Good day, ladies and gentlemen and welcome to the Fortinet Q4 Fiscal Year 2011 Earnings Announcement Conference Call. (Operator Instructions) As a reminder, this conference may be recorded.
And I would now like to introduce your host for today’s conference Ken Goldman. Sir, you may begin.
Hi, great and good afternoon and thank you for joining us in this conference call to discuss Fortinet’s financial and operating results for the fourth quarter and full year 2011. Joining me today are Ken Xie, Founder, President, and CEO of Fortinet; and Michelle Spolver, Vice President of Corporate Communications.
In terms of structure of the call, I will begin with a review of our operating results before I turn the call over to Ken to provide additional perspective of the performance of our business. I will then conclude with some thoughts on our outlook for the first quarter and full year 2012 before we open up for the questions.
As a reminder today we are holding two calls. Following this call, we will hold a second conference call to provide an opportunity for financial analysts and investors to ask more detailed financial questions. Second call will begin at 03:30 PM Pacific Time and will also be webcast from our Investor Relations website and is accessible as detailed in the earnings release.
Before I begin, I know you are waiting for this. Let me first read the disclaimer. Please note some of the comments we make today are forward-looking statements, including those regarding the financial guidance for the first quarter of fiscal 2012, our ability to execute on our 2011 momentum, market opportunities and pipeline, expectations regarding renewals, service revenue, product revenues and ratable on other revenue, impact of investments on our sales and R&D teams, expectations regarding non-GAAP gross margin and our cash balance expenses, expectations regarding inventory levels and hiring trends, and expectations around our competitive position, market awareness, market share and macro-economic environment and demand for security solutions.
These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in these forward-looking statements. Please refer to our SEC filings, in particular, the risk factors described in our Forms 10-K and 10-Q for more information on these risks and uncertainties and limitations apply to our forward-looking statements. Copies can be obtained from the SEC or by visiting the Investor Relations section of the website.
All forward-looking statements reflect our opinions only as of the date of this presentation. We undertake no obligation and specifically disclaim any obligation to update forward looking statements.
Also please note that we will be discussing certain non-GAAP financial measures on this call. Our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and on slides 15 through 18 of the presentation accompanying today’s prepared remarks. Please refer to our website for important information including our earnings press release issued a few minutes ago and slides that accompany today’s prepared remarks. A replay of this call will also be available on our website.
So relative to Q4 2011 financial results, I am very pleased to report that Fortinet had a great fourth quarter, which was ahead of our expectations and represented a very strong finish to a record year. Our performance was driven by high growth in network security and UTM markets, solid execution of our business plan, our superior product offerings and market share gains across all geographies.
Combination of these factors has been a driving force behind Fortinet’s success since we have been a public company and has contributed to two consecutive years that we have meaningfully overachieved each of our primary financial objectives, including billings, revenue, profitability and free cash flow. Moreover, we have met or exceeded our quarterly for eight consecutive quarters.
We are in a large and a growing market. Security sector remains healthy with robust demand, and our core UTM market is one of the fastest growing segments within the space. Our stated goal has been to grow faster in our core market, which is growing a little less than 13%. Fortinet grew at more than twice its level in 2011 with growth accelerating (inaudible) and as we expanded our footprint in key segments, such as large enterprise and service provider.
We are well positioned in the fastest growing segments of security market and our total adjusted market is increasing. We are growing simply faster than major competitors.
And recall in 2011, there were few areas of business that have received particular attention from investors during the year, including billings growth and renewals, traction enterprise and EMEA performance. We previously shared that we expected the metrics to improve in each of these areas and you will see by financial results that we did exactly what we said we would do. In fact, we overachieved.
The bottom line is our business is strong and is right here where we experienced non-recurring issues we delivered. And let me really go through a few of those that we did talk about this past year.
First in billings, we had a strong finish to the year from a billings perspective. On our 3Q call, we said that we expected billings to accelerate in Q4 in part due to high renewal activity that coincided with seasonality. As anticipated, (indiscernible) didn’t factor, so we did in the fourth quarter to $140.6 million representing year over year growth of 27% and exceeding our guidance of $131 million to $135 million.
In addition, with new business gained, our deferred revenue balance as of December 31 increased $20 million compared to September 30, 2011. Second, Fortinet is winning in enterprise and high end markets, which currently accounts for roughly two-thirds of our business. We saw particular strength in penetrating large enterprises during Q4 (indiscernible) the numbers of large deals over 250K grew 24% year over year. Additionally, as we remind you in 3Q, we had significant enterprise deal which was the largest in the company’s history.
Growth in enterprise and high end is primarily due to Fortinet’s ability to deliver continuous innovation and unmatched performance through our customized ASICs. We offer one of the best (indiscernible) firewalls available and we are deploying a significant number of them in the enterprise environments.
We’ve talked about several of our next-generation firewall wins in large enterprise environments in past calls and during Q4 we had several more that I will mention later. However, I want to highlight one of the largest enterprise next-generation firewall wins we had in the quarter.
It was a multi-million dollar deal with a large healthcare organization in North America that’s working to consolidate share days (ph) reduce costs to enhance service. They require upgrade firewall solutions selected multiple Fortinet products, including FortiGate 2140 and FortiGate-5001B high end chassis systems along with FortiManager and FortiAnalyzer products.
We beat out Cisco and Juniper because we were the only global vendor who could provide integrated firewall, IPS and application control at very high performance levels.
Finally, we achieved solid growth in the fourth quarter, with billings and revenues increasing 17% and 22% respectively on a year over year basis. As we communicated, much growth in EMEA we had during Q2 was predicated by several one-time occurrences. Growth accelerated during the remainder of the year through the solid execution of our sales team in the region and ongoing demand for our market leading products.
We executed extremely well in 2011 and our financial results demonstrate this as shown on slide 3. Before diving into Q4 financial results, I’d like to put our annual performance in perspective and highlight how we delivered against our initial forecast we provided in our fourth quarter call the prior year.
Billings. With regard to billings, we shared initial billings guidance at $440 million to $460 million (indiscernible) ended up achieving $476 million total billings, up 27% compared to the prior year. Revenue, we also surpassed our revenue guidance, comparing full year revenue of $433.6 million in 2011, up 34% year over year. This compares to initial guidance of $370 million to $385 million and note that our initial guidance did not include approximately a $20 million positive impact from change of revenue recognition rules at the beginning of the year.
In terms of profitability we significantly outperformed our original expectations. We delivered non-GAAP operating margin of 24.4% and non-GAAP EPS of $0.45 for the year, well above our initial guidance of non-GAAP operating margin of 19 to 20%, non-GAAP EPS of $0.31 to $0.32 which is also adjusted.
We achieved this despite continued investments in sales, support and R&D. We also had over the course of the year favorable FX impacts on our expenses, primarily in Canada and Europe. From a cash flow point of view, we are in a great position from a cash flow. We ended the year with $539 million in cash. We generated $135 million of free cash flow in 2011 which represents a 36% increase year over year.
