Fortinet, Inc.
Q2 2011 Earnings Call Transcript

Published: 20 Jul 2011

[Operator:]

Good day ladies and gentlemen and welcome to Fortinet Second Quarter 2011 Earnings Announcement. (Operator Instructions) I would now like to turn the conference over to Mr. Ken Goldman, Chief Financial Officer. Sir, you may begin.

[Kenneth Goldman:]

Good afternoon and thank you for joining us in this conference call to discuss Fortinet’s financial and operating results for second quarter 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 performance of our business. I will then conclude with some thoughts for the third quarter and full year 2011, before we open up for your questions. As reminded 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 second call will begin at 03

[Ken Xie:]

Thank you, and thank you everyone for joining us on this call. As Ken Goldman noted Fortinet had a strong second quarter reporting finance results that meet and exceed all our target. The UTM Threat Management, the Unified Threat Management market remain one of our strong and growing, and at the price of all size increasingly consolidate their security to reduce complexity and cost, and a service provider realize the flexibility to enable delivery of the priority of a managed security services. Fortinet continues to stress in authorization in a UTM market and extend our lead over competitors. As you see in the most recent security appliance tracker show Fortinet hold its leadership of the worldwide UTM market for the 21st consecutive quarter and continue to gain market shares. Additionally, Frost & Sullivan recently awarded Fortinet with its 2011 North American market leadership award for the UTM. Attributing to our leadership in our strong UTM product and our ability to enhance the value and meet consumer requirement. Now, over (inaudible) for the employee in the engineering related growth, we are taking innovation, security and quality very seriously. So we are proud of the product we produce and like some many other security vendor who just talk about having the most secure product and hype them through heavy marketing, we believe the true validation come from the customer endorsement and also the third party certifications. Many of our sales wins come from referrals by customer and the partner who use our product and we believe no other security vendor has as many certifications as Fortinet has today. So, we are the only UTM vendor to endure rigorous testing to earn certifications across our whole security functions and the technologies UTM offers. For example, Fortinet firewall functions is certified by ICSA lab, FIPS and Common Criteria EAL 4+, which is the highest level governing firewall certification today. Additionally, it also earned IPv6 ready status and a NEBS Level 3 certified on the FortiGate 5000, which has the industry’s best performance of around 500 gig firewall support. Fortinet IPS solution is certified by ICSA Lab and also is IPv6 ready. And, our Fortinet antivirus technology is certified by ICSA lab VP100 and we are the first and only UTM vendor in the space to be certified for Nava (ph) based high speed antivirus functions. These independent certifications demonstrate our ability to consolidate multiple security technology into single device (inaudible) while still maintaining highest standard of a performance, security and accuracy. Specifically in Q2 Fortinet has earned and maintained the following certifications. ICSA certification for antivirus, corporate firewall, Nava (ph) intrusion prevention, SSL VPN and the WAP application firewall. Fortinet also earned 11th virus bulletin VBSpam award for the highest spam catch rate, its sixth consecutive VB 100 award for the best in class antimalware capabilities. Additionally, FortiGate system achieved IPv6 Phase 2 Readiness Certification which provides a confidence in environment around IPv6 networks or IPv4 network being transitioned into the new protocol. And finally, as a testament to the design, development and manufacture and delivery of Fortinet product, service and process, we also achieved ISO 9001 2011 certification for high standard of the quality and management. Coming from engineering background myself I am all excited to see the impact of Fortinet innovation of finest result. In Q2, a number of key deals were included recently introduced product. For example, several large distributed enterprise deal in the U.S. retail sector include sales of FortiGate 80CM and 60CM. Integrated wireless broad band UTM appliance as well as the recently introduced FortiGate AP wireless controller product. One of such deal was with a U.S nationwide retailer who purchased more than 600 FortiAP 20B and FortiGate 80C appliance to secure each of the current and future store as well as to complying with the PCI regulations. (Inaudible) for FortiGate 3040B, FortiGate 3140B, and 4950B remain one of our strong, as these high performance appliance product through the several deal for this quarter with large enterprise service provider. One thing I would like to highlight is the six figure win with a large manufacturer in Japan. Following the earthquakes and the tsunami earlier this year they initiated anew disaster recovery project that include building backup data center for one of their key factories. To secure, it's a 10 gig Nava (ph) backbone. They select a FortiGate (inaudible) multi gig appliance based on our unmatched performance capability and we won this deal against the Juniper. As just detailed business wins, high performance (inaudible) remain one of the Fortinet’s biggest differentiator and that’s why a sales drive. We continue innovating and improving in this area and deliver our eighth generation of FortiASIC Content Processor, the CP8 in last quarter. Later this year we will introduce a new FortiGate product which will incorporate a FortiASIC CP8 and (inaudible) the security performance bond. So, in closing, I’m pleased with the second quarter result and I feel confident in our ability to continue to grow and drive security innovation and quality in the market. Now let me turn the call back to Ken Goldman who will give the final outlook for the Q3 and the rest of the year.

