Michelle Spolver - Vice President of Corporate Communications & Investor Relations Ahmed Rubaie - Chief Financial Officer and Chief Operating Officer Ken Xie - Co-Founder, Chairman, Chief Executive Officer and President

Robert P. Breza - RBC Capital Markets, LLC, Research Division Sterling P. Auty - JP Morgan Chase & Co, Research Division Scott Zeller - Needham & Company, LLC, Research Division Rob D. Owens - Pacific Crest Securities, Inc., Research Division Melissa Gorham - Morgan Stanley, Research Division Aaron Schwartz - Jefferies LLC, Research Division Shebly Seyrafi - FBN Securities, Inc., Research Division Michael Turits - Raymond James & Associates, Inc., Research Division Erik Suppiger - JMP Securities LLC, Research Division Gray Powell - Wells Fargo Securities, LLC, Research Division Daniel H. Ives - FBR Capital Markets & Co., Research Division Ron Zember Richard G. Sherlund - Nomura Securities Co. Ltd., Research Division Catharine Anne Trebnick - Northland Capital Markets, Research Division John Weidemoyer

Good day, ladies and gentlemen, and welcome to your Fortinet Q2 2013 Earnings Announcement. [Operator Instructions] And as a reminder, today's conference is being recorded. And now, I would like to turn the conference over to your host, Michelle Spolver.

Good afternoon, and thank you for joining us on this conference call to discuss Fortinet's financial and operating results for the second quarter of 2013. Joining me today are Ken Xie, Fortinet's Founder, President and CEO; and Ahmed Rubaie, our CFO and COO. In terms of the structure of the call, Ahmed will begin with a review of our operating results before turning the call over to Ken to provide additional perspective on the market and our Q2 business and product highlights. Ahmed will then conclude with some thoughts on our outlook for the third quarter and full year 2013 before we open up the call for questions. As a reminder, today we are holding 2 calls. For those who have additional or more detailed questions, we will hold a second conference call at 3:30 p.m. Pacific Time. Both calls will be webcast from our Investor Relations website and will be accessible as detailed in our earnings release. Before we begin, let me read -- first read this disclaimer. Please note 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 Forms 10-K and the most recent 10-Q, for more information. All forward-looking statements reflect our opinions only as of the date of this presentation, and we undertake no obligation and specifically disclaim any obligation to update forward-looking statements. Also please note that we will be discussing certain non-GAAP financial measures on this call. Our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and on Slides 12 and 13 of this presentation that accompany today's remarks. Please refer to the Investor Relations section of our website at www.investor.fortinet.com for more important information, including our earnings press release issued a few minutes ago and the slides that accompany today's prepared remarks. A replay of this call will also be available on our website. Note that we routinely post information on our website and encourage you to make use of that resource. With that, let me now turn the call over to Ahmed.

Thanks, Michelle, and thanks, everyone, for joining us today. I'm pleased with our execution during the second quarter, where we beat our guidance expectations on revenue and earnings, and came in at the high end of our guidance range on billings. Despite the continued macro challenges and uncertainty, we balanced our growth investments and continued to gain market share against our larger competitors. Consistent with our April expectations for the quarter, we continue to see mixed macro signals across geographies, extended sales cycles, and conservative purchasing behavior by enterprise companies and service providers. Having said that, we did see an uptick in engagement with service providers, as they are shifting their focus to high-capacity LTE service and continue to deliver managed security services. Also, while the theme in Enterprise generally continues to be cautious spending, we are seeing more engagement there as well. Of course, we are well positioned to help service providers modernize their networks, as well as enterprise companies scaled to the next-generation firewall, and other network security needs, which we believe could materialize into exciting business opportunities in Q4 and 2014. Before we delve in the results, let me spend a few minutes discussing specific execution improvements that we focused on during the quarter. As I've been discussing with you since April, we were very proactive in replenishing our inventory base in Q2 to help avoid product shortages similar to what we encountered back in Q1. We have an impressive product list, which we continue to build on to be the differentiated innovator in the space. We made good progress in Q2 in getting our inventory to more appropriate levels. After significant due diligence, we have concluded that inventory turns between 2 and 3 are more appropriate for our business, as opposed to the historical 4-turns-plus. Our…

Okay, thank you, Ahmed, and thanks to everyone joining us on this call. As Ahmed discussed, in the second quarter, we saw a continuation of a macro issue experienced in Q1. However, Fortinet executed well, so we had a solid quarter that meet or exceed our guidance across all metrics. We also grow our market share and enhanced our channel program and introduced a new product that we believe will both help further differentiate us and also drive the future revenue. So the latest IDC network security appliance market share data show that Fortinet has the largest year-over-year revenue growth of the top 5 vendors in the space, with a growth rate of 16.6%. Fortinet also improved our leadership position on Gartner UTM Magic Quadrant, moving further up and to the right, remaining in the top position of the Leaders Quadrant. Despite the spending conservatism recently seen from the service providers, we believe the future looks bright. The trend of delivering security as a service continue to gain momentum in the market and also drive a nice part of Fortinet's high-end business. And while still in the early stage, the move to the 4G LTE mobile networks is fueling exciting discussion with the carriers. So Fortinet's 4G LTE solution brings security benefits such as the ability to recognize and have full security around individual mobile device, and uniquely meet the rather high-performance security processing that the 4G LTE carrier network will require. Thus, we believe we are very well-positioned to benefit from this trend with our custom FortiASICs, which allow us to deliver industry-leading performance, as well as our FortiGate UTM platforms. So Ahmed talked a bit about the strong performance we had from our channel, which helped drive low- and mid-range deals during the quarter, and brought about more…

