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Fortinet (NASDAQ:FTNT)

Q3 2012 Earnings Call

October 16, 2012 4:30 PM ET

Executives

Michelle Spolver - VP, Corporate Communications & IR

Ken Goldman - CFO

Ken Xie - Founder, President and CEO

Analysts

Sterling Auty - JPMorgan

Erik Suppiger - JMP Securities

Keith Weiss - Morgan Stanley

Walter Pritchard - Citi

Jonathan Ho - William Blair

Brent Thill - UBS

Jonathan Ruykhaver - Stephens Incorporated

Jayson Nolan - Robert W. Baird

Robert Breza - RBC

Shaul Eyal - Oppenheimer & Company

Rick Sherlund - Nomura

Aaron Schwartz - Jefferies

Ron Zember - Bank of America

Rohit Chopra - Wedbush

Scott Zeller - Needham and Company

Brian Freed - Wunderlich

Operator

Good day, ladies and gentlemen and welcome to your Fortinet Q3 ‘12 earnings announcement. At this time, all participants will be in a listen-only mode. Then later we will conduct a question-and-answer session, which instructions will be given at that time. (Operator Instructions) And as a reminder, today’s conference is being recorded.

And now, I would like to introduce your host for today Michelle Spolver. Please go ahead ma'am.

Michelle Spolver

Good afternoon everyone and thank you for joining us on this conference call to discuss Fortinet's financial and operating results for the third quarter of 2012. Joining me today are Fortinet's Founder, President and CEO, Ken Xie; CFO, Ken Goldman and Nancy Bush who will be serving as our Interim CFO following Ken Goldman’s departure later this week.

In terms of the structure of the call, Ken Goldman will begin with a review of operating results before turning the call over to Ken Xie to provide additional perspective on our performance of our business and products. Ken Goldman will then conclude with some thoughts on our outlook for the fourth quarter and fiscal year 2012 before we open up to the call for questions of which all of us will be available to answer.

As a reminder, today we're holding two calls. Following this call, we will hold the second conference call to provide an opportunity for financial analysts and investors to ask more detailed financial questions. The second call will begin at 3.30 pm Pacific Time and will also be webcast from our Investor Relations website and is accessible as detailed in our earnings release.

Before we begin, let me read firstly this disclaimer. Please note that some of the comments we make today are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in these statements. Please refer to our SEC filings, in particular, the risk factors described in our Form 10-K and 10-Q for more information. All forward-looking statements reflect our opinions only as of the date of this presentation and we undertake no obligation and specifically disclaim any obligation to update forward-looking statements.

Also please note that we'll 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 slide 14 and 15 of the presentation that accompanies today’s remarks. Please refer to our Investor Relations section of our website for more 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. Note that we routinely post information on our Investor Relations' website and we encourage you to make use of this resource.

I will now turn the call over to Ken Goldman to review Fortinet's third quarter operating results.

Ken Goldman

Very well done Michelle. That was nice to do. Now let me start, this is my last one, so I’ll have some concluding remarks after we go over guys, but thank you all for joining us today on our third quarter call.

Fortinet did have a solid third quarter. Our results were in line with our expectations across our key operating metrics and we delivered a combination of billings growth of 22% along with our Non-GAAP operating margin 25%. Well, the microenvironment remains volatile. Demand in the security market remains strong and Fortinet’s consistently winning and growing share where others in the space are losing share are turning flat. We’re at a good market, you can say a great market, great position with broad range of acceptable products and a strong track record of innovation.

Our advantage is and largely remains due to our extensive product portfolio, variable UTM functionality and unmatched performance allows us to pursue and win a wide variety of deals cross all geographies where those be portfolio (inaudible) management are a subset of that such as next-generation firewall or single function security solutions. Additionally features sets such as virtualization, advanced routing also differentiate us enhanced by the high end high space, areas where we continue to gain momentum during the third quarter. Evidence of this is the fact that we saw 56% increase in a number of deals greater than 250,000 and a growing number of deals greater than 1 million in Q3. We are at the beginning of very strong new product cycle with the launch of our FortiOS 5.0 operating system across mobile products in our next generation ASICs that will be integrated into a number of new products in our pipeline that we’re very excited about.

Feebly these advancements will further standpoint as technology leadership, in addition to driving a continued market share gain. Ken will talk more about this shortly in his prepared remarks. (inaudible) grow twice as fast to market and we believe we’re well positioned to do so based on a combination of a strong product portfolio and investments we make in the business. We have an exceptional track record of executing the public company and are confident about the company’s strategic direction and long-term success.

I’ll discuss third quarter results in more detail. The numbers for Q3 can be seen on slide three. In terms of billings, 145 million, an increase of 27 million or 22% year-over-year. As a reminder, we bill in US dollars, so our billings are not impacted by FX fluctuations. I should note that year-over-year billings growth would have been two points higher at 24%, were it not for the impact of patent sales at actually both periods. 1.8 million this quarter and 2.6 million in the year ago period. These patents do not relate to our core offerings in our limited use for our needs.

Well, I would normalize 24% billings growth as a strong performance and is consistent with our guidance, we did experience a bit more Q3 seasonality, anticipated coming up a very strong second quarter performance in a difficult comparison to last year.

In addition from geographic perspective, we were expecting stronger performance from China during the quarter. The volatility we often face in that market was accentuated by reliance on large deals. We have taken steps to enhance our channel and management sales teams and expect performance there to improve over time. And you may recall that we cite a similar need to improve execution in the UK about a year ago and after making changes to our sales organization in channel, we have reported some record quarters in the UK. We are confident that we can do same in the future in China. All things considered, those growth reinforce the fact that we continue to grow and gain market share, we once again saw a solid increase in new enterprise throughout the year deals as we continue to grow a pleasant to Fortune 500.

Geographic breakdown and billings growth, Americas 21%, EMEA 22%, and APAC 27% compared to Q3, 2011. Excluding the patent sales, Americas billings growth would have been 23%. As you can see, this is very consistent across all of our geographies. And all three regions, exhibit strong year over growth.

Americas had solid performance across verticals and regions particularly in Canada and Latin America. We continue to gain traction in large enterprise market and won a number of next generation firewall in UTM deals with Fortune 500 companies.

In EMEA, we were pleased with our execution despite the economic conditions and some of period seasonality that we saw strong growth in the UK, Germany and South Africa. Our high end products over a number of large enterprise deals as customers look to consolidate the security services and required high performance. In addition, we are very successful in the carrier vertical this quarter and add some key reference customers in the finance vertical.

In APAC, we have record quarters in Japan, Korea and Taiwan, which was partially offset by trans-performance which I' just referred to.

In Q3, in the recent quarters, we've been successfully growing our enterprise sales, repositioning our regional brand from the low-end to mid and high-end. This has led to larger enterprise deals in key verticals. In terms of product segmentation, you can see that in slide four. We saw a nice pickup in our high-end SMB products, which accounted for 36% and 34% respectively of product billings in Q3. A growth in high-end FortiGate products was attributed to strong sales of our FortiGate-1000C, 3240C and 3950B and 5000 Japanese based platform to identify this as service providers. Our entry level FortiGate-40C, 60C and 100D products also gained share. And we sold many entry level products for enterprise branch office deployments. In terms of deal size breakdown, number of large deals in Q3 increased year-over-year in all categories. A number of deals over 100 case for Q3 was 168 in comparison to 130 for the last year same quarter, for over 250 was 61 that compares to 39 in 3Q last year and over half a million was 16 versus 13 in Q3 last year. We also had number of deals of 1 million or more during the quarter and we continue to see more deals larger than 1 million.

In terms of billings per vertical, they were approximately as follows. For Q3 and I won’t go through prior numbers, but for Q3 service providers about 28%, government 11, retail and financial services are also around 11 and education 7.

As I mentioned earlier, we had very good success in selling to a number of Fortune 500 enterprises across key verticals including financial services. This is a market segment we've been aggressively targeting and I want to highlight a few represented 3Q deal which demonstrate success.

First, we had seven figure actuation firewall win for the large bank of North America that was looking to refresh it’s firewalls to enhance network security for datacenter, head office and branch locations. The company chose Fortinet over Cisco due to our highly scalable product line, deeper and more accurate application control and strong enterprise class support.

Demonstrating further tracks and financial services, we also won a multiphase deal with a large global investment trading bank whereby our high-end FortiGate appliances will be deployed in data centers of their numerous trading exchanges to buy 10 gigabit per second firewall. The customer has a complex technical environment that demanded very high performance and low latency, consistent and predictable uptime in virtualized firewall, and virtualized firewall management announcement reporting capabilities.

