Q1 2023 Fortinet Inc Earnings Call
This is 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 and operating results for the first quarter of 2023 before providing guidance for the second quarter of 2023 and updating the full year. We'll then open the call for questions during the Q&A session. We.
Do ask that you. Please limit yourself to one question and one follow up question to allow others to participate before we begin I'd like to remind everyone that on today's call. We will be making forward looking statements 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.
<unk> and our most recent Form 10-K and Form 10-Q for more information all forward looking statements reflect our opinions only as of the date of this presentation and we undertake no obligation and specifically disclaim any obligation to update forward looking statements also all references to financial metrics that we make today are non-GAAP unless stated otherwise our GAAP results and GAAP to non.
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 for today's earnings call will be posted on the quarterly earnings section of our Investor Relations website immediately following today's call lastly, all references to growth are on a year over year basis unless noted otherwise.
I'll now turn the call over to Ken.
Peter and thank you to everyone for joining today's call will review I'll stand in first quarter 2023 years old.
First quarter revenue growth was 32% due to strong growth in both product and service revenue was 35% product revenue growth, we continued to gain market share by being the leading product revenue company in established acute industry.
These strong product revenue growth will help ensure our future service revenue growth.
Quarterly service revenue grow over 70% for the first time.
In six years.
We have a significant opportunity to upsell value added secured service to our large installed base.
In the first quarter Isd win in OTA bookings to cancer continued.
To account for over 25% of total bookings and our goal is to become the number one network firewall secure SD Wan Ot security market over the next couple of years.
<unk> is leading the trend of a network security convergence on the cyber security consolidation.
Gartner expects that by the year 2030 to secure networking market will be larger than traditional networking traditional networking lacks awareness and the control of a content applications users device on the location.
<unk> seen the same now reported Codell was developed 50 years ago.
Fortinet to Q&A Watson solution has expanded from Nexgen firewall to SD Wan SD branch five G. The internal segmentation GTA and Universal SaaS fee.
<unk> to secure networking market cannot achieve double digit growth annually for the foreseeable future.
In today's environment.
<unk> are looking to consolidate multiple security vendors and our functions.
Deployed across their expanding opex surface to lower their total cost of ownership and momentum in cost, while improving visibility and automating real time threat detection and response.
Floating at maintenance release of 40, <unk> four together with the $45 <unk>.
The industry in better integration and automation.
Well as a thought to us evolution, where lower total cost of ownership.
For the OS enable organizations to deploy the Fortinet security fabric to every edge, allowing to acuity to dynamically scale and adopt us network evolves.
Last month, we announced universal SaaS, which support in hybrid infrastructure enabled assumed networking security features that are available now applies to be delivered as a service.
We've seen a single console.
Many of our service provider partners collaborating with us on these offerings.
Also we announced enhancements to several of the Fortinet security fabric solutions, including endpoint security cloud security <unk> and <unk>.
As mobile genus acuity continue to converge and customers looking to consolidate vendors and corn products.
We believe they are well positioned to achieve our 2000 25 billion target of a $10 billion.
<unk> generated and new non OPEC operation margin of at least 25% for each of the next three years.
Before the before attending the call over to Ts I would like to thank our employees customers partners suppliers worldwide for their continued support and hard work.
Thank you Ken and good afternoon, everyone, let's start with the key highlights from our strong first quarter performance.
Our strong first quarter results reflect the continued demand for our broad portfolio of cyber security and networking solutions and the demand for consolidation and convergence that is delivered by our integrated single platform strategy.
Total revenue growth of 32% was led by a strong product revenue growth and service revenue growth accelerating to over 30%.
Billings increased 30%, our eighth consecutive quarter of at least 30% billings growth.
Secure SD Wan and Ot bookings once again accounted for over 25% of total bookings.
Our strong top line results reflect continued customer demand across both core and enhanced platform technologies and highlights the diversification of our business model by solutions geographies customer segments and industry verticals.
We continue to deliver balanced growth and profitability with better than industry average top line growth and strong profitability. Despite the continued economic uncertainty.
The first quarter operating margin of 26, 5% represents the highest first quarter operating margin and our 14 year history as a publicly traded company.
Free cash flow of 647 million.
Representing a margin of 51%.
It was up 23 percentage points.
Both the free both the quarterly free cash flow and free cash flow margin or Fortinet post IPO Records.
Last month, we hosted nearly 3000 customers and partners of our very successful accelerate conference.
Let me recap three key themes, one the expanding firewall deployment environment to convergence and three consolidation.
So starting one today's rapidly evolving threat landscape and connectivity.
He has a comprehensive approach to firewalls and network security.
A combination of hardware Virtualized software and security services.
In fact, Gartner anticipates that.
2026, more than 60% of organizations will have more than one type of firewall deployment.
Which will prompt adoption of hybrid mesh firewalls.
Fortinet is well positioned to capitalize on this expansion of firewall deployments and form factors as we've been delivering hybrid mesh firewalls for years on a single operating system.
Second the company was founded 20 years ago on the belief that the convergence of security and networking will become an industry standard.
