Fortinet's CEO Discusses Q1 2014 Results - Earnings Call Transcript - Q&A Session

| About: Fortinet, Inc. (FTNT)

Fortinet, Inc. (NASDAQ:FTNT)

Q1 2014 Earnings Conference Call - Q&A Session

April 23, 2014 18:30 ET

Executives

Michelle Spolver - Vice President, Corporate Communications and Investor Relations

Ken Xie - Co-Founder, Chairman and Chief Executive Officer

Drew Del Matto - Chief Financial Officer

Analysts

Aaron Schwartz - Jefferies

Gregg Moskowitz - Cowen & Company

Jason Noland – Baird

James Wesman - Raymond James

Melissa Gorham - Morgan Stanley

Jonathan Ho - William Blair

Erik Suppiger - JMP

Kazim Andac - Deutsche Bank

Robert Breza - Sterne

Sterling Auty - JPMorgan

Michael Turits - Raymond James

Operator

Good day, ladies and gentlemen and welcome to your Fortinet Q1 2014 Earnings Financial Analyst Q&A. At this time, all participants will be in a listen-only mode and then we will go into a question-and-answer session for which instructions will be given at that time. (Operator Instructions) And as a reminder, today’s conference is being recorded.

And now I’d like to turn the conference over to your host, Michelle Spolver.

Michelle Spolver - Vice President, Corporate Communications and Investor Relations

Hi, everybody. Thank you for joining the second call in half hour after the other one ended. Before we start, I have Ken Xie and Drew Del Matto here with me in the room. And again, the purpose of the call is to answer any of the remaining questions that you have. Before we start, a reminder that all forward-looking statements made during this call are subject to the disclaimer I read during our earlier call.

So with that, I think we can open up the line and take some questions.

Question-and-Answer Session

Operator

Okay. (Operator Instructions) And we will take our first question from Aaron Schwartz from Jefferies. Aaron, please go ahead.

Aaron Schwartz - Jefferies

Hi, good afternoon. You obviously – and I know you covered this on the last call, but saw very good traction with the large deal flow. And Drew you sort of alluded to this, but in the fact that you are seeing I guess a mix shift in your business towards large deals and I guess that’s related to the dedicated investments in the enterprise team here. Can you just walk through how you manage the pipeline differently, how you sort of manage the sales funnel etcetera, because those are always lumpier and the timing is a little bit more difficult, but just how you sort of manage that process given the shift in the business?

Drew Del Matto

Yes, I will do that, Aaron and also probably take you through kind of what’s changed, because I am saying to people that, that’s a bit – I don’t know the dynamics, but we are building process I think is the way to say it and adding headcount. So it creates a bit of complexity until things normalize is one way to think about it. But yes, so – I mean, quite frankly we are using salesforce.com more religiously probably than it’s ever been used before here. And so that happens globally and people domestically may do that differently than people in the Southern Hemisphere or the Eastern Hemisphere or the eastern part of the world. And it takes a little bit of time to get everybody online and get using the same process and doing it in the same way and us analyzing it and being able to make valid conclusions on it in the same way. It’s a bit of kind of getting the pulse to go and get it to beat at the same cadence and then making sure that we are kind of watching that, if you will.

The other thing that’s changing is, I think we are doing a lot more – we are spending more on marketing, let’s say. And as we drive campaigns, we are trying to monitor those campaigns and the turn of those into leads as we invest in generating ads from campaigns, let’s say, online ads, whether it’s on LinkedIn or as you read some article, we know you had some interest in our products of network security and we serve you an ad and then we are monitoring that – those types of situations. And you do that in a variety of ways, but we are linking tools to do that so that we can monitor those investments through to SSD – through the salesforce.com, excuse me, SFDC, salesforce.com and then ultimately through to the billing. And again, new people, new process just kind of takes a while to get it, I would say, normalized and working in a consistent manner globally.

Aaron Schwartz - Jefferies

And I know – you know you are newer to Fortinet, so maybe this is a question you can’t answer, but as you go through that process and I think this question sort of hit on with the guidance question on the first call, but is there a different sort of coverage ratio that you think of until you get comfortable with the process or different sort of conservatism that you take just given if there is a mix shift you just timing of large deal flows is obviously tricky for anyone?

Drew Del Matto

Is that in terms of – are you asking that with respect to guidance?

Aaron Schwartz - Jefferies

Yes.

Drew Del Matto

Basically how conservative is the guidance?