We won this deal against Juniper who were their incumbent security provider based upon our ability to best meet significant performance and availability in virtualization requirements.

We also had a multi-million dollar days and deployment win for the leading e-commerce company in US that was looking to increase its online payment transaction business in new retail point of sale market while at the same time build merchant and customer trust through faster, more secure transactions. Fortinet beat out Check Point and Cisco due to our superior firewall performance and low latency along with our ability to quickly provide customized management features.

Finally this is what new existing service provider customers continues to grow. In the third quarter, we won a large deal with existing customers with one of Asia’s largest global service providers. They selected our that FortiGate appliances to secure traffic over their 4G LTE network and project their multimedia messaging services network to gain the name Apple Face Time programs. This (inaudible) with Fortinet along with our ability to best meet their high performance and application security requirements enable Fortinet to beat eight other competitors vying for this deal.

So let me now move to revenue. Again, some of the numbers I’m talking to you, you can see, I’m trying to include in our pro-forma numbers, but I’m trying to differentiate so you know our numbers, I can see our numbers normalize for our (inaudible) patent sales. So, total revenue was 136 million in the quarter, it’s up 17% year-over-year to exclude the 1.8 million and 2.6 million impact from the previously mentioned sales, again Q3 of ‘12 and ‘11 respectively, revenues would have been 134.5 are up 18% year-over-year.

3Q revenue records are in the same fast where revenue rules applied in 2011. If you look at this product and services revenue, together they grew 20% year-over-year which both excludes the patent sales and the impacted lower rate ratable revenues and I would argue is more representative of our recurring revenues. From a geography split revenue you can see that in slide 5 and six. Revenues continue to be diversified globally which remains a key strength of our business. In Q3, we saw a healthy growth across all geographies and you can see that again in terms Americas around 42% for the quarter, in terms EMEA around 33 and APEC around 25.

In terms of the geographic split, remember we go by the built to address. In terms of Americas 57.2 million was a 50 million in prior year which increased 14% of your normalize and for the patent sales in both quarters 17%. The Americas region did experience a little bit more seasonality this quarter, especially coming off of a strong over achievement in Q2. We are penetrating large enterprise accounts in the US and that continue to work to improve in verticals such as financial services and the federal government.

EMEA came in at 45.6 was 37.9 million last year, representing year-over-year increase of 20%. APAC was 33.5 million compared 28.5 last year growth of 18% year over year.

Look at now slide seven, you see revenue breakdown product and services. Product revenue of 63 million was up 19% year-over-year tuned by growth across all product segments. In the entry level, our recently introduced FortiGate-100D shows solid growth and our FortiGate-40C and 60C continue to gain share along with their Wi-Fi counterparties at FortiAP line. In the mid-range, we continue to have strong sales on our FortiGate-600C, new 800C products and increased demand from our FortiGate-1000C, 3040B, 3930B and 5000C platforms with large enterprises and service providers.

19% growth is primary result of an usually high product mix in Q3 2011 as a 63 million product revenue in this quarter is up over Q2 and slightly lower billings. In terms of service and revenues, 69.8 million up 21% compared to 57.8 last year. And increased service revenue is as a result of consistent growth and support in subscription offerings, as well as strong growth in a professional services revenues as a result of more large enterprise customers who require onsite resources.

In terms of renewal rates, continued in the mid to high 70% range compared to where we’ve been trending in previous quarters, Q3 renewal do experience seasonality similar to that of our overall business where we generally experience a lower level of renewals in Q3 and high renewals in Q4, in large part due by Europe and a number of co-term contract expire in Q4.

In other words 3.5 million which includes a 1.8 million in the product and patent sale. This revenue category will continue to decline over time as we empathize the balance of the pre-2011 deferred revenue in accordance with our new revenue recognition rules adopted last year.

In terms of headcount, let me just quickly go through. As you see slide eight, we ended with 1,844 employees up 92 from the prior quarter 1,527 in Q3 of last year. We continue to hire deployment and as a result are seeing healthy growth across all our verticals and geographies. So net headcount increased 5%, sequentially and 21% year-over-year.

In terms of revenue per employee, we are pretty consistent. We came in at 301,000 in the quarter which is actually relatively flat over the respective periods third quarter and the year over year.

In terms of, let me now talk about income statements, our overall non-GAAP gross margins increased slightly to 73% from 72% Q2 as non-GAAP product gross margin was 62% in Q3, up 1 point from Q2 of this year and Q3 of last year. Services gross margin was 83%, down two points from last year but consistent sequentially as we continue to make significant investments in our support organizations.

Total non-GAAP operating expenses were $65.4 million in Q3, an increase of 20% year-over-year and includes 1.3 million of one-time legal dispute settlements. Excluding these one-time expenses, operating expenses were up 18% year-over-year and consistent with revenue growth. Increases were primarily driven by the increase in headcount to support our growth and partially offset by favorable FX rates compared to prior year.

As a percentage of revenues, total non-GAAP operating expenses during Q3 were 48% roughly comparable to 47% the last year and 30% during the second quarter of 2012. Non-GAAP R&D increased 17% to 18 million. We continue to invest in hardware, software and on our quality teams. Particularly as you see, the recently released FortiOS 5.0 and some of the new ACIXs.

Relative 2% of revenue is pretty comparable for the respective periods. Non-GAAP sales and market increased 19% year over year to 40.9 million as we expanded our sale teams, particularly in Americas and EMEA. And percentage of revenues during Q3 of this year and last was around 30% of sales. In terms of non-GAAP G&A increased $1.6 million to $6.6 million, primarily related to incur 1 million of expense to settle the litigation matter refereed previously.

In terms of profitability, non-GAAP operating income was $34.1 million, up 9% year-over-year including the patent sales and legal expenses. Excluding these items however, operating income would have increased 18% in line with revenue growth. Non-GAAP operating margin was 25%. We had 27% operating margin in a quarter last year. But excluding onetime items, margins were comparable at 25% as 1.8 patent sales in Q3 this year was offset by 1.6 million on various one time legal sum expenses. While 2.6 million patent sale last year added two points operating margin. I would add that the 1.6 million of legal expenses included 0.3 million in COGS, 0.3 million in sales expense and 1 million in G&A.

Non-GAAP net income was $23.2 million in Q3, compared to 21.7 in 3Q last year, increase of 7% year-over-year, includes the one-time items previously noted. If we exclude the effect of patent sales and one-time legal expenses, non-GAAP net income increased 16%.

Excluding the impact of the patent sales, non-GAAP EPS was $0.14 greater than $0.12 last year and diluted shares outstanding were 167 versus 164 last year. You can see a reconciliation of non-GAAP and GAAP on slides 15 and 16.

In terms of GAAP, GAAP net income was 17.2 million compared to 17.9 in the third quarter. Year-over-year GAAP does include additional 3 million of stock based composition expense and a higher GAAP tax rate compared to 3Q of 2011.

GAAP tax expense was provision of 36% of pre-tax income compared to 34% last year, 36% rate does bring the year-to-date rate to 34% from 33 in Q2.

In terms of balance sheet and cash flow, you can see that in charts ’11 and ’12. And from a cash, let me just mention that we ended the quarter with 690 million, cash equivalents and short and short long term investments or $4.14 per share. Cash generated from operations was 41 million on a GAAP basis. Our 27the consecutive quarter generated cash from operations excludes of one-time items. Free cash flow of 24 million in the third quarter was in line with our guidance includes 40 million that approaches land and buildings at our Silicon Valley headquarters which we closed in Q3. This purchase did not impact our operating cash flow, adjusted for this 14 million, our free cash flow would have been 38 million.

Net AR decreased 5 million to 90 million from 95 million in Q2, DSO were 59 days which is tend to be in the low end and we do seasonally a little bit better in DSOs in Q2. We do expect DSOs generally to be in the range of 65 to 75 days.

In terms of inventory. Inventory again increased by 5 million, 26 million this quarter. We are continuing to invest in inventories to put our growth particularly for Q4 in a void channel backlog and in stock as I said before seasonally high demand in Q4. It also increased somewhat due to the more pronounced billings that I talked about before, more pronounced billings seasonality I talked about before. Inventory balance without incline of our net inventory returns to 3.1. Net PPT increased 26 million highlighted by the 14 million plus for our land and buildings.

Turning to deferred revenues, increased 340 million up 65 million to 24% year-over-year and 9 million sequentially. Sequential increase of primarily now services deferred revenue balance which increased by 12 million offset by 300 million decrease in ratable products. Short term deferred increased 231 million, 4 million in terms of versus 2Q long term deferred revenues increased to 09 million, up 33% year-over-year and up 5 million or 4% versus Q2.

