Fortinet Inc (FTNT) 2009 Q4 法說會逐字稿

Good day and welcome to the Fortinet fourth-quarter 2009 earnings announcement conference call.

As a reminder, today's conference is being recorded.

At this time I would like to turn the call over to Mr.

Ken Goldman.

Good afternoon and thank you for joining us on this conference call to discuss Fortinet's financial and operating results for the fourth-quarter and full-year 2009.

Joining me on this call are Ken Xie, Founder, President and CEO of Fortinet, and Michelle Spolver, Vice President of Corporate Communications.

In terms of the structure of the call, I will begin with a review of our operating results before turning the call over to Ken to provide additional perspective on the performance of our business.

I will then conclude with some thoughts on our outlook for the first quarter and full-year 2010 before we open up for questions.

As a reminder, today we are holding two calls.

Following this call we will hold a second conference call to provide an opportunity for financial analysts to ask more detailed financial questions.

The second call will begin at 3:30 PM Pacific time, and will also be webcast from our Investor Relations website.

It is accessible as detailed in our earnings release.

Before I begin let me first read this disclaimer -- Safe Harbor statement.

Please note some of the comments we make today are forward-looking statements, including statements regarding our financial guidance for the first quarter of 2010 and the full year, as well as statements regarding the momentum of our business going into 2010 and our positioning for continued growth in 2010, statements regarding UTM market trends, and our expectations to address some product shortages that we experienced in Q4.

These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in the forward-looking statements.

Please refer to our SEC filings, in particular risk factors described in our registration statement on Form S-1, and any risk factors described in our upcoming report on Form 10-K for more information on these risks and uncertainties and on the limitations that apply to our forward-looking statements.

Copies can be obtained from the SEC or by visiting the Investor Relations section of our website.

All forward-looking statements reflect our opinions only as of the date of this presentation, and we undertake no obligation to revise or publicly release the results of any revision of these forward-looking statements in light of new information or future events.

Also, please note that we will be discussing certain non-GAAP financial measures on this call.

Our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and in the slides that accompanies today's prepared remarks.

Please refer to our website at http://investor.fortinet.com for important information, including our earnings press release issued a few minutes ago and slides that accompanies today's prepared remarks.

A replay of this call will also be available on the website.

Please note that we routinely post important information on our Investor Relations website, and we encourage you to make use of that resource.

So let me first talk about 4Q.

We are very pleased with our performance during the quarter.

We met or exceeded our goals across key metrics during our first quarter as a public company, including revenue, billings, unit shipments, operating profitability and cash flow.

It was a strong finish to a record year for Fortinet, despite challenging macroeconomic conditions, and we enter 2010 with enthusiasm and momentum.

I am just going to mention a couple of numbers that frankly stick out to me to really focus on.

If you look at 2009 in total on a non-GAAP basis we achieved billings of $282 million, which was up 12% year-over-year.

We had revenue of $252 million, up approximately 19%.

Non-GAAP operating income was $35 million, up 244%.

Our free cash flow was $58 million, up 65%.

In terms of fourth-quarter non-GAAP, billings were $82 million, up 13%.

Revenue is $71 million, up 20%.

Non-GAAP operating income $11 million, up 46%.

Non-GAAP earnings-per-share at $0.13.

It was actually less up by $0.01 than last year.

Free cash flow of $16 million, pretty close or comparable to last year -- the prior year.

If I now go to the income statement let me talk to a few items, and you'll see it is on slide two.

Our billings were $82.3 million, an increase of $9.7 million or 13% compared to the prior year.

Refreshing your memory, our billings drive both deferred revenues plus current period product revenues.

Products usually account for approximately 35% to 40% of our quarter's revenues, with the balance recognized from deferred revenue on the balance sheet.

Historically then approximately 55% to 60% of our current quarter revenues are recognized from the balance sheet.

Billings growth of $9.7 million would have been somewhat higher if not for a drawdown in America's distributed inventory and some product shortages on high-end products, which we expect to have rectified in Q1.

On slide three, product segmentation, you can see billings of entry-level, mid and high end products continues to be well distributed at approximately one-third each.

Additionally, investments made last year in growing our enterprise and high-end sales resources began to pay off, as we saw a growth in larger deals.

For example -- larger deal sizes -- the number of deals over $100,000 for fourth quarter was 98.

That compares to 67 in 3Q of '09, and 51 for the prior year.

The number of deals over $250,000 for the fourth quarter was 34.

And that compares to 21 in 3Q '09, and 18 prior year.

