What changed in this filing

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Item 7. Management’s Discussion and Analysis

2021-02-19 compared with 2020-02-26 · 293 added, 172 removed, 347 unchanged (57% of the section changed)

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These statements include, among other things, statements concerning our expectations regarding:

• the duration and impact of the COVID-19 pandemic;

• continued growth and market share gains;

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• expected impact of sales of certain products and services;

the impact of macro-economic, geopolitical factors and other disruption on our manufacturing or sales, including the impact of the coronavirus and other public health issues and natural disasters;

• the impact of macro-economic, geopolitical factors and other disruption on our manufacturing or sales, including the impact of the COVID-19 pandemic and other public health issues and natural disasters;

• the proportion of our revenue that consists of our product and service revenue, and the mix of billings between products and services, and the duration of service contracts;

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• the effects of government regulation, tariffs and other related policies;

drivers of long-term growth and operating leverage, such as increased sales productivity, functionality and value in our standalone and bundled subscription service offerings;

• drivers of long-term growth and operating leverage, such as sales productivity, functionality and value in our standalone and bundled subscription service offerings;

• growing our sales to businesses, service providers and government organizations, our ability to execute these sales and of the complexity of selling to all segments (including the increased competition and unpredictability of timing associated with sales to larger enterprises), the impact of sales to these organizations on our long-term growth, expansion and operating results, and the effectiveness of our internal sales organization;

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• trends in our operating expenses, including sales and marketing expense, research and development expense, general and administrative expense, and expectations regarding these expenses;

risks and expectations related to acquisitions or sales of assets, including integration issues related to product plans and products, including the acquired technology;

continued investments in research and development, and expectations that our research and development expense will increase in absolute dollars during 2020;

continued investments in our sales resources and infrastructure and marketing strategy, and expectations that our sales and marketing expense will increase in absolute dollars during 2020;

expectations that our general and administrative expense will increase in absolute dollars during 2020;

• risks and expectations related to acquisitions, including integration issues related to product plans and products, including the acquired technology;

• expectations that our operating expense will increase in absolute dollars during 2021;

• expectations that proceeds from the exercise of stock options in future years will be adversely impacted by the increased mix of restricted stock units versus stock options granted;

estimates of a range of 2020 spending on our headquarters expansion project;

expectations regarding uncertain tax benefits and our effective domestic and global tax rates, and the impact of the Tax Cuts and Jobs Act (the “ 2017 Tax Act ”) and the Ninth Circuit’s Altera decision regarding stock-based compensation in cost sharing arrangements;

• estimates of a range of 2021 spending on our headquarters expansion project and of the anticipated completion timeline for the project;

• expectations regarding uncertain tax benefits and our effective domestic and global tax rates, and the impact of the Tax Cuts and Jobs Act (the “2017 Tax Act ”) and the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”);

• expectations regarding spending related to real estate and other capital expenditures and to the impact on free cash flows;

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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 Part I, Item 1A of this Annual Report on Form 10-K and those discussed in other documents we file with the Securities and Exchange Commission (the “SEC”).

We undertake no obligation, and specifically disclaim any obligation, to revise or publicly release the results of any revision to these and any other forward-looking statements.

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Business Overview

Fortinet is a global leader in cybersecurity solutions provided to a wide variety of organizations, such as enterprises, communication service providers, government organizations and small businesses.

Fortinet is a global leader in cybersecurity solutions provided to a wide variety of organizations, including enterprises, communication service providers, government organizations and small businesses.

Our cybersecurity solutions are designed to provide broad visibility and segmentation of the digital attack surface through our integrated Fortinet Security Fabric platform, which features automated protection, detection and response.

The focus areas of our business consist of:

Network Security —We derive a majority of product sales from our FortiGate network security appliances.

Our FortiGate network security appliances include a broad set of built-in security and networking features and functionalities, including firewall, next-generation firewall, secure web gateway, SSL inspection, SD-WAN , intrusion prevention, SSL data leak prevention, VPN , switch and wireless controller and wide area network edge.

• Security-Driven Networking —We derive a majority of product sales from our FortiGate network security appliances.

Our FortiGate network security appliances include a broad set of built-in security and networking features and functionalities, including firewall, next-generation firewall, secure web gateway, secure sockets layer (“SSL”) inspection, software-defined wide area network (“SD-WAN”), Intrusion Prevention system(“IPS”), sandboxing, data leak prevention, virtual private network (“VPN”), switch and wireless controller and wide area network (“WAN”) edge.

Our network security appliances are managed by our FortiOS network operating system, which provides the foundation for FortiGate security functions.

We enhance the performance of our network security appliances from branch to data center by designing and implementing SPU technology within our appliances, enabling us to add security and network functionality with minimal impact to network throughput performance.

Infrastructure Security —The Fortinet Security Fabric platform is a broad, automated and integrated security platform that extends beyond the network to cover other attack vectors.

Other infrastructure solutions covered include Secure Access (Wi-Fi and switch).

Cloud Security —We help customers connect securely to and across their hybrid, public and private cloud environments by offering security through our virtual firewall and other software products in public and private cloud environments.

Our cloud security solutions, including virtual appliances and hosted solutions, extend the core capabilities of the Fortinet Security Fabric platform to provide businesses with the same level of cybersecurity and threat intelligence in and across cloud environments that they receive on their physical networks.

Fortinet cloud security offerings are available across all major cloud providers, including Amazon Web Services, Microsoft Azure, Google Cloud, Oracle Cloud, Alibaba Cloud and IBM Cloud .

We enhance the performance of our network security appliances from branch to data center by designing and implementing Security Processing Units (“SPUs”) technology within our appliances, enabling us to add security and network functionality with minimal impact to network throughput performance.

• Infrastructure Security —The Fortinet Security Fabric platform extends beyond the network to cover other attack vectors.

Other infrastructure solutions covered include teleworker and remote security solutions such as FortiAuthenticator, FortiClient and FortiToken, as well as Secure Access (Wi-Fi and switch).

• Dynamic Cloud Security —We help customers connect securely to and across their individual, hybrid and multi-cloud environments by offering security through our virtual firewall and other software products and through integrated capabilities with major cloud platforms.

Our public and private cloud security solutions, including virtual appliances and hosted solutions, extend the core capabilities of the Fortinet Security Fabric platform in and across cloud environments, delivering security that follows their applications and data.

Our Secure SD-WAN for Multi-Cloud solution automates deployment of an overlay network across different cloud networks and offers visibility, control and centralized management that integrates functionality across multiple cloud environments.

Our Cloud Security portfolio also includes securing applications, including email and web.

Endpoint Protection, Internet of Things and Operational Technology Security —We protect end-customers from advanced threats that target their devices and the data that reside on them through our advanced endpoint solutions that provide core endpoint protection, advanced threat protection, incident monitoring, and response.

Additionally, the proliferation of IoT and the digitization of OT devices has generated new opportunities for us to grow our business.

Fortinet cloud security offerings are available for deployment in major public and private cloud environments, including Amazon Web Services, Microsoft Azure, Google Cloud, Oracle Cloud, Alibaba Cloud, IBM Cloud and VMWare Cloud.

We also offer managed IPS and web application firewall (“WAF”) rules delivered by FortiGuard Labs as an overlay service to native security offerings offered by Amazon Web Services.

• Endpoint Protection, Internet of Things (“IoT”) and Operational Technology (“OT”) Security —We protect end-customers from advanced threats that target their devices and the data that reside on them through our advanced endpoint solutions that provide core endpoint protection, advanced threat protection, incident monitoring, and response.

Additionally, the proliferation of IoT and OT devices has generated new opportunities for us to grow our business.

We offer network access control solutions that provide visibility, control and automated event responses in order to secure IoT devices.

We also develop and provide AI -driven security operations solutions, including FortiGuard security services that can be applied across the entire Fortinet Security Fabric platform .