If we adjusted free cash flow to two items, excess tax benefit and amortization of investment premium, the number would increase to $142.5 million (indiscernible) can be our free cash flow. During this call, we will refer to this metric as adjusted free cash flow. Please see the reconciliation – on slide 13 for a reconciliation of adjusted free cash flow to cash flow from operating activities.
Cash generation continues to reflect (indiscernible) our questions, profitability, working capital management (indiscernible) of our business model.
Let me now provide some high level thoughts on the fourth quarter. In terms of some of the key numbers for the fourth quarter, you can see them on slide 4. Billings were $140.6 million, an increase of 27% year over year, exceeding our guidance of $131 million to $135 million. Reminder that we billed worldwide U.S. dollars, or those that are not impacted by FX fluctuations.
Revenues were $120.9 million, up 29% year over year, exceeding our guidance of $114 million to $116 million. Non-GAAP operating income was $32.4 million, up 40% year over year. Non-GAAP operating margin was 26.8% exceeding guidance of 24% to 25%.
Non-GAAP EPS was $0.14, exceeding guidance provided of $0.12. Free cash flow was $30.7 million, $0.19 per share. This amount does not include the $10.6 million excess tax benefit which by the way did increase quite a bit from Q3 and prior quarters and is relcassed (indiscernible) to the financing section of the cash flow statement.
If you include this tax benefit and offset by 3 million amortization of investment premiums, adjusted cash flow would have been $38.3 million. Also as projected last quarter, we increased our inventory balance by approximately 3 million to address entry level and mid range product shortages. Importantly, we also settled our patent litigation with Trend Micro for one-time cash payment of $9 million. We paid this amount to Trend in Q4 and we were occurred no-food (ph) related cash flow since we amended the agreement through 2015.
So the majority of this amount was already accrued and expensed in prior periods and during Q4. As a result of this settlement, we will save on future royalties as well as legal costs going forward and that creates certainty of expense. This lump sum cash payment is excluded from cash flows similar to the end related $3 million patent settlement payment we received in Q1 of 2011.
To summarize, we had great fourth quarter we delivered. We exited 2011 with solid sales pipelines, we remain confident in our ability to execute and build deployment momentum during 2011.
So in terms of going through the P&L now for Q4 income statement, billings were $140.6 million, an increase of $29.6 million, 27% compared to the same period last year. Strong service renewals in Q4 led to a $20 million increase in deferred revenue balance.
Geographic breakdown of billings growth, Americas was 36% in terms of growth. EMEA was 17% and APAC 20% compared to Q4 2010. Americas and APAC each delivered another strong quarter, we experienced acceleration in EMEA’s growth again this quarter compared to earlier in the year.
On slide five, you see product segmentation. High end products accounted for 38% of products billings compared to 35% in Q4 last year and 37% for all of 2011 driven by continued traction of large enterprises and service providers.
In terms of deal size breakdown, the number of large deals grew in all categories during Q4. Number of deals over 100,000 in Q4 was $192 million. That compares to $142 million for Q4 of the prior year. Number of deals over 250K was 57 million compared to 45 million. Number of deals over 500K was 15 million compared to 13 million.
With regard to the quantity of deals over 500K, deals in 2011 were much larger than 2010 in aggregate amount. In addition, we had number of deals of $1 million or more during the quarter.
In terms of billings by key vertical, as reminder, earlier this year, we began to break at approximate billings by top five verticals, service providers, financial services, healthcare, retail and government. These were best estimates given we sell through channel. So I will ride through these numbers quickly as Q4 and the full year per vertical.
Service provider Q4 was 28%, for the year was 25% to 30%. Government, 14% for Q4, 15% for the year. Retail, 8% for Q4, approximately 10% for the year. Financial services 8% for Q4, approximately 10% for the year. Education is 7% for each and healthcare 4% for Q4, approximately 5% for the year.
In terms of (indiscernible) revenue, revenue was $120.9 million in the fourth quarter, which was up 29% year over year. On 6 and 7, you can see geographic split of revenues. Our revenue continues to be diversified quite well globally. In Q4 we saw a health growth across all geographies which enabled us to exceed our revenue targets.
The geographic split of revenues calculate use of bill-through address as I noted. Americas came in at $146.3 million, it was $35.9 million for our year, increasing 29% year over year. Key driver in our strong performance overachievement in Americas is continued traction of large enterprises and service providers both in terms of new customer wins in addition to security new deployments for the existing customers.
One of the biggest deals this quarter was a multi-million dollar deal we won with existing service provider customer, which is a U.S. Fortune 20 company. It puts a large array of Fortinet products to serve at the platform deliver security and gateway services, the cloud, colocation sites and private node customers. It’s the multi-phase deal that we won against (indiscernible) from Juniper, McAfee, SourceFire due to breadth of our UTM security functionality, virtualized offerings and superior performance we operate and our integrated solutions.
Among our net new enterprise wins, was the Fortune 100 company, one of the most well known technology companies in the world. It’s part of the network (indiscernible) refill for industry specific search engine division, this company with a very high performance advanced firewall that can support an extremely high volume time-sensitive transactions in a high bandwidth (indiscernible) per second environment.
We won that against Juniper, we won based on the superior and unmatched performance of our FortiGate high end appliances. The Americas, both Latin America and Canada performed exceptionally well during the quarter. Similar to past quarter, we had seen the benefits of the investments we have made to build our sales infrastructure. One important win in Latin America was with a large government organization in the healthcare space. They are upgrade in network infrastructure like group of hospitals that require a superior security solution to protect multiple data centers.
They chose Fortinet’s high performance FortiGate products with next generation firewall functionality, and we beat out Juniper, Cisco and Checkpoint.
In terms of EMEA, we achieved $44.2 million compared to $36.1 million in the prior year representing a year-over-year increase of 22%. Trends of EMEA strengthened this quarter. Our EMEA team executed well as we accelerated. The reason was in the quarter was driven by key wins in enterprise and service providers. Strong service renewal and our ability to close deals that have been screwed in prior quarters.
We had another impressive quarter in France, along with certain Italy, Germany, and UK. Continued to make traction enterprise segment in EMEA as well. One large enterprise brand deployment deal we won was with a large (indiscernible) management company which needed to enhance its security to achieve PCI compliance to more than 500 parking sites. It’s likely we will be deploying FortiGate UTM appliances, we beat our Juniper in the six-figure deal.
We also had number of large provider deals in EMEA. One was with one of the region’s largest telecom providers which is in the process of becoming (indiscernible) required security for the cloud-based firewall service. We beat our Juniper and Cisco based on breadth of functionality, high performance and virtualization capabilities.
In terms of Asia, we achieved $30.4 million versus $21.6 million the prior year, increasing 41% year over year. Strong growth in APAC region particularly in China as well as Japan and Taiwan. Across the region, we continue to move up, continue to win more business with enterprises and service providers. One of the wins was with a large enterprise deal with a financial service company in Hong Kong which was consolidating its data centers and required very high performance and low latency next generation firewall (indiscernible) some of their networks. One of which focused on security shredding.
