Fortinet, Inc. Q2 FY2023 Earnings Call

Good day and thank you for standing by. Welcome to the Fortinet Q2 '23 earnings call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Peter Salkowski, Senior Vice President of Finance.

Thank you, Trace. Good afternoon everyone. This is Peter Salkowski, Senior Vice President of Finance and Investor Relations at Fortinet. I am pleased to welcome everyone to our call to discuss Fortinet's financial results for the second quarter of 2023. Speakers on today's call are, Ken Xie, Fortinet's Founder Chairman and CEO, and Keith Jensen, our Chief Financial Officer. The live call will be available for replay on the Investor Relations website. Ken will begin our call today by providing a high-level perspective of our business. Keith will then review our financial and operating results for the second quarter of 2023 before providing guidance for the third quarter of 2023 and updating the full year. We will then open the call for questions. During the Q&A session, we ask you to please limit yourself to one question and one follow-up question to allow others to participate. Before we begin, I'd like to remind everyone that on today's call, we will be making forward-looking statements. These forward-looking statements are subject to risks that could cause actual results to differ materially from those projected. Please refer to our SEC filings, in particular the risk factors in our most recent Form 10-K and Form 10-Q for more information. All forward-looking statements reflect the 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, our references to financial metrics that we make today on today's call are non-GAAP unless stated otherwise. Our GAAP results and GAAP to non-GAAP reconciliations are located in the earnings press release and in the presentation that accompanies today's remarks, both of which are posted on the Investor Relations website. Ken and Keith's prepared remarks for today's earnings call will be posted on the quarterly earnings section of our Investor Relations website immediately following today's call. Lastly, all references to growth are on a year-over-year basis unless noted otherwise. I will now turn the call over to Ken.

Thanks, Peter. Thank you all for joining today's call to review our second-quarter 2023 results. Total revenue in the second quarter increased 26%, driven by strong revenue growth in our services, which grew 30% for the second consecutive quarter, with 34% growth in existing subscriptions and non-FortiGate product growing over 45%, which is nearing a $2 billion annual run rate. Building performance of 18% leads to more normalized product revenue growth of 18%. We believe our building performance reflects large enterprise concern with the macro environment in addition to some uniquely indigestion after two years of elevated 30%-plus product building growth during the supply chain shortage. According to IDC's latest quarterly security tracker, Fortinet continues to be the number one unit in the firewall category for ten consecutive years with over 50% market share, and we are now the market share leader in both units and revenue. Based on the latest Westland Advisory on Security and Cybersecurity report, Fortinet was named the leading ITOT network protection platform. We are currently one of the top and fastest-growing OT security vendors in the market that Westland Advisor expects to grow to $33 billion by 2030. Our integrated platform, proprietary ASIC security processor, and ability to converge network and security both on-prem and in the cloud across a single fully integrated operating system leverage advantages to drive future growth. In addition to our leading network security solution, we have increased our go-to-market investment in universal settings as demand for IoT security, cloud security, and security operations grows. We have dedicated more resources to support hybrid infrastructure and a hybrid world. Today we announced the new FortiGate 90G, our first next-generation firewall after our previous generation, with a new security processor known as FortiASIC, delivering industry-leading security functionality, performance, stability, and power efficiency at a cost-effective price. The FortiGate is fully integrated with our FortiGuard AI-powered security service and shows secure computing power reaching up to 16 times greater than the average of our competitors' similar price models while using over 90% less power than competing solutions. We also announced two new SD-WAN services under our performance monitoring service to simplify operation and enhance digital experiences. This new SD-WAN service showcases our commitment to expanding our service leverage and our leading installation base for future growth. We see our single vendor SASE solution opening a large new market, and one where our sizable SD-WAN installed base can be leveraged as a significant market access point. Together with the newly announced SD-WAN service, we plan to accelerate our global point-of-presence deployment, with a dual strategy of investing in our own infrastructure as well as working with service providers. Fortinet recently announced the results of our IT-dependent analysis by Forrester, which showed the cost savings and benefits of the current FortiGate next-gen firewall and FortiGuard AI-powered secure services within enterprise data centers, which included more than 300% return on investment over three years, payback in six months, and 90% reduction in time spent on manual updates. An independent analysis by Enterprise Strategic Group established that customers who deployed Fortinet Security operation solutions, such as FortiEDR and FortiNDR, reduced their time to detect and respond to incidents from an average of three weeks to one hour. This demonstrates the substantial impact that artificial intelligence, machine learning, and the integration of Fortinet's Secure Ops fabric product have on the operations' ability to secure today's rapidly expanding attack surface. Finally, new developments in AI, such as generative engines, show great promise for various applications in security. We believe AI technologies can significantly improve productivity and can be scaled to a large customer base in areas such as malware detection, threat hunting, event correlation, automation, as well as network design and troubleshooting. Before turning the call over to Keith, I would like to thank our employees, customers, partners, and suppliers worldwide for their continuous support. Keith.

