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Executives

Ken Goldman - CFO

Ken Xie - Founder, President and CEO

Michelle Spolver - Vice President, Corporate Communications and IR

Analysts

Walter Pritchard - Citi

Jonathan Ho - William Blair

Erik Suppiger - JMP Securities

Lauren Choi - JPMorgan

Keith Weiss - Morgan Stanley

Brent Thill - UBS

Jayson Nolan - Robert Baird

Jonathan Ruykhaver - Morgan Keegan

Rick Sherlund - Nomura

Brian Freed - Wunderlich Securities

Tal Liani - Bank of America Merrill Lynch

Rohit Chopra - Wedbush Securities

Dan Cummins - Think Equity

Fortinet, Inc. (FTNT) Q2 2012 Results Earnings Call July 25, 2012 4:30 PM ET

Operator

Good day, ladies and gentlemen and welcome to the Fortinet second quarter 2012 earnings announcement. At this time, all participants are in a listen-only mode. Later we'll conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to Ms. Michelle Spolver, Vice President, Corporate Communications and Investor Relations. Ma'am, you may begin.

Michelle Spolver

Thank you. Good afternoon and thank you for joining us on this conference call today to discuss Fortinet's financial and operating results for the second quarter of 2012. With me today are Fortinet's Founder, President and CEO, Ken Xie and CFO, Ken Goldman. In terms of the structure of the call, Ken Goldman will begin a review of the operating results before turning the call over to Ken Xie to provide additional perspective on our business. Ken Goldman will then conclude with some thoughts on our outlook for the third quarter and full year of 2012 before we open up the call for questions.

As a reminder, today we're holding two calls. Following this call, we will hold a second conference call to provide an opportunity for financial analysts and investors to ask more detailed financial questions. The second call will begin at 3.30 pm Pacific time which will also be webcast from our Investor Relations website and is accessible and detailed in our earnings release.

Before we begin, let me read the disclaimer. Please note that some of the comments we make today are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in these statements. Please refer to our SEC filings, in particular, the risk factors described in our Form-10K and 10Q for more information. Our forward-looking statements reflect our opinions only as of the date of this presentation and we undertake no obligation as specifically disclaims -- any obligation to update forward-looking statements.

Also please note that we'll be discussing certain non-GAAP financial measures on this call. Our GAAP results and GAAP to non-GAAP reconciliation can be found in our earnings press release and on slide 15 and 16 of today's presentation that accompanies our remarks. Please refer to our Investor Relations section of our website at www.investor.fortinet.com for important information including our earnings press release issued a few minutes ago and slides that accompany today's prepared remarks. A replay of this call will be available on our website. Note that we duly post information on our Investor Relations' website and we encourage you to make use of that resource.

I will now turn the call over to Ken Goldman to review Fortinet's second quarter operating results.

Ken Goldman

Well, nice job, Michelle. By the way I noticed how she shortens it when she has to present versus myself. And for those that have asked, I've actually reduced some of my comments to make it a little bit more condensed, which I think all of you would be probably happy with.

But let me first start off and say that Fortinet delivered a strong second quarter. While we are concerned about the economic environment and though I don't want to say we're immune to it, I will say that demand for security and Fortinet solutions in particular remain solid in the quarter. We execute well across all three geographies.

Our future financial results clearly reflect this and we again perform well in a number of key metrics including; billings, $146 million which grew 32% year-over-year, highest growth rate achieved since Q1 2011 and exceeded guidance of $136 million to $140 million. Revenues were $129 million, up 25% year-over-year and also exceed our guidance range. We witnessed strong revenue growth across all geographies.

Product revenue grew 32% year-over-year. Operating income was $28 million, increase of 28% year-over-year even as we invested aggressively again in R&D, sales and customer support headcount. Earnings per share were $0.12 in line with guidance as again we made hiring and other investments that we had planned for. Free cash flow came in at $41 million, exceeding our guidance range of $35 million to $40 million as we ended Q2 with a cash balance of $644 million.

Finally, deal sizes got larger and our high-end price increased to 35% of total billings. We won several deals with Fortune 50 companies across a number of key verticals. This is the eleventh quarter as a publicly traded company where we achieved upbeat guidance expectations and we did (inaudible) met some challenging economic times. Let me reiterate some of the main reasons why.

First, our strong technology vision and business strategy and we're executing well against this. Second, our business is diverse in terms of product segmentation, vertical breadth and geographic reach and we are [embarking] a strong new product cycle. Our customer target base is broad and our Fortinet FortiGate offering is being deployed in a variety of ways whereas the core next generation standalone firewall, a full blown UTM solution or managed security services offering. Thus we were able to compete and win numerous types of deals. This is a key differentiable advantage for Fortinet because it provides us a large addressable market.

Third, we are leading the innovations, delivering the highest performance security products in the market to our custom ASICs which provide a significant advantage that none of our competitors can offer. High performance and low latency are factors in a majority of our enterprise and high-end wins. Four, we also have a strong cohesive senior team who has worked together for numerous years, including two (inaudible) in top positions who have great passion of the business and has established track record of success.

And finally we are benefiting from market trends such as network security growth, virtualization and mobility as well as increases in network performance and bandwidth-intensive applications that require high performance security in the enterprise and high-end environments.

The momentum for Fortinet is strong. We plan on maintaining this by continuing best in R&D and sales and marketing infrastructure. We have an excellent track record in defining and running our own playbook for long-term success. Our consistently strong performance illustrates our strategy is working and we are effectively executing against this plan.

Looking to the future, we are very excited about the upcoming launch of our new FortiOS 5.0 operating system, the next generation ASICs which we expect to further enhance our market leading position and maintain a momentum. Ken will talk more about this in his remarks.

So now let me go through the second quarter results in more detail. I'll now talk about income statement relative to Q2. Billings is noted with $146 million, an increase of $36 million or 32% year-over-year that exceeded our guidance range of $136 million to $140 million. A solid increase of new enterprise multiyear deals coupled with strong service and renewals in Q2 contribute to a $17 million increase in the deferred revenue balance. As a reminder, we bill world-wide US dollars, so our bill is not impacted by FX fluctuations.

In terms of geographic breakdown, Americas grew at 39%, EMEA 24% and Asia-Pac 33% compared to Q2 '11. All regions still have strength. The strongest forms again are coming from Americas which for the 10th consecutive quarter had growth of more than 30%. We also saw continued rebound in EMEA. There is further evidence that we are successfully moving forward from the issues we accounted mid last year.

On product segmentation, slide 4, we saw a nice pick up in our mid range to high-end enterprise products which each accounted for 35% of our product billings in Q2. The mid range growth was driven by continued large retail customer deployments with a high volume of extended service contracts as well as traction of our FortiGate (inaudible) appliances. Growth in our high end was due to strong sales of FortiGate-39, 50b, the 5,000 series of large enterprises and service providers and ripping sales of new products.

In terms of deal breakdown, let me go through a number of deals in 2Q versus year-over-year. Number of deals over 100,000 for 2Q was 168. That compares to 127 in Q2 '11, over 250 was 55 versus 37 in the comparable quarter last year. Number of deals of 500 was 19 versus '11 in the same quarter of last year. Of the deals over 500,000, I want to point out the details were larger as we had a large number of deals of 1 million or more during the quarter.

