Fortinet Inc (FTNT) 2010 Q1 法說會逐字稿

Good day, ladies and gentlemen and welcome to your Fortinet Q1 2010 earnings announcement. At this time, all participants will be in a listen-only mode, but later we will conduct a question-and-answer session, which instructions will be given at that time. (Operator instructions.) And as a reminder, this conference is being recorded.

And now, it's my pleasure to announce your host, Ken Goldman.

Yes, thank you. Thank you for all joining us on the conference call to discuss our financial and operating results for the first quarter of 2010. Joining me on this call are Ken Xie, Founder, President and CEO, 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 (sic) quarter and full-year 2010 before we open it up for questions.

30 p.m. 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. Please note some of the comments we make today are forward-looking statements, including statements regarding our financial guidance for the second quarter of 2010 and full year, as well as statements regarding the momentum of our business going into 2010, our plan to continue to invest in sales headcount and research and development, improvements in the economic environment, our ability to continue to gain market share across all geography and customer segments, our focus on delivering new and innovative products and gaining market share, and expectations of services revenues to increase over time due to our deferred revenue model. That's a mouthful.

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 the risk factors described in our registration statement on Form S-1 and 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.

Please note we will also 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 on slides 11 and 12 of the presentation accompanying today's prepared remarks.

//investor.fortinet.com for important information, including our earnings press release issued a few minutes ago and slides that accompany today's prepared remarks. A replay of this call will also be available on our website. Please note that we routinely post important information on our Investor Relations website, and we encourage you to make use of that resource.

Okay. Let me now -- after that, let me talk about our first quarter. I'm very pleased to say we had an excellent start to this year, reporting one of the strongest [season- --] first quarters in the Company's history. We executed very well in our first full quarter as a public company relative to all of our key operating and balance sheet metrics and exceeded the high end of our guidance from a billings, revenue and profitability perspective.

Let me first discuss a few metrics which really tell the story about this quarter, as can be seen on Slide 2. Fortinet had robust growth in billings and revenues, with billings growth of 32% and revenue growth of 29% year over year, both of which represent an acceleration of growth compared to last quarter and the year-ago period. In addition, the balance of our billings and revenue performance across all major geographies is a result of the investments we made early on to build out a truly global business.

Along that same vein, products and services were also nicely split, with about 40% for products and 60% from services. Product sales were up 40% year over year, driven by unit growth, also up approximately 40%. This is our best year-over-year growth of products since Q4 of '08 and fastest growth for units since Q4 '06.

Non-GAAP operating income of approximately $9 million, representing a non-GAAP operating margin of 13% and an increase of 400 basis points compared to the first quarter of 2009.

We have a crystal clean balance sheet in terms of our growing cash balance, driven by record free cash flow of $21 million during the quarter. In addition, our accounts receivable are very clean. Our inventory balance declined again compared to 4Q '09. We ended the first quarter with a cash and investments balance of approximately $281 million compared to $260 million at the end of 2009.

We experienced an improving economic environment in the first quarter that began at the end of last year. The threat landscape continues to increase in volume and complexity. Network security remains a must-have for enterprises of all sizes, and we are hopeful this trend will continue in the coming quarters.

Recent study by Citigroup, enterprise CIOs reported improving network security as among their highest priorities. We hear this over and over again. Network security has been a high priority for enterprise even [in advance] of the economic downturn. And now, with economic conditions stabilizing we are encouraged with the momentum we are seeing so far in 2010 and believe that Fortinet remains well positioned to continue to gain market share across all geography and customer segments.

So let me go into a little bit more detail and take you through the income statement. And you can see again, this is on slide 2. Billings were $79.4 million, an increase of $19.2 million, or 32%, compared to the prior year and compare favorably to our guidance of $70 million to $72 million. As a reminder, Fortinet defines billings as revenues recognized, plus the change in deferred revenues from the beginning of the period to the end.

If I now move to product segmentation, which you can see on Slide 3, billings of entry-level, mid-, and high-end products continues to be well distributed at approximately one-third each. Investments made last year in growing our enterprise and high-end sales resources are beginning to pay off, as we saw the high-end account for approximately 27% of our product billings. I would also point out that a portion of our entry-level products are also being sold to large enterprises with branch offices.

And now turning to larger deal sizes, the number of deals over $100,000 for 1Q was 84, compared to 57 the same quarter last year and 98 in Q4. The number of deals over $250,000 was -- the number of deals over -- for 1Q was 22 and that compares to 12 in 1Q as well as 34 in 4Q. So a nice growth for both of those metrics year over year.

Returning to revenue, total revenue was $69.8 million for the quarter, an increase of 29% on a year-over-year basis and solidly above the high end of our guidance of $65 million to $67 million.