Now turning to revenue.

Total revenue was $70.7 million for the fourth quarter, an increase of 20% on a year-over-year basis.

Fortinet saw good performance across all three geographic regions.

The Americas was $24.8 million versus $21.3 million the prior year.

EMEA was $28.6 million, with $22.7 million the prior year.

And Asia Pacific was $17.3 million versus $15.1 million in the prior year.

As a note, total revenues generated outside the Americas was 65% of revenue in this past fourth quarter versus 64% the prior year.

In terms of Fortinet's diversified product -- business profile from a geographic perspective that can be now seen on slide four.

Turning to product revenue, product revenue was $29.4 million, which was an increase of 12% on a year-over-year basis.

This represented the highest year-over-year growth in product revenue during 2009, and it was against a solid comparison quarter.

In terms of markets, we saw good traction with the enterprise and service provider segments.

We are actually seeing results in investments that we have made in these areas.

Services revenues was $37.4 million in the fourth quarter.

That compares to $29.9 million in the year ago quarter, up 25%.

I would note that our subscription model is a recurring revenue source that provides Fortinet with visibility.

As mentioned earlier, the growth in deferred revenues is an important indicator regarding our recurring revenue growth.

Renewal rates continued to reach the low to mid 70s range for service revenues.

Contrary to the traditional software approach, Fortinet renewals are tied to the life of the client, not the lifespan of customer engagement.

When an existing customer purchases a new Fortinet appliance to replace their existing one, either because they are upgrading their infrastructure or because their appliance has matured and reached its end of life, we recognize this as a new subscription versus a renewal.

Finally, ratable product and services revenue came in at $3.9 million, an increase of $1 million or 32% on a year-over-year basis, and up 9% sequentially.

The year-over-year increase was due to a slight decrease in the weighted average service period over which such revenue was recognized.

A couple of measures of revenue quality.

DSL remained stable at 69 days versus 70 days at prior year.

That is consistent with our target range of 65 to 75 days.

We continue to see excellent aging of the receivables.

Deferred revenue balance increased to $201.9 million, which is up $30 million or 18% year-over-year, and $11.6 million or 6% versus 3Q '09.

We ended fourth quarter with 1,223 employees compared to 1,196 at third quarter and 1,118 the prior year.

As you can see on the chart on slide five of the presentation, Fortinet is a globally diversified business with headcount dispersed worldwide.

To that point, operational efficiency gains were made.

While our total revenues increased 20% year-over-year, the increase in headcount was 9% versus the prior year.

Revenue per employee has steadily increased over the years, as you can see on slide six, which tracks revenue per employee back to 2007.

I am now going to quickly go over some of the income statement cost ratios.

I would add that we have additional non-GAAP financial measures in this section, and you can see those reconciled on our website.

Total non-GAAP gross margin was 73% in Q4 2009, and that compared to 70% in Q4 2008.

This was driven by non-GAAP (inaudible) margin of 61% for 4Q compared to 54% in Q4 of 2008.

The increase was primarily due to a reduction in warrants-related cost and a modest change in inventory charges.

Total non-GAAP operating expenses were $40.4 million in Q4, an increase of 20% year-over-year, which was in line with the growth of our revenue.

The increase in non-GAAP operating expenses related primarily to expansion in our sales channels and investments in new product development.

As a percentage of revenues total non-GAAP operating expenses during the fourth quarter was 57%, which was unchanged from the same period last year.

Non-GAAP R&D expense increased 22% year-over-year to $10.4 million.

As a percentage of revenues during 4Q non-GAAP R&D was 15%, in-line with the same period last year.

This is below our long-term model, although we expect to increase expenses moving forward.

I would also note that given much of our R&D is in Canadian, the Canadian dollar, the FX rate, changed about 12% period to period, and that did contribute about $1 million to the increase in expense.

Non-GAAP sales and marketing expense decreased 22% year-to-year to $25.8 million.

And as a percentage of revenues, it increased about 37% compared to 36% the prior year.

This was driven by an increase in sales headcount of 16%, and other marketing promotional spending, and some impact to the euro in terms of FX rates.

Non-GAAP general administrative expense was essentially flat at $4.2 million.

When you add the percentage to revenues it declined to 6% compared to 7% the prior year.

In terms of profitability, non-GAAP operating income of $11.3 million represented non-GAAP margin of 16% compared to $7.7 million and 13% operating margin the prior year.

Other income declined $1.5 million 4Q '09 compared to same period, primarily due to FX gains that were incurred in the prior year.

