Fortinet Inc (FTNT) 2012 Q4 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by, and welcome to the Fortinet Fourth Quarter 2012 Earnings Financial Analyst Q&A. (Operator instructions.)

As a reminder, this conference is being recorded.

Now my pleasure to turn the call over to Michelle Spolver, VP of IR. Please go ahead.

Hi, everybody. Thank you for joining our first call, and also our second call. So in the room with me today I have Ken Xie, our Founder and CEO, Nancy Bush, our Interim CFO, and then also we have Jim Bray and Doug May, who are senior members of our finance team. So feel free -- as you guys know, it's a Q&A only session, so feel free to ask the questions now. I know we have investors and analysts on the phone, so both are free to ask questions.

So, Operator, we could take our first question now.

(Operator instructions.) Sterling Auty with JPMorgan.

Yes, thanks. Hi, guys. So, couple of kind of housekeeping, administrative. I missed it if you said it, but can you give us a sense of what percentage of subscriptions were kind of multi-year?

Yes. We didn't give that out. I don't think we saw a significant change in that.

It's similar (inaudible).

Yes, similar enough that it's been.

Yes. Also, let me (inaudible) that the Safe Harbor statement Michelle read is still apply on this one.

And I think, to answer your question, it's similar like we have before, so we don't see much change.

Okay. And on the renewals, where do you see the best renewal rates in terms of the different solutions that are under subscription?

As we still see, the majority similar, like 80% come from the bundle. It's difficult to say which function, so that's bundle. We offer four function in the renew, like antivirus and intrusion, the spam, and also the URL filter. So that's where the super-majority still from the bundle. We don't see much change in there.

No. I think it's just between the FortiGuard with the bundle and the traditional maintenance services, that those are normally renewed together.

Yes.

Okay. One more housekeeping, and then one other. When you look at 2013, what kind of CapEx levels are kind of embedded in the free cash flow guidance?

I think that kind of a traditional rate around what we're doing for equipment that we put into the business, right, whether it's going into the labs or out to customers for proof of concepts, is probably something you can model for 2013. We're doing some technology infrastructure, and that could have a range of $4 million or $5 million over the course of a year. Some of that might slip into 2014. And then, we're looking at some office space, and we're maybe $2 million, $3 million, $4 million in that range, maybe not.

The other piece that's going to kind of impact the free cash flow, our tax payments will go up a little bit year-over-year. So in your model, you should just model 50% of the GAAP tax rate for cash tax payments.

Okay. And last question would be, I guess I missed it. I think you covered part of it, but in terms of the sales and marketing hiring, where are those personnel being deployed? Is it still channel managers, or at this point are you actually handling some of those enterprise accounts direct?

It's more enterprise. It's really the enterprise team, and also we starting cover the vertical space. Even (inaudible), we started dividing the finance service, the healthcare, education, so it's really the enterprise is (inaudible) hard right now.

Okay, but those enterprise, are you still fulfilling through the channel but selling direct, so kind of a full model, or has anything changed in how you're going to market with that group?

Yes, we still fulfill from the channel, so we're coming--.

--Right--.

--Channel, yes.

Okay, thank you.

Yes, it's all the direct [catch] model we have, yes.

Jayson Nolan with Robert W. Baird.

Yes, thank you. I wanted to come back to the competitive landscape for a second and ask a couple of questions. First, on F5, Ken, they've made more of a push into security. Are you seeing them pop up in competitive situations?

No. They are -- maybe they make some progress in the data center, but we have not seen them running the enterprise or in some other areas. I think that, so far in the field, we don't meet the F5 yet. And they are still more in their data center space.

And then, anything new relative to the FRX at Juniper, the 5585 at Cisco? Have there been any changes, really, in the last quarter or two there?

Not really. I think still they are falling way behind for both company. Right now is really you can look on the growth there is really not quite there. I think some of the customers, they may -- I think that the way Juniper, Cisco play still try to combine their routing, switching, whatever, with network security together, that kind of approach. But if [bet] on the security only, they are way behind on both the function and on the performance.

Okay, thank you.

Thank you.

Michael Turitz with Raymond James.

Hey, Nancy -- everybody, Ken, Nancy, everybody. So first of all, back, Nancy, on the cash taxes, can you just review what your cash taxes were for fourth quarter in 2012? And I just wanted to make it clear that it's 50 -- we should think of the cash 50% of whatever the GAAP taxes are? That's what we should think of those cash taxes for next year?

Yes, we paid $7 million in Q4, and we're going to pay a similar amount already in Q1. And then, you can model out the rest of the year.

Do we think it'll be similar the rest of the year?

Yes. Well, 50% of the rate. I mean, the more money you make, the more [you have] to pay, so whatever's in the model.

Right, 50% the rate, so whatever my dollar amount I expect for GAAP taxes for the full year, I should take half of that, and that's what I should--?

--Yes, correct.

And what was that -- how did things end up on the full year basis for cash taxes in '12?

17.

Yes.

17, yes. And then, back on the competitive perspective, if I think about it on a segment basis, I think let's pick three sort of arbitrary segments -- SMB, Enterprise, and maybe Carrier -- who are you seeing in each of those different segments, and is there any change?

