-party devices to enable network logging,
analysis and reporting. Additional functions such as vulnerability assessments and traffic analysis provide additional value for
customers seeking to control and monitor their network infrastructure and security policies. A full range of content and log data,
including traffic, event, virus, attack, Web content, and email data may be archived, filtered and mined for compliance or historical
analysis purposes. The appliance comes with a suite of standard reports as well as the ability to customize reports.
Additional Fortinet Solutions
We also offer other appliances and software that protect our end-customers from security threats to other critical areas in
the enterprise, such as messaging, Web-based applications and databases, and employees’ computers or mobile devices.
FortiMail
Our FortiMail appliances provide protection against threats conveyed by messaging applications, including blended
threats such as a coordinated, single attack comprised of spam, viruses and worms. These systems offer flexibility to support a
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variety of existing deployments with minimal change to existing infrastructure. The FortiMail systems utilize a customized
operating system designed to inspect and clean both inbound and outbound email traffic. FortiMail detects security threats through
sophisticated antispam, antivirus and anti-malware engines. Additional functionality designed to eliminate deployment barriers and
increase system value includes email routing, system virtualization, and archiving.
FortiDB
Our FortiDB appliance provides a comprehensive solution for database security assessment, identifying potential
vulnerabilities that otherwise could be exploited by attackers. This solution is able to discover databases within a network
infrastructure allowing administrators to confirm known databases and identify potentially harmful unknown or unauthorized
databases. The ability to evaluate and report on database software and database server vulnerabilities provides the database
administrator with a comprehensive list of security concerns and recommended actions to remediate them ensuring a security-
hardened database environment.
FortiClient
Our FortiClient product is an endpoint software solution designed to be used in connection with our FortiGate appliances
to provide security features for enterprise computers and mobile devices. The feature set includes personal firewall, IPsec VPN,
antivirus, Web filtering, WAN acceleration, DLP and antispam. FortiClient is supported by FortiGuard security subscription
services to help ensure endpoints are protected on a real-time basis against current and emerging threats. FortiClient software is
available for Microsoft Windows XP, Microsoft Vista, Microsoft Windows Mobile and Symbian operating systems.
FortiWeb
Our FortiWeb appliances provide Web application firewalls and networking features designed to protect, balance, and
accelerate Web applications. The FortiWeb is designed for medium and large enterprises, cloud service providers and consumer
Internet and e-commerce companies, and can significantly reduce the deployment time and complexities of introducing Web
applications. The FortiWeb applies our industry leading threat research to protect Web application servers, improving the security
of confidential information and aiding in legislative and PCI DSS compliance. FortiWeb goes beyond traditional Web application
firewalls to provide XML security enforcement, application acceleration, and server load balancing.
FortiScan
Our FortiScan appliance provides endpoint vulnerability management, inventory (asset and software) industry compliance
evaluation, patch management and remediation, auditing and reporting. These tasks are important for enterprises to assess and
ensure the defensive capabilities of their endpoints. The ability to provide agent-less and agent-based vulnerability assessment
allows for flexibility in deployment with minimal impact on endpoint configurations. Additionally, administrators are able to
remediate vulnerabilities found within endpoints from a central location without user participation simplifying security and
compliance initiatives.
FortiBridge
Our FortiBridge bypass appliances ensure availability of network resources in the event of power loss or failure of
Fortinet and third-party devices. This function enables organizations that have already deployed high availability security
infrastructure (where a system fails over to either an active or standby unit) to provide additional protection of network
connectivity. FortiBridge appliances preserve network availability in the event of a power failure or a device malfunction,
bypassing the device altogether with a fail-open solution.
FortiSwitch
Our FortiSwitch Ethernet switches provide Gigabit Ethernet (GbE) switching with 10-Gigabit Ethernet uplinks for large,
high-performance network, and power over Ethernet (POE) support for small offices and remote offices that have deployed
wireless-enabled devices. These features enable a wide range of network environments to take advantage of Fortinet's high-speed,
low latency switching technology.
FortiAP
Our FortiAP wireless access points provide secure WiFi client access. FortiAPs tunnel all wireless traffic to a FortiGate or
FortiWiFi via the integrated wireless controller technology in FortiOS. FortiGate or FortiWiFi platforms provide centralized
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management of multiple FortiAP access points. This product allows organizations to deploy a broad, integrated security solution
for all wireless and wired traffic.
Services
FortiGuard Security Subscription Services
Security requirements are dynamic due to the constantly changing nature of threats. Using automated processes, our
FortiGuard Labs team, comprised of over 100 professionals, identifies emerging threats, collects threat samples, and replicates,
reviews and characterizes attacks. Based on this research, we develop updates for virus signatures, attack definitions, scanning
engines, and other security solution components to distribute to end-customers through our FortiGuard global distribution network.
Our FortiGuard security subscription services are designed to allow us to quickly deliver new threat detection capabilities to end-
customers worldwide as new threats evolve. End-customers purchase FortiGuard security subscription services in advance,
typically for a one-year term, to obtain coverage and access to regular updates for antivirus, application control, intrusion
prevention, Web filtering, and antispam functions for our FortiGate appliances; antivirus, Web filtering and antispam functions for
our FortiClient software; antivirus and antispam functions for our FortiMail appliances; vulnerability management for our
FortiAnalyzer and FortiScan appliances, database functions for our FortiDB appliance, and web functions for our FortiWeb
appliances. We provide FortiGuard services 24 hours a day, seven days a week.
FortiCare Technical Support Services
Our FortiCare services are our technical support services for the software, firmware and hardware in our products. In
addition to our standard support service offering, we offer a premium service that offers faster response times and dedicated
support oriented towards major accounts.
For our standard technical support offering for our products, channel partners often provide first level support to the end-
customer, especially for small and mid-sized end-customers, and we typically provide second and third level support to our end-
customers. We also provide knowledge management tools and customer self-help portals to help augment our support capabilities
in an efficient and scalable manner. We provide technical support to partners and end-customers 24 hours a day, seven days a week
through regional technical support managers located worldwide.
Training Services
We offer training services to our end-customers and channel partners, through our training department and authorized
training partners. We have also implemented a training certification program to ensure an understanding of our products and
services. As of December 31, 2010, more than 20,000 individuals have participated in our training programs.
Professional Services
We offer professional services to end-customers primarily for large implementations where expert technical resources are
required. Our professional services consultants help in the design of deployments of our products and work closely with end-
customer engineers, managers and other project team members to implement our products according to design, utilizing network
analysis tools, attack simulation software and scripts.
Customers
We sell our security solutions through channel partners to end-customers of various sizes—from small businesses to large
enterprises and service providers—and across a variety of industries including telecommunications, government, financial services,
retail, education, technology, healthcare and manufacturing. An end-customer deployment may involve one of our appliances or
thousands, depending on our end-customers’ size and security requirements. As of December 31, 2010, we had shipped over
675,000 appliances to more than 5,000 channel partners and 100,000 end-customers worldwide, including a majority of the 2010
Fortune Global 100.
During fiscal 2009 and 2008, one channel partner, Alternative Technology, Inc., a subsidiary of Arrow Electronics, Inc.,
accounted for approximately 12% of total revenue. During fiscal 2010, no single customer accounted for more than 10% of total
revenue.
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Sales and Marketing
We primarily sell our products and services directly to distributors who sell to resellers and service providers, who, in
turn, sell to our end-customers. In certain cases, we sell directly to government focused resellers, very large service providers and
major systems integrator partners who have large purchasing power and unique customer deployment demands. As of
December 31, 2010, our distribution channel program had more than 5,000 channel partners worldwide. We work with many of the
world’s leading technology distributors, including Arrow Electronics, Inc., Ingram Micro Inc. and Tech Data Corporation.
We support our channel partners with a team of experienced channel account managers, sales professionals and sales
engineers who provide business planning, joint marketing strategy, and pre-sales and operational sales support. Additionally, our
sales team often helps drive and support large enterprise and service provider sales through a direct touch model. Our sales
professionals and engineers typically work alongside our channel partners and directly engage with end-customers to address their
unique security and deployment requirements. Our sales cycle for an initial end-customer purchase typically ranges from three to
six months but can be longer especially for large enterprises, service providers and government customers. To support our broadly
dispersed global channel and end-customer base, we have sales offices in over 30 countries around the world.
Our marketing strategy is focused on building our brand and driving end-customer demand for our security solutions. We
execute this strategy by leveraging a combination of internal marketing professionals and a network of regional and global channel
partners. Our internal marketing organization is responsible for branding, product marketing, channel marketing and sales support
programs. We focus our resources on programs, tools and activities that can be leveraged by partners worldwide to extend our
marketing reach, such as sales tools and collateral, product awards and technical certifications, training, regional seminars and
conferences, webinars and various other demand-generation activities.
Manufacturing and Suppliers
We outsource the manufacturing of our security appliance products to a variety of contract manufacturers and original
design manufacturers. Our current manufacturing partners include Flextronics International Ltd., Micro Star International, Ltd.,
Creation Technologies, Inc. and a number of additional Taiwan-based manufacturers. 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 headquarters in Sunnyvale, California, or to our logistics partner in
Taoyuan City, Taiwan, where accessory packaging and quality-control testing are performed. We use one third-party logistics
provider that accounted for a material portion of our shipments in fiscal 2009 and in fiscal 2010. We believe that outsourcing our
manufacturing and a substantial portion of our logistics enables us to conserve capital, better adjust manufacturing volumes to
meet changes in demand and more quickly deliver products, while allowing us to focus resources on our core competencies. Our
proprietary FortiASIC, which is the key to the performance of our appliances, is fabricated by contract manufacturers in foundries
operated by UMC and TSMC. Faraday (using UMC’s foundry) and K-Micro (using TSMC’s foundry) manufacture our ASICs on a
purchase order basis. Accordingly, they are not obligated to continue to fulfill our supply requirements, and the prices we are
charged for the fabrication of our ASICs could be increased on short notice.
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 central processing units from Intel, AMD, RMI and
VIA and network chips from Broadcom, Marvell and Intel, are available from a limited or sole source 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.
Research and Development
We focus our research and development efforts on developing new products and systems, and adding new features to
existing products and systems. Our development strategy is to identify features, products and systems for both software and
hardware that are, or are expected to be, needed by our end-customers. Our success in designing, developing, manufacturing and
selling new or enhanced products will depend on a variety of factors, including the identification of market demand for new
products, product selection, timely implementation of product design and development, product performance, effective
manufacturing and assembly processes and sales and marketing.
As of December 31, 2010, our research and development organization had headcount of 428 people predominantly in
Canada, China, and the United States. Our research and development expense in fiscal 2010 was $49.8 million, in fiscal 2009 was
$42.2 million and in fiscal 2008 was $37.0 million.
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Intellectual Property
We rely primarily on patent, trademark, copyright and trade secrets laws, confidentiality procedures and contractual
provisions to protect our technology. As of December 31, 2010, we had 55 issued U.S. patents, 11 issued Chinese patents, 1 issued
Japanese patent, 94 patent applications pending for examination in the United States and 19 patent applications pending for
examination in China. We also license software from third parties for integration into our products, including open source software
and other software available on commercially reasonable terms.
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 agreements with our employees,
consultants, vendors and customers, and generally limit access to and distribution of our proprietary information. However, we
cannot assure you that the steps taken by us 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 property rights. In particular, leading companies in the networking industry have extensive
patent portfolios. From time-to-time, third parties, including certain of these leading companies, have asserted and may assert
patent, copyright, trademark and other intellectual property rights against us, our channel partners or our end-customers. Successful
claims of infringement by a third 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 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, operating results or financial
condition to be materially and adversely affected. We typically indemnify our end-customers, distributors and certain resellers
against claims that our products infringe the intellectual property of third parties.
Competition
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:
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product performance, features, effectiveness, interoperability and reliability;
technological expertise;
price of products and services and total cost of ownership;
brand recognition;
customer service and support;
sales and distribution capabilities;
compliance with industry standards and certifications;
size and financial stability of operations; and
breadth of product line.
Our competitors include networking companies such as Cisco Systems, Inc., and Juniper Networks, Inc., security vendors
such as Check Point Software Technologies Ltd., McAfee Inc. (pending acquisition by Intel, Inc.), and SonicWALL, Inc. (acquired
by Thoma Bravo), and other point solution security vendors.
We believe we compete favorably based on our products’ performance, reliability and breadth, and our ability to add and
integrate new networking and security features and based on our technological expertise. Several competitors are significantly
larger, have greater financial, technical, marketing, distribution, customer support and other resources, are more established than
we are, and have significantly better brand recognition. Some of these larger competitors have substantially broader product
offerings and leverage their relationships based on other products or incorporate functionality into existing products in a manner
that discourages users from purchasing our products. Based in part on these competitive pressures, we may lower prices or attempt
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to add incremental features and functionality.
Conditions in our markets could change rapidly and significantly as a result of technological advancements or continuing
market consolidation. The development and market acceptance of alternative technologies could decrease the demand for our
products or render them obsolete. Our competitors may introduce products that are less costly, provide superior performance or
achieve greater market acceptance than our products. In addition, our larger competitors often have broader product lines and
market focus, are in a better position to withstand any significant reduction in capital spending by end-customers in these markets,
and will therefore not be as susceptible to downturns in a particular market. The above competitive pressures are likely to continue
to impact our business. We may not be able to compete successfully in the future, and competition may harm our business.
Employees
As of December 31, 2010, our total headcount was 1,336 people including payrolled contractors. We had 428 in research
and development, 486 in sales and marketing, 283 in services and support, 31 in manufacturing operations, and 108 in a general
and administrative capacity. As of December 31, 2010, our headcount was 314 people in the United States, 430 in Canada, 83 in
France, 216 in China and 293 in other countries.
None of our U.S. employees are represented by a labor union with respect to his or her employment with us; however, our
employees in France, Spain and Italy are represented by collective bargaining agreements. We have not experienced any work
stoppages, and we consider our relations with our employees to be good.
Available Information
Our web site is located at www.fortinet.com, and our investor relations web site is located at http://investor.fortinet.com.
The information posted on our website is not incorporated 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 Exchange Act of 1934, as amended, 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. You may also
access all of our public filings through the SEC’s website at www.sec.gov. Further, a copy of this Annual Report on Form 10-K is
located at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information on the operation of the
Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330.
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. Additionally, we provide notifications of news or announcements regarding our financial
performance, including SEC filings, investor events, press and earnings releases, as part of our investor relations web site. The
contents of these web sites 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. You should carefully consider the following risks and all
other information contained in this 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, and you may lose some or all of your
investment.
Risks Related to Our Business
Our quarterly 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 and may be difficult to predict, including:
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the level of demand for our products and services;
the timing of channel partner and end-customer orders;
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the timing of shipments, which may depend on many factors such as inventory levels and logistics, our ability
to ship new products on schedule and accurately forecast inventory requirements, and potential delays in the
manufacturing process;
the mix of products sold, the mix of revenue between products and services and the degree to which products
and services are bundled and sold together for a package price;
the budgeting cycles and purchasing practices of our channel partners and end-customers;
seasonal buying patterns of our end-customers;
the timing of revenue recognition for our sales, which may be affected by both the mix of sales by our “sell-
in” versus our “sell-through” channel partners, and by the extent to which we bring on new distributors;
the accuracy and timing of point of sale reporting by our sell-through distributors, which impacts our ability
to recognize revenue;
the level of perceived threats to network security, which may fluctuate from period to period;
changes in end-customer, distributor or reseller requirements or market needs;
changes in the growth rate of the network security or UTM markets;
the timing and success of new product and service introductions by us or our competitors or any other change
in the competitive landscape of our industry, including consolidation among our competitors or end-
customers;
deferral of orders from end-customers in anticipation of new products or product enhancements announced
by us or our competitors;
decisions by potential end-customers to purchase network security solutions from larger, more established
security vendors or from their primary network equipment vendors;
price competition;
changes in customer renewal rates for our services;
changes in the length of services contracts sold;
insolvency or credit difficulties confronting our customers, affecting their ability to purchase or pay for our
products and services;
any disruption in our channel or termination of our relationship with important channel partners;
insolvency or credit difficulties confronting our key suppliers, which could disrupt our supply chain;
general economic conditions, both domestically and in our foreign markets;
future accounting pronouncements or changes in our accounting policies; and
increases or decreases in our expenses caused by fluctuations in foreign currency exchange rates, as a
significant portion of our expenses are incurred and paid in currencies other than the U.S. dollar.
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, including fluctuations in our key metrics. 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 and based on forecasted revenue trends. Accordingly, in the event of
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revenue shortfalls, we are generally unable to mitigate the negative impact on margins in the short term.
Reliance on a concentration of shipments at the end of the quarter could cause our 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, historically we have received a substantial portion of a quarter's sales orders and generated a substantial
portion of a quarter's revenue during the last two weeks or last days of the quarter. If expected revenue at the end of any quarter
is delayed for any reason, including the failure of anticipated purchase orders to materialize, our or our logistics partners'
inability to ship products prior to quarter-end to fulfill purchase orders received near the end of the quarter, our failure to
manage inventory to meet demand, our inability to release new products on schedule, any failure of our systems related to order
review and processing, or any delays in shipments based on trade compliance requirements, our revenue for that quarter could
fall below our expectations or those of securities analysts and investors, resulting in a decline in our stock price.
We rely significantly on revenue from subscription and support services which may decline, and, because we recognize
revenue from subscriptions and support services over the term of the relevant service period, downturns or upturns in sales
are not immediately reflected in full in our operating results.
Services revenue accounts for a significant portion of our revenue, comprising 53.0% of total revenue for fiscal 2010,
55.2% of total revenue for fiscal 2009, and 49.7% of total revenue for fiscal 2008. Sales of new or renewal subscription and
services contracts may decline and fluctuate as a result of a number of factors, including 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 or reductions in our customers' spending levels. If our sales of new or renewal subscription and services contracts
decline, our revenue and revenue growth may decline and our business will suffer. In addition we recognize subscription and
service revenue monthly over the term of the relevant service period, which is typically one year but has been as long as five
years. As a result, much of the revenue we report each quarter is the recognition of deferred revenue from subscription and
services contracts entered into during previous quarters. Consequently, a decline in new or renewed subscription or service
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 new or renewed sales of our subscriptions or services is not
reflected in full in our results of operations until future periods. Our subscription and service 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 service
contracts must be recognized over the applicable service period. Furthermore increases in the average term of services contracts
would result in revenue for services contracts being recognized over longer periods of time.
Managing inventory of our products and product components is complex. Insufficient inventory may result in lost sales
opportunities or delayed revenue, while excess inventory may harm our gross margins.
Our channel partners may increase orders during periods of product shortages, cancel orders if their inventory is too
high, return product or take advantage of price protection (if any), or delay orders in anticipation of new products. They 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 certain
products or ship products increases for any reason, this could result in inventory shortfalls. Management of our inventory is
further complicated by the significant number of different products and models that we sell.
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. 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 and customer requirements. 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, which we experienced in the fourth quarter of fiscal 2009, may lead to shortages that result in
delayed revenue or loss of sales opportunities altogether as potential end-customers turn to competitors' products that are
readily available. If we are unable to effectively manage our inventory and that of our distribution partners, our results of
operations could be adversely affected.
We rely on third-party channel partners to generate 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 will be harmed.
Substantially all of our revenue is generated through sales by our channel partners, which include distributors and
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resellers. We depend upon our channel partners to generate sales opportunities and manage the sales process. To the extent our
channel partners are unsuccessful in selling our products, or 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, and keep them motivated to
sell our products, our ability to sell our products and operating results will be harmed. The termination of our relationship with
any significant channel partner may also adversely impact our sales and operating results.
We provide sales channel partners with specific programs to assist them in selling 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. Our channel partners generally do not have minimum purchase requirements. They 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. They may have incentives to promote our competitors' products to the detriment
of our own. They may cease selling our products altogether. We cannot assure you that we will retain these channel partners or
that we will be able to secure additional or replacement partners. 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,
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 or our channel partners violate
laws or our corporate policies. If we fail to manage existing sales channels, our business will be seriously harmed.
If we are not successful in continuing to execute our strategy to increase our sales to larger end-customers, our results of
operations may suffer.
An important part of our growth strategy is to increase sales of our products to large enterprises, service providers and
government entities. Sales to enterprises, service providers and government entities involve risks that may not be present (or
that are present to a lesser extent) with sales to small-to-mid-sized entities. These risks include:
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increased competition from larger competitors, such as Cisco Systems, Inc., Check Point Software
Technologies Ltd., McAfee, Inc. (pending acquisition by Intel, Inc.), and Juniper Networks, Inc., that
traditionally target enterprises, service providers and government entities 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 with us;
more stringent requirements in our support service contracts, including stricter support response times, and
increased penalties for any failure to meet support requirements; and
longer sales cycles and the associated risk that substantial time and resources may be spent on a potential
end-customer who elects not to purchase our products and services.
Large enterprises, service providers and government entities often undertake a significant evaluation process that
results in a lengthy sales cycle, in some cases over 12 months. Although we have a channel sales model, our sales
representatives typically engage in direct interaction with our distributors and resellers in connection with sales to larger end-
customers. Due to the lengthy nature, the size and scope, and stringent requirements of these evaluations, we typically provide
evaluation products to these customers. We may spend substantial time, effort and money in our sales efforts without being
successful in producing any sales. If we are unsuccessful in converting these evaluations into sales, we may experience an
increased inventory of used products and potentially increased write-offs. In addition, product purchases by enterprises, service
providers and government entities are frequently subject to budget constraints, multiple approvals, and unplanned
administrative, processing and other delays. Finally, enterprise, service providers and government entities typically have longer
implementation cycles; require greater product functionality and scalability and a broader range of services, including design
services; demand that vendors take on a larger share of risks; sometimes require acceptance provisions that can lead to a delay
in revenue recognition; and expect greater payment flexibility from vendors. All these factors can add further risk to business
conducted with these customers. If sales expected from a large 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.
The average sales prices of our products may decrease, which may reduce our gross profits and adversely impact our
financial results and the trading price of our common stock.
The average sales prices for our products may decline for a variety of reasons, including competitive pricing pressures,
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discounts we offer, a change in our mix of products, anticipation of the introduction of new products or promotional programs.
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 that compete with ours in order to promote the sale of other products or may bundle them with
other products. Additionally, although we price our products and services worldwide in U.S. dollars, currency fluctuations in
certain countries and regions may negatively impact actual prices that partners and customers are willing to pay in those
countries and regions. Furthermore, we anticipate that the average sales prices and gross profits for our products will decrease
over product life cycles. We cannot assure you that we will be successful in developing and introducing new offerings with
enhanced functionality on a timely basis, or that our product offerings, if introduced, will enable us to maintain our prices and
gross profits at levels that will allow us to maintain profitability.
Defects or vulnerabilities in our products or services, the failure of our products or services to prevent a virus or security
breach, or misuse of our products could harm our reputation 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 or cause our products or services to be vulnerable to electronic break-ins or cause them to fail to help secure
networks. 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 subscription updates or our FortiGate appliances could result in a failure of our FortiGuard services to
effectively update end-customers' FortiGate appliances 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 fail to meet the increased requirements of a growing
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 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 services to prevent the security breach, could adversely affect the
market's perception of our security products. 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
improper shipment of our products or if our products are provided by an unauthorized third-party. Any defects, errors or
vulnerabilities in our products, or misuse of our products, could result in:
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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;
loss of existing or potential end-customers or channel partners;
delayed or lost revenue;
delay or failure to attain market acceptance;
negative publicity, which will harm our reputation; and
litigation, regulatory inquiries or investigations that may be costly and harm our reputation.
Our business and operations have experienced rapid growth, and if we do not appropriately manage any future growth, or
are unable to improve our systems and processes, our operating results will be negatively affected.
We have a high volume business that has grown over the last several years. We rely heavily on information technology
systems to help manage critical functions such as order processing, revenue recognition, financial forecasts, inventory and
supply chain management and trade compliance reviews. However, we have been slow to adopt and implement certain
automated functions, like Electronic Data Interchange, which could have a negative impact on our business. For example, a
large part of our order processing relies on the manual processing of emails internally and from our customers. Combined with
the fact that we may receive a majority of our orders in the last few weeks of any given quarter, a significant interruption in our
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email service or other systems could result in delayed order fulfillment and decreased revenue for that quarter. To manage any
future growth effectively, we must continue to improve and expand our information technology and financial infrastructure,
operating and administrative systems and controls, and continue to manage headcount, capital and processes in an efficient
manner. We may not be able to successfully implement improvements to these systems and processes in a timely or efficient
manner. In addition, our systems and processes may not prevent or detect all errors, omissions or fraud. Our failure to improve
our systems and processes, or their failure to operate in the intended manner, 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. Our productivity and
the quality of our products and services may 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 manage any future growth effectively could result in increased costs and harm our results of operations.
We have a history of losses and may not maintain profitability, and our revenue growth may not continue.
We have incurred net losses in most fiscal years since our inception, including net losses of $21.8 million in fiscal
2007, $5.3 million in fiscal 2006, $14.2 million in fiscal 2005 and $59.0 million in fiscal 2004. As a result, we had an
accumulated deficit of $18.7 million at December 31, 2010. Although we were profitable in fiscal 2008, 2009 and 2010, we
may not be able to sustain profitability in future periods if we fail to increase revenue or deferred revenue, manage our cost
structure, or are subject to unanticipated liabilities. Revenue growth may slow or revenue may decline for a number of possible
reasons, including slowing demand for our products or services, increasing competition, a decrease in the growth of our overall
market, or if we fail for any reason to continue to capitalize on growth opportunities. Any failure by us to maintain profitability
and continue our revenue growth could cause the price of our common stock to materially decline.
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” in this 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, stock-based
compensation, valuation of inventory, warranty liabilities, and accounting for income taxes.
We offer retroactive price protection to 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 adversely affect our
results of operations.
We provide certain of our major distributors with price protection rights for inventories of 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 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, or delays in hiring required
personnel, particularly in engineering and sales, may seriously harm our business, financial condition and results of operations.
We have experienced 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 in the locations where we have a substantial presence and need for highly-skilled personnel: the San
Francisco Bay Area, Vancouver, Canada and Beijing, China. A large portion of our employee base is substantially vested in
significant stock option grants, and the ability to exercise those options and sell their stock may result in a larger than normal
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turnover rate. 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.