Aaron Schwartz - Jefferies

Or is it a different sort of coverage ratio you think about with the sales coverage versus the plan or how do you...

Drew Del Matto

I think there is two questions in there. I’ll try it this way. Look I think we’re very comfortable with guidance. I think what we can see the forecast certainly supports our guidance. That would be how I would answer that question. In terms of coverage model that’s variety of questions because that could go to how many accounts per rep, if you will and that is something we’re looking at. You know, we feel like right now we have a lot of accounts to cover and probably not enough people to cover them efficiently. And then the second – then there’s ultimately a piece of that in terms of what’s your FC ratio and so forth and so on. You know, I think we’re starting to figure most of that out. I think there’s still opportunity for improvement and I think as we get – Ken and I are trying to be very metric focused as we go through this and we’ve done some – you know that feels like we made some progress last quarter and to be true some of that was in place before I came here. But there is a focus of improving it.

And I would say Ken just working with Ken to share a little bit, you know, he’s very focused on measuring ROI as much as anyone. And people as a leader I think that translates throughout the organization. So he’s a great leader on that front. I think it makes it very convenient for us and makes probably my job a little easier and the marketing job a little easier as we try to implement these things and tracking them because he expect that we do that and that’s from the top of the company.

Ken Xie

And also, Andrew, before joining Fortinet he worked with Symantec I guess much, much bigger company for nine years. So that’s why he know the space better, know the model better and also a lot of like the service-based model. So that also helped Fortinet growing going forward. So that we see as a – we much better shape compared to like a couple quarters ago.

Aaron Schwartz - Jefferies

Great, thank you very much.

Drew Del Matto

You are welcome, Aaron.

Operator

Thank you. And our next question comes from Nandan Amladi from Deutsche Bank. Please go ahead. And if you will check your mute button, your phone maybe muted. So we will go with our next question coming from Gregg Moskowitz from Cowen & Company.

Gregg Moskowitz - Cowen & Company

Okay, thank you very much and congratulations, everyone on a very nice Q1. I guess the first question is you alluded to some vertical areas where your current coverage is a little light. And I am wondering if you could elaborate on where you see particular opportunity there?

Michelle Spolver

I am sorry, go ahead. So I don’t know that we alluded to areas that were light. I think we talked about there were certain areas that we saw better or bigger opportunities and where we are putting our investment focus. One of those areas is the enterprise I think is what we called out.

Drew Del Matto

Yes. I think we called it out, but Gregg, I think there are opportunities in a variety of the verticals the ones you would go to. And not to try to bind ourselves too much, but clearly, areas like healthcare and financial services are opportunities that probably any company would be looking at as they create their coverage models and be focused. I mean, if you look at the – just the general IT spend in those areas, I mean, those are obviously areas that would be of particular interest.

Gregg Moskowitz - Cowen & Company

Okay, that’s helpful, Drew. And then within the high-end obviously very good performance there and you talked to some of the components, I guess, I am just kind of wondering it sounds like service providers continue to strengthen enterprise, obviously, you are seeing more traction, but just kind of wondering how you might sort of parse the strength there, whether it be across enterprises versus MSSPs versus telcos, just if you have a little bit more color around that?

Michelle Spolver

I think, service provider I wouldn’t say continued to increase. We continued to see sort of a stabilization or normalization in spending with service providers that took effect really in Q4 of last year. So, if you look at sort of the mix of our vertical mix, service provider gained a percentage point, it was 25% in Q4, 26% in Q1. So we saw a bit of growth there, but not a lot and the large deals indicate that we saw a lot of growth. So therefore, we saw sort of most in attraction within the enterprise, large enterprise.

Drew Del Matto

Yes. And I think the deals – we picked the deals and the script that we shared to be a good reflection of kind of what we thought was a good reflection of how the business felt to us or appeared for the last quarter. I think, there was – we mentioned a variety of enterprise, some service provider, and a little bit of MSSP in there as well. And I don’t think there was a big mix shift. I think definitely there is a tailwind as we invest in the enterprise, I don’t know that tailwind is the right word, but we are actually obviously getting some traction there as you can see in the deal stats.

Gregg Moskowitz - Cowen & Company

Okay, perfect. And my apologies if I was a bit off on the service provider commentary just jumping across back-and-forth between multiple calls tonight. And I guess just a couple other questions, Drew, any thoughts I guess on this point as to how 2014 CapEx may shape up?

