Q2 2021 Fortinet Inc Earnings Call
[music].
Good day, and thank you for standing by and welcome to the Fortinet second quarter.
The 2021earnings call at this time, all participants are in a listen only mode. After the speaker's presentation. There will be a question and answer session. That's the question. During the session you will need to press star 1 on your total so and keep that.
The.
The advice of today's conference is being recorded if you require any further assistance speech breaths, sorry zero I would now like to hand, the conference over to your speaker of today Pizza Selco ski Vice President of Investor Relations. Sir. Please go ahead.
Thank.
Catherine Good afternoon, everyone. This is Peter Keith Vice President of Investor Relations at Fortinet I am pleased to welcome everyone to our call to discuss Fortinet. The financial results for the second quarter of 2021, which we are hosting from inside of our new building speakers on today's call are Ken Xie Fortinet, the founder Chairman and CEO and Keith Jensen, our Chief Financial Officer cause.
This is a live call that will be available for replay via webcast on the Investor Relations website.
Ken will begin our call by providing a high level perspective on our business. Keith will then review our financial and operating results for the second quarter before providing guidance for the third quarter and updating the full year. We will then open the call for questions. During the Q&A session. We ask that you. Please keep.
Your questions brief and limit yourself to 1 question to allow others to participate before we begin I'd like to remind everyone that on today's call. We were working 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.
The most recent form 10-K on form 10-Q for more information.
All forward looking statements reflect your 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 reconciliation is located in our earnings press release and on the presentation that accompanies today's remarks, both of which are posted on the 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.
Thank you everyone.
Todays call to review our outstanding second quarter 2021 of the result.
<unk> increased 35% to $961 million driven by solid execution and was the best it has been since the 2015.
So curious steam on account for 14% of second quarter of buildings.
For total revenue growth, 30% to 800 on 1 moment.
Part of the up 41%.
Put all of them the growth was the highest for nearly 10 years.
Cash flow was 295 million.
The Zip code level with.
With strong business momentum, we remain focused on gross.
Good day, we announced the expansion of our Forte, Ken who the cost secured of services, adding a new suite of service called for the trust.
Or do you trust the quality of service to offer of user base of licensing not form of the user across of our positions on the higher security platform.
On April on commissions to EBITDA.
Easy to manage and secure class haul network endpoint and cloud reached.
<unk> traditionally has been signed loaded.
The initial service level being offered for Zero Trust network access on that.
Lumpy modification.
The current <unk>.
Curious the Cuda services, which cover all fortinet.
Fortinet security fabric product with C level officers, including clinical on the clinical by solving technical support on PON the issuance of resolution.
Additionally, we'll do constitute a service has been fine tuned for different segment with added individual services for enterprise.
Bongos will commercial on the packages for SMB.
The average industry, leading set of intelligence from what he called lab, who took on.
Insecure service on for a market, leading AI enabled security capability, that's regularly adjust the protection across the Fortinet security fabric.
Today, we announced the new 40 day sort of a 100 F. The industry's first high performance next generation firewall with integrated Zero Trust network access and advanced malware protection.
Powered by the Fortinet NP 7 Asics SBU the.
<unk> hundred <unk> offers on average 6.2.
The small performance the other competitive products based on all the acuity compute region.
This makes the sort of behind the F. The best protection for high speed the internal network 10 of these centers.
We continue to see the momentum on the adoption of SD Wan the upfront.
<unk> access and cloud solutions, among the world's largest service providers.
In May of Fortinet was recognized as the winner of the Microsoft Security customer impact of award.
Last week Fortinet was named Google Cloud plenty plenty of security partner of the year.
<unk> 4 innovative thinking.
Net outstanding Kosmos surveys on the best in class you sell the <unk>.
The product that services.
Before turning the call over to Keith I would like to thank our employees customer on the partners worldwide for their cash.
<unk> continues to report on how work.
Thank you, Ken and add your comments.
We should note that as of the prior quarter billings growth product revenue growth and total revenue growth all accelerated sequentially.
All 3 of growth rates, we're at 5 year, Fortinet highs and product revenue growth was at its highest in over 9 years.
Okay, let's start the more detailed Q2 discussion with revenue.
Total.
<unk> of $801 million was up 30% driven by industry, leading product revenue growth of 41%.
The product revenue growth was broad based across geographies for the gate of the non core to get products and across the use cases.
The illustrating market acceptance and customer demand for our integrated single platform.
With fabric strategy across the customer infrastructures.
Our financial strategy includes the rule of 40 target.
Target the total of the revenue growth percentage on operating margin to be at least 40.
In the second quarter strong demand and execution drove this actual total to be a rule of 55.
The security Watergate product revenue growth was 40%, while we continue to see robust growth from our secure SD Wan functionality of <unk>.
The already of the growth was driven by 4 to get revenue from other capabilities, which are embedded in the <unk> operating system.
Non Florida gate product revenue growth was over 40% for the second consecutive quarter.
And it was.
Strong growth from our integrated security fabric products.
1 additional comment on our product revenue growth.
Product revenue growth was a reflection of our continued strong organic growth and not the result of a few large deals drawing down backlog, nor an unusual number of delayed transactions from the prior quarter.
Order of pulled in from future periods.
Service revenue of 500 of $3 million was up 24%.
Support and related services revenue of $230 million was up 26%.
The security subscription services revenue of $273 million was up 23%.
Moving to the mix of 40.
Driven by <unk> and non <unk> platform revenue.
For the great product and services revenue increased 26% driven.
Driven by very strong demand for both branch and high end for the gate products.