The effective tax rate, again for non-GAAP -- as for GAAP, we did have a valuation allowance reduction -- the effective tax rate for non-GAAP was 21% compared to 9% in the prior year.

Thus, non-GAAP net income of $9.2 million was approximately flat compared to the fourth quarter of 2008.

Non-GAAP diluted earnings per share was 13% (sic - see press release] compared to 14% -- $0.14 in the fourth quarter of 2008.

We did add a chart, which you can see in terms of 7, on diluted -- average diluted shares outstanding, which was 70.8 million compared to 66.9 million in the prior year.

Then again, I would mention that there's a full reconciliation between our non-GAAP and GAAP results in our earnings press release.

And for those non-GAAP financial measures that are not described in the earnings press release, the slides accompanying today's prepared remarks are posted on our website.

So let me now quickly talk about full-year results.

Billings came in at $282.4 million -- this is for the full year.

It increased 12% compared to 2008.

Total revenue was $252.1 million, an increase of 19% compared with 2008.

Within total revenue, Fortinet product revenue was $98.7 million, up 4% compared to 2008.

Growth was higher in the second half, as we believe that our product sales were adversely impacted early in the year by the economic slowdown, which affected billings and product growth as customers held onto their products longer.

Service and revenues was $139.2 million, up 32%.

And the ratable revenue was $14.3 million, up 20%.

From a profitability perspective, full year non-GAAP income from operating income was $35.2 million, representing non-GAAP operating margin of 14% compared to 5% in 2008.

We had great progress overall in our non-GAAP operating margins, where non-GAAP gross margins improved to 73% from 69% in 2008.

Effectively we can control costs.

Total non-GAAP operating expenses for the year increased 10% versus revenue growth of 19%.

That even takes into account the impact of foreign exchange on our expenses.

And recall that all of our billings and revenues are in dollars.

Non-GAAP net income was $30.5 million in 2009, leading to non-GAAP diluted earnings-per-share of $0.47.

Cash flow from operations for the year increased $25 million to $62.3 million, an increase of 65% compared to last year.

Let me now take just a couple of minutes on the balance sheet and cash flow.

You can see these on slide eight, nine, and 10.

If you look at cash, it is an important driver, as you know, in our business.

We ended the year with $260.3 million in cash, cash equivalents and investments, an increase of $107.9 million from 3Q, primarily from our IPO of $90 million, which does include warrants and options exercised in connection with the IPO.

And cash generated from operations of $16.6 million in 4Q '09.

Cash flow from operations is primarily the sum of non-GAAP operating income, plus depreciation, plus net changes in deferred revenues, accounts receivables and accounts Payable's.

And again, you can see that on chart 10.

This marks our 15th consecutive quarter of generating positive cash from operations, exclusive of one-time items.

We have been thus cash flow positive since 2005.

A few of the balance sheet highlights.

AR balances increased to $54.6 million from $44.1 million during Q3, driven by higher billings plus a modest increase in DSOs at the end of the quarter.

As I noted, aging continues to be excellent and current.

Inventory remained stable all year at approximately $10.6 million.

I would note that since the second half of 2007 we have consistently improved net inventory turns to approximately 3.7 in Q4 from a low of about 1.3 times.

Our working capital increased [$316.2 million] to $161.7 million compared to 3Q '09.

So let me summarize before I turn it over to Ken.

We are quite pleased with Fortinet's financial results in our first quarter as a public company.

Fortinet saw improvement in key metrics on both a quarterly and annual basis -- billings, revenue, gross margins, operating profit, deferred revenue, cash flow.

We also continue to leverage the efficiencies in our business.

You will see that in headcount, inventory and expense controls.

And gaining marketshare and traction in key new and existing accounts.

So let me turn it over to Ken, and then I will summarize the guidance at the end.

Thank you, Ken.

And thanks to everyone for joining us on the call.

I am here pleased to share with you that Fortinet is the strongest it has ever been.

So in Q4 and the full year of 2009 Fortinet met and exceed our financial targets.

We have achieved 15 straight quarters as the number one leader in the unified threat management market according to IDC.

Fortinet's products and technology has been validated by our large and growing base of more than 75,000 customers, including a majority of our 2009 Fortune global 100 companies.

We shipped all 500,000 security (inaudible) in Q4, since Fortinet launch the product in the middle of 2002.

Fortinet as the pioneer and the number one leader in UTM, our solution virtually improves security, simplifies deployment and management.

And it lowers the total cost of ownership by integrating managed security feature and technology into a single platform.

