Fortinet Inc (FTNT) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fortinet second-quarter 2016 earnings financial analysts' Q&A call.

(Operator Instructions)

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.

Hello 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 prioritize here so the three people that were in the queue that didn't get to ask questions can answer them first. But let's still try and keep the questions to one per person so we can at least make it [manageable]. And with that, you can start, we can take the first question.

Catharine Trebnick, Dougherty.

Thank you very much. My question is on your small business, it looks like in billings [up], 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.

Hi Catharine, it's Drew. You're talking about SMB when you ask that between North America and Asia Pacific?

Yes.

One thing is, Catharine, is we don't break the business up SMB as a portion of business, we do report entry-level product billings -- product billings for entry-level products. And that did do well this quarter. We talked a little in the earlier call about a lot of that was due to two large deals with two large customers that had, they were 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 we can't really project on what's happening on SMB going forward. 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 units.

Also you can see the vertical percentage at [regional] was also pretty high, that's where it (inaudible; background noise) space. I think these (inaudible) actually will help even further.

The SoC3 chip is coming out, a few products coming out and coming forward on the low end, which is a bit of a tailwind.

Yes, that's the most popular, the number one selling product worldwide with all our [competitors, and that's the super star of the products.]

Okay, thank you very much. I'll come back into the queue, goodbye.

Sterling Auty, JPMorgan.

Thanks, hello guys, I apologize [you've] probably gone through [this a bunch] but I had a bunch of earnings and I wasn't able to be on the earlier call. The number one thing I'm getting in my conversations 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, 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?

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 it. 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 outs.

So if you a longer term deal when there's a carve out from hardware to subscription or FortiCare or whatever, then you have to times it times three or five, whatever 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 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 so there's a price advantage when you're going to renew anyway [of] doing it upfront. But anyway it creates more of a carves out. I think that's really the number one thing.

The other thing that's going on is there's 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.

Now the other piece that I think you're talking about, and I would almost put that last, was more kinds of 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, 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 sheet. And the next piece of it is the metered model, which is a lot more than last year, but again not huge number but that's driving it up some.

Also I will add (multiple speakers) the vertical and also product mix also probably more favor to the subscription site because you can look -- I mentioned the service provider and also the retail enterprise, and the service provider tends to buy the short term [constitution] compared to the big enterprise, the retail, the digital enterprise, they tend to buy many year long term subscriptions.

So that's also a tendency because (inaudible) was also mentioned the (inaudible) product, that mostly goes to the retail branch office. They tend to come in for the multiple year model compared to the service provider, because their customer may change from 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%, in the low 20%s and also the retail goes up, that's also helping shift some of the revenue from the product side to the service side.

And Sterling, the last thing I would add and it felt like you have another part to your question so (inaudible), again the Americas 15% growth doesn't help that line, right? So that's another headwind on the product line.

Right, but just following on that, so it sounds like the increased carve out, the longer duration is a culmination 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?

Well yes, 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 yes, you're right, we've been building out 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. (multiple speakers)

Sorry but sure, the revenue yield being down, that explains the product revenue but it doesn't explain the strength in subscription. I was a saying the strength subscription has to 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 there's something that happened this quarter.

Sterling, one other thing that we've been doing is focusing on, customers, when they light up a 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 if you think the economic value created by driving faster registration, I think 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 ensuring customers are registering faster than they were in the past. And that's another tailwind if you will to the subscriptions line. You're basically start the amortizations faster.

Got it. Thank you, guys.

Walter Pritchard, Citi.

Hello, it seemed like there are a few mixed inputs around the traction in the enterprise this quarter, and I'm wondering if you could, Drew, just summarize, you did mention here that you did see some strength in the retail vertical with some of the highly distributed, but you saw some weakness in the high end product lines which sometimes shift into enterprise, although it sounds like the service provider was weak and did contribute to that as well, so I just wanted to get a quick summation of what you felt like the enterprise business did this quarter.

I think it was fine internationally. Clearly the growth internationally, EMEA grew 36%, A-Pac grew 37%. Even those, the businesses were just strong across the board however you 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. And we're being upfront about it. We didn't see the productivity we wanted see in North America and that's where we're very focused.