[Kenneth Goldman:]

So, yeah, let me go to the guidance and then we’ll open up to Q&A. Relative to third quarter we expect billings to be in the range of $114 million to $118 million, which reflects growth of 22% year-over-year at the midpoint. We expect revenue in the range of a $101 million to $103 million, which is the midpoint is about 20% growth. Gross margin to be consistent around 74%. Non-GAAP operating margin to be in the range of 20% to 21%. Non-GAAP earnings per share expected to be approximately $0.09 to $0.10 per share. This is based on expected diluted share count of $165 million to $167 million. Now, I would also note that we expect FX rates on expenses to have had one time impacts of those EPS, free cash flow of approximately $30 million, and pro forma tax rate of approximately 33% for the quarter and for the balance of the year. In terms of for the full year we expect billings to be in the range of $460 million to $470 million modestly up from our prior guidance. The midpoint represents approximately 24% growth in the year, and this would again result in further market share gains. We expect total revenue to be in the range of $395 million to $410 million, was up from $390 to $400 million previously provided. The midpoint reflects growth of 24% for the year and higher than previously guided annual growth of 22%, gross margin to remain at approximately 74% to 75% and operating margins of around 21% for the year both atop of our target ranges. EPS for the year of approximately $0.36 $0.37 up from approximately $0.35 which is put adjusted in, I guess some rounding there, and based and based on expected way to do the check out of approximately the same of 165 to 167 million shares. And this assumes about a three set impact from FX on expenses. We expect free cash flow to be in the range of a $135 million to $140 million, cash flow per share approximately $0.83, up from $125 million guidance we previously provided. At the midpoint this growth is approximately 38% for the year and all of this is also shown on the slides that we provided. So, in closing, we are pleased with our second quarter performance. Our high level execution defined with momentum in the UTM market continues to drive our strong performance from a revenue, profitability and cash flow perspective. Looking ahead, we are excited about the pipeline of business as we enter the second half of 2011. We remain extremely focused on growing our business globally and that includes EMEA, APAC and we are also confident about reenergizing growth in EMEA. As Ken noticed, we continue to focus on product innovation and we do have some new product introductions expected later this year. So, now, let me turn it over to the operator for your questions. Operator?

[Operator:]

Thank you. (Operator Instructions) First question comes from Philip Rueppel from Wells Fargo Securities.

[Philip Rueppel:]

Thanks very much. You mentioned Ken that you have confidence that Europe will bounce back. Can you give us a little more granularity of what some of the issues were, was it widespread, was it particular countries that were perhaps weaker than others or particular products or verticals that – and what does give you the confidence that some of those issues might turn around over the course of the next quarter or two?

[Kenneth Goldman:]

Yeah, I think a few things. Yeah, we did see some weakness – well, first of all I would say there was a little bit – we saw a little malaise in Europe overall. Two is, I think in certain countries that was more pronounced. I think the things we can do in some of those countries will better, and it has to do with in some case how we organize some of the people we have over there, also some of the people we have added as well. And then in terms of my confidence, if you will, our confidence, we look at our forecast for Q3, we look at the momentum we see in the deal flow in terms of Q3, the pipeline and so forth. As we see that see some of the – we did take some actions, if you will, in terms of not let anybody go but sort of reallocating or changing some people around that we feel quite confident that we will see improved results in EMEA. Again, I think we did – again I don’t think it's totally ourselves, but what I’ve heard from some others that EMEA was, there was a little bit of malaise in EMEA, but that’s not an excuse, we think we will do better, we plan to do better given everything we know today in Q3 and Q4.