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
senior management, particularly Ken Xie, our Co-founder, President and Chief Executive Officer, Michael Xie, our Co-
founder, Vice President of Engineering and Chief Technical Officer, and Ken Goldman, our Vice President and Chief Financial
Officer, could significantly delay or prevent the achievement of our development and strategic objectives. In addition, key
personnel may be distracted by activities unrelated to our business. The loss of the services, or distraction, of our senior
management for any reason could adversely affect our business, financial condition and results of operations.
Adverse economic conditions or reduced information technology spending may adversely impact our business.
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 economic conditions, weak economic conditions in certain
geographies, or a reduction in information technology spending regardless of macro-economic conditions, could adversely
impact our business, financial condition and results of operations in a number of ways, including longer sales cycles, lower
prices for our products and services, higher default rates among our distributors, reduced unit sales and lower or no growth.
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.
We outsource the manufacturing of our security appliance products to a variety of contract manufacturing partners and
original design manufacturing partners.
Our reliance on our third-party manufacturers reduces our control over the manufacturing process, exposing us to
risks, including reduced control over quality assurance, product costs and product supply and timing. Any manufacturing
disruption by our third-party manufacturers 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.
These manufacturers fulfill our supply requirements on the basis of individual purchase orders. We have no long-term
contracts or arrangements with certain of 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 interruptions for any reason, such as a natural disaster, epidemic, capacity shortages, or
quality problems, at one of our manufacturing partners would severely affect sales of our product lines manufactured by that
manufacturing partner.
Our proprietary FortiASIC, which is the key to the performance of our appliances, is fabricated by contract
manufacturers in foundries operated by UMC and Taiwan Semiconductor Manufacturing Corporation, or TSMC. Faraday
(using UMC's foundry) and K-Micro (using TSMC's foundry) manufacture our ASICs on a purchase order basis, and these
foundries do not guarantee any capacity and could reject orders from either Faraday or K-Micro or try to increase 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 temporary or long term inventory shortages of our FortiASIC as well as increased
costs. Our suppliers may also prioritize orders by other companies that order higher volumes of products. If any of these
suppliers 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 or specific product models, our business would be harmed.
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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
EU RoHS and other similar laws. See “If we fail to comply with environmental requirements, our business, financial condition,
operating results and reputation could be adversely affected” for information on the effects of the failure to comply with these
laws.
Because some of the key components in our products come from limited sources of supply, we are susceptible to supply
shortages or supply changes, which could disrupt or delay our scheduled product deliveries to our customers and may result
in the loss of sales and customers.
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 in the supply of these components
and the risk that component suppliers discontinue or modify components used in our products. We have faced component
shortages in the past. Certain of our limited source components for particular appliances and suppliers of those components
include: specific types of central processing units from Intel Corporation, Advanced Micro Devices, Inc., RMI Corporation and
VIA Technologies, Inc. and network chips from Broadcom Corporation, Marvell Technology Group Ltd. and Intel. 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 increasing lead times for the purchase of components incorporated into
our products. Our reliance on a limited number of suppliers involves several additional risks, including:
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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;
price increases;
failure of a component to meet environmental or other regulatory requirements;
failure to meet delivery obligations in a timely fashion; and
failure in component quality.
The occurrence of any of these 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.
We are exposed to fluctuations in currency exchange rates, which could negatively affect our financial condition and results
of operations.
Our sales contracts are primarily denominated in U.S. dollars and therefore substantially all of our revenue is not
subject to foreign currency risk. However, a strengthening of the U.S. dollar could increase the real cost of our products to our
customers outside of the United States, which could adversely affect our financial condition and results of operations. In
addition, a majority of our operating expenses are 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 and
Canadian dollar. Although we have been hedging currency exposures relating to certain balance sheet accounts
and have recently entered into cashflow hedges relating to certain operating expenses incurred outside of the United States, 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.
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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.
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:
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economic or political instability in foreign markets;
greater difficulty in enforcing contracts, accounts receivable collection and longer collection periods;
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;
costs of complying with U.S. laws and regulations for foreign operations, including the Foreign Corrupt
Practices Act, import and export control laws, tariffs, 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 arrangements that may impact financial results and result in restatements of financial statements and
irregularities in financial statements;
the potential for political unrest, terrorism, hostilities or war;
management communication and integration problems resulting from cultural differences and geographic
dispersion; and
multiple and possibly overlapping tax structures.
Product and service sales 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 from time to
time. Failure to comply with these regulations could result in adverse affects 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 delays in revenue recognition, financial reporting misstatements, fines, penalties, or the prohibition of the
importation or exportation of our products and services and could have a material adverse effect on our business and results of
operations.
We are subject to governmental export and import controls that could subject us to liability or impair our ability to compete
in international markets.
Certain of our products are subject to U.S. export controls and may be exported outside the U.S. only with the required
export license or through an export license exception, because we incorporate encryption technology into our products. If we
were to fail to comply with U.S. export licensing, U.S. Customs regulations, U.S. economic sanctions and other 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, we may also be adversely affected, through reputational harm and
penalties. Obtaining the necessary export license for a particular sale may be time-consuming, and may result in the delay or
loss of sales opportunities.
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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 in
reputational harm. In addition, various countries regulate the import of certain encryption technology, including import
permitting/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.
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 and laws relating to the recycling of electrical and electronic equipment. The laws and regulations to which we
are subject include the European Union, or EU, RoHS and the EU Waste Electrical and Electronic Equipment (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 and the similar laws of other jurisdictions ban the use of certain hazardous materials such as lead,
mercury and cadmium in the manufacture of 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 noncompliant inventory. We expect to incur more of these costs in the future. With respect
to the EU RoHS, we and our competitors rely on an exemption for lead in network infrastructure equipment. It is possible this
exemption will be revoked in the near future. If revoked, 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 reengineer our products to use components
compatible with these regulations. This reengineering and component substitution could result in additional costs to us or
disrupt our operations or logistics.
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 entities, 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 entities. Sales into government entities are
subject to a number of risks. Selling to government entities can be highly competitive, expensive and time consuming, often
requiring significant upfront time and expense without any assurance that we will win a sale. Government demand and payment
for our products and services may be impacted by public sector budgetary cycles and funding authorizations, with funding
reductions or delays adversely affecting public sector demand for our products. Most of our sales to government entities have
been made indirectly through our distribution channel. Government entities 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 governmental entity, the financial health of the distributor could be substantially harmed, which could
negatively affect our future sales to such distributor. Governments routinely investigate and audit government contractors'
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administrative processes, and any unfavorable audit could result in the government refusing to continue buying our products
and services, a reduction of revenue or fines or civil or criminal liability if the audit uncovers improper or illegal activities. Any
such penalties could adversely impact our results of operations in a material way. Finally, for purchases by the U.S.
government, the government may require certain products to be manufactured in the United States and other high cost
manufacturing locations, and we may not manufacture all products in locations that meet the requirements of the U.S.
government.
False detection of viruses or security breaches or false identification of spam or spyware could adversely affect our business.
Our antivirus and our intrusion prevention services may falsely detect 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 antispam and antispyware
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
antispam 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. Any such false identification of important
files or applications could result in negative publicity, loss of end-customers and sales, increased costs to remedy any problem,
and costly litigation.
If our internal network system is compromised by computer hackers, public perception of our products and services will be
harmed.
We will not succeed unless the marketplace is confident that we provide effective network security protection.
Because we provide network security products, we may be a more attractive target for attacks by computer hackers. Although
we have not experienced significant damages from unauthorized access by a third-party of our internal network, if an actual or
perceived breach of network security occurs in our internal systems it could adversely affect the market perception of our
products and services. In addition, such a security breach could impair our ability to operate our business, including our ability
to provide subscription and support services to our end-customers. If this happens, our revenue could decline and our business
could suffer.
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, to resolve any issues relating to our products. If we or our
channel partners do not effectively assist our customers in deploying 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
enterprise, service provider and government entity end-customers require higher levels of support than smaller end-customers.
If we fail to meet the requirements of the larger end-customers, it may be more difficult to execute on our strategy to increase
our penetration with larger end-customers.
As a result, our failure to maintain high quality support services would have a material adverse effect on our business,
financial condition and results of operations.
Changes in our provision for income taxes or adverse outcomes resulting from examination of our income tax returns could
adversely affect our results.
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, including:
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earnings being lower than anticipated in countries that have lower tax rates and higher than anticipated in
countries that have higher tax rates;
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changes in the valuation of our deferred tax assets and liabilities;
expiration of, or lapses in the research and development tax credit laws;
transfer pricing adjustments including the effect of acquisitions on our intercompany research and
development and legal structure;
an increase in non-deductible expenses for tax purposes, including certain stock-based compensation
expense, write-offs of acquired in-process research and development, and impairment of goodwill;
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 income tax provision for the period in which the settlement take place;
a change in our decision to indefinitely reinvest foreign earnings;
changes in accounting principles; or
changes in tax laws and regulations including possible changes in the United States to the taxation of
earnings of our foreign subsidiaries, and the deductibility of expenses attributable to foreign income, or the
foreign tax credit rules, or changes to the United States income tax rate, which would necessitate a
revaluation of our deferred tax assets and liabilities.
Significant judgment is required to determine the recognition and measurement attribute prescribed in ASC 740-10
(formerly referred to as Statement of Financial Accounting Standards (SFAS) Interpretation No. 48, Accounting for Uncertainty
in Income Taxes-an interpretation of SFAS No. 109 (FIN 48)). In addition, ASC 740-10 applies to all income tax positions,
including the potential recovery of previously paid taxes, which if settled unfavorably could adversely impact our provision for
income taxes or additional paid-in capital. Further, as a result of certain of our ongoing employment and capital investment
actions and commitments, our income in certain countries is subject to reduced tax rates and in some cases is wholly exempt
from tax. Our failure to meet these commitments could adversely impact our provision for income taxes. In addition, we are
subject to the continuous examination of our income tax returns by the Internal Revenue Service and other tax authorities. We
regularly assess the likelihood of adverse outcomes resulting from these examinations to determine the adequacy of our
provision for income taxes. There can be no assurance that the outcomes from these continuous examinations will not have an
adverse effect on our results of operations.
Although we released our entire valuation allowance in fiscal 2009, we may in the future be required to establish a
new valuation allowance. We will continue to assess the need for a valuation allowance on the deferred tax asset by evaluating
both positive and negative evidence that may exist.
We are currently under audit by the Canada Revenue Agency for fiscal years 2006-2009 associated with our
international transactions. The California Franchise Tax Board has notified us of their intent to examine our fiscal 2008 and
2009 California tax returns. The scope of the California Franchise Tax Board examinations is unclear at this time.
If the ultimate determination of income taxes assessed under the current Canadian or California audits or under audits
being conducted, or to be conducted, in any of the other tax jurisdictions in which we operate results in an amount in excess of
the tax provision we have recorded or reserved for, our operating results, cash flows and financial condition could be adversely
affected.
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 and subject to uncertainty 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
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losses, our ability to use tax credits, or effective tax rates by jurisdiction is different than those estimated, 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.
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, taxing
authorities may impose tax assessments or judgments against us that could materially impact our tax liability and/or our
effective income tax rate.
In addition, we may be subject to examination of our income tax returns by the Internal Revenue Service and other tax
authorities. If tax authorities challenge the relative mix of U.S. and international income, our future effective income tax rates
could be adversely affected. While we regularly assess the likelihood of adverse outcomes from such examinations and the
adequacy of our provision for income taxes, there can be no assurance that such provision is sufficient and that a determination
by a tax authority will not have an adverse effect on our business, financial condition and results of operations.
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, or technologies and
intellectual property, such as patents. If we identify an appropriate acquisition candidate, we may not be successful in
negotiating the terms of the acquisition, financing the acquisition, or effectively integrating the acquired business, product,
technology or intellectual property into our existing business and operations. We may have difficulty incorporating acquired
technologies, intellectual property or products with our existing product lines and maintaining uniform standards, controls,
procedures and policies. 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. In addition, any acquisitions we are able to complete may not be accretive to earnings and may not result in
any synergies or other benefits we had expected to achieve, which could result in write-offs that could be substantial. Further,
completing a potential acquisition and integrating acquired businesses, products, technologies or intellectual property will
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, have contained and may contain undetected
defects or errors, especially when first introduced or when new versions are released. For example, one of our high-end product
models has been experiencing a defect in limited deployments. Product errors have affected the performance of our products
and could delay the development or release of new products or new versions of products, adversely affect our reputation and
our end-customers' willingness to buy products from us, and adversely affect market acceptance or 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 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 our products, and have an adverse effect on our business
and financial performance, and any necessary revisions may cause us to incur significant expenses. The occurrence of any such
problems could harm our business, financial condition and results of operations.
Although we have limitation of liability provisions in our standard terms and conditions of sale, they may not fully or
effectively protect us from claims as a result of federal, state or local laws or ordinances or unfavorable judicial decisions in the
United States or other countries. 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. In addition, even claims that ultimately are unsuccessful could result in our
expenditure of funds in litigation and divert management's time and other resources.
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Our business is subject to the risks of earthquakes, fire, power outages, floods and other catastrophic events, and to
interruption by manmade problems such as terrorism.
A significant natural disaster, such as an earthquake, fire, a flood, or significant power outage 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. In addition, natural disasters could affect our manufacturing vendors
or logistics providers' ability to perform services such as manufacturing products on a timely basis and assisting with shipments
on a timely basis. For example, our primary international logistics provider is located in Taiwan which is an area known for
typhoons. 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 missing financial targets, such as
revenue and shipment targets, for a particular quarter. In addition, 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 the economy
as a whole. Given our typical concentration of sales at each quarter end, 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. All of the aforementioned risks may be augmented if the disaster recovery plans for us and our
suppliers prove to be inadequate. To the extent that any of the above results in delays or cancellations of customer orders, or the
delay in the manufacture, deployment or shipment of our products, our business, financial condition and results of operations
would be adversely affected.
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 will 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 enterprise 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. 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. For example, in the first quarter of fiscal 2009, we released a new model within our FortiGate
product line and, after its initial release, we detected errors in the product that required us to redesign certain aspects of the
product which delayed the availability of the product for one quarter and delayed our recognition of revenue from large orders
that included such product until the following quarter when the product became available. 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 will be harmed.
Our 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 will impair the market acceptance of our products, which in turn will harm our business,
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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 users' 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 will impair the growth of our business.
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 research and develop new products and enhanced versions of our
existing products 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:
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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 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;
defects, 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;
easing of 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.
Unless we continue to develop better market awareness of our company and our products, our revenue may not continue to
grow.
We are a relatively new entrant in the network security market and we believe that we have not yet established
sufficient market awareness of our participation in that market. Market awareness of our capabilities and products is essential to
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our continued growth and our success in all of our markets, particularly for the large enterprise, service provider and
government entities markets. If our marketing programs are not successful in creating market awareness of our company and
products, our business, financial condition and results of operations will be adversely affected, and we will not be able to
achieve sustained growth.
Demand for Unified Threat Management products may be limited by market perception that UTM products are inferior to
network security solutions from multiple vendors.
Sales of most of our products depend on increased demand for UTM products. If the UTM market fails to grow as we
anticipate, our business will be seriously harmed. Target customers may view UTM “all-in-one” solutions as inferior to security
solutions from multiple vendors because of, among other things, their perception that UTM products 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, UTM solutions create a “single point of failure” in their networks, which means that an error, vulnerability or
failure of the UTM product may place the entire network at risk. In addition, the market perception that UTM solutions may be
suitable only for small and medium sized businesses because UTM lacks the performance capabilities and functionality of other
solutions may harm our sales to large enterprise, service provider, and government entity 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 the UTM market in general, demand for UTM 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 or another well known UTM vendor exposing a “single point of failure” could significantly increase these concerns
and perceptions and may harm our business and results of operations.
We face intense competition in our market, especially from larger, better-known companies, and we may lack sufficient
financial or other resources to maintain or improve our competitive position.
The market for network security products is intensely competitive and we expect competition to intensify in the future.
Our competitors include networking companies such as Cisco Systems, Inc. and Juniper Networks, Inc., security vendors such
as Check Point Software Technologies Ltd., McAfee, Inc. (pending acquisition by Intel, Inc.), and SonicWALL, Inc. (acquired
by Thoma Bravo), and other point solution security vendors.
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, technical and other resources.
In addition, some of our larger competitors have substantially broader product offerings and leverage their
relationships based on other products or incorporate functionality into existing products in a manner that discourages users
from purchasing our products. These larger competitors often have broader product lines and market focus, are in a better
position to withstand any significant reduction in capital spending by end-customers in these markets, and will therefore 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 network security threat are often able to deliver these specialized network security products to the market
more quickly than we can. Some of our smaller competitors are using third-party chips designed to accelerate performance.
Conditions in our markets could change rapidly and significantly as a result of technological advancements or continuing
market consolidation. Our current and potential competitors may also establish cooperative relationships among themselves or
with third parties that may further enhance their resources. In addition, current or potential competitors may be acquired by
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third parties with greater available resources, such as Juniper's acquisition of NetScreen Technologies, Inc., Intel's pending
acquisition of McAfee and Check Point's acquisition of Nokia's security appliance business. As a result of such acquisitions,
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. 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.
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 Systems, Inc. and Juniper Networks, Inc.
offer, and may continue to introduce, network security features that compete with our products, either in stand-alone 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.
Risks Related to Intellectual Property
Our proprietary rights may be difficult to enforce, which could enable others to copy or use aspects of our products without
compensating us.
We rely primarily on patent, trademark, copyright and trade secrets laws, confidentiality procedures and contractual
provisions to protect our technology. We purchased most of our issued U.S. patents and many of our pending U.S. patent
applications from other entities. 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 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.
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 assure you 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 property 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
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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 source software components, and failure to comply with the terms of the underlying
open 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
the GNU Public License (GPL), the GNU Lesser Public License (LGPL), the BSD License, the Apache License and others.
From time-to-time, there have been claims against companies that distribute or use open source software in their products and
services, asserting that open source software infringes the claimants' intellectual property rights. We could be subject to suits by
parties claiming infringement of intellectual property rights in what we believe to be licensed open source software. Use and
distribution of open source software may entail greater risks than use of third-party commercial software, as open source
licensors generally do not provide warranties or other contractual protections regarding infringement claims or the quality of
the code. Some open source licenses contain requirements that we make available source code for modifications or derivative
works we create based upon the type of open source software we use. If we combine our proprietary software with open source
software in a certain manner, we could, under certain open 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 United States courts, and there is a risk that these licenses
could be construed in a way that 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
generally available, in source code form, our proprietary code, 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 could adversely affect our business,
operating results and financial condition.
Claims by others that we infringe their proprietary technology could harm our business.
Patent and other intellectual property disputes are common in the network security industry. Third parties have
asserted and may in the future assert claims of infringement of intellectual property rights against us. They may also assert such
claims against our end-customers or channel partners whom we typically indemnify against claims that our products infringe
the intellectual property 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, future
litigation may involve patent holding companies 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.
We have been involved in patent disputes in the past, are currently involved in several patent disputes, and likely will
be involved in additional disputes in the future. In May 2004, Trend Micro Incorporated filed a complaint against us alleging
that we infringed a Trend Micro patent related to antivirus software. The International Trade Commission, or ITC, subsequently
instituted an investigation which resulted in an exclusion order and a cease and desist order prohibiting us from selling a broad
array of our products in the United States. In January 2006, we settled the lawsuit with Trend Micro, and subsequently the ITC
terminated its action and rescinded the orders. Pursuant to the settlement and license agreement, we initially paid Trend Micro
$15.0 million. The settlement and license agreement provides for additional quarterly royalty payments, not expected to exceed
1% of our total revenue each quarter, through 2015. In November 2008, we filed a complaint against Trend Micro in the United
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States District Court for the Northern District of California alleging, among other claims, that the patents that are the basis for
the ongoing royalty payments are invalid and consequently that we have no contractual obligation to pay the royalties. Trend
Micro moved to dismiss the case, and, in June 2009, the court dismissed the case without prejudice on procedural grounds, and
we appealed the dismissal in July 2009. Based on the dispute, we ceased paying royalties under the settlement and license
agreement. In August 2009, Trend Micro filed a complaint against us in the Superior Court of the State of California for Santa
Clara County alleging breach of contract and seeking a declaratory judgment that we are obligated to make certain royalty
payments to Trend Micro. In December 2009, we withdrew our appeal of the June 2009 dismissal by the United States District
Court for the Northern District of California and filed a new complaint against Trend Micro in the United States District Court
for the Northern District of California alleging, among other claims, that the patents that are the basis for the ongoing royalty
payments are invalid and consequently that we have no contractual obligation to pay the royalties. In February 2010, Trend
Micro filed demurrers in the state Superior Court action regarding Fortinet's affirmative defenses that Fortinet has no obligation
to pay royalties because the Trend Micro patents are invalid or unenforceable. In March 2010, Trend Micro filed a motion to
dismiss our new complaint that we filed in the United States District Court for the Northern District of California. In May 2010,
the state Superior Court denied Trend Micro's demurrer in its entirety. Also in May 2010, the United States District Court for
the Northern District of California denied Trend Micro's motion to dismiss without prejudice and stayed the action before that
court pending the conclusion of the state Superior Court action. In January 2011, in response to petitions for re-examination we
filed with the U.S. Patent and Trademark Office ("PTO"), the PTO issued an initial office action that Trend Micro's patents at
issue were invalid. In January 2011, we filed a motion to stay the Superior Court case pending final resolution at the PTO. Our
motion to stay is currently pending. At this stage it is not possible to predict the outcome. An adverse outcome in this dispute
could result in accelerated royalty payments and additional damages.
As discussed in "Item 3-Legal Proceedings," from time to time we are subject to lawsuits claiming patent infringement
and there are lawsuits claiming patent infringement currently pending. 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. In addition to the lawsuits
described in "Legal Proceedings," several other non-practicing patent holding companies have sent us letters proposing that we
license certain of their patents, and, given this and the proliferation of lawsuits in our industry and other similar industries by
both non-practicing entities and operating entities, 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 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 property 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.
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 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 have a material adverse effect on our business, operating results,
and financial condition. Moreover, the inclusion in our products of software or other intellectual property licensed from third
parties on a nonexclusive basis could limit our ability to differentiate our products from those of our competitors.
Risks Related to Ownership of our 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, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, as well
as 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 and 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. The Sarbanes-Oxley Act requires, among other things, that we assess the
effectiveness of our internal control over financial reporting annually and disclosure controls and procedures quarterly. We
completed our evaluation of our internal controls over financial reporting for fiscal 2010 as required by Section 404 of the
Sarbanes-Oxley Act of 2002. Although our assessment, testing and evaluation resulted in our conclusion that as of December
31, 2010, our internal controls over financial reporting were effective, we cannot predict the outcome of our testing in future
periods. If our internal controls or disclosure controls are ineffective in future periods, our business and reputation could be
harmed. We may incur additional expenses and commitment of management's time in connection with further evaluations, both
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of which could materially increase our operating expenses and accordingly reduce our operating results.
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 accounting pronouncements,
such as changes to standards related to revenue recognition recently adopted by the FASB, the increased use of fair value
measure, the recent proposed change to revenue recognition, lease accounting, financial instrument accounting standards, and
the potential requirement that U.S. registrants prepare financial statements in accordance with International Financial Reporting
Standards (“IFRS”), could have a significant effect on our reported financial results or the way we conduct our business.
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 covers us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price would
likely 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 is likely to be volatile.
The market price of our common stock is subject to wide fluctuations in response to, among other things, the risk
factors described in this periodic report, and other factors such as rumors or fluctuations in the valuation of companies
perceived by investors to be comparable to us.
Furthermore, the 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.
Our failure to raise additional capital or generate the significant capital necessary to expand our operations and invest in
new products could reduce our ability to compete and could harm our business.
We expect that our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for at least
the next twelve months. After that, we may need to raise additional funds, and we may not be able to obtain additional debt or
equity financing on favorable terms, if at all. If we raise additional equity financing, our stockholders may experience
significant dilution of their ownership interests and the per-share value of our common stock could decline. Furthermore, if we
engage in debt financing, the holders of debt would have priority over the holders of common stock and we may be required to
accept terms that restrict our ability to incur additional indebtedness. We may also be required to take other actions that would
otherwise be in the interests of the stockholders and force us to maintain specified liquidity or other ratios, any of which could
harm our business, operating results and financial condition. If we need additional capital and cannot raise it on acceptable
terms, we may not be able to, among other things:
•
•
•
•
•
develop or enhance our products and services;
continue to expand our sales and marketing and research and development organizations;
acquire complementary technologies, products or businesses;
expand operations, in the United States or internationally;
hire, train and retain employees; or
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•
respond to competitive pressures or unanticipated working capital requirements.
Our failure to do any of these things could seriously harm our business, financial condition and results of operations.
Concentration of ownership among our existing executive officers, directors and their affiliates may prevent new investors
from influencing significant corporate decisions.
As of February 17, 2011, our executive officers, directors and their affiliates beneficially owned, in the aggregate,
approximately 21.1% of our outstanding common stock. As a result, these stockholders are able to exercise a significant level
of control over all matters requiring stockholder approval, including the election of directors, amendment of our certificate of
incorporation and approval of significant corporate transactions. This control could have the effect of delaying or preventing a
change of control of our company or changes in management and will make the approval of certain transactions difficult or
impossible without the support of these stockholders.
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:
•
•
•
•
•
•
•
creating a classified board of directors whose members serve staggered three-year terms;
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;
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.
As a Delaware corporation, we are also subject to provisions of Delaware law, including Section 203 of the Delaware
General Corporation law, which prevents some 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 or 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.
ITEM 1B.
Unresolved Staff Comments
Not applicable.
ITEM 2.
Properties
Our corporate headquarters are located at 1090 Kifer Road, Sunnyvale, California in an office consisting of
approximately 107,000 square feet. The lease for this office expires in September 2013. We sublease approximately 23,000
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square feet of this space pursuant to a sublease that expires in December 2011.
