Fortinet Inc (FTNT) 2011 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Fortinet Second Quarter 2011 Earnings Financial Analyst Q&A session. (Operator instructions.)

Yes, hi. This is Ken Goldman, and Ken Xie is here with me, and just as a reminder that the earlier comments about forward-looking statements apply to this call as well. This call will go probably from probably about 45 -- I'd say about 45 minutes. So again, this is just meant to expand [from] any other questions. I'm hoping we're -- I can just imagine some more questions on Europe and billings, but go forward, I think our numbers speak for themselves.

So with that, we'll let the first question start.

Jonathan Ho from William Blair.

Good afternoon, guys. So the first question I have is related to your comments around basically the deferred growth. When we did the calculations relative to the product growth, it doesn't even seem like deferred is growing by 20% of the product growth, and I just don't understand that dynamic. I know you guys said that some of the carriers don't buy multi-year contracts. But can you talk a little bit about why the deferred piece of the billings is growing a little bit more slowly than maybe we would expect, just given the product [signing]?

Well, I'm actually not sure what you're trying to look at, so yes, you may have to send me a note on that, because the way billings work, it's purely revenue plus change in deferred. That's how we calculate billings. And then, I think I said before, China used to be -- China used to be part of billings, but would be deferred over a long period of time, and now that goes into our normal revenue rec rules. But other than that, I can't really add much because, frankly, billings is just a combination of revenue plus change in deferred. It's numerics.

Got it. I think what I'm trying to say is, if you sell I guess a lot of the product -- I mean, we typically would expect a maintenance contract, which is around 20% of that product, to be attached with it, and therefore that typically goes into the deferred category outside of just the billings number. But, I mean we can chat about it afterwards.

I guess one thing I also wanted to understand a little bit better is that we've seen kind of a long list of impacts given on Europe. Is there any way that you guys can maybe rank-order these in terms of the importance in terms of impact on the quarter, or just give us a sense of which had more of a magnitude impact in terms of the various factors?

Are you asking what are the various factors of why Europe was not as good as maybe we collectively would have liked?

You got it.

Yes. I mean, to me, I look at it as really maybe three things. One is the economic environment. I mean, it's actually a little bit hard to separate, but I look at the economic environment. I look at sort of specific issues related to some of the areas, like Middle East, and then our ability to execute and perform to our expectations. And I actually have a hard time sort of crossing out one versus the other in terms of level of importance, but I think they're all -- all contributed to us not achieving quite the numbers we would have liked from a billings point of view in Europe.

This is Ken Xie. [Obviously, yearly], the big project in a secure space is a part of the big IT infrastructure renewal or kind of a new deployment. Sometimes some bigger deal can be impact by the economic environment there, so that's also the case with the -- in some of the Europe country. Some bigger project could be delayed because the (inaudible) issue or some other spending issue there.

Got it, and just one final one. When we look at sort of a normalized billings rate for Europe, I mean, what should we be just ballpark thinking about? I know you guys don't give guidance, but, I mean, the 2% clearly too low, and you guys have given color that it's probably not going to be the 30% that we're seeing in North America. I mean, where do you think is more of a reasonable number in a normalized environment?

Yes, I think in the order of 15% to 20%, maybe 25% is the kind of growth that we should experience over there.

Great. Thank you.

Sterling Auty from JPMorgan.

Yes, thanks. Hi, guys. In terms of when you look at the product line in Europe, the sales in Europe in the quarter, was there any part of the product line that was particularly weak, maybe the low and the mid, or was it really just across the board?

Yes. I hate to sort of use the word "across-the-board weakness." I wouldn't characterize that. I don't think there was any -- and I don't think it's product-related at all. I think it's related to the comments -- the three comments -- the three sort of consequences, if you will, that I [numerated] before relative to the contributing. But I don't think it was any particular product, no.

Okay. And then, when you look at some of the newer products, like the mail product and others, how has the traction in those been in any of the geographies? So in other words, if you look at the adoption curve on some of the newer products that have been introduced over the last 12 months or so, how are they tracking?

They are -- this is Ken Xie. They are relatively very small and still immaterial. It's really -- I think it's probably -- not have much impact on the number.

But the reality is, interestingly enough, we've actually had some of the better success in Europe over the last few quarters, and we're taking some -- we're having some of the folks that work on that helping us around the world. So Europe actually we have seen a little bit [past] some [of the] better traction in some of the newer product areas.

All right, great. Thank you, guys.

Michael Turits from Raymond James.

In Europe -- this is going to sound repetitive. I'm sorry to begin that way. But in Europe--.

--That's repetitive.

I don't know what to tell you.

(Inaudible.)