They did some enterprise business, that's where the large retail deals were. Certainly they're focused on the enterprise but growing 15% it would be hard to support an argument that they did extremely well on that side.

And on the comments you mentioned that you saw customers pushing things to the last minute trying to drive discounts and so forth. Is competitively that sort of tactic working in the industry? We hadn't heard that several quarters ago as really a price sensitivity and so forth. I'm wondering relative to customers pushing things to the last minute to try to drive discounts, do you think they're seeing network from other vendors and that's why you're getting caught up in that as well?

I think so. Discounting is more of an incumbent defensive strategy, they're trying to stay installed and not get displaced. 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 TCO 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 has already probably been factored in. You do get some grinding from time to time and it does push deals to the end of the quarter and they certainly are playing off. 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 yes but I think it was a factor, it certainly was a factor in pushing things to the end of the quarter.

Thank you very much.

Jayson Noland, Robert Baird.

Thank you. This is a follow up to an earlier conversation on sales reorg, and Drew I believe you said there may have been some attempts to empty pipelines in the March quarter. Is this changes that Patrice made to [comp] plans and quotas that may have incented behavior?

No, I think you just, I mean the deals were there. I think the exact comment wasn't, I didn't use the word attempt, I think they just closed deals that were there. They closed them there because, not everybody's accounts changed and you have some of that, and then I think you also people picking up some deals that were in the pipeline and developed along the way, and so there was just more business closed. There's a newer model in place that transcended Q1 in terms of the six month or longer sales cycle, that's how I would characterize it.

So some business happened to be there in Q1, they closed because it was developed at that point and then I think if you rebuild some of the lead engine and the handoffs and development to closing of the deals, probably took the sales cycle, created a new sales cycle let's say beyond the six month pushing it into the second half of the year.

Okay, but fair to say that sales structure, sales teams, comp plans are in place now for the second half in the US?

Yes, they were place for the first half, but I'm just saying that those two are almost non sequitur in a sense, but if there were deals to close they closed them. In Q1. They were there already.

Thanks.

Rohit Chopra, Buckingham.

Thanks very much, hello, 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?

Yes, globally. I think that's all around. Yes, that's right. I think the protection of the installed base and support, defending the [involvement; installment].

And the question I had was 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 currency or anything like that or demand, in that region? I think other vendors have already started to move prices. That was just an example, but there are a lot of people already making changes in price. Are you seeing anything like that or any changes?

Again our TCO is very compelling. We've done less on adjusting prices, certainly downward, if anything we're more biased on the upwards. We're very focused on making sure we're not overly compelling quite frankly, which we use 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. More directly we haven't done anything to adjust for currency.

My last question is related to the competitive environment. Incumbents have released a ton of new products out there, I'm just wondering if that delayed things in general, so outside of any sales force reorg issue, have any evals or [any fight] 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?

No, what we hear more or see more, witness more let's say, and 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 slices out there now in terms of they a stronger role in buying behavior. They're thinking architecturally and strategically. I think that's the type of thing that probably puts more pause in the system than anything.

Then I think the other factor is a lot of money has been spent on security over the last year, as we have all these products. I think they're thinking about how to one, consolidate and then also how do they get a more affordable wallet every 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.

Okay. I appreciate it, Drew, thank you.

Tal Liani, Bank of America.

Thanks for taking my question. This is Mike Feldman for Tal. Just one on AccelOps. Can 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 [logarithm]? 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.

This is Ken. We try to (inaudible) manage security related SIEM. That's where the Accel product will be renamed the FortiSIEM will be working together with the other Forti (inaudible) product there. Especially we have the biggest [improvement] globally, probably double the number two, and that's where we're helping drive all these lower management cost. At the same time the sale product also help us to go through multiple vendor management together, like some other networking, some other storage, they can also use in the FortiSIEM product (inaudible) visibilities and (inaudible) the Forti fabric strategy better.