Drew Del Matto

Yes. Actually, again we are not giving guidance, but we are guessing that for the next three quarters, I think we are going to spend about – we figured about $15 million for the rest of the year in CapEx...

Ken Xie

On top of our normal.

Drew Del Matto

Yes, on top of our normal run-rate, because about a $15 million and we still have some building costs left. Here we just moved into our new building. We have a solar project going on here. I think it’s like $4 million in there. And then we are also going to start an ERP project at some point. We haven’t really started that yet, but that will start. And so it’s about $15 million more than probably the prior year, the run rate. Yes.

Gregg Moskowitz - Cowen & Company

Okay, fantastic. That’s great. And then just lastly either for Drew or for Ken just wondering if you had any update on the COO search? Thank you.

Ken Xie

We still open – still going on and also like we review that’s the area we can also improve in the company long-term, but like I said, we don’t want to rush into someone in our position, but we still open searching right now.

Gregg Moskowitz - Cowen & Company

Perfect. Thank you very much.

Drew Del Matto

You are welcome, Gregg.

Operator

Thank you. And our next question comes from Jason Noland from Baird. Sir, please go ahead.

Jason Noland - Baird

Thank you. And just a follow-up to the previous question, would this role – the COO role be focused on internal ops or external sales and marketing activities or a bit of both?

Ken Xie

Probably more towards the field outside. And but also – depending on background also probably help internal, I mean also would be helpful, but is so far we see how to help in the – if we look at company spending probably somehow in this network secure space, the sales and marketing is the biggest spending probably even like double, triple the spending on R&D and some other outside. So that’s where we feel if there is a way we can be more efficient and also better return on an investment and now more aggressive invest. So, that’s where the sales and marketing and also build a bigger capability, that’s probably the area we want to have the position to be more focused. At the same time internal, we also see the team starting to do much better improving this area.

Jason Noland - Baird

Okay, thanks Ken. A question on NFV, we hear a lot about the potential for architectural change in the networking market with SDN and NFV and carrier. In the carrier market, do your customers engage with you in regards to network function virtualization? And do any of them tell you what they’re uncomfortable with a custom basic in preference to off-the-shelf hardware? Just wondering how much this comes up with your carrier customers.

Ken Xie

I think first, we use an older CPU, older network processor chip whether like Broadcom, Qualcomm whatever available on the market – the same as our competitor. We never lack of any usage of the commercial chip on the market. And then in addition to that it’s what makes unique for Fortinet also gives us a lot of advantage is we also build our own chip because network security market is relatively small compared to what the network in some other server market – PC market. And that’s where almost no chip companies try to build a chip dedicated for the network security, which also needs heavy processing power to process all these security functions. So, that gives us a much better performance advantage and also we can offload the CPU or other network processor from the market, so we can offload that to the basic chip. And that gives us like a huge advantage compared to some other company just using software to do the job, which whether it would be slow on the CPU or the CPU cannot handle module function, security function or the virtualized function, network function of SDN in a sense. So, that’s where – in the platform side, we have a better platform more performance, better function, more function compared to the software-only using the standard PCS server to do the job.

On the other side, I still feel the virtual network function NFV, and some other SDNs still relatively early stage and market – whole market set still kind of not quite defined yet. That’s where – if you look in the report like a couple weeks ago from Gartner, they say in like 2017, probably three years from now, the whole network security still less than 10%. Doing the virtualized deployment, that’s where like in the data center and enterprise are in this care service provider, so still relatively small. So that’s where I believe the platform we have gives us more advantage compared to the software standard server because we do use all the latest CPU, process chip but just additional ASIC boost performance beyond the CPU and network process can handle give us much better advantage and also free up the CPU to handle some other functions.

Jason Noland - Baird

Okay.

Michelle Spolver

The only thing actually that I would add, Jason, is that, I think the first part of the question is, do we engage directly with carrier customers? We do. So I mean that type of deal and that in terms of the size of those deals, we would engage directly with. And then the other thing is that from a stats perspective we’re in pretty much all of the top carriers in the world and the reason, the primary reason that they buy Fortinet is for the performance, which is enabled by our ASIC. So I understand the question but I think the answer is more than comfortable dealing with us and our technology approach.