In terms of billings by key vertical, 2Q goes per vertical approximately as follows. Service derives around 26% and it's really ranged from 27% to 30% over the last few quarters. Government was a little higher at 14% versus say 11% last year Q1 and 13% in Q2 of '11. Retail was 13% which is pretty comparable to Q1 of this year and up from 10% last year. Financial services about 9% and education around 7%.

As I mentioned earlier, Fortinet is winning the market due to our broad product portfolio, flexible UTM functionality in unmatched performance, as well as networking capabilities like virtualization and advanced routing that differentiates us in enterprise and high-end. Ability to comply well for the regulation class key verticals, especially retail, has also contributed numerous wins.

I want to highlight a few Q2 deals, which demonstrate this as well as showcase the diversified customer base. (Inaudible) and I will only cover those in this particular section. We are next-generation firewall win with enterprise Fortune 50 technology company US who went to win a thorough Global Corporate Firewall refresh selection process and shows Fortinet's high-endpoint FortiGate appliances over Check Point and Juniper.

Engaging to integrate firewall and IPS functionality, we will be using content filtering DLP. (Inaudible) and retail had numerous FortiBridge UTM wins within this sector during the quarter. One with the US Fortune 50 retailer who will be using our FortiWiFi appliances to comply with PCI regulations and secure more in 1,200 stores.

Additionally, they select our FortiWeb application firewall appliance to protect their customer facing retail website. Competitors for these deals look Cisco and Barracuda. We had a seven figure win with one of Europe's largest telecommunication carriers who selected our FortiGate-5000 appliances as a core firewall to secure their mobile networks. In this case, we replaced Juniper.

Lastly among a number of high performance, low latency next generation firewall deals we won this quarter was a significant seven figure financial service deal in Asia in which our FortiGate appliances will protect numerous different financial firms in a region. We won a deal over Check Point (inaudible) demonstrating deliver the highest firewall performance and lowest latency.

In terms of revenue, $129 million in second quarter, up 25% year-over-year and exceed our guidance range of $123 million to $127 million. And I would note that 2Q revenue metrics were in the same revenue rules as FASB rules as applied last year.

Product and services revenue together grew 28% year-over-year which excludes the impact of the lower revenue which will continue to decline over time and (inaudible) is more reflective of our ongoing business. Once again our billing received revenue growth but over time we expect revenue to more closely match billings growth.

In terms of geographic split, you can see that in slide 5 and 6, our revenue continues to be diversified globally. It remains an underlying strength of our model. We saw a healthy growth across all geographies which again enabled us to exceed our revenue targets.

In terms of geographic split, Americas is $51.9 million versus $40.5 million last year increasing 28% year-over-year. Key drivers for our strong performance were our continuous space within large enterprises and key verticals such as retail and education and our achievement again in Latin America.

In terms of EMEA, $43.7 million versus $36.6 million last year represent year-over-year increase of 19%. I would say that despite continuing challenges in many regions, EMEA forms continues to strengthen this quarter and performed exceptionally well with the UK and Middle East showing particular strength.

A comment on technology advantage, investments to grow our sales team, a well support channels in this region haves led to continued success.

In terms of Asia Pacific, $33.4 million versus $25.8 million last year increased 29%. APAC again delivered solid growth particularly in China, Japan, and Korea. We have continued to win more business with larger enterprise accounts for select and solid networks security solutions and high performance firewalls to secure their infrastructures.

Product revenue on slide 7, product revenue, product and service revenue I should say, product revenue was $61.7 million as noted, up 32% year-over-year and it was driven by increased demand for our Midwest products FortiGate-200B, 300C, 2000C and high end products including the FortiGate-1000, 1000C, 350B and 5000 series to identify this and series providers.

Service revenue was $65.4 million, up 24% compared to $52.7 million last year. This increase was a result of consistent growth and support in subscription offerings as well as significant growth in our professional services revenue as more enterprise customers acquired onsite resources. Renewal rates remained consistent in mid to high 70% range.

In terms of ratable, I just would say it was $1.9 million. As I have noted, it will continue to decline over time.

In terms of headcount, slide 8, you see that we ended Q2 with 1,762 employees, up 107 from Q1 and compared to 1,475 in Q2 of last year. We continue to hire aggressively. Headcount increased 6% on a sequential basis and 19% year-over-year. It seems to be globally diversified, 70% of our employees located outside the US and gives us a balanced cost structure.

While sales and R&D still represent about a 30% each, the fact is we are increasing our support headcount, it was now at 24% of headcount in G&A, now was at 7 operations over 2.

In terms of annualized revenue per employee, we actually hit the $302,000 in the second quarter. It was annualized, up 5% from second quarter last year. I would say that we grew billing 32%, revenues 25% year-over-year and really 28% if it exclude ratable compared to a 19% increase in headcount. And I would add that revenue per employee is now doubled over the last four years.

In terms of some of the key income statement ratios, non-GAAP product gross margin was 61% for Q2 and service gross margin was 82%, both down largely from last year. Overall, non-GAAP gross margins up 72% were attracted by couple of factors. We have invested in our cost of goods to support high dense requirements and certain products for upcoming FortiOS 5.0. We do expect this to be temporary as we bring cost down in the future.

Additionally, one of our largest retail customers which we talked about in the past purchased higher quantity Midwest products during the quarter with lower than average gross margins. I would add though overall APs FortiGate unit volumes have remained relatively consistent through this period.

Service gross margins were impacted by the fact we are investing heavily in our tech support and professional service staff given our recent penetration more enterprise and high end accounts and what we look at for the future.

We did also have a higher mix of product revenues than we assumed. We expect services revenues to go up over time and overall non-GAAP gross margins to return to the 73-plus range.

In terms of non-GAAP operating expense, they were 64.5 in Q2. Though operating expenses were up 18% year-over-year, it was compared to revenue increase of 25% which was we demonstrating leverage in our operating model. Increase was primarily driven by increase in headcount to support our growth and probably offset by favorable FX rates compared to prior year.

As a percentage of revenues, total non-GAAP operating expenses during Q2 were 50% compared to 53% in the same period last year and 52% during the first quarter this year. Non-GAAP R&D expense decreased 21% year-to-year to $18.1 million that was represented by 14% as compared to 15% for both Q2 '11 and Q1 2012 as we continue to invest in hardware, software and especially even quality teams (inaudible) [17:42].

Non-GAAP sales and marketing increased 19% year-over-year to $40.8 million and we continue to expand our sales team particularly in Americas and EMEA. As a percentage of revenues during Q2, non-GAAP sales and marketing were 32%, down 1 percentage point from prior year.

Non-GAAP G&A increased slightly $5.7 million. As a percentage of revenues, during Q2 non-GAAP G&A was industry leading 4% compared to 5% in prior year.

In terms of profitability, non-GAAP operating income was $28 million, up 28% year-over-year to represent non-GAAP operating margin of 22% as compared $22.2 million last year.

We have made a constant effort to improve our position in certain markets and geographies as we balance these investments to maintain approximately comparable year-over-year operating margins before expecting to grow margin again in the future.

Other income increased modestly $2.6 million. Non-GAAP net income was $19.5 million in Q2, $315.3 million in Q2 '11, increase of 28% year-over-year. Non-GAAP diluted EPS was $0.12 compared to $0.09 for last year.

As I mentioned at the beginning of the call, there is a full reconciliation to our non-GAAP and GAAP results in our earnings press release and in slides 14, 15 of the presentation of the company today and prepared remarks and for those non-GAAP financial measures that are not described in the earnings press release.

