Fortinet Inc (FTNT) 2017 Q2 法說會逐字稿

Good day, ladies and gentlemen, and thank you for your patience.

You've joined the Fortinet Second Quarter 2017 Earnings Financial Analyst Q&A.

(Operator Instructions)

As a reminder, this conference may be recorded.

I would now like to turn the call over to your host, Ms. Kelly Blough.

Ma'am, you may begin.

Hi.

Thanks, everyone, for calling back in.

We appreciate your time this afternoon.

I just wanted to remind you all that the forward-looking statements that I read for the 1:30 call still applies to this one.

And unless you want me to read them again, please remember that.

And we look forward to your questions.

You can go ahead and take questions, operator.

(Operator Instructions) Our first question comes from the line of Sterling Auty from JPMorgan.

On the first call, we went through a lot of elements.

And I just want to kind of level set, take a step back and ask you, when you look at the performance in the quarter, where did you think the biggest strength in the quarter was?

And did that outperform your expectations?

And on the flip side, where did you think the biggest weakness in the quarter was?

And did that underperform your expectations for the quarter?

Overall, Sterling, I would say we were -- again, we were towards the middle of guidance, if you will.

So we were, I'd say, generally at expectations.

I think the -- probably the best story I would think about it was parts of Southern Asia and the U.S., for sure.

I think those are the places where we've been doing extremely well.

I can't say that we were particularly disappointed with any region, if you will.

Yes, on the vertical, I'd say, enterprise doing well, especially the fabric, and also a lot of potential to double, triple the deal.

And as you see, the bigger deals also got more growth.

And also, the high end, the 7,000, also starting to contribute in the bigger deal.

And on the service provider kind of probably a little bit slow.

Yes, the service part, I think that's right.

I think the service provider -- again, more pay-as-you-go, I think, is what we're seeing as they focus on cash flow, Sterling.

Well said, Ken.

That's right.

And when you say pay-as-you-go, I want to make sure I understand that.

So in other words, they're not doing big, chunky deals.

They're just buying a box here or there where they need it?

Buying as needed, yes.

So instead of buying the big chunk, the big shipment, they tend to just buy just a little bit.

Buying by the drink.

And would that service provider sluggishness be North America or international, or both?

I think more North America, basically.

Okay.

And then one other question there and I'll turn it over.

So there's a couple of mentions, both in the prepared remarks and the questions, about cloud, about Amazon, Azure, et cetera.

And I think, Ken, you had said that some of those deals are in lieu of things that are traditionally may have gone through a service provider.

And what I'm curious about is what are you seeing from your solution set being adopted in the cloud?

And could that have contributed also to what you saw on the service provider?

And are we in some sort of transition where you just need -- you need to hit a point of scale in the AWS/Azure piece to compensate?

Definitely the AWS/Azure piece is growing fast.

And also, the traditional service provider also starting consider offer the cloud solution now.

So that may delay some of their decision whether what kind of an architecture or infrastructure they may moving forward.

So that's (inaudible).

From our side, we have the best technology product to do all of this cloud solution.

At the same time, we also integrated team together.

Before, it's kind of a separate team for cloud and service provider.

Now it's one team, so we feel that's also helping, like make future trend or direction.

Our next question comes from Saket Kalia of Barclays Capital.

A couple of questions from my end.

So Drew -- I think we're all looking at an inline billings result and a slight raise for the year, which is great.

And it certainly sounds like there's a healthier pipeline, but can you maybe talk about how your expectations for average duration of maybe some of those services contracts, or perhaps close rates on deals in the back half has changed?

I guess essentially with an inline result, you maybe would have expected an inline guide.

And so what were the biggest puts and takes to drive the slight increase for the full year guide?

Okay.

So I heard a couple of questions there.

I think you were asking about guidance and then you were asking about duration.

Is that fair, Saket?

Yes, absolutely, Drew.

And kind of the interrelation between the 2.

Okay.

So look, I -- let's just start with the duration piece.

I think that's a reflection of going deeper into the enterprise.

At the end of the day, it's a long-term commitment to the fabric, which we believe is a good thing.

Clearly, it has -- it favors deferred revenue versus revenue, if you will.

But overall, it's a competitive thing.

We win competitively.

It's a long-term commitment to the fabric, primarily in the enterprise.

So that's how we think about it.

I think the question on guidance, yes, we do -- we feel like we -- from a bottoms up perspective, what we're seeing from our teams and what's indicated in the funnel looks, I think, good.

It certainly supports what we've guided and that's primarily what's driving it is our visibility into the deals going forward.

Yes.

The other thing that I want to add is really like the Magic Quadrant leadership in the enterprise.

We are like 6 months into live, we were first time guiding there in quite a few years.