SMB still, like [Sony one] a part of Dell now, so I feel the channel starting to worry about Dell may go direct or follow the other server model. And then, the other players quite small. Since (inaudible), the [treatment] do have a little bit lower end, but they're both on the product on the performance or function kind of behind, so we don't see much in there.

And then, in the carrier, that's where tend to be some networking company, the Juniper, Cisco there, but I would say, in the last few years, their security box starting falling behind on both the performance [and] function there.

And enterprise, we see the Palo Alto in the last few quarters starting pretty aggressive there, but it's -- but Palo Alto relatively weak on the performance, and also the function also kind of more narrow compared to the Fortinet. And so, that's where -- and then, also, I think they're more dedicated and more -- put a lot of effort on the marketing and sales in the enterprise, and we starting catch up there. So we can see the growth we have on the enterprise. It's very fast growing, and probably same level as Palo Alto. But once we invest more this year, we are quite confident we can release a strong, better product. We are quite confident we can do better.

So it sounds like you're making progress in financial services, obviously a big chunk of enterprise. And I know I missed some of this on the call, but what have you been doing to compete more effectively in enterprise and in financial services, and what do you expect to be doing?

I think if we just paid a little bit more time to really engage, close the deal, and the same time, also sometime the marketing message also helping us (inaudible) there, because sometime -- in early day, some customer a little bit confused about what are the next-gen firewall, UTM, or all these multi-function device. But once they have the box, once they evaluate, they can see the detail, what's the function, what's the performance, then they starting kind of just more comfortable. I think that just after you uncover what's under the marketing message, see the real solution, the real box, they can see the real benefit of solution product there.

Yes, Michael, it's Michelle. We also -- as you remember a year or so ago, and since that time have been investing in growing our enterprise team and verticalize that team. So, like, financial services has its own vertical, and we've been investing in that area, too. As we said before, it takes a couple quarters to sort of reap the results.

Right. Last question, coming really in a different direction, you made an acquisition of the small CDN type of networking company. Any thoughts on what you do with that technology? And are you thinking about delivering some security now as a cloud service? Obviously there've been people that have been -- Web application firewall, DDOS from the cloud, and also utilizing a network. What are your thoughts there? Is that a direction you could go?

I think that's overall long-term strategy well for certain cloud solution there, but this acquisition immaterial, so that's where we did not particular like [line] out there. It's a sort of IP for the team, and they have very good team there, and they probably a little bit ahead of their space, their time in there. But we have, like, a pretty good solution to address the cloud security, so with this team, and also the IP, some technology, we feel we can put it together to make it better for the long-term. But the deal is immaterial. It's more for the IP for the team there.

Right. I was more just interested in whether or not you saw a network delivery, or cloud delivery of security services as a direction you'll be moving.

Actually, in our OS5 we announced in October last year as three months ago, we do address some kind of cloud-based security issues, like one function we mentioned about the sandboxing. Sometimes you can do the sandboxing [relation] in a box. Somehow you also need to send back to the cloud which -- like they have an additional way to, like, sandboxing. Similarly [it all] -- it is a behavior-based [attack] there. So that's where a combination of both in the box and also in the cloud solution, that's where making is all the best solution. That's part of the FortiGuard -- we call the FortiGuard Secret Service, including the signature update, including the, like, cloud-based secure solution there.

I think that, long-term-wide, we see the service provider, we see some other -- even some enterprise, they all -- some application more cloud-based. With it, they do need this cloud-based solution, but it's -- but for us, I think in both -- but cloud also need (inaudible) side, so that's where sometimes in-the-box can provide more faster real-time solution compared to the cloud. Sometimes they can gain more deep analysis and have a multiple way to [similarly] address the issue, and also can collect more bigger data, do some more broad analysis. Each solution have their advantage, but also address a little bit different issue there.

Right. Okay, Ken, Nancy, Michelle, thank you very much. I appreciate it.

Yes, thank you.

Thank you.

Thank you.

Keith Weiss with Morgan Stanley.

Thank you guys for taking my call. I just wanted to clarify on the CapEx commentary for FY '13. Should we be thinking about it in terms of looking at sort of the typical spend that you guys were doing in 2012 being, let's call it, $1.5 million to $2 million a quarter ex- the building? And then, on top of it, there's $4 million to $5 million in technology initiatives and another $2 million to $3 million in office space, or is that all included?

No, that's -- you got it right.

Which one was it, the--?

--(Inaudible) spend.

Okay, that $1.5 million to $2 million?

Yes, and then the technology infrastructure, and then the building.

Okay. So if we took sort of the high end of that range of $2 million, it'd be $8 million in sort of typical spend, plus the $4 million to $5 million, plus the $2 million, $3 million is how we should be thinking about it?

Correct.

Excellent. And then, in terms of the product line outside of the core FortiGate product, we saw some press releases in the back half of the year in Q4 about Web application firewall for Amazon. You had another one about wireless security. I think it's a 48-P line. Could you give us an update on that sort of -- that whole bulk of products that are outside of FortiGate? Any closer to sort of breaking out how big of a percentage of the overall business it is? And maybe are there some particular standouts in parts of that portfolio that are doing particularly well?