[Ken Xie:]

This is Ken. Let me also add some point. Traditionally we are more strong in Southern Europe, now we are starting keeping our hands – we are in northern part of Europe. And also, in Europe we also have some plan to go to sort of vertical market compared to we are more to in by country by region as we did in US, like two or three years ago. So US in the last two, three years we have more transitioned into the vertical market focused. We also believe some Europe change may be benefit to more focusing some vertical market.

[Kenneth Goldman:]

Yeah, so I would say, so in summary I think it reflects certainly the environment but also some things I think – in our feeling we can do better in certain of the countries or regions verticals in Europe as well. Nonetheless, we did have some good wins, the revenue growth was good, but we also expect that we will do better in terms of billings going forward.

[Philip Rueppel:]

Great, thanks very much.

[Operator:]

Thank you. Our next question comes from Jonathan Ruykhaver from Morgan Keegan.

[Jonathan Ruykhaver:]

I guess kind of a follow up question to the previous one. Can EMEA lag the growth that you’ve driven in the US and APAC over the last couple of quarters? Can you just talk to why that’s been the case, is it competitive, is it just more difficult process to displace the large incumbents in that geography relative to the Americas and APAC?

[Ken Xie:]

Yeah, Jonathan, I know you follow Fortinet for almost ten years. You know, when we started selling like in 2003, the first few years actually we have each region above one third, and then Europe started more catching up a few years later, then US started growing faster in the last couple of years. Now, we see APAC starting to get strong. The size of economy of APAC also starting pretty close to Europe right now. So we see that APAC strong growing, Fortinet is a world banner, it's a global company and that’s where we kind of – one have the global growth. That’s the strategy we have, have global overall growth and more balanced out. So that’s – I don’t see particular weakening in the Europe it's more how we can chip in each region and continue to grow and balance out.

[Kenneth Goldman:]

I think the only thing I would say is, traditionally we can say that we have somewhat a higher market share in Europe overall than we have in so many other parts of the world, so that – so it’s not as easy to gain market shares than might be say in Americas, so that’s one aspect. The other aspect was the environment, economic environment, and the third is, in some cases I think we think we can do somewhat better than we did. So we are going to take – we are going to put some extra emphasis if you will in terms of doing that.

[Jonathan Ruykhaver:]

I’m just trying to understand and reconcile. If you look at the macro concerns in Europe I guess nobody knows what’s going to happen going forward. But it sounds like you might have had customers there that just decided to rein in spending because of those concerns. What gives you the confidence that that business actually comes back? I think you kind of suggested it's execution and people related, but if you could explain a little bit more where you get that comfort?

[Kenneth Goldman:]

Well, obviously we have to execute, the proof will be in terms of results for Q3. But I think at least what I would tell you is I look at it in terms of, seeing the business that we have in our pipeline, seeing the confidence our people have relative to going into the quarter and seeing what we believe we can close this quarter and the momentum we’re seeing there. So I think it's sort of the benefit of seeing the internal forecast we have, our expectations, the pipelines we have, and our ability we believe to execute better than we did in Q2.

[Jonathan Ruykhaver:]

Okay. I guess given that – given what you just said and then looking at the guidance for revenues, you are so many billings growth, those added revenue growth in 3Q, but is there a territory that you expect to be down sequentially from a geographic standpoint given the midpoint of that revenue guidance range is below what you just posted for 2Q?

[Kenneth Goldman:]

I’m not sure I understood your question on revenue. I think in terms of – we’re hopeful that we – if you go back in prior years Americas usually in terms of billings is up a bit in Q3 even though it's seasonally (inaudible) the summer and APAC tends to be flattish. So, Europe tends to be lower in Q3 versus Q2. Yeah, we think we can do a little bit better than that and maybe keep those numbers comparable. We’ll see. So that’s what we are hoping for. In terms of revenues, I think the thing that we do look at is, is the mix of our business. I think as I pointed out earlier we did have a particularly good mix of billings in terms of products this past quarter, that’s sometimes a little hard to gage, and so I just want to be a little cautious there, I don’t want to get ahead of myself in terms of what our guidance could be in Q3 relative to revenues. Because it is somewhat mix dependent of the billings. I mean obviously services gets amortized into the quarter but the amount of revenue we can recognize from billings is predicated and tight to deal with than we do during the quarter.