So that's what will be helping driving has in the enterprise pipeline deal.

And also, I mentioned in the script, the reason where the GDPR in general is more positive, especially the fabric approach, has a much better infrastructure security solution compared with the other competitor, the traditional network security, which a lot of the big enterprise customers also like the fabric and offer for the internal segmentation, the endpoint, cloud, email, the WiFi and the FortiSwitch.

All of this working together is really helping us make (inaudible) more positive.

And so that's -- and also the new product like the 7000 series and some other transition from D to E, there's a lot of positive things starting -- going on.

So that gave us some confidence.

Got it.

Got it.

And then for my follow-up, a lot of talk about the service provider vertical.

I think Kelly hopefully mentioned something in response to a question earlier that the expectations for a service provider really aren't that high in terms of what's baked into guidance.

And so the question is, has your outlook for some deals improved?

Well I guess, what verticals have the outlook improved in to maybe compensate for, call it, a tough comparable for service provider, call it, longer sales cycles, whatever you want to call it.

What other verticals may be compensating for that to sort of drive the billings outlook for the year?

It's primarily enterprise, Saket.

And I think you could go down in there.

I think we certainly have been doing well in financial services, health care and the government space.

That's what we've been seeing.

Our investments have really been focused there.

That's where our results have been.

Our next question comes from Ken Talanian of Evercore ISI.

So you had a nice uptick in the services and other part of your gross margin.

I was just wondering, should we start to think about this business getting to a level or -- of scale where we could continue to see improvement over time?

You mean in gross margin in general or in the products -- or in the services question (inaudible)?

The services, specifically.

I think so, Ken.

And I think that's reflected in our -- the margin ramp -- the operating margin ramp.

The guidance that we've been giving 150, 200 basis points a year out to 2022.

So yes, that's absolutely part of the equation.

Okay.

And I guess a separate question, but -- is there any consideration being given to extending your share repurchase program beyond the most recent authorization?

Really getting more aggressive there.

Well, we just doubled it, Ken.

So I mean, we went from $300 million authorized to $600 million.

And I think we said we'd do a minimum of $150 million this year.

We've already done $133 million -- we've done $33 million of that $150 million, but we had set that as a minimum.

And so I think that is more aggressive than history.

Our next question comes from Walter Pritchard of Citi.

I'm wondering -- just, Ken, a follow-up to what I asked on the call.

So you're talking about more fabric-type deals.

And I think you highlighted there some of the non-FortiGate products is driving that.

And I guess as I think about the enterprise, those aren't necessarily the products I would think that a larger enterprise customer would buy from you.

They're -- you've got best-of-breed products in some of those markets.

And I'm wondering if you could just help put a finer point on fabric sales in the enterprise.

How much of it is subscriptions that are adding on to the base?

How much of it is some of these products?

I mean, I think at FortiSIEM -- you've got Splunk, for example, is best-of-breed in that market.

You've got Proofpoint in the email space.

And just trying to get a sense of where you're seeing traction in some of those non-attached products and then how that ties into the fabric.

Yes.

I also gave the example like how to protect from the ransomware.

Like there's a few line.

They can defend it like the FortiMail.

We see the market ramp up.

It's really the best email product to stop out is the spam, ransomware, all these kinds of things.

That's really, the ransomware come from email.

And then the other part is also the traditional -- the FortiGate, the Sandbox.

That's also do the protection.

And then there's also the endpoint FortiClient.

We see very, very good ramp up also and starting at some meaningful bigger number there.

And that's also the endpoint and also prevent the ransomware come from external device.

And then the FortiSwitch and the FortiAP, that's pretty unique, and this is the device.

They're working with both FortiGate, FortiManager, FortiAnalyzer and FortiSIEM.

So when they see some of the attack log, they can quarantine some internal device and also do the internal segmentation, internal isolation, which also can cut off the ransomware from connect with the server, encrypt the file and do further damage.

So all this is additional layer beyond the traditional -- the FortiGate firewall approach.

That's really the whole things working together as a fabric.

We see a lot of big enterprise.

They do have a separate solution and most have come from different vendors.

So once we have this fabric and working together, they're all like it a lot.

This just really give them the total visibility, manageability and that's what they don't have before.

In the past, the fabric-ready, I mentioned there's a Microsoft, there's a Cisco, there's HP, there's quite a lot of other 27 leading IT provider all working together with us.

And that also further gave the better manageability, visibility and we call the actionable security intelligence that can stop all this attack in real-time automatically.

So that's the big enterprise like this and that's kind of a feed their future whether sort of consolidation, making the management more easy and the real-time protection.

So that's the whole fabric story and FortiGate is still part of it, but you can see the other part also gave the additional protection, additional layer beyond the traditional network can do.