Fortinet's diversified business profile from a geographic perspective can be seen on Slide 4 of this presentation. Fortinet saw good performance from all three geographic regions during the quarter. By way of background, the geographic split of revenue is accounted for by the bill-to address.

Turning to the Americas, we saw revenues of $23.8 million compared to $19.1 million the prior year, representing an increase of approximately 24%. We had a strong quarter in the US, with increased deals to large enterprises and major accounts as a result of the investments made in growing this business.

Sales cycles are shortening. An example of this was a win we had with a leading global technology distributor for a major security infrastructure upgrade internally across the world. The deal went from RFP to close in one quarter, which is a sign of pent-up demand and budget. We beat a host of vendors, including Juniper and Cisco. We also saw strong sales in the retail and entertainment sectors. We won deals with major food chains, one of the largest clothing retailers in the world, a major casino and a large US airline. Service provider business grew significantly, with large wins to new and existing accounts who are using our solutions to protect their own infrastructures as well as deliver managed security services.

Finally, we saw business pick up in [select] geographies in Latin America and Canada, with (inaudible) in Canada, especially in the government sector, coinciding with the end of their buying season.

Turning to EMEA, our revenues were $27.1 million compared to $20.8 million the prior year, increasing 30%. The sub-region including Italy, Turkey, Greece and the Middle East produced the highest sales in EMEA and also saw the strongest growth year over year, with some notable wins, including a large government agency in the southern European region migrating to a consolidated security approach and selected us over Cisco and Juniper. The agency will be protecting its [fibernet] regional offices using our FortiGate UTM appliances for firewall, IPS, antivirus, web content filtering and anti-spam.

A Middle East utility company who selected a variety of Fortinet products, including FortiGate, FortiWeb, FortiMail, and FortiClient to help protect its new customer care and billing system. This was a net new win against Cisco, Juniper, CheckPoint, Symantec, and McAfee.

Investments made in entering new countries in the Middle East and the Nordics has paid off with some of the highest growth coming from these two regions.

Let's turn to Asia-Pacific. Revenue of $18.9 million compared to $14.3 million; 32% growth and effectively we're seeing renewed growth in that important region. A driver of A-Pac business this quarter was very good growth in Japan, where one of a number of wins included a large deal with a government agency that purchased FortiGate appliances to protect [a server and] network that connects regional hospitals to government offices throughout the country.

Now, turning to product revenue, you can see on Slide 5 revenues were $27.1 million, an increase of 40% on a year-over-year basis. As I noted earlier, this represented one of the strongest seasonal first quarters in the Company's history, which traditionally has shown more seasonality compared to the fourth quarter. That said, first quarter 2009 was especially light due to the then-negative economic conditions. Growth was driven by the positive impact from being a public company, as well as new products introduced last year, including our FortiOS 4.0 operating system, new models of our FortiGate B series of high-end performance UTM appliances, including the 200B, 310B, 620 and 1240.

In terms of markets, we had good traction in the enterprise and service provider segments and this is very, very important in terms of seeing results from those investments made earlier. Unit shipments were up approximately 40%, coincidentally in line with the product revenue growth and high-end unit shipments grew a bit more strongly than company-wide unit growth, strengthening the product mix.

Services revenues was $38.6 million first quarter. That compares to $31.6 million in the year-ago quarter, up 22%. As I explained in our last call, our services revenue is made up of FortiGuard Security Subscription and FortiCare Support Subscriptions. In the majority of cases, customers purchase these together. Our subscription models are a recurring revenue source that does provide Fortinet with visibility. The growth in deferred revenues is an important indicator regarding our recurring revenue growth. We expect our recurring services revenues to increase over time due to our deferred revenue model and our growing installed base of security platforms. Renewal rates [reach] over time in the 7% range of service revenues. There is opportunity for improvement here, especially the lower end.

Finally, our ratable parts and services revenues came in at $4.1 million, an increase of $0.8 million or 23% on a year-over basis and up 3% sequentially.

Couple of thoughts on revenue quality. I think I said, DSO remains stable at 66 days, comparable really to prior year and much of what we saw last year, well within our target range of 65 to 70 days, especially good with the increase in deferred revenues. The aging quality -- I'm sorry, the A/R aging and credit quality remain excellent.

Deferred [net] revenue balance increased to $211 million, which was up $33.9 million, or 19% year over year, and $9.6 million, or 5%, versus 4Q '09.

Revenue per employee annualized basis increased to $226,000 in the first quarter, up from $193,000 first quarter of the prior year.

Turning quickly to headcount, we grew headcount slightly. We ended one -- first quarter with 1,246 employees. That compares to 1,223 in the fourth quarter of last year and 1,129 in the first quarter of the prior year. As you can see on Slide 6, Fortinet is a globally diversified business, with headcount disbursed worldwide and approximately one-fourth of that headcount in the US. You can also note that sales and marketing headcount is now a little bit higher than R&D as we continue to invest in this area to position ourselves for future growth and market share gains.