I am products included 10, NP 7 powered for the gate models.
Representing approximately 25% of high end 40 gig shipments.
<unk> 40 of our basic driven in Florida gates give customers, 5% to 10 times more computing power than firewalls running on common Cpus.
The advanced computing power creates additional speed and.
The capacity to continue to add functionality to our operating system further driving our price for performance advantage.
The combination.
<unk> of the ASIC advantage and the common operating system across products.
The vendor consolidation lowering total cost of ownership.
And increasing automation.
Non Florida gave product and services revenue grew 39%.
It accounted for approximately 30% of total revenue.
Up over 2 percentage points.
The integrated security fabric consists of the complete range of.
Pretty close on that.
Yes.
And the.
Okay.
Net of a rehearsal for all our hands on meeting later on today folks.
On the inside Scoop on what Patrice was going to say.
So we started again if I may now.
Before we get the product and services revenue grew 39% and accounted for approximately 30% of total revenue up over 2 percentage points.
The integrated security fabric consists of the complete range of form factors and delivery methods, including of physical and virtual appliances cloud SaaS and perpetual software.
As well as hosted of non hosted solutions.
Together, they provide a range of security solutions and form factors, enabling integrated protection for the hybrid environments.
The expanding digital attack surface from network Datacenters to endpoints to the cloud.
Let's turn to revenue by GL the sum.
On slide 5 revenue in EMEA increased 34% the <unk>.
<unk> revenue increased 29% and APAC posted revenue growth of 24%.
Product revenue growth from both the Americas and EMEA regions was over 40%.
Moving to billings second quarter billings were $961 million up 35%.
We saw strong growth in both the 48 and.
The non Watergate segments of the security fabric platform.
The 40 gig segment delivered billings growth of over 30% the accounting for 71% of total billings.
As shown on slide 6 branch in high end <unk> posted very strong billings growth.
The non <unk> segment accounted for over 29% of total billings.
And deliver of billings growth of over 45%.
Driving a 2 point mix shift to non <unk> products and services.
Given the continued strong performance, we believe our non floating gate platform is on a pace to be a $1 billion business. This year.
Secure SD Wan billings represented 14.
And the total billings and.
And as the key functionality from an integrated SaaS solution.
In terms of billings by G. L. EMEA outperformed all Geos, followed by the Americas and APAC.
Europe had a very good quarter in.
The growth in the Americas was driven by the United States, which was up sequentially by more than 30 percentage.
Points.
Latin America continued to recover from the pandemic induced slowdown closing billings growth from the mid twenties for the second consecutive quarter.
The average contract term was approximately 28 months up 2 months from the second quarter of 2020, and 1 month from the first quarter of 2021.
Yes.
Deals over $1 million increased from 59% to 79.
And the pipeline for deals of $1 million continues to look good for the remainder of the year.
Secure SD Wan deals over $1 million increased from 13 to 19.
Moving to worldwide billings by industry verticals.
The buildings by vertical illustrate.
The the diversification in our business model and importantly suggest the current threat landscape is driving security investments and industries that may have historically shown lower investment levels.
For example, the verticals of the historically not been in our top 5 combined for billings growth of over 75%.
Service providers accounted for 14% of total billings and were up 25%.
Moving back to the income statement.
Revenue growth of 41% drove a 3 point shift on the product and services revenue mix and along with it.
Gross margin decrease of 160 basis points to 77, 5%.
Product gross margin improved 70 basis points to 61, 7%.
Services gross margin decreased 160 basis points to $86.9 with data center investments and FX accounted for about 100 basis points of the impact.
Operating margin of 25, 4% was at the top end of the guidance range.
Despite a 350 basis point headwind from the gross margin decline of weaker U S dollar and increased travel and marketing event costs.
We ended the quarter with the total head count of 9043, an increase of 17%.
Moving to the statement of.
Assuming the cash flow of summarized on slides 7 and 8.
Free cash flow for the second quarter came in at a quarterly record of $395 million.
Benefiting from strong revenue growth.
Good 1 good month, 1 linearity and.
And lower capital expenditures.
In the quarter, we repurchased approximately 455000 shares of common stock for a total cost of $92 million.
On an average share price of approximately $201.
The remaining share repurchase authorization at the end of the second quarter was $921 million.
With the authorization set to expire at the end of February 2022.
We ended the first half of the year with total cash and investments of $3.4 billion, an increase of $1.7 billion.
This includes the proceeds from our $1 billion investment grade debt issuance during the first quarter of 2021.
Dsos returned to pre pandemic levels decreasing 7 days year over year, and 15 days quarter over quarter to 66 days.
Inventory turns increased to 2.7 times from 2.
The items, reflecting strong product sales on the quarter.
Capital expenditures for the quarter were $24 million and we have started to move into the new Sunnyvale building.
We estimate third quarter capital expenditures to be between $65 million to $75 million, which includes a $30 million of payment for the new campus building.
We estimate 2000.
<unk> capital expenditures to be between 175 and $200 million.
With the acceleration of the growth and a little more understanding of the post pandemic work patterns, returning our attention to reviewing our facilities footprint and the needed office and warehouse capacity in the U S and Canada.
As we work through this process it is possible that our estimate of capital expenditures.
The next few quarters will increase as we prepare for the next phase of our growth.
Looking forward, our goal remains to balance growth and profitability.
And given the growth opportunities that we believe lie ahead, we continue to expect the tilt of our bias within this framework.
More towards growth of at least the next several quarters.
The opportunities we see are supported by a strong pipeline.
Increased sales effectiveness the.