Got it.

And then just Drew, 2 quick questions for you.

One, could you update us on CapEx for the remainder of the year, given what you saw in the quarter?

And then I think this may predate you, but just trying to understand on the service provider comment about pay-as-you-go.

I think we've actually heard Fortinet talk about that in the past when service provider was soft.

And I guess I'm surprised to hear that it was anything other than kind of pay-as-you-go for the last few years, given the constraints in the carrier markets.

So if you could just talk about sort of conditions in the carrier market versus the past as it's been fairly challenging, I think, as a space?

Sure, Walter.

Look, we have had a tradition of -- or history of larger deals in the carrier space, for sure.

I think the way we're seeing pay-as-you-go is a newer phenomenon for us, to be frank.

The carriers certainly in North America seem to be more focused on cash flow and matching their ROI, if you will.

And so for that -- us, that is a newer phenomenon than we've been seeing.

I think we probably have cited it as a risk in the past.

I don't think we've cited it as an issue within a quarter that I can recall.

And then on CapEx, yes, we're sticking -- I mean for the year, we're sticking with $30 million to $40 million.

We're -- I'm sorry.

We're sticking with the $150 million and about $120 million real estate.

And then how much have we done?

(inaudible)

We've done $100 million of the total CapEx?

$100 million, yes.

$100 million.

We've done $100 million of the total CapEx.

So of the $150 million, we've done $100 million.

Our next question comes from Gabriela Borges of Goldman Sachs.

My question is for Ken on the internal segmentation conversations that you're having with customers.

I'd love to understand any color on what those conversations look like?

Is the business being split between physical firewalls and virtual firewalls?

How does the magnitude of orders compare to what you would typically see in 1 or 2 years ago for that type of fiber customer?

And do you see the TAM as being incremental or additive to what you would typically serve within that customer?

It's a great question.

We do meet a lot of our customers, especially the big enterprise.

They say that traditional app security, even the next gens cannot really stop the new attack and also especially the mobile device, the cloud and some other application.

That's where the internal segmentation protect where the data is.

It's very, very important.

And also the internal, the 2 challenges, really, the performance is extremely high compared with the internet connection and also the deployment has to be nonintrusive, easy deployed.

So that's where the internal segmentation, the Switch WiFi is also -- play a bigger role there.

So that's where -- like a finance service more leading in this, the internal segmentation, the infrastructure protection compared with the traditional network security -- network firewall security solution.

That's where we see the trend moving to that direction is -- that's what's different than like 17 years ago when I started Fortinet that we called the second generation network security compared to the first generation like my previous company, Netscreen, which is the firewall and the VPN is really the connection security.

The UTM management firewall, of course, is a content application security.

They look at inside the connection.

Now compared to 17 years ago, the data starting to go to cloud, go to the mobile device, go to all these kind of things no longer just inside the network, inside the server company now anymore.

So that's where the infrastructure approach and the fabric approach, including internal segmentation get much better, more effective to twist the data, to protect itself.

And also even inside the company, if you only have certain like a Switch WiFi to (inaudible)the same trust environment, that's what -- how past is doing -- is no longer enough.

That's where even internally like a different department or a different server, you may need to treat it differently.

That's the internal segmentation and the infrastructure combined with WiFi with a Switch, with a different application like a mail web and the host client endpoint.

And it's starting to quite important and the cloud end point is the same thing.

And also IoT even further, this kind of infrastructure approach.

We see rather strong interest and especially the big enterprise customer.

That's also can make a much larger addressable market.

It can double/triple the deal.

So that's where we see some of the deal -- we get a bigger deal and grow faster is some of the contribution from the infrastructure fabric approach.

Our next question comes from Melissa Franchi of Morgan Stanley.

This is Hamza Fodderwala in for Melissa Franchi.

Maybe just a follow-up to the previous question.

Could you give us any sense for how big the virtual appliance business is today?

How is that growing?

And did you see any pause in spending as customers evaluate their cloud plans for the year?

The virtual appliance building, it's growing fine.

The -- not sure what...

We don't break out the revenue or the billings by virtual versus appliance.

Yes, the virtual business is growing fine.

Okay.

And then on the pause in spending?

So you're asking about a pause in spending related to cloud?

Related to...

Yes, like basically as customers evaluate their cloud plan whether they go physical or virtual, like was there any pause as they evaluate their security architecture during Q2?

Yes, we've talked about it in the service provider space, but we haven't really seen it...

The enterprise business was good.

So I don't think we've seen that.

Okay, fair enough.

And then just one quick follow-up for me.

You mentioned a slowdown in hiring.

It seems like based on my calculation that the number of salespeople this quarter was slightly lower than the one last quarter.