[Jonathan Ruykhaver:]

Right. Okay, just one final question. You just alluded to the mix kind of moving back towards the midrange products. The high-end products, if you look at the percentage of total billings, declined from March quarter, can you comment on the dynamic there, does it reflect any slowdown in the telcos vertical?

[Kenneth Goldman:]

No, I think it's always a challenge when you give metrics as you can read too much into one or two points, and I would just tell you in all candid that’s pure noise level when we have one or two points up and down from quarter to quarter. Again, I don’t expect to see big changes in that trend. I think the point we try to make in some of my long prepared remarks, is the reality is there are opportunities from us all the way from entry level SMB and enterprise, and frankly we need to do – we need to grow market share in all three of those “segments.” And so, while we continue to be very, very focused on the enterprise and service provider probably because I think people don’t always give us the credit we deserve in that area, the reality is there're opportunities all up and down in chain in terms of growing market share, and that applies to Americas, applies to Europe or applies to APAC.

[Jonathan Ruykhaver:]

Okay good enough. Thank you.

[Operator:]

Thank you. Our next question comes from Adam Holt from Morgan Stanley.

[Keith Weiss:]

Keith Weiss on the line for Adam Holt. I wanted to ask you about the large deal environment. After a very good Q1 what we’re seeing like is a disproportionate amount of large deals, you have seen like a little bit tougher large deal environment. Is that something that you saw out there, was it macro related, maybe if you can give us some color into slight step down into the number of large deals you’ve been signing.

[Kenneth Goldman:]

Yeah, at least from what I can tell right know that I do not think there is anything – that we at least read into that. I mean we did have a greater number of deals in the 100 as well as the 250, but not necessarily in the 500 and over. So, I do not think there is anything there that does sort of – that will move around a bit and so at least from what I can tell right now and then talking to our sales folks I do not think there is any real indication there that we are seeing any real change in the market opportunity for us.

[Keith Weiss:]

Got it. And then in just – there were a couple of things you said on the call that speak to the diversions between the growth you are seeing in total revenues versus the growth that you saw on billings. One is obviously the accounting change and stuff being recognized upfront rather than you put on to the balance sheet. You made some mention of deal size or deal lengths shortening of those long term contracts being less prevalent in the quarter. Could you also quantify or maybe sort of breakdown what causes that diversions between the revenue growth rate and the billings growth rate in the quarter.

[Kenneth Goldman:]

Well, yeah, what I tried to do is, again revenue to some extent does lag as you know billings. Billings does include a variety of things, it includes new products, it includes the services that go with those, it includes renewals and then you have the, not the issue, but you have the complexity of doing one, two or three year types of deal as well. So all of that take into account into revenue as well as the point you make relative to we did gain some revenues on a year-over-year basis not quarter-to-quarter relative to going to the new revenue reg rules as of Q1 of this year. But, again, the mix, I mean, the mix in terms of billings and whether the services component of that, renewals component of that and product component, all of that affects what revenues we’ll recognize in the quarter, and so that is all taken into account.

[Keith Weiss:]

Got it.

[Ken Xie:]

Keith, this is Ken, let me add a few points. Also the product growth is also very, very important meaty indicator. Because we have more than half of the revenue come from service, which we have to recognize during the period. But product growth, with 50% product growth is also very, very strong. So what we see is really, a lot of service provider they tend to buy short pan on the service likely more preferred renewal year by year compared to some of the SMB they tend to lock in for multiple years. So that is where we see very, very strong in the product growth, but also on the other side really sometime the patent of the service purchase also change. We do not quite have the solid data yet, but from the product growth we feel pretty comfortable for the long term service growth.

[Keith Weiss:]

Okay, that makes sense. And then just if I can speak on one more. You mentioned some actions around, change of some people around in EMEA. Can you delve a little bit further into that of exactly what types of actions that you took, is there any higher than normal turn in EMEA sales people, were there any just sort of changes on top of sort of the sales leadership in EMEA?

[Kenneth Goldman:]

I will say this way. We wanted to make the accountability a little clearer. So no change in people, it’s just a question of making sure the accountabilities are a little clearer, cleaner and in some cases we have added some folks in certain countries in EMEA as well that we think will contribute to improved performance.