Somebody was asking about products, like any difference in the product. How about across segments, size segments, in other words? Was Europe stronger in SMB versus in Enterprise?

No. Needless to say, I give the same answer. It's not at all related to that. I think it's more certain geographies in more of a general not doing as well as we would have liked than product related, so product or type of product related. So no, I submit that we had -- in my prepared remarks, remember, I noted some of the large deals we won in Europe. So no, it's -- I wouldn't characterize it as product or type of product related at all.

Well, actually, I was -- my thought was maybe the opposite, in other words. I mean, you're great -- do a lot of big high-end deals, but you do some low-end deals. Was SMB more impacted in Europe?

I don't think so, and -- I don't think so.

So all the questioners that -- I hate to mention a competitor, because it's just -- it's sort of impolite, but--.

--All right--.

--but Checkpoint seems like they did fine in Europe, actually. Their growth rate accelerated a little bit. So I don't know if anybody put this to you on the call.

I'm not sure what the growth rate -- I thought I saw somewhere they grew 10% in Europe, but maybe I missed that.

They did, but they weren't, like, a real fast grower to begin with. They grew 7% the prior quarter, and I forget what it was the quarter before that. But in other words, Europe accelerated a little bit for them. So can you think of any reason why they would have -- relative to their kind of metrics, why they would have done fine, not seeing a fall-off whereas you guys did?

I think also probably Checkpoint did not include Middle East in the Europe. For us, we do include the Middle East in there, which kind of [leave me] more concerned right now in the situation.

Was Middle East the problem as opposed to Europe?

Remember, I mentioned it was one of the three. I mean, what call EMEA, remember, I said three -- one of my first questions was asked, what are the areas that contributed, and I said one of them was the economic environment, another one was Middle East, then I said another one was our own execution. So all three of those contributed to EMEA, and that's how we describe EMEA in terms of our growth.

Yes. Sorry, I was on and off the call. So Middle East, your execution, and what was the third?

The three was the economic environment, Middle East, and our own execution.

Okay. What about any -- I mean, I know you give some metrics about high-end versus low-end in general. What about just across the board? Obviously the high-end deals came in a little bit lower as a percentage of total, 34% versus 37%. Do you see a trend -- I mean, but then again, your mid-range was up a little bit, so it kind of -- does that offset that? Is that noise, or (inaudible) -- is there a trend there?

I don't see -- that's going to -- yes, a point or two, whatever, 34%, 35%, 37%. It's all -- I mean, when you're talking about what percent, you're talking about a million or two, which is, frankly, noise in the scheme of life. And so, no, I don't see any trend whatsoever where -- I think the trend over time has been a little bit more enterprise and a little less on the entry level. But the problem I have with the -- so that trend -- we're pretty comfortable with what our percentages are now, because reality is each of the three have to grow, and we're focused on growing each of the three.

So what about at the high end? Can we get some feel for what the mix has been between carrier and -- what's called carrier and enterprise, or carrier and non-carrier?

Well, I think I gave -- again, right before, I gave in terms of high verticals. I gave the relative percentage as best we know it today in terms of those. I don't know if you weren't listening on that or you want me to repeat that, but--.

--Saying not listening [makes it sound] like I don't care (inaudible)--.

--I have to go with the best defense is a good offense [here]. What the hell, Mike? Give me a break.

Well, what -- do we have those on a historical basis at all, or is it just--?

--No, because the reason -- the reason is we have just now been putting that information into our system because we're just now collecting it. It's not as easy for us, just to be very clear, because we go through the channel, and we don't always know where -- many times we do know, some other times we don't know the ultimate end user, and so we're just now collecting that data, and even then it's a -- I'm just being careful that it's our best guesstimate. I think I said before that 25% to 30% was service provider for the first half, and approximately 15% for government, 10% financial services, 10% retail, and 5% to 10% on healthcare. But again, we don't have -- I will say it this way - these are not auditable types of numbers that we can really, because we don't have the systems yet -- A, we don't have systems, and B, even our channel doesn't always know where it's go -- or we don't know, because it goes to the channel sometimes, where the ultimate customer is.

Or do you have a sense of the trend, even directionally, you can tell us about over time?

I would say, directionally, we had a pretty good quarter in government, and certainly I talked about retail is going up over time. And we're making some progress on financial services, although a long way to go.

And then, on the rev-rec issues, there's $5.7 million more that went to product than deferred this quarter? That's relative to the prior system kind of on a year-over-year basis, right?

