Q2 2022 Fortinet Inc Earnings Call
Yeah.
Good day, and thank you for standing by.
Welcome to the Fortinet second quarter earnings 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 to ask a question. During this session you will need to press star one one on your telephone.
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I would now like to hand, the conference over to your Speaker today Peter Sowinski. Please go ahead.
Thank you. Good afternoon, everyone. This is Peter Feld Koski, Vice President of Investor Relations at Fortinet I am pleased to welcome everyone to our call to discuss <unk> financial results for the second quarter of 2022 speakers on today's call are Ken Xie Fortinet.
And Keith Jensen, our Chief Financial Officer was a live call that will be available for replay via webcast on our Investor Relations website.
Ken will begin our call today, providing a high level perspective on our business. Keith will then review our financial operating results for the second quarter, we're providing guidance for the third quarter updating the full year. We will then open the call for questions. During the Q&A. We ask you. Please limit yourself to one question and one follow up question.
For others to participate.
Before we begin I'd like to remind everyone that on today's call 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.
The date of this presentation and we undertake no obligation.
Pacifically 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 are located in the earnings press release and in the presentation that accompanies today's remarks, both of which are posted on the Investor Relations website, Ken in Keith's prepared remarks today for the earnings call will be posted.
On the quarterly earnings section of our Investor Relations website immediately following today's call. Lastly, all references are on a year over year basis, unless noted otherwise I'll now turn the call over to Ken.
Thanks Peter.
Thank you to everyone for joining today's call to review our outstanding second quarter 2022 resolved.
Total billings increased 36% the sixth consecutive quarter of at least 35% year over year building growth.
Revenue growth, 29% driven by a 34% in the product revenue growth.
SD Wan in OTA bookings grow over 60% and 75%, which together accounted for 25% of total second quarter bookings.
Our better than expected performance demonstrate the strong demand for our service security innovation.
Fortinet is at the forefront of a networking security convergence.
Enabling our customers to reduce complexity, while securing and connecting our hybrid and remote user to advanced acuity with superior performance.
Today, we announced the 40 gig four to 800 F. Our latest innovation in converged network security to.
40, <unk> hundred <unk> is toward flat its compact firewall for Hyperscale data center on the <unk> network.
<unk> by putting a <unk> the 4800 App delivers security computing region.
Average five to 10 times better performance than competitive solutions across the six most common and important functions.
A leader in a common magic quadrant for one aging infrastructure.
Fortinet continues to take market share for secure SD Wan.
Immigrate secure SD Wan solution powered by putting the <unk> deliver huge performance to QD and efficiency over traditional offerings.
Additional tool convergence consolidation of vendors and the product functionality is the other major trend, particularly in our security.
Recent a seesaw survey Gartner fund the percentage of of companies surveyed who want fewer security provider increased to 75% for only 29% in 2020.
But it's almost certainly a part of our line built mostly by our in House Engineering and development innovation.
Fortinet has benefited from this consolidation with our security fabric mesh offering.
It wasn't our securities Master platform deliver unparalleled protection with a broad integrated and automated protection across multiple edge and point to a data center and hybrid cloud environment.
These two major trends convergence and consolidation position fortinet well for long term growth.
Before turning the call over to Keith I would like to thank our employees customers partners and suppliers worldwide for their continued support and hard work that are contributing to <unk> strong growth.
Thank you Ken and good afternoon, everyone. Let's start the more detailed quarterly discussion second quarter results were solid and broad based across geographies customer sizes industries and use cases.
Having market share gains and demonstrated the strong growth from our three key growth drivers.
First an elevated threat environment.
The convergence of security and networking.
Third the consolidation of security products across our platform offerings.
Total revenue of $1 billion $30 million was up 29%.
I assume the $1 billion milestone in quarterly revenue for the first time in our history.
Total product revenue growth was up 34%.
Core platform and platform extension product revenue growth was up 35% and 33% respectively.
We continued to see robust product revenue growth from a wide range of security use cases.
<unk> secure SD Wan.
And operational technology or Ot.
Total service revenue growth increased sequentially to 25%, resulting in service revenue of $629 million.
Support and related service revenue was up 26% to $289 million while.
While security subscription service revenue was up 25%.
Our two points sequentially to $340 million.
Service billings defined as total billings minus product revenue.
We're up 36%.
The year over year growth rate for short term deferred revenue.
It has increased for six quarters in a row.
From just under 21% in Q4 of 2022.
To just over 31% in Q2 of 2022.
The highest short term deferred revenue growth rate.
Over six years.
The accelerating growth rate for service billings in short term deferred revenue.
It reflects the earlier pricing actions that quickly appeared in product revenue.
We're now beginning to appear in service revenue.
The pricing benefit more than offset various service revenue headwinds, including <unk>.
Suspending services in Russia.
An increase in the average number of days between when a customer purchases and subsequently activates a security service contract.
And the impact of contract manufacturers delaying deliveries to later in the quarter.
Which limits our service revenue on new sales recognized in the quarter.
With the growth and pricing benefits more than offsetting these headwinds.
We expect service revenue growth will continue to accelerate through 2022 and into next year.
As summarized on slide six total revenue in the Americas increased 23%.
EMEA revenue increased 28% and.
In APAC posted revenue growth of 42%.
