Fortinet Inc (FTNT) 2011 Q3 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing and welcome to the Fortinet Q3 2011 earnings announcement conference call. (Operator Instructions). As a reminder, this conference may be recorded. I now turn the call over to Ken Goldman. Sir, the floor is yours.

Okay. Thanks. Great. Good afternoon and thank you all for joining us on this conference call to discuss Fortinet's financial and operating results for the third quarter of 2011.

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

In terms of the structure of the call, I will begin with a view 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 and outlook for the fourth quarter, fiscal 2011 and a little bit on fiscal 2012 before we open up for questions.

As a reminder, today we're holding two calls. Following this call we will hold a second conference call to provide an opportunity for financial analysts to ask more detailed financial questions. The second call will began at 3.30. And, by the way, I would make a comment that all are welcome to joint that call. The second call will begin at 3.30 p.m. Pacific and will also be webcast from our Investor Relations website. It is accessible as detailed in our earnings release.

Let me also read this disclaimer or Safe Harbor statement. Please note that some of the comments we make today are forward-looking statements, including those regarding the financial guidance for the fourth quarter, fiscal 2011 and fiscal 2012, market opportunities, introduction of new products and our expectations regarding the impact of our business, our growth initiatives, impact of the newly adopted FASB revenue recognition rules, including our deferred revenue ratable balance, expectations regarding renewals, services revenues and product revenues, impact of investments in our sales, R&D and marketing teams, expectations regarding revenues for EMEA region, inventory levels and our expectations regarding days sales outstanding, inventory levels and our hiring trends and expectations around growth and market share gains in advanced security solutions.

These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in our forward-looking statements. Please refer to our SEC filings, in particular the risk factors described in our Forms 10-K and 10-Q for more information on these risks and uncertainties and on the limitations that apply to our forward-looking statements. Copies of these reports 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. We undertake no obligation and specifically disclaim any obligation to revise or publicly release the results of any revision of these forward-looking statements in light of new information or future events.

Boy, I read that fast.

Also, please note that we will be discussing certain non-GAAP financial measures on this call. Our GAAP results and GAAP-to-non-GAAP reconciliations can be found in our earnings press release and on slides 14 and 15 of the presentation that accompanies today's prepared remarks. Please refer to our website at 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. Note that we routinely post important information on our Investor Relations website. We encourage you to make use of that reference.

So now, relative to Q3, let me start with Q3 2011. We are very pleased with Fortinet's results. We had exceptional performance across all operating metrics, including record billings, revenue and profitability. Fortinet has never had as great a market opportunity as exists today. It is important, however, that we continue to execute well and invest in our products.

Within the overall technology market, the security sector is one of the strongest performers and we continue to gain market share. We're investing in sales and R&D, as well as marketing to expand brand awareness, strengthen our value proposition and expand our distribution channel. We are benefiting from market trends in MSSP and the SaaS delivery of security, virtualization and network security and mobility, as well as increases in network performance and bandwidth-intensive applications that require high performance security.

We are leveraging our broad product set, which positions us to benefit from untapped demand for our products within all customer segments, be they SMB, enterprise and telco for a variety of deployment scenarios, whether that is UTM, firewall, security protection in wireless and so forth.

We also have an exciting new lineup of products coming out in Q4 that will further strengthen our position across all the high-end, mid-range and entry-level spectrums. Ken will talk much more about these shortly.

These trends helped drive our record Q3 results and our outlook for Q4 which I will share with you. First, let me touch upon a few highlights of the quarter. We saw healthy deal volumes, driven by (inaudible) and enterprise data center deployments, core enterprise deals and continued strength in the retail and telco sectors.

Q3 was the best quarter ever in the enterprise segment. We closed the biggest enterprise contract in the Company's history. Fantastic performance in emerging markets, such as Latin America and Southeast Asia.

In addition to driving strong revenue growth, exceptional growth concerning the economic environment, we are managing our business operations very efficiently. Free cash flow exceeded expectations, operating margins were will ahead of our long-term model and revenue per employee increased markedly.

We ended the quarter with over $0.5 billion in cash and investments.

Before diving into the Q3 results, let me add three items I want to point out that occurred during the quarter. First, Q3 included $2.6 million from patent sales that favorably impacted our results, including billings, revenue, free cash flow and earnings per share.

The patents we sold were part of the portfolio we acquired earlier from CoSine early in our history. These patents do not relate to our core offerings and are of limited use for our needs.

At the same time, billings and revenue may have been several million dollars higher were it not for inventory shortages, which resulted from demand for specific products that exceeded our forecasts, coupled with timing of the related orders. We are investing in increasing our inventory levels during Q4 in order to minimize risk of additional inventory shortages and also to meet the demand for a number of new products being released.

And, as a reminder, we adopted the new FASB revenue recognition rules at the beginning of 2011. Consequently, Q3 revenue increased approximately $5.1 million compared to the previous rules. Certain product revenue which can now be recognized upon shipment in both China and the US. would not have been recognized under previous revenue recognition rules.

We believe had the previous recognition revenue rules remained in effect, the impact would have been less, as we have also changed certain business practices to mirror the changes to the revenue rules. As has been the case, the new revenue recognition rules were taken into consideration when we provided our third quarter guidance.

The key numbers in Q3 can be seen on slide three. Our billings were $118.4 million, and increased 25% year over year or 22% excluding the patent sale impact. Revenues were $116.4 million, up 37% year to year or $113.8 million or 34% excluding the patent sale.

Non-GAAP operating income was $31.4 million, up 52% year over year or up 40% without the patent. Non-GAAP operating margin was 27%, up approximately 3 percentage points year to year, or 25% without the patents.

Non-GAAP EPS was $0.13. $0.01 a share came with the patent sale. And free cash flow was $34.7 million or approximately $0.21 per share.

We achieved record high revenues, driven by continued strong growth in both the Americas and APAC, at 41% and 38%, respectively. EMEA revenue growth was also solid at 31%, up from 24% year-over-year growth reported in our second quarter. We are pleased with our strong execution and progress of re-energizing growth in the region.

In terms of profitability, profitability was again above expectations and our long-term model. The non-GAAP operating margin was the highest ever at 25%, excluding the impact of the patent sale I mentioned.

We are pleased with our profitability, particularly given our accelerated hiring efforts and continued investments in sales, support and R&D in order to support growth, continuing expense control and continued leverage in our business model.

Free cash flow of $34.7 million exceeded our guidance of $30 million. Cash generation continues to be reflected in our collections, profitability and working capital management.

Turning to the details of our third quarter financial results and the income statement in Q3, billings were $118.4 million, an increase of $23.7 million or 25% compared to the same period last year. Billings were negatively impacted somewhat by the product shortages I just spoke about.

Geographic breakdown on billings growth -- Americas, 36%; EMEA, 13% -- again, it was 13% up from the low single digits last quarter -- and APAC, 23% compared to Q3 2010. Americas and APAC had another strong quarter and EMEA's growth accelerated compared to Q2, consistent with our previous commentary that we expected it to recover from our Q2 performance.

In terms of product segmentation, you can see that on slide four. Billings of high-end products accounted for 37% of product billings, compared to 39% in Q3 last year and 34% in Q2. Driven by strength in the entry-level segment in EMEA, and distributed enterprises in the Americas, we achieved a slightly higher percentage of mid-range and relatively consistent high-end product billings as compared to the same period a year ago.

In terms of deal-size breakdown, the number of large deals grew in all categories during Q3, which is typically a seasonally slower category. The number of deals over $100,000 for Q3 was 130 and that compares to 101 in Q3 of last year and 127 in Q2 of this year. Deals over $250K was 39, which compares to 38 in Q3 last year and 37 in 2Q this year. The number of deals over $500,000 was 13, same as 13 in Q3 last year and 11 in Q2. We also had a very large deals of $1 million or more during the quarter.

Billings by key vertical -- last quarter we started to break out approximate billings by our top five verticals -- service providers, financial services, healthcare, retail and government. These are the best estimates we can provide, given that we do work with our channel partners.

From a year-to-date point of view -- I will actually year-to-date numbers and Q3. Service provider for year to date is 25% to 30% and for Q3 is approximately 28%. Government year to date is about 15%, Q3 about 11%. Retail approximately 10%, Q3 14%. Financial services 10% year to date, about 9% for Q3. Healthcare 5% to 10%, a little less than that in Q3 at 3%.

Now moving to revenue, total revenue at $116.4 million in third quarter, up 37% year over year, or $113.8 million net of the patent sale, which is up 34%, well above our guidance range.

The geographic split of revenue is shown on slides five and six. In Q3 solid performance across all geographies enabled us to exceed our revenue targets.