Yes, it's about -- yes, that's about right. The reason I -- if you go back to my comments -- is why it's not apples to apples, and this is an important element, is because we are working to the new revenue rec rules, and so therefore our business practices mirror the new revenue rec rules in how we ship and so forth. So I can't tell you that we would have done $5.7 million less necessarily under the old revenue rec rules. That would be a -- that would not be the correct interpretation. We actually don't know. All I can tell you is we're operating on our GAAP numbers to the new revenue rec rules. And the other numbers we give is done for analytical purposes, but it's not numbers that are our GAAP numbers.

Right. One other question, too, about the billings trend. I mean, obviously, EMEA was really weak, 2%, but you did see a decline in Americas billing growth also, 45% and 64%, and then down to 32%. So was there -- is there a general weakening also? I know you were good in APAC.

No, I think Americas actually did pretty well. So no, I think we would say we're pleased with Americas, and growing 30%-plus, the market growing in the low teens, we think is quite reasonable. There will be some [cause] we hopefully grow fast in that, and some we may not grow as fast as that. So in that case, I don't probably see a trend.

Even though, is 45% and 64% the last two?

Yes, but I don't -- those aren't sustainable growth rates, in my opinion. I think without forecasting, giving guidance here, I think 30% or so is something that we hope to grow at in Americas for a while. Again, that's not guidance, but that's our goal. I think to grow much beyond that would not be a trend.

Well, here's the key question, right, is when you were doing billings growth, it was in the mid-30s, and now this quarter you delivered billings growth that was, what, in the low 20s, low to mid 20s. So we look at billings growth because it's forward-looking, and so what's -- how should we think of it, Ken? I mean, if you're sitting in my shoes and are trying to value the stock, trying to think about what's really the sustainable growth rate for this company, should we think of it once whatever the kind of temporary stuff that happens in Europe is -- is it the 30%-plus grower that the billings number were promising, or is it -- is something going on that it looks like it's more of a 20%, going forward?

Well, let me say it this way. We have not changed in terms of our targets here in terms of what we sort of drive ourselves to, and that is the 30% growth. So we think 30% growth is what we should be challenging ourselves, if you will, and targeting, and we certainly have every hope that we get numbers close to that. Now, I'm not going to give you guidance to that effect because there are always pluses and minuses, but we have not changed any of our internal goals as a company here because of, so to speak, Q2. So no--.

--So 30%--?

--And by the way, we've had other quarters -- I mean, you go back to the downturn in '09 where we grew I think about 12%, if I recall the numbers right, and so that number does go up and down. And even then -- even though we're private -- but we said to ourselves that our goal was to grow 30%. So no, we have not changed from what our internal targets are.

So 30% target's still across the board?

We still have that target, yes. And that may be a mix, where some region's higher than 30% and some region's less than 30%, because I'm not going to suggest that we can continue to do 30%, or get back to 30% in EMEA, given our higher penetration we have there.

Great. All right, great, Ken, thanks a lot. It's always tough dealing with a couple of disappointments.

I mean, again, it's sort of -- it is what it is in terms of people -- there's a couple of key leading indicators in us, which clearly one is billings, one is product revenues, and so forth. Overall, we delivered, we think, a pretty solid quarter. Can we do a little bit better in some areas? Absolutely, and we're focused on that.

Okay. Thanks very much.

Walter Pritchard from Citi.

Hey, guys, thanks. Just a few quick ones, Ken, on renewal rate. Was there any change in the annuity renewal rates you saw on the base?

No. I think I said before that the renewal rates tend to be in the mid to high 70s, and that's the kind of trending we're seeing this past quarter.

Okay. And then just on FX, did you give a -- I didn't hear it, I was jumping on two calls here -- but any detail on the FX impact on billings or revenue?

It didn't affect billings or revenues, and it did affect expenses on a year-over-year basis, I believe around $2 million in the quarter. And so, yes, that's what we did -- we talked about a $10 million increase of total expenses, FX contributed about $2 million of the increase.

Got it. And then just -- I guess we do this math. We look at your annuity attachment. I tried to ask this on the public call, but I'll just maybe state it a different way here and see if we can get to the bottom of it. But your total billings of I think $110 million, your product billings of $47 million, although I guess a little bit less than that because of the drawdown. We calculate your annuity attach on that product billing was probably the lowest it's been since we've been able to calculate it here, at around 50% attach of annuity to product billings to new. And I'm just -- we assume the renewal continues as is, and the new is really a swing factor. I'm wondering, is there any reason why that would go down? I mean, that was, as we look at it versus our expectation, that it's a few million we're talking about here, but that was the delta.

Maybe you can send us your calculation, because I'm not sure -- but you remember, though, the [MIPS] is going to change going forward just because, again, we're able to recognize certain revenues that in the old days we would not be able to recognize. So you can't necessarily look at apples and apples here in terms of our numbers. And maybe when we show the old numbers, you can take a look at that again in our Q. But without seeing your numbers and having -- deal with it live here, I'm not sure I can comment much more.