In addition to our headquarters, we lease approximately 14,000 square feet of data center space and a total of
approximately 69,000 square feet of office space in several buildings in Burnaby, Canada under various leases that expire
between January 2012 and July 2015, approximately 16,000 square feet of office space in Ottawa, Canada under a lease that
expires in February 2014, approximately 19,000 square feet of office space in Sophia, France under a lease that expires
in December 2013, and approximately 26,000 square feet of office space in Beijing, China under a lease that expires in
August 2011. We also lease sales and support offices in Australia, Austria, Belgium, Egypt, Germany, Hong Kong, India,
Indonesia, Israel, Italy, Japan, Korea, Malaysia, Mexico, the Netherlands, New Zealand, Philippines, Poland, Russia, Saudi
Arabia, Singapore, Spain, Sweden, Switzerland, Taiwan, Thailand, United Arab Emirates, and the United Kingdom. We believe
that our existing properties are in good condition and are sufficient and suitable for the conduct of our business.
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ITEM 3.
Legal Proceedings
In August 2009, Trend Micro Incorporated (“Trend Micro”) filed a complaint against us in the Superior Court of the
State of California for Santa Clara County alleging breach of contract and seeking a declaratory judgment that we are obligated
to make certain royalty payments to Trend Micro pursuant to a settlement and license agreement entered into in January 2006.
We maintain that the patents that are the basis for the royalty payments are invalid and consequently that we have no
contractual obligation to pay the royalties. We filed an action in the Northern District of California that is stayed pending the
resolution of the state court action. We have continued to accrue expense based on the quarterly royalties provided for in the
settlement and license agreement. In January 2011, in response to petitions for re-examination we filed with the U.S. Patent and
Trademark Office (“PTO”), the PTO issued an initial office action that the Trend Micro patents allegedly forming the basis for
the royalty payments are invalid. In January 2011, we filed a motion to stay the state court case pending final resolution at the
PTO. Our motion to stay is currently pending.
In January 2009, we filed a complaint against Palo Alto Networks, Inc. (“PAN”) in the United States District Court for
the Northern District of California alleging, among other claims, patent infringement. In November 2010, we filed a second
complaint against PAN in the United States District Court for the Northern District of California alleging infringement of three
additional patents. On January 20, 2011, we entered into a settlement and patent license agreement with PAN pursuant to which
we agreed to license certain asserted patents and certain related patents in return for an up-front payment by PAN and ongoing
quarterly payments over three years. The parties also agreed upon a three year covenant not to sue for patent related claims.
In August 2009, Enhanced Security Research, LLC and Security Research Holdings LLC (collectively “ESR”), a non-
practicing entity, filed a complaint against us in the United States District Court for the District of Delaware alleging
infringement by us and other defendants of two patents. In June 2010, the Court granted our motion to stay pending the
outcome of reexamination proceedings on both asserted patents. There is a related action that was dismissed by the Court, and
that dismissal has been appealed by ESR to the Federal Circuit.
In July 2010, Network Protection Sciences, LLC, a non-practicing entity, filed a complaint in the United States
District Court for the Eastern District of Texas alleging patent infringement by us and other defendants. Currently the case is in
the early stages.
In September 2010, WordCheck Tech, LLC ("WordCheck"), a non-practicing entity, filed a complaint in the United
States District Court for the Eastern District of Texas alleging patent infringement by us and numerous other defendants. In
January 2011, we entered a settlement and license agreement with WordCheck pursuant to which WordCheck dismissed the
litigation against us in return for an immaterial payment by us to WordCheck.
In April 2010, an individual, a former stockholder of Fortinet, filed a class action lawsuit against us in the Superior
Court of the State of California for the County of Los Angeles alleging violation of various California Corporations' Code
sections and related tort claims alleging misrepresentation and breach of fiduciary duty regarding the 2009 repurchase by
Fortinet of shares of its stock while we were a privately-held company. In September 2010, the Court granted our motion to
transfer the case to the California Superior Court for Santa Clara County.
In addition to the above matters, we are subject to other litigation in the ordinary course of business. The results of
legal proceedings cannot be predicted with certainty. If we do not prevail in any of these legal matters, our operating results
may be materially affected. At this time, we are unable to estimate the financial impact these actions will likely have on us.
ITEM 4.
(Removed and Reserved)
Part II
ITEM 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity
Securities
Our common stock is traded on The NASDAQ Global Select Market under the symbol “FTNT” since our initial
public offering on November 18, 2009. Prior to that time, there was no public market of our common stock. The following
table sets forth, for the time periods indicated, the high and low closing sales price of our common stock as reported on The
NASDAQ Global Select Market.
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Holders of Record
Fourth Quarter 2010
Third Quarter 2010
Second Quarter 2010
First Quarter 2010
Fourth Quarter 2009 (from November 18, 2009)
High ($)
33.46
25.21
18.63
20.11
18.36
Low ($)
24.08
16.00
15.00
15.69
16.55
As of February 17, 2011, there were 131 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 intend to retain all available funds and any
future earnings to support the operation of and to finance the growth and development of our business. 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.
Stock Performance Graph
This performance graph shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), or incorporated by reference into any filing of Fortinet under the Securities Act of
1933, as amended, or the Exchange Act, except as shall be expressly set forth by specific reference in such filing.
The following graph shows a comparison from November 18, 2009 through December 31, 2010, of the cumulative
total return for our common stock, the NASDAQ Composite Index, and the NASDAQ Computer Index. Such returns are based
on historical results and are not intended to suggest future performance. Data for The NASDAQ Composite 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.
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COMPARISON OF CUMULATIVE TOTAL RETURN*
Among Fortinet, Inc., The NASDAQ Composite Index and
The NASDAQ Computer Index
_______________________
* $100 invested on 11/18/09 in stock or index, including reinvestment of dividends.
Sales of Unregistered Securities
In October 2010, we issued 83,546 shares of our common stock in connection with a net exercise of a warrant to
purchase 120,000 shares of our common stock with an exercise price of $7.47 per share. We believe this transaction was
exempt from the registration requirements of the Securities Act of 1933, as amended, in reliance on Section 4(2) thereof, as a
transaction by an issuer not involving a public offering.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
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ITEM 6.
Selected Financial Data
You should read the following selected consolidated historical financial data below in conjunction with the section
titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated
financial statements, related notes and other financial information included elsewhere in this Annual Report on Form 10-K. The
selected financial data in this section is not intended to replace the financial statements and is qualified in its entirety by the
consolidated financial statements and related notes thereto included elsewhere in this Annual Report on Form 10-K.
We made the decision in the first quarter of 2009 to change our financial reporting periods from a fiscal to calendar
basis. This change was implemented in the third quarter of 2009 upon completion of required system changes. Accordingly,
commencing in the third quarter of fiscal 2009, we began operating and reporting financial results on a calendar quarter and
year basis. Our third quarter of fiscal 2009 ended on September 30, 2009, and our fiscal year 2009 ended on December 31,
2009. This transition had the effect of increasing the number of days in our twelve months ended December 31, 2009 by four
days. In 2005, we adopted a fiscal year that ends on the Sunday closest to December 31 of each year. Our 2006, 2007 and 2008
fiscal years ended on December 31, 2006, December 30, 2007 and December 28, 2008, respectively. Prior to the third quarter
of fiscal 2009, our interim fiscal quarters ended on the Sunday closest to March 31, June 30 and September 30 of each year.
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Consolidated Statement of Operations Data:
Revenue:
Product
Services
Ratable product and services
Total revenue
Cost of revenue:
Product (2)
Services (2)
Ratable product and services
Total cost of revenue
Gross profit
Product
Services
Ratable product and services
Total gross profit
Operating expenses:
Research and development (2)
Sales and marketing (2)
General and administrative (2)
Total operating expenses
Operating income (loss)
Interest income
Other income (expense), net
Income (loss) before income taxes
Provision for (benefit from) income taxes
Net income (loss)
Net income (loss) per share (3)
:
Basic
Diluted
Weighted-average shares outstanding:
Basic
Diluted
Fiscal Year (1)
2010
2009
2008
2007
2006
($ amounts in 000's, except per share amounts)
135,140
172,046
17,510
324,696
51,944
26,967
6,295
85,206
83,196
145,079
11,215
239,490
49,801
111,968
22,380
184,149
55,341
1,815
(815)
56,341
15,096
41,245
0.59
0.53
70,363
78,203
98,686
139,172
14,257
252,115
42,166
22,265
5,544
69,975
56,520
116,907
8,713
182,140
42,195
96,291
18,320
156,806
25,334
1,981
198
27,513
(32,666)
60,179
1.93
0.78
26,334
65,219
94,587
105,292
11,912
211,791
41,397
19,441
4,634
65,472
53,190
85,851
7,278
146,319
37,035
87,717
16,640
141,392
4,927
2,614
1,710
9,251
1,888
7,363
0.02
0.02
20,017
26,642
70,131
74,152
11,083
59,469
39,590
24,407
155,366
123,466
35,948
15,941
4,763
56,652
34,183
58,211
6,320
98,714
27,588
72,159
20,544
120,291
(21,577)
3,507
(1,991)
(20,061)
1,781
(21,842)
(1.13)
(1.13)
19,276
19,276
24,166
9,496
7,302
40,964
35,303
30,094
17,105
82,502
21,446
54,056
12,997
88,499
(5,997)
2,376
(503)
(4,124)
1,220
(5,344)
(0.28)
(0.28)
18,861
18,861
________________________
(1)
Our fiscal years ended on December 31, 2010, December 31, 2009, December 28, 2008, December 30, 2007 and December 31, 2006.
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(2)
Includes stock-based compensation expense as follows:
Cost of product revenue
Cost of services revenue
Research and development
Sales and marketing
General and administrative
Total stock-based compensation
Fiscal Year
2010
2009
2008
2007
2006
($ amounts in 000's)
101
929
2,339
3,810
2,136
9,315
102
658
1,963
3,020
1,718
7,461
67
400
1,049
2,512
1,271
5,299
553
416
1,452
3,928
2,983
9,332
99
52
135
354
414
1,054
(3)
Amounts related to 2008 have been corrected. See Note 7 to Consolidated Financial Statements.
Consolidated Balance Sheet Data:
Cash, cash equivalents and investments
Working capital
Total assets
Convertible preferred stock
Common stock including treasury stock and
additional paid-in capital
Total stockholders’ equity (deficit)
2010
2009
2008
2007
2006
As of Fiscal Year End
($ amounts in 000's)
387,460
201,776
545,422
—
249,000
232,454
260,314
161,652
387,213
—
201,340
142,452
124,190
38,193
199,105
94,368
90,161
12,862
145,192
94,368
64,041
12,399
109,311
94,368
20,854
(5,229)
13,438
(18,925)
4,087
(7,217)
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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 of 1933 and Section 21E of the Securities Exchange Act of 1934. These
statements include, among other things, statements concerning our expectations regarding:
•
•
•
•
•
•
•
•
•
•
•
•
the continued realization of efficiency gains in our sales and marketing organization as well as efficiency
gains in our overall headcount measured by revenue per employee;
growth in our high-end business and further penetration in certain verticals;
the significance of stock compensation as an expense;
the proportion of our revenue that consists of our product and service revenues and future trends with respect
to service revenue as we renew existing services contracts and expands our customer base;
our royalty payments to Trend Micro;
the impact of our product innovation strategy;
trends in product revenues, costs of services revenue, service gross margin and overall gross margin;
trends in our operating expenses, including personnel costs, research and development expense, sales and
marketing expense and general and administrative expense;
investments in research and development and sales and marketing staff to address market opportunities and
to position ourselves for future growth;
the impact of seasonality on our business;
the sufficiency of our existing cash and cash equivalents to meet our cash needs for at least the next 12
months; and
the impact of inflation and foreign currency exchange rates;
as well as other statements regarding our future operations, financial condition and prospects and business strategies.
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 Item 1A of this Annual Report on Form 10-K and those discussed in other documents we file
with the Securities and Exchange Commission. We undertake no obligation to revise or publicly release the results of any
revision to these forward-looking statements. Given these risks and uncertainties, readers are cautioned not to place undue
reliance on such forward-looking statements.
Business Overview
We provide network security solutions, which enable broad, integrated and high performance protection against
dynamic security threats while simplifying the IT security infrastructure for enterprises, service providers and government
entities worldwide. As of December 31, 2010, we had shipped over 675,000 appliances to more than 5,000 channel partners
and to more than 100,000 end-customers worldwide, including a majority of the 2010 Fortune Global 100.
Our core UTM product line of FortiGate appliances ships with a set of security and networking capabilities, including
firewall, VPN, antivirus, intrusion prevention, application control, Web filtering, antispam and WAN acceleration
functionality. We derive a substantial majority of product sales from our FortiGate appliances, which range from the
FortiGate-30, designed for small businesses and branch offices, to the FortiGate-5000 series for large enterprises and service
providers. Our UTM solution also includes our FortiGuard security subscription services, which end-customers can subscribe
to in order to obtain access to dynamic updates to the antivirus, intrusion prevention, Web filtering and antispam functionality
included in our appliances. End-customers can also choose to purchase FortiCare technical support services for our products.
We complement our core FortiGate product line with other appliances and software that offer additional protection from
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security threats to other critical areas of the enterprise, such as messaging, Web-based traffic and databases, and employee
computers or handheld devices. Sales of these complimentary products have grown in recent quarters, although these products
still represent less than 10% of our total revenue. During the fourth quarter of fiscal 2010, we began shipping virtual appliances
for our FortiGate and FortiManager product lines, which help secure the end-customer's "cloud-based" network infrastructures
with the same functionality as the traditional physical appliance in their respective product lines.
Fiscal 2010 was our first full year as a public company, following our initial public offering in November 2009. We
believe the greater visibility and brand recognition derived from being a public company, combined with success in selling to
the enterprise and service provider customers and new product introductions, served as contributors to the acceleration in our
business during fiscal 2010. Sales of FortiGate products have generally been balanced across entry-level (FortiGate-30 to -100
series), mid-range (FortiGate-200 to -800 series) and high-end (FortiGate-1000 to -5000 series) models with each product
category representing approximately one-third of FortiGate sales, with some degree of variability from year to year and
between quarters. During fiscal 2010 we executed well against our strategy to grow the high-end segment of our business,
consisting of sales to large enterprises, service providers and telecommunications companies. The percentage of our FortiGate
related billings from the high-end category increased to 34% in fiscal 2010 from 30% in fiscal 2009, while the entry-level
category decreased from 38% to 35%, and the mid-range category remained relatively flat over the same period.
We also believe continued product innovation has strengthened our technology advantage as evidenced by the
introduction of several noteworthy new FortiGate appliance models such as the FG-60C, FG-3040B, and FG-3950B. During
fiscal 2010 we also made a significant investment in our salesforce to expand our global presence both geographically as well
as by industry segment. We believe these factors have allowed us to penetrate into larger enterprise and service provider
accounts as evidenced by the increase in the number of deals involving sales greater than $100,000 and a substantial increase in
the number of deals greater than $250,000 and $500,000 compared to fiscal 2009.
Continuing to grow our enterprise and high-end business will remain a strategic priority in fiscal 2011, as we continue
to focus on further penetrating the financial services, healthcare, federal government and service provider verticals, which tend
to purchase our mid-range and high-end products. Though we are a global, geographically diversified business, with 62% of
our total revenue generated outside of the Americas region in fiscal 2010, we see opportunities to further expand our
geographic presence across all regions. We intend to continue to invest in sales and research and development staff to address
these opportunities.
Billings, a non-GAAP financial measure that we define as total revenue plus the change in deferred revenue (further
described under "Non-GAAP Financial Measures"), were $375.4 million, an increase of 33% compared to fiscal 2009. Total
revenue was $324.7 million for fiscal 2010, an increase of 29% compared to fiscal 2009. Product revenue was $135.1 million,
an increase of 37% compared to fiscal 2009, and a greater percentage of total revenue (42% in fiscal 2010, compared to 39% in
fiscal 2009). A factor in the product revenue growth was the introduction of new products over the past year, including some
non-FortiGate products. Services revenue in fiscal 2010 was $172.0 million, an increase of 24% compared to fiscal 2009.
Services revenue is important to our future revenue and profitability as it provides a source of recurring revenue for us,
representing 53% and 55% of total revenue for fiscal 2010 and 2009, respectively. Ratable product and services revenue in
fiscal 2010 was $17.5 million, an increase of 23% compared to fiscal 2009.
For fiscal 2010, $124.0 million, or 38%, of our total revenue was generated from the Americas, representing an
increase of 34% from fiscal 2009. Europe, Middle East and Africa ("EMEA") generated $121.6 million, or 38%, of our total
revenue during fiscal 2010, representing an increase of 27% from fiscal 2009. Asia Pacific and Japan ("APAC") generated
$79.1 million, or 24%, of our total revenue during fiscal 2010, representing an increase of 24% from fiscal 2009.
In fiscal 2010, we experienced increased leverage from our prior investments in our sales and marketing organization,
combined with our continued focus on effectively managing related expenses, as evidenced by the fact that sales and marketing
expenses increased 16% from fiscal 2009, while our revenue increased 29% from fiscal 2009 (as discussed under "Results of
Operations" below). We are also seeing improvements in productivity and efficiencies in our overall headcount as our
annualized fiscal 2010 revenue per employee, defined as revenue divided by average headcount, reached $254,000, up from
$217,000 for fiscal 2009. Although headcount increased during fiscal 2010 from 1,223 at the end of fiscal 2009 to 1,336, our
pace of hiring was slower than originally targeted for fiscal 2010, as it was a challenge to hire qualified sales and technical staff
as quickly as we had anticipated due in part to the competitive landscape, the degree of specialized security expertise required,
and increased turnover as the business climate improved within our industry.
Our Business Model
Our sales strategy is based on a distribution model whereby we primarily sell our products and services directly to
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distributors who sell to resellers and service providers, who, in turn, sell to our end-customers. In certain cases, we sell directly
to government-focused resellers, large service providers and major systems integrators, who have significant purchasing power
and unique customer deployment requirements. Typically, FortiGuard security subscription services and FortiCare technical
support services are purchased along with our appliances. We invoice at the time of our sale for the total price of the products
and subscription and support services, and the invoice generally becomes payable within 30 to 90 days. We generally recognize
product revenue up-front but defer revenue for the sale of new and renewal subscription and support services contracts. We
recognize the related services revenue over the service period, which is typically one year from the date the end-customer
registers for these services (the date on which the services can first be used by the customer); although, it could be longer as we
are experiencing growth in sales of multi-year support and subscription contracts. Sales of new and renewal services increase
our deferred revenue balance, which contributes significantly to our positive cash flow from operations.
Key Metrics
We monitor the key financial metrics set forth below to help us evaluate growth trends, establish budgets, measure the
effectiveness of our sales and marketing efforts and assess operational efficiencies. Our total deferred revenue increased by
$50.7 million from $201.9 million at December 31, 2009 to $252.6 million at December 31, 2010. Revenue recognized plus the
change in deferred revenue from the beginning to the end of the period is a useful metric that management identifies as billings.
Billings for services drive deferred revenue, which is an important indicator of the health and visibility of our business, and has
historically represented a majority of the revenue that we recognize in a typical quarter. We also ended fiscal 2010 with $387.5
million in cash, cash equivalents and investments and have had positive cash flow from operations every fiscal year since 2005.
We discuss revenue, gross margin, and the components of operating income and margin below under “Components of
Operating Results,” and we discuss our cash, cash equivalents, and investments under “Liquidity and Capital Resources.”
Deferred revenue and cash flow from operations are discussed immediately below the following table.
2010
Fiscal Year or as of Fiscal Year End
2009 (3)
($ amounts in 000's)
2008
Revenue
Gross margin
Operating income (1)
Operating margin
Total deferred revenue
Increase in total deferred revenue
Cash, cash equivalents and investments
Cash provided by operating activities
Free cash flow (2)
___________________
(1) Includes:
Stock-based compensation expense:
Non-cash asset acquisition related write-offs:
324,696
252,115
211,791
73.8%
55,341
17.0%
252,631
50,701
387,460
103,383
99,607
72.2%
25,334
10.0%
201,930
30,313
260,314
61,971
57,382
69.1%
4,927
2.3%
171,617
40,362
124,190
37,686
34,888
9,315
—
7,461
2,387
5,299
—
The non-cash acquisition related write-offs are expenses for intangible assets that have no future value.
(2) Free cash flow is a non-GAAP financial measure, which we define as cash flow from operations minus capital expenditures, as further
described below.
(3) Commencing in the third quarter of fiscal 2009, we began operating and reporting financial results on a calendar quarter and year basis.
Our third quarter of fiscal 2009 ended on September 30, 2009, and our fiscal 2009 ended on December 31, 2009. The impact of the reporting
period change had the effect of increasing the number of days in the 12 month period ended December 31, 2009 by four days.
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 unamortized portion of services revenue
from subscription and support service contracts. We monitor our deferred revenue balance because it represents a significant
portion of revenue to be recognized in future periods.
Cash provided by operating activities. We monitor cash provided by operating activities as a measure of our overall
business performance. Our cash provided by operating activities is driven in large part by advance payments for both new and
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renewal contracts for subscription and support services. Monitoring cash provided by operating activities enables us to analyze
our financial performance without the non-cash effects of certain items such as depreciation, amortization and stock-based
compensation expenses, thereby allowing us to better understand and manage the cash needs of our business. Our cash
provided by operating activities was $103.4 million in fiscal 2010, $62.0 million in fiscal 2009, and $37.7 million in fiscal
2008. In fiscal 2010, free cash flow (a non-GAAP financial measure, described under "Non-GAAP Financial Measures" below)
was $99.6 million, compared to $57.4 million in fiscal 2009 and $34.9 million in fiscal 2008.
Non-GAAP Financial Measures
To supplement our consolidated financial statements presented in accordance with U.S. GAAP, we consider certain
financial measures that are not prepared in accordance with GAAP, including non-GAAP gross margin, non-GAAP income
from operations and non-GAAP operating margin, non-GAAP operating expenses, non-GAAP net income and non-GAAP free
cash flow. These non-GAAP financial measures are not based on any standardized methodology prescribed by GAAP and are
not necessarily comparable to similar measures presented by other companies. Non-GAAP gross margin is gross margin as
reported on our consolidated statements of operations, excluding the impact of stock-based compensation expense, which is a
non-cash charge, and for fiscal 2009 only, non-cash asset acquisition related write-offs. Non-GAAP income from operations is
operating income, as reported on our consolidated statements of operations, excluding the impact of stock-based compensation
expense and for fiscal 2009 only, non-cash asset acquisition related write-offs. The non-cash asset acquisition related write-offs
that we exclude from our fiscal 2009 non-GAAP financial measures are charges for intangible assets that have no future value,
but these charges do not include amortization related to the intangible assets that provide an ongoing benefit to our recurring
operations. Non-GAAP operating margin is non-GAAP income from operations divided by revenue. Non-GAAP operating
expenses exclude the impact of stock-based compensation expense. Non-GAAP net income is net income plus stock-based
compensation expense and non-cash asset acquisition related write-offs, less the related tax effects. Free cash flow, an
alternative non-GAAP measure of liquidity, is defined as net cash provided by operating activities less capital expenditures.
We use these non-GAAP financial measures internally in analyzing our financial results and believe they are useful to
investors, as a supplement to GAAP measures, in evaluating our ongoing operational performance and enhancing an overall
understanding of our past financial performance, as they help illustrate underlying trends in our business that could otherwise
be masked by the effect of the expenses that we exclude in these non-GAAP financial measures. Furthermore, we use many of
these measures to establish budgets and operational goals for managing our business and evaluating our performance. We also
believe that the use of these non-GAAP financial measures provides an additional tool for investors to use in comparing our
recurring core business operating results over multiple periods with other companies in our industry, many of which present
similar non-GAAP financial measures to investors.
These non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial
information prepared in accordance with GAAP. There are a number of limitations related to the use of these non-GAAP
financial measures versus the nearest GAAP equivalent of these financial measures. First, these non-GAAP financial measures
exclude certain recurring, non-cash charges, namely, stock-based compensation expense. Stock-based compensation has been,
and will continue to be for the foreseeable future, a significant recurring expense in our business and is an important part of our
employees' compensation that reflects their performance. Second, the expenses that we exclude in our calculation of these non-
GAAP financial measures may differ from the expenses, if any, that our peer companies may exclude when they report their
results of operations. We compensate for these limitations by providing the nearest GAAP equivalents of these non-GAAP
financial measures and describing these GAAP equivalents in our Results of Operations below.
The following tables reconcile GAAP gross margin, income from operations, operating margin, certain operating
expenses and net income as reported on our consolidated statements of operations to non-GAAP gross margin, non-GAAP
income from operations, non-GAAP operating margin, certain non-GAAP operating expenses and non-GAAP net income for
fiscal 2010, 2009 and 2008. For fiscal 2010, both GAAP and non-GAAP results below include approximately $1.3 million of
payroll tax expense resulting from the exercise of employee stock options during the year. Payroll tax expense associated with
stock option exercises during fiscal 2009 and 2008 was immaterial.