Thanks, Ken. As you've gathered, we continue to expect strong demand for network security solutions, and we expect Fortinet to be well-positioned over the long term. However, there are continued mixed macro signals in certain geographies and cautious spending behaviors. As a result, we generally expect a similar selling environment in Q3 as we saw in Q2, and continue to anticipate an uptick in our seasonally-strong fourth quarter. We expect to continue investing for current and future growth, but in a more selective and disciplined manner than previously envisaged. We also plan to remain focused on execution improvements, as I outlined at the beginning of the call. With that as background, let me update our guidance for Q3 and the rest of the year. During the third quarter, we expect billings to be in the range of $158 million to $162 million, up approximately 10% year-over-year. Total revenue is expected to be in the range of $149 million to $152 million, up 10% year-over-year at the midpoint. Gross margin is expected to be approximately 71% to 72%. Non-GAAP operating margin is expected to be approximately 17% to 18%, reflecting continued selective growth investments. Non-GAAP earnings per share is expected to be approximately $0.10 to $0.11 per share, based on an expected diluted share count in the range of 168 million to 170 million. Now turning to the full year of 2013, and consistent with our message back in April, we continue to expect Q4 to deliver a modest increase, given the normal seasonal uptick combined with some benefit from continued internal execution improvements. With that as background, we expect billings to be in the range of $660 million to $670 million, up approximately 10% year-over-year at the midpoint. We have slightly lowered this range by $5 million to account for…

[Operator Instructions] And we'll take our first question from Robert Breza from RBC Capital Markets.

I just wanted to get a little bit more perspective, as you look at the landscape here relative to the change that you mentioned in terms of your guidance. Are you seeing a heavier discounting environment or how is kind of product discounting working relative to what you've seen over the past couple of quarters?

Thanks for the question, Rob. Good to have you back on the call. The succinct answer to your question is we are seeing no pricing pressure at all.

Okay. Is that the same geographically, North America, Europe, or is that just an overall comment?

It is both specific, as well as across the board.

And our next question is from Sterling Auty from JPMorgan. Sterling P. Auty - JP Morgan Chase & Co, Research Division: So similarly, just from a high level, I want to make sure that I'm piecing this together correctly. It felt like there were certain things that maybe felt a little bit better in June. You're looking for a similar environment in the third quarter, but yet, you're still trimming the billings. What parts of the environment are you baking in a more cautious outlook? Is this service provider or is it a particular geographic region?

Yes, good question, Sterling. I think, consistent with our discussion back in April, it's really a continuation of mixed signals, starting at the service provider level, spending behavior across the enterprise and across geographies, meaning guys that sit in my shoes are writing smaller checks. And albeit we're not losing anything to competitors, it's just that buying behavior is resulting in smaller chunks, if you will. And in terms of geographies, we continue to be cautious in emerging markets like Latin America. And obviously, while we had a very solid quarter in EMEA on average, we continue to be cautious in EMEA as well.

Sterling, also, I had one area really[ph] . For the service provider, they're more in a transition towards the 4G LTE. So we see a lot of testing, and actually, we engaged, what we call, a testing result of carrier to see how to secure the next generation, the 4G kind of mobile deployment. So that's kind of -- is a bigger channel environment. And also, we believe we have the best position to cover in this area, because the performance, the expertise and also the customer base and plus the rich features, gives us the best position to play in this space going forward. Sterling P. Auty - JP Morgan Chase & Co, Research Division: I know the DSO didn't really give an indication of it but can you comment to the linearity in the quarter?

I think the linearity in the quarter was not anything different from Q1. Like most of our quarters, Sterling, a lot of what goes on is in the latter part of the quarter, and particularly in the last couple of weeks. Being it's the first quarter under my belt, I didn't really see anything that's out of the ordinary. Sterling P. Auty - JP Morgan Chase & Co, Research Division: Okay. And last question. Can you quantify how much impact on cash flow the inventory churn change has?

Well, I think, in the current quarter, it was probably an increase closer to $10 million. And if you go to the balance sheet, you'd probably see it in the payables. So there's a mix of what we paid for and stuff sitting on the payables. But I can tell you, at a high level, we replenished by about $10 million.

And our next question is from Scott Zeller from Needham & Company. Scott Zeller - Needham & Company, LLC, Research Division: Regarding Service Provider, there was something in the prepared remarks about protecting mobile devices and 4G LTE. Could you comment on the way in which your solutions are deployed, whether it's some of the larger SKUs for internal use or if it's the balance moving towards some of the smaller devices that are remote-managed? If you could just comment on the mix perhaps and the behavior in buying is changing at all in Service Provider?