The geographic split of revenues is calculated using the bill-to address and for Americas we had $50.0 million versus $35.4 million at prior year, increasing 41% year over year. Without the patent sale, Americas revenue grew 34%, driven by sales of our mid-range products to distributed enterprises.

So, we saw another quarter of very strong performance in the Americas region, which is a primary driver to our revenue coming in above our guidance.

We remain committed to executing growth initiatives, including building out our vertical focus teams and further penetrating the large enterprise market. We are continuing to see the results of these efforts paying off.

For example, growth in the Americas were driven by a robust deal flow in the large enterprise market, you'll see as retail sector. As I have mentioned in past quarters we continue to have phenomenal success in the retail vertical as a result of our ability to provide a complete PCI-compliant security solution, delivering segmentation, rogue access detection and WiFi capabilities.

If you recall from last quarter, we mentioned that we had secured a proof-of-concept with a large retail chain and Fortune 50 company which has more than 8,000 locations across the US. We are very pleased to announce that we have won the business, closing the largest deal in Fortinet's history. This win is a two-part store-to-core deployment, which includes installing FortiGate-200B UTM appliances to secure 8,000 stores for PCI compliance purposes, as well as installing our high-end FortiGate-5000 and FortiGate-3950 products to serve as a core firewall for its three data centers.

We beat out Cisco and Juniper for this business, based on our breadth of UTM wireless functionality for store deployment and our unparalleled firewall performance and complementary networking features. In addition, the centralized management capabilities of FortiManager and our professional services were also favorable factors in the win.

This will be a multi-quarter rollout.

This is just one of several PCI-compliance-driven retail deals we won during Q3 with brand-name retailers and restaurant chains. One such example is a 6-figure deal we won with US Fortune 100 company and one of the nation's largest retailers. Fortinet's UTM appliances were chosen as part of a broader network upgrade and PCI compliance project and will serve as a security to protect more than 2,000 department stores.

As I mentioned previously, we had another excellent quarter in Latin America as we gained traction on our sales efforts (inaudible) in the region. We closed a number of deals with local government entities and service providers.

Two examples of 6-figure deals we won in Latin America were with government entities. The first one we beat out Cisco and Check Point, based on our high-end performance -- I'm sorry -- based on our high performance next generation firewall functionality. In the other deal we beat out Cisco based on our complete UTM solution and functionality.

Now turning to EMEA. We did $37.9 million versus $28.9 million the prior year, representing a year-over-year increase of 31%. Growth in the quarter accelerated from 21% year over year last quarter. The pipeline remains strong as we look into Q4.

As many of our larger EMEA deals in Q2 and Q3 of last year were multi-year contracts, we had less renewal opportunities this quarter. Our EMEA team did a great job selling appliances to new customers, particularly in the high-end enterprise and carrier segments, resulting in greater upfront product revenue. We expect more renewals in the EMEA region in the fourth quarter.

France, in particular, had a very strong quarter, which helped us reinvigorate growth in the overall EMEA region. We are pleased with the overall results for EMEA. We continue to secure broad-based deployments with large enterprise and service providers, which were business drivers for the region during the quarter.

Service provider sector was particularly strong in EMEA this quarter. Our success in this sector has been based partly on our ability to provide a carrier-grade hardware platform that offers very high performance for data center deployments, broad functionality to enable flexible delivery of main security, superior virtualization and virtual domain technology and complementary networking features.

A few examples of key wins in EMEA this quarter included a large deal with a European mobile carrier where we displaced the incumbent firewall provider and beat out Juniper, Cisco, Check Point and cFosSpeed. After rigorous testing, our high-end FortiGate systems were selected to secure their -- I'm sorry, to secure their core and protect internal networking services.

We also won a 6-figure deal with a UK-based service provider where we deployed our high-end FortiGate-3950 appliances to secure their high-speed network and won due a significant performance advantage. I would also add that we are certainly seeing better performance in the UK.

In terms of Asia-Pacific, $28.5 million versus $20.7 million in the prior year, increasing 38% year to year, driven by growth in the mid-range and high-end product segments.

There was very strong growth in the APAC region, particularly in Japan, which had a record quarter. Q3 was also an excellent quarter in Southeast Asia and continues the strong growth we have seen in recent quarters.

Across the region, we continue to move upstream to win more business with enterprises and service providers. Ken will discuss the win with a large regional service provider, but let me highlight a key enterprise win with a local government utility that operates one of the most sophisticated power grids and ranks among the Fortune Global 200.

This was a firewall refresh deal to protect several facilities. This customer selected Fortinet over Check Point and Juniper based on the superb performance and very low latency our high-end FortiGate systems.

To the product revenue, $53.1 million, up 48% year over year. You can see slide seven for this.

As we've said in the past, product revenue is an important leading indicator. The strong Q3 increase bodes well for services growth over the next few quarters.

Similar to last quarter, in Q3 a richer mix of our billings were product related. As mentioned earlier, many of our large deals in Q2 and Q3 of last year were multi-year contracts and we had fewer opportunities for renewals, particularly in EMEA, this quarter.

Note that the product revenue metric may move around a bit more due to the new revenue recognition rules. As a result, product revenue has some volatility to the overall mix of billings each quarter.

Demand for our high-end, high performance FortiGate-5000 blade chassis products continued to enable us to sell well into enterprise data centers. We are well positioned going into Q4 and 2012 due to our strong new product portfolio lineup.

In terms of services revenue, $57.8 million, up 30% compared to $44.5 million a year ago. We do expect our services revenue to increase over time due to our growing installed base of customers, which drives the increase in our deferred revenue balance.

Renewals remained in the mid-to-high 70% range, comparable to our peak rate we have seen over the past several quarters. Q3 renewals experienced seasonality similar to that of our overall business, where we general experience a lower level of renewals in Q3 and higher renewals in Q4 in large part driven by Europe and a number of coterminous contracts expire in Q4.

In terms of ratable and other revenues, $5.5 million, the revenue from the patent sale more than offset the declining ratable revenue amortizations due to the new revenue recognition rules.

Quickly, just a little bit on headcount on slide eight. You'll see that we ended the quarter with 1,527 employees, which compares to 1,475 in Q2 and 1,336 in Q4 of last year. Similar to last quarter, we ramped up hiring in sales and R&D with net headcount increasing 4% on a sequential basis and 17% year over year. And you can see also our headcount tends to be globally diversified with approximately 76% of our employees located outside of the US.

You'll also see -- you'll see there functionality, sales and R&D account for approximately one third each, with sales headcount well balanced across the three main geographies. Service support accounts for approximately 21%, with G&A 8% and operations at 2%.

In terms of annualized revenue per employee, we achieved $310,000 in third quarter, up 18% from $263,000 in the third quarter and $288,000 the second quarter.

We grew billings by 45%, revenue by 37% compared with a 17% increase in employee headcount. Actually, over the past four years, our revenue per employee has doubled, which signifies how we're driving leverage in our business model.

In terms of some very quickly income statement cost ratios, non-GAAP gross margin was 74% in Q3, which is consistent with third quarter last year with last quarter.

Total non-GAAP operating expenses were $54.6 million, which is up 26% year over year compared to a revenue increase of 37% year over year. This increase was driven primarily -- was primarily driven by headcount additions. Foreign exchange also had an impact of approximately $2.7 million negative or increase, primarily due to Canada and Europe exchanges -- exchange rates.

Non-GAAP operating expenses were flat sequentially, driven by lower events expense, such as from vacations taken in the summer months, particularly in Europe. As a percentage of revenue, total non-GAAP operating expenses during Q3 were 47% compared to 51% in the same period last year and 53% second quarter of 2011.

Q3 non-GAAP R&D expense increased 30% year to year to $15.3 million. It was 13% as a percent of revenues. Non-GAAP sales and marketing increased 32% year to year, now at 30% of revenues. Non-GAAP G&A decreased 8% year to year, as we had lower legal fees, to $5.0 million and representing 4% of revenue.

Non-GAAP operating income came in at $31.4 million and represented a non-GAAP operating margin of 27% or -- in comparison to 24% operating margin last year and 22% operating margin in the second quarter of 2011. In terms of -- by the way, excluding the $2.6 million impact from sale of patents, non-GAAP operating margin would have been 25%, which is an all-time best for us.

We continue to show tremendous leverage in our operating income year over year and expense as a percent of revenues declined 4% year to year.

In terms of effective tax rate, the non-GAAP was 33%, similar results for the year and that compares to 35% prior year. Non-GAAP net income was $21.7 million. It compares to $13.5 million in Q3 of last year, an increase of 61% year over year.

Non-GAAP diluted earnings per share were $0.13, $0.12 excluding the patent sale, compared to a split-adjusted $0.09 for third quarter of 2010.

And, by the way, there's a full reconciliation of all the GAAP to non-GAAP numbers in our press release, as well as our slides 14 and 15 that accompany this.