These solutions help customers better secure their environments by delivering deeper intelligence and insights and by narrowing the gaps in security skills and resources that are present in many organizations.

In addition to our security solutions, our customers, channel partners and end-customers may purchase FortiGuard and other security subscription services to receive threat intelligence updates, FortiCare technical support services across all of our products and the support of Technical Account Managers, Resident Engineers and professional service consultants for implementations or training services.

• AI-Driven Security Operations —We develop and provide Artificial Intelligence (“AI”) driven security operations solutions, including FortiGuard and other security subscription services, endpoint detection and response, and our security orchestration, automation and response (“SOAR”) capabilities and solutions, that can be applied across the entire Fortinet Security Fabric platform.

These solutions deliver intelligence and insights.

In addition to our security solutions, our customers may purchase FortiGuard and other security subscription services to receive threat intelligence updates and protection updates delivered by FortiGuard Labs, FortiCare technical support services and the support of TAMs, REs and professional service consultants for implementations or training services.

Correction of Prior Period Financial Data

As discussed further in Note 2 of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K, we identified an immaterial error related to the commencement of revenue recognition for certain FortiCare support service contracts, which resulted in an understatement of revenue during the years ended 2019 and 2018, respectively.

The correction of this error resulted in increases to service revenue, gross profit and operating income of $6.8 million and $3.4 million for the year ended 2019 and 2018, respectively.

Net income increased by $5.2 million and $2.7 million for the year ended 2019 and 2018, respectively.

This resulted in an increase to diluted net income per share of $0.03 and $0.01 for the year ended 2019 and 2018, respectively.

We evaluated the effect of this correction on the previous results of operations and determined that it did not materially impact any trends previously disclosed.

This correction did not impact net cash provided by operating activities, billings or free cash flows.

Financial Highlights

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Service revenue was $1.68 billion in 2020, an increase of 22% compared to $1.37 billion in 2019.

• Total gross profit was $2.02 billion in 2020, an increase of 22% compared to $1.66 billion in 2019.

• We generated operating income of $531.8 million in 2020, an increase of 52% compared to $351.0 million in 2019.

Cash, cash equivalents and investments were $2.21 billion as of December 31, 2019 , an increase of $493.3 million , or 29% , from December 31, 2018 .

Deferred revenue was $2.14 billion as of December 31, 2019 , an increase of $449.1 million , or 27% , from December 31, 2018 .

We generated cash flows from operating activities of $808.0 million in 2019 , an increase of $169.1 million , or 26% , compared to 2018 .

In 2019 , we repurchased 1.9 million shares of common stock under the Repurchase Program for an aggregate purchase price of $140.9 million .

Operating income for 2020 included gains on an IP matter of $40.2 million.

• Cash, cash equivalents and investments were $1.96 billion as of December 31, 2020, a decrease of $254.3 million, or 12%, from December 31, 2019.

• In 2020, we repurchased 11.7 million shares of common stock under the Repurchase Program for an aggregate purchase price of $1.08 billion.

In 2019, we repurchased 1.9 million shares of common stock for a total purchase price of $140.9 million.

• Deferred revenue was $2.61 billion as of December 31, 2020, an increase of $496.2 million, or 24%, from December 31, 2019 .

Short-term deferred revenue was $1.39 billion as of December 31, 2020, an increase of $237.0 million, or 21%, from December 31, 2019.

• We generated cash flows from operating activities of $1.08 billion in 2020, an increase of $275.7 million, or 34%, compared to 2019.

Our revenue growth was driven by both product and service revenue.

On a geographic basis, revenue continues to be diversified globally, which remains a key strength of our business.

In 2020, the Americas region, the Europe, Middle East and Africa (“EMEA”) region and the Asia Pacific (“APAC”) region contributed 42%, 38% and 20% of our total revenue, respectively, and increased by 17%, 21% and 23% compared to 2019, respectively.

Product revenue grew 16% in 2020.

We experienced revenue growth across several of our hardware and software products, including FortiGate enabled with SD-WAN features.

Service revenue growth of 21% in 2019 was driven by the strength of our FortiGuard and other security subscription revenue, which grew 24% .

During the second quarter of 2019, we reclassified the 100 series of our FortiGate product from an entry-level product to a mid-range product.

Prior periods have been reclassified to conform with current period presentation.

Including this reclassification, we saw a mix shift from high-end to mid-range products in 2019.

During the fourth quarter of 2019, we acquired enSilo Limited (“enSilo”) and CyberSponse Inc.

(“CyberSponse”) to further strengthen our Fortinet Security Fabric platform by providing real-time automated endpoint detection and response capability (enSilo) and security orchestration, automation and response products and services (CyberSponse).

The impact of these acquisitions, individually and in the aggregate, were not material to our consolidated financial statements.

In 2019 , our revenue growth outpaced our growth in operating expenses.

As a result, operating expenses as a percentage of revenue decreased by two percentage points compared to 2018 .

We experienced revenue growth across several of our hardware and software products, including SD-WAN and teleworker and remote security solutions.

Service revenue growth of 22% in 2020 was driven by the strength of our FortiGuard and other security subscription revenue and FortiGate technical support and other service revenue, which both grew 22% in 2020.

Our billings were diversified on a geographic basis.

In 2020, approximately 50% of our billings in the aggregate were from over 80 countries that individually contributed less than 3% of our billings.

During the fourth quarter of 2020, we acquired Panopta Holdings LLC (“ Panopta”) to provide a platform for monitoring the health and performance of network and IT infrastructure.

During the third quarter of 2020, we acquired OPAQ Networks, Inc.

(“OPAQ”) to further enhance the Fortinet Security Fabric platform by providing enterprises with the zero trust network access SASE cloud solution.

The impact of these acquisitions were not material to our consolidated financial statements.

In 2020, we recognized gains of $40.2 million on an IP matter in connection with a mutual covenant-no-to-sue and release agreement with a competitor in the network security industry.

Excluding the gains on the IP matter, operating expenses as a percentage of revenue decreased by 1.3 percentage points compared to 2019.

Headcount increased by 16% to 8,238 employees and contractors as of December 31, 2020, up from 7,082 as of December 31, 2019.

The acquisition of enSilo and CyberSponse increased headcount by 135 employees.

Excluding these two acquisitions, headcount would have increased 19% year over year.

The impact of the coronavirus outbreak on our business remains uncertain, and, though the majority of our products are manufactured outside of China, certain components for our products and certain of our products are manufactured in China and Taiwan and we have international shipping and logistics centers in Taiwan.

While any significant impact is uncertain at this point, if the coronavirus outbreak continues to spread, the business disruption caused thereby could have a material negative impact on our billings, revenue, gross margin, operating margin, cash flows and other financial results for the first quarter of 2020 and certain periods thereafter.

COVID-19 Update

The United States and the global community we serve are facing unprecedented challenges posed by the COVID-19 pandemic.

In response to the pandemic, we have taken a number of actions to protect our employees, including restricting travel and directing most of our employees to work from home.

Where onsite work is permitted, we have implemented measures such as staggered work shifts, social distancing, the use of face coverings, health safety awareness training and frequent disinfection of shared spaces.

We have implemented our readiness plans, which include steps to maintain critical internet infrastructure with many employees working remotely.

We are also providing free online information technology security training for the public, aimed at helping high school and college students and professionals augment their security skill sets to open career opportunities and to help narrow the security skills gap.

As of December 31, 2020, there have been over 800,000 registrations for our free online trainings since we launched the program.

We will continue to provide free online trainings in 2021.

While the broader implications of the COVID-19 pandemic on our employees and overall financial performance remain uncertain, we have seen certain impacts on our business and operations, results of operations, financial condition, cash flows, liquidity and capital and financial resources as of and during the year ended December 31, 2020.

