Jul 29, 2016
Executives
Michelle Spolver - Fortinet, Inc. Andrew H.
Del Matto - Fortinet, Inc. Ken Xie - Fortinet, Inc.
Analysts
Catharine A. Trebnick - Dougherty & Co.
LLC Sterling Auty - JPMorgan Securities LLC Walter H. Pritchard - Citigroup Global Markets, Inc.
(Broker) Jayson A. Noland - Robert W.
Baird & Co., Inc. (Broker) Rohit Chopra - The Buckingham Research Group, Inc.
Michael H. Feldman - Bank of America Merrill Lynch Melissa A.
Gorham - Morgan Stanley & Co. LLC Saket Kalia - Barclays Capital, Inc.
Andrew M. Boyce - Piper Jaffray & Co.
Imtiaz Koujalgi - Deutsche Bank Securities, Inc. Fatima Aslam Boolani - UBS Securities LLC Erik L.
Suppiger - JMP Securities LLC Gabriela Borges - Goldman Sachs & Co. Gregg Moskowitz - Cowen & Co.
LLC Jeremy Benatar - Raymond James & Associates, Inc. Ken Talanian - Evercore Group LLC
Operator
Good day, ladies and gentlemen, and welcome to the Fortinet Second Quarter 2016 Earnings Financial Analyst Q&A Call. At this time, all participants are in a listen-only mode.
However, later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, today's program is being recorded.
I would now like to introduce your host for today's program, Michelle Spolver, Chief Communications Officer. Please go ahead.
Michelle Spolver - Fortinet, Inc.
Hi, everybody. Thank you for dialing back in with a shorter break than we wanted.
I'm sorry that the other call ran over. I have Ken and Drew with me here and we're happy to take whatever follow-up questions we have.
And I'm going to try – I'm going to prioritize here, so the three people that were in the queue that didn't get to ask questions can ask them first. But let's still try and keep the questions to one question per person, so we can at least make this call manageable.
So, with that, Jonathan, you can start and take the first question.
Operator
Certainly. Our first question comes from the line of Catharine Trebnick from Dougherty.
Your question, please.
Catharine A. Trebnick - Dougherty & Co. LLC
Oh, hi. Thank you very much.
My question is on your small business. It looks like in billings that was a nice percentage overall.
Can you provide some color between North America and Asia Pac on how well that did and what you think the outlook for that particular segment is? Thank you.
Andrew H. Del Matto - Fortinet, Inc.
Hi, Catharine. It's Drew.
You're talking about SMB when you asked that between North America and Asia Pacific?
Catharine A. Trebnick - Dougherty & Co. LLC
Yes, yes.
Michelle Spolver - Fortinet, Inc.
The one thing is, Catharine, is we don't break the business at SMB as a portion of the business. We do report entry level product billings – or product billings for entry level products and that did do well this quarter.
We talked a little bit in the earlier call about a lot of that was due to two large deals or two large customers that had their distributed enterprise deployments that had a mix of high-end products and a lot – several thousand low-end products, so that does affect the mix. And then we're not really – we can't really project on what's happening on SMB going forward.
But I think the SMB business for this quarter was pretty much in line with what we've been seeing and the uptick was really more towards – because of the larger enterprise deals with the low-end unit.
Ken Xie - Fortinet, Inc.
Also you can see the vertical percentage at retail also pretty high and that's where the big enterprise (02:22).
Catharine A. Trebnick - Dougherty & Co. LLC
Okay.
Ken Xie - Fortinet, Inc.
And I think these three actually will help even further.
Andrew H. Del Matto - Fortinet, Inc.
So it's a little bit (02:30) SOC3 chip is coming out, a few products are coming out coming forward on the low-end which is a bit of a tailwind.
Ken Xie - Fortinet, Inc.
Yeah. That's the most popular; the number one selling product worldwide between all our competitors and that is the superstar of the product.
Catharine A. Trebnick - Dougherty & Co. LLC
Okay. Thank you very much.
I'll come back into the queue. Bye-bye.
Operator
Thank you. Our next question comes from the line of Sterling Auty from JPMorgan.
Your question, please.
Sterling Auty - JPMorgan Securities LLC
Yeah. Thanks.
Hi, guys. I apologize.
You've probably gone through this so much, but I had a bunch of earnings, so I wasn't able to be on the earlier call. The number thing I'm getting in my conversation with investors is trying to triangulate, you really beat our subscription number by a lot, but it sounded like duration was up and the bookings or billings number wasn't that much bigger to help me understand why subscription beat by so much.
So, I understand you talk about virtual, but are some of these virtual deals actually coming in with either monthly billings or quarterly, so it's not showing up in deferred revenue or billings or how can you help me understand the strength in subscription versus the billings number?
Andrew H. Del Matto - Fortinet, Inc.
Yeah. I wouldn't start with that explanation, Sterling.
The first point I tried to make and I hate to get into an accounting conversation, but unfortunately we have to kind of go there a little bit just to understand that, one, the duration went up. And if you look at last year, Q2 2015, we had a tremendous quarter, very nice product revenue growth, and a lot of it because we sold a lot of one-year deals quite frankly.
So when duration goes up, you end up exacerbating or multiplying the carve-out. So, if you do a longer term deal, when there is a carve-out from hardware to subscription or FortiCare or whatever, then you have to time it times three, four, five, whatever the duration is.
And so, there was a multiplying carve-out factor, if you will, which pushes more in deferred. And I think you've been seeing kind of a shift into the longer term revenue over the last year.
Again, customers are buying the way they want to buy. We're agnostic.
We publish a price list. You can look at it and say, well, one, they're driving lower total cost of ownership.
And so there is a price advantage when you're going to renew it anyway of doing it upfront, but anyway, it creates more of a carve-out. And I think that's really the number one thing.
The other things going on is there's just more subscription content, and so as we raise prices, more of an invoice tends to end up on the deferred line, and then amortizes and ends up coming back in terms of services revenue and drives that up longer term versus shorter term. And so, you're starting to see those layers of that build and they roll off into revenue.