We won this seven-figure two-phased deployment deal against Checkpoint, Juniper, Cisco again based on our ability to provide superior deployments and lower latency firewall technology.
We also won a large multi-phase deployment deal with an existing customer which is one of the leading mobile service providers in Korea. Numerous FortiGate high end UTM appliances will be security and service providers gaming, via phone call and messaging service networks. We won based on our superior performance and ability to support their – an MSRP, Message Session Relay Protocol requirements.
In terms of product revenues, $57.4 million, up 40% year over year. The fees on slide 8, demand for high end FortiGate 1240B, 3040B, 3930B and new FortiGate 1000C products continued to enable us to set well into large enterprise customers. We also saw a nice direction where we can introduce FortiGate 200C and 600C mid range products and FortiGate 20C and 40C entry level products, as well as continued growth with FortiWiFi and FortiAP wireless products.
In terms of services revenues, $61.1 million, up 27% compared to $47.9 million in the quarter a year ago. Service revenue is expected to continue to grow over time due to expanding installed base to customers which drives the increase in our deferred revenue balance.
In terms of renewals, renewals remained in the mid to high 70% range, comparable to where we’re trending all year, because of the history trends, renewals were essentially seasonally strong in Q4 which contributed to the $20 million increased deferred revenue in the quarter. Ratable and other was $2.3 million and as I just noted, continued to decline.
In terms of head count, here is on slide 9, we ended the Q4 with 1,583 employees compared to 1,527 in Q3 and 1336 in Q4 the prior year, so we increased approximately 200 employees last year. So net head count increased 4% on a sequential basis and 18% year over year.
Our head count continues to be globally diversified with approximately 70% of our employees locate outside the U.S. which provides us balanced and lower cost structure. Function, the sales and R&D account for approximately one-third of each with sales head count well balanced across three main geographies. Service and support account for approximately 22% with G&A at 7%, and operations at 2%.
And you can see on slide 10, annualized revenue per employee was $311,000 at fourth quarter, up 10% from the $284,000 in the fourth quarter of the prior year and $310,000 in the third quarter. We effectively grew those by 20% in revenue by 29% year over year and 18% increase in employee head count. Interestingly over the past four years, revenue per employee has doubled, which signifies how we are driving leverage in our model.
In terms of some other ratios, our non-GAAP gross margin was 74% in Q4 which has been consistent. Non-GAAP product gross margin was 62% in Q4, consistent with Q4 of 2010. We do see some variability in this metric depending on miss within product families but we remain comfortable with non-GAAP product gross margins above 60%.
Non-GAAP service gross margin was 85% during Q4 comparable with last year. We do expect non-GAAP gross margin to remain within our target range. One thing that is very important to note regarding gross margin going forward. During the quarter, we settled the litigation with Trend Micro which virtually eliminates the royalties we have been incurring or accruing for the past five years.
Our non-GAAP operating expenses were $56.7 million in Q4, up 22% year over year compared to a revenue increase of 29%. This increase was primarily driven by increase in head count to support our growth. And as a percentage of revenues, our total non-GAAP operating expenses during Q4 were 47% compared to 49% the prior year and 47% during the third quarter of 2011.
Non-GAAP R&D increased 20% year over year to $14.6 million and as a percentage of revenues was 12%. Non-GAAP sales and marketing increased 25% year over year to $56.9 million and was 31% as a percent of revenues. Non-GAAP G&A increased 6% to $5.1 million. As a percent of revenues during Q4 non-GAAP G&A was 4% compared to 5% in the prior year and we do believe 4% expense to revenue ratio is best in class in our industry.
In terms of profitability, non-GAAP operating income was 32.3% and represented non-GAAP operating margin of 27% compared to $23.2 million and 25% operating margin last year and patent sale adjusted 25% operating margin in the third quarter of 2011. This reflects a growth of 40% year over year.
We achieved tremendous in operating income year over year and expenses as a percent of revenues declined 3 percentage points year over year. Other income increased $0.5 million in Q4 and this was primarily due to high interest income from a larger cash balance. Non-GAAP net income was $22.3 million, compared to $17.3 million in Q4, ’10, an increase of 29%.
Non-GAAP diluted earnings per share were $0.14 compared to $0.11 in the fourth quarter of 2010 and this is an all time best for us. Diluted shares outstanding were $164.5 million compared to $160.7 million in the prior year.
The growth rate non-GAAP net income was lower than non-GAAP operating income 29% versus 40% respectively due to the higher pro forma tax rate during Q4 of ’11, 3% compared to 4Q ’10, 27% which includes some catch-up.
As I mentioned in the beginning of the call, there is a full reconciliation between non-GAAP and GAAP results in the earnings release and slides 15 and 16 of this presentation that accompany today’s prepared remarks and for those non-GAAP financial measures that are not described in the earnings press release.
Just quickly a summary of 4Q profitability results, on GAAP basis, GAAP net income was $16.5 million. On a GAAP tax expense was 40%, pre-tax income in Q4 was 40, annual rate from 29% to 32%, as our taxable income increased and deductions remained flat. GAAP diluted earnings per share were $0.10 compared to $0.10 in the prior year.
So for the full year, quickly the summary, billings came in at $475.8 million, increase of 27%. Revenue came in at $433.6 million, an increase of 34%. Product revenue increased to $197.3 million, up 46% year over year. Service revenue $220.3 million, up 28% year over year.
From a profitability perspective, non-GAAP gross margin came in at 74. We controlled cost expenses. Total non-GAAP expenses increased 23% compared to revenue growth of 34% and billings growth of 27%. Non-GAAP operating margin grew to 24% from 20% prior year. And our non-GAAP net income was $73.1 million in 2011, an increase of fully 64% over the non-GAAP net income of $44.6 million in 2010.
Earnings per share for – non-GAAP earnings per share came in at $0.45 2011 compared to $0.29 with split adjusted in 2010.
So let me quickly talk about the balance sheet. This is on slides 11, 12, and 13. We ended the quarter with $539 million in cash, cash equivalents and short and long term investments, $3.27 per share. $36 million increase in Q4 ’11 was primarily due to cash generated from operations. Less than $6 million from exercise of stock operations during the quarter, netting that $9 million Trend Micro patent settlement. Adjusted free cash flow was approximately $38 million.
Cash generated from operations was $22.6 million on a GAAP basis as the 23rd consecutive quarter of generating cash from operations excludes the one-time items. And as shown on slide 13, excluded $10.6 million excess tax benefit and $3 million in amortization of investment premium gives us an adjusted free cash flow of $30.3 million, a $0.23 per share, up 29% from Q4 last year, and which effectively matches our total cash less stock exercises which again as a way we really think of cash flow here in terms of increase in cash less two financing activities.