Today UTM become one of the biggest, fastest growing market within (inaudible) security space.

The newest IDC research show that UTM reached $1.7 billion market during 2008.

And it is expected grow to $3.2 billion by the year 2013, which represent a compound annual growth rate of 13.8%.

Fortinet as a pioneer and the number one leader is well-positioned to keep gaining market share.

We will keep invest heavily in R&D and innovations, which has contributed to 40 issued patents and more than 100 pending patent applications today.

Fortinet has more certified products and features than any other vendor in the UTM market.

Our broad productline covers SMB, enterprise and service providers, and protects network infrastructure, endpoint user, database and applications.

Now some key product and technology highlights during Q4.

We launched and began shipping our FortiGate 200B and FortiGate 1240B, which leverage our new FortiASIC nano processor to deliver industry-leading performance and port density.

And (inaudible) new offering, which also including the FortiGate 310B and FortiGate 620B, which were introduced early in 2009.

Also in Q4 almost all FortiGate are production shipping with new FortiOS 4.0, which we introduced in early of 2009 and get very good feedback from our customers.

The FortiOS 4.0 integrate a lot of new feature, including application control, data leakage prevention, and the wide-area network acceleration.

We also announced FortiGate OS products, which introduced network security, together integrated with (inaudible) IP into a single platform for the SMB market.

And [FortiMail] set an industry new benchmark for the IPv6 high-performance with 56 KB per second of IPv6 security processing support on our FortiGate 5000 platform.

Also during Q4 Fortinet validate our technology and business standard with new certification and awards.

The FortiMail is the e-mail security appliance being awarded Virus Bulletin's highest level platinum certification in a VBSpam award.

Fortinet channel program is winning impressive honors in Q4.

Named Security Company of the Year by CRN, and overall winner of security appliance category in (inaudible) channel annual report card.

Now let me quickly switch to some Q4 sales highlights.

We keep expanding our customer base across all regions and markets.

A few of our large customer win during the quarter include one of the world's largest telecommunication provider, who will be using Fortinet FortiGate system for managed security service.

This is a repeating business.

An international Fortune 1000 finance institution, where Fortinet displaced an incumbent competitor, this begin as a (inaudible) fresh opportunity and expanded into a UTM win after demonstrating the increased security and the productivity of a consolidated solution.

And a global managed security service provider purchased thousands of low-end FortiGate device for a [annual] upgrade, and (inaudible) compliance project for a large retail customer.

In conclusion, I am confident that Fortinet is well-positioned for 2010.

We are a pioneer and a leader with advanced and (inaudible) that product and technology in the UTM and the network security space.

And we will keep aggressively invest in innovation and growth.

With that, let me turn it back to Ken Goldman.

Before reviewing guidance, let me remind you that guidance consists of forward-looking statements.

And please keep in mind my earlier comments regarding such statements.

Relative to the first quarter, I would remind you that we do have some seasonality in our business.

The first quarter we are targeting billings to be in a range of $70 million to $72 million, which the midpoint represents year-over-year growth of approximately 18%.

Total revenue would be in the range of $65 million to $67 million, which the midpoint represents year-over-year growth of approximately 22%.

Non-GAAP operating margins would be in the 8% to 10% range.

That would add a couple of points [a way] to expenses in Q1.

In addition to increased investments in salesforce, headcount and R&D during, the first quarter there were increased expenses related to benefits restarts and employee merit raises.

Non-GAAP earnings-per-share is expected to be in the range of $0.05 to $0.06 per share, based on an expected diluted share count in the range of 74 million to 77 million.

I would add that we still expect tax rate to be approximately 39%.

As it relates to the full year, we are not providing specific guidance, but would share that our goal is to grow revenue and billings faster than the market, which based on current market estimates, would have us charging growth in the midteens range for 2010.

It is still early as the year has just begun, and our plan is to provide an update on our full-year growth target after another quarter or two, as we get a few more public orders under our belt and we have increased visibility with respect to the economic outlook.

Thus, with respect to margins (inaudible) that most of analysts are around 12% on a non-GAAP operating margin perspective for the full year 2010.

As of now, we are comfortable with that.

And as the year moves on we will update our view based on our growth, direction of the economy, and the pace of our investments.

Relative to the free cash flow for the full year, we are comfortable with an initial range of $45 million to $50 million, which takes into consideration several factors for 2010.

We do expect to incur higher cash outflows for taxes.

We expect to increase our net accounts receivable due to the growth in billings.