So let me just quickly summarize. We delivered a strong combination of growth and profitability for the third quarter which was in line with our guidance. We had a number of regions that performed exceptionally well as we continue to gain market share and penetrate large enterprise markets across a number of key verticals.

We are especially excited to be embarking a very strong product cycle as we launch our FortiOS 5.0 in new ASICs which we believe will further differentiate and strengthen our position in the market.

Let me now turn the call over to Ken, who will now talk about our products and then I’ll finish up and talk about guidance.

Ken Xie

Thank you, Ken. And thanks for everyone for joining us on our call this afternoon. As Ken shared, Fortinet had a good third quarter and delivered results that was within our target range. Even in light of the macroeconomic challenge that continues in certain countries, so I’m pleased to say, we experienced growth across all regions in the market segment. So we continue in gain traction in large enterprise and closed out several deal with the Fortune 100 companies. And we expand and enhanced our broad security product portfolio, all this has a lead to the market share gain in the overall network security market of which we grow our share 27% year-over-year and faster than any other reported vendor, you can see this on the slide 13 in the presentation.

So a few minutes ago we announced our new FortiOS 5.0 software and the FortiASIC-SoC2, which we are very excited about. So the FortiOS 5.0 is our fifth generation of operation system and bring more than 150 new features to our FortiGate, FortiManager, FortiAnalyzer, and FortiClient products. So this makes Fortinet more competitive and able to meet the demand of the large scale enterprise, specifically in the area of advanced threat protection, security management and mobility.

The major firmware release come from Fortinet average suite of four years and each release build up on our release in pioneer in innovation. So, you can look by the history over the last 10 years. So, each FortiOS release delivered innovation that helped to change the market. So, with the FortiOS 5.0, Fortinet has continued to lead and define the network security space. So, we are providing our customer with more security, more control and more intelligence to enable the best and the broadest functionality that is fully integrated with our high performance FortiASIC and FortiGate systems.

So this combination gave our customer superior network security performance, management and analysis. To test some of the exciting new feature in a FortiOS 5.0, including the dynamic advanced stride protection using our unique client reputation technology that analysis and ranks each device on the network based on the range alpha behavior and to provide specific action about information that abled organization to identity the compromise the system and potentially protect a zero day attack in real time.

Additionally, our new advanced anti-movement detection system and on device behavior based heuristic engine and the cloud based AV service, that include operating system, Sandbox and net IP reputation database for advanced malware detection. The FortiOS firewall also has new feature that address enterprise mobility and the BYOD challenges, but identify device and up high specific access policy as well as the security profile according to the device type, the device group, the location and the usage.

And finally, we are bringing more sophisticate and intelligence to the enterprise security managements with automated adjustment of a rule based policy for user and the guest based on the location, the data application profile and enhance the reporting and analysis to provide administrators with more intelligence on the behavior of their network, the user device application under the threats.

So the combination of our ability to offer the broadest array of syndicate security technology under the highest security performance and the lowest latency in the industry is the primary reason why Fortinet is winning over others in the market.

In addition to the FortiOS 5.0, we also announced today our next-generation FortiASIC SoC2, is the seasonal chip tool, the second generation, which combines a general purpose processing power with Fortinet custom ASIC technology into a single chip, which consist of 109 million transistors, simplify the overall product design while deliver more than double the performance of the previous generation of FortiASIC SoC.

So, the FortiASIC SoC2 started design into the certain FortiGate appliance now and planning to ship in early next year. So, additionally, we plan to unveil other ASIC, FortiASIC deal in 2013 rather than that, we'll keep raising the performance by even further. But during the third quarter, we also reached an important company milestone. So the shipment of our 1 million FortiGate appliance considerably adjusts over (inaudible), so this is quite an achievement coupled with the fact that we now have over 150,000 customers including a majority of the Global Fortune 100 company, this is evidence of Fortinet's tremendous attraction in the market that could have only been achieved through ground breaking innovation, consistently effective execution and a true desire to win.

Speaking of wining, during the third quarter, Fortinet and its products continue to win award and certification by credible third party. Including the 2012, Frost & Sullivan European Information Security Vendor of the Year Award, in which this leading Analyst Firm named Fortinet the Best Information Security Vendor in Europe and credited us as of one of the few remaining pure-play security vendor that's continued to drive the meaningful innovation in terms of a product functionality that cost performance and address enterprise new security challenges.

We also earned an NSS Labs recommended rating in its recent network intrusion prevention comparison test. The FortiGate-3240C effectively blocked 96% of attacks and currently identified 100% of NSS evasion attempts without error. So with latency of less than 10 milliseconds, we proved to be the fastest IPS solution in our price class and NSS Labs state that Fortinet demonstrated excellent protection capability, as well as the performance maintaining consistent report and high protection rates throughout the testing process and set for multi-gig environment looking to upgrade defense from their current IPS. The Fortinet FortiGate-3240C provide excellent protections.

Our FortiGate-3140B next generation firewall also compete ICSA next generation firewall evaluation. It's the first test to provide a standard way for customer to compare a product claiming to offer the next-generation firewall protection. So this adds to the Fortinet’s long list of ICSA lab certification including firewall, antivirus, IPSec VPN, SSL-VPN, network IPS, web application firewalls.

So during the quarter we also win our 27 VB100 award in Virus Bulletin comparative review. Virus Bulletin staff tested Fortinet's antivirus capability with numerous other endpoint security solutions for stability, malware cache rates and false positive rate. And finally, the FortiGate-5140B won the 2011 Communication Solutions Product of the Year award based on innovation, tuition and the technology features.

So technology innovation has been and remains Fortinet’s greatest strengths and strategy focus and we’re very excited about opportunity ahead of us with a new FortiOS 5.0, the new appliance and the FortiASIC ruling out over the next few quarters, so in traction in enterprise and high-end and the great talent team within Fortinet and a healthy overall network security market of which we are increasingly gaining share, though there is still some uncertainty in the macro environment I'm confident in our ability to continue to grow and execute it well.

So now let me turn the call back to Ken Goldman, who will discuss our finance outlook for Q4 and rest of the year.

Ken Goldman

So, before I review our guidance, I will remind you the same forward-looking statements I discussed earlier or actually Michelle discussed earlier do apply. And while we continue to remain attentive to the overall economic volatility falling into the Q4 with good momentum, we believe our business is strong. We are in a position to continue to grow faster than market. Getting our goal has always been to grow approximately twice the size, twice the growth of the market for the reasons Ken really discussed.

Based on our in line Q3 results, as well as the healthy volume we see at this time, our guidance for the full year remains consistent within the ranges we discussed in last quarter's call.

Looking forward to 2013, at this very point, we're again comfortable saying expectations for the full year revenue growth in the mid to high-teens range in light of the fact that we are still early in our planning process and we are larger and we are facing more difficult comparisons. The economic environment remains steady. I disused this actually, it's pretty much the same thing we said this time last year just to sort of give you a little directional input that we pretty much see as we go into thinking about next year. Pretty much we're looking at this point in time the same as we sort of looked at this time last year. We will refine these numbers clearly after we announce our Q4 results and as forward quarters go forward next year.

Specifically to guidance, we expect billing for the full year to be in the range of $590 to $600 million which is up 25% year-over-year at the midpoint. Results in billing for the fourth quarter to be in the range of $162 million to $172 million which at midpoint represents growth of 19% year-over-year. We expect a significant increase in renewals due to seasonality and that this implies the deferred revenue balance will increase around $20 million in Q4.

Full revenue for full year to be in the range of $524 million to $528 million and up 21% year-over-year at the midpoint, this puts total revenue in the fourth quarter to be in the range of $142 million to $146 million, which at the midpoint represents year-over-year growth of 19%. Gross margin approximately 73% for the full year in fourth quarter, operating margins of approximately 24% for the full year and approximately 25% for Q4.

Non-GAAP earnings per share for the full year were approximately $0.51 based on expected weighted average diluted share count of approximately 166 million to 168 million. Non-GAAP EPS for the fourth quarter is expected to be approximately $0.15 based on expected diluted share count in the range of 168 million to 170 million.

EPS is the sum at the low range of our prior range and really gives the fact that expense growth has really been relatively comparable to revenue growth, but we do expect this growth to begin to moderate over time.

Free cash flow is expected to be in the range of 150 million to 155 million for the full year and 37 million to 42 million for the fourth quarter. Excluding the 14.5 million land and buildings purchase we made during Q3, our free cash flow range would have been a 165 million to 170 million in terms of the range we gave for the year.

In addition, we expect cash flow from operations to be in the range of 173 million to 178 million for the year and we assume our pro forma tax rate of 34% for the full year and fourth quarter.