Just quickly, GAAP net income was $17.9 million compared to $14 million in third quarter last year. GAAP tax expense provision was 34%, which is up somewhat from earlier in the year, which brings our annual rate now to 29%. And GAAP diluted earnings per share were $0.11.

In terms of balance sheet, you can see those in charts 10, 11 and 12. In terms of -- let me talk to a couple key metrics.

Cash and equivalents ended the quarter at $503 million, $3.07 per share, $34.5 million increase from Q2, primarily driven by cash generated from operations, in addition to exercise of stock options. Cash generated from operations was $36.0 million. This is our 22nd consecutive quarter of generating cash from operations, exclusive of one-time items. Free cash flow, as I mentioned, was $34.7 million, or $0.21 per share.

In terms of just other balance sheet, net AR increased $3.6 million to $75.8 million. DSOs were 59 days, below last quarter and actually below our target of 65 to 75. Again shows very high quality of revenue and we achieved strong collections for the quarter of $110 million.

Inventory, which is not what we hoped, actually decreased by $0.7 million to $13 million. As I mentioned, we did experience a shortage of inventory on certain products as demand was well above our forecast. We are investing in inventory to minimize the risk of inventory shortages going forward and expect Q4 inventory levels to be higher than Q3. Thus, our net inventory turns were 5.2 compared to 4.0 in Q2.

Nothing new in net PP&E. It stays stable around $7.5 million.

In terms of deferred revenue balance, increased to $275.1 million, up $39.9 million or 17% year over year or $1.9 million or 1% sequentially.

Our services revenues -- services deferred revenue balance decreased $4.1 million and product increased $0.7 million. That was offset by $2.9 million decrease in our ratable balance, which will continue to decline due to new revenue recognition rules. So, again, the overall number increased higher but our decrease in ratable balance does reduce the overall growth. I would also add the billings this past quarter were driven by a higher mix of product billings as opposed to renewals, particularly in EMEA.

Short-term deferred revenues increased to $192.9 million, up 22% year over year, and long-term deferred revenue increased to $82.2 million, up 7% year over year. And with the new FASB rules, (inaudible) revenue is no longer being deferred over several years.

So to summarize, we had an exceptional third quarter, driven by healthy demand for our products, combined with our solid execution and continued market share gains. We are excited about a number of recent product announcements that should lead to healthy product flow in the fourth quarter and going into 2012. I will discuss our guidance in more detail later, but let me first turn the call over to Ken.

Okay, thank you, Ken, and thanks, everyone, for joining us on the call. Fortinet had a strong third quarter. We're very pleased with our result. As Ken noted, we exceeded our finance target, we grew the market share and we made great traction across all verticals and extended our innovation by introducing a few new products that will both help further the differentiation of ourselves with competitors and also drive the future revenues.

So, during the third quarter our global business was fueled by the continuation of security trends, as I have spoken before. So, the first trend is the increased adoption of consolidated UTM security appliance, which integrates many security functions, with each key function passed all the major industry certifications and reduces complexity and cost while providing broader and deeper protection.

So as a pioneer and a market leader, Fortinet has benefited well from this trend and winning business across all segments.

So in Q3, we continued our success in enterprise in winning a lot of retail, university and large enterprise.

So, we had several wins this quarter with major US universities. One of these was with a East Coast university, which sought to upgrade its server-based firewall solution to a next generation firewall UTM. After extensive technical evaluations, Fortinet won this deal against Palo Alto Networks and (inaudible) Check Point due to our superior performance and advanced layer two to layer three networking functions and a single pane of glass large-scale management.

So, we believe we have a great product set and opportunity in the education market and has been -- has started again to build out our education vertical sales team in the US to help us further growing in this space.

The second trend is related to performance, which continues to be a drive to security deployment in the enterprise and service provider environment. These customers require (inaudible) security solution to meet increased security speeds and secure more bandwidth-intensive applications.

Fortinet's ability to provide a high security performance through our custom network and (inaudible) security ASIC, the FortiASIC, set us apart from the competitors and remains one of the key factors why we win.

So, one example in Q3 was a win with a leading credit card company in Europe -- in EMEA as part of a network redesign and upgrade that required very high performance security for both their core data center and also the network gateway.

So, we won this deal over Check Point and (inaudible), primarily based on our ability to provide highest (inaudible) speed firewall and multi-gig IPS performance.

So, another trend we continue to see is the shift towards delivering security as a managed service. So, we have done very well in this space due to the performance, the virtualization and the carrier-grade network functions we often in our high-end solutions.

Service providers around the world are using Fortinet solutions as the platform to deliver an array of cloud and customer-based managed security services. So, we are proud to count the super majority of the world's leading telecommunications companies as our customers.

So, one example in Q3 deal is we win the SK Telecom, which is the number one mobile provider in Korea, to protect its 24 million subscribers using its 3G and 4G LTE service. So, SK Telecom selected FortiGate-3950 for carrier upgrade and AT service and a 10-gig for its (inaudible) server farm. So we won this against Cisco and Juniper based on our ability to provide unmatched performance, flexibility and future reach and ease of management.

So this trend and our own innovations are driving continued growth and market share gains for Fortinet. So, as we see, most recent (inaudible) shows Fortinet grows its leadership in the worldwide UTM market for the 22nd consecutive quarter to 17%. And Fort & Sullivan recently recognized our growth by awarding Fortinet its 2011 Asia-Pacific Growth Leadership Award in the firewall VPN market.

As many of you know, Fortinet is first and foremost a technology company and innovation is at the core of everything we do. So, I'm very excited about a number of our recently announced products and expanding our solution portfolio across the high-, mid- and low-end and further differentiate us on functionality and performance.

This includes a new FortiGate-300C, FortiGate-600C and FortiGate-1000C middle-range appliance that offers superior security price performance and in the case of the 600C and the 1000C, flexible port and connectivity options that are ideal for the growing enterprise.

And early this month, we also introduced a new entry-level UTM appliance for the small business and telecommuter and remote branch office, plus the small retail outlet. The new FortiGate and the FortiWiFi-20C and 40C appliances provide broad UTM protection in wired and wireless environments.

We also expanded the virtual appliance line with the FortiGate-VM for Citrix Xen Server environment, introduced FortiScan VM and added FortiWeb-3000C with the new FortiWeb 4.3 release, which includes the web (inaudible) and advanced application load balancing to help improve application performance.

A few weeks ago, we also held our first-ever global partner conference, attended by more than 600 channel partners from around the world. Partners came away even more excited about our product line, the channel commitment and also the marketing opportunity across all sectors, from SMB to enterprise to service providers.

We continue to hear that no other vendor can match Fortinet's technology, super performance with deep and broad security and network functionality. As we enter the last part of this year, I have confidence in Fortinet's business and openness with the future.

So, let me turn the call back to Ken Goldman, who will provide us the financial outlook for Q4 and the rest of the year.

Okay. Let me try to get this done quickly, so we can get to the Q&A part. Let me remind you the guidance does consist of forward-looking statements and please keep in mind my earlier comments regarding such statements.

From a higher-level perspective, we are certainly cognizant of the uncertain global economic environment, which is taken into consideration in our forecast, along with data on our sales pipeline and feedback from the field.

All things considered, we remain confident in Fortinet's outlook and expect continued growth and market share gains. We believe there's good demand for security solutions and we have the right products at the right -- for the right customers at the right time. We are making inroads across the spectrum, demonstrated by some of the wins I spoke to earlier and the continued growth of our pipeline.

With that, let me begin with the guidance for fourth quarter. Billings are expected to be in the range of $131 million to $135 million, which at the mid-point represents growth of 20% year over year.

We expect a nice increase in renewals due to seasonality and thus this implies our deferred revenue balance will increase $15 million to $20 million. Total revenue expected to be in the range of $114 million to $116 million, which at the midpoint represents year-over-year growth of 23%, approximately.

Gross margin is expected to remain approximately 74%. Non-GAAP operating margin expected to be in the range of 24% or 25%. Non-GAAP earnings per share expected to be approximately $0.12 based on approximately the same number of shares as this past quarter.

Free cash flow is expected to be in the range of $32 million to $35 million on cash flow per share of approximately $0.21 per share.

I would add that we do expect -- we have built in a several million dollar increase in inventory this current quarter.

I would also say that historically this metric has closely tracked our view of free cash, which is the total increase in cash balances, net of any financing activities, primarily stock option exercises. As certain non-cash items such as excess tax benefits become larger, our free cash flow metric may not align exactly with our internal view, which is how we have been providing guidance.

Our pro forma tax rate is expected to be 33%, which is the same.

Based on our fourth quarter guidance, and historical performance in third quarter we have raised our full-year 2011 guidance as follows. Billings should be in the range of $466 million to $470 million, which is up from our prior guidance of $460 million to $470 million and at the midpoint about 25% growth year over year.