Are you seeing any above-normal levels of sales attrition at all?

No.

We see the hiring behind our plan as because we tend to be a little bit more careful.

The hiring environment is very good, very healthy.

We are going to catch up some of the hiring miss in the first half of the year.

So that's where we are -- we still invest in the growth.

But at the same time, we also commit to meet the margin target we gave out.

Our next question comes from Michael Turtiss (sic) [Turits] of Raymond James.

It's Michael Turits.

Again, I wanted to come back to the question of if something -- if there's anything that you really perceive that has changed from last quarter to this quarter.

It was a big beat and a raise last quarter was more in line and in line this quarter.

So was it service provider?

And did service provider change?

Because, obviously, they've been kind of weak for a while.

Or are there other things that have changed?

That's really what we're trying to figure out here.

Yes, sure, Michael.

Fair enough.

I would say service provider was certainly the most disappointing part of the business.

So I would -- generally speaking, everything else was pretty much in line.

And what do you think caused service provider to change?

I'd just make that clear that the service provider goes up and down, but I just want to make sure, in your view, it changed from what they were doing last quarter and what drove it?

Yes.

Well, this is what I was saying.

I do think they're just more focused on buying near-term what they need as they need it.

I characterized it as pay as you go.

I think more than ever, they seem to be -- remain -- continue to focus on that as they are very focused on their CapEx and their cash flow.

Yes, I would just add to that, Michael, that our guidance is really based on a bottoms-up approach, looking at the pipeline, looking at expected close rates, that sort of thing.

And that was a disappointment in service provider this -- in Q2.

And as a result, and I think we talked about this on the previous call, we're sort of looking at that a little bit more cautiously going forward.

Yes.

The other comment I have is really, I mentioned there is a cloud trend.

So service provider also may take a little bit long time to evaluate.

And also we are starting to offer the new 7000 series, and that also takes a long time to evaluate.

So we have the new platform and especially in the bigger enterprise service provider, they take a longer time and whether using the new one or the old one, also takes some time.

So we do see a lot of test and interest in the discussion but is probably...

I think Ken is saying, it's taking longer and they're smaller deals, if you wrap up what we just said.

And is there any increased competition?

Because obviously, with -- look, you guys have been leading in service provider for a long time, but both Check Point and Palo have expanded upward into that market, have been attacking it.

So any sign of them just making it tougher?

No.

I don't see they come close because especially the new 7000 we offer is -- even increase the gap, both on the technology, the product performance.

I think this is really -- it's more service provider, the way they do the evaluation, the bigger market trend transition from some traditional service provider to some -- the new -- some cloud-based and some IoT and mobile, all these kind of things.

And also probably the 5Gs -- also the international also starting -- try to planning some of that also.

And I just want to make sure I've got it on margins that -- the margin beat this quarter, it really was -- not -- it was just the hiring push outs, nothing else, right?

Just that, I think the work on the accounting standard probably is going to be a little more back-end loaded, Michael.

So they're probably a little lower than we thought, too, but I think primarily head -- it's really primarily headcount.

Our next question comes from Fatima Boolani of UBS.

Maybe my first one for Ken.

Ken, a couple of weeks ago, Fortinet announced an alliance with Microsoft around cloud security.

And I was hoping to get your perspective on Fortinet's role in the relationship as well as the scope of opportunities that can arise from this partnership and if it's exclusive in any way.

Yes, that's part of what we call the Fabric-Ready program because Microsoft has a big enterprise customer base and also a lot of surveys there with their new product, all these things.

So we are very happy with the partnership and now, we have all the leading information technology vendor working with us in the, we call, the Fortinet Fabric-Ready program.

So that's where we're making the whole IT infrastructure solution more secure and also a different vendor working together.

So we have the interface, we can now working with them and start sharing the information visibility and take actionable intelligence to really offer better security.

And that's a big partnership we really view as has a lot of potential going forward.

That's helpful.

And maybe a question for Drew around the -- back to the vertical mix.

The government business has been growing steadily as the billings mix.

And I recall a couple of years ago, I think back half of '14 or '15, the company had taken steps to verticalize some of the sales areas, and federal was one of them.

So I'm wondering if that's really starting to kick in?

Or if the recently rolled out Fortinet federal program that you announced, the new subsidiary, that's changing the tune a little bit.

I'd love to get a little bit more detail on that.

That's been a really strong and increasingly stronger vertical for you.

Yes, look, first of all, Fatima, it's worldwide government.

But we did have a good quarter in the U.S. I think we mentioned a couple of deals in the script.

And so that was good.

I think it's our focus.

The fact that our products perform well, we have the efficiency and also -- obviously, the security effectiveness and back just to the Fabric that the customers are buying, they're looking at the Fabric.