Thank you, Ken. And good afternoon everyone. Let's start with the key highlights from the second quarter. Billings grew 18%, along with product revenue growth, while service revenue growth held firm at 30%, resulting in total revenue growth of 26%. OT and SD-WAN revenue continue to perform well, with revenue from these products rising 60% and 40%, respectively. In a sign of our strength in the small and mid-sized customer segments, we added a record 6,500 new logos. Operating margins of 26.9% exceeded the high end of the guidance range by 140 basis points. Free cash flow was strong at $438 million, representing a margin of 34%, benefiting from the deferral of certain cash tax payments to the fourth quarter. Looking at billings in more detail, billings of $1.54 billion were led by non-FortiGate billings, which grew over 30%, representing 34% of total billings. Non-FortiGate billings growth was driven by networking, FortiGate VM, NAC, and cloud. As Ken mentioned, non-FortiGate is nearing a $2 billion annual revenue run-rate. In terms of industry verticals, government and manufacturing topped the list as a percentage of total billings, with manufacturing up almost 50%, while government and construction grew over 30%. Retail was impacted by a very difficult comparison, as the industry nearly doubled in the year earlier period. Deal size over $1 million increased from 122 to 134 deals. Turning to revenue and margins, total revenue grew 26% to $1.29 billion, driven by non-FortiGate growth of over 45% and service revenue growth of 30%. This was the second consecutive quarter of greater than 30% service revenue growth. Security subscriptions represent over 55% of all service revenue and have seen strong increasing sequential quarterly growth dating back to Q1 of '22 of 23% to Q2 of '23 at 34%. Product revenue of $473 million increased 18%. Product lead times and backlogs are expected to approach normal levels in the third quarter. Total gross margin of 77.9% was up 140 basis points, driven by a 160 basis point increase in product gross margin to 63.5%. Product gross margin has benefited from earlier pricing actions and easing cost pressures but was partially offset by certain inventory charges. Service revenues constituted 63% of total revenues, delivering a gross margin of 86.2%. Higher service revenue mitigated higher labor costs and increased cloud delivery costs as we continue to expand our cloud SASE delivery models. Our single vendor SASE solution is opening a large new market, leveraging our sizable SD-WAN installed base as a significant market access point. We plan to accelerate our point of presence deployment with a dual strategy of investing in our own POPs as well as working with third-party providers to accelerate our deployment. Operating income of $348 million grew 36%, outpacing revenue growth by more than 10 points as operating discipline resulted in significant operating leverage. Operating margins of 26.9% exceeded the high end of the guidance range and increased by 210 basis points due to strong gross margin performance and operational efficiencies. Earnings per share increased 58% to $0.38, also exceeding the high end of guidance. Looking into the statement of cash flow summarized on Slides 7 and 8, free cash flow increased 55% to $438 million. The adjusted free cash flow, which excludes real estate investments, was $498 million, representing a 38.5% adjusted free cash flow margin. Free cash flow benefited from the deferral of approximately $190 million in cash tax payments. Capital expenditures were $77 million, including $59 million of real estate investments. The board recently increased the company's share repurchase authorization by $500 million, bringing the total available share buyback authorization to around $2 billion. I would now like to share a few significant wins from the quarter that exemplify the strength of our broad and integrated platform. First, a global pharmaceutical leader signed an eight-figure deal with Fortinet Cybersecurity Fabric, investing in our OT-aware secure networking architecture, as well as our AI operations and threat intelligence solution. Recognizing the market shift to a platform-based approach to security, this company chose Fortinet to secure its highly regulated and sensitive medical data, which continues to drive global operational and financial efficiencies through our broad integrated and automated platform approach to cybersecurity. In another significant deal, one of the largest U.S. school districts, which had recently upgraded its datacenter firewalls to FortiGate, sought to improve its network security posture with a NAC solution that offers better visibility to the devices connected to the network. Fortinet competed against multiple peers, winning the deal due to FortiNAC's ease of implementation, centralized management capability, and superior risk remediation, as well as tight integration with the existing Fortinet security fabric. This high seven-figure deal was the largest NAC deal in Fortinet's history. Finally, in a seven-figure displacement in our largest FortiSASE deal to date, a large bank embarking on its digital transformation journey selected our FortiSASE solution for over 5,000 users, integrating SD-WAN and SASE into a holistic solution that delivers comprehensive security both from the cloud and on-prem while ensuring consistent security policies for all users, regardless of their location, and wherever applications are accessed. These transactions illustrate how Fortinet's platform