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2010
Fiscal Year
2009
2008
Amount ($)
% of
Revenue
Amount ($)
% of
Revenue
Amount ($)
% of
Revenue
($ amounts in 000's)
Total revenue
GAAP gross profit and margin
Stock-based compensation expense
Non-cash asset acquisition related
write-offs
Non-GAAP gross profit and margin
GAAP income from operations and margin
Stock-based compensation expense:
Cost of revenue
Research and development
Sales and marketing
General and administrative
Total stock-based compensation
Non-cash asset acquisition related write-
offs
Non-GAAP income from operations and
margin
324,696
239,490
1,030
—
240,520
55,341
1,030
2,339
3,810
2,136
9,315
—
252,115
182,140
760
2,387
185,287
25,334
760
1,963
3,020
1,718
7,461
2,387
73.8
0.3
—
74.1
17.0
0.3
0.9
1.2
0.4
2.8
—
211,791
146,319
467
—
146,786
4,927
467
1,049
2,512
1,271
5,299
—
72.2
0.3
0.9
73.4
10.0
0.3
0.8
1.2
0.7
3.0
0.9
64,656
19.8
35,182
13.9
10,226
69.1
0.2
—
69.3
2.3
0.2
0.5
1.2
0.6
2.5
—
4.8
Operating Expenses:
Research and development expenses:
GAAP research and development
expenses
Stock-based compensation
Non-GAAP research and development
expenses
Sales and marketing expenses:
GAAP sales and marketing expenses
Stock-based compensation
Non-GAAP sales and marketing
expenses
General and administrative expenses:
GAAP general and administrative
expenses
Stock-based compensation
Non-GAAP general and administrative
expenses
Total operating expenses:
GAAP operating expenses
Stock-based compensation
Non-GAAP operating expenses
2010
Fiscal Year
2009
2008
Amount ($)
% of
Revenue
Amount ($)
% of
Revenue
Amount ($)
% of
Revenue
($ amounts in 000's)
49,801
(2,339)
15.3
(0.9)
42,195
(1,963)
16.7
(0.8)
37,035
(1,049)
47,462
14.4
40,232
15.9
35,986
111,968
(3,810)
108,158
22,380
(2,136)
20,244
184,149
(8,285)
175,864
34.5
(1.2)
33.3
96,291
(3,020)
93,271
38.2
(1.2)
37.0
87,717
(2,512)
85,205
6.9
(0.4)
18,320
(1,718)
7.3
(0.7)
16,640
(1,271)
6.5
16,602
6.6
15,369
56.7
(2.5)
54.2
156,806
(6,701)
150,105
62.2
(2.7)
59.5
141,392
(4,832)
136,560
17.5
(0.5)
17.0
41.4
(1.2)
40.2
7.9
(0.6)
7.3
66.8
(2.3)
64.5
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Table of Contents
Fiscal Year
2009
($ and share amounts in 000's, except per share amounts)
2008
2010
Net Income:
GAAP net income
Stock-based compensation expense (1)
Non-cash asset acquisition related write-offs (1)
Provision for income taxes (2)
Non-GAAP income before provision for income taxes
Tax effects related to non-GAAP adjustments (3)
Non-GAAP net income
Non-GAAP net income per share - diluted
Shares used in per share calculation - diluted
41,245
9,315
—
15,096
65,656
(21,010)
44,646
0.57
78,203
60,179
7,461
2,387
(32,666)
37,361
(6,877)
30,484
0.47
65,219
7,363
5,299
—
1,888
14,550
(2,948)
11,602
0.17
67,122
____________________
(1)
(2)
(3)
Stock-based compensation expense and non-cash asset acquisition related write-offs are added back to GAAP net income to reconcile to non-GAAP
income before taxes.
Provision for income taxes is our GAAP provision that must be added to GAAP net income to reconcile to non-GAAP income before taxes. The
provision for fiscal 2009 included a $37.8 million tax benefit from the reversal of our valuation allowance.
We used a 32% effective tax rate in fiscal 2010 to calculate non-GAAP net income for fiscal 2010. The 32% effective tax rate reflects the exclusion
of GAAP based stock option benefits, as well as the reinstated Federal R&D Credit. Our effective tax rate for fiscal 2009 was 18% which reflects
only our foreign tax provision as our US operations had net operating losses to offset any taxable income.
Billings:
Revenue
Increase in deferred revenue
Total billings (Non-GAAP)
Cash Flow:
Net cash provided by operating activities
Less purchases of property and equipment
Free cash flow (Non-GAAP)
Net cash provided by (used in) investing activities
Net cash provided by financing activities
Components of Operating Results
Revenue
2010
Fiscal Year
2009
($ amounts in 000's)
2008
324,696
50,701
375,397
252,115
30,313
282,428
211,791
40,363
252,154
2010
Fiscal Year
2009
($ amounts in 000's)
2008
103,383
(3,776)
99,607
(283,710)
34,019
61,971
(4,589)
57,382
13,757
78,049
37,686
(2,798)
34,888
(53,706)
2,117
We derive our revenue from sales of our products and subscription and support services. In fiscal 2010, we recognized
our revenue in accordance with the guidance in ASC 985-605-25 (formerly referred to as Statement of Position, or SOP 97-2,
Software Revenue Recognition and SOP 98-9, Modification of SOP 97-2, Software Revenue Recognition, With Respect to
Certain Transactions) which is discussed in further detail in “—Critical Accounting Policies and Estimates—Revenue
Recognition” below. According to ASC 985-605-25, revenue is recognized when persuasive evidence of an arrangement exists,
delivery has occurred, the price is fixed or determinable and collection is probable.
Our total revenue is comprised of the following:
•
Product revenue. Product revenue is generated from sales of our appliances and software. The substantial
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majority of our product revenue has been generated by our FortiGate line of appliances and we do not expect
this to change in the foreseeable future. Product revenue also includes revenue derived from sales of
FortiManager and, FortiAnalyzer, as well as some of our other products. We generally recognize revenue for
products sold to distributors under the “sell-in” method upon shipment to the distributor and, for “sell-
through” distributors, upon sale to their end-customer. As a percentage of total revenue, we expect our
product revenue may vary from quarter-to-quarter based on seasonal and cyclical factors discussed below
under “—Quarterly Results of Operations” but generally may remain at relatively comparable levels.
Services revenue. Services revenue is generated primarily from FortiCare technical support services for
software updates, maintenance releases and patches, Internet access to technical content, telephone and
Internet access to technical support personnel, and FortiGuard security subscription services related to
antivirus, intrusion prevention, Web filtering and antispam updates. We recognize revenue from subscription
and support services over the service performance period. Our typical contractual support and subscription
term is one year from the date of registration. We also generate a small portion of our revenue from
professional services and training services and we recognize this revenue upon completion of the project. As
a percentage of total revenue, we expect our services revenue to remain at relatively comparable levels.
Ratable product and services revenue. Ratable product and services revenue is generated from sales of our
products and services in cases where the fair value of the services being provided cannot be segregated from
the value of the entire sale. In these cases, the value of the entire sale is deferred and recognized ratably over
the life of the service performance period. See “—Critical Accounting Policies and Estimates—Revenue
Recognition.” In fiscal 2009 and 2010, ratable product and service revenue represented approximately 5% to
6% of total revenue.
•
•
Our total cost of revenue is comprised of the following:
•
•
•
Cost of product revenue. A substantial majority of the cost of product revenue consists of third-party
manufacturing costs. Our cost of product revenue also includes product testing costs, write-offs for excess
and obsolete inventory, royalty payments, amortization and any impairment of applicable acquired intangible
assets, warranty costs, shipping and allocated facilities costs, stock-based compensation costs, and personnel
costs associated with logistics and quality control. Personnel costs include cash-based personnel costs such as
salaries, benefits and bonuses. Royalties reflect amounts related to Trend Micro since 2006, which Trend
Micro claims are owed through 2015, as discussed in “Item 3 - Legal Proceedings.” For fiscal 2009 and 2010,
this royalty represented approximately 1% of total revenue and we do not expect this percentage to increase
substantially in the foreseeable future.
Cost of services revenue. Cost of services revenue is primarily comprised of cash-based personnel costs
associated with our FortiGuard Labs team and our technical support, professional services and training teams,
as well as depreciation, supplies, data center, data communications, facility-related costs and stock-based
compensation costs. We expect our cost of services revenue will increase as we continue to invest in
subscription and support services to meet the needs of our growing customer base.
Cost of ratable product and services revenue. Cost of ratable product and services revenue is comprised
primarily of deferred product costs and services-related costs.
Gross profit. 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, any excess inventory write-offs, manufacturing costs, the
mix of products sold and the mix of revenue between products and services. We believe our overall gross margin for the near
term will remain at comparable levels or decline modestly compared to that achieved in fiscal 2010.
Services revenue has historically increased as a percentage of total revenue since inception, and this trend has had a
positive effect on our total gross margin given the higher services gross margins compared to product gross margins. We have
generally maintained consistent services gross margins in fiscal 2009 and fiscal 2010.
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 of cash-
based personnel costs such as salaries, benefits, bonuses and, with regard to the sales and marketing expense, sales
commissions. They also include non-cash charges, specifically, stock-based compensation. We expect personnel costs to
continue to increase in absolute dollars as we hire new employees.
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•
•
•
Research and development. Research and development expense consists primarily of cash-based personnel
costs. Additional research and development expenses include ASIC and system prototypes and certification-
related expenses, depreciation of capital equipment, facility-related expenses and stock-based compensation
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, except for capital equipment which is depreciated over time. Our development teams are primarily
located in Canada, China, and the United States. We expect our spending for research and development to
increase in absolute dollars and may increase modestly as a percentage of total revenue compared to fiscal
2010 results.
Sales and marketing. Sales and marketing expense is the largest component of our operating expenses and
primarily consists of cash-based personnel costs including salary, benefits and commissions. Additional sales
and marketing expenses include stock-based compensation, promotional and other marketing expenses,
travel, depreciation of capital equipment and facility-related expenses. We intend to hire additional personnel
focused on sales and marketing and expand our sales and marketing efforts worldwide in order to increase
our presence in new geographic markets and enterprise verticals, add new customers and increase penetration
within our existing customer base. Accordingly, we expect sales and marketing expenses to increase in
absolute dollars and to continue to be our largest operating expense.
General and administrative. General and administrative expense consists of cash-based personnel costs as
well as professional fees, stock-based compensation, depreciation of capital 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, information technology and other consulting costs. We expect that general
and administrative expense will increase in absolute dollars as we hire additional personnel, make
improvements to our information technology infrastructure, and defend our intellectual property.
Interest income. Interest income consists of income earned on our cash, cash equivalents and investments. We have
historically invested our cash in money market funds, commercial paper, corporate debt securities and U.S. government debt
securities.
Other income (expense), net. Other income (expense), net consists primarily of foreign exchange and related hedging
gains and losses. Foreign exchange gains and losses relate to foreign currency exchange re-measurement. The hedging gains
and losses are related to our settled balance sheet hedges.
Provision for income taxes. We are subject to tax 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 the local country which are
generally lower than U.S. tax rates, and may be subject to current U.S. income taxes. Our effective tax rates differ from the
U.S. statutory rate primarily due to foreign income subject to different tax rates than the U.S., research and development tax
credits (particularly the recently reinstated U.S. Federal Research and Development Tax Credit), withholding taxes,
nondeductible compensation and expenses and adjustments related to our intercompany transfer pricing.
The income tax provision for fiscal 2010 was comprised primarily of domestic income taxes, foreign income taxes and
withholding taxes. The 2010 effective tax rate was impacted by the inclusion of stock option benefits, which affected the
transfer pricing calculations between some of our foreign subsidiaries as well as the reinstated U.S. Federal Research and
Development Tax Credit. The income tax provision for fiscal 2009 reflected a tax benefit related to the release of the valuation
allowance, which resulted in the recognition of deferred tax assets. For periods beginning in 2010, as a result of fully reversing
our valuation allowance, we expect that our effective tax rate will approximate the U.S. federal statutory tax rates plus the
impact of state taxes, research and development tax credits (when applicable), withholding tax, nondeductible compensation
and adjustments related to intercompany transfer pricing.
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 U.S. GAAP. These principles require us to make estimates and
judgments that affect the reported amounts of assets, liabilities, revenue and expenses, cash flow and related disclosure of
contingent assets and liabilities. Our estimates include those related to revenue recognition, stock-based compensation,
valuation of inventory, warranty liabilities and accounting for income taxes. We base our estimates on historical experience and
on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ from these
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estimates. 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 our significant accounting policies, which are described in Note 1 to the financial statements
included in this 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
We derive revenue from sales of products, including appliances and software, and services, including subscription,
support and other services. Our appliances include operating system software that is integrated into the appliance hardware and
is deemed essential to its functionality. As a result, we account for revenue in accordance with ASC 985-605 and all related
interpretations. See “—Recent Accounting Pronouncements in the notes to the consolidated financial statements” for a
discussion of new revenue recognition standards that we will be required to adopt for fiscal 2011. We are still assessing the
impact of the new standards and have not reflected in this annual report any impact such standards may have on our
consolidated financial statements.
No revenue can be recognized until all of the following criteria have been met:
•
•
•
•
Persuasive evidence of an arrangement exists. Binding contracts or purchase orders are generally used to
determine the existence of an arrangement.
Delivery has occurred. Delivery occurs when we fulfill an order and title and risk of loss has been transferred
or upon delivery of the service contract registration code.
The fee is fixed or determinable. We assess whether the fee is fixed or determinable based on the payment
terms associated with the transaction. In the event payment terms differ from our standard business practices,
the fees are deemed to be not fixed or determinable and revenue is recognized when the payments become
due, provided the remaining criteria for revenue recognition have been met.
Collectability is probable. We assess collectability based primarily on creditworthiness as determined by
credit checks and analysis, as well as payment history. Payment terms generally range from 30 to 90 days
from invoice date.
For arrangements that include customer acceptance criteria, no revenue is recognized prior to acceptance. We
recognize product revenue on sales to distributors that have no rights of return and end-customers upon shipment of the
appliance, once all other revenue recognition criteria have been met. We also make sales through distributors under agreements
that allow for rights of return. We recognize product revenue on sales made through such distributors upon sale by the
distributor to the end-customer, at which time rights of return generally lapse. Substantially all of our products have been sold
in combination with subscription or support services. Subscription services provide access to our antivirus, intrusion
prevention, Web filtering, and antispam functionality. Support services include rights to unspecified software upgrades,
maintenance releases and patches, telephone and Internet access to technical support personnel, and hardware support.
We commence our subscription and support services on the date the customer registers the appliance. The customer is
then entitled to service for the stated contractual period beginning on the registration date.
We use the residual method to recognize revenue when an arrangement includes one or more elements to be delivered
at a future date and vendor-specific objective evidence ("VSOE") of the fair value of all undelivered elements exists. Under the
residual method, the fair value of the undelivered elements is deferred and the remaining portion of the contract fee is
recognized as product revenue. In cases where VSOE of fair value of the undelivered elements does not exist, typically for
subscription and support services, revenue for the entire arrangement is recognized ratably over the performance period of the
undelivered elements. Revenue related to these arrangements is included in ratable product and services revenue in the
accompanying consolidated statements of operations. VSOE of fair value for elements of an arrangement is based upon the
pricing for those services when sold separately. Revenue for professional services and training is recognized upon completion
of the related services.
We offer certain sales incentives to channel partners. Additionally, in limited circumstances we may permit end-
customers, distributors and resellers to return our products, subject to varying limitations, for a refund within a reasonably short
period from the date of purchase. We reduce revenue for estimates of sales returns and allowances. We estimate and record
reserves for these sales incentives and sales returns based on our historical experience. In each accounting period, we must
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make judgments and estimates of sales incentives and potential future sales returns related to current period revenue. These
estimates affect our net revenue line item on our consolidated statement of operations and affect our net accounts receivable,
deferred revenue or accrued liabilities line items on our consolidated balance sheet. Historically, there have been no significant
adjustments to these estimates related to prior periods.
At December 31, 2010, our allowance for sales returns was $2.0 million compared to $5.0 million at December 31,
2009. The decrease was the result of improved efficiency in processing sales incentives through the system at period end. If our
allowance for sales returns was to increase by 10%, or $0.2 million, our net revenue would decrease by $0.2 million for fiscal
2010.
Stock-Based Compensation
Employees. We have accounted for stock-based awards to employees in accordance with ASC 718 (SFAS 123R),
which requires compensation expense related to share-based transactions, including employee stock options, to be measured
and recognized in the financial statements based on a determination of the fair value of the stock options. The grant date fair
value is determined using the Black-Scholes-Merton (“Black-Scholes”) pricing model. For all employee stock options, we
recognize expense over the requisite service period using the straight-line method. Our option pricing model requires the input
of highly subjective assumptions, including the expected stock price volatility, expected term, and forfeiture rate. Any changes
in these highly subjective assumptions significantly impact stock-based compensation expense.
Non-employees. During fiscal 2010, 2009 and 2008 we issued to non-employees in exchange for services, options to
purchase shares of common stock. These options vest over periods of up to 48 months, and in accordance with ASC 505-50
(formerly referred to as Emerging Issues Task Force (EITF) Issue No. 96-18), we accounted for these options as variable
awards. The options were valued using the Black-Scholes option pricing model.
Valuation of Inventory
Inventory is recorded at the lower of cost (using the first-in, first-out method) or market, after we give appropriate
consideration to obsolescence and inventory in excess of anticipated future demand. In assessing the ultimate recoverability of
inventory, we are required to 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 additional 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.
Warranty Liabilities
We generally provide a one-year warranty on hardware products and a 90-day warranty on software. A provision for
estimated future costs related to warranty activities is charged to cost of product revenue based upon historical product failure
rates and historical costs incurred in correcting product failures. If we experience an increase in warranty claims compared with
our historical experience, or if the cost of servicing warranty claims is greater than expected, our gross margin could be
adversely affected.
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 estimating future tax consequences, generally all expected future events other than enactments or changes in the tax
law or rates are considered. Valuation allowances are provided when necessary to reduce deferred tax assets to the amount
expected to be realized.
We operate in various tax jurisdictions and are subject to audit by various tax authorities. We provide for tax
contingencies whenever it is deemed more likely than not that a tax asset has been impaired or a tax liability has been incurred
for events such as tax claims or changes in tax laws. Tax contingencies are based upon their technical merits, relevant tax law
and the specific facts and circumstances as of each reporting period. Changes in facts and circumstances could result in
material changes to the amounts recorded for such tax contingencies.
We account for uncertain tax positions in accordance with ASC 740-10 (FIN 48), which defines the confidence level
that a tax position must meet in order to be recognized in the financial statements. ASC 740-10 requires that the tax effects of a
position be recognized only if it is “more likely than not” to be sustained based solely on its technical merits as of the reporting
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date. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic
adjustments and which may not accurately anticipate actual outcomes.
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
operations 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. During the
fourth quarter of fiscal 2009 we concluded that it was more likely than not that we would be able to realize the benefit of our
deferred tax assets in the future. We based this conclusion on historical and projected operating performance, as well as our
expectation that our operations will generate sufficient taxable income in future periods to realize the tax benefits associated
with the deferred tax assets. As a result, we released all of the valuation allowance on our net deferred tax assets. We will
continue to assess the need for a valuation allowance on the deferred tax asset by evaluating both positive and negative
evidence that may exist. Any adjustment to the net deferred tax asset valuation allowance would be recorded in the income
statement for the period that the adjustment is determined to be required.
We make estimates and judgments about our future taxable income that are based on assumptions that are consistent
with our plans and estimates. Should the actual amounts differ from our estimates, the amount of our tax expense and liabilities
could be materially impacted.
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.
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Consolidated Statement of Operations Data:
Revenue
Product
Services
Ratable product and services
Total revenue
Cost of revenue
Product
Services
Ratable product and services
Total cost of revenues
Gross profit
Product
Services
Ratable product and services
Total gross profit
Operating expenses
Research and development
Sales and marketing
General and administrative
Total operating expenses
Operating income
Interest income
Other income (expense), net
Income before income taxes
Provision for (benefit from) income taxes
Net income
2010
Fiscal Year (1)
2009 (2)
($ amounts in 000's)
2008
135,140
172,046
17,510
324,696
51,944
26,967
6,295
85,206
83,196
145,079
11,215
239,490
49,801
111,968
22,380
184,149
55,341
1,815
(815)
56,341
15,096
41,245
98,686
139,172
14,257
252,115
42,166
22,265
5,544
69,975
56,520
116,907
8,713
182,140
42,195
96,291
18,320
156,806
25,334
1,981
198
27,513
(32,666)
60,179
94,587
105,292
11,912
211,791
41,397
19,441
4,634
65,472
53,190
85,851
7,278
146,319
37,035
87,717
16,640
141,392
4,927
2,614
1,710
9,251
1,888
7,363
____________________
(1)
(2)
Our fiscal years ended on December 31, 2010, December 31, 2009 and December 28, 2008.
Commencing in the third quarter of fiscal 2009, we began operating and reporting financial results on a calendar quarter and year
basis. This change in period end had the effect of increasing the number of days in fiscal 2009 by four days.
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Revenue
Product
Services
Ratable product and services
Total revenue
Total cost of revenue
Total gross profit
Operating expenses
Research and development
Sales and marketing
General and administrative
Total operating expenses
Operating income
Interest income
Other income (expense), net
Income before provision for income taxes
Provision for (benefit from) income taxes
Net income
Fiscal Years 2010 and 2009
Revenue
2010
Fiscal Year
2009
(as % of revenue)
2008
41.6
53.0
5.4
100.0
26.2
73.8
15.3
34.6
6.9
56.8
17.0
0.7
(0.2)
17.5
4.6
12.9
39.1
55.2
5.7
100.0
27.8
72.2
16.7
38.2
7.3
62.2
10.0
0.8
0.1
10.9
(13.0)
23.9
44.7
49.7
5.6
100.0
30.9
69.1
17.5
41.4
7.9
66.8
2.3
1.3
0.8
4.4
0.9
3.5
Fiscal Year
2010
2009
Amount ($)
% of
Revenue
Amount ($)
% of
Revenue
$ Change
% Change
($ amounts in 000's)
135,140
172,046
17,510
324,696
123,961
121,604
79,131
324,696
41.6
53.0
5.4
100.0
38.2
37.5
24.3
100.0
98,686
139,172
14,257
252,115
92,621
95,886
63,608
252,115
39.1
55.2
5.7
100.0
36.7
38.1
25.2
100.0
36,454
32,874
3,253
72,581
31,340
25,718
15,523
72,581
36.9
23.6
22.8
28.8
33.8
26.8
24.4
28.8
Revenue:
Product
Services
Ratable product and services
Total revenue
Revenue by Geography:
Americas
EMEA
APAC
Total revenue
Total revenue increased $72.6 million, or 28.8%, in fiscal 2010 compared to fiscal 2009. The Americas region
contributed the largest portion of this growth. Product revenue increased $36.5 million, or 36.9%, compared to fiscal 2009. The
increase in product revenue was primarily driven by higher product sales volume across all regions. When looking at the mix of
product revenue, there was a greater mix of our high-end products due to increased sales to enterprise and service provider
customers as evidenced by a 79% increase in the number of $500,000+ deals in fiscal 2010 compared to fiscal 2009. Services
revenue increased $32.9 million, or 23.6%, in fiscal 2010 compared to fiscal 2009 due to the recognition of revenue from our
growing deferred revenue balance consisting of subscription and support contracts sold to a larger customer base and our
increased focus on contract renewals. The growth in services revenue tends to lag growth in billings and product revenue due to
amortization of revenue over the service period. The growth in ratable product and services revenue was due to a slight
decrease in the weighted-average service period as a result of a decrease in the average contractual term of support contracts for
arrangements in which we recognized product and services revenue ratably.
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Cost of revenue and gross margin
Cost of revenue:
Product
Services
Ratable product and services
Total cost of revenue
Gross margin (%):
Product
Services
Ratable product and services
Total gross margin
Fiscal Year
2010
2009
$ Change
% Change
($ amounts in 000's)
51,944
26,967
6,295
85,206
61.6
84.3
64.0
73.8
42,166
22,265
5,544
69,975
57.3
84.0
61.1
72.2
9,778
4,702
751
15,231
4.3
0.3
2.9
1.6
23.2
21.1
13.5
21.8
Total gross margin increased 1.6 percentage points in fiscal 2010 primarily due to improved product margins in fiscal
2010 compared to fiscal 2009. Product gross margin increased 4.3 percentage points in fiscal 2010 compared to fiscal 2009
primarily due to a greater mix of our high-end products and the absence of asset acquisition related write-offs compared to a
$2.4 million write-off in fiscal 2009. From time to time, we have experienced sales of previously reserved inventory. During
fiscal 2010, we experienced a positive impact of 0.7 percentage points due to the sale of fully reserved inventory compared to a
positive impact of 1.1 percentage points in fiscal 2009. Services gross margin was relatively flat as we continued to make
investments in our Americas support, professional services and FortiGuard global security research organizations. Services cost
increased by $4.7 million primarily due to a $2.9 million increase in cash-based personnel costs related to headcount increases.
Travel, depreciation and other expenses increased a combined $0.8 million. In addition, occupancy-related costs increased $0.7
million and stock-based compensation increased $0.3 million. Ratable product and services gross margin increased 2.9
percentage points as a result of leverage achieved from cost reductions with respect to overhead.
Operating Expenses
Fiscal Year
2010
2009
Amount ($)
% of
Revenue
Amount ($)
% of
Revenue
$ Change
% Change
($ amounts in 000's)
Operating expenses:
Research and development
Sales and marketing
General and administrative
Total operating expenses
Research and development expense
49,801
111,968
22,380
184,149
15.3
34.5
6.9
56.7
42,195
96,291
18,320
156,806
16.7
38.2
7.3
62.2
7,606
15,677
4,060
27,343
18.0
16.3
22.2
17.4
Research and development expense increased $7.6 million, or 18.0%, in fiscal 2010 compared to fiscal 2009 primarily
due to an increase of $5.2 million in cash-based personnel costs as a result of increased headcount to support continued
enhancements of our products, higher occupancy-related costs of $1.7 million due to a move into a new office facility in
Vancouver with significantly increased square footage, plus early termination and moving costs, an increase of $0.4 million in
stock-based compensation expense, and an increase of $0.3 million in product development related expenses, such as non-
recurring engineering (NRE), testing and certifications. A 10% increase in the Canadian dollar exchange rate against the US
dollar also significantly contributed to the increase in research and development expenses.
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Sales and marketing expense
Sales and marketing expense increased $15.7 million, or 16.3%, in fiscal 2010 compared to fiscal 2009 as we
continued to increase our sales headcount in order to expand our global footprint. The increase consisted of cash-based
personnel costs of $14.5 million as a result of increased headcount, a $1.3 million increase in travel as a result of our overall
sales growth of 29% and particularly sales growth in the Americas of 34%, a $0.8 million increase in stock-based compensation
expense, and a $0.2 million increase in professional services. These increases were partially offset by a $1.1 million decrease in
marketing-related expenses. As a percentage of revenue, sales and marketing expenses decreased 3.7 percentage points due to
the leverage we are achieving from the investment in our salesforce during the past year, as evidenced by revenue growth of
29% exceeding sales and marketing expenses growth of 16%.