Just a couple of comments on the GAAP numbers, GAAP net income was $14 million in the second quarter of 2012 compared to $14.5 million in the second quarter of 2011. The year-over-year GAAP net income declined was impacted by additional $4 million of stock-based compensation expense and our higher GAAP tax rate compared to Q2 of '11.

GAAP tax expense provision was 37% of pretax income in Q2 '12 and 25% in prior year. The 37% rate for Q2 was a result of bringing the year-to-date rate to 33% from 28% in Q1 due to lower stock option exercises deduction in Q2 than in Q1. And I would add the 33% is very comparable to 34% pro forma rate we are using.

Let me just talk a couple of metrics relative to balance sheet and cash flow. You see that as well I think on chart 12, we ended the quarter with $644 million in cash, cash equivalent, and short and long-term investments of (inaudible) $3.88 per diluted share. Cash generated from operations was $44 million on a GAAP basis. It was our 26th consecutive quarter of generating cash from operations exclusive one-time items.

You can see that free cash flow of $88 million in the first half of 2012 grew $18 million or 26% year-over-year. If you look at this in terms of absolute cash flow, this was driven primarily related to $28 million in GAAP net income, $37 million increase in deferred revenue in the first half and $20 million in non-cash items. The depreciation, and stock-based compensation offset by $8 million investment in additional inventory. I would add that we paid approximately $7 million more cash taxes in the first half of 2012 versus first half of 2011.

In terms of net AR increased $10.6 million to $95.4 million. DSOs were 67 days which is really pretty comparable to what we achieved in the past. We had strong cash taxes behind $32 million in Q2.

Inventory increased by $2.8 million to $20.8 million. We continued to invest in one way inventory to support our growth and frankly avoid channel backlog which we would have from time to time. Inventory turns have remained between 3.9, 4.1 over the last few quarters.

Deferred revenue balance increased to $331 million, up $58 million or 21% year-over-year and $17 million sequentially which was $10 million higher than increase in 2Q '11. The sequential increase was primarily in our service deferred revenue balance which increased $18 million. Short-term deferred revenues increased to $227 million, up 18% year-over-year and up $10 million or 5% versus 1Q '12.

Long-term deferred decreased to $105 million, up 30% year-over-year and up $7 million or 7% versus 1Q due to increase in large deals with multi-year service contracts. And I think you would see that there those are pretty increases now pretty reflective of just the overall balances.

So in summary, we executed well during Q2 showing that go-to-market strategy investments and sales of organization are paying up. Our business growth which is leading indicator of business was better than we have experienced since Q1 of '11 despite again a challenge – well know challenging economic environment. We have a strong colleagues of team, a differentiated product offering and a consistent strategy and vision that really hasn't just evolved, that hasn't changed fundamentally over the 12 years of the company. We are winning the market and we will continue to compete hard to grow our position.

Let me now turn the call over to Ken and then I will wrap it up with forward guidance.

Ken Xie

Okay, thank you, Ken. And thanks to everyone who joined us on the call this afternoon. As Ken Goldman (inaudible) would have had a great second quarter and even in light of the difficult economic conditions, our billings growing across all regions and the market segment. We execute well in our strategy and grow our enterprise business and win large accounts. We continue to develop and deliver innovation and differentiate ourselves in the market. So this has lead to the market share gains in both the UTM and overall network security market.

So early today we announced the new IDC data that show Fortinet advanced its market share position and also now the fourth largest network security company in the world surpassing McAfee and the Microsoft and that we gained share in the global UTM also which we are now leading both in the revenue and the unit shipment.

So now I want to take a few minutes talk about our technology advantages. It seems something we get ask about often and at a times get at least represented and astute, but the technologies why we are winning the market.

So first, Fortinet delivered these routing technologies through our comprehensive FortiGate integrated secured appliance, the FortiOS operating system and the FortiASIC and FortiGuard threat protection service. So Fortinet platform integrate security function together into a single manageable flexible platform that was built from the ground up to address the content and -- and to address the current emergence threat whether from a network, on application of blended attack and to provide the processing power to brought real time performance.

So as threat has evolved and performance need has increased so we have added more layer to our flexible architecture and the more processing power to our FortiASIC to address them, and we will continue to do so in the future.

So our family of FortiGate appliance are for the broadest security protection available and we have a more secured certification from third party lab ICSA and NSS to ensure the highest quality, accuracy, reliability and performance. There are different terms being used by different analyst firm and vendor who are talking about reinventing the network security. Most of time review is just like a reinventing some name for the similar technology. So based on IDC data and a report which we did (inaudible) early today the so-called next generation firewall is a subset of the UTM offering and IDC content was in the UTM market share and analysis.

So Fortinet platform supersedes both next generation firewall and UTM functions today. So we integrate advanced firewall and have wires IPS and application control technology into a FortiGate platform more than 10 years ago. And in fact, we [achingly] named the company app secure for the first two year before changed name to Fortinet.

So as you can see on the slide 13 of our presentation which whenever you have seen in the last 12 years since we started company in 2000, Fortinet vision has been to address the new content and application security threat compared with the traditional firewall which does handle the connection level security. So a lot of our customer deploy our FortiGate system as next-gen firewall all the others choosing then as full UTM.

So in regarding to the performance, the unmatched security throughput only we can offer by leverage all customer FortiASIC chip in addition to off-the-shelf processor is what truly set Fortinet apart from all other security vendors. Our ability to deliver the (inaudible) firewall with over 500 (inaudible) new application and security performance for both IPv6 and IPv4 traffic as well as acceleration across other security functions, gave us the best solution for enterprise service provider data center environment.

Over the past several quarters we have shared numerous high-end win and in almost every case performance was a key factor why we were select over competitors. Just a few weeks ago, we also announced a new FortiGate 800C which set a new price performance standard at a middle range level as the first UTM deliver over 10-Gig performance and run about $10,000 price range.

So finally, we dedicate to the network security and have an extensive product portfolio to cover a whole space. In addition to our UTM offer, we also offer the complementaries to the product to secure email, web application, database and point mobile device and more. So we not only believe our product but our customer and third party too.

So we are proud to have recently received many awards and certifications, including achieving our 25th Virus Bulletin 100 Security Certification Award and our (inaudible) awards as well as the Information Security Company of the Year as SC Congress Canada, the Best Integrated Security Solution and SC award Europe, the Best Transformation Security Solution award Asia and Information Management award, and two Computerworld Asian customer care award for high quality customer service and the Best Firewall under the best integrated security from the Network Products Guide's 7th Annual 2012 Hot Companies and Best Products Awards.

So looking forward to the rest of the year, I'm excited about Fortinet's position. So we are executing well and making great traction in key market. We have a powerful arsenal of new technology coming to the market, including our FortiOS 5.0 operation system, the new FortiASIC chip systems.

So now let me turn the call back to Ken Goldman who will discuss our finance outlook and Q3 and the rest of the year.

Ken Goldman

Before reviewing guys, let me remind you that the guidance consists of forward-looking statements and please keep in mind our earlier comments regarding such statements. Well, we remain mindful of the overall economic volatility, particularly in EMEA. We believe Fortinet is well positioned to maintain a momentum for the remainder of the year, due to our broad network security product offerings, unique technology differentiation, a superior price performance advantage. Our goal is to keep pushing and powering through to gain share and our guidance is reflect of the environment as we see it right now.