[Keith Weiss:]

Got it. Thank you very much guys.

[Operator:]

Thank you. Our next question comes from Jonathan Ho from William Blair.

[Jonathan Ho:]

Good afternoon guys. Can you talk a little bit about your opportunities within the US Federal government vertical and maybe what you are seeing there in terms of an opportunity, I know it’s all pretty small part of your business, but you guys talked about the sort of the certifications. Can you just give us some color on what you see there in terms of UTM adoption?

[Ken Xie:]

Like I said we started building a federal team more based in DC locally with the leadership like Phil Fuster, he is the VP of Federal, joined about one year’s ago. So, but federal deal you only take quite some time and also some time depend on the budget process. Right now, the fed (inaudible) very small, immaterial for us right now, but we do see the potential growing quick and also larger deal there, because the product provision and the function we have is more like a high speed, high quality and/or secure result certification fitting the space well, and also we are a US based company. So with that we do see the good potential going forward, just we somehow got in that space relatively late because the company in early days was more based on the region not based on the vertical market. But we started changing this vertical focused structure about a couple of years ago especially in US and we are seeing very, very good result right now.

[Jonathan Ho:]

Got it. And can you talk a little bit about the service provider penetration, just how far are we into this opportunity and some of these are multi-stage rollouts, can you give us maybe a sense of where we stand in terms of probably speaking of your pipeline at that high end market.

[Ken Xie:]

I think still in very, very early stage because a lot of service provider are starting trying to offer – I mean they are in a trial model and they also try to offer the value added security service beyond the broadband internet service. But I have to say what’s the price model, what kind of service they can provide, the value they can add is still more in the early stage. But they do see the benefit of UTM, which one platform they can offer multiple service based on the cost money, so they have the flexibility using the single platform to offer different service. Also like the virtual domain, virtualized service also is welcomed by the service provider. But it’s in very, very early stage, but they do see the huge benefit, it's much better margin and the customer also like the service provider to play more role in a secure clean pipe there. So that’s where we see the huge potential going forward.

[Jonathan Ho:]

And if I could just maybe one last one in, I mean in terms of the push out in Europe, you guys talked about some of the deals maybe getting flipped out, can you maybe quantify what that is and what are the fields of clause in the third quarter.

[Kenneth Goldman:]

Yeah, I don’t want to get quite that goony (ph) because I think that could be misleading. So I think I would just rather say what I said relative to optimism relative to Q3, but I do not want to get into specific deals closing and so forth with only a couple of weeks into the quarter.

[Jonathan Ho:]

Fair enough. Thank you.

[Operator:]

Thank you. Our next question comes from Walter Pritchard from Citi.

[Walter Pritchard:]

Hi guys, not to beat the dead horse on the Europe. I guess I just wanted to get a little bit more insight into how – we have gotten used to conservative guidance out of Fortinet. I am just wondering if you could help us understand if you look at Q3 in the year, how conservative your guidance may be and in particular how are you treating large deals in terms of the guidance? It sounds like this quarter may have been a little bit of a surprise, I am just wondering if you are changing sort of how you are forecasting those in the guidance for the quarter and the year?

[Kenneth Goldman:]

Yeah, no I would not say we have really changed our methodology of guidance. I mean, I think, if you look at this past quarter, I think in the case of all the metrics we follow we overachieved except that you would say that we were in line in terms of billings. And so, clearly if like anything else you want to do better than your forecast. So our goal is continue to do better than we guided, I mean that’s our goal. The guidance reflects that any one time our best feel for what we see in terms of the overall environment and market and our ability to execute. So that is how we guide and then we obvious, if we can we want to do the best we possibly can and so that’s where we go into any quarter. But I wouldn’t say that we particularly, I mean, we have not seen any change in the environment that says we should pull in our horns, we should get concerned, we should get nervous that would be the absolutely wrong take away from this call. Our perspective is we are in a growth market, a very good market, we are very well positioned, we have a good new product flow coming out, there is nothing in any of our regions including Europe that concerns us relative to our ability to forward execute. So, we are raring to go relative to Q3 and finishing out this year.

