Fortinet's CEO Discusses Q3 2011 Results - Earnings Call Transcript

Fortinet, Inc. ( FTNT)

Q3 2011 Earnings Conference Call

October 24, 2011 16:30 ET

Executives

Ken Goldman – Chief Financial Officer

Ken Xie – Founder, President, and Chief Executive Officer

Michelle Spolver – Vice President, Corporate Communications

Analysts

Philip Rueppel – Wells Fargo

Michael Turits – Raymond James

Jayson Noland – Robert W. Baird

Keith Weiss – Morgan Stanley

Walter Pritchard – Citi

Shaul Eyal – Oppenheimer

Aaron Schwartz – Jefferies

Jonathan Ruykhaver – Morgan Keegan

Sterling Auty – JPMorgan

Jonathan Ho – William Blair

Scott Zeller – Needham & Company

Dan Cummins – ThinkEquity

Rohit Chopra – Wedbush

Erik Suppiger – JMP Securities

Alan Weinfeld – David Securities

Presentation

Operator

Good day, ladies and gentlemen and thank you for standing by. And welcome to the Fortinet Q3 2011 Earnings Announcement Conference Call. Currently, all participants are in a listen-only mode. Later, we’ll conduct a question-and-answer session and instructions for questions will be given at that time. (Operator Instructions) As a reminder, this conference may be recorded.

And now, I will turn the call over to Ken Goldman. Sir, the floor is yours.

Ken Goldman – Chief Financial Officer

Good afternoon and thank you all for joining us in this conference call to discuss Fortinet’s financial and operating results for the third quarter of 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 view 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 outlook for the fourth quarter fiscal 2011. We will open our fiscal 2011 before we open up for 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 to ask more detailed financial questions. And by the way I would make a comment all are welcomed to join our call. Second call will begin at 03:30 PM Pacific and will also be webcast from our Investor Relations website and is accessible as detailed in the earnings release.

Let me also read the disclaimer Safe Harbor statement. Please note some of the comments we make today are forward-looking statements, including those regarding the financial guidance for fourth quarter, fiscal 2011 and fiscal 2012 market opportunities, introduction of new products and our expectations regarding the impact on our business, our growth initiatives, impact of newly adopted FASB revenue recognition rules, including our deferred revenue available balance, expectations regarding renewals, services revenues and product revenues, impact of investments on sales, R&D, and marketing teams, expectations regarding revenues from EMEA region, expectation regarding days sales outstanding, inventory levels in our (indiscernible) trend, and expectation around growth for market share gains 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 our 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 of these reports can be obtained from the SEC or by visiting the Investor Relations section of the website.

All forward-looking statements reflect our opinions only at the date of this presentation. We undertake no obligation and specifically disclaim any obligation to revise or publicly release results of any revision of these forward-looking statements in light of new information of future events.

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 14 and 15 of the presentation accompanying today’s remarks. Please refer to our website at www.investor.fortinet.com 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. Note that, we routinely post important information on our Investor Relations website and we encourage you to make use of that reference.

So, now relative to Q3, let me start with Q3, 2011. We are very pleased with Fortinet’s results. We accept some performance across all operating metrics including record billings, revenue, and profitability. Fortinet has never had as greater market opportunity as it exists today. It is important, however, that we continue to execute well investing our products. Within the overall technology market, the security start is one of the strongest performance and we continue to gain market share. We are investing a sales in R&D as well as market expandable awareness, strength in the value proposition expand our distribution channel.

We are benefiting from market trends in MSSP and the SaaS delivery security, virtualization and network security mobility as well as increases in network performance and bandwidth intensive applications that require high performance security. We are leveraging our broad product set, which positioned us to benefit from untapped demand for our products within all customer segments, be the SMB enterprise and telco for a variety of deployment scenarios whether it is UTM, firewall, intrusion protection, wireless, and so forth. We also haven’t signed new line for our parties coming out in Q4 that will further strengthen our position across all high-end, mid range and entry level spectrums. Ken will talk much more about these shortly. These trends help drive a record Q3 results and our outlook for Q4, which I will share with you.

First, let me touch upon a few highlights of the quarter. We saw healthy deal volumes driven by traction enterprise data center deployments, core enterprise deals, and continued strength in the retail and telco sectors.

Q3 was the best quarter ever in the enterprise segment. We closed the biggest enterprise contract in the company’s history. Fantastic performance in emerging markets such as Latin America and Southeast Asia. In addition to driving strong revenue growth, systems growth can turn the economic environment. We are managing our business operations very efficiently. Free cash flow exceeded expectations operating wise well ahead of a long-term model and revenue per employee increased markedly. We ended the quarter with over $0.5 billion of cash and investments.

Before diving into Q3 results, let me add three items I want to point out that occurred in the quarter. First, Q3 incurred $2.6 million from patent sales that favorably impacted our results including the billings, revenue, free cash flow, and earnings per share. Patents we sell were probably the portfolio we acquired early from close side in earlier history. These patents do not relate to our core offerings of limited use for our needs. At the same time, billings may have been $7 million higher. We are not inventory shortages, which resulted from demand for specific products that exceed our forecast coupled with timing of the related orders. We are investing and increasing our inventory levels during Q4, in order to minimize risk of additional inventory shortages and also to meet the demand for number of new products being released.

And as a reminder, we adopted new FASB revenue recognition rules at the beginning of 2011. Consequently, Q3 revenue increased approximately $5.1 million compared to the previous rules. Churn product revenue which cannot be recognized upon shipment both China and U.S. would not have been recognized on the previous revenue recognition rules. We believe that previous recognition revenue rules we made effect, the impact would have been less as we have also changed certain business practices to mirror with the changes to the revenue rules. As has been the case, the new revenue recognition rules were taken into consideration when we provided our third quarter guidance.

The key numbers for Q3 can be seen on slide three. The billings were $118.4 million and increased 25% year-over-year or 22% excluding the patent sale impact. Revenues were $116.4 million, up $0.37 yet year-to-year or $113.8 million or 34% excluding the patent sale. Non-GAAP operating income was $31.4 million, up 52% year-over-year or up 40% without the patent. Non-GAAP operating margin was 27%, up approximately 3 percentage points year-over-year or 25% without the patent.

Non-GAAP EPS was $0.13 (indiscernible) came with a patent sale. The free cash flow was $34.7 million or approximately $0.21 per share. We achieved record high revenues driven by continued strong growth in both the Americas and APAC as 41% and 38% respectively. EMEA revenue growth also saw the 31%, up from 24% year-over-year growth toward that second quarter. We are pleased with our strong execution and progress of reenergizing growth in the region.

In terms of profitability, profitability is again about the expectations in a long-term model. The non-GAAP operating margin was the highest ever at 25% excluding the impact from the patent sale I mentioned. We are pleased with the profitability, particularly given our accelerated hiring efforts and continued investments of sales, support, and R&D in order to support growth. Continued expense control and continued leverage in our business model. Free cash flow of $34.7 million exceeded our guidance of approximately $30 million. Cash generation continues to reflect strength in our collections, profitability, working capital management.

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