To begin with (inaudible) for third quarter, billings expected to be in a range of $143 million to $147 million, which is the midpoint. It represents growth of 23% year-over-year. As a reminder, due to our over performance in billings during Q2, we expect there to be mostly more seasonality during Q3, specifically in EMEA than we experienced in Q3 of last year. Total revenue is expected to be in the range of $134 million to $137 million whereas the midpoint represents year-over-year growth of 16%. However, excluding the $2.6 million patent sale in Q3 of last year, revenue growth would be close to the 20%.

Gross margin is expected to be in the range of 72% to 73%. Non-GAAP operating margin is expected to be approximately 24%. Non-GAAP EPS is expected approximately $0.14 based on an expected diluted share count in the range of 167 million to 169 million. Free cash flow of approximately $38 million to $40 million excludes $14 million for the purchase of random buildings near our Silicon Valley headquarters, which we expect to close in Q3 which will reduce the free cash flow rate to $24 million, $26 million. This purchase does not, however, impact our operating cash flow which we expect to be in the range of $40 million to $42 million in Q3 and no change at this point in the performance (inaudible) of 34%.

We are increasing our overall guidance for the full year based on the strength of our second quarter as well as a healthy networking security business environment that we see at this time, and therefore expect billings to be in the range of $590 million to $600 million, up from a prior guidance of $580 million to $590 million and the midpoint puts us at approximately 25% growth for the year (inaudible) educations are fairly gaining market share during 2012.

Total revenues to be in the range of $525 million to $530 million, up from prior guidance of $515 million to $530 million basically are now at range. Midpoint puts our growth range at 22% for the year. Now remember we had the patent sale which helped us somewhat last year. Gross margin to be in the range of 72%, 73% and operating margin to be around 24% for the year.

We've narrowed the EPS range to be $0.51 to $0.53, up from prior guidance and based on our expected diluted share count of approximately $166 million to $169 million. Free cash flow is expected to be in the range of $165 million to $170 million, up from our prior guidance that excludes the impact of the LAN billing projects I've mentioned earlier. Cash flow from operations for the year is expected to be in the range of $173 million to $178 million.

As I close, I would like to particularly thank those long-term shareholders who continue to support us and have shown faith as we near three years as a public company, as we march toward the $500 million annual revenue level.

So with that, let me -- we'll all take questions and answers. So I'll turn the call over to the operator.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) First question comes from Walter Pritchard from Citi.

Ken Goldman

Hi, Walter. Walter?

Operator

Our next question comes from Jonathan Ho from William Blair.

Jonathan Ho – William Blair

Good afternoon, guys. Congratulations on the strong quarter. Can you just give us a little bit of additional color around sort of what you guys are seeing in terms of the pipeline and perhaps how you feel about that as we start the second half, and as you've seen sort of the first couple of weeks of this quarter?

Ken Goldman

Thanks Jon. We don't tend to try -- I would say this as I think about it. Our quarters tend to start out where we tend to build momentum as the quarter goes on. And so we have business that supports our numbers as we see it and then as we get more data points during the quarter, it allows us just to -- like in last quarter to overachieve.

So in this particular quarter, I would say July looks fine. Sometimes you go through the August, which -- I don't know if you're (inaudible) but you get August which particularly in Europe there's a fair amount of time off and then you come back to September. I would say there's nothing dissimilar that we are seeing right now than we have experienced in past Q3s as to how we see the quarter unfolding and so forth. But like anything else, you gain more data point as the quarter goes on.

Jonathan Ho – William Blair

Got it. And just in terms of your EMEA bookings, they were definitely very impressive this quarter. Could you maybe talk to sort of what you thought were the main factors driving that and how sustainable that is? I think you talked about the seasonality maybe kicking in a little bit more into the back half of the year? Thanks.

Ken Goldman

I think there's a [nice thing to me] about EMEA and Europe if they were even listening, but we saw some things last year and mid of the year that we felt we couldn't -- did correct. We also thought -- we probably didn't get ourselves just prepared for at least the challenge economic times that seemed to be prevalent in Europe, but frankly over this entire period of time. And so I think what's helped us is consistency of terms of the folks. I mean in some cases we've added some new folks like n the UK that we have talked about. Other cases we have improved our channel. And in many other cases we just have very good focus (inaudible) people and know the playbook, so to speak.

So I think that's more -- consistency is a message and constant day by day, week by week execution and making sure we never take our eye off the ball. It's really back to basics execution. I don't know if Ken has any other thoughts, but that -- so our growth consistently improved quarter after quarter since Q2 of last year in EMEA.

Jonathan Ho – William Blair

Great. Thank you.

Operator

Thank you. Our next question comes from Erik Suppiger from JMP Securities.

Erik Suppiger – JMP Securities

Yes, first off just on the European revenues. Can you give us some degree of color on what kind of breakout you have between Northern and Southern Europe?

Ken Goldman

Yeah, I mean I would say this. If you look at -- we clearly are seeing a little bit weakness in some of these Southern Europe countries and I'm thinking of Italy and Greece as you would expect. France has continued to do well. So Central Europe and France continued to do well. Germany is doing better, but still has opportunity. UK is doing very well for us. We had a good quarter in the Middle East as an example. But in -- I'll say this way, we are holding our own in the group we call ITG of all things, as I've mentioned this before, Italy, Turkey, Greece. We're holding our own but clearly that's not where the growth is coming in, in Europe.

Erik Suppiger – JMP Securities

But what is your exposure to kind of the, maybe the ITGs or with Southern versus Northern versus UK?

Ken Goldman

I would say we had -- no region represents more than approximately 20% of Europe, of EMEA -- let's just say of EMEA. So you should think of 20% roughly, I don't give exact numbers, but roughly 20% is where the larger regions would be as a percentage of EMEA.

Erik Suppiger – JMP Securities

And when you say larger regions, would that be Northern, Southern and UK?

Ken Goldman

Yeah, I'm thinking of UK, Central, Southern. I'm not going to go through everyone but things like that including Middle East and (inaudible) yes.

Erik Suppiger – JMP Securities

Okay. And then in North America or in Americas, how was your breakout this quarter between (inaudible) versus outside of the United States?

Ken Goldman

Well, we'll give a little bit more breakout in our Qs. I don't want to give all of that, but I think I already commented that we again had a very strong quarter in Latin America. We had a very strong quarter in how we break -- we have a group called enterprise in our Americas area that had a very, very strong quarter again and that again reflects that our penetration in the mid and higher end enterprises. Our basic channel business did well also. And so that really is how we see it, some other areas more comparable to what they've done in the past. Actually Federal had an okay quarter as well this past quarter.

Erik Suppiger – JMP Securities

Okay. And then finally on your carrier business, I think you said that was 26% down from 30% in the March quarter if I have the right numbers. Was that a weaker sector in this quarter? Is there a difference in terms of the carrier spending and what do you see for the second half of the year?

Ken Goldman

No, I would say that's in yield as it varies from 25% to 30%, yeah that's in [ratio] if you go back to Q2 of '11, it was 27%, 26% this quarter, 30% in Q1. So no, I would say that's in a realm of -- so up and down noise level.

Erik Suppiger – JMP Securities

Any general commentary about the carrier spending outlook?

Ken Goldman

I think it looks -- again, remember the bulk of our business is MSSP as a service provider. We are providing the service to their customers and I think our perspective is it looks good to us for the second half of the year.