The architecture that, that provides, the visibility, management capabilities and orchestration are resonating at all levels, including the government, which is run very much like an enterprise.

So it's very much in sync with what we're seeing across the enterprise.

And a just quick housekeeping one for me, if I can sneak it in.

The U.S. dollar has really turned its fortunes around and it's been weaker relative to global currencies.

How has that impacted your OpEx because I know most of it is outside the U.S., if at all?

It's factored into the guidance going forward, Fatima.

Would you be able to quantify that in any way to help us out?

Yes, (inaudible) the shift in it was at the end of the quarter.

And remember, we have a balance because we have -- you know, we're very global and so if the euro increases in value, there's other currencies that can offset that at risk.

But it wasn't a huge impact to the quarter and most of it seemed to happen at the end of the quarter.

Our next question comes from Jayson Noland of Baird.

Drew, I wanted to ask about the 150% to 200% operating leverage target starting next year.

So you're assuming a certain level of top line growth there, I assume.

The question is what's your willingness to scale leverage faster or slower if the growth rate is lower or higher relative to your assumption?

So are you strongly committed to 150% to 200%?

Are you willing to flex it up or down with top line growth?

Look, I think we are committed to the 150 to 200 basis points.

Again, we are focused on growth but we have -- we've taken into a balance of scenarios to think through that, Jayson.

Our next question comes from Gregg Moskowitz of Cowen and Company.

I just wanted to go back to service provider briefly and really wanted to clarify, was the predominant factor this quarter the increase in pay-as-you-go activity?

Or did you also see a change in sales cycles and closure rates as some service providers evaluate product and architecture?

Well, Gregg, an apology for calling you Michael on the last call.

No worries.

Look, I think it was both.

As we said -- as Ken and I were trying to explain, I think Ken was talking about longer evaluation cycles, and I think that's true.

Even with the high-end series, the 7000 series, resonating very well at that level.

But we are seeing them do more smaller deals.

So it just seems to be smaller transactions and then, I think, just longer evaluation cycles.

Okay.

And then just a follow-up on operating margin because Drew, you did beat operating margins by roughly 370 basis points this quarter versus where consensus was.

And I just wanted to confirm that as well, you would attribute all of that to lower-than-expected hiring levels in the quarter as opposed to operating expense discipline that was tracking faster than expected?

Well, we've actually -- I mean, fair enough.

I'd say it's primarily headcount.

The other thing that some of the accounting standard work is pushed out into the back half of the year.

So that's a piece of it as well which we'll pick up in the back half.

But yes, I mean, we've definitely been focused on efficiencies and I think that comes through.

But again, that type of thing is reflected in our guidance generally.

But we are making good progress on that front.

We've been laser focused on efficiencies for quite a while.

Our next question comes from Erik Suppiger of JMP.

First off, did you give us any update on the contribution from the non-FortiGate products in the quarter?

Apologize if I missed that.

Not a specific number, but it was very good.

The emerging products are growing very well, Erik.

Can you tell us whether they are past the 10% threshold?

Well, the thing is that we don't break -- I mean, we don't break it out by groups -- by group of non-FortiGate products.

We have a whole bunch of smaller products under that umbrella.

So as a whole, I mean, the non-FortiGate products are significant, but individually, it's -- we're not going to break it out that way.

And I think Ken talked earlier about some of the products that are doing very well, FortiMail, FortiClient, FortiSandbox...

But you can't tell us in aggregate if the non-FortiGate...

Yes, Jason.

We haven't broken that out.

Okay.

Secondly, on the GDP from the call earlier, it sounds like you're not suggesting that's a catalyst.

Would that have been a cause for some pause in Europe, to your point, and will it pick up?

No Jason.

We said -- I'm going to repeat what I said, I think, almost exactly.

I think it was, look -- I think, first of all, we're early stage.

And in the early stages, they're really looking at privacy.

And the point of that is really to help people understand that I think with GDPR right now, they're just focused on getting their -- the right licenses agreements in place and thinking about their architecture going forward.

And so that didn't cause us to stall.

We thought we were in line with expectations there.

I think going forward, what we said is the opportunities exist because now, once they get through the privacy part of it, they really start thinking about security and compliance.

Security in terms of architecture.

And then compliance, because they have to report the breaches under the rules.

And so those are a big piece of it, they're going to think about that architecturally.

And then what I said along with that, we just haven't seen it as a catalyst yet.

Focus on the last word, yet.

Also, we don't see the European slowdown some other competitors say we'd see it as very normal, and GDPR definitely gave us more potential going forward.

It's more positive.

Yes.

I mean, I think if you step back, I mean the architectural approach is what we're doing with the Security Fabric.