Demonstrating the inherent operating leverage in the business and consistent with the 400 basis point increase in year-over-year operating margin for the quarter, our total revenues increased 29% year over year, compared to a 10% increase in employee headcount from 1Q '09. And I talked about revenue per employee and you can see that on Slide 7, the nice progression over the last two-plus years.

In terms of a couple other metrics on the income statement, cost ratios, non-GAAP gross margin was 73% in both Q1 of this year and last. And it's also comparable to what we achieved in all of 2009. Non-GAAP product gross margin of 58% was again very consistent, as well non-GAAP services gross margin of 84%.

Total non-GAAP operating expenses were $41.8 million, which is an increase of 20% year over year, which was about two-thirds growth of our revenues and again reflected the leverage from our recent investments in our sales channels and new product development. As a percentage of revenues, total non-GAAP operating expenses during 1Q were 60% and that compared to 64% for the same period last year. As we had noted, also in this quarter we had incurred our annual merit increases, plus experienced the renewal of various government benefits that start at the beginning of the year.

Non-GAAP R&D expense increased 20% year over year to $11.4 million and in terms of revenue during 1Q non-GAAP R&D was 16%. That compares to 18% in the same period last year. It is somewhat at the lower end of our model. Now, what drove this is both the increase in headcount of about 7% as well as the increase in the Canadian exchange rate vis a vis the US rate. And remember, we have a goodly number of our headcount in R&D in Vancouver.

Non-GAAP sales and marketing expense increased 22% year over year to $25.9 million. As a percentage of revenues, however, non-GAAP sales and marketing was 37% this year compared to 39% last year. This increase was primarily driven by increased headcount.

Non-GAAP G&A expense increased 6% year over year to $4.6 million, and this represented about 7% as a percent of revenue compared to 8% last year.

Non-GAAP operating income was $8.9 million and represented a non-GAAP operating margin of 13% compared to $4.8 million and 9% operating margin last year. Our operating margin was well above the guidance of 8 to 10% that we noted as a result of solid expense management combined with better than expected revenue.

Other income declined $0.7 million in 1Q compared to the same period. That's really because we had an FX gain last year. Effective tax rate for non-GAAP results for the quarter was 35%. That compared to 10% in the prior year. And based on the annual estimate for geographic split of income as well as the various tax credits we expect to achieve or incur in various locations, Fortinet plans to use a 35% tax rate for the year, subject to the various discrete items that may occur in the quarter.

Not-GAAP net income was $5.8 million in 1Q. That compared to $5.4 million the first quarter of 2009. Non-GAAP diluted earnings per share was $0.08, which was above our guidance range of $0.05 to $0.06 and compares to $0.08 the first quarter of 2009.

EPS held steady taking into account really two key factors, if you look at it from year over year. We had a higher tax provision of 35% this year versus a 10% provision last year. In addition, diluted shares outstanding were 74.9 million compared to 65.9 million the prior year. This growth consists of a 7 million increase in weighted shares outstanding, primarily to shares issued in the IPO and a 2 million increase in the calculation of diluted options, due to the higher market value of Fortinet stock.

As we mentioned at the beginning of the call, there's a full reconciliation between our non-GAAP results and GAAP results in our earnings press release and on slides 11 and 12 of the presentation accompanying today's prepared remarks.

Turning to very quickly on GAAP numbers again, you can see all these on our charts. GAAP net income was $4.2 million. The GAAP results in 1Q include $2.1 million in stock-based compensation. GAAP diluted earnings per share were $0.06 compared to a loss of $0.07 the prior year. Loss per share in the prior year resulted from a net loss attributed to common stockholders of $1.5 million, which included a $5.2 million noncash charge for the premium paid to repurchase convertible preferred shares.

Let me now move to our balance sheet and you can see this on Slides 8, 9, and 10. Just really a few quick comments here. Cash continued to be an extremely important indicator of the health of our business. We ended the quarter with $280.9 million in cash, cash equivalents and short-term -- short- and long-term investments, an increase of $20.6 million from 4Q, really driven by improved working capital management.

Cash (inaudible) from operations was $22 million in 1Q. Cash flow from operations is primarily the sum of non-GAAP operating income plus depreciation, net changes in deferred revenues, accounts receivable and accounts payables. This marked the 16th consecutive quarter of our generating positive cash from operations, exclusive of one-time items. We have been cash flow positive now since 2005.

A/R balance has decreased to $51.3 million from $54.6 million at Q4. Again, very good collections across the board. Inventory declined to approximately $9.9 million from $10.6 million. Channel inventory comparable to last year -- last quarter as well. I would point out since the second half of 2007 we have now increased our inventory turns to 4 times compared to 1.3 back then.

Working capital decreased $19 million to $142.7 million, but that takes into account the fact the balance sheet reflects $32.8 million in long-term investments which have an average maturity of 18 months.

