Fortinet Inc. (NASDAQ: FTNT) Q2 2020 earnings call dated Aug. 06, 2020
Corporate Participants:
Peter Salkowski — Vice President-Investor Relations
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Keith Jensen — Chief Financial Officer
Analysts:
Rob Owens — Piper Sandler — Analyst
Fatima Boolani — UBS — Analyst
Shaul Eyal — Oppenheimer — Analyst
Sterling Auty — JPMorgan — Analyst
Brian Essex — Goldman Sachs — Analyst
Hamza Fodderwala — Morgan Stanley — Analyst
Brad Zelnick — Credit Suisse — Analyst
Walter Prichard — Citi — Analyst
Tal Liani — Bank of America — Analyst
Amit Daryanani — Evercore — Analyst
Presentation:
Operator
Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Fortinet Second Quarter Earnings Announcement Conference Call. [Operator Instructions]After the speakers’ presentation there will be a question-and-answer session. [Operator Instructions]
I would now like to hand the conference over to your speaker today. Peter Salkowski. Thank you, and please go ahead, sir.
Peter Salkowski — Vice President-Investor Relations
Thank you, Chris. Good afternoon, everyone. This is Peter Salkowski, Vice President of Investor Relations at Fortinet. And I am pleased to welcome everyone to our call to discuss Fortinet’s financial results for the second quarter of 2020. Speakers on today’s call are Ken Xie, Fortinet’s Founder, Chairman, and CEO; and Keith Jensen, our Chief Financial Officer. This is a live call that will be available for replay via webcast on our Investor Relations website. Ken will begin our call today by providing a high-level perspective on our business. Keith will then review our financial and operating results for the second quarter, provide some additional details regarding our second quarter performance and some insights into how July performed, before providing guidance for the third quarter of 2020. We’ll then open the call for questions. During the Q&A session, we ask that you please keep your questions brief and 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 and these forward-looking statements are subject to risks and uncertainties, which 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 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, all references to financial metrics that we make on today’s call are non-GAAP unless stated otherwise. Our GAAP results and GAAP to non-GAAP reconciliations is located in our earnings press release and in the presentation that accompanies today’s remarks, both of which are posted on our Investor Relations website. Lastly, all references to growth are on a year-over-year basis unless noted otherwise.
I will now turn the call over to Ken.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Thank you, Peter and thank you to everyone for joining today’s call to review our second quarter 2020 result. We are very pleased with the solid second quarter performance. Revenue increased 18% to $616 million, with product revenue up 12% and service revenue up 22%. Secure SD-WAN climbed to 12% of total second quarter billings, the first time it’s been over 10%. In today’s environment, enterprise are focused on effectively and cost efficiently deploy and security across their physical and digital network. To meet these challenges, Fortinet was founded on the vision of bringing security and networking together in what we refer to as security-driven networking. Gartner supports a similar concept, which they call Secure Access Service Edge or SASE. Fortinet is an industry leader in building, integrating and automating security product and service into Fortinet secure fabric, including FortiSASE. With the recent acquisition of OPEC network, Fortinet has enhanced its FortiSASE solution with expanded cloud delivery, including firewall as a service and real trust network access.
Additionally, FortiSASE was built to be partner-friendly empowering MSPs and big global customers to easily integrate our build for the SASE platform into their own offerings. A critical component of Fortinet Secure Fabric platform is SD-WAN. We recently announced the new FortiGate ATF, which expand our SD-WAN portfolio for brand services and work for home. The FortiGate as powered by the latest FortiSPU SoC4 can deliver security compute rating as much as 25 times higher than a industry average appliance using generic CPUs. According to Gartner, worldwide SD-WAN equipment market data for the first quarter of 2020, Fortinet has the highest revenue growth and was the top three for market share. We attribute this growth to our ability to deliver secure, high-performance SD-WAN anywhere from home to the branch to the cloud. Security investment remains a priority for enterprise and service providers, demonstrated by the strong growth of our high-end FortiGate plans during the last quarter. Today, we released the FortiGate 4400F, the only firewall in the industry capable of secure hyperscale data center and 5G networks. Powered by the NP7 network processor, the 4400F delivers the highest performance with secured compute reaching of up to 13 times higher than our competition.
The release of several new appliance powered by our latest FortiASIC SPU, together with cloud and software-based virtual machine to deploy security anywhere, we are able Fortinet to capitalize on this investment and put us in a strong position going forward. Before turning the call over to Keith for a closer look at our second quarter performance and our guidance, I would like to take a moment to welcome the over 400 people who joined Fortinet during the second quarter, as well as welcome OPEC team, who recently joined and to thank our employees, customers and partners worldwide for their continued support to manage our response to the ongoing COVID-19 pandemic, please?
