Fortinet Inc (FTNT) 2012 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to your Fortinet Q3 2012 earnings financial analyst Q&A. (Operator Instructions). As a reminder, today's conference is being recorded.

And now I would like to introduce your first host, Michelle Spolver.

Hi, everybody. Thank you for joining the call very shortly after our first one ended. I'm going to turn the call over to Ken Goldman, Ken Xie, and Nancy Bush to take Q&A. I just wanted to remind you that our forward-looking statement disclaimer I read earlier still applies.

And, with that, I'm going to turn the call over to Ken.

Great. So, glad to take your questions. It's probably most helpful if there are different questions that we maybe have already asked -- I'm sure we'll get a few twists on the same question, but that's -- anyway, glad to take your questions if time allows. So, with that, operator, we're glad to start right in.

Sure thing. (Operator Instructions). Rob Owens, Pacific Crest Securities.

Could you address the inventory build and what you guys are seeing on that front. Apologize if this came up on the call, but I don't recall it being discussed in depth.

No. It's very fair. It did go up. It has gone up now for a few quarters. It really is two or three factors. One is we have had a constant decision to increase inventory, particularly in run rate products because, for the channel business, we find that, if you don't have inventory either here or in the channel, you're likely to lose the business when customers come requesting it. So that's one thing. Two is we do tend to build more inventory in anticipation of Q4, which is seasonally a stronger quarter for us. And three is, as we've talked about, a couple areas where we didn't do quite as well as we would have liked in terms of our billings numbers, particularly in China, which happens to be heavily product oriented. And so that had less demand and, therefore, less going out of inventory. So those three reasons account for inventory being a little higher than we had expected. But we had expected inventory to go up in Q3 for other reasons, the first two reasons I mentioned.

The other reason is really -- we have two shipment centers, one in the US and the other one in Taiwan, which has an almost equal amount of shipment go out to worldwide because we have to balance the two shipping centers to avoid the rush shipment amount of two shipping centers. That's probably -- from our calculation, a little bit more inventory will enable us to reduce the rush air shipment cost amount of two shipping centers and also supporting the partner better. So that's where we gradually build up some inventory. And that's more a benefit of us overall compared to the cost of the rush shipments that mostly happen in the quarter end. But, on the other side, is also the reason Ken Goldman just mentioned -- also drive this Q3 inventory a little bit up beyond what we planned.

Great. And then, with regard to the patent sale, was it in the expectations as you were looking into the quarter? And I know these things come with irregular timing, but is there any sense of normalcy? Should we expect one a year or a couple a year as we think about the model?

No. We knew it was an opportunity for it to occur, but, frankly, it is pretty random when it comes and our ability to close it on a certain timeframe. So I don't think I could give you any sense at all if there's any certainty, if you will, that going into next year we'll do this. It's possible. But I don't think there's any certainty at all that we will do these. And so I would say it's more random that it will occur.

Great. And, as you look at the strong product growth you guys continue to see, how much of this is new opportunities versus replacement opportunities? I understand it's a channel-based model and relatively indirect. But are you seeing any greenfield, or is it mainly replacing other folks, including yourselves, with higher-throughput boxes?

I think it's both. Ken can talk about it, but I actually -- absolutely think it's both. I think of a lot of greenfield opportunities. I would say probably, if I had to sort of anecdotally think, it's probably more greenfield than replacing folks. But I don't know. Ken, what do you think?

Yes. That's -- in enterprise we do see replacing the current player. But these -- some other like service providers and cloud center, which is more new opportunity.

Okay. And last question from me. Sorry to tie up so much time, but I missed it on the call. Billings by geo. Could you run through those again real quick? I didn't get them on the call.

Let me get that quickly. In terms of -- Americas was up 21%. EMEA was 22%. And APAC was 27%. And so the comment I made is all three regions were very consistent, and so, therefore, the geographic growth was very consistent. In Americas, if you take out the quarter-over-quarter because we had patent sales in both quarters, Americas growth would have been 23%. So you would have had Americas 23%, EMEA 22%, and APAC 27%, probably the most consistent growth across all three regions that I can ever remember.

And how did that compare sequentially?

Why don't we get back to you on that because I don't have that in front of me.

Okay. Thanks, Ken. Thanks, guys.

Rick Sherlund, Nomura.

Back on the inventory question, with the new products, is there any concern about the obsolescence of any of the inventory you were left with at the end of the quarter?

No, not really, because what we really do is, before we announce a new product, we work through the inventory we have. And so we really transition it. And so there's always a chance for that. We had more of those issues years and years ago. But, today, we really don't. We time, if you will, new product intros and the ramping up of those with the ability to wind down inventory on the existing products. And so, even if that means we have to delay a month or two, we'll do that.

Okay. And you had such a tremendous acceleration in billings over the last four quarters. Your comparisons with billings are going to look pretty tough the first half of next year. I'm just wondering what your thoughts are on that and how I should be thinking about it, if there's other considerations. I don't know if new products help in the first half of next year -- but how we ought to be thinking about how that might play out over the course of the year.