We expect to invest in inventory to support our growth.

So in closing, I would say we feel really good about Q4 in that we met and exceeded our expectations.

And feel Fortinet is well-positioned for continued growth in 2010.

With that, I will turn it over to the operator.

And I will be the moderator for the Q&A session.

(Operator Instructions).

Robert Breza, RBC Capital Markets.

Ken Goldman, as you look at the free cash flow expectations from a year-over-year perspective, you talked about investing in inventory, etc.

Can you tell us, or help us understand, the drawdown of inventory and the shortfall here in Q4 and then how that influences the cash flow going into next year as well?

Thanks.

Relative to cash flow, as we thought about it -- it was really in the order I provided it.

We had paid virtually no taxes and cash taxes in prior years, including '09.

And we will be a taxpayer in 2010.

So we are still working exactly how much that is, but we will be paying quite a bit more in taxes in '10.

We also expect to grow faster, and so we expect to show more growth in billings, so that will affect our AR.

Then from an inventory point of view I would say that is -- again, we ended the year around $10.6 million.

It is not dramatic, but on the other hand, I think we are probably working as tight as we can.

And so I am thinking a little bit more of that we will have there.

And frankly instead of improving on turns that we did in the year of '09, turns should stay the same or maybe go down a little bit, as we did have in some of the higher-end products -- I don't want to get quite more specific.

We did move out some shipments a little bit into Q1.

So I would say, as I think about it, the real one that I know is really different is we will be paying out taxes in cash in '10.

Ken Muth, Robert Baird.

It is James Falkoff on for Ken.

Thanks.

Can you just comment a little on the pipeline and the opportunities in the service provider segment a little more?

And then maybe in particular could you comment a little on what you're seeing with respect to cloud services adoption and the impact that is having on the industry.

Let me -- I will start with the service provider, and then I would suggest that maybe Ken takes the cloud and the opportunity there.

We did have really across-the-board, whether it was in Americas or Europe -- and Asia as well, a very strong year in '09 relative to service providers.

We do expect another good year in '10.

We don't necessarily talk about pipeline per se, but we certainly do know there is a lot of opportunities there, both with some of our existing accounts, and particularly some accounts where we can extend our share of those accounts.

So I think in the main we see a lot of opportunity there.

Frankly, we see a lot of opportunity in the enterprise space, where we are really invested heavily recently in terms of sales.

And so that is one of our target growth markets in 2010, particularly in Americas, but also around the world.

About the cloud, I will let maybe Ken to add a couple of comments on that.

Yes, we do see -- there is quite some growth on the service base on a cost base security offer from all these telecom service providers.

And the Fortinet product, we have our strung on a high-end.

Especially the ASIC or satellite high-performance platform gained market advantage in telecom and the service provider environment.

And also last year we also had the [net] certification, which all the telecom -- major telecom equipment vendor require there.

So that was the (inaudible) some good increase in sales into this cost base and the service provider base -- the deal we have.

And also we see some expanding the data center worldwide, which also security is an important piece of that.

Very good.

Thank you.

Todd Raker, Deutsche Bank.

Two questions for you, Ken.

First, can you give us some insight in terms of the product shortage at the end of the quarter, any ability to kind of quantify the impact of that and what it would have done to billings?

And just talk from a high-level perspective how you're going to make sure that doesn't happen going forward.

I would say it had a modest impact.

I don't want to absolutely quantify the amount.

In terms of never happening again, I'm not going to go there, because we may have from time to time -- we may have product issues.

Again, what we balance, and I think we have done a pretty good job of it, is stock outs versus not having excess inventory.

I refresh some of you that back a few years ago we had significant excess inventory.

So what we're trying to really balance is having product, and it goes both on forecast and trends we have, with the idea that we continually upgrade our new products.

And we are constantly bringing out innovative products, which means we have to manage very closely the inventory we have on products that are "towards the end of their life".

So there is a balance here.

It is something we manage.

And it is -- the good news here is I think we are losing business; it may be delayed a tad.

Then second question for you.

This is more financial issue.

If I look at the cost of products, going from non-GAAP to GAAP, I think there is an impact of about $1.6 million, something along those lines.

Stock comp is a small component of that.

It is $1.689 million.

What was the big impact there?

I don't have that right in front of me.

I think it may be the warrant expense, but I (multiple speakers).

I will circle back on the second call on that one.

We had two warrants that were exercisable upon going public, and so therefore we took a charge, if you will, for those upon going public.

In total that was about $1.5 million in total.