The other piece that I think you were talking about and I would almost put that last was more kind of the virtual content. Software has more of a deferred nature to it.
You favor the deferred, the undelivered elements, in terms of how you account for it over the upfront element. It's always been the case.
And then we're selling more virtual, so that's a piece of that. So that rolls back into the services line as that comes off the balance sheets.
And then the next piece of it is the metered model, which is a lot more than last year, but again, it's not a huge number, but that's driving it up some.
Ken Xie - Fortinet, Inc.
Also, I would add (06:17) and also product mix also probably more favor to the subscription side, because you can look in the – I mentioned the service provider and also the retail big enterprise, and a service provider tends to buy the short-term subscription compared to the big enterprise that, the retail – the typical enterprise, they tend to buy many year long-term subscription, so that's also you can see the – because Ken also mentioned the SMB product, that mostly go to the retail branch office. They tend to commit for the multiple year model and compared to the service provider, because their customer may change year-to-year and they tend to be more committed to the short-term model.
So that's where the technical carrier goes down to the 19% from the low 20% and also the retail go up and that's also kind of helping shift some of the revenue to the – from product side to the service side.
Andrew H. Del Matto - Fortinet, Inc.
Yeah. And Sterling, the last thing I would add and it sounds like you have another part of the question (07:28).
Again, the Americas 15% growth doesn't help that line, right? So that's another headwind on the product line.
Sterling Auty - JPMorgan Securities LLC
Right. Right.
But just following on that, so it sounds like the increased carve-out, the longer duration is a combination of what's been happening, the last couple of quarters all kind of layering in and hitting this quarter, not so much something that happened dramatically this quarter itself.
Andrew H. Del Matto - Fortinet, Inc.
Yeah, the duration adds more carve-out. We had a lower – absolutely had a much lower revenue yield on the products that we shipped this quarter versus a year ago.
That's one point. The other point is the Americas had – the 15% growth hurts that line upfront, but yeah, you're right.
We've been building those layers over time and that drives it up again, but it tends to characterize a recurring revenue relationship, which we have been focused on building quite frankly from a strategic perspective.
Ken Xie - Fortinet, Inc.
(08:32).
Sterling Auty - JPMorgan Securities LLC
But, Drew, the revenue yield being down, that explains the product revenue but doesn't explain the strength in subscription. I was saying the strength in subscription has to be the layering effect of what you've done the last couple of quarters all coming in and benefiting this quarter, because it looked like this quarter is more back-end loaded, so it didn't seem like it was something that happened this quarter.
Andrew H. Del Matto - Fortinet, Inc.
Sterling, one other thing that we've been doing is focusing on, our customers when they light up the project. We've been trying to get better at getting customers to register the product.
And so if they register sooner, you start amortizing sooner. And if you register sooner, you also renew sooner.
And so when you think of the economic value created by driving faster registration, I mean, there's another factor. And there's a lot of factors into this quite frankly, but that's another thing that's occurring, where we've been very focused on the hygiene of recurring customers are registering faster than they were in the past and that's another tailwind, if you will, to the subscriptions line.
You basically start the amortizations faster.
Sterling Auty - JPMorgan Securities LLC
Got it. Thank you, guys.
Andrew H. Del Matto - Fortinet, Inc.
You're welcome.
Operator
Thank you. Our next question comes from the line of Walter Pritchard from Citi.
Your question, please.
Walter H. Pritchard - Citigroup Global Markets, Inc. (Broker)
Hi. It seemed like there were a few mixed inputs around the traction in the enterprise this quarter, and I'm wondering if you could kind of, Drew, maybe just kind of summarize.
You did mention here that you did see some strength in the retail vertical in some of those highly distributed, but you saw some weakness in the high-end product lines which sometimes ship into enterprise, although it sounds like service provider was weak and did contribute to that as well. So, I just wanted to kind of get a quick summation of what you felt like the enterprise business did this quarter?
Andrew H. Del Matto - Fortinet, Inc.
I think it was fine internationally. Clearly, the growth internationally; EMEA grew 36%, APAC grew 37%.
The businesses were just strong across the board is how I would characterize that. In the Americas, North America particularly, that's where the challenge was.
What we pointed out earlier, Walter, I don't know if you were on the earlier call, but we said Brazil – specifically country wise, Brazil and Canada had a rough quarter. Then when you go into, again, those commodity-based economies, we've kind of called out before.
I think Brazil has different issues beyond commodities, right? They have political issues.
But anyway, those were challenged. But we're being upfront about it.
We didn't see the productivity we wanted to see in North America. That's where we're very focused.
And they did some enterprise business, that's where the large retail deals were. Certainly, they're focused on the enterprise, but growing 15%, it'd be hard to support an argument that they did extremely well on that side.
Walter H. Pritchard - Citigroup Global Markets, Inc. (Broker)
And on the comments you mentioned that you saw customers pushing things till the last minute trying to drive discounts and so forth, is competitively that sort of tactic working in the industry? I guess we haven't heard that several quarters ago as really price sensitivity and so forth.
I'm wondering relative to customers pushing things till the last minute to try to drive discounts, do you think they're seeing that work from other vendors and that's why you're getting caught up in that as well?
Andrew H. Del Matto - Fortinet, Inc.
I think so. I think – look, discounting is more of an incumbent defensive strategy.
They're trying to stay installed and not get displaced. It clearly exposes them at risk.
That's the thing. And they try to play it off of us.
What I said earlier and I think we've said before, is that we generally – even though our TPO is very compelling and probably more compelling than others, we try not to just play the price card, right? You're really trying to win strategically and sell the Fabric, and if you've done that, price is already probably being factored in.
You do get some grinding from time to time and they do – it does push deals to the end of the quarter and they certainly are playing off. Look, we don't always cave.
We try to be thoughtful about where you do, when you do, but I'm sure we all do that some. But, yeah, I think it was a factor.