General and administrative expense
In fiscal 2010, general and administrative expense increased $4.1 million, or 22.2%, compared to fiscal 2009. The
increase was primarily due to a $1.8 million increase in legal expenses to support various patent litigation matters and a $0.6
million increase in accounting-related expenses due to being a public company. In addition, cash-based personnel costs
increased $1.3 million and stock-based compensation expense increased $0.4 million.
Interest income and other income (expense), net
Fiscal Year
2010
2009
$ Change
% Change
($ amounts in 000's)
Interest income
Other income (expense), net
1,815
(815)
1,981
198
(166)
(1,013)
(8.4)
(511.6)
The $0.2 million decrease in interest income in fiscal 2010 compared to fiscal 2009 was due to lower interest rates
earned, despite higher balances of cash, cash equivalents and investments. The change in other income (expense), net for fiscal
2010 when compared to fiscal 2009 was the result of foreign exchange losses in fiscal 2010 due to the weakening of the U.S.
dollar against the Australian Dollar, Chinese Yuan, and Japanese Yen.
Provision for (benefit from) income taxes
Fiscal Year
2010
2009
$ Change
% Change
Provision for (benefit from) income taxes
Effective tax rate (%)
15,096
26.8
_________________________
*not meaningful
($ amounts in 000's)
(32,666)
(118.7)
47,762
*
*
Our effective tax rate was 26.8% for fiscal 2010, compared with an effective tax rate of negative 118.7% for fiscal
2009. The provision for income taxes for fiscal 2010 is comprised primarily of federal, state and foreign income taxes. The
2010 effective tax rate is impacted by the inclusion of stock option benefits, which affected the transfer pricing calculations
between some of our foreign subsidiaries, as well as the reinstated U.S. Federal Research and Development Tax Credit. The
increase in the provision for income taxes for fiscal 2010 compared to fiscal 2009 reflected the release of the valuation
allowance against our net deferred tax assets in fiscal 2009. We generated pretax income in fiscal 2009 and 2008. As a result of
this positive earnings trend and projected future taxable income, we reversed approximately $44.2 million of deferred tax asset
valuation allowance in fiscal 2009 after having determined that it was more likely than not that our deferred tax assets would be
realized. This reversal resulted in recognition of an income tax benefit totaling $37.8 million. Our estimates of future taxable
income represent critical accounting estimates because such estimates are subject to change and a downward adjustment could
have a significant impact on future earnings. Furthermore, we continue to evaluate our net deferred tax asset position, in
regards to the likelihood of realization of our deferred tax assets.
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Table of Contents
Fiscal Years 2009 and 2008
Revenue
Revenue:
Product
Services
Ratable product and services
Total revenue
Revenue by Geography:
Americas
EMEA
APAC
Total revenue
Fiscal Year
2009
2008
Amount ($)
% of
Revenue
Amount ($)
% of
Revenue
$ Change
% Change
($ amounts in 000's)
98,686
139,172
14,257
252,115
92,621
95,886
63,608
252,115
39.1
55.2
5.7
100.0
36.7
38.1
25.2
100.0
94,587
105,292
11,912
211,791
75,367
79,755
56,669
211,791
44.7
49.7
5.6
100.0
35.6
37.7
26.7
100.0
4,099
33,880
2,345
40,324
17,254
16,131
6,939
40,324
4.3
32.2
19.7
19.0
22.9
20.2
12.2
19.0
Total revenue increased $40.3 million, or 19.0%, in fiscal 2009 compared to fiscal 2008, primarily due to growth in
services revenue. The Americas and EMEA regions contributed the largest portion of this growth. Product revenue increased
$4.1 million, or 4.3%, compared to fiscal 2008. The increase in product revenue was primarily driven by higher product sales
volume, predominantly in the Americas region, as we expanded our distributor base to include those that focus on high volume
sales of entry-level products. While there were no material price changes between the periods, the shift in product mix towards
our entry-level products had the effect of decreasing our average sales price. Services revenue increased $33.9 million, or
32.2%, in fiscal 2009 compared to fiscal 2008 due to recognition of revenue from our growing deferred revenue balance
consisting of subscription and support contracts sold to a larger customer base. The increase in services revenue also reflects
additional services revenue amortization of approximately $1.6 million due to our reporting period transition discussed above.
The growth in ratable product and services revenue was due to a slight decrease in the weighted-average service period over
which such revenue was recognized, due to a decrease in the average contractual term of support contracts for arrangements in
which we recognized product and services revenue ratably over the performance period.
Cost of revenue and gross margin
Cost of revenue:
Product
Services
Ratable product and services
Total cost of revenue
Gross margin (%):
Product
Services
Ratable product and services
Total gross margin
Fiscal Year
2009
2008
$ Change
% Change
($ amounts in 000's)
42,166
22,265
5,544
69,975
57.3
84.0
61.1
72.2
41,397
19,441
4,634
65,472
56.2
81.5
61.1
69.1
769
2,824
910
4,503
1.1
2.5
—
3.1
1.9
14.5
19.6
6.9
Total gross margin increased 3.1 percentage points in fiscal 2009 primarily due to improved product and service
margins and a higher mix of services revenue in fiscal 2009 compared to fiscal 2008. Product gross margin increased 1.1
percentage points in fiscal 2009 compared to fiscal 2008 primarily due to lower warranty-related return costs which resulted in
a savings of $3.2 million, partially offset by $2.4 million of asset acquisition related write-offs. The 2.5 percentage point
52
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increase in services gross margin was primarily due to growth in services revenue resulting from a larger customer base to
leverage our support cost structure. Services cost increased $2.8 million primarily due to $2.0 million of higher cash-based
personnel costs related to headcount increases in our professional services and training teams and an increase of $0.3 million in
stock-based compensation expense. Ratable product and services gross margin was unchanged in the period.
Operating expenses
Fiscal Year
2009
2008
Amount ($)
% of
Revenue
Amount ($)
% of
Revenue
$ Change
% Change
($ amounts in 000's)
Operating expenses:
Research and development
Sales and marketing
General and administrative
Total operating expenses
Research and development expense
42,195
96,291
18,320
156,806
16.7
38.2
7.3
62.2
37,035
87,717
16,640
141,392
17.5
41.4
7.9
66.8
5,160
8,574
1,680
15,414
13.9
9.8
10.1
10.9
Research and development expense increased $5.2 million, or 13.9%, in fiscal 2009 compared to fiscal 2008,
primarily due to an increase of $3.7 million in cash-based personnel costs as a result of increased headcount to support
continued enhancements of our products. We also had an increase of $0.9 million in stock-based compensation expense, an
increase of $0.2 million in depreciation expense and $0.2 million in supplies and other expenses.
Sales and marketing expense
Sales and marketing expense increased $8.6 million, or 9.8%, in fiscal 2009 compared to fiscal 2008, primarily due to
increased cash-based personnel costs of $5.4 million based on increased headcount primarily in the U.S., a $1.3 million
increase in promotional and other marketing-related expenses, a $0.4 million increase in travel, a $0.4 million increase in
depreciation costs, and a $0.5 million increase in stock-based compensation expense, offset by a $0.5 million decrease in rent
and occupancy-related expenses. As a percentage of revenue, sales and marketing expenses decreased 3.2 percentage points.
General and administrative expense
In fiscal 2009, general and administrative expense increased $1.7 million, or 10.1%, compared to fiscal 2008. The
increase was primarily due to a $0.9 million increase in external legal services, a $0.5 million increase in accounting-related
services, a $0.5 million increase in rent and occupancy-related expenses and a $0.4 million increase in stock-based
compensation expense. These increases were partially offset by a $0.5 million decrease in computer related supplies and a $0.2
million decrease in travel expenses.
Interest income and other income (expense), net
Interest income
Other income (expense), net
Fiscal Year
2009
2008
$ Change
% Change
1,981
198
($ amounts in 000's)
2,614
1,710
(633)
(1,512)
(24.2)
(88.4)
The $0.6 million decrease in interest income in fiscal 2009 compared to fiscal 2008 was due to lower interest rates
earned, despite higher balances of cash, cash equivalents and short-term investments. The change in other income (expense),
net for fiscal 2009 was the result of a stronger U.S. dollar compared to the Euro, British Pound and the Canadian dollar in 2008
when compared to 2009.
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Provision for (benefit from) income taxes
Provision for (benefit from) income taxes
Effective tax rate (%)
_________________________
*not meaningful
Fiscal Year
2009
2008
$ Change
% Change
($ amounts in 000's)
(32,666)
(118.7)
1,888
20.4
(34,554)
*
*
Our effective tax rate was negative 118.7% for fiscal 2009, compared to an effective tax rate of 20.4% for fiscal 2008.
The provision for income taxes for fiscal 2009 is comprised primarily of federal, state and foreign income taxes as well as the
release of the valuation allowance. The decrease in the provision for income taxes for fiscal 2009 compared to fiscal 2008 was
attributable to the release of the valuation allowance against our net deferred tax assets. We generated pretax income in fiscal
2009 and 2008. As a result of this positive earnings trend and projected future taxable income, we reversed approximately
$44.2 million of deferred tax asset valuation allowance in fiscal 2009 after having determined that it was more likely than not
that our deferred tax assets would be realized. This reversal resulted in recognition of an income tax benefit totaling $37.8
million.
Quarterly Results of Operations
The following table sets forth our unaudited quarterly statements of operations data for the last eight fiscal quarters.
The information for each of these quarters has been prepared on the same basis as the audited annual financial statements
included elsewhere in this annual report and, in the opinion of management, includes all adjustments, which includes only
normal recurring adjustments, necessary for the fair presentation of the results of operations for these periods. This data should
be read in conjunction with our audited consolidated financial statements and related notes included elsewhere in this annual
report. These quarterly operating results are not necessarily indicative of our operating results for any future period.
54
Table of Contents
Consolidated Statements of
Operations Data:
Revenue:
Product
Services
Ratable product and
services
Total revenue
Cost of revenue:
Product (2)
Services (2)
Ratable product and
services
Total cost of revenue
Total gross profit
Operating expenses:
Research and
development (2)
Sales and marketing (2)
General and
administrative (2)
Total operating expenses
Operating income
Interest income
Other income (expense), net
Income before income taxes
Provision for (benefit from)
income taxes
Net income
Net income (loss) per share
attributable to common
stockholders (3):
Basic
Diluted
Mar 29,
2009
Jun 28,
2009
Three Months Ended
Mar 31,
Dec 31,
2010
2009
Sept 30,
2009 (1)
($ amounts in 000's, except per share amounts)
Jun 30,
2010
19,326
31,573
3,295
54,194
8,305
5,048
1,301
14,654
39,540
9,876
21,763
4,672
36,311
3,229
714
494
4,437
663
3,774
24,451
33,473
3,421
61,345
10,316
5,357
1,306
16,979
44,366
10,534
24,341
4,516
39,391
4,975
535
(282)
5,228
652
4,576
25,550
36,712
3,602
65,864
10,428
5,550
1,455
17,433
48,431
10,797
23,468
4,490
38,755
9,676
428
(64)
10,040
29,359
37,414
3,939
70,712
13,117
6,310
1,482
20,909
49,803
10,988
26,719
4,642
42,349
7,454
304
50
7,808
27,110
38,625
4,060
69,795
11,314
6,468
1,593
19,375
50,420
11,934
26,723
5,059
43,716
6,704
268
(250)
6,722
2,151
7,889
(36,132)
43,940
2,504
4,218
31,037
40,964
4,330
76,331
11,822
6,818
1,525
20,165
56,166
12,676
27,777
5,933
46,386
9,780
399
87
10,266
3,397
6,869
Sept 30,
2010
Dec 31,
2010
35,913
44,527
4,531
84,971
13,263
6,565
1,615
21,443
63,528
12,389
26,987
5,993
45,369
18,159
514
(402)
18,271
4,254
14,017
41,080
47,930
4,589
93,599
15,545
7,116
1,562
24,223
69,376
12,802
30,481
5,395
48,678
20,698
634
(250)
21,082
4,941
16,141
(0.07)
(0.07)
—
—
0.11
0.10
1.02
0.62
0.06
0.06
0.10
0.09
0.20
0.18
0.22
0.20
_____________________________
(1)
Our transition to a calendar year and quarters beginning in the third quarter of fiscal 2009 had the effect of increasing the number of days in fiscal
2009 by four days relative to fiscal 2010.
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Table of Contents
(2)
Includes stock-based compensation expense and asset acquisition related write-offs as follows:
Three Months Ended
Mar 29,
2009
Jun 28,
2009
Sept 30,
2009
Dec 31,
2009
Mar 31,
2010
Jun 30,
2010
Sept 30,
2010
Dec 31,
2010
24
124
378
644
27
172
498
692
($ amounts in 000's)
25
169
516
767
26
193
571
917
24
208
554
866
26
234
587
897
380
1,550
404
1,793
459
1,936
475
2,182
496
2,148
520
2,264
26
242
600
1,017
549
2,434
25
245
598
1,030
571
2,469
—
631
93
1,663
—
—
—
—
1,550
2,424
2,029
3,845
2,148
2,264
2,434
2,469
Cost of product revenue
Cost of services revenue
Research and
development
Sales and marketing
General and
administrative
Total stock-based compensation
Asset acquisition related
write-offs
Total stock based compensation
and asset acquisition related
write-offs
_______________________________________________
(3)
See Note 7 to the Consolidated Financial Statements.
Seasonality, Cyclicality and Quarterly Revenue Trends
Our quarterly results reflect seasonality in the sale of our products, subscriptions and services. In general, a pattern of
increased customer buying at year-end has positively impacted sales activity in the fourth quarter. In the first quarter we
generally experience lower sequential billings and product revenues, which results in lower product revenue. Our product
revenue in the third quarter can be negatively affected by reduced economic activity in Europe during the summer months.
During fiscal 2010, the growth in the Americas during the third quarter more than offset the slight decline in Europe, but this
may not always be the case. Similarly, our gross margins and operating income have been affected by these historical trends
because expenses are relatively fixed in the near-term. Although these seasonal factors are 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 a quarter. We believe this is due to customer buying patterns typical in this industry.
Our total quarterly revenue over the past twelve quarters has increased sequentially in every quarter except for the first
quarters of fiscal 2010 and fiscal 2009. We believe these declines in the first and third quarters of fiscal 2010 are based on
seasonality as discussed above, which particularly impacts our product revenue. Product revenue in all of the quarters of fiscal
2010 was higher as compared to the same periods in fiscal 2009, which we believe was due in part to the investments made in
our sales organization and improvements in overall corporate IT spending.
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Table of Contents
Consolidated Statements of
Operations Data:
Revenue:
Product
Services
Ratable product and
services
Total revenue
As a percentage of revenue:
Revenue (%):
Product
Services
Ratable product and
services
Total revenue
Quarterly Gross Margin Trend
Mar 29,
2009
Jun 28,
2009
Sept 30,
2009
Three Months Ended
Mar 31,
Dec 31,
2010
2009
($ amounts in 000's)
Jun 30,
2010
Sept 30,
2010
Dec 31,
2010
19,326
31,573
3,295
54,194
24,451
33,473
3,421
61,345
25,550
36,712
3,602
65,864
29,359
37,414
3,939
70,712
27,110
38,625
4,060
69,795
31,037
40,964
4,330
76,331
35,913
44,527
4,531
84,971
41,080
47,930
4,589
93,599
35.7
58.3
6.0
100.0
39.9
54.6
5.5
100.0
38.8
55.7
5.5
100.0
41.5
52.9
5.6
100.0
38.8
55.3
5.9
100.0
40.7
53.7
5.6
100.0
42.3
52.4
5.3
100.0
43.9
51.2
4.9
100.0
Gross margin has fluctuated on a quarterly basis primarily due to shifts in the mix of sales between products and
services, types of products sold and the average selling prices of our products. Product gross margins in the fourth quarter of
fiscal 2009 decreased due to asset acquisition related costs of $1.7 million. Services gross margins have increased or remained
relatively flat, with minor fluctuations, from the first quarter of fiscal 2009 through the fourth quarter of fiscal 2010 due to
higher revenue and a larger customer base over which to spread related costs. We experienced a slight decrease in services
gross margins during the fourth quarter of fiscal 2009 and first two quarters of fiscal 2010 due to an increase in headcount as
we invested in support personnel.
Mar 29,
2009
Jun 28,
2009
Sept 30,
2009
Three Months Ended
Mar 31,
Dec 31,
2010
2009
Jun 30,
2010
Sept 30,
2010
Dec 31,
2010
Gross Margin by
Component of Revenue:
Gross margin (%):
Product
Services
Ratable product and
services
Total gross margin
57.0
84.0
60.5
73.0
57.8
84.0
61.8
72.3
59.2
84.9
59.6
73.5
55.3
83.1
62.4
70.4
58.3
83.3
60.8
72.2
61.9
83.4
64.8
73.6
63.1
85.3
64.4
74.8
62.2
85.2
66.0
74.1
Mar 29,
2009
Jun 28,
2009
Sept 30,
2009
Three Months Ended
Mar 31,
Dec 31,
2010
2009
Jun 30,
2010
Sept 30,
2010
Dec 31,
2010
Reconciliation of GAAP to
non-GAAP gross margin:
GAAP Gross margin (%):
Stock-based
compensation
Asset acquisition-
related write-offs
Non-GAAP gross margin
73.0
0.3
—
73.3
72.3
0.3
1.0
73.6
70.4
0.3
2.4
73.1
72.2
0.4
—
72.6
73.6
0.3
—
73.9
74.8
0.3
—
75.1
74.1
0.3
—
74.4
73.5
0.3
0.1
73.9
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Table of Contents
Liquidity and Capital Resources
Cash and cash equivalents
Investments
Total cash, cash equivalents and investments
Working capital
Cash provided by operating activities
Cash provided by (used in) investing activities
Cash provided by financing activities
Effect of exchange rates on cash and cash equivalents
Net increase (decrease) in cash and cash equivalents
2010
As of Fiscal Year End
2009
($ amounts in 000's)
2008
66,859
320,601
387,460
201,776
212,458
47,856
260,314
161,652
56,571
67,619
124,190
38,193
2010
Fiscal Year
2009
($ amounts in 000's)
2008
103,383
(283,710)
34,019
709
(145,599)
61,971
13,757
78,049
2,110
155,887
37,686
(53,706)
2,117
(937)
(14,840)
At December 31, 2010, our cash, cash equivalents, and investments of $387.5 million were held for working-capital
purposes and were invested primarily in money market funds, commercial paper, corporate debt securities and U.S. government
debt securities. We do not enter into investments for trading or speculative purposes. We believe that our existing cash and cash
equivalents will be sufficient to meet our anticipated cash needs for at least the next twelve months. Our future capital
requirements will depend on many factors including our growth rate, the timing and extent of spending to support development
efforts, the expansion of sales and marketing activities, the introduction of new and enhanced products and services offerings,
the costs to ensure access to adequate manufacturing capacity and the continuing market acceptance of our products. In the
event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us or at
all. If we are unable to raise additional capital when desired, our business, operating results and financial condition would be
adversely affected.
Net income
Adjustments for non-cash charges (1)
Net income before non-cash charges
Increase in deferred revenue
Increase (decrease) in income tax payable and deferred tax assets, net
Increase in accrued payroll and compensation
Increase (decrease) in accounts payable and accrued liabilities, net
Increase in accounts receivable
Increase in inventories
Increase in prepaid expenses and other assets, net
(Increase) decrease in deferred cost of revenues
Net cash provided by operating activities
2010
Fiscal Year
2009
($ amounts in 000's)
2008
41,245
16,593
57,838
50,701
11,739
5,465
4,800
(17,784)
(5,946)
(3,794)
364
103,383
60,179
(15,166)
45,013
30,313
(6,996)
630
5,203
(8,508)
(2,012)
(609)
(1,063)
61,971
7,363
9,574
16,937
40,363
(1,936)
5,030
(2,644)
(18,350)
(189)
(294)
(1,231)
37,686
____________________
(1)
Non-cash charges primarily consist of stock-based compensation expense, depreciation and amortization, write-off of intangible assets, gain on
disposal of fixed assets, amortization of investment premiums, excess tax benefit from employee stock option plans, and reversal of the valuation in
fiscal 2009.
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Table of Contents
Operating Activities
In fiscal 2010, operating activities provided $103.4 million in cash as a result of our strong performance primarily
driven by billings growth, profitability, and the ability to successfully manage our working capital. Net income was $41.2
million, increased by non-cash adjustments of $16.6 million and sources of cash of $73.1 million partially offset by uses of
cash of $27.5 million. Non-cash adjustments consist of stock-based compensation expense of $9.3 million, amortization of
investment premiums of $7.3 million, and depreciation and amortization of $5.7 million, partially offset by an excess tax
benefit from employee stock option plans of $5.7 million. Sources of cash were related to a $50.7 million increase in deferred
revenue which was attributable primarily to increased sales of our subscription and support services, which have yet to be
recognized in income, an $11.7 million increase in income tax payable and deferred tax assets, due to our continued
profitability and timing of tax payments (cash paid for taxes was $2.5 million), a $5.5 million increase in accrued payroll and
compensation primarily related to increased headcount and employer taxes related to the exercise of stock options, a $4.8
million increase in accrued liabilities and accounts payable, related to timing of payments, and a $0.4 million decrease in
deferred cost of revenues. Uses of cash were related to a $17.8 million increase in accounts receivable due to the overall growth
of our business with days sales outstanding remaining flat (70 days), a $5.9 million increase in inventory primarily to support
new product releases in the latter part of the year combined with the overall growth of our business, and a $3.8 million increase
in prepaid expenses and other assets. Days sales outstanding is calculated as the ratio of ending accounts receivable, net of
allowances, divided by average daily sales for the preceding 90 days.
In fiscal 2009, operating activities provided $62.0 million in cash as a result of net income of $60.2 million, decreased
by non-cash adjustments of $15.2 million, increased by sources of cash of $36.1 million, and partially offset by uses of cash of
$19.2 million. Non-cash adjustments consist of a tax benefit from the release of our valuation allowance of $30.2 million and
excess tax benefit from employee stock option plans of $1.6 million, offset by stock-based compensation of $7.5 million,
depreciation and amortization of $5.9 million, write-off of intangible assets of $2.4 million, and amortization of investment
premiums of $0.8 million. Sources of cash were related to a $30.3 million increase in deferred revenue which was attributable
primarily to increased sales of our subscription and support services, a $5.2 million increase in accounts payable and accrued
liabilities due to timing of payments, and a $0.6 million increase in accrued payroll and compensation primarily related to
increased headcount. Uses of cash were related to an $8.5 million increase in accounts receivable due to the overall growth of
our business with days sales outstanding remaining flat (69 days), a $7.0 million decrease in income tax payable and deferred
tax assets, a $2.0 million increase in inventory, a $1.1 million increase in deferred cost of revenues and a $0.6 million increase
in prepaid expenses and other assets.
In fiscal 2008, operating activities provided $37.7 million in cash as a result of net income of $7.4 million, increased
by non-cash adjustments of $9.6 million, sources of cash of $45.4 million, partially offset by uses of cash of $24.6 million.
Non-cash adjustments consist of stock-based compensation expense of $5.3 million and depreciation and amortization costs of
$4.3 million. Sources of cash were related to a $40.4 million increase in deferred revenue, which was attributable to increased
sales of our subscription and support services, and a $5.0 million increase in accrued payroll and compensation primarily
related to increased headcount. Uses of cash were related to a $18.4 million increase in accounts receivable due to the overall
growth of our business and a 13 day increase (from 57 to 70 days) in days sales outstanding due to slower customer payments,
a $2.6 million decrease in accounts payable and accrued liabilities, related to timing of payments, a $1.9 million decrease in
income tax payable and deferred tax assets, a $1.2 million increase in deferred cost of revenues related to the increase in ratable
products and services deferred revenue, a $0.3 million increase in prepaid expenses and other assets, and a $0.2 million
increase in inventory.
Investing Activities
In fiscal 2010, our investing activities consisted primarily of purchases and sales of investments, and to a much lesser
extent, capital expenditures. The $283.7 million of cash used by investing activities was due to net purchases of investments of
$280.0 million reflecting primarily the transfer of funds from money market to corporate bonds, agency notes and commercial
paper during the period. This was offset by $3.8 million used for capital expenditures.
In fiscal 2009, our investing activities consisted primarily of purchases and sales of investments associated with our
investment balances and capital expenditures. The $13.8 million of cash provided by investing activities was due primarily to
net maturities of short-term investments of $18.9 million. Additionally, we used cash of $4.6 million for capital expenditures
and $0.5 million for the purchase of certain technology assets.
In fiscal 2008, the $53.7 million of cash used in investing activities was due primarily to $48.8 million in net
purchases of investments. Additionally, we used cash of $2.8 million for capital expenditures, $1.0 million for the purchase of
assets from IPLocks and $1.0 million for the purchase of certain other technology assets.
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Financing Activities
In fiscal 2010, our financing activities resulted in net cash provided of $34.0 million as a result of receiving proceeds
of $29.1 million from the exercise of stock options and warrants to purchase our common stock and an excess tax benefit from
employee stock option plans of $5.8 million related to option exercises, partially offset by $0.9 million of issuance costs paid in
connection with our initial public offering, which had been accrued as of December 31, 2009.
In fiscal 2009, our financing activities resulted in net cash provided of $78.0 million as a result of receiving proceeds
of $91.5 million, net of issuance costs paid of $3.3 million, from the sale of common stock in connection with our initial public
offering in November 2009. In addition, we received proceeds of $4.0 million from the exercise of stock options and warrants
to purchase our common stock and had an in excess tax benefit from employee stock option plans of $1.6 million, all partially
offset by $15.8 million related to the repurchase of our preferred and common stock in the first half of fiscal 2009.
In fiscal 2008, our financing activities related to proceeds of $2.1 million, as a result of exercises of stock options to
purchase our common stock.
Contractual Obligations and Commitments
The following summarizes our contractual obligations as of December 31, 2010:
Operating leases (1)
Purchase commitments (2)
Royalty commitments (3)
Total (4)
Payments Due by Period
Total
Less Than
1 Year
1-3
Years
4-5
Years
More Than
5 Years
20,438
18,566
4,000
43,004
($ amounts in 000's)
7,493
18,566
1,000
27,059
11,636
—
2,500
14,136
1,309
—
500
1,809
—
—
—
—
________________________
(1)
(2)
(3)
Consists of contractual obligations from non-cancelable office space under operating leases.