Ken Xie

Yes, that’s where you will see like a semi-competitor introduce some chassis-based solution earlier this year. I have to say they are way behind and also they are still using the standard server, which is difficult to survive in the high-speed high redundant like carrier environment. So we are doing this, while we have dedicated chassis, dedicated hardware for 10 years now and kind of dominant in this carrier space. So far we’re not seeing a software-based competitor. They can able to really compete or survive in this environment of high-speed and high redundant environment.

Jason Noland - Baird

It makes sense. I appreciate all the color.

Ken Xie

Thank you.

Operator

Okay, thank you. And our next question comes from Michael Turitz from Raymond James. And Michael, if you would check your mute button at this time.

James Wesman - Raymond James

Hey, guys. Sorry about that. It’s James sitting in for Michael. I had a couple of questions on the model. First, Drew, I wanted to make sure I heard you correctly on CapEx. Did you say that you’d spend $15 million on top of the normal run rate for Q2 through Q4 or is that for all of 2014?

Drew Del Matto

Q2 through Q4.

James Wesman - Raymond James

Q2 through Q4? Okay, thanks.

Drew Del Matto

You had it right other than that.

James Wesman - Raymond James

Got it, okay. Then I had a comment – sorry I missed it I been going back-and-forth on a couple of calls, you had said you were comfortable with 14% growth consensus for the year but was that figure for revenue or for billings, or for both?

Drew Del Matto

What we said was, one, we are not giving annual guidance. We said that we’re just kind of directionally telling people that we believe we can grow 2x or better of the indicative benchmark how Gartner and IDC are calling the market, call those the benchmarks of 6% to 7%. So those kind of come up to the 14 range as you’ve seen we’ve been obviously Q1 is doing better than that. And I think Q2 is north of that as well.

Michelle Spolver

Yes. And the 14% number was the high end of that as a market growth range.

Drew Del Matto

Yes.

James Wesman - Raymond James

Okay. So basically no change, it’s you are keeping the 2x guidance?

Drew Del Matto

Yes.

James Wesman - Raymond James

Okay. Taking a look at cash flow, for cash flow from ops, I mean, is there any reason that shouldn’t grow in line with net income for this year?

Drew Del Matto

Yes. So we gave you – well cash from operations, I see. Yes, let’s see, the tax rate, I will give you maybe – does it help to just kind of give you where we see the anomalies?

James Wesman - Raymond James

Sure.

Drew Del Matto

Yes, I think so. I think the one thing that’s always the wild card by the way is collections. We obviously had a good collections quarter in Q1. Somebody asked me the question about linearity. You can see that the benefit of the linearity kind of shows up in Q1. So hard to predict how those happen to Q4, but I think that’s probably reasonable to assume we will have a similar pattern to the prior Q4 in terms of how that works.

In terms of cash tax, I think for the year, we will end up spending I believe about $36 million to $37 million, call it, $37 million. And we guided a kind of one-time payment last quarter of 18 in Q1 that we actually did make. It was roughly in that range. I think we have paid about $23 million in taxes overall last quarter. With the anomaly, there was a one-time true up piece in there that gets you up to that amount. And so that I can’t think of any other anomalies on cash from operations, you have the inventory turns number to the north, so that can vary quarter-to-quarter a little bit, but that’s how I would think about it.

James Wesman - Raymond James

Okay, great. Thank you, guys.

Drew Del Matto

Sure.

Operator

Thank you. And our next question comes from Keith Weiss from Morgan Stanley. Keith, please go ahead.

Melissa Gorham - Morgan Stanley

Hi. This is Melissa Gorham again for Keith Weiss. So just a follow-up question for Ken on competition, specifically related to Cisco, just wondering if you are seeing increased competition with Cisco just given that they have Sourcefire now and that’s integrated into the business? Is that change how you feel about Cisco from a competitive perspective?

Ken Xie

We have not seen much in the last couple quarters after Cisco acquired Sourcefire. I think first we are not quite direct competing with Sourcefire before the acquisition. And after that we also don’t quite see much change so far. On the other side like Drew mentioned like a 70%, 80% of enterprise customer really looking for the network security they want to buy from like a non-networking company. They try to be different, like deployment compared with the traditional network deployment they have their. So that’s also making a lot of enterprise they need to have a different vendor, different layer protection.

Drew Del Matto

I think, Melissa, this is Drew. Just a little bit of color on it. I think the point of that is the best-of-breed matters in this space clearly in security and we obviously have a network performance advantage vis-à-vis our competitors and certainly Cisco. The longer term, when best-of-breed matters, their ability to focus on security when they are doing all these other things we believe that that’s potentially an advantage for us, generally becomes diluted focus over time when big company acquires a small company so I’m sure they’re doing fine so far but I guess we’ll see how it goes longer term.