The growing success with a single integrated security platform strategy, and the convergence of security and networking.
The response of the current threat environment.
And our development efforts, which include continuing to invest in our ASIC.
Could vantage, which enables the shared operating system across the security fabric platform.
It drives our price for performance advantage increase.
The increase of capacity to add features and functions, while maintaining price points.
I'll now review our outlook for the third quarter summarized on slide 9 which is subject to disclaimers regarding forward looking information the Peter provided at the beginning.
On the call.
For the third quarter, we expect billings in the range of $940 million to $960 million.
The revenue of the range of 800 million to $815 million.
Non-GAAP gross margin of 77.578, 5%.
Non-GAAP operating margin of 24 of 5 to 25, 5%.
<unk>, which includes an estimated 200 basis point headwind from foreign exchange and increased travel and marketing costs.
Non-GAAP earnings per share of <unk> 90 to 95.
Which assumes a share count of between 169 and $171 million.
We expect the non-GAAP tax rate of 21%.
With that we are raising.
'twenty 1 guidance.
And expect billings on the range of $3 billion $870 million to $3.920 billion, which of the midpoint represents growth of approximately 26%.
Revenue in the range of $3 billion $210 million to $3 billion $250 million, which of the midpoint represents growth.
Of our 20 approximately 24, 5%.
Total service revenue the range of $2.45 million.
2.2 billion to $2.75 million, which.
Presents growth of approximately 23% and apply its full year and implies full year product revenue growth of approximately 28%.
Non-GAAP gross margin.
Both of about 7% of 79%.
Non-GAAP operating margins of 25% to 27%, which.
Which includes an estimated 200 basis point headwind from foreign exchange and increased travel and marketing costs.
Non-GAAP earnings per share of $3.75 to $3.90.
Which assumes the share count of between 168 and 100.
The $70 million.
We expect our non-GAAP tax rate to be 21%.
We expect cash taxes to be approximately $90 million.
Along with Ken I'd like to thank our partners customers and the Fortinet team for all of their hard work execution and outstanding success in the first half of 2021.
I'll now hand, the call back over to Peter.
70 <unk> session.
Hey, Keith operator, Catherine we're ready to open the call for questions. Please.
Sure as a reminder to ask the question you will need to press star 1 on your telephone keypad sort of draw.
On your question press the pound key.
Please standby, while we compile the Q&A roster.
For the Q.
First question is from Brian.
Of.
Goldman Sachs. Sir Please go ahead.
Great. Thank you for taking the question and guys. Congratulations on the results really nice set of results this quarter.
Maybe to start off Ken I know you've talked for years.
Not having exposure to the firewall refresh cycles within your business could.
Could you maybe unpack a little bit the product revenue performance are you starting to see perhaps.
Some exposure to the refresh cycles of others is this more.
Rip and replace.
The infrastructure upgrades or expansions, maybe if you can.
Maybe give us a little bit of an understanding of what's going on behind the product revenue growth this quarter.
Yes, Thanks, Brian.
Quick question.
The industry.
Whether it be independent of the alpha the pandemic.
Probably.
I'm kind of a whole host.
Profit Tianjin.
It's no longer the traditional.
And of border kind of the firewall won't be enough you have to expand into the Wan side like secure SD Wan the size of the Chi and also on the internal have to do a back of the internal segmentation, replacing the switch with secure suite and Wi Fi.
<unk> on all of these kind of lastly on we're all kind of internal attacks. So.
So that's where and also.
So the consolidation also going on and I also need to have with.
US like a different part of infrastructure the acute integrate together total protect the that's a whole lot of time multi multi kind of attack surface protection there.
So thats why we receive.
<unk> Chen for the the whole architecture.
Of how to.
Architect of New protection architecture total protect of the whole infrastructure security of their.
So thats probably different than the test to refresh of the traditional firewall, but it's the the new expand of the infrastructure need to be have all protection. There. So that's what we see like the probably.
We have announced today some of the 100 local inside the.
The high speed network environment.
All of these kind of.
Carnival segmentation within the data center protection in all of these kind of tenants and then also the receive our strong growth whether the secure SD Wan and also on the <unk> growth.
The travel a lot of.
Charles.
<unk> work on home solution. There that's 1 of the unit grow profit EBIT, even much faster there.
So we this is the whole infrastructure of being Chen of reconstitute driven networking started kind of adopt by the data both on the price and also.
I will give on kind of vertical.
Got it that's Super high.
<unk>, maybe to follow up service provider was slightly lower as a percentage of revenue this quarter.
I understand that on the <unk>.
Revenue side and the high end you saw a lot better growth, but it is the should we think about that segment, particularly to the extent that they might be selling through for SaaS or you might be getting better traction with opaque.
Helpful. I mean, how should we think about growth of the service provider market is that still to come or is that a more stable kind of mid <unk> grower segment for you.
And the ramp up stage during the early stage of ramp up compared to last quarter, probably lag down about 15%. This quarter grew about 20 of fiber.
The 5%.
So it's starting to ramp up like I mentioned, they are there of kind of building the infrastructure ledger for the <unk> on our SaaS.
We have a different strategy of SaaS strategy actually quite a different unprofitable differentiate from other player.
We have a dual strategy.
We are probably the only.
It can be.
So the beauty of SaaS E on the same time.
The service revenue, we kind of.
On the margin entity. There also you of masking some of our own infrastructure.
Some customers don't have a service provider 1.
Working with them.
So have a kind of on kind of SaaS solutions. We should also you think weighted.
With the 40 OS inside for the OIS they have been.
The SaaS user across the.