Well, it's hard. I don't want to get too specific today. You're right. I think the comparisons will be tougher in the, certainly, first two quarters. I think we made it a little easier for ourselves in Q3. But the -- on the other hand, I think the -- if I think about it, the environment we're selling into is good. The product -- between the Forti OS, FortiManager, FortiAnalyzer all new. And then I think of some of the newer products that we'll take into account, the new processors. I think the Company has a lot to sell. So whether the numbers are a little harder -- again, I was -- consistent with what we suggested for next year in terms of growth starting off the year -- I mean starting off next year with what I said now. And so we'll start, hopefully, conservative and, hopefully, bring the numbers up over the year.

Okay. And, Ken, as far as incentives to the channel, as we talk to resellers, we picked up it looked like there were some more incentives offered in the quarter. You hate to extrapolate from chatting with a couple of resellers. What's your perspective on what you guys are trying to accomplish in terms of incentives in the quarter?

I don't think there's anything specific that's new. We do various spiffs from quarter to quarter. We believe that there's an opportunity for us to grow faster in the channel. We look at issues that SonicWALL is having, for example. We believe, in the mid range, there are certain price points where our market share is less than numero uno in the US. And so we are focusing on increasing our share in certain price segments and against certain competitors that we think we can really compete heavily against. And so I don't think there's anything specific to point out other than the fact that we are competing -- we're going to compete pretty aggressively.

I don't see the percentage we kind of -- the dollar what we channel partner together had much change there. It's really we try to be more focused on certain factors, more like enterprise and also try to drive some kind of more like direct deal related incentive in certain scenarios and also increase the lead generation. So that's probably some change we made in the last quarter.

And also in the channel we're hearing rumblings of a couple really big deals in Europe. I know you don't disclose deals over $1 million. But was there anything unusual that really moved the needle in the quarter in terms of large deals?

Boy, there you go again, Rick. Q3 or Q4? I wasn't quite sure.

No. That was for Q3. If you can answer Q4, I'd be delighted to hear your thoughts there.

I just wasn't sure because you've asked about forward quarters, too, with that same question. No. There wasn't any one deal that moved the needle significantly this quarter. I think, in some other quarters, as I mentioned, particularly with a particular customer that did move the needle a bit more than some others -- but I wouldn't call any particular deal this quarter in Europe or otherwise that really moved the needle. I would say we do some deals $1 million to $2 million, but I can't think of any deals that are larger than that.

Okay. Interesting. Well, Ken, it's been fun following you around company to company. I don't know that you're going to see me on Yahoo. But it's like playing with a good golfer. You hate to keep saying good hole, good hole. But good job, and a pleasure working with you.

Thank you. You're a better golfer than I am. And I'm sure we'll see each other.

Thanks.

Michael Turitz, Raymond James.

Just a bunch of clarifications. I'm 99% sure about this. But the patent's in the ratable section. Right?

Yes.

Okay. And then the large retail -- the retail tail-off that we were talking a little bit -- I just want to clarify the idea that that retail deal was somewhere in the couple million per quarter over about five quarters.

Yes. It could be a little higher than that or a little lower than that quarter to quarter. So that's a good midpoint. But it could have been a little higher than that and a little lower than that quarter to quarter, never even close to seven figures. But it could be a little higher than $2 million.

Well, seven figures is millions, but that's --

I mean eight figures. (Inaudible).

Seven, eight -- you know.

Never eight figures.

Just to be clear. And, on the patents, same thing. Really, there was -- were there any patents in between -- patent sales in between third quarter last year and this third quarter?

No. I'm looking. No. We had $2.6 million in Q3 of last year and, as I said before, the $1.8 million this quarter.

Okay. And you would get me on this that I've asked before, but cash taxes -- what were they in the quarter? What do you expect it to look like for the year? Any early thoughts on next year?

Let me get that number. I think it was $4 million for the quarter. I think it was $10 million or $12 million for the year to date. What I said before was $5 million to $6 million for -- Yes. $10 million year to date, and I said $5 million to $6 million as best I know right now or maybe a little higher. But that's roughly $5 million to $6 million in Q4.

And any thoughts on what cash taxes look like next year?

No, but I would just say this. We are working on structures that, from an operations point of view and from a tax point of view, will help our tax rate over time and may help a little bit over even 2013. I don't want to give anything more specific because it's too early for us to give. But I think, over time, we believe our tax rate here will go down, both our GAAP and pro forma. From a cash point of view, we're starting to pay a reasonable percentage of our pretax income -- a reasonable percentage of our tax provision in cash. My sense is that will continue to go up, as well, over time, that percentage.

Okay. And, on the --

If you look at this year -- if you look at the overall year, we expect to pay $15 million or $16 million against the -- real cash against the tax provision.

Okay. And, by the way, I just missed this. What was the percentage of billings from financial services? I don't think you gave that one.

11% I think. Wasn't it? It was 11%.

11%. On the OS product cycles, just kind of refresh. What was -- ? I think you said it, but just remind me when the last one was. And what was the financial impact? Is it measurable in any way?

The last 4.0 release in, I think, Q1 or Q2 2008 is about, like, three and a half years ago. And, ASIC, every year, we have a new release. This one, the last (inaudible) -- it's also like around three years ago.