That's still relatively small, and the super-majority still out of FortiGate and the FortiGate-related product. We do see the customer need that combine with the sort of Wi-Fi or [BROD] together with the FortiGate and then the same thing for the other -- for the Web -- for the other security there. So that's where we try to leverage the customer, the partner try to go in there. And also, some of the function we see maybe future can be part of -- integrated into the future FortiGate function there. So that's where -- but it's still pretty small there.

Got it. Any kind of indication you give us, and maybe what percentage of deals combine products outside of the FortiGate product, maybe give some benchmarks to how well that sort of upsell strategy is (inaudible)?

I think single digit, probably even low single digit.

Yes.

Yes.

Got it. Got it. And then, in terms of -- again, coming back to the competitive environment, one of the concerns you heard a lot during Q4 was about increasing price competitiveness in the marketplace. Could we get your view on sort of how price competitiveness has been trending over the last couple of quarters?

We don't see much price pressure there. That's where, like, the margin, or gross margin we're keeping [I see as] improvement there. The one thing really, every new generation of product tend to be few times faster than the older one, and we tend to keeping the same price as the previous generation. It's more identified by the model number, so that's where the 3600C will be comparable to the 3600B and the A in a previous one. The same thing for 800C, the same thing for, like, 600C, so that's the way we do it. (Inaudible), they have, like, pretty much the same gross margin because their technology keeping advance in the semiconductor, then they double the speed every two years, so that's where. So far, we are not thinking the pressure have to be like a aggressive discount to win the deal. Security's still more addressed as solution instead of try to compete the price there.

Yes, I would agree with Ken. Our technology differentiation doesn't seem to have created that scenario for us, right?

Yes. The other thing relate, the speed we have, the broad function we have, we don't see the competitor really come close. So our issue really is really how to get into the door. Once we get in the door, we have a -- one of our high successful grades. So that's where we try to enhance the lead generation, the marketing effort, and also keeping invest in enterprise sales. So that's where we see as a potential big growth there. It's really kind of helped.

The market definitely going to help in there because, I have to say, in the last few quarters, sometimes the marketing side confused a little bit about whether the next-gen firewall or the UTM or different way, whether address different issue. It's the same box and the same solution. It's really just the multi-function integrate together platform compared to the old single-function platform. So that's where -- but once the customer, like, have the box, and it seems (inaudible) more cleared out right now compared with before.

Got it. Excellent. That's helpful. And then, maybe reversing that question, with the performance improvements that you guys see -- and I think you mentioned 10 times the performance improvement going from one generation of ASIC chip to the next, as you add the new ASIC chips into the product line, do you guys see an opportunity to perhaps increase pricing on some of the appliance, given that increased performance?

I think we have the -- so each segment, we have the product there, like address SMB, Enterprise, or Carrier, so we have a price coverage from, like, a few hundred dollar to, like, over -- like single appliance over, like, $100,000, and also the chassis-based solutions of $500,000 to $1 million is fully loaded. So we don't see the need. I basically -- so we're keeping refresh on each price segment product once we see whether the ASIC and old -- or some other network [chip] out a CPU [got old].

So that's sort of every three, four years you get a refresh off each product line. So that's the way -- the one we announced last week, the 600c, is to replace the previous, so the 600b is really about maybe four, five years ago. So that's where each new product will replace the previous product there, but a similar price.

And I think definitely the performance is much better, few time faster than the previous version, but we just don't quite see the need to changing the price right now. If you raise the price, then they bump into the other one, the next to it, right? That's [toward] the 3900 series, and then even the 5000 series. So that's kind of seems not what we intend to do.

Got it. And then, one last one from me. Your cash balances are building very nicely. Any kind of indications on what you plan to do with that cash on a going-forward basis?

We are -- like we say, we're keeping investing in the sales, marketing, and the technology. And we may also consider more openly for some acquisition. [I think that] so far we did a (inaudible) relatively small. But if we see some good deal, some good, like, way we can leverage, we can work in kind of benefit, we'll be more open for some bigger deal compared we have before.

Got it. So no plans for -- I'm sorry.

Still need to be relate to what we are doing. And also, we understand that [merger-acquisition] has a lot of risk. We tend to be more careful to evaluate, and also take a (inaudible) low rate. We are quite risk-averse to -- well, deal with some merger-acquisition.

But still no plans for potentially repurchasing shares on the horizon?

We're open for that, but it's really we'll see what's the best way to address the long-term benefit. But right now, we're open for all the options, but it's a -- that's one of an option, but right now we just feel probably just keeping invest in the long-term growth will be better.

Excellent. Thank you, guys.

Thank you.

Erik Suppiger with JMP Securities.

Thank you, and congratulations. Few things. You had talked about seeing Palo Alto somewhat more. How does your win rate with Palo Alto compare to your win rate when you're competing against the larger vendors, like Cisco, Juniper and Checkpoint?

We are working on competing [of] them. The issue, Palo Alto, I mean, is really -- they are relatively -- the message is really they are do good job on the marketing. Sometime the message that they deliver, sometime the customer may seeking pretty fresh there. But then, when they do the real technical testing, see the function, see the performance, see how secure, and even see all the third-party test at the [occasion], then we have more advantage there. So we have more high win rate when they go to that level.