strategy, integrated operating systems, and proprietary ASIC technology continue to resonate with customers. Given the heightened interest in AI technology, we could not conduct this call without discussing Fortinet's investment and innovations in AI. Fortinet has been at the forefront of AI and machine learning innovation for many years, leveraging deep learning and artificial neural networks to power our products and security services, enabling a faster, stronger, and more accurate defense for our customers. One of our first AI-powered use cases was the introduction of the virtual FortiGuard Threat Analyst. FortiGuard addresses threats in real time with machine learning, coordinated protection, and is extensively used in malware detection and threat hunting. Every time a threat is identified, FortiGuard generates threat intelligence that automatically updates defense signatures across the fabric. In cloud environments where scale and speed are critical, AI and machine learning help security teams keep pace with threats on multiple fronts. All of this happens seamlessly and behind the scenes. Today, our platform, Guest and Analyzer, handles over 100 billion events every day to deliver over 1 billion security updates daily across the Fortinet security fabric and ecosystem. While many of our competitors OEM their security from different security vendors, our AI-driven FortiGuard threat intelligence has been built in-house, which allows us to leverage AI across different sources. Adversaries increasingly utilize AI in their playbooks to drive cyberattacks, which only increases the rapidly evolving cybersecurity threat landscape. We continue to invest in AI and machine learning technologies across our products, including generative AI, natural language models, and other implementations to enhance, simplify, and automate security for our customers. Before moving on to guidance, I'd like to offer some observations about the second quarter and the industry. Regarding the second quarter, we believe macro influences impacted our billing performance due to average contract duration. We saw shorter contract durations, with the average term decreasing by 1.5 months to 28 months, creating a 4 to 5-point billings headwind year-over-year. Normalizing billing growth with this change in contract duration yields billing growth in the low-20% range. It's not unusual for some enterprise deals to be pushed to future quarters, but in Q2 '23, we experienced an unusually large volume of deals expected to close in June that were instead postponed. From a market perspective, CIOs continue to prioritize and invest in securing their organizations in light of rising cybersecurity threats. We see new regulatory requirements, such as those recently announced by the SEC and the EU Cyber Resilience Act, continuing to provide market tailwinds as organizations increase their cybersecurity investments to comply with stringent new regulations. The cybersecurity industry remains highly relevant as CIOs prioritize cyber spending within their overall IT budgets, and the long-term demand drivers for Fortinet remain solid. That said, we do anticipate a return to more normal seasonality for Fortinet in the back half of the year, as the tailwinds from supply chain-driven growth subsides, and we cycle the prior period's price increases. Moving on to guidance. For the third quarter, we expect billings in the range of $1,560 million to $1,620 million, which at the midpoint represents growth of 13%, consistent with our quarter-over-quarter seasonality pre-pandemic. Revenue is anticipated in the range of $1,315 million to $1,375 million, which at the midpoint represents growth of 17%. Non-GAAP gross margin of 75.5% to 76.5%. Non-GAAP operating margin of 24.5% to 25.5%. Non-GAAP earnings per share of $0.35 to $0.37, assuming a share count of between 795 million and 805 million. Capital expenditures of $100 million to $130 million, with a non-GAAP tax rate of 17% and cash taxes of $25 million. As previously mentioned, backlog is expected to approach normal levels in Q3. For the full year, we expect billings in the range of $6,490 million to $6,590 million, which at the midpoint represents growth of 17% and applies slightly below normal seasonality in Q4. Revenue is anticipated in the range of $5,350 million to $5,450 million, which at the midpoint represents growth of 22.3%. Service revenue in the range of $3,350 million to $3,410 million, with the midpoint representing a growth of 28.2%. The service revenue guidance implies product revenue growth of 13.5%. Non-GAAP gross margin of 75.25% to 76.25%. Non-GAAP operating margin of 25.25% to 26.25%. Non-GAAP earnings per share of $1.49 to $1.53, assuming a share count of between 795 million and 805 million. Capital expenditures of $335 million to $385 million due to our continued cloud data center and facilities investments. Non-GAAP tax rate of 17%, with cash taxes of $460 million, approximately $380 million of which is due in the fourth quarter. We continue to execute our long-term strategy and remain confident in our strategy and our solutions. While it's early to be providing guidance for next year, we would expect our near-term performance to represent a short-term trough. Given our confidence in our solutions, we anticipate that growth comparisons will ease as we move through 2024, and at this early stage, we expect billings growth to approach high-teens by the fourth quarter of 2024. And with that, I'll now hand the call back over to Peter to begin the Q&A session.