It's great stuff for, obviously, long term, but is it either a quarter in or quarter out basis? Should we really expect that there's any measurable financial impact from these or just like, hey, it's real good? It's real healthy.

I was going to say it's hard to tie it back to the specific operating system -- tie it back specifically to the operating system. I mean, I think, in 2008, we had some good growth when that came out. But it's really -- you see growth in the products that are running the operating system, but you can't really tie revenue growth opportunity specifically to the operating system or the ASIC.

Okay. And then my last question was just -- did you discuss leadership changes in management in North America? What were they? I think I missed that. I think you were talking about it.

There's no leadership changes whatsoever. We didn't have anything to talk about. And there isn't anything to talk about.

All right. Thanks. Sorry. It was a long call. I was getting fuzzy near the end.

Let me sort of give you a sense because I think it's important. When you look at the GAAP numbers, in terms of the quarter, it was about $10 million provision of income tax, and we spent about $4 million in cash. For the year to date, the GAAP provision was $23 million, and we spent about $10 million. So, if you think about it -- I know, Michael, this has been a question that you've had. We're spending -- we're putting out in cash a little less than 50% of our provision. So I see that, as best I can tell now, going up over time as a percentage. It's probably based upon various deductions that we have, including stock option deductions. But versus years ago when it was 0%, we're paying a material amount, 45% or 50%, if you will, of our tax provision in cash. So you shouldn't think of a cliff going on here in terms of a new cash tax going on in 2013.

Right. Thanks a lot. I'm done. Thanks.

Keith Weiss, Morgan Stanley.

The question that I'm getting inbound more than anything else -- I'll ask you guys to do my job for me -- is kind of -- how do you know this is seasonality, perhaps some execution issues, versus competition issues? Investors are asking me this. I'll ask you the question. What do you guys look to when you're looking -- ? I'm sure you have sort of reports coming in on sales reports. But what do you guys look to in particular to gain confidence that this isn't an issue with increasing competition? Maybe it's from some new vendors out there, maybe some old vendors sort of getting up off the floor making it harder to gain share on a go-forward basis.

I'll let Ken answer it. But I'll tell you I look at the win/loss reports. I look at the business that we were winning, as well as what's in the quote/unquote pipeline, if you will, for Q4. And then you look at where we stand in network security space. And so I am very confident that -- and then we talked about China and so forth and a few other things that we think will close this -- I don't think it's at all a competitive situation whatsoever. Sometimes, from quarter to quarter, you will get somewhat bigger numbers to achieve and so forth, and sometimes that happens or doesn't happen. And I would point out the same thing we described last year in the UK, in which we got similar concerns in Europe in total. We got similar concerns, and we felt at that time it was specific to some things we could improve on. And I would say we feel the exact same way.

The only thing that I would add to that is there's no question -- it's not necessarily losing deals. But it's a question of -- in all the opportunity that we could be in because of the perception of us in terms of maybe, by some, as primarily a UTM supplier and not an NGFW supplier. And so that's not a question of losing anymore than not in the quarter. It's more a question of do we compete in every deal that we should. And I think that's an area where we can sharpen our messaging and ensure that we are competing in more deals. So that's how I see it.

Yes. I agree. None of the things we mentioned really relate to the competitor, whether in China or some other region or some other (inaudible). It's more like -- I see this more like in the (inaudible) level. It's sometimes (inaudible) for me. I've been in this company 12 years, in this space 20 years. It's nothing of concern right now. But, on the other side, I do agree sometimes the new competitor come into the space -- they bring some new message, especially in some other price. We also feel we may be able to keep improving some message to respond to some of the requests from customer. For us, really, the strong area is always our technology, our product side. Wherever we are invited in the door, we have a much bigger chance to win compared to other competitors. It's really how to pass the message at level -- to get into the door first. So that's an area we think we starting doing something to address, especially after in the last couple years we started building a market enterprise team right now.

I honestly -- everything I see, there's nothing endemic and changing our opportunities. And I think we improve our messaging and maybe improve how we work with some of the industry analysts. I think that will continue to help the Company. But you look at it. Just go back in all three regions. You sort of stand back and say all three regions grew billings in excess of 20%. So good, solid growth. Yes, we're down a little bit in the Americas from what we did in Q2. And maybe Q2 was a little abnormal, if you will. But I would still suggest that we're -- we've been growing pretty consistently at well over 20% for quite a long time. And, without sort of creating guidance right now, I think the opportunities certainly continue growing at heavy rates going forward.

Honestly, like we mentioned, in certain countries, we see the economy -- some maybe challenges there. But, on the other side, we also got feedback from our partner -- our channel partner. So that's probably mostly (inaudible) solutions, which is a multi-function and can help in saving the cost both on the product side and also on the management costs. So that's where, so far, we get all very positive feedback about the new release we have and also the technology we build going forward.

Got it. That was very helpful. Ken Goldman, you talked about China's more heavily product oriented perhaps than other regions. Can you remind us of what the dynamic is there that makes it more product oriented or more heavily product oriented? And what does that actually mean in terms of -- for understanding the impacts on the income statement from China being weak. Is that why we'd see it more so in product revenues than sort of overall billings?