[Walter Pritchard:]

And then just one follow-up to that, I guess, Ken, the product revenue and I assume product billings was better than we had modeled and you have the -- annuity in services attached was lower on that. I am wondering you did mention less term lengths at more of the deals for one year. I am wondering if beyond term length there was any other dynamic that resulted in less services attached or annuity attached per dollar on product revenue.

[Kenneth Goldman:]

No, I don’t think so. I mean, again, that will vary a little bit from quarter to quarter. But I don’t think there is anything in particular that we would see there in terms of types of deals we do. I mean sometimes deals – we get services after the fact, sometimes we get one year services and sometimes we’ll get three years, pretty much don’t get much beyond that. So, no, I don’t see anything there. My own sense is that that number will sort of go up and down a little bit from quarter-to-quarter and not necessarily be a distinct trend one way or the other.

[Walter Pritchard:]

Great. Thanks a lot.

[Kenneth Goldman:]

With the one exception which I did say in the long term is try not to use (inaudible) over a number of years and we don’t do that anymore. So that will – so there will be a little less that goes into the services especially because of China which now is under the normal revenue reg rules and not amortized and deferred over, you know, which used to be a lengthy number of years.

[Walter Pritchard:]

It makes sense, thanks.

[Operator:]

Thank you. Our next question comes from Michael Turits from Raymond James.

[James Wesson:]

Hey guys this is James Wesson sitting in for Michael. First question billings growth in the low 20s is quarter down from the mid 30s last, why the deceleration, is it just the function of weaker Europe or were there other factors?

[Kenneth Goldman:]

Well, I mean if you look at our numbers APAC and the Americas grew quite nicely, it's a plus. So, we had good growth there. Even when we were going in terms of plus, you know, Europe tended to be in the 20 percentish range plus or minus, so again remember what the comment we made earlier is, we do have somewhat higher share in Europe and so the ability to grow on that higher share is not as easy as it is to speak in Americas or Asia PAC. But I mean our billings growth would’ve been certainly higher than what we showed had EMEA been a little bit more like what used to, and as I said before, we are – at least given where I sit today we are hopeful and confident that we will see better growth out of Europe this following quarter.

[James Wesson:]

Okay.

[Kenneth Goldman:]

I mean you really look at it, if you had Europe 15% to 20%, we would’ve back in the thirtyish or so kind of growth there. And that, you know, again, we haven’t changed. That remains our goal. So, it is clearly – we are very, very focused now. Again I don’t give guidance to that range. But our goal has always been consistently to grow at the 30% range approximately.

[James Wesson:]

Got it. Okay. And then, you’re talking about verticals early in the call. Can you describe what the pipeline looks like for the financial services sector in the second half and what you’re seeing in deals?

[Kenneth Goldman:]

Yeah, I don’t know if I have it quite that granular at this particular time and probably don’t want to get quite to that level of detail. So, in terms of pipeline by vertical.

[James Wesson:]

Okay. Just a quick thing on housekeeping, what was the cash tax rate for the quarter and what do you expect it to be for next?

[Kenneth Goldman:]

Well, that’s a good question. I don’t know the tax rate but we continue to – we will have all that in our queue, but it's in the couple three million as I think I’m guessing here that we spend in – it maybe not even a couple of million in taxes. So, we are not helping the governments in terms of paying down the deficit. But it remains very, very low and it's primarily because of the exercises of stock options and the deductions they are on.

[James Wesson:]

And should I be making that similar assumption for next quarter?

[Kenneth Goldman:]

My sense is it will be pretty similar for Q3, yes.

[James Wesson:]

All right. Thank you, Ken.

[Operator:]

Thank you. Our next question comes from Sterling Auty from JPMorgan.

[Sterling Auty:]

Hi, guys. Just one question. In terms of linearity in the quarter, we’ve been hearing from a lot of people that the quarter was very backend loaded, was that same for you across the board and different geographies or do you think it just was more due to the macro or is this maybe a trend that’s starting to push even more backend loaded than normal.

[Kenneth Goldman:]

No, I actually don’t think we had a backend loaded quarter. As you can see I’m actually very pleased with our DSO at 63 days. So, I don’t really believe our quarter was any fundamentally different in terms of linearity than prior quarters. Again, we feel quite good up and down in our balance sheet anyhow if you were looking at that balance sheet and certainly AR and DSO was good, inventories we made in very, very good control. PP&E net, modest and so, no, I would say no real change.