The trust and the who access on some other part is also kind of of different than the competitor and eventually we also hopefully can use of ASIC class salary to add additional pumping empower to all kind of on site. The solution. There so thats, where we feel.
<unk>.
Non current investment, but once we have it will have a huge advantage compared to other competitors.
Alright Thats helpful color. Thank you very much on congrats again.
Keith.
Our next question, yes, Sir our next question from hands the final Waller.
<unk> of <unk>.
Sandy you May go ahead.
Hey, guys. Thank you for taking my question I had a follow up regarding the the prior question on on on some of the drivers of product revenue growth. So Ken.
As the customer start coming back into the office or as we move into this more hybrid work environment.
You talked a lot about these larger network transformation deals I was wondering what do you see the pipeline looking like for those larger deals heading into the back half and beyond and do you think that.
Some of the things that we saw on the past hold the 18 months its going to be an accelerant for those.
More larger infrastructure type deals.
We see the pipeline was strong for the launch of multiple part of dogs.
Which.
Mike.
Oh sure I mean, the cover multiple part of infrastructure.
And also the part of then the growth of 41% is also less channel with you all.
Product revenue from than the traditional all of the somewhat.
Competitor of the using the CPU only so we have the latest CPU from trade, but also the 1 of them and you say in the last 21 years.
Just like the put out we announced today the sort of 500 as based on all calculation, we call. The secure computing region basically for the same cost what's the functional performance compared to other competitor.
Later on the industrial average so we'll have a seat on better performance basically like a because of the comfort and Paula Reynolds the huge fall of music.
So thats whats changing the landscape of.
Hi, Mike.
The the product all of the network security product or some other are there other leverage the AC.
As of this huge company and Paul gave us much better more function and the better performance easily replace a lot of our competitors of ours.
Same time, we do see the expansion total addressable market whether of the Wolfcamp a home low kind of secure internal.
You can turn on that work inside the company inside data center.
The class a lot of high end product gross so the hard on product percentage also we see probably pretty high so maybe the <unk>.
In the last few quarter on even a few years.
Got it that's helpful and maybe just a follow up question for Keith or Ken Keith.
Keith you mentioned the.
The operating margin in the.
Which also having up out of a 200 basis point.
Impact from FX.
I was just wondering just on your spending plans around hiring on.
What youre seeing there, it's obviously a very competitive market for talent. These days and I'm wondering if that's been factored at all into your guidance.
Yeah, I think we obviously pay attention.
Back out of our recruiting in 2 of our attrition rates.
I think the metric that we gave was that our overall head count increased 17% I would offer that the.
The sales head count actually grew significantly more than that so I don't I think that we're in a bit of a sweet spot in the kind of relates to what Ken was saying just a moment ago in terms of the success that we're having.
I think it could reach.
Read through to the high end for the gates as probably being the data center deployments and probably taking advantage of some of some competitors that are going through a refresh cycle and at the same time some of the branch.
The gates, maybe you can be reflective of digital transformation and I think the audience of salespeople understand that in the see the opportunities there.
Thank you.
Okay.
And Sir our next question from Sterling Auty of J P. Morgan you May go ahead.
Yes, Thanks, guys for my 1 question I just wanted to dive into Keith in your prepared remarks, you made the comment that the majority of growth was driven by 40.
Our of driven by for the gate revenue from other capabilities embedded in the operating system I wondered if you could kind of Peel back the onion, there what does that mean and what capabilities were you referring to that were in particular demand in the quarter.
Yeah, I think we've tried to make the point in the past that the.
Some people.
People think about the firewall somewhat simplistically and we probably track close to 12 of the different 12 to 15 different firewall use cases.
When do you want to talk about my micro segmentation of Ips et cetera.
All of those the totality of those.
The growth there was was contributed more if you're willing to SD Wan SD Wan itself still.
<unk> contributed very nicely at 14% of our total billings.
Which probably puts of close to about 35% of probably 55% growth. So I think there's a long list of things of that of firewalls used for and we were very pleased with the success that we saw throughout that suite of offerings.
Also especially the the 47.
We have of beauty and the other trust now access and the ability of SaaS you. There we see was strong.
And that's the area both on the service provider enterprise from work from home solution here.
Understood. Thank you.
Thank you.
Yes, Sir our next question.
<unk> saw on that Rob Lynch.
Sandler you May go on.
Great. Thank you guys for taking my question and following the lead of Mr. Auty I'd like to ask 1 question.
Could you elaborate a little bit on your commentary around some of these non traditional verticals that.
Our.
We are starting to tick up meaningfully and spend as this more onetime in nature or these verticals are just starting to wake up to some of the security issues that we're reading about in the media every day and to them and maybe you could comment a little bit around your Ot success and your strategy there. Thanks.
Rob I think you did a very good job of laying all of the dots.
The connect there.
We're looking at industries or verticals, such as manufacturing transportation.
Energy utilities or what have you.
See the dramatic growth that we saw on that segment of the business, where we've historically talked about our top 5 financial services government service provider.
The tack on retail and they've been very consistent about that 65.
66%, but we saw a significant shift this quarter 2 of those others on it was just the sheer growth that we saw on those others in.
And the point that you alluded to Ot Ot performed very very strongly in the quarter and I think thats consistent with what we saw that vertical growth in those other verticals of it I just mentioned.
Thank you.
Very much.
Yeah.
Our next question from I'm not sure <unk> of Cowen <unk> Company you May go ahead.
Thank you also single question in mind.
When we look at the billings upside revenue upside.
Printed can you on a path for us the mix between new logos and the current installed base.
