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spk13: At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1-1 on your telephone, and you will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1-1 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Aaron Ovadia, from the Director of Investor Relations. Aaron?
spk04: Thank you, and good afternoon, everyone. This is Aaron Ovadia, Director of Investor Relations at Fortinet. I am pleased to welcome everyone to our call to discuss Fortinet's financial results for the second quarter of 2024. Joining me on today's call are Ken Zee, Fortinet's founder, chairman, and CEO, Keith Jensen, our CFO, and John Whittle, our COO. This is a live call that will be available for replay via webcast on our Investor Relations website. Ken will begin our call today by providing a high-level perspective on our business. Keith will then review our financial and operating results second quarter of 2024 before providing guidance for the third quarter of 2024 and updating the full year. We will then open the call for questions.
spk12: During
spk04: the Q&A session, we ask that you please limit yourself to one question and one follow-up question to allow others to participate. Before we begin, I'd like to remind everyone that is on today's call that we will be making forward-looking statements, and these forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected. Please refer to our SEC filings, in particular their risk factors, and our most recent Form 10-K and Form 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, all references to financial metrics that we make on today's call are non-GAAP, unless stated otherwise. Our GAAP results and -non-GAAP reconciliations are located in our earnings press release and the presentation accompanying today's remarks, both of which are posted on our investor relations website. The prepared remarks for today's earnings call will be posted on the quarterly earnings section of our investor relations website immediately following today's call. Lastly, all references to growth go on a -over-year basis, unless noted otherwise. I will now turn the call over to Ken.
spk18: Okay, thank you, Aaron, and thank you to everyone for joining our call. We are pleased with our strong execution in the second quarter as we successfully balanced growth and profitability. We achieved record operation margin, which increased 820 basis points to 35 percent and managed to build in on the revenue and high end of the guidance range, reached our full-year 2024 revenue and operation margin guidance, and we continue to invest for growth, gaining market share in secure networking and investing in fast-growing unified CRC and secure operation market. Secure networking customers are increasingly recognized of 40 OS and 40 AC technology, offering 5 to 10X better performance than our competitors while increasing security effectiveness and providing a low total cost of ownership. For over 20 years, we have been leading the shift to networking and security convergence, and the industry projection now indicates secure networking will surpass traditional network by 2026, four years earlier than previously anticipated. In the second quarter, unified SASE accounted for 23 percent of total building, up one point. We expect our differentiated unified SASE offering to become the leader in the SASE market. We believe we are the only company that has built all the SASE functions organically in a single operation system. We have converged networking and security stacks, including our market-leading SC1, ZTNA, Secure Web Gateway, CASB, Firewall, and many other innovations. Our SASE offering provides flexible enforcement, delivering a better user experience while securing access to applications on-premise and in the cloud. Furthermore, we continue to build our own SASE delivery infrastructure, including leverage of 40K technologies, providing us with a competitive long-term cost advantage. As announced earlier today, we acquired Next DLP and Next Generation Cloud-Native SAS Data Protection Platform, extending from endpoint to cloud. This will allow us to enter the standalone enterprise DLP market, as well as integrate the market with our 40-SASE solution. We also recently improved our position in the government's quadrant for single-vendor SASE, and are the only vendor included in all five of major network security magic quadrants, single-vendor SASE, network firewall, HD1, Secure Service Edge, and enterprise-wide and wireless-line infrastructure. Each of these solutions run on a single, unified operating system, 40 OS, with AI-powered 40-Guard, Secure Service, and unified management. AI-driven Secure Ops count for 10 percent of total building. In the second quarter, up one point. Our comprehensive Secure Ops portfolio, backed by over a decade of AI experience, offers the broadest range of sensor and advanced analytics to continuous access activity to identify some cyber threats. 40AI harnesses Genitive AI to turbocharge our platform and help security operations teams make better informed decisions and respond to threats faster by
spk42: identifying
spk18: the most complex tasks. 40AI is available in FortiAnalyzer, FortiSim, and FortiSore, and will soon be available in other Fortinet products.
spk19: In addition,
spk18: we are pleased to further expand our Secure Ops portfolio with acquisition of Layswap, and we believe that together our solutions form one of the most comprehensive four-step cloud security solutions available from single-vendor. Layswap's organically developed AI-driven cloud-native application protection platform will be combined with the power of Fortinet Security Fabric Platform, ensuring broad protection across network, cloud, and endpoint. This acquisition increases our total addressable market by 10 billion, and adds a team of talented engineers dedicated to cloud-native security while also expanding our sales force that can sell entire Fortinet portfolio solutions. Yesterday, we announced several enhancements to Fortinet OT security platform, which already stands as the most comprehensive OT security platform on the market. Enhancements include new recordizer points, advanced secure networking and secure operation capability, and expanded partnerships with leading OT vendors, reflecting Fortinet's commitment to security for the growing cyber-physical system market. As further evidence of our innovation and commitment to excellence in OT, we recently earned prestigious Red Dot Product Design Award for FortiGate-Rect 70G with DU5G Modern. Fortinet was the only secure security company to receive this recognition in the industry next-generation firewall. Before turning the call over to Keith, I wish to thank our employees, customers, partners, and suppliers worldwide for their continued support and hard work.