PP&E is stable at $6.7 million and I talked to you, deferred revenue balance of $211 million, which is up 19% year over year and 5% sequentially.

Thus, overall we reported solid financial results in this first quarter this year. We are pleased with our strong growth in new countries and new geographies. Our investment in our global go-to-market strategy is showing early signs of paying off.

We continue to show meaningful improvements across our key metrics. We continue to see strong growth in billings, in revenues, as we gain market share and traction at new and existing accounts. We expanded our operating margins which well exceeded our previously issued guidance of 8 to 10%. Lastly, we are pleased with our strong cash generation and improved balance sheet metrics up and down the balance sheet.

And now I'd like to turn the discussion over to our CEO, Ken Xie, for some additional commentary on the security landscape and our (inaudible) business highlights before coming back to provide our outlook for this year.

Thank you, Ken. And thank you to all for joining us on the call. As Ken noted, we are off to an excellent start in 2010 and are well pleased with our first-quarter results which are among the strongest we have ever achieved.

Fortinet executed well in both growing the sales and also manage our expense. So an improved economic environment, together with the return we have on the investment we made in sales and R&D and the new product we introduced last year helped us grow in our business and achieve impressive 32% growth in billings and also 29% growth in revenue compared to one year ago. So we see strong growth in all three regions and made further traction in the enterprise and the service provider segments, so growing the number of large deals by around 50% year over year.

As we mentioned in our last earning call and during our road show, we have and continue to invest in our enterprise sales organization as well as placing a strong focus on attacking the key vertical market.

Some trends and highlights we saw during the quarter -- we continued to see the security function consolidation and together with the firewall refreshment. So this is the key driver of our UTM sales, especially in the enterprise and the high-end service provider market, where we saw very strong and the good business growing there.

We also saw the traction of our non-FortiGate new product, including the FortiWeb, the FortiMail, the FortiClient. All these products are all internal developed by ourselves. We also see the product revenue increase together with the unit shipments. That signified a new [business] begin over the last year.

Additionally, we continued to gain market share and win over our competitors, both in the new deal and also within the existing account, based on the strong value proposition we offer [through] the industry leading product. So our strong security technology proven to make difference, enable us to win many (inaudible - highly accented language) and enterprise deals against our competitors through the breadth of our solution and our ability to adopt [whatever] specific security requirement was also a strong (inaudible). And a few key wins this quarter -- I mean in Q1 -- included one of the major enterprise, who is also the largest clothing company in the world. So that our FortiGate product for firewall protection for over 650 retail locations throughout the US, as well as for the full UTM protection at the company's headquarter and help achieve the PCI compliance. So we beat Juniper for this deal, which over $300,000.

A larger major telco company in EMEA purchased our FortiGate product for the firewall and the intrusion protection in its telecommunications service, based on the unique GTP support and also the virtualization capability we have. So this deal is over $2 million. And we also beat Juniper and a few other competitors. So we have repeat business with existing large telco customer who are using our technology to secure their own infrastructure and deliver the managed security to their customers.

So now let me review a few of our most significant (inaudible) and product highlights in Q1 2010. So in terms of our marketing leadership we keep gaining market share in the UTM space, which also, UTM is the fastest growing segment in security, in the whole security industry. So we are now 16 consecutive quarter of UTM revenue leadership according to the latest IDC Tracker data. We are also growing our overall UTM market share to [14.7%,] validate that we continue to gain share from our competitors.

Additionally, for the second year in a row we were the only UTM vendor to be positioned as the leader category in the Frost & Sullivan annual award UTM product marketing report. And just yesterday, we were also awarded (inaudible) security vendor of the year by (inaudible) Middle East. This award is based on outstanding performance and leadership as well as the product innovation, the breadth of the product and the solution, major customer wins and also regional reach and the business strategy we have.

So on the product side, we keep extend and enhance our FortiGate together with the FortiWeb, FortiMail, FortiManager appliance family we have. And also introduced a new family we call FortiAP. It's a secure access point in the WiFi space. As we go forward we'll remain focused on growing and growing an efficient business and continue to deliver innovation to the market.

So our priority keeping deliver new and innovation product, keeping ahead of the UTM platform with the new features to address the industry's needs and also driving the high performance through our new FortiASIC chip. So we believe we are the only company has their own designed dedicated security chip which enable us a significant competitive advantage on the performance and also [offload] that the computer need.

So we are going to offer a new chip we call [ISOC], our (inaudible) chip which combine the network and the [counter] security with the CPU and integrate together into a single chip. So we're going to marriage this new technology in a chip into a new FortiGate product later this year.

On the other side, because of the advantage we have on the FortiASIC chip being viewed by our partner, we are also starting to working together with a partner who can leverage our FortiASIC chip, working in their area and keeping improving the performance also on the security on the network side. However, we do not expect a material revenue impact short term for this offering of our FortiASIC to our partners.