Okay. And then, is it right to think about your product revenue growth on a normalized basis, about 32% if we adjust for the China change? Think it was 5.7--.

--Well, again, it wasn't just China. It was several factors in there. And so, no, I don't want to at all say that because I don't acknowledge or agree that you can just take a certain number that I gave and subtract that out from product revenues this quarter because, again, we manage our business to -- as I said before, to mirror the business practices of the new -- mirror our business practices to the revenue rules as they exist today. And I would suggest that we might have done things a little differently under the old revenue rules. So no, I don't agree with that number.

Okay. Okay. And then, just two other questions. They're kind of related, I guess. It sounds like you haven't at all adjusted your hiring plans, either up or down, based on the performance in the quarter. Is that a fair statement?

It's absolutely fair. We continue to hire as aggressively as we possibly can. Globally we're hiring sales, we're hiring in marketing, hiring in R&D. So there has been no diminution of our hiring expectations or plans.

Okay. And then just last question for you, Ken. I mean, you've been around the block a few times here. I'm just wondering, you see a few companies in this position where, if I hear you, sort of macro, and I think everybody acknowledges maybe the macro's a bit more of a question than it was three and six months ago. And then you've had some company -- sounds like company-specific execution issues in Europe, and yet you narrowed your guidance range up by about $5 million to a tighter range for the year. And I'm just -- I mean, you could or couldn't predict the reaction of the stock, but it seems like you're kind of now in a situation where the expectations are where they were before, and the stock is down. It seems like there could have been another tact to take the number down for the year to reflect some of the uncertainty, both macro as well as your own execution. I'd just love to hear kind of your perspective on why you didn't take that path.

Because I don't -- you're right. I mean, you never quite know these things. I would say a variety of things. One is I don't think the economic environment fundamentally is changing, and so I'm not looking to a new downturn, a new recession. Two is, if I felt that -- or we felt that we had [systematic] issues across the board, that would be a different thing. We don't think we did. I know the old cockroach theory, and one leads to another, and so forth. But I think, given everything we know, it wasn't -- we did not have an across-the-board issue. We had something where we would have liked to have done somewhat better in Europe than we do, or EMEA than we did. My own sense is, looking at the data we have in front of us, that we will do improved results this quarter. So we didn't feel it was necessary to bring expectations down because that would have been unwarranted from what we see.

Got it. Okay, great. Thanks for doing this call and taking my questions.

Dan Cummings from ThinkEquity.

Thanks a lot, guys. Yes, maybe before I ask a question, I just -- a couple clarifications maybe for the benefit of some of the other callers. Your billings growth guidance went up by 100 basis points for the year here. Obviously product revenue growth is an important component of billings. In other words, you went to plus-24% billings growth guidance for the year from plus-23%, and that's guidance, right? So that's the promise. The promise is not 30% as it was earlier characterized. So that's correct, right?

I mean, that's another way of saying it. Yes, we never tried to differentiate. We never promised 30%. I said that was our target. You are right. We actually brought our guidance up a little bit, modestly, in terms of billings. We did bring it up I think in all categories a little bit this quarter. But we've never had -- it's a valid point -- that we always felt we would have a little bit higher growth in the first half than second half, and so nothing's changed. The only thing that's changed is we didn't over-achieve, which people would have hoped, in Q2.

No, right. But, I mean, a company of your size normally doesn't have the means to balance out weakness with tremendous strength in other regions. I mean, I definitely want to point that out. But to get to the product revenue growth now, which you really can't call out as being somehow special really as a result of the accounting, because you grew, I think, 16% quarter-on-quarter. Even if you de-seasonalize that and say, okay, it's half of that, you compound that, and there's still ample potential to do 30% product revenue growth this year. So I just -- I see just kind of an absurd over-reaction here tonight. I lived through this with NetScreen seven or eight years ago, where one region went sour temporarily, but obviously these are global markets.

The question I really had was on the managed services environment overall globally, if you could just kind of discuss what's new on the margin region-by-region in the managed services markets. Thanks.

Yes. Let me first see the -- I think the managed services market, they tend to using the high-end box, which is the 5000 platform is the most popular one. The high-end service -- I mean the high-end box tend to have a better margin compared to the low-end product. So I think that that's related to the gross margins, but we don't see a -- I think the gross margin -- the more service provider come in, we feel the margin can be better. But on the other side, we also want to grow the market share in SMB and the Enterprise, so that's probably the comment I had. Yes, I think that the product percentage, I'm not sure that the calculation is kind of hard to compare that now.