Gardner shares this belief, noting date, we expect the size of secured networking market to overtake the traditional networking market by 2030.
We believe secured networking at scale, where its most effectively an ASIC technology.
Since its inception Fortinet has been deployed for developing proprietary ASIC technologies to build application specific solutions to support convergence that traditional CPU based solutions are less efficient.
<unk>, both networking and security.
Third vendor and product functionality consolidation strategies continue to become more commonplace.
Looking to Gardner here again, and up 75% of organizations are pursuing a cyber security vendor consolidation strategy in 2022.
Up from 29% in 2020.
Our integrated 40 OS platform allows customers to converged networking functionality with security capabilities, while consolidating cyber security products and functionality.
With 40, <unk> significant computing power advantage.
Pos get consolidate more security functions and solutions, while maintaining our performance and cost advantage.
Specifically 40 OS supports many security applications, including network firewall SD Wan SaaS fee.
Wi Fi security DNA.
DNA VPN and SSL with a variety of use cases for each security application for.
For example, a firewall use cases include data center branches edges virtual cloud native micro segmentation, both east West and North South and firewall as a service.
Our convergence and consolidation strategy provide security across our customers' entire digital infrastructure, while lowering their operating costs.
Now, let's take a closer look at the first quarter.
Billings grew 30% to $1 5 billion driven by enhanced platform technology solutions.
In terms of industry verticals government and financial services top of the list as a percentage of total billings with financial services up over 40%.
Instructions media and utilities were all up at least 50%.
Those growth benefited from better than expected backlog contribution.
While the backlog cancellation rate increased quarter over quarter. It was lower than we had forecasted in our model.
We continue to believe there is an elevated cancellation risk in future periods for networking equipment backlog.
Bookings grew double digits in the quarter of a challenging comparison of 50% growth in the first quarter of last year.
We continue to see success with our strategy to expand further into the large enterprise segment with a number of deals over $1 million, increasing 38% to 124 deals in buildings on these deals increasing 50%.
One of these deals was an eight figure expansion and upsell opportunity at a fortune 50 retailer.
The retail I was looking to replace their firewall point solutions with a more holistic cyber security solution.
After purchasing 40 manager at 40 analyzer in the fourth quarter of last year.
This customer selected 40 gig Vms for a very competitive effort, a very competitive process for their 2000 store locations.
As part of our new 40 Flex program.
40, flex the new points based consumption program supporting hybrid mesh firewall deployments as well as a variety of other security solutions.
The customer selected Fortinet due to this substantial value offered by our unified platform.
And a significant technical requirements.
In the first quarter, we added approximately 6100, new logos, reflecting the support of our channel partners through their investments and the investments we've made in them.
Average contract term was flat year over year at 27 months and down one month quarter over quarter.
Turning now to revenue total revenue grew 32% to $1 6 billion driven.
Driven by strong demand for core and enhanced platform technologies, increasing 23% and 50% respectively.
Product revenue of $501 million increased 35%.
Despite the very difficult comparison to last year's first quarter at 54% with its very strong contribution from acquisitions.
Product revenue growth was driven by strong growth in enhanced platform technologies, and improving supply chain dynamics and our earlier pricing actions.
Service revenue was up over 30% to $762 million.
The highest growth rate in services since 2016.
The average number of days between when the customer purchases and subsequently activates the security service contract declined slightly sequentially and remained elevated on a year over year basis.
Service revenue growth was closely aligned with our short term deferred revenue growth rate in recent periods.
Short term deferred revenue growth was over 30% for the fourth consecutive quarter.
Total gross margin of 76, 3% was up 190 190 basis points.
Including a 440 basis point increase in product gross margin to 61, 8%.
Product gross margin benefited from earlier pricing actions improved discounting and easing cost pressures.
Service gross margin of 85, 9% picked up 70 basis points as price increases offset increased investments in data centers and points of presence or pumps.
Operating margin of 26, 5% was up 450 basis points.
Due to the strong gross margin performance a foreign exchange benefit.
And revenue growth that was 10 points higher than our 22% head count growth.
As previously noted 26, 5% is our highest ever first quarter operating margin as a public company.
Looking at the statement of cash flow summarized on slides seven and eight.
Free cash flow was a quarterly fortinet record at $647 million and benefited from elevated receivables in the fourth quarter of last year and the subsequent cash collections as well as the record setting operating margin and the timing of Capex projects.
Adjusted free cash flow, which excludes the real estate investments was $662 million, representing a 52% adjusted free cash margin and our highest margin since 2009 IPO.
We've come to expect some quarterly variances in our free cash flow results with the first quarter, often stronger due to the seasonally strong fourth quarter billings.
Capital expenditures were $30 million, including $15 million of real estate investments.
This was lower than expected due to the timing of real estate activities.
Cash taxes were $21 million.
The board increased the company's share repurchase authorization by $1 billion and.
And the total available share buyback authorization is now $1 5 billion for repurchases through February 2024.
Looking forward, we are excited about the growth drivers that we've discussed previously as well as our new single vendor Universal SaaS offering.