Actually, Ken Xie said it also. Yes. What we said is it tends to be more firewall oriented applications, and so, therefore, the amount of bundles with subscription is much lighter. And so, therefore, it is a higher component of products in the billings, and so, therefore, the way to think about it is more of the billings are up-front, recognizable revenue as product revenue. And that's historically always been the way China is with us. And so it's the nature of what we do there.

Got it. And then a last one from me would just be on the products outside of FortiGate, something that I always ask about and you guys don't comment too often on the calls. Any particular products within that portfolio that you guys are seeing good traction on? Any sort of change in how you're going to be positioning that or maybe the focus you're going to be putting on some of those products on a go-forward basis?

I would say, right now, it's all relatively small. So I don't think any of the product has much material impact on the number. But we do see some of the technology area -- we see a steady ramp-up quickly, like the Web security. We have the FortiWeb and also the other -- like the DDoS, which we acquired a company earlier this year, also starting to ramp up quick. And, also, the FortiMail is the one we have (inaudible), one of the best solutions on the e-mail security because the other players starting kind of -- whether shrinking or not in the region. So we're starting to see that product also starting to kind of pick up right now. But, overall, it's still relatively small, immaterial.

Ken's right. But, on the other hand, I think, sometimes in the States -- we're doing pretty well there. And the new products continue to ramp up nicely. I think you'll see more opportunity in that area. And it's not a new product or a different component. But I think you'll see us put more emphasis on the FortiManager and FortiAnalyzer in a way that they're really well appreciated by our customers. And so I think you'll see more revenues. That's part of the FortiGate product line. But you'll see -- I believe you'll see more revenues coming from those, as well, particularly with the new 5.0 products. But I think, as you get into 2013 and 2014, I fully believe the other products will become material to our results.

Excellent. Thank you, guys.

(Inaudible).

I just want to be clear. You did guide for mid to high teens billings growth in fiscal 2013. Right?

Correct. That's what I said.

Okay. So you have a strong pipeline now. I think you need a couple of quarters to turn around China. You have these new technologies, which are going to permeate the market over the next couple quarters. So what's the basis of mid to high teens? You were at high 20s for many, many quarters. What's the basis for mid to high teens, and what's the potential for returning to the mid 20s?

Well, I thought that's where you were going. I think there are several bases. One is we'd like to start at a comfortable number, the same thing we did in October of 2011. And, as someone else pointed out, we do have some pretty high comps to worry about, if you will, in the first half of next year compared to the first half of this year. And three is, you know, going into a new year with all the uncertainty in the world and cliff this and cliff that and so forth, I'd rather start -- of course, I'm not going to be here, but, having said all that, I'd rather start -- we all agree we'd rather start at a number that we think we can build upon, hopefully, as the year progress. And so that's worked well for us, and I think it's the right way to go.

Okay. A second question is on your OpEx. You hired 92 people, a 5% increase in headcount sequentially, last quarter. But, if you take away the legal settlement, your OpEx was basically flat at $64 million sequentially. So I'm curious how to square those together. Was your hiring backend loaded? How should we think about OpEx for Q4?

Well, we take that into account with Q4 because you do get the benefit in Q3 of people taking vacation. That goes against the accrual. We are continuing to -- the first quarter, in particular, you get all -- and this is not just the US but a lot of countries. You have all the new reinstatement of payroll taxes that you get maxed out in a lot of first or second quarter. So you have the benefit of various payroll taxes that get maxed out over first couple quarters, US and others. And then you have a heavier proportion of vacations that get utilized in Q3 vis-a-vis either Q2 or Q4.

Okay. And, so far, you've not seen weakness in Europe. Your results there are very strong, strong on a billings growth basis as well. But maybe you can talk about the possibility of weakness in Europe in the fourth quarter. Is there a possibility -- a reasonable possibility that it gets worse?

Well, I'm not sure what you mean by worse. If you look at Europe over time -- again, we don't guide specifically with that detail. But, historically, Europe has a very strong Q4. And so, you know, I fully expect that we will have a good quarter in EMEA Q4. It is -- it tends to be very, very strong for us, and we tend to be off a little bit in Q2 versus -- I'm sorry -- Q3 versus Q2. And so -- I don't think -- so far, there's nothing in the macro environment that suggests a change in that. And so that's all I can say relative to that.

Okay. And, I guess, the last one from me is -- you have these new products. I think it's going to take a couple quarters for them to ramp. How can you be so sure that the weakness -- the slower growth in the Americas was not a pause in front of these new products?

I think (inaudible) analysis is really -- the new products more like have a long-term benefit because, for us, we most sell in the FortiGate system. So the Forti OS and the ASIC that's basically built into the system, which is -- we would not try to sell the Forti OS or the Forti ASIC right now. It's really enabled the new opportunity and also kind of has the performance and the function there. So that's where it's like (inaudible) and how we released the 4.0, the 3.0 in the past. We don't see like much impact on the quarter right after the release.