Okay. I think, the mobile device, definitely, we see quickly becoming very, very popular, especially the smartphone now is the new mobile device, which the 4G LTE help interconnect all of them together much faster. But as another mobile device, they have a limited like a memory computing power compared with the traditional PC. So that's required a service provider provide a much cleaner environment and also try to manage from a service provider area instead of a lot of the customer themselves. But also, they need like a huge performance, a processing power compared to the traditional mobile approach. So that's what we see, this kind of a high demand of this new approach in the carrier space, how to secure the new mobile device, both coming from enterprise and also the consumer area, and so we engage in many kind of testing. There's still more in the early stage, but has a huge potential to really become a huge business opportunity going forward. Scott Zeller - Needham & Company, LLC, Research Division: I guess, just to follow-up, are you seeing a change in the mix of SKUs when you sell into Service Provider, either towards lower end or higher end, or is it relatively stable, the balance of service provider?

This is more -- I think, I believe, once the 4G LTE go forward, probably more in the high end, it's different than the traditional MSP. The traditional MSP we see 2 models, 1 is some bigger service provider data center, they more use a centralized approach with a bigger box to manage few hundred or few thousand customers. And other MSP approach is really the low end, the CPU deployment, which they remote-manage the smaller device on customer side. But for the 4G LTE, so far, we see most attachments [ph] are the bigger box, the carrier grade and the reserve. Whether the chassis-based or kind of huge box, the need to support like millions of customers. So that's all the more high-end requirement. Scott Zeller - Needham & Company, LLC, Research Division: So it sounds like the mix is unchanged at this point but it may move towards higher-end?

I think, once the LTE is fully deployed, definitely, would drive the high end.

And our next question is from Rob Owens from Pacific Crest Securities.

I just want to ask a couple of questions around the inventory and the level. With the strong sequential increase in product, and I think you talked about a range of 2 to 3 turns, curious why that's more in the middle of the range than maybe at the high end? And maybe just a little bit of color as to why you're taking those turns down so aggressively? Is it a function of more product breadth as to kind of the back end weighted nature of the quarter or just maybe strategically, a little color as to why you're going to this level.

Sure, Rob. No, it's really more of a strategic play, but it's also, in part, in reaction to what took place in Q1. So in my other head as Chief Operating Officer, I spent a fair bit of time in my first few weeks studying how we actually go about inventory planning and how things play out. If you heard me answer the linearity question, it continues to be back-end loaded in the quarter. And so it's a heavy speculation game in terms of what goes on at the end. Given our cash balance, quite frankly, I thought the better part of wisdom is to replenish based on what we see in the truly convertible pipeline, bring it on board and be thinking at least 2 quarters out, not just the current quarter. So that's really the thought process and the methodology that went into place. I said 2 to 3 because I really think that's where we need to be going forward. We're just starting the journey. It worked quite well. It was very calm and collective in getting our stuff out the door. I was on the warehouse floor myself until the last hour that Friday. So I feel very good about what we've been able to do. And I see it also as a journey of continued improvements as we go forward, so we're not done yet.

Also I want to add is, I think, based on the past quarter, inventory and also the backlog and also the additional cost for the rush shipment and then also for the loss of business opportunity, if we have the inventory shortage. So we built the operation model to compare what's the cost with excess inventory on one side and also compare to the cost for the actual inventory, but also kind of with a loss of the -- I mean, there's -- once we determined we have excess inventory, there's some cost for the excess inventory. But on the other side, if we have inventory shortage, we also see a high-cost, opportunity cost, and also, the rush shipment cost. Because we have 2 shipping centers, one is in Sunnyvale, U.S., one in Taipei. So the rush cost also costs us a lot of dollar. So I think based on the model, we kind of try to find out what's the optimal inventory levels. So that will take us some time to see what's the best model to give us the best value and also the lowest cost, so that where we come up with the number, 2 to 3 turns of inventory will be the optimal model, compared to before, we have 4 turn of inventory per year.

We'll take our next in line from Keith Weiss from Morgan Stanley.

This is Melissa Gorham calling for Keith Weiss. I just have a question on EMEA. It was the region that outperformed, which was pretty impressive in this kind of macro environment. Just wondering if there was anything specifically that you did in that region, from changes maybe to sales or the channel or whatnot, that drove that outperformance?

Thanks for the question, Melissa. It's, in part, what we've been investing. So it's part of the fruit we're reaping in our continued investment in sales and marketing. So if you go back to 1 year ago, we were talking about investing in the EMEA region. So that certainly helped in terms of execution. But I think we need to look at EMEA on balance and seasonality of EMEA, also with balance with what's going on in the macro. So I wouldn't interpret 22% year-over-year growth to be the going run rate. We were very pleased with what we were able to do, and certainly was part of what we expected when we guided back in April. So in short, I think, what I would tell you is we feel very good about our sales capability in EMEA, our channel capability in EMEA, and we're navigating the storm as it comes along.

Yes, the investment, I kind of believe really when the economy goes downturn, that's the best time for hiring people, to invest in the business. So that's what we did in early 2009. And in EMEA, we see the slowdown about 2 years ago. And then, we found out that we're in a good environment for hiring some additional good people on board. So that's when we started doing that 2 years ago. So now, you can see the result of that investment starting to translate into a faster growth. I think, in U.S., we're also starting to do similar things, starting like a couple quarters ago. And we believe will take about 1 to 2 years to see some of the return, see some of the result. And we feel sometimes the downturn is really the best opportunity to really invest into the business.