spk25: Keith. Thank you, Ken, and thank you, Aaron. And good afternoon, everyone. Let's start with the key highlights from the second quarter. Overall, we are very pleased with our execution in the quarter. We achieved record gross and operating margins at 81.5 percent and 35.1 percent, respectively, while delivering top-line numbers at the high end of our guidance range. Revenue grew 11 percent as product revenue exceeded our expectations, driven by robust software revenue growth and sequential hardware growth that more closely aligned with historical norms. We also added 6,300 new logos as we continue to invest in our channel partners. As you'll hear in a moment, we believe we are on a pace for another rule of 40 year. At the same time, we accelerated our investments in the fast-growing Unified SASE and security operation markets for the acquisitions of Lacework and Next DLP. Lacework strengthens our position in the high-growth CNAP market and expands our total addressable market by $10 billion, while Next DLP improves our position in the standalone enterprise data loss prevention market. Combined, 4NET will gain over 900 customers and talented sales and engineering teams. And I'll just pause here to offer a very warm welcome to members from both companies. Continuing with our Q2 highlights, we have taken the lead in partnering with the U.S. Cybersecurity and Infrastructure Security Agency, or CISA, through a Secure by Design pledge and are leading with our responsible transparency practices. We want to emphasize we understand customer trust is paramount to our business. Our continued success across all customer segments and each of our three pillars represents hundreds of thousands of end customers testing and buying for our net security solutions. Simply stated, this is a significant scale advantage and a responsibility few others have and also offers customers validation at a very robust level. We are committed to responsible updates in deployment processes, supply chain controls, product security measures, and transparency. To understand more about the proactive measures we take to safeguard our customers and our reputation, please visit our trust website at 4NET.com backslash trust. Looking at billings in more detail, total billings were consistent year over year at $1.54 billion, overcoming the headwind from the drawdown and backlog in the comparable quarter. At the same time, total bookings increased year over year and more importantly, the sequential growth rate approached pre-COVID pre-supply chain norms. Unified SASE and SecOps delivered strong growth along with software, while product sales recovered more than expected. We continue to see significant progress from our investments in both pillars and saw strong pipeline growth of 45% for Unified SASE and 18% for SecOps. Both pillars are gaining significant momentum within our install base as over 90% of Unified SASE and SecOps billings are coming from existing customers. Larger enterprises continue to be our largest customer segment, with large and mid-enterprises combining to represent 86% and 82% of Unified SASE and SecOps solutions respectively. Within Unified SASE, 40 SASE buildings continue to grow at triple-digit rates, as existing customers can seamlessly integrate our solution within minutes to secure their hybrid workforce, while 40 client customers are able to use a single agent to secure Internet, private and SaaS applications. We've also integrated 40AP with 40 SASE for securing thin edges and unmanaged devices. Our Unified SASE solution continues to gain market recognition for the second consecutive year. We've been recognized as a challenger in the Garden of Magic Quadrant for single-vendor SASE, with the third highest placement in the ability to execute access. And as mentioned earlier, we are further improving our 40 SASE solution by adding powerful data loss prevention capabilities from Next DLP. Rounding out the building's commentary, SMB was again the top performing customer segment, while international emerging was again our best performing geography. On an industry-vertical basis, technology and transportation grew at double-digit rates, while service provider and manufacturing were more challenged. Turning to revenue and margins, total revenue grew 11 percent, to $1.434 billion, driven by service revenue growth and software licenses. Service revenue of $982 million grew 20 percent, accounting for 68.5 percent of total revenue. Service revenue growth was led by 36 percent growth in SecOps and 27 percent growth in Unified SASE. As noted on slide five, Unified SASE includes SSE and related technologies together with SD-WAN. Product revenue decreased 4 percent, but better than expected, to $452 million. Excluding the impact of backlog, product sales growth improved 14 points quarter over quarter, and a similar amount year over year. Software license revenue growth continued to accelerate at 26 percent and represented a high teens percentage of product revenue, a nearly five-point increase in the software mix year over year. Combined revenue from software licenses and software services such as cloud and SaaS security solutions increased 32 percent, accelerating from 23 percent a year ago, and providing an annual revenue run rate of over $800 million. Total gross margin increased 360 basis points to a quarterly record of 81.5 percent, and exceeded the high end of our guidance range by 400 basis points, benefiting from higher product and services gross margin, as well as a five-point mix shift to higher margin service revenues. Product gross margin of 66 percent increased 250 basis points year over year, mainly due to increased software mix and lower indirect costs. On a quarter over quarter basis, product gross margin increased from 56 percent to 66 percent, as hardware demand increased and inventory levels and related inventory charges moved closer to historical norms. Service gross margin of 88.6 percent increased 240 basis points, as service revenue growth outpaced labor cost increases and benefited from the mix shift towards higher margin for the security subscription services. Operating margin increased 820 basis points to a quarterly record of 35.1 percent, and was 840 basis points above the high end of our guidance range, reflecting the record gross margin, as well as cost efficiencies within the business. Looking at the statement of cash flows summarized on slides 16 and 17, pre-cash flow was 319 million for the quarter, and 927 million for the first half of 2024, or 1.1 billion after adjusting for real estate and infrastructure investments. Cash taxes in the quarter were 252 million. As a reminder, last year's second quarter benefited from the deferral of approximately $190 million in cash tax payments, which were ultimately paid in the fourth quarter of 2023. Infrastructure investments totaled 23 million. The average contract term in the second quarter was 