Fortinet Inc (FTNT) 2012 Q2 法說會逐字稿

完整原文

使用警語:中文譯文來源為 Google 翻譯,僅供參考,實際內容請以英文原文為主

  • Operator

  • Good day, ladies and gentlemen, and thank you for standing by and welcome to the Fortinet Q2, 2012 Earnings Financial Analyst Q&A session. It's now my pleasure is to turn the floor over to Ken Goldman, Chief Financial Officer. Sir?

  • Ken Goldman - CFO

  • Great, thank you and this is an initial matter. I would note that the forward-looking statements disclaimer that Michelle discussed earlier today applies to all forward-looking statements made during this call as well.

  • So, with that, let's just without further adieu just take any of the other follow-up questions.

  • Operator

  • Thank you, sir. (Operator Instructions). Our first questioner in the phone queue is Rick Sherlund with Nomura. Please go ahead. Your line is open.

  • Ken Goldman - CFO

  • Hey, Rick.

  • Rick Sherlund - Analyst

  • Yes hey thanks, Ken. Hey, Fred, did you have a question as well? Fred and I are collaborating on this. I'm sorry; he's just stepping in. I think on the expense side -- Fred. Oh here you are. Come and run; they're live. I didn't know I was going to be the first question.

  • Hey, guys, sorry about that. On the non-GAAP to non-GAAP reconciliation for your income statement, G&A adjustment is $578,000 in Q2 on the Power Point slides but for the income statement or what was given in the press release it was $1.056 million. I'm just wondering if you could tell us what the difference between those two is?

  • Ken Goldman - CFO

  • I don't have that in front of me right now. Maybe on that one you could just list some if we can get it figured out quickly here, we could just handle that off line.

  • Rick Sherlund - Analyst

  • All right, thanks. Exhausted me earlier.

  • Ken Goldman - CFO

  • If I can get a full description I'll--

  • Unidentified Company Representative

  • Looking at the net between the patent settlement that paid to us in stock [comp] G&A, the 578.

  • Ken Goldman - CFO

  • Why don't we just commit that's a reconciliation. We'll send -- we'll add something on our website or somewhere so that everyone can see what the exact reconciliation is on that.

  • Rick Sherlund - Analyst

  • Okay, thank you.

  • Michelle Spolver - VP, Corporate Communications

  • Is that the only question, Rick and Fred, that you guys have?

  • Rick Sherlund - Analyst

  • Yes we're -- you guys exhausted me earlier so I think we're good for now, thanks.

  • Michelle Spolver - VP, Corporate Communications

  • Okay, all right, thanks.

  • Operator

  • Thank you, gentlemen. Sterling Auty, JP Morgan.

  • Sterling Auty - Analyst

  • So I apologize if you went into some of this. We're bouncing between earnings calls, but I wanted to drill into the high end in Telco. On the high end you talk about the Fortune 50 wins. Are you seeing a noticeable change in terms of who your resellers are or which distributors might be pushing the product that's helping because it seems like technologically you've been there for a while but you're starting to gain more traction in that in the high end and I'm trying to reconcile kind of what's causing the traction now. Is it perhaps you're getting better channel traction with the technology?

  • Ken Xie - CEO

  • I think high end is mostly come from high cash model, which we do the team. It's about two years ago is called Enterprise Team. So that's where, especially in US, is mostly there as our high cash enterprise team and, which eventually will fulfill from the channel.

  • Ken Goldman - CFO

  • Yes I think the -- but fundamentally our approach and who is doing what has not really changed. So we haven't really seen a marked change in either our reseller or distributors in terms of what's selling in through the service providers.

  • Sterling Auty - Analyst

  • Okay and then specifically to the Telco, you've always had that nice practice where you've been representative in managed security service part of their business, but you've been gaining wins in their data center side. Are you finding that they're leveraging their expertise that they've built with that managed services to then breed in house or how much of it is it feels like Juniper has had some performance issues? Cisco obviously is back out there with a 55/85 seems to kind of stem the tide on the technology, but is there enough of a shake-up in the technology that performance wise you've got an edge?

