Fortinet Inc (FTNT) 2010 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by and welcome to the Fortinet Q3, 2010 earnings analyst analysis Q and A. At this time all participants are in a listen-only mode. Later we'll conduct a question and answer session and instructions will follow at that time. (Operator Instructions). As a reminder this conference may be recorded.

And now I'll turn the program over to Ken Goldman and Ken Xie. Please go ahead.

Thank you, operator, and again we don't have -- I think you probably heard enough of me in terms of my prepared remarks so this is purely -- I understand a number of you are on the call, but this is purely for Q and A and for those who didn't have enough chance to ask questions earlier. So, operator, if you would just whoever wants to go first is -- be fine.

(Operator Instructions). Our first question in queue Lauren Choi with JPMorgan. Please go ahead.

Hey guys, again, just a question on your I guess, gross margin mix between your higher end and medium and low end boxes. Could you give me some ideas in terms of what the gross margins of those are?

Yes you're asking questions on gross margin. It sort of varies by product and so I don't really give it out by each of the segments that you're asking for. I mean in many cases the higher end will be somewhat higher margins but it depends upon the particular customer and what they order and so forth. So but in general higher end products will have somewhat higher product margins than the lower end.

Okay is that differential pretty large or it again depends on products?

I think it's within a few percentage. I think this time it's also our part of margins tend to be 60 to 65. Last quarter kind of Q3 close to the high side of 60 to 65 and the [server] is always the same probably the same, about 85%.

Okay, got it. And apology if I missed this but it might have been the first question that someone asked. Did you guys talk about duration in the quarter, or any indication if that changed? I know you mentioned that there were more three year deals, or you're seeing, just wondering.

No, we didn't bring up anything changed. You get a sense of that in the fact that the long-term deferred grew faster sequentially than short-term deferred, but other than that I didn't bring up the average longevity, if you will, in terms of our deals, other than anecdotally.

Right, but I guess you know you did have a great billings kind of beat the relative to what we were expecting. Just curious as was duration different than in quarters past, anything?

No I wouldn't say so. As a matter of fact, in Q3 you won't get -- I mean there is a little spike in Q4 from renewals so we'll have a little bit more renewals because you do have a number of customers like you have co-terminus deals where they renew at the end of the year. So from a renewal opportunity point of view that number has been relatively consistent the last couple quarters and then clearly when you do more renewals that those can be longer term but I don't think there is anything other than that that I can sort of point to.

Okay and just last question, we've seen sometimes at the end of the year that you see some tax rate changes. Are you expecting anything there or still kind of at that 35% mark?

My sense is there, if anything, there is a little pressure to go down. So I mean we're being a little bit -- well, reasonably conservative in terms of the pro forma rate. You see that in terms of the GAAP being somewhat lower as well in the pro forma rate.

What we don't have in our numbers is any impact that might occur if the R&D credit gets extended. That's the same for us and a lot of companies where right now companies are not assuming the R&D tax rate this year because it hasn't been renewed by Congress. So, at the extent that that got renewed, that certainly would reduce our annual and Q4 tax rate.

Okay great, thanks.

Todd Raker, Deutsche Bank.

Hey, guys, good quarter. So a few questions for you; first, if I just look longer term historically it looks like revenue growth has trailed the billings growth by roughly 3% to 4%. Would you expect that trend to hold if I look out a year or two?

No actually it's not quite that case. If you look at I think it was '09, there's a period of time I know where revenue actually was growing faster than billings growth and what happens is there's a lag because of the way services work in terms of growth in revenues to billings. And so if billings are accelerating, revenue growth will take a time to catch up and the same thing if billings are decelerating you'll get the benefit of revenue growth from the -- effectively the deferred revenue backlog, if you will. It's a catch up phenomenon.

Yes, just trying to get a sense -- I mean 33% billings growth is the highest growth rate we've seen in over two years.

Don't get too excited though.

I mean, how much of this is market growth versus competitive share and if I look out, forget about Q4 but if I look out in 2011, where do you expect the market growth to be versus what you're seeing this year?

I think the market data we got is from IDC, still like one year old is 13 some percent. That's also in Q2. That's in my presentation in the slide 14. You can see the Q2 data for IDC we took in in market share in the UTM space. So that's where, but I think it's that but overall market if you study recover maybe even above that is the number but it's difficult to say. We don't have a big picture yet.