Well, yes, we don't have historical data.

Is your managed services opportunity primarily still just with the Telcos, or are you seeing other types of managed service providers try to extend your platform to their customers?

Still mainly the Telco. And while they do have some other service provider, like sometimes they provide a [comp]-based service, some other like a data center service, they're also starting to offer some security service to their customer. But it's all [rather] early stage, because I have to say majority data center, some other Telco, they still don't quite have any security service offer to the customer yet. It's more in the early stage. But [obviously], the product positions is much better than any other competitor because the (inaudible) Telco-based platform on the 5000, and also the performance we have leveraged on the [ASIC], and also the multi-function single platform, which has much, much better position compared to any other competitors. So [while it's in -- while we're] early stage, and also the service provider tend to planning for quite a long rollout because they tend to be more carefully through the long-term planning. The same thing for the data center and for some other comp-based service. The deal tend to be -- take time to materialize.

Then this is a net change in the pipeline for the second half of the year with respect to managed services, strongly positive, or could you give us some color on that?

It's difficult to say, but we do form a group specialize in the -- I mean the managed service provider space. That's just happened in the last quarter. So that's the group will be focused on the service provider space. That's not happened before.

Thanks. Can I ask one more question on product? You recently revised and have upgraded your end point client product. Can you tell us about what your thinking is there and what kind of opportunity that can be in the near-term over the next six to 18 months for Fortinet?

There's two thinking. One is really the end point is always a part of the total solution, so our end point's more targeted enterprise, which they have the FortiGate. They want to use the same FortiManager to manage both on the network side and also on the host, on the client side. On the other side, we do see now that there's a lot of handheld device, mobile device, whatever, that have more security concern. And that's combined -- was in the mobile and the handheld device compared to what's happening in the network space. I mean, the network side is really more beneficial for a lot of enterprise. So that's why we kind of have some new function, new feature in a new release, more help in the enterprise customer, and also some branch office, some home user, to run and enhance the total security solution. We're not targeting the consumer market like some other company try to more target in our space, but we are trying to provide a total best security service to our customer.

Thanks, Ken.

Thank you.

(Operator instructions.) Keith Weiss from Morgan Stanley.

Hey, guys, thanks for taking my question. I think we've covered most of the topics pretty exhaustively. Maybe just a couple of account or sort of modeling questions. In terms of the accounting impact, 5.7 in Q2's up 3.3 in Q1, I believe. Is there any way to assess or get an idea of what that -- what those impacts will be in forward quarters or sort of what's in your guidance for 3Q and what's in your guidance for the full year?

It's actually very hard because the only thing I know pretty much -- and even I don't know -- is China, because (inaudible) what we do in China for revenue. So my -- again, my sense is the number will probably be close to the Q1, but because we basically have adjusted the way we handle deals to the new revenue rec, it's -- that's why I tried to suggest over and over again it would be a wrong assumption and conclusion to assume that it's a clean delta between the old and the new because that's not the case. We operate today under the new revenue. We do our business practices that way. And so what we would have done under the old would be different, too. So I don't even look at it that way.

But you have said that your guidance does account for the change in accounting.

Because that's the way we run the business.

Got it.

We're not running the business in the old way, so I don't know what that would have done in the old way.

Right. But how do you come up with the -- like how do you calculate that $5.7 million number?

Yes, we actually run our revenue twice each month -- for each quarter under the old revenue rec rules and under the new revenue rec rules.

But you don't do that in sort of the guidance exercise, so that's what--.

--Right, we do not -- because I don't know what we're going to do. I can't do it for guidance because I don't know what deals we're going to do.

Got it. Got it. And then, in terms of the ratable line in our model, how should we be thinking about that on a going-forward basis? You told us last quarter that should continue to decline. Should we look for continued declines through -- I mean, I would assume you're going to see continued declines through at least FY '11. When we start to look into 2012 and beyond, could you see that start to sort of flatten out and normalize, or will it continue to--?

--I think (inaudible), it'll go as close to zero as possible. I mean, it may not always be zero. There may be some things we have to [ratablize]. But I think, over time, it -- over a number of years, it -- it certainly is where I would think of it after a couple-three years. It's just immaterial. Don't even worry about it.

Got it. Got it. Perfect. And then, just to revisit the hiring question, you did step up your hiring this quarter. You were talking about sort of hiring at rates that you feel comfortable with. Is there a -- sort of a seasonality in your hiring we should be thinking about? I think you had, like, net 89 new hires this quarter. Is there anything of a front loading in the first half of the year [that] hiring, so those absolute numbers should come down a little bit in the back half, or should that 90 range--.