Okay. That makes sense. And that actually leads me into my next question. You mentioned that you are investing for growth and you definitely see that in the op margin guidance. I'm just wondering where those dollars are going to go, from either a functional perspective or are they going in sales and marketing and R&D, and also from a geo perspective?

Yes, I think, in general, Melissa, they are going across the board between sales and marketing and R&D, and obviously, some infrastructure support as well in operations and G&A. I'm not really prepared to give you specifics as to geographies, we do that based on our execution in quarter and we balance the equation and prioritize where we think we're going to get the best return going forward.

And our next question is from Aaron Schwartz from Jefferies.

Ahmed, I think you spoke about the longer sales cycles that you're facing, I think you also spoke about some -- taking some steps from an operational standpoint to address that. I was wondering if you could specifically talk to some of the things that you're planning here in the back half? And then, secondly, now that you've had a little bit of time to take a look at the business, I was interested in your perspective of where you think the service attach rate is on your customers? I know you spoke about some customers upgrading to new appliances, do you think the company is getting the proper attach rate or is there opportunity to increase that?

You bet, Aaron. Thank you for the question. In terms of your first question -- and I apologize, I forgot.

Just the operational steps you're taking to address longer sales cycles.

Yes. And to the extent that sales -- I wrote down the second part. Sorry about that. From a competitive perspective, I'm not going to give you too much color on what we're doing, maybe that's why I selectively forgot it. But I will tell you, what we're doing is where we're seeing it, we're obviously, as we guide for any prospective quarter, we're offsetting -- where we see weakness, we're offsetting in other areas where we can get better execution. So that's part one. Part 2, in terms of extended sales cycles in particular, we're effectively making sure that we've got all the right resources, and particularly in areas, as Ken talked about, where there is testing of newer approaches to doing things. So in the service provider world, where they're looking at shifting more to the 4G LTE, we're making sure that we're pulling our best resources on those accounts to manage customer demand. Beyond that, it's really just a simple tackling and blocking as we go forward. In terms of the services attachment, I am actually very, very pleased with what we were able to do in the current quarter and equally as important as we look forward because, as you know, at the end of the day, that is higher-margin stuff, as well as giving us more predictability or more visibility in guiding our revenue. And I see it across our entire customer base, across geographies, and I'm equally as encouraged by the demand out of the larger enterprise companies for our professional services. So I think the attachment is very good, and I expect it to continue to be in the same range.

This is Ken, I can add a little color. So for the first question, I think, if we look on the Fortinet business, we kind of have a 1/3 in each of the area, like the SMBs, like SMB channel is about 1/3, we're doing quite well. We keep on growing and also has probably the best channel program in the space and also with the best product. And then, you see the carrier service provider, they're more in a transition to the -- whether the 4G LTE or some other cloud-based operation model there. So we're also doing well because they're part of our strong feet into the high-end, the carrier environment. And then in Enterprise, we also see some good growth last year and then -- but also Enterprise need a more marketing and need some other additional like support into the channel, and also some other like some feature, like what are the ATPs, some other things we need to feed the customer need. So we're also enhancing the marketing program right now, and also pass the ATP subscription service we talked about in my script, is also we feel is quite important to keep growing in enterprise environment. So that's for all the 3 segments, I think we covered quite well.

And our next question is coming from Shebly Seyrafi from FBN Securities.

Can you talk about your thoughts on Cisco acquiring Sourcefire, how you think that changes the competitive landscape? Did you think that makes Cisco more formidable or do you think that Sourcefire within Cisco actually slows down their sales?

I think, first, we are not directly competing with Sourcefire. We are more into the intrusion detection provision, that's really deployed behind a firewall. I know, in the last couple of years, they started to add some firewall function there. But the primary business still in the intrusion detection provision space, so that's where we have -- we pretty much have not seen them, compete with them. And also, the sectors, they are more into the big enterprise and the government sector, which is also the area we try to grow going forward. So we don't see much overlap there. And I think, Cisco probably added Sourcefire because some of the advanced IDP, intrusion detection and prevention function, is needed in their latest offer. But also, I have to say, sometimes the integration, both on the team and on the product, is also quite a challenge. I know Cisco is traditionally doing pretty good job on merger relation[ph] . But to integrate all this product function and the team, I have to say, so far, from my experience, I have not seen much successful integration yet.

One more, if I can. Your Americas and EMEA billings growth accelerated in Q2, but I think you're concerned about EMEA slowing down in the back half. But APAC slowed down quite a bit, as I see it. So I'm just wondering, in terms of the guide down on the billings for the full year, is this driven, in a priority sense, if you can prioritize this, more by Asia slowing down or EMEA not maintaining that momentum it had in Q2?

No. I think, it's broader than just EMEA. I was merely giving color on the 22% in the current quarter. So I think, when you look at the rest of the year, first of all, in terms of Q3, we expect it to be more like Q2. And whether that's slightly up in one place, slightly down in another, on balance, it will resemble Q2 from a selling environment perspective. As you look further into Q4 and triangulating on the rest of the year, Q4 is seasonally our strongest quarter. We have been working on multiple areas of execution on the sales front, so we're expecting some improvements, and it's really across all pockets. So nothing specific to a geography or a sector.