Obviously, things like the Magic Quadrant, I think, help us in the sense.

And then with it, really, to get that visibility and real-time reporting and prevention capabilities that you need, you need the orchestration, the management.

And I think the key on the visibility is key and then, obviously, internal segmentation is going to be something that matters for privacy, as well, best-in-class architecture.

I'd like to add that I think we might have maybe confused people when we talked a little bit about our Q3 guidance.

What we intended to say on Europe in Q3 is that it's typically seasonally a low season for Europe, and everyone knows that.

We are a little more exposed than other companies are to Europe because of our globally distributed business.

So the commentary about Europe in Q3 was meant to reflect seasonality and we did not say that we saw slowness in Europe in Q2.

And I just want to make sure that is understood.

Typical sequential seasonality is what the comment meant.

Would you be willing to suggest whether you think the GDPR could be a catalyst in 2017?

Or is that something you would anticipate more in 2018?

Well, let's put it this way.

That's something we certainly are focused on and we view as an opportunity.

Our next question comes from Catharine Trebnick of Dougherty.

I've been jumping between 2 calls so hopefully, I'm not making you go back.

One thing on federal government for Q3, that's typically a pretty heavy spending, are you seeing any change in that in your forecasting or guide?

We don't -- we had a good quarter in Q2, for sure, Catharine, so we feel good about what we're doing there.

We cited the vertical and our federal subsidiary there.

We would certainly hope it helps, but we don't really guide by vertical, and you know some of these investments do take time to pay off, to be frank, especially in the vertical.

But -- and it's something, certainly, we're focused on.

Okay.

And then another question is, overall in Europe, did you see -- you're more exposed, right?

In between the conversation, did you say that you saw some issues in EMEA at all during the quarter that were macro-related.

I know F5 made a big to-do about Europe being late for them.

Was there any issues with you in the macro?

No.

We said Europe was in line with our expectations.

Okay.

And how well did you do in Asia Pac in general?

Is that pretty strong?

Or pretty...

Yes, good quarter, good quarter.

Probably more focused towards the southern part of APAC, but it was a good quarter.

Our next question comes from Andrew Nowinski of Piper Jaffray.

Andrew?

Hey, guys.

Sorry, it's Jim Fish on for Andrew.

First, what's going on in the mid-market for Fortinet?

As we've typically seen you guys perform a little bit better there.

And actually, conversely, high end looked pretty good.

Was that primarily due to the strength in the financial services?

I think 2 part contribute to the high-end.

One is that the (inaudible) 7000 definitely is the big high-end, and also the Fabric story and also can make (inaudible) contribute to the middle range they're part of.

But definitely, you see the newer product in the high-end come up and also the transfer from the D to E also happening more in the low-end first and -- but also enterprise still pretty strong and that we see a big potential in enterprise.

Got it.

And then going back to the service provider.

Can you actually just remind us how much of that market is more in managed services as opposed to sort of their own network build-outs?

I say the bigger part is more managed service.

The small part is really security only infrastructure.

So that's where the managed service part -- there's definitely -- there's certain consideration about how the cloud, how the sales may change in, the mobile IoT may change in the space.

And their own infrastructure, also sometimes evaluation of the -- because the 7000 series we only started selling like early this year, would take some time to evaluate and all the other things.

So that's we see the service provider a little bit under the performance last quarter.

Our next question comes from Howard Smith of First Analysis.

I want to go back to the hiring, the headcount.

It sounds like, as you said in your original conference call, the environment for hiring is actually pretty good.

So what was it, if you could give us some insight in your thinking that caused you to hire below plan in Q2?

And what is it that you saw that gives you the confidence now to plan to catch up here as we go into Q3?

I think compared to 1 to 2 years ago is both the customer side and also on the vendor side is a little bit -- as they call, the rush buy, rush hiring scenario and now, it's starting more normal.

And I think there's also a little bit more vendor competitors starting -- try to look in the margins compared to a growth and the major cost -- what cost there is.

So I think from what we see the candidate, there's much more candidate available and most will come from the competitor.

And security space is still growing well and also, we also offer a very good training program, so we have the -- probably the biggest training program we call The Network Security Expert Training Program.

Has about 100,000 people certification issued.

It's really helping increase the pipeline of hiring.

And so all these are helping.

But on the other side, we also tend to be slightly higher standard in the first half of this year for the hiring, both on the sales or the technical people there, and that's where we kind of -- a little bit, I mean, behind the hiring plan, but I think we can -- with the bigger pipeline, with the healthy candidate pool environment, I think we can -- I feel we can catch up in the second half.

Okay.

That's very helpful color.

And then maybe Drew or maybe even Kelly, I think I did misinterpret what you were saying about the guidance for Europe in Q3, so I'm glad you clarified that.