So you look at stock-based comp, all the charges, that is one of the costs, in addition to the normal stock-based comp.

Okay, thanks guys.

I will circle back on the second call.

Jonathan Ruykhaver, ThinkEquity.

Congratulations on the strong performance.

Can you comment on where renewal rates were in the quarter?

With comments like that, you will get indicted over here more often.

As I talked about, the renewal rates really were pretty consistent -- actually very consistent this quarter relative to prior quarters.

We -- what happens with us is we end the quarter with a certain renewal rate and then it takes us a quarter or two to fully renew those that may have expired, just because of the time it takes.

So that is why I mentioned the number we achieve in the mid-70s over time.

I think there is a limit to what we can achieve, just because products do get superseded.

And that is a new subscription when products get superseded as opposed to renewals.

Having said that, we definitely feel they can do better.

I think the area that we were working on is a category called 5000 under accounts, in which we know is a lot of opportunity to renew.

But between us and the resellers sometimes it is hard to address the size of those opportunities.

So we think there is a few more points of renewal we can gain.

But again this is not the software business where you have basically in perpetuity the product, and therefore you constantly renew them.

When you talk about a few points of improvement, is that something just through better alerting, better monitoring that you can drive as we look into the rest of this year or is it going to take longer?

I think we're focused on it, hopefully, to make some progress.

We certainly want to make progress this year.

And so I think it is this year or the next year opportunity, not a manana opportunity, if you will.

Jonathan, it is Ken Xie.

I also want to add a point (inaudible).

During the recession the customers tend to hold the products longer, which gave some higher renewal rate, because each of our products have a lifespan maybe four or five years.

So after four or five years, whether they're going to buy a new product or something else.

So that is where we are the expanding fast-growing stage sometime the renewal [reach out] it is more because of the upgrade of the product.

So that is probably -- we also have some impact on the [renewal remodel].

Right.

So as the budgets got loose you expect those may be some catch up on the maintenance that didn't renew previously?

Yes, that is where if their budget is high, they may tend to do the renewal instead of buy a new product.

Okay.

So when they buy the new product for us is counting, even the same customer for us, is counting as a new service instead of renewal.

Yes, new subscription.

Right, okay.

Just looking at the UTM market and competitive dynamics, Checkpoint is rolling out a new architecture to support these multifunction software blades.

Have you seen any kind of change in landscape from a competitive standpoint because of that in the marketplace?

Not really.

I think for us, we still believe we have been focusing in this space for nine, ten years, and has a consistent focus on developed ASIC, improve the performance, and also integrate all these features together into a single platform.

So far we don't see any competitor come close to what we offer today.

Okay.

One quick final question.

Just on the WAN acceleration features, I'm curious, what kind of protocols or applications do you optimize today?

And are we going to keep router protocol and application support over time?

You see, we announced 4.0 last year, with many new features, including data [looting] prevention, the WAN acceleration (inaudible).

Usually it takes a couple of years to move from software into the ASIC to accelebrate.

So whenever a new feature come out we always -- we are starting kind of see how to improve the feature with ASIC on the speed side.

And also then we can free up the CPU to add some new feature here.

I think that is a constant effort there.

So we have up to [two ASIC] product family.

One is accelerating the content layer and one is accelerating the network layer.

So we are constantly keeping improving.

That's where we announced the new network processor family in 2009.

It was very good performance acceleration, especially in the middle range.

That is a [full] product we announced in last year 2009.

Okay, that's all I have for now.

Thanks.

Sterling Auty, JPMorgan.

Ken Xie mentioned in his prepared remarks one of the deals you won was a firewall refresh that turned into a UTM deal.

Can you give us more color and commentary in terms of what you're seeing in customers taking more multi-service, so more than just firewall, firewall VPN, in the products?

And Ken Goldman, can you give us maybe some commentary in terms of what the impact is and maybe driving the service and routable revenue faster because of the more multifunction devices that you might be selling?

Yes, (inaudible) customer is one of the financial institutions.

It is a big financial institution.

As you know, for the big enterprise they tend to have a lot of security expert, and each may be dedicated to a different area.

For this case the customers tried to upgrade refresh their old firewall offering, their firewall product.

And the UTM (inaudible) has a few different -- few advantage over the firewall.

One, it is (inaudible).

Today we see a lot of what they call blended attacks, so it is really the (inaudible) combined with the spam intrusion firewall, whatever.

So it is very difficult to have a different [point] product work together to defend this blended attack.

Also, a lot of these big enterprise, they also prefer to have something they call a multi-skin.