Thank you, Keith. Operator, just one quick reminder before doing the Q&A; if you can please limit yourself to one question and one follow-up question. Operator, you can open the call.

Thank you. Our first question is from an unidentified analyst. Your line is open.

Good afternoon. Thank you for your question. Ken, you mentioned the billings performance and guidance indicates enterprise concern about the macro environment. Could you elaborate on what you've observed from a macro perspective? You also mentioned a weak service provider business. Investors may see parallels to what occurred at Juniper last week in the carrier space. Could you share your thoughts on how those dynamics might be similar or different from your observations?

Sure. I think for the carrier service provider, we do see they are probably a little bit behind in offering certain services because the carrier service provider, if you look back 10-15 years ago, was our biggest market; about 30% market share came from the carrier service provider. Nowadays, security needs additional services like SASE, and all these functionalities that service providers are a bit behind on. So we're still working closely with them to help them accelerate their service capabilities. At the same time, we're also starting to invest a bit more into our own infrastructure, which, combined with the new services we announced today, including two new SD-WAN services, we believe will drive a lot of new opportunities in the security space and assist service providers in accelerating their security service offerings beyond traditional services.

I would probably add to Ken's comments, particularly as we talk about service providers and other verticals and customer segments. There are some lessons we can see from manufacturing, which performed extremely well in the quarter. They seem to believe they are under pressure in the threat environment, so their spending remains robust. The government sector was also strong; they have steady budgets that may not be influenced by a slowing economy as much as some other industries. Retail, on the other hand, is a clear indicator of a vertical that can be impacted by a slowing economy. As Ken mentioned, this idea of digestion relates to the high purchasing around SD-WAN technologies and implementations seen a year ago, leading to a current period of negative growth in the retail vertical.

We also observe that some cloud providers are starting to enter the security space, which can confuse some enterprise customers. It may take longer for them to evaluate various solutions. However, we firmly believe that a hybrid approach, combining on-premises and cloud solutions, will provide the best outcome for customers, even if the cloud may be costlier, around 3x to 5x more than on-prem solutions. In total, this hybrid approach likely creates the best solution for customers.

That’s helpful. A quick follow-up for Keith: you mentioned that a reinvigoration of a high-teens billings growth next year. How does performance this quarter and your outlook for the rest of the year impact 2025, specifically the $10 billion billings target that you've previously presented?

As we go through the second half of the year and enter our normal planning cycle for 2024, we'll assess what we're observing for our 2025 targets at that point.

Thank you for your question. Our next question comes from Gabriela Borges with GS. Your line is open.

Hi, good afternoon. Thank you. Keith, regarding the medium-term outlook, your comment on high-teens billings growth by Q4 '24, could you discuss how you thought about derisking the six-month and 18-month outlook? What leading indicators are you watching to determine when billings growth and product revenue will trough? Thank you.