I thought in addition to seasonality and your kind of greater exposure than most, you were saying that with kind of increased deal size, some of your deals now have more signatures, more process than maybe a year or 2 ago and that was also factored in, or am I reading too much into it?

No, I think we're getting good feedback that maybe that's something we'll take out of the script next year.

And the -- I think the point is that, that was really just to say that there's a seasonality where -- we have an international focus and that's the typical seasonality that we see.

We were just reminding people that we have more of a concentration of business in Europe...

Well, and I also think they were 2 separate points, right?

The sequential.

Europe seasonality and then more large enterprise deals results in more signatures and so that...

Right, right, but not the specific intersection of those 2 with the signatories on vacation more than normal.

No, no.

I think there's nothing out of trend is the point.

Our next question comes from Anne Meisner of Susquehanna.

Drew, just a quick follow-up on the repurchase.

Your share count guidance implies sort of a net issuance of shares, but it sounds like you're going to be more aggressive in the back half.

And given the increase in the authorization, so maybe you can explain that a bit and just help us understand what's going on there and if you can talk about sort of longer term, is the intention to repurchase more shares than what gets issued via SEC?

Or just to sort of offset the issuance?

Well, I could talk about this year, Anne.

Certainly, we're going to get more aggressive in the back half of the year.

I do think the doubling the share repurchase authorization, I think, should give you some guidance for, I think, both the near and longer term.

Clearly, there is -- that is something that we're focused on.

I think we're showing a commitment to wanting to do that.

We were trying to tell people we'd get a minimum this year of $150 million, $150 million and I think we've done $33 million to-date, so it would be $150 million less the $33 million, but that's at a minimum.

I think there -- the other signal there is -- and I think a lot of people know how we've been buying back on very opportunistic basis, I think we'd probably come up a little bit on that.

Okay, great.

And then not to beat a dead horse, but -- so the quarter was kind of just in line and you called out some weakness in service provider, which is an important vertical for you guys.

And now, you expect sort of better billings for the year based on the guidance.

So is there any additional sort of qualitative color you can give us on the pipeline?

Is there -- do you have more large deals than you typically would have?

You did say something about large deals and a key one, you called out that large 8-figure deal.

Do you have deals like that in the pipeline?

Maybe not quite that size but...

Well, yes.

I mean, Anne, it'd be hard to guide.

We look at -- we don't really guide by deal size so it's kind of -- it's hard to give too much color on that.

But I would say this.

Where we've been doing very well is in the enterprise.

The enterprise tends to buy the larger deals.

They're very focused on the Fabric and that's been resonating.

If anything, we would think the Magic Quadrant, being in the leadership quadrant of the Magic Quadrant is a helpful thing.

And so when you put that together, I think that, along with the visibility we have into the funnel, that's what supports our view on guidance.

Okay.

And was there a large deal in Q2 that maybe got pushed out till later in the year?

No.

Okay.

And just a quick follow-up on the seasonality that you mentioned.

You kind of discovered that seasonality last year, I guess.

And prior to that, I don't recall product revenue ever being sequentially down into Q3.

Is there a reason why the business is becoming more seasonal?

I know you called out Europe, but is there more seasonality to the business based on Europe?

Well, no, not particularly based on Europe, but enterprise would be obviously more seasonal than your average SMB business because SMB is kind of a more run rate, channel-driven business.

And as you move up into the enterprise, you are going to have different kinds of sales cycles.

Our next question comes from Keith Bachman of Bank of Montreal.

It's really a comment that falls on the past question to put it in slightly different ways.

I think your stock has been penalized, if you would, for some perceptions of consistency, particularly around top line.

And to echo the previous comment, this quarter was, if you, basically, average billings and revenue it was an in-line quarter.

You're lowering guidance a little bit for Q3 relative to where Street numbers were and yet, you're raising numbers for Q4.

So in effect, you're sending some mixed signals on in-line quarter but raising guidance.

I mean, so we're left trying to answer -- and it's only a little bit of a raise to be fair, but it puts more stress on Q4.

And so what you said is, to answer the question from the previous comment, is you see enterprise demand enough to support the pipeline.

I hope that's the case because again, it would be more palatable if this had been somewhat of a beat this quarter and then you kind of raise the full year numbers, but you didn't.

And so something had to, in terms of instill confidence, to raise the numbers for the year or else investors are going to be left with some concerns about, is there a potential miss coming, particularly in Q4?

We appreciate the feedback.

All right.

So I mean, I guess the answer is that you want to just echo what was previously said, is you think there's enough in the pipeline to get this all done?

Yes.

I mean, we've guided -- I'm not sure how else I could answer that question, Keith.

I think it's a fairly small amount that we're talking about here, too.