Keith Jensen — Chief Financial Officer
Thank you, Ken. Let’s start the second quarter review with revenue. Total revenue of $616 million was up 18%, driven by non-FortiGate products and service revenue growth of 25%. Non-FortiGate revenue growth benefited from very strong demand for virtual machines and our work-from-home solutions. FortiGate product and service revenue growth was 16% and benefited from record levels of billings for our secure SD-WAN solution. To a large extent, our second quarter revenue growth, together with the backdrop of the COVID-19 pandemic, affirms the benefits of our diversification across geographies, customer segments and industry verticals. At the same time, it illustrates the level of revenue predictability in our business model. Our continued growth in this environment is a result of our strategic internal investments made to expand our global sales force, invest in our channel partners and extend our cost for performance advantage as we update our product offerings and penetrate adjacent security markets. Product revenue grew 12% to $212 million — excuse me, $212 million, benefiting from strong demand for secure SD-WAN, high-end FortiGates and FortiGate virtual machines. Our work-from-home solutions continue to provide a tailwind to grow. Our growth rates and industry reports suggest, we continue to take market share in both the firewall and SD-WAN markets, markets where we have contributed leadership and innovation. Moving to service revenue. Service revenue grew 22% to $404 million, representing 66% of total revenue. Over 90% of service revenue was from deferred revenue at the beginning of the quarter and continues to support our revenue growth and predictability.
FortiGuard security subscriptions revenue increased 22% to $223 million. FortiCare technical support revenue increased 22% to $181 million. The revenue mix shift from 8/5 support to our higher-priced 24/7 support was nine points, with 24/7 support now representing 64% of the mix. Let’s shift to billings. Total billings increased 14% to $711 million. The total billing growth was negatively impacted by approximately two points by training and professional services and other miscellaneous products, which are products not classified as FortiGate, fabric or cloud. Earlier this year, we announced our decision to make our Network Security Expert, or NSE, online training and certification program free to the public. While this decision resulted in a reduction in training billings and training revenue, we’re very excited about the demand we are seeing with our NSE training. As of this week, the number of NSE registrations for 2020 is well over 500,000. And the number of NSE certifications issued is up over 200% to nearly 200,000. Looking at billings by product segment. FortiGate billings increased 14% and accounted for 73% of total billings. FortiGate billings include our secure SD-WAN solutions. And as Ken mentioned a moment ago, SD-WAN passed over the 10% threshold for the first time ever, representing 12% of total billings. Non-FortiGate billings also increased 14%, with strong demand from our virtual and work-from-home solutions, offset by smaller contributions from switches and access points. And as I mentioned, billing declines for professional services, training and other miscellaneous products. Our geographic performance aligned with a path of the pandemic. And with it, highlighted the geographic diversification of our business, APAC being further along, outperformed all GEOs, followed by Europe, while North America was impacted more.
Our North America results include the United States, where we saw headwinds from the education and local government verticals where the COVID-19 pandemic remained an issue. By comparison, the retail segment was by far and away the strongest-performing U.S. vertical with growth well over 40%, as we saw the continued expansion of the SD-WAN solution. The U.S. SMB segment provided strong growth, illustrating the strength of our U.S. channel programs, the remaining opportunity in this market and solid execution by our channel partners and the Fortinet channel team. Looking more at the Americas, our analysis and discussions with our channel partners suggest that certain transactions were delayed into the second half of this year, as these companies focused on their capital structure and other immediate priorities. Moving now to worldwide billings by industry verticals. The diversification of our business model was again on display with our top five verticals continue to account for about two-thirds of total billings. Worldwide government sector topped all verticals with 19% of total billings. Service providers and MSSPs accounted for 15% of total billings. Financial services with 14% of total billings had a very strong quarter with billing growth of 33%. And despite COVID-related concerns, the retail vertical posted worldwide billings growth of 27%, accounting for 10% of billings as it continued to benefit from SD-WAN and the strong U.S. performance I mentioned a moment ago. We saw strong growth in retail sub-verticals, such as drug stores, groceries and portions of the wholesale industry. At the end of the second quarter, total deferred revenue increased 24% to $2.3 billion. Short-term deferred revenue increased 24% to $1.3 billion. Looking now at deals by dollar size. The number of deals over $1 million increased 28% to 59%. Secure SD-WAN accounted for 13 of these deals over $1 million. This performance illustrates our continued ability to move upmarket into the enterprise segment and the continued acceptance of our differentiated single unit, secure SD-WAN offering.