It certainly was a factor in pushing things to the end of the quarter.
Walter H. Pritchard - Citigroup Global Markets, Inc. (Broker)
Thank you very much.
Andrew H. Del Matto - Fortinet, Inc.
You're welcome.
Operator
Thank you. Our next question comes from the line of Jayson Noland from Robert Baird.
Your question, please.
Jayson A. Noland - Robert W. Baird & Co., Inc. (Broker)
Okay, great. Thank you.
This is a follow-up to an earlier conversation on the sales reorg. And Drew, I believe you said there may have been some attempt to empty pipelines in the March quarter.
Is this changes that Patrice made to comp plans and quotas that may have incentive behavior?
Andrew H. Del Matto - Fortinet, Inc.
No, I think you just – the deals were there. I think that comment wasn't – I don't think it was – I didn't use the word attempt, I think they just closed deals that were there.
They closed them there because – look, not everybody was – not everybody's accounts changed and you have some of that. And then I think you also have people picking up some deals that were in the pipeline and developed along the way, and so there was just more business closed.
I think there is a newer model in place that transcended Q1 in terms of the six months or longer sales cycle. That's how I would characterize it.
So some businesses happened to be there in Q1, they closed because it was developed at that point. And then I think as you rebuild some of the lead engine and kind of the handoffs and development of the – and to closing of the deals, just probably took the sales cycle, created a new sales cycle, let's say, beyond the six months, pushing it into the second half of the year.
Jayson A. Noland - Robert W. Baird & Co., Inc. (Broker)
Okay. That's fair to say that the sales structure, sales teams' comp plans are in place now for the second half in the U.S.?
Andrew H. Del Matto - Fortinet, Inc.
Oh, yeah. They were in place for the first half.
But I'm just saying that they – I think those two are kind of almost non-sequitur in the sense that – look, if there were deals to close, they closed in Q1. They were just – they were there already.
Jayson A. Noland - Robert W. Baird & Co., Inc. (Broker)
Thanks.
Andrew H. Del Matto - Fortinet, Inc.
Yeah.
Operator
Thank you. Our next question comes from the line of Rohit Chopra from Buckingham.
Your question, please.
Rohit Chopra - The Buckingham Research Group, Inc.
Yeah. Thanks very much.
Hi, Drew. I just wanted to ask you a question.
Jayson was asking something about pushing things to the end to get discounts. Was that globally or is that just in North America?
Andrew H. Del Matto - Fortinet, Inc.
Yeah, globally. I think that's all around.
I think...
Rohit Chopra - The Buckingham Research Group, Inc.
That was global.
Andrew H. Del Matto - Fortinet, Inc.
...I think – yeah, that's right. I think the protection of the installed base is the point.
Defending the installed base.
Rohit Chopra - The Buckingham Research Group, Inc.
And the question that I had was when you gave your – when you gave the outlook, you talked a little bit about caution and one of the things you mentioned was Brexit and EMEA. I just want to get a sense.
Are you – we're about a month into the quarter, are you seeing specifically any challenges in EMEA or the UK specific and are you having to make price changes to adjust for a currency or anything like that or demand in that region? I think other vendors have already started to move prices.
Dell was just an example, but there's a lot of people already making changes in price in the region, so..
Andrew H. Del Matto - Fortinet, Inc.
I don't...
Rohit Chopra - The Buckingham Research Group, Inc.
Are you seeing anything like that or any changes?
Andrew H. Del Matto - Fortinet, Inc.
Again, our TPO is very compelling. I think we've had – we've done less on adjusting prices certainly downward, if anything, we're more focused – we're more biased on the upwards.
We're very focused on making sure we're not overly compelling quite frankly, but I think we've seen in the past – which we used as a basis to raise price on the UTM bundle over a year ago and then we released the enterprise bundle this year. We're very thoughtful about trying to add more value to those as we do that.
But, more directly, we haven't done anything to adjust for currency.
Rohit Chopra - The Buckingham Research Group, Inc.
Okay. My last question is just related to the competitive environment, there's – incumbents have released a ton of new products out there.
And I'm just wondering has that maybe just delayed things in general? So outside of any sales force reorg issue have any evals or any FUD out there creating maybe a longer sales cycle by the incumbents with their new products.
Are you hearing of anything like that from the sales force?
Andrew H. Del Matto - Fortinet, Inc.
I think, no, what we hear more or see more – witness more, let's say, and we do – Ken and I talk to customers as well. You see more new people in organizations and I think they're thinking more strategically.
There's obviously more sizes out there now, for instance, and they have a stronger role in buying behavior. They're thinking architecturally and strategically.
I think that's the type of thing that probably puts some more pause in the system than anything. Then, I think the other factor is that, a lot of money has been spent on security over the last year.
They have all these products. I think they're thinking about how should one consolidate and then also how do they get a more affordable wallet over time, let's say, right?
So I'm sure that CFOs around the world are very focused on ensuring that the budgets are appropriate for the long-term models of the company and so they probably get a little pressure on that side.
Rohit Chopra - The Buckingham Research Group, Inc.
Okay. I appreciate it, Drew.
Thank you.
Andrew H. Del Matto - Fortinet, Inc.
You're welcome.
Operator
Thank you. Our next question comes from the line of Tal Liani from Bank of America.
Your question, please.
Michael H. Feldman - Bank of America Merrill Lynch
Hi, thanks for taking my question. This is Mike Feldman for Tal.
Just one on AccelOps, so could you talk a little bit about the competitive technology differentiation between the FortiSIEM and some of the leaders in the market like a Splunk or a LogRhythm? And then from a go-to-market standpoint, when do you expect your channels to be fully educated on the solution and selling it in the marketplace?
Thanks.
Ken Xie - Fortinet, Inc.
Well, this is Ken. I think we try to well manage security-related SIEM, that's where the AccelOps product what we renamed the FortiSIEM will be working together with other Fortinet products there.