I will have a couple of quick closing remarks and frankly no one in this room quite knows what I'm going to say, so you will see what I do. And I’ve decided to say it this way. There is really never a great time to leave, but there is a good time to start a new challenge. We have accomplished a lot over the past five years as a team and three year as a public company. We are a recognized leader in network security market, overtaking a number of previously larger vendors. We have delivered compound growth well over 25% in our key top line metrics and operating margins nearing 24 % and 25% with free cash flow of margins well in excess of 30%.

We managed expenses and investments with care and diligence. We work hard with a brighter focus on our mission. Our balance sheet is impeccable with cash and investment balances nearing 700 million and no debt. I would say that our track record for innovation is as good as any company have ever been associated with products coming out on time and on budget. Moving forward I've never been more confident that market opportunity, our positioning and our ability to continue to overachieve in our metrics. We have a great team in place here.

Finally, I'd like to thank Ken and Michael, our regional venture investors, the Board and team around me for an exciting and productive five years, helping to lead this company and give the shareholders probably a faith, confidence in investments, my best. Thank you.

Michelle Spolver

All right operator, we can turn the call over to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) So we’ll take our first question coming from Sterling Auty from JPMorgan. Please go ahead.

Sterling Auty - JPMorgan

Ken Goldman, congratulations on the conclusion to a very successful 10 year at Fortinet and good luck with your new position with Yahoo.

Ken Goldman

Thank you.

Sterling Auty - JPMorgan

In terms of the comment that you made about maybe some greater seasonality in the quarter around the bookings, I guess I wasn't clear in terms of which geographies that kind of hit and you think that seasonality was more to the segment as a whole or anything specific maybe keying up going into new product refresh?

Ken Goldman

It’s hard to sort of say if new products. We tend to think it doesn’t affect us in a negative way. My own opinion has always been when you do have new products, it’s nothing else that gives your sales force more confidence going out and meeting customers.

When I was thinking about that comment, I was thinking about Americas probably saw a little bit more seasonality than we used to seek, sometimes we grow in Americas more in Q3 than from Q2. If you look at it, last year, EMEA came off a tough Q2, so it’s easier to have a small reduction from Q2 to Q3 last year and so we saw a little bit more seasonality in EMEA, although again they had a very good quarter, but they came off a stronger Q2 this year compared to what they did last year.

And one more thing in EMEA, I think generally we see the environment there okay with a little bit softness in the areas like Southern Europe, like Italy that you would expect. And then in Asia Pac, I don’t think we necessarily saw any particular seasonality there with the only thing I've pointed out before was some changes we’re making in China due to more volatile results than we would like.

Sterling Auty - JPMorgan

Okay. Maybe one follow-up on a different subject, the time sale. I know last year you talked about maybe you will be doing these time to time, but is there other patents you’ve identified that you have that you would like to trend? And what kind of drives the decision around the timing of these sales?

Ken Goldman

Well, timing is sort of random. Although having said that, it seems to happen in Q3 of both years. So it is sort of random and it's primarily when someone comes to us and looks for some patents and we feel the patent is not core to what we believe is really important to us and so it's a way for us to monetize an asset, if you will, that is not core and important to us, but doesn't limit us in any way forward. So from my perspective, maybe others have a different opinion, it’s a little bit opportunistic based upon some folks coming to us and enquiring about the ability to buy some patents and frankly if the price makes sense to us, we'll go do it.

Ken Xie

We have a relatively very strong patent portfolio, and over 110 issue patent and other were 100 pending patents and also we pioneered quite a lot of since in this space. We also have very strong legal team which keeping driving us has a lot of business opportunity, so what sort of patent we see not a co-patent now have overlap, is not a patent, so we’re always looking for opportunity to get some business here.

Operator

Okay. Thank you. And we’ll take our next question from Erik Suppiger from JMP Securities. Please go ahead.

Erik Suppiger - JMP Securities

Yes, on the service provider front, I think you said that was about 28% of revenue on booking services?

Ken Goldman

Correct, on billings.

Erik Suppiger - JMP Securities

On billing. I thought historically that's been in the kind of 30%, 33% range and yet you were saying that was a strong sector for you. Can you explain?

Ken Goldman

Yes, I think if you look at that it was, if I get the numbers in front of me, we did 26% in Q2 of this year and we did 28% for Q3 of last year, so there may have been some quarters in which it was little higher than that, but in terms of three quarters that I'm looking at in front of me is, again is 26, 28, 28.

Erik Suppiger - JMP Securities

Okay. And do you think, as we look forward, is that going to start growing as a percentage of revenue?

Ken Goldman

That's always hard to tell because to grow as a percent something else has to go down. My own opinion is that it will be relatively consistent. We are doing somethings as Ken noted in new products, which really is focused on that particular space and we really do have a great market share there, particularly on the ability to have a demand security service business. Having said that, retail is a little bit down this quarter, I should have pointed out that one of the things that also affect us a little bit this past quarter was a tail-off of one of the large deals that had actually a nice tail so what if you will over a number of quarters and that particular customer is growing great, but we didn't necessarily ship a lot to that customer this quarter.

So that's why you saw retail go down a couple of points, if you will from prior quarters, but I think we'll continue to make progress in financial services. You witnessed that going up a couple of points this quarter vis-à-vis historical numbers and although education wasn't necessarily up from quarter-to-quarter, up nicely from Q3 of last year was only 3% and I think that's an area that again we see good growth when you look at what's happening in the future.

Ken Xie

Yes, we also win a few Fortune 100 company in Q3, which we believe would drive some future growth long-term wise.

Erik Suppiger - JMP Securities

Okay. Secondly, Ken your guidance for free cash flow in the December quarter is forward to be flat to down, given the renewals that you're expecting, why would you expect that?

Ken Goldman

Well, again I think, you look at a variety of things, you look at the AR balance going into Q4 and our strong DSO we had going in Q3, so part of it is the timing you have and really the balance sheet I should say you have and it's not that dissimilar from what you saw last year Q3 to Q4 in terms, so that's why in other quarters you go in like in Q1, you go into the very strong AR balance and it helps you a lot in free cash flow. We expect cash payments to be up a little bit. As you noticed in the cash flow statement this quarter, we put as a footnote, payments we’re making on cash tax payments, so that's very transparent now. We think that will go up $1 million or $2 million as well in Q4 versus Q3 and so for all those factors and then you’re always getting something with the timing of the abilities. But frankly a lot of renewals, they do come in December is sort of called term is for the end of the year and obviously that will be collectible in Q1.

Erik Suppiger - JMP Securities

Okay. Then lastly given the new ASIC and the new OS, is there any vendor that you think that will be particularly advantageous for, is it addressed maybe on the IPO side, vendors like Sourcefire in particular or anybody that, that would be strategically aligned against?

Ken Xie

I think that the new OS, like I mentioned, they increased the more security to defend today's new attack there and also we added more manageability and also especially in the mobile device WLT which enterprises are facing a challenge today. And the ASIC actually enabled us to have all this function keep adding in at the same time improved performance. The current functions improved a lot. Like mentioned in the press release, like a one function, like the VPN function, we improved performance 10x, 10 times compared with the previous associated chip.

So we are not quite target particular, certain vendor what in IPS or that we basically even with the platform gave us more advantage on a customer they can use in the single function or using the combination of a multifunction, because the platform can provide a best performance whether on a single function or combination of a function, which none of our competitor has this advantage on the platform on our ASIC.

So that feels, overall, we’ll be keeping gaining market share in the whole space and also show a great advantage compared with competitor which are dependent on the general purpose CPU and software to deliver the performance.

Operator

Okay. Thank you. And we’ll take our next question from Keith Weiss from Morgan Stanley. So Keith, please go ahead.

Keith Weiss - Morgan Stanley

One of the things I wanted to dig into is, in your tenure for Fortinet, I think one thing you are well renowned for is your ability to set a conservative guidance and there is an expectation that you guys have I think in 10 or 12 quarters come in at least the high-end or above that guidance range. If you look back at Q3 in terms of coming in right in the middle of the guidance range, but not coming in towards the high-end or above that guidance range. What do you think were some of those key determinants of what sort of didn’t pan out, where that traditional conservatism kind of broke down a little bit versus what we've seen historically?

Ken Xie

I don't know if it broke down, but I think there is a couple of areas like in any quarter marginally a few things can go right and help you overachieve or not and I think a couple areas that they did not overachieve this quarter and I think about which we talked about China, there's a few transactions that we would have liked to close in Q3 that we believe will close in Q4 have already closed. We did see some softness in certain areas of Europe.