Despite macro conditions that may be more readily impacting other industries, our pipeline growth remains strong.
In particular.
<unk> pipeline growth indicates continued strength in our European business.
Moving to a summary of our success with the large enterprises.
Large enterprises continue to favor fortinet, leading cost our performance advantage.
And they're increasingly more appreciative of our integrated platform.
The platform strategy allows customers to converged networking functionality with.
The security capabilities and consolidate multiple point products.
Our success with the large enterprise customers include.
Global 2000 bookings growth of over 65% year over year.
And on a rolling four quarter basis.
Large enterprise booking growth of over 55% year over year.
And on a rolling four quarter basis.
And the number of deals over $1 million increased over 50% to 120 to 122 deals.
And the total billings value of these transactions doubled.
Secure SD Wan bookings grew over 60%.
Reflecting the convergence of networking and security as well as a strong ROI for our customers.
<unk> bookings were up over 75%.
Reflecting the continued response to the elevated threat environment.
Shifting to billings billings of $1 3 billion were up 36%.
As Ken pointed out representing the fifth consecutive quarter of billings growth in excess of 30%.
I'll pause here to offer thoughts on product refresh cycles and their impact on our financial results.
Specifically, we do not believe new product releases driving near term spike in our topline growth.
Rather we believe the continuous nature of our product releases drives long term growth.
For example.
Each new ASIC is included in a series of products released over several years.
Our most recent ASIC chip the <unk> security processing unit.
It was introduced in Q1 of 2020.
Including the 48, 4800 App announced today.
We have released nine high end core platform products with Emt seven chip.
And over the next several quarters, we will release several additional midrange and high end products with E&P seven.
And lastly, I would note that since the start of 2019, we have released over 23, New Florida Gate models.
While some of our competitors.
Which have much shorter product SKU list may have shown clear signs of our product refresh cycles, our strong long term performance illustrates an extended series.
Of overlapping product maturity curves.
For our platform billings were up 32% and accounted for 69% of total billings.
Shown on slide seven mid range 40 gates posted very strong billings growth for the ship mixing five points in their favor driven by demand as well as supply availability.
Platform extension billings were up 44%.
And accounted for 31% of total billings.
The mix shift up over one five points.
Average contract term was up one month year over year to 29 months.
Driven by the strength from large enterprise customers.
And the 50% plus increase in the number of deals greater than $1 million.
Worldwide.
Government billings grab the largest share of the mix at 15%.
And were up 45%.
The top five verticals accounted for 60% of total billings.
Moving back to the income statement total gross margin of 76, 5%.
Exceeded the midpoint of the guidance range by approximately 125 basis points.
Even if component labor and freight costs increased.
And the year over year revenue mix shifted to points to product revenue from higher margin service revenue.
Product gross margin of 61, 9% was up 20 basis points year over year.
And 450 basis points sequentially.
As pricing actions product mix, and lower discounting offset higher component and other costs.
Service gross margin of 85, 9% was down 100 basis points due to increased costs associated with the expansion of our data center footprint as well as labor costs and other costs parse.
Partially offset by benefits from FX and some of the earlier pricing actions.
Operating margin of 24, 8% exceeded the midpoint of the guidance range by approximately 200 basis points.
The year over year comparisons saw the FX benefit offset by lower gross margins increased travel and marketing costs and other costs.
Head count increased 27% to 11508.
Looking at the statement of cash flow summarized on slides eight and nine.
Free cash flow was 284 million and was impacted by increases in DSO and cash taxes.
DSO increased 14 days year over year, and five days sequentially to 80 days.
Due to the change in billing linearity driven by the timing of inventory deliveries from contract manufacturers.
And new R&D capitalization rules increased second quarter cash taxes by $85 million to $110 million.
Second half cash taxes of approximately $135 million are expected to be more evenly spread across the third and fourth quarters.
For the first half of the year, our adjusted free cash flow margin, which excludes real estate spending was 34%.
Capital expenditures for the quarter were $39 million, including 21 $21 million for real estate investments.
We repurchased approximately $14 4 million shares of our common stock for a cost of $800 million.
Bringing the total year to date shares repurchased to $25 8 million for a total cost of $1 5 billion.
The board increased the share repurchase authorization by $1 billion.
The remaining repurchase authorization is now $1 billion and $30 million.
Inventory turns of three one times, we're up a half turn year over year and down to half turns sequentially.
Moving to bookings and backlog.
As a reminder, backlog is excluded from current quarter billings and revenue.
Nonetheless, as it expected to provide increased visibility in the topline tailwind in future quarters.
Bookings were up 42% to $1 4 billion.
Total backlog of $350 million is up $72 million sequentially and reflects a very strong demand.
Of the total backlog networking equipment accounted for about 50%, while Florida case accounted for about 40%.
We believe our backlog is very strong and sticky.
Existing customers account for over 95% of total backlog.
No single end customer accounts for more than low single digits as a percentage of backlog.
There are four deals in backlog all from previously existing customers.
With the remaining balance of over $2 million.
But that together account for only 6% of total backlog.
Just 4% of ending Q1 backlog was canceled in Q2.
And about half the deals in the backlog have been partially fulfilled.
Suggesting the double ordering is not a significant contributor to backlog.
Consistent with the first quarter, we shipped approximately 60% of the prior quarters backlog in the current quarter.