Total revenue would be in the range of $427 million to $429 million, which is significantly up from $395 million to $410 million previously provided. The midpoint is around 32% growth for the year and higher than our previously provided guidance of 24%.

Gross margin no difference, around 74% and operating margin for the year 23% or 24%. All these are at the top end of our range.

EPS to be approximately $0.43, up from our previous guidance of $0.36 to $0.37 and based on the weighted average shares of about 164 million or 165 million.

Free cash flow to be in the range of $137 million to $140 million and cash flow per share approximately $0.84, which is up modestly from our previous guidance of $135 million to $140 million and representing growth of about 40% year over year.

It's interesting -- I went back and if you look at it on our Q3 2010 earnings call last year, we said we were comfortable with expectations of mid to high teens revenue growth for the full year 2011. We have been fortunate to significantly outperform with our current guidance calling for approximately 32% revenue growth.

As we look ahead to 2012, at this early point, we are again comfortable setting expectations for the full year revenue growth in the mid to high teens range in light of the fact that we are still early in our planning process. We are larger and we will be facing more difficult comparison and the economic environment remains unsettled.

Also, we will not have the favorable benefit that we had this year of the new revenue accounting rules.

And, as we've done historically, we will continue to refine our 2012 forecast in the quarters ahead as we gain additional points.

From a probability perspective, our current full-year 2011 non-GAAP operating margin target of 23% to 24% is well above our initial guidance. As we look ahead to 2012, we will plan to maintain this level of efficiency and profitability. At the same time, we will continue to invest in our business to drive growth and continued market share gains. As a reminder, this level of profitability is better than the long-term target model that we shared during our IPO a couple years ago.

So, now let me turn the call to the operator and we'll take your questions and answers.

Thank you, sir. (Operator Instructions). Our first questioner in queue is Philip Rueppel with Wells Fargo. Please go ahead.

Great. Thanks very much. I was just curious about a little more granularity on the rebound on Europe or EMEA. In particular, I mean, you had mentioned that the Middle East had been an issue in the past. Did you see the rebound both in billings and revenue due to just sort of macro environment, due to better execution or some of the big deals or the pent-up demand that didn't close last quarter? Thanks.

I think the overall perspective is better execution all the way through in terms of working with the pipeline, closing the deals in the timeline that we had expected. I mean, there's still opportunities.

You mentioned Middle East. We're still working to -- we think there's more improvement to be made there. We have done a lot in terms of hiring in several countries, including the UK. So, there is more work to be done. So, we think we've found a stable point.

I would add, for the Company to grow -- I mean, clearly our goal -- not that I'm trying to provide guidance -- but our goal in the Company is to grow well over 20%. The only way we can do that is to have -- from a billings point of view is to have EMEA also grow either in the high teens or 20% because we do expect some of the other areas we have relatively lower share there and more opportunity for larger growth.

So, while we've made progress, there is still more to be done. But I don't think it's one particular area in Europe as opposed to just better managing the business throughout the quarter and particularly in September.

Okay and then just one quick one on sort of the guidance for Q4. Even the high end suggests on a revenue basis that it's sort of flattish sequentially. Are you making any -- are you pointing to any issues that you see about slowing in any regions or anything like that, that would preclude you from sort of seeing normal seasonality of a year-end budget flush or is it just too early to tell. Thanks.

No, I'm not trying to point to anything negative at all. Actually, the reality in Q3 we had a very favorable -- and I've said this in Q2 and it's not always going to happen -- but we had a very favorable product mix. So, in terms of the billings we had a good percentage of the billings that went to, basically, bundled products and in terms of that percentage we had a number of products that didn't have services, necessarily, with them. Sometimes when people buy non-FortiGate products or products they use more as firewalls and so we were able to recognize a greater amount of that -- those revenues in Q3.

And that's always a little bit hard to predict and so, with reasonable caution, I'm trying to make sure we don't get ahead of ourselves for Q4, because that's just a hard number to predict in terms of that -- in terms of percentage of billings that goes to products versus services. And, as you noted, I did expect a somewhat higher percentage of our billings in Q4 to be of the renewal nature versus product nature.

Yes. Okay, great. Thanks very much.

Thank you. Our next questioner in queue is Michael Turits with Raymond James. Your line is now open. Please go ahead.

Hey, guys. One other question on the guide, first. Billings guide, at the midpoint, looks like it's around 20%, which is a deceleration. So any thoughts there?

And then also it seems if I -- the deferred revenue grew a lot slower again on the long term versus the short term. I was just wondering how long -- what's going on in terms of that trend, it seems, towards shorter term lengths, which I assume is what's driving that and what kind of impact it might have on billings or cash flow going into next year?

I may have you repeat your first question, but on the second question, the challenge there, a little bit, is how often do we do multi-year deals. And so that -- just to be very clear, we don't provide real incentives to do multi-year deals. Sometimes certain customers want to do them because they want to lock in their budgets and expenses. But we don't provide, overall, a real incentive to do that. So, that's -- therefore, our long-term deferred, if we don't do multi-year deals then our long-term deferred won't go up as much.

And that can move around a little bit. But that's the real reason. I would also say as we're able to recognize more of our billings up front, over time those numbers will track a little closer. So you'll revenue and billings track a little closer to each other than this past quarter.

The last point I'd make is sort of the same thing I said a little while ago. We clearly internally target for numbers higher than we would -- over time, than we would guide. We're trying to gain share. It's very important for us to gain share, but I don't feel it's prudent to provide this numbers as guidance, because there's a lot of moving parts in our business model.

Right. And so my other question, Ken, was just on the guide for next quarter in terms of billings, which at the midpoint looks like it's around 20% growth. So that's a bit of a deceleration. So, any thoughts on that, why we would see that?

Yes, we just looked -- we looked and we want to be cognizant of the environment that we still feel is a little bit uncertain out there. So, we are looking at that. Honestly, we have a number of, as I said before, product shortages. I think we are cognizant -- we are concerned, also, the timing of that and our ability to -- how much we'll get -- how much we'll recover all of that this quarter.

I guess, in some respects, it's a nice problem to have and on the other respects it's a lousy problem to have because we're missing opportunity. So, that's a little bit -- and that's been sort of in the medium-end product lines, a lot of the newer products, as well. And so part of my thinking there relates to the ability to recover, if you will, from some product shortages that did impact our last quarter.

Okay, great. Good luck, Ken. Thanks very much.

Thank you.

Thank you, sir. Our next questioner in queue is Jayson Noland with Robert W. Baird. Please go ahead.

Thank you and congratulations on the quarter, gentlemen.

Thank you.

I wanted to ask about inventory shortages first. Ken, were those driven by supply constraints or just surprisingly high levels of demand?

Ken would tell me it's my fault, but (laughter) we try to balance availability of product versus not having backlog. Having backlog is really anathema in this business because when you have a channels-based business when you have backlog it means you don't supply your customers, your channel partners, on time and you give your competitors an opportunity. So it's not good.

So the answer to your specific question is primarily the demand for certain of our products was well above, not only our forecasts, but the trend data that we have. So the data was quite above any expectations we would have, either by looking at what the forecasts or looking at history.

So, I'm not going to ascribe any blame to our vendors versus our ability to forecast and then seeing some demand. And some of that demand came in toward the end of the quarter where we weren't able to react quick enough to bring in product to meet that.

You don't expect any supply constraints into Q4?

Well, I'm not sure. Remember I just made that comment a little while ago. We still, today, have some supply constraints and going out of the quarter, we'll see.

Okay. A follow-up --

That's part of my being a little cautious on my billings guidance.

Okay. A follow-up question on new products. The 5140 came out for the carrier market, 300C and others for corporate. Is there still more to come, it sounds like, in Q4? And is the margin profile of these products roughly in line with corporate average today?

Definitely more to come and every quarter we release a few products. Just this product, we tried to get the low end which leverages our system-on-chip, which we feel has a huge advantage over competitors because we integrate multiple functions into the chip to get enhanced performance. A software firewall company can only depend on the CPU.

And also, the middle range, also we feel we have a much better price/performance compared to our competitors.

So that also enhances our position, because in the past if you look at we're marketing in the high end, in the carrier space, but even some of our competitors more label us into the SMB or some low end, but, actually, our percentage of low end actually is smaller than our high end.

So that's where with the new product we hope we can penetrate all these SMBs and some low-end market, which is dominated by a kind of different competitor compared with the high end. So, I think the new products will keep coming in the next few quarters.

And the margin profile is in line with the corporate average?

Yes.

Okay. Thank you, gentlemen.

Thank you, sir. Our next questioner in queue is Keith White with Morgan Stanley. Your line is now open. Please go ahead.