Conversely, some aspects of our business do not appear to have been significantly affected.

During the year ended December 31, 2020, we have observed the following:

• In most countries, our employees ability to travel was reduced.

In-person sales and marketing events or meetings that would normally have been held were canceled, postponed or converted into virtual events.

As a result, expenses related to travel and marketing events decreased significantly.

To the extent that it becomes safe for our employees to travel and for us to hold or attend marketing events, these expenses may increase in the future, although we cannot predict if or when such expenses will increase or return to pre-pandemic levels.

• After performing additional credit review of our existing customers, including obtained credit reports and reviewing their latest available statements of financial position, we increased the allowance of credit losses for certain accounts receivable.

The allowance for credit losses was $2.5 million as of December 31, 2020.

Provisions, write-offs and recoveries were not material during the year ended December 31, 2020.

• We have offered payment terms in excess of our contractual agreements to certain distributor customers, which has resulted in an increase to the average collection period of our trade receivables.

As of December 31, 2020, 97% of our outstanding trade accounts receivable was due to be collected during the first quarter of 2021.

• The countries and geographic regions in which we experienced the fastest billings growth in the fourth quarter of 2020, as compared to the fourth quarter of 2019, were countries and geographic regions in which the COVID-19 pandemic is generally considered to have had a comparatively shorter or less severe impact on the local population and economy during the quarter.

• We have noted that, for some of our customers, sales cycles appear to have lengthened, though it is unclear whether this trend will persist.

• Our average service contract duration increased by approximately two months in the fourth quarter of 2020 as compared to the fourth quarter of 2019.

• In order to mitigate supply chain risk and in anticipation of fourth-quarter demand, we have increased our on-hand stock of certain products.

• The yield on investment-grade debt has decreased, and while the risk of credit losses on our investments and cash equivalents has not changed significantly, as the debt securities in our portfolio have matured, they have been replaced by securities with lower effective interest rates.

This has contributed to a decrease in our interest income during the year ended December 31, 2020, compared to the same periods last year.

• In accordance with the CARES Act, we have deferred the deposit and payment of our employer’s share of Social Security taxes.

This did not materially affect net cash provided by operating activities during the period.

T hrough the filing of this Annual Report on Form 10-K, t here have been no material changes to the trends described above.

Going forward, however, the situation is uncertain, rapidly changing and hard to predict, and the COVID-19 pandemic may have a material negative impact on our future periods.

If we experience significant changes in our billings growth rates, it will impact product revenue in the current quarter and FortiGuard and FortiCare service revenues in subsequent quarters, as we sell annual and multi-year service contracts that are recognized ratably over the contractual service term.

In addition, the broader implications of the pandemic on our business and operations and our financial results, including the extent to which the effects of the pandemic will impact future results and growth in the cybersecurity industry, remain uncertain.

The duration and severity of the economic downturn from the pandemic may negatively impact our business and operations, results of operations, financial condition, cash flows, liquidity and capital and financial resources in a material way.

As a result, the effects of the pandemic may not be fully reflected in our results of operations until future periods.

For further discussion, see Part I, Item 1A of this Annual Report on Form 10-K.

Business Model

We primarily sell our products and services through a two-tier distribution model.

We sell to distributors that sell to networking security and enterprise-focused resellers and to service providers and MSSPs , who, in turn, sell to our end-customers.

In certain cases, we sell directly to large service providers and major systems integrators.

We also offer our products across major cloud providers, and have recognized on-demand revenue from Amazon Web Services, Microsoft Azure, IBM Cloud, Google Cloud and Oracle Cloud.

We have also recognized revenue from customers who deploy our products in a bring-your-own-license (“ BYOL ”) arrangement at a cloud provider such as Amazon Web Services, Microsoft Azure, Google Cloud, Oracle Cloud and Alibaba Cloud.

We typically sell our security solutions to distributors that sell to networking security focused resellers and to service providers and managed security service providers (“MSSPs”), who, in turn, sell to end-customers.

At times, we also sell directly to large service providers and major systems integrators who may sell to our end-customers or use our products and services to provided hosted solutions to other enterprises.

Our end-customers are located in over 80 countries and include small, medium and large enterprises and government organizations across a wide range of industries, including telecommunications, government, financial services, retail, technology, education, manufacturing and healthcare.

An end-customer deployment may involve as few as one or as many as thousands of appliances and other Fortinet Security Fabric platform products, depending on the end-customer’s size and security requirements.

We also offer our products through major cloud providers, and have recognized revenue on a usage basis from Amazon Web Services, Microsoft Azure, Google Cloud, Oracle Cloud, Alibaba Cloud and IBM Cloud.

We have also recognized revenue from customers who deploy our products in a bring-your-own-license (“BYOL”) arrangement in private clouds or at cloud providers.

In a BYOL arrangement, a customer purchases a software license from us through our channel partners and deploys the software in a cloud provider’s environment.

Similarly, customers may purchase such a license from us and deploy in their private cloud.

Typically, our customers purchase our hardware products and software licenses, as well as our FortiGuard security subscription and FortiCare technical support services.

Similarly, customers may purchase such a license from us and deploy in third-party clouds or in their private cloud.

Our customers purchase our hardware products and software licenses, as well as our FortiGuard and other security subscription and FortiCare technical support services.

We generally invoice at the time of our sale for the total price of the products and security and technical support services.

The invoice is typically payable within 30 to 45 days.

We also invoice certain services on a monthly basis.

Standard payment terms are generally no more than 60 days, though, as noted in the COVID-19 Update above, we have recently offered extended payment terms to certain distributor customers.

We monitor a number of key metrics, including the key financial metrics set forth below, in order to help us evaluate growth trends, establish budgets, measure the effectiveness of our sales and marketing efforts, and assess operational efficiencies.

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Year Ended or As of December 31,

2020 2019 2018

(in millions)

Revenue $ 2,594.4 $ 2,163.0 $ 1,804.6

Deferred revenue $ 2,605.3 $ 2,109.1 $ 1,666.8

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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 unrecognized portion of service revenue from FortiGuard security subscription and FortiCare technical support service contracts, which is recognized as revenue ratably over the contractual service period.

The majority of our deferred revenue balance consists of the unrecognized portion of service revenue from FortiGuard and other security subscription and FortiCare technical support service contracts, which is recognized as revenue ratably over the contractual service period.

We monitor our deferred revenue balance, deferred revenue growth and the mix of short-term and long-term deferred revenue because deferred revenue represents a significant portion of free cash flow and of revenue to be recognized in future periods.

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We define billings as revenue recognized in accordance with generally accepted accounting principles in the United States (“GAAP”) plus the change in deferred revenue from the beginning to the end of the period and adjustments to the deferred revenue balance due to adoption of Financial Accounting Standards Board (“FASB”) Topic 606, Revenue from Contracts with Customers (“Topic 606”), less any deferred revenue balances acquired from business combination(s) during the period.

We consider billings to be a useful metric for management and investors because billings

drive current and future revenue, which is an important indicator of the health and viability of our business.

We consider billings to be a useful metric for management and investors because billings drive current and future revenue, which is an important indicator of the health and viability of our business.

There are a number of limitations related to the use of billings instead of GAAP revenue.

First, billings include amounts that have not yet been recognized as revenue and are impacted by the security and support contractual service period agreements.

First, billings include amounts that have not yet been recognized as revenue and are impacted by the term of security and support agreements.

Second, we may calculate billings in a manner that is different from peer companies that report similar financial measures.

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Year Ended December 31,

2020 2019 2018

(in millions)

Revenue $ 2,594.4 $ 2,163.0 $ 1,804.6

Change in deferred revenue 496.2 442.3 347.1

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Free cash flow (non-GAAP).

We define free cash flow as net cash provided by operating activities minus purchases of property and equipment.