Consists of minimum purchase commitments with independent contract manufacturers.
Consists of minimum royalties claimed by Trend Micro pursuant to the January 2006 settlement and license agreement between Trend and Fortinet,
which are subject to dispute. See “Item 3—Legal Proceedings.” We have accrued a total payment including interest of $4.3 million as of
December 31, 2010, related to amounts under the settlement and license agreement with Trend Micro which have not been paid pursuant to the
dispute.
No amounts related to ASC 740-10 (FIN 48) are included. As of December 31, 2010, we had approximately $11.2 million of 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.
(4)
Off-Balance Sheet Arrangements
During fiscal 2010, 2009 and 2008, 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.
Recent Accounting Pronouncements
See Note 1 of Notes to Consolidated Financial Statements for recent accounting pronouncements that could have an
effect on us.
ITEM 7A.
Quantitative and Qualitative Disclosures about Market Risk
Interest Rate Fluctuation Risk
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 and short-term investments in a variety of securities, including commercial paper, money
market funds, government and corporate debt securities and certificates of deposit. The risk associated with fluctuating interest
60
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rates is limited to our investment portfolio. A 10% decrease in interest rates in 2010, 2009 and 2008 would have resulted in a
decrease in our interest income of approximately $0.2 million, $0.2 million and $0.3 million, respectively.
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 U.S.
are denominated in foreign currencies and are subject to fluctuations due to changes in foreign currency exchange rates,
particularly changes in the Canadian Dollar (CAD), Euro (EUR), British Pound (GBP), and Japanese Yen (JPY). To help
protect against significant fluctuations in the value and the volatility of future cash flows caused by changes in currency
exchange rates, we engage in foreign currency risk management activities to hedge balance sheet items denominated in EUR,
GBP, and CAD, and occasionally to hedge future forecasted cash outflows denominated in EUR. 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 creditworthiness of these parties. These contracts typically have maturities between one and three months. We account for
our hedges under ASC 815 Derivatives and Hedging. We record changes in the fair value of forward exchange contracts related
to balance sheet accounts as other income (expense), net in the consolidated statement of operations. Gains or losses resulting
from settled forward exchange contracts related to future forecasted cash outflows are recorded in operating expenses in the
consolidated statement of operations, in the same period the hedged items occur. Gains or losses resulting from unsettled
forward exchange contracts related to future forecasted cash outflows are recorded in other comprehensive income in the
consolidated balance sheet. We recognized an expense of $0.8 million in other income (expense), net in fiscal 2010 due to
foreign currency transaction losses.
Our hedging activities are intended to reduce, but not eliminate, the impact of currency exchange rate movements. As
our hedging activities are relatively short-term in nature, long-term material changes in the value of the U.S. dollar versus the
EUR, GBP, CAD, or JPY could adversely impact our operating expenses in the future.
Inflation Risk
Our monetary assets, consisting primarily of cash, cash equivalents and short-term investments, are not affected
significantly by inflation because they are 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.
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ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Stockholders’ Equity (Deficit) and Comprehensive Income
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Page
63
64
65
66
67
68
The supplementary financial information required by this Item 8 is included in Item 7 under the caption “Quarterly Results of
Operations.”
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Table of Contents
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of
Fortinet, Inc.
Sunnyvale, California
We have audited the accompanying consolidated balance sheets of Fortinet, Inc. and subsidiaries (the "Company") as
of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders' equity (deficit) and
comprehensive income, and cash flows for each of the three years in the period ended December 31, 2010. Our audits also
included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of
Fortinet Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in
the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic
consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the Company's internal control over financial reporting as of December 31, 2010, based on the criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission
and our report dated February 24, 2011 expressed an unqualified opinion on the Company's internal control over financial
reporting.
/s/ Deloitte & Touche LLP
San Jose, California
February 24, 2011
63
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ASSETS
CURRENT ASSETS:
FORTINET, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(in thousands, except per share amounts)
December 31,
2010
December 31,
2009
$
66,859
246,651
$
72,336
13,517
8,158
8,849
3,788
420,158
7,056
37,443
5,543
73,950
1,272
545,422
12,761
16,303
19,670
169,648
218,382
82,983
11,603
312,968
$
$
212,458
47,856
54,551
10,649
9,652
3,100
3,951
342,217
6,387
31,671
5,743
—
1,195
387,213
10,987
15,050
13,991
140,537
180,565
61,393
2,803
244,761
75
251,920
(2,995)
2,181
(18,727)
232,454
545,422
$
67
204,268
(2,995)
1,084
(59,972)
142,452
387,213
Cash and cash equivalents
Short-term investments
Accounts receivable, net of allowance for doubtful accounts of $303 and $367 at
December 31, 2010 and December 31, 2009, respectively
Inventory
Deferred tax asset
Prepaid expenses and other current assets
Deferred cost of revenues
Total current assets
PROPERTY AND EQUIPMENT—Net
DEFERRED TAX ASSET—Non-current
DEFERRED COST OF REVENUES
LONG-TERM INVESTMENTS
OTHER ASSETS
TOTAL ASSETS
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable
Accrued liabilities
Accrued payroll and compensation
Deferred revenue
Total current liabilities
DEFERRED REVENUE—Non-current
OTHER NON-CURRENT LIABILITIES
Total liabilities
COMMITMENTS AND CONTINGENCIES (Note 9)
STOCKHOLDERS’ EQUITY:
Common stock, $0.001 par value — 300,000 shares authorized; 75,085 and 67,517 shares
issued and 74,381 and 66,813 shares outstanding at December 31, 2010 and December 31,
2009, respectively
Additional paid-in-capital
Treasury stock
Accumulated other comprehensive income
Accumulated deficit
Total stockholders’ equity
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
See notes to consolidated financial statements.
64
$
$
$
Table of Contents
FORTINET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
Fiscal Year
2010
2009
2008
REVENUE:
Product
Services
Ratable product and services
Total revenue
COST OF REVENUE:
Product
Services
Ratable product and services
Total cost of revenue
GROSS PROFIT:
Product
Services
Ratable product and services
Total gross profit
OPERATING EXPENSES:
Research and development
Sales and marketing
General and administrative
Total operating expenses
OPERATING INCOME
INTEREST INCOME
OTHER INCOME (EXPENSE)—Net
INCOME BEFORE INCOME TAXES
PROVISION FOR (BENEFIT FROM) INCOME TAXES
NET INCOME
Net income per share attributable to common stockholders
(Note 7):
Basic
Diluted
Weighted-average shares outstanding:
Basic
Diluted
$
$
$
$
$
135,140
172,046
17,510
324,696
$
98,686
139,172
14,257
252,115
51,944
26,967
6,295
85,206
83,196
145,079
11,215
239,490
49,801
111,968
22,380
184,149
55,341
1,815
(815)
56,341
15,096
41,245
0.59
0.53
70,363
78,203
$
$
$
42,166
22,265
5,544
69,975
56,520
116,907
8,713
182,140
42,195
96,291
18,320
156,806
25,334
1,981
198
27,513
(32,666)
60,179
1.93
0.78
26,334
65,219
$
$
$
94,587
105,292
11,912
211,791
41,397
19,441
4,634
65,472
53,190
85,851
7,278
146,319
37,035
87,717
16,640
141,392
4,927
2,614
1,710
9,251
1,888
7,363
0.02
0.02
20,017
26,642
See notes to consolidated financial statements.
65
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FORTINET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT) AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
(in thousands)
Convertible
Preferred Stock
Common Stock
Treasury Stock
Shares
Amount
Shares
Amount
Shares
Amount
Additional
Paid-In-
Capital
Accumulated
Other
Comprehensive
Income (loss)
Accumulated
Deficit
Total
Stockholders’
Equity
(Deficit)
Comprehensive
Income (loss)
BALANCE—December 30, 2007
40,480
$ 94,368
19,277
$
Exercise of stock options
Stock-based compensation
Net unrealized gain on investments—net of taxes
Net change in cumulative translation adjustments
Net income
Comprehensive income
BALANCE—December 28, 2008
Repurchase of convertible preferred shares
Repurchase of common shares
Convertible preferred shares converted to common
shares in connection with initial public offering
Proceeds from initial public offering, net of issuance
costs
Exercise of warrants
Exercise of stock options
Proceeds from issuance of common stock
Warrants issued
Stock-based compensation
Excess tax benefit from employee stock option plans
Net unrealized gain on investments—net of taxes
Net change in cumulative translation adjustments
Net income
Comprehensive income
BALANCE—December 31, 2009
Exercise of stock options and warrants
Stock-based compensation
Excess tax benefit from employee stock option plans
Net unrealized gain on investments - net of taxes
Net unrealized gain on derivatives qualifying as
cash flow hedges
Net change in cumulative translation adjustments
Net income
Comprehensive income
BALANCE—December 31, 2010
—
—
—
—
—
—
—
—
—
—
—
—
1,443
—
—
—
—
—
40,480
94,368
20,720
(3,004)
(3,183)
—
—
—
—
(37,476)
(91,185)
37,476
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
$
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
7,657
150
1,414
100
—
—
—
—
—
—
—
67,517
7,568
—
—
—
—
—
—
—
75,085
$
20
1
—
—
—
—
—
21
—
—
37
8
—
1
—
—
—
—
—
—
—
—
67
8
—
—
—
—
—
—
—
75
$
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(704)
(2,995)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
(704)
(2,995)
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
$
13,418
$
783
$
2,116
5,299
—
—
—
—
20,833
(9,585)
—
91,148
87,380
1,875
2,695
162
725
7,461
1,574
—
—
—
—
204,268
29,102
9,315
9,235
—
—
—
—
—
—
—
65
(1,148)
—
—
(300)
—
—
—
—
—
—
—
—
—
—
(33)
1,417
—
—
1,084
—
—
—
98
74
925
—
—
(704)
$ (2,995)
$
251,920
$
2,181
$
See notes to consolidated financial statements.
66
(18,925)
2,117
5,299
65
(1,148)
7,363
—
(5,229)
(12,768)
(2,995)
—
87,388
1,875
2,696
162
725
7,461
1,574
(33)
1,417
$
$
$
60,179
—
$
142,452
29,110
9,315
9,235
98
74
925
41,245
(127,514)
—
$
—
—
—
7,363
—
(120,151)
—
—
—
—
—
—
—
—
—
—
—
—
60,179
—
(59,972)
—
—
—
—
—
—
41,245
—
(18,727)
—
$
$
232,454
65
(1,148)
7,363
6,280
(33)
1,417
60,179
61,563
98
74
925
41,245
42,342
Table of Contents
FORTINET, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income
Adjustments to reconcile net income to net cash provided by operating activities:
Fiscal Year
2010
2009
2008
$
41,245
$
60,179
$
7,363
Depreciation and amortization
Write-off of intangible assets
Gain on disposal of fixed assets
Amortization of investment premiums
Stock-based compensation
Excess tax benefit from employee stock option plans
Income tax benefit from release of valuation allowance
Changes in operating assets and liabilities:
Accounts receivable—net
Inventory
Deferred tax assets
Prepaid expenses and other current assets
Deferred cost of revenues
Other assets
Accounts payable
Accrued liabilities
Accrued payroll and compensation
Deferred revenue
Income taxes payable
CASH FLOWS FROM INVESTING ACTIVITIES:
Net cash provided by operating activities
Purchase of investments
Maturities and sales of investments
Purchase of property and equipment
Payments made in connection with asset acquisition, net
Change in restricted cash
CASH FLOWS FROM FINANCING ACTIVITIES:
Net cash provided by (used in) investing activities
Proceeds from exercise of stock options and warrants
Proceeds from initial public offering
Offering costs paid in connection with initial public offering
Repurchase of convertible preferred shares
Repurchase of common shares
Excess tax benefit from employee stock option plans
Net cash provided by financing activities
EFFECT OF EXCHANGE RATES ON CASH AND CASH EQUIVALENTS
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
CASH AND CASH EQUIVALENTS—Beginning of period
CASH AND CASH EQUIVALENTS—End of period
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for taxes
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Purchase of property and equipment not yet paid
Accrued offering costs not yet paid
5,696
—
14
7,349
9,315
(5,781)
—
(17,784)
(5,946)
(4,278)
(3,849)
364
55
2,437
2,363
5,465
50,701
16,017
103,383
(416,376)
136,380
(3,776)
—
62
(283,710)
29,110
—
(872)
—
—
5,781
34,019
709
(145,599)
212,458
66,859
2,483
135
—
$
$
$
$
5,935
2,387
—
836
7,461
(1,574)
(30,211)
(8,508)
(2,012)
(9,578)
(190)
(1,063)
(419)
3,046
2,157
630
30,313
2,582
61,971
(137,231)
156,126
(4,589)
(549)
—
13,757
3,978
91,565
(3,305)
(12,768)
(2,995)
1,574
78,049
2,110
155,887
56,571
212,458
4,746
849
872
$
$
$
$
$
$
$
$
4,234
—
—
41
5,299
—
—
(18,350)
(189)
205
(214)
(1,231)
(80)
(1,864)
(780)
5,030
40,363
(2,141)
37,686
(80,588)
31,742
(2,798)
(2,000)
(62)
(53,706)
2,117
—
—
—
—
—
2,117
(937)
(14,840)
71,411
56,571
3,615
67
—
See notes to consolidated financial statements.
67
Table of Contents
FORTINET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business—Fortinet, Inc. (“Fortinet”) was incorporated in Delaware in November 2000 and is a leading provider of
network security appliances and UTM network security solutions to enterprises, service providers and government entities
worldwide. Fortinet’s solutions are designed to integrate multiple levels of security protection, including firewall, virtual
private networking, antivirus, intrusion prevention, web filtering, antispam and WAN acceleration.
Initial Public Offering—In November 2009, we completed our initial public offering, whereby 14,375,000 million
shares of common stock were sold to the public at a price of $12.50 per share. We sold 7,656,683 shares of common stock and
selling shareholders sold 6,718,317 common shares. We received $87.4 million in net proceeds, comprising of gross proceeds
from shares issued by us in the initial public offering of $95.7 million plus an administrative fee reimbursement of $1.7 million,
offset by underwriting discount of $6.7 million and total offering costs of $3.3 million. Upon the closing of the initial public
offering, all shares of convertible preferred stock outstanding automatically converted into 37,476,035 shares of common stock.
Basis of Presentation and Preparation—The consolidated financial statements include the accounts of Fortinet and
its wholly owned subsidiaries (collectively, the “Company,” “we,” “us” or “our”). All intercompany transactions and balances
have been eliminated in consolidation. Beginning 2005 fiscal year, we adopted a 52- to 53-week year ending on the Sunday
closest to December 31 of each year. Commencing in the third quarter of fiscal 2009, we began operating and reporting
financial results on a calendar quarter and year basis. Our 2009 fiscal year ended on December 31, 2009. Fiscal 2010 and 2009
were comprised of 365 days and 368 days, respectively.
Use of Estimates—The preparation of consolidated financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of
revenues and expenses during the reporting period. Such management estimates include implicit service periods for revenue
recognition, litigation and settlement costs and other loss contingencies, sales returns and allowances, reserve for bad debt,
inventory write-offs, reserve for warranty costs, valuation of deferred tax assets, and tangible and intangible assets. We base our
estimates on historical experience and also on assumptions that we believe are reasonable. Actual results could differ from
those estimates.
Certain Significant Risks and Uncertainties—We are subject to certain risks and uncertainties that could have a
material adverse effect on our future financial position or results of operations, such as the following: changes in level of
demand for our products and services, seasonality, the timing of new product introductions, price and sales competition and our
ability to adapt to changing market conditions and dynamics, changes in the expenses caused, for example, by fluctuations in
foreign currency exchange rates, management of inventory, internal control over financial reporting, market acceptance of our
new products and services, demand for UTM products and services in general, failure of our channel partners to perform, the
quality of our products and services, general economic conditions, challenges in doing business outside of the United States of
America, changes in customer relationships, litigation, or claims against us based on intellectual property, patent, product
regulatory or other factors (Note 9), product obsolescence, and our ability to attract and retain qualified employees.
We rely on sole suppliers and independent contract manufacturers for certain of our components and one third-party
logistics company for certain distribution of our products. The inability of any of these parties to fulfill our supply and logistics
requirements could negatively impact our future operating results.
Concentration of Credit Risk—Financial instruments that subject us to concentrations of credit risk consist primarily
of cash, cash equivalents, short-term investments, and accounts receivable. We maintain our cash and cash equivalents in fixed
income securities with major financial institutions, which our management assesses to be of high credit quality, in order to limit
the exposure of each investment. Deposits held with banks may exceed the amount of insurance provided on such deposits.
Credit risk with respect to accounts receivable in general is diversified due to the number of different entities
comprising our customer base and their location throughout the world. We perform ongoing credit evaluations of our customers
and generally do not require collateral on accounts receivable. We maintain reserves for estimated potential credit losses.
At December 31, 2010, no single distributor customer accounted for more than 10% of net accounts receivable. At
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FORTINET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
December 31, 2009, one distributor customer accounted for 15% of net accounts receivable.
During fiscal 2010, no single distributor customer accounted for more than 10% of total net revenues. During fiscal
2009 and fiscal 2008, one distributor customer accounted for 12% of total net revenues for each fiscal year.
Financial Instruments and Fair Value—We apply fair value accounting for all financial assets and liabilities and
non-financial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a recurring basis.
Due to their short-term nature, the carrying amounts reported in the consolidated financial statements approximate the fair
value for accounts receivable, accounts payable, accrued compensation, and other current liabilities.
Comprehensive Income (Loss)—ASC 220 (formerly referred to as SFAS No. 130, Reporting Comprehensive
Income) establishes standards for the reporting and displaying of comprehensive income and its components. Comprehensive
income includes certain changes in equity from non-owner sources that are excluded from net income. Specifically, cumulative
foreign currency translation adjustments, unrealized gains and losses on available-for-sale investments, and unrealized gains
and losses on derivatives are included in comprehensive income in stockholders' equity.
Foreign Currency Translation—Assets and liabilities of foreign subsidiaries are translated into U.S. dollars using the
exchange rates in effect at the balance sheet dates and revenue and expenses are translated using average exchange rates during
the period. The resulting foreign translation adjustments are recorded in accumulated other comprehensive income (loss).
Foreign currency transaction gains (losses) of $(0.8) million, $0.1 million and $1.4 million, are included in other income
(expense), net for fiscal 2010, 2009 and 2008, respectively.
Cash, Cash Equivalents and Available-for-sale Investments—We consider all highly liquid investments, purchased
with original maturities of three months or less, to be cash equivalents. Cash and cash equivalents consist of cash on-hand,
balances with banks, and highly liquid investments in money market funds, commercial paper, government securities,
certificates of deposit, and corporate debt securities.
We classify our investments as available-for-sale at the time of purchase since it is our intent that these investments are
available for current operations, and include these investments on our balance sheet as either short-term or long-term
investments depending on their maturity at the time of purchase. Investments with original maturities greater than three months
that mature less than one year from the consolidated balance sheet date are classified as short-term investments. Investments
with maturities greater than one year from the consolidated balance sheet date are classified as long-term investments.
Investments are considered to be impaired when a decline in fair value is judged to be other-than-temporary. We
consult with our investment managers and consider available quantitative and qualitative evidence in evaluating potential
impairment of our investments on a quarterly basis. If the cost of an individual investment exceeds its fair value, we evaluate,
among other factors, general market conditions, the duration and extent to which the fair value is less than cost, and our intent
and ability to hold the investment. Once a decline in fair value is determined to be other-than-temporary, an impairment charge
is recorded and a new cost basis in the investment is established.
For debt securities in an unrealized loss position which are deemed to be other-than-temporary, the difference between
the security's then-current amortized cost basis and fair value is separated into (i) the amount of the impairment related to the
credit loss (i.e., the credit loss component) and (ii) the amount of the impairment related to all other factors (i.e., the non-credit
loss component). The credit loss component is recognized in earnings. The non-credit loss component is recognized in
accumulated other comprehensive loss.
Inventory—Inventory is recorded at the lower of cost (using the first-in, first-out method) or market, after we give
appropriate consideration to obsolescence and inventory in excess of anticipated future demand. In assessing the ultimate
recoverability of inventory, we are required to 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 additional inventory write-downs, which could have an adverse impact on our gross margins and
profitability.
Deferred Cost of Revenues—Deferred cost of revenues represent the unamortized cost of products associated with
ratable products and services revenue, which is based upon the actual cost of the hardware sold and is recognized over the
service periods of the arrangements. Deferred cost of revenue associated with short-term deferred revenue is classified as short-
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YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
term and deferred cost of revenue associated with long-term deferred revenue is classified as long-term.
Property and Equipment—Property and equipment are stated at cost. Depreciation is computed using the straight-
line method over the estimated useful lives of the assets, generally one to three years. Evaluation units are transferred from
inventory at cost and are amortized over one year from the date of transfer. Leasehold improvements are amortized over the
shorter of the estimated useful lives of the improvements or the lease term.
Impairment of Long-Lived Assets—We evaluate events and changes in circumstances that could indicate carrying
amounts of long-lived assets, including intangible assets, may not be recoverable. When such events or changes in
circumstances occur, we assess the recoverability of long-lived assets by determining whether the carrying value of such assets
will be recovered through undiscounted expected future cash flows. If the total of the future undiscounted cash flows is less
than the carrying amount of those assets, we record an impairment charge in the period in which we make the determination. If
such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying
amount of the assets exceeds the fair value of the assets.
Deferred Revenue—Deferred revenue consists of amounts that have been invoiced but that have not yet been
recognized as revenue.
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 estimating future tax consequences, generally all expected future events other than enactments or
changes in the tax law or rates are considered. We assess the likelihood that some portion or all of our deferred tax assets will
be recovered from future taxable income within the respective jurisdictions, and to the extent we believe that recovery does not
meet the “more-likely-than-not” standard, based solely on its technical merits as of the reporting date, we establish a valuation
allowance. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require
periodic adjustments and which may not accurately anticipate actual outcomes.
We operate in various tax jurisdictions and are subject to audit by various tax authorities. We provide for tax
contingencies whenever it is deemed more likely than not that a tax asset has been impaired or a tax liability has been incurred
for events such as tax claims or changes in tax laws. Tax contingencies are based upon their technical merits, relevant tax law
and the specific facts and circumstances as of each reporting period. Changes in facts and circumstances could result in
material changes to the amounts recorded for such tax contingencies.
Stock-Based Compensation—We apply ASC 718 (formerly referred to as SFAS No. 123R) to our stock option
grants, which requires compensation expense related to share-based transactions, including employee stock options, to be
measured and recognized in the financial statements based on fair value. Under ASC 718, the fair value of each option award is
estimated on the grant date using the Black-Scholes option pricing model.
Advertising Expense—Advertising costs are expensed when incurred and is included in operating expenses in the
accompanying consolidated statements of operations. Our advertising expenses were not significant for any periods presented.
Research and Development Costs—Research and development costs are expensed as incurred.
Software Development Costs—The costs to develop software have not been capitalized as we believe our current
software development process is essentially completed concurrent with the establishment of technological feasibility.
Revenue Recognition—We derive revenue from sales of products, including appliances and software, and services,
including subscription, support and other services. Our appliances include operating system software that is integrated into the
appliance hardware and is deemed essential to its functionality. As a result, we account for revenue in accordance with ASC
985-605 (formerly referred to as Statement of Position 97-2 (SOP 97-2) Software Revenue Recognition), and all related
interpretations.
No revenue can be recognized until all of the following criteria have been met:
•
Persuasive evidence of an arrangement exists. Binding contracts or purchase orders are generally used to
determine the existence of an arrangement.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
•
•
•
Delivery has occurred. Delivery occurs when we fulfill an order and title and risk of loss has been transferred
or upon delivery of the service contract registration code.
The fee is fixed or determinable. We assess whether the fee is fixed or determinable based on the payment
terms associated with the transaction. In the event payment terms differ from our standard business practices,
the fees are deemed to be not fixed or determinable and revenue is recognized when the payments become
due, provided the remaining criteria for revenue recognition have been met.
Collectability is probable. We assess collectability based primarily on creditworthiness as determined by
credit checks and analysis, as well as payment history. Payment terms generally range from 30 to 90 days
from invoice date.
For arrangements which include customer acceptance criteria, no revenue is recognized prior to acceptance. We
recognize product revenue on sales to distributors that have no right of return and end-customers upon shipment of the
appliance, once all other revenue recognition criteria have been met. We also make sales through distributors under agreements
that allow for rights of returns. We recognize product revenue on sales made through such distributors upon sale by the
distributor to the end-customer, at which time the rights of return lapse. Substantially all of our products have been sold in
combination with services which consist of subscriptions and/or support. Subscription services provide access to our antivirus,
intrusion prevention, web filtering, and anti-spam functionality. Support services include rights to unspecified software
upgrades, maintenance releases and patches, telephone and Internet access to technical support personnel, and hardware
support.
We commence our subscription and support services on the date the customer registers the appliance. The customer is
then entitled to service for the stated contractual period beginning on the registration date.
We use the residual method to recognize revenue when an arrangement includes one or more elements to be delivered
at a future date and VSOE of the fair value of all undelivered elements exists. Under the residual method, the fair value of the
undelivered elements is deferred and the remaining portion of the contract fee is recognized as product revenue. In cases where
VSOE of fair value of the undelivered elements does not exist (typically due to a lack of VSOE on the subscription and support
services for that specific arrangement), revenue for the entire arrangement is recognized ratably over the performance period of
the undelivered elements. Revenue related to these arrangements is included in ratable product and services revenue in the
accompanying consolidated statements of operations. VSOE of fair value for elements of an arrangement is based upon the
pricing for those services when sold separately. Revenue for professional services and training is recognized upon completion
of the related services.
We offer certain sales incentives to channel partners. We reduce revenue for estimates of sales returns and allowances.
Additionally, in limited circumstances we may permit end-customers, distributors and resellers to return our products, subject
to varying limitations, for a refund within a reasonably short period from the date of purchase. We estimate and record reserves
for sales incentives and sales returns based on historical experience.