So our challenge really how to get into the door, and -- because sometime some customer still confused about the different turn of the solution there. But once the customer starting go to the evaluation stage, we have a huge advantage, is the winning rate's very, very high to, again, not only Palo Alto, a whole lot of competitors.

So once it goes into a bake-off, then they kind of fall in line with some of the other traditional competitors?

Yes, they tend to have, like, a multiple competitor to get in when they do the IP, [other] things. So what's where we perform well, because we have the highest performance, more broad function, and also the certification, the function coverage way beyond the other competitor have.

Okay. And you talked about seeing them in the enterprise. Is that largely contained in the larger enterprise, where you're coming into their segment of the market, or have you seen them expanding into maybe more mid-size, where they're coming into your segment of the market?

I think that pretty much all size of enterprise. When we see them, sometime more like from the finance sector, finance service sector and some other, I think it's kind of interesting things, like if in the space, like whether education or some other enterprise where they're more technical people, which they more involved in the testing evaluation, so we have more of a high winning rate. But if some others, relatively medium size enterprise, which they depend on some marketing message or whatever, there probably they [got in] more than we are.

Then, in the distributor enterprise, bigger part of (inaudible) the solution to address the branch office, and also the management side also kind of behind. So that's also kind of a -- we have a (inaudible). But overall I have to say, with our added investment, even if you look on last year, we grow 55% in enterprise growth, right? So that's basically where we're going to invest more, and we also will kind of put more investment into the marketing and the lead generation. So that we feel we can do better.

Yes. I mean, I think just [takes down] in that, Eric, is that I think, if we're seeing them more, it's because we're encroaching on their core market, which is basically the enterprise US more than they are coming into our markets that they haven't played in previously.

Okay. And you talked about investing in the sales and marketing. Does that include expanding your channel presence? They have a pretty broad presence for a young company. Are you adding channel partners, or what changes are you doing on the channel front?

We have a pretty good channel, result of the biggest, the top three channel partner -- I mean the distributor US is our channel partner. I think that they're -- I'm not sure they are really there yet, but it's -- they probably maybe more close about certain, like, (inaudible). [I think] on the other side, their team is more dedicate, just focus in one or two segment compared we have more broad approach. But with the focus we're starting doing this year I think is -- we have a very workable solution, going forward.

And I think you should just keep in mind, Palo Alto's still kind of focused in the Americas, and we have a broad presence overseas, right? So there's a little bit of a mismatch there.

That's a great point. Are you adding resellers in North America? Might we see some expansion of your channel in the US?

We already have a pretty well developed channel in the US.

Okay.

And I think there is core. Like Ken was saying, there's more really high-end systems integrators or high-end VARs that only focus on the very large customers. We have relationships with those VARs. We probably can look to sort of deepen the relationships. But I think we have a pretty broad channel in the US already, so it's not an issue of expansion. It might be going deeper into some of the key VARs.

Okay. And then, Nancy, if I look at the guidance on the billings, it looks like the guidance for the March quarter is about 17% growth year-on-year, and then for the year it's more like 19%. So that implies some acceleration in the latter half, or the latter quarters. Is that because the comps are maybe easier in September, or what would cause the year-over-year growth rates to accelerate?

Well, I think as we alluded to on the call, we're making investments in the first quarter. So as some of those marketing programs hit, some of the salespeople have been online longer, we should see some acceleration in the back half of the year.

Okay, good. And then, lastly, and you might have referenced this, the gross margin is down a point. What was the reason why the gross margin come down in 2013?

Well, I think we improve the gross margin on the same compared to last quarter. I think, like I mentioned in the Q2 earning, I believe, once it's really -- when we starting do the OS -- Forti OS5, we basically increases the flash memory in a lot of system there, so that's what keeping the price the same for a lot of the FortiGate. So that's maybe, like, has a little bit impact on the gross margin. But then, we're starting to see [starting] coming back, so that's pretty much the difference. And also, not how we see some bigger deal in, like, Q1, Q2, which also have some [lumpy] impact in the margin, I believe, right?

Good. Well, thank you very much, and congrats on a good quarter--.

--(Inaudible) service.

We are continuing to invest in our services to help address the enterprise market.

Yes, service we invest more, hiring other people there, also special enterprise. And service, we tend to have more, like if you look kind of one to two years ago it's about 85%. Now it's 82%, because we -- keeping invest in there. But that service long-term, still no change.

Very good. Okay, thank you very much.

Aaron Schwartz with Jefferies.

Good afternoon, just had two real quick questions, the first probably for Nancy here. The inventory build on the balance sheet presumably tied to everything you're doing on the product side. Can you just address that, and then your expectations for how that shapes up into '13?

So we actually went down quarter-over-quarter, from 26 to 21. And so, we'll continue to target turns of about 4X.

4X through '13?

Yes. I think you should keep in mind, we want to -- we're trying to manage inventory such that we never miss an opportunity to take a revenue dollar right, and so you'll see some bumps here and there as we go. We just want to be sure on the low end we keep supplying.