As our operation and R&D teams did an excellent job navigating a tough supply chain environment.
Nonetheless, we still expect supply chain constraints to be challenging throughout the remainder of the year.
We're continuing to address the supply chain challenges in a number of ways.
Holding by increasing inventory purchase commitments redesigning products qualifying additional suppliers and certain pricing actions.
We believe that even with these actions demand will continue to outstrip supply.
As a result, we expect backlog to continue to increase in 2022.
And while the situation is very dynamic we believe we will have access to sufficient inventory to meet our guidance.
As we balance our pricing actions with the opportunity for continued market share gains we.
We have passed along most but not all cost increases.
We expect ongoing gross margin volatility from these increases as well as shifts in our product mix related to inventory availability.
Before reviewing our guidance and.
The software a few fortinet specific observations and areas you may have heard discussed elsewhere.
In Q2, we noticed certain larger transactions with increased our longer negotiating cycles.
Also linearity pushed to later in the quarter and later in the last month of the quarter, mainly due to supply constraints and deliveries.
Lastly, close rates were strong and importantly, the aggregate value of deals that push were within our historical norms.
Now I'd like to review our outlook for the third quarter as summarized on slide 10.
Subject to the disclaimers regarding forward looking information that Peter provided at the beginning of the call.
For the third quarter.
We anticipate our solid third quarter pipeline growth across deal types sizes and geographies to support the following.
Bookings in the range of $1 $455 million to $1 billion $485 million. We've said mid point represents bookings growth of 36%.
Billings in the range of $1 billion and $385 million to $1 billion $415 million.
Which represents growth of 32%.
Revenue in the range of $1 billion $105 million to $1 billion $135 million, which represents growth of 29%.
non-GAAP gross margin of 75% to 76%.
non-GAAP operating margin of 25% to 26%.
non-GAAP earnings per share of <unk>, 26 to 28, which assumes a share count of between 810 and $820 million.
We estimate third quarter capital expenditures between 105 and $115 million.
We expect a non-GAAP tax rate of 17%.
For the full year, we anticipate backlog that could approach or possibly exceed $500 million.
That will be offset by robust industry growth pipeline strength and market share gains fueling our growth and supporting the following.
Billings in the range of $5 $560 million to $5 billion $640 million, which at the midpoint represents growth of 34%.
Revenue in the range of $4.350 billion to $4 billion $400 million.
Which represents growth of 31%.
Total service revenue in the range of $2 billion $620 million to $2 billion $670 million.
Which represents growth of 27% and implies full year product revenue growth of 38%.
We expect non-GAAP gross margin of $75 to 76%.
non-GAAP operating margin of 25% to 26%.
non-GAAP earnings per share of $1, one to $1, six which assumes a share count of between 810 and $820 million.
We estimate full year capital expenditures between 300 $330 million.
We expect our non-GAAP tax rate would be 17%.
We expect cash taxes for the year to be $265 million.
As I mentioned earlier cash taxes paid or higher in 2022 due to the new R&D capitalization rules in the U S.
Along with Ken I'd like to thank our partners customers suppliers and all members of the Fortinet team for all their hard work execution and success.
Now I'll hand, the call back over to Peter to begin the Q&A session.
Thank you Keith as a reminder, during the Q&A session. We ask that you. Please limit yourself to one question and one follow up question to allow others to participate.
Please open the call for questions.
Thank you at this time, we will conduct a question and answer session. As a reminder to ask a question you will need to press star one one on your telephone and wait for your name to be announced please standby, while we compile the Q&A roster.
Our first question comes from the line of Brian Essex with GFS.
Brian Your line is open great.
Great. Thank you good afternoon, and thank you for taking the question.
Congrats team on our next set of results for the quarter.
I was wondering if maybe Keith I, certainly appreciate the commentary and granularity.
With our full year revenue guide can we maybe unpack some of the commentary on the services side and the lower.
Services revenue guide for the year, maybe help us understand what's going on there and maybe pair that with your comments on <unk>.
Ladies and observations and how much insight you might have there that get folks comfortable with up there isn't pull forward. Thank you.
Yes, I don't think Brian I think pull forward really applies to the service revenue line, but maybe youre et cetera, a couple of questions of US I think to answer your question about service revenue I think the biggest change from where we started the year is really about Russia.
You think about Russia, we talked to the very beginning is about one 5% of our total revenue.
And it applies to the service revenue is line as well.
Earlier in the year, we stopped recognizing revenue on existing contracts for services that provide in Russia in conjunction with our suspending our services.
At that time, we did not anticipate it would be a full year event, but we are now and if you kind of think through that one 5% of service revenues, Russia. So we've really backed out now for the full year about $25 million of revenue related to Russia that thats the largest change there I think.
The delay in registrations.
From when contracts are sold when they are actually registered by customers I think we've pretty much got it out a quarter, what we expected on that that seems to be something in the current environment with inventory constraints that we're going to continue to see.
I think the linearity part of it is a little bit new in that.
Because the shipments occurred later in the quarter, there really wasn't the opportunity to get the service revenue from those Q2 shipments that we would normally get.
I think those are really the parts to put together there.
On the other side I would probably point to again, the short term deferred revenue billings.
And the number that we're putting out there on the growth that youre seeing with that with that number as well as <unk>.