On other side, starting from middle last year, we introduced a middle range of FortiGate product with enterprise, like the 200B, the 310B, the 620B, and the 1240 B product, which offer [140] port each with gigabit [wire] performance, (inaudible) FortiASIC chip. So we believe eventually this offer in the middle enterprise FortiGate product will start replacing some of the switch in enterprise market. Because this middle range product with the FortiASIC delivers a wire speed like a switch platform and also a higher application and security awareness among all these enterprise level. So the functionality and the speed we offer in this area is a huge advantage.

We are also going to keep gaining market share as one strategy going forward by further penetrating enterprise and service provider segment and also keep growing our channel and also the SMB market. And we are keeping continue to invest emerging country and region and keeping hiring the top talent sales person to try and supporting our growth.

So now let me turn the call back to our CFO, Ken Goldman, who will give a discussion of finance outlook for Q2 and the rest of the year.

Yes. Before reviewing guidance I'll remind you that guidance consists of forward-looking statements and please keep in mind my earlier comments regarding such statements.

In terms of the guidance for the second quarter we are targeting billings estimated to be $81 million to $83 million, which at the midpoint represents year-over-year growth of approximately 19%. Total revenue estimated in the $72 million to $73 million range, which at the midpoint represents year-over-year growth of approximately 18%. And we see a comparable mix between products and services for Q2 compared to Q1.

We're looking at non-GAAP operating margin to also be comparable to the first quarter of this year. Couple of points related to expenses in Q2 -- we do expect to continue to invest in sales headcount and R&D and there will be some increase in G&A for various public company legal expenses.

Non-GAAP earnings per share expected to be in the range of $0.08 to $0.09, which is based on expected diluted share count in the range of 75 million to 76 million.

In terms of full-year, guidance total revenue to be in the range of $290 million to $300 million, which at the midpoint represents year-over-year growth of approximately 17%. I would note that's up from the mid-teens growth that we had previously guided. EPS to be in the range of $0.33 to $0.37. Finally, given our strong free cash flow generation during the first quarter, we are now comfortable with a free cash flow guidance range of $50 million to $60 million, which was up from our previous range of $45 million to $50 million. Certainly a number of variables in timing related to working capital does contribute to us providing a relatively wider range.

So we did take a little longer time today. We had a lot of, frankly, we thought, important information to provide. And so we took a little longer than we would have normally liked. But it was a good quarter where we met and exceeded our expectations and feel extremely well positioned for continued growth in 2010.

With that, let me turn it over to the operator and we will begin the Q&A session. Thank you. Operator?

(Operator instructions.) Robert Breza.

Hi. Congratulations on a great quarter. Ken Goldman, I wanted to ask just if you could help us understand the investments that you plan to make throughout the next couple quarters here and specifically where you might be making those. Thanks.

Yes, thank you. Relative to investments, I think to me, to some extent it's more of the same. We continue to -- I think Ken and I, we continue to look at hiring good people in sales. And so we will continue to do that. I think that some of the investments we can make in marketing that will continue to help our awareness. So we will look to expanding somewhat in our marketing efforts.

R&D will continue to be an expense area for growth. That's one area, if you look at year over year, we have been impacted somewhat by the strong Canadian currency. But we will continue to invest there.

So I think -- I want to say a couple of things relative -- to put this in context. We are very, very focused on gaining market share and improving our operating leverage for the year. So we will continue to work to do both of those. And we do look at it over a year-over-year kind of basis, so we are very, very focused on that. But in terms of your question on investments, that's what I see.

So we may see a little bit faster headcount growth than we saw in Q1 relative to what we're trying to do in Q2, particularly in the sales side.

And maybe a follow-up for Ken Xie. As you look and you mentioned the new chip technology, Ken, can you tell us or maybe give us a range of what kind of performance impact you see coming from that new chip technology later in the year? Thank you.

I think each generation chip we target try to improve the performance like 50 to 100%. And so but each chip usually take about two to three years. And we do have the networking (inaudible) here we call [network] processor and then the [content] processor. And then we also starting offer a new chip. (Inaudible) both this chip together with the CPU called (inaudible) chip.

Is difficult to say how much percentage will begin, I mean, on the performance later because we keep improving the chip in the last (inaudible) years and we're keeping investing in there. But the reason we start to offer the chip to some of our partners, because they start to see that advantage, using that chip to offload a CPU and same time to increase the performance a lot compared to a software running on a CPU. So that's where we feel if they're not a direct competitor we are okay to open up this new -- this chip and create a win/win situation.

Great. Thank you.

Okay. Next question, please?

Sterling Auty.

Yes, thanks. Hi, guys. Two questions -- in terms of the headcount that you're adding, especially in sales and marketing, how much is being directed towards the channel effort versus direct effort?