Our universal SaaS offering and delivers a comprehensive solution that extends a convergence of networking and security from the edge to remote users, while helping teams drive operational efficiency and reducing complexity and costs by consolidating vendors.
In fact, Gartner predicts that by 2025, one third of new SaaS deployments will be based <unk> on a single vendor SaaS offering.
From 10% in 2022.
As we bring universal's faster to market, we expect to make various investments, including increasing our pops.
Our guidance reflects the impact of these investments to both our gross margin and capital expenditure estimates.
Moving to guidance I'd like to review our outlook for the second quarter and full year summarized on slides 10, and 11, which is subject to the disclaimers regarding forward looking information that Peter provided at the beginning of the call.
For the second quarter, we expect billings in the range of $1 billion $560 million to 1.600 billion, which at the midpoint represents growth of 21%.
Revenue in the range of $1 billion $280 million to $1 billion $320 million, which at the midpoint represents growth of 26%.
non-GAAP gross margin of 75, 5% to 76, 5%.
non-GAAP operating margin of 24, 5% to 25, 5%.
non-GAAP earnings per share of 33 to 35.
Which assumes a share count of between $790 million and $800 million.
Capital expenditures of $80 million to $110 million.
A non-GAAP tax rate of 17%.
Cash taxes of $35 million, which is lower than our prior expectation as the deadline for certain tax payments has been extended to the fourth quarter.
The second quarter guidance assumes backlog decreased decreases during the quarter.
For the full year, we expect billings in the range of $6 billion $750 million to $6.810 billion, which at the midpoint represents growth of 21%.
This guidance assumes a low single digit impact our billings growth from backlog.
Revenue in the range of $5 billion $425 million to $5 billion $485 million, which at the midpoint represents growth of 23, 5%.
Service revenue in the range of $3 billion $370 million to 3.400 billion, which at the midpoint represents growth of 28%.
The service revenue guidance implies product revenue growth of 16%.
non-GAAP gross margin of 75% to 76%.
non-GAAP operating margin of 25% to 26%.
non-GAAP earnings per share of $1 44 to $1 48, which assumes a share count of between 795 and $805 million.
Capital expenditures of $400 million to $450 million due to the continued cloud data center and facilities investments.
non-GAAP tax rate of 17% cash taxes of $390 million with approximately $300 million in the fourth quarter.
The full year estimates assume backlog returns to historical levels later this year.
As we wrapped up the prepared remarks, maybe one additional observation.
Over many years the Fortinet team and his partners are offering has offered very solid and consistent level of execution execution across a wide range of economic cycles and other challenges.
Like many others, we see a level of economic uncertainty in front of us and we look forward to this possible challenge and delivering on our goals.
I'll now hand, the call back over to Peter to begin the Q&A.
Thank you 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 Chris. 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 will be depressed star one one on your telephone and wait for your name to be announced.
To withdraw your question Press Star one again.
Please standby, while we compile the Q&A roster.
Our first question comes from Brian Essex from Jpmorgan. Your line is open.
Hi, good afternoon, and thank you for taking the question and congrats on a nice a nice quarter, particularly in a tough macro.
Maybe <unk>.
<unk> and nice acceleration services revenue this quarter and I know Ken talked about.
More effectively selling or selling value added services.
Curious services into your installed base, how much is due to that better attach rate of secure services.
This changes in registration policy or pricing increases in the quarter.
Yes.
Great question, Brian and I think when we Peel back the onion look back that we saw in 40 guard, which is the security services part of the business.
And Youll see this in our SEC filings next week.
<unk> growth was 35% to 40 guard. So we started looking more.
Simply have added to Ken's point, where we saw there were areas like SaaS products and offerings that are attached to existing customers.
Certain cloud offerings, what we call pay as you go if you will were attached to it as well and I would describe those as being a significant driver to the growth I think the price benefits would probably take the number two slot and then the number three slot would be.
Some changes in the registration behavior by that I mean, the customer did register a little bit faster in the first quarter.
That lag that registration policy change that we implemented in the first quarter a specific call out it's not really having an impact in the first quarter, nor did we really expect one so kind of an order I think it was selling into the install base price increases and then some wide improvements in the registration behavior also with the new <unk> for <unk> in launch.
And we started to have a more function. We can also enable much more service going forward for both the current customer installation base and also some new customers.
Got it that's helpful maybe as a follow up Keith.
I think you've commented on lower than expected cancellation rate.
I know the question of the ASP impact on billings from.
From backlog training and what some of your assumptions are particularly given what you see in macro I know you talked about you expect to be at normalized rates for backlog by the end of the year, but maybe if you can then contextualize or quantify that.
To the extent that you're able to.
Yes, I think in the guidance, particularly as we look at the full year.
Difficult to figure out exactly which quarter some of that backlog is going to end up in or be canceled.
But for the full year I think we've talked about low single digit growth that would be coming from the backlog I do think that.
The risk to cancellations increases as the year progresses and by that I mean.
If a customer has only been in backlog for a week or a month or something like that.