We define free cash flow as net cash provided by operating activities minus purchases of property and equipment and excluding any significant nonrecurring items.

We believe free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by the business that, after capital expenditures, can be used for strategic opportunities, including repurchasing outstanding common stock, investing in our business, making strategic acquisitions and strengthening the balance sheet.

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Year Ended December 31,

2020 2019 2018

(in millions)

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Purchases of property and equipment (125.9) (92.2) (53.0)

Proceeds from intellectual property matter (50.0) — —

Free cash flow (non-GAAP) $ 907.8 $ 715.8 $ 585.9

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• Product revenue .

Product revenue is primarily generated from sales of our appliances.

The majority of our product revenue has been generated by our FortiGate product line, and we do not expect this to change in the foreseeable future.

Product revenue also includes revenue derived from sales of fabric hardware and software products, including FortiGate software licenses.

As a percentage of total revenue, we expect that our product revenue may vary from quarter-to-quarter based on certain factors, as discussed below under “—Quarterly Results of Operations,” and we expect the trend to continue in 2020.

Product revenue is primarily generated from sales of our physical and virtual machine appliances.

While the majority of our product revenue continues to be generated by our FortiGate product line, our Fabric appliance and software products are growing faster.

As a percentage of total revenue, our product revenue has varied from quarter-to-quarter.

• Service revenue .

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As a percentage of total revenue, we continue to expect service revenue to be higher than product revenue.

Our service revenue growth rate depends significantly on the growth of our customer base, the expansion of our service bundle offerings, the expansion and introduction of new service offerings and the renewal of service contracts by our existing customers.

Our service revenue growth rate depends significantly on the growth of our customer base, the expansion of our service bundle offerings, the expansion and introduction of new service offerings, the attach rate of service contracts to new product sales, and the renewal of service contracts by our existing customers.

Our total cost of revenue is comprised of the following:

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Service revenue and software licenses have had a positive effect on our total gross margin given the higher gross margins compared to hardware product gross margins.

During 2019 , service gross margin benefited from renewals and continued sales of services and subscriptions, growing faster than related expenses.

Product gross margin benefited from gains in average selling price, as well as lower direct and indirect product costs as a percentage of product revenue.

It also benefited from deal mix, software revenue growth and a stable product transition environment.

Cost of product revenue was comprised of direct product costs and indirect costs, including inventory reserves and other manufacturing overhead.

Overall gross margin in 2020 will be impacted by service and product revenue mix, but we expect it to be comparable to overall gross margin in 2019.

During 2020, product gross margin benefited from gains in average selling price, as well as lower direct and indirect product costs as a percentage of product revenue.

It also benefited from product mix, software revenue growth and a stable product transition environment.

Service gross margin benefited from renewals and continued sales of services and subscriptions, growing faster than related expenses.

Overall gross margin in 2021 will be impacted by service and product revenue mix.

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 primarily of salaries, benefits, bonuses, stock-based compensation, and sales commissions, as applicable.

Personnel costs are the most significant component of operating expenses and consist primarily of salaries, benefits, bonuses, sales commission and stock-based compensation.

We expect personnel costs to continue to increase in absolute dollars as we expand our workforce.

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We record all research and development expenses as incurred.

Our research and development teams are primarily located in Canada and the United States.

As of December 31, 2020, approximately 90% of our research and development teams were located in Canada, the United States and India.

• Sales and marketing .

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partner cooperative marketing arrangements), as well as travel, depreciation of property and equipment and facility-related expenses.

intend to hire additional personnel focused on sales and marketing and expand our sales and marketing efforts worldwide in order to capture market share in the enterprise market.

We intend to hire additional personnel focused on sales and marketing and expand our sales and marketing efforts worldwide in order to capture market share.

• General and administrative .

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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, tax, information technology and other consulting costs.

Our professional fees principally consist of outside legal, auditing, tax, information technology and other consulting costs.

• Gain on intellectual property matter.

Gain on intellectual property matter consists of the amortization of the deferred component of an agreement with a competitor in the network security industry, whereby, the competitor party paid us a lump sum of $50.0 million for a seven-year mutual covenant-not-to-sue for patent claims.

Interest income—net.

Interest income—net consists of interest earned on our cash, cash equivalents and investments.

Interest income—net consists primarily of interest earned on our cash equivalents and investments.

We have historically invested our cash in corporate debt securities, certificates of deposit and term deposits, commercial paper, money market funds, and U.S.

government and agency securities.

Other income (expense) — net .

Other income (expense)—net consists primarily of foreign exchange gains and losses related to foreign currency remeasurement, as well as the gain on the sale of an investment in a privately held company and the impairment charge on an investment in a privately held company.

Other expense — net .

Other expense—net consists primarily of foreign exchange gains and losses related to foreign currency remeasurement, as well as the gain on the sale or the impairment charges of our investments in privately held companies.

Provision for (benefit from) income taxes.

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Our effective tax rate differs from the U.S.

statutory rate primarily due to foreign income subject to different tax rates than in the U.S., nondeductible stock-based compensation expense, federal research and development tax credit, state taxes, withholding taxes, excess tax benefits related to stock-based compensation expense and the tax impacts of the 2017 Tax Act .

Critical Accounting Policies and Estimates

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Revenue Recognition

On January 1, 2018, we adopted Topic 606, Revenue from Contracts with Customers, using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018.

Results for reporting periods beginning after January 1, 2018 are presented under Topic 606, while prior period amounts are not adjusted and continue to be reported under ASC Topic 605 (“Topic 605”), Revenue Recognition.

Beginning in 2018, revenues are recognized when control of goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

Prior to 2018, revenue was recognized under Topic 605 when all of the following criteria were met:

(i) persuasive evidence of an arrangement existed, (ii) delivery has occurred or services have been rendered, (iii) sales price was fixed or determinable and (iv) collectability was reasonably assured.

Under Topic 606, we determine revenue recognition through the following steps:

Revenues are recognized when control of goods or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services.

We determine revenue recognition through the following steps:

• identification of a contract or contracts with a customer;

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Our sales contracts typically contain multiple deliverables, such as hardware, software license, security subscription, technical support services and other services, which are generally capable of being distinct and accounted for as separate performance obligations.

We evaluated the criteria to be distinct under Topic 606 and concluded that the hardware and software licenses were distinct and distinct in the context of a contract from the security subscription and technical support services, as a customer can benefit from the hardware and software licenses without the services and the services are separately identifiable within a contract.

Our hardware and software licenses have significant standalone functionalities and capabilities.

Accordingly, the hardware and software licenses are distinct from the security subscription and technical support services, as a customer can benefit from the product without the services and the services are separately identifiable within a contract.

We allocate a transaction price to each performance obligation based on relative standalone selling price.

If not observable through past transactions, we determine standalone selling price based on the historical pricing and discounting practices for those services when sold separately.

We determine standalone selling price for a product or service by considering multiple historical factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies and the term of a service contract that fall within a reasonably range as a percentage of list price.

Under the previous standard, Topic 605, revenue from contracts that contain products and services is allocated to each unit of accounting based on an estimated selling price using vendor-specific objective evidence (“VSOE”) of selling price, if it existed, or third-party evidence (“TPE”) of selling price.

If neither VSOE nor TPE of selling price existed for a deliverable, we used our best estimate of selling price for that deliverable.

For multiple-element arrangements where software deliverables were included, revenue was allocated to the non-software deliverables and to the software deliverables as a group using the relative estimated selling prices of each of the deliverables in an arrangement based on the estimated selling price hierarchy.

The amount allocated to the software deliverables was then allocated to each software deliverable using the residual method when VSOE of fair value existed.

If evidence of VSOE of fair value of one or more undelivered elements did not exist, all software allocated revenue was deferred and recognized when delivery of those elements occurred or when fair value was established.