  • Ken Xie - CEO

  • Yes I think that's where the performance in the carrier space is pretty much is a key function. They need it and the performance and low latency and the same kind of multiple function and reliable platform. So that's the part that we see the competitor relatively slow to come up the product that meets the service provider demands. I think it's -- I will say that the whole space still relatively new. Even some service providers still try to see what's the best way to offer the service to the customer, but it's a fast growing space and there's a lot of potential.

  • Sterling Auty - Analyst

  • Okay and last question, Ken Goldman, you had the easier compare in Europe than a lot of the other venders. You had the 2% growth and bookings or building.

  • Ken Goldman - CFO

  • Yes we like that; thank you.

  • Sterling Auty - Analyst

  • But now that you look into the second half where you started to see the rebound last year, how comfortable are you in terms of the pipeline and, more importantly, the execution mix you have now because it feels like you've got away from some of the countries with the weaker economies and showing a little better performance in Germany, etcetera. Is that really what helped in this quarter and what gives you confidence in the second half?

  • Ken Goldman - CFO

  • Yes I'd say two things. One is clearly Q3 last year was an improvement from Q2 but we still had a ways to go and really that's the whole message to me, which where we're working this thing sequentially as much as anything else in terms of improving upon our performance. And so we look at when we develop a quarter we look at each region and the folks we have in that region and the business opportunities, pipeline, whatever term you want to use. So that's how we think about it and go forward.

  • So yes we know certain areas have issues, be it Italy, be it Spain, whatever and again I think the thing that's really helped us lately is really the breadth of our products and frankly the verticals. And so we're not dependent upon any one vertical or any one geography and so, while there are certain areas that we do expect to be continuing relatively weakish like I just mentioned, we think other areas can pick up some of the slack, if you will.

  • I mean that's really how we've run this thing last few quarters as we've improved from the year, very, very modest growth we had last year in Q2.

  • Sterling Auty - Analyst

  • Got it. Thanks, guys.

  • Operator

  • Walter Pritchard, CitiGroup.

  • Walter Pritchard - Analyst

  • Hey thanks. I'm sorry for the earlier absence. Ken, I just wanted, Ken Goldman, I think we heard pretty clearly the explanation around the services gross margins with your investment in technical support and so forth as you grew the business. Just wanted to make sure I understood the reason why you saw the product gross margin turn at the low end of where it's been historically?

  • Ken Goldman - CFO

  • Yes, no I think the -- I'll get it here but the reasons are really threefold and just give me one little second here and I'll have it right in front of my face. Ken actually expanded upon this and I hope you heard this before but we talked about the increase in cost of goods for selected products relative to solid-state storage in terms of creating capability, different capability as well as additional capability relative to compared for 50. We talked about that.

  • We talked about one of our larger customers that actually ordered more than we had assumed and that's the customer we've talked about in the past that was sold for a number of quarters. And sometimes I think about that 8x you guys heard from some other folks and I can't imagine how many, many times this customer has ordered from us.

  • But nonetheless, now that margin from a product side is a little bit less than we've seen in the past and then, there's always, the various mix issues and so forth, but those are the primary reasons and then we talked about the services gross margin, which really was both the investment we're making in technical support as well as professional services.

  • Walter Pritchard - Analyst

  • And just on the mix, I mean if I look at your mix just kind of by low, mid, high it didn't look like it was that much different. Are you referring to mix of product within those groups?

  • Ken Goldman - CFO

  • Exactly, yes we'll have mix of product within that and the various pricing that we see within that, yes.

  • Walter Pritchard - Analyst

  • Okay got it and then I guess the other question relative to Europe, does it feel like that environment is getting worse or does it feel like it's stable?

  • Ken Goldman - CFO

  • Yes it's a little hard to tell. I think in certain regions I think I would say it's probably getting a little worse. What I see sometimes is people talking about payment terms and so forth and so you see you'll hear that from time to time and we stick to our guns.