I think, again, we don't announce early -- we don't announce new hardware products until we've built up inventory on the new products and taken down our inventory on the existing products they're going to replace. So we manage that transition as effectively as we possibly can. And, because, on the operating system, you would get that product -- you would get that even if you buy products now. We don't necessarily think that that's a delay mechanism for people buying the existing products.

Okay.

Yes. The (inaudible) level sometimes has a little bit more impact compared to the OS level and also the ASIC. ASIC, basically, enables the system to go much faster, more stronger. It's more like (inaudible) or whatever. It's similar. The OS level is really the long-term benefit of it compared to the system level, which leverages a new chip, and the new OS just makes it kind of more attractive.

Okay. Thank you very much. Good luck to you, Ken Goldman.

Jonathan Ho, William Blair.

Just one question from me. You talked a little bit about some of the traction that you've gotten in the financial vertical. And I just wanted to get a little bit more color. I mean, you talked about now having some marquis reference customers. What does this mean in terms of that vertical? Can we expect you to maybe start picking up in terms of traction here? And what would be sort of the timing around that impact?

I think, generally, if you go across the world, historically, we've done pretty well and continue to do pretty well. And I think, in the Americas and, particularly, in the New York area, we are now making steady progress there. And, as we look out, we think we'll continue to make steady progress there. So I think it's going to be hard for us to take down any multi, multi-million-dollar deals, just being extreme here for a second, in New York because it takes a while to win these deals. But we're going to continue chipping away. And I do see us both in Q3 as well as, prospectively, Q4 next year continuing to make progress there. We're going to be opening up a major, new office there. We have a lab there. We've continued to recruit sales folks there. So we do believe that we will continue to make good progress there.

Got it. And just one other one. Did you say that you had already closed some of the deals that had been pushed out in China? I just want to make sure that I understood that correctly.

I didn't say specifically China. I said some deals that we had hoped to close in general we had closed. But I didn't want to get specific to China.

Got it. Thank you.

Tom Ernst, Deutsche Bank.

It's actually (Inaudible) on behalf of Tom. I had a clarification. I think you made a comment that you're not refreshing all the appliances with the new ASIC (inaudible). It's going to happen over a phased manner. What kind of timeline are we looking at by the time you refresh all your appliances with the new ASICs?

We tend to refresh each -- like, right now, we have like 20-plus FortiGate model. The price ranges from like a few hundred dollars to the (inaudible) probably million dollars. So that's where -- each three to four years, we refresh like one model at a particular price -- like, an example, the FortiGate 300 -- originally, the [Forti 300ABC] right now is the latest version. So that's where we tend to space out. So, each quarter, we may come out like one or two or three FortiGate could be in the middle range or lower or high end. So that's the way we kind of keep refreshing and then leverage that. So each model is really leveraged the latest (inaudible) for the ASIC and also the other memory chip or whatever, all this kind of thing. Also, some other (inaudible) in the market. So that's the way we -- we tend to not change all this all together very quickly. Like, whatever we can -- it's really based on the -- if some product just be in the field in the last one or two years, it probably still has another two or three years life there. But, if some product (inaudible) three or four years, we probably will be refresh that one first. So that's the way we kind of keep in the progress in the last 12 years.

So this is spread out over a year? I'm trying to get a sense of when would the old ASIC be completely phased out of your appliances.

It probably will take us like around three or four years to completely phase out. So that's -- if we say totally phase out, that takes about three to four years.

Got it. Okay. Just one more question from the retail -- the large retail deal. If you add up the total deal size over five quarters, was it in excess of $10 million?

I would say it's in that range. Yes. I'm having a hard time. I can't get my seven-, eight-, and nine-figure numbers -- I was a little reluctant to tell you whether it was eight or nine or ten figures. But, if you're saying in the range of $10 million, I think that's about right over a number of quarters.

Got it. Okay. That's it for me for now. Thanks.

Jayson Nolan, Baird.

Just a clarification relative to the silicon. The NP6 family includes multiple chips, I believe. It's not just a staggered product launch.

I still see that's the one -- (inaudible) two chips, which included some of the function for NP and some of the function from the CP family (inaudible) general purpose CPU. So that's with the system on chip we just released.

Is there another chip release scheduled for next year, Ken?

Yes.

And when you say functionality is shifting off of CP, that's coming off the RMI chip onto this new gen-two SoC?

No. It's different. RMI chip is really more on the network processor side. We're still using the chip from the market, whatever the network processor or (inaudible) or other chip. But we also specifically designed the chip two support in the security function, which is not available on the market. I think RMI is one of the networking process chips we really use in the high end (inaudible) with our own Forti ASIC NP, the network processor, which is -- I believe, the new generation will come up next year.

Okay. Thanks. It's probably best to take some of that offline. Last question from me on wireless LAN. I haven't heard you guys mention that portfolio for a while. But what are you seeing there? Any revenue traction?

We see some good progress, especially on the [under price] with a lot of current customers starting to the BYOD to manage all the mobile device. So that's where the wireless LAN is starting to see some good traction there. But, right now, I see it still has a lot of potential and good opportunity to grow in. So, right now, they're growing faster than the average, but it's a very small base.