When the undelivered element for which we did not have VSOE of fair value was support, revenue for the entire arrangement was recognized ratably over the support period.

The same residual method and VSOE of fair value principles applied for our multiple element arrangements that contained only software elements.

We establish standalone selling price using the prices charged for a deliverable when sold separately.

If not observable through past transactions, we determine standalone selling price by considering multiple historical factors including, but not limited to, cost of products, gross margin objectives, pricing practices, geographies and the term of a service contract.

Deferred Contract Costs and Commission Expense

Beginning in 2018, we recognized commission expense based on Topic 606’s guidance for contract costs.

Under this new guidance, we recognize sales commissions related to product sales upfront while sales commissions for service contracts are deferred as deferred contract costs in the consolidated balance sheets and amortized over the applicable amortization period.

Costs for initial contracts that are not commensurate with renewal commissions are amortized on a straight-line basis over the period of benefit, which we have determined to be five years and which is typically longer than the initial contract term.

We defer contract costs that are recoverable and incremental to obtaining customer sales contracts.

Contract costs, which primarily consist of sales commissions, are amortized on a systematic basis that is consistent with the transfer to the customer of the goods or services to which the asset relates.

Costs for initial contracts that are not commensurate with renewal commissions are amortized on a straight-line basis over the period of benefit of five years.

Significant estimates, assumptions, and judgments in accounting for deferred contract costs include, but are not limited to, identification of contract costs, anticipated billings and the expected period of benefit.

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We review significant new claims and litigation for the probability of an adverse outcome.

Estimates can change as individual

claims develop.

Estimates can change as individual claims develop.

The actual liability in any such matters may be materially different from our estimates, which could result in the need to adjust our liability and record additional expenses.

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Our selection of an accounting policy for 2018 with respect to the Global Intangible Low-Taxed Income (“GILTI”) tax rules was to treat GILTI tax as a current period expense under the period cost method.

For 2019, we were not subject to GILTI.

For 2019 and 2020, we were not subject to GILTI.

We will continue to monitor and assess the impact of the 2017 Tax Act and ongoing guidance and accounting interpretations issued in response to the 2017 Tax Act.

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Year Ended December 31,

2020 2019 2018

(in millions)

Consolidated Statements of Income Data:

Product $ 916.4 $ 788.5 $ 674.4

Service 1,678.0 1,374.5 1,130.2

Total revenue 2,594.4 2,163.0 1,804.6

Cost of revenue:

Product 352.4 324.6 291.0

Service 217.6 181.3 159.4

Total cost of revenue 570.0 505.9 450.4

Gross profit:

Product 564.0 463.9 383.4

Service 1,460.4 1,193.2 970.8

Total gross profit 2,024.4 1,657.1 1,354.2

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General and administrative 119.5 102.1 93.0

Restructuring charges

Gain on intellectual property matter (40.2) — —

Total operating expenses 1,492.6 1,306.1 1,119.8

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Interest income—net 17.7 42.5 26.5

Other income (expense)—net

Other expense—net (7.8) (7.5) (6.6)

Income before income taxes 541.7 386.0 254.3

Provision for (benefit from) income taxes 53.2 54.3 (80.6)

Net income $ 488.5 $ 331.7 $ 334.9

Year Ended December 31,

2020 2019 2018

(as percentage of revenue)

Product 35 % 36 % 37 %

Service 65 64 63

Total revenue 100 100 100

Cost of revenue:

Product 14 15 16

Service 8 8 9

Total cost of revenue 22 23 25

Gross margin:

Product 62 59 57

Service 87 87 86

Total gross margin 78 77 75

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General and administrative 5 5 5

Restructuring charges

Gain on intellectual property matter (2) — —

Total operating expenses 58 60 62

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Interest income—net 1 2 1

Other income (expense)—net

Other expense—net — — —

Income before income taxes 21 18 14

Provision for (benefit from) income taxes 2 3 (4)

Net income 19 % 15 % 19 %

Percentages have been rounded for presentation purposes and may differ from unrounded results.

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Year Ended December 31,

Revenue Amount % of

Revenue Change % Change

(in millions, except percentages)

Product $ 916.4 35 % $ 788.5 36 % $ 127.9 16 %

Service 1,678.0 65 1,374.5 64 303.5 22

Total revenue $ 2,594.4 100 % $ 2,163.0 100 % $ 431.4 20 %

Revenue by geography:

Europe, Middle East and Africa (“EMEA”)

Asia Pacific (“APAC”)

Americas $ 1,077.2 42 % $ 920.2 42 % $ 157.0 17 %

EMEA 991.9 38 816.5 38 175.4 21

APAC 525.3 20 426.3 20 99.0 23

Total revenue $ 2,594.4 100 % $ 2,163.0 100 % $ 431.4 20 %

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We continued to experience diversification of revenue globally, and across both customer and industry segments.

Revenue from all regions grew, with the Americas contributing the largest portion of our revenue growth on an absolute dollar basis.

Revenue from all regions grew, with EMEA contributing the largest portion of the increase on an absolute dollar basis and APAC contributing the fastest growth on a percentage basis.

Product revenue increased by $127.9 million, or 16%, in 2020 compared to 2019.

We experienced revenue growth across many of our hardware and software products due to an increase in product revenue from our SD-WAN FortiGate solutions and growth in sales of our Infrastructure Security solutions.

We experienced revenue growth across many of our products due to an increase in product revenue from our FortiGate SD-WAN solutions, software licenses and our security fabric platform products.

Service revenue increased by $303.5 million, or 22%, in 2020 compared to 2019.

FortiGuard security subscription and FortiCare technical support and other revenues increased by $144.8 million, or 24%, and by $96.1 million, or 18%, respectively, in 2019 compared to 2018 .

The increases were primarily due to the recognition of revenue from our growing deferred revenue balance related to FortiGuard and other security subscriptions and FortiCare technical support and other contracts.

FortiGuard security subscription, FortiCare technical support and other revenues increased by $167.9 million and $135.6 million, respectively, or 22% in 2020 compared to 2019.

Of the service revenue recognized in 2020, 68% was included in the deferred revenue balance as of December 31, 2019.

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Year Ended December 31,

2020 2019 Change % Change

(in millions, except percentages)

Cost of revenue:

Product $ 352.4 $ 324.6 $ 27.8 9 %

Service 217.6 181.3 36.3 20

Total cost of revenue $ 570.0 $ 505.9 $ 64.1 13 %

Gross margin (%):

Product 61.5 % 58.8 %

Service 87.0 % 86.8 %

Total gross margin 78.0 % 76.6 %

Total gross margin increased by 1.5 percentage points in 2019 compared to 2018 , driven by improvements to both product and service gross margins.

Total gross margin increased by 1.4 percentage points in 2020 compared to 2019, driven primarily by improvements to product gross margins.

Product gross margin increased by 2.7 percentage points in 2020 compared to 2019.

Product gross margin benefited from gains in average selling price, as well as lower direct and indirect product costs as a percentage of product revenue.

It also benefited from deal mix, software revenue growth and a stable product transition environment.

product revenue was comprised primarily of third-party contract manufacturers’ costs and the costs of materials used in production.

Service gross margin increased by 0.8 percentage points in 2019 compared to 2018 , as our service revenue growth outpaced our growth in related personnel costs.

Product gross margin benefited from lower direct costs of hardware as a percentage of product revenue and increased software sales.

Cost of product revenue was comprised primarily of third-party contract manufacturers’ costs and the costs of materials used in production.

Service gross margin increased by 0.2 percentage points in 2020 compared to 2019, as our personnel costs grew slower than our service revenue and we experienced lower costs to replace and repair our products.

Cost of service revenue was comprised primarily of personnel costs.