Well, everything is -- I'm not quite sure I understand fully the question. I mean, again, we have a direct sales force, some of which will work directly with the channel, some of which works more directly with the customers, for example in the enterprise. But all of the business, virtually all of the business gets fulfilled through the channel. So they all work in some form or another with the channel.

If you're asking specifically the business that we have, particularly in the US, with the channel, we do believe we can grow faster there and so we will be adding headcount there. I don't have exact number in front of me, but clearly that is -- we think there's a major effort and opportunity in the SMB space, if you will, to grow and increase revenues -- or billings, really, and then revenues.

Yes. No, that was exactly it. And then a follow-up question -- your commentary about the high-end in terms of the units actually growing, can you give us some color around what the pricing looks like? Was there anything out of the ordinary in terms of discounting or price pressure? Or do you think the demand environment and the pricing environment is kind of consistent?

I would say a couple of things. One is I think the pricing environment is generally consistent. The fact that units and revenues went up about the same says the overall ASP was about the same. And there's always mixes within the various product groupings or whatever. But I would say it's generally benign in terms of competitiveness from a pricing point of view. There are cases where we will compete heavily in some of the high -- I'm sorry, lower end, high unit count opportunities. So there pricing can get competitive. But I don't think there's anything significant from a pricing point of view vis a vis this quarter compared to much of last year.

All right, great. Thank you.

And the other thing I'd say is the key for us to really maintain margins is to keep on bringing out the successive generations to our products. So as we bring out new generations, that allows us to, if you will, move -- either get the full value for the product or move up in terms of pricing. And that's what we're really very focused on this year.

Great. Thank you.

Adam Holt.

Thank you and congratulations on the quarter. My first question is about the enterprise traction as well, I guess. Are you seeing really full UTM deployments at the enterprise? Are you seeing any consistencies with respect to what kinds of functions are driving deals in the enterprise? And then secondly, as you look into the pipeline would you expect the mix to remain similar to what we saw in the first quarter or are there any end markets that are really accelerating faster than others?

Let me -- this is Ken. I'll take the start and maybe ask Ken Xie to add a little bit. But the -- I have to say, first of all, if you look at the three regions around the world, over time Europe has always been very, very good at going -- addressing the enterprise space. And they continued to do exceptionally well this past quarter. I think to me what's probably more heartening is we are really starting to see traction in the US in enterprise. We had a solid quarter in Q1.

Probably more importantly, when we look out for the year we see a lot of very, very good accounts are going forward. And so we -- with our expanded sales force, expanded financial services coverage, expanded retail coverage, and entertainment, which I mentioned before, I think there's a good opportunity for us to really grow that business really quite impressively as we go forward this year.

The other thing I was really happy to see is Japan I think probably had its all-time best quarter. You remember I think Asia-Pac was growing, but really modestly for the last few quarters and really had a almost a breakout quarter this quarter, in which we had strong growth. And Japan in particular had a very, very good quarter, so hats off to those folks.

So those are some of the things that I think about when I look at this quarter and how I think we're positioned going forward. And I think the breakout we made from a couple years past relative to really separating out an enterprise sales organization in Americas and really focusing on that business is starting to really pay off.

Adam, this is Ken Xie. I definitely see the UTM starting kind of quite well getting the enterprise space. And even you can see some of our competitors which they are not earning their total security business really flat. But then the UTM definitely starting replacing some of the firewall. We also see the same trend. And so the enterprise starting to more understand just the firewall alone can not really secure the environment. So they all kind of asking the UTM (inaudible.) So we see some acceleration in the UTM in the enterprise environment. That's where we also see much stronger growing in the enterprise UTM space compared to some SMB space.

And if I could just ask one other follow-up, maybe a housecleaning item on the tax rate. Ken, if I heard you right, the tax rate's going to be 35% for the year. And to the extent that you are starting to see some strength or some acceleration outside the US, do you think there's an opportunity for that to move lower over time as the mix shifts? Or is that really what the right level to be is for awhile?

I think for us we don't a benefit of a favorable structure yet internationally. We are working on that as we speak. And so I -- the reason -- I think the only thing that could -- we have a couple of things could change the rate one or two points, not a lot this year. So I think it's a good rate to use going forward for now. I think the other thing that you may have heard from other companies is we're all waiting for the R&D credit to get -- come back. And that could help a bit a well. But I think from a planning purposes, I think 35% is the right rate to use.

Great. Thank you.

Jonathan Ruykhaver.

Yes, thank you. Congratulations on the performance, guys. First question, just looking at the billings mix across entry, mid and high-end, obviously you've talked about the better performance you're seeing in the enterprise environment. But looking at the year-over-year comparison, isn't most of that still driven by what's going on in the telco, where you are really landing some big deals?