[Sterling Auty:]

All right, great. Thank you.

[Operator:]

Thank you. Our next question comes from Shaul Eyal from Oppenheimer & Company.

[Shaul Eyal:]

Thank you for taking my question. Good afternoon guys, two quick questions on my end. When you guys don’t win displacement or just contracts up, what’s the reason behind it, is it pricing, is it product related?

[Ken Xie:]

This is Ken Xie, let me try to answer. I think most of the time we don’t win maybe more because we do not quite see some of that deal, because some of the bigger player, especially some bigger networking company they try to leverage their marketing power, they have some other product to bundle all these things together. But when we get in – and always the product, the technology, the performance is the reason the customers join us. I don’t think we are really loosing because they’ll compete much on the pricing. It's really – we believe we have the best value, we have the best performance in the space. That keeps us winning.

[Kenneth Goldman:]

But we’ll continue to work on – this is never ending. So you need to keep on working on features and performance, and so, having the full sample of the features and, yeah, sometimes customers focus on one feature versus another, and so, we will continue to bring that out in our product line.

[Shaul Eyal:]

You guys indicated that there is a number of products coming in the second half probably some of them in the third quarter. Could it be that some of your European customers made matters kind of held back a little bit on spending in anticipation for those kind of new products, could it have anything to do with it a little bit.

[Kenneth Goldman:]

No I wouldn’t necessarily suggest that. We tend to have from quarter to quarter, some quarters are a little higher than other quarters in terms of new product intros. But, no, I don’t necessarily think that was the flavor for Europe. And by the way, in Europe, we say Europe, Middle East and Asia, and so one of the areas that I think in particular that we – I think I said this last quarter too is, Middle East is clear an area where instability makes a little bit more challenging.

[Shaul Eyal:]

Okay, sure. All right thank you very much.

[Operator:]

Thank you. Our next question comes from Dan Cummins from ThinkEquity.

[Dan Cummins:]

Thank you. Could I go back to some things that you referenced before about your success in Europe, traditionally was skewed to southern Europe. As you move sales resources and focus perhaps proportionately north, does that involve doing anything fundamentally different than you’ve done traditionally with respect to the channel, could this perhaps require more investment spending in channel resources or sales resources in northern Europe? Thanks.

[Ken Xie:]

We just want to keep expanding into all the country all the region. And like, right now we have more aggressive hiring in the Northern Europe, and also keeping the hiring spent in the Southern Europe. So that’s pretty much the plan we have.

[Dan Cummins:]

Yes, so now, I don’t see it – I mean we are very focused on our ratios. So we feel we can continue to exhibit the kind of margins I showed and it also make investments that we think are necessary in certain areas to grow our business. As Ken said, there are some emerging countries in Europe that we can do better on. There are some – Northern Europe as well, we can do better. So, there are areas that we did well this quarter and some other areas we don’t we could do a little bit better. But from an investment point of view and from a Channel point of view we don’t see any dramatic changes from that perspective, I would say it's more nuance changes than dramatic changes.

[Dan Cummins:]

Can I ask just one follow up question in terms of your kind of an internal performance assessments. I guess, does that -- to the extent that you are acknowledging perhaps company specific issues and in addition to the macro environment, does that – just by implication does that also include your channel resources, your channel sales and productivity side.

[Kenneth Goldman:]

Yeah I don’t know – I mean it’s like – I think my comment really is more generic in that I think we definitely feel we could and can do better in our growth in Europe and we are focused on that. And again, I do not see any dramatic changes. I think this may be a sort of a nuance in terms of focus in certain areas and then perform a little bit better. So I do not see any nuance around the channel. I mean every quarter we look at different players, we do from time to time make some changes. And so, there is nothing dramatic though that I am suggesting here.

[Dan Cummins:]

Okay. Thank you.

[Operator:]

Thank you. Our next question comes from Rohit Chopra from Wedbush Securities.

[Rohit Chopra:]

Couple of questions. One, I want to go back to Jonathan’s question, because I didn’t hear the answer. But I wanted to get an understanding of the competitive environment. We picked up a couple of companies who were discounting extremely heavily especially in Europe towards the end of the quarter. Did that have an impact on your ability to close deals in your analysis?