Seeing somewhat less probability that they're going to cancel but the longer it takes to deliver on that backlog I think the cancellation risk continues to increase.
Also pointed Lenny.
You mentioned the callback normal end of year, we see it later this year could be neither could be towards the end.
But in Q1 that they'd all pushing Tim did a great job.
To reduce the backlog, which also helping.
<unk> customer and lowered some cancellation rate.
Got it very helpful. Thank you both very much.
Thank you one moment for the next question.
This question comes from the line of Gabriele <unk> with Goldman Sachs. Your line is open.
Good afternoon. Thank you.
Alright.
It's a follow up question on forecast.
We've had so much noise in the industry around supply chain and kind of the Cadillac product cycles. How do you all think about true demand and potentially planner and the risk of demand. Thanks box to the next question Kevin Morris Chang. Please thank you.
I think probably some of that move we referred to the traditional network security secure some enterprise deployment enterprise.
But we do see the solution has a much broader use case.
And also expand too much.
Stephen market opportunities in the traditional.
Firewall.
Also the SD Wan Ot.
Also <unk> strong growth continue to helping play both the new customer and also expanding the current existing customer.
Hosting the F&B space relatively Greenfield, we also see pretty healthy faster growth, probably even faster than.
The traditional enterprise, which is monthly placement I think holidays IC contributing to two pretty healthy.
Keeping saying double digit growth.
<unk> for the whole hosted network security space.
Yes that makes sense, thank you and ill turn the call over to you.
Yes.
As we start to execute more on that conversion of selling network.
The convergence of networking.
Jeremy when.
When you look at the classic network, one competitive how do you think about barriers other than notation for classic networking vendors.
I anticipate charity and become more competitive.
At the time.
Okay.
Have you seen from the.
Part of the architecture.
Sure.
It's a lot different.
Because acuity and need multiple company empower.
To handle the amount of unstructured data.
Rich.
Additional networking company, probably more based on some structured data handle some fixed next protocol.
Much less company in power needed to process, the data compared with us now with security.
And also we would have to implement a function and new function come up every year in the sulfur first and then keeping enhancing employee performance leveraged ASIC.
And that's also we don't see networking company doing some of that probably.
Maybe slow on where to come up with a new function for the security space.
Kind of.
Have a different architecture.
<unk>.
Supporting the secure computing needed.
And then with security.
Thus, we see so.
So far we have not see the traditional networking company ready come close.
Due to some acquisition, but so far I don't see anybody come up to machines to meet a new demand from customers. Both on a function and also Honda. This survey found that.
On the infrastructure change.
Thanks.
Congrats on the quarter.
Thank you.
Thank you one moment for the next question.
The next question comes from the line of <unk> <unk> of Citi. Your line is open.
Thank you good afternoon I appreciate you taking my questions.
Ken just a technology vision question for you you are very very bullish on the SaaS the opportunity that was very apparent at the accelerate conference as well.
But I'm curious as to why your teeth.
Taking the FERC to build out data centers and points of presence to delivery George Universal chassis strategy versus maybe some of your peers and competitors for maybe relying on third party providers and Hyperscale area and then I have a quick follow up for Keith.
First of all SaaS.
Kind of.
It's a bit different than some of our competitor, we do believe need to be a universal need to be more broadly deployed.
Also more than average amount of service provider infrastructure.
It's kind of a hybrid environment instead of a cloud only a SaaS solution and reduce <unk>.
Expanding some of them will pop because they are.
Definitely there is some user.
Like weather.
Don will go homeless some other cloud SaaS fee to.
Q some of their traffic here on an auto side DSO huge base of customer needs.
Using SaaS, our kind of service model on average plus service provider out of their current infrastructure and.
Even outside of appliance.
So thats one seven point, we also see a 40.
<unk> 40, <unk> 40, Aep's hardware agent, helping for the trophy for the 48.
To process all of these.
SaaS traffic there.
So that's where that's the reason we kind of put aside in a single <unk>.
On the networking side of function like SD Wan five Jihad, Andrew Pasta security <unk> holidays.
Sub lease obligations.
That's where we have a more integrated more broadly distributed.
Average whatever the hybrid infrastructure scientists solution here.
Also the reason we continue to build some other pop maybe different than some others, maybe certain cloud provider because we do see the car provider potentially also can be the service provider to offer SaaS.
And also from the.
The point.
Point of view, even maybe more investment funded beginning to build some pop ourself, but long time will be more profit model. So it will be have a better margin.
So some of them will take some time to to to make sure we build a healthy ecosystem, both with our partner and also leased a investment for long term benefit.
I appreciate that detail.
And Keith just quickly for you kind of a tactical question on the billings outlook.
Using the full year by less than half of the beat in <unk>.
So when you think about the first half and so maybe from a bottom up perspective.
Through Western Ed.
Underpinning that conservatism I can appreciate the macro with generally but you can kind of give us some more.
Tangible considerations or thinking about.
And from a bottom up perspective on getting to that guidance for the full year. Thank you.
Yes.
I would say.