Operating expenses

Year Ended December 31,

Year Ended December 31, Change % Change

Revenue Amount % of

(in millions, except percentages)

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General and administrative 119.5 5 102.1 5 17.4 17

Gain on intellectual property matter (40.2) (2) — — (40.2) *

Total operating expenses $ 1,492.6 58 % $ 1,306.1 60 % $ 186.5 14 %

Percentages have been rounded for presentation purposes and may differ from unrounded results.

* Not meaningful

Research and development

Research and development expense increased by $64.3 million, or 23%, in 2020 compared to 2019, primarily due to an increase in personnel-related costs of $49.0 million as a result of increased headcount to support the development of new products and continued enhancements to our existing products.

We intend to continue to invest in our research and development organization, and expect research and development expense to increase in absolute dollars in 2020.

In addition, product development costs, such as third-party testing and prototypes, increased $12.3 million.

We currently intend to continue to invest in our research and development organization, and expect research and development expense to increase in absolute dollars in 2021.

Sales and marketing

Sales and marketing expense increased by $144.6 million , or 18% , in 2019 compared to 2018 , primarily due to an increase in personnel-related costs of $103.9 million as a result of increases to sales and marketing headcount in order to drive global market share gains.

In addition, marketing expenses increased by $16.8 million.

We intend to continue to make investments in our sales resources and infrastructure and marketing strategy, which are critical to support growth, and expect sales and marketing expense to increase in absolute dollars in 2020.

Sales and marketing expense increased by $145.0 million, or 16%, in 2020 compared to 2019, primarily due to an increase in personnel-related costs of $173.4 million as a result of increases to sales and marketing headcount in order to drive global market revenue increases.

This increase was offset by savings related to decreased travel and fewer in-person marketing events as a result of the COVID-19 pandemic.

We currently intend to continue to make investments in sales and marketing resources, which are critical to support our future growth, and expect sales and marketing expense to increase in absolute dollars in 2021.

General and administrative

General and administrative expense increased by $9.1 million , or 10% , in 2019 compared to 2018 , primarily due to an increase in personnel-related costs of $6.1 million and an increase in litigation costs of $3.1 million.

Certain facilities, depreciation, and information technology costs are allocated to other organizations based on headcount.

We expect general and administrative expense to increase in absolute dollars in 2020.

General and administrative expense increased by $17.4 million, or 17%, in 2020 compared to 2019, primarily due to an increase in personnel-related costs of $9.3 million, an increase in legal-related costs of $2.5 million, an increase in professional services fee of $2.2 million and an increase in the provision for expected credit losses of $2.0 million.

We currently expect general and administrative expense to increase in absolute dollars in 2021.

Gain on IP matter

In January 2020, we entered into an agreement with a competitor in the network security industry, whereby, in February 2020, the competitor party paid us a lump sum of $50.0 million for a mutual covenant-not-to-sue for patent claims.

In 2020 we recorded a $40.2 million gain on intellectual property matter in our consolidated statements of income.

See Note 12 of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for additional information regarding the gain on IP matter.

Operating income and margin

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Operating income as a percentage of revenue increased to 20% in 2020 compared to 16% in 2019.

The increase in operating margin is primarily due to the improvement in gross margin by 1.5 percentage points.

In addition, as a percent of total revenue, research and development expense decreased by 0.7 percentage points, sales and marketing expense decreased by 0.4 percentage points and general and administrative expense decreased by 0.4 percentage points.

The increase in operating margin is primarily due to the $40.2 million gain on IP matter, the 1.4 percentage point improvement in gross margin and the 1.6 percentage point decrease in sales and marketing expense as a percentage of revenue.

Interest income—net and other expense — net

Year Ended December 31,

2020 2019 Change % Change

(in millions, except percentages)

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Other expense—net $ (7.8) $ (7.5) $ (0.3) 4 %

Interest income—net increased in 2019 as compared to 2018 , primarily due to higher interest rates and, to a lesser extent, higher invested balances of cash, cash equivalents and investments.

Interest income—net decreased in 2020 as compared to 2019, primarily due to lower interest rates and, to a lesser extent, lower invested balances of cash, cash equivalents and investments.

Interest income—net varies depending on our average investment balances during the period, types and mix of investments, and market interest rates.

The change in other expense—net in 2019 as compared to 2018 was the result of a $3.8 million impairment charge on an investment in a privately held company during 2019 compared to a $2.2 million gain on the sale of an investment in a privately held company in the same period last year, partially offset by $3.5 million decrease in foreign currency exchange losses.

The change in other expense—net in 2020 as compared to 2019 was the result of a $4.3 million impairment charge on an investment in a privately held company during 2020 compared to a $3.8 million impairment charge on an investment in a privately held company in the same period last year.

Provision for (benefit from) income taxes

Year Ended December 31,

Year Ended December 31, Change % Change

(in millions, except percentages)

Provision for (benefit from) income taxes

Provision for income taxes $ 53.2 $ 54.3 $ (1.1) (2) %

Effective tax rate 10 % 14 %

Our provision for income taxes for 2020 reflects an effective tax rate of 10%, compared to an effective tax rate of 14% for 2019.

The provision for income taxes for 2020 was comprised primarily of a $146.8 million tax expense related to U.S.

federal and state taxes, other foreign income taxes, foreign withholding taxes and unrecognized tax benefits.

The provision was partially offset by a tax benefit of $44.3 million from the FDII deduction, excess tax benefits of $42.0 million from stock-based compensation expense and tax benefits of $7.5 million from federal research and development tax credits.

Our provision for income taxes for 2019 reflects an effective tax rate of 14%, compared to an effective tax rate benefit of 32% for 2018.

The provision for income taxes for 2019 was comprised primarily of an $88.8 million tax expense related to U.S.

The provision for income taxes for 2019 was comprised primarily of a $90.3 million tax expense related to U.S.

federal and state taxes, other foreign income taxes and foreign withholding taxes and a $10.1 million tax expense for an unrecognized tax benefit related to the Ninth Circuit’s opinion in Altera Corporation and Subsidiaries vs.

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The provision was partially offset by excess tax benefits of $39.3 million from stock-based compensation expense and tax benefits of $6.8 million from federal research and development tax credits.

In 2018, our effective tax rate benefit of 32% was comprised primarily of impacts related to the 2017 Tax Act, including a benefit of $164.0 million from the realignment of our tax structure and operations that resulted in a book-to-tax basis difference from previously taxed off-shore deferred revenue.

These benefits were partially offset by a $32.6 million increase in the transition tax for finalization of the provisional estimates under Staff Accounting Bulletin No.

118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act, $20.5 million of tax expense for the impact of the GILTI and $29.6 million of tax expense related to U.S.

federal and state taxes, other foreign income taxes, foreign withholding taxes and a decrease in tax reserves.

Quarterly Results of Operations

The following table sets forth our unaudited quarterly statements of income data for the last eight quarters.

Unaudited Quarterly Results of Operations

The following table sets forth our unaudited quarterly statements of income for the last eight quarters.

The quarterly results of operations for the four quarters of 2019 were adjusted for an immaterial error related to the commencement of revenue recognition for certain FortiCare support service contracts, which resulted in an understatement of revenue.

See Note 2 of the notes to consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K for further detail.

Additionally, the quarterly results of operations for the first two quarters of 2020 were also adjusted to reflect the correction of the immaterial error related to the commencement of revenue recognition for certain FortiCare support service contracts, which resulted in an understatement of revenue.

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.