Moving back to the income statement. As shown on slide four, gross margin improved 260 basis points to 79%. Product gross margin improved 340 basis points to 61%. Product gross margin continued to benefit from the lower cost structure of our newer generation of FortiGate products and over 40% growth in software products. Services gross margin increased 120 basis points to 88.5%, reflecting the benefit of the FortiCare revenue mix shift to 24/7 support. Operating margin for the second quarter increased 370 basis points to 27.3%, benefiting from the improvement in gross margin and lower employee travel and marketing programming expenses shift towards virtual events. Total headcount ended the quarter at 7,756, an increase of 23%, driven by the increased investments we’ve made to grow our business and reflecting a continued decline in sales and other attrition rates. With our continued growth, strong operating margins and free cash flow, we do not anticipate any COVID-19-related layoffs in the foreseeable future. In fact, we plan to capitalize on our many opportunities by continuing to hire and invest in our balanced growth strategy. Given the strong operating income performance, net income for the second quarter was $135 million. Our earnings per diluted share increased $0.24 to $0.82 per diluted share. On a GAAP basis, we reported net income of $112 million or $0.68 per diluted share versus GAAP income of $73 million or $0.42 per diluted share a year ago.
Moving to the statement of cash flow, summarized on slide seven and eight. Free cash flow increased 21.5% to $216 million. The average contract term in the second quarter continued to be within the range we provided at the Analyst Day, declining one month year-over-year to 26 months and moving up one month sequentially. As we stated on the first quarter call, we expected to leverage the strength of our balance sheet as a competitive advantage to support our partners and our customers. Average contractual payment terms increased to 62 days or 17% sequentially, in line with our expectations and reflecting our decision to provide geographically targeted extended payment term plans. Capital expenditures for the second quarter were $31 million, including $21 million related to construction and other real estate activity. We estimate capital expenditures for the third quarter to between $50 million and $60 million. And for all of 2022 between $165 million and 185 million. Delays related to the new campus building have moved a portion of the previously expected 2020 capex spending into the first half of 2021. We expect full year cash taxes to be approximately $40 million, and our full year non-GAAP tax rate to be 22%.
In the second quarter we repurchased approximately 1.4 million shares of our — for an aggregate purchase price of approximately $140 6 million. In July, the board authorized an additional 500 million for our share repurchase authorization and extended the term to February 2022. As of today, remaining share buyback authorization is approximately $1 billion. Before moving to guidance, we wanted to offer some additional thoughts related to the ongoing COVID 19 pandemic. We have and we plan to continue leveraging the strength of our balance sheet, which may increase DSOs and inventory levels. The economic and business impact of the pandemic seems in line with the ability of different countries and geographies to reopen and avoid temporary shutdowns and uncertainty. For example, after strong earnings growth in April, we saw slower growth because we completed May then followed by a bounce back to strong growth in June and again, strong in July. At the same time, the remaining Q3 pipeline points to a good level of improvement in both the U.S. and worldwide.
In the second quarter, our channel partners reported some deals being delayed into the second half of the year. The concept of delayed not lost seems supported by the increases in our pipeline, as well as the July selling activity. Clearly there remains an elevated level of uncertainty about future pandemic — excuse me, about future pandemic events, and economic conditions. As we look forward, I’d like to review our outlook for the third quarter, summarized on slide nine, which is subject to disclaimers regarding forward looking information that Peter provided at the beginning of the call. In the third quarter, we expect billings in the range of $705 million to $730 million, revenue in the range of $630 million to $645 million. Non-GAAP gross margin of 78% to 79%. Non-GAAP operating margin of 25.5% to 26.5%. Non-GAAP earnings per share of $0.76 to $0.78, which assumes a share count of between 168 and 170 million. We expect a non-GAAP tax rate of 22%. For 2020, due to the continued uncertainty associated with the economic impact from the COVID-19 pandemic, we’re not issuing full year guidance at this time. And finally, along with Ken, I’d like to welcome all the team members who have joined us including the Opaq team. I would also like to thank our partners, customers and Fortinet team for all their support and hard work during these difficult in unique times.
I’ll now hand the call back over to Peter to begin the Q&A.
Peter Salkowski — Vice President-Investor Relations
Thank you, Keith. Chris, you’d like to open the line for questions please.
Questions and Answers:
Operator
Operator: Thank you. [Operator Instructions] And our first question comes from a line of Rob Owens with Piper Sandler. Your line is now open.
Rob Owens — Piper Sandler — Analyst
Great. And thank you guys for taking my question this afternoon. I want to start on the SD-WAN side of things in the success that you’re obviously seeing there through the metrics now over 10% of billings but just what that pipeline looks like, have you seen more of a rush given COVID work from home and the opportunity to replace a lot of these conditions relative to branch types of solutions, or are you seeing as much of robust demand I guess from that forward like. Thanks.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
SD-WAN is a long term benefit for both [Indecipherable] and also SMB, and because it’s also low the cost of connect to the internet at the same time, making more decisions, and for us also building with ASIC security together, so they can also have additional security, additional benefit and cost much lower compared to some other competitors.