Accounts Receivable—Trade accounts receivable are recorded at the invoiced amount, net of allowances for doubtful
accounts and reserves for sales returns and allowances. The allowance for doubtful accounts is based on our assessment of the
collectability of customer accounts. We regularly review the allowance by considering factors such as historical experience,
credit quality, age of the accounts receivable balances and current economic conditions that may affect a customer's ability to
pay. The reserve for sales returns and allowances is based on specific criteria including agreements to provide rebates and other
factors known at the time, as well as estimates of the amount of goods shipped that will be returned. To determine the adequacy
of the reserves for sales returns and allowances, we analyze historical experience of actual rebates and returns as well as current
product return information.
Warranties—We generally provide a one-year warranty on hardware products and a 90-day warranty on software. A
provision for estimated future costs related to warranty activities is recorded as a component of cost of product revenues when
the product revenues are recognized, based upon historical product failure rates and historical costs incurred in correcting
product failures. In the event we change our warranty reserve estimates, the resulting charge against future cost of sales or
reversal of previously recorded charges may materially affect our gross margins and operating results.
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YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
Accrued warranty activities are summarized as follows ($ amounts in 000's):
Accrued warranty balance—beginning of the period
Warranty costs incurred
Provision for warranty for the year
Accruals related to changes in estimates
Accrued warranty balance—end of the period
Fiscal Year
2010
2009
2008
2,257
(1,337)
1,069
(111)
1,878
2,882
(1,502)
1,169
(292)
2,257
1,744
(1,030)
2,252
(84)
2,882
Foreign Currency Derivatives—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 U.S. are denominated in foreign currencies and are subject to fluctuations due to
changes in foreign currency exchange rates, particularly changes in the CAD, EUR, GBP, and JPY. 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 hedge balance sheet items denominated in EUR, GBP, and CAD, and
occasionally to hedge future forecasted cash outflows denominated in EUR. 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
creditworthiness of these parties. These contracts typically have maturities between one and three months. We account for our
hedges under ASC 815 Derivatives and Hedging. We record changes in the fair value of forward exchange contracts related to
balance sheet accounts as other income (expense), net in the consolidated statement of operations. Gains or losses resulting
from settled forward exchange contracts related to future forecasted cash outflows are recorded in operating expenses in the
consolidated statement of operations, in the same period the hedged item occurs. Gains or losses resulting from unsettled
forward exchange contracts related to future forecasted cash outflows are recorded in other comprehensive income in the
consolidated balance sheet.
Additionally, independent of any hedging activities, fluctuations in foreign currency exchange rates may cause us to
recognize transaction gains and losses in our consolidated statements of operations. Our hedging activities are intended to
reduce, but not eliminate, the impact of currency exchange rate movements. As our hedging activities are relatively short-term
in nature, long-term material changes in the value of the U.S. dollar versus the EUR, GBP, CAD or JPY could adversely impact
our operating expenses in the future.
The notional amount of forward exchange contracts to hedge cash flows associated with operating expenses and
balance sheet accounts as of December 31, 2010 was (amounts in 000's):
To hedge operating cash outflows:
Currency
EUR
To hedge balance sheet accounts:
Currency
EUR
GBP
CAD
Recent Accounting Pronouncements
Buy/Sell
Notional
Buy
2,900
Buy
Buy
Buy
5,012
1,074
10,272
In January 2010, the Financial Accounting Standards Board (FASB) issued revised guidance on disclosures related to
fair value measurements. This guidance requires new disclosures about significant transfers in and out of Level 1 and Level 2
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
and separate disclosures about purchases, sales, issuances, and settlements with respect to Level 3 measurements. The guidance
also clarifies existing fair value disclosures about valuation techniques and inputs used to measure fair value. The new
disclosures and clarifications of existing disclosures are effective for us beginning in the first quarter of 2010, except for the
disclosures about purchases, sales, issuances, and settlements relating to Level 3 measurements, which will be effective for us
in the first quarter of 2011. The adoption of the relevant disclosures related to transfers in and out of Level 1 and Level 2 in the
quarter did not have a material impact on our financial statements and we do not expect the additional disclosures that are
required beginning in the first quarter of fiscal 2011 to have a material impact on our financial statements.
In September 2009, the EITF reached a consensus on ASC 605-25 (formerly referred to as EITF 08-1, Revenue
Arrangements with Multiple Deliverables). ASC 605-25 eliminates the criterion for objective and reliable evidence of fair value
for the undelivered products or services. Instead, revenue arrangements with multiple deliverables should be divided into
separate units of accounting if the deliverables meet both of the following criteria:
•
•
The delivered items have value to the customer on a standalone basis
If the arrangement includes a general right of return relative to the delivered items, delivery or performance
of the undelivered items is considered probable and substantially in the control of the vendor.
ASC 605-25 eliminates the use of the residual method of allocation and requires, instead, that arrangement
consideration be allocated, at the inception of the arrangement, to all deliverables based on their relative selling price (i.e., the
relative selling price method). When applying the relative selling price method, a hierarchy is used for estimating the selling
price for each of the deliverables. The hierarchy establishes that the method for determining estimated selling price should be
chosen in the following order of priority:
•
•
•
VSOE of the selling price;
Third-party evidence (TPE) of the selling price – prices of the vendor’s or any competitor’s largely
interchangeable products or services, in standalone sales to similarly situated customers; and
Best estimate of the selling price.
In September 2009, the FASB reached a consensus on ASC 985-605 (formerly referred to as EITF 09-3, Certain
Revenue Arrangements That Include Software Elements). Arrangements to sell joint hardware and software products where the
software and non-software components function together to deliver the product's essential functionality will no longer be
scoped into software accounting rules, but will be subject to non-software multiple element accounting guidance (ASC
605-25). ASC 985-605 and ASC 605-25 provide a list of items to consider when determining whether the software and non-
software components function together to deliver a product's essential functionality. ASC 985-605 must be adopted for
arrangements entered into beginning January 1, 2011, and may be early-adopted. We will adopt ASC 985-605 and ASC 605-25
in the first quarter of 2011, and are currently evaluating the impact of adoption on our consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
2. FINANCIAL INSTRUMENTS AND FAIR VALUE
The following table summarizes our investments in available-for-sale securities ($ amounts in 000's):
December 31, 2010
Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Fair
Value
Available-for-sale securities:
U.S. government and agency securities
Corporate debt securities
Commercial paper
Municipal bonds
Term deposits
51,989
213,237
38,914
11,069
5,263
Total available-for-sale securities
320,472
—
159
5
11
—
175
(46)
—
—
—
—
(46)
51,943
213,396
38,919
11,080
5,263
320,601
December 31, 2009
Amortized
Cost
Unrealized
Gains
Unrealized
Losses
Fair
Value
Available-for-sale securities:
U.S. government and agency securities
Corporate debt securities
Commercial paper
Municipal bonds
Total available-for-sale securities
2,000
27,279
3,983
14,561
47,823
—
44
—
—
44
(2)
—
—
(9)
(11)
1,998
27,323
3,983
14,552
47,856
The contractual maturities of our investments are as follows ($ amounts in 000's):
Due within one year
Due after one year
Total
December 31,
2010
December 31,
2009
246,651
73,950
320,601
47,856
—
47,856
Available-for-sale securities are reported at fair value, with unrealized gains and losses, net of tax, included as a
separate component of stockholders’ equity (deficit) and in total comprehensive income. Realized gains and losses on
available-for-sale securities are included in other income (expense), net in our consolidated statements of operations.
Realized gains and losses from the sale of available-for-sale securities were not significant in any period presented.
Fair Value Accounting—We apply ASC 820 which establishes a valuation hierarchy for disclosure of the inputs to
fair value measurement. This hierarchy prioritizes the inputs into three broad levels as follows:
Level 1—Inputs are unadjusted quoted prices in active markets for identical assets or liabilities.
Level 2—Inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for
the assets or liabilities, either directly or indirectly through market corroboration, for substantially the full
term of the financial instruments.
Level 3—Inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair
value. The inputs require significant management judgment or estimation.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
The valuation techniques we use to measure the fair value of money market funds were derived from quoted prices in
active markets for identical assets or liabilities. The valuation techniques used to measure the fair value of all other financial
instruments, all of which have counterparties with high credit ratings, were valued based on quoted market prices or model
driven valuations using significant inputs derived from or corroborated by observable market data.
We classify investments within Level 1 if quoted prices are available in active markets.
We classify items in Level 2 if the investments are valued using quoted prices for identical assets in markets that are
not active, using quoted prices for similar assets in an active market, or using model-based valuation techniques for which all
significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full
term of the assets.
The following table presents the fair value of our financial assets as of December 31, 2010 and December 31, 2009
using the ASC 820 input categories:
December 31, 2010
December 31, 2009
Assets:
U.S. government and agency securities
Corporate debt securities
Commercial paper
Municipal bonds
Term deposits
Money market funds
Foreign currency contracts
Total
Reported as:
Cash equivalents
Short-term investments
Prepaid expenses and other current assets
Long-term investments
Total
Aggregate
Fair
Value
51,943
213,396
52,415
11,080
5,263
7,078
74
341,249
20,574
246,651
74
73,950
341,249
Quoted
Prices in
Active
Markets For
Identical
Assets
(Level 1)
Significant
Other
Observable
Remaining
Inputs
(Level 2)
—
—
—
—
5,263
7,078
—
12,341
51,943
213,396
52,415
11,080
—
—
74
328,908
Quoted
Prices in
Active
Markets For
Identical
Assets
(Level 1)
Significant
Other
Observable
Remaining
Inputs
(Level 2)
—
—
—
—
—
179,444
—
179,444
1,998
27,323
3,983
14,552
—
—
—
47,856
Aggregate
Fair
Value
1,998
27,323
3,983
14,552
—
179,444
—
227,300
179,444
47,856
—
—
227,300
Subsequent to the issuance of the 2009 consolidated financial statements, we determined that $41,875 of securities
should be classified as Level 2 investments (rather than Level 1 corporate debt investments as originally classified) as such
investments are not actively traded. Accordingly, we have corrected the classification of corporate debt securities from Level 1
to Level 2 in the table of fair value measurements as of December 31, 2009. In addition, we also identified that municipal
bonds were previously included within corporate debt securities as of December 31, 2009. We have corrected the presentation
by including municipal bonds as a separate category of investments in the fair value table.
We did not hold financial assets or liabilities which were recorded at fair value using inputs in the Level 3 category as
of December 31, 2010 and December 31, 2009.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
3. INVENTORY
Inventory consisted of the following ($ amounts in 000's):
Raw materials
Finished goods
Inventory
December 31,
2010
December 31,
2009
2,593
10,924
13,517
1,904
8,745
10,649
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
4. PROPERTY AND EQUIPMENT—Net
Property and equipment consisted of the following ($ amounts in 000's):
Evaluation units
Computer equipment and software
Furniture and fixtures
Leasehold improvements and tooling
Total property and equipment
Less: accumulated depreciation and amortization
Property and equipment—net
December 31,
2010
December 31,
2009
10,607
9,561
1,087
4,548
25,803
(18,747)
7,056
8,449
8,827
1,191
4,134
22,601
(16,214)
6,387
Depreciation expense was $5.7 million, $5.0 million and $4.3 million in 2010, 2009 and 2008, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
5. ACQUISITIONS
On June 10, 2008, we completed the acquisition of certain technology assets of IPLocks, Inc. (IPLocks), a privately-
held company that provides database security and compliance solutions, for a cash payment of $1.0 million. The total purchase
of the transaction was allocated to IPLocks’ tangible and identifiable intangible assets acquired and liabilities assumed based on
their estimated fair market values as of the acquisition date. The purchase price allocation resulted in purchased net tangible
assets of approximately $153,000 and purchased identifiable intangible assets of approximately $847,000. Identifiable
intangible assets consist of purchased software and technology. The fair value assigned to identifiable intangible assets acquired
is determined using the income approach, which discounts expected future cash flows to present value using estimates and
assumptions determined by us. Purchased identifiable intangible assets are amortized on a straight-line basis over three years.
In the third quarter of 2009, we performed an impairment analysis and determined that the purchased technology assets were
impaired. As a result, we wrote off the remaining net book value of $444,000 associated with these assets. The write-off is
included in cost of product revenue in our consolidated statements of operations for fiscal 2009.
6. INTANGIBLE ASSETS
On July 7, 2009, we acquired certain technology and fixed assets for $0.9 million in cash. We allocated $428,000 to
tangible assets and $472,000 to purchased technology assets. The purchased technology assets were being amortized on a
straight-line basis over the estimated life of the technology. In the fourth quarter of 2009, we performed an impairment
analysis and determined that the purchased technology assets were impaired. As a result, we wrote off the remaining net book
value of $185,000 associated with these assets. The write-off is included in cost of product revenue in our consolidated
statements of operations for fiscal 2009.
On October 23, 2008, we acquired certain technology assets for a warrant to purchase 120,000 shares of our common
stock at an exercise price of $7.47 per share. The warrant expires on October 23, 2011, and was only exercisable subsequent to
the closing of an initial public offering of securities by us. Upon the completion of our initial public offering in November
2009, we recognized the fair value of this warrant as consideration for the purchase of the acquired technology. We allocated
the entire purchase price of $723,000 to the purchased technology assets. In the fourth quarter of fiscal 2009, we performed an
impairment analysis and determined that the purchased technology assets were impaired. As a result, we wrote off the net book
value of $723,000 associated with these assets. The write-off is included in cost of product revenue in our consolidated
statements of operations for fiscal 2009. The warrant remained outstanding as of December 31, 2009. The warrant was
exercised during the fourth quarter of 2010.
On September 22, 2008, we acquired certain technology and fixed assets for a cash payment of $1.0 million and the
issuance of a warrant to purchase 150,000 shares of our common stock at an exercise price of $7.47 per share. The warrant
expires on September 22, 2011 and was only exercisable subsequent to the closing of an initial public offering of securities by
us. We allocated $119,000 to the tangible assets and $881,000 to the purchased technology assets. The purchased technology
assets were being amortized on a straight-line basis over the estimated life of three years. In the second quarter of 2009, we
performed an impairment analysis and determined that the purchased technology assets were impaired. As a result, we wrote
off the remaining net book value of $280,000 associated with these assets, net of escrow reimbursement received of
$351,000. The write-off is included in cost of product revenue in our consolidated statements of operation for fiscal 2009. Upon
the completion of our initial public offering in November 2009, we recognized the fair value of this warrant of $755,000 as
additional expense in cost of product revenue. The warrant was exercised in connection with our initial public offering.
7. INCOME PER SHARE
Basic net income per share is computed by dividing net income attributable to common stockholders by the weighted-
average number of common shares outstanding during the period. Diluted net income per share is computed by dividing net
income attributable to common stockholders by the weighted-average number of common shares outstanding, plus the dilutive
effects of convertible preferred stock on an if-converted basis plus the dilutive effects of stock options.
Net income per share information for fiscal 2009 gives effect to the repurchase of convertible preferred shares (Note
10). The excess of the fair value of the consideration paid for such preferred stock over the carrying value of the preferred stock
represents a return to the preferred stockholders and is treated in a manner similar to the treatment of dividends paid to the
holders of preferred stock in the computation of earnings per share. As a result, the premium paid is subtracted from net income
attributable to common stockholders in determining earnings per share.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
In November 2009, all of our outstanding convertible preferred stock converted into common stock in connection with
our initial public offering. For periods that ended prior to such conversion, net income per share information is computed using
the two-class method. The convertible preferred shares were entitled to receive annual non-cumulative dividends of $0.02,
$0.05, $0.12, $0.12 and $0.30 per share for Series A, B, C, D, and E, respectively, payable prior and in preference to holders of
common stock. After the payment of such dividends, convertible preferred shares were further entitled to receive a
proportionate amount of any dividends paid on common stock on an if-converted basis. As a result of such dividend rights, the
convertible preferred shares are considered to be participating securities. Under the two-class method of computing earnings
per share, net income attributable to common stockholders is computed by an adjustment to subtract from net income the
portion of current year earnings that the preferred stockholders would have been entitled to receive pursuant to their dividend
rights had all of the year’s earnings been distributed. No such adjustment to earnings is made during periods with a net loss, as
the holders of the convertible preferred shares had no obligation to fund losses.
A reconciliation of the numerator and denominator used in the calculation of basic and diluted net income per share
follows ($ and share amounts in 000's, except per share amounts):
Numerator:
Net income
Premium paid on repurchase of convertible preferred shares
Income allocated to participating securities
Net income attributable to common stockholders-basic
Undistributed earnings reallocated to common stock
Net income attributable to common stockholders-diluted
Denominator:
Basic shares:
Fiscal Year
2010
2009
2008
41,245
—
—
41,245
—
41,245
60,179
(9,266)
—
50,913
—
50,913
7,363
—
(6,910)
453
90
543
Weighted-average common shares outstanding-basic
70,363
26,334
20,017
Diluted shares:
Weighted-average common shares outstanding-basic
70,363
26,334
20,017
Effect of potentially dilutive securities:
Employee stock options
Warrants to purchase common stock
Convertible preferred stock
7,762
78
—
5,871
19
32,995
6,613
12
—
Weighted-average shares used to compute diluted net income per share
78,203
65,219
26,642
Net income per share attributable to common stockholders:
Basic
Diluted
0.59
0.53
1.93
0.78
0.02
0.02
Net income has been allocated to the common and preferred stock based on their respective rights to share in
dividends.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
The following outstanding options were excluded from the computation of diluted net income per common share
applicable to common stockholders for the periods presented, as their effect would have been antidilutive (in 000's):
Options to purchase common stock
8. DEFERRED REVENUES
Fiscal Year
2010
2009
2008
1,503
4,584
5,010
Deferred revenues consisted of the following ($ amounts in 000's):
Product
Services
Ratable products and services
Total deferred revenues
Reported As:
Short-term
Long-term
Total deferred revenues
December 31,
2010
December 31,
2009
4,466
219,022
29,143
252,631
169,648
82,983
252,631
4,141
168,314
29,475
201,930
140,537
61,393
201,930
9. COMMITMENTS AND CONTINGENCIES
Leases and Minimum Royalties—We lease our facilities under various noncancelable operating leases, which expire
through the year 2015. Rent expense was $7.0 million, $6.1 million and $4.9 million for fiscal 2010, 2009 and 2008,
respectively. Rent expense is recognized using the straight-line method over the term of the lease.
We entered into a Settlement and Patent License Agreement with Trend Micro in January 2006 (see "Litigation"
below). The aggregate future noncancelable minimum rental payments on operating leases and minimum royalties payable if
we continued paying under the Trend Micro Settlement and License Agreement as of December 31, 2010 are as follows ($
amounts in 000's):
Fiscal Years:
2011
2012
2013
2014
2015
Total
Rental
Payment
Royalty (1)
7,493
5,337
4,031
2,268
1,309
20,438
1,000
1,000
1,000
500
500
4,000
(1) Consists of minimum royalties claimed by Trend Micro pursuant to the January 2006 settlement and license agreement between Trend Micro and
Fortinet, which are subject to dispute (see "Litigation" below). The settlement and license agreement provides for additional quarterly royalty payments, not
expected to exceed 1% of our total revenue each quarter, through 2015. We have accrued a total payment including interest of $4.3 million as of December 31,
2010, related to amounts under the settlement and license agreement with Trend Micro which have not been paid pursuant to the dispute.
Contract Manufacturer Commitments—Our independent contract manufacturers procure components and build our
products based on our forecasts. These forecasts are based on estimates of future demand for our products, which are in turn
based on historical trends and an analysis from our sales and marketing organizations, adjusted for overall market conditions. In
order to reduce manufacturing lead times and plan for adequate component supply, we may issue purchase orders to some of
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
our independent contract manufacturers which may not be cancelable. As of December 31, 2010, we had $18.6 million of open
purchase orders with our independent contract manufacturers that may not be cancelable.
Litigation—In August 2009, Trend Micro Incorporated (“Trend Micro”) filed a complaint against us in the Superior
Court of the State of California for Santa Clara County alleging breach of contract and seeking a declaratory judgment that we
are obligated to make certain royalty payments to Trend Micro pursuant to a settlement and license agreement entered into in
January 2006. We maintain that the patents that are the basis for the royalty payments are invalid and consequently that we
have no contractual obligation to pay the royalties,. We filed an action in the Northern District of California that is stayed
pending the resolution of the state court action. We have continued to accrue expense based on the quarterly royalties provided
for in the settlement and license agreement. In January 2011, in response to petitions for re-examination we filed with the U.S.
Patent and Trademark Office (“PTO”), the PTO issued an initial office action that the Trend Micro patents allegedly forming
the basis for the royalty payments are invalid. In January 2011, we filed a motion to stay the state court case pending final
resolution at the PTO. Our motion to stay is currently pending. We cannot currently predict the outcome of this dispute nor
determine the amount or a reasonable range of potential loss, if any.
In January 2009, we filed a complaint against Palo Alto Networks, Inc. (“PAN”) in the United States District Court for
the Northern District of California alleging, among other claims, patent infringement. In November 2010, we filed a second
complaint against PAN in the United States District Court for the Northern District of California alleging infringement of three
additional patents. On January 20, 2011, we entered into a settlement and patent license agreement with PAN pursuant to which
we agreed to license certain asserted patents and certain related patents in return for an up-front payment by PAN and ongoing
quarterly payments over three years. The parties also agreed upon a three year covenant not to sue for patent related claims.
In August 2009, Enhanced Security Research, LLC and Security Research Holdings LLC (collectively “ESR”), a non-
practicing entity, filed a complaint against us in the United States District Court for the District of Delaware alleging
infringement by us and other defendants of two patents. In June 2010, the Court granted our motion to stay pending the
outcome of reexamination proceedings on both asserted patents. There is a related action that was dismissed by the Court, and
that dismissal has been appealed by ESR to the Federal Circuit. We cannot currently predict the outcome of this dispute nor
determine the amount or a reasonable range of potential loss, if any.
In July 2010, Network Protection Sciences, LLC, a non-practicing entity, filed a complaint in the United States
District Court for the Eastern District of Texas alleging patent infringement by us and other defendants. Currently the case is in
the early stages. We cannot currently predict the outcome of this dispute nor determine the amount or a reasonable range of
potential loss, if any.
In September 2010, WordCheck Tech, LLC ("WordCheck"), a non-practicing entity, filed a complaint in the United
States District Court for the Eastern District of Texas alleging patent infringement by us and numerous other defendants. In
January 2011, we entered a settlement and license agreement with WordCheck pursuant to which WordCheck dismissed the
litigation against us in return for an immaterial payment by us to WordCheck.
In April 2010, an individual, a former stockholder of Fortinet, filed a class action lawsuit against us in the Superior
Court of the State of California for the County of Los Angeles alleging violation of various California Corporations' Code
sections and related tort claims alleging misrepresentation and breach of fiduciary duty regarding the 2009 repurchase by
Fortinet of shares of its stock while we were a privately-held company. In September 2010, the Court granted our motion to
transfer the case to the California Superior Court for Santa Clara County. We cannot currently predict the outcome of this
dispute nor determine the amount or a reasonable range of potential loss, if any.
In addition to the above matters, we are subject to other litigation in the ordinary course of business. The results of
legal proceedings cannot be predicted with certainty. If we do not prevail in any of these legal matters, our operating results
may be materially affected. At this time, we are unable to estimate the financial impact these actions will likely have on us.
Indemnification—Under the indemnification provisions of our standard sales contracts, we agree to defend our
customers against third-party claims asserting infringement of certain intellectual property rights, which may include patents,
copyrights, trademarks, or trade secrets, and to pay judgments entered on such claims. Our exposure under these
indemnification provisions is generally limited to the total amount paid by our customer under the agreement. However, certain
agreements include indemnification provisions that could potentially expose us to losses in excess of the amount received under
the agreement. To date, there have been no claims under such indemnification provisions.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
10. STOCKHOLDERS’ EQUITY
Common Shares Reserved for Issuance—At December 31, 2010, we had reserved shares of common stock for
issuance as follows (in 000's):
Reserved under stock option plans
18,790
Warrants—In conjunction with an agreement to purchase certain technology assets (Note 6), we issued a warrant to
purchase 120,000 shares of our common stock at an exercise price of $7.47 per share. The warrant was exercised during the
fourth quarter of 2010.
Convertible Preferred Stock—In connection with the initial public offering, our authorized and outstanding
convertible preferred stock was converted into common stock as of December 31, 2009. Authorized and outstanding
convertible preferred stock was as follows as of December 28, 2008 ($ and share amounts in 000's):
Series A
Series B
Series C
Series D
Series E
Total
Authorized
Shares
Outstanding
Shares
Amount
4,000
5,000
6,000
15,000
10,500
40,500
4,000
5,000
6,000
15,000
10,480
40,480
900
2,794
8,689
28,663
53,322
94,368
Stock Repurchase—While we were a privately-held company, during the first six months of fiscal 2009, our Board of
Directors approved a stock repurchase authorization. This repurchase authorization allowed us to repurchase up to $20.0
million of our convertible preferred and common stock at $4.25 per share through June 17, 2009. This repurchase authorization
expressly excluded our board members and senior management. We repurchased 704,632 shares of common stock and
3,004,165 shares of convertible preferred stock for a total consideration of $15.7 million.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
11. STOCK PLANS
2000 Stock Plan—During 2000, we adopted the 2000 Stock Option Plan (the Plan), which includes both incentive
and non-statutory stock options. Under the Plan, we may grant options to purchase up to 21,500,000 shares of common stock to
employees, directors and other service providers at prices not less than the fair market value at date of grant for incentive stock
options and not less than 85% of fair market value for non-statutory options. Options granted to a person who, at the time of the
grant, owns more than 10% of the voting power of all classes of stock shall be at no less than 110% of the fair market value and
expire five years from the date of grant. All other options generally have a contractual term of 10 years. Options generally vest
over four years.
2008 Stock Plan—On January 28, 2008, our Board of Directors approved the 2008 Stock Plan (the 2008 Plan) and
French Sub-Plan, which includes both incentive and non-statutory stock options. The maximum aggregate number of shares
which may be subject to options and sold under the 2008 Plan and the French Sub-Plan is 5,000,000 shares, plus any shares
that, as of the date of stockholder approval of the 2008 Plan, have been reserved but not issued under the 2000 Plan or shares
subject to stock options or similar awards granted under the 2000 Plan that expire or otherwise terminate without having been
exercised in full or that are forfeited to or repurchased by us.