28 months, flat year over year, and up one month quarter over quarter. DSO decreased seven days year over year and increased two days quarter over quarter to 68 days. While we did not repurchase shares in Q2, share buybacks have totaled $5.3 billion over the last four plus years, and the remaining buyback authorization is $1 billion. Now I'd like to share a few significant wins from the second quarter. In a seven-figure deal, an international government agency purchased 12 solutions across all three pillars, including eight SecOps solutions. This new customer selected FourNet because of our operating system's ability to consolidate over 30 networking and security functions into a single unified platform, covering SecOps, SASE, and secure networking. The customer was impressed with the integrated security, -to-end visibility, and automated response features of our 40 OS operating system. Next, in a seven-figure win, a large utility company expanded our partnership by signing their first enterprise agreement with us to safeguard their OT environment. This deal displaces five legacy vendors and includes ruggedized equipment deployed at the customer's power plants, control centers, and substations. Keys to this expansion win were our proven expertise in securing critical infrastructure and our -for-performance advantage. And lastly, in a competitive displacement win, a retail store chain purchased our 40 SASE solution in a seven-figure deal. This customer chose FourNet because of our integrated 40 OS platform as they were able to seamlessly integrate 40 SASE with their existing FourNet security solutions. Now I'd like to offer some comments on customer inventory digestion and the firewall refresh cycle. Last quarter, we pointed to a 25% improvement in the number of days to register 40-guard contracts from its peak and view this as an early, the soft indicator that, quote-unquote, inventory digestion at end users appeared to be normalizing, and the firewall market could start to show signs of recovery. To provide an update on this indicator and other signs of possible improvement in the firewall market, we can share that, as shown on slide 19 in the second quarter, the days to register security service contracts improved another 12 days and has now returned to 2020 pre-supply chain, pre-COVID crisis levels. Inventory commitments and levels are normalizing at our contract manufacturers and in the channel. And as noted earlier, the sequential increase in hardware sales in the second quarter aligned more closely with historical norms. While these indicators are positive, we believe customers are currently managing a tough macro environment in a key election year in the US, and we believe this is having an impact on our customers' purchasing decisions. As a result, we believe a full refresh cycle is unlikely to occur in 2024, but more likely in 2025. Moving on to guidance, as a reminder, our third quarter and full-year outlook, which are summarized on slides 21 and 22, is subject to the disclaimers regarding forward-looking information that Aaron provided at the beginning of the call. Before reviewing the outlook, I'd like to offer a few modeling notes in light of our LACEwork and NEXT DLP acquisitions, covering estimates included in our Q3 and full-year guidance. For billings, the acquisitions increase Q3 by approximately one-half point and the full year by approximately one-third point. Total revenue, increase Q3 and full-year growth by one point and one-half point respectively. For gross margin, they decrease Q3 and full-year margins by less than one-half of a point for each period. For operating margin, they decrease Q3 and full-year margins by three points and 1.5 points respectively. Inclusive of these acquisition-related estimates, for the third quarter we expect buildings in the range of ,000,000 which at a midpoint represents growth of 5%, revenue in the range of ,000,000 to ,000,000 which at a midpoint represents growth of 10.5%. Non-GAAP gross margin of 79 to 80%. Non-GAAP operating margin of 30.5 to 31.5%. Non-GAAP earnings per share of 56 to 58 cents which assumes a share count of between 767 and 777 million. Capital expenditures of 40 to 60 million. A non-GAAP tax rate of 17%. And cash taxes of 125 to 145 million. And again for the full year, inclusive of the numbers we gave a moment ago, we expect buildings in the range of ,000,000 to ,000,000. Revenue in the range of ,000,000 to ,000,000 which at a midpoint represents growth of 10%. Service revenue in the range of ,000,000 to ,000,000 which at a midpoint represents growth of 18%. Non-GAAP gross margin of 79 to 80%. Non-GAAP operating margin of 30 to 31.5%. Non-GAAP earnings per share of $2.13 to $2.19 which assumes a share count of between 767 and 777 million. Capital expenditures of 320 to 360 million. Non-GAAP tax rate of 17%. And cash taxes of between 525 million and 575 million. I look forward to updating you on our progress in coming quarters. Before we begin the Q&A session, it is with deep sadness that we recognize the passing of our friend, Peter Sulkowski, our SVP of Finance and Investor Relations. Peter was an integral part of the Fortinet team for over six years and was renowned for his passion for mentoring and developing the next generation of leaders. We'll miss Peter and fondly remember his commitment to fostering talent and nurturing potential within our company. I know that Peter worked closely with many of you on this call and the outpouring of condolences and heartfelt memories you've shared since his passing. Clearly shows the positive impact he had on so many people's lives. Peter took great pride in his contribution to Fortinet and rightly so, having contributed to increasing shareholder value from $8 billion to $46 billion during his tenure at Fortinet. We'll miss Peter. Aaron,
spk04: back to you. Thank you, Keith. As a reminder, during the Q&A session,
spk34: we ask
spk04: that you please limit yourself to one question and one follow-up question to allow others to participate. Operator, please open the line for questions.
spk13: Thank you. At this time, we will conduct the question and answer session. As a reminder, to ask a question, you will need to press star 1-1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1-1 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Brian Essex of JPMorgan. Your line is now open.
spk30: Thank you very much for taking the question. And obviously, sorry for your loss. Keith, if I could maybe touch on the margins, I think it's incredible margin results for the quarter. Could you help me understand or maybe unpack outside of the gross margin benefit that you saw in the quarter? Maybe help me understand where you saw better cost efficiencies, how sustainable are they, particularly in light of the effort to incentivize the channel and the sales force to focus more on selling SecOps and SASE with maybe some incremental effort?