Hi, Keith.

How you doing?

Good.

Very nice quarter. I just wanted to go back to the billings growth versus revenue growth question one more time, just to make sure that we're clear on that. This is the second quarter in a row where you're talking about revenue growth in the mid-30s with mid-20s billings growth and because product revenues are so strong in the quarter, it seems to us from the outside like there is something of a services or a subscription-attach issue going on that's causing that separation.

So, I just wanted to make sure that we're clear of why billings growth has been sustaining -- or why revenue growth is sustaining so far above billings growth and when -- and what's sort of the catalyst for those two to come back together? And does it come back together more so in line with the billings growth or with the revenue growth?

I think the last one's an important question, right? The last comment, I mean.

The -- there's a variety of things that's helping revenue this year, one of which is we do have the benefit, as I said, about $5 million of revenue that would not have been recognized under the old way. So the revenue, you are getting a little bit of pickup in revenue because of the new revenue rules.

We did have -- we are seeing more non-FortiGate products in our billings and so that's helping the revenue component. Because as you look at it, as I think I said before, we have a little bit greater percentage of our billings that's going to hardware-related billings than services and then with that, we have a higher percentage going to what we call non-bundled hardware, which does not have services. Because sometimes, again, if a customer is using it more as a pure firewall, you may not -- you won't have the subscription base that you have otherwise.

So, there are some things there. Then the other point is year over year you may have happened to have a very strong multi-year renewals last year in Q3. We didn't have that this year.

So, let me go forward and talk as we think about it. Clearly, we are -- it's simple math. You can't keep on forever having revenue growth higher than billings. And so we are very focused on having -- growing billings faster. My own sense is it'll take us into '12 to do that where we will focus based on better supply of the products that I talked about before, still improving Europe to get its growth somewhat higher than we had before and also increasing our global footprint across the board.

So there's a variety of things that we are doing that I'm not saying we're going to get to 30% growth, but we certainly would like to get higher growth and have the numbers be in the 20s somewhere in terms of both those numbers.

Having said all that -- to make a long story short here -- I'm not trying to guide to that right now and we'll be prudent, if you will, in our guidance for '12 and hopefully we can continue to improve upon that as we get more data points during the year.

Excellent. And if I could throw in one point for clarity, the patent sale, the $2.6 million that you gained from the patent sale, what exactly made that a revenue event versus something in other income or the like? And just -- was that included in the $118 million billings number? Is that part of that number?

Yes, it is. And what it is, it's a sale and so, therefore, it's a revenue item and that's both how we handle it internally and it gets reviewed externally.

So, no, we did that and this is a one-off. We may do some deals from time to time, both in terms of selling some patents as well as, frankly, buying some patents and it's not going to be an every quarter phenomenon, but we would expect to also buy some patents over time and to that case, it'll hit our expenses from an amortization point of view.

Excellent. Thank you, guys.

Thank you, sir. Our next questioner in queue is Walter Pritchard with Citi. Please go ahead. Your line is now open.

Hey, Ken, just a couple questions on the numbers. Just on product gross margins, it looks like those ticked down a bit quarter to quarter and I know you said not to read too much into them, but it was probably the biggest swing we've seen from one quarter to the next and I just wanted to get any detail on that?

I think it went down about 2 percentage points from 63 to 61. And, again, I think I look at that number as anything over 60 is consistent with our thinking. It will be a function of the not only the mix between the high-end, medium and low-end, but sometimes the mix within those ranges.

So, it's, frankly, a little bit of noise in terms of our ability to forecast and see what actually results between 61, 63. If it goes below 60, that would have me a little bit concerned, because I am very focused on. And, frankly, over time if we get a number more to 65%, 67%, because that's how we can overall -- get our overall gross margins up.

But I think it only went down a couple of percentage points, if I'm not mistaken, Q2 to Q3.

Got it. And then just related to cash taxes, you talked a little about next year. I'm just wondering, cash taxes next year, any change in what you see next year versus what you saw this year?

Yes, I'm glad you asked, actually. I mean to say that. The -- we did a lot of review of that and I would say we expect -- inherent in the assumptions I gave is that we expect cash taxes to be -- very low in Q4 and as we stand today, our cash taxes -- again, and people have asked me questions on this, but in terms of what we actually pay for taxes in cash will be approximately the same in '12 as it is in '11 and that's primarily, as we get a better handle on our stock option redemptions and what's been achieved so far this year and what we have going forward, that's our best feel at this point.

So I think our cash taxes will be, basically, in the single-digit millions.

And then for Ken Xie, just on the new products, how should we think about the ramp of some of those? I know some of those are higher end and it may take a while, but how should we think about impact in Q4 versus is that really impact next year that we see those?

Probably more impact in first half of next year, because once the new product is introduced it usually takes two quarters to ramp up and I think that probably we'll see the benefit next year.

Okay, great. Thanks a lot.

Thank you, sir. Our next questioner in queue is Shaul Eyal with Oppenheimer. Please go ahead.

Thank you, operator. Good afternoon, guys. Good quarter.

Thank you.

A couple quick questions on my end. The inventory shortage you talked about, I think you mentioned that but for the shortage the revenue would have been even higher. Is that shortage kind of baked into the fourth quarter assumptions?

Yes, I think I said -- you're right about revenue, although the real impact was also on billings, because we couldn't bill for products that we didn't have. And we've made assumptions as to the timing of solving the quote/unquote inventory shortages and so forth. We're being a little cautious because the problem you have sometimes is to the extent it's low-end products and your channel doesn't have it, there's a chance you could lose that business to a competitor. So, that's the hard one for us to gauge right now.

So, we tried to be prudent, if you will, or cautious, whatever term you want to use, in terms of our forecast for both billings and revenues in Q4.

And also, some of those components, the lead time could be a few months. Sometimes the inventory may take a longer time to bring back up.

Yes, what Ken has mentioned is there are some components with a vendor or two in some of the products we use where it's nothing negative on them, but they do have longer lead times than we're used to and so that -- we are -- that more affects our ability to upside some numbers than make our forecasts.

Is that -- and it's more kind of the chip-related or the (inaudible) --?

Chip-related.

Got it. That's fair. Ken, who did you sell the patents to, if I may ask?

Yes, I don't think. Yes. I'm looking at my friendly General Counsel here and he's saying to me we're going to announce that, I think. It's not financial, so we can't announce it.

And just kind of one final on capitalization any new thinking on that end?

On capitalization, meaning?

On cash. How do you use the $500 million?

Yes, there's no -- actually, a fair question. We haven't really thought anything new on that as to -- we certainly consider does it make sense to buy back stock. We have not made decisions along that line. We do look at, from time to time, both some small and a little bit bigger than small acquisitions, if you will. Still have not pulled the cord on any of that, as well.

So for right now, it will build up and that's all I can really say, but we are mindful of it's at zero -- basically at zero percent interest income it's not earning us very much.

Thank you very much. It was a good quarter.

It's a question we don't have a new response yet to.

Thank you.

Thank you, sir. Our next questioner in queue is Aaron Schwartz with Jefferies. Your line is now open. Please go ahead.

Good afternoon. I just had a follow-up question for some of the other ones earlier, but in terms of the -- it seems like less of a revenue deferral rate in the period. Is that just more of a function of scheduled renewals that you had in the period or are you actually seeing a customer preference for shorter-term deals?

It's more the former. It is -- then we went -- we actually did a little, because we got significant questions this last quarter, we did a lot of work and study on this and there is a seasonality to our renewals that does occur more so in Q4 and so the renewal opportunity in Q4 is quite a bit higher than Q3. And, as I pointed out before, we did have several renewals in Europe last quarter in Q3 went for multi years and we didn't -- so, therefore, you couldn't renew that this past quarter.

And I can't really add much more than what I said before is that you look at the mix of billings in terms of products versus services and then within that, how much is -- of the bundled hardware, how much of that goes to -- or hardware, how much of that is bundled versus doesn't come with services, if you will, because of the nature of the products we ship.

In terms of long term, I think this goes back, I think this goes back to what I think, sometimes there are certain customers like to lock it in. There are other times when, frankly, we don't provide -- and we actually -- people have asked me this, why would people do long term, because we don't provide favorable discounts or anything else and so sometimes we get those deals, sometimes we don't. And last few quarters customers have been more willing -- more desirous, if you will, just to do one-year deals.

Okay, so that shift maybe down to one-term deals and I'm just trying to get a sense, I guess, for the seasonality into Q4, but do you get the sense or maybe you don't have enough data, a shift to the shorter-term deals is sort of macro related?

No, I don't think that's macro related. No, I actually don't. I think it's more specific to the nature of our business and what customers are looking to do from time to time. I don't really think that's macro related.