  • So I think in two or three countries you clearly agree so that we don't sell much but nonetheless you hear it in there and you'll see a little bit in Italy and Spain. And so I think in those countries, yes, I think maybe the margin is a little tougher. I think in the rest of Europe I would say it's more the same but it's always hard to tell from week to week.

  • Walter Pritchard - Analyst

  • Got it and then just a technical question for Ken Xie. We've seen VMware with this Nicira acquisition and the notion that some of these networking functions ultimately kind of move into software and so forth. And I'm just wondering what is your -- if you look at your strategy today mostly been around your own software design leveraging hardware that you control. What is your longer-term strategy if you look at potentially networking functions that are done purely in software distributed around the network and so forth where it's possible you guys aren't going to be able to control the hardware that runs on if that model really takes hold?

  • Ken Xie - CEO

  • I think that's the approach other ICs and software design. I think you will find that we still try harder deliver certain applications based on the need and also based on whatever the -- how urgently they want it delivered at the quality of service. So that's probably much less concern was inside all this wars or these attacks, all the intrusion there.

  • So I see kind of like different infrastructure players starting to try to move more up to the application to some content side. But it's security still kind of unique compared to what all these network layer approach, which more address -- with from the use of putting some security policy point of view how they make a better, cleaner, safer environment there. I think so far it's still too early to see what was the impact and but I see it's probably we usually partner well with the some of the now working companies. Even some of them have some of their security approach but is the yearly kind of -- you have a lot of need to address in the total solution there.

  • So, so far we have not seen much. I think for VMware so far we do partner with them for some approach but we have not seen that the new ST has any impact in the security yet.

  • Walter Pritchard - Analyst

  • Okay great; thanks a lot.

  • Operator

  • Jayson Noland, Robert W. Baird.

  • Jayson Noland - Analyst

  • Okay thank you, just one topic. This perception that Fortinet is just an SMB player and not large enterprise even though you guys do really well in MSSP. We've talked about in the past, past investment being made in sales and marketing to try to improve the positioning in large enterprise, maybe an update on that?

  • Ken Xie - CEO

  • Yes I think that's where the competitor likes to label us more to the SMB because we know our product is really more competitive in the high end and also there's a certain research firm try to because they've tried to put us in that category compared to the one we're working in the long time with IDC there. But it's related to the market has a somewhat comparative probably more aggressive, even do better in certain areas in the marketing. Before us we still believe the long term like even if you want to have long-term growth we need to have a built in solid foundation there, both in the technology and also on the infrastructure and also on the business model there.

  • So that's where like the slides I presented in earnings call, I think the whole landscape is really the enterprise. The customer is starting to realize that they need more than the traditional firewall approach. So now since that happens it started changing with help of multiple venders in this space, try to educate the space there. Even they use different terms. They try to position little bit differently, but in the end really who has a better kind of powerful amount of capability to deliver the additional function to address the content and the application and perhaps also kind of not slow down the performance.

  • Because I personally do believe really if you're using the PC and server try to address the traffic to secure need of hundreds of PCs software behind, there's a lot of limitation. So that's where the approach we have to build a platform with our own ASIC, with our own OS without other function needed and this is much better platform to address the new need in the content in application layer, which need much more competent requirement compared to just handle the traditional firewall under the network layer.

  • I think eventually so far the market approach we have is not much as compared to other competitor. We have to say most of our customers come from the referral customer, which we feel is a -- we need to give them better support. That's a long-term win so that's where you can that the value of the long-term customer value at the whole net is much better. So for us really we want to make sure they have a better support. We have the infrastructure and the product and also the team can provide support before we ramp up too quick or we enter certain space, which we cannot really support them well.

  • I think we want to keep these to make sure the customer -- the quality of supporting is a very important factor for us to keep in moving forward. But the same time we also realize sometime maybe we can more aggressive on certain space through the marketing. So that's the last few quarters we started changing some structure, especially in the enterprise space and also some other vertical space, and maybe we're also kind of thinking less is more, both on the marketing and the sales and also on the supporting in certain vertical space.