Any qualitative color on discussion will be appreciated.
Yeah, but always keep new logos were very strong on the quarter.
Yes.
Up about 50% year over year.
I would give the numbers in the past the kind of suggests that 5000 customers that we ended the quarter. Obviously, the very strong quarter is going to be north of that free.
As part of the response of second part of the response, you would not normally expect to see that the new customers in the in the initial quarter would be significant.
The rest of revenue, but rather of contributors to revenue growth over the longer period of time.
But there was a.
A very strong performance from the new logo segment in terms of custom.
Customers are signed up with us in the quarter.
Thank you.
Okay.
Our next question from Mr. Keith.
Pretreatment of Barclays. Please go ahead.
Okay, Great Hey, Thanks for taking my question here.
Ken maybe maybe for you you touched on this a little bit on your prepared remarks, but can you just talk a little bit about the new pricing options.
That you announced recently.
Specifically.
Kelly do you feel like there is demand for that per user.
Pricing for kind of access to the broader for the care and in Florida Guard portfolio, and and what sort of what was sort of some of the early feedback as you may be tested those options.
We do see going forward, especially like work from home volume.
All of the remotely.
You've sort of lessons on top of multiple devices, including the mobile operating on device work from home and also the internal inside Enterprise company there.
Like of cover multiple.
Mike on not just the 40 K the vehicles through to the other.
The new class net access, but also some andre length of lab on may or some other application of cash.
Kind of.
Some part of you put throughout the datacenter they need access.
So thats the per user license will make it much easier for the use of for the customer to <unk>.
Using.
The security of surveys in the in the <unk>.
Multiple part of infrastructure of module cover multiple part out there.
So that's where we feel that it is also important.
Add on top of the current 40 Ken.
Each cover all of the part of rehab and also the 40 <unk> cover the product needs of real time update on the.
All of these on the subscription all of these kind of things. There. So we feel these are for the trust is probably the trend in the future of busted into some kind of on pop.
Especially if we see the the deal.
Cross net access so that you'll have a pretty quick gross opportunity rich.
The 48 hours.
They have all of the spirit in and also the identity of <unk>.
Some of our.
Make sure Dennis.
Cross the multiparty infrastructure can easily.
10 of the management of user we feel all of US to serve is also kind of setting kind of our important.
Sometimes the run path, but we do see there is a.
On the <unk>.
Entries and the demand from the customer that's assets also the reason the.
The launches.
The trial surveys.
Got it thank you.
Keith.
Okay.
Our next question, Sir from Mike or groups of Keybanc you May go ahead.
Huge.
Each quarter of course, I think for both Keith Pan for Ken a lot of people.
Circling around on trying to understand the strength on the upside.
I guess I'd like to just try to compare where the demand was last year during 2020 to where it is this year and why it seems so much stronger has there been a shift.
Say from remote access focus to more breach or what has changed both qualitatively and quantitatively that we're seeing this acceleration.
Last year, the probably more like.
On the rush, the supporting whatever Ken making working.
Working remotely.
But this weighted.
<unk> see the infrastructure need to be operating to be changed to the most of appointing this long time.
So that's where we see a lot of of new infrastructure design and how to supporting not just work remotely, but also secure the whole infrastructure different part of infrastructure from day 1 access.
Internal segmentation.
And also even the <unk> SD Wan all of the internal Wi Fi. So there's just a lot of.
Security architecture of cover multiple part of.
Part of it's a.
Of all of our strong interest and also Keith mentioned the Ot some under is because of the readiness.
<unk> also that the I'd also love of our strong.
Yeah, Michael I think I agree with Ken completely and maybe just add if you think back about Q2.2020, specifically at least for us.
As of quarter that was characterized probably buy.
A lot of software, we did very well with our software and.
The fourth quarter last year, but on the flip side of that anything that requires somebody to be on premise on the data center or taking on a large deployment of our phased deployment of something like that Q2 of last year. There really wasn't much of that obviously today I think it's a year later, it's a very very different environment in that regard and then I do think Youre also seeing the threat environment and.
Things like the Ot part of the business do very very well.
Great. Thanks Kelly.
Our next question from Jonathan Ho of right.
You May ask your question.
Okay.
Hi, Good afternoon, I just wanted to understand.
And the second youre running into any issues around the supply chain or potential of chipset shortages and does this lead to any potential impact to your order cadence says it all.
Jonathan I'd love to say, the we're completely immune to chip shortages of such but I can't say that.
I do think debt as we talked about last quarter.
Order of the fact that our inventory turns.
Around 2 or suggested that we have 6 months of inventory on hand.
We do in some of the chip manufacturers.
The focus on a 52 week lead time, I think I feel very very good about how the manufacturing and operations team executed in the second quarter and how they.
If things for the third quarter for the rest of this year I would offer that as part of the forecasting process on the guidance setting process that is that has become a more.
The significant input if you will end of that process of making sure that we've accounted for it.
All of our estimates of any challenges that we may have will move through the rest of the year.
Thank you.
Okay.
Our next question from Ben Bollin of Cleveland Research, Sir you May go ahead.
Good afternoon, everyone. Thanks for taking the question.
Ken historically when there are periods.
Like this where you see accelerated purchase behavior.
Little bit of a balance of plant if you will.
Inevitably there's a bit of a digestion period after the fact as customers learn.
How to deploy and consume what they just purchased.
Could you talk a little bit about how fabric.
And the variety of organization and sales of the channel is.
Addressing our thinking about that potential risk into the future.
Yeah.
Yes definitely.
We see more and more customers see the benefit of.