So that's the piece we don't quite have before, and this will help enhance all of this. The other part where we can have more actionable and to any live intrusion, any incidence response working with a [FortiCard] and that's where like (inaudible) you can quickly do the analysis and also response to the break in.

Okay. And then when you expect to have the channel partners fully ramped up on the product and in the market selling it?

There are two strategies. One really keeping enhancing the current product with the FortiGate [diagnostic] probably we're already starting 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 early Q4, so we'll leverage that sales FortiSIEM product to launch (inaudible) service as necessary on top of the (inaudible) which China bought 15% of the (inaudible) per year and also 24x7 which China bought 25% of the (inaudible) price and this will be probably about 35%, and we will still in the evaluation beta testing stage but the full rollout probably will be early Q4.

Thank you.

Melissa Gorham, Morgan Stanley.

I 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?

Yes, that's correct.

So if you are calculating organic billings 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 give us an idea of what we should expect from inorganic perspective?

So Melissa let me make sure I heard you correctly. I think you're basically asking we adjust out the $4 million in billings? Is that the first question?

Yes, no, I just wanted to confirm it was $4 million, and 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?

So $4 million is correct on the addition, and you can see it's not in organic, it's not in the billings. It gets removed. Then the second piece was very little contribution.

First of all it's a subscription model, and just anytime it's near term destructive, 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.

Certainly very little, even though it comes over, there's some duration and there's 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 on top on, of a tailwind from that business.

Now on the op margin side or the expense side, if we do nothing, it actually contributed probably $1 million of OpEx, uncovered OpEx in June. So you can 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 they're 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 place, whether AccelOps people or Fortinet people that they're driving the appropriate level return on the investment. And if it makes sense for us then we keep it, if not then we deal with it.

There's some R&D folks there that will stay but they offset 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 [captail] 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 have just done anyway sooner. So you're in a way front loading people you would have 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 our op margin.

Okay, that's helpful, thank you.

Saket Kalia, Barclays.

Thanks for squeezing me in here again. Maybe just stay on that topic of AccelOps there, Drew, and just talk about general expense in Q2 to Q3. So first, how much, realizing AccelOps is small, roughly how much does AccelOps going to contribute or did it contribute in total expenses in Q2?

And then 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 easily -- (multiple speakers) -- because the question I think that we're all getting is the sequential change in expenses, it's kind of flat to down compared to historically we've seen it being sort of up. And so while we know that hiring is obviously the biggest lever, I'm wondering how much of the acquisitions of all of the discretionary pieces may play into that compare so any commentary there would be really helpful.

Yes, absolutely. 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. The cost was about $1 million on the OpEx line. And so I think 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 and so you have people getting into accelerators, you get some skew of the business in terms of several large deals. They hit us. And I think our competitors see this from time to time too, so there is something there. And we're very focused on that one as well there. There's opportunity there I would say.

We also are looking at things we do, we talk about synergies in AccelOps, and synergies is a broader conversation because there are at AccelOps, we talk 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 that the right model in place. You're looking at deal margins, contribution margins, we're getting more and more focused on those types of things, which ultimately drive productivity. But we may take out costs or not spend more on those areas, again headcount would be one of those.

The other one is even just like marketing. And so 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 United States 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 at any other company, there's some controllable expenses, I could get into things like T&E and just other things that are out there that we're very focused on, just to make sure if we need enhanced controls or account scrutiny that we're going to that.

Sure. But it seems like maybe the new thing or the thing I probably missed on the last call was commissions maybe seems like it was a little bit higher than we were expecting -- (multiple speakers) -- and that maybe managed a little more in the back half.

Yes, we're certainly focused. I think I probably didn't say the word commissions, I was probably enveloping it in the concept of productivity. But it's in there.

Got it. Thanks a bunch.

Andy Nowinski, Piper Jaffray.

Thanks for taking my question, this is Andrew on for Andy here. 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?

We actually do have a linearity feature in the commission plans. I do think part of it is just the fact that the North America -- the sales cycles, we have new people, new organization, I think the sale cycle's just made that hard to do. I do also think there's some buying behavior that we talked about, where our customers are holding deals to get a bigger deal.