spk25: Yeah, I think the gross margin is the largest driver of what you saw in the operating margin, particularly when you look at it on a -over-quarter basis. And in that, we talked about or made reference to a more normalized environment for us in terms of inventory levels, turns and what we're seeing with channel inventory, but also commitments to our contract manufacturers. So I think that we've been working through that for probably the last three quarters, maybe four quarters. And with that, I would say I think we've returned to a more normal state. And so I would expect that to continue on. I think we're getting a little more contribution from sales and marketing than maybe I'd like at the moment. And I would expect us to make a little bit more investments there as we look through the second half of the year. Keep in mind, we're getting a very large group of sales people, as Ken made reference to, from both the LACE work and the next DLP acquisitions. But I think we feel certainly comfortable with the guidance that we've given for both Q3 and for the full year on the margin line.
spk30: Great. Maybe just a quick follow-up, but how should we anticipate the impact of the operating margin to reflect on pre-cash flows we look through the rest of the year? Should we look at historical spread between margin and cash flow margins and maybe estimate kind of ballpark the same kind of spread, or are there going to be more puts and takes like timing of past payments that are going to mess with that pre-cash flow margin as we find in our models? Thanks.
spk25: Yeah, I don't, I mean, I think that a good starting point is to look at the improvement in operating margin flowing through to pre-cash flow. Some of the changes that we monitor would be things like contract duration, but you've seen now that industries and companies have been talking about contract duration for several quarters, and you really haven't seen that come through to us yet. I shouldn't say yet, but it's going to come through to us. And so I'm not, I think we have opportunity to leverage our balance sheet more with our customers and prospects than we have, but I don't see over the next 90 days or 180 days a dramatic shift in that area.
spk30: Okay, thank you very much, I appreciate it.
spk13: Thank you. One moment for our next question. Our next question comes from the line of Hansa Futterwalla of Morgan's Dally. Your line is now open.
spk21: Good evening, thank you for taking my question and echo my condolences for Peter and his family. We'll definitely miss him. Keith, I wanted to follow up on the margin question because obviously it was a very strong beat, I think a lot more than any of us were expecting. Historically, Fortinet has kind of managed the business towards this 25% plus type operating margin on rate. I'm curious, is this the new base that we should sort of think Fortinet goes off of longer term or is this sort of a one time margin out performance, given what you saw on the gross margin side coming out of the inventory digestion? Thank you.
spk25: Yeah, again, I think the inventory part of that is I think we've worked our way back to a more normalized state. So I think that is our business model going forward put it that way. There can always be something that changes but I don't see us anticipating something on the gross margin line and that is by far and away the biggest opportunity there. I think it also says that we clearly have the opportunity to invest more and go to market than we did in the first half of this year and I think we've factored in some of that investment
spk05: ideas
spk25: or those ideas in our forecast and our guidance. In terms of whether or not I can cry when I increase the margin the way I did, that's a different topic and I'll let him respond to that.
spk18: So we're benefited from the service revenue which has a much higher margin compared with the product revenue. So once the product starting growing because product has a low gross margin, that's probably what impact margin but the product is also the leading indicator of future service. So that's where we kind of also be happy to see the product starting also starting growing now which I think in going forward with the product has a higher percentage that's probably also will impact the margin.
spk41: Makes sense, thank you.
spk01: Thank you.
spk11: Thank
spk13: you, one moment for our next question. Our next question comes from the line of Fatima Bulani of Citi. Your line is now open.
spk03: Thank you for taking my questions and I wanted to share my condolences for Peter. He was just a fantastic person and he will absolutely be missed. Keith, I wanted to zero in on your comments regarding software license growth. You talked about that experience accelerating 26% year on year I believe and now it constitutes a high team percentage of your product revenues. I wanted to understand what are the drivers behind that massive mix shift and how we should think about the trajectory of this mix shift in the context of your guidance for the remainder of the year and bringing into consideration some of the hardware digestion potential prolonging comments that you shared as well if you can help us square that away, thanks.
spk25: Yeah, I think the software license if you step back and look at what the business model is not to make it overly simplistic. We wanna, it's so compelling to start with a firewall and it's very compelling to start with the ASIC. So a physical part of it. We don't always do that but we almost always start with a firewall whether it's physical or virtual. Really what you wanna do is get the operating system in the hands of the customer and what form factor that takes is fairly agnostic about that. But once that happens then you start to see the knock on effect of either selling more firewall use cases and other form factors into organizations or you're seeing that full portfolio of the set ops product line take hold as it continues to expand throughout organizations. So I would expect that we're gonna continue to see tailwinds and growth no doubt about it from the software part of the business. Will there be a mix shift that slows a little bit when firewall and FortiGate starts to return? Sure, absolutely. But this has been a trend that we've talked about a little bit I think last quarter and probably some earlier quarters about the software mix and the mix shift that we've been seeing. So I would expect that that's gonna continue on given the success we're seeing in the other two pillars.
spk18: Yeah, in the FortiGate, FortiOS, we see customers that in turn are more and more functioned which also enable more service for us. And think on the FortiSASI secure op has also FortiSASI pretty much all service space and plus a lot of secure op. Secure op has high percentage in the software compared to the hardware on the secure networking part. So that's both helping drive the additional software and making the growth.
spk02: Thank you very much, very clear.