  • That's the highest starting of salary. You can see last quarter pretty much first quarter we started adding more than 100 people and we'll continue to do this investment in the next few quarters and we do believe eventually long-term wise we'll benefit from this investment.

  • Ken Goldman - CFO

  • Yes, just kind of I would add that to the extent that we can continue to penetrate even more so in select in New York based financial services firms, certain government customers as well because those are sometimes looked at from some of the research proofs that Ken referred to as indicative of selling into the high-end enterprise.

  • So, while we do quite well overall in the enterprise, there are certain segments that once we do better that will go a long way to helping our reputation, if you will, as an enterprise provider.

  • Jayson Noland - Analyst

  • Okay, thanks for the color, guys.

  • Operator

  • Aaron Schwartz, Jefferies.

  • Aaron Schwartz - Analyst

  • I just had two very quick questions, the first on sort of the product mix and the gross margin. Do you -- how responsive are you to sort of pricing changes to steer product mix shift one way or the other?

  • Ken Goldman - CFO

  • We actually don't. We don't change our list pricing very much at all. Every once in a while we'll do that. We certainly when we introduce new products, then we have a chance to reset the stage if you will.

  • The area it does affect us though is we do from time to time beyond our allowed discounts we do make discount exceptions for certain customers or certain situations. So that will affect us from time to time. So that's where we're more dynamic. The overall pricing and list pricing that is not dynamic quarter-to-quarter other than new products.

  • Aaron Schwartz - Analyst

  • Okay and the second question I had and I apologize if you covered this earlier, but did you provide any currency impact on your expenses, sort of what that was in the quarter?

  • Ken Goldman - CFO

  • I'm sorry what that--?

  • Aaron Schwartz - Analyst

  • The currency impact on the expenses?

  • Ken Goldman - CFO

  • No, it was -- I'm trying to think if it was -- I think about a million to two, close to two million. On the year-over-year basis about two million help.

  • Aaron Schwartz - Analyst

  • Two million help, okay terrific; thanks for taking the questions.

  • Ken Goldman - CFO

  • That's a year-over-year.

  • Operator

  • James Westman, Raymond James.

  • James Westman - Analyst

  • Hey, Ken, first question take a look at margins for 2013. Should we expect a little bit of improvement, say about 50 bps or should we be looking more towards (inaudible)?

  • Ken Goldman - CFO

  • So you're asking, I think, relative to overall gross margins for '013?

  • James Westman - Analyst

  • For overall operating margin looking at 2013 over 2012?

  • Ken Goldman - CFO

  • Well we haven't really put our plan together or reset the plan. I would say this; I don't want to give a hard number. And so we do expect to improve margins but the balance we're working on is to look at how fast we can grow and continue to take share and improve margins at the same time. And so that's a balance and we haven't put together distinct numbers for next year but we do want -- we do like the fact that we have increased our growth recently and if there's margin would rather continue doing that and at the same time we do think, and Ken talked about before, some things we can do improve product gross margins. We do think in services side we're making an investment today that will pay off and so therefore we can hopefully slow that relative increase.

  • I think in R&D at 14, 15 that's pretty much our model. A G&A four that's about our model and sales and marketing were around 32ish right now. I think there we'll balance it but maybe that does go down as a percent of revenue over time a bit as we see more leverage there.

  • But right now I think it's our approach to keep on adding folks if we think we can bring incremental. One other point I'd make is, as we noted, we don't spend a lot in marketing and I don't expect this has been "a lot in the future" but we probably will make some incremental investments there.

  • James Westman - Analyst

  • And then you mentioned a bunch of larger seven figure deals in the quarter. Were then any, how do you say, very large deals or eight figure deals that you got in the quarter, any eight figure ones in particular?

  • Ken Goldman - CFO

  • No, I'm looking, no. I didn't think there was and everyone in this room says no.

  • James Westman - Analyst

  • No eight figure deals, okay.

  • Ken Goldman - CFO

  • No.

  • James Westman - Analyst

  • And then taking a look over at cash flow, I mean any reason in 2013 and out it shouldn't grow with net income?