One just kind of a general thought Africa, raising it to some extent I think probably gives you a little bit of a of a message that we feel good about our strategy and the execution that level that we can bring to the to the market, but more specifically and more tactically as we look through that look to the second half of the year. There is probably a little more.
Rigor and effort if you will and trying to look at what we see coming in the second half of the year and I would give you that probably the two headlines that were looking at one is we're still very very pleased with the pipeline. The pipeline continues to grow continues to be.
Well above anything that we're talking about growth rates for.
For the company for the full year, but I think a nuance that maybe you're talking about nuance really come into play now is more about close rates. It's not just as simple as taking your pipeline, assuming youre going to have close rates.
We're at the same level they were in prior periods and that when we use the term close rates not a suggestion that deals are getting loss, but this continual cycle that we seem to be and where some of the larger enterprise deals in particular are taking longer they're pushing out a lot of pushes.
Not that there's been an increase in losses, but the continual push and so with that in mind I think a fair amount of attention on looking at our full year guidance on what we really think our close rates maybe for the second half of this year.
Thank you.
Thank you one moment for the next question.
Okay.
This question comes from the line of second Korea of Barclays. Your line is open.
Okay, Great Hey, good afternoon, everyone. Thanks for taking my questions here.
Ken maybe you can maybe just to start with you.
Great to see Fortinet sells the whole breadth of the platform, particularly within the enterprise.
Could you just maybe talk about anything that you can do to make it easier for customers to consolidate spending with fortinet, whether thats, an enterprise license agreement or any other any other thing that sort of makes it easier to combine.
Consolidate those vendors, which was the theme I think was talked about earlier.
Definitely see some somehow.
Some healthy growth on the Paris agreement and also we are working closely with Chi.
Channel partner with a service provider.
So leveraging there.
Their connection their resource due to healthy ecosystem.
Two to grow together.
But I also see the.
For enterprise level. They also see the benefit of consolidation definitely.
And also not just consolidate some uptick through the product, but also on the <unk>.
<unk> infrastructure group beyond the traditional network security.
So thats also we see pretty healthy growth in Q1, we can see that we called enhanced.
Hi.
And technology side also has a pretty healthy growth.
Salesforce also you can see them number.
1 million deal both on the number and also on the dollar wise has a pretty healthy growth continuing a salaried.
And grow beyond the total building growth. So that's it that's a pretty healthy trend, we see going forward.
<unk> customer consolidate.
And second maybe this cases to go along a little deeper on what Ken was talking about there and I'll give you maybe for quick example, so.
Enterprise agreement is something that we've been doing now for probably a couple of years, we track those is in.
In some ways the different line of business in terms of the growth rates and particularly as we move into the enterprise I think that's been very important to be there and we've been very successful with it I think another illustration of trying to make it easier for customers with the example of a large retailer we gave on the call today and we've talked about the points program, which is an easier way I think sometimes for them to get on board and consume more of the product.
<unk>.
And I think also then when we sell making sure that our salespeople are well trained on the value proposition that we're offering not just on the cost of the appliance or the throughput of the performance, but also what it means to the customers' management costs and overhead costs as well.
I think those types of things are all going into play here to support what Ken was talking about about making it easier for customers to consume our products.
Got it that's super helpful. Keith maybe maybe for my follow up for you.
Great to see that 30% growth and acceleration in services revenue maybe the question is how do you think about what.
What portion of your existing subscription base hasnt seen that cumulative impact of the price increases you've done yet right like clearly the price increases on products have been fully baked, but how much of the base or maybe how long will it take for the subscription base just to fully realize that pricing as well.
Yes, great question.
It didn't really look at the numbers posted this quarter was it last quarter a couple of things to keep in mind average contract term call. It 27 months if all the contract for 27 months, you can do that math, but theyre not summer one and some are three year contracts and in terms of the renewals that are coming through so probably one of the five year contracts sorry, Peter Thank you for that.
So it does have a long tail and again I'd refer you back to how many quarters or how a few years that we talked about seeing the uplift that came when we converted 24 by seven support for me by five that was something that continued to provide a benefit for several years.
The tail gets smaller obviously as you go further out.
The majority of what's of the existing contracts.
More than 50% are under the new pricing.
Very helpful. Thanks, guys.
Sure.
And thank you one moment for the next question.
The next question comes from the line of Shaul Isle of TD caller. Your line is open.
Thank you good afternoon, congrats on results and guidance.
Macro.
Keith maybe starting with you can you comment can you provide us with some color about the financial vertical performance this quarter.
Yes, Phil.
Services have always been one of our let's say always but for a long time, but on the top three.
And it can be a bit feature.
Future famine, there with some very large deals in the quarter, but I don't think Theres anything there was it was number two in this particular quarter. Thank you Peter.
I don't think Theres any really large deals that drove that number I think it was we saw growth and success not only in the U S. But also internationally, particularly in Europe , and so I think it was a strong quarter for us in that way in that area.
Got it got it.
From a product mix perspective, so the entry level performed the best.
The high end.
Is that just to mix or a macro reflection and also did you have any eight digit wins this quarter.
So we've talked about yes, we did.
Okay.
Talking about one in the script.