Ken Xie

Also from the function part if you look like more than 10 years ago when we started the UTM multifunction firewall, which already have the intrusion integrated long time ago more than 10 years ago, so far after Cisco acquired Sourcefire probably they put a lot of effort trying to integrate that into their existing firewall but we have not seen much in the field yet.

Melissa Gorham - Morgan Stanley

Okay, that’s helpful. That’s it for me. Thank you.

Ken Xie

Thank you.

Operator

Thank you. And our next question comes from Jonathan Ho from William Blair.

Jonathan Ho - William Blair

I know you guys went through this on the call, but I just wanted to make sure I understood the accounting around the agreement not to sue from Palo Alto. Can you maybe walk through that transaction just help us understand exactly where the different pieces fit? And then we will go from there.

Drew Del Matto

Sure, Jonathan. Is that – are you asking – I think you’re asking about the accounting question. How we’re treating it from an accounting perspective?

Jonathan Ho - William Blair

That’s right. So the $20 million – I mean it shows up in cash flow but then where does it show up on the balance sheet? What amounts this quarter is it amortized?

Drew Del Matto

Yes. I am not staring at the balance sheet but there is going to be basically a year’s worth. So think of it this way, we are amortizing it over the period – the six-year period evenly so much 20 – what is it, 72 months and six years, if I get my math right here?

Jonathan Ho - William Blair

Yes.

Drew Del Matto

So whatever $20 million is divided by 72, that would be how much per month that will go as will be contra-expense – contra-OpEx. And then we basically, so we pay them. So we obviously credit – yes, they pay us. Excuse me. So we get cash, if I get that right. So the cash appears on our balance sheet. And then the other side of the ledger is appearing on what you would call accrued liabilities. I am sure it shows up in accrued liabilities and some – and there are some current portion of that and there is some long-term portion of it. The current portion would be one year’s worth at any given time. So I think that was roughly – I think I saw the number when I was reviewing it, roughly $3 million or slightly north, so something like that.

Ken Xie

Yes. And also...

Jonathan Ho - William Blair

About a year’s worth?

Drew Del Matto

Yes. So 20 divided by six years would be about $3 million. Yes, it’s about $3.5 million.

Ken Xie

Yes. This is really that continued after – that since the – like three years ago, there is – I think it’s a $6 million payment. And then also looking in the last few years – and I will not say every quarter, but every year we have a multiple like IP kind of income because we are very strong and we are innovating the space and start a lot of technology and product. We are the pioneer really early in this area, which some other company may try to follow. So that gave us a very, very strong position on IP and technology.

Jonathan Ho - William Blair

Got it. That’s it for me in terms of questions. Thank you.

Drew Del Matto

Sure, Jonathan.

Operator

Thank you. And our next question comes from Erik Suppiger from JMP.

Erik Suppiger - JMP

Yes. Two quick questions. One just on the LTE opportunity, you said that you are not seeing much of that at this point, do you think that you are going to start seeing some of those deployments this year or is that beyond 2014?

Ken Xie

I think first what I’d say is really I see the first tier also probably more in U.S. than not quite as some deployment yet. But if they do accelerate a lot of testing and we do see the second tier, third tier and also some other international region started doing in early stage, because if you try to do the cloud, a mobile solution, especially securities mobile device, it probably goes to the carrier, the LTE, that’s pretty much only like variable solution today. So that’s where – and also we see some other vendor, they initiated, they called a clean pipe that’s where we try to help the enterprise to add additional layer of protection from an infrastructure side. That’s also starting. I think it’s probably some European country a little bit ahead compared to some U.S. first tier carriers right now.

Erik Suppiger - JMP

Is there a testing at this point, first tier carriers? Does that mean that you would expect deployments within the year, within 2014?

Ken Xie

There is testing going on, but I cannot give the timing of when we will be landing the deal.

Erik Suppiger - JMP

Okay.

Michelle Spolver

Yes, and it’s really up to them, Eric. I mean, it’s really not up to us. The testing it’s thorough testing, it will take some time and there is other things that they are considering, that they have to consider too. So, it’s really up to them.