So, there is a little bit more, like at the margin we would have liked to have done, which I talked about, which would have then placed us at the higher end of the range. I would say though, and Q3 is always what I call a tougher quarter to call because you go into this period of August where it's hard to figure out exactly where you're going to come out and then business comes really strongly back in September. But I would there's a few million here or there that we would have liked to have done a little better in billings which would have translated into revenues and all the way down the income statement. So, that again, I think in a lot of times like Q2 I think came in very, very strong and so that was good. We try to sort of add some caution to Q3 in terms of how we think about Q3 given the significant over-performance in Q2 and perhaps we didn't account for Q2, as well as we could have.

Keith Weiss - Morgan Stanley

Okay. Got it. And then in terms of the free cash flow guidance, just to clarify, when you gave free cash flow guidance for the full year last quarter, am I correct in thinking that you excluded the land purchase sale when you presented it last quarter whereas this quarter when you're presenting it, you're including it and that really represents…

Ken Goldman

I talked to both numbers I believe last quarter. I am looking at my faithful group here and they are nodding their heads. So, I must have. So, I think we talked about both numbers. And so, there is, I'd say very unequivocally, there is no surprise in free cash flow both in terms of the inclusion coming in right on target in Q3 with or without the building and it is no surprise relative to our annual guidance visibility. We always pointed it out 14 million and so cash flow is actually coming in right on target, free cash flow. And you could see that by the way and the building gets sort of not to worry about the capital when you look at operating cash flow and so that number is very, very clean because it's obviously before capital expenditures.

Keith Weiss - Morgan Stanley

And then maybe one for Ken Xie, just in terms of the search for the CFO, any sort of standpoint you can give us or any frame of reference on the timeframe you’re expecting this to take or when we should start? Perhaps we can expect a decision on a permanent CFO to be made?

Ken Xie

Yes. We have a wide list of candidates, like over 20 to 30 candidates we have on the list. But also we have pretty strong internal team Ken helped build it up, Nancy is here also. I think we keeping doing quite well, so we are not going to rush into whatever we can get. We really want to search for the best candidate both outside and inside. So I think we’re carefully and actively interview and review all the candidate right now, so it's no time limit right now.

Ken Goldman

Suffice to say that, I think as we have been very clear, Nancy who is in this room will be interim and so will be the go to person as we speak.

Ken Xie

I believe Nancy and we are also attending the November Investor Conference in Boston and New York.

Keith Weiss - Morgan Stanley

Good luck.

Operator

Okay. Thank you. And we’ll take our next question coming from Walter Pritchard from Citi. So, Walter please go ahead.

Walter Pritchard - Citi

Ken Xie, just had a question on your end. I'm wondering when you look at a software defined networking world and one where you can't necessarily deploy your own appliances all over for part of a security architecture, do you have a solution plus in there and how do you guys anticipated addressing that sort of architecture?

Ken Xie

I think, as ISDN definitely gave us a good opportunity because they trend in the way since the networks still gathered altogether and obviously, especially help in all the datacenter, so I think ISDN will have some impact on the traditional firewall which you certainly look in the connection there, but that's where like 12 years ago when we started forging our way through the security content, no need to be addressing the content in application layer. So, that's the region we have and I think that ISDN definitely will help in some company to manage the connection there, but it's really the security today most come from the current applications, so that will gave us kind of a more opportunity and including secure ISDN itself. So that’s the precision we have but also we are actively participating in ISDN, in all the activity there.

Walter Pritchard - Citi

Great. Thanks for a lot for taking the question.

Ken Xie

By the way, one of the strong here we have is a service provider. They are also quite actively involved in ISDN and also we see some bigger data center where upon a service provider, enterprise already implement some of ISDN, which we also participate in. So it’s quite exciting space where we bring some change into the whole network landscape but it's also a good opportunity for the company who react quickly and keep up the R&D distribution so eventually we'll have more benefit of the change.

Operator

Okay, thank you and we’ll take our next question from Jonathan Ho from William Blair. So Jonathan please go ahead.

Jonathan Ho - William Blair

You know just taking a look at some of the specific challenges that you saw in China, can you may be talk a little bit more specifically about what it was that took place there and what some of the specific steps you're taking to improve the performance in China?

Ken Goldman

Well, I’ll bring it up and you know Ken may want to add, but I think that we’re going to make a change basically at the country management level. We’re going to work hard to create a better channel capability there, last few quarters have been very successful in Japan. We don’t talk about Japan very much but Japan has been a strong success story for us as we have and continue to build out the channel there. I think in retrospect, we're probably a little bit too dependent on larger deals in China than we probably appreciated. And that made the business a little bit more volatile where we came up, a very good Q2 and as I just point out not so good Q3. So I guess in nutshell, we are going to make some changes in the top in sales, leadership there and we’re going to put more focus on creating a viable channel structure there and therefore lessen our dependence on larger direct sale deals and I don't know if Ken wants to add to that.

Ken Xie

Yes I agree with Ken Goldman as really we in the past probably there is quite heavy on some bigger deal instead of the wrong reach channel pass, so that’s what the percentage of the channel, probably China is pretty small. So we want to keep enhance the channel part which gives us better run-rate. On the other side is really the whole economy on mainland China, we also feel quite a slowdown on the (inaudible) for the country-level leadership change in there. So, that's probably also kind of a slowdown some of the spending is on bigger deal. So, that's probably the two factor is once the internal way to keeping improving our sales structure like more broad in both the deal and under the channel and also the broader product segment, and also the bigger environment also kind of we feel could be improved better later this year or next year. But China is relatively small overall of our business there. So, we hope we can grow faster over there, so we feel is the change in economy so we can do better.

Jonathan Ho - William Blair

Got it and just in terms of the new products that you're releasing, with the significant step-up in performance that you're seeing, would you anticipate then that you'd be offering more price performance in terms of equivalent products or is there going to be any performance shift, for example, offering twice the performance or three times the performance versus prior generation appliances?

Ken Xie

I think every like four, five years we tend to renew each price brand, upper price range of the product. So, I think the most loss due are quite well is the semiconductor. Right now as every two year you can double the performance. So, that's whether the new ASIC and also the new FortiOS will help in improve the performance. At the same time, they can also add in more function while the performance also keep improving.

So, that's where the advantage from the platform we have because ASIC will keep us to keeping improve the performance of the current function and then move away from the computation from the general-purpose CPU, while the new software can be added into the CPU and same time the old function once moved to the ASIC like the VPM we mentioned in ASIC-SoC2, we see 10x of the performance improvement there. So, that's the cycle we keep in going on in the last 12 years since that accompany. So I think the longer we're keeping doing this one we see the more advantage we have over the performance and plus the additional function we can keep enhancing the platform compared to the software only solution, which they can only depend on CPU. So if there is a module function, if there is auditing then the performance have to drop a lot because the function compute on a CPU performance.

So, I think for us, we both leverage wherever we see the new generation of FortiASIC come in, then also the new generation of the CPU technology come in, so we tend to keeping upgrade the FortiGate system. So, we see a few new FortiGate system will come out of R&D in the next few months.

Operator

Okay. Thank you. And we’ll take our next question from Brent Thill from UBS. Brent, please go ahead.

Brent Thill - UBS

Ken, good luck on the other side of 101. On just the bookings, I know you don't talk about that, but your billings was obviously lighter, but can you just talk about the strength of the bookings in the quarter and perhaps the GSM deals coming late in the quarter that you're unable to invoice their four impact in the billings.

Ken Goldman

No the reality is bookings and bill, the reason we don't describe bookings is because basically bookings are very similar. There are some quarters in the past where we've got (inaudible) inventory and so we’ve left a little bit on the table but as we’ve added to our inventory in last several quarters, we haven’t had that issue. So I would say in bookings and billings are pretty comparable and therefore we didn’t leap. Sometimes we're left with a couple of few million that we have to ship next quarter, that wasn’t the case this quarter.

Brent Thill - UBS

Okay. And just real quickly in the government. Can you just describe what you saw in terms of their fiscal flush? Did you achieve what you'd like to see? Any color would be helpful. Thanks again.

Ken Goldman

Yes we don’t have the sort of federal government, has always been a very small percentage of our company, there are just some others you may deal with. We are doing some things that frankly we think is going to position us much better in the federal sector as we go forward, maybe not too much in the fourth of quarter, but as we think about ’13 -’14. But so I would say we're much more problematic relative to our gaining business in federal, and so we’re doing some long term things to get in the right programs and develop sustainable business there which is not at all affected by so called budget flush in the federal government. So, no, I will say that it had no impact on us.

Operator

Okay. Once second while we take our next question. And our next question is coming from Michael Turitz from Raymond James. Please go ahead Michael.

