Fortinet, Inc.
Q2 2013 Earnings Call Transcript

Published: 31 Jul 2013

[Operator:]

Good day, ladies and gentlemen, and welcome to your Fortinet's Q2 2013 Earnings Financial Analyst Q&A. [Operator Instructions] And as a reminder, this conference is being recorded. And now I would like to turn it over to your host, Michelle Spolver.

[Michelle Spolver:]

Hello, everyone, again. And thanks again for joining this call. As a reminder, we hold this follow-up call to answer remaining questions that have come in since the last call. Joining me in the room today is Ahmed Rubaie, our COO and CFO; and Ken Xie, our Founder and CEO. Before I turn the call over for questions, I want to just remind you that all forward-looking statements made during this call are subject to the disclaimer stated in our earlier call. So with that, operator, we could take our first question.

[Operator:]

[Operator Instructions] And we'll take our first question from Aaron Schwartz from Jefferies.

[Aaron Schwartz:]

One follow-up for me. I apologize if I missed it. But I was wondering if you could just run through sort of the rationale and the thinking on the inventory change?

[Ahmed Rubaie:]

Yes, sure, Aaron. At the end of the day, in the first quarter, we missed -- part of our revenue miss was being short on product. So not only was that a miss in terms of Q1 numbers, it triggered the question of whether we have the right inventory model based on our current business run rate and where we're going prospectively. So we did a deep dive in terms of where a business of our size, our breadth of product SKUs should be and came to the conclusion that the historical turns of 4-plus was probably very difficult to manage going forward. So we took it down to 2 to 3. And part of the logic that where we had more flexibility than other companies is the fact that our cash position and cash generation is pretty healthy. And so we traded to make sure that we live healthier from an operational perspective going forward. Therefore, you should expect us to be running at 2 to 3 inventory turns going forward.

[Aaron Schwartz:]

Okay. And then switching to margins, you spent quite a bit of time on the call sort of talking about the reinvestments in the business and also some discipline there. I've gotten a question or 2 on this, but I know you're not guiding to '14, but is there any reason not to think that you should start to see a little better expansion in the out years given some of the investments you're making this year?

[Ahmed Rubaie:]

Well, I think -- I'm glad you gave me the ability to talk beyond just 2014. I think, look, prospectively, we will absolutely endeavor to get margins in line with our top line growth. At the end of the day, what we will not do is stop spending where we think it appropriate, particularly when we can afford it, at the cost of inhibiting future growth. So at the moment, you're catching us on the downside where we've taken billings down for the year, but we continue to see a fair bit of opportunity. Admittedly, we were underinvested back in 2010, 2011. We started in 2011. And the business was running at about 20% plus. So now it's running a little bit lower, and it's in our best judgment that it's going to continue to grow, so we're going to continue to invest. All that being said, for the current year, I think the point we were trying to impart on you guys is that relative to our expectations back in April, we slowed the dial down a little bit. We've given you what we think are the new numbers for the next 2 quarters. And, yes, at some point, you should expect us to be disciplined in tying both operating margins and free cash flow to a more congruent level of top line growth. I'm just not, a, ready to disclose that at the moment, b, nor do I think we are there factually.

[Ken Xie:]

This is Ken. I think 2 other point I want to add is one thing compared to a similar competitor, who also like a dedicate network security company, one, like I said before, is probably through profit and almost no growth, which also kind of trapped in the model. And also, I think in this space, gaining market share is still quite important, because it's so fragmented. And the other company, I think, is probably all the growth, but pretty much no profit. And also sometimes the spending grow faster than the sales. I think we're in the middle, has a better control and also more lever. We can -- probably can justify, to justify the balance amount of growth and also the profit and to best position going forward. And also, the second point really if you look kind of in the 2011, 2012, we've taken opportunity to invest in Europe and also in EMEA area. And we're starting to see some good return right now. Because if you -- once there's some tough environment and some of the competitors are starting to slow down, that's the best time to whether it be invest into the team, the channel and also expanding the marketing program. And then after 1 or 2 years, and then there's a lot of positive return from the investment. So that's also what we are starting to do in American here in the last couple of quarters.

[Aaron Schwartz:]

Okay. And last one, if I could squeeze one in here. You guys have an extremely strong balance sheet, Ahmed. I don't know if you have, and I know this is a group decision with the board and others, but just wondering what your perspective or opinion is on that current capital structure of the company.