Yes. I think we have acquired a broad part [online and the] two shipping center worldwide, so that need to be balanced. So that's where I tend to be keeping some healthy inventory will be needed. But I have to say Q4 a little bit tight, so that's where -- we still don't want to miss in some opportunity which, because of product shortage, we lost some deal there, so that's where we tend to, like -- I think some investment in the inventory probably will help in -- for the long-term benefit of the Company.

And our over-achievement on billings in Q4 probably brought inventory down lower than we expected it to be.

Yes.

Okay. And then, a follow-up question to one that was asked earlier, but on the [XPN] acquisition, can you disclose the headcount on that? I don't know if you can. And then, also, are you going to continue to run the CDN service? It doesn't appear so. I just don't know if that's sort of officially been transitioned off, or if that's your plan. Thanks.

Yes. We're not going to disclose the headcount that we acquired, right, but it was immaterial to our overall spend rate.

Yes, it's immaterial, basically.

Okay. And then, on the CDN services side?

I think we keep some of the service, but it's more for the team there. So they don't have much service before, I have to say, but team is pretty good, and also some of the IP, some of the R&D ideas is pretty good. Service side is -- we are trying to maintain some of the service, but it also depends on the long-term value of some of the cost there. But I think, so far, we see some benefit of it, but it's still quite immaterial, basically, both on their service and also on the deal side.

Okay, thank you.

Rick Sherlund with Nomura.

Thanks. Ken, I just wanted to go back to this issue of channel and discounting. I understand you don't change prices. We do hear from talking to some resellers, and sometimes it's really hard to reconcile what I'm hearing from them versus your reported results. So sometimes they seem like they're just wrong, or maybe they're just looking at a small part of the business. But they do say they're seeing more aggressive promotions and discounting in the channel in the US. Are you changing your channel promotions or something? Is there any change?

Yes, we're not changing any discount (inaudible), but the one we try to help is where they open the door, so that's where we try to -- like if there's some customer helping us, like, open some new deal, we tend to give them some incentive. It's not about, like, try to discount more since.

As I talked about on the call, we changed the programs that we do with the channels, and I think it goes to better direct leverage and correlation into revenue. And they like it and we like it, and we'll continue it. It's not additional discounting.

Okay. And on the issue of the US government, I heard Michelle's comment that it's a global government business, and it's doing well. If I can just kind of hyper-focus on the US government for a minute, because it's important, as a broader perspective, not just for you guys but for everybody, we're curious. Particularly if we're going to go into a period of sequestering, did you see some slower business in the US government? We're hearing a lot of that. I'm just curious if you've seen any of that.

The US government sector for us is pretty small, right? And so, I wouldn't say that a slowdown or a sequestering would have a big impact into our forecast into 2013.

All right. So government overall I think you said was 11% of total, and so you're saying the US government is--.

--That's worldwide.

(Inaudible) federal, [is what it is]. So, I mean, there's US government, so you have state and local, and then you have federal. The federal component is a small percentage of our overall government percentage, and that would be -- federal government would really sort of be the one that's most impacted, or most cautious or stalled if the sequestering happened.

Great. That's good news, thanks. I'm happy to hear that. And Nancy, back on the taxes, I'll go back to the transcript. Could you just repeat what the tax rate's expected to be, pro forma, and GAAP for 2013?

35 for GAAP, and 33 for pro forma.

33, okay. Now, I noticed in Q4 the cash flow looked terrific. Your receivables were lower than I thought. Also, taxes payable jumped up. I was thinking it would stay around four, and it jumped up to 12. Does that go back down in the next quarter just in terms of the quarterly payments? If I look at cash flow for Q1, is there a reversal of that in Q1?

It won't go up. It might be something similar, I think. We make quarterly payments, right? And some of that is, at year-end, you go through and really true up all your accounts worldwide and through all the different buckets, so I think some of that just came from that result of truing up accounts.

Okay. And lastly for me on the pipeline, it seems like you're clearly benefiting from the investments you've made in the past, and it's really -- just to show the kind of growth you're showing in international as well as the US is kind of exceptional. But as you give us guidance and you look out to Q1, can you give us a sense of kind of the focus on the pipeline and what you're seeing as you scrub that pipeline? Does it look as solid as it has in the past? Are you sensing greater uncertainty about the pipeline? What can you tell us, sort of bottoms-up, as you're looking at the pipeline?

You know, we have a lot of different facets when we look at it, right, because we're in a lot of countries, and we play across a lot of segments. So it's just like any other quarter. There are some puts and takes in different regions, depending on that. I think we continue to see, as you mentioned earlier, good results from previous investments that we've made, and then we have a lot that comes off the balance sheet, right? So not anything a lot different than we've had every quarter.

Yes. The other thing you can see, you mentioned the investment from the past. I think we'll be starting do some more investment in the last one to two quarter, even this quarter. You can see the headcount growth. Most of this growth is from the sales. So last quarter we grow about 100.

I think, going forward, like we try to match the headcount growth to the company growth, which is in the last, like, two or three years we are kind of behind, so we try to catch up there. So that's probably -- once the team in the position is also take, like, the six core months, even like one or two years to really starting ramp up, so that's where we see the long-term benefit of keeping invest in the growth. But I have to say, they also need a little bit time to ramp up, yes, some of the new people join the team.