Free cash flow also reflected $2.9 million increase in inventory related investment product inventory throughout Q4. And revenue net AR increased $19.7 million to $95.3 million from $75.8 million in Q3. This was really due to $22.2 million in billings quarter to quarter. DSO came in at 71 days. Inventory net decreased by $2.9 million to $15.9 million from $13 million in Q3. Net inventory turns were 4.4 compared to 5.2 in Q3and 3.9 in Q4 of ’10. APP&E (ph) increased to 8 million compared to 7.5, again remains relatively modest.
Deferred revenue balance increased to $294.8 million, up $42.2 million, 17% year over year and $19.7 million or 7% sequentially. Deferred revenues during 2011 would have been approximately $20 million higher, if not for the new revenue recognition rules.
Our services deferred revenue balance increased $22.4 million offset by a $2.3 million decrease in our ratable balance which will continue to decline in the future quarters. Short term deferred revenue increased to $206.9 million, up 22% year over year and up $14 million versus Q3. And our long term deferred revenue increased to $87.9 million, up 6% year over year and up 5% versus Q3 of ’11.
I would also remind you, under the new revenue rules, short term revenue and long to be deferred over several years. So let me summarize.
Fourth quarter experienced what was an exceptional year for Fortinet. We significantly outperformed across all metrics relative to expectations we laid out at the beginning of the year and frankly during the year. Our business is doing well. Network security environment is robust driven by trends such as increase in threats, mobility, broad based applications and managed security services.
Fortinet continues to lead one of the highest growth segments of the market and we are growing faster than that market and gaining share. We continue to sell our high performance UTM and next generation firewall solutions gives us a significant performance of interests over our competition.
In a moment, Ken will talk an exciting announcement we made today that validates we have the world’s fastest firewall. Additionally, have the comprehensive solution portfolio of complementary UTM products is growing and provides us with opportunity to address the broader $10 billion network security market. Our vertically focused go to market approach and sales team and ongoing product innovation continue to drive us success, penetrating large enterprises and service providers broadening our global footprint and expand into new verticals. I will discuss the guidance in more detail there but first let me turn the call over to Ken to provide a more color on overall market and our competitive edges.
Thank you Ken and thank you everyone for joining us on the call. Fortinet in 2011 was strong with a great execution in the growth of our Q4 and the full year. As Ken noted, we again exceed our finance projections, grow our market share, further our penetration in key vertical and extend our innovation in several new product introduced over the course of the year.
So having been in the network security for more than 20 years, I witnessed this resilience regardless of the market condition. So security has remained among the top spending product year after year. So I am happy to say that right now is no different. The network security market is healthy and robust and Fortinet is in a great position to continue to succeed, and again market share, not only in our core UTM market but also in the other network security market that we address. So we have the best and broadest security platform available to leverage both the latest industry standard processors and server across our own FortiASIC to provide additional performance boost that other vendor cannot offer today.
In terms of the market opportunity, for UTM as Ken mentioned, our intention has been to outgrow this market and so far we have grow more than doubled and has been significantly outpaced our major competitor. IDC’s most recent data show, Fortinet continue to lead the worldwide UTM market with 18% market share and we have had consistent share gain in each quarter. So Fortinet also has a great and growing position in overall network security appliance market. We are among the top five large vendor in the entire of the market share. So this including a standalone firewall IPS and other network security is about $10 billion market as Ken mentioned.
And finally, our total addressable market opportunity also extend to the market we serve with our portfolio of non-FortiGate product, including web security, the database security, email security, and endpoint security to just name a few. So we got asked often why we went and enable to succeed in growing so well.
So first is the performance. So early today we made a trend setting announcement a third party testing by BreakingPoint proved that FortiGate-5140B is the world’s fastest firewall. So when tested in real world traffic condition, including a standard network as well as the web 2.0 application traffic.
We delivered up to 559 Gig of throughput. This is approximately three times faster than our closest competitor. We will be showcase on the replicating this test in RSA show next month. So come and see it in our booth.
As I mentioned early, our massive performance is made possible by leverage both the latest industry’s processor and server plus our own custom network and content FortiASIC chip to provide additional performance for optional and further security scanning and a lot the additional feature, we cannot result affecting overall performance. As a result, Fortinet offer the best performance in the industry and this is a key factor of why we are winning in the enterprise and the high end.
Ken walked through a number of customer win against the competitors where our low latency firewall and multi-giga performance was a key criteria and clearly set us apart from competitors. And one example of such win in Q4 was with a Europe leading finance service exchange. This was a existing customer and again selected our high end performance and low latency firewall and (indiscernible) mission critical platform. So we displaced and won this deal over Juniper and Cisco based on a mass speed and a low latency of our FortiGate solution.
The second one is the presence of functionality and flexibility of FortiGate appliance. So Fortinet offer a broadest array of network and the content security functions in our network security gateway, which enable and proceed in the choice for customer select the technology that best fits their needs by providing capability and easy upward pass for the future.
In addition to our market leading FortiGate security gateway, we also offer a fancy family of a complementary security product, including web application, database, email and endpoint security, as well as the management and analysis and ability of scanning and assessment. And while this product represent a small portion of our revenue today, sales of the FortiGate product are growing quite and represent a future opportunities.
So the third party product certification is something we and our customer value very much, and I am proud to say that FortiGate of Fortinet hold the most certification than any security vendors. And in addition to the recent breaking point task (ph) which validate our massive performance. We also hold the technology and product certification from ICSA Labs, BB100, the common criteria ICSA Lab as we’re after ISO 9001 certification which validate our product development and operation quality.
But perhaps the most important is that Fortinet path is our innovation. So with more than 1000 employee and engineer related role, we are constantly innovating and deliver new technology edged product. So we recently announced few new product, including the FortiWeb family and some other new FortiGate. So this added product allows in 2011 expand and enhance our solution portfolio.
Additionally, we also have a array of new product of FortiASIC chip under the new version of FortiOS operation system coming out this year that will both expand our solutions and continue to reach the security performance even higher. As we move into 2012, I am confident in our position and opportunity in front of us. Fortinet is well positioned to continue to grow and gain market share and remind our competitive force in the industry as we continue to execute well and deliver innovation and have helped to fuel our growth and the success to date.
So now let me turn the call back to Ken Goldman who will take and discuss our finance outlook for Q1 and rest of this year.
So I will be quick now. Before reviewing guidance let me remind you that our guidance consists of forward-looking statements and please keep it in mind my earlier comments regarding such statements.
Turning to guidance, as we begin 2012, we are excited about the deals in our pipeline and we believe there are many growth opportunities lie ahead for the company. While there continues to be some level of volatility in the global economy, we believe the macro environment entering the year has proved somewhat compared to where we said a year ago. Equally and more important to mention network security solution is quite strong and Fortinet’s competitive position in market where it continues to strengthen.
We’re now a much more substantial company with nearly $500 million in billings and over $500 million in cash, 18% market share with continued share gains driven by innovative and visionary products and consistently strong execution. Combination of these factors provides us with confidence to increase our outlook for the full year 2012 as compared to initial views we shared on our last quarter’s call.