[Ahmed Rubaie:]

Yes, sure. So, look, it's not lost on me that our cash balance exceeds our revenue guidance for the year. And we need to do something with our cash position. At the moment, and for the foreseeable future, it's all about growing the business. And at the moment, obviously, organically. As we look further out, it's too early to make judgments, but one key lever that we could use the cash for is larger-scale acquisitions, once we are comfortable with our internal execution. And then all the natural capital structure questions that will come up in terms of stock buyback and so on, I just think right now, given where the business is when I walked in, meaning on the back of this quarter, changing macro dynamics, getting execution in place so that we build a better plan for next year, as well as a long-term model that will answer some of your previous questions in terms of financial discipline, profitability, free cash flow, et cetera, it is then and only then that I think we'll be conversant in what we should do more with our cash position. I hope that makes sense to you.

[Operator:]

And our next question is coming from Michael Turits from Raymond James.

[Michael Turits:]

So back to my same question on CapEx and then a little bit more on carrier. So I just want to really make sure we're clear that the $20 million spend for the building, my understanding is $10 million to $12 million was -- is this year. Did you go back, Ahmed, and figured out sort of how much was in the previous guide? So what's incremental this year? And then I also wanted to make sure we knew how much you thought the full incremental impact of the inventory change is on cash for this year. And then lastly, where we might be on cash tax rate for this year and next. And then I want to talk about carrier.

[Ahmed Rubaie:]

Michael, with sincere apologies, I did not get a chance. As you know, the break ended up only being a half hour. So I did not -- we can follow up with specific numbers for you, but let me just make sure we're on the same page until we get you the more detail. At end of the day, yes, your recollection is right in terms of the current year. Now this is a building project, and if you've been through building projects, things can be up, they can be down. So for -- based on what I know right now, we have made the decision to accelerate that where we can get, number 1, get the project done and on time, but number 2, get as much of it done in the current year. And that's where my $10 million to $12 million comes in. How much more is that relative to what I thought in April? We'll get you the numbers, but my guess is it's about at least $5 million more than was envisaged back in April. Cash taxes are the same. So whatever Michelle is giving you in April to model, I don't think I'll change that. But I'll let her preempt me on that and correct me. And then in terms of inventory, we took it up by 10. I think there's another probably another 10 by the time we get through Q4. Does it all get paid for in the current calendar year? It all depends, because a lot of our contract manufacturers are outside the U.S., and it all depends on the timing of when we do these things. So at the end of the day, you take a combination of all of that, and that's basically the reason for lowering the free cash flow guidance. And of course, not to forget, billings were taken down by $5 million as well.

[Michael Turits:]

And then a separate question on carriers. So did the carrier business come back this quarter? In the end, I was a little unclear on that. Obviously, it's bad last quarter. And other companies have said it was better, and the carriers themselves have come back and at least reiterated the guidance for CapEx for the full year, so the general take has been the carrier environment is firming a bit.

[Ahmed Rubaie:]

Yes, I think for us in terms of the migration from Q1 into Q2 and the outlook for Q3, it's pretty much what we talked about in April. It didn't get worse, it didn't get any better. What we did see more of is us getting invited to the table in terms of -- and I think this is congruent with what you're saying, I think carriers now are out of their budgetary issues, at least having flushed through what they're going to be able to spend on CapEx, et cetera. So they're now starting to think about next steps like the 4G LTE, which, as you know, has been in discussion for a while. It's just getting more of a focus. So what that means for us is in the last quarter, different from Q1, we were invited to more discussions, and as Ken alluded to, to more testing environments, and across the world in the carrier space. So I wouldn't say for us, and I know others have said better, others have said worse, I think for us, it's status quo for the moment. However, we're encouraged by the notion that we're still at the table and particularly in terms of thought leadership. And remember, as many pointed out on the call, that, that is the smaller part of our business with carriers. The bigger part, the sell-through, continues to be stable, but not any better, not any worse, than what we saw coming out of Q1. The good news, though, is as they're looking out further, the spending is returning. I would still stay more cautious than perhaps my counterparts elsewhere because the spending behavior hasn't returned to normal levels. And all of that is reflected in, a, my guidance in Q2, having met the guidance, we exceeded it in Q2; and also, the look-forward guidance I gave you for Q3 and the rest of the year. So I gave you a mouthful there, but I was trying to triangulate multiple things for you.