Whether you call their bluff or not, it doesn't prevent them from doing that. So that is certainly in the mix. But yes we're looking at that. But that is not an unusual issue. I think we were probably better than most companies in the (inaudible) a year ago, and then I just think more recently is where it's become more back end loaded. (Multiple speakers).

We've seen that with a number of companies that have reported already in terms of linearity, and while we didn't -- the uncertainty in the environment that you talked about in the main call probably had something to do with it. If you think about Brexit, we were asked a lot about did we get affected, is future performance affected by Brexit, it didn't from deal standpoint but it probably did in delaying some purchasing. Those deals came in, but I think there was probably some caution on customers end, and again I think it's more, hopefully you get back to better linearity. We have 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.

Definitely, that's fair. If I could just sneak one more in here, I guess given the free cash [fullness], 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 to what you think free cash flow, where it might trend in Q3 would help.

Yes, so again fair question and surprised somebody hadn't asked that yet. But we don't guide on free cash flow. We do talk about CapEx though, and we've had some opportunities.

We been talking about real estate for a while. We're basically out of space here in our Sunnyvale headquarters. And there's some offices in where we pay leases that have come up as opportunities for us to buy.

So we're actually going to guide up on the CapEx side. 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 as high as $80 million or $90 million or the year. And 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. Then we have 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 a couple of properties that one we're in and another one that's adjacent have come up sale, and we've been talking to those people for quite a while and they just happened 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 right price and we'll move forward on this.

Definitely. That's all I had. I appreciate it.

Imtiaz Koujalgi, Deutsche Bank.

I have a couple questions. Drew, how much was the duration in Q2 of last year?

Give me one second (laughter) 21 months. (Inaudible) 23.

And this quarter you said it was 22 to 24 months, I'm sorry?

23 months.

Thanks. And then one question on the sales reorg. I know you guys did sales reorg in North America in Q1. When was the sales reorg done in EMEA? Was it done at the same time or was it done in a prior quarter, and --

They were done together. But we've been stronger internationally to be frank. Those have been more add to the current model and the leaders probably expanded their responsibility, kept some of their responsibility and expanded it.

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 American piece is (inaudible) and somebody bought a leader from Europe over to run North America, he was extremely successful, the most successful of our leaders in Europe, and from a large company, a global company, so that was the idea there. So it's more new, certainly there's more newness to the model in the US, North America really.

Got it. And the linearity was back end loaded, was it just in the US or was it all across all the regions?

Probably more so in North America.

We did see it around the globe --

It was around the globe but I would say probably more so in North America.

Got it. And then one last one. You mentioned about the increased duration resulting in a hard carve out of subscription revenues. (inaudible) why would that impact product revenues negatively? Because you don't defer product revenues, right? Regardless of the duration (multiple speakers) you don't (inaudible) product revenues are in the quarter.

You carve out more to the subscription. The way the accounting works is you basically balance the invoice based on a benchmark of what the price should be. And then if you, duration, if there's a carve out, if it's a one year deal you'll only do one [extra] carve out. If there's a three year deal you do three (inaudible), if there's a five year deal, you do five (inaudible).

And so it exacerbates, multiplied is probably a better word, the accounting carve out. And then it gets pushed in the subscription revenue because what you're trying to do is balance the undelivered element with the upfront or the delivered element, the product is the delivered element.

And so the accounting rules favor the undelivered element historically. And hardware is a little different than software but you still have this relative ratio carve out thing without getting into an accounting conversation. But I think it the point is it multiplies the carve out when that exists. And we did see, I could check that, we checked that by looking at the top deals and we could see that the upfront revenue yield was much lower than a year ago and we attribute that to the carve out.

Got it.

And the multiplication factor, yes, the duration factor.

Got it. That's all from me. Thank you very much.

Brent Thill, UBS.

Good afternoon, guys, it's Fatima on for Brent, thanks for taking the question. Drew, just to double-click on this product use subscription and carve out and revenue deferral mechanic that you are more pronouncedly experiencing. Is it fair to say you're having significantly more traction in selling bundles versus individual subscriptions and that's one of the reasons why you are seeing a bigger carve out?