Service billings itself and I think the last comment on this and we haven't talked about it before is that the service contracts are really a use it or lose it contract, meaning it's not that they have the ability to cancel they just have the ability to postpone the registration for a period of time, whether it's depending upon the geography, whether thats 90 days or one year lead happier. So eventually.
When it comes to revenue, but the timing has been pushed out to that aspect.
Got it that's very helpful. Thank you.
Thank you Brian .
Our next question comes from Fatima Fulani with Citibank.
Good afternoon, and thank you for taking my questions.
Keith just wanted for you just with respect to some of the backlog excuse me detail and commentary that you shared I want to hone in on the cancellation rate that you quantified for US I believe you said it was about 4%.
Can you give us a sense of what are some of the reasoning behind the cancellation and what gives you confidence that that 4% is it going to stretch or escalate into maybe mid to high single digits. Thank you.
Yes, I think I would point to some of the factors that we've talked about before I think that last quarter, we talked about the cancellation rate being 5% I think we're seeing it now at 4%.
I think it's unlikely that existing customers, particularly those that have received partial shipments are going to cancel.
Also I wanted to think that it's naive that backlog gets older and that's also why we provide that 60% of shipments from prior backlog number for the street to try and understand it but if that number starts to tick up obviously theres more risk in it.
I think it's important to understand the guidance that we provide really isn't reflecting in any sort of shift in the backlog that we're going to ship a lot of things from backlog.
I think we're fairly prudent in that regard and I think we're also comfortable with that got scribed as the stickiness of the backlog number.
Operator next question, Okay, Alright, Thank you for that question for Tamar.
The next.
Our next question comes from Adam Borg with Stifel.
Hey, guys. Thanks.
Thanks, so much for taking the questions maybe just on the macro you can talk a little bit about the demand environment.
And I highlighted some delayed deals and elongated linearity can maybe go a little bit deeper here and talk about what these customer conversations look like are these tied to any particular.
Verticals or geographies you talk about that large enterprises are larger deals I'd love to hear about the midsize and smaller deals.
Ken.
So we do see.
A lot of customer expansion of enterprise.
Starting some new infrastructure to sell <unk>.
And I won't find anywhere.
Also expense security beyond the traditional network security and into a ledger.
Internal segmentation to prevent analysis ransomware attack all go to work from home.
The same time have more.
Staple security product need to be also made integrate together so we couldnt consolidation both on the part outside on the lender side.
A few of these kind of trend will be lost for the next few years will be pretty lofty unchanged and on.
At the same time.
Keith also mentioned <unk> security.
So the environment also implied so thats, where we see the trend was keeping go in for the next few years.
If you look on the building number.
Compared to two years ago I mentioned in my script.
We have a sort of almost 35% of the building inquiries in the last five quarter.
Compared to two years ago Q1, plenty plenty is only about 14%.
So we do see the change in our southern region and also on the conversions consolidations going on in the whole space right now it will be it will be pretty much tied to amount of growth.
Our next question comes from Keith <unk> with Barclays.
Okay, Great Hey, guys. Thanks for taking my my question here.
Keith maybe for you I wanted to talk a little bit about bookings can.
Can you just can you just talk about how bookings did versus your expectation. This quarter I think the guide coming into Q2 was for about 40% growth. We came in at 42, clearly better, but but but.
A bigger delta on the billings versus the guide and so can you just talk about how to read into that if there is anything to consider there with just those two those two kind of in relation to each other.
Yes.
Obviously, 42% bookings I think we have been over 40% now for three quarters, maybe four quarters on the bookings line, we feel really really good about it I think the one thing that we're looking at internally is just that.
The interplay between bookings backlog and billings and trying to really get a sense of what the.
Direction of the business and the example, I kind of gave US we had a very good.
Quarter on the mid range of the product.
But some of that was due to availability demand was very strong but it is also because we have the midrange product available we didn't have as much product available on the low end.
Now as we shift to this third quarter I think we're probably going to see the low end availability improved rather dramatically.
So when you're looking at billings information that we have historically disclosed in trying to gauge the direction of the business gets a little bit distorted now just in terms of what's available and I think of the total we look at bookings and backlog theres some of that as well in terms of.
The characterization of what the booking is versus the characterization of what's available to ship into what comes on the billing side.
Sure.
Got it very helpful. Thanks.
It.
Also compared to one year to go maybe a tough comparison, because we are starting to see that deceleration about five quarters ago.
Wonderful. Our next question comes from Adam Kendall with Raymond James.
Okay. Thanks, good afternoon Keith.
In the prepared remarks about still expecting supply challenges for the rest of the year and to offset Youre thinking increased purchase commitments qualifying additional suppliers and pricing actions I wanted to zoom in on that last point on pricing actions to see if you would maybe put a finer point on timing and magnitude for expected pricing actions and secondly, you sounded positive on <unk>.
Elasticity and confident on the elasticity moving forward, but just curious what underpins that confidence, especially in international markets with dollar strengthening local currencies and fixed budgets et cetera. Thank you.
Yes, great question and I'll take the last one first because I think it's probably very important probably forgot the first one already so.
One of the things that we do is we track very religiously.
Our CRM tool when a customer if we lose a deal we want to know why is it because we could not overcome the incumbency is it because the channel partner may have had.
Our bias if you will from one of our competitors.