[Michael Turits:]

No, that's great. And then my last question on carriers. So in the 4G LTE, the bake-offs or proof-of-concepts or wherever you are, who are the other competitors there? And I think Ken said, what, are these the largest boxes I think that you sell? And when do you think that this might turn into revenue? And when does this demand turn into dollars?

[Ken Xie:]

It is difficult to say when it will be turned into revenue. But I can say some of the, I would say, software-based network secure vendor don't have much solution there, because it's a carrier environment, it's more high-speed and performance and reliability-driven environment which need a lot of our expertise. And we have been working in that space for many, many years. And so that's probably what I can say.

[Michael Turits:]

So who do you see competitively? Is it Juniper, is it Cisco? Who do you see?

[Ken Xie:]

I think for us -- I think for the carriers, quite interestingly, they do need a few things. First, the high-speed and reliable solution carrier environment, that's where the software network vendor don't quite have much there. And then, but toward some of the traditional networking company, they still lack a lot of security function. They still lack the sense the 4G environment need to handle the security. And so that's where we feel we have quite good position in that area. And a part also, a lot of relate to certain lack of virtualization and other things in high-speed environment. I think so far, we feel pretty comfortable has the good position to do this worldwide.

[Ahmed Rubaie:]

So Michael, so that we leave your point with clarity and we don't confuse you or others, at the end of the day, our point on the 4G LTE is not that it is our expected revenue in the near term or massive revenue at any point in time or any of the above. The point was more about the fact that we're a differentiated innovator in the space. And as these carriers slowed down, to your point now, they're returning to normal day business, and they're thinking about what they need to do to modernize their mobile network, we are the first folks getting invited back in to handle those discussions. And why, to Ken's point? Because we are the one with the bigger chassis that can handle better reliability, faster performance and can connect the dots on all those fronts. I would say, however, when you think about the carrier space at large, and, again, I'm cognizant of the fact that some have said better, some have said worse, I think from us, based on everything I see in the lighthouse, it is pretty steady-eddie. It's not better, it's not worse, but we're excited that at least we're part of the forward-thinking innovation as we go forward. Does that help you tie it together?

[Michael Turits:]

Yes, of course.

[Operator:]

And our next question is coming from Jayson Noland from Robert Baird.

[Jayson Noland:]

And I guess tied to that same topic with carrier. Ken, with the MT6 coming here in the second half, it seems like it would be tricky to avoid some seasonality, given test cycles that large carriers would want to go through.

[Ken Xie:]

Can you repeat the question a little bit? Sorry, I try to repeat.

[Jayson Noland:]

Your new high-end ASIC is coming out in the second half here. And I know you said you're going to stagger the release. It just seems like it would be logical to assume that carriers would want to go through a longer testing cycle.

[Ken Xie:]

I think some of the MT6, this platform will be participating in the testing in the later part of this year. Like I said, we released the FortiASIC-SoC end of last year. And then this year, the high-speed MT6, called nanoprocessor 6th generation, will be come out and which will be upgrade some of the product, including our high-end products. So I think it's -- the MT6, I think the timing is pretty good, because even still we're in the early part of the chip release, but it's -- we already see the huge advantage to leverage this MT6 technology to address the high-speed multifunction mobile environment.

[Michelle Spolver:]

Yes, let me actually just add, too, Jayson, and we've said this sort of in the past, is that we haven't historically seen any type of significant pause by customers based on new ASICs because we continue to refresh our ASICs, because it's not -- customers don't necessarily know which products are going to have the new ASICs and when. Looking back historically, we really haven't seen any sort of spikes and dips based on new ASICs.

[Jayson Noland:]

Is this mostly next year revenue, '14?

[Michelle Spolver:]

Definitely, yes. We talk about releasing the ASIC later the year, and then we have to work to integrate it into new products. So from a revenue standpoint, you'd see that in 2014.

[Ken Xie:]

Yes, also like last week, we announced that some part [indiscernible] that the ISoC 2 which we announced probably end of last year, so it takes some time to start inbuilding in the system.

[Jayson Noland:]

Understood. And then last question, is it -- is this -- is the network processor V6, is that mostly a FortiGate-5000-related ASIC or is it more broad than that?

[Ken Xie:]

It's more high-end. It's also -- some of the middle-range may also leverage that.