And our next question is from Michael Turits from Raymond James. Michael Turits - Raymond James & Associates, Inc., Research Division: Ahmed, I wonder if you could bridge with as much detail as you can, the reduction in the free cash flow guidance of down to $10 million to $15 million. Exactly on a full year basis, how much is the contribution down, obviously know how much down from billings, how much of the contribution down, if you want to say it, from margin, how much from inventory? And is all the CapEx in this year, the $20 million? And perhaps, what should we think about cash taxes? And then, equally as important as that bridge is how should we think about '13 into '14. In other words, what are the puts and takes that would make cash flow go up or down relative to net income growth? Does CapEx just return back to normal, do we have a kind of more consistent inventory turns on a year-over-year basis, cash taxes, et cetera?

Yes. I appreciate the question, Michael. Let me see what I can do on this call, and if you need more detail, we can cover it on the next call. But if you look back, we guided $140 million to $150 million back in April. Now we're guiding $130 million to $135 million. Billings, we've taken down by $5 million, so that's the first part of your bridge. The building, we accelerated the commencement or the start of the renovation. So I expect the total building cost to be around $20 million, a good $10 million to maybe $12 million of that to be spent in the current calendar year. And I'll know more as, obviously, the months go on in terms of what we're actually spending, but that's what we're currently projecting. We're expecting to move in early next spring, so there shouldn't be any further CapEx costs as related to the building after Q2 of next year. And then, in terms of inventory, we replenished by about $10 million, and I think, if you reconcile what's on the payables, some of that got paid for in the current quarter, some of it is on payables for next quarter, and that will also take place into Q4. So between those 3 items is really how you get to $130 million to $135 million. Cash taxes is pretty much the same, as we talked about it previously. And if you need more detail and taking and tying numbers, we can do that on the next call. I just don't have it in front of me. Michael Turits - Raymond James & Associates, Inc., Research Division: I guess, just at a high-level, if I think about CapEx which you just told me about, '13 going into '14, should I think that year now as working capital being more neutral? And at least cash flow from ops growing closer to in line with net income?

Yes, I think, the way to think -- and I'm not ready to talk 2014, but if you want just model at a high level, I think -- I gave you the detail on the CapEx and when it will stop. I think, in terms of working capital and particularly on inventory, expect the return of inventory turn of 2 to 3. If you want to be conservative, model down to the 2. And then, in terms of continued investments in the business, right now, based on what we see, at least for the rest of the year, we're still continuing to invest, albeit slower than we thought back in April. So you could assume similar levels for now until we actually study and put in the plan for next year.

And our next question is from Erik Suppiger from JMP Securities.

First off, the 4G LTE comments you made. In the past, most of your carrier businesses has come from managed security service providers. Can you give us some relative size, what you think the LTE market could be for you versus the managed security service providers? And then, secondly, on the operating margin, the guidance of 18% to 19% for the year, how do you look at that in terms of the longer term opportunity? Do you still anticipate that, that can move up into the low 20s or is this a spending level that you think is more -- it will be sustained for the foreseeable future or what is it that will give you better leverage as we move forward?

Why don't I take the second part of your question first and let Ken give you some more color on where the product opportunity is, Erik. So if you look at operating margins, unfortunately, I'm really only prepared to talk about the rest of the year. But I think it should be discernible to you that, relative to when I walked in the door in April, we're dialing back a little bit, and at the same time though, staying ahead of the game. So we have the ability financially, meaning our balance sheet position, our cash position is very strong, our cash generation is very strong. We see the opportunity, we see the level of engagement, whether it's with service providers or enterprise companies, and so it would be actually foolish to stop the clock on investing at the moment. So we're going to continue investing in growth. And for the foreseeable future, meaning, until December 31, I'm giving you the range of 18% to 19%. Obviously, over time -- and give us a chance to get through navigating the current year and building out next year's plan. But over time, it's not lost on me or Ken or anybody else that our spending needs to be more congruent with our top line growth, and we will manage that with the appropriate discipline. In terms of your own observation about a good chunk of our business, about 75% or so of the business comes from the sell-through model. And 20% to 25% from the sell-to. We're excited about both ends, but I'll let Ken comment on what the 4G LTE opportunity is in the sell-to.

Okay. I think the traditional MSSP program is still going on well. And the MSP, really we have half come from we call the centralized service provider program, and other half come from the CP. It's more like a decentralized managed remote device, whether on the customer side or some other DSL or some other broadband service, and they're using whether it could be monthly rental program, whatever the managed -- the smaller device on the customer side. So I think that side is still doing well. But the difference really, the service provider tend to more manage the pipe, more manage the -- like one who have the Internet access, they can give some -- like take out the spam e-mail or take out a virus or make the access more clean and also block some of the -- like the DDoS attack. The difference in the LTE is because the mobile device is kind of a -- the LTE [indiscernible] more targets certain end-user of certain enterprise, which they have some modern, like an iPad or some modern mobile device. It's a little bit different. And so far, we see the LTE testings are pretty much all centralized, the bigger part, high-end box, compared to the service providers are half the high-end box and the other half is really the smaller box in the customer side. And also, the performance requirement on the LTE is also much huge compared with the traditional MSP, because for them, really make sure the security of the 4G and network will not bring down the network because of the reliability that the access of the network for a mobile device will be the key to number 1. So the reliability requirement is much higher. The performance requirement, also much higher. And also, they also need flexibility and also make sure they can secure the traffic. Because one thing about 4G traffic, there's a lot of active content or kind of the content could be dangerous or could be kind of improper for certain user. So that's where they also need to not only go through this higher processing requirement, but also need to process a lot of content inside the traffic. So that's a little bit different than the traditional service provider. But it's really the LTE deployment started going, I see it probably will more drive to the high-end business.