I'm trying to think of the mechanics of that, I think that's right. Yes, that's right, because versus just firewalls a year ago, maybe you're seeing more bundles, certainly, right, and I think customers are buying more strategically. So qualitatively that make sense.

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?

We don't compensate them that way but we train them that way, because obviously we want to drive the recurring revenue stream. It's higher margin, it's recurring obviously with predictability, all the reasons you'd want a recurring revenue stream. And so we're certainly favor the trading, and if you could at our pricing we've obviously been biased that way as well, and we'll continue to do that. Again (inaudible) UTM bundle year and a half ago, enterprise more recently, and then we even talked about FortiCare 360 bundle including the AccelOps technology coming out probably in Q4.

Understood. But the appliance itself is still your primary security functionality delivery vehicle, right? I mean, at the end -- (multiple speakers) -- client --

Yes, 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's 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.

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%, so substantially better than the overall business. I'm wondering if you can give us a sense of what proportion of your, call it, entire subscription services family of offerings is unattached versus attached to an appliance sale?

Most are probably attached. There can be some follow-on business, most are attached, that would be way to think about it. Now AccelOps, again we're going to wrap it into a bundle, but currently it's a separate product albeit pretty small. That is a subscription product that would stand alone as of right now. But I think that's the only -- I guess you could buy some of the other ones as a subscription, whether you bought through AWS for instance, that'd be one ways, or some other service provider offering.

So just to be clear, FortiWeb and FortiMail and your Forti WAF offering, it would have to be associated with an appliance purchase? Or do you have to be a pre-existing Fortinet customer to able to enjoy the security fabric benefits from those offerings?

FortiMail, FortiWeb, I forgot the other one you said, FortiSandbox, they have specific, there will be a, so say you buy FortiSandbox and you probably wouldn't buy the bundle, because you'd buy their [RAPT] service to go with that FortiSandbox. Similar to FortiMail you'd probably buy the email security 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 protection through the bundles.

Understood. That's it for me. Thank you very much.

Erik Suppiger, JMP.

Thanks. First off, I just 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's pick up to 23 months? Is that the right chronology?

Yes.

Okay. Secondly, you added about 300 headcount, over 300 in Q2, and you are looking for a decline on the OpEx flat to down and the OpEx in Q3. Would you be surprised if headcount is actually down by the end of Q3? Is that something that's possible?

I probably wouldn't want to guide on headcount, but just keep in mind that 55 to 70 came over through AccelOps. And so that's a way to think about it. I think our model has matured, we're very focused on managing the headcount. Could it be flat? I think that's a possibility. I wouldn't guide one way or the other.

Okay. And then did you say CapEx this year will be $70 million to $80 million? Is that what you said?

$80 million to $90 million. (multiple speakers) -- again it depends on the timing of the -- so we haven't closed any of these deals. What I said that we're in one building that came up for sale, and then some adjacent properties have come up for sale at the Sunnyvale headquarters. For any of you who've been here you could 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 so we would have been 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 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. But I have to guide up just because one literally came to us yesterday.

Okay. But you are suggesting that analysts factor the $80 million to $90 million into their models for 2016?

Yes, I am.

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?

I haven't guided forward on 2017, but clearly these are things we would have had in the long term model that we were going to do over time. Our key is to get them at the right price.

Okay. Lastly, education had a nice pick up in the quarter. I'm sure that's partly because of seasonal strength 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?

No. We called out in the commentary a couple deals that were with larger universities. But it wasn't anything we did, we won the deal but we didn't do anything thing as a company to make a bigger focus on education. To your point it tends to be a bigger year of seasonality in terms of buying but then we also got a few bigger deals that were universities, and they're more international.

Was that more international? Is that correct?

Pretty much, I mean it's both but the ones we called out in the script are international. I think we've probably got universities around the world. I don't think there's anything to really dig so much in there other than it's sort of a mix of customers that made up this quarter and did pretty well in education.