So I guess the question everyone wants to ask I don't know if you guys are willing to answer, but if I look out to 2011 I mean clearly the comps are going to get a lot harder here. I mean, what's a reasonable bar to be thinking about in terms of organic billings growth?

Well, I gave that guidance and that was a good as I could think of relative to what we're planning for next year and you know I'll just get it in front of me again to make sure I have it here.

Yes I'm sorry I missed that; that would be great if you would go through that.

Yes that's it but the guys want to see exactly how I said it here. I changed my wording a little bit here. I guess I didn't give billings. I gave revenue, sorry. My sense is -- I mean without having the definitive number right now we said revenue would grow mid to higher teens and that's probably as close as I can give right now for billings. You are right. We're coming off both the revenue but even more so in billings at a higher comp and that will put some challenge to that number, so that -- maybe that number is more in the mid teens versus the higher teens.

And again, I apologize. I missed this part of the call, Ken. Did you guys give any kind of discussion around margin expectations in '011?

Yes we said that the margins, the operating margins, will be comparable to this year in terms of overall percentages. And, by the way, I should just add too that all of my remarks now have the same disclaimers that we had relative to forward-looking statements that I said relative to our earlier.

Okay. All right thanks, guys.

So in terms of -- you know, and basically I mean if you really go back when we went public we talked about a [largiture] model of 18% to 20% plus. We hit that in terms of Q4 much before we had expected -- I mean Q3, much before we had expected and we're saying in terms of our guidance that that's comparable to what we expect in Q4 of this year. So we have basically left the operating margins in terms of we can achieve next year margins comparable to '010 and that's taking into account our growth but also making the right investments to further growth and honestly we're already basically at what we had expected to be down the road.

All right thanks, guys.

Michael Turits, Raymond James.

Hi guys and again I been jumping around calls so I apologize too but what, can you just clarify for me really what was the out performance in this quarter, what did better than you expected?

I'm not sure there's any one thing. Obviously, the fact that we had some larger deals was very helpful and that really contributed. The fact that the currencies during much of the quarter and they certainly have turned around, I can tell you that. But they certainly helped us from an expense point of view early to mid part of the quarter, and so that was clearly a help. I think we continue to do a little bit better than we expect in terms of just overall expense management and really controlling expenses very, very tightly. So that does--

Ken, mostly I was thinking on the top line just in terms of more business.

Top line, I don't think there's any one thing. I think America certainly was helped by several larger deals and if anything that really contributed to a better quarter and we're suggesting that not to assume the same number of large deals in Q4. So I would say that's one thing. You know APAC had a good solid quarter. I'm not sure it's much better than what we had hoped, but maybe a bit, so Asia Pac definitely did better overall, certainly than our guidance has suggested and I would say May was right on but overall what we thought we would do.

Did you talk about what you cash tax rate was in this quarter and what you expect it to be next quarter?

No and I don't have that in front of me. As much detail as I have is what we showed on the cash flow chart you had there. It was -- but I would say that and we'll have more on that in our Q but it was very, very big. Amount of money we paid for taxes was very, very low from a cash point of view and that's because of our basically disqualified dispositions you have on non-qual exercises.

Now if I think about cash flow going into next year, I know you never say that certainly always uncertain is that cash tax amount, but if I X'd that out should I think of cash flow into next year pretty much growing at the same kind of rate as net income?

Well, I actually think of it a little bit like growth in certainly revenue and net income because that's sort of EBITDA which drives it. The reason I decided not to give guidance there is we are coming off of such an out performance in terms of Q3 that I wanted to take a little bit more time before I gave formal guidance for that. Clearly in terms of how we think about the target for it you are correct, but in terms of me providing direct guidance, I want to look at the working capital we ended this year with and a variety of other things because we have done, in my opinion, a pretty good job overall of managing inventory, managing PP&E. AR is in very, very good shape and I don't necessarily want to forecast that until I have my hands better on the details.

I'm sorry; did you give free cash flow guidance for 4Q?

We did. We said it would be $15 million to $17 million.

And what was the reason for that big move down from where you were this quarter?

Don't get too greedy.

Sorry.

We did very, very well in Q3. Well, part of Q3 if you really look at it is that's why I keep on focusing everyone on the delta between deferred revenue and receivables and AR change and the fact is we were able to bring DSO down this quarter by six, seven days. I don't have the exact and so I do not expect us -- as a matter of fact, I said specifically DSO would be more likely in our normal range of 65 to 75 so DSO is more likely to go up next quarter than the decline has had in Q3 so that will be a use of cash pretty significantly vis-à-vis this quarter.