--Well, if you remember, 35 of those came from [a track switch]. So I think there's -- if you take that out, I think that normalized rate is about what we think is probably realistic to do.

Okay, on a quarter-in, quarter-out basis.

In our seasonality, we went ahead hiring, and there was a few recruiter, dedicated recruiter on board this year, just tried to enhance the hiring in both sales and R&D. So that's the two area. Last year we behind, we're way behind the hiring plan, so this year I think we want to keep [enhanced] because that's the future growth come from how this -- the team, the hiring. So that's where we tried to invest right this year.

Definitely. Definitely. And then one last one from me on the distribution channel. How are you guys feeling about your efforts in sort of recruiting new partners? Any kind of color you could give us on the distribution channel expansion efforts and where we're at right now?

I think the strategy right now, I don't think we changed much on the distribution channel there. We are more focused in some vertical market, which also result in more focusing [sort of] in the [system integration] (inaudible) sort of vertical area. So that's the part we want to enhance. The other part we feel we can get in also some market share in some other [DMI] market, which we not quite focused in the past. I think probably the main thing's really, there's a -- [probably] some vertical area we're not quite focused in the past, which we want to have a special team to more focus in -- sort of in vertical area, both in US and also overseas.

Yes. I mean, I think there's -- we're talking to some additional partners we may bring on as well. I can't really announce anything here yet, but we are talking to some additional partners that we'll bring on separate from channel partners.

Yes. I think that [probably] will be leveraged the new chip we released last quarter, the CPA. So every two, three years we have a new FortiASIC, which give us much better performance and also more function. So that was the chip, [starting put in] a new platform will be much better than the platform we have, and also better than the competitors.

Excellent. Well, thank you very much for the time, guys.

Thank you.

Philip Rueppel from Wells Fargo Securities.

Great, thanks, and I'll try to be brief because a lot of questions have been answered. But one area we haven't talked about much is sort of the slowdown in big deals above $500,000. Was that -- and I know you talked about how that's going to move around, and there were some very nice, big deals over $1 million -- but were the close rates for the pipeline of big deals, were they a disappointment to you, or was it just that the pipeline was a little bit lighter going into the quarter?

Yes. I mean, I don't know about going in or going out. I just know that we didn't have as many larger deals in Europe this quarter that we've had in some other quarters. And so I think, ultimately, the number of large deals we have to close in the timeframe of Q2 in Europe contributed to EMEA not being quite as strong as we would have liked.

Right. Okay, that's helpful. And was the shift to more deals that were annual annuities versus multi-year, did that sort of also shift those metrics around, or is that just an unrelated--?

--[Clearly, the extent] -- we don't have as many multi-year deals, that affects billings. Doesn't, as we know, affect revenues, but it would affect billings.

Okay. And then, just finally, were there any kind of mega-deals in the quarter, US or otherwise?

You'd have some deals over $1 million. I don't know if -- I don't think characterize them as mega-mega. I did talk about one large deal that we had recognized revenue on that's going through proof of concept and acceptance and so forth, that we'll see how that ends up coming in. But that was a deal that we did not -- we were not able to recognize any revenue in terms of the quarter -- in terms of our numbers.

Great. Well, that's it for me. Thanks for taking my questions.

Jayson Noland from Robert Baird.

Okay, thank you. I think most questions have been asked once, if not twice, so I'll try to stick with incremental. And just to clarify, there were 15 deals north of $500,000 in the quarter?

No. I think it was 11, but let me double-check. I think my number's 11, but let me just -- it was 11, yes.

Okay. And that compares to 13 in Q4 '10 and 18 in Q1?

Actually, both were 18 for that, and we had -- just to go through the numbers again, the number of deals over $100,000 was 127. That was up from any of the prior periods, actually probably the highest ever. And we did have 37 deals over $250,000, which compares to 32 in Q2 last year and 34 in 1Q, or this year.

Okay, so the biggest change was to the largest deals north of $500,000?

Correct.

Okay. A question on -- well, on the Riverbed call earlier tonight, it was similar comments around EMEA, that they saw macro and execution-related issues. And I guess--.

--Well, give my best to Jerry, then. [Maybe he's] given his best to me.

How do you differentiate between macro and execution? I would think that's -- it's kind of hard to tell what's what there.

Well, that's true, and I was asked that question before, and gave three areas that I think contributed. And my own sense is I don't think the environment is tough enough that we can't execute. Let me say it that way. So Q2 is done, and I think we have enough hand-wringing by all of us on Q2, if you will. But I think there is enough opportunity in our business in Europe, in EMEA, in the environment, and I think we can do just fine. And so we're going to take ownership to deliver numbers in Q3 in Europe, and so I think we've done enough hand-wringing, if you will, of Q2 results in EMEA.