So the market grow about 50% year-over-year. So we see a lot of potential, a lot of pipeline. We do believe we’re keeping gaining market share. Because our solution is very unique, huge advantage compared to other competitors. And with additional sales capacity we added, like we added 23% even during the pandemic typically be more time to train the new salespeople and then maybe typically be more time to plan a new customer but we do see a huge potential going forward.
Rob Owens — Piper Sandler — Analyst
And then secondarily I guess focusing on the SASE opportunity, and some of the dialogue from previous calls maybe could touch on the Opaq acquisition. Was this customer-driven, was this opportunistic from your perspective, offensive, defensive?
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
We have this FortiSASE like I mentioned, even in the last time the earnings call. And we do believe as a part of the whole infrastructure. So as the cloud deliver we already have some other cloud deliver but Opaq definitely keep enhances and we’re making more broad, more flexible for customer for the partner to leverage the product infrastructure we’re building.
And so we do see this is really has offer we have and the same time, we do have the broader offering both on the platform and also on the function and also on kind of different forms of deployment compared to other competitors, this is keeping enhance our position.
Rob Owens — Piper Sandler — Analyst
Great, thank you very much.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Thank you.
Operator
Thank you. And our next question comes from the line of Fatima Boolani with UBS. Your line is now open.
Fatima Boolani — UBS — Analyst
Good afternoon. Thank you for taking the questions. Ken, maybe a bigger picture question for you, you know, the combination of SD-WAN adoption in a more durable work-from-home environment, maybe as giving investors, the sense, and perhaps it’s misplaced, but giving investors in the sense that the traditional enterprise branch office is potentially at risk from either a refreshed footprint perspective and a cannibalization perspective. So I’m wondering, if you can help us parse through sort of some of the puts and takes as to what happens to your branch office footprint. And what some of those misconceptions might be as customers adopt SD-WAN and/or stay at home or permanently in shelter in place situation. And then, I have a follow-up for Keith.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Yeah. The under price also including some brand profit and we do see some slowdown in U.S. But on the other side if you look at our products which come out like the SoC4 come out one year ago, we started building a product like 4400F and 60F o 40F that we just announced the 80F last week.So we can see the run popping, especially in the SMB including the U.S. as the co-op like over 40% it’s above and strong. International little bit high on the U.S. to adopt some new products, including some posted the low-end UCS and also the high-end NP7 which started released about in this year. So it’s starting to ramp up. So that’s one we see the benefit of the new products, which easily have a performance like four five years, better and the same cost, which we use in the reconstitute computing region to benchmark compared to the other competitor is a huge advantage. So we see when we have the new product, the gross net income up — come up while quickly after the testing and evaluate adopt the product. But on the other side, it might also give that additional cost benefit, together with the new product cost performance benefit. So that’s what helping drive in the SMP we see studying growing quite well. And also last quarter after we are announce the high-end product like one or two quarter we suddenly see the high-end also starting to ramp up leveraged NP7.
So that’s the trend. And I do believe, some time enterprise take a little bit more time during this pandemic, to do some deployment. But what we do see a lot of evaluation going on. We do see some other interest, including combined, we call security networking together because security driven networking. So the whole infrastructure, that’s what it, sells probably what more engaged into the network content. And also traditionally the most helpful security and now its network content also starting engage together with us to call the security driven networking. So that’s we see the trend going on quite well. And also like a Keith mentioned, its a region-by-region. So it’s a payback study grow up and other quick over 20% and since the pandemic there situation little bit better recover it will better. And then we’ll also see, Europe probably also going over 10%, the U.S. is a little bit slow. But we do believe later this year next year and next year that question over waste a new part are lined up is the addition of cells capacity we build, which will continue to match, what we’re seeing our strong potential going forward.
Keith Jensen — Chief Financial Officer
Yeah I think Ken does a great job of covering off some of the diversification considerations, whether it’s by geographies and where different geographies may be and also by verticals. But it’s also important to note that SD-WAN is also a significant component of savvy. And also for Work From Home Solutions.
Fatima Boolani — UBS — Analyst
Fair enough. And Keith have you any comments on the Billings performance specifically this quarter, and just double clicking into four to get gate Billings because that includes both your traditional sort of network security perimeter security, and a secure SD-WAN piece. I’m wondering if you can kind of qualitatively talk to sort of what drove the bus this quarter, and how you’re thinking about the secure SD-WAN versus non-secure SD-WAN FortiCare pipeline for the remainder of the year and what’s baked into your 3Q guidance? And that’s it for me. Thank you.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
So a lot of topics, Fatima. Maybe I’ll — I know you do a good job. Look, I think when we look at the pipeline for Q3, which was what we’ve guided to. I think we feel very good about the SD-WAN opportunity. Clearly, we saw perhaps in the U.S. in the month of May, a bit of a pause on maybe some projects that were as we got towards the end of May, but clearly, as we exited Q2 and we’ve moved into Q3, we can see that that our customers are making plans to continue moving forward SD-WAN build outs and additional opportunities that we’ve seen in the pipeline made associates a comfortable talking about crossing over 10% threshold for the first time. Now, we’ll see how it actually comes into play. And I think, I’ve lost track of some of your earlier comments, I’m sorry.