Especially, we have the biggest deployment globally, probably more than double the number two and that will help in lower the management cost, at the same time, the AccelOps product also help us to go to multiple vendor management together like there are some other networks and some other storage, and the channels we use in the FortiSIEM product to get visibility and drive what we call the Forti Fabric strategy better. So that's the piece we don't quite have before and this will help enhance all this.
And the other part, really, we can have a more actionable and through any like the intrusion, any incident response working with FortiGuard, that's where any like a break-in or whatever we can quickly do the analysis and also respond to the break-in.
Michael H. Feldman - Bank of America Merrill Lynch
Okay. Okay, and then when do you expect to have the channel partners fully ramped up on the product and in the market selling it?
Ken Xie - Fortinet, Inc.
There is two strategy. One, really keeping enhanced shipment of the current product with the FortiGate side.
That's probably what we're already studying to go to the field. And the other part we're launching we call the FortiCare 360.
So that's the part we're helping the current customer to manage their deployment better, so that probably will be in the early Q4. So, we're leveraged the AccelOps FortiSIEM product to launch service.
And so that's a service on top of the 8x5, which had bought 15% of the hour per year and also 24x7 which had about 25% of the hour price. This will be probably about 35% and we're still in the evaluation beta testing stage, but the formal launch probably will be early Q4.
Michael H. Feldman - Bank of America Merrill Lynch
Thank you.
Operator
Thank you. Our next question comes from the line of Melissa Gorham from Morgan Stanley.
Your question, please.
Melissa A. Gorham - Morgan Stanley & Co. LLC
Great, yes. I just want to follow up on the question before on AccelOps.
Drew, I think you said there was a $4 million contribution to deferred revenue from AccelOps this quarter.
Andrew H. Del Matto - Fortinet, Inc.
Yeah, that's correct.
Melissa A. Gorham - Morgan Stanley & Co. LLC
So if you're calculating organic billings, then it makes sense to take out that $4 million in deferred revenue. And then in terms of what you have embedded in the guidance moving forward for AccelOps, can you maybe give us an idea of what we should expect from an inorganic perspective?
Andrew H. Del Matto - Fortinet, Inc.
And so, I think – Melissa, let me make sure I heard you correctly. I think you're basically asking did we adjust out the $4 million in billing.
Is that the first question?
Melissa A. Gorham - Morgan Stanley & Co. LLC
Yeah. No, I just wanted to confirm it was $4 million, and then just in terms of your guidance for the full year, are you assuming any inorganic contribution from AccelOps either to the top line or in terms of expenses?
Andrew H. Del Matto - Fortinet, Inc.
So, the $4 million is correct on the addition and you could see the math, it's not inorganic, but it's not in the billings. It gets renewed.
So, the second piece was very little contribution. First of all, it's a subscription model.
And I think just any time near term, it's near-term disruptive, especially, when you're trying to drive synergies in the business. We're more focused on getting it into the bundle.
Again, we'll sell it separately as an offering, but I wouldn't expect much there. It's certainly very little.
Even though it comes over, there is some duration in their deferred revenue as well. So it's not like that's all going to roll off in the next six months, if you will a little bit.
But we don't expect much topline of a tailwind from that business. So, on the op margin side or the expense side, if we do nothing, they were – it actually contributed probably $1 million of OpEx – uncovered OpEx in June.
So, you could extrapolate that forward to kind of get a sense for how that might impact the year if we don't do anything. But we're very focused, as I said, and putting that in the mix of our model, again, their primarily a Western Hemisphere entity, probably mostly North America, and we're looking at that and driving the synergies across that business.
Again, just the easy way to think about it, from our perspective, it's all about productivity. How do we ensure that if we have people in place, whether it's AccelOps people or Fortinet people that they're driving the appropriate level – appropriate return on the investment.
And if it makes sense for us then we keep it, if not, then we deal with it. There are some R&D folks and they will stay, but they will offset that other hiring that we would've done and it's almost as though, because we're talking a little bit about – the people are asking us about how much can you really tamp down on hiring.
But think of AccelOps as really forward hiring on the R&D side, so we're offsetting some of something that we would've just done anyway sooner. So you're in a way front-loading people you would've hired, but then what we're really trying to do is make sure we do get that benefit and offset it.
And Ken and I are very focused on who's being offset, what's being offset, and trying to drive that down so that it has a minimal, if any, impact on op margin.
Melissa A. Gorham - Morgan Stanley & Co. LLC
Okay, that's helpful. Thank you.
Andrew H. Del Matto - Fortinet, Inc.
You're welcome.
Operator
Thank you. Our next question comes from the like of Saket Kalia from Barclays.
Your question, please.
Saket Kalia - Barclays Capital, Inc.
Hey, guys. Thanks.
Thanks for squeezing me in here again. Maybe just to stay on that topic of AccelOps there, Drew, and just talk about general expenses in Q2 to Q3, so, first, how much, realizing AccelOps is small, roughly how much does AccelOps kind of contribute or did it contribute in total expenses in Q2?
And then kind of secondarily, did you see an elevated level of discretionary spending, whether it's marketing campaigns or T&E or whatever the case may be something non-hiring that could be brought back easily?
Andrew H. Del Matto - Fortinet, Inc.
Good question.
Saket Kalia - Barclays Capital, Inc.
Because, the question I think that we're all getting, right, is the sequential change in expenses, it's kind of flat to down compared to – historically, we've kind of seen it being sort of up, and so while know that hiring service is obviously the biggest lever, I'm wondering how much of the acquisition as well as the discretionary pieces may play into that compare. So any commentary there would be really helpful.
Andrew H. Del Matto - Fortinet, Inc.
Yeah, absolutely. And I think it's a great question.
I'll say what I said and you can tell me if you want more on AccelOps, but it was about $1 million negative in June for cost up, that's about $1 million on the OpEx line. And so I think I answered the rest of how we were dealing with that going forward.