[Jayson Noland:]

So beyond just a chassis product?

[Ken Xie:]

Yes.

[Operator:]

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

[Nandan Amladi:]

Quick question about your comment on the M&A earlier. Cisco is acquiring Sourcefire and, obviously, some of the space seems to be starting to consolidate. What are the areas that you think you might be interested in to round out your portfolio?

[Ahmed Rubaie:]

Let me start, and then I'll let Ken calibrate. So at the moment, I think everybody comes with their own DNA. Our DNA at Fortinet to date has been to add technology tuck-ins, technology enhancements, as well as additional engineering and innovation talent and products that are complementary to what we do and taking our own portfolio forward. They have not been of any scale historically. There is nothing to make of my comment. I was answering in the context of what to do with cash in the future. At the end of the day, we're focused on our own internal execution at the moment, and we will continue looking for small technology enhancements and tuck-ins. So we don't have anything contemplated at the moment. In terms of what space and what product enhancements to look after, I'll let Ken take that. That's just to make sure we're not confusing things on the M&A commentary.

[Ken Xie:]

Okay. I think the space we play in is about $8 billion or $10 billion in that security space. And like I said before, I see there is 3 trend going on. While it's early, somehow there are more [indiscernible]. Their speed go faster and faster. We already see the 40-gig, the 100-gig that did come out. And even the 400-gig and also terabit are already starting in the engineer design process. So with all these higher-speed going on every 18 to 24 months, you almost double the network speed. Definitely you need a more dedicated, high-speed appliance, secured gateway, to really secure all these network traffic. Because you have to be in line to really stop all the bad things there. So that's where the network gateway or security device cannot be slower than the network speed. Otherwise you will slow down the whole network. Because network security so far is mostly about the device. So that's the first trend. It's go faster and faster, don't follow the more slow. The second one we see, the multifunctions are integrate together. And the reason really is there's so many different applications, there's just so many different kind of traffics that get in. It's so difficult to have -- or too costly to have a multiple box, each only secure 1 or 2 functions or 1 or 2 kind of traffic. So you see the IPS starting integrated to the firewall, some other like [indiscernible], some other Web traffic also integrate together. So that's where some call it app control, some call it the next-gen firewall and also UTM is also the term being used for 10 years. So there's a multifunction starting to integrate together, we see the multiple vendor. I don't believe, even like Cisco, they bought Sourcefire, there's a kind of an intention to integrate some of it together. And then the third thing that we also see, the functions starting moving to a higher layer, be on the traditional connection layer, which is firewall use, and it's go to the content, go to application, try to secure the user, secure the application. So there is a lot of move to the higher layer. This also need additional processing power beyond process and network traffic. And so all these 3 trend we feel feed us well because we have a good platform. But also, from time to time, we also want to do some acquisitions. So far, I think in -- since company start 13 years ago, I think we acquired -- it's about 10 company. Most acquisition more based on some technology, some team and certain product. But going forward with our cash, starting approaching $1 billion, we may kind of open up a little bit more kind of even certain vertical space or certain customer base, but we still want to lead in the technology. So that's the long-term company strategy. But so far, we're putting confidence on our engineer team to keep up the changing in the space and also using the best platform technology to address the customer need right now.

[Operator:]

And our next question is coming from Walter Pritchard from Citi.

[Unknown Analyst:]

This is actually Jim Fisch [ph], Walter's associate. I think you guys were providing on the call before more on the carriers, and we've kind of talked about it right here. Can you kind of just go into the growth rates behind some of those verticals, if you can? And any commentary on those would be great.

[Ken Xie:]

Let me try some of that. I think about 2 years ago, we started changing the sales marketing strategy more, trying to target certain vertical space compared in the early days, more regional-based, city-based. And certain verticals, you see the earnings release like education, some of the high-end service provider were doing well. Because I feel they're more like technology -- or kind of technical focused. So for them, you really involve a lot of testing, a lot of technical evaluation. That we tend to do well. In certain areas, certain enterprise markets, sometimes certain customers too much of dependent for the marketing message. That's the area we're also keeping improving right now and also want to invest more going forward. And we also started trying to engage some other third-party testing and make sure we cover all the certification, all the testing, make sure they can see the advantage of technology. So that's where kind of a certain vertical market, I believe, going forward, we may have to invest more on the marketing to open -- to grow more in certain vertical market. Because a lot of customer in certain verticals, they are more dependent on the marketing message. The other trend I'm starting to see kind of interesting, the MSSP area, because security is starting to become more complicated than some of enterprise can manage. So they tend to be more kind of working together with service provider. So on service provider side, they do need a platform has a flexible multifunction and also kind of address multiple customer need in the same time, in the same park and also in a virtualized environment. That's we also have a lot of advantage. And even from early days acquisition of CoSine, also a lot of function we add in, the virtualization we add in. So that's also kind of changing the vertical space a little bit. Ahmed, do you want to add something?