Erik Suppiger – JMP Securities

Well, good. Well, congratulations. Thank you very much.

Ken Goldman

Thank you.

Operator

Thank you. Our next question comes from Lauren Choi from JPMorgan.

Lauren Choi - JPMorgan

This is Lauren for Sterling Auty. Ken Goldman, can you walk us through just the three months of the quarter, was there any of these months that were more challenging than the other? And just general kind of thoughts on linearity in the quarter would be great?

Ken Goldman

Yeah, we don't intent to -- thanks for the question. We don't intend to get too detailed on month to month. But I would say nothing dissimilar in this quarter in terms of the trends. We started off good. We had a very good June. We are not like a software company or some other companies in which you have this last couple of days of extreme [hecticness]. So I would say nothing really abnormal relative to how the business came in during the quarter. I think that what I had seen last few quarters is good continuity and credibility with the forecast with the sales folks putting together relative to both businesses. They expect to close week by week and what they expect to do for the quarter.

Lauren Choi - JPMorgan

Great. I think you touched upon this in your comment around deferred revenue, but was there any changes to the duration? Did it lengthen or shorten?

Ken Goldman

In looking at my (inaudible) team here and they're going to give me some -- I'm still am not sure I would, so I'm not sure. They say it went up -- the deterioration went up a little bit actually, nothing dramatic.

Lauren Choi - JPMorgan

Okay. And lastly I guess the pick up toward the higher end in the products mix, was there anything that you guys are doing specifically that's creating that or any function of the macro economy that you think it's going towards that end? And is this sustainable?

Ken Goldman

I would say there's two key points. One is, we don't always get enough credit for it and we keep on fighting this issue with us [penetrating the] enterprise and we -- enterprise in Americas is where we really break it out and EMEA is always this strong. We are doing quite well in the enterprise, that's point one. Point two is Canada has noted that there is some areas in the mid end and certain price points where our market share is not as much as we would like. And so we have both from a product point of view and a competing point of view, if you will, we're aggressively going after market share.

So I would say both the area itself. That's why the mid and the high end, there's different focuses. On the high end we continue to penetrate, we continue to do well. In the mid end, there's actually -- sometimes you don't get as much credit from the financial community but the reality is there's a lot of great business there and we are bringing our products, we're competing aggressively there for that business because in some cases, we're not number one and we want to be number one.

Lauren Choi - JPMorgan

All right, thank you.

Operator

Thank you. Our next question comes from Keith Weiss from Morgan Stanley

Keith Weiss – Morgan Stanley

Good morning guys and thank you for taking the question. The first question I wanted to ask was…

Ken Goldman

(Inaudible) one of the question (Inaudible) question whether I'm going to take it or not.

Keith Weiss – Morgan Stanley

If you will please, I just wanted a breakdown a little bit deeper into the gross margins, particularly the product gross margin commentary. I didn't quite follow sort of the explanation of sort of the impact ahead of the next FortiOS and the FortiASIC release. Can you just dig into that aspect a little bit and sort of walk through why that's a temporary impact and sort of how it alleviates over time?

Ken Goldman

Yeah, some of it has to do with -- we'll describe more of this at a such time as we formally introduce (inaudible) and this call is not meant to do that, so that's point one. Two is we have a number of products, however, that we have increased particularly storage capability to them and so the product costs in some of our products has gone up as we prepare those products to bail themselves, if you will, of the new operating system.

And so -- and the reason I say those costs can -- storage costs, as you well know, tend to go down over time and so we are seeing and expect to see continued reductions in those cost over time. But as we increase the storage in certain products that did increase, and this is both mid and high end, but a lot in the mid end, this did increase some of the product costs for those products.

Ken Xie

This is Ken. I think one thing it's only particular around the FortiGate is only -- in the last few quarters, we starting increase the flash memory without changing the price. And that's the flash memory actually are helpful for the new function we are going to release new feature later this year, which can help collect a lot of behavior and also the usage information which can set automatically our smart kind of policy. So the flash memory price also you can see coming down quite a lot in the last few weeks, coming down probably close to 10%, 15%. So that eventually would help us on the margin coming back, because we tread up with our -- even a lot of capability that we now needed today, but we feel going forward we'll be more -- well, we're helpful for the user and so that's a -- but that's just one small part of it.

The other parts where there's only investment into the (inaudible) because if we keep up the growth, we feel the number one issue is really how to supporting customer better. So far for them number one we're to get new customers all come from happy referring customer. So that's all come from the best support, because -- that's what we feel pretty sometime. We're not trying to target, grow the fastest one, but we also want to make sure whenever a customer using a product, it can get best support. So that's where we feel the investment support evolution is very important and also would be the future of growth foundation. So that's where we want to keep the investment into the support, and you can see that the high in that -- that we are selling highest, especially in the supporting areas.

So that's also impact by some supporting margin, so we feel once the company is (inaudible) coming back with margin. And there's still rising, Ken mentioned a little bit. Once we have produced some of the large enterprise, there's two things. Ones that we tend to have a much bigger deal across multiple years, so that's -- lot of revenue. In early days (inaudible) but also a lot of long-term surveys going forward. And the second part really sometime the bigger deal they tend on the negotiate may be more compared to the chain of kind of deal. So that also has the impact. But all these combinations has hurt the gross margin, but we believe this thing will be come back pretty soon.

Keith Weiss – Morgan Stanley

That was very helpful.

Kenneth Goldman

Yes. So obviously, part of that relates to the product cost and part of that relates to the services margins.

Keith Weiss – Morgan Stanley

Right. And I guess while you guys pricing US dollars and obviously don't have a translation impact from FX, I think one of the concerns is that your products do get more expensive in Europe that it just did a lot of customers expensive from those guys. Is there any extensive impact on gross margins from that and just your European customers want a kind of FX discount if you will, just sort of sort of split the difference with you versus what they have to pay in terms of Euros?

Ken Xie

No, I think it's interesting, so it's about two-third being as of come from international. So international tend to have a little bit higher lease price and also the distributor get a little bit more discount because tend to support them more on the marketing and also the technical support. So that's where they lead a little bit more margin to support in their additional effort in the marketing and support. So that's the additional discount they needed compared to some US distributor, which the company do more marketing and also technical support. So that I think that's the model, I don't think it's really changed in the last few years and both our partner and also a few are comfortable for this model, which gave the international lease price a little bit higher than US.

Kenneth Goldman

Yes. I mean that's exactly correct. I mean, obviously from time to time you will have to – from deal to deal you may have to compete a little bit more and discount and try to say whether it's competition or for the customer comparing your FX related, but I wouldn't describe in significant in terms of our overall margins to that.

Keith Weiss – Morgan Stanley

Nice one. Thank you very much, guys.

Operator

Our next question comes from Brent Thill from UBS.

Brent Thill – UBS

Ken, you're obviously seeing a different environment than most technology companies, maybe if you can just give us your sense on the second half of the year? It seems like your better execution is breaking the headwind of the macro challenges, but is there anything specifically that is giving you that confidence to bring your billings numbers up for the back half of the year wherever one else seems to be being more cautious as we had during the second half?

Kenneth Goldman

Yes. Thanks, Brent. I think I've seen a little mix what people are projecting. I think there is a couple of factors here. One is, there is some to be sensed for continuity of execution in team and just being not having big changes. Sometimes I see other companies, you have a change in organization and you have a pickup before you move forward. I think that's one as I really sit back and think about it.