The other things that hit us were commissions and so, again, where you have these larger deals, the duration, you're paying the full commissions on these. So, you have people getting into accelerators, you get some skew of the business in terms of several large deals they can – they hit us.
And I think our competitors see this from time to time too. There is something there, and we're very focused on that one as well.
There's opportunity there let's say. We're also looking at things we do, and we talked about synergies in AccelOps, and synergies is a broader conversation because although there are AccelOps, we've talked about offsetting, hiring that we would have done anyway, we're also talking about sales productivity and making sure that we don't have any overlaps, Ken even mentioned overlays, those types of things.
You want to make sure you have the right model in place, we're looking at deal margins, contribution margins, we're getting more and more focused on those types of things, which not only drive productivity, but they – we may take out costs or not spend more on those areas. And again head count would be one of those.
The other one is even just like marketing, and so as you build things you find that some things are working better than others, and so – or you're doing something twice, maybe you're doing something in Europe that you don't need – you're doing in the U.S. too and you may find some synergies there.
And that's where we're also focused on a few things. There's other areas like you would find in other any company you can, there are some controllable expenses.
I could get into things like T&E, and – just the other things that are out there that we're very focused on. Just to make sure that if we need enhanced control, let's say or enhanced scrutiny that we're going to do that.
Saket Kalia - Barclays Capital, Inc.
Sure, sure, but seems like, I guess maybe the new thing or is the thing that I probably missed from the last call was commissions, maybe it seems like it was a little bit higher than what we were expecting and that maybe...
Andrew H. Del Matto - Fortinet, Inc.
Yeah.
Saket Kalia - Barclays Capital, Inc.
...managed a little bit more in the back half.
Andrew H. Del Matto - Fortinet, Inc.
Yeah. We'd certainly focus that – I think I'd probably didn't say the word commissions.
I was probably enveloping it in the concept of productivity, but it's in there.
Saket Kalia - Barclays Capital, Inc.
Got it. Thanks a bunch.
Andrew H. Del Matto - Fortinet, Inc.
You're welcome.
Operator
Thank you. Our next question comes from the line of Andy Nowinski from Piper Jaffray.
Your question, please.
Andrew M. Boyce - Piper Jaffray & Co.
Hey, thanks for taking my question. This is Andrew on for Andy here.
I guess, coming back to the sales incentive side of things, are you guys looking at implementing any programs or are there any changes you guys can make to your incentive structure to improve linearity?
Andrew H. Del Matto - Fortinet, Inc.
Well, we actually do have a linearity feature in the commission plans. I do think part of it is just the – the fact , you know the sale cycles, you know you have new people, new organization.
I think the sales cycle has just made that hard to do. I do also think there's some buying behavior that we've talked about.
Where our customers are holding deals to get a better deal, whether you call their boss or not, it doesn't prevent them from doing that. So even that is certainly in the mix.
But, yeah, we're looking at that, but I mean, that's not an unusual issue. I think we were probably better than most companies linearity wise a year ago.
And then I just think just more recently is where it's become more backend loaded.
Andrew M. Boyce - Piper Jaffray & Co.
Okay, I see it. Go ahead
Michelle Spolver - Fortinet, Inc.
I was going to say we've seen that through with a number of companies that have reported already in terms linear earnings. While we didn't, I think that the uncertainty in the environment that you talked about in the main call, probably had something to do with it.
Andrew M. Boyce - Piper Jaffray & Co.
Yeah.
Michelle Spolver - Fortinet, Inc.
If you think about Brexit, we were asked a lot about, did we get affected, anything that in future performance affected by Brexit, I mean, it didn't from deal standpoint, but it probably did in delaying some purchasing, it – those deals came in, but I think there is probably some caution on customers, and again I think it's more, hopefully you get back to better linearity, we have sort of incentives in place, which we have had in place to help that. But at the end of the day, I think it's more being driven by customers.
Andrew M. Boyce - Piper Jaffray & Co.
Definitely, that's fair. If I can just sneak one more in here, I guess given the free cash flow in this, are you guys comfortable with where the street is at, I know, you won't provide guidance for that number specifically, but any commentary you can provide, I guess, to what do you think free cash flow might – where it might stand at Q3 would help?
Andrew H. Del Matto - Fortinet, Inc.
Yeah, so again, fair question, and surprised somebody hasn't asked that yet, but the – we don't guide on free cash flow, we do talk about CapEx though, and we've had some opportunities, look we've been talking about real estate for a while, we're basically out of space here in our Sunnyvale headquarters, and there are some offices in where we pay leases that have come up as opportunities for us to buy. We were actually going to guide up on the CapEx slide, I think we were at $55 million for the year, we're now going to say that we're going to give ourselves some room to buy some real estate, and that could go up to probably $80 million or $90 million for the year.
When we look at these properties, they're either adjacent properties or properties we're in, and there's very compelling reasons to do it, again we have the cash to do it. The payback on these is usually seven years or so.
We may not do it, but it's amazing in the last month that a couple of properties that one we're in, and another one that's adjacent have come up for sale, and we've been talking to those people for quite a while, and they just happen to come up now. They would have come up next year or the following year anyway, but we're going to give ourselves some room, so – we do get the price, then we'll move forward on that.
Andrew M. Boyce - Piper Jaffray & Co.
Definitely, that's all I had. I appreciate it.
Andrew H. Del Matto - Fortinet, Inc.
You're welcome.
Operator
Thank you. Our next question comes from the line of Taz Koujalgi from Deutsche Bank.
Your question please.
Imtiaz Koujalgi - Deutsche Bank Securities, Inc.
Hey, guys. Thanks for squeezing me in.
I have a couple of questions. Drew how much was the duration in Q2 of last year?
Andrew H. Del Matto - Fortinet, Inc.
Give me one second. 21...
Michelle Spolver - Fortinet, Inc.
21 months
Andrew H. Del Matto - Fortinet, Inc.
21 months
Imtiaz Koujalgi - Deutsche Bank Securities, Inc.