That is when multiple line of protection.

So even though there may be a firewall, they prefer some other UTM, or they have intrusion and also UTM that can offer the same features, so they can get the actual protection.

In the past the high-performance we have (inaudible) integrated solutions that make us a win in this one.

The customer, they are very happy to select this.

It is a one-pass [N] feature.

Instead of just offer one feature single point product, they are happy to have the capability to turn on additional features going forward.

So that is the main reason we win this deal.

Let me just quickly -- you asked about service and ratable.

I would first of all say that we ended the year at $202 million deferred.

So that gives us very good coverage, if you will, of future services revenues.

Heretofore our service revenues have grown faster in products, and that is because of our expanding installed base.

We are very focused, honestly, in '10 of increasing our product revenues, and so I hope to see that more balance out into '10.

In terms of ratable, I would say we did benefit a little bit on some shorter service periods and what we called some demo units, by the way we handle demos.

So I would expect the growth in ratables to be more modest, if you will, going into 2010.

As a follow-up, historically I think there has been certain reasons why customers would bring you in to solve a problem.

One of the questions I am getting from investors a lot is, when you look at the enterprise and the telco, as you look in the fourth quarter, what was the most common thing that you saw for a reason for you to bring it in?

Was it firewall refresh?

Was it the blended attacks or was it -- can you not just point to one area that was the biggest reason that you were brought in?

I feel there are certain customers, they have a budget needed spending in Q4.

That is [really] Q4 tend to be the most strong quarter for a lot of IT company.

For this one they realized the firewall kind of a -- what do you call it -- box is difficult to match the current network speed, and that is why they need to have some upgrade.

Then the reason they select [us for their] UTM is really they realize UTM is a new generation for the network equipment.

So they do offer much more features and also defend the latest attack compared to the traditional firewall can offer.

Also, for the UTM, because each of the feature like a firewall, VPN, intrusion, we go through all the most application we can guard and make sure each single feature also be the best in that space.

So the customers are happy with just using it as a firewall intrusion.

That also gave us -- give us an opportunity to expand into some firewall IPS market there.

So that is -- I would say probably they have to spend money in Q4 sometimes.

Samuel Wilson, JMP Securities.

Just two very small questions.

First, post-IPO, post the buzz, can you give us a sense, did you see an increased RFP activity, and any increased competition in the marketplace, just as the Company has been more well known here in the last couple of months?

I'm not sure if that is one question or two questions.

But we certainly do see more interest.

I think clearly financial services now -- many of the larger financial services companies, particularly in the US, have a better understanding of Fortinet, so it is helping us get engaged in possible opportunities.

We are also hiring to support that opportunity.

So we are seeing that.

So I can't necessarily pinpoint any specific business per se, but I do think over time -- it is still early, but I do think over time it will definitely help us.

I think in the case of Europe we have always enjoyed in many of the regions there a very good marketshare.

I think the positive there for us is they now have financial statements and so forth, and we have a lot less detours, if you will, as to going through our numbers confidentially with them prior them making a selection.

Ken Goldman, just one quick question.

Given the product shortages and the answers you gave previously, if I read you correctly, it is your intent to carry slightly higher inventory levels to deal with potential and future product shortages?

Is that fair?

Yes.

Again this is at the margin, so I think -- and we balance it.

The balance is really -- you don't want to miss business because of your products.

We do have a tremendous number of distinct products, and so it always is a challenge in terms of making sure we keep the right amount in terms of the quantity by products and so forth.

But I think the real point I am trying to make is, I think I said before, we increased our inventory turns from 1.3 roughly -- 1.3, 1.4 to 3.7.

I think that is probably (inaudible) as high as we can go for now.

So that made the margin go down a little bit, as we are not quite as tight on some of our inventories.

So it is not a big -- I wouldn't call this a major item in terms of -- because again, you're talking about inventory that is less than $11 million, so a small increase is not going to add a lot.

But I do want to point out that I think we have to probably -- we won't be seeing improved turns for a while and they may go down a tad.

Great.

Great quarter, gentlemen.

Thank you.

Erik Suppiger, Signal Hill.

Congratulations.

On the product billings it looks like there was a shift towards the entry-level products.

Was that because of the product shortage or was there any notable reason for the shift?

I am not quite sure when I look at -- in other words, the chart I am looking at it shows entry-level for the year was 38%, and for the fourth quarter was 31%.

So I am not sure what is causing you to come to that conclusion in terms of products.

Okay, I was thinking of for the year.