The other thing is, there is no question in my mind it is insecurity. First of all, it's a growth business particularly network security. And I do think you have frankly some companies that are winning and some companies not winning as much if I could say it that way. And so we are gaining share and innovation really is driving. Innovation and performance, as Ken noted, is really what's driving our business. And so I think the demand is there, but you have to go – you have to take that demand if you will. And we are leading by very consistent bringing our new products quarter-after-quarter and continue to see a message, I think that's really – that has been our winning strategy here.

Brent Thill – UBS

Okay. Just a quick follow-up on your conversion rates in the back half of the year, are you assuming similar conversion rates that you are seeing now, are you taking the slightly more cautious view on what you expect your pipeline to convert into revenue?

Kenneth Goldman

Yes. That's always a hard one because you have good visibility for couple three months, and then after that, it's hard to see too you much. And so you based it on trends what people are seeing and so it is a general sense. But as we look at the business and the flow of business is continued to be very good, as Ken noted, we're getting a multiple customers come back to buy more. And without saying too much, we feel very, very good about our new product particularly in Q4 that will be coming out even more so than – some of the new products in Q3.

Ken Xie

Yes. Also plus we will to target doing a long-term technology announcement advantage we have. And so that's where the new chip, the new OS. That's kind of match well of the – some of the vision, which kind of address the change in the whole network security landscape. I think this is starting to kind of a people – more people realized that change in happening right now in the last few quarters. And that we're thinking there is quite a lot of replacement of the traditional firewall by this UTM device right now compare to – or is especially happening on the price space.

Brent Thill – UBS

Great, nice job.

Operator

(Operator Instructions). Our next question comes from Jayson Nolan from Robert Baird.

Jayson Nolan - Robert Baird

Great, thank you. Ken, just a follow-up on the Q3 billings guidance, flat sequential that basically just tough comp in Q2, you are not seeing anything in the pipeline there?

Kenneth Goldman

Yes. No, I think let me say this way, I think you don't want to be a hero in terms of guidance. I think that can get you in trouble. And so we obviously did better in Q2 as we can see than we had projected. So our Q3 really hasn't changed in terms of how we see internally, but clearly, from what you see, we did better in Q2. And so other than that, no, we are not trying to suggest anything else in terms of how we see the Q2 versus Q3 in terms of seasonality or terms of business outlook and so forth. So no.

Jayson Nolan - Robert Baird

Okay. Thank you. A question on the FortiASIC and the 5.0, I think you guys have said in the past no expectation of seasonality there, but why wouldn't we expect some pent-up demand at least for the ASIC product?

Ken Xie

That one will give us more advantage on the performance. I think what issue really starting to see in the space since we found the company about 12 years ago – 12 years ago is really once we address the new security threat comes from the content and application, so they need a much more computing power. So that's additional computing power need to come from certain processor or certain ASIC chip. So that's where the FortiASIC device advantage to address the new function with better performance. So that's have a huge advantage compared to a lot of a software company approach. I think it's – right now I see the whole market starting to realize the traditional firewall may not quite secure, so you need that additional function in the content, in application but this additional function which has a huge performance impact. So I think as we see a few new company trying to address this new security function, but then the performance become a huge problem.

So we see many customers when they deploy some kind of new approach, we saw the huge performance impact. So that's the one that each we have identified and so we have tried to soft since long time ago with the few generation of FortiASIC. So that each generation we tend to improve the performance allowed and also keeping moves and function from the CPU into the chip which faster and at the same can kind of improve the CPU performance of the modest function.

So I think that's the benefit for the FortiASIC and FortiOS is really more try to address the new change in the space that all this kind of (inaudible) or the [MDM] or some other mobile security issue at the same time or the new change in application in the space. I think it's for the current customer which lot has a FortiGate, it had a support and all this account firms we upgrade, and that the new FortiASIC will be keeping building a new FortiGate system just like the FortiGate-800 which has announced few weeks ago. So that's the one will be gradually come out every quarter with the two new system and the helping improving the performance and functionality there.

Jayson Nolan - Robert Baird

Would either refresh open ups the possibility of larger deals are more big deals?

Ken Xie

Definitely will enable us to getting more deal because with the additional function of performance is open up more doors for us. And like we said we are very strong especially in the high end in the carrier space, in the data center. Now we're starting to see the big enterprise, see the benefit of the UTM with a good performance and also that not in the function to address that security need.

Jayson Nolan - Robert Baird

Thanks. Congrats in the quarters.

Ken Xie

Thank you very much.

Operator

Our next question comes from Jonathan Ruykhaver from Morgan Keegan.

Jonathan Ruykhaver – Morgan Keegan

Yes. Hi, that is brilliant performance. I wondered if you could talk a little bit about the financial services vertical. It's a vertical even making some investments around from sales capacity standpoint. So just kind of curious what kind of progress you have seen in that vertical from a proof of concept perspective and when might we see some of those opportunities moving forward?

Ken Goldman

So as we see you'll see it. No. We are seeing some improvements there, we're actually have an improved quarter in Americas they're trying to get the numbers here. Financial services, you know happened little bit from Q1, actually not as quite as good as last year's Q2. But it did start to – a significant win we had over there in financial services, some pretty good deal this quarter over Asia-Pacific, you know I think there is more work to be done there I think there – we are frankly quite confident we have the products and the capabilities and we're doing some things to – I mean to say improve our ability to execute in that area in Americas, so I'll just leave at that.

Ken Xie

Yeah. I think the big (Inaudible) in the finance service, it was some of their IT spending whatever also kind of more flat compared to some other – other vertical markets. But we believe we're keeping gaining share in our space.

Jonathan Ruykhaver – Morgan Keegan

Is there anything in terms of architecturally -- are those networks are configured and the firewalls are configured, that makes it more difficult? Or is it just a matter of spending the time and executing.

Ken Xie

I think maybe both because people starting to realize in the finance (Inaudible) that the traditional network security approach, not good enough. So they need to gradual upgrade so that's a one trend they're seeing there. And the second part also we – we're also keep ahead the theme and really keeping – (Inaudible) the space.

Jonathan Ruykhaver – Morgan Keegan

Right okay, then just one final quick question. Check Point introduced their – news there is of high-end appliances for the enterprise and service provider, late last year, did you see those new products in the market? Do you see them competing more effectively with service providers?

Ken Xie

We're not quite seeing the margin at service providers. Service provider is a very special market, which the performance availability and [virtual relation] and the compare other the multiple (Inaudible) and also the multiple functions are quite important. So far we don't see real competition from other vendor yet.

Jonathan Ruykhaver – Morgan Keegan

Okay. Okay, good. That's all I had thanks.

Ken Xie

Well, thank you.

Operator

Thank you. Our next question comes from Shaul Eyal from Oppenheimer & Co. Pardon me, your line is open, if you have your phone line muted in [earphone] please.

Ken Xie

I know you're there, Shaul.

Operator

Our next question comes from Rick Sherlund from Nomura.

Rick Sherlund – Nomura

I wonder if I could just touch for a moment back on Palo Alto and are you seeing them much in the market and, you know, their claims to have better architecture, better scalability. What are your thoughts on -- I understand how you're positioning your products and how you sell, but in the market is this issue coming up much for you?