And this quarter you said was 22 months to 24 months, I'm sorry.
Andrew H. Del Matto - Fortinet, Inc.
23 months, 23 months.
Imtiaz Koujalgi - Deutsche Bank Securities, Inc.
Got it. Okay.
Thanks. And then, one question on the sales reorg.
I know you guys did just reorg in North America in Q1, when was the similar sales reorg done in EMEA, was it done in the same time or was it done in the prior quarter and...?
Andrew H. Del Matto - Fortinet, Inc.
They were done together, but I – we've been stronger internationally to be frank. I think those have been more add to the current model and the leaders probably expanded their responsibility, capped some of their responsibility and expanded it.
In Americas, we had a change – in North America, we had a change in leadership along with Patrice becoming the global, running it globally. And, so Patrice still runs Europe right, but the North America piece is new to him, for instance, and then he brought a leader over from Europe to North America, who was extremely successful – the most successful of our leaders in Europe and from a large company – global company, and so that was the idea there, so it's more new, it's certainly there's more newness to the model that we have, North America really.
Imtiaz Koujalgi - Deutsche Bank Securities, Inc.
Got it. And the linearity was backend loaded, it was just in the U.S.
or was it all across all the regions?
Andrew H. Del Matto - Fortinet, Inc.
I probably believe more so in North America.
Michelle Spolver - Fortinet, Inc.
We did see it around .....
Andrew H. Del Matto - Fortinet, Inc.
Yes, it was around the globe but I would say probably more so in North America.
Imtiaz Koujalgi - Deutsche Bank Securities, Inc.
Got it. And then, one last one, I mean you mentioned about the increased duration resulting in high carve out of subscription revenues, but I'm still not clear why would that impact product revenues negatively because you don't defer product revenues, right, regardless of the duration you don't have spot revenues in the quarter?
Andrew H. Del Matto - Fortinet, Inc.
You carve out more to the subscriptions. The way the accounting worked is, you basically balance the invoice based on a benchmark of what the price should be, and then if you – duration, if there is a carve out, if it's a one-year deal, you only do 1x of the carve out.
If there's a three-year deal, you do 3x. If it's a five-year deal, you do 5x.
And so, it exacerbates, multiplies if I could call it a better word the accounting carve out, and then it gets pushed into subscription revenue because what you're trying to do is balance the undelivered element with the upfront of the delivered element, a product of the delivered element. And so, the accounting will favor the undelivered element historically, and hardware is a little different than software, but you still have this kind of relative ratio carve out thing without getting into the accounting conversation, but I think the point is it more applies to carve out when that exists.
And we did see, look I could check that. We checked that by looking at the top deals, and we could see that the revenue – upfront revenue yield was much lower than a year ago, and we attribute that to the carve out and the multiplication factor, yeah, the duration factor.
Imtiaz Koujalgi - Deutsche Bank Securities, Inc.
Got it. That's all for me.
Thank you very much.
Andrew H. Del Matto - Fortinet, Inc.
You're welcome.
Operator
Thank you. Our next question comes from the line of Brent Thill from UBS.
Your question please.
Fatima Aslam Boolani - UBS Securities LLC
Good afternoon, guys. It's Fatima on for Brent.
Thanks fr taking the question. Drew, I just did a double-click on kind of this product use subscription and in carve out, and revenue deferral mechanics that you are more pronouncedly experiencing.
Is it fair to say that you're having significantly more traction in selling bundled versus individual subscriptions and that's one of the reasons why you're seeing a bigger carve out.
Andrew H. Del Matto - Fortinet, Inc.
I am trying to think of the mechanics of that, I think that's right. Yeah, that's right because first it's kind of just firewalls a year ago, maybe you're seeing more bundles certainly, right.
And I think customers are buying more strategically or qualitatively if that makes sense.
Fatima Aslam Boolani - UBS Securities LLC
And so are you incenting your sales organization to encourage customers to buy the UTM bundle or the enterprise bundle as opposed to paying 20% of the list price for one singular functionality. Is that the right way to think about that underlying dynamic?
Andrew H. Del Matto - Fortinet, Inc.
We don't compensate on that way, we don't trade on that way, because obviously if you want to drive. We want to drive the recurring revenue stream, higher margin it's recurring obviously predictability.
You know all those reasons you'd want a recurring revenue stream. And so we're certainly favoring the trading, as you could look at our pricing is obviously been biased that way as well, and we'll continue to do that.
Again, we really see enterprise – UTM bundle year-and-a-half ago, enterprise bundle more recently, and then we talked about FortiCare 360 bundle including the cell locks technology coming out probably in Q4 (37:22)
Fatima Aslam Boolani - UBS Securities LLC
Understood. But the appliance itself is still your primary security functionality delivery vehicle, right?
I mean at the end of the day...
Andrew H. Del Matto - Fortinet, Inc.
It is, but there's more...
Fatima Aslam Boolani - UBS Securities LLC
You still have to sell appliance.
Andrew H. Del Matto - Fortinet, Inc.
Yeah. It is, but there is more software and there is more – the metered model is moving a little bit.
There's just more other things. There is more breadth of selling, we talked about growth across the product line.
We are focused on the fabric. The idea there is to get deployed, land and expand.
The breadth of the product is the best way really to attach yourself to the customer longer term, and expand longer term, and again drive those recurring revenues.
Fatima Aslam Boolani - UBS Securities LLC
That's really helpful and maybe flipping the question around a little bit, you did talk about non-FortiGate billings up in excess of 50% or substantially better than the overall business. I'm wondering if you can give us the sense of what proportion of your, call it entire subscription services family of offerings is unattached versus attached to an appliance sale?
Andrew H. Del Matto - Fortinet, Inc.
I think most are probably attached. There can be some follow on, but most are attached, I think is the way to think about it.
Now AccelOps, again, we're going to try to wrap -- we're going to wrap it into the bundle, but it's – currently it's a separate product albeit pretty small. That is a subscription product that would standalone right now, but I think that's the only – I guess you could buy some of the other ones as a subscription.