Okay. Understood. Thank you.

Dan Cummins, Think Equity.

A couple questions. First, on the enterprise business, I'm curious if -- I guess, how are you doing relative to your own expectations? And, relative to the comment before about your visibility around all the available opportunities, I wonder if growing your product footprint perhaps more strategically through some M&A -- I understand your longstanding preference for organic growth. Could that possibly expose Fortinet to a larger buying audience, maybe one that's more objective? The networking guys tend to be very, very parochial and loyal. Thanks.

I think the first question is about how the enterprise -- we think -- we started building (inaudible) team. It over achieved the target. It's doing a great job there. And, on (inaudible), we probably need to improve (inaudible) how to position or how to increase the lead gen (inaudible) more like open the door. So, for us, once we're invited into the bid, into the testing, we have a much higher chance to win compared to any other competitor because the performance, the function we have. For us, we need to improve in the area of how to get more invited into the deal. So that's the area we want to keeping invest.

Related to the other question, some other opportunity through M&A, I think we (inaudible) early this year some of the Company technology, more on the technology side, which can target some high-end enterprise market or carrier market. And, at the same time, the testing like come from (inaudible) also proves we have a much better performance also a multi-tier solution compared to competitor, especially on the latency, which is 5 to 10 milliseconds compared to competitor over 100 milliseconds (inaudible) performance a few times better than the competitor. So that's all enabled us to be the strong player in the enterprise and the high-end. It's really how we can help in the sales -- open the door and get into compete in the deal. It's the one we need to improve in going forward.

Okay. And then, I guess, the same, general question about performance versus expectations overall for the non-gateway products, which, I guess, are top to bottom in terms of the market strategy you address. How are you doing? We've been talking about this for a while. Do you think that the new product footprint is broad enough in terms of strength and brand?

In the past, we always tried to drive from the technology side. But it's, now, we also try to -- with a strong enterprise team on board right now, we also try to help them to drive from the position from the lead gen side. But, still, once we get into the door -- I think that's where, if you look at an area which less depends on some analyst position -- it's more dependent on the (inaudible), like in the carrier space in some university. We have a much stronger position and a high percentage because the customer is able to test themselves. So, if certain enterprise more depend on one or two industry analyst comments, that's the area we probably -- it's a little bit behind. And that's where we try to improve in with all the major wins we have. So I think the major deal win is probably above the average growth we have today in the overall company. So that's really the area we want to keep invest more. And, at the same time, we also want to keep improving the market in the lead gen position side to enable these sales to get into more deals.

All right. Thank you very much, Ken.

Walter Pritchard, Citi.

Ken, just, first of all, congratulations on the new job. And probably won't talk to you much at Yahoo. But I wish you well there.

On the guidance, I think a couple people asked this on the call. And I think you mentioned that you could have narrowed it. I just want to understand kind of how you're guiding for Q4 or how you're thinking about the extra $5 million or $6 million that you put into that range and what could drive the outcome if it were to come at either, I guess, the high end of the low end. I'm trying to understand if the extra $5 million or $6 million is on the high end or the low end.

(Inaudible) extra $5 million or $6 million.

Well, your normal guidance is like $4 million to $5 million in a Q4 if I look in terms of the range on billings.

That's true. But, you know, the way we thought about it was we kept the annual guidance the same and just didn't tighten it down. We just didn't tighten it down. You know, I think, like anything else, what would be on the higher end is, frankly, each region does a little bit better than we expect them to do, if you will. We do sort of look at the midpoint of the guidance being the midpoint. That's how we look at year over year and so forth. And we could have tightened it down and could have increased the bottom of the range a little bit and maybe reduced the top end just to be the same midpoint. And we decided to leave it where it is and not -- the messaging we really wanted to have was to keeping the guidance consistent with what we showed last quarter overall. We aren't necessarily suggesting that there's more variability in our numbers than usual.

But, to be fair, a year ago, you did -- when you got into the situation, you did take the range down from a $10 million or so range for the year coming into Q4 to narrowing it to $4 million to $5 million.

I think what we saw last year is was we overall -- I don't have it in front of me. But my sense is, last year, we increased the range a little bit. And, when we do that, then the natural tendency is to narrow it a little bit. In this case, it was more straightforward just to leave the range where it was. I don't think I want to get any more -- tighter in the range than where we are. We expect a lot of folks to end up with somewhere in the midpoint of the range, which is historically -- sometimes people have the higher end of the range. I'm sort of suggesting the range is a range, and it could be the midpoint or whatever.

And then I may have missed this because this been a lengthy call here, and I've been on and off. But, on Europe, did you highlight where in Europe? You said you did see some disappointment in parts of Europe. Did you highlight where that was?

I didn't use the word -- that's your word, disappointment. I said in southern -- like Italy -- not necessarily southern Europe but, really, Italy -- we have a region called Italy, Turkey, Greece. And, as you would expect, that area probably is not the strongest economically right now. And so that area tends to be a little bit more challenged, if you will, relative to growth versus some other areas in EMEA.