Under the 2008 Plan and the French Sub-Plan, we may grant options to employees, directors and other service
providers. In the case of an incentive stock option granted to an employee, who at the time of grant, owns stock representing
more than 10% of the total combined voting power of all classes of stock, the exercise price shall be no less than 110% of the
fair market value per share on the date of grant and expire five years from the date of grant, and options granted to any other
employee, the per share exercise price shall be no less than 100% of the fair market value per share on the date of grant. In the
case of a nonstatutory stock option and options granted to other service providers, the per share exercise price shall be no less
than 100% of the fair market value per share on the date of grant.
2009 Equity Incentive Plan—On November 17, 2009, our Board of Directors approved the 2009 Equity Incentive
Plan (the 2009 Plan) and French Sub-Plan, which includes awards of stock options, stock appreciation rights, restricted stock,
restricted stock units, and performance units or performance shares. The maximum aggregate number of shares that may be
issued under the Plan is 9,000,000 shares, plus any shares subject to stock options or similar awards granted under the 2008
Stock Plan and the Amended and Restated 2000 Stock Plan that expire or otherwise terminate without having been exercised in
full and shares issued pursuant to awards granted under the 2008 Stock Plan and the Amended and Restated 2000 Stock Plan
that are forfeited to or repurchased by the Company, with the maximum number of shares to be added to the Plan pursuant to
such terminations, forfeitures and repurchases not to exceed 21,000,000 shares. The shares may be authorized, but unissued or
reacquired common stock. The number of shares available for issuance under the 2009 Plan will be increased on the first day of
each fiscal year beginning with the 2011 fiscal year, in an amount equal to the lesser of (i) 7,000,000 shares, (ii) five percent
(5%) of the outstanding shares on the last day of the immediately preceding fiscal year, or (iii) such number of shares
determined by the Board.
Under the 2009 Plan and the French Sub-Plan, we may grant awards to employees, directors and other service
providers. In the case of an incentive stock option granted to an employee who, at the time of the grant, owns stock
representing more than 10% of the voting power of all classes of stock, the exercise price shall be no less than 110% of the fair
market value per share on the date of grant and expire five years from the date of grant, and options granted to any other
employee, the per share exercise price shall be no less than 100% of the fair market value per share on the date of grant. In the
case of a non statutory stock option and options granted to other service providers, the per share exercise price shall be no less
than 100% of the fair market value per share on the date of grant. Options granted to individuals owning less than 10% of the
total combined voting power of all classes of stock generally have a contractual term of seven years and options generally vest
over four years.
Stock-based compensation under ASC 718—Stock-based compensation is accounted for in accordance to ASC 718,
which requires compensation costs related to share-based transactions, including employee stock options, to be recognized in
the financial statements based on fair value. Under ASC 718, the fair value of each option award is estimated on the grant date
using the Black-Scholes option pricing model. We determined weighted-average valuation assumptions as follows:
Valuation method—We estimate the fair value of stock options granted using the Black-Scholes valuation model.
Expected Term—The expected term represents the period that our stock-based awards are expected to be outstanding.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
As we do not have sufficient historical experience for determining the expected term of the stock option awards granted, we
have based our expected term on the simplified method available under ASC 718-10 (formerly referred to as Staff Accounting
Bulletin 110).
Expected Volatility—The computation of expected volatility for the periods presented includes the historical and
implied stock volatility of comparable companies from a representative peer group selected based on industry and market
capitalization data and to a lesser extent, our weighted historical volatility following our IPO in November 2009.
Fair Value of Common Stock—The fair value of the shares of common stock that underlie the stock options we have
granted has historically been determined by our board of directors. Because there has been no public market for our common
stock, prior to our initial public offering in November 2009, our board has determined the fair value of our common stock at the
time of grant of the option by considering a number of objective and subjective factors, our sales of preferred stock to unrelated
third parties, our operating and financial performance, the lack of liquidity of our capital stock and trends in the broader
network security and computer networking market.
Risk-Free Interest Rate—We base the risk-free interest rate used in the Black-Scholes valuation model on the implied
yield available on U.S. Treasury zero-coupon issues with an equivalent remaining term.
Expected Dividend—The expected dividend weighted-average assumption is based on our current expectations about
our anticipated dividend policy.
The following table summarizes the weighted-average assumptions relating to our stock options as follows:
Expected term in years
Volatility (%)
Risk-free interest rate (%)
Dividend rate (%)
Fiscal Year
2010
2009
2008
4.6
38 – 43
1.1 – 2.4
—
4.5 – 4.6
43 – 52
1.3 – 2.3
—
4.5 – 4.6
44 – 47
2.3 – 3.3
—
Stock-based compensation expense is included in costs and expenses as follows ($ amounts in 000's):
Cost of product revenue
Cost of services revenue
Research and development
Sales and marketing
General and administrative
Total stock-based compensation
Fiscal Year
2010
2009
2008
101
929
2,339
3,810
2,136
9,315
102
658
1,963
3,020
1,718
7,461
67
400
1,049
2,512
1,271
5,299
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
A summary of the option activity under our stock plans and changes during the reporting periods are presented below
(in 000's, except per share amounts):
Balance—December 30, 2007 (9,111 shares were vested at
a weighted-average exercise price of $1.46 per share)
Additional shares authorized
Granted (weighted-average fair value of $2.46 per
share)
Forfeited
Exercised (aggregate intrinsic value of $7,119)
Balance—December 28, 2008 (9,125 shares were vested
at a weighted-average exercise price of $2.26 per share)
Additional shares authorized
Granted (weighted-average fair value of $2.86 per
share)
Forfeited
Exercised (aggregate intrinsic value of $10,490)
Balance—December 31, 2009 (10,252 shares were vested
at a weighted-average exercise price of $3.32 per share)
Granted (weighted-average fair value of $7.18 per
share)
Forfeited
Exercised (aggregate intrinsic value of $117,934)
Balance—December 31, 2010
Options vested and expected to vest—December 31, 2010
Options exercisable—December 31, 2010
Shares
Available
for Grant
Number
of Shares
4,645
12,580
5,000
—
(7,232)
2,635
—
5,048
6,887
(4,203)
1,317
—
7,232
(2,635)
(1,444)
15,733
—
4,203
(1,317)
(1,414)
9,049
17,205
(2,416)
912
—
7,545
2,416
(912)
(7,464)
11,245
10,952
6,006
Options Outstanding
Weighted-
Average
Exercise
Price ($)
Weighted-
Average
Remaining
Contractual
Life (Years)
Aggregate
Intrinsic
Value ($)
1.86
—
7.47
3.95
1.47
4.12
—
7.99
6.71
1.91
5.05
19.40
11.11
3.89
8.42
8.26
4.79
4.77
4.16
263,855
165,530
At December 31, 2010, total compensation cost related to unvested stock-based awards granted to employees under
our stock plans but not yet recognized was $25.8 million, net of estimated forfeitures. This cost is expected to be amortized on
a straight-line basis over a weighted-average period of 2.40 years. Future option grants will increase the amount of
compensation expense to be recorded in these periods.
The total fair value of awards vested under our stock plans was $8.5 million, $5.5 million and $3.8 million for fiscal
2010, 2009 and 2008, respectively.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
Additional information regarding options outstanding as of December 31, 2010, is as follows:
Exercise Prices ($)
Number
Outstanding
0.05–1.95
2.15–7.44
7.47
7.68–12.5
16.86
17.17
17.98
30.56
0.05–30.56
2,175
775
5,538
566
1,193
189
452
357
11,245
Options Outstanding
Weighted-
Average
Remaining
Contractual
Life (Years)
Weighted-
Average
Exercise
Price ($)
Options Exercisable
Number
Exercisable
Weighted-
Average
Exercise
Price ($)
3.45
5.21
4.58
5.53
6.11
6.36
6.59
6.84
4.80
1.33
3.33
7.47
9.56
16.86
17.17
17.98
30.56
8.42
2,175
662
3,012
132
18
—
7
—
6,006
1.33
2.63
7.47
9.26
16.86
—
17.98
—
4.79
Non-employees—During fiscal 2010, 2009 and 2008, we issued to non-employees in exchange for services, options
to purchase 11,030, 13,000 and 29,000 shares of common stock, respectively, at a range of exercise prices from $7.47 to $30.56
per share. These options vest over periods of up to 48 months, and in accordance with ASC 505-50 (formerly referred to as
Emerging Issues Task Force Issue No. 96-18, Accounting for Equity Instruments that are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling Goods or Services), we accounted for these options as variable awards. The options
were valued using the Black-Scholes option pricing model with the following weighted-average assumptions:
Expected term, in years
Volatility (%)
Risk-free interest rate (%)
Dividend yield (%)
12. INCOME TAXES
Fiscal Year
2010
2009
2008
4.4 – 6.8
38 – 43
1.1 – 2.4
—
5.2 – 7.5
43 – 52
1.3 – 2.3
—
6.0 – 8.5
44 – 51
2.3 – 3.6
—
The pre-tax book income for the periods ended is as follows ($ amounts in 000's):
Domestic
Foreign
Total Pre-Tax Book Income
December 31,
2010
December 31,
2009
December 28,
2008
50,556
5,785
56,341
22,667
4,846
27,513
(65)
9,316
9,251
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
The provision for income taxes for the periods ended is as follows ($ amounts in 000's):
Current:
Federal
State
Foreign
Total current
Deferred:
Federal
State
Foreign
Total deferred
Provision for (benefit from) income taxes
December 31,
2010
December 31,
2009
December 28,
2008
10,633
(82)
9,298
19,849
(4,119)
(626)
(8)
(4,753)
15,096
4,882
1,003
1,173
7,058
(35,331)
(3,850)
(543)
(39,724)
(32,666)
1,332
589
(243)
1,678
—
—
210
210
1,888
The provision for income taxes differs from the amount computed by applying the statutory federal income tax rate as
follows ($ amounts in 000's):
Tax at federal statutory tax rate
Stock-based compensation expense
State taxes—net of federal benefit
Research and development credit
Foreign income taxed at different rates
Other
Change in valuation allowance
Total provision for income taxes
December 31,
2010
December 31,
2009
December 28,
2008
19,719
(2,308)
(1,098)
(948)
(1,066)
797
—
15,096
9,629
1,311
821
(356)
(1,064)
1,202
(44,209)
(32,666)
3,237
1,049
573
(199)
(3,047)
721
(446)
1,888
Significant permanent differences arise from the portion of stock-based compensation expense that is not expected to
generate a tax deduction, such as stock compensation expense on stock option grants to certain foreign employees, offset by the
actual tax benefits in the current periods from disqualifying dispositions of shares held by our U.S. employees. For stock
options exercised by our U.S. employees, we receive an income tax benefit calculated as the difference between the fair market
value of the stock issued at the time of the exercise and the option price, tax effected. Due to this, our income taxes payable
have been reduced by the tax benefits from employee stock plan awards. The income tax benefits for fiscal 2010 and 2009
associated with dispositions from employee stock transactions of $9.3 million and $1.3 million, respectively, were recognized
as additional paid-in capital. Amounts prior to fiscal 2009 were not material.
As of December 31, 2010, we did not recognize deferred tax assets relating to excess tax benefits for stock-based
compensation deductions of $9.5 million, of which $5.5 million related to net operating losses and $4.0 million related to tax
credits. Unrecognized deferred tax benefits will be accounted for as a credit to additional paid-in-capital when realized through
a reduction in income taxes payable.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets as of each of the
years ended are presented below ($ amount in 000's):
Deferred tax assets:
Net operating loss carryforward
Deferred revenue
Nondeductible reserves and accruals
Depreciation and amortization
General business credit carryforward
Stock-based compensation
Other
Total deferred tax assets
December 31,
2010
December 31,
2009
1,920
25,173
10,990
2,029
1,243
4,225
21
45,601
3,144
21,915
9,607
1,412
1,574
3,655
16
41,323
In assessing the realizability of deferred tax assets, we considered whether it is more likely than not that some portion
or all of our deferred tax assets will be realized. This realization is dependent upon the generation of future taxable income
during the periods in which those temporary differences become deductible. Management concluded that it is more likely than
not that we would be able to realize the benefit of our deferred tax assets in the future.
As of December 31, 2010, we had federal and state net operating loss carryforwards of approximately $15.1 million
and $37.5 million, respectively. The federal and state net operating loss carryforwards begin to expire in the year 2031 and
2012, respectively. The Internal Revenue Service imposes significant restrictions on the utilization of net operating loss tax
credit carryforwards. Our ability to use our net operating loss carryforwards to offset any future taxable income may be subject
to limitations if equity transactions occur that would result in a change of ownership. As of December 31, 2010, we have tax
credit carryforwards available to offset our future federal and state taxes of approximately $1.7 million and $2.1 million,
respectively. The federal tax credits begin to expire in 2027. The state credits carry forward indefinitely.
The Company's policy with respect to its undistributed foreign subsidiaries' earnings is to consider those earnings to
be indefinitely reinvested and, accordingly, no related provision of U.S. federal and state income taxes has been provided. Upon
distribution of those earnings in the form of dividends or otherwise, we may be subject to both U.S. income taxes (subject to an
adjustment for foreign tax credits) and withholding taxes in the various foreign countries. At December 31, 2010 we have not
recorded U.S. income tax on approximately $19.4 million of foreign earnings that are deemed to be permanently reinvested
overseas.
At December 31, 2010, we had $12.1 million of unrecognized tax benefits, of which, if recognized, $11.0 million
would favorably affect our effective tax rate. Our policy is to include accrued interest and penalties related to uncertain tax
benefits in income tax expense. As of December 31, 2010, accrued interest and penalties were $0.2 million. As of December
31, 2009, accrued interest and penalties were not significant.
The aggregate changes in the balance of unrecognized tax benefits are as follows ($ amounts in 000's):
Balance, beginning of year
Increases for tax positions related to the current year
Increases for tax positions related to the prior year
Balance, end of year
Fiscal Year
2010
2009
2008
3,387
8,696
—
12,083
1,952
440
995
3,387
1,928
24
—
1,952
As of December 31, 2010 and December 31, 2009, $11.2 million and $2.5 million, respectively, of the amounts
reflected above were recorded as a liability and included in other non-current liabilities in our consolidated balance sheet.
As of December 31, 2010, there were no unrecognized tax benefits that we expect would change significantly over the
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FORTINET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
next 12 months.
We file income tax returns in the U.S. federal jurisdiction, and various U.S. state and foreign jurisdictions. As we have
net operating loss carryforwards for U.S. federal and state jurisdictions, the statute of limitations is open for all tax years.
Generally, we are no longer subject to non-U.S. income tax examinations by tax authorities for tax years prior to 2005.
13. EMPLOYEE BENEFIT PLAN
We have established a 401(k) tax-deferred savings plan (the 401(k) Plan) which permits participants to make
contributions by salary deduction pursuant to Section 401(k) of the Internal Revenue Code. We are responsible for
administrative costs of the 401(k) Plan and have made no contributions to the 401(k) Plan since inception.
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FORTINET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
14. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
During fiscal 2009 and fiscal 2008, we paid compensation of $166,000 and $142,000, respectively, to two employees
who are directly related to a former board member. This individual ceased being a board member as of October 2009.
In February 2008, we entered into a 23-month non-cancelable facility lease agreement, determined to be an arm's
length transaction, with an entity affiliated with one of our former board members. Under the terms of the agreement, in 2008,
we paid approximately $284,000 for tenant improvements and $316,000 for a refundable deposit. For fiscal 2009 and fiscal
2008 we paid $917,000 and $757,000, respectively, for office rent and operating expenses. The lease expired on December 31,
2009.
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FORTINET, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
YEARS ENDED DECEMBER 31, 2010, DECEMBER 31, 2009 AND DECEMBER 28, 2008
15. SEGMENT INFORMATION
ASC 280 (formerly referred to as SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information), establishes standards for reporting information about operating segments. Operating segments are defined as
components of an enterprise about which separate financial information is available that is evaluated regularly by the chief
operating decision maker in deciding how to allocate resources and in assessing performance. Our chief operating decision
maker is our chief executive officer. Our chief executive officer reviews financial information presented on a consolidated
basis, accompanied by information about revenue by geographic region for purposes of allocating resources and evaluating
financial performance. We have one business activity, and there are no segment managers who are held accountable for
operations, operating results and plans for levels or components below the consolidated unit level. Accordingly, we are
considered to be in a single reportable segment and operating unit structure.
Revenue by geographic region is based on the billing address of the customer. The following tables set forth revenue,
interest income and property and equipment by geographic region ($ amounts in 000's):
Revenue
Americas
Europe, Middle East and Africa
Asia Pacific and Japan
Total revenue
Interest Income
Americas
EMEA
APAC
Total interest income
Property and Equipment
Americas
EMEA
APAC
Total property and equipment—net
Fiscal Year
2010
2009
2008
123,961
121,604
79,131
324,696
92,621
95,886
63,608
252,115
Fiscal Year
75,367
79,755
56,669
211,791
2010
2009
2008
1,798
14
3
1,815
1,953
27
1
1,981
2,596
15
3
2,614
December 31,
2010
December 31,
2009
5,585
616
855
7,056
4,988
504
895
6,387
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ITEM 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
ITEM 9A.
Controls and Procedures
Management's Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as
defined in Exchange Act Rule 13a-15(f) and 15d-15(f). Management conducted an evaluation of the effectiveness of our
internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that
our internal control over financial reporting was effective as of December 31, 2010. Management reviewed the results of its
assessment with our Audit Committee. The effectiveness of our internal control over financial reporting as of December 31,
2010 has been audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in its report,
which appears in this Item under the heading “Report of Independent Registered Public Accounting Firm.”
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the
effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934 as
of the end of the period covered by this Annual Report on Form 10-K. The evaluation included certain internal control areas in
which we have made and are continuing to make changes to improve and enhance controls. In designing and evaluating the
disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of
disclosure controls and procedures must reflect the fact that there are resource constraints and that management is required to
apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Based on that evaluation, our chief executive officer and chief financial officer concluded that our disclosure controls
and procedures are effective to provide reasonable assurance that information we are required to disclose in reports that we file
or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in
Securities and Exchange Commission rules and forms, and that such information is accumulated and communicated to our
management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions
regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in our internal control over financial reporting during our fourth fiscal quarter that have
materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders of
Fortinet, Inc.
Sunnyvale, California
We have audited the internal control over financial reporting of Fortinet, Inc. and subsidiaries' (the “Company”) as of
December 31, 2010 based on criteria established in Internal Control - Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective
internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting,
included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to
express an opinion on the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding
of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design
and operating effectiveness of internal control based on that risk, and performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's
principal executive and principal financial officers, or persons performing similar functions, and effected by the company's
board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the
maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of
the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that
could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or
improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a
timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future
periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of
December 31, 2010, based on the criteria established in Internal Control - Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United
States), the consolidated financial statements and consolidated financial statement schedule as of and for the year ended
December 31, 2010, of the Company and our report dated February 24, 2011 expressed an unqualified opinion on those
financial statements and consolidated financial statement schedule.
/s/ DELOITTE & TOUCHE LLP
San Jose, California
February 24, 2011
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ITEM 9B.
Other Information
None.
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ITEM 10. Directors, Executive Officers and Corporate Governance
Executive Officers and Directors
Part III
Information responsive to this item is incorporated herein by reference to Fortinet’s definitive proxy statement with
respect to our 2011 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year
covered by this annual report on Form 10-K.
As part of our system of corporate governance, our board of directors has adopted a code of business conduct and
ethics. The code applies to all of our employees, officers (including our principal executive officer, principal financial officer,
principal accounting officer or controller, or persons performing similar functions), agents and representatives, including our
independent directors and consultants, who are not employees of the Company, with regard to their Fortinet-related activities.
Our code of business conduct and ethics is available on our website at www.fortinet.com under “About Us—Investor Relations
—Corporate Governance.” We will post on this section of our website any amendment to our code of business conduct and
ethics, as well as any waivers of our code of business conduct and ethics, that are required to be disclosed by the rules of the
SEC or the NASDAQ Stock Market.
ITEM 11.
Executive Compensation
Information responsive to this item is incorporated herein by reference to Fortinet’s definitive proxy statement with
respect to our 2011 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year
covered by this annual report on Form 10-K.
ITEM 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Information responsive to this item is incorporated herein by reference to Fortinet’s definitive proxy statement with
respect to our 2011 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year
covered by this annual report on Form 10-K.
ITEM 13.
Certain Relationships and Related Transactions, and Director Independence
Information responsive to this item is incorporated herein by reference to Fortinet’s definitive proxy statement with
respect to our 2011 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year
covered by this annual report on Form 10-K.
ITEM 14.
Principal Accounting Fees and Services
Information responsive to this item is incorporated herein by reference to Fortinet’s definitive proxy statement with
respect to our 2011 Annual Meeting of Stockholders to be filed with the SEC within 120 days after the end of the fiscal year
covered by this annual report on Form 10-K.
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ITEM 15.
Exhibits and Financial Statement Schedules
(a) The following documents are filed as part of this Form 10-K:
Part IV
1.
2.
Financial Statements: The information concerning Fortinet’s financial statements and the Report of
Independent Registered Public Accounting Firm required by this Item 15(a)(1) is incorporated by reference
herein to the section of this Form 10-K in Item 8, titled “Financial Statements and Supplementary Data.”
Financial Statement Schedule: The following financial statement schedule of Fortinet, Inc., for the fiscal
years ended December 31, 2010, December 31, 2009 and December 28, 2008, is filed as part of this Form 10-
K and should be read in conjunction with the Consolidated Financial Statements of Fortinet, Inc.
SCHEDULE II—VALUATION AND QUALIFYING ACCOUNTS
Allowance for Doubtful Accounts:
Beginning balance
Charged to costs and expenses
Bad debt write-offs
Ending balance
Fiscal Year
2010
2009
($ amounts in 000's)
2008
367
8
(72)
303
318
161
(112)
367
384
191
(257)
318
Schedules not listed above have been omitted because they are not applicable or are not required or the information
required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto.
3.
Exhibits: See Item 15(b) below. We have filed, or incorporated into this 10-K by reference, the exhibits listed
on the accompanying Index to Exhibits immediately following the signature page of this Form 10-K.
(b) Exhibits:
The exhibit list in the Index to Exhibits immediately following the signature page of this Form 10-K is incorporated
herein by reference as the list of exhibits required by this Item 15(b).
(c) Financial Statement Schedules: See Item 15(a) above.
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Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly
caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on February 25, 2011.
SIGNATURES
FORTINET, INC.
By:
/s/ Ken Goldman
Ken Goldman, Chief Financial Officer
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and
appoints Ken Xie and Ken Goldman, jointly and severally, his attorney-in-fact, with the power of substitution, for him in any
and all capacities, to sign any amendments to this Annual Report on Form 10-K and to file the same, with exhibits thereto and
other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all
that each of said attorneys-in-fact, or his substitute or substitutes, may do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Ken Xie
Ken Xie
President, Chief Executive Officer and Director
(Principal Executive Officer)
February 25, 2011
/s/ Ken Goldman
Ken Goldman
Chief Financial Officer
(Principal Financial and Accounting Officer)
February 25, 2011
/s/ Michael Xie
Chief Technical Officer and Director
February 25, 2011
Michael Xie
/s/ Pehong Chen
Director
Pehong Chen
/s/ Hong Liang Lu
Director
Hong Liang Lu
/s/ Greg Myers
Director
Greg Myers
/s/ Christopher B. Paisley
Director
Christopher B. Paisley
February 25, 2011
February 25, 2011
February 25, 2011
February 25, 2011
/s/ John Walecka
Non-Executive Chairman of the Board and Director
February 25, 2011
John Walecka
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Exhibit
Number
EXHIBIT INDEX
Description
Incorporated by reference herein
Form
3.1
3.2
4.1
4.2
10.1†
10.2†
10.3†
10.4†
10.5†*
10.6†
10.7†
10.8†
10.9†
10.10†
10.11†
10.12†
Date
August 10, 2009
Amended and Restated Certificate of Incorporation
Registration Statement on Form S-l, as amended (File
No. 333-161190)
Amended and Restated Bylaws
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
Specimen common stock certificate of the Company
Registration Statement on Form S-l, as amended (File
No. 333-161190)
November 2, 2009
Third Amended and Restated Investors Rights
Agreement, dated as of February 24, 2004, between the
Company and certain holders of the Company’s capital
stock named therein
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
Forms of Indemnification Agreement between the
Company and its directors and officers
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
2000 Stock Plan and forms of agreement thereunder
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
2008 Stock Plan and forms of agreement thereunder
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
2009 Equity Incentive Plan and forms of restricted stock
unit award and restricted stock agreement thereunder
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
Forms of stock option agreement under 2009 Equity
Incentive Plan
Separation and Change of Control Agreement, dated as
of August 7, 2009, between the Company and Ken Xie
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
Separation and Change of Control Agreement, dated as
of August 7, 2009, between the Company and Michael
Xie
Separation and Change of Control Agreement, dated as
of August 7, 2009, between the Company and Ken
Goldman
Separation and Change of Control Agreement, dated as
of August 7, 2009, between the Company and John
Whittle
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
Offer Letter, dated as of August 31, 2007, by and
between the Company and Ken Goldman
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
Offer Letter, dated as of August 31, 2007, by and
between the Company and John Whittle
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
Form of Change of Control Agreement between the
Company and its non-executive officers
Registration Statement on Form S-l, as amended (File
No. 333-161190)
August 10, 2009
10.13
Fortinet, Inc. Bonus Plan
Current Report on Form 8-K
21.1
List of subsidiaries
Registration Statement on Form S-l, as amended (File
No. 001-34511)
January 26, 2010
August 10, 2009
23.1*
24.1*
31.1*
31.2*
32.1*
Consent of Independent Registered Public Accounting
Firm
Power of Attorney (incorporated by reference to the
signature page of this Annual Report on Form 10-K)
Certification of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Certification of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
________________________________
† Indicates management compensatory plan, contract or arrangement.
* Filed herewith.
98