Fatima Boolani — UBS — Analyst
Fair enough. I’ll get back queue. Thanks so much.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Okay.
Operator
Thank you. And our next question comes from the line of Shaul Eyal with Oppenheimer. Your line is now open.
Shaul Eyal — Oppenheimer — Analyst
Thank you. Good afternoon, gentlemen, congrats on the quarter. Keith or Ken, so U.S. was the fastest region this quarter next week we’ll mark the middle of the quarter, the third quarter. Can you talk to us about the performance so far, within the U.S., what’s the pipeline is looking like?
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
We do see some enterprise customer has — interest about this data SASE, and just like some other cloud or some other platform — deployment infrastructure. So that’s where we make it as the whole infrastructure security offering, and the dollar or the amount of revenue whatever — still relatively small, which may not impact much of the total, total building or revenue there. But there’s an interest about this and make it — so customer want to us to make sure has some kind of flexibility and also brought offering. So that’s where we see the OPEC acquisition has what we have on the 40 SASE and also offer more broad, both on the product on the deployment on the infrastructure side to, to beat customer demand.
Keith Jensen — Chief Financial Officer
Yeah. And then add to Ken’s comments just pulling back and looking at it even maybe little more broadly, and to the comments that were made in the prepared remarks, we are very pleased with what we saw in terms of July, selling activity, and the pipeline built worldwide as well as in the U.S.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
At the same time, like we say, we also keep supporting our partner, including the service provider, and even some, some big global customer they also want to build in their own SASE just like the cloud sometime they have the private cloud or the leverage public cloud or the hybrid cloud. So it’s a similar since we’ve seen here in SASE which we also support in the partner customer tried to have a version of a SASE which is based on the service on your infrastructure to deploy some security function.
Shaul Eyal — Oppenheimer — Analyst
Understood. Thank you so much for that. We’ll talk later.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Thank you.
Operator
Thank you. And our next question comes from the line of Sterling Auty with JPMorgan. Your line is now open.
Sterling Auty — JPMorgan — Analyst
Yeah. Thanks. Hi, guys. You mentioned, you know continued tail winds from work from home, but we have seen the growth rate on the product side, and to certain extent the billings ex the adjustments you mentioned, start to fade. So I guess my question is do you expect that those trends can continue on for multiple more quarters, or do we faced further deceleration in the back half as some of the work from home tailwind fade further.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
We do see the Enterprise Service Provider the high-end continue to grow maybe because the new product is announced earlier this year. And also some SMB, some other parts also have lower healthy growth. And also, even some of the products had for work from home continue to grow in — like we mentioned the FortiToken, FortiAuthenticator and some other product. So it’s probably not as a rush by like we experienced in some back in March, but there is still pretty strong the whole total network security growth.
Sterling Auty — JPMorgan — Analyst
Okay. And then one follow-up. We’ve heard from multiple companies about accelerating digital transformations. How did the digital transformations and shift to the cloud impact your business either positively or otherwise?
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
We see pretty strong in the retail right. So if retail, they can order online, they can do whatever, deliver or some other. Definitely they have a lot of benefit. So that’s where we see large strong growth in retail. Probably benefit from the digitalization and some other vertical or even some other region have less sort of similar sense, and especially we say — that’s why we called a security network networking. It’s combined security networking together. And even itself, traditionally, they’re more engaged with the security team. Now they see a lot of increase fundamental content, partially because IT was a part of FortiGate function, but other party do see, at least to the networking security to working together, wanted to knock no center [Phonetic] all the stock combined together. It’s also a trend there. So that’s where we see quite a good progress combined the security network together, which we redesigned from our beginning, not just SD-WAN, including a Wi-Fi. But if I’ve see Wi-Fi a little bit slow right now, because especially enterprise Wi Fi in the office, not many people go to office, but they do see a lot of interest in that direction. And also the 5G receive strong entries have ramp up.
Sterling Auty — JPMorgan — Analyst
Got it. Thank you.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Thank you.
Operator
Thank you. And the next question comes from the line of Brian Essex with Goldman Sachs. Your line is now open.