Michael Turitz - Raymond James & Associates

As you're looking to fourth quarter, is there anything that keep you particularly conservative? You know again, historically you've been conservative in a great way. But anything that makes you cautions on fourth quarter, because one way or another I mean you know I gather that you know it was a sequentially tough comp, it was a year over year tough comp, but you've still got into both billings and revenue growth just under 20% and to a billing sequential that's a little bit below seasonal sale. Is there anything that kind of suggest that whatever was holding things a little bit wide over performance this quarter is extending in the next quarter, I got a follow up or so.

Ken Goldman

I'll say this way, I think we’re very pleased with, you look overall at EMEA and given where we came from mid-last year, I think we have shown sustainable growth now and the opportunities in the low 20s. And I think we feel pretty good if you will going forward EMEA. Clearly we are cautious to some extent because of the uncertain environment over there. In Asia pacific we are, we are very confident there. We had a very good quarter in a number of countries, we think we are well-positioned to do Q4 as well. In terms of China, we're not expecting any real pickup from what we did in Q3, so we are assuming that would take a couple of or three quarters beyond Q4 to see some sustainable increase there.

And Americas come up some very-very good quarters and we wanted to see how it goes in Q4. We think we’re well positioned in Q4. I think a lot of it is going to depend upon, like anything else the excitement you have from some of the new operating system. And I would say that I think we will have a number of very exciting new products that Ken alluded to. But it's probably going to be more helpful early next year than they will be in Q4. So I would say Americas growth in Q4 is probably pretty consistent overall with what saw in Q3, in terms of what we see today.

Michael Turitz - Raymond James & Associates

And then just a follow up, so one thing, you talked about the retail, that large retail deal coming up. Can you be more specific about that in terms of how many quarters that had impacted you and how much that was a negative fall off at this quarter? The other thing is you didn’t mention anything about the margin guide for the next year or if you have anything there?

Ken Goldman

Yes, so I think its maybe off by a quarter but I think it’s about five quarters that transaction there. We never gave specific numbers, it never was in the kind of numbers of you know seven days till I get my numbers right here. So it could be easily in the low millions in the quarter and you know that was, I would say relatively immaterial in terms of our results in Q3. So you know it wasn’t unexpected, I don’t want to give you a sense it was unexpected, so we did assume that, but yes it is one of the factors that made it a little more challenges in Q3 versus Q2, but it was expected. And again we have a great business with them and we expect overtime to do a lot more with them, but the particular projects we're working on is basically complete in terms of the installation.

In terms of margins you know I think I'd rather hold off on that and let the company sort of speak to that in Q1. You know I think it's a balance there just talking from side any way, is a balance there to can we continue to invest productively and use that accelerate growth because this is all about growth or is it make sense to let some of that margin or revenue fall through the bottom line and I think there is a point that that it'll make sense to let some of that fall through and how much of that in '013, I think I'll let the company talk to may be in January.

The only thing I would say is over time, which same thing I've said over a long time. If you look at what are the ways to think about it, which is why I first said in remarks and if you look at our free cash flow margins you can look at those numbers, that's in the low 30s, and that's - our expenses are really driven by billings more so than revenues and so to the extent that we see growth in billings we'll continue to invest and are high equipped to achieve those billings and therefore you know because billings are quite a bit over time higher than revenues, you'll see lower operating margins and you will free cash flow margins. To the extent that we at some point see growth or you can't invest to bring the return and my sense says, as my sense say over time you'll see operating margins trend to free cash flow margins.

Operator

Okay, thank you. And we'll take our next question coming from Jonathan Ruykhaver from Stephens Incorporated.

Jonathan Ruykhaver - Stephens Incorporated

Good afternoon. Ken Goldman, good luck on the new opportunity. So, two quick questions - looking at the new Fortinet OS, the 5.0 and also the new security processor that will be available to customers coming on maintenance, are there any features or functions that customers will be able to achieve without newer hardware?

Ken Xie

I think all the - like I mentioned, in the last few quarters, we already (Inaudible) how we're in the field prepared to - well, it's a new FortiOS 5.0. We've added a flash memory, we've added some moderate resource there in the FortiGate system in the field. So, that enable pretty much all the FortiGate in the field, especially shipping them in the last few quarter and kind of upgrade to this FortiOS 5.0 as long as the customer have the support and maintenance contract with us.

Jonathan Ruykhaver - Stephens Incorporated

Okay. But you're saying that you made that hardware available, but to get the full benefits of 5.0, but those customers do need to upgrade and purchase that new hardware?

Ken Xie

No. They are already building into the hardware we are shipping in the last couple of years actually.

Jonathan Ruykhaver - Stephens Incorporated

Okay and the new security processor, what is the timing on the availability of that?

Ken Xie

It's already designed, starting design here into the new appliance we're going to release in the next few months.

Jonathan Ruykhaver - Stephens Incorporated

Okay, so later this year going into next year?

Ken Goldman

About 1Q - Q2 next year, not Q4.

Ken Xie

Yeah. It will be probably Q4 have some chance to beta it, but probably it will be more Q1.

Jonathan Ruykhaver - Stephens Incorporated

Is there any risk that the introduction of that, I mean I know Ken Goldman you've suggested in the past the product introduction facility impact sales cycles, but if there is some significant change in terms of performance or functionality, why wouldn't that be some pause for concern in terms of the pipeline activity going into December?

Ken Xie

I think the FortiOS, I don't see has any impact because that's where whatever Fiber-to-the-Ethernet most of the customers have today, they can upgrade to the new OS and also that we will later in the - later this quarter or next quarter, we start also shipping the processor with the new OS. On the ASIC, we have three ASIC family, so the quantum processor is probably the most of the FortiGate system, the iSource 3 chip is running, and then there's also we call the narrow processor of the FortiASIC NP that's mostly in the high end and then this iSource chip is integrated in the CPU together with some (CPN and NP) function there. But that will probably more go to the some lower and some middle range there, so that's the one we, once we have the refresh cycle of the hardware starting to come out, so we're starting designing this one.

So I think for us basically whenever we see the new CPU or the new FortiASIC or some module changing the memory and all this comes to where we tend to redesign the platform every three to four years. So we tend to not changing the price of the, like we have, like from (Inaudible) 300, 300A, 300B, 300C right now, that's the FortiGate. So we tend to maintain relatively same price at the same time we are kind of improving the performance, so that's where the product cycle we go through.

Ken Goldman

I would like to add to this comment. The reason we've always said what we said is, is that the process is getting incorporated new products over time and we don't announce that ahead of time. And so with products that may or may not be incorporated on is not known by customers until we are ready to announce it, and so we manage the transition both in terms of our inventory and the ability to ramp up the new products in a way to minimize that transition if you will, so that's probably the biggest element there. The other thing is some of our existing customers will continue to buy the existing products, because they already have that in their infrastructure and so it's harder for them to incorporate new products. So we actually will still sell the legacy products to many of the existing customers.

Jonathan Ruykhaver - Stephens Incorporated

Right okay. Okay that makes sense. Just one final quick question. Ken Goldman, you mentioned in terms of growth in America, the company has been increasing success in penetrating the large enterprise. Does that imply any new execution challenges or changes to sales cycles as you compete more effectively or more frequently in the large enterprise?

Ken Goldman

No, I don't think so. I think if you really think past over the last several years, you know we have done in my opinion a fabulous job of building out the enterprise organization in Americas. It's run by a very competent sales manager. We continue to, that's an area we have overachieved every quarter that I can think of in terms of what our forecasts have been for the quarter. We continue to win ever larger deals, it's an area where even though some others get a lot of notoriety if you will for firewall and so forth, we do very-very well there.

And I think we will work to improve if you will some of our messaging so we can even more better address, if you will, the high end high performance firewall market in which our product strength would compete very-very effectively and I think Ken alluded to a lot of that.

Ken Xie

Yeah I agree with what Ken mentioned. So, in the last couple of year we started building a large good enterprise team especially in US. And now we also want to keeping in rest in some other marketing positions, some lead generation. I think for us we found as early whenever we get invited to compete with the competitors, larger the old one or the new one, we have a lot of high percentage win rate. For the term that we're facing from (Inaudible) sometimes we are not knowing the deal and some leads not quite come in. So, that's where we are going to keep hands in the market in a position side and also have a more two open (Inaudible) especially on the enterprise side. So, that we believe will also help in the future growth in other segment.

Operator

Okay, thank you. And we'll take our next question from Jayson Nolan from Robert Baird. Please go ahead Jason.

Jayson Nolan - Robert W. Baird

Okay great, thank you. And just to follow up on that last topic that change in messaging, how much of that would fall into more of a push in sales and marketing spend. I noticed that trended pretty flat quarter-on-quarter.