Feature issue, a functionality issue or something like that.
But also very specifically do we lose on price and we've been tracking that now for over a year and that percentage, which is low.
Lower than the other ones that I just gave them to you has been extremely consistent and so with that very consistent loss percentage. If you will I translate that into price elasticity, which tells me that the question is always how far can you push the envelope. We know we come into the conversation with a significant price performance advantage the street, sometimes or Cal charters may say, 30% or 40%.
We've known that from the beginning of this phase of the economic cycle and the question becomes how far where can we push that but again keep in mind. Our goal is really to try over a longer period of time.
Just match the cost increases and maintain a consistent margin. It's not that we're really trying to take down more margin that you will get volatility quarter to quarter because of the mix and things like that so long winded way to say I think I really hang my head on what I'm seeing and we're tracking on the CRM data about reasons that we lose deals and reasons that we win deals.
Since you had a comment about pricing.
Policies tend to be.
Justify the price by small stack, but also kind of.
More often like we do have a new price.
Price book basically every quarter.
Also the Odyssey is really like the product we released today.
Average for the same function for the team.
Price range.
As a <unk>, 5% better than competitors that Keith mentioned on the CRM on the track, we don't see any loss.
A lot of changes.
If you do not actually conclude because.
We still have a huge price item mandate.
<unk>.
The other thing also maybe you mentioned to the surveys.
One thing we may try to improve and innovate going forward is ready even in the last few quarter, we increased the price on the new product release, but we are not changing the price for the expired product basically the products do.
Adding to the service.
Alright, so thats one thing we may because of labor costs on the surface on supporting so we may have to increase the price.
You bet outdated no longer shipping because all of a sudden resulted renewal.
<unk> tied to the old product.
We're shipping about is the customer steel buying the renew buying a service based on the old product.
So thats probably.
We can also.
Helping improving Assortments and also will help in the margin.
Conversely, the additional costs, especially on the labor.
Very helpful. Thank you.
Our next question comes from Michael <unk> with Keybanc.
Hey.
So two questions first.
Maybe it seems obvious in some ways, but do you feel like this is the first time that you talked about this linearity issue as well as the extension of the negotiation cycles. So do you simply tied to macro being worse right now or do you have any other insights to it.
And then I just wanted to make sure that in your mind second question, you really think that it's really primarily services as a result of those things that shortfall in the year and Youre happy with product.
Yes.
I think the while setting aside the fact that might be you broke the rule and you asked two questions from Peter said were only one and a follow up okay.
Hey, Mike Paul Sorry.
Alright.
You will hear a question.
Yes.
I think what we're seeing in linearity. Unlike a quote unquote normal in a world where you can kind of look at linearity and DSO and can get a sense for whether or not a company is pushing to close deals at the end of the quarter and maybe it's a more challenging quarter.
Or the timing of when the finished Linda inventories delivered from the contract manufacturers. We saw it we see a shift in that linearity of when we receive inventory from our contract manufacturers that ship then in translates into when we can turn around QA, it et cetera, and ship it out to our customers and sell it.
So there's a different aspect of linearity that's come into play here now so service contracts that maybe would have been sold in the first month of the quarter actually got sold in the third month of the quarter. So we lose service revenue from that and you see that appearing in the DSO and Youll see it appearing on the free cash flow.
On the on the negotiating side of it I think what we saw and I don't know if this is common to errors, but.
What we saw was probably the first two weeks of June .
And maybe there is more conversation around recession any concerns there if you will a bit of a pause in terms of deal closure rates for those first 10 days of June and then a reacceleration as we got through the end of June .
We did notice I did notice during that timeframe.
Maybe additional parties were being introduced to either as an approved or a negotiator. If you will on some of the larger deals just to make sure on the customer side that they were making the right decision.
And I think that's why I went on to say in the prepared remarks, not only did we noticed this shift but the close rates which were important.
We're up just a tad in the quarter. So I think there was just for whatever reason there was a slight pause there for a couple of weeks in June and everybody came back and got the deals done by on the customer side on our side at that last week in June .
And the reason for Liberty longer closing times, an eight figure deal.
Foster.
I mentioned.
Do you have over a million dollar grew over 50% year over year.
Thats the bigger deal also tend to be taken over a longer time to close and also we see more like a deal involving multiple products not just <unk>, but also we call the non application platform.
The platform extension, which also taken at longhorn capacity, that's going to cost.
On the supply chain and study.
Before the pandemic, we probably ship majority most of the put up I see now we pretty much have we put out by here.
That's where the timing of a supply shipping of product to us is a pretty critical upward of the guarantee and.
Last quarter, we do experience a lot of product being shipping on end of the quarter.
Our pipeline that's drive linearity, even if we have the <unk>, but we have to wait.
We've got a couple of months before the product we're shipping to the customer more towards the quarter end because of supply shipping glass per day, marking the end of the quarter.
So we do see long term this will be changing improving where PPE increase some of the product inventory.
Improving the product.
Also banner among them.
Excuse me have you seen by either by some by ASM by Ocean.
Thanks, guys.
Thank you Michael next.
Our next question is from Keith Bachman with BMO.
Hi, Thank you good segue from Michael's question, Keith I wanted to try to understand you talked about a few different things.
Impacting the year guide.
To put context around it.