At the same time, we’re still early in the year and do not want to get ahead of ourselves. We expect to provide quarterly updates over the course of the year as we continue to gain more data points and visibility. Also the adoption of new revenue recognition rules in 2011 gave us benefits to revenue that we will not get in 2012. All things considered, our increased guidance for 2012 is also off a higher base due to our strong Q4 results. So therefore our expectations are for the year, billings to be in the range of $565 million to $575 million, mid-point puts us at approximately 20% growth for the year, again allowing us to gain further market share.
Total revenues to be in the range of $505 million to $520 million, mid-point puts us a growth rate at 18% for the year compared to our initial view of mid to high teens we shared in last quarter’s call. As we remind you, we will not see the favorable year over year benefit of the new revenue accounting rules during 2012.
Gross margin approximately 74% and operating margin would be comparable to 2011 at 24% for the year. Both at the top end of our target ranges. We expect our operating margin increase over the course of the year as it’s seasonally low in the first quarter due to certain payroll related tax expenses, combined with the fact that we play to continue to invest for growth.
EPS to be approximately $0.48 to $0.52, based on our expected diluted share count of approximately 167 million to 170 million. From a adjusted free cash flow perspective, we are targeting in a range of $160 to $170 million for fiscal ’12. We put in guidance as adjusted free cash flow which accounts for excess tax benefits resulted from option exercise under our employee equity incentive plans since it more accurately reflects the company’s free cash flow generation capabilities.
We expect to have a cash balance of over $700 million by the end of 2012. Now turning to our guidance for the first quarter of 2012. I would also remind you that we faced keyword headwinds and expenses, higher expense related to payroll related expenses, employee merit increases, less vacation usage. The expense headwinds could be approximately $3 million. In addition, we intend to continue investments in sales and R&D. This comes at the same time seasonally lower revenue in Q1 compared to Q4. That’s still always to be expected to raise of $122 million to $127 million, which the midpoint represents growth at 17% year over year.
Total revenues expect to be in the range of $112 million to $115 million which at midpoint represents growth of approximately 22%, again remind you that we want to get the same sequential increase as we did in Q1 ’11 which resulted from the new revenue recognition rules.
Gross margin expect to remain approximately at 74%, non-GAAP operating margin expected 21% to 22%. Non-GAAP earnings per share expected to be approximately $0.11 based on expected diluted share count in the range of 165 million to 167 million. Adjusted free cash flow expected in the range of $35 million to $40 million. Pro forma tax rate again expected to remain the same around 33%.
So now, I know we will take little bit time. I will turn the call over to the operator for Q&A and just to remind you that we will have another session after this and it’s around 3.30 Pacific to extend – we don’t have time to answer all questions now, so we will handle that time as well. So I refer to the operator.
(Operator Instructions) Our first question comes from Sterling Auty of JPMorgan. Your line is open.
Sterling Auty – JPMorgan
Two questions. First, within the EMEA improvement that you saw in the last couple of quarters, for the fourth quarter, can you talk to where you saw the biggest improvements, by country and how much that it was pure execution versus maybe improvement in end market demand?
Well, I think I referred to that little bit, I talked about it. A record quarter in France, I talked about strength in Germany, UK, and Italy. So those are some of the areas we mentioned. It’s always hard to differentiate the market itself from our own execution. So my sense is it’s probably little of both but maybe little bit more so in our execution because I think we have – some of the things we discussed in Q2 results, we have moved on from, as I noted, I think that contributed to our improved results in EMEA.
Sterling Auty – JPMorgan
I apologize if you said this one as well. But if you look at that region, service provider you had a lot of traction them using it in the managed services. You mentioned a number of times but how much of the improvement is managed services through service provider versus maybe improvement in terms of going through direct distribution to an enterprise?
I think it’s all of the above. There is a number of – we look at certain wins that we feel is represented but I think we have continued to do well in large enterprises in Europe and we did actually well in Europe enterprises as well before. We really saw a contribution of that – those enterprises in the U.S. So we have been doing well in enterprise segments in Europe for quite some time but some of the more pronouncing, if you will, in Q4 were service providers in Europe.
Our next question comes from Walter Pritchard of Citi Investment Research & Analysis. Your line is open.
Walter Pritchard - Citi Investment Research & Analysis
Ken, I was wondering two questions on a number – one, around your product impact on the change in rhetoric from a year ago, what the impact was on the fourth quarter year over year? And then the second question, if you can break out for us your expectations around the excess tax benefit from stock options both in Q1 and the year so we can sort of compare that to other companies’ cash flows to look at that differently.
I am not going to be ready to talk to that. It’s a little hard to – a lot would go in that number, it’s one of the reasons why it’s little complicated. And so when we think about free cash flow, we sort back into it the other way around. We look at how much cash we’re going to grow and we look at how much we gained from stock exercises. My sense is it will be less than 10.8 we experienced in Q4. So maybe 78 but honestly that number is hard to pin down. We had about $5 million relative to the new revenues in Q4 compared to what it would have been under the new rules.
Our next question comes from Keith Weiss of Morgan Stanley. Your line is open.
Keith Weiss – Morgan Stanley
I was wondering if you could delve into the competitive environment a little bit further. Particularly around Checkpoint and other networks, two vendors that we’ve been hearing a lot. Checkpoint in particular, their entrée into sort of higher end boxes and trying to get further into service provider. Have you guys seen any competition from them in the service provider space and then in terms of how other networks, are you seeing them in the marketplace out there?
This is Ken. Let me answer this one. I think for Checkpoint they do ship them off highest compared before they are mostly in the software and router server. I think their blade strategy makes them kind of more partner starting and to some more in the server market. But the issue is really the server, not really design to be the network gateway. So that’s where the dedicated box pass additional (indiscernible) ASIC that’s helped a lot. Because when you have the servers CPU, if there is a multiple function enabled, that’s starting to come up. So our assumption may impact that with other.
So that’s where the dedicated ASIC chip pass the CPU, CPU is the best possible to do with ASIC in the network gateway. Palo Alto, I think their success in the certain market in like finance service, or certain commerce sector there, so we don’t see them outside this segment and also by most market research firm that the function that they offer just a subset of the UTM. I think that quite a few market researching firm have headache with some function there as the sub-feature set in a broad UTM. So that’s way we see them kind of more successful in this sort of segment.
I want to add to that. The interesting we hear investors deal, you folks hear a lot of noise if you will from our competitors particularly Checkpoint and Palo Alto. And while they’re both doing well, I don’t know if Palo Alto is doing this private but just to remind people that we are growing approximately twice as fast as Checkpoint. So to the extent they think they have taken share, whatever share they are taking, we are taking more of it. So I will remind folks of that and so we are growing at a pretty health cliff, we are a company doing over $400 million in revenue and close to $500 million in billings even though you might think otherwise from some of the noise out there.
Obviously the product release we did today is sort of performance we test, and as Ken and I’d say three times than the number of Checkpoint on that and probably ten times the number of the other network has. So that’s all in a real traffic result application with everything in order big or small sets of packet.