A moment ago.
I think we commented that it was an eight figure deal if I'm not mistaken right without giving a specific number yet.
I don't recall, if there was a second eight figure deal there was a second.
Also.
<unk> be pretty healthy growth I can say, the smbs that moat greenfield half within our security.
See more and more SMB need and then we'll say purely to protect their happiness.
Comps on some other lesson one attack.
On the price because it kind of more replacement.
And also a lot of enterprise kind of.
Maybe to be our main C&C.
Obviously, some on the hour more depend on the service.
So thats the impact some of the high end.
Also the other benefit for some of the.
The low and mid <unk>.
Most.
I would say most.
SD Wan and some of the OTT deployment may be more towards that lower range.
Got it. Thank you appreciate it well done.
Thank you.
Thank you one moment for the next question.
This question comes from Rob Owens of Piper Sandler Your line is open.
Thank you very much and good afternoon. Thanks for taking my question wanted to start around Opex or the corollary operating margin and a very strong first quarter here I think you mentioned it was the strongest Q1 that you've had since your public if I go back through results since you've been public Q1 has never really been the high watermark from an operating margin standpoint, So walk me.
Through your thought process as the rest of this year plays out was there some aberration in Q1 that really helped drive that or just a lot of conservatism as we look ahead.
Yes, I think we called out three things and maybe focusing on tier one we had a very strong gross margin in the quarter and I'll elaborate on that in a moment and then also FX continues to provide a tailwind.
More commentary about the gross margin, particularly the product gross margin as we move through the supply chain challenges and then into inflation et cetera over the last couple of years I think we've talked publicly that our goal is to try and keep the product gross margin around 61% or so.
The fourth quarter came in obviously very low we did not anticipate that we'd be able to time, our price increases in the cost increase is perfectly. So they went through the income statement in the same quarter so to speak.
And with that I think you saw a little bit of pressure in the fourth quarter that you saw kind of revert in the first quarter.
I think longer term, we also look at product gross margin.
As an opportunity sometimes for us to continue to invest in growth and I think we've thought of first quarter gross margin certainly well above that band that I, just talked about and with that in mind as we start to see some of the costs moving out of the equation.
Introduce new products I think it will be looking at that in terms of is there an opportunity there to make certain investments in growth, while maintaining the margin commitments that we've talked about.
Great and then.
Follow up did want to touch on the Iot business and the strength Youre seeing there can you talk a little bit from a go to market standpoint, and some of the channel programs because it does seem like there is some new.
Large channel partners out there that are very excited about the opportunities. Thanks.
Yes, I think Ot, we do look at I mean, youre always trying to organize our sales force around verticals geographies or what have you.
And I think when we started to see the opportunity several years ago.
<unk> and Ken made a decision to start separating that out and having really a separate sales function and some people that specialize in that.
Do think that we probably got some first mover advantages by by doing that.
Particularly as we look at Europe , and then quickly followed thereafter by the U S and yes. There are some large names that are in that space that are providing technology security technology, but technologies in the Ot space.
That have been very receptive, if you will to conversations and opportunities to meet with us.
Thank you very much.
One moment for our next question.
Okay.
Okay.
Okay.
Okay.
The next question comes from Adam Borg of Stifel. Your line is open.
Awesome.
Thanks, so much for taking the questions.
Just for Keith obviously, it's great to see a strong collections and a record free cash flow.
And you also talk about contract terms being consistent year on year and I was just curious, though just given the tougher macro are you seeing any pushback by customers around willingness to pay upfront and then I have a follow up.
Yes, well first of all I want to <unk>.
<unk> on the $600 million of free cash flow.
For several more quarters, but I'm trying to let people know that a lot of the things fell our way in the quarter. There is always the other conversation and part of the sales cycle. If you will.
Customers a lot of one year three year five year deal.
And certainly in a rising in an environment, where interest rates have gone up I think there is a lot more many more conversations that exist around.
Payment terms and things like that I do believe that.
Just as we just talked about in the second quarter of 2020 with Covid hit we have a very strong balance sheet.
We obviously have very strong margins.
And it's appropriate for us to look at that to that as opportunities to leverage our balance sheet, sometimes that may be in the form of extended payment terms or what have you in our income statement in the form of how how we want to go about discounting and supporting growth.
I think that again the.
Strength that we've had we have the ability to do those things. If the question is around what are we seeing from some of the enterprise customers and can swing a lot of this as well.
We see deals that go from five years to three years sure.
It more than we've seen in the past.
Kind of look back of the contract term data point that we gave and say, maybe but not a lot kind of a thing.
On payment terms. The channel has always offered a financing function I think they prefer to provide the financing function.
I think we provide support to the financing function to the channel by making capital available to them through payment terms.
That's really helpful and maybe just as a quick follow up.
That was up a little bit over 600 people at quarter over quarter.
Over 21, 5% year on year, just curious how you think about headcount growth either.
<unk> our latest here again, just given the macro thanks again.
Yes, we are.
We look in the <unk>.
Hi, Tom Hi, Tom.
Probably the same pace.