  • Ken Goldman - CFO

  • Any reason in '13 that about cash flow what was it?

  • James Westman - Analyst

  • That cash flow shouldn't grow with net income.

  • Ken Goldman - CFO

  • Oh net income, yes I think it should be -- I think the growth should be comparable. I mean again I've been standing here and I don't have a plan in front of me in '13, just to be clear, but I think it would now -- I mean, the negative is we will probably be paying a little bit more in taxes on an incremental basis but we're now starting to pay a fair amount of taxes as well and so I think rough sense I think that's about right.

  • James Westman - Analyst

  • Okay and then I guess again on the cash tax, what do you start to find the rate to be for 2012 and then in '13 I am assuming is it going to be higher? I mean, are you guys going to be paying a cash tax pretty close to your income tax now?

  • Ken Goldman - CFO

  • Yes I haven't -- I don't want to -- I want to hesitate there. I expect that, as you said before, to pay somewhat higher cash taxes in '13 than my current run rate of 56 per quarter today, or at least we expect today. There are -- frankly, there are a number of variables that go into that so it's a little hard to say but I think at the margin the tax cash will go up somewhat on a relative base, on a proportionate basis to our income.

  • James Westman - Analyst

  • All right that does it for me. Thanks, guys.

  • Operator

  • Dan Cummins, Thinkequity.

  • Dan Cummins - Analyst

  • Thank you, two follow-ups on federal and on that other company in the market that's now public. First, on federal I was re-reading the notes from last year, Ken Goldman, and you didn't seem--

  • Ken Goldman - CFO

  • I hate when you do that.

  • Dan Cummins - Analyst

  • Last year's 3Q, well you know it was a big federal quarter for many tech companies. You didn't seem particularly -- you weren't touting a big performance there in federal last year in the 3Q so I presume it doesn't present much of a tough compare. Obviously it's a small part of your business but I am curious what strategy you have around getting better traction and building a bigger federal business and how you're coming with that.

  • And then I wanted to also ask just in terms of Palo Alto's ability to now go out with a higher profile and perhaps sign up even more partners in the channel, if that -- if you expect that to trigger more kind of servicing demands, economic requests from the channel for better terms on support and what have you. I am just curious if you have built in any kind of contingency for their expanding channel presence in your model. Thanks.

  • Ken Goldman - CFO

  • Yes I am going to take the last one first. I don't think -- I mean I think they have their channel partners and we have ours. Sometimes there is a little bit of overlap but I don't -- at least nothing I can point to at this moment that we think is going sort of change. I mean yes maybe they have a little more high profile but they have always been a high profile company since they started shipping so there's not that much has changed relative to them and, again, I mean we're doing just roughly $500 million of business so we're doing quite well in of ourself and you can maybe ask the same question of them I think.

  • The -- in terms of federal I probably won't be touting federal either. We still have work to do there and I've been consistent with even my message last year on that relative to mixing and the hiring mix of people we have there, ability to win specific contract programs and continue to execute so I would say on a relative basis we're putting more emphasis in some other areas than we are in federal at this moment so, while we expect over time to do better there, we are emphasizing some other areas and more so.

  • Ken Xie - CEO

  • Yes I think it's for us really it's really how we can (inaudible) our [scale] better. That's really to both on the same technology and the product and also on the team we build up here. That's where we're not particularly trying to focus on certain space and so for us really both on the vertical market and also on the region we try to build some team structure early enough and gradually kind of scale up so we feel that will be the model or give us better growth over long-term so that's compared to some other competitors.

  • They're programming strongly in one or two areas because the limitation of the product or the limitation of the team there so that's where we, like the [Forti Suite] we mentioned like so because on the function we cover quite a broad function. I think it's more than other companies and also we have the research team, which has close to 200 people that we call the FortiGuard subscription service, which covers from all the virus, antivirus technology, to the end solution to the span to all the other web security issues there and that's the number of functions and also the depth of the coverage is really we feel much deeper compared with some other competitors.