[Kenneth Goldman:]

No, I wouldn’t say that it had. If it had any impact I surely didn’t see it. So, no, I don’t – discounting and pricing and so forth and wins and losses, again, I don’t see that as having – assuming I didn’t see it, it having any impact, I really don’t. I think again our ability was – some deals might get pushed out as opposed to losing it from pricing. So, no, I don’t the competitive situation has changed in Europe either or other areas of the world. So, I would not say it's that issue either. Again, I think it is in our ability to close deals in the timeframe we expect to close deals.

[Rohit Chopra:]

Okay. And then I’m just going to stay on the European that everybody else seems to want to know what’s going on. So, governments in Europe, were you able to determine if they were a greater contributor to any of the decadence or the slow down.

[Kenneth Goldman:]

I don’t know that. I don’t have any detail there. So, it certainly wasn’t discussed very much internally. So I do not think that – I would not characterize that as indicative of any real trend, no, that I know of anyway.

[Rohit Chopra:]

Thanks guys.

[Operator:]

Thank you. Our next question from Rob Owens from Pacific Crest.

[Rob Owens:]

Thank you very much. Just a couple of quick questions. You mentioned how you are operating margin guidance was handling the long term target. At what point do you either change the target or increase your spent to get there. And at what level of revenue does the model yield margins within the target? Is it the midpoint?

[Kenneth Goldman:]

Well, yeah, the second was really the same as the first really if I think about it. And I think we will – as we look to the end of this year and thinking about our forward plans for next several years we will take another look at our long term margins. Clearly we are doing better. I think the ability to invest is consistent with the guidance we gave, and so, we don’t want to go backwards really. Clearly, others in our space also are making very good margins. So we see opportunity to continue to do well. I don’t want to give a number yet, because we haven’t put it together. But, we will take another look at what today – we set the model up a couple of years ago that we felt that was sort of our intermediate model. We have already over achieved that and we will take a look at going forward to what we can do beyond that hopefully when we put our numbers together.

[Rob Owens:]

Okay, great. And as you look ahead to Q3, and specifically in the year ago period, is there a tough federal compare in the September ’10 quarter?

[Kenneth Goldman:]

I don’t remember any – we had a very good Q3 last year. You are right about that. I don’t recall I don’t have it front of me here, a very tough – some people looking at numbers. So now the question is, the comment is, no, we do not have a tough federal compare Q3 versus Q3 of last year.

[Rob Owens:]

Okay, great, thanks again.

[Kenneth Goldman:]

But we did have a good margin last year and we did – some of them last year over achieve some of our revenues and we did actually end up under spending.

[Rob Owens:]

Great, thank you.

[Kenneth Goldman:]

Can I add one more thing? I think last year we were also helped by currencies. So, last year I think the dollar happened to be a little stronger and that helped us from the currency and expenses point of view and, yeah, that’s been the opposite effect this year.

[Operator:]

Thank you. And our next question comes from Norman Heimlich from Dundee Securities.

[Norman Heimlich:]

How much of your business is coming from the third world, Asia, Brazil, and the faster growing areas, and that is number one. And number two, just in case you didn’t know, but the stock is down over 20%, I mean after the market.

[Kenneth Goldman:]

Yeah, I knew we weren’t doing – people were sort of, in my opinion, sort of over – taking too much into an issue relative to billings and so be it. But, again, I think that – surely that’s an issue that we will have – the only way you can dispel that is to perform. And so, we know in Q3 and Q4 we have to perform there. So I totally understand that. Relative to the emerging area, we do not have that specifically broken out in terms of Brazil. We do know whether you are talking about Eastern Europe, some of the Asian countries, as well as Brazil and so forth, there is India whatever, there are opportunities to – we are very focused on that. Let me say it that way, and we do think we can grow even faster there as we invest.

[Norman Heimlich:]

What would it cost to invest?

[Kenneth Goldman:]

You know, I am not going to specifically take it – our investments are up, predicate – are all inclusive if you will in terms of the guidance I provided.

[Norman Heimlich:]

Okay, thank you.

[Operator:]

Thank you. I’m showing no further questions at this time.

[Kenneth Goldman:]

Okay. So, let me stop there. Just remind you that we do have another call at 3

[Operator:]

Ladies and gentleman thank you for participating in today’s conference. This concludes our program for today. You may all disconnect and have a wonderful day.