[Ahmed Rubaie:]

No, I don't think there's anything further to add. I gave you the statistics earlier in my prepared remarks. In terms of service providers, which I think is where you started your question, Jim, it's -- yes, the Q2 delivery was 25%. Q1 was 25%, Q2 last year was 26%. So that's all pretty steady in the same neighborhood, and you got the additional color on other verticals from Ken.

[Unknown Analyst:]

Okay. I have one follow-up, though. With EMEA -- I mean, you guys were talking at points that it was strong. But I believe it was last quarter that you guys were highlighting that parts of EMEA were weak, especially I think it was Central. If you could provide any color on that, that would be good.

[Ahmed Rubaie:]

I don't recall giving specific color, but it may have happened when the company missed its earnings. Here is how I would look at EMEA, Jim. I would say EMEA has to be looked at on an annualized basis. So one light quarter followed by a strong quarter, and as you know, Q3, with most of Europe on vacation in August, et cetera, so you have to balance all of those things. In terms of the particular strength that we saw, I would say that's our own fruits in this last quarter in Q2 in terms of execution. Where geographically within Europe? We saw some strength out of Germany. Believe it or not, we saw some strength out of Southern Europe, but I'm not ready to call that a trend by any stretch of the imagination. So I put Europe still in the penalty box as a macro. And we're focused on our own investments that we've made, to Ken's point. When things went south in Europe, we doubled down and hired better talent and more talent. And so as we're navigating the storms in Europe, like everybody else, no different, we're actually executing better and balancing the full year equation with a quarter like Q1 as followed by a strong quarter like Q2, and then you get seasonality in Q3 and so on. And all of that is factored into the numbers we gave out back in April and the numbers we gave out today.

[Operator:]

And our next question is from Scott Holmes [ph] from IGH [ph] Capital.

[Unknown Analyst:]

When I look at your slide deck, in these FortiGate billings pie charts, the one piece of the pie that stands out, both from last quarter and this quarter, is the mid-range products. The percent of revenue -- or percent of FortiGate billings Q2 to year-over-year and then versus year-to-date full year 2012, it's the mid-range that looks weak. It looks like telco rebounded. So when you break down that mid-range product growth, what's going on there? And is that any sort of sign of new weakness versus last quarter? Or what's going on at the mid-range?

[Ken Xie:]

This is Ken. I think that comparison compared to 1 year ago, the bigger deal we mentioned about is really the middle range for the multimillion dollar.

[Michelle Spolver:]

Yes, and that happened, Q2 of last year, we had a deal, Scott, for your benefit, I think, I'm not sure if you knew the story all that well last year. But we did a multimillion-dollar deal, the largest deal in our history, and it rolled out over several quarters. The biggest contribution of it is coming in Q2 of 2012. And it was thousands of mid-range products. So that is sort of why that slice of the pie looks different this quarter and it looked different last quarter, I mean, year-over-year comp.

[Unknown Analyst:]

So last quarter, was it starting to roll off of that big deal as well?

[Michelle Spolver:]

No. Well, when did it finish? When did that -- a little bit. Yes, it did. A little bit, but not as much as the year prior. The contribution wasn't as much as the year prior. And definitely, we didn't see any of it this quarter, in Q2, and we had a lot in Q2 of 2012.

[Unknown Analyst:]

And just on the cash position, at $20, you could buy back a quarter of your stock outstanding. If you were to preference uses of cash here in your minds, what have you talked about being the preference for cash?