spk13: Thank you. One moment for our next question. Our next question comes from the line of Gabriela Borges of Goldman Sachs. Your line is now open.
spk09: Good afternoon, thanks for taking the question.
spk10: Either for Ken or for Keith. On the file or refresh cycle, I can appreciate your comments on not expecting to see a recovery in 2024. Sheriff, talk a little bit more detail on why you think we'll see it in 2025. To what extent are customers giving you an indication that they will be refreshing in 2025 perhaps as we get through the election and some of the macro, perhaps because of their updated depreciation plans. Any color on why you think the timing will be 2025 would be helpful, thank
spk18: you. I think it's probably more Keith. Keith, come, I think the rest of the year probably still pretty tough, like environment where the election some interest rate is still pretty high, the money cost is pretty high. That's where some company may not really want to spend some long term investment which is to have the product revenue and building infrastructure. So that's what we feel. Also, if you look at historically, every four years or four to five years, the network gear, whether network and network security, they need to be refreshed for faster, more function there. So that's where we feel when we starting this supply chain issue, they artificially push up the things like starting 2001, maybe next year will be pretty much four year cycle now. So some company may starting looking to refresh the product they purchased four, five years ago, especially in certain vertical, like retail some other, we see pretty strong growth in early days of a supply chain issue. And we feel probably in the next one to two years, they may start in return to see some investment on their infrastructure. On the other side, we see that the big trend we always believe always a hybrid mode, even there's like we have a very advanced of SaaS infrastructure side, but also to secure OT, IoT area, to secure a lot of infrastructure, work from home. And we do need appliance in the field. And also even for SaaSy, we do offer both the cloud-based SaaSy and also on-premise based, private SaaSy. So that also needed some hardware to support it locally
spk17: for
spk18: the customer.
spk07: Thank you. And our condolences to the team as well.
spk01: Thank you.
spk13: Thank you. One moment for our next
spk08: question.
spk13: Our next question comes from the line of Tal Liani of Bank of America. Your line is now open.
spk36: Hi guys. The fact that, can you go back to the fact that the bank billings,
spk35: you
spk36: made two acquisitions this quarter. You didn't change the billing guidance for the year, but you did beat the numbers for this quarter by 20 million. So in effect, you reduced the billing for the next two quarters. What are the drivers in billings? I know we spoke about it in the past, but what are the drivers for billings and what's the outlook for billings going forward? Second question is your, you grew revenues by 11%, but when you look at OPEX, they're flat. And you don't do buybacks now. What's the outlook for buybacks and what's the outlook for OPEX? Will it start growing now that you started executing on revenue growth?
spk25: Yeah. Tal, I think I kind of missed, you're very, very faint on your questions. Or maybe if you can give us maybe a little louder recap of the two questions you had.
spk18: I think I touched some part about the two acquisitions and the impact on billing. I believe the both acquisitions, I think it's a, this work maybe this year will contribute, maybe at the point in.
spk25: Yeah, I think that, I mean, if you kind of look at the recap of the year, there's not a lot of variability in it, if you will. We were a little bit light in the first quarter. We came back and recovered the first quarter shortage in the second quarter. Now you see us looking at the third quarter and maybe taking that just a little bit off of some of the street numbers and looking to see, getting a little bit of that back in the fourth quarter, but we're kind of taking the third quarter correction to the street numbers and putting it into the full year number. But yes, offsetting a very, very similar amount in terms of what we expect to get from the acquisitions. And that leaves the full year range very much intact. And I understand that, to cut to the quick, I understand part of that is, I'm taking, I'm getting inorganic benefit in that number of the half point that we talked about. And really taking down the organic part of the business. But again, I think we're talking about small numbers here.
spk37: Got it. My second question, if you can hear me okay
spk36: now, but my second question was about OPEX that was flat and no buybacks. What's the outlook on those items?
spk25: Yeah, I think the OPEX is probably a little lighter on the sales and marketing line than maybe we would like to see, particularly as we start looking at more opportunities as we get into the second half of the year and into 2025. So, hopefully we'll find some opportunities there to make investments. Obviously you're gonna get a fairly significant movement there from the two acquisitions that we just did. And we gave the number about what the OPEX impact was going to be, that will largely be in sales and marketing. Buyback, I think that we still remain being opportunistic. And that opportunistic number changes every 90 days as we reset our plans.
spk18: Yeah, and also in the market, whether the private company, public company, we see the multiple problem move strongly for multiple position now compared to the last two, three years. So, we should go back to more reasonable. So, that we see some opportunity there. Thank you.
spk13: Thank you. One moment for our next question. Our next question comes from the line of Rob Owens of Piper Sandler. Your line is now open.
spk44: Yeah, thank you guys for taking my question. Curious, relative to the macro and obviously a lot of cross currents out there, maybe what you're seeing via your different customer sizes and different theaters, thanks.
spk25: Yeah, I think because we are so diversified as you kind of alluded to it, 70% of the business is international and a little bit less than 30 in the US. And yes, there's been a lot of elections around the world this year, but it's sort of the US election maybe weighing on people and every kind of taking a position of waiting to see. As you move, pull back from that, the international emerging part of the business has been strong, very strong for several quarters and continues on to be so. So, a lot of those are oil producing countries and similar. So I think they've done well in this economic cycle. They're a little more at risk there perhaps with geopolitical events in some of those countries, but to this point, it really hasn't had an impact there. We are much more likely to have the number one market share when you move outside the US and parts of Europe and the Middle East and Latin America and parts of APAC. And I think having an incumbency advantage, if you will, helps you in those more challenging times because you're there, you're on site and you have that opportunity to cross-sell and up-sell your install base.