And this was included in our guidance.

Yes.

Yes. Okay, thank you.

Walter Pritchard with Citigroup.

Thanks. Most of my questions have been answered, I guess. Just wanted to clarify, on the gross margins year-over-year, it sounds like it's a split, the slight decline you're expecting to the split between product with more flash content, as well as services with buildout of more customer support operations. Is that the right way to think about it?

Right. We gave the range of 72 to 73, so if we do see some impact, it would be from those factors.

Okay. And then, just for the services billings you saw in the quarter, I think I heard -- we were jumping between calls, but I think I heard a higher mix of professional services in the quarter. Could you just make sure that we're straight on what impact professional services had during the fourth quarter?

It's not super-large. We just wanted to call out we're starting to see more of that. So from quarter to quarter, we might see a little bump here or there just because we're closing them out.

Okay, got it.

You'll see a lot more large enterprise -- okay.

Yes. No, no, maybe -- Nancy, go ahead.

Oh, I was just going to say we've seen more large enterprise customers, right, and they require people onsite. We call them resident engineers, and they in general pay for them. But sometimes a resident engineer has to complete the project before we can take the revenue, right, so it has a little more lumpiness than our regular service or subscription, which is amortized out ratably.

Okay, got it. And then, I guess Ken Xie, for you two questions, one on acquisition. Should I read into your comments that you're looking more for revenue in terms of when you say bigger acquisitions? Because I thought of the Company historically as maybe technology tuck-ins here or there. You've been buying -- you've bought some assets in the past, but just trying to get a sense of, when you say larger, that is it revenue that you could leverage through your channel?

I'm not quite clear the question.

Yes, I don't--.

--I guess what I'm asking is are you looking to buy revenue in larger acquisitions.

No, I think that first we tend to be more careful on the large acquisitions. And second is really we believe the growth we have, that the product advantage we have is -- we don't think that revenue is really the one we target. We try to see what's the future, how to leverage the current -- the product we have, and so that's where, so far in the acquisition, we are more like some technologies, some IP, some team there. We don't see the revenue as really kind of as [long-term] advantage. It's really more -- I think for this company, we try to more target investing in the long-term instead of the short-term revenue and a number. We feel, once we have the long-term advantage and build a solid foundation, that that's probably more important than some short-term numbers.

Got it. and then, Ken, just for you on -- just so we think about STN and sort of that architecture there, your products, your software is very integrated in with your own hardware and so forth. I'm just wondering how you look at operating in a world where you don't get to count on your own ASIC to execute in security enforcement and so forth. How do you abstract away your FortiOS and so forth away from your ASICs, your new world where you might be operating on a more commodity platform?

Yes, I think that that's where the network space probably was starting changing but still in the very early stage for the other STNs and (inaudible) in there. The difference about this company, and also like compared to some other networking company, even my previous company, is really with the ASIC we try to go to the application, go to the content side, and that's what STN, they try to separate what's the content and what's the routing like command and control side.

So I think that's where the architecture we have drives well -- [feed] well for the long-term some separation about data and the control. But I have to say, I still more in the lower layer, even if separate control on the data, still more in the layer three, layer four. We try to more address into the content and application, open up the packet, try to see what's inside. And so that's still above -- way above the current STN are addressing right now. So the layer we address is much higher, much deeper, and also it's beyond even both STN and some other networking [ST] device drives today.

I mean, to be clear, do you have to extract that away, or do you have to operate in a world where you're executing on somebody's else's hardware architecture, or is that something you don't envision having to do because of the way security appliances may still be deployed?

Yes, we are. We both -- involving in both, like the STN, the IP [basics], and all the others [since]. And that seems really for our appliance, our solution, the box, really, they all including all the network layer function there. So that's where -- and also, we kind of [particularly] had to go through the lower layer to address the higher layer, like layer six, layer seven issue there. So that's all in the -- so we are very involved in the STN, more involved in IP basics, but address the changing the whole network landscape there.

Great. Thanks a lot.

Thank you.

Walter, we hope you feel better. You don't sound very good.

Thanks. Yes, working on it.

Rob Owens with Pacific Crest Securities.

Yes, this is Ben calling in for Rob. And I was just -- honestly, most of the questions have been answered by now, but I was curious regarding the gross margin, specifically the service margins throughout the year, whether those are going to ramp similar to what you're getting with the operating margins, considering you were saying that there's going to be more investment at the beginning of the year.

Are you thinking that service gross margins would be different than 82%? Just trying to understand the question.

Well, you talk about (inaudible) investments at the beginning of the year and how that margin (inaudible)--.

--Right, but it's really in the sales and marketing component, not in the gross margin.

Okay, so the (inaudible)--.

--The service (inaudible) -- we've added headcount. I think the thing here was is that we've been making investments in services here for more than a year now. But I think at this point, we're expecting things to really hold from where they were in Q4.

Okay, great. And my other question was regarding the DSOs. Where do you typically target DSOs, and is there anything that we should be thinking about as far as how those might change in 2013?

No, our DSOs stay pretty relatively within a range, so nothing different from the range itself, 65 to 70.

75.

Yes, 75.