And we'll take our next question from Gray Powell from Wells Fargo.

So Check Point talked about introducing some lower end SMB and mature branch office devices. How do you view the competitive environment on that side of the market? And do you foresee any changes in competitive intensity over the next 6 months or so?

Not really. You can see the press release we made last week for the 10 products. You can compare the performance, the function and also the price we have, because we are the only company in the network security space who have leveraged the ASIC chip technology. So we built our own recorder, FortiASIC system chip is already the second generation now. It has a huge performance and a cost advantage and also can enable us to add much more function compared to just use the CPU and they build a smaller computer to address this as SMB security solution. So I think we have a huge technology and a product advantage and also we have a quite broad channel, and we believe we'll continue to lead in this area.

And just to add to that, Gray, I mean, with my other head as COO and having spent a lot of time out with customers in my first quarter on the job, it's very clear when you're talking to the technical people at customers, there's really no match on the performance side, and particularly, as Ken points out, as we've unrolled now the second generation. So if you have any of those questions, I encourage you to actually talk to technical people in companies and you'll get a pretty straight answer.

Got it. That's very helpful. And then one more, if I can. Just how many sales people do you have focused on the larger Enterprise segment now? And then just -- can you just maybe talk about hiring plans there for the next 6 to 12 months, and where you're actually bringing in the salespeople from?

Yes, you'll have to forgive me. We don't actually disclose count. But I can tell you that it's an area where the company, long before I showed up, has spent a lot of rigor in building up that team, and I support it. We will continue to be doing so. Where do we hire from? We hire from across the landscape and focus on picking up A players. So we're very pleased with what we've done to date, and we're going to continue pushing the pedal. And then again, you'll have to forgive me, much like the question earlier, I don’t want to give away too much from a competitive perspective.

And our next question comes from Daniel Ives from FBR. Daniel H. Ives - FBR Capital Markets & Co., Research Division: Few questions. Ahmed, what -- I mean, obviously now, a quarter that you've been there, what are some observations that maybe in the close process you think Fortinet could have been doing better, maybe you've changed relative to, we'll call it, 2 of the last 3 quarters being choppy?

Yes. I would say it's never about 1 person, whether that's me or anybody else, that would walk into the role. I think in terms of being without a CFO for a couple of quarters plus and then Ken and the board deciding to bring in an operational CFO with an operating responsibility including sales and so on, that has given me the ability to at least get under the hood and look at multiple things. The areas that we focused on as a team are the ones I highlighted for you. So the first order of business is just simple blocking and tackling. What did we miss in the first quarter, let's make sure we don't repeat that again. That's things like inventory, and lo and behold, as we learned as a team, at the end of the day, we should have been running at lower turns just given where we are. I would say the other bit isn't so much that Fortinet was asleep at the wheel, I think it's the macro that's causing the navigation to change a little bit. And that was quite timely that I walked in right at the time of us missing earnings, as well as the macro really hitting the sector, and us, in particular, pretty hard. And so my focus was, during the quarter, is exactly as I outlined it. Operationally, make sure we didn't miss a beat in the quarter. In terms of sales execution, where we could make an immediate difference, we focused on it. And now we're, as I alluded to, we're making a heavy focus on the rest of the year, now that we have another quarter of macro navigation under our belt. And really to be frank, more planful for 2014. So I'm actually -- since you've given me the opportunity, I'm very pleased with, first and foremost, the fact that the product is very differentiated; and secondly, that we've got such a terrific team that has rallied to immediate change and immediate focus on execution improvements. So I'm encouraged by our ability to continue to grow, gain market share and execute better. Daniel H. Ives - FBR Capital Markets & Co., Research Division: Okay. And just as follow-up, the second half guidance, does that reflect the macro staying exactly as it is today, no improvement, no degradation?

I think, Daniel, in terms of Q3, I would say, yes, it's not any better, it's not any worse. And that's kind of where I was, even though -- I was only 1 week on the job when I gave guidance in April. But it turned out to be pretty close to the money. I don't see anything different today in terms of the next couple of months and wrapping up Q3. I do, however -- have spent some time under the hood, and as I look further out to Q4, Q4, if you go back and study it, whether it's back in 2010, 2011 or 2012, it's generally sequentially up from Q3 by about 17% to 20%. And so you take that, along with some of our ability to pay a return on investments, like we showed in EMEA this last quarter, as combined with some of the more encouraging discussions or engagements -- engaging discussions, I should say, we've been having, all of that mixed in a blender is our comfort level with Q4 and our full year guidance for the rest of the year. And we'll obviously update you as the quarter goes along, as well as, as we finish up Q3.

And our next question comes from Tal Liani from Bank of America.