Your revenue guide for 'twenty, two isn't changing which I think is viewed as a disappointment to investors now underneath that services revenues is getting compressed a little bit and so as you think about why why the revenue estimate type going higher for the year.
Is there a change in the demand level, whether it's the elongation because you said in fact, there was two weeks sort of weak at the end of June but it sounds like during.
The last two.
Through the third of August things have normalized or is it beef and or is it be supply chain issues that are causing you to not raise your revenue guidance season. This year.
<unk> billings modestly I'm, just trying to understand what are the forces.
That are impacting the lack of raise if you will.
Is it the demand side and or is it the supply side.
Yes, I don't really think that necessarily either demand or supply I would start the conversation by saying I think the pipeline growth is extremely strong and we feel very very good about that I do think there is a fair amount of uncertainty as we look out beyond the third quarter to the fourth quarter in terms of direction as the economies may go what inflation may do.
Our supply chain.
We did as you pointed out cover the shortfall if you will in the service revenue.
Economies may go what inflation may do and a little bit of supply chain.
We did as you point out cover the shortfall if you will in the service revenue in the product revenue. So I think thats, a pretty good size of us being bullish and feeling very very good about our competitive advantage.
And I think that the other aspect of it.
Talked about is just the large deals and how we're seeing the success in the enterprise.
Getting a little more dependent on large deals that we have in prior years and some of the close rates around those.
Think that while we are bullish we think we have competitive advantages I don't know as we get through the fourth quarter. If this is really a good time.
To think about that in a very very.
Aggressive fashion.
Okay. Okay.
Just to clarify so it sounds like you want to be a little bit conservative or you don't want to get ahead of yourself on particularly the Q4 guide some of these numbers where they are on revenues in particular.
I think that's a fair description.
Okay, I will cede the floor.
Peter.
Thank you.
Our next question comes from Shar <unk> with Cowen.
Thank you to maybe good afternoon that means to <unk>.
From the prior question from revenue maybe to Opex.
Youre hiring plan appeared to remain largely on track.
What's the current thinking on second half.
It's becoming a little easier in recent months given some layoff some private competitor.
We want to maintain.
Healthy margin and then also keeping growing and gaining market share I agree to hiring relatively.
Maybe easier.
Compared to like a few quarters ago, especially in San Francisco to space.
So for US we feel we have a good pace on hiring especially idea with steel.
Keeping gaining market share.
Yes the margin.
And as the housing margin basically both on the gross margin and also on the operating margin side. So we have a few.
We have pretty solid platinum balance among the growth and margin.
Yes, I think Ken spot on with that I would probably offer a couple of things to support one as you continue to hear us talk about our inventory commitments looking out now.
Six quarters or more I think the read through that is that we still felt fairly bullish about it.
And the other aspect of it and can be referenced earlier. This year, we talked about 25% operating margins in different ways over the years.
As being an average of target what have you.
And obviously.
In this environment to with a high inflation to come in successfully and still be providing guidance for the full year of 25, 6% while growing the top line aggressively while taking market share I think we feel very good about how the sales team. The engineering team. The operational teams support teams et cetera are all working together and driving the growth of the company the execution.
Okay.
Thank you Joe.
The next question comes from Hamzah <unk> with Morgan Stanley .
Hey, guys. Good afternoon. Thank you for taking my call.
Maybe a question for both Ken and Keith Ken.
Just given the general pressure on budgets and the macro environment are you seeing a little bit more.
Impetus to from customers to want to consolidate to a converged security networking platform like a fortinet and then for Keith if youre seeing any.
Yes.
Let's say elongated negotiating cycles and whatnot.
More weighted towards the core platform corrugate side or the platform extension type switches and access points. Thank you.
It's a very good question definitely we see the convergence.
The amount of network security.
Also the <unk> salary.
Salary, it's kind of a change, especially.
Inside the company is now working also will from remote anywhere.
So thats, where we see that pretty strong growth and also.
Im not a connected device, making the homecare space also we see very strong growth like we mentioned IC, one grew 60% and.
<unk>, 75%, and we still keeping growing and gaining market share there and the same time.
To secure the whole infrastructure.
Not only is spending on the network security into the networking side, but also might.
Beyond the network security with endpoint as a cloud.
These are all now.
Mike application level.
My apologies to all working together, so we do see how in LDS.
Are you seeing a convergence on the consolidation will be.
Fifth Fortinet.
Fortinet multiple vehicle going forward, it's more long term growth driver for us and we procure these lossmaker plenty to ESD and start a company really last month, Mike from ASIC technologies with R&D with.
Most of the product.
<unk> developed.
We integrate automate together.
We do see that timely, citing calming and.
While this investment starting to see some good return and also we have warehousing business model.
It seems like your knowledge about 13 years now.
And the balance of growth and also.
Housing margin.
This will make the company to last longer than the same time.
We'll also kind of.
Keeping masking the longtime to photo that Shenzhen also.
Operating Malaysian and quickly.
Customer benefit.
<unk> also launched a new management.
And Hamzah I think youre, a speculation about where the larger or the timing comes in as is accurate and that is.
It's going to be in that one third of our business that is large enterprise.
One of the dollars are larger obviously, and so theyre going to customer spending lot more time with the ROI, but I think more importantly.
To your second point, you can catch it on by adding in more of the platform products into a deal youre, perhaps a little more likely to run into.