spk18: Yeah, in the US, that's the next growing area, which also need more direct marketing, direct sales. That's also need more investment. So that's what we do plan to invest more into sales marketing to keep gaining market share in the US.
spk44: And Keith, as you contemplate these acquisitions and a little bit of makeshift to software, and I realize hardware is weak right now with a potential recovery next year, but how are you thinking about billing's duration? You shaved some off the back half and I think some of that's probably the makeshift towards software as we kind of look overall at the model and the increase in revenue, but as we contemplate 2025, how should we think about billing's duration and potential compression with more cloud-based or software deals that are likely shorter in nature?
spk25: Well, I look forward to seeing you in November, in November at the Analyst Day, when we'll talk more about 2025 and midterm numbers. But in the interim, I would probably say that if it's a white space account in some of these places, like Laceworks would be, for example, I think it's gonna be much more prone to having a shorter duration contract. If it's part of that 90% of me selling SecOps or SASE solutions to my install base, what I'm seeing to this point is my install base continues to purchase in terms of contract duration the way they have historically. So they haven't, if I sell something from the SecOps portfolio into one of my firewall customers, they tend to sign up for a longer duration contract than you may see from my point solution vendor.
spk44: Great, thanks. Thoughts are with you and the team. Thank
spk13: you. Thank you. One moment for our next question. Our next question comes from the line of Shaul Ayo of TD Cohen. Your line is now open.
spk15: Thank you. Hi, good afternoon, everybody. Keith Orken. So listening to Keith's commentary about that potential reef recycle not taking place in the second half of this year, but most likely during 2025, and again, not trying to front run the November Analyst Day, but should we be thinking about 2025 accelerating over 2024? And again, I don't mean, you don't have the current visibility to go back to 2025, but just conceptually, is it fair to assume
spk14: another year of double digit growth?
spk17: We do believe next
spk18: year there's, I think first overall, we see the long-term convergence, networking convergence to network security we're still keeping going. And that's why we do give the CAGR in secure networking areas about 15% -over-year growth. If you look in the image presentation slide there, I forgot which page. But on the other side, we also see a lot of new opportunity whether in the OT area, in the unified SAASI, and also upsell, cross-sell, which all help in driving, I have to say probably like 90% of customers initially move by a 40-gate getting the file when they were securing market first, which we have a huge advantage over competitor. But after that one, they keep expanding beyond that network security go to the other area. So that's what happening for the unified SAASI for the secure up. And now the product, especially on the 40-gate firewall side, we starting to see kind of a go back to normal starting growing with the market now. So we do feel probably next year will be whether the refresh cycle, which after that's where the existing customer, if they have the product for four or five years, that's probably the average time they starting refresh. And so we do see probably next year we're starting up that process.
spk39: Got it. Thank you.
spk11: Thank you. One moment for our next question.
spk13: Our next question comes from the line of Brad Selnick of Deutsche Bank. Your line is now open.
spk32: Great. Thanks so much for taking the question. Steve, I think you called out the service provider segment is more challenged this quarter after being a strong performer last quarter. And I know it's lumpy and remains a top vertical as it always has been before. But can you share an update on what's happening in that segment and in particular, how your value prop and unified and focus
spk40: on
spk32: unified SAASI and SEC ops applies in this important vertical?
spk18: Yeah, I don't feel the service provider telecom slowed down. It's really kind of lumpy. And on the other side, we also started to see the telecom service provider more interest in the... in the offer their own SAASI using a product solution or kind of helping customer do the private SAASI, localized SAASI, which also will help in drive our long-term growth. But I do believe -term-wise, the service provider will be still the big... if not the biggest, probably one of the biggest part of the whole cybersecurity business because they have the infrastructure, they have the customer relation. So we still want to keep in focus on the service provider area. But for them, it's really the self-security with Lung and the deal pretty big. You know, like a figure deal. That's where the lumpiness probably impacts the quarterly. But if you look at more long-term, multi-quarter annually, I do believe they're still keeping growing.
spk25: Yeah, again, spot on, right? It's a lumpy industry. Financial services can be, too, at times, as well. But I think more importantly, I think the conversations around their own independent SAASI solution that they can bring to market is something that's getting a lot more conversation from the service providers. I think we saw it first internationally, and we're starting to see a little bit more of it here domestically. That's a pretty exciting opportunity if it continues to move forward.
spk32: Thanks, Keith, and thanks, Ken. Just a quick follow-up on the very impressive operating leverage that you've shown us, particularly on the sales and marketing line, where I know, Keith, you said that it's more than you'd like to see at this point. But just structurally, like to see it down, albeit very slightly sequentially, on a dollar basis, especially as you outperformed on the top line and billing this quarter. I'm just trying to understand where it comes from, and is there anything structurally that's changed that we should be thinking about, whether it's commission deferral rates, channel rebates, or anything else other than headcount? Thanks.
spk25: Yeah, I think there's a few things going on there. I think probably nine months ago, we looked at the cost structure pretty closely and across a number of areas. The first place that people kind of look at when they're in that boat is marketing programs, and they get hit pretty hard early on. I think you kind of see that roll through. You do make changes to your compensation programs, whether it's for direct sales people or for channel people, what have you. And I think maybe as we're coming out of that environment now, it's important for us to kind of revisit some of those decisions and making sure that we kind of talk about the investment opportunities that we have in the sales and marketing line. And I think I would include the channel net as well. And that's why I would say that, to your point, or you're repeating me, probably a little bit lower than we would have liked it to have been in the second quarter, and I think we'll continue to make good market investments here in the second half of the year.
spk18: Yeah, I agree with Keith. We're starting tracking more carefully for the ROI for each investment in marketing sales and also try to improve in the efficiency with the marketing sales. On the other side, we are a little bit behind hiring in the sales market side, which we intend to accelerate. So that's actually what will drive the future for us.
spk29: Thanks very much, guys. Thank you.
spk13: Thank you. One moment for our next question. Our next question comes from the line of Adam Tindall of Raymond James. Your line is now open.
spk28: Okay, thank you. I just wanted to continue the margin discussion. Obviously, you had great product gross margin performance this quarter on top of those tight cost controls. And the question really is around pricing dynamics in the core firewall business from here. The supply chain sounds like it's clearly normalized. You've had multiple years of price increases during this period of time. What are your expectations of the pricing dynamic in core firewall from here? What would it take to maybe even consider reducing price back to historical at some point? And any comments that you wanna make on the competitive environment in light of this? Thank you.
spk18: I think we have not increased the price in the last few quarter. I think that because we still believe we have a huge advantage with our 40-80, 40-OS technology has a more function, better performance, lower total cost ownership and also energy costs. So we feel we're keeping that advantage over our competitors. On the other side, we don't see any pressure to also decrease price or kind of a discount more. So that's where we feel we're keeping pretty stable for the price and at the same time, let the customers see that the benefit of our product solution and with better performance, more function, which also will drive the future service. I think the bigger environment also, we don't feel changed much. Definitely we see the inventory all go back to normal whether own kind of inventory and also the channel inventory. That's also more helping driving the healthy behavior in the business also in the supply chain area. Maybe Keith has some.
spk25: Just to repeat what Ken said, maybe with a more granularity, I think the price increases that you referred to were really probably at late 21, 2022 impact and I don't think we're really raising prices at 23. We did take some prices down at the end of 23 and in the very beginning of 2024, but that's really been the only pricing actions we've taken last six months and then to Ken's point, I think we're at a moment where we think that's probably the value for the solution is very, very strong. I think the energy costs that Ken mentioned it's gotten a lot of traction internationally in Europe, but you're starting to see more conversation around that in the US and that could be people concerned about energy consumption and issues with AI and EV and government actions on manufacturing. So I do think the energy cost advantage is coming into play more. And then last one of that was discounting was, I think very much in line. I think we actually improved, quote unquote, improved discounting, meaning higher prices by about a point quarter over quarter and kind of a similar number one way or the other for the full year. So we obviously have room given the margins to use discounting and pricing as a lever, but I think there's other things that we'd like to push on first.
spk06: Makes sense, thank you.
spk11: Thank you. One moment for our next question.
spk13: Our next question comes from the line of Adam Borg of Stifl. Your line is now open.
spk33: Awesome, thanks for taking the question. And also the condolences on Peter's passing. He certainly missed all of us. We'd love to talk about the next DLP acquisition. Maybe talk a little bit more about what's attracting you to the standalone enterprise data protection market overall and next DLP in particular.
spk24: Yeah, thanks for the question. This is John Whittle. There's a lot of positivity around that. We obviously just announced it today. We closed it yesterday. We did a lot of diligence on the company. The tech is great. And not only will we plan to offer it standalone, but also integrated with our Fort Assassi solution. And so I think it's another step in steadily bolstering our Fort Assassi solution. We feel very, very confident in our strategy there. For the most part, as you know, we've done some tech and talent tuck-ins. Most of our technology is organic. I think to some of the earlier questions, you think about the firewall market coming back next year. And we really just started kind of organizing our solutions into these three pillars less than a year ago. And the amount of progress we've made and the execution we've made and kind of developing very, very competitive solutions in Sassi and SecOps in addition to secure networking is pretty impressive. And I think this is an important step along the way to continue to develop the best Sassi solution out there to protect our customers.
spk33: That's great. And maybe just as a quick follow-up there, John, maybe just could you comment on current levels of Salesforce productivity for Sassi and SecOps and the opportunities for improvement from here? Thanks again.
spk20: Sorry, the sales execution with Sassi and SecOps?
spk33: Just general Salesforce productivity as you've gone through many months at this point of training and just ramping of the ability to sell that across your
spk22: company globally. Yeah, no,
spk24: it's a really good question. I think what we're seeing is it does take time. We are very focused on that broad sales enablement. I always say, I mean, the opportunity just abounds from our solution set. And we're always with this customer first focus. So in terms of protecting and serving our customers, the opportunity abounds. I think our sales for, the good news is they have a ton of opportunity. I always say they're gonna suffer more from indigestion than starvation, but we've got a really a big focus in the company to really train up that Salesforce, enable that Salesforce, make sure we have the incentives in the right place and make sure we have the support. So when they do qualify different opportunities and different solution sets, we have the support to support them in that sale. So I think like Keith had alluded to, we often land with the firewall and then expand and give that support to our Salesforce with Sassi and SecOps solutions. And we're seeing a lot of success there. Great, thanks again. Thank you.
spk13: Thank you. One moment for our next question. Our next question comes from the line of Saqib Kahlia of Barclays. Your line is now open.
