With its stock up 26% year to date, some investors may think it's a bit late to board the Fortinet (NASDAQ: FTNT) train. The good news is Fortinet, like many of its peers, is still in the process of transitioning to a recurring revenue model via its cloud-based security software subscriptions, and there's a way to go before it hits the finish line.
That said, as investors saw again last quarter, Fortinet is making significant progress, and it's evident on both its top and bottom lines. It wasn't long ago the notion of generating a profit, let alone significant bottom-line growth, seemed little more than a pipe dream. But for a host of reasons, those days are gone, which is why it's time to get greedy with Fortinet stock.
Another quarter, another step in the right direction
The $363.5 million in revenue Fortinet generated in the second quarter of 2017, a pleasantly surprising 17% jump year over year, got much of the press, and rightfully so. Fortinet's revenue "beat" resulted in a stock price pop, and its increased guidance for the current quarter and the balance of 2017 added to the good tidings.
But Fortinet's strong sales took a back seat to a few other key areas that demonstrated dramatic improvement and, assuming it can continue to perform -- which there seems little doubt it can and will -- are the real reasons it's time for some greediness.
A primary initiative of founder and CEO Ken Xie is to boost Fortinet's steady and reliable recurring revenue foundation, and in that regard last quarter was an unmitigated success. Product sales inched up a mere 4.4% in the second quarter to $142.5 million, which was right in line with Fortinet's relatively new revenue goals.
The so-so product sales gain was more than offset by Fortinet's whopping 26% increase in service revenue to $220.8 million. And with $1.16 billion in deferred revenue on the books, up 28% over a year ago, it's safe to say Fortinet's ongoing service-related revenue improvements will continue in the quarters and years ahead.
But wait, there's more
One of the benefits of Fortinet's focus on recurring revenue is that it costs less to service existing customers than rely solely on new sales. Though Fortinet still has some work to do, particularly as it relates to spending on sales and marketing, last quarter was another example its efforts in controlling costs are taking hold.
Operating expenses inched up a mere 3.6% to $239.3 million compared to a year ago. Considering Fortinet's 17% jump in revenue, the minor increase in spending is more than acceptable. However, an area to monitor is Fortinet's sales costs, which at $166.34 million last quarter equaled 46% of total revenue, a bit high but improving with each successive quarter.
For some perspective, Fortinet's peer and competitor Check Point Software (NASDAQ: CHKP) spent $114.7 million on sales and marketing last quarter, equal to just 25% of its $458.6 million in sales. Granted, Check Point is further along in its transformation to a subscription-based, recurring revenue model, but it serves as an example of what Fortinet investors can look forward to in the future.
Last, but certainly not least
Ultimately, for fundamental investors at least, top-line growth is fine, but are revenue gains translating to increased profits? In Fortinet's case, its continued sales improvement combined with its expense management efforts is showing where it counts.
Last quarter, Fortinet generated earnings per share (EPS) of $0.13, which blew the doors off last year's loss of $0.01 a share. Adjusted EPS, a metric often cited to account for one-time costs, also surpassed expectations, nearly doubling to $0.27 compared to 2016's second quarter of $0.14 a share.
Growing revenue where it counts, getting a handle on expenses, and ballooning profits are why it's time for investors to get greedy with Fortinet stock.
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Tim Brugger has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Check Point Software Technologies. The Motley Fool recommends Fortinet. The Motley Fool has a disclosure policy.