Whether you did it, you bought through AWS for instance. That would be one way or some of those service provider offerings.
Fatima Aslam Boolani - UBS Securities LLC
Okay. Just to be clear, FortiWeb and FortiMail, and your FortiAP offering, it would have to be associated with an appliance purchase or do you have to be a pre-existing Fortinet customer to be able to enjoy the kind of the security fabric benefits from those offerings?
Michelle Spolver - Fortinet, Inc.
Whether like FortiMail, FortiWeb, I forgot the other one you said, FortiSandbox, they have specific – there will be a – let's say, you buy FortiSandbox, and you probably wouldn't buy the bundle, you should buy our APT service to go with that FortiSandbox similar to FortiMail you can probably buy the email security and subscription service. But the vast majority of customers who buy FortiGate will buy the bundle, because they'll use it for a lot of different – they'll be able to get the benefits of the integrated threat protections through the bundles.
Fatima Aslam Boolani - UBS Securities LLC
Understood. That's it for me.
Thank you very much.
Operator
Thank you. Our next question comes from the line of Erik Suppiger from JMP.
Your question, please.
Erik L. Suppiger - JMP Securities LLC
Yes, thanks. First off, I want to be clear, did you say that duration last year was about 21 months, and it was also 21 months in the first quarter.
So it's been flat. And then this quarter, it saw a pick up to 23 months, is that the right chronology?
Andrew H. Del Matto - Fortinet, Inc.
Yes.
Erik L. Suppiger - JMP Securities LLC
Okay. Secondly, you added about 300 head count in the – over 300 in Q2, and you're looking for a decline on the OpEx flat to down and OpEx in Q3.
Would you be surprised, if head count is actually down by the end of Q3? Is that something that's possible?
Andrew H. Del Matto - Fortinet, Inc.
I probably wouldn't want to guide on head count. But just keep in mind, that I think, 65 to 70 came over through AccelOps.
And so that's a way to think about it – I think, our model is matured, we're very focused on managing the head count. Could it be flat?
I think that's a possibility. I wouldn't guide one way or the other.
Erik L. Suppiger - JMP Securities LLC
Okay. And then did you say CapEx this year will be $70 million to $80 million, is that what you said?
Unknown Speaker
$80 million to $90 million.
Erik L. Suppiger - JMP Securities LLC
$80 million to $90 million? And...
Andrew H. Del Matto - Fortinet, Inc.
We're guiding upside, again it depends on the timing (41:35). So we haven't closed any of these deals.
What I said is that we're in one building that came up for sale, and then some adjacent properties have come up for sale in the Sunnyvale headquarters. For any of you who've been here been here you know, you could probably see we're out of space.
And it makes sense to buy those. We haven't done those.
The price has to be right. But there is a chance we'll do those, and we would have done those eventually.
I would put it out there and we tend to look at a payback model – certainly under – I think I used the word around seven years, but certainly under eight years or nine years, something like that. These are just things we would have done.
You're effectively accelerating spend on those things if that happens – if those do happen. But I have to guide up just because one literally came to us yesterday.
Erik L. Suppiger - JMP Securities LLC
Okay. But you are suggesting that analysts factor the $80 million to $90 million into their models for 2016.
Andrew H. Del Matto - Fortinet, Inc.
Yeah. I am, I am.
Erik L. Suppiger - JMP Securities LLC
And is that somewhat of an anomaly in light of these two transactions in which case calendar 2017 presumably wouldn't be at that level?
Andrew H. Del Matto - Fortinet, Inc.
I haven't guided for it on 2017 but clearly we're – these are things we would have had in the long-term model that we were going to do over time, we were trying to do over time. Our key is to get them at the right price.
Erik L. Suppiger - JMP Securities LLC
Okay. Lastly, education had a nice pick up in the quarter.
I'm sure that's partly because of seasonal strengths but even on a year-over-year basis, it was pretty strong. Was there anything unique to education in the June quarter that would explain why it was strong even year-over-year.
Michelle Spolver - Fortinet, Inc.
No, I mean we called out in the commentary a couple of deals that were with larger universities, but it wasn't anything that we did, that means – we won the deal, but we didn't do anything as a company to a make a bigger focus on education. I think to your point, it tends to be a bigger year seasonality in terms of volume, but then we also got a few big deals, bigger deals that were universities, and they were more international.
Erik L. Suppiger - JMP Securities LLC
Was that more international, is that correct?
Michelle Spolver - Fortinet, Inc.
Pretty much, I mean it's both but the ones we called out in the script were international, but I think we probably got universities around the world, but there wasn't anything, I don't think there's anything to really dig so much in there other than it's just sort of a mix of customers that made up this quarter and we did pretty well in education.
Erik L. Suppiger - JMP Securities LLC
It wasn't a function of E-Rate funding or anything unusual from the federal side, was it?
Michelle Spolver - Fortinet, Inc.
No, these ones were more traditional next generation firewall, datacenter firewall, there wasn't internal segmentation firewall deals, it wasn't associated with E-Rate.
Andrew H. Del Matto - Fortinet, Inc.
Universities, not grade schools.
Michelle Spolver - Fortinet, Inc.
Yeah.
Erik L. Suppiger - JMP Securities LLC
Very good. Thank you.
Operator
Thank you. Our next question comes from the line of Gabriela Borges from Goldman Sachs.
Your question please.
Gabriela Borges - Goldman Sachs & Co.
Great. Thank you.
A lot of discussion on the overall macroenvironment and how the buying patterns may have changed year-over-year, just curious when you look at your internal business from the win rates that you are seeing when you compete, if you're seeing any change in the win rate? Thank you.
Andrew H. Del Matto - Fortinet, Inc.
No. <: I mean, I don't think we are seeing a change in the win rate.
We are still – our win rate is still very strong, we've always sort of said that it's even increasing and we can go in and test against competitors, and we do extremely well, and I think that hasn't changed in terms of win rates.