Reflecting back on the industry, network security has maintained a relatively strong growth pace, averaging between 10% to 20% over the past 30 years. We believe our unique advantage in solutions—having developed our own ASIC—positions us strongly in the competitive landscape. For example, the product we announced today shows about 10x better performance and additional functionalities compared to competing solutions while achieving significantly lower energy consumption, potentially 90% less. This new SP5 generation demonstrates that advantage with a 14-application engine integrated into the ASIC chip, which is more than double the previous version. This significantly drives growth for the next few quarters as we plan to introduce new products regularly, with additional models showcasing the convergence of networking to network security; this sector is projected to surpass traditional networking by 2030. We expect growth to continue in the non-FortiGate segment as well, with an impressive performance of 45% growth. Factors contributing to this growth include consolidation trends and shifts in security budget allocations recognizing the importance of cloud spending.

I’d like to correlate that with the guidance setting for Q3 and Q4. Given the research on various environments we've been in, we need to be quite nimble with our assumptions and what we expect moving ahead. The assumptions for Q3 were largely based on the actual results we observed in Q2. Billings for Q3 are projected to show solid growth between 1-2% sequentially, reflecting the usual growth trajectory. We might see a somewhat more cautious outlook for Q4, particularly as the seasonality assumption applied indicates lower growth than in past periods. We aim to balance expectations with the strength of last year’s Q4 as a comparison.

We are also excited to highlight growth in emerging segments like SD-WAN and OT, which grew 40% and 60%, respectively, contributing to 25% of billings. Additionally, we expect our 5G growth to ramp up, meaning we are well positioned with top-notch products for these new solutions, so we are optimistic about growth.

That all makes sense. Thank you. Just to clarify, should we assume that Q4 will be the trough for billings growth?

I would need to recheck our actual comparisons, as there are nuances between bookings and billings that can get tangled. However, the growth patterns in Q4 and Q1 must be pondered as we navigate the guidance process.

Additionally, you can refer to slide 10 of our finance presentation, which provides a retrospective over the last 13 years, showing some key growth and margin information.

I appreciate that. Thank you.

Thank you very much. Next, we’ll hear from Tal Liani with Bank of America. Your line is open.

Yes. Thank you. I will ask both of my questions together, with your permission. First, Palo Alto is reporting their quarterly call for Friday evening, which is historically perceived as a bad sign for that quarter. Given your results, does it indicate a deterioration in the environment over the last three months, and if so, what is the source? Are we seeing backlog challenges, or are customers simply deciding to postpone purchases? I'm trying to discern the meaning behind both your and Palo Alto’s reports, as both successful firms seem to be presenting cautious outlooks. The second question is for Keith; you noted projects have been pushed out. However, if they are merely pushed, why is billings guidance declining from 18% to 13% to 11%? If projects are delayed, shouldn't we expect a recovery in the second half from those pushouts from 2Q?

I’ll start, and Ken can share his insights regarding others in the industry. Yes, we did have pushouts in the quarter, but I’m encouraged by how deals have closed in July. I want to be clear: I’m not suggesting there will be a recovery for each pushout in Q3 or Q4, but I anticipate seeing some results stemming from Q2. But also, I’m observing some deals might shift from Q3 to Q4, and I believe the comparable figures from Q3 and Q4 from the previous year are pretty positive.

I can’t comment on why Palo Alto is timing their report for Friday, but regarding the industry, we have observed that many large companies are tightening budgets and taking longer to finalize deals. This trend has not only emerged this quarter but began early this year—it's difficult to predict how long it will persist. However, the security domain is generally underspending, which will eventually trend back upward after several quarters. Moreover, as economic circumstances tighten, companies often feel compelled to stick with existing products and opt for additional services, a factor we’ve been supporting by providing upgraded services such as the SD-WAN solutions we launched today. Overall, our product revenue continues to grow, and we've achieved number one market status in product revenue in the network security arena, holding over 28% market share.

I appreciate your response! Could you discuss backlog trends? How much of what we’re seeing in the last quarter's guidance is dependent on backlog trends versus the current environment? We're all looking through this. Will we achieve single-digit growth in the first half of '24 instead of double digits as you predict for the end of the year?

Backlogs have already returned to normal levels, similar to the state before the supply chain issues. Last year, as operations were streamlined, we addressed the supply challenges, and the majority of backlog relates to network products. Our backlog has eased up significantly in the first half of this year. There are cancellations, but generally the cancellation rate has remained in the low double digits.

Ken has given you a CEO perspective, but from a numbers point of view, we still have some backlog that will contribute modestly in Q3. By Q4, we believe we will be close to normal backlog levels.

Thank you for your question. Our next question comes from Brad Zelnick with Deutsche Bank. Your line is open.

Thanks very much for taking my question. I want to ask one of Tal's questions maybe a little differently. A lot of what you shared suggests your market position remains strong, and we’ve always thought your architecture’s price performance advantage could enable you to gain share in a tougher environment. If it's tough for Fortinet, does that implicitly mean it’s tougher for others? Can you share any insights on competition, such as win rates or pricing dynamics in the market?

I believe we maintain a competitive advantage with our unique ASIC chip technology. Our product revenue still grew by 18%, while some competitors like Checkpoint reported a negative 12% growth, and others are posting low single-digit gains. So we feel confident in gaining essential market share. That said, we also see some opportunities for further consolidation, leveraging our existing installation base. Secondly, there appears to be an inventory build-up among certain customers or partners, which has been impacting current sales, along with our recent service grace period policy change, which shortened the window for channel partners to activate services.

Regarding win rates for our top three competitors, we haven’t seen a significant change in those rates; they remain consistent. One area for us is that we had many deals lined up that were expected for closure—those that did not close late in the quarter. There may be an interplay between broader macro conditions, but we will assess any potential internal improvements needed as we analyze detailed deal progress.

The regional cautiousness seems to be consistent with the strong growth we exhibited in previous years, nearly doubling—now it is leveling off. The carrier service provider segment is still not ramping up, but we hope to see that change soon.

Thanks for the color, Ken. A final question for Keith regarding pricing trends, which has been favorable across the entire market due to supply constraints over the last couple of years. As supply eases, what do you see in pricing dynamics, and how does that factor into your assumptions for billings guidance this year and next?

Historically, when we introduce a new product, we typically price it relative to its predecessor. As we transition into the second half of the year, we may seize a few targeted pricing action opportunities surrounding specific use cases. For instance, if we are reaching the lower end of the market that engages low-cost franchise models, we may provide incentives to our channel partners at that level. Margins on product remain very strong, and we have that financial flexibility.

Thank you for your call. Our next question comes from Eunji Song with Morgan Stanley.

Hi. Thank you for taking my question. Regarding cancellation rates, could you provide directional insights on backlog cancellation rates and what’s incorporated in your end-of-year guidance?

Last quarter, I think we suggested cancellation might be in the high single digits. This quarter, we are now suggesting it’s in the low, low double digits. However, as backlogs continue to decrease, it won’t impact our operational dynamics significantly whether cancellation rates move from low double digits to mid-teens or even potentially 20.

Thank you. Lastly, could you share what percentage of revenue came from SD-WAN and OT security this quarter?

Combined, we see SD-WAN and OT security together accounting for over 25%, similar to what we've observed in previous quarters, with SD-WAN growing at 40% and OT growing at 60%.

We have over 25% of the numbers from bookings, but I don't believe we've shared a revenue percentage for that.

Thank you. Our next question comes from Saket Kalia from Barclays.

Hey guys, thanks for taking my question. I want to focus on SASE within the competitive landscape. Do you perceive the growing prevalence of SASE affecting firewall appliance decisions?

I think it’s a slightly different market. Some telecom service providers are taking a longer time to modernize, giving SASE providers opportunities to grow their services. Nonetheless, telecom service and cloud providers possess a significant infrastructure and cost advantage to provide additional security services. We're collaborating with them as we simultaneously enhance our infrastructure, supporting more services beyond SASE, such as SD-WAN and our FortiGuard services. Compared to other SASE providers, our model is more profitable and cost-efficient since we own our infrastructure.

For my follow-up, Keith, can you address the billings duration in the second half of this year? Any insights on how it fits into the previous context regarding your growth projections?