This is Ron Zember on for Tal. So last quarter, you guys spoke about a change in the spending patterns of service providers. And you mentioned that some deals -- or some deals' sales cycles are taking a little bit longer, taking longer, and some deals that you were expecting to come in the first quarter didn't. And you expected them to come a little further out. So just wondering, what was the traction on those deals. Are those deals responsible for the increase in growth that we saw this quarter?

Yes, I think, look, I don't comment on specific deals, Ron. But at the end of the day, I will tell you that what we expected to happen in Q2, for the most part, happened. In terms of discernible behavior, what we're seeing is, sales cycles are lengthening, and it's subjective, so it varies from place to place. Some are requiring more senior executive-level approval. Some are getting that approval, but they're getting it in bits and chunks, meaning you can spend a fraction or a percentage now and another percentage a quarter from now. The good news is this. I can tell you that we've not lost a single one of those deals and we certainly have not lost anything to the competitors. So it continues to be part of our pipeline. And if it's partial, we're happy to go along for the ride. And as Ken pointed out, if it's more engaging in terms of thought leadership, since we are the differentiated innovator in the space, we're happy to go along for the ride as they continue their shift into the 4G LTE and just becoming better service providers themselves.

And just a quick clarification, on the $10 million to $12 million CapEx that you mentioned for the rest of the year, associated with the building, is that incremental to what was already in guidance last quarter?

No, no, no. It's -- we accelerated. So I talked about the building in the last quarter. I included a portion of that. But just given the timing and the ability to actually get started and be able to get things at a lower price, we started moving the project forward. So a chunk of that $10 million to $12 million -- and you'll have to forgive me, I don’t have it in front of me -- was already accounted for. So when you're building that bridge, it's really -- the lower billings of $5 million, a few million dollars or more for the acceleration of the project. And also, by the way, in part, to get some of the stuff done and executed in the current year. So we can come in rolling with the punches in 2014, as well as the continued investments we talked about.

Understood. And just a quick housekeeping item, and I apologize if I missed this. Are you -- did you guys break out headcount by geography and by department within the company?

We don’t break it out by number. I mean, essentially, you can figure it out because there is -- okay. So we don't, we don't. And so the answer is, no. In the past, we had given a pie chart which sort of showed where each of the -- where the headcount sort of falls, but we don’t do that anymore.

But the trends are the same. The trends are the same.

Yes, trend is pretty much the same, yes.

Nothing new and different.

And our next question is from Rick Sherlund from Nomura.

On the government business, 13% of revenues. I wonder if you can you just update us, we're kind of curious what's happening with government. Some companies suggested maybe this sequester is going to turn out to be worse than expected for Q3. Other companies say no, it seems to be doing fine. It seems like it's holding up pretty well for you. What's your take on the sequester and the impact on Q3, maybe Q4?

I'll give you my opinion on the question, and let Ken add or subtract from it. From what I've seen, Rick, is it's pretty steady Eddie for us. So it's neither better nor worse. And I really can't -- I know, I'm aware that others have commented one way or the other, but for us, it continues to be steady.

Yes. I think also, the 13% is more worldwide. And also counting all the government spending, not only the federal, the discretionary is more related to the U.S. federal, which is a very small percentage for us, so we don't see that has much impact or probably even not material to us.

Great. And on the inventory, how should we think about inventory risk going forward if your turns are going to decrease?

Well, I think, for now, we're managing the risk as we go forward. I did say, though, at the -- in the prepared remarks, that I view this to be the first step of the journey. Based on what we've done so far and how the quarter played out and the pipeline for the current quarter, I feel very good about what we've done and continue to do. But I will also, in tandem, promise you that we will keep our diligence and rigor on this, because we obviously can't afford it to go the other way. And in doing that, I also studied where the company has been previously, even in its private days before going public. And so at the end of the day, we -- based on information available to us, we feel like we've managed and mitigated the risk. But by the same token, never say never. So we'll keep a close eye on it.

And our next question is from Catharine Trebnick from Northland Securities.

Okay, I hate to do this to you, Ken and Ahmed, but could we go back to the LTE. I have 2 quick questions so I make sure I understand it. My understanding right now is there is not really any revenue contribution from any wins in LTE, but you are looking -- the carriers do have some RFPs out there, so you're looking to be in part of that build, is that correct?

Yes, you are right, Catharine. It's more in the testing stage.

Okay. And then the other thing I didn't quite understand, and I'm sorry to make you do it again, is which one of your security products are the ones that you feel best tailored to be in more on the mobile side, I guess, I'd call it more the left hand, the radio side of the network?

I think pretty much the high-end 5000s. That's the chassis-based to feed a carrier environment.

Okay. And would you say the opportunities that you're testing are more domestic or international, or could you provide any more color for that?

It's more worldwide.

And our next question is from Nandan Amladi from Deutsche Bank.

It's actually Taz [ph] on behalf of Nandan. On the Service Provider vertical, if I remember correctly, I think last quarter you had mentioned that the billings from Service Providers declined 9% year-over-year in Q1. How is that metric in the Q2 quarter?

It's about the same. It's at 25%, I believe.

You're talking about it as a percentage of total, it's 25%.