Gabriela Borges - Goldman Sachs & Co.
Great.
Michelle Spolver - Fortinet, Inc.
If you look at even market share gains and we're growing well above two times the market but clearly we're continuing to gain share and win over competitors.
Gabriela Borges - Goldman Sachs & Co.
Great. Thank you.
Operator
Thank you. Our next question comes from the line of Gregg Moskowitz from Cowen & Company.
Your question please.
Gregg Moskowitz - Cowen & Co. LLC
Okay. Thank you.
First I just had a clarification on wireless and I know of course you wouldn't explicitly breakout Meru, but in Q1 you would say that wireless was about 7% total billings of which Meru was maybe a little bit more than half. Does that change one way or another this quarter, I wasn't quite clear on that?
Andrew H. Del Matto - Fortinet, Inc.
Yeah. Wireless – wireless is a little better than 7% and this quarter I think we're still under, yeah, about 7%.
So, I don't see any big change there, Gregg.
Gregg Moskowitz - Cowen & Co. LLC
Okay. And then just getting back to service provider falling below 20% of billing.
So, I think Drew this is the first time that that's occurred in the company's history at least as a public company. Do you think that goes back above 20% in the second half?
Michelle Spolver - Fortinet, Inc.
Yeah, I know you asked Drew, but either one of us can answer it. Gregg, it's Michelle.
I mean it is abnormal because we usually are seeing it – the range is usually above is above like 21% and 25% So, I do think this quarter was – the reason why it fell below was because of the deals that we talked about, so I don't know if you're asking to expect those deals to come in. As we said, the deals didn't get lost, they didn't go to a competitor.
Our hope is that they do come in, I think we probably will get to more normalized level. And I think we are changing with the service provider environment and right now we're not saying any types of change in that environment.
Gregg Moskowitz - Cowen & Co. LLC
Okay. Great.
Thank you.
Operator
Thank you. Our next question comes from the line of Jeremy Benatar from Raymond James.
Your question please.
Jeremy Benatar - Raymond James & Associates, Inc.
No, my question was answered. Thanks, guys.
Andrew H. Del Matto - Fortinet, Inc.
Okay. Thanks.
Operator
Thank you. Our next question comes from the line of Ken Talanian from Evercore ISI.
Your question please.
Ken Talanian - Evercore Group LLC
Hi, guys. Thanks for taking my question.
Just a couple of clarification points on your deals. Do you always collect cash up front?
And also along those lines, do you either regularly or occasionally defer the comp associated with multi-year deals?
Andrew H. Del Matto - Fortinet, Inc.
We could yeah, I mean we collect within normal terms I mean that I think you need up front basically within under, does that not paid like year later or something like, the answer is yes. We – then – we defer the comp the only time, no I don't believe with the further comp.
So if the deal is recognized, if we call it deal billing or we call it a deal where we pay the comp, and then it's not smooth, if that's what you're asking.
Ken Talanian - Evercore Group LLC
Yeah and the cost....?
Andrew H. Del Matto - Fortinet, Inc.
Deferred and then amortized. We don't amortize commissions we don't defer them, we are – we're still taking them as we basically, as the deal happens and we accrue it, and we'll pay it out in the next pay cycle, and they get paid in July basically,
Ken Talanian - Evercore Group LLC
Okay and so along these lines, I think at one point you've actually disclosed services and other billings I think up until 3Q of last year if I'm not mistaken. I was curious, one is that on the uptrend, and then as you – given all the commentary, I'd assume that services will become a larger part of your business going forward, and are you waiting for guidance on the upcoming changes to revenue recognition to perhaps making a decision around that?
Andrew H. Del Matto - Fortinet, Inc.
We were waiting – we've been hearing everybody's been getting (49:07) question. The -- well let me – let me take in two parts.
We don't really guide on the mix. I mean I'd be more biased on the services line.
Obviously, the accounting that I talked about basically forced that to happen, again as we focused – we are delivered – absent the accounting, and what I – hopefully we've been very clear on for quite a while now is we're very focused on growing recurring revenue streams. And those tend to be articulated in a subscription, and so that's the focus, we charge more for them.
We have more content, and then we charge more. Again with the added sell offs to the bundle we call it – it's a FortiCare 360 bundle – FortiGuard 360 bundle that'll hopefully come out in Q4, be richer, be a higher price product.
We had the enterprise bundle come out recently. We saw some of that in Q2.
And again that favors the line. And then the accounting does the same thing because when it gets deferred it tends to come back on the services line.
Now shifting forward into the revenue recognition change we're talking about almost year-and-a-half out now right, if it happens. That we don't see a big change there yet, again not to get too far into an accounting conversation, but my understanding is that if you're under the (50:37) standard that it basically is similar.
We're on a sell-in model too, which I think it kind of forces you – it points more to that because it's going to just deliver the elements concept – our performance units concept and delivers a unit of performance, so I wouldn't formally guide or say that but I think that's our reaction right now. That's our kneejerk valuation, and we've talked about it with our auditors as well, and that's generally where we think we are.
Could be some change, we obviously have to go through it, but right now we don't think it'd be material, we will let you know if that changes.
Ken Talanian - Evercore Group LLC
Okay. Great.
Thanks very much.
Andrew H. Del Matto - Fortinet, Inc.
Yeah.
Operator
Thank you. .
And this does conclude the question-and-answer session. I'd like to hand the program back to management for any further remarks.
Michelle Spolver - Fortinet, Inc.
Now, I can actually close the call. I'd say thank you all for the time that you spent today in our first call and second call.
Hopefully, we were able to answer about most if not all the questions. And I will be around if you have further questions, and let's say, we are also going to be doing some conferences this quarter, so we'll be out seeing you on the road as well.
And thanks a lot. Have a good evening.
Operator
Thank you, ladies and gentlemen for your participation in today's conference. This does conclude the program.
You may now disconnect. Good day.