The fabric of component of Fabry, which kind of a multiple part of it.
3 of the automate together.
So that's also making the non of 40 day grow faster than the 40 day and will be over a billion dollars.
The over billion dollars of this year.
Absolutely.
The customer.
The customer by the multiple part of most of the already.
Good luck with the weather.
The customer already touched some of them hard and just keep the expanding beyond the what's the initial purchase so we do see the.
The interest kind of struck on stronger and on the non.
Non of Fortinet also keeping grow much faster than the 40 day, which.
<unk> spending.
From.
On whatever the current installation base within the beat on the price.
That's also the the Gardner for kind of you see the the integration of the consolidations that in kind of a more and more important for these have begun the price because the.
Manage multiple part of from different vendors of much higher cost compared.
The language like that.
The platform approach, which Ken multiple product, how the different part of infrastructure.
With the ultimate took out of at least the.
The fortinet fabric kind of appropriately.
Yeah Keith.
And the kind of build on Ken's comment I think the that is the business strategy right. If we look.
Parents of our installed base of customers and see how the adoption progresses in terms of the number of fabric products that they add over what period of time, we would certainly expect that to continue on and then if you look from the current quarter of the new customers that we added those are largely those of buying firewalls, if you will and maybe 1 or 2 things if you.
At our on the fabric suite, but as we would expect them as I understand they have the digests installed the firewalls, but as we get is they get to know and understand our product and the integration strategy more and more that will have the opportunity to come back in and sell them additional products and services as we go forward.
Thank you.
And our next question from the power of the Tid you May now ask your question.
Okay, great. Thanks.
Yeah, so I'd like to stick with the the.
<unk> of non Florida, gates, and fabric and cloud and just sort of the the strength that you've been that you've been seeing there.
Within the Bakken.
African cloud what are like the biggest of the biggest product components that have the that have the most momentum and then how should we think about just the sustainability of that demand longer term.
The non of Fortitude, we have almost 30 product most of the developing internally.
The.
Yes.
So part of that knocked the well I mean the.
Regional pull out because of up and down quarterly and also on.
Pretty much all contribute.
Kind of to the growth, we don't see any any 1 of too much kind of.
Compared with the auditors.
Probably.
Maybe some on length of return.
Southern since all of it but at this stage we can see.
Its also dependent on the cost of my environment, depending on the sale of supporting.
Some of them have an email on what can we <unk> some of the website some of the endpoints some of us access control of some.
Kind of asked on boxing.
Cloud of protein it's acquire the.
Quite a wide haulage of Oh.
Kind of even cover all of this.
The 20th sort of product.
So thats, where it has lots of different cultural breakout and then try to see the trend, but we do see the common message daily.
Some solid the integrate automate the approach definitely has a huge benefit compared to.
Separate product kind of on different vendor.
Got it that's really helpful. Thank you very much and congratulations on the great results.
Thank you.
Okay.
And every 1.
The comfort you ask the question you will need to press star 1 on your telephone Keith out.
That is again star 1 on your telephone keypad.
And our next question Sam Adams.
Raymond James You May now ask your question.
Okay. Thank you I wanted to ask us.
The question, Ken you had record quarterly free cash flow, so Keith stealing of poor job of managing that more efficient balance sheet, you talked about at the analyst day.
But all joking aside can you got significant liquidity available both on the balance sheet and can imagine lenders, beating down your door. So if you could double click on the key areas that you.
The consider to enhance the value proposition I would just imagine the SaaS is accelerating of the SD Wan leader for example of some of the secure web gateway players on the private markets are more mature and would that be an area of consideration or any other key areas that you would consider enhancing the value of proposition inorganically. Thank you.
Would you ever definitely keeping the closely watching all of the offer.
The change in the industry and also new technology all of these things, but also we want to keep the innovation culture of rehab. The last 21 years and also keep the organic growth of a strong.
I'd, probably leave the cash level of investment strategy.
The covered loans.
Yeah, I think for us I mean, we.
We look at our R&D spending as a source of investment not the traditional capital allocation, but we are have historically been of buy versus.
Pardon me of build versus buy a company and that is to we feel strongly about the importance of having the platform to be to.
The integrated.
You do see us doing tuck in acquisitions, sometimes they take a little bit longer to bring to the market, perhaps because the.
The technology, the things that we want to work with a little bit more before we bring them out.
So I don't think Thats the surprise.
I don't know that that precludes us from doing something larger in the future, but we'll look at those opportunities as they come up.
On the continuing focus will be.
Finding the opportunities to rebalance the balance sheet was a little bit of the of deploying some of the cash that we raised the debt offering perhaps the repurchase some some share buyback if you will and at the same time also as we look out for the next 3 to 5 years and we anticipate continued growth, perhaps a little more investment if.
Our facilities what kind of.
That's helpful. Thank you.
Our next question from Irvin Liu of IV GOR ISI, Sir you May go ahead.
Hi, Thanks for letting me on and I would also like to add my congratulations on the great quarter.
I had it.
Question on SD Wan.
Was wondering if you can perhaps unpack some of the drivers behind the continued momentum here, whether the current hybrid work environment has been a contributor behind the behind the strength and can you help us understand what workers gradually returning to offices means for you.
If you will.
Yes. Good question the SD Wan, we can see more of a strong demand and then also.
Huge potential.
The approach we have is unique with the security from our begin an average of 40 K has a huge company on power part of what the OSV day, we see.
<unk>.
The advantage compared to some other comp.
Competitor, everybody using the universe of Cpus amount of approach, which Keith.
The code at any function because the company on part of mutation.