You have to look at right to left.

I'm sorry, maybe we should have done it differently.

But for the year, entry-level is 38, and for the quarter it is 31.

I would add a little commentary.

We did see that it goes -- consistent with my comments earlier -- we did see good demand at the higher end products.

And just like anything else, you always want to grow the pie, so you want to grow all those areas.

But nonetheless, we did see a little bit more growth in the high end this particular quarter.

That's fine.

On the free cash flow, what is your CapEx assumption in terms of the cash flows for next year?

I don't have that exact number, but we tend to run in the order of $3 million to $5 million a year.

It tends not to be a great -- a very high number.

So you can see the net PP&E I think is only around $6 million for us.

So it is a modest number, and so therefore the difference between operating cash flow and free cash flow is pretty modest.

The $45 million to $50 million, that was the free cash flow?

Yes.

Then what was linearity for the quarter?

The linearity didn't change much from prior quarters.

We tend -- historically we tend to ship about 40% in the first two months, and about 60% in the last month, plus or minus a few percentage points either way.

So it tends to be about the same.

And we really didn't see much difference this past quarter.

Then lastly, the services revenue growth was 1% or 2%.

What was the reason you had said?

Did you say it was a shorter period?

I'm sorry, can you repeat the question again?

The services, the growth in the services revenue on a sequential basis was somewhat modest.

What was the reason for that did you say?

I was only talking year-over-year.

I don't think there is anything distinct in terms of quarter-to-quarter in terms of really the sequential revenues.

Again, I am pretty much focused on, A., the total revenues and the growth year-over-year.

Very good.

Thank you.

One thing also.

The service revenue in Q3 we changed from 13 week to actually the calendar quarter.

So that is probably a couple of days more in Q3.

That would explain it.

Thank you very much.

(Operator Instructions).

Rohit Chopra, Wedbush Securities.

I had three questions.

Is there any way to quantify new versus existing customers in the quarter?

We have not been able to do that.

It is a little hard -- I know where you're coming from, particularly if you cover software.

It is a good metric.

For us it is a little harder because of the [two-tiered] channels we go through with distributors and resellers.

So it is a number we don't have -- at some point we may get better delineation, but at this point, unfortunately, I don't have that data, otherwise I would share it with you.

Then I just wanted to come back to the competition issue.

I just wanted to find out who you are actually running up against most, when you're going up.

Especially when you do large deals, like carrier deals, who you are running up against?

And there is a way to quantify win rates when you go up against some of these large players?

We see, like in a lot of our big deals, we see Juniper and Checkpoint and sometimes Cisco.

We don't keeping the winning rate, but as I know, it is the customer really that hands down the product do the [testing], we have always a much,, much bigger chance to win, because the product is always much better.

What is the second question?

That was it.

And my last question --.

And the opportunity for us in terms of win rates is when we track it, we don't see often where we missed winning a deal.

Our biggest problem, honestly, continues to be making sure we have the sales coverage, and the accounts know us so that we are in there and can compete for the business.

That continues to be, as much as anything, what keeps us from winning those deals, if you will.

So basically getting into those deals is really (multiple speakers)?

We don't know what we don't know.

Right, exactly.

Then my last question is, is there any update on the Trend Micro litigation, any update you can provide?

Yes, let me talk to a couple of things here relative to the three -- really there are three kinds of litigation we are involved in.

In terms of Trend, I would add that we settled with them a few years ago.

There were new facts that were uncovered that caused us to relitigate, if you will.

As of now there is nothing really new on them.

In the case of Palo Alto Networks (inaudible) we did add three new patents.

In terms of our suit, I would add today that we are now up to total of 40 patents and something like 100 plus pending patent applications.

So we continue to litigate that.

As you know, we are involved with ESR and DeepNines, who many would consider patent trolls.

In terms of ESR there is a number of companies involved with them.

There is nothing really new I can say there.

In terms of DeepNines, we continue to talk with them and as of yet we have not been served.

That does conclude our question-and-answer session.

I would now like to turn the call back over to management for any additional or closing remarks.

Thank you.

And so it is always good to have the first quarter under your belt, as they say.

We will have another call in approximately an hour, and it will be focused on -- well, focused on anything you want to ask us in more detail.

But if there are any specific questions in that webcast format relative to your financial models, we are happy to talk to you about it.

So, again, thank you very much for -- on the call and for those on the --.

And I call you in an hour and we will talk to you then as well.

Thank you.

That does conclude today's call.

We do appreciate everyone's participation.