Additional competitors are into people internally.
That are champions of those competitors and so theres a little more than it takes to get across the finish line because they are more complex in that way.
I'll fill Phil I'll fill the void here, especially if I think as a reminder, we did 122 deals over $1 million in the quarter, which.
That's a pretty fantastic number for us.
Second quarter <unk>.
Our next question is from Gray Powell with BT IAG.
Okay, great. Thanks.
Thanks for thanks for taking the question.
So Keith I know you hit on this.
Once or twice already but I just want to make sure I understand that dynamic on the services billings. So if I back out products revenue from short term billings.
Looks like the annual recurring component of billings.
Actually accelerated pretty nicely I'm calculating like 29% in Q1, improving to 40% in Q2, I don't need you to Boston numbers, but directionally does that seem right to you and then if so how much of that was driven by pricing dynamics that you talked about versus just the.
The natural cadence of the business.
But I do think your math is directionally correct.
A lot more time to get them to say anything more about how accurate is actually you may or may not be because kind of looking at a different way.
And I would say again, if you think about the timing of when our price increase is effective I just kind of go through the process.
Being.
Pre announce to the channel partners I think 60 days of advance notice.
And then what are those actually start to have an impact on it but.
Keeping that in mind, you arent you do see the impact on pricing actions.
Fairly quickly on product revenue and on billings, whether it's a product.
Or whether it is a service items right you will see it there but on service revenue you won't see that benefit for an extended period of time.
And I think one thing that May help people. If you think back of our shift from $8. Five supports a 24 by seven support and we talked about that for several years because when we turned off by five support with that came a price lift and a question that we were addressing scheme for <unk>.
<unk> 12 quarters, probably in a row was how is that mix shifting and how is that coming into it and we are providing information back that about all the billings so to speak around the 24 by seven but youre not seeing the revenue mix that way because it's got to that mix has to evolve over time as you go through the installed base price increases for service revenue. This is just another flay.
At the same thing that way you.
We're going to see the benefit over a much longer period of time on the service revenue line you will see the benefit in billings much sooner and Thats why we gave that information earlier any kind of crazy looking at that's a very good leading indicator of where service revenue growth is going to go in the future.
Okay. That's really helpful. And then just a real quick follow up you mentioned $25 million or $25 million headwind on service revenue from Russia, which is a new headwind does that apply to billings as well or was that purely a revenue dynamics.
That was a revenue dynamic and I would probably say it.
240% of that probably there are 30% to 50% of that would have been one billings dynamic.
In terms of where we were just beginning of the year, where we'll end up now.
Got it okay. Thank you very much.
Hope next question.
Our next question is from John <unk> with William Blair.
Yes.
Hi, This is John one for Jonathan Thanks for taking my question.
Sure.
I'm here.
Talk about retention.
Cloud security capabilities.
I'm curious if the type of customer profile that is interested there.
I suspect that probably an existing fortinet a customer that's transitioning to the cloud.
Sure.
And I'm curious if there also maybe a fabric mesh.
So there might be an all end customer.
And all I was wondering if that customer can you.
Can you talk about the characteristics of the people that are going that route.
You're going to see.
The cloud security.
Well.
Pretty much on a similar pace.
Micah networking appliance growth and also we do see a lot of.
Klaus acuity.
Comps for service provider in specialty care and service provider somewhat also combined with an offer and <unk>. These two gander.
So thats, where we keeping theme.
For benefit acuity and the need to secure the whole infrastructure not just a cloud, but also our pines and some other part of the infrastructure. So we do see more and more customer when the currency to or overall two gander. So basically cost security also drive a lot of other part of our San Francis Qt auto part of infrastructure for <unk>.
Charity.
Also we do believe long term the service provider.
In the telecom space also.
Securities <unk> and also like even the cloud provider.
Pay a lot of our important at all on the sense of security, especially on the service part.
Lastly, we also wanted to keeping supporting them.
So thats, where we see that.
It's kind of a few more hybrid environment going forward.
Especially with more and more device connected with a lot of 100.
We see.
Kind of what the whole infrastructure security kind of more and more important in the connect continued all part of security to Canada is quite important.
Our next question is from Gregg Moskowitz with Mizuho.
Okay. Thank you for taking the question. Good afternoon, guys I would like to ask about your backlog, which has significantly and consistently increased over each of the last three quarters, it's dramatically above year ago levels. So Keith you've made it clear that the backlog should further rise by year end, which is great but at the same time, it's not going to grow forever.
And it is common to see dips in the company's backlog due to seasonality a significant order shipments cancellations et cetera.
So it would just be helpful to get your sense of perhaps when we begin to see ebbs and flows in the backlog metric. If you could offer anything there that'd be helpful. Thanks.
Okay.
When the supply chain, you're going to get better can you handle that one.
If you compare to end of Q1, we increased backlog of $127 million.
And then the end of Q2, we increased by 72 million, it's a little bit better.
Less than half of Q1 and also less than end of Q4. So there is some kind of improvement or increase in the backlog.
But also we've put a lot of effort to sourcing different parts different lender product you see a product line, we began quite broad right now and also can help you leverage some kind of.
I mean.
Some alternative.
Kind of a more broad supply chain for us.
So thats why I do BV.
Because the demand is still one of our strong and.