And was that a surprise versus your guidance, or was that -- ? I mean, I guess, most people, I would have expected, thought that that area probably would be weaker given --

I wasn't suggesting Europe was light. I was just suggesting that the area that -- you know, in terms of our ability to over achieve, there's a little bit more challenge if you will in that region because that area is regionally light vis-a-vis year-over-year performance.

Okay. Got it. Thanks. That's clear. Thanks a lot, Ken.

Erik Suppiger, JMP.

Two questions, just one on the US enterprise. You've said the enterprise is the fastest-growing segment and financial is the fastest-growing segment. Was that still the case this quarter?

I didn't -- to be clear, I said the enterprise -- in the Americas, I said the enterprise historically has been fastest growing. And Ken mentioned, too, we've done quite well in areas like Latin America in Americas too. Financial services overall did well, but I didn't necessarily say it did well in Americas per se. Just to be -- sometimes you have to be careful. You're juxtaposing regions and verticals on top of each other, and sometimes you get a little bit more minute detail than we provide per se. But, over time -- over the last three years or so, enterprise in the Americas has done very, very well. And so it's a substantial amount of our business now in Americas. And I could add the same -- the Latin American folks have done a phenomenal job, too, over this period of time in terms of growing their business from a relatively small percentage of our Americas business. We broke out financial services separate from all that, you know, a year and a half or two years ago. And we're now starting to see some traction there. But, frankly, we have a long way to go to be where we want to be in the Americas financial services.

Okay. Secondly, earlier you had mentioned that you were -- you might be missing out on some deals, maybe next-gen firewall deals, where you're positioned in the UTM. Is there any particular aspect of the new operating system that will significantly bolster your application control capability that would enable you to participate more so in that aspect of the market?

I think, from the technology, the function side is really no different, whether it's called a next-gen or the UTM because we have all the app control and all the other like IPS (inaudible) in there, like even before the other level competitor even started company. So it's been -- it's really the name come from different research firm and also some kind of enterprise lesson to different research firms. So that's some kind of message a little bit mismatched there. So I think it's (inaudible). The enterprise team is starting building up, and also the function and performance keeping better and better. We also see that the investment going to some of the enterprise lead gen is starting to more make sense. And, if some of enterprise there more understand the turnaround on the next-gen or they like to turn that way compared to UTM, we have no problem to just use a different term. But, on the other side, with the technology we have, it's already beyond the next-gen firewall and also beyond some other analysts' position, even for the UTM. So that's the part. I think, once we can get into the door to customers starting testing the product, that -- they can see the huge benefit of the performance or the function of the security. So that's the first step we try to pass, really, how to get in the door. So that's some -- kind of the message and also kind of takes some weight there.

But I do think the 5.0 does give us the opportunity to position us even better from a market point of view in these areas, call it NG, FW, or maybe another term. And so I think it will give us the opportunity to go out there both with the industry analysts, as well as customers, and compete even more heavily in that space.

Okay. And then, lastly, does the new OS -- ? or are there any new products, particularly, in the managed security service provider space that's going to make a noted difference in the fourth quarter coming up?

Like I said, probably the Forti OS probably is more long-term impact. I don't feel it will be that much in the Q4. But we do start in trying to build some into the new portal, but it probably will be more coming in Q1 instead of Q4. Maybe we have some chance to [pay] that portal in Q4, but it's some of the new portal leverage, the new chip, probably will be Q1.

And it would initially be integrated into carrier products earlier on. Is that right?

Don't have to be -- the FortiGate -- some of the FortiGate -- the carrier product we have right now has been there, like, one or two years old. So it's probably more go towards some of the middle range or some lower end. The carrier one is more used in the MP, the FortiASIC MP technology, which is [more] released next year.

Okay. Very good. Thank you.

Catharine Trednick, Northland Securities.

My question -- if we can go back to the distributors a little bit, it seems like you were short $3 million in North America, and I just want to make sure I heard this right on the earlier conference call. Do you think that you don't have the right mix of distributors or the distributors really didn't have that much to do with it and it's maybe a combination your marketing messaging and the distributors? I'm just trying to rationalize in my head some of that.

Well, first of all, I don't remember specifically saying we were $3 million off in the Americas. So, I don't remember being that specific. And I would say this. I don't think it's an issue at all with our channel and how they're doing versus our expectations. No. I think it's more of -- we would have liked, overall, to do a little bit better, some things we would have like to have brought into the quarter that will go into, hopefully, another quarter. But I don't think it's anything specific to the channel. We feel very, very good about the channel. We don't have -- we're not in the process of making any significant -- we always look to adding resellers and so forth, but I don't think -- in terms of the channel partners, I don't think there's any change we anticipate right now.

Okay. Thanks. And then this whole thing that we've all talked about or everyone has on your messaging versus UTM versus the next-generation firewall and the fact that you've had a lot of these capabilities before the name came out from Gartner versus someone else. What type of things internally, besides getting closer to this research analyst, do you plan on doing with the channel, for instance, to make it more effective for you to go upstream to the large enterprise and capture some of the deals that you were left off of?