Okay, terrific. And then the second question for me, if I could, and I apologize if you provided this earlier, but in terms of the larger transaction that you talked about in the quarter, was that a 10% customer in the quarter in terms of recognized revenue?

No. I'm glad you asked. The nice thing about that customer is it's -- it's in the millions but not big millions, because I think -- remember I said in the call -- so, no, it's not even close to a 10% customer and it will go -- it will be deployed over several quarters into '12.

Okay. And that will just be billed in each of the quarters?

Correct. It will -- as we -- yes. And so we only bill and ship as they deploy. Remember, I talked about 8,000 stores, so as they deploy across the 8,000 stores, we only deploy and ship to, basically, a series of dates over that period of time.

Okay, terrific. Thanks for taking my questions.

So, therefore, it's not really in backlog. It's not in deferred. It's just -- it'll be billed and shipped as a contract that gets billed and shipped each quarter.

Thank you, sir. Our next questioner in queue is Jonathan Ruykhaver with Morgan, Keegan. Please go ahead. Your line is now open.

Yes. Hey, guys. Good afternoon. Ken, can you disclose the percentage of non-FortiGate products in product revenue and how that number might compare to last quarter a year ago?

I don't have that percentage as yet. We'll look at it whether we may have it for the Q. The number is growing and we're making progress. Still not -- well, it's still a big opportunity for us is the best way of saying it. And, again, that's part of it, as well as the extent that customers -- as we play, quote/unquote in the pure firewall business, you'll get some customers that, therefore, don't need the subscription part of the service.

Right. That's what I'm trying to get a feel for, how much of that revenue outperformance is due strictly to pure firewall, in other words, more in FortiGate -- non-FortiGate products.

I gave you a rough sense, but, yes, I'd probably prefer not to actually provide that number at this point.

But do you sense as you go into large enterprise where throughput might be the primary decision or factor in decision making, that that continues to be the case?

I think it's a little bit as how we market ourselves as we go into some of the various enterprise, financial services opportunities where it may be more of a quote/unquote firewall opportunity than a UTM opportunity. And so it's -- in some respects, I would argue, it's opening up another market for us than we have really focused on in the past. I mean, Ken may have a different perspective, but that's the way I would sort of look at it.

The only thing else I would add, Jonathan, is that a lot of deals that we've talked about in the last couple quarters and I think one this quarter were very high performance and low latency as key drivers and tend to be a firewall deal.

Right, okay -- Go ahead, Ken.

(inaudible), Michelle, regarding -- because FortiGate is also being used as a firewall, which pretty much no need for much subscription. That's probably the majority of some additional product side.

The non-FortiGate is very small. It's probably 3%, at most, because the FortiGate still drives the super majority of our growth and the non-FortiGate does sometimes sell together with FortiGate but is a very, very small percentage.

Right, okay. That's a good explanation. I guess, Ken, as a follow on, you mentioned financial services and you have suggested that there's some opportunities in that vertical with some proof of concepts. Can you just update us on where those opportunities might be?

Yes, I think financial services we see some good growth and because we built a team about nine months ago and they're starting engage a lot of deals and we see very good growth potential there.

The other new market we see is really the education market, so we are -- in my script I say this already. We won a few major universities and also we're starting getting a lot of universities. So this quarter, we're starting to build a team dedicated for the education market.

So, what's different in the education market is really the customers tend to be very technical. They do a lot of testing and evaluation themselves. It's much less influenced by the marketing or some other opinion by some marketing firm. So that we see is a huge benefit because our products, basically technically very strong, both on the performance and on the security side. But we probably do less marketing compared with some other firms.

So, we feel that the education market really has a pretty strong technical background to evaluate and test the product and they see the real benefit. So, that we see potential huge growth in this education market for us.

Okay, good. Good enough for me. Thanks, guys.

Thank you.

Thank you.

Thank you, sir. The next questioner in queue is Sterling Auty with JPMorgan. Please go ahead. Your line is now open.

Yes, thanks. Would you quantify the impact of the shortages of products on billings as being greater than the impact, the benefit of the sale of patents or less than?

Is it 2.40 or 2.41.5 right now? I'm not going to get that specific. I think I said several million and I think I'll leave it at several million. It's -- and, by the way, it's always -- it's a little hard to know exactly. I mean, we know, what we didn't ship, but you never quite know whether -- you never quite have zero backlog, either. So, I would just say several million.

Okay. And then on the improvement in EMEA, I think historically you've talked about some of the countries that have made up the bigger contribution. You gave some examples like UK on one-off deals, but how would you describe the mix of revenue within EMEA in terms of where you're seeing the strength and where is, maybe, some further areas of improvement?

Well, as I look at the -- I think what I already talked about we did quite well in France. Let me just sit down here and take a look at some of these numbers here.

We're still doing pretty well in areas like, surprisingly, Italy. We did show improvement in the UK this past quarter, as well. But then there's some other regions and the Middle East we still have a ways to go and then some other regions I would say were flattish quarter-to-quarter in Europe.

But overall we saw improvement and we are extremely focused on more improvement in Q4.

Okay. And then last is for Ken Xie. Check Point just went through and refreshed their product line. Their very high end is claiming some very high throughput numbers. When you look at some of the bakeoffs that you've had in the quarter and some of the real-world testing, how would you kind of stack up the performance of the leading vendors out there when it comes to just kind of the pure performance in a firewall VPN and a UTM implementation?

I think so far in -- we don't quite see Check Point in the service provider. We do see them in the enterprise provider because service provider they need a special box to be carrier grade and also pass the [NIPS] certification which need to have a very high availability and also redundant there. So that needs a more special power design and (inaudible) computer with a blade basis, which is more in the server market, software-based.

So I think we see Check Point probably sell more appliance compared to before and -- but I have to say in the high end we still see more Cisco-Juniper and still not much in Check Point yet. But on the other side, Cisco and Juniper, they lack all the functions, whether on the higher anti-virus or intrusion function compared to what we have. So that's pretty much the high end we see today. Still a lot of service provider and we do get some vertical markets, like enterprise and financial services, which we see more Check Point there.

Got it. Thanks, guys.

Thank you.

Thank you. Our next questioner in queue comes from [Cara Cackowski] with Bank of America/Merrill Lynch. Your line is now open. Please go ahead.

Hello. This is Tal Liani. Sorry, I used Cara's line.

I have just one question about revenue breakdown by regions, because when I look at the sequential growth, which is about $13 million, roughly, $10 million comes from the Americas, if my numbers are right, and there's $3 million in Asia-Pacific. So, if you focus on the Americas, I'm wondering if you can, on top of this, if you can relate to this $3.5 million you referred to at the beginning. Which region was it allocated to?

And second, what happened to federal. I think, Ken, you went through it very quickly at the beginning. I just couldn't write it fast enough. What happened to federal? We've seen very strong orders -- I should say "federal," I should say "government." We have seen very strong orders from other companies this quarter and I'm wondering if it explains some of this $10 million sequential increase? Thanks.

Yes, you mentioned the $3.5 million. I'm not sure what $3.5 million you're referring to.

I think you said at the beginning -- maybe I'm wrong what the number is -- at the beginning you said that there is a one-time -- oh, sorry, for the patents that you sold.

Yes, the patent was $2.6 million, not $3.5 million.

$2.6 million. I apologize. Yes.

$2.6 million, yes. And then that, obviously, was all Americas. Yes, I don't think there's anything else unique in terms of the various breakdowns of revenue. I think, as a matter of fact, I was sort of pleasantly happy to see the growth in all three regions from a year-over-year revenue point of view was quite comparable, if you will, in relative percentage.

Interestingly enough, in the federal part of the government we still have work to do. We're still not -- we're not making progress. On the other hand, there wasn't a great amount of revenue. We did not have a big revenue quarter or billings quarter in federal this past quarter, in Q3. We're in a number of programs there that didn't get funded in Q3 and, therefore, we're hopeful they'll come in Q4. But we'll see.

So the growth in the Americas, if you exclude the $2.6 million, the growth in the Americas is coming -- can you identify any specific segments or is it across the board?

Well, it actually consisted with -- let me go back to some data I showed before. It was consistent with some of the data I said in Q3 relative to the percentage of our billings by each segment and I -- and so in this case, service provider was about 28% of our total business and we did have a good service provider quarter in Q3. Government was 11% and what this -- I said before for the year to date it was 15%. So, a little less than we've done for the year. Again, that was all government, not just federal.

The area that I mentioned was higher was retail, which was 14% versus 10% for the year. And I commented not only the one particular deal, but a number of other deals in retail that we did see billings and revenue in the Americas.

Got it. Second and last question, the difference between bookings and revenues, if I go back year-over-year, quarter-over-quarter or even your guidance, there is quite a good difference between bookings and revenues. In this particular quarter in September, there was only $2 million of a difference in the question. But then there was $2.6 million, also, in the mix, so maybe if I remove that, maybe $4.6 million. I'm not sure how it goes into the bookings side.