I think probably the [economy] when we introduced the product. When we started in last year Q3 to introduce the middle range, like a 310B, the 620, 1240 and then the Q1, the 200B. So this middle range to more target enterprise I think we started enter pretty much in the second half of last year. Compared to one year ago, that's where starting to see the ramp up very quickly in this middle range.

Yes. I think we have introduced some other products there and without saying too much, we have a lot in our plate relative to new introductions there. And so we think there's a lot of -- it is driven by products and we have a lot in mind relative to new product intros this year.

Right. But looking at specifically the high end, the FortiGate 1000 to 5000, those are -- aren't those mostly in terms of the activity you're seeing in the pul- -- is a lot of that from the telco vertical?

From the vertical yes, but I think it's also from the enterprise. So you're absolutely right. The service provider is a key component of that. But the enterprise is as well. And when I look at what we're trying to do going forward there a number of opportunities in the enterprise, financial services, whatever, that again would be more on the higher end.

Okay. Okay. Good. And then also, on the telco vertical can you tell us how large that vertical is as a percent of revenues, how it compares to maybe a year ago? And should we expect that vertical to grow as a percent going forward?

We don't have -- we have the data in the Americas. We don't have the data quite laid out that way across the world. So it's probably more anecdotal. Clearly in the US where there's a much higher, from a relatively smaller space in Q1 of last year. So I don't want to get too taken away here. In the rest of the world I don't have those numbers the way I can sort of give to you. So I'll say anecdotally it's up, but I think it's probably up pretty consistent to the rest of the company.

Okay. And also, still in that telco vertical, did this compliance requirement on the advanced telecom computing architecture, Ken, I'm kind of wondering how important is that in winning business. And do any of your competitors have that ATCA compliance?

I think as the ATC is starting to get more popular we do see some other companies starting moving to this direction. I think going forward we are keeping introduce the next generation ATCA-based product. And we definitely want keeping gaining market share there.

Okay. Okay, good, and just one final quick question. The FortiOS 4.0, can you talk about a little bit about the new features are on DLP and WAN-OP and what kind of uptake you're seeing from customers on those features?

Yes. We see the lot of customers very excited about the new features, especially some large enterprise with lot of branch office, because like the [WAN] acceleration of recent feature is it's a (inaudible) because is for some branch office. Because it integrate together with secured gateway. And also some DLP, I think this is prevention feature also, kind of will address the enterprise need. And so we see this feature kind of working out quite well.

So you're seeing those capabilities being validated in larger enterprise environments?

Yes. That additional feature enable us to win some deal over competitor which they don't have. So that's give us more advantage on the feature side and the past performance we already have by the FortiASIC.

Right. Okay, great. Thanks, guys.

Okay. Next question, please?

Todd Raker.

Hey, guys. Nice quarter. Just two kind of housekeeping questions. If I look at the deferred revenue line, it looks like the incremental change short-term and long-term is pretty balanced. Long-term was up about $5 million. Are you guys seeing any indication that you're signing more multi-year deals or that contract length is extending out a little bit, especially as you penetrate larger enterprise?

And then secondly, if you could just comment in terms of linearity in the quarter? I mean, are you seeing any changes in the economy picks up here in terms of improved linearity? Thanks.

Let me take it and then Ken can add. Yes, linearity was very consistent this quarter to prior quarters. Some of the regions did a little bit better, maybe, in linearity. But generally it's not -- to us it seemed like there was good business all through the quarter. So it's not necessarily when you look at stuff sometimes booked but you see sort of the level of activity. And I was really happy to see the level of activity that was really good right from the beginning of the quarter right through to the end of the quarter. And so from activity coming in and working the deals, the sales force was very, very active all quarter long. And so I would really look at it that, from the point of view.

And, I'm sorry, your other question related to --

Multi-year --

Multi-year, yes. (Inaudible.) We are seeing, interesting enough, some extension of the multi-year contracts. I think we're seeing a number of customers that didn't want to lock in their deals. And so whether it's -- even some deals in the three, four, five year range, which surprises me, that we are seeing out there. So there's a little bit (inaudible) to that. And so that's moving out a little the average length of deferred. And it does have some impact a little bit as to our thinking when we provide revenue guidance. It does impact the guidance of revenue as to when we see that deferred revenue being recognized. And so we do see a little bit greater opportunity now, already showing up, if you will, for '011. And so, yes, we are seeing a little bit, net increase, if you will, in multi-year contracts.

Okay. Thanks, guys.

Douglas Ireland.

Thank you. I was wondering on the service provider revenue where they're offering the service to their own customers, do you get a view of the growth of seats that are in a region that are doing better in that, where your successes are in terms of the service providers offering that then as a service? And is that a revenue driver?