So we do see some trouble keeping.
Get a little bit better and better.
But like I said, we probably expect that backlog will reduce in Q.
Q3 Q4.
The increase is probably will be less each quarter and I think in this way and then maybe next year, we're starting to see some kind of improvement.
Backhaul.
But overall these are engineered.
Kind of.
But the investment we made in the operation and the manufacturer we do see some spending.
Who does it would be bad enough.
Yes makes sense.
The logical place to ask questions.
<unk> Com is a great I would just add.
Add to that keep in mind the.
This is why we provide some of the metrics. There. We're not there is a lot of airplane orders. These are relatively small dollar items by compares to what you may see in other industries and that's why we gave some of the metrics on the size of if you will and the fact also that their existing customers and many of those have been partially fulfilled and they all have the same concern and the question is how do you get comfortable that that that that back.
It is sticky and it's going to be here when the product and the supply chain loosens up and Thats why were giving us metrics for people I guess im sort of context I would keep in mind. These are.
Are these sort of comparatively to other industry construction industry airline what have you yes. These.
These are very small dollar amount, yes also the AGM, what backlog probably much better than the competitors.
Keeping mentioned in the last two or three quarter every quarter. Even if we include the backlog and then we will fuel probably like 60% almost 60% the previous quarter backlog.
So thats what <unk> also put a short few months compared to most other competitors. Some time may take one to two years to deliver.
I'm asking about is a pretty good position and also the customer trust.
We're working with US during these are supply chain shown at same time, we offer quite a broad product. There's always some kind of alternative product because suggests our customer to us if one or two products I am shortage.
Very helpful color. Thank you both.
Yes, I think we can deliver over 90% of bookings every quarter IBD.
Yes, they are looking at between.
290% to 95%.
Paul can we deliver the product.
Thanks, Greg.
Our next question comes from Andrew Nowinski with Wells Fargo.
Okay. Thank you for squeezing me in and congrats on another great quarter.
I had a question on free cash flow. So I think you said you expect the lower supply appliances to dramatically improve in Q3.
So is there a margin or free cash flow impact that mix shift in Q3, and then related to that given.
Given the shortfall in services that we saw in Q2 and the negative impacted add on and free cash flow should we expect free cash flow to rebound in Q3, and Q4 or are you assuming the linearity remains unchanged in most quarters. Thanks.
I'm, assuming the linearity.
Have any reason to think that's going to be any different I'm looking for a reason to find but I certainly have not found one yet so when we look at what our expectations are internally from while we don't guide to free cash flow. We're trying to give information that's helpful to others I would assume that I have no reason to assume anything other than we will still see more of the same if you will and then I think the.
First part of your question was.
You asked about low end and about margin.
Maybe I can offer a little bit of commentary there when you look at our.
Florida Gate firewall product families will be entry level or low energy call. It mid range and high Ed in general the margins increase the gross margin increases as you move up from the entry level to the higher end of it so from that aspect of it and that's why the comment in the script that there can be gross margin volatility both from the pricing actions that we've taken.
And the discounting as well, but also the mix of our product so in a quarter that we see a.
Higher mix of higher end.
Firewall shipments margins will be higher.
By definition, but there's many puts and takes in there that when we go through the gross margin guidance that we give.
Hopefully, we're considering all the different puts and takes that are in there not just the mix of the inventory and the pricing actions.
Thank you.
No.
Operator last question please.
Our last question comes from Roger Boyd with UBS.
Hey, Thank you very much for taking the questions.
I was curious just to go back to the backlog for a second you had mentioned the split about 50 50 between 40 gate and networking portfolio. Just wondering if you could talk about how you expect that mix to trend through the end of the year and I guess the follow up to that is what youre seeing.
Around the supply constraints between those two product portfolios. Thanks.
Yes, it might double check the numbers I think it was 50%.
<unk> 40 between 40 gig and networking equipment.
By type of backwards networking equipment is 50% and firewalls over 40% in cats and dogs for the remainder of it.
<unk>.
I think.
Everything that we seem to read in here probably knows more the pressure certainly seems to be.
Talking about term more intense on switches and access points than they do on firewalls for lot of reasons I think we're more successful firewall.
Yes, I agree.
Probably on the direction wise, we do see the 40 paid.
Inventory will be improving.
Probably the percentage maybe Libya.
Backlog probably be more towards the.
Switching in AP side, which is.
Probably the whole industry suffering some other supply issue.
Okay, because we are more able to.
Rachel redesign and also use our own E Cig, which is also helping.
Kind of reduce the backlog and supply on time for the <unk>.
Customer.
Got it.
From the beginning.
This backlog issue almost 11 years ago.
Definitely we see that shifting more towards the network insights that have longer backlog.
Very clear thanks for the color.
Thank you. Thank you.
I would now like to turn it back to Peters Koski.
Thank you I would like to thank everyone for joining our call today Fortinet will be attending investor conferences hosted by Keybanc Citi Bank Evercore Stifel and Goldman Sachs. During the third quarter Fireside chats with available will be available through our IR website.
Please let me now if you have any follow up questions feel free to contact me and have a great rest of your day. Thank you very much.
Thank you for your participation in today's conference. This does conclude the program you may now disconnect.
Vince will begin shortly to raise Johan during Q&A you can dial one one.
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