  • And also in the vertical space we also tend to build in the team for long-term and gradually build up the team and also the structure there, so that's where we are not quite particularly trying to heavily marketing into one or two spaces only.

  • Dan Cummins - Analyst

  • Could I ask a follow-up about the service provider sector and get your assessment of the readiness of the service provider, the managed market. I'm sorry, the managed market, to really adopt the policy, the application user device policy approach to management or do you still regard and expect the managed market to remain primarily a port in protocol. What's really the current need right now for the app controls in the managed market?

  • Ken Xie - CEO

  • I think whereas we sell into the service providers, still the majority, super majority, is the bias because their customer has the need for security service so that's where the technical companies, some other internet service provider, which they're using the FortiGate to provide additional value added service beyond the internet service there. So we also have a quite a moderate service provider in the evaluation stage we believe will be also a huge opportunity going forward. That's the whole space. Eventually we do believe a lot of whether SMB or enterprise it means more to the service provider model, which have the service provider to take care of a lot of security compared to now they have to have their own IT to do a lot of security themselves.

  • Dan Cummins - Analyst

  • And do you, and regarding Palo Alto and this is my last question and I sure appreciate you guys taking the time for all these questions. Do you see them much in the service provider space or do you really not face off against them there yet? Thanks.

  • Ken Xie - CEO

  • No we have not seen them in the service provider space because they're still missing the major function of the performance there because service provider space, the (inaudible) and the [technical] space is really you need a lot of performance and also much more function than some in the price need and also the virtualization is other key area so they can more flexibly deploy the service to their customers. So so far we're not seeing much other competitors, including Palo Alto.

  • Dan Cummins - Analyst

  • Thanks very much.

  • Operator

  • (Operator Instructions). Keith Weiss, Morgan Stanley.

  • Keith Weiss - Analyst

  • On the last call and you could choose whether or not you want to answer these again, on the last call I thought you seemed to indicate that perhaps due to a sort of revisit the potential for further margin expansion in the year as we got further on, in light of the growth you're seeing, should we take away that sort of on the balance, given the good growth opportunities, that there's not going to be a lot of further room for margin expansion this year?

  • Ken Goldman - CFO

  • Well, I think I suggested some modest margin expansion in Q3 and then somewhat more in Q4. That's how the whole year gets to 24 but I don't see us outperforming, if you will, significantly on operating margins, operating margin percentage, because of the factors we talked about earlier.

  • Ken Xie - CEO

  • Yes I think out of the three we talked about I think the service side will continue to invest, will continue to build because we believe that's the long-term foundation for keeping growing there. And on the bigger deal [Fortinet] and that's tough to control, is dependent on the what's happening in the sales side.

  • On the product side to invest in the product without raising the price, I think that's pretty much too [for] the inside and the part of it because we're already starting up with all the products with much more flash memory, whatever, and also the price of the flash memory starting coming down very quickly in the last few weeks so that's probably down I think probably like 10% to 15% already, so that probably also helps them so that's the three factors we talk about have some impact on the gross margin so we do believe there's a certain improvement we can make going forward.

  • Ken Goldman - CFO

  • Yes and (inaudible) I mean to the extent that we had out performance in billings and revenues and retail that that will have an impact, if you will, on growth and operating margins and so we'll see that. And again, we're balancing. I mean I think the -- Ken talked about adding about 100 people per quarter for a while. We think that's the right move for us because there's really three core areas. One is development and two is sales, where we see bang for buck and three is in support and frankly if you look at support that's one of the bigger areas we have been adding headcount. And it's a testament, if you will a testimony, to us expanding more and more in the enterprise and higher end accounts that require full 24/7 support.

  • Ken Xie - CEO

  • That's kind of what you said put a lot of money and the marketing which we were keeping the improving there, we still put a lot of money to make the customer happy, the current customer happy so they're becoming that promoter of our product to the other customers is why the model, which we have been using so that's so far we have a majority customer comes from the referral customers. That's the testimony of the model we are most successful. That's what we feel has also given us the long-term benefit, the long-term [smooth] growth compared trying to hike the market in certain sales sector there.