I think we offer the product by selling the appliance, the [system] appliance, not by per user seat. So in that case really we do see a (inaudible) the network speed, the infrastructure, so we keep increase. We do -- the service provider to keep on adding new FortiGate appliance to really handle the bigger band width. So far I don't think we tracking by seat.

We don't -- yes, we -- our direct sales folks may have that data, but we don't have that it at hand at our level, so at least right here.

That's okay. If it's not driving revenue except as capacity, then capacity's a fine metric. The other question I had was I saw in the quarter, or late in the last quarter, where you added a wireless controller. I was wondering if you could talk about traction with that product and any other adjacent areas you're intending to incorporate in the UTM?

Yes. I think that request come from our customer, especially a lot of enterprise customer and also the regional vertical market, which they probably most of them do the WiFi deployment instead of to cable into the [wiring] there. So I think (inaudible) is a wireless deployment security has more become issue compared to the wired environment because there's a more open access to all this WiFi environment. So that's where the combination of a security gateway with a WiFi is a big part for lot of enterprise offi-...enterprise customer and also the branch office there. So the customer do ask us kind of like make it available, like try to combine the two together.

So that's where we spent the last one or two years, to keeping develop both on the (inaudible) access point and also the software side, manage both security and the WiFi together. So we see some good acceleration of a customer when combine these two together. So that's where we announce in (inaudible) in March of the WiFi and the dedicated A/P access point together with (inaudible) FortiGate. And then you can turn every single FortiGate as a controller port to manage access point or manage some (inaudible) A/P. So that's able the current customer who already have the FortiGate and also the new customer who want to deploy the WiFi environment kind of a more comfortable on the security side.

Thank you.

Thank you. Okay. Operator, do we have any other questions?

Yes, we do have one more question. Rohit Chopra.

Thanks for taking my questions. I know we have a call afterwards, so I'll keep this brief. I had three quick questions. Were there any changes in accounting policies, any new accounting policies that you adopted in the quarter?

Well, I know you have three questions so the quick answer is no. We have not changed to the new revenue rec rules. We do not anticipate doing that early, so our goal -- my goal -- we have to, but -- and that we -- our plan is to do it in 1Q of 2011. So there were no changes in our accounting policies.

Thanks, Ken. Last quarter we talked a little bit about supply chain shortages. I just wanted to get a sense of what you're seeing out there as far as supply chain goes?

Yes, interesting perspective. We did see improvement this quarter in terms of we had a few little shortages, but generally nothing of a major magnitude. What we are seeing is a couple of things. One is some of the business coming in toward the end we don't have time to turn it around, partially because we have -- as you can tell, when I talk about inventory turns of 4.0, 4 times, we really reduced our inventory. Probably (technical difficulty) we can be if not a little too tight. So we've seen that. And I think the ability to quickly adjust schedule to the channel -- well, to the vendors is a little tighter now. So I don't think -- there's not a dramatic change, though. I don't want to suggest that. But our forecasting needs to be a little tighter now as we think about it relative to the ability to be flexible with our suppliers.

Last question and you may have sort of answered this indirectly. But last quarter you qualitatively gave a view of how you ended December. I think you said that December ended very strong. Can you sort of qualitatively give us a view of how March ended?

Yes. Well, maybe I did sort of say -- I think our perspective was we had good levels of business, if you will, really right from the get-go in Q1 and that continued all the way through the quarter. Like anything, you have some regions we'll do a little bit more percentage-wise in the quarter versus other regions. But I was actually happy to see really good business coming in all through the quarter. And that's really how we ended the quarter. And so I think that the enthusiasm, if you will, and the confidence of the sales organization is quite good right now. And I think as we gain more traction with our market visibility and the awareness of the company and as we continue to add sales groups and as we particularly do better in some of the enterprise segments that we've been investing in, I think that bodes well for us going forward.

The thing that's a little hard for us to figure out, though, and I think I've seen this from other companies reporting, is how seasonal this year's going to be versus other years. I don't think any of us have a really good feel for that, so our guidance we're going [to comp] -- I sense a seasonality, but I think it's a little hard to figure out this year, because we didn't see as much a seasonal drop in Q1 as we may have in other quarters -- in other years. And I don't know whether last year was as much a factor of the economic environment or not. So it's really a little bit hard to tell today what the seasonality that's going on and how that compares to prior years.

Thanks, Ken. That was great.

Okay. Do we have any other questions? Operator? If we don't --

(Operator instructions.)

Yes, we like the comments. But if you, again, remember that we'll have another call at 3:30 Pacific Time. So to the extent you don't have a question now but you want to bore into some other factors, that will be a webcast call as well at 3:30.

30 I welcome you to join at that point and for any other future qu- -- any other additional questions.

So thank you. Thank you for listening. And we had a lot to cover. Sorry I took a little longer than we would like, but I think it was helpful. So with that we'll end the call.

Okay, ladies and gentlemen. This does conclude your conference. You may now disconnect and have a great day.