And what we'll grow inventory is I would expect just a tad and a little bit more in PP&E so and if you look at the numbers I'm assuming profit will be a little less in Q4 than in Q3 so that also reduces the cash flow.

Okay great, guys. Thanks very much. Good quarter.

Keith Weiss, Morgan Stanley.

I was wondering if you could talk a little bit about you mentioned on the call an increased focus on the enterprise. Is there anything in particular that you're doing to increase that focus on the enterprise, anything structural with the sales force or your go-to-market strategy to increase that focus?

Yes I mean not necessarily in Europe and Asia Pac where we're basically over the years we've done effectively pretty well there. In think in the Americas we keep on segregate. If you go back a couple years ago we broke out the America sales force into in terms of we separated the enterprise from federal channel and so. And now what we're doing is we're further breaking out the enterprise in terms of financial services so we're giving that its own basically descriptive and direct reporting relationship and we're focusing now separately on retail and separately in healthcare so what we're doing is hiring people dedicated to these various verticals within enterprise to focus on that business and I think we'll do -- we'll probably do more and more of that also in the service provider business, which is another segment within the America sales forces. We think about different segments. We can even sub-segregate, if you will, in that area. So that's the structural stuff we're doing.

Got it. Excellent and then you continue to see nice gross margins and nice gross margin improvement. Are we starting to see any of the benefit from some of the sort of technical back end work that you guys have been doing, including that system on the chip that was first available last quarter?

Oh you mean the system on chip, the new part of FortiGate 60C, that definitely gave us more cost and performance advantage compared with the older solution so greater CPU, there for the ASIC on some of the network device. You know, single chip has given us given us a better margin and also a better performance. But another side in this space there's always competition who will get a better performance and a better chip, I mean leverage the different technology into the product all the time, so that's where I think it's probably we can see some benefit using the system-on-chip solution in the next few quarters.

Excellent and any guidance on where you guys see headcount ending up the year?

I didn't give it directly. We ended the quarter at 1,300. If I were -- I think we'll probably add about 50ish people this quarter roughly.

(Operator Instructions). Erik Suppiger, Signal Hill Capital.

So you talked about a number of large deals I guess towards the end of the quarter but it looks like the number of deals in excess of $500,000 actually declined from last quarter. Can you talk a little bit about how large a large deal is for you or kind of what is your upper range?

Yes, no I mean the number of deals over $500,000 were up year-over-year 13 versus 8. They were down a bit from Q2, actually correct where we had 18. I don't know what the upper range is. I would say this, I just called it a multi-million dollar deal. It certainly they are not -- what is it called -- $10 million was eight figures? I want to make sure I don't get it -- certainly not in that range where that figures is I think that's eight, isn't it? Okay I'm asking the wrong Mike. Henchmen here they're still a little slower reacting here but it wasn't that big and so I would say it's closer to the one than the ten is what I would say in terms of the largest deal we've done, which is what we did in the quarter.

Juniper has been doing very well with the SRX product line. Have you seen anything in particular coming out of Juniper in terms of their competitive landscape?

The SRX [model] replaced in their old firewall product so we have some features, especially UTM feature, like the [antivirus] where is the intrusion, which the SRX doesn't quite have, so that's why we see sometimes the vision with the SRX on the firewall side but not UTM part.

Okay that still doesn't have near the functionality or the feature set that you have?

Yes they don't provide the full UTM feature as we are, especially the feature like the antivirus, some other Wi filters, some other intrusion, some other function there.

Your share count from Q2 to Q4 is increasing about 6%. Is that because of price, the stock price, or were there some noted grants that have been coming out?

It isn't so much the grant. What does cause the growth is more so the two things. One is the exercises, which does increase the outstanding and depending upon how they were included in the fully diluted before could increase the number of weighted shares. And then two, which is I guess is a happy phenomena, is the stock price has gone up which certainly increases the trade view method for the trade for equipment shares.

All right and then lastly, on the revenue guidance it does seem conservative. I would presume that we would see the deceleration, the most deceleration, in the product growth and when I say deceleration I am talking about sequential growth or year-over-year, but the biggest change would presumably be on the product side going into Q4 and that is presumably because you're not expecting to have the same number of large deals in Q4. Is that the right--?