Ken Xie

I think, first the whole network security space definitely have – we see all the new – we see new technology, that's healthy and helped the whole space. As for the -- that's where – likely said – (Inaudible) when we started the company 12 years ago, and we see the need to address the content application area, and the Palo Alto also tried to address the similar problem, but they had started much later than we are. And I think they help educate the whole space, but I still see their biggest problem really is the performance, when you enable the additional function in the content – in application, with that additional (Inaudible) power – what's also the performance will suffer a lot. So that's the issue we addressed since we founded company 12 years ago.

But I do see the kind of heavily invested in certain space which, where we are not quite focused before and that we're starting kind of what change in improving in the last few quarters and starting catch up quickly. I think it's their overall – I think really the new dedicated security company, like where the Palo Alto, or Fortinet or some other company they tend to kind of a (Inaudible) space changing quicker and they can provide a better solution and the quicker solution to the new market issue there. So that's keeping the whole space more healthy and also a kind of address the customer need.

Rick Sherlund – Nomura

So how much – how often do you see them in the market now?

Ken Goldman

Yeah, I think we intersect maybe 15% to 20% of the time. My sense is, they don't see us because they, as you can say they're focused on certain areas that we hadn't focused on in the past and the same on our side as well. You know, might we see each other a little more in the future perhaps, but I think there's a plenty of opportunities for both companies given that we're all driving innovation.

Rick Sherlund – Nomura

And Ken, as far as the overall macro environment goes we've talked a lot about this already, but I'm – in most companies or – I think it's a little harder to get their numbers, it feels like, we're not seeing quite the upside maybe that we did before. You guys seem to be executing very well. You've got some new product momentum. If we look at some of the verticals like, government, you say that did well. That's the vertical we've heard issues within the US. Any reason to believe that either government vertical might look softer going forward or, anything on the horizon there, you're getting a little more concerned about – does this feel like you're having to work harder to get to the deals. And some color around the tone of the environment.

Ken Xie

Yeah, that's why I used – that's why I thought about I used the word towering through, because clearly you know you don't just sit there and wait for a deals to fall in your lap and so yeah, you have to go out and compete very hard. I mean, I think the space we happen to be in is generally doing okay. In terms of – because there's some much going on in security. And the thing that really it drives me really is it, how pervasive the need is, for a product and so. You know, we cover you know virtually every vertical and so you have the – your classic industrial companies, you have healthcare, you have education, you have government, you have retail and et cetera, et cetera. And so I think that really helps a lot. Is that you can go and address all these various segments and like anything in any business, there's always some ups and downs you have in any quarters. You know that well the rest of you in line know that well, and then having the breadth of vertical, that – when we address the breadth of verticals really helps us a lot as well as geographies.

You know, do you have from times to times some accounts you have to make sure you stay on relative to collections, yep, but we made our collections quota last quarter so. This is all about staying on top of every little piece of the business. And executing and I think it will be really harder to have big upside surprises than maybe in the past what people would not be as prevalent to over-order I do a larger deals but I think the plan we have is really pretty much the same as it has been in the past.

Ken Xie

Yeah, but I think the overall space is as close to $10 billion the whole network security, what I'd say today or probably the majority still the traditional firewall, and which not addressing the content and the application security. So that's in the slide 13, I can see, it's our vision 12 years ago, how to address the new side of (Inaudible) from the content and application layer there. I think that – that's what the new company tend to – gaining market share because we're still relatively small in the whole market share. And we do believe in the next few years the whole market will be all adopt, it's a new security approach which not only address the traditional connection layer security, which the firewall or traditional firewall, (Inaudible) but also a new content application security draft the UTM handbook, so that I think that – that seems to – we're gaining the market share, it is a huge market, it is really helping us growing faster than the whole market space.

Ken Xie

Selling is you know obviously a great skill, what appeals you will particularly in SMB for UTM there's the ability to be very very cost effective with, what appliance. So have an effective – a very cost effective solution for a lot of accounts that, might have had multiple products.

Rick Sherlund – Nomura

All right. Okay, thank you.

Operator

Thank you. Our next question comes from Brian Freed from Wunderlich Securities.

Brian Freed – Wunderlich Securities

Hi, guys. Good afternoon. I had a couple of questions about the product mix in the quarter, you know, first hearing from (Inaudible) that you're seeing an uptick in demand for FortiWiFi, wanted to see if you could confirm that and really who you're seeing from a competitive standpoint there.

And then secondly, I have heard from other vendors that there might be some shift more towards the lower end products, as people look to drive cost saves. I wondered if you're seeing any similar product mix shifts at usual sales cycles?

Ken Xie

The first one on the WiFi, is mostly comes from our current customer, so they don't view as efficient and also as kind of – frankly to have a different infrastructure to manage the wireless security – that's mostly network security company addressing today, and also the WiFi management security. So that's where the -- seems like a 4.0 about two-three years ago, we started adding the WiFi management in the current FortiGates. A lot of current customers started to see the huge benefit of it. But as DoS, so now that the focus we have still more on the network security side. Which I specially – what can result as a service provider, resulted and the price right now. That the WiFi has just – starting change in the whole space, I think eventually, could be a huge market because whether the under-priced or some other ones studying kind of a more deployed the WiFi wireless even some, (Inaudible) more deploy some wireless solution there. So that will give us more advantage because we have a leading positions in the wireless and the network security area.

And on that lower end we do see a from time to time a customer trying to compare the price, the function there. So one advantage we have, both for the low and the high end is really leverage the FortiASIC, especially we have the search, we call system-on-a-chip, we've integrated that multiple security function together with the CPU with memory, so that can generated the whole landscape with this new chip level approach, and with much better price performance, which we don't see any others current vendor – current solution can compete with us. So that's where every new generation of chip will be helping us.

I think that the new ASIC coming out later this year including this system on chip, the FortiASIC SoC.

Rick Sherlund – Nomura

Okay. And I guess, I understand – but in terms of these customers who are constrained on CapEx, are you seeing any shift from higher end products to lower end products here within your "universe"?

Ken Goldman

No, I don't think so.

Ken Xie

No, not much. I think one approach, we also try to help customers address also (Inaudible) really they become more moved to the service provider. So a lot of the security service provider can offer kind of a like a – whether cloud-based or service-based approach, we've recently used in the FortiGate as a best product – best tool to help them to address this new need, so we're thinking that's the approach eventually will also help customer address the CapEx (Inaudible).

Rick Sherlund – Nomura

And then just a clarification on some earlier questions, I think there's always concern around a new ASIC transition, that there might be purchasing freeze, as people wait for the new product. As you look at your past ASIC transitions, because you state, you staggered rollout tend to alleviate those on product freeze issues?

Ken Xie

No, we have not seen that kind of –

Ken Goldman

Yeah. We -- maybe exiting – the answer is really yes. We don't see anything that – you know, with it. It doesn't alleviate it. You're right, because first of all, that we – we can say we stagger the – utilization of the ASIC in various projects and that gets – that gets sort of staggered if you will over time. And so we don't preannounce which products those will be, so we manage two things, one is the inventory of existing products as we sort of go through, not the end of life but as we sort of phase them out, if you will.

And we bring on new products but it's – it's product-by-product that we introduce new ASIC as opposed across the line.

Ken Xie

Yeah. I think even we say we will have the new FortiASIC, FortiOS come out, but we are not selling the FortiASIC or FortiOS directly it all goes to the FortiGate system, which every quarter we have some new product which give much better performance and also a kind of more fitting the customer need. I think we'll continue to have this approach. I think it's a benefit of some of the OS and ASIC probably take some time from, time to time customers, but even using a current solution we all have a huge advantage over the competitors right now.