[Ahmed Rubaie:]

I think we've been very clear. I think in our minds, it's organic growth, navigating the angles that were thrown at us this year, which was thrown at everybody in terms of mixed macro signals, in other words, making sure that we're positioning our sales and marketing dollars, our innovation dollars, as well as the infrastructure support in this business grew pretty quickly, both pre-IPO and post-IPO. So we got to make sure we build the business on the right foundation. And then secondarily, as we tie our shoes better, our ability to potentially look at acquisitions that are of a different scale than we have in the past. But that's further down the path. And then at some point, we will also re-examine -- the math you are doing is correct in terms of where the stock is and what the amount can be. But I think the better part of wisdom right now is we have gained market share in this business. We've climbed up the ladder very quickly. We're in the third leading spot against our large competitors. And we've got to keep going and continuing to gain more market share, growing this business. And as part of that, we will also be responsible in terms of looking at things like stock buyback, but it is not in the current year.

[Operator:]

Our next question is coming from Melissa Gorham from Morgan Stanley.

[Melissa Gorham:]

This is Melissa again for Keith Weiss. I just have a follow-up on America's growth. So last quarter, you said that you saw some challenges in Latin America. I think you also noted that this quarter as well. Just wondering if you could provide more color on how the growth was in the U.S. relative to the other regions of the Americas.

[Ahmed Rubaie:]

I think, overall, when you think about the Americas -- so first of all, Latin America is about 20% or so of the Americas' total. Second of all, we had, and you just heard the dialogue between Scott and Michelle, a pretty tough comp in terms of Q2 of last year with not only a very large multimillion-dollar deal other than the fact it was the largest deal we've ever done as a company. So there really isn't any more color to give you on the U.S. specifically. I think I've given you color on spending behavior or the service provider spaces, et cetera. What I can supplement is in terms of Latin America, I'm not sure I elaborated too much on that. You're right in that we signaled it as an issue in the last quarter. I don't think it got any better, nor did it get any worse, and it was factored into my numbers back in April, and it was factored again in my numbers today. And we're hoping to see more execution productivity as the year nears the end and as we build the plan for next year. But the macro continues to be mixed between what's coming out of Brazil and Mexico, for everybody, not just us.

[Melissa Gorham:]

Okay. And then one other question. Do you have any update on the integration of Coyote Point, and did it contribute any revenue in the quarter?

[Ahmed Rubaie:]

I think the integration is going very well. It's part of the company, and it did contribute revenue. When we integrate companies, we don't split out financials. So it's a very small acquisition, as you know. So I don't know what revenue it contributed, but I do know it contributed revenue in line with our internal expectations.

[Operator:]

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

[Erik Suppiger:]

Yes, I just want to come back to the competitive dynamics. In the past, you've talked a little bit about Palo Alto, seeing them more. What was your perception of them? And then you talked about your service for persistent -- advanced persistent threats. What kind of attach rate are you getting for that? And how do you perceive your relative position vis-à-vis FireEye and Palo Alto and Sourcefire? How do you envision your position in the market?

[Ken Xie:]

I think it's a little bit more different marketing message, different way to position. And I think the 3 company you mentioned, they're probably more try to target some of the like sort of function sometime won't be behind the firewall, second layer or third layer. And that's where compare Fortinet is more in the primary firewall, it's a high-speed inline device. And also is multifunction, sometime even can cover the second layer, third layer, it can cover. We also starting to address some of the ATP, like I mentioned in my script, which we view as also kind of important to be integrate as a part of the gateway and also helping the customer to defend some of the latest some day-to-day attacks plus some of the behavior-based attack. So that's where -- but some different market research firms and different vendor, they may call some different name. But from our point of view, it's really the multifunction device starting in kind of a more dominant area in the network security. And also customers starting more need to go to the higher layer, like I mentioned, the 3 trend early of the call. And that's also kind of the trend we view. We have the platform that can address better than the competitors.

[Ahmed Rubaie:]