That's a good part of it. I mean we did have a particularly rich mix of products versus services in the billings we had this quarter and I tried to explain it and so it has to do with both in terms of new deals versus renewals and then of the new deals how much of that is product versus services and to the extent that's higher end products and larger deals that can skew the numbers to greater products and so we took that into account and we did assume that our product revenue would go down sequentially and services revenue would go up modestly and that's our best feel right now.

So you actually think the product revenue would decline sequentially in the December quarter.

Flat to decline.

Okay and then is that also why the gross margin would actually see a downtick? Is that the same factor is playing out there?

Well, I mean we hit at 75% in Q3. That's the best we've ever done by far and I just don't want us to get too excited about that number. I think a 73, 74 is certainly well within the range of 71 to 74 we had given for our model and 73 to 74 is on the very high end of the model. And, as I think I've also said that there are nuances which I can't forecast or just between the kind of deal, the customer is at discounting and everything else and pricing that I just feel it's safer to say 73 to 74.

Okay very good. Thank you.

(Operator Instructions). Jonathan Ho, William Blair.

Just a couple of quick questions, with regard to some of your high end product sales are the customers right now buying everything they need or is this more of a trial basis for the new products, which could potentially lead them to come back for additional sales down the road?

I think like the bigger deal we had is really it's just the initial stage. There's a few more stages where we'll go through together for deployment so that's really the bigger project. Bigger deal always goes through different phases and that we see from both on a service provider and also on the big enterprise, really the initial stage only a small part of it.

Okay and just in terms of maybe the renewal rates that you guys are seeing. Can you talk a little bit about what you're seeing out there and was there anything unusual in the churn?

In the churn?

Yes relative to your renewal rates for you?

No I don't think so. I think that the renewal rate is really -- I think what we're finding is some low hanging -- if I sort of think about it, low hanging fruit in that we've gone up several percentage points from where we were a year or 18 months ago and that's honestly because we have people really dedicated and focused on it and management is focused on it as well and so that's an area where I think we -- where we're really grabbing some low hanging fruit that we weren't really addressing earlier.

And so that's why I think that's as much as anything else for what's contributed to this quarter doing quite well and frankly, last quarter we did quite well too and what happens with our renewals is a couple of things. One is we hit a certain yardstick towards basically early the following quarter and then we keep on. Basically some of those deals don't go away. It just takes a while for us to renew them and so our renewal rate for a particular quarter will keep on going up over time, as we find a way to get those renewed and generally what doesn't get renewed are deals where the product gets superseded. Maybe the customer goes blind. In other words they're okay, they don't want to keep the support going on so they just go blind, if you will, in terms of subscription and support or they just supersede their whole product themselves.

Got it.

They go out of business, which happens too from time to time.

Yes that's never good. Just a final question in terms of the sales cycle, are you guys seeing anything unusual there in terms of either shortening or lengthening of the sales cycle?

No I think the only thing is the larger deals I think I did say this on the call before. The larger deals will take a somewhat longer sales cycle, particularly in the financial services where if they're doing a complete refresh and looking at new architectures, they may take six to 12 months to go do that. I think other than that I think these sales have tended to be pretty consistent.

Great thank you.

And at this time I am showing no additional questioners in the queue. I guess I'll turn the program back over to Ken Goldman for any closing remarks.

Yes I don't have any closing remarks but, again, to the extent that anyone has a further question either in their models, from a financial point of view or a balance sheet point of view, I would just say this. I mean we do think long and hard about the guidance. We think it's extremely important that we provide our best feel for what we're seeing out there and what we think is really achievable so I mean I just want to reemphasize and providing guidance there are a lot of factors that come into play, including the environment, the plus and minus that go on in any quarter, our investments that we want to make to grow our business and frankly sometime out performance in prior quarters.

So I would really highly recommend that folks stay within our guidance and, if you noted, I talk a lot of time against the midpoint of our guidance in terms of growth and so that was a number I was trying to point to. So again, I am happy to stay and Ken is happy to stay if there are any more questions but I just wanted to summarize on that.

So, operator, there are no more questions so again thank you very, very much and appreciate your attention to our call. We really do thank you. And thank you to some of the newer analysts that I know have covered us or just started coverage with us in the last few weeks and so glad to have you on board and, again, thank you for spending time with us and to work up your analysis of us and our models. Thank you.

Thank you, sir. Ladies and gentlemen, this does conclude today's Q and A session. Thank you for your participation and have a wonderful day. Attendees, you may now disconnect.