Rick Sherlund – Nomura

Okay, thanks for the clarification, I appreciate it.

Ken Goldman

Thank you.

Operator

Thank you. Our next question comes from Tal Liani from Bank of America Merrill Lynch.

Tal Liani – Bank of America Merrill Lynch

Hey guys

Ken Xie

Hi, Tal.

Tal Liani – Bank of America Merrill Lynch

Most of my questions were answered I just have one question about competitive landscape, Cisco has new products and it looks like, Check Point has new products and it looks like what's happening right now in the market is pushing everyone to bring products to market. You're outgrowing the market clearly, so who do you take share from, predominantly? And is there any change in the competitive landscape, which means competitors you've taken share maybe three years ago, you're -- now we change your taking from others. I'm just wondering if you can characterize the competitive landscape that way. Thanks.

Ken Xie

I think, if you look at IDC report, we released today, it's the study just come up on the IDC, so last year we become a number 4 behind Cisco, Check Point and Juniper. But our growth probably much higher than the all these other players, and so that's mainly keeping gaining market share there.

As for particularly which vertical market, which country, it's really depend, as certain country we are winning a lot of enterprise, some other country is really the service provider, we dominate. It's a whole mix, because for us really kind of what different is most other vendor we are kind of very evenly split up across the product line from low end (Inaudible) high end, and also from the region so that gave us kind of more advantage and instead to depend on one or two vertical markets or one or two region, we feel we are more stable, more smoothly keeping gaining share growth overall.

Ken Goldman

I don't think – yes the other way of this – relatively high level (Inaudible) I don't give any permanently has changed, we are – we've been gaining share over the number of incumbents for the last several years. And I even with some products at some others talked about – it really hasn't fundamentally changed in terms of our ability to gain share, while some others are losing share.

Ken Xie

Yeah, I think as that probably we have better companies really, we really try to get a long term benefit, long-term approach, whether from the ASIC chip on the technology, also it have the sales (Inaudible) now the infrastructure. So which we feel that we can – scale better and the more long-term more smoothly, instead I will just go up and down in certain vertical space, or certain region. So that's the philosophy the approach we have since we started company. How we can gradually gaining market share, overall instead of a just particular market or particular region. And I think it's a result that kind of strategy we feel we can keep on gaining share.

Tal Liani – Bank of America Merrill Lynch

Thank you.

Operator

And our next question comes from Rohit Chopra from Wedbush Securities.

Rohit Chopra – Wedbush Securities

Ken Goldman, I want to ask you a question again on gross margin, it's down 300 basis points, sequentially, 400 basis points year-over-year. But I want to get a sense of really how much of that decline is some of the products costs that you talked about, some of the mix issues that you talked about in the quarter, and maybe other. Is there a way to parse that out, it is a big decline, year-over-year. So I just want to get.

Ken Goldman

Yeah, I mean year-over-year, you're correct. There is not that (Inaudible) quarter-over-quarter. I think the each of the factors of equal way that when we looked at it, and so I know they're getting one stands out, in terms of that. I would also add that we're within the range, we've always given relative to our models, in terms of gross margin model. And you know what, our expectations that we'll inch up if you will as we look forward to the next couple, or three quarter but relative to the factors that I pointed out I think that within the realm of it, when we did our analysis [to all] pretty equal.

Rohit Chopra – Wedbush Securities

Okay. And temporary means, like you said two to three quarters, correct?

Ken Goldman

So that's why I said, you know, I suggested we would inch up the gross margin in Q3 in terms of my guidance, that's what I gave you. And we haven't given exclusive guidance for Q4, but we gave guidance for the whole year.

Rohit Chopra – Wedbush Securities

Okay. Last question just on the government, it was fairly strong this quarter. Just trying to get a sense, are you seeing above normal seasonality, worse than normal, as you had into the government quarter, just to get a sense of that as you see that around the globe?

Ken Goldman

Yeah, and you know my sense is Q3, you know, it won't be anything abnormally different for us. You know, we're still certainly in the Federal, we're still relatively very very small player so seasonality won't really be a factor for us there because we're just such a small player.

And the rest of the government, it's still spread around the world that I just – at least at this point I don't see anything fundamentally different.

Rohit Chopra – Wedbush Securities

Thanks, Ken. I appreciate it.

Operator

Thank you. Our next question comes from Dan Cummins from, Think Equity.

Dan Cummins – Think Equity

Thank you, and thanks for all the detail on the call, I really do appreciate it. I have a question on the DDoS business. Did you see any – or did you record revenue really -- material revenue from the [Entry-Guard] acquisition. And just a question for Ken Xie about the strategy of offering robust DDoS appliance and where that fits in the overall product portfolio going forward, how important is it? Thanks.

Ken Xie

Okay. I think it's relatively new portal for us I'm not quite sure, I think probably the revenue is immaterial I believe.

Ken Goldman

Revenue is just – we've A, it's surely a good start, but it's relatively, yeah it's – it's certainly relatively immaterial. I would say, Ken's going to add to this, as we feel quite positive, I don't want to say bullish, because that will be overstated I think a little bit. But we feel quite positive about the opportunity for it to contribute, and even though we haven't pointed this out that much in last couple of quarters, our non-FortiGate product are contributing a nice healthy amount to our business still not each of them material but nonetheless helping us

Ken Xie

I think in the long term, what we see is – it's a great team and a good company we acquired and also we're working together to build a new generation of the DDoS product. At same time we also try – there's a lot of customer demand for the solution, so we also help in provide the customer their current need than the product they have in the past.

I think the market in the DDoS will be a it's a very fast growing market and the strategy we have really, there's a sort of function, the main ingredient to the UTM, but most other function we probably will be putting the standalone DDoS product, which secure the whether the commerce or website of some data centre there so this is quite an exciting space and we see a lot of potential there.

Ken Goldman

And I would say, I just want to add there, it's it's merely the not material, absolutely it's not material relative to growth quarter-over-quarter or year-over-year.

Dan Cummins – Think Equity

Ok Thank You very much

Ken Xie

Thank You

Operator

(Operator Instructions)

Our next question comes from [James Weston from Raymond James].

Unidentified Analyst

It's [Weston] sitting in for Michael Turitz, Ken Goldman, just quick question what was cash taxes this quarter and what do you expect on the basic 3Q?

Ken Goldman

Cash taxes was around $5 million and you know, I think that's the range you have to assume for the next couple of quarters. It will be roughly around there.

Unidentified Analyst

All right, so mid-single digit million. Great, thanks guys.

Ken Goldman

Correct. Single-digit millions. But certainly as I mentioned I think what I said before, $7 million up from the same period for first half over first half. Up to $7 million or so last year, where we paid virtually no cash taxes and it is becoming reasonably material now.

Operator

I'm showing no further questions at this time.

Ken Goldman

Okay, well why don't we end there so to speak. We will be back on the line, Michelle what time we'll be back on the line?

Michelle Spolver

About a half hour.

Ken Goldman

3:30 West Coast time, 6:30 East Coast for those who want to come back in and ask any other questions you've missed. So until then I guess you're free to call back in, otherwise we do thank you for staying the time actually for about an hour and a half that we were here to present our results. And we appreciate it. So with that I'll end the call. Thank you.

Operator

Ladies and gentlemen that you for participating in today's conference this concludes our program for today you may all disconnect have a wonderful day.

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