It wasn't a function of E-Rate funding or anything unusual from the federal side, was it?

No, these were more traditional next generation firewall, data center firewall. There was an internal segmentation firewall deal but it wasn't associated with E-Rate.

Universities, universities, not grade schools.

Very good. Thank you.

Gabriela Borges Goldman Sachs.

Thank you. A lot of discussion on the overall macro environment and how the buying patterns may change year-over-year. Just curious when you look at your internal business and the win rates that you're seeing when you compete, if you're seeing any change in the win rates? Thank you.

No, I don't think we're seeing any changes in the win rates. Our win rate is still very strong. We've always sort of said that it's even increasing and when we can go in and test against a competitor we do extremely well. I think that hasn't changed in terms of win rates. (multiple speakers) -- if you look at even market share gains, and we were growing well above two times the market so clearly we're continuing to gain share and win over competitors.

Great, thank you.

Gregg Moskowitz, Cowen and Company.

Thank you. First I had a clarification on wireless, and I know of course you don't explicitly break Meru, but in Q1 you had said that wireless was about 7% total billings, of which Meru was maybe a little bit more than half. Did that change one way or another in this quarter? I wasn't quite clear on that.

Yes, wireless is a little better than 7%, this quarter I think it was still -- yes, it was about the same. So I don't see any big change there, Gregg.

Okay, and then just getting back to service provider falling below 20% of billings. 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?

(inaudible) -- it's Michelle. Yes, it is abnormal. We usually are seeing it, the range usually above [21%] and 25%. So I do think this quarter, the reason why it fell below was because of the deals that we talked about. So I don't know if you're asking do we expect those deals to come in? 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 levels -- (inaudible - background noise) --nothing weird changes with the service provider environment and right now we're not seeing any types of change in that environment.

Great. Thank you.

Jeremy Benatar, Raymond James.

My question was answered. Thanks, guys.

Ken Talanian, Evercore ISI.

Thanks for taking my question. A couple 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?

We collect within normal terms. I think you mean upfront basically under -- they're not paid like a year later or something like that. The answer is yes.

Do we defer the comp? No, I don't believe we defer the comp. So if the deal's recognized, if we call it a deal, we pay the comp and then it's not smooth if that's what you're asking. (multiple speakers)

We don't amortize commissions, we don't smooth them. We're still taking them as we basically -- as the deal happens we accrue it then pay it out in the next pay cycle and it gets paid in July basically.

Okay, so along those lines I think at one point you 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. Are you waiting for guidance on the upcoming changes to revenue recognition to perhaps -- (multiple speakers) -- around that?

We've been hearing everyone's been getting the (inaudible) question. Well let me take it two parts. We don't really guide on the mix. I'd be more biased on the services line.

Obviously the accounting that I talked about, basically of course if that would happen, again as we focus -- we are delivering -- absent the accounting, and 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 the subscription. So that's the focus.

We charge more for them. We add more content and then we charge more. Again we do add AccelOps to the bundle, it's a FortiCare 360 bundle, that'll hopefully come out in Q4. It'd be richer, it'd be a higher-priced product, we had the enterprise bundle come out recently, and sold 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 you're talking about almost a 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 [O 81] standard, that it basically is similar.

We're were on a [sell in] model too, which I think it kind of forces you, it points more to that because it's going to this delivered elements concept, or performance units concept and delivery of -- a unit of performance, so I wouldn't formally guide or say that, but I think that's our reaction right now, just our knee-jerk valuation, and we've talked about 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'll be material. We'll let you know if that changes.

Great. Thanks very much.

(Operator Instructions)

And this does conclude the question answer session. I'd like to hand the program back to management for any further remarks.

I can actually close the call. We'd say thank you all for the time that you spent today in our first call or second call. Hopefully we were able to answer most if not all of the questions, and I will be around if you have further questions, and that's it. We're also going to be doing some conferences this quarter so we'll be out seeing you on the road as well. Thanks a lot, have a good evening.

Thank you, ladies and gentlemen, for your participation in today's conference. This does conclude the program. You may now disconnect. Good day.