Brian Essex — Goldman Sachs — Analyst
Hi, good afternoon and thank you for taking the question, Keith, I was wondering maybe if you hit a little bit more on billings, maybe a little bit softer than we’d expected in the quarter and then, kind of a nice guidance for next quarter. Maybe some of the dynamics behind that and in particular interested in large deal dynamics, particularly US Financial Services where we’ve heard about some weakness in the quarter. Understand retail is really strong, but maybe a little bit more color on that and how it might impact billings.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
I think the financial services strength that we saw in the quarter was outside of the US. Obviously, New York got hit, or the Northeast got hit pretty hard with a pandemic in the second quarter. So that financial services growth that we gave on billing I think it was 33%. That’s really an international growth number and it kind of speaks to the diversification of the business. And we’ve talked before about our diversification. The US represents maybe 25% to 30%. Obviously our largest country, but not a majority as it is with some other businesses. So, we did feel the effect particularly towards the middle part of the quarter there was some of the things that were happening in the uncertainty in the U.S. on our toll numbers, but we were very pleased when we saw that said earlier related to Asia Pacific and the rest of the world.
Keith Jensen — Chief Financial Officer
And Octopod ready study make the second harbor last year we started ramp up the hiring and sales capacity additional marketing lead gen and then the epidemic actually slow down some of the new sales back. I mean, become a like a more productive or whatever. I wish the productivity level for what expect at the same time. Some of them, maybe take a longer time to reach the new customer, especially in the U.S., we do have quite some cells, and the capacity that’s actually the pandemic slows things down a little bit, but with the additional hiring, with additional new ball a position and we have we do believe, was the epidemic starting to get better, especially U.S., we will see more strong growth potential.
Brian Essex — Goldman Sachs — Analyst
Got it. Maybe Keith just a quick follow up quickly. Nice cash flow in the quarter, not better than we thought. Maybe some of the puts and takes outside of Billings and change in deferred that drove that and outlook for the rest of the year from, you know, particularly from a working capital perspective.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Yeah, I think the other part of it is a collections are very strong and I applaud the collections team for the great job that they did, working with our channel partners could bring the cash in. I think we’re perhaps a little more successful in that then than we planned. I think when you look at our free cash flow numbers. You’re going to get from quarter to quarter a little bit of volatility, because we try not to over manage the timing of payments and things of that nature. So it’s probably better to look at a couple quarters string and string those together to look at terms, but in terms of the key drivers yeah it’s Billings, you know, you can get something with inventory and payables, but I think the margin part of that, you know really is, is a large driver that that outperformance on the margin line. Really manifests itself in many ways, one of which is in the free cash flow.
Brian Essex — Goldman Sachs — Analyst
All right, very helpful. Thank you very much.
Operator
Thank you. And our next question comes from the line of Hamza Fodderwala with Morgan Stanley. Your line is now.
Hamza Fodderwala — Morgan Stanley — Analyst
Hi, thank you for taking my question. Keith, I just wanted to dig in a little bit on the comments that you made around some of the sales cycles towards the end of the quarter I’m wondering if you know how do cycles progress toward Layton Q2, what if any deal, sort of, you know, had slipped out and in Q3 and you know whether or not those have been closed so far and in July?
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Yeah fair question and I think the thing that we’ve seen with a pandemic and I’ll pull this up a little bit. If you go to the guidance setting process obviously you start with a pipeline and then you start making certain assumptions about the close rate. And while we felt good I felt good about what I was seeing in April. Nonetheless, we’ve made some adjustments to our expected close rate in the quarter, the second quarter. And as we got to kind of leading to your question, you know the last the last week of the quarter. I think we saw perhaps a few more deals that did not get the final signature that we expected them to get. And then your follow on party your question is what are we seeing in July. And that’s why I’m making the point that I think I’m very, very pleased overseeing in terms of July sales activity whether you measure it based on growth or linearity against our target, as well as the pipeline, and as well as considering what we might call pandemic related close rates.
Hamza Fodderwala — Morgan Stanley — Analyst
Got it’s. And then just a follow-up question, if I may. On the government vertical, obviously, that’s a big one for you. Could you comment a little bit about on how that grew from a year-on-year perspective? And what you see the pipeline, especially with the U.S. federal close coming out?
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Yes. So keep in mind, our U.S. federal business — our federal business is — our government business excuse me, has three components. It has a U.S. fed, it has international governments and it has state and local governments. And I would say that the performance was strong across at about 26% growth, 25% growth, but that was not driven by state and local government, state and local government suffered. And then the U.S. Fed part of our business is not a huge part of our business. So you’re really looking at, while the U.S. Fed did well, we had nice, very attractive growth internationally with our government segment.
Hamza Fodderwala — Morgan Stanley — Analyst
Got it. Okay. Thank you.
Operator
Thank you. Our next question comes from the line Brad Zelnick with Credit Suisse. Your line is open.
Brad Zelnick — Credit Suisse — Analyst
Excellent. Thanks so much. You guys continue to execute well, putting up better results than your nearest competitors. And the diversification of your business is on full display this quarter, which is great to see. Can you comment at all just in terms of the competitive dynamic that you’re seeing out there? And maybe anything that you can share in terms of the pricing dynamic as well?