Keith Weiss – Morgan Stanley
My other question was on attach rate. In 2Q and 3Q you were talking about some larger boxes sold into enterprise and service provider space. These were without subscription and press and attach rate coming, can you give us an update on sort of has that leveled off? What direction is that heading in?
Basically they haven’t changed. And again, I think there’s sometimes a misunderstanding of attach rates and where drives are, renewals is more of the seasonality of the renewals and the attach rate. So in terms of, we had about the same in terms of what we call, non-bundled hardware versus bundled hardware. So if anything, it maybe moved to non-bundled but not really much. And so I have the numbers here, what really drives our businesses is it’s a timing of our renewals and how that impacts.
And then over time, to the extent that we do sell more products as really firewalls, if you will, clearly, they would have service with it but won’t have as much as subscription to it. So we still sell service, our tag as we call it, but we won’t necessarily sell as much as subscription service.
Our next question comes from Jonathan Ruykhaver of Morgan Keegan. Your line is open.
Jonathan Ruykhaver - Morgan Keegan
Ken, can you talk a little bit about the dynamics between performance and deep packet inspection, and specifically in high throughput environment, specifically your customers are able to get that deep packet inspection that is required to protect against these web based threats or FortiGate appliance or are they simply increasingly in injury for safer inspection block you are putting several device behind your FortiGate appliance.
I view this type of like a (indiscernible) still may have different technology, like a traditional safer firewall that just look at the packet header and fashion and then there is a deep packet inspection. They do look at some content but that’s a packet by packet. But there is other layer, need to go to the full content sometime the web security needle do the full content, that’s like the virus, some other content who assembled the packet would have full inspection. So that’s where the FortiGate UTM, we have all this as a three layer color. So I think for certain enterprise service provider, they may just – if you connect – try the secured connection, that’s where the traditional firewall is okay. But if certain instruction you have to use deep packet inspection to block certain instruction but for some other web content and virus, it has to the full content inspection. So that’s where Fortinet is the pioneer with all the UTM anti-virus gateway.
So that’s kind of multiple different functions and application in a same path form, that’s the customer can decide when to turn off. So that’s where the testing we did really is because of the addition of full ASIC advantage we have, we are able whether firewall the deep packet inspection or the motherboard inspection, so they are not packet that much because we have ASIC and together with the regular CPU to the acceleration. So that’s the competitor which they totally depend on their CPU which a lot of (indiscernible) CPU. And also CPU is put on a server platform may not be the best for the network security platform.
Jonathan Ruykhaver - Morgan Keegan
To ask the question a little bit differently, we did see June quarter, or September quarter lower in tax rate in goods and services. So did that imply avenue is more just a play in firewall, in either situation, large enterprise environments, is there a separate standalone IPX drive in the next generation firewall device begin deployed?
The big enterprise tend to have a multiple box, even maybe multiple pin behind the different function area compared to service provider SMBs intend to have boxful feature of box depend on what they need. So that’s probably the case. But today the next pack, the new perfect, a lot of blend type they have to be, make sure the multiple box need be working together. So that’s where the UTM, integrated function together they have more advantage than finally the blended attach.
But as I said, the big enterprise – they may choose some dedicated function but the trend we see is moving to the multiple function solution now.
Jonathan Ruykhaver - Morgan Keegan
A quick follow up question. The blade partnership in the UK, can you just comment on why you partnered with (indiscernible) sales activity in the UK and sort of distribution capacity in that region?
There is a small distributor, not quite I think have any impact on us. We also keep on recruiting more and better distributor come to working with us.
Our next question comes from Michael Turits of Raymond James.
Michael Turits – Raymond James
When it was a negative factor billings was trembling. It does seem that for the long term deferred growth more slowed than short term deferred, and glad to see short term is holding and growing just fine. But with the long term deferred growing more slowly are you seeing that contraction in term length and that does that function as a one year basis?
The long term deferred did increase, I think did increase last quarter. Other than that, I think I said many times here, I don’t think there is really anything you can take from that. Sometimes we do long term deals, we are down this really very little you can read into that.
Michael Turits – Raymond James
On cash tax rate, I know it’s term figure out, but I may have missed it but what do you think your cash tax rate was for the quarter for this year and what you are anticipating for the next year?
You ought to assume, we always spent around $1 million or so in cash taxes. And depends on what you use for pre tax income next year. But I am thinking we actually will increase our cash tax next year to the 8 to 10 million potentially.
Our next question comes from Jonathan Ho of William Blair.
Jonathan Ho – William Blair
With regard to your guidance, can you maybe give us a little bit of thought around your growth for 2012 relative to the product segments? Should we expect kind of a continuation of exiting trends or what are your thoughts around just the three segments?
One of the challenges you have on pie chart because to the extent one grows faster than the other, that can be good or bad, again the goal here is to grow all segments, first. Second of all, as you saw we did announce a number more recently that addressed the entry and middle level range areas. And so I am not sure my sense is what probably – but we experienced in Q4 for the year but may not quite as strong as that in terms of high end early in the year. But that’s a little bit of a guesstimate on my part because that’s a number that we sort of comes about at the end of the quarter as opposed to number that we drive during the process if you will.
And also on the technology product side, this year we do have a new FortiASIC come out, every year we have FortiASIC come from industry family, the network processor, obviously some chip. And also every quarter, we tend to have a new platform of FortiGate platform come out and also some non-FortiGate platform. Also this year we have the new FortiOS, we tend to have the FortiOS every two or three years. So this year we will probably have new FortiOS 5.0 will come out by later year.
And it will be a strong product year. But I look at it as clearly we are a company that’s been driven by products foremost. We have pushed the envelope where the market is going, that’s really been the express and strength from a getgo. Coupled with a stronger and stronger sales platform and with a good distribution channel. And I think Ken just noted we look forward to a strong new product with new ASICs and new operating system this year as well. But that’s the history of this company.
Jonathan Ho – William Blair
Just in terms of the sales and R&D investments you guys talked about, for 2012, where do you guys see sort of the leverage points left in your distribution channel, what do you think you can add to?
Are you talking about how we can do better in terms of operating margins over time?
Jonathan Ho – William Blair
I am talking about investments where those are going to go, and where you see opportunity within your current distribution market?
First, the UTM market is about 2 to 3 billion, we are about 18% market share, we are gaining market share every quarter. Also the UTM, if you also kind of address, the overall the network security market is about 10 billion, we are only 5, 6% of the market. So that’s also a lot of room to grow because we feel we have a huge advantage on the platforms , we are still the only company that own a chip with the leverage to latest CPU server and keep the best performance, also the function and also most of the other vendor, that’s I think gaining market share and that’s the focus of this year.
So we gained through structural things, we think over time we will accelerate our business in China. We have entered some of the emerging countries like Russia last year. I think as I look at it, I don’t think it’s a major change, now we just want to fill out if you will, we are already in and continue to execute in some of the areas little bit better than we did in sort of the middle of the year in some of the areas we talked about. So I don’t think there is any real change in our strategy or any new markets, we are actually in most of the ones we want to be at this point. Now the question is filling them up more.