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Three Months Ended

Dec 31, 2020 Sep 30, 2020 Jun 30, 2020 Mar 31, 2020

As Reported As Reported As Previously Reported As Corrected As Previously Reported As Corrected

(in millions, except per share amounts)

Consolidated Statements of Income Data:

Product $ 288.4 $ 223.8 $ 211.9 $ 211.9 $ 192.3 $ 192.3

Service 459.6 427.3 403.6 405.7 384.6 385.4

Total revenue 748.0 651.1 615.5 617.6 576.9 577.7

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Product (1)(2)

107.4 84.3 84.4 84.4 76.3 76.3

Service (1)(2)

59.6 54.9 50.7 50.7 52.4 52.4

Total cost of revenue 167.0 139.2 135.1 135.1 128.7 128.7

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Research and development (1)

89.0 90.0 82.1 82.1 80.3 80.3

Sales and marketing (1)(2)

291.4 266.7 253.8 253.8 260.0 260.0

General and administrative (1)

32.4 29.4 28.9 28.9 28.8 28.8

Gain on intellectual property matter (1.2) (1.1) (1.1) (1.1) (36.8) (36.8)

Total operating expenses 411.6 385.0 363.7 363.7 332.3 332.3

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Income before income taxes 171.7 128.4 121.6 123.7 117.1 117.9

Provision for (benefit from) income taxes

Provision for income taxes 25.0 5.0 9.5 9.9 13.1 13.3

Net income $ 146.7 $ 123.4 $ 112.1 $ 113.8 $ 104.0 $ 104.6

Net income per share :

Basic $ 0.90 $ 0.76 $ 0.69 $ 0.70 $ 0.61 $ 0.61

Diluted $ 0.89 $ 0.75 $ 0.68 $ 0.69 $ 0.60 $ 0.60

Three Months Ended

Dec 31, 2019 Sept 30, 2019 Jun 30, 2019 Mar 31, 2019

As Previously Reported As Corrected As Previously Reported As Corrected As Previously Reported As Corrected As Previously Reported As Corrected

(in millions, except per share amounts)

Consolidated Statements of Income Data:

Product $ 238.8 $ 238.8 $ 197.1 $ 197.1 $ 189.9 $ 189.9 $ 162.7 $ 162.7

Service 375.6 379.3 350.4 351.0 331.8 333.9 309.9 310.3

Total revenue 614.4 618.1 547.5 548.1 521.7 523.8 472.6 473.0

Cost of revenue:

Product (1)(2)

92.7 92.7 79.0 79.0 82.7 82.7 70.2 70.2

Service (1)(2)

47.8 47.8 45.1 45.1 45.6 45.6 42.8 42.8

Total cost of revenue 140.5 140.5 124.1 124.1 128.3 128.3 113.0 113.0

Total gross profit 473.9 477.6 423.4 424.0 393.4 395.5 359.6 360.0

Operating expenses:

Research and development (1)

71.2 71.2 69.9 69.9 67.4 67.4 68.6 68.6

Sales and marketing (1)(2)

257.1 257.1 227.4 227.4 226.5 226.5 215.9 215.9

General and administrative (1)

27.2 27.2 26.1 26.1 24.3 24.3 24.5 24.5

Total operating expenses 355.5 355.5 323.4 323.4 318.2 318.2 309.0 309.0

Operating income 118.4 122.1 100.0 100.6 75.2 77.3 50.6 51.0

Interest income—net 9.9 9.9 11.4 11.4 11.0 11.0 10.2 10.2

Other expense—net (0.6) (0.6) (6.0) (6.0) (0.4) (0.4) (0.5) (0.5)

Income before income taxes 127.7 131.4 105.4 106.0 85.8 87.9 60.3 60.7

Provision for income taxes 12.5 13.2 25.6 25.8 13.1 13.7 1.5 1.6

Net income $ 115.2 $ 118.2 $ 79.8 $ 80.2 $ 72.7 $ 74.2 $ 58.8 $ 59.1

Net income per share :

Basic $ 0.67 $ 0.69 $ 0.47 $ 0.47 $ 0.42 $ 0.43 $ 0.35 $ 0.35

Diluted $ 0.66 $ 0.67 $ 0.46 $ 0.46 $ 0.42 $ 0.42 $ 0.34 $ 0.34

(1) Includes stock-based compensation as follows:

Three Months Ended

2020 Sept 30,

2019 Sept 30,

(in millions)

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Three Months Ended

2020 Sept 30,

2019 Sept 30,

(in millions)

3 unchanged sentences

In the first quarter, we generally experience lower sequential customer buying, followed by an increase in buying in the second quarter.

The third quarter is often consistent with the second quarter.

In 2020, seasonality was impacted by the COVID-19 pandemic.

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 each quarter.

On a quarterly basis, we have usually generated the majority of our revenue in the final month of each quarter and a significant amount in the last two weeks of each quarter.

We believe this is due to customer buying patterns typical in this industry.

Consistent with the seasonality note above, our total quarterly revenue over the past eight quarters has generally increased sequentially in each quarter, except in the first quarter of 2019 and 2018.

Product revenue, in each quarter in 2019 , increased as compared to the same quarter in 2018 , which we believe was due to investments we made in our sales and marketing organizations, continued product innovation and a robust security market.

We continue to see a shift from product revenue to higher-margin, recurring service revenue.

Total gross margin has fluctuated on a quarterly basis primarily due to seasonality of product sales and seasonality of cost increases.

Product gross margin varies based on the types of products sold and the average selling prices of our products.

In 2019, product gross margin was impacted by new product introductions and the mix of high-end, mid-range and entry-level products.

Service gross margin benefited from the growth of our customer base and renewals.

Consistent with the seasonality note above, our total quarterly revenue over the past two years has generally increased sequentially each year.

Product revenue increased year-over-year as compared to 2019, as we have continued product innovation and successfully launched new product models, expanded our solution sales, with focus on SD-WAN and work from home solutions and continued our investments in our sales and marketing organizations.

Due to our growing customer base, we continue to see a relative shift from product revenue to higher-margin, recurring service revenue.

Total gross margin has fluctuated on a quarterly basis primarily due to the relative service and product mix as well as the seasonality of cost increases.

Product gross margin varies based on the types of products sold, their cost profile and the average selling prices of our products.

In 2020, product gross margin was impacted by new product introductions and the mix of high-end, mid-range and entry-level products and other Fabric appliances as well as increasing software sales.

We have been able to improve our direct cost of appliances with newer generations, and our product gross margin continuously benefits from increasing software sales.

Service gross margin is impacted by revenue growth and our personnel-related costs, third-party repair and contract fulfillment, data center and cloud hosting, supplies and facility-related costs.

Liquidity and Capital Resources

As of December 31,

2020 2019 2018

(in millions)

Cash and cash equivalents $ 1,061.8 $ 1,222.5 $ 1,112.4

Investments 893.8 987.4 604.2

Total cash, cash equivalents and investments $ 1,955.6 $ 2,209.9 $ 1,716.6

1 unchanged sentence

Year Ended December 31,

2020 2019 2018

(in millions)

2 unchanged sentences

Net cash used in financing activities (1,171.6) (195.6) (202.6)

Net increase in cash and cash equivalents

Liquidity and capital resources may be impacted by our operating activities, as well as by our stock repurchases, proceeds associated with stock option exercises, issuances of common stock under our equity incentive plans and payment of taxes in connection with the net settlement of equity awards, real estate and other capital expenditures and business acquisitions.

In recent years, we have received significant capital resources from billings, the exercise of stock options and our Employee Stock Purchase Plan (“ ESPP ”) purchases.

Additional increases in billings may depend on a number of factors, including demand for our products and services, competition, market or industry changes, and our ability to execute.

proceeds from the exercise of stock options in future years to be impacted by the increased mix of restricted stock units versus stock options granted and also to vary based on our share price.

There will not be future proceeds from purchases under our ESPP, which was terminated in February 2019.

Net (decrease) increase in cash and cash equivalents $ (160.7) $ 110.1 $ 301.4

Liquidity and capital resources is impacted by our operating activities, as well as by our stock repurchases, proceeds from the issuances of common stock under our the Amended and Restated Fortinet, Inc.

2009 Equity Incentive Plan (the “2009 Plan”) and payment of taxes in connection with the net settlement of equity awards, real estate and other capital expenditures and business acquisitions.