There has been recent discussion about billing duration. We saw a modest slowdown in duration, and over the past few quarters, I've said it isn’t uniform. The annual growth comparison yielded a shortened duration impacting growth by about 4-5 points. For what it's worth, when we look ahead towards Q3 and Q4, duration impacts are factored into guidance considerations as well.

Additionally, as employees return to the office, we're seeing interest in a universal SASE approach that supports both on-premises and remote work. Companies aim to manage the traffic without sending it back and forth unnecessarily, and enterprise customers are also exploring private SASE solutions.

Thank you for your question. Our next question comes from Shaul Eyal with TD Cowen. Your line is open.

Can you talk about the performance of your go-to-market strategy as it pertains to your top sellers? Did you see any major imbalances this quarter?

I don't have that specific data at hand.

We did see some noteworthy releases from exclusive networks, which account for around 30% of sales, but overall performance seems balanced.

Thank you for your question. Our next question comes from Joseph Gallo with Jefferies. Your line is open.

Given your platform breadth, you have a better perspective than most. When interacting with CISOs, what is the health of the cyber budgets? Where are you observing the most resistance? Furthermore, with your optimistic outlook for '24, what gives you confidence this period of digestion will last only one or two quarters? Is there any historical context to support that?

CISOs have plenty to manage when it comes to securing their infrastructure, and they’re faced with budgets that are being influenced by fluctuating market pressures. We see new use cases emerging, such as firewalls and security in the cloud or at the Edge. The intense threat environment creates substantial pressure on CISOs as they manage their budgets. Regarding 2024, we will utilize our traditional planning cycle to analyze how the contrasts will influence outcomes, making reasonably anticipatory adjustments reflecting more normalized spending patterns.

CISOs express challenges as they can't find enough operational personnel to support the hybrid work environments. This leads them to rely more on outsourced services. They also keenly manage new infrastructures, addressing both on-prem and cloud solutions. Ultimately, ensuring that security remains a high priority for them.

Thank you, that's very insightful. As we navigate this digestion phase, how should we consider future hiring investments? While you have seen outperformance in profit during the first half, your guidance doesn’t necessarily indicate sustained performance. Where should we expect incremental investments, given the growth versus profit balancing act as billings moderate?

We're still hiring, but substantial growth may be slightly behind top-line growth. We’re focused on improving productivity and efficiency. We're also enhancing certain hygiene processes that may have been neglected during the pandemic, ensuring performance accountability.

As Ken indicated, we have adequate sales capacity to reach our targets. And our historical operating margin has been around 25%, with continuous performance above that. This provides us the flexibility to invest more significantly in our channel partners to enhance collaboration, particularly over the next 6-12 months.

It's important to refer to slide 10 in our financial presentation, which includes key margins over the past 13 years. We’ve consistently generated GAAP profit since our IPO and possess margins that allow us to invest in growth.

Thank you. Our next question comes from Andrew Nowinski with Wells Fargo. Your line is open.

Thank you. Regarding geographic demand trends, how sustainable is the demand seen in international regions like Europe? Are they lagging behind the US in terms of macroeconomic impact?

We maintain a competitive advantage in regions like Europe and other international markets. Fortinet is often viewed as the incumbent and holds the number one market share position. While IT budgets may fluctuate due to macroeconomic pressures, we believe we can navigate these challenges given our strong foothold.

I appreciate it. Lastly, concerning the 6,500 new logos you added in the SMB segment, how do you compare against Microsoft's new Entra solutions in that space?

We leverage our extensive installation base and superior technology, particularly in network security. Microsoft certainly has a robust customer base within the enterprise market, but they don't specifically address network security needs as we do. We believe there is potential for both companies in this space.

That concludes our question-and-answer session. I would now like to turn the call back over to Peter Salkowski for closing remarks. Thank you for joining today’s call. Fortinet will be attending investor conferences hosted by Deutsche Bank, Goldman Sachs, Oppenheimer, Rosenblatt, and Stifel during the third quarter. Links for the fireside chat webcasts will be posted in the Events and Presentations section of Fortinet’s Investor Relations website. If you have any follow-up questions, please feel free to contact me. Have a good rest of your day. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.