To the extent that we continue to see that we could work with distributors or resellers that better reflect our mission, we will continue to look at it and basically make improvements there.
We also have the partnership with some of our large partners, so that’s obviously we would try to address this year.
Our next question comes from Jayson Noland of Robert Baird.
Jayson Noland – Robert W. Baird
In my model I show Americas down 7%, Ken, sequentially in Q4, is any color you can add there?
Give me a second to look at those numbers. Reminder, we had a patent sale in Q3, I am not sure I have Americas here yet. We had patent sale in Q3 for 2.6, that also affected Americas in Q3 from a revenue point of view.
Jayson Noland – Robert W. Baird
To point out though, I would have expected Americas to come up with Q4 sequentially.
Nothing I can point out at this point in time.
Jayson Noland – Robert W. Baird
On the large deals, 15 large deals, few north of a million, could you talk about your mix by vertical, I think in the past that’s been tilted a little towards service provider and healthcare?
I don’t think the mix – you saw the numbers of mix didn’t really change too much. So by the way the Americas, the ability to keep on increasing quarter to quarter. So we will look at the revenue more, but billings keep on increasing. So I am not quite sure whether the revenue is more but from a mix point of view or industry point of view, nothing substantial there.
Jayson Noland – Robert W. Baird
What’s your calendar ’12 ratable revenue for the new guidance?
I think that has been going down $1 million a quarter. Over time there will be negligible. And maybe 8 to 10 million for the year.
Our next question comes from Erik Suppiger of JMP Securities.
Erik Suppiger – JMP Securities
First off on the model, if I look at the guidance for billings 2012, it looks like you are guiding for the March quarter to be midpoint kind of 17% year over year growth but for the year you are guiding for about 20% growth, is there a thought process or is it too wide we might see some acceleration on a year over year basis?
I think we are always a little bit more sanguine in relative to the forward quarter and the most nearest quarter. I think we look at last year’s Q1 and looked pretty strong to us as well. So we took into account our prior guidance we gave for the year and so forth and Q1, so we felt this was probably the most reasonable thing to provide at this point of time.
Erik Suppiger – JMP Securities
Secondly, there was a number of references to deals where you were competing with Juniper, and I think you have seen a lot of them in the service provider space. Who is the competitor you see most in the service provider space? And have you seen an incremental change in your win rate in that segment of that market in the last quarter or two?
Yeah, we do certainly Juniper and Cisco on the service provider. I would say we have developed a great market share there and in some cases the deals aren’t competitive that might have been previously their installed base. And so it’s almost become run rate business for us, in many not all service providers. I mentioned a few examples where we did compete Juniper or Checkpoint or whatever, would say more opportunities and in many cases MSSP, a much more run rate opportunities where we – pretty much almost all suppliers.
Erik Suppiger – JMP Securities
Has that market picked up in light of Dell’s acquisition of SecureWorks? Has that made any difference?
Not that I can point to, no.
Erik Suppiger – JMP Securities
Any commentary about what revenues you are generating from your non-FortiGate appliances?
It little bit depends on how you define on FortiGate whether you include things like related products like FortiAnalyzer, FortiMail and so forth. Pure non-FortiGate, in order words, FortiGate is probably around 10-ish percent. The related products, non-appliance product, has a higher percentage than that.
Erik Suppiger – JMP Securities
Would you expect that to increase over the course of 2012?
I think the pure non-FortiGate I think that percentage will over time increase.
Our next question comes from Rohit Chopra of Wedbush Securities.
Rohit Chopra – Wedbush
A couple of questions. Just wanted to know if there were any promotion driving some of the renewals or would you say that, that was normal year end activity for the renewal base? And then on CapEx, Ken, just wanted to get a sense of your expectations for 2012?
We don’t really – the other time we do promotions honestly here is when we have end of – (indiscernible) end of life of a product and we want to – we do sell inventories. But we didn’t do anything special at all relative to renewals to incent people to do either renewal this year or multi-renewals this year. No, nothing at all there from the point of view.
In terms of property equipment, I don’t have that in front of me. We have tended to spend anyway from a half to $1 million per quarter, roughly and it hasn’t really changed. Most of that is really test equipments, so we have had to include a lot more test equipments in terms of maybe evaluation equipment but that tends to be relatively modest and just as you can tell from our fourth quarter numbers, tends to just little bit over depreciation which is why net PP&E only got a run off modestly.
Our next question comes from Brent Thill of UBS.
Brent Thill - UBS
Curious if you could just give us your pipeline outlook for the service provider market in 2012 and one of the catalysts moving to 10-gig Ethernet operating cycle in the data centers, how big of tailwind is that for you in 2012?
We don’t really provide detailed pipeline metrics. I would say as we look across, look at the business, Americas and Europe, we feel good about it. Really our product positioning, and our customer positioning relative to continued expand our opportunities and share there. But I am not going to share any specific numbers with you.
Brent Thill - UBS
I think in overall market, the service providers in the network security space, still early stage and also most data centers don’t have any network security measure there because the data center is too huge for the network security gateway to secure it, because network security tends to do more function calculation compared to the routing and some other server. So that’s where – that’s a huge opportunity for any of the network security vendor to address this market.
Our next question comes from Aaron Schwartz of Jefferies.
Aaron Schwartz – Jefferies
I just had a question on sort of the revenue outlook. Last year, you had a similar outlook and you have substantially exceeded that. And part of the reason there is obviously a huge increase in sales productivity. As you look at the plan this year, how much or how dependent are you on just outright sales hiring to sort of meet or outperform the revenue plan relative to sales force productivity increases?
A couple of points. One, just want to make clear that we had almost flattish Q4 to Q1 and again that was because we saw about 4 million in revenue due to the new rules vis-à-vis Q4 ’09 – Q4 ’10. So be little careful in terms of that.
In terms of sales, certainly I would say we are going to bring on sales capacity probably relatively close to what we increased billings. So our sales and billings go hand in hand much more so than revenue. I would, even to the prior question, I just remind people, revenue has to do with as much as mix in the quarter, renewals versus products and so forth. So that’s why – any particular reason revenues may or may not go up quarter to quarter just because of the mix of billings in the quarter.
So in terms of as we go into ‘012 we are aggressively continuing to look at headcount across the world in sales. So there is no change in our perspective hiring aggressively in sales.
Aaron Schwartz – Jefferies
I know you don’t give this metric every quarter but maybe given that we are at the start of the year, maybe you could provide some color on it. Could you provide maybe the mix, if you look at your total deferred revenue, the mix between just traditional maintenance and the subscription component.
I don’t even know, I look at some of our folks in this room here. I think the mix tends to be little bit more so on subscription than in support, and maybe 60:40, but it’s not a number that we really track.
Our next question comes from Scott Zeller of Needham & Company.
Scott Zeller – Needham & Company
I just wanted to ask about the split at the high end versus large enterprise versus service provider. How do you see that trending through 2012? Do you see maybe leaning more towards service provider or enterprise?