In recent years, we have received significant capital resources from our billings to customers and, to some extent, from the exercise of stock options by our employees.

Additional increases in billings may depend on a number of factors, including demand for our products and services, competition, market or industry changes, macroeconomic events such as the COVID-19 pandemic and our ability to execute.

We expect proceeds from the exercise of stock options in future years to be impacted by the increased mix of restricted stock units versus stock options granted to our employees and to vary based on our share price.

In February 2020, we received a cash payment of $50.0 million pursuant to a mutual covenant-not-to-sue and release agreement with a competitor in the network security industry.

In July 2020, our board of directors approved a $500.0 million increase in the authorized stock repurchase amount under the Repurchase Program and extended the term of the Repurchase Program to February 28, 2022, bringing the aggregate amount authorized to be repurchased to $3.0 billion.

In 2020, we repurchased 11.7 million shares of common stock under the Repurchase Program for an aggregate purchase price of $1.08 billion.

As of December 31, 2020, $1.01 billion remained available for future share repurchases under the Repurchase Program.

Construction of a second building at our headquarters campus started in the fourth quarter of 2018 and related spending will continue in 2020 and until project completion.

We estimate 2020 real estate spending, including the headquarters campus project, to be between $150.0 million and $160.0 million dollars.

Construction of a second building at our headquarters campus started in the fourth quarter of 2018 and related spending will continue until project completion.

We estimate 2021 spending on the second building of our headquarters campus project to be between $50.0 million and $60.0 million, which was moved from 2020 due to a delay to the project schedule as a result of the COVID-19 pandemic.

We estimate construction to be completed in the first half of 2021.

As of December 31, 2020, our cash, cash equivalents and investments of $1.96 billion were invested primarily in deposit accounts, money market funds, corporate debt securities, commercial paper, certificates of deposit and term deposits and U.S.

government and agency securities.

government securities.

It is our investment policy to invest excess cash in a manner that preserves capital, provides liquidity and generates return without significantly increasing risk.

We do not enter into investments for trading or speculative purposes.

The amount of cash, cash equivalents and investments held by our international subsidiaries was $109.3 million as of December 31, 2019 and $956.6 million as of December 31, 2018.

The decrease in cash, cash equivalents and investments held by our international subsidiaries related to changes in our international tax structure.

The amount of cash, cash equivalents and investments held by our international subsidiaries was $119.8 million and $109.3 million as of December 31, 2020 and as of December 31, 2019, respectively.

We believe that our existing cash and cash equivalents will be sufficient to meet our anticipated cash needs for at least the next 12 months.

Our future capital requirements will depend on many factors, including our growth rate, the timing and amount of our share repurchases, 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 continuing market acceptance of our products and our investments in purchasing or leasing real estate.

Our future capital requirements will depend on many factors, including our growth rate, the timing and amount of our share repurchases, the expansion of sales and marketing activities, the introduction of new and enhanced products and services offerings, the continuing market acceptance of our products, the timing and extent of spending to support development efforts, our investments in purchasing or leasing real estate and macroeconomic impacts such as the COVID-19 pandemic.

Historically, we have required capital principally to fund our working capital needs, share repurchases, capital expenditures and acquisition activities.

4 unchanged sentences

Non-cash adjustments consist primarily of stock-based compensation, amortization of deferred contract costs and depreciation and amortization.

Changes in operating assets and liabilities consist primarily of changes in deferred revenue, deferred contract costs, accounts receivable and inventory.

Our operating activities during 2019 provided $808.0 million in cash as a result of the continued growth of our business and our ability to successfully manage our working capital.

Changes in operating assets and liabilities primarily resulted from an increase in sales of our FortiGuard security subscription and FortiCare technical support services to new and existing customers, as reflected by an increase in our deferred revenue.

Changes in operating assets and liabilities consist primarily of changes in deferred revenue, deferred contract costs and accounts receivable.

Our operating activities during 2020 provided $1.08 billion in cash as a result of the continued growth of our business and our ability to successfully manage our working capital.

Changes in operating assets and liabilities primarily resulted from an increase in sales of our FortiGuard and other security services subscription and FortiCare technical support services to new and existing customers, as reflected by an increase in our deferred revenue, and proceeds from the mutual covenant-not-to-sue and release agreement.

Our total deferred revenue balance grew $496.2 million, or 24%, during 2020.

Our operating activities during 2018 provided $638.9 million in cash as a result of the continued growth of our business and our ability to successfully manage our working capital.

Our total deferred revenue balance as of December 31, 2018 of $1.69 billion represented a 26% increase year over year.

Investing Activities

The changes in cash flows from investing activities primarily relate to timing of purchases, maturities and sales of investments and purchases of property and equipment.

Historically, in making a lease versus purchase decision related to our larger facilities, we have considered various factors including financial metrics and the impact on our employees.

In certain cases, we have elected to purchase the facility if we believed that purchasing rather than leasing is more in line with our long-term strategy.

We expect to make similar decisions in the future.

Historically, in making a lease versus ownership decision related to our larger facilities, we have considered various factors including financial metrics and the impact on our engineers and other employees.

In certain cases, we have elected to own the facility if we believed that ownership rather than leasing is more in line with our long-term strategy.

We may make similar decisions in the future.

We may also make cash payments in connection with future business combinations.

During 2019, cash used in investing activities was primarily driven by $375.5 million expended on purchases of investments, net of maturities and sales of investments, $92.2 million spent on purchases of property and equipment and $34.6 million used for the acquisitions of enSilo and CyberSponse , net of cash acquired.

During 2018, cash used in investing activities was primarily due to $60.2 million spent for purchases of our investments, net of maturities and sales of investments, $53.0 million spent on capital expenditures and $21.7 million used for the acquisitions of Bradford Networks, Inc.

and ZoneFox Limited, net of cash acquired.

During 2020, cash used in investing activities was primarily driven by $125.9 million spent on purchases of property and equipment, a large portion of which relates to our headquarters building construction, and $40.2 million used for the OPAQ and Panopta acquisitions, net of cash acquired, and partially offset by $92.0 million provided by sales and maturities of investments, net of purchases of investments.

Financing Activities

The changes in cash flows from financing activities primarily relate to repurchase and retirement of common stock, proceeds from the issuance of common stock under our equity incentive plans, taxes paid related to net share settlement of equity awards and payments of debt assumed in business combinations.

During 2019, cash used in financing activities was $195.6 million , primarily due to $145.1 million used to repurchase shares of our common stock, $46.5 million used to pay tax withholding, net of proceeds, from the issuance of common stock and $3.7 million of payments of the debt assumed in business combinations.

During 2018, cash used in financing activities was $202.6 million, primarily due to $211.8 million used to repurchase shares of our common stock and $10.1 million of payments of the debt assumed in business combinations.

This was partially offset by $19.3 million of proceeds from the issuance of common stock, net of tax withholding.

The changes in cash flows from financing activities primarily relate to repurchase and retirement of common stock and taxes paid related to net share settlement of equity awards, net of proceeds from the issuance of common stock under the 2009 Plan.

During 2020, cash used in financing activities was $1.17 billion, primarily due to $1.08 billion used to repurchase shares of our common stock, $86.1 million used to pay tax withholding, net of proceeds from the issuance of common stock, and $4.1 million used to pay debt assumed in connection with the OPAQ acquisition.

Contractual Obligations and Commitments

1 unchanged sentence

Payments Due by Period

Less than 1 year

More than 5 years

Total Less than 1 year 1 - 3 years 3 - 5 years More than 5 years

(in millions)

Inventory purchase commitments (1)

$ 259.4 $ 259.4 $ — $ — $ —

(1) Consists of minimum purchase commitments with independent contract manufacturers.

8 unchanged sentences

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis