Fortinet, Inc.

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, Erin Ovadia, from the Director of Investor Relations. Aaron?

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. During the Q&A session, we ask that you please limit yourself to one question and the 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, in 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 GAAP to non-GAAP reconciliations are located in our earnings press release in 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 are on a year-over-year basis unless noticed otherwise. I will now turn the call over to Ken.

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 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 SaaS and secure operation market. Secure networking customers are increasingly recognized of 40OS and 40AC 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 as security convergence, and the industry's 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% 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 a converged networking and security stack, 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 application on-premise and in the cloud. Furthermore, we continue to build our own SaaS eDeliver infrastructure, including leverage of 4G technologies, providing us with a competitive long-term cost advantage. As announced earlier today, we acquired Next DLP, a next-generation cloud-native SaaS data protection platform extending from endpoint to cloud. This will allow us to enter the standalone enterprise DLP market, as well as integrate market with our 40 SASE solution. We also recently improved our position in the GaN magic quadrant for single vendor SASE and are the only vendor included in all five of major network security magic quadrant. Single vendor SASE network firewall, SD-WAN, secure service edge, and enterprise-wide and wireless LAN infrastructure. Each of these solutions run on a single unified operating system for the OS with AI-powered FortiGuard secure service and unified management. AI-driven secure op counted for 10% of total building in the second quarter, up one point. Our comprehensive SQL portfolio backed by over a decade of AI experience offers broadest range of sensor and advanced analytics to continuous access activity to identify signs of cyber threats. FortiAI harness generative AI to triple-charge our platform and help security operation team make better informed decision and response to threats faster by the most complex task. FortiAir is available in FortiAnalyzer, FortiSIM, and FortiSOAR, and will soon be available in other FortiAir products. In addition, we are pleased to further expand our secure app portfolio with the acquisition of Lacework, and we believe that together our solutions form one of the most comprehensive four-step cloud security solutions available from a single vendor. Laceworks' organically developed AI-driven cloud-native application protection platform will be combined with the power of Fortinet's Security Fabric platform, ensuring broad protection across the 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 the entire Fortinet portfolio of solutions. Yesterday, we announced several enhancements to Fortinet's OT security platform, which already stands as the most comprehensive OT security platform on the market. Enhancements include a new recognized appliance, advanced secure networking and secure operation capability, and expanded partnership 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 Rack 70G with DU5G Modern. Fortinet was the only security company to receive this recognition in an 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.

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 growth in operating margins at 81.5%, and 35.1% respectively while delivering top line numbers at the high end of our guidance range. Revenue grew 11% 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 with the acquisitions of Lacework and NextDLP. Lacework strengthens our position in the high-growth CNAP market and expands our total addressable market by $10 billion, while NextDLP improves our position in the standalone enterprise data loss prevention market. Combined, Fortinet 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've 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 in each of our three pillars represents hundreds of thousands of end customers testing and buying Fortinet 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 and 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 Fortinet.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 fillers 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 40SASE 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 buildings 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% to $1.434 billion, driven by service revenue growth and software licenses. Service revenue of $982 million grew 20%, accounting for 68.5% of total revenue. Service revenue growth was led by 36% growth in SecOps and 27% growth in Unified SASE. As noted on slide five, Unified SASE includes SSE and related technologies together with SD-WAN. Product revenue decreased 4%, 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% 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%, accelerating from 23% 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% 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 mixed shift to higher margin service revenues. Product gross margin of 66% 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% to 66% as hardware demand increased and inventory levels and related inventory charges moved closer to historical norms. Service gross margin of 88.6% increased 240 basis points as service revenue growth outpaced labor cost increases and benefited from the mix shift towards higher margin FortiGuard security subscription services. Operating margin increased 820 basis points to a quarterly record of 35.1% 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 slide 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. 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 4Net 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 end-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 price for performance advantage. And lastly, in a competitive displacement win, our retail store chain purchased our FortiSASI solution in a seven-figure deal. This customer chose Fortinet because of our integrated FortiOS platform, as they were able to seamlessly integrate FortiSASI with their existing Fortinet 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 FortiGuard contracts from its peak and view this as an early but soft indicator that quote unquote inventory digestion and end users appear 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 U.S., 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 we do any 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 increased Q3 by approximately one-half point and the full year by approximately one-third point. Total revenue increased Q3 and full year growth by one point and one-half point respectively. For gross margin, they decreased Q3 and full year margins by less than one-half of a point for each period. For operating margin, they decreased 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 $1,530,000,000 to $1,600,000,000, which at the midpoint represents growth of 5%, revenue in the range of $1,445,000,000 to $1,505,000,000, which at the 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 $6,400,000 to $6,600,000. Revenue in the range of $5,800,000 to $5,900,000, which at the midpoint represents growth of 10%. Service revenue in the range of $3,975,000 to $4,025,000, which at the 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 counted between $767 and $777 million. Capital expenditures are $320 to $360 million. Non-GAAP tax rate of 17% and cash taxes are 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 has 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, back to you. Thank you, Keith. As a reminder, during the Q&A session, 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.

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 JP Morgan. Your line is now open.

Brilliant. Thank you very much for taking the question. And, you know, 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, obviously, 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?

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 quarter-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 get through the second half of the year. Keep in mind we're getting a very large group of salespeople, as Ken made reference to, from both the lacework 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.

Great. Maybe just a quick follow-up, but how should we anticipate the impact of the operating margin to reflect on free cash flow as we look through the rest of the year? Should we look at historical spread between margin and cash flow margin and maybe estimate kind of ballpark the same kind of spread, or are there going to be more puts and takes like timing of, you know, tax payments that are going to, you know, mess with that, you know, free cash flow margin as we fine-tune our models? Thanks.

I think a good starting point is to look at the improvement in operating margin flowing through to free 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. 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.

Okay. Thank you very much. I appreciate it.

Thank you. One moment for our next question. Our next question comes from the line of Hansa Futterwala of Morgan Stanley. Your line is now open.

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, you know, Fortinet has kind of managed the business towards this 25% plus type operating margin run 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 outperformance given what you saw on the gross margin side coming out of the inventory digestion headwinds? Thank you.

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... 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 in 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 ideas or those ideas in our forecast and our guidance. In terms of whether or not I make Ken cry when I increase the margin the way I did, that's a different topic, and I'll let him respond to that.

Also, we're benefiting from the service revenue, which has a much higher margin compared with the product revenue. So once the product started growing, because product has a lower growth margin, that's probably what impacts the 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 going forward with the product has a higher percentage, that probably also impacts the margin.

Makes sense.

Thank you. Thank you.

Thank you.

One moment for our next question. Our next question comes from the line of Fatima Bulani of Citi. Your line is now open.

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 accelerating 26% year-on-year, I believe, and now it constitutes a high team's 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.

Yeah, I think the software license, if you kind of step back and look at what the business model is, not to make it overly simplistic, 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 want to do is get the operating system in the hands of the customer. And what form factor that takes is, we're 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, the SecOps product line, take hold as it continuously expands throughout organizations. So I would expect that we're going to continue to see tailwinds and growth, no doubt about it, from the software part of the business. You know, will there be a mix shift that slows a little bit when firewall and FortiGate starts to return? Sure, absolutely. But, you know, this has been a trend that we 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 going to continue on given the success we're seeing in the other two pillars.

Yeah, in the FortiGate, FortiOS, we see customers that in turn are more and more function, which also enable more service for us. And same time, the 4D SASE secure op has also, 4D SASE pretty much all service-based and plus a lot of secure op. Secure op has higher percentage in the software compared with hardware on the secure networking part. So that's both helping drive the additional software and making the growth.

Thank you very much. Very clear.

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.

Good afternoon. Thanks for taking the question.

Either for Ken or for Keith, on the silo-refresh cycle, I can appreciate your comments on not expecting to see a recovery in 2024. Share with us 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, or perhaps because of their updated depreciation plans? Any color on why you think the timing will be 2025 would be helpful.

Thank you. I think it's probably more keys. I think it's the right-of-year timing. probably still pretty tough to make an environment where the election or some interest rates are still pretty high, the money costs are still pretty high. That's where some companies may not really want to spend some long-term investment, which is to drive 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, network security, they need to be refreshed for faster, more function there. So that's where we feel when we start in this supply chain issue, they artificially push up since like starting 2001. Maybe next year will be pretty much four-year cycle now. So some company may start in looking to refresh the product they purchased four, five years ago. especially in certain vertical, like retails and moderate, we see pretty strong growth in early days of 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 the big trend, we always believe, always a hybrid mode. Even there's a, like we have a very advanced SASE 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 SASE, we do offer both cloud-based SASE and also on-premise-based private SASE. So that also needs some hardware to support locally for the customer.

Thank you, and our condolences to the team as well.

thank you thank you one moment for our next question our next question comes from the line of tal liani of bank of america your line is now open hi guys um the the fact that uh can you go back to the fact that billings uh you made two acquisitions this quarter you didn't change the billing guidance for the year but 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 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?

Thanks. Yeah. Tal, I think I kind of missed, you're very, very faint on your questions there. Maybe if you can give us maybe a little louder recap of the two questions you had.

I think I touched some part about the two acquisitions' impact on buildings. I believe that both acquisitions, I think this work maybe this year will contribute maybe.

Yeah, I think that if you kind of look at the recap of the year, there's not a lot of variability. And 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.

Got it.

My second question, if you can hear me okay now, but my second question was about OPEX that was flat and no buybacks. What's the outlook on those items?

Yeah, I think the OPEX is probably a little lighter on the sales and marketing line than maybe Widow. 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, you know, hopefully we'll find some opportunities there to make investments. Obviously, you're going to get a fairly significant movement there from the two acquisitions that we just did and we gave the number about what the OpEx impact is 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.

Yeah, and also in the market, whether the private company, public company, we see the multiple probably more friendly for merchandising now compared to the last two or three years. So the ratio go back to more reasonable. So that we see some opportunity there. Great. Thank you.

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.

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.

Yeah, I think, you know, because we are so diversified, as you kind of alluded to it, you know, 70% of the business is international and a little bit less than 30 in the U.S. And, yes, there's been a lot of elections around the world this year, but it's sort of the U.S. election maybe weighing on people and everybody's kind of taking a position of waiting to see. As you move, pull back from that, you know, the international emerging part of the business has been strong, very strong for several quarters and continues on to be so. You know, a lot of those are oil-producing countries and similar. So I think they've done well in this economic cycle. You know, 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 U.S. in 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.

In the U.S., that's the next growing area, which also needs more direct marketing, direct sales. That also needs more investment. So that's where we do plan to invest more into sales marketing to gain market share in the U.S.

And Keith, as you contemplate these acquisitions and a little bit of mixed shift to software, and I realize hardware's weak right now with a potential recovery next year, but how are you thinking about billing's duration? You know, you shaved some off the back half, and I think some of that's probably the mixed shift 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?

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 Lacework would be, for example, I think it's going to 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, you know, if I, if I sell something from the psychop portfolio into one of my firewall customers, they tend to sign up for a longer duration contract than you may see from a point solution vendor.

Great. Thanks. Thoughts are with you and the team. Thank you.

Thank you. One moment for our next question. Our next question comes from the line of Shaul Ale of TD Cohen. Your line is now open.

Thank you. Hi, good afternoon, everybody. Keith or Ken, 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 to 2025, but just conceptually, is it fair to assume another year of double-digit growth?

We do believe next year there's, I think first overall, we see the long-term convergence, networking convergence to network security still keeping going. And that's why we do give the CAGR in secure networking areas about 15% year-over-year growth. If you look in the investor 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 SASE, and also upsell, cross-sell, which all help in driving, I have to say, probably like 90% of customers initially move by a full decade, getting the firewall network security market first, which we have a huge advantage over competitors. But after that one, they keep expanding beyond the network security, go to the other area. So that's what's happening for the unified SASE, for the secure op. Now the product, especially on the 40-grade firewall side, we're starting to see kind of go back to normal, starting growing with the market now. So we do feel probably next year will be 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're starting to refresh. And so we do see probably next year we're starting that process.

Got it. Thank you.

Thank you. One moment for our next question.

Our next question comes from the line of Brad Selnick of Deutsche Bank. Your line is now open.

Great. Thanks so much for taking the question. Keith, 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 for Fortinet. But can you share an update on what's happening in that segment, and in particular, how your value prop and focus on unified SASE and SEC ops applies in this important vertical?

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 offer their own SASI using a product solution, all kind of helping customers do the private SASI, localized SASI, which also will help in drive our long-term growth. But I do believe long-term wise, the service provider will be still the biggest, 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 long and the deal pretty big, usually like eight-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.

Yeah, I can 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 SASE 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 going to So it's a pretty exciting opportunity if it continues to move forward.

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, 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.

Yeah, I think there's a few things going on there. I think, you know, probably nine months ago, we looked at the cost structure pretty closely and across a number of areas. And 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. And 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 or 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 they kind of talk about the investment opportunities that we have in the sales and marketing line. And I think I would include the channel in that as well. And it'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 go-to-market investments here in the second half of the year.

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 the efficiency with the marketing sales. On the other side, we are a little bit behind on hiring in the sales marketing side, which we intend to accelerate. So that's actually what will drive the future for us.

Thanks very much, guys. Thank you.

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.

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 and 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 want to make on the competitive environment in light of this? Thank you.

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 ASIC, 40 OS technology has a more function, better performance, lower total cost ownership, and also energy cost. 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 the better performance more function which also will drive the future service uh i think the bigger environment also we don't feel changed much uh definitely we see that the inventory i'll go back to normal whether you know 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.

Just to repeat what Ken said, maybe with a more granularity, I think the price increases that you referred to were really probably up late 2021, 2022 impact, and I don't think we're really raising prices at 2023. 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 of note we've taken the last six months. And then to Ken's point, I think we're at a moment where we think it's probably the value for the solution is very, very strong. I think the energy costs that Ken mentioned is starting to get, it's gotten a lot of traction internationally in Europe. But you're starting to see more conversation around that in the U.S., 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 the last one on that, discounting was, I think, very much in line. I think we actually improved, quote-unquote, improved discounting the entire prices by about a point quarter over quarter and kind of a similar number one way or the other for the full year or 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.

Makes sense. Thank you.

Thank you. One moment for our next question.

Our next question comes from the line of Adam Borg of Stifel. Your line is now open.

Awesome. Thanks for taking the question. And I'll also echo the condolences on Peter's passing. He's certainly missed by 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.

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. You know, 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 Asasi solution. And so I think it's another step and steadily bolstering our Fort Sassy solution. We feel very, very confident in our strategy there. For the most part, as you know, I mean, we've done some tech and talent tuck-ins. Most of our technology is organic. I think to some of the earlier questions, you know, 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 in kind of developing very, very competitive solutions in SASE 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 SASE solution out there to protect our customers.

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 SaaS and SecOps and the opportunities for improvement from here. Thanks again.

Sorry, the sales execution with SaaS and SecOps?

Just general Salesforce productivity as you've gone through, you know, many months at this point of training and just ramping of the ability to sell that across your company globally.

Yeah, no, it's a really good question. You know, I think what we're seeing is it does take time. We are very focused on that broad sales enablement. You know, 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 force, you know, the good news is they have a ton of opportunity. You know, I always say they're going to suffer more from indigestion than starvation, but We've got a really big focus in the company to really train up that sales force, enable that sales force, 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 sales force with SASE and SACOP solutions. And we're seeing a lot of success there. Great. Thanks again. Thank you.

Thank you. One moment for our next question. Our next question comes from the line of Sakek Kalia of Barclays. Your line is now open.

Okay. Great, guys. Thanks for taking my questions here. And tip my cap to Peter as well. We're going to 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 SASE and sort of maybe what sounds like a higher mix of virtual might sort of play into that?

Yeah, there's a the infrastructure probably different than the last refresh cycle. You see more hybrid working environment, whether working remotely, and also more supporting broad connection, including connect all these OT, IoT device level. For the SASE, we always believe also should be a hybrid SASE environment, not just cloud only. You do need to have a private SASE, some other local SASI offered by service provider and also sometimes the SASI also needs to secure some device which cannot install a software agent like using a 408040 switch to secure this agentless device. So that's where we feel this also will always kind of the unified SASI 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 they refresh. On the other side, network security always probably the biggest market. I mean, it's been the biggest market in cybersecurity for probably 30 years now, 20, 30 years. And keeping expanding because more people's devices get connected, more applications to access, or even access the cloud, you do need to secure on the network side. So that's what we see. when you try to access the network side and also the long-term convergence of network and network security, that's also what drives the refresh. That's also, you can see the Ghana research, we point out the convergence of a network and network security also starting accelerating. 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 at 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 a strategy we have.

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, you know, call it a roughly 800 million run rate. Can we just touch on, even anecdotally, you know, 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?

Well, I think whether it's a virtual firewall or any other software product, 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 SecOps 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 the hosting costs is a little harder, but those aren't as big numbers. As you see those SecOps 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 a pocket on these things, cloud provider fees in developing the SaaS solutions, and still bring up the services gross margin. And by the same token, you know, being able to absorb the charge for lacework on the operating margin line, you know, because we've managed the business in terms of cost of goods sold for the product side, you know, I think we're really, really pleased with how those two things have worked hand in hand.

Absolutely. It shows. Thanks very much.

Thank you. One moment for our next question. Our next question comes from the line of Joseph Guyot of Jefferies. Your line is now open.

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 and product in 2Q. Was there some large deals or region, segment, or vertical that stood out, especially since you don't expect the refresh benefit? And so now count is like a great question.

I mean, we've talked about eight figure deals. And, you know, at our size, eight figure deals, because kind of still whips off 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 and q2. So I wouldn't want to 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, You know, what you see in a strong market is a lot of deals starting 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.

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 billing's re-acceleration 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.

Yeah, I don't think that the form factor really impacts the visibility in terms of what's in 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.

Yeah, we probably would do some more deep study to maybe, I understand we'll get some color next year and also some midterm model in November 18, which also the 15th anniversary of IPO.

Thank you.

Thank you. Thank you. This concludes the question and answer session. I would now like to turn it back to Aaron Overia, Director of Investor Relations.

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 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.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Thank you. Thank you. Thank you.

Thank you. Thank you. you you

Good day and thank you for standing by. Welcome to the Fortinet second quarter earnings call. 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?

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. During 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, in 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 GAAP to 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 are on a year-over-year basis unless noticed otherwise. I will now turn the call over to Ken.

Okay, thank you, Erin, 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%, and managed to build in revenue at the 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 chassis and secure operation market. Secure networking customers increasingly recognize our 40OS and 40AC technology, offering 5 to 10X better performance than our competitors. by including security effectiveness and providing a low total cost of ownership. For over 20 years, we have been leading the shift to networking as 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% 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 a converged networking and security stack, 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 application on-premise and in the cloud. Furthermore, we continue to build our own SASE delivery infrastructure, including leverage of FortiGate technologies, providing us with a competitive long-term cost advantage. As announced earlier today, we acquired NextDLP, a next-generation cloud-native SaaS data protection platform extending from endpoint to cloud. This will allow us to enter the stand-alone enterprise DLP market, as well as integrate market with our 40 SaaS solutions. We also recently improved our position in the ground magic quadrant for single-vendor SaaS and are the only vendor included in all five of major network security magic quadrants, Single Vendor SASE, Network Firewall, SD-WAN, Secure Service Edge, and Enterprise Wireless LAN Infrastructure. Each of these solutions run on a single unified operating system, 40OS, with AI-powered 40G secure service and unified management. AI-driven secure op counted for 10% of total building in the second quarter, up one point. Our comprehensive secure op portfolio backed by over a decade of AI experience offers broadest range of sensor and advanced analytics to continuous access activity to identify signs of cyber threats. FortiAI harness generative AI to turbocharge our platform and help security operation team make better informed decision and response to stress faster by the most complex task. FortiAir is available in FortiAnalyzer, FortiSIM, and FortiSOAR, and will soon be available in other FortiAir products. In addition, we are pleased to further expand our secure app portfolio with acquisition of Lacework, and we believe that together our solutions form one of the most comprehensive four-stack cloud security solution available from a single vendor. Laceworks' organically developed AI-driven cloud-native application protection platform will be combined with the power of Fortinet Security Fabric platform, ensuring broad protection across the network, cloud, and endpoint. This acquisition increased our total addressable market by $10 billion and added a team of talented engineers dedicated to cloud-native security while also expanding our sales force that can sell the entire Fortinet portfolio of 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 a new recognized appliance, advanced secure networking, and secure operation capability, and expanded partnership 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 Rack 70G with DU5G Modern. Fortinet was the only security company to receive this recognition in an 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.

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 growth in operating margins at 81.5%, and 35.1% respectively while delivering top line numbers at the high end of our guidance range. Revenue grew 11% 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 with the acquisitions of Lacework and NextDLP. Lacework strengthens our position in the high-growth CNAP market and expands our total addressable market by $10 billion, while NextDLP 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've taken the lead in partnering with the U.S. Cybersecurity and Infrastructure Security Agency, or CESA, 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 in each of our three pillars represents hundreds of thousands of end customers testing and buying Fortinet 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 and 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 Fortinet.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 fillers 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 40SASE 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% to $1.434 billion, driven by service revenue growth and software licenses. Service revenue of $982 million grew 20%, accounting for 68.5% of total revenue. Service revenue growth was led by 36% growth in SecOps and 27% growth in Unified SASE. As noted on slide five, Unified SASE includes SSE and related technologies together with SD-WAN. Product revenue decreased 4%, 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% 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%, accelerating from 23% 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%, 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 mixed shift to higher margin service revenues. Product gross margin of 66% 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% to 66% as hardware demand increased and inventory levels and related inventory charges moved closer to historical norms. Service gross margin of 88.6% increased 240 basis points as service revenue growth outpaced labor cost increases and benefited from the mix shift towards higher margin FortiGuard security subscription services. Operating margin increased 820 basis points to a quarterly record of 35.1% 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 Fortinet 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 end-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 price for performance advantage. And lastly, in a competitive displacement win, our retail store chain purchased our FortiSASI solution in a seven-figure deal. This customer chose Fortinet because of our integrated FortiOS platform as they were able to seamlessly integrate FortiSASI with their existing Fortinet 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 FortiGuard contracts from its peak and view this as an early but soft indicator that quote unquote inventory digestion and end users appear 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 U.S., 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, it's subject to the disclaimers regarding forward-looking information that Aaron provided at the beginning of the call. Before we do any 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 increased Q3 by approximately one-half point and the full year by approximately one-third point. Total revenue increased Q3 and full year growth by one point and one-half point respectively. For gross margin, they decreased Q3 and full year margins by less than one-half of a point for each period. For operating margin, they decreased 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 $1,530,000,000 to $1,600,000,000, which at the midpoint represents growth of 5%, revenue in the range of $1,445,000,000 to $1,505,000,000, which at the 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 $6,400,000 to $6,600,000. Revenue in the range of $5,800,000 to $5,900,000, which at the midpoint represents growth of 10%. Service revenue in the range of $3,935,000 to $4,025,000, which at the 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 counted between $767 and $777 million. Capital expenditures are $320 to $360 million. Non-GAAP tax rate of 17%, and cash taxes are 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 has 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, back to you. Thank you, Keith. As a reminder, during the Q&A session, 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.

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 JP Morgan. Your line is now open.

Thank you very much for taking the question. And, you know, 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, obviously, 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?

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 quarter-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 salespeople, as Ken made reference to, from both the lacework 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.

Great. Maybe just a quick follow-up, but how should we anticipate the impact of the operating margin to reflect on free cash flow as we look through the rest of the year? Should we look at historical spread between margin and cash flow margin and maybe estimate kind of ballpark the same kind of spread, or are there going to be more puts and takes like timing of, you know, tax payments that are going to, you know, mess with that, you know, free cash flow margin as we find in our models? Thanks.

I think a good starting point is to look at the improvement in operating margin flowing through to free 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. 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.

Okay. Thank you very much. I appreciate it.

Thank you. One moment for our next question. Our next question comes from the line of Hamsa Fadarwala of Morgan Stanley. Your line is now open.

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, you know, Fortinet has kind of managed the business towards this 25% plus type operating margin run rate. I'm curious, is this the new base that we should sort of think Fortinet goes off of longer term, or is it sort of a one-time margin outperformance given what you saw on the gross margin side coming out of the inventory digestion headwinds? Thank you.

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... 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 in 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 ideas or those ideas in our forecast and our guidance. In terms of whether or not I make Ken cry when I increase the margin the way I did, that's a different topic, and I'll let him respond to that.

Also, we're benefiting from the service revenue, which has a much higher margin compared with the product revenue. So once the product started growing, because product has a lower growth margin, that's probably what impacts the 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 going forward with the product has a higher percentage, that probably also impacts the margin.

Makes sense. Thank you.

Thank you.

Thank you.

One moment for our next question. Our next question comes from the line of Fatima Bulani of Citi. Your line is now open.

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 accelerating 26% year-on-year, I believe, and now it constitutes a high team's 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.

Yeah, I think the software license, if you kind of step back and look at what the business model is, not to make it overly simplistic, 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 want to do is get the operating system in the hands of the customer. And what form factor that takes is, we're fairly agnostic about that. So 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 SecOps product line take hold as it continues to expand throughout organizations. So I would expect that we're going to continue to see tailwinds and growth, no doubt about it, from the software part of the business You know, will there be a mix shift that slows a little bit when firewall and FortiGate starts to return? Sure, absolutely. But, you know, 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 going to continue on given the success we're seeing in the other two pillars.

Yeah, in the FortiGate, FortiOS, we see customers that in turn are more and more function, which also enable more service for us. And same time, the 4D SASE secure op has also, 4D SASE is pretty much our service base and plus a lot of secure op. Secure op has high percentage in the software compared with hardware on the secure networking part. So that's both helping drive the additional software and making the growth.

Thank you very much. Very clear.

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.

Good afternoon. Thanks for taking the question.

Either for Ken or for Keith, on the silo-refresh cycle, I can appreciate your comments on not expecting to see a recovery in 2024. Share with us 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, or perhaps because of their updated depreciation plans? Any color on why you think the timing will be 2025 would be helpful. Thank you.

I think it's probably more keys. I think the rest of the year is probably still a pretty tough environment, whether election or some interest rates are still pretty high, the money costs are still pretty high. That's where some companies may not really want to spend some long-term investment, which drives 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 security, they need to be refreshed for faster, more function there. So that's where we feel when we start in this supply chain issue, they artificially push up since like starting in 2001. Maybe next year will be pretty much four-year cycle now. So some company may start in looking to refresh the product they purchased four, five years ago, especially in certain vertical like retail, some other obviously 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 the big trend, we always believe, always a hybrid mode. Even there's a, like we have a very advanced SASE infrastructure side, but also to secure OT, IoT area, to secure a lot of infrastructure, work from home. And we do need an appliance in the field. And also, even for SASE, we do offer both the cloud-based SASE and also on-premise-based private SASE. So that also needs some hardware to support locally for the customer.

Thank you. And our condolences to the team as well.

Thank you.

Thank you. One moment for our next question. Our next question comes from the line of Tal Liani of Bank of America. Your line is now open.

Hi, guys. Can you go back to the fact that you 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 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?

Thanks. Yeah. Tal, I think I kind of missed, you're very, very faint on your questions there. Maybe if you can give us maybe a little louder recap of the two questions you had.

I think I touched some part about the two acquisitions' impact on buildings. I believe that both acquisitions, I think this work maybe this year will contribute maybe.

Yeah, I think that 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 at the and really taking down the organic part of the business. But again, I think we're talking about small numbers here.

Got it.

My second question, if you can hear me okay now, but my second question was about OPEX that was flat and no buybacks. What's the outlook on those items?

Yeah, I think the OPEX is probably a little lighter on the sales and marketing line than maybe we would like to see, particularly if we start looking at more opportunities as we get into the second half of the year and into 2025. So, you know, hopefully we'll find some opportunities there to make investments. Obviously, you're going to get a fairly significant movement there from the two acquisitions that we just did, and we gave the number about what the OpEx impact is 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.

Yeah, and also in the market, whether the private company, public company, we see the multiple probably more friendly for merchandise now compared to the last two or three years. So the ratio go back to more reasonable, so that we see some opportunity there. Great. Thank you.

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.

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.

I think because we are so diversified, as you kind of alluded to, 70% of the business is international and a little bit less than 30% in the U.S. And yes, there's been a lot of elections around the world this year, but it's sort of the U.S. election maybe weighing on people and everybody's 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. You know, a lot of those are oil-producing countries and similar. So I think they've done well in this economic cycle. You know, 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 U.S. 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.

In the U.S., that's the next growing area, which also needs more direct marketing, direct sales. That also needs more investment. So that's where we do plan to invest more into sales marketing to gain market share in the U.S.

And Keith, as you contemplate these acquisitions and a little bit of mix shift to software, and I realize hardware's weak right now with a potential recovery next year, but how are you thinking about billing's duration? You know, you shaved some off the back half, and I think some of that's probably the mix shift 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?

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 Lacework would be, for example, I think it's going to 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, you know, if I sell something from the psych op portfolio into one of my firewall customers, they tend to sign up for a longer duration contract than you may see from a point solution vendor.

Great. Thanks. Thoughts are with you and the team. Thank you.

Thank you. One moment for our next question. Our next question comes from the line of Shaul Ale of TD Cohen. Your line is now open.

Thank you. Hi, good afternoon, everybody. Keith or Ken, 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 to 2025, but just conceptually, is it fair to assume another year of double-digit growth?

We do believe next year there's, I think first overall, we see the long-term convergence, networking convergence with network security still keeping going. And that's why we do give the CAGR in secure networking areas about 15% year-over-year growth. If you look in the investor 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 SASE, and also upsell, cross-sell, which all help in driving, I have to say, probably like 90% of customers initially move by a full decade, getting the firewall and network security market first, which we have a huge advantage over competitors. But after that one, they keep expanding beyond the network security, go to the other area. So that's what's happening for the unified SASE, for the secure op. Now the product, especially on the 40-grade firewall side, we're starting to see kind of go back to normal, starting growing with the market now. So we do feel probably next year will be 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're starting to refresh. And so we do see probably next year we're starting that process

Got it. Thank you.

Thank you. One moment for our next question.

Our next question comes from the line of Brad Selnick of Deutsche Bank. Your line is now open.

Great. Thanks so much for taking the question. Keith, I think you called out the service provider segment is more challenging 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 for Fortinet, but can you share an update on what's happening in that segment, and in particular, how your value prop and focus on Unified SASE and SecOps applies in this important vertical?

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 offering their own SASI using our product solution, all kind of helping customers do the private SASI, localized SASI, which also will help in drive our long-term growth. But I do believe long-term wise, the service provider will be still the biggest, 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 long and the deal pretty big, usually like eight-figure deal. That's where the lumpiness probably impact the quarterly. But if you look at more long-term, multi-quarter annually, I do believe they're still keeping growing.

Yeah, I can 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 SASE 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. But that's going to That's a pretty exciting opportunity if it continues to move forward.

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, 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.

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 across a number of areas. And 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. And I think you kind of see that roll through. You do make changes to your compensation programs, whether it's for direct salespeople or for channel people or 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 I kind of talk about the investment opportunities that we have in the sales and marketing line. And I think I would include the channel in that as well. And it'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 go-to-market investments here in the second half of the year.

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 the efficiency with the marketing sales. On the other side, we're a little bit behind on hiring in the sales marketing side, which we intend to accelerate. So that's actually what we'll drive the future for us.

Thanks very much, guys. Thank you.

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.

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 and 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 want to make on the competitive environment in light of this? Thank you.

I think we have not increased the price in the last few quarters. I think that because of we still believe we have a huge advantage with our 40 ASIC, 40 OS technology has a more function, better performance, lower total cost ownership, and also energy cost. 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 the better performance more function which also will drive the future service uh i think the bigger environment also we don't feel changed much uh definitely we see that the inventory i'll go back to normal whether you know 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.

Just to repeat what Ken said, maybe with a more granularity, I think the price increases that you referred to were really probably up late 2021, 2022 impact, and I don't think we're really raising prices at 2023. 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 of note we've taken the last six months. And then to Ken's point, I think we're at a moment where we think it's probably the value for the solution is very, very strong. I think the energy cost that Ken mentioned is starting to get, it's gotten a lot of traction internationally in Europe. But you're starting to see more conversation around that in the U.S., 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 the last one on that, 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 or 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.