No, I think the metric that I was talking about was the growth in billings coming from Service Providers. And I think you gave a metric last quarter that the billings from Service Providers declined 9% year-over-year?

Taz, while I'm new to the game, I don't recall giving that metric.

We didn't. So, Taz, it's Michelle. I mean, we did not. So what we gave last quarter, what we give every quarter is the mix -- the vertical mix. It's not -- and so that stayed consistent. So 25% in Q1 and then 25% in Q2. So it was consistent.

I think maybe what you're referring to is overall billings [indiscernible]...

No, what I did -- I think my stats were based on your -- based on the revenue -- based on the billings mix from last year. So if you give the mix by vertical year-over-year, and then I guess, based on that, we can figure out what the growth rate of the mix was.

Yes.

Bring your calculator, we'll sit down and go through it.

Last year, year-over-year, was the only change. It was -- it represented 26%. But I do think Q4 -- I don't have that number, so I think sequentially Q4 to Q1, there was more of an extreme shift.

Okay. On the LTE opportunity, now you're seeing a lot more opportunity it seems like on the LTE side than -- I mean, traditionally you've seen the growth coming from the managed service side, and now you're seeing a lot of opportunity on the LTE side.

No, no, no. We actually see growth on both. I think the point that Ken was trying to underscore, which I picked up as well in my prepared remarks, is we are viewed as a thought leader in the space. So we continue to see growth from both ends. Obviously, service providers are in mixed baskets at the moment. But from our perspective, we expect growth from both ends. The point we were trying to underscore is, we are a thought leader, helping service providers focus on what they're going to do next in terms of modernizing the mobile network.

Right. And I think from an LTE standpoint, one other thing that we talked about in our prepared remarks is, the opportunity can be a long-term opportunity, so I wouldn't expect it tomorrow. The other thing is, it is still correct that the majority of our Service Provider business comes from MSSP. The LTE, in protecting own carrier networks, is part of the minority of business, but it's still something that we're excited about and we're having some exciting discussions.

Got it, very helpful. Now that the companies just be different on both -- on the different sides? Would you see different companies you're competing with on the LTE side versus the companies that you compete with on the managed security side?

Not usually, no.

Okay. Just one last one, if I could. The revenue from government was 13%. How much of that is U.S. federal out of the 13%?

We don't break that out, but federal is just a small piece of that. But that government revenue or billings that we break down is worldwide.

It's worldwide and it's state and local, that's provincial in other places, so it's pretty much across the broad. That's why I said it's pretty steady Eddie.

Okay. And this is the last one, hopefully. A lot of growth in the entry-level products. Was any of that driven by the refresh from the SOC -- the second generation SOC chip?

We just announced the 10 products last week, so we probably see -- the next few quarters, we'll see some good growth there. I think that last quarter, you might see probably only one product, the FortiGate-60D that you've seen. As you'll see, now we added 10 more, so we'll see, probably more will come in the next few quarters because the performance improvement is huge. The second-generation chip is a few times faster and also is about like 109 million transistors compared to the previous. It's a few times larger, faster chip. So it gives a lot of advantage.

And our next question comes from John Weidemoyer from William Blair & Company.

This is a John Weidemoyer for Jonathan Ho. I just want to clarify -- I have 1 clarification and 1 question. On the 4G LTE transition, just want to be clear, this is a related -- this is unrelated to the demand falloff that we saw in the first quarter in the Services Provider sector, right? This is a separate simultaneous undercurrent of activity. It's not like that vertical market, some of those providers withheld some of their spending because they're contemplating any other type of technology spend in this other space, correct?

That's exactly right, John. I think, let me try one more time. The point really here about the 4G LTE is the service providers, outside of their day-to-day business, are busy thinking about how to modernize their mobile networks, and across the world. So it's a new area, where innovation is required. We are being invited to the table as a differentiated innovator in the space. And that's -- the whole point is just, we're excited about a future opportunity and about the fact that we've got a seat at the table ahead of others. That's really the point.

Okay. And my question is, on the APAC region, I'd like to reask the question a little differently, because I just want to make sure I don't misunderstand your viewpoint. With revenue growth having been down in the second quarter, below our expectations and a continued deceleration from prior quarters, are you -- I'm curious about your outlook for the second half. Would you characterize -- when you said there were puts and takes across the geographies, and I believe you were implying Europe and Asia, would you characterize the macro volatility in those 2 regions to be approximately equal then?

This is Ken. I think in Asia, probably Japan is the biggest business to come from APAC. And in the last 2 quarters, we see some foreign currency exchange add some pressure to our channel partner. Because we sell worldwide in U.S. dollar, but our channel partner sell in the local currency. So sometimes, when the currency changing, they make a favor, they make a kind of a margin squeeze. So that's probably maybe happen in Japan because the currency changed quite a lot in the last couple of quarters. But since it's already stabilized, so we feel probably the worst -- we hope the worst is already over.

This does conclude our Q&A portion of the call. I'd like to turn it now back to the hosts for any concluding remarks.

Okay, everybody. Thanks for all of your questions, and appreciate the time you gave us. We'll be back on at 3:30 for those of you that want to come back on or those of you that did not make the call. I look forward to seeing many of you during the investor season.

Okay, ladies and gentlemen, this does conclude this portion of the call. You may now disconnect, and have a great day.