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Yes. I think with the — like a 73% business come from FortiGate. So with the new release of like today is the high-end and most high-end product to support hyperscale. So we see the performance that keep increased so we are getting much better, better and same time, in the last few quarters, the SoC [Phonetic] based like from 60F to 80F to 100F, 40F is also starting to see huge eventually the increase of growth in the field, especially, you can see the SMB, they usually buy this low-end SoC based product also is growing quite well. So that’s where from the product we see because we’re keeping invest long-term in the ASIC, which has a much better competing power and a secure function compared to the general purpose CPU. So that we call [Indecipherable] come from like 25 time better to like today’s products like 13 times better than the competitor. It’s a huge advantage and the plus additional function like SD-WANs and other parts. So we see a quite a huge adventures and more cap compared to competitor. They probably will keep in pushing some software or some other formal deployment, which because it did have a difficult time competing with us into this appliance or some base. But for us also we will position to have the whole infrastructure solution not just appliance base, but also in cloud and in the software base and then also offer different kind of deployment, different kind of service. We also see quite a period of healthy growth from that angle
That’s where the — we call fabric approach, fabric solution [Indecipherable] almost double compared to FortiGate growth. So we still see pretty healthy like ones you get in leverage of FortiGate then we tend — and it will expand into under 100 [Phonetic] FortiGate, growth. So that benefit the fabric advantage through keeping help us growth, faster above average because its really the consolidation is still the — still is the trend in the whole industry there. So customers want to reduce the management cost. They prefer to consolidate some of the vendors, which we started to see more benefit for us because most product function, we do develop in-house, which make it integrate and automate on day one compared to some other competitive dependent acquisitions more difficult to integrate and automate. automate. So that’s what we see is we continue to invest long-term both on the product technology, infrastructure side and we do believe it’s a long-term game. And so that’s where so we’re keeping gaining market share. And we do see the gap at bigger, and we have more advantage right now.
Keith Jensen — Chief Financial Officer
Yes, Brad, it’s Keith. I would continue on with on with on with Ken’s comments there a little bit. And keeping in mind, I made a reference to it in the text that, we’re seeing a new cost advantage evolved within the E series, and we expect it to continue with the F series. I mean I think that the company can has done a tremendous job with the ASIC advantage of driving down the cost in subsequent generations of the chip at the same time, driving up the performance. That gross margin performance that I mentioned earlier in the script, that actually came with it with just a small headwind with discounting for the first time. And you may have been asking a discounted question. This kind of is the first time we’ve seen that in several quarters, about 0.5 point, if you will, perhaps about 0.5 point, if you will, perhaps increase in discounting. But that cost structure that’s coming with the ASIC advantage that I made reference to is more than enough to outweigh that.
Brad Zelnick — Credit Suisse — Analyst
Thank you both so much for the very thorough answers. And I would just say that the competitive differentiation of your strategy continues to shine through. Congrats and thanks for taking my question.
Keith Jensen — Chief Financial Officer
Thank you.
Walter Prichard — Citi — Analyst
Hi. Two product questions. First, just on the — I think last — last quarter, you had some real strength in the remote access things like authenticators and tokens. Just curious how that continued into this quarter. And then also on the SaaS side, when are you talking about having an integrated SaaS SD-WAN product in the market?
Keith Jensen — Chief Financial Officer
I’ll take the first one. In very round numbers, I would say, if I got a benefit numbers, call it, very round very round numbers, $10 million in the first quarter. I probably got half that benefit in the second quarter on those three work-from-home products.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
I’ll take the first one. In very round numbers, I would say, if I got a benefit numbers, call it, very round very round numbers, $10 million in the first quarter. I probably got half that benefit in the second quarter on those three work-from-home products.
Walter Prichard — Citi — Analyst
Great. Thank you.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Thank you.
Operator
Our next question comes from the line of Tal Liani with Bank of America. Your line is now open.
Tal Liani — Bank of America — Analyst
Hi, guys. My question is more general about the market. The data shows that the firewall market has been slowing down tremendously in the last few quarters, six or seven quarters of decline. What is your experience with the market? I’m trying to understand if your continued growth is a question of continued share gain or new products that are compensating for firewall weaknesses. So what’s your view of the overall market and the drivers for firewall demand in the market? Thanks.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Yes, the traditional firewall, they’re mostly secure border, which is positioned between the internal network LAN and also the Internet. That part is, like I say, there’s a — no longer enough. There’s a multiple way you can bypass that and also a lot of application, a lot of — since also go beyond the company network, they go to the cloud. They go to some other part like mobile access. So that’s where the traditional firewall where we do see the growth slow down. That’s where we keep expanding beyond like we expand the WAN as we call secure network in that space and building FortiGate and make it part of the WAN solution and also kind of cloud solution. At the same time, internally also expand both internal segmentation, like with the switch with Wi-Fi access point, not part also growing very, very well and quite strong. And so like I said, I — we keep in saying now, we say it’s a third-generation of network of security infrastructure from the traditional connection base to when we — Fortinet we call the content application based security. And now it’s more like the whole infrastructure security including both the traditional gateway and also go to the Internet and the WAN connection, cloud solution and SASE and the same going with funnel for the segmentation for the switch for the Wi-Fi, it’s the whole — and plus the end point of different application, so it’s the whole infrastructure security, we feel is a new trend, which we prepare all this using the fabric, using ASIC, increase the computing power to address the network speed issue.