The fund on low cost CPU, So thats, where we do believe we will be the build.
Leader of the mental on either in a few months.
Spacehive non now definitely will be soon.
And SD Wan all for kind of huge advantage like availability of the cost savings compared with the traditional networking protocol mpls or some other part and also a lot of service provider also starting kind of.
Focus on the SD Wan all part of it.
Some of the pot.
Also kind of seeding all kind of the longtime bigger picture of reconstitute driven networking, which would be.
Compared to today all of the network and just sort of the connection on the speed and the constitutes of and that we can also need to look on application the content.
The device behind the user behind.
<unk> I know you went different kind of the location. There. So that's why we see how does the kind of security function of add on top of that once it has huge potential on the.
Which is do you want on the secured SD Wan on so just 1 part of it but also the secure the site.
And also internal <unk> regions include the wildfire, we do see a lot.
Sort of a potential too.
Since secured and covered the whole infrastructure.
Got it thank you.
Thank you.
Our next question from Taz <unk> of Guggenheim partners.
Go ahead.
Hey, guys. Thanks for taking my question I have a question on the attach of supported subscription free of progress this quarter because it looks like you had strong momentum in product.
The strong billings will make the most of it looks like the upside and proud I've been lead to maybe sort of similar upside in Berlin was there of defense and product mix, which led to.
Difference in that sort of every.
Production and support this quarter.
Well I think the you know, we we track our attach rates on our renewal rates. If you will within those bands you're seeing on the analyst day of plus or -2%.
And I think that we were comfortably inside of those bands. So there was nothing unusual.
In that regard.
The piece of the services billings in total we're probably going to go back on check the best quarter that we've had in 4 years or so.
I feel I think we feel good about the both the services and the product performance on the quarter.
Got it and just 1 follow up you gave us the mix of balance between reported get them on.
That's the same kind of mix you have on the product line also.
So the 70.30, roughly is that the mix of non.
The non photo get into sort of get in the product line or is the is that the mix different from product.
Yes, I don't have that number in front of me, but I don't have a reason.
All of them being significantly different we look at them and I'm trying to recall, what we made in the script just a moment ago in terms of.
Product revenue.
I think the.
Yeah, I think we've offered 40 gig product revenue growth in the script as well as non Florida gates of product growth and we said there of both.
For the game was 40% and non Watergate was over 40%.
The growth rates, we don't we haven't given a breakdown by by mix.
For product, we Havent, given 40 day product in non-GAAP product as a mix we haven't given.
Got it.
Very helpful. Thanks, guys.
Our next question from Patrick Colville of Deutsche Bank.
Go ahead.
For the today. Thank you so much for taking my question.
The 41% point of course is extremely impressive.
I guess the questions where people think from investors around the cyclicality of you kind of.
I guess, whether it's secular growth and so could you just help us understand where the onetime.
Pets.
Because of recent hack so because of the recent events or post corona of ours that led to the kind of very strong number or are you feeling that.
The follow on market there comes from some secular dynamics that we should be aware of.
We do see the amount of product.
The benefit going into the.
A lot of a new part of.
Infrastructure on kind of a new area.
And.
That's also on that Keith mentioned.
Besides the top 5 vertical we can see the entre of vertical grow faster much faster than the top 5.
Ah studies Telecom service provider.
Finance service education.
The tax something on that.
But but but also make them on infrastructure, we do see like.
The deploy on the land side on the whatever the smart CD or some other kind.
Vertical the.
Turning sort of structure within data center, even work from home.
There is a quite a broad kind.
Kind of.
Mike if I can buy and pattern compared to before.
And that's also we do believe the eventual will drive. The addition of service because of the western part of our revenue go on.
Kind of in service revenue will come in later.
So cost of production of the New 40 Trust service with fewer salt.
I'll also add additional layer of.
The potential first surveys for the future.
It's the.
Definitely not.
Definitely the center.
Bob mentioned early on as soon as the chairman of the security infrastructure.
It's not kind of a refresh of the price of the traditional firewall, which also from time to time, you will be upgraded because of network that faster and faster, but also expanding into the new infrastructure part of and also.
That's kind of a new area.
We can see all kind of grow faster than the traditional medical pharma surveys on some other part.
Yes.
The Kent's comments I think it was the.
And it has been for a while now that we just saw a lot of tailwind.
On the tailwind of included whether it's SD Wan or <unk>.
And the example.
The refresh of opportunity. If you will is really an opportunity for us too we've used the opportunity to displace the incumbent.
As compared to 4 net debt has 500000 customers in the 70 different firewall models and we even today, we announced the new firewall and are in our press release.
Historically.
As of Blips with us in terms of spikes from refresh.
But on the flip side some of the competitors. The legacy players have a shorter list of customers in the shortlist of products.
And maybe you are not doing as well and Gartner magic quadrants as we are so we view that as an opportunity.
Do you think that other tailwind that came into the quarter, we talked about the verticals.
<unk> seen mentioned it again and also when I look at our customer sizes, whether SMB to always of the global 2000 did very very well.
I think 1 thing that stood out for US was the mid enterprise of the commercial part of the business.
That came on very very strong in the quarter as well. So I think there was a long long list of tailwind for us.
Ken.
And our favorite on net product revenue growth number the also the review of the.
The introduction of the new products on the component part of vantage come from ASIC.
It's a kind of pick on beaver compared to how the competitor.
Not only helping make the mic.
Mike the replacement.
Some of the installation base, but also expanding of the newly area at the end.
Turn on the highest.