  • Ken Goldman - CFO

  • And if I sort of without naming anybody but I mean clearly you like to be in a position where yes you do want to increase operating margins and so forth percentage wise. On the other hand you really try and bring back the most absolute operating dollars you can and so we're trying right now to -- we think there's an opportunity to grow and so we think there's the opportunity to invest and see growth from that and that's the balance that we make frankly on a constant basis, both for this year and I think some others asked about next year.

  • And then so while we do want to see operating margin expansion, we think the best course frankly is make sure the absolute dollars are growing as rapidly as possible and we see some others doing that in our industry and some others maybe ham struck a little bit because that margins may be at peak levels.

  • Keith Weiss - Analyst

  • Got it. And then in terms of hiring, I mean one of the things we hear a lot when we talk to people in the valley is how difficult it is to find quality people and how those quality people are getting more expensive. How well have you guys been able to hire up to that? I mean obviously this quarter you hit that hundred person quota. Is it getting more difficult or is it getting more expensive to find the right people?

  • Ken Xie - CEO

  • We are a more global Company.

  • Ken Goldman - CFO

  • There's only 25%. Remember I talked about 25% of our headcount is in the US and so we -- our largest R&D actually is in Vancouver. We have other operations in Canada as well and so we are quite spread out geographically so yes I think on the margin it is a little harder hiring here but on the other hand we are very, very geographically diversified.

  • Ken Xie - CEO

  • Yes you can look on the [chart], the slide number eight on the presentation that talks about a location, the cost and the function for all the people, all the teams we have. We feel we have a much balanced approach, which can make the team very stable and also will be good for the long-term growth.

  • Ken Goldman - CFO

  • Like support, for example, we may do that more and in Czechoslovakia or Mexico it's the way we're expanding support in various regions outside of certainly Sunnyvale. And R&D, as I mentioned before, and sales clearly we're going to put sales people where the accounts are.

  • Keith Weiss - Analyst

  • Got it and can you remind me where you guys are in terms of quota carrying sales headcount?

  • Ken Goldman - CFO

  • Yes I could but I am not.

  • Keith Weiss - Analyst

  • It was worth a try. Thank you for answering the questions, guys.

  • Operator

  • Erik Suppiger, KME Securities.

  • Erik Suppiger - Analyst

  • Just one quick one, the free cash flow you're projecting it to be down sequentially in the third quarter in spite of net income increasing. What's the reason for that?

  • Ken Goldman - CFO

  • Well, the -- there's [three] things going on in third quarter. Let me get the cash flow so I have it in front of me here. First of all, are you referring to the number before -- the 38 to 40, not the one after the building, right?

  • Erik Suppiger - Analyst

  • Yes it's--

  • Ken Goldman - CFO

  • Yes I think there's a couple or three things. One is it's a nuance but it's hard for me to explain without just a short call here. The way our ESPP works it's a source of cash in Q2 and a use of cash of Q3 so that's a difference of about $4 million or $5 million quarter-to-quarter. I think; I am looking at my trusty guys here. So I think that's about $4 million or $5 million sequentially different from Q2 to Q3 because Q3 is when it gets paid, "it gets paid out." And then we assume a little bit higher cash taxes as well in Q3 so those are probably the two major things that are affecting and I think we'll probably bring AP down a little bit. We had a lot of purchases of inventory and other products late in Q2, which we paid more so in Q3.

  • So those are three things. I think part of that is we enter Q3 with higher AR, about $10 million, and so that will help us on the top side of cash collections.

  • Erik Suppiger - Analyst

  • Good and just your guidance for the year of 24%, that implies an operating margin as you exit the year up towards the 27-ish percent or so. How should we think of the OpEx, the individual line items for that? Is you pay sales people on bookings, is that right? Or billings, is that right?

  • Ken Goldman - CFO

  • That's exactly right; we pay them on billings. You're exactly correct.

  • Erik Suppiger - Analyst

  • So I would think that you will see a pretty good acceleration in Q4 on the sales and marketing, is that right?