We keep in doing this in the — for about 20 years since we found the company. So we starting to see the investment we made, whether from ASIC, the technology for the product side, for the infrastructure side, starting more benefit us and differentiate Fortinet compared to some other competitors, still relatively — it’s the same approach compared to the early day on network security. So that’s what we see is as a gap and advantage we have is kind of big and bigger going forward.
Tal Liani — Bank of America — Analyst
Got it. And the migration to SASE, isn’t it going against your core offering?
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
No. It’s a part of the whole infrastructure security and like SD-WAN because for the SASE is really you need to access to it, right? So that’s where SD-WANs and other parts really have the good way to access that. So we are built in into the FortiGate and has huge performance and functional advantage. And at the same time, the service model leverage, the infrastructure we have, the customer base we have, that’s where the OPEC acquisition keeping enhanced this part. So that what we address some of the new things the customer need. And at the same time, the partner also see how can like working closely with them to supporting the customer better, given the additional flexibility no matter what kind of format of secure deployment they want.
Tal Liani — Bank of America — Analyst
Got it. Great. Thank you.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Thank you.
Operator
Thank you. [Operator Instruction] And our next question comes from the line of Amit Daryanani with Evercore. Your line is now open.
Amit Daryanani — Evercore — Analyst
Good afternoon guys. Thanks for taking the questions. I guess first one, you guys mentioned a couple of times about certain deals just getting pushed out from June into the September quarter. Any sense you could give in terms of the deal size or the verticals where you saw this happening? And I guess if you didn’t have any of these issues, what would the June quarter revenue look like?
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
I don’t know if there was a common — well, first of all, large deals for us, it would be $1 million, right? They’re not $10 million, $20 million or $30 million deals. So, you’re probably looking at some number of those transactions that moved. I don’t know that there was a common theme in terms of verticals, if you will. I do think that it was a bit more of a challenge in the U.S. than it was in other geographies on that close rate for the last week of the month — or the last week of the quarter.
Amit Daryanani — Evercore — Analyst
Got it. And I guess, last quarter on this one, you’ve talked some amount about perhaps using your financial strength as a way to essentially accelerate your share gains. Could you just touch on what impact would that have in your free cash flow or even your margins perhaps? Just want a sense — just trying to get a sense of how much are you willing to flex your model? And what sort of share gain aspirations would you have from these dynamics that you would take on?
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
Yes. There’s probably three places that you could see. One is looking at the inventory because we’re — in this environment, we’d like to keep a little more inventory on hand and so when you look at the inventory turns, I think the number was 2.2 in the quarter, and that’s probably down about one. And so you can do some math there and quantify it. You can also look — the second place you would see it is on the extended payment terms. We provide the metric of what our contractual payment terms were as of at the end of the quarter, which I think was 67 days, and that’s up 17%. The third place that we can flex a little bit is on discounting, and I kind of covered that a moment ago that while discounting in the current economic environment is a fact of life, and we did have a slight increase in discounting, for us, it was outweighed by the structural difference in our cost structure, which more than that outweigh it. So, in terms of flexing our balance sheet and looking at the cash flow model, if you will, I think the key place for inventory and then looking at the collections.
Keith Jensen — Chief Financial Officer
And just one correction on the contractual payment terms, it was 62 days.
Ken Xie — Founder, Chairman of the Board, and Chief Executive Officer
I’m sorry.
Amit Daryanani — Evercore — Analyst
Perfect. Thank you.
Keith Jensen — Chief Financial Officer
I’m happy. I’m happy it’s 62.
Operator
Thank you. And this does conclude today’s question-and-answer session. I would now like to turn the call back to Peter Salkowski for closing remarks.
Peter Salkowski — Vice President-Investor Relations
Thank you, Chris. I’d like to thank everyone for joining on today’s call. Fortinet will be attending the following virtual investor conferences during the third quarter. We’ll be doing the Oppenheimer Conference next week on August 11th, the Citibank Conference on September 9th, and the Collier Securities conference on September 10th. Event presentations will be webcast and links for these webcast will be available on the Investor Relations website of the Fortinet IR site. If there are any follow-up questions, please feel free to contact me. Have a great rest of your day. Thank you very much. Have a good day. Take care.
Operator
[Operator Closing Remarks]