Speed of environment, but also has the multiple function beyond the traditional network security by 5 <unk> P. M. On like we mentioned, whether it's on the Zurich Continental access of the module maker by the SaaS.
On Japan like SD Wan on the hygiene.
Acuity, which none of the traditional firewall half and that's also what club of the additional.
South on on the product and also the future service, which is not refresh compared to the traditional firewall.
They don't have that.
SaaS solution or don't have the company empower.
Keith add additional function of the current performance demanding and some of that.
What we see with the strategy we have.
Average assets pumping and part of engage on the ft.
Russell.
Additional function and the addition of performance much lower cost and starting on working firewall.
Great. Thank you so much.
Thank you.
Our next question from Polyone of Bank of America, You May go ahead.
Great. Thank you.
I wanted to talk about gross margin.
If I'm correct, if I'm not it's not going to be the first time, but if I'm correct. Your gross.
Margin.
Had gotten down about the 140 bps sequentially and I also checked it versus consensus it's a slower 100 bps lower than consensus this quarter next quarter and 200 bps below consensus for the year for the guidance. So.
Do I have any do you have them.
Stake in my calculation or is the north can you elaborate on gross margin why is it lower sequentially in the guidance yes.
I think what Youre seeing the call is the the.
The mix shift right the price.
The mix shift versus the services mix shift.
You can do some pretty simple math on the second quarter and you can get to when you have 41% product revenue.
The growth at 61% to 62% gross margin.
First of all the services, that's fairly constant at 23% and 88% gross margin that 25% swing on gross margin.
I'll take that back and you look at a 20 point of 25 point over performance on product.
It works out to be just about 1 point.
Maybe just a little bit north of 1 point on the more on the gross margin line.
Also you can look on the point on gross margin, we actually improved year over year.
Even the cost kind of an increase but we do the improved the product gross margin on now.
Also we do believe with the product gross margin.
Product gross.
The 1%, we can grab a lot of of future growth in the service. That's also the reason we enhanced the 40 cheer on the 40, <unk> and seem kind of out of 40 Trust and which we do believe we'll keeping making the future. So that the service starting kind of grow faster going forward.
Is there any.
We're changing the pricing environment.
But if there is no there is no change on the discounting discounting for the quarter was neutral for US if you will.
We have sort of taken certain steps as we look forward to some of the changes of the cost structure that we're seeing from our suppliers and we've taken certain steps in terms of our own pricing going have.
Many of the hip yet, but they will hit in time for when we actually see those costs on our income statement.
Can you elaborate on the last point what does it mean, so do you expect the margins to decline or do you expect to increase prices in anticipation.
I don't expect I do not expect margins the decline now.
Beyond beyond what will happen.
And with the mix shift if you will between product and services right to the extent, we continue to over ex the over performance.
A form of the product line the way, we just did slip of pressure on the on the gross margin line, but keep in mind.
On the operating margin came in right at the high end of the range. So I think we successfully manage that and it's.
Certainly very consistent with what we foreshadowed earlier in the year.
We said within our framework. This is a year on which we would tilt towards growth. We obviously did that putting up 35% billings growth of 41% product growth and at the same time, delivering 25% of operating margin plus spring.
We also did more investment on the infrastructure, which kind of on making the service revenue gross margin lower.
But also will help in the future of additional services come in.
Great. Thank you.
The call.
Our next question from <unk> <unk> of Oppenheimer, you May ask your question.
Thanks.
The results as well guys.
And I was hoping.
Sure Linda.
You gave a lot of great color on on the backdrop, and what you're doing and how you're executing well on the field.
But maybe you can tie it up also with the competition discussion maybe you can kind of help us understand what youre seeing from your competitors right now.
Who do you see is.
As most vulnerable for share of losses, it's clear that you're going to continue to gain share on this marketplace for the foreseeable future.
But who do you see as the more vulnerable vendors here debt.
The to cede to you and others that.
Bring to the table of what you can bring to the table.
Uh huh.
Go ahead of the competitors.
Good [laughter].
And.
We just have some some loans on strategy of investment which.
Please give us more advantage right.
Whether from the the ASIC chip, which we starting 2 of 21 years ago, starting during the other part of fabric products.
Nuclear and ultimate from day 1.
Some of them.
The more comp of acquisition make agent of lot of difficult due to the integration and automation and in.
In terms of the organic growth there.
On the other side, we do see this sort of market shifted Tianjin. We also wanted to take the time on.
Each of asset strategy, we have probably on the lender.
What can be the service provider to see their status you need of long term to put out further on the same time duties on infrastructure as a modest and integrated with the.
In the 40 day for the OS is the single hole as a part of cover both of the SaaS the their trust in our excess on.
On that caused part of that's nicely on security, making the product kind of.
More easily.
Usually if a customer.
To deploy in seating.
The environment plus some of them in much much better.
We continue to have this kind of a lot of loans.
Strategy.
Some of US see the what gave us Michael.
Non term benefits going forward.
Very good alright, thanks, guys.
Thank you.
I'm curious that would be our of last question for the skol.
And I'll turn it back of weight to Peter's all cash.
You May go ahead.
Thank you Catherine I'd like to thank everyone for joining the call today Fortinet will be attending the following the investor of virtual investor conferences. During the third quarter were doing the Oppenheimer Conference on August 10, and Keybank on on August 11th Vince.
And then with presentations will be webcast. The nose webcast links that are going to be up on our upside of actually they already up on our website as.
Do you have any questions. Following this call. Please feel free to reach out to me as with that have a great day and take care of branch.
This concludes today's conference call. Thank you all for joining you may now disconnect.
Okay.
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As of now.
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