Ken may have given perspective. But my own sense is that it may be little bit more enterprise. I think finite numbers, the service providers in the world, whereas the enterprise, I think as we continue to exhibit performance that you saw in today’s press release, I think there is more for us to – more up to us to gain there. I think over time our ability to grow more in enterprise is probably a bigger opportunity than the service provider side.
Our next question comes from Dan Cummins of ThinkEquity.
Dan Cummins – ThinkEquity
This first question is, just a quick one on Europe. How far off the company average do you suppose your European operations will grows this year? I think in the past you have set the target higher than what recent performance had been, how is that progress on that front, and how do you think you are able to do looking ahead?
I would first of all say, we have not initially, Dan, that we set, we don’t really provide guidance by region. And I think I have also commented that in Europe, a market share in most countries tends to be higher on a relative basis than in the Americas that we have less opportunity to grow from a market share point of view and overall growth.
And lastly, Europe, it’s hard to tell the economic environment, certain countries are in recession, others may or may not go into recession. So think my sense is we will continue to have less growth in Europe vis-à-vis Americas or Asic-Pac is, so you ought to expect a growth in Europe should not be as high as other regions in the world, for the reasons I just mentioned.
Dan Cummins – ThinkEquity
And just in mid January, you had a series of announcements around a software refresh, new appliances, I think on the secure mail gateway and then some market entry to new appliances in IP address management. Is it fair to say that you have kind of a dedicated strategy involving some marketing expenditures to really jumpstart these initiatives apart from little bit away your sweet spot in gateway appliances? Is that – could you attribute some of the flat margin guidance to that?
No, the focus still on the FortiGate UTM but from time to time some of our customer and also partner do want us to maybe work closely with some other market segments. You probably mentioned this one way enough the FortiDNS, that’s the one actually we partner with some other vendor and we also have home-grown like a FortiWeb, some other FortiMail, keeping selling together with the FortiGate UTM. But still the focus like Ken Goldman said, like 90% of our business still focus on the FortiGate UTM.
First of all, we said in the last quarter that our operating margins would be comparable in ’012 versus ’11, so now our margins we ended up over achieving in ’11. So that also reflects higher ’12. As you recall, we did several percentage points better in’11 than we had previously expected early in the year. So the key point to think of, we are operating a higher plateau for now if you will, higher marker than we had expected. So when we say guidance relative to constant, it’s certainly up from a higher base. That’s the first point.
In terms of investments, yeah, I think we have been very clear that we want to gain share, we do well, you have seen the numbers from some of the other competitive had announced to this point. And so I think we are doing quite well against all of them relative to growth, market share and so forth. And we still – the nice thing is we still see opportunities for expanding our product line and growing faster and we think that’s the right strategy for us.
Our next question comes from Brian Freed of Wunderlich Securities.
Brian Freed - Wunderlich Securities
A couple of quick questions and mostly housekeeping here. But in terms of the settlement with Trend Micro, can you give any additional color in terms of what impact that might have in terms of operating expense going forward? How much are you spending on legal related debate, had it tapered off somewhat?
I think we never said exactly the legal expenses. I do think we have put in our Qs in the order of $500,000 to $700,000 roughly per quarter is what we were spending for the royalty. So I think that’s in our Qs. And if you go through our numbers, we have a modest amount, we’ll probably put in our Q, we will see relative to going forward, amortization expense relative to go forward. No further cash expense on that and no further legal expense. If a nice pick up if you will in terms of both the certainty of our costs as well as in fact, much lower costs going forward. And it certainly takes the variability out of that number going forward.
Brian Freed - Wunderlich Securities
And the second question, I think you said in the comments earlier that, there was no additional tax until 2015. Is there – do you to renegotiate at that point in time?
All I said is that the agreement extends – basically the agreement extends the same as the original agreement was due for 2015. And all we did is pay up and negotiated license settlement on that. Beyond that, I think all the patents end that we discussed – all the patents that are relevant there end by that period of time. So even though they are not material, they are not valid any more.
(Operator Instructions) Our next question comes from Alan Weinfeld of David Securities.
Alan Weinfeld – David Securities
I was just wondering and you have such a choice, I think 18 different security technologies on, that point, kind of your integrated security appliance, I think everyone wants something integrated today and you always go with the appliance as first option, then the software. This week there is going to be I think the first IPO in the security market in a long time. And there are lot of people who, I guess, think their point products are best of breed but again, you obviously offer the best of breed firewall and then package of everything else. When you do get in there and obviously unseat all these other people who are generally firewall vendors, where the average amount of other products, is there a number or dollar amount, how do you look at it that you are able to kind of cross-sell into that account. And maybe you are able to take out the web filtering person that’s in there or are you able to take out any virus person that’s in there because yours are close enough to be best of breed and everyone wants to get from 50 security and there is down to hopefully 10 in the future.
I think the basic functions still come from the firewall intrusion anti-virus and also the web security. I think that’s because there are still applications, we will have like the web security, email security, that’s till the most target application there. I think compared to other single function box is the advantage probably is lower latency and because also the FortiASIC, that can boost additional function without impact other function there or the performance. So that’s the benefit of the platform we have compared to whether it’s a CPU server based or some other single solution, I think that’s where – it really is the performance, really is the huge advantage we have. Even you have a multiple function but also the performance is also much better than the competitors.
So that’s where because there is a whole network security space also go with the network space themselves. Because the network tend to grow like every two or three years on the speed. That’s where the network security also need to keep pop out of the performance in the network space. That’s where the performance is always the challenge for the vendor, which not only the multiple function impact the performance but also the network itself keeping growth and bust. I think that’s where the performance and also the addition function we can provide.
Alan Weinfeld – David Securities
I was just curious, I knew you have done much better than middle market has as well as your down rate large enterprise. But how many large enterprises, is it Fortune 50, or is flat to the Fortune 100 can actually use the 500 gigs of speed. Is that used by large part of either Fortune 500 or is that really for certain type of customers, maybe 30, 40% of your customers are service providers or just those really, really large enterprises?
I think all the service provider and also most the big enterprise all use 40 gig solution, network solution, that’s where and especially when you target to the data center and also the big, there are a few 100 gig is very popular. Actually the market is huge and – but also most of these few 100 gigs throughput is still insecure, but in the security biased.
This is Ken. I am going to suggest that we have any follow up or further questions that we hold them to the next call which will be about 35 minutes because we have some other things we have to do between now and then. So let me end the call here. Thank you all for listening and again we sent the – Is this the same caller number? Same caller number at 3.30 Pacific Time that Ken and I will also be here with Michelle to answer any follow up questions that you want to ask us. So let me just end it here. And I look forward to those that want to stay on the call, get back on the call, to call back in about 35 minutes. And again, thank you for your standing by this relatively elongated call. Appreciate it.
Thank you. Ladies and gentlemen, thank you for participating in today’s conference. This concludes today’s program. You may all disconnect. Everyone have a great day.
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