Pumping coil at the top line.
Also total same contract improving somewhat efficiency.
So we are now looking for high clinical ulcer.
Bob the topline evenly necessity some quite some aaas, we also needed to some more investment at alpine investment.
The company so far we feel we have a pretty healthy finance model.
And this also could be the opportunity to also gaining some market share.
Great. Thanks again.
Thank you.
As a reminder to ask a question. Please press star one on your telephone and wait until your name is <unk>.
Please standby for the next question.
This question comes from if I could run from Oppenheimer <unk> Company. Your line is open.
Thanks, Hey, guys nice results.
My first question I guess is on <unk>.
U S enterprise.
<unk> in general, but just the enterprise vertical clearly one of the most important growth opportunities for your long term can you talk about.
Progress over there when rates displacements.
Is it macro making things easier or more difficult for you specifically in the U S.
First we continue to invest in the U S. Enterprise, we also see as a huge growth potential for us because we have a relatively small market share.
We sent out a strong part of our technology we have.
On the other side the become Marvin definitely slow down some of the enterprise.
Southern decision went to refresh on samsonite.
But on the other side.
Our solution has a better loan.
Our total cost of ownership and also can expand beyond the traditional network security and also helping customers consolidate.
All of this combined together, we do see the U S enterprise definitely has a strong growth area for us.
Okay. Thanks, and then maybe a follow up on the competitive side then Ken maybe.
You can talk about.
What have you seen out of your competitors here in the U S.
Abnormal activity from this.
Discounting or or otherwise.
Uh huh.
I think June .
Slowdown of some of the peak.
Mom and.
Definitely.
The competitor starting to more and more aggressive ledger.
<unk> Com I will offer some free.
Yes.
At some time if necessary.
Some presented as a free service.
But from our angle we see.
We have much better.
Product position March brought.
Infrastructure coverage.
Better surveys and also both on the <unk>.
Performance angle.
That definitely has a profile much better for the same function same cost at the same time.
Our survey is also has much more value and cost lower competitors. So.
So for US we have not experienced.
Price pressure is cost pressure.
Some more about a <unk> 10 increase.
Increased coverage increased.
That leaves Jan our pipeline and.
And also to meet the customer need.
<unk> environment changed.
Okay. Thank.
Thank you.
Tim talked about I think is fantastic.
I think keep in mind, we don't we have a very different kind of talked about on the prepared remarks, a very diverse customer base. If you will.
Between being international between being very large mid small and SM.
MSP has et cetera, so I don't want to put a policy in place that covers every geography and it covers every customer size and I think what's really talking about here is something that for us represents.
15% of our business, maybe just a little bit less and because it's at that size is something that we can really more I think target our responses to as we get deeper into the selling function as opposed to some broad announcement that we're going to give away services for two years or something like that.
Very good thank you.
Thank you one moment for the next question.
This question comes from the line of Andrew song with Morgan Stanley . Your line is open.
Hi, Thank you guys. So much for taking my question I'm on for <unk>.
Hamzah firewall of Morgan Stanley .
Could you just share a little bit more about your current interest around this.
Customer interest around the Sofie product Ann.
What are some of the responses around this so far.
It's a pretty strong growth and also we're working with.
We.
A lot of our service provider.
Both on the input side to side, all secured a server site and all sorts of SaaS, because we do believe.
It should be.
Ecosystem.
A lot of player instead of just a vendor to offer their own SaaS because a lot of.
I think probably most of the customer they preferred some of that data.
Beam process controlled himself, whether some private SaaS or some data sovereignty keeping the data within certain geo.
Where we see that.
The SaaS approach, we call Universal SaaS customer <unk>.
That offer both cloud based on primary space, all kind of language service provider infrastructure.
I'll be multinational industry long time.
So thats where.
You win some.
We kind of particularly Multan well about a SaaS function in a single wise.
That's making more easy for the customer for the service provider to deploy SaaS fee.
<unk>.
Their environment.
So we see more of a healthy pipeline and the strong growth kind of our salary growth.
And that's also based on kind of a more healthy margin.
Kind of a model of incentives.
Let me see money all of our growth. So we want to maintain that as a model and also working closely with our partner to offer kind of.
SaaS you presented to the passengers.
Got it thank you and just one more around profitability. So how are you guys thinking about.
That flows down over the next few years, and where do we see that margin leverage.
Andrew can you repeat that you cut out at the beginning of that question.
Yes, no worries.
So the question is around profitability and I was just wondering what you guys are thinking about upside to profitability as growth slows down.
Where should we expect to see that margin leverage.
We see the metered model would be data and thinking about kind the kind of pie.
non-GAAP Opex margin is 25% each year in the next three years.
Got it. Thank you yeah, I think one thing.
I think hamzah.
Hamzah about this before as well keep in mind, the two thirds of the business roughly of service revenue.
That's producing.
Our gross margin Thats in.
In the mid Eighty's. So that's those are longer term contracts. So I think we do.
The business model is such that we would have time to react if there was something really dramatic that happened in the industry.