I think the UTM message is still doing quite well into the service provider, the MSP, and also even some education market. But certain large enterprise, which they are (inaudible) customer -- they followed some term from the Gartner. From our side, the UTM term come from IDC almost ten years ago when we started launch the products. Really (inaudible) subset of how UTM defined because UTM function, like AV or whatever is not in the next-gen firewall. But whatever the next-gen firewall function are in the UTM. So that's where even the IDC report -- they put the next-gen firewall was a part of the UTM, including the report on some new IPO vendor there. So that's where the overall -- that's where, for us, at least, the buildup of the enterprise team. That's what the feedback for us from customers. Maybe you should just not have to use the name for IDC and open to some Gartner name. Maybe that's more easy to open the door. So we also have no problem with that. It's just a term from different research firm. It did not change what the real product is. So that's where we see something we can be more flexible.

On the other side, really, once we get in the door, like I said, we have a higher chance to win over other competitors. It's really just how to enable us to more get into the door sooner, quicker.

Okay. Thank you. And do you ever publish run rates on a quarterly/quarterly basis or not?

Not specifically. No. We don't.

One other way to compare it, really, because, right now, I have to say the market -- now the security market a little bit confusing whether it's a firewall or the UTM or the next-gen or some other things. Maybe the way -- (inaudible) on slide 13 you can see we just use the overall. That wasn't (inaudible). That's where sometime this confuse some vendor whether they use the blade or they're using whatever the appliance or they're using other things. So that's where the overall network security market growth probably will be more instead of try to fit into certain category. That's where we see we be in the number four in the overall market. We quickly move up right now and also among the top ten. We have all the vendor on the list from IDC. We are the fastest growing to gain market share right now.

Yes. I do see that. All right. Thank you very much, gentlemen.

Brian Freed, Wunderlich.

Two quick questions. First, can you give any color on what your quota-carrying sales force number was at the end of Q3 versus the end of Q2?

Are you asking what each salesperson has as a quota?

No, just how many quota-carrying salespeople you have.

Yes. We've been asked that question a lot and decided not to give that number.

Okay. And then the --

Good try though.

And then the second question. Relative to your guidance and realizing that you put up end line numbers, you guys have -- it's been kind of suggested you were light in North America. You talked about being light in China. But, if you look at North America, Europe, and Asia, and China, those four areas, can you talk about which areas actually performed in line with your expectations for Q3 versus below, broadly, not just kind of on a narrow basis. And then, more detailed, in North America, how much of the sequential deceleration was the effect of the large retail deal rolling off versus broader softness?

That's a lot in there. I think the retail -- again, we knew the retail was going to roll off, so that was not -- the retail customer. That was not a surprise. And so that does affect sequentially, but, again, not a surprise from the guidance point of view. You know, I would say probably the majority of Americas came in at or above expectations. The couple things, regions, or whatever that didn't come in quite as well as we would have like. But the majority of the Americas did come in at internal and external expectations. In EMEA, I would say, generally, quite good. Came in very, very close all across the board relative to what we would have liked to have achieve there. So Americas -- no issues whatsoever. In Asia Pac, if you take China out, frankly, we've been right on line with what we had hoped to do. I'm looking at the numbers right here. And so, yes, I think, if China had made its number, so to speak, in terms of what we hoped to do, we would have been right in line with APAC. EMEA, right in line. So no issues there. I did talk about some weakness in ITG, but that was assumed, if you will, in our planning. And Americas, 80% or whatever, very good. There were a couple things we could have done a little bit better. That's how I would look at it.

So relative to your internal planning, China was the only real material shortfall.

In terms of material, millions, yes. I think I already talked about someone asking about $2 million-ish. That's the relative, right range.

Okay. Thanks so much.

Aaron Schwartz, Jefferies.

I'll try to make this real quick here. You've pointed out some legal expenses in the quarter. Is that complete, or will that sort of continue into Q4?

As far as we know, that's complete. So, yes. It's three separate things that either expensed or accrued. And, as far as we know today, that is nonrecurring. And we have not factored in incremental expenses for litigation-like expenses in Q4.

Okay. And then the second piece here is -- you've continued here to talk a little bit about somewhat of a mix shift to multiyear subscription terms or, I guess, longer subscription terms. We can't really see it in the deferred mix all that much. But you did provide some specific commentary to the renewal activity in Q4. What are you assuming there? Are you assuming sort of that continued mix shift of sorts to longer-term deals?

No, not necessarily. The only -- I'm saying renewals is -- because many of our customers try to (inaudible) to an annual budget cycle, they like to do their renewals late in the year. And so we have historically, and even more so over time, more renewals coming up in Q4 than we might have in other quarters. So certain quarters are seasonally more than others. And this has nothing to do with the longevity of renewals. It's just that the renewals come up in terms of whether they're annual, two, or whatever -- they're coming up for renewal, if you will, in Q4 versus Q3 or a different quarter.

Okay. Terrific. Thank you.

It's independent, really, of the longevity of multiyear renewals.

Got it. Thanks so much.

Okay. I think, with that, we will complete our call. Thanks again. I appreciate the attention on the call. And we did get the call a little earlier, and I would like to thank the finance and IT teams for getting our results two days earlier this quarter than prior quarters. So well done by them.

So, with that, thank you.

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