And, Erik, maybe what I can do is just supplement what Ken just said. Given the fact that I'm still fairly new and have a fresh perspective, although I'm not anywhere near Ken's expertise. He's been a visionary in this space for a number of years. As you know, this is his third company. But I'll give you what I've learned. First of all, from the standpoint of profile and DNA of companies across this fragmented and increasingly more fragmented space, we're kind of the one in the middle, and in my judgment, balanced for continued gain of market share, continued growth above market. And I know all of you guys are eager for me to put out a long-term model, which we will do next year in terms of what to expect in terms of top line growth and what's commensurate profitability of free cash flow, but when you look at it, and Ken articulates it every now and then, you've got on the one end Palo Alto Networks, and I'm not here to comment, by the way, on specific competitors. And I'll never do that. But what I'm telling you is public information is that They've spent an enormous amount of money and continue to do so on marketing. We haven't gone that far, and perhaps we should do a little bit more of it. Then you've got other ends like Check Point, who are equally as solid as we are from a financial perspective but don't have the same growth levels that we've seen. So I would put us in the middle, and to be honest, in my 2 hats that I wear here, I'm more focused on the fact that when I speak to technical people at a customer level, our product is differentiated because of its performance, its agility and the fact that we can integrate more functionality. And so as a result, what we're trying to do is improve on our execution so that we continue to stay ahead of everybody else. In terms of your -- the other angle of your question, are we seeing anything discernibly different in the competitive landscape? I would say Q2, even though I'm not an expert on Q1, but I did enough due diligence walking in, was pretty much the same and similarly as I look at our pipeline in Q3 and the rest of the year. And it's good to have all those folks around, at the end of the day, you can't win everything, But I can tell you when the test comes down to performance and capability, we tend to win the game.

[Operator:]

[Operator Instructions] We'll take our next question from Sterling Auty from JPMorgan.

[Sterling P. Auty:]

Curious, when you look at the implied guidance for the fourth quarter, how much of that is based on your previous comments in the earlier call about just historical pattern and how much is based on the pipeline? Because I do think that one of the issues investors had coming into the call was some of that sequential jump in the fourth quarter.

[Ahmed Rubaie:]

Yes, and rightly so, Sterling. I get it. So I think my response is it's blended. In other words, when we looked at the numbers, much like we did in April, by the way, but for the pull-down, at the end of the day, it's about studying the pipeline, studying the typical sequential uplift and also some element of what's going on, not so much that spending behavior has changed. As I stated repeatedly, it hasn't. But at least, as some have pointed out on the call, our checks are getting released versus getting held back, as was the case in Q1. So I would say all of that put together gives us the ability to look at our Q4 number as a makeup of our full year number to be reasonable, based on everything we know today.

[Sterling P. Auty:]

Okay. And I wanted to circle back to the cash flow guide. Specific to the inventory management but more from a payables perspective, is there anything different that you're going to be able to do in terms of managing your payables? So what I'm curious about is the net impact to cash flow from this inventory change. Might you have some flexibility to influence the cash cycle on the payable side?

[Ahmed Rubaie:]

Yes, look, the world I live in, Sterling, is if I owe somebody money, I got to pay them, and I got to pay them on time. So in terms of anything to be managed, that's not our normal approach. These are long-term contract manufacturers, and it's just not the right way to manage business. So I think there's nothing to read into. If something fell in the payables, it's just literally timing, because that last week, and, of course, it was my first iteration at that last week of business here at Fortinet, it's pretty busy and very active, particularly back in the warehouse. So I think for now, the salient things to take away is a correction of the turns, lower turns, which means buying more inventory, started doing it in the quarter. And sometimes, it's going to flush through payables. Sometimes it's going to be hanging on the balance sheet into the next quarter. And when you look at overall this year, to date, we replenished by 10. When it's all said and done, as I said earlier, we'll probably replenish at 20 above normal levels, which keeps us at that average turn of 2 to 3. And then we'll pay them when they're due.

[Sterling P. Auty:]

Okay. And last question, Ken, when you look at some of the ancillary products, I think there was a question on the ADCs and the acquisitions, or if you look at database or if you look at some of the other ancillary or peripheral products, are any of them of the size that are starting to move the needle? Or are they still kind of nice add-ons?

[Ken Xie:]

Not quite move the needle yet, but we do see -- because some of the product we later intend to integrate in the next version of our FortiOS. We want to understand some of the functions first. And some of it, some of others, we may eventually try to build a dedicated team and try to focus more. But right now, I'd say it's all relatively small.

[Operator:]

Okay. And it appears this does conclude our Q&A session. So I would like to turn it back to Ahmed Rubaie for concluding remarks.

[Ahmed Rubaie:]

Well, thank you all for coming back on the second call and for your questions on both calls. I'm particularly appreciative of the patience you have given me in my first quarter. As you can tell, we're heads down working on execution, trying to make the business run on a better foundation for growth, and we're very excited about where we are and where we're going and look forward to seeing all of you during the investor season.

[Operator:]

Okay. Ladies and gentlemen, this does conclude your conference. You may now disconnect, and have a great day.