Ken Goldman

I don't know what it's going to be. I mean we are spending more with the channel and some of that FX expense, some of that the way it gets accounted for FX revenue as a contra if you will. So, I think we will continue to push hard in that. We have - in this particular quarter, we have various partner meetings in which we're going to do, I think a better job of with that messaging. So, I think you'll see more from the company along those lines, but I don't necessarily think it'll change our financial model.

Jayson Nolan - Robert W. Baird

Okay. Large deals over 500K trending down slightly quarter-on-quarter, Ken is that a function of China mostly?

Ken Goldman

No, let me see those numbers again, I don't think, no, that was definitely not a function of, well obviously China was down as I said before, but let me just find my data in front of me here. So, yeah it's right in front of me, which number you're looking at [100 or 250 or 500].

Jayson Nolan - Robert W. Baird

Over 500?

Ken Goldman

So over 500 it was, 16 versus 13 year-over-year, now yeah, it's a little bit down from Q2, if you will. But it's not unusual to see some downish if you will, sequentially in Q3. And clearly we did have less number of larger deals in China, I don't know how much of that was effective. We did definitely a less larger deals in China.

Jayson Nolan - Robert W. Baird

Just to talk about the SoC Gen 2, I think Ken Xie said that's a lower end chip, but why wouldn't new silicon drive, bigger deal sizes and why wouldn't we see a pause as new silicon comes to market?

Ken Goldman

(Inaudible) It's a low-end, it's a chip that integrate a few function including CPU inside the chip, which can also go to the mid or high end system in the port level there. So, just whenever there is a new generation of FortiASIC, just like the new CPU come out. It take a little bit time to gradually design into the 40 gig system. So, that's where, but the chip enable us to really deliver much better performance the hardware platform. So, I'm not sure that’s your question.

Nancy Bush

The only thing I'd add is that we don't refresh our entire product line with the new ASICs at once. We're continually refreshing the product line and bringing the ASICs in over a period of several quarters.

Ken Xie

Yeah and also because sometime the customer still using the current product for a while, and so we don't have to refresh it if they since keep doing well. Even this quarter, we have a customer still buy the product we design like a seven, eight years ago, so that's where.

Jayson Nolan - Robert W. Baird

So do you feel comfortable with your visibility in closed rates in large deals over the next couple quarters as these new products come up?

Ken Xie

This new product definitely enable us to get into some environment in the past, it's pretty much impossible for any network security company to get in because the performance requirement because the function requirement, so that's where with this new OS and new chip which enable us to really open a lot of new opportunity for us.

Operator

Okay, thank you. And our next question is from Robert Breza from RBC. Please go ahead Robert.

Robert Breza - RBC

Hi, thanks for taking my questions, for Ken Xie, I guess kind of break here. Can you talk to us a little bit about what you’re seeing in China from a competitive perspective, is there any kind of spillover from kind of the Huawei kind of issues as it relates to kind of government and just curiously a little bit more background and color on the competitive landscape in China? Thanks.

Ken Xie

Huawei definitely is one of the major player there and they are starting there in the security probably like a few years ago. It has the partnership with Symantec, the joint venture and then Huawei acquired the other half of the joint venture I think it's about two years ago. So, that quickly play in that market. There is a few local smaller players and smaller more local company, but we also see some moderate. I think there are pretty much old other player like Cisco, Juniper, Checkpoint and we are all playing in the market. It's similar to the rest of the market. It's really quite a fragment in the market I have to say, but certain, the common own-enterprise - sometimes they have a certain certificatory requirement which more favor to local company, which is difficult for us to compete.

But overall the market is still quite fragmented and the other thing we see is really, even like the market in US and European, they're more moved to the UTM and the function like antivirus or intrusion. But China is still more relatively in a firewall, the traditional firewall market. So, that's where we are a little bit behind them moving the new function is better like a UTM, compared to the rest of the other country. So, that's the overall landscape. I do see it's a huge market because they build a lot of a new infrastructure, especially some cloud infrastructure which need something like the high performance solution which we have more advantage compared with some other software solutions, but it's kind of permits the market over there.

Operator

Thank you and our next question is coming from Shaul Eyal from Oppenheimer & Company. Shaul please go ahead.

Shaul Eyal - Oppenheimer & Company

Two quick ones on mind, Ken Goldman, how should we be thinking about license revenues specifically as it relates to the fourth quarter? It came slightly I think below consensus estimate. How should we be thinking kind of heading forward?

Ken Goldman

You know, you are talking about product revenue I presume?

Shaul Eyal - Oppenheimer & Company

That is correct. Yes product revenues.

Ken Goldman

Because you said license, yeah. Product revenue tends to track billings. The only caveat is I expected to go up sequentially. The only caveat in this is that both Q4s, people are saying Q4 this year is we do have a seasonally large amount of renewal billings and so to the extent that renewals will make a little bit higher percentage of our overall billings, you won't have the normal increase of product revenue sequentially because a greater percentage of that increase is coming from, if you will, renewals, which is obviously amortized over time, and as I talked about before will account for the, what we said about $20 millionish if you will of increase in deferred revenue.

Shaul Eyal - Oppenheimer & Company

Got it. That is helpful. And could you guys, I don't Ken Xie or Ken Goldman, can you address kind of (inaudible) kind of the talk, kind of what's the current thinking in that respect?

Ken Xie

I think for Fortinet, I think we have the sales and marketing well integrated together, that's where future is, the marketing will try to support in the sales. So, most can be part of the sales organization, especially the field channel marketing, all these area. So, Greg has come to us a little bit over one year ago, stays here for probably one-year. I think it's a - but its (inaudible) a personal reason to move back to I believe Texas, is his own personal reason. Other than that I don’t have much comment I can make.

Operator

Okay thank you and our next question is from Rick Sherlund from Nomura. Please go ahead Rick.

Rick Sherlund - Nomura

I wanted to drill down just a little more Ken on your comments about seasonality in the Americas. Just a little more granularity on that, are you seeing it in large deals, is it channel, and how do we know that it’s seasonality. You know seasonality kind of implies, you see something that suggest it’s stronger in Q4. So I just wonder if we could kind of flesh that out a little more.

Ken Goldman

Well, you never, like we also don’t know as we see Q4 right. But you know we look at where Q3 landed and what Q2 - what we did in Q2 and we look at some of the business that we see that nothing is going to translate into Q4 from Q3. It’s our impression that it is seasonal, it would coming off a number of quarters in which Americas is very-very well, had some very large deals and frankly if you look at a number of very large technology - deals of technology customers in the West Coast area if you will. So we continue to do quite well there. But I think as we look at it and we look at the makeup of our forecast, that's how we developed our thoughts, if you will, for Q4.

Rick Sherlund - Nomura

Was it primarily a big deals done in, when you talk about seasonality?

Ken Goldman

Yeah. There was a couple of things that we would have liked to have seen come in in Q3 that for whatever reason didn't make it across the line and that we expect we'll be fighting in Q4. And I think you know as I look at it the organization is very healthy. The business that we see out here is very-very healthy and our product was very healthy. So, I think we all think there is room here, if you will, that we are all well positioned for our Q4, and honestly for as we go into '013.

Rick Sherlund - Nomura

It’s odd because we usually expect Europe where we hear about issues more with the economy and big deals not closing in, and you did relatively well it looks like with big deals in Europe this quarter.

Ken Goldman

Yeah I think in the case of Europe we did a good quarter. Europe came, you know again I think Europe was much more normal for us in terms of Q2 to Q3, than last year where we had a tougher Q2 going into, and they give us a little bit opportunity to get back, if you will in Q3. I think in the case of, you know again, let’s not overdo this if you will. There’s a (Inaudible) couple of $3 million that we would have liked to have seen in Americas, but we really were not off very much from where we had hoped. It's a modest amount, and so I don't want to overstate, if you will, a concern here where concern really is not warranted.

Rick Sherlund - Nomura

Yeah and on the competitive front or just the overall macro environment, you are suggesting you haven't really seen much of a change Q3 versus Q2?

Ken Goldman

Yeah I mean, I think if you talk to the sales, I mean they feel very good about what's going on in the environment and certainly the demand for security, as the continued new products and innovation going on security, and sort of the necessity if you will. I would say the diversity of applications across every single vertical you can think of. And so I don't think there is any diminution if you will of the opportunity out there. And my own opinion is, it will all be about execution as we go forward. I have confidence the products would come out and then we have to go and sell it. So I think we're just well-positioned.

Operator

Thank you and we'll take our next question from Aaron Schwartz from Jefferies. Please go ahead Aaron.