Okay, thank you. A question on new products in the second half. Should we expect those to open up TAM and new competitors, kind of like your wireless LAN entry?

I think it's because the chip is more focused on the FortiGate, I don't [view] -- [let's] leverage the technology on the FortiASIC we have is not -- I think it's still majority of -- super-majority of (inaudible) still come from the FortiGate UTM family.

Okay. And then just a couple more questions, Ken Xie. We've heard in China that the customer base there broadly outside of Fortinet doesn't like to pay maintenance. Is that something you guys have wrestled with in that specific geography?

I put it this way - in China, the UTM concept not as popular as over here and the other country, so they're still in a [firewall] timing, or whatever. So that's where the super-majority be (inaudible), still just the firewall. But for us, in US and Europe, we do see -- the customers see the importance of [secure the] content like all the wires, all the intrusion, beyond just control the connection of firewall. So I have to say, China there, they are way behind on some of the newest technology can be secured, the content [wires] and the intrusion there. So that's probably the main reason we don't see a high percentage of the subscription product being as the other product [were].

Well, you're right, services component in China is clearly less than our normal average.

Okay. And last question from me, managed services at large Telco, just with more and more SMBs considering the cloud or a third-party IT provider, is it fair for us to think of your service provider business as a percentage of revenue increasing over time?

I think that's all depend on the big trend in the space. But right now, if you look at the vertical market we're starting to try to track in this quarter, the service provider has the biggest percentage, because service provider also tend to go to the high end, the bigger box, and also with other virtualized service to secure multiple customer use a single platform. But I believe, long-term-wise, will be huge space because security's starting to become much more complicated, and also some -- even the regular IT guys have difficult time to manage all these different area of security. So that's where the service provider will start play more important role, going forward. But I have to say, this is kind of also a relatively new early-stage area. It's too difficult to judge how quick they were growing. But definitely, the value of service provider starting to get more and more important in the security space.

Okay, that makes sense. Thank you, gentlemen.

Thank you.

Michael Turits from Raymond James.

Yes, it's follow-ups if we can do them. Any indication of how Europe's doing in July?

No. I'm not going to get into week-by-week, so I'm not going to go there. I think I would say it this way - I took into account, or we took into account, the collective -- everything we see when we provided our forward guidance and comments relative to regions, but I'm not going to get into week-by-week and day-by-day performance.

That's good. Just a clarification - the deals over $500,000, was that really only a fall-off in Europe, or were those large deals weaker in other geos also?

I don't have that breakout here. I just know that we discussed, after the quarter was over, the fact that we did have a lesser number of deals close in Europe than we perhaps historically have had.

Okay. If you do the model in the next quarter and keep kind of like only a couple percent growth in services and go to the top line, it implies product down sequentially. You haven't -- sequentially. You haven't seen that in a bunch of years. Does that make sense to have product down in third quarter?

Well, I don't know if that will occur. I mean, a lot of it will depend upon what the billings are. To the extent that we hit our billings, product -- it could be flattish. I mean, I gave a range of 101 to 103 in revenue, so it depends upon what number you're using there. Obviously, 101 makes it tougher to have growth, 103 makes it easier. We did have a little bit richer mix in product this past quarter, as I said, and so I don't know if that will occur in Q3. So I made that comment, and it's hard to sort of, within a million or two, be able to forecast the translation of billings into product revenues and so forth. So that's what counts for how we sort of gave guidance on overall revenues.

Okay. [Trent], you said that you're doing more annual -- fewer multi-year deals. I apologize, I missed it. Why--?

--We said that relative to this past quarter. We didn't say that necessarily going forward.

Okay, just this quarter.

Yes, that's correct.

Even though the -- two questions, one why, and then two, it didn't seem to show up that way in terms of deferred revenue. The mix was long-term to--.

--Yes, because the long-term grew so much slower than short-term deferred revenue, so that's -- at least that's how I see it. Part of that relates to how we handle China, too, which has changed. Again, I think, going forward, I don't have enough data. My sense and hope is we'll get back to a little bit the way we were. I would say it this way - we compensate our sales force for billing irrespective of the kind of billing it is, and so that number can vary a little bit depending upon the timing of renewals and when renewals come up, the kind of new deals we do, and the length of the bundles in terms of services. And we don't always know, and they don't always know, exactly what the customer's going to ask for going into a quarter. So it's not 100% science in terms of these numbers, going forward.

So there's no trend that you know why it was shorter term?

I don't see a particular trend, no.

Okay. And can you quantify it at all, the shorter term length?

Not in what I already gave.