spk27: Okay, great guys. Thanks for taking my questions here and tip my cap to Peter as well. We're gonna miss him. Ken, maybe just to start with you. I wanted to get into just the firewall refresh for next year a little bit. I mean, you've seen so many refresh cycles over the years. How would you sort of compare this upcoming cycle versus others in the past and maybe touch on how Sassi and sort of, maybe what sounds like a higher mix of virtual might sort of play into that?
spk18: Yeah, great. There's the infrastructure probably different than the last refresh cycle. You see more hybrid work environment, whether working remotely and also more supporting broad connection, including connect all these OT IoT device level. For the Sassi, we always believe also should be a hybrid Sassi environment, not just cloud only. You do need to have a private Sassi, some other local Sassi offered by service provider and also sometimes the Sassi also need to secure some device which cannot install a software agent, like using a 40 AP 40 switch to secure this agentless device. So that's where we feel this also will always kind of, the unified Sassi will be the long term future we believe, which also combine both the hardware and the software and infrastructure and appliance together. So that's where the refresh. Other side, network security always probably the biggest market in the cybersecurity for probably 30 years now, 20, 30 years and keeping expanding because more people device get connected, more application to access, or even access the cloud, you do need to secure on a network side. So that's what we see when you try to access the network side and also the long term convergence of a networking network security. That's also what drive the refresh. That's also you can see the Ghana research we point out the convergence of a networking network security also starting our seller region. So originally I think last year they say by 2030, the secure networking will be larger than traditional networking. Now they say 2026, four years ahead, the secure networking will be larger than the traditional networking. So that's where we really invest long term on this trend and with all these 40 OS, 40 ASIC and making the best both appliance and infrastructure the ASIC OS technology and the same time also try to invest more in the sales marketing area to really catch the trend and also keeping gaining market share. So that's the strategy we have.
spk27: That makes a lot of sense. Keith, if I could fit in one quick follow up just on the software mix in product, I think you said call it a roughly 800 million run rate. Can we just touch on even anecdotally, roughly how much of that is sort of virtual firewall versus sec ops and I realize they're coming in at software gross margins, but can you put a finer point on that and sort of what that aggregate business might be coming in at from a gross margin perspective as we think about that gross margin shift long term?
spk25: Well, I think whether it's a virtual firewall or any other software product or the software licenses are all coming in at very, very attractive margins. I think that when you look at some of the staff solutions that are sitting in the services line for sec ops and so forth, you get a very wide range of margins there, but it's only because of the relative size or maturity of the solution. Obviously something that's very new and absorbing a lot of hosting costs is a little harder, but those aren't as big numbers. As you see those sec ops solutions get greater and greater traction and more critical mass, the margins start to normalize. I think kind of what's really been exciting is the ability to absorb those data center pop, colo, everybody's got their hand in the pocket on these things, cloud provider fees and developing the SaaS solutions and still bring up the services gross margin. And by the same token, being able to absorb the charge for lace work on the operating margin line, because we've managed the business in terms of cost of goods sold for the product side, I think we're really, really pleased with how those two things will work hand in hand.
spk26: Absolutely, it shows. Thanks very much.
spk13: Thank you. One moment for our next question. Our next question comes from the line of Joseph Gaiot of Jeffreys. Your line is now open.
spk31: Hi, thanks for the question. I also want to echo my condolences to the team and Peter Stanley, big shoes to fill. I just wanted to double click on what drove the better performance in product in 2Q. Was there some large deals, a region segment or vertical that stood out, especially since you don't expect the refresh benefit? Until
spk25: now,
spk31: which counted by five.
spk25: No, great question. I mean, we've talked about eight figure deals and in our size, eight figure deals can kind of still whip us all around, as you saw in the fourth quarter last year, we did six of them. We had one six figure, eight figure deal, Q1, we had two in Q2, so I wouldn't attribute it to that. I think that, yeah, I think what we saw the last month of the quarter, particularly as we got into the last week of the quarter, what you see in a strong market is a lot of deals started to fall in place and we're getting across the finish line. I think we saw a lot more positiveness, if you will, at the end of Q2 than maybe we saw, say, at the end of Q3 or something like that last year.
spk31: Okay, thanks. And then just on a follow-up to that, and I think it was a follow-up to Fatima's question, given that mix shift you now expect in the second half, given the delayed refresh, what is your confidence or visibility into the billings or reacceleration in the second half? Do you, in theory, have more visibility now, given that it's less hardware-based, or how are you thinking about that? Thank you.
spk25: Yeah, I don't think that the form factor really impacts the visibility in terms of the source and the pipeline, or how we work with the sales teams in terms of forecasting. I've not noticed a difference, if you will, in close rates between a virtual machine and a physical machine.
spk18: Yeah, we probably would do some more deep study to maybe, on another state, we'll get some color next year and also some midterm model in November 18th, which also the 15th anniversary of IPO.
spk23: Thank you.
spk13: Thank you. Thank you. This concludes the question and answer session. I would now like to turn it back to Aaron Ovary, Director of Investor Relations.
spk04: Thank you. I'd like to thank everyone for joining today's call. Fortinet will be attending investor conferences hosted by Deutsche Bank, Goldman Sachs, and Oppenheimer during the third quarter. We will also be holding an analyst day on November 18th, where we expect to update our medium term financial model. The webcast links will be posted on the events and the presentation section of Fortinet's Investor Relations website. If you have any follow-up questions, please feel free to contact me. Have a great rest of your day.
spk13: Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.
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