Aaron Schwartz - Jefferies

Good afternoon. Ken, I understand sort of your cautious toning and sort of not trying to overplay things one way or the other, and you did just talk about how you aren’t set up well here in Q4, but the billings range is a little wider into Q4 than normal. Can you just walk us through some of the reasons there? Is this more because of the product cycle, I think you've pointed out that some of the uncertainty there, is this more because they'll take a couple of quarters to fix China? Can you just walk us through some of that?

Ken Goldman

Yeah I think the easiest, frankly, is we decide just to keep the range as same as last quarter and I didn't want to tune it and get too tight, if you will. So yeah, I think we could have reduced a little bit, if you will, but we felt. Generally the scheme of our guidance was to keep it consistent for the year as it was last quarter. We did tighten the revenue a little bit because frankly there is less variability that can occur in revenue one quarter than two quarters just because of the nature of revenue the way our model works. So the only area that we wanted to really be lot more specific, if you will, was on earnings per share because with Q3 behind us and sort of looking at the revenue that we guided, it was clear to us and the large number of shares, it's clear to us; there is less variability if you will on earnings per share. And so I think that's as much as anything else and filling the midpoint where is about right. And so to get a tighter on the range, we didn't think it would be that helpful.

Aaron Schwartz - Jefferies

Okay and then second question if I could. You talked a little bit about sort of changes you made in Europe last year and the success you had off of that and now some changes here in China. Ken as you sort of transition on, can you just talk about the consistency globally with the sales management team in each region just as we think about maybe consistency here going forward? You know you spoke about the leadership in North America, how long is the consistency been there a couple of years down?

Ken Xie

I think on the executive level, the sales management teams are (sable), both International VP, Patricia and also the American VP, Mike Valentine has been with us like a seven, eight or nine years. So you know country manager level from time to time, we may do some changing, because some of our country manager are probably more strong in certain like the major - still major cause, are moderate maybe more strong in the channel. So, from time to time based on the stage we're growing, so we may kind of keeping - improving a little bit on the country manager level there. So, that's what happened in the U.K. one year ago and also what's happening in China right now. I think the overall the team is allover healthy, very stable, very strong and both in the field and also in the headquarter here.

Operator

Thank you. And our next question comes from Tal Liani from Bank of America. Please go ahead.

Ron Zember - Bank of America

This is Ron Zember on for Tal. First of all, congratulations Ken on the new opportunity, best of luck there.

Ken Goldman

Thank you.

Ron Zember - Bank of America

Real quick question, if you look at year-on-year growth and compared products and services, it appears that this is a first quarter, where services are actually growing faster than products. Should we see that as a turning point or is this is kind of a fluke?

Ken Goldman

Well, I certainly hope not. As you well know I've said for long time, this company that billings and product revenues is the real drivers of the business and that's our goal is to continue to have higher growth. And you know I don't want to give guidance, you know we don't get that specific in guidance, but the goal will remain that billings and product revenue will grow fast on services because that's what drives the business. So, yes, that is the fact that occurred this quarter, but I would say, that certainly everything we're doing from a new product point of view and driving sales and so forth is to drive product revenues at this point faster than services.

Ken Xie

I just think really China tend to be more forward towards the products side and their services side is presented as an average, so that maybe a little bit impact.

Ken Goldman

The other one, we missed in China, so to speak that we did this quarter, there is a disproportionate amount of China billings, there is product revenues because of the nature of the business we do there, and so that has a more major impact on our product revenues as well as frankly on inventories.

Ken Xie

Yeah, it's more because the market there and China is already just by the firewall instead of by the whole UTM. So that's why when you buy the firewall is going to market the product, not much subscription service.

Ron Zember - Bank of America

That's great. And just one housekeeping, and I'm sorry if I missed it. Were there any deals over $1 million?

Ken Goldman

Yes, but we don't actually describe how many but, they were, yes, but we don’t - that's the message we don’t, we give - the number is over 500, but we don’t give specifically how many over $1 million, but they were, yes.

Ron Zember - Bank of America

Thank you very much and best of luck Ken.

Ken Goldman

Thank you. We're going to have to sort of, because we have another call coming up pretty soon here, so why don’t we take one or two more key questions, but otherwise - how many questions?

Michelle Spolver

We have four in the queue.

Ken Goldman

So operator, we will take the four questions, but I think it is pretty well we have to hold on to, just those four questions that are already in the queue.

Operator

Okay we'll take our next question from Rohit Chopra from Wedbush. Please go ahead.

Rohit Chopra - Wedbush

Thanks very much and Ken, let me add to the congratulations, good luck, a lot of work at Yahoo! to get done. A question on competition, Rick asked a little bit about this, but the incumbents out there have been extremely aggressive over the last two quarters as far as pricing. Have you noticed any change in sales cycle or have you - anything going on out there with incumbents rather than the new people? I wanted to get one question in on partners. Palo Alto and Citrix are trying to team up to develop something to go against F5. Is there a need for Fortinet to partner up somebody to withstand some noise in the channel to get to the customer to be more relevant?

Ken Goldman

I'll take the first and let Ken Xie take the second, but I think the pricing, I mean you often time to time see some of the older line companies try to compete particularly when they're losing business and they would try to sort compensate by using price and we will need to be competitive because the customer will sort of use that as a starting point, but I don’t see that and we don’t see that as changing sales cycles or effectively changing the price, and I think I can only argue the numbers they sort of speak themselves when you look at the overall network security shares with some of the existing players vis-a-vis Fortinet and you know frankly I believe we’re one of the top four that we think we can be in the top three shortly. So that’s how I react to that relative to the other question, let Ken take it.

Ken Xie

I think right now we don’t have many technology partner compared to the one you mentioned the other competitor. Because we believe we have very strong engineer team with close to 1,000 R&D engineer working on many technology really pioneer the space. So compared to competitor you mention they have to license and have ours have a license at UIL, and also even the virtualization.

So I think for us it’s all our strong area. So that’s why in this area we believe we have the best solution with all the certification, with the best performance there. But we do partner with some other, like the solution provider including some biggest company, the biggest name in the space, try to provide a total solution to the customer. So that partnership is starting to develop well right now.

Operator

Thank you. And our next question is from Scott Zeller from Needham and Company. Please go ahead Scott.

Scott Zeller - Needham and Company

Thank you. A question about the distribution partners in the US. With the recent arrival or debut of competitors, have you noticed any perhaps distraction amongst the distributors and whether attention is being spent with these partners versus yourself?

Ken Goldman

No, we don’t see any changing and on the other side we have one of the best channel programs and that gives us quite a broad access to the market, both in the high-end carrier, big enterprise and also the SMB. So we continue to see the improvement, the huge improvement we have with our channel partner in US. So far we don’t see the competitor, especially some newcomer. So, they are not sign up with some of the major partner we have to date yet.

Operator

Thank you and our final question is coming from Brian Freed from Wunderlich. Please go ahead Brian.

Brian Freed - Wunderlich

Thanks for accepting me and congrats Ken on your new venture. Two quick questions. I guess first, can you give a little more clarity in terms of the magnitude of the shortfall in China? Are we talking a couple of million a quarter that indicating the much of the shortfall relative to consensus and Q4 can be attributed to that or are there areas that are driving that?

Ken Goldman

I think to just to interrupt you, I'm sorry, I think that's approximate good round number.

Brian Freed - Wunderlich

Okay. And then the second question is to follow-up on the technology partnership question. Do you see some opportunities for technology partnerships outside of the core areas and for example the voice over IP area?

Ken Xie

I think some of our technology we feel can expand beyond the levels the security improved in the voice IP the video and also some storage, some networking area. But that's more long-term solution. So we kind of engage with some player in the space, but it's moreover early stage. We believe maybe a couple of years or few years later, the technology we develop both on the chip level, another on the (Inaudible) sulfur level can enable some modest space kind of leverage the technology we have - kind of expand beyond the network security space.

Brian Freed - Wunderlich

Okay, thank you.

Ken Goldman

So thank you. I think when is the next call?

Operator: In about 20 minutes.

Ken Goldman

So about 20 minutes for those who couldn't get quite their question in, we will be back online in about 20 minutes, so just feel free to call in. I think it's the same number, Michelle?

Michelle Spolver

Yes.

Ken Goldman

Same number, feel free to call in. Again thank you, thank you for your kind comments and I'm sure you will be hearing from me somewhere in the future. So, thank you. I'm hopeful I will see all of you as well in the future.

Ken Xie

And also I want to thank and appreciate Ken. Ken Goldman worked with us for the last five years and did a great contribution for our success. Thank you Ken and also good wish for the new position in Yahoo!

Ken Goldman

New opportunity and challenge. Thank you.

Michelle Spolver

Thank you.

Operator

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

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