Ken Xie

Yes, but all I have to say we are ahead of any other player because the speed, the technology, the broader function we offer and also the – I think pretty much all of them now – its already existing customers and which have work of experience, overall solution in the last 10 years. So we are in much, much better position compared to any other – other one tried to get in there.

Erik Suppiger - JMP

Okay. Second question, just to be clear, your free cash flow was $50 million. If we adjust for the Palo Alto payment it would be around $30 million. Do you expect that your adjusted for that Palo Alto payment, do you think that your free cash flow going forward would still be – in the second quarter would had still be below what you were in n the year ago quarter for the June quarter or is there anything going on in June that would cause cash flow to pick up from those levels?

Drew Del Matto

Well, I think CapEx is going to be slightly higher. Let me just – give me just a second here. And yes, so we are going to have about $5 million of cash up – CapEx over the prior year. I think we obviously had a strong collections quarter in Q1. And so I believe we have – I believe AR is lower $20 million going into the quarter versus the end of December. And I would want – you would probably want to take that into account or certainly this change year-on-year, we have very good DSO. So I think that was 59 days versus 66 last year. And so that’s going to be $10 million, $12 million of collections benefit in Q1 versus Q2.

Erik Suppiger - JMP

Okay, so it sounds like...

Drew Del Matto

You definitely have some, you are kind of downdraft, yes, you have got a couple of downdrafts there.

Erik Suppiger - JMP

So it’s going to be considered down significantly from the year ago quarter, the June quarter of ‘13? Is it presumption that you are going to be for the year probably below last year’s free cash flow levels?

Drew Del Matto

Well, again, we are not giving annual guidance, but I think I said earlier I gave somebody that we have spend – I think the DSO thing hopefully you can figure out how that in your model, how you believe that normalizes year-on-year. Clearly, there is a collections delta in Q1 versus Q2. Potentially that normalizes by the end of Q4, right? It’s just hard to call Q4 linearity at this point. But over and above the typical rate, I think over and above we have said about $15 million of CapEx this year versus last year.

Erik Suppiger - JMP

Additional CapEx versus last year?

Drew Del Matto

Yes, versus last year, that would be the big thing. And then obviously you had PAN and you had the tax payment those roughly offset.

Erik Suppiger - JMP

Okay, very good. Thank you.

Drew Del Matto

You’re welcome.

Operator

Thank you. And our next question comes from Nandan Amladi from Deutsche Bank. So please go ahead with your question.

Kazim Andac - Deutsche Bank

Hi, it’s Kazim here for Nandan. I have a couple of questions. One is on the NP6 processor, you mentioned that it’s included in the new hired appliances you released last year. When was this chip released and having appliances today fueled the NP6 chip?

Ken Xie

I think we announced the 3700D in October, end of October last year and then this 300D probably in the end of December. And then the shipments starting ramp up Q1 and then there is a few other (indiscernible) and even the middle range in the process to be upgraded later this year. Thus I think I mentioned that NP6 compared to NP4 on the chip level performance we see 5X, 5X to 10X depends on function improvement. And we have three-chip family. The network processor is more towards the high-end and middle range and then the system chip is more towards the low end, which we refresh the product last year. And then there is also we call the content processor and that’s pretty much the coprocessor pretty much met through CPU. That’s where pretty much apply to all the products both the low and middle and high end, that’s the one like early question that mentioned about. We do use the latest CPU, but this is kind of a coprocessor and also the network processor gave us much more additional performance boost compared to what CPU can do because ones a function moved to this chip they can be more than 10X performance gain there. So that’s where the processor still going on, so every quarter we may have a couple products we announced using the new chip. But is kind of strategy so far is really when we are announcing we want to make sure we have all the inventory we have a lot of planning other things going on the timing we tried to make sure once we announce when customer need it, we have the product available. So that’s the strategy we have.

Kazim Andac - Deutsche Bank

So right now you we have only two appliances the 3700 and the 1500 with the new chip as of now?

Ken Xie

Yes, there is more coming.

Kazim Andac - Deutsche Bank

How long does it take for you to like put that in all your products when you have a new chip released how long is the rollout of that new chip to the entire appliance range?

Michelle Spolver

I think it’s usually about three years I think to go through our whole product line based on ones that use ASIC.

Ken Xie

To design chip, each chip you got to take about two to three years and that during that process that we gradually update sometimes because the better CPU, sometimes but really it’s also the chip will help or lot. It also depend on the timing. And really we are trying to manage the release, not everything come up in one or two quarter, just kind of during the process, we kind of gradually upgrade the product line instead of try to rush out into first few quarters.