Make sense. Thank you.

Thank you. One moment for our next question.

Our next question comes from the line of Adam Borg of Stifel. Your line is now open.

Awesome. Thanks for taking the question. And I'll also echo the condolences on Peter's passing. He's certainly missed by 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.

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. You know, 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 Ford Asasi solution. And so I think it's another step in steadily bolstering our Fort Sassy solution. We feel very, very confident in our strategy there. For the most part, as you know, I mean, we've done some tech and talent tuck-ins. Most of our technology is organic. I think to some of the earlier questions, you know, 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 in kind of developing very, very competitive solutions in SASE 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 SASE solution out there to protect our customers.

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 SaaS and SecOps and the opportunities for improvement from here. Thanks again.

Sorry, the sales execution with SaaS and SecOps?

Just general Salesforce productivity as you've gone through, you know, many months at this point of training and just ramping of the ability to sell that across your company globally.

Yeah, no, it's a really good question. You know, I think what we're seeing is it does take time. We are very focused on that broad sales enablement. You know, 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 force, you know, the good news is they have a ton of opportunity. You know, I always say they're going to suffer more from indigestion than starvation, but We've got a really big focus in the company to really train up that sales force, enable that sales force, 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 alluded to, we often land with the firewall. and then expand and give that support to our sales force with SASE and SACOP solutions. And we're seeing a lot of success there. Great. Thanks again. Thank you.

Thank you. One moment for our next question. Our next question comes from the line of Sakek Kalia of Barclays. Your line is now open.

Okay. Great, guys. Thanks for taking my questions here and tip my cap to Peter as well. We're going to miss him. Ken, maybe just to start with you, I want to dig 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 SASE and sort of maybe what sounds like a higher mix of virtual might sort of play into that?

Yeah, there's a the infrastructure probably different than the last refresh cycle. You see more hybrid working environment, whether working remotely, and also more supporting broad connection, including connect all these OT, IoT device level. For the SASE, we always believe also should be a hybrid SASE environment, not just cloud only. You do need to have a private SASE, some other local SASI offered by service provider and also sometimes the SASI also needs to secure some device which cannot install a software agent like using a 408040 switch to secure this agentless device. So that's where we feel this also will always kind of the unified SASI 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 they refresh. On the other side, network security always probably the biggest market. I mean, it has been the biggest market in cybersecurity for probably 30 years now, 20, 30 years. And keeping expanding because more people's devices get connected, more applications to access, or even access the cloud, you do need to secure on the network side. So that's what we see. when you try to access the network side and also the long-term convergence of network and network security, that's also what drives the refresh. That's also, you can see the Ghana research, we point out the convergence of network and network security also starting to accelerate. 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 the result is 40 OS, 40 ASIC, and making the best both appliance and infrastructure, the ASIC OS technology, and at 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 a strategy we have.

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?

Well, I think whether it's a virtual firewall or any other software product, the software licenses are all coming in at very, very attractive margins. I think that when you look at some of the SaaS solutions that are sitting in the services line for SecOps 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 SecOps 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 their pocket on these things, cloud provider fees in developing the SaaS solutions, and still bring up the services gross margin. And by the same token, you know, being able to absorb the charge for lacework on the operating margin line, you know, because we've managed the business in terms of cost of goods sold for the product side, you know, I think we're really, really pleased with how those two things have worked hand in hand.

Absolutely. It shows. Thanks very much.

Thank you. One moment for our next question. Our next question comes from the line of Joseph Guyot of Jefferies. Your line is now open.

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 and product in 2Q. Was there some large deals or region, segment, or vertical that stood out, especially since you don't expect the refresh benefit? And so now it's kind of like a great question.

I mean, we've talked about eight figure deals. And, you know, at our size, eight figure deals, because kind of still whips off 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 and q2. So I wouldn't want to attribute it to that. I think that, you know, I think what we saw the last month of the quarter, particularly as we got into the last week of the quarter, You know, what you see in a strong market is a lot of deals start 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.

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 mixed shift you now expect in the second half, given the delayed refresh, what is your confidence or visibility into the billing's re-acceleration 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.

Yeah, I don't think that the form factor really impacts the visibility in terms of what's in 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.

Yeah, we probably would do some more deep study to maybe, I don't know if they will get some color next year and also some midterm model in November 18, which also the 15th anniversary of IPO.

Thank you.

Thank you. Thank you. This concludes the question and answer session. I would now like to turn it back to Aaron Overia, Director of Investor Relations.

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 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.

Thank you for your participation in today's conference. This does conclude the program. You may now disconnect.