Can you just speak about the difference? You mentioned it briefly on one of the answers, but why is it different only in 3Q but not in 2Q or 4Q or for the year last year? What is so --?

Well, again, this comes back to the point I made earlier is we are recognizing more of the -- and, actually, in our nomenclature we call it "billings." We actually don't refer to it as "bookings." Bookings is a different number for us, which we don't really disclose. It's pretty close to billings, but the number I disclose is billings, which means it's really what we bill out, primarily to our partners, and then revenue is as it is what we can recognize.

But we have had a narrowing between those two numbers for the last couple quarters, partly because of the higher mix of products in the billings, which I described before, and therefore it's up front, partly because the ratable deferred is going down as we work that ratable off and, again, that's partly because of the new revenue rules.

Remember the comment I made -- one of the last comments I made was we expected that number to be $15 million to $20 million increase in deferred in Q4 as we have more renewals coming up for our -- to be renewed in Q4 from a timing point of view than we had in Q3. We're finding more of our customers are creating coterminous, so they're making the deals to renew sort of at the end of the year, if you will. So, therefore, we have a lot more renewal opportunities in Q4, which will be billing for services but won't have any revenue attached to them.

So, I expect to see a bigger difference between billings and revenues. I mentioned earlier, $15 million to $20 million in Q4, versus the $2 million we had in Q3.

The other point, really, the backlog, the few million dollar backlog will be in the 4Q will not be in the billings, so that also contributed a little bit, making the numbers very close.

Got it. Thank you, guys.

Any questions?

Yes, sir. Our next questioner in queue is Jonathan Ho with William Blair. Your line is now open. Please go ahead.

Hey, guys, great quarter. In your preliminary outlook for 2012, you talked a little bit about your expectations for the security spending environment. Can you give us a little bit more of a sense of what you're hearing from various CIOs and other folks that you're talking to for 2012?

I'll let Ken answer that but I was giving expectations for our own business, primarily, as I see it, not necessarily for the industry at large other than -- I didn't give a number for the industry at large other than saying qualitatively it looks good.

I think that certainly every few years the enterprise need to be refreshed, replaced, whatever the network security that they have today. So we do see the trend, starting a few trends ago. The integrated solution, whether you call it UTM or (inaudible), which is the same functions, same features, starting to take over as the new trend there.

So, I think we'll continue to see this new integrated solution get into the enterprise in the next few years. That's where we introduced a few new products we feel because the customer benefits from the multi-function, the price/performance with this UTM or integrated solution.

So I think that even the whole economy environment maybe slow down a little bit, but the integrated solution tend to be more cost-saving, so the customer benefits from that.

The other thing, like I mentioned, is really the performance starting to get more and more important, especially, in the bigger data center environment and, plus, the service provider, which offers all these kinds of added services, that also will help to drive the growth a lot.

One thing we also keep trying to improve is really the SMB. We see -- now because -- especially in the new emerging markets that there's still kind of trying to deploy more Internet to the SMB, to the business owner, there. So we see the smaller end user, SMB side, also has pretty quick growing, especially in the new emerging markets.

So, I think that overall, we feel probably the network security space probably will be growing faster than the overall IT security and then the integrated solution definitely will be growing faster than the overall network security growing. So, I think that the whole IT security probably maybe about 5%, the network security -- maybe a different industry analysts have different feedback -- probably about 10%. And definitely the UTM or the next-gen firewall, the integrated solution, probably grow faster than 10%.

So, we feel we have a good product technology and also being there earlier than other competitors, we will benefit from this trend. But overall still relatively, if you look at overall network security, which from $8 billion to $10 billion, so the integrated part only counts about like $2 billion or $3 billion and other is more single firewall, IPS, or intrusion VPN, all those kind of things. There's still huge room to grow. It's still a huge market.

So, I think we'll probably enjoy the growing faster than market in the next few years.

Great. And just a quick follow up, in terms of your distribution channel strategy, we've typically thought of your distribution channel as being pretty extensive at this point. Where do you see additional opportunity? And you guys made some change-outs in your distribution channel over the past couple of quarters. How do you see that kind of impacting the business over the next couple of quarters?

I think the -- it's kind of a different strategy for US and also for international-wise. The US, I think we have all the major distributors work with us, but on the other side, we also need to work in with more specialized system integrators. So, that's the part we've not quite focused in the past. But these special system integrators, they work in certain vertical market, like we mentioned in the financial services, in education, in healthcare. So we definitely will keep enhancing to work with the system integrators and still fulfill from the distributors.

On the international-wise, I think there's still a lot of green space, green area, we need to keep expanding ourselves. At the same time, certain layer countries overseas we all think and try to specialize the team focused in sort of vertical markets a country or two. Right now we're pretty much focused by country, by region, like we did in the US a few years ago. So, but in US, starting like two, three years ago, we started more focusing in some vertical markets that we see the bigger deals, we see some huge wins, because once we focus in certain vertical markets, tend to be -- which tend to be bigger deals, but also take a longer time to close the deals.

So, that's the sales starting kind of more focus to get a bigger deal done. I think we'll keep expanding in the US in certain vertical markets, especially the system integrator part, and the international also starting try to vertical -- focus certain vertical markets, also.

Great, thank you.

Thank you.

Thank you, sir. Our next questioner in queue is Scott Zeller with Needham & Company. Your line is now open. Please go ahead.

Thank you. Regarding the EMEA region, if I recall correctly, there was an effort in the past to maybe develop some of the newer regions or developing regions of Europe and that effort was difficult previously. Was there a refocusing of resources towards, perhaps, where you'd been successful previously? Can you tell us about that?

I would say we're focusing -- we're adding folks, for example, in Russia, which has not been an area that we had invested in. So, we are -- as we think about Q4 and our planning for '12, we are going to try to expand in some of the lesser developed more emerging areas of the greater Europe area, if you will.

And so that's what we're really doing. That's one of the reasons why we want to continue to add sales coverage.

Did the choices on where to invest during the quarter help with the rebound in EMEA or was it just, as you had said earlier, better execution?

No, I think it's just better execution. I don't think it's -- No, I wouldn't call that part of the contribution for Q3. No.

Okay, thank you.

Thank you, sir. The next questioner in queue is Dan Cummins with ThinkEquity. Please go ahead. Your line is now open.

Thanks. I'll just -- I'll do one here and hold two for after intermission. Can you give us some sense of whether the success that you had with --

There won't be any popcorn for intermission. (laughter).

Okay. Can you give us a sense whether you think the success that you had with your large deals in the quarter, to what extent could that have impacted product gross margin? And what are you thinking about product gross margin for the 4Q and for 2012? Thanks.

Well, I would say it this way. Some of the products that we will sell into retail may have a little bit lower gross margin than our high-end products. So, you will get, sometimes, a mix shift between some of the categories of customers in terms of the kind of products that they will -- that they order that will have some impact on our product gross margin.

And then, how about just the forward outlook or maybe the long-term guidance on product gross margin?

I don't think I have anything more on product -- I don't have anything more. I did make a comment earlier, as you recall, that historically we've been somewhere between 60% and 65%. I think for us to increase our gross margin beyond the 74%-ish range within operating, we would like to see that margin, longer term, to get up above that number, but I -- we have not set a clear guidance, if you will.

You have to balance that with, right now we're much more focused on market share and so to the extent that -- and so we're -- we worked hard -- maybe another way to answer your question, we work hard on getting products out as quickly as we can, innovate as quickly as we can and we're not as focused, yet, on working every last dollar of product cost that we could and it would help gross margin. Again, our focus is really bringing out the newest and best products, as opposed to wringing out the last few cents in them. That may become more important as time goes on, but not -- we don't see that right now a focus for either this year or next year.

Okay, thank you.

Thank you. Our next questioner in queue is Rohit Chopra with Wedbush. Please go ahead. Your line is now open.

Thanks. I just want to ask a couple questions. I just needed some clarity on the inventory issue. Are you saying that the deals that you weren't able to ship, are those lost deals, Ken?

No. Right now those are backlog -- in what we call backlog. What you worry about is this, to the extent you don't have inventory and a customer comes into the channel looking for X, Y, Z product and they can't get it from you, do they go somewhere else? And so, that's sort of a hidden backlog, if you will.

Okay, good. I just wanted to get a sense of that. And then, can I come back to the gross margin issue on product? There was also some discounts which you guys didn't talk about this quarter. There's some trade-up discounts. There's some competitive trade-in programs. When you do that kind of thing, like on the trade-in program and you had some 40% or 45% discounts, do they have to renew their services or do they already have the existing service contract and then they buy a new piece of hardware? And is that a contributor to the fact that you don't have the subscription revenue going?