Kazim Andac - Deutsche Bank

Alright. Do you guys typically see any kind of refresher product upgrade after you introduce the new chip into the appliances?

Ken Xie

We are putting this way. We are starting to see more opportunity, which leveraged higher performance. That’s where we mentioned the 3700D is the first one in the industry, which has the 40-gig interface in our price. So, we announced like October last year so we see a lot of opportunity, which because so far none of the other competitor or software product, they can deliver this wire speed 40-gig performance in a single interface. And we also mentioned like I’d say – I think this year will be the opportunity to upgrade to the 40-gig to the 100-gig interface, so a lot of things starting into the testing right now, but it’s not announced yet.

Kazim Andac - Deutsche Bank

Got it. And just one sort of accounting change that you have this quarter, so just to be clear there is no change in the revenue recognition your revenues will remain the same as you had previously. You are seeing your operating income will go up slightly, because now you are including the payment sale also when you calculated the operating income?

Drew Del Matto

Yes. So again these are – the only accounting change really was non-GAAP. And yes, the way the prior – it was 6 million over three years that was contra. They removed that from contra expense. So in other words, they took the favorable impact out of OpEx. And so going forward, again these were just non-recurring. I mean it’s a recurring number. And it’s insignificant per quarter. So that will be a contra expense item in OpEx, contra OpEx going forward. Again as we discussed divide the $20 million divided by $72 million times however many months in the quarter that being the reason I said that is because we didn’t have any benefit in January. It just was two months this quarter because we started it in February. And then the other change was we collapsed the ratable line I think – I should just point out why we’re doing this. We collapsed the ratable line into the services and other line. But that has no impact on margins, revenue, anything. There is no revenue to be clear there is no revenue recognition change.

Kazim Andac - Deutsche Bank

But so the operating income is going up. What I want clarify is your OpEx changing or your operating income is going up because now you have higher revenues for your non-GAAP operating income?

Ken Xie

So when I look at the sheet that Michelle just sent around the operating income for the previous quarters is slightly higher in the new presentation?

Drew Del Matto

Yes. On constant revenue, you would have a slightly I think it’s about 30 bps due to this change. It was about 600K a quarter I believe that was contra expense, that’s it, that’s the only change on a retrospective basis.

Kazim Andac - Deutsche Bank

So the OpEx goes down, right? And the non-GAAP OpEx goes down?

Drew Del Matto

That’s correct. That’s correct and no impact to revenue whatsoever.

Kazim Andac - Deutsche Bank

Got it. Okay. Just one final one, I think Ken mentioned on the last call that your exposure to certain verticals is lower in terms of sales capacity? What would be – what verticals would you classify as the ones that you think you need to increase your sales capacity?

Drew Del Matto

Can you repeat the question, please?

Kazim Andac - Deutsche Bank

In the last call I think Ken mentioned that some of verticals you are not as staffed up in terms of sales capacity, what verticals would those be?

Ken Xie

I think Drew mentioned about like finance service healthcare, that’s the two big industries, especially in U.S.

Drew Del Matto

Yes. I think the way we answered the question was, look, I mean, just logically, we are not really trying to define our verticals, I think, on the call yet. But logically, if you look at where the big buckets of IT spend are, you’re going to pretty quickly go to healthcare and financial services, and that would be assuming we take a logical approach that’s where we’d be looking.

Kazim Andac - Deutsche Bank

Got it. Okay, perfect. That’s awesome. Thank you.

Drew Del Matto

Yes. You are welcome

Operator

Thank you. And our next question comes from Robert Breza from Sterne. So please go ahead, Robert.

Robert Breza - Sterne

Hi, thanks for taking the time. Just a real quick simple question, as you’re thinking about the linearity of the year and you talk about growing at 2x times the growth rate, anything you see from just the seasonal perspective, how we should think about our models for either – obviously, second half given that you gave us the June quarter? Thanks.

Drew Del Matto

Yes, again – sure, Robert. The – again, we are going to have to just stick to with what we just said, which is we are looking to grow at 2x or north of the IDC Gartner benchmark of 6% to 7%. Really can’t respond any more than that.

Robert Breza - Sterne

Thanks.

Operator

Thank you. And our next question comes from Sterling Auty from JPMorgan.