  • Ken Goldman - CFO

  • Well, it's funny. I am laughing a little bit only because I guess some -- another call or question whether we're seeing any operating margin improvement in the second half and I was saying yes and you're actually pointing it out that we are seeing operating margin improvement in the second half but the -- yes I think [his 27] may be a little on the high side to get to an overall 24, so I just say 27 may be a little high but we tend to get leverage in Q4 in terms particularly in the sales. You're absolutely right in terms of sales and marketing so we will get leverage there.

  • Clearly Q4 is, as we project anyway, a high point in terms of billings and therefore revenues and expenses tend to be relatively controlled and you get some benefit from various tax, payroll tax, whatever, that are paid effectively non-linearly because you pay them and some of them cap out. So all that helps us, helped us last year Q4. We expect that to help us in Q4 of this year as well.

  • Erik Suppiger - Analyst

  • Very good. Thank you.

  • Operator

  • Jonathan Ho, William Blair.

  • Jonathan Ho - Analyst

  • I just wanted to understand a little bit around sort of the large deal metrics. Your guys have talked about sort of large retail deals and large service provider deals in the past and I just want to know is there any large deals that you guys currently have that maybe will roll off in the next couple of quarters or sizable enough that we should be concerned about it or thinking about it?

  • Ken Goldman - CFO

  • Well, we take down the count where we give our thoughts for going forward. We've had one relatively large deal that we said that would play out over a number of quarters. It's interesting in that particular account while one aspect of their business is playing out, they continue to order more for other aspects of their business so while that does have some lumpiness from quarter to quarter, we are hopeful that that business will continue and maybe different products for different purposes. So but again, as I -- some other caller asked, we don't have any 10-figure deals and so it's not like we have this very, very lumped, very extraordinary large deal that would roll off and would be a real challenge going forward. So we don't tend to have -- well, I can't think of any deal in any quarter in which we've ever had this but a 10-figure deal in a quarter in terms of billings. Our revenues, clearly our revenues there matter.

  • Jonathan Ho - Analyst

  • That's helpful and then just in terms of the service provider vertical itself, can you maybe give us a little bit of color around the penetration there and perhaps what inning we're in in terms of selling your products to service providers? Is it still relatively early stage or are we getting further along?

  • Ken Xie - CEO

  • I think it's still relatively early stage because there are a lot of service providers still more in the test phase. Once in some time for the service providers challenge really once they have the product that they also need to build a team to starting to provide a service, which takes a little bit longer time compared to just getting a product in position there. So that's the part sometimes that's I view a lot others still more in the early stage to see what they can offer, whether they have the people, have the capability to offer some of the service.

  • Jonathan Ho - Analyst

  • Great thank you.

  • Ken Goldman - CFO

  • And, by the way, the other approach is some service providers are further along and, as Ken said, some are more very early, so it really is a mix and again we -- the nice thing about our service provider business is very, very global. I mean I pointed out a deal in Asia Pac. We have a number of those every quarter, the same for Europe and same for the Americas. Latin America, so that business is very, very globally spread out.

  • Jonathan Ho - Analyst

  • Got it; thank you.

  • Operator

  • (Operator Instructions). Presenters, at this time I am showing no additional questioners in the queue. I'd like to turn the program back over to you for any additional or closing remarks.

  • Ken Goldman - CFO

  • Okay thanks. Yes we now have nothing really further. We will follow up on the one question relative to GAAP to non-GAAP reconciliation so we'll provide some additional clarity to that. I could do it now but I think I'd rather have it so it's very, very factual in print so we'll follow up with that.

  • And otherwise thank you and I can't think of any investor conference in august but we will be at a number of investor conferences in September, so I look forward to seeing many of you there or various maybe folks that might be coming to see us during the month of August so thanks again and appreciate your interest.

  • Operator

  • Thank you, sir. Ladies and gentlemen, this does conclude today's conference. Thank your for your participation and have a wonderful day. Attendees, you may disconnect at this time.