Okay, perfect. Thank you very much.

Sometimes (inaudible).

Nick Romano with Andor Capital.

Yes, hi, thank you. I have a couple questions. The first is I was just wondering if you could talk about whether you're expecting greater than usual seasonality when you look at Q1.

From Q4? It's about similar to previous years.

Okay. Well, it seems in the past that you guys have been only -- the worst one I've seen in the last few years was down about 3% sequentially. I don't know if that means -- could there be some large deals that were pulled into Q4 and you guys (inaudible)--?

Are you sequentially quarter-over-quarter?

Yes, did you pull out the patent when you calculated it?

No, but that's, what, $2 million?

Just in the product and the services, yes. I think that changed the percentage a little bit.

I think there's a couple things, Nick. I mean, so one is we're coming off of a very strong Q4, a very strong Q4. It was better than we expected, so that might -- that would sort of impact the quarter-over-quarter growth. I think from a chip -- I think we look at this Q1 as typical from a seasonality perspective in prior years, and our guidance for the quarter is similar to what we've done before.

Okay. Could I just ask you to clarify one thing, then? When you look at Q4, would you just characterize that -- I mean, it was a great quarter. so would you characterize it as just a strong quarter all around, or was there a particular deal or two that you might have pulled in from the March period?

It was a strong quarter all around, and we don't comment on the current quarter.

Okay, excellent. And then, on the operating expenses, just with the -- I don't know if you had answered this elsewhere, but the G&A came down quite a bit, and you guys -- if we do the dollar spend that you guys are sort of targeting for March, it sounds like that ticks up quite a bit from December. Is there a big tape-out coming in R&D, or something along those lines, or what's sort of the progression that goes from December to March? How should we think about that?

So you mixed a couple components there. I'll answer more generally and see if it gets to your question. So we added in sales and marketing resources so that we can get them started earlier in the year and make them more productive by the end of the year. Q4 to Q1, just on G&A, I know last quarter we settled a legal settlement, so I don't know if we have similar legal expenses baked into Q1 or not, but I think it came down quarter-over-quarter from a G&A perspective.

Okay, great, that helps. And then, just lastly, I don't know if you provided it, but in the past you guys have talked about the verticals and what they contributed. Is that something you could run (inaudible)?

Yes. Service providers, 29%, government at 11%, retail, 8%, financial, 12%, and education, 6%.

Okay, thanks very much. Great job.

Thank you.

James Westman with Raymond James.

Hey, guys, sorry about that.

No problem.

Taking a look at the 1Q guide, when I model out services and license and I take a look at it seasonally, it looks like the product revenue is seasonally light. I'm getting about a 16% sequential decrease. I'm modeling about 12% year-over-year there, with about a 2% services sequential increase, and that's getting into the midpoint. Am I thinking about it the right way?

I'm asking my guys.

What was the second part, on the services sequential?

Yes.

Sure. So I'm modeling about 2% services growth sequentially, and then I'm modeling the product line about 12% year-over-year, which gets me a 16% sequential decline. But that seems--.

--Yes, it's one thing (inaudible)--.

--You guys have -- I'm sorry, go ahead.

Oh. So one thing that happens in Q1 is our services revenue amortizes daily, and there's 92 days in Q4 and 90 days in Q1, so that kind of results in a little bit of a slowdown between the two quarters.

And then, we also had the higher than normal professional services revenue in Q4 that we're not expecting in Q1.

Okay. So I guess the question is, I mean, A, am I looking at license the right way? With that much of a seasonal decline, you guys have usually done about a mid-single digit decline in that quarter the last three years. But, I mean, with those comments, are you guys still expecting services to grow sequentially next quarter?

I think it's probably going to be flat.

Flat to even down a little bit, potentially.

So services next quarter could be flat to down, what, low single digits, maybe (inaudible) digits?

Yes.

Yes, little bit.

Partially due to the days and partially due to the professional services.

Okay, so flat to low single digits down (inaudible) for you guys for the services line in Q1?

Yes.

Okay.

Yes, it was -- I'm just trying to think through it. I thought your product was a little low, so I get it.

Okay. Yes, if I am -- I'll play with it, but yes, that -- okay, so that's good to know for services. And then, just for the record--.

--You know, feel free to shoot us a question if you have more later.

Yes, and then just one last one, just looking at revenue for the rest of the year. Any reason revenue for the rest of the year wouldn't come out seasonally? Any factors we're not thinking about?

None that I know of, right? We went through the past two years. I think we're thinking about it pretty similar to the way it's occurred in the past two years.

Yes, and we'll give sort of an update every quarter, because I think there's, obviously what Nancy said, none that she knows of, or none that we know of. There's uncertainty that you can't necessarily predict in Q1, so we will give an update every quarter.

Okay, sounds good. Thanks, guys.

Catharine Trebnick with Northland Securities.

Oh, hi.

Hey, Catharine.

Thanks for taking my question. Yes, and I got in late, so pardon if I ask a question again. Could we just go back to this competitive landscape, and -- well, first of all go back to the number of deals. You had said that there were several over $1 million. Are you quantifying that? Is there a comparable I could look at in 4Q 20--?