Okay. And you raise free cash flow growth by -- guidance for the year by $10 million to $15 million, even though your billings at the midpoint in [terms of guide], only went up a couple million. Last quarter's flipped. I mean, you raised most metrics but kept free cash flow. What freed you up to feel like you could get more aggressive on free cash flow guidance this quarter?

Well, one is I got two quarters in my belt, and it's pretty hard to take away what we've already achieved in terms of better performance. And so I thought we translated the better performance in Q2 through the balance of the year. We continue to do -- we're doing a little better -- I mean, what drives cash flow, clearly billings, which is up a little bit from what we gave last time, not a lot, and profitability, which is also up from what we had before. And so far, we're doing better on collections than I would have anticipated in terms of our AR.

All right, Ken. Thanks, and thanks for your patience.

Rob Owens from Pacific Crest.

(Inaudible) the cash flow. What about DSO and sustainability, because obviously that has a contribution there, as well?

Yes, I don't want to suggest we're [always] going to be -- we gave a range of 65 to 75. We came in a little lower than that this quarter. I think being in that rage of 65 to 70 is a range that I still feel okay with. Clearly, I'd like to be 70 or less if we can because that does really help us in terms of overall cash flow. But what drives cash flow, again, is billings, collecting those billings, and then the profitability, which is directly related to the amount we spend for both inventory and operating expense.

And was there a collections improvement, or you mentioned on the call how linearity was actually (inaudible)--.

--Yes, I don't have the prior quarter, but we did get to 63 days this quarter, which I know was better than Q1. We're looking up Q1. But yes, I know Q2 was absolutely better in DSO than Q1.

Okay. Was there any [talk switch] contribution in the quarter?

Yes. We had about $1 million of revenue.

And from a bookings standpoint?

I think it was about the same as I recall, roughly that amount.

Okay. And then you also mentioned, when you lose, you're not seeing deals [against] some of the bigger players. Given the state and some of the challenges of some of these bigger players, are you seeing any irrational behavior around pricing at this point?

No. We get asked that question fairly frequently, actually. It came up a couple times today, a few times today. Not really. I mean, pricing generally doesn't win business, and so, I mean, it may be some very low-end deals that it does. But in terms of mid- to high-end, pricing is sort of negotiated toward the tail end of a deal, after you've really won it, and then they negotiate the price. And so maybe from time to time at some very low end, pricing is a consideration for winning or losing. But for the most part in our business, it's a lagging part of the negotiation, not a forward.

Yes. [Another comment], really, we compete on the performance, on the secure function and on the feature we deliver. We not try compete on the price. That's the company -- [all this year's] strategy.

And then last question I guess from a high level, given all the visibility around cyber-security, right, and everything going on, why don't you think the market's accelerating, especially for a player like you that has probably lower sales cycles than others in the market?

I think definitely the -- it's for all [level] people, from, like, the CEO-executive level to some other employees and consumer level, they're more aware that -- the importance of the security (inaudible) compared to, like, a few years ago, because all these -- the big news come out. But on the other side also, lot of new deployment, especially in the infrastructure side, is also depend on the -- some of the big IT project. So the other side, I see the trend is really the service provider starting to, like, offer some of the [cream pie] or some other better added service beyond the Internet access. So that's a few since starting changing, but definitely there's more news recently about this security [break-in] compared to few quarters ago.

And do you think there was any fallout or any lag in demand as a result of some of the vulnerabilities that were discovered in some of the firewalls in years, notably earlier in the quarter?

I have to say probably fewer -- lot of enterprise, they're still using the old firewall security device, which can only secure the connection, compared to the concept of whether (inaudible) UTM or some (inaudible) firewall, which more focus on the content [mechanism] of ours, the intrusion, some other application control. That few, like, only happen in -- as in Fortinet, we started doing this almost 10 years ago, but the bigger trend most starting to show up in the last few years. So long-term-wise, definitely there's a few problem with lot of enterprise will want to upgrade a firewall to the new UTM, which is this new trend. Otherwise, they have to deploy the firewall and then the other antivirus, the other intrusion, or some other -- it's just so complicated to manage, so costly to manage. So that's the bigger trend there, but I have to say also only a few -- last couple years, enterprise starting to realize the importance of a secure -- both on the firewall connection side and also secure on the content side.

Okay, great. Thanks, guys. Thanks, Ken and Ken.

Yes, maybe time for one more because our hour's going to be over. So this will have to be the last question.

(Operator instructions.) I'm showing no one in queue at this time.

Okay. Well, thanks. I think we sort of went over a bunch of stuff a bunch of times, so anyway, thanks, and look forward to seeing many of you at various conferences that we'll be attending later this quarter.

Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This concludes our program for today. You may all disconnect, and have a wonderful day.