Yes, yes.

To be fair, it is a small amount.

It's just an unusual set of circumstances, I would suggest.

We have a follow-up question from Walter Pritchard of Citi.

Just one question on product gross margin.

That number, it looks like ticked down a little bit on the quarter.

Just wondering what drove that?

And you are -- if I look back at levels from last year, you are still quite a bit below those levels.

I'm wondering, is it a mix thing, is it pricing thing?

No, Walter, I think we called out -- well, I know we called out in the script that basically, it's the transition.

We had some reserves on the transition into the new product lines, and that was really what drove the margin down.

We didn't really see -- we didn't see price pressure, if you will, that would contribute to that.

We believe (inaudible) it was our inventory reserves.

Do you expect those to come back if you -- should those come back?

Yes, I think.

Look, we don't guide to it, but I -- we're not thinking that's the norm.

Our next question is a follow-up from Fatima Boolani of UBS.

Drew, your customer count is in excess of $300,000 and your enterprise bundle has now been in the market for about a year -- a little over a year.

Can you, at a high level, help us understand what proportion of the base: a, has bundles of any kind; b, if there's any granularity you can provide, what proportion of the base might have adopted SMB bundles or enterprise bundles, just so I have a better understanding of sort of what the opportunity is within the base to kind of keep pushing the bundle strategy?

Yes.

I think it's -- think of it as being half or slightly more who have the buy -- the bundles, Fatima.

And then on the enterprise bundle itself, we had a good uptake, but not across the installed base.

I'd say, if anything, we're very focused on doing more in the installed base and we feel like we've been doing that as we sell them the multiproduct deals and customers adopt the Fabric.

Did -- was there something else in your question?

No, that's it.

That's really helpful.

And just to double click on the buyback.

So you had about $190 million net at the end of the last quarter and then you did another $33 million, but you doubled it from $300 million to $600 million.

I just wanted to understand those numbers so I'm clear in my mind.

And then Part B of that is what sort of cadence should we expect through January 2019, that would be helpful?

Sure, I think -- that's right, we doubled the share authorization from $300 million to $600 million.

And as I said, we would -- we're going to do a minimum of $150 million this year.

And I think the authorization reflects the -- gives us some room, not only for this year if we decide to go north of there or go beyond or even next year, gives us some room, I think, entering the year, certainly, and throughout.

That's just the thought process beyond there.

What was the other part of the question?

Just in terms of the buyback cadence beyond...

Yes, I mean -- sorry, we don't really -- I think I -- what I said earlier when someone asked was that we'll probably -- we talked about opportunistic, and I think we've described to people in the past about how we think about that, buying more on dips and probably come up a bit on that, I believe, is what I said.

And then I would add just a little clarification.

We did $111 million in -- up through the end of 2016 and then we did $33 million this quarter.

So we're at $144 million total...

Over the last 2...

Over the last (inaudible) years.

$111 million last year.

And then -- and -- wait, now -- I'm sorry, we're $144 million and we just talked about $150 million for the remainder of this year.

So...

No, no, not for the remainder.

We've -- $150 million in total for the year.

Oh, in total for the year, sorry.

Also, the other (inaudible) opportunities, really, the Fabric, we have actually only single-digit of customer, the amount is $300,000, started using the Fabric.

So there's over 90% of customer base do not quite have the Fabric approach yet.

So that's also a huge potential.

Can also add a lot of addressable market.

So that's also we see as a pretty potential there.

And the last one for me before I overstay my welcome.

Drew, can you remind us your position on commission, amortization?

I know some of your competitors are doing it and would that just be part of the ASC 606 work that is slated for the back half?

Well, it's slated for next year and it's a requirement under the new standard -- new accounting standard.

So yes, it's -- you would -- I believe the way it works is that the product, the upfront portion is immediate expense.

The commission's related to the upfront portion and then the part that you apportion to the services is amortized over the life of the contract or the life of the customer, depending upon how you view that.

So is it fair to assume that 150 and 200-basis-point margin ramp that you're kind of expecting is on an organic basis?

That's correct.

I think the way I would think about it is the 150 to 200 basis points is based on our financials before adjusting for the ASC 606.

I think that's what you're saying.

Either you adjust the model and then you go up the 150 to 200 and then to the extent that there are adjustments, those become inorganic adjustments to the baseline, if that makes sense.

And at this time, I'd like to turn the call back over to Ms. Blough for any closing remarks.

Ma'am?

Thank you, everyone, for your time today, and we look forward to seeing you out this quarter in various conferences.

Have a good evening.

Thank you, Ms. Blough.

Thank you, ladies and gentlemen.

That does conclude your program.

You may disconnect your lines at this time.

Have a wonderful evening.