--Yes, we quantify it as single-low double digits, (inaudible), yes, sorry.

Low double digits.

Low double digits.

Yes, but Catharine, we haven't given out -- what we've talked about in prior quarters is that the number -- we had several deals over $1 million, and those deals had been growing, and also they were growing in size, so $1 million versus $2 million or $3 million. So this is the first quarter we've talked about sort of where they -- gave some sort of a perspective on how many we have.

Right. And then, you had said it, and then did I hear that right, 100% growth year-over-year?

Yes.

Okay, thanks. And then, the other question is just some context and color that I thought was interesting. You had said that from a domestic piece that you've pretty much built out your channel, and that internationally you have some good channels, and that was different than one of your competitors, Palo Alto. Can you name, like, your top five channel partners in the United States?

We don't really give that out.

I know. I just had to ask. Sorry. I thought I'd try it. You never know.

Do you want their contact number, too?

Yes, definitely it'd help out. Well, you know how (inaudible) I can be. I'm a little tired here. So no, that was about some of them, and then just quickly in overall, just so I have this right, you're saying that the billings growth is 19%, your midpoint in revenue 18%, and that's pretty much where I'm at, so it looks like then I'm right in line.

You are.

Oh, and then back to Nick Romano's question, did you give a full year on your vertical markets, or you just gave the December quarter?

No, those are quarterly. That's a quarterly.

That's a metric we give on a quarterly basis.

Okay, got it, then I have it in the right column. All right, thanks a lot. Oh, one more thing, billings by geography, I missed that.

Let me find the slide here real quick.

Americas, $54.7 million, EMEA, $53.5 million -- oh, what does she want? Oh, I'm sorry, I'm sorry. Okay. So Americas billing by geo, or billings by geo in Q4, Americas, $68 million, EMEA, $66.9 million, and APAC, $39.4 million.

Thank you very much. Good quarter. Congratulations. Nice job.

Thanks.

Thank you.

Dan Cummins with B. Riley.

Thank you. I'll just take myself off speaker here. First, just wanted to say thank you to Nancy, didn't skip a beat here, no loss in quality or quantity of metrics, and we really appreciate that.

We have great employees.

Yes, I'm sure you do, but they're well-communicated, thank you. So my question is around win rates down-market, if you will. I'm always amazed at how many well resourced, loved by the channel competitors have been able to really stick around in UTM. And a number of them have even raised new capital recently. They've attracted private equity. So if you could just talk about your visibility into that part of the market that is more channel-driven, perhaps, and your own awareness of win rate and success -- I know Ken Goldman talked a lot about concerns that Fortinet may be overlooking opportunities to consolidate share faster down-market. Thanks.

We don't really track win rates and loss rates, so it's not a metric that we see. I wouldn't say that we see any newer, smaller competitors coming in that are changing what we're doing. I do know that we're working with some of the channel partners that service the lower end of the model to see how we can increase share, particularly maybe take some of Sonic Wall's share, but that's probably the extent of what I would have as information.

And the same comment you made previously about the market not being price-driven overall, would you assert that that's -- is true as it was 12 months ago in -- I mean, let's say the lower two-thirds of the market?

Yes. I believe -- I've been here for a while now, and we win on performance and we win on price performance and total cost of ownership. I think a lot of people, when we starting explaining some of the ROIs to them, doesn't matter what space we're in. It's not that some aren't more competitive than others, but think we see more we want to focus on marketing in the upcoming year, and not broad marketing, right, but target marketing to get us into more deals so that we can continue our wins.

Okay, and then just one final question. Are there any the large deals -- the very large deals over the last several quarters that have an expected falloff, or kind of a last big order sense to them that you can see in the next two to three quarters?

No, we don't have anything similar to what we experienced from a large deal that we signed in 2011 that continued into 2012, don't have anything like that currently in our forecast.

All right. Thank you.

Thank you.

Michael Turitz with Raymond James. (Operator instructions.) Erik Suppiger with JMP Securities.

Yes, two quick questions for Nancy. One, can we assume that the ratable revenue comes down by $1.9 million, be about $1.5 million in the March quarter?

Yes, the Q3 and Q4 both include the patent, so [ultimate] ratable, so you should take that out for your ratable run rate.

Okay. And then, secondly, your DSOs were good, but you said that you had good collections in the quarter. How was the linearity in the quarter?

We don't really talk a lot about that. I'm not so sure -- our collections team is just phenomenal, right, so even when I look at collections, I'm not so sure it would have had anything to do with linearity. I think they just went out and collected the money.

Can you comment whether linearity was consistent with past quarters?

It was.

Okay, very good. Thank you.

(Operator instructions.) Presenters, I'm showing no additional questioners in the queue. I'd like to turn the program back over to you for any additional or closing remarks.

No, I think we don't have any closing remarks, other than saying, again, thanks for your time in joining the call. We had a lot of good questions. And yes, certainly feel free to contact me -- it's Michelle -- if you have any additional questions.

Yes. We also have a few investor conference we are attending in the next few months, so where we're (inaudible).

And the RFA Trade Show's coming up.

I was going to say, RFA's coming up.

(Inaudible) very visible here.

Okay, thank you.

All right, thanks a lot.

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