Sterling Auty - JPMorgan

Yes. Thanks. Hi guys. I have been bouncing around between calls as well. So sorry if this is a repeat, but the billings growth in Asia, I think you mentioned a tough compare, but you mentioned Japan was good, China was good, were there any areas in Asia that lagged behind and maybe what’s happening there?

Michelle Spolver

Sorry. Sterling, repeat the question one more time?

Sterling Auty - JPMorgan

He was asking the question. Sterling was saying he heard that China was good…

Michelle Spolver

Yes, we don’t break out anything more in terms of percentage of contributing to business other than we’re trying to give color of what regions did well and in Asia, clearly Japan – what we have said is Japan is the biggest most significant contributor to that region. China’s very small and part of – overall part of APAC for us.

Drew Del Matto

Yes, I would just share, Sterling, we had a bit of organizational change over there. Not going to mention countries and so forth, but there probably was a little bit of impact of that from that as well.

Sterling Auty - JPMorgan

Okay. And then Ken, technology wise, heart bleed has been obviously in front of everybody’s minds. Did you have any exposure in terms of the exploit in the products? Number one. And number two, did perhaps that open up the door for you, especially seeing as how a couple others did have some other exposure, did you that give you some opportunity to go talk to customers about your solutions?

Ken Xie

I think our solutions can protect that one long time ago. And also we have like a special protect all the data center of e-commerce, all this area. So, I think combined FortiGate and some other we have that we call complimentary of FortiGate like a FortiWeb did EOS so is very nice deployment solution and that’s actually starting – definitely starting to raise more interest in how we can protect their – like the data center or e-commerce center there. So, that’s where since awareness of sometimes are quite dangerous to do lot of whether the e-commerce whatever or the Internet, so you need to have better protection in all the sense. I think, we see some more interest in this area. And also the product up in there, even before the news come out has been protecting all the customer already, so that’s where we see so far customer base is happy with our solution.

Sterling Auty - JPMorgan

Okay, thank you.

Operator

Thank you. (Operator Instructions) Our next question comes from Michael Turits from Raymond James. Michael, please go ahead.

Michael Turits - Raymond James

Hey, guys. Just a follow-up on the cash taxes issue, I think you said $37 million cash taxes for 2014 after you guys paid just $25 million last year. So, could you remind me why that’s been as accelerated payment this year and what it might be in 2015, because I’d hate to run that out?

Drew Del Matto

Well, yes, it was a true up, Michael. Obviously, we – if we had a better number going forward we would be accruing it now. We would be – you would have to build it into your – either GAAP or non-GAAP tax rate, your non-GAAP actually over time. So, this was just a true up from things from the past. And we assume the best that is that we do our taxes correctly and we don’t have true ups going forward. So, I wouldn’t predict that – it wouldn’t obviously be wise to predict that there is some tax true up going forward, although look, I mean, quite frankly there is always something, I am sure if we were looking at past, but I would expect that’s in the normalized rate and that we would get back to that going forward.

Michael Turits - Raymond James

Should I think after this is kind of like a 35% GAAP effective tax rate and the same thing on cash taxes, 35% of GAAP?

Drew Del Matto

Well, I think we are saying 30 – for again, we are not giving long-term guidance, but I think 33% is the right rate to use for non-GAAP. And then the cash rate for the year I don’t really – it would be hard to give you the cash, the actual cash tax rate, but I can give you the number, which is the 37%.

Michael Turits - Raymond James

Well, I am trying to figure out going forward after that, what’s the safe way to model 2015 and afterwards, I know you can’t give guidance but...

Drew Del Matto

Yes, I haven’t thought out that far, Michael, in terms of how that would look. You would have to look at pre-tax income and I haven’t modeled that out.

Michael Turits - Raymond James

Okay.

Drew Del Matto

So, I would use – I mean just to play it safe, I would use the 33%.

Michael Turits - Raymond James

That’s what I want to do. Okay, thank you very much.

Drew Del Matto

Yes.

Michael Turits - Raymond James

Okay.

Operator

Thank you. So I am showing no further questions at this time.

Michelle Spolver - Vice President, Corporate Communications and Investor Relations

Okay, great. Well, thank you everybody for joining both of our calls. Appreciate it. If you have any further questions, feel free to reach out and I am happy to answer anything else we can.

Ken Xie - Co-Founder, Chairman and Chief Executive Officer

Okay, thank you.

Michelle Spolver - Vice President, Corporate Communications and Investor Relations

Thank you very much.

Operator

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

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