I mean, I'm not quite sure where you're thinking of the -- the only time we give, that I can think of, special discounts is we have excess inventory or too much inventory in particular products we may do some things to motivate the channel to sell those products. But that would be on older, mature products as opposed to anything that's current or newer.

Okay. Well, the ones I'm referring to were in the quarter. There were some trade-up programs for 38% off or 40% off on some bundling or something like that.

I'm not aware in the Company where we're doing any of these. Probably some of the channel partners, maybe they do certain trade-up, but in the Company-wise, I think we do believe the value of the product, so we tend to think the product has a good value and is a good price.

Yes, I mean, as Ken says, I mean, the channel, to the extent that they're -- we don't have defined end-user customers, and to the extent that they want to do some special arrangements, that's certainly their prerogative.

And then my last question is just, you mentioned that on some of those deals where you weren't able to close them, they're more in the mid range and that's where you ran out of product. But doesn't that also -- when you start closing these deals, don't they also put pressure on the gross margin, product gross margin? Is that wrong?

I don't think -- no, because those -- so, it doesn't affect you at all, because we didn't ship those products and I would say those products, generally, have probably comparable gross margins. They're not the very, very lowest of end products and not the very highest end, either. So, I don't -- so we didn't ship it, but I think the margins on those -- the gross margins on those products are probably comparable to our overall average.

Okay. And that has nothing to do with people trading down in a difficult environment?

Nothing to do whatsoever. Nothing to do whatsoever.

Okay, thank you.

Thank you, sir. The next questioner in queue is Erik Suppiger with JMP Securities. Your line is now open. Please go ahead.

Good afternoon. Congratulations. Just two quick ones. On the product shortages, what are the lead times for the products that you are short at this point?

And also, what was the linearity? It sounds like you had good DSOs, but you're saying that you had a very strong demand at the end of the quarter for some of these products. So what was the linearity in the quarter like?

Linearity was actually pretty normal for a Q3 in terms of you have a decent amount of business in July-August, but, frankly, everyone gets back to work in September, so you do ship more in September. But we did have -- we were able to do a good job of overall collecting and we're finding our -- both we do a good job and I think our partners do a good job of paying us.

You asked about lead times. That varies all over and I can't give you a number that would help you, I don't think, because I mean it this way. It is -- as we increased our orders last quarter, we expect those to come in early this quarter and lead times can be, jeez, it can be anywhere from four to eight weeks to, frankly, months and months because of certain components. So, it varies all over the map in terms of lead times.

There are other times when we may put orders for a Q4, which we try to move into Q3, or Q1 try to pull into Q4. All those things you do with some success. If you order products new, then the lead times, they do vary, depending upon where you are in having -- whether your vendors have the components and, therefore, the lead time would be a few weeks. Do you ship by sea or by air changes. So, there's a lot of dynamics that goes into the lead time.

Okay, very good. Thank you.

Than I'm not sure we'll even answer on the -- after intermission.

Thank you. We do have time for one final questioner. Our final question for today's event comes from [Alan Windfield] with [Davis Securities]. Your line is now open. Please go ahead.

Congrats on the comeback, guys.

Yes, I thought you'd give me a stock quote.

(laughter) Well, it looks like it came out at $21, but I was curious, there's all this talk about these, quote, application firewalls, next generation firewalls, application awareness. What do you think these types of things from, say, a Palo Alto or some other companies like that are going to offer -- are going to mean to the market, compared to the things that you're doing?

I think if you look at overall network security, over doing this for the last 20 years with three companies, basically, there's a different technology we developed in this area. Actually, from early days, most tried to stop certain -- like the traffic, the filter, the header, and then to the network drive translation than that, which go to the layer three, layer four, and then the so-called application control is more go to the packet layer, just look at both the header and the content of the packet. That more applies to the intrusion space.

And then to the -- go to the highest, layer seven, to the application layer and also need the assembly, the whole content, that's where the virus or the other things cross the multiple package, compared to just the -- I would call the deep-packet inspection or the stream [wave] which only look inside the packet, not across the packet, not somebody hosting. So that's different level technology.

I think the application layer, whatever, is nothing new. So it's been -- that's where 10 years ago when we started the Company we called app secure where they try to address the application layer and then we found out, really, to secure things you need to go to the full content layer, to assemble the packet, go to the full content to take out the virus and take out other things.

And the market may count different and also sometimes the market is kind of the old term, they may come up a new term, but on the technology side, the function side, when the customer takes the box to the testing, it's the same thing. It's really -- the trend we see is really go to higher layers, which see both the content of the user, the application, the traffic, compared to in the early days you just see the connection, just say where is it coming from? And so we didn't even see the content.

That's where whether the UTM or the next-gen firewall, application control, they all try to look at the content. But also looking at content, there's different levels. Some of them just look inside, one packet by packet. So that's where the stream [wave], some intrusion and some application control, but some of them also go beyond looking at the full content, assembly the content. That's where the virus tend to cross multiple content.

So, that's the other part we do is do the full content inspection, at the same time using the ASIC to accelerate beyond what the CPU can do.

I think, overall, also different marketing firms have different terms for these things, but in the end, they all pretty much deliver similar functions. They all tend to address the same issues the user's facing.

And also, I have to say, Fortinet we deal not too much on the marketing side. So that's where we kind of see more successful in some of the customers like the telecom service provider and also we're starting to see in the education market, which they're very technical. They tend to do the testing themselves, instead of more depend on the marketing firm to tell them what's the term, what's the next things will come up.

So, that's where -- I think we're really improving our marketing area and also with the bigger size we are and the result of cash, I think we're keeping investing in the marketing space. On the other side, we're still fundamentally a technology company. So we do believe, drive the technology and also keep up innovation is the core value we can provide to the space. So, that's where we're keeping enhancing.

I think that we do believe we have some unique technology we've developed in all these years, whether from all these integrated functions or leverage ASIC to (inaudible) the speed and also give the service provider the tools, from virtualization to all these dimension service, the carrier-grade solutions.

I think there's a lot of huge benefit and also the different technologies we build up all these years. But I think that the whole space is definitely starting changing and we're keeping growing and follow the Internet chain. I think this is -- this is good space and (inaudible) innovation and all the other technical players. So that's where we position ourselves.

I don't know if you could answer this, because I'm sure you have so many different technologies on top of your appliance, but the customers that you sold to, did you have the most interest in your email security or anti-virus or web security intrusion prevention? Or what was, besides the core ASIC-fired, the fastest firewall in the universe and the block every threat out there, the software content on top? Could you possibly name what was hot in driving all the billings during the quarter?

I think that the firewall really go to layer four or layer five is the basic building block to add additional security functions on top of it, which include the intrusion, the anti-virus, the web security and also the span on other things.

That's where the performance of firewall is quite important and that's when I built my previous company, NetScreen, we tried to more focus on the firewall performance but after you set up the firewall, which only can control the connection but they cannot really see the content, we see the real thing is really in the content side. That's where the intrusion, anti-virus and also the web security started to come in more important.

And I have to say, if you look at now this intrusion probably more go to the packet layer kind of addresses most of it, but anti-virus you really need to the full content layer, across multiple packets, with our full assembly. That's the most difficult part. I think we are still the only major vendor that can address this one in the high-speed network environment and also with our solution the ASIC and other things.

Another thing, the anti-spam we tend to do a little bit different platform. That's where the FortiMail comes in and also we have the basic function covering the FortiGate, also. So it depends on the customer, the vertical market, difficult to say like which function drives most of the sales, but I have to say probably 80% of our customers buy the box they enable multiple functions.

So, that's pretty much the drive, because the integrated function, we feel, is needed and because today's environments no longer depend on a single technology or single function can defend it. It really has to be the joint force, has to be the joint force, joint function can defend it, what they call the blended attack or kind of make it more easy to manage and also lower the cost. Because security, I have to say, probably majority issue of the break-in is really how people manage it and even we provide the best tool, but if we make it too complicated to manage across multiple boxes, multiple vendors, sometimes they still have issues there.

So, that's the best I can give, really. More than 80% is really they enable the multiple functions.

Thank you very much. I appreciate it.

Okay.

Thank you, sir. And at this time, I'm showing no additional questioners, in the queue. I'd like to turn the program back over to management for any closing remarks.

Thank you. We didn't get much of an intermission here. So I think -- infamous term, but I think we'll be back on in about 15 to 20 minutes. So stand by for those who have any last questions you haven't gotten a chance to ask and we'll be back on in about 15 or 20 minutes.

'Bye now and thank you all for coming and listening to our call. Appreciate it.

Thank you, sir. Ladies and gentlemen, this does conclude today's program. Thank you for your participation and have a wonderful day.