But part of that is for that to happen I think it would probably have to see some sort of shift in the behavior of the bad actors the nation states. The organized crime groups et cetera, and we don't think that that's on the on the landscape.
Great. Thank you so much.
Uh huh.
Thank you please standby for the next question.
Okay.
This next question comes from the line of Tal Leone with Bank of America. Your line is open.
Hey, guys.
What we've seen with <unk>.
<unk> in the last.
Two quarters is that they they make great numbers, but.
When you look at the composition.
Customers are slowing down and sales to existing customers aren't going up like we've seen it through multiple companies in our space.
So the question is whether you can prove.
<unk> with some data on sales to existing customers versus new customers.
And how is the current environment on customer acquisition on new customer acquisition.
Yes, so as a reminder to all good to hear from you again.
So if you think of the business being extremely diversified whether that's geographically or by customer segments. One third small once they are dead at large.
As I called out in the script that we added over 6000, new logos in the quarter.
So obviously and Thats.
Probably a growth rate that's easily in the double digits.
New logos take a while to really produce revenue for us tends to be.
Less than 10% of total revenue from the new logos. So it creates the opportunity to continue to sell into them.
Yes.
Ken's comment a moment ago to your question here.
Do we see large enterprises in the U S still.
Still moving forward robustly with all their various digital transformation projects I think the word on the street is best.
That slowed down a little bit.
And in that environment I do think that income is sometimes have an advantage, but also our cost or performance argument and debate is something that youll see customers, perhaps more receptive to in the current macro environment.
Okay.
Current macro environment is the duration of contracts going down.
Alright.
Lord flat it was flat year over year down one month quarter over quarter.
Got it okay. Thanks.
Which which assembly rise me in the room very politely every first quarter down one month.
On a sequential.
Yes.
Okay.
Thank you one moment for the next question.
This question comes from the line of Andrew Nowinski of Wells Fargo. Your line is open.
Okay. Thank you and congrats on a nice quarter. So I wanted to ask about your SaaS offering as well you talked to at the accelerate conference about.
I think having 8% to 10, new use cases driving demand for the firewall, but im wondering if SaaS he could be one of those use cases as well, meaning as the firewall appliance a critical component of your SaaS offering.
Yes that definitely is a one hour.
They use case, especially the universal SaaS, sometimes they call.
Private SaaS fee.
For some customer service.
Service provider they want to have more control over their data.
Thats, we see.
But both SaaS.
The service model customer benefit and service provider.
People had added Ottawa and then by the same time, David and the flexibility Alpha ledger for some traffic to the cloud out to the pop I will have a process on premise and then buy it applies.
So that's we see that the huge benefit.
Universal chassis solution.
Reaches a lot different than some other sassy player and a lot of customer.
The primary interest to this AD unit.
<unk> approach.
Thanks, Ken and then.
Maybe a question for Keith just as it relates to your Capex, you talked about a component of that being used to build out more pops.
To support the SaaS offering but is that something like how should we think about capex in that investment beyond 2023, as you continue building out your network.
Ken and I are smiling at each other we've had this conversation.
Sure.
I think I've been here for nine years as of this week one thing I've come to appreciate as I can behave like a long term investor with that in mind owning critical real estate assets tends to have a better payback than leasing them over an extended period of time.
Whether that's in R&D facilities, whether that's in manufacturing and warehouse facilities or that as you as we move into the SaaS environment market as well as other cloud offerings.
It's not just investments in SaaS, if you will but it's also investments in larger data centers in order to deliver various.
Cloud based services and solutions and I think you've heard us talk about that in the last several earnings calls and the guys out.
Data center is having an impact on our margins for services and Capex spending. So I don't think there should be a surprise there, but I think it is an indication of our looking to expand into more fully into some of these other markets.
Got it thank you.
No.
Thank you one moment for our final question.
Yeah.
Our last question comes from the line of shrink Qatari from Baird. Your line is open.
Hey, Thanks for taking my question, so far Ken or Keith I think Keith you mentioned about the fact that services.
Our party per sandwiches.
Surprisingly strong and contrary to what we are hearing from.
Our peers in poverty. So just can you expand a word about upon the underlying drivers I know you touched up on it.
But I just wanted to expand on the geographical diversity are.
Is it increased kind of embed as far vendor consolidation that is benefiting you guys in that vertical.
Then just elaborate and then I have a quick follow up.
Okay.
Yes, I would say, it's all of the above is happening geographically I think is happening with customers that we took down earlier that are expanding with us with additional firewalls and additional security for additional services as well.
I think the.
The market if you will financial services, if you step back and look at what's happening there specifically the firewalls over the last several years, there's probably two legacy vendors there that when they are when they are.
Contracts are up for renewal and we've talked about this for a long period of time that they are exposed.
And it creates an opportunity to come in for a competitive displacement and I think that some of the other comments or questions. Today as is it is it more.
In this environment for competitive placements I wasn't sure. If you got to work a lot harder to make it happen and you've got to make your value proposition more well known.
But I think again I think its expansion I think as opportunities to displace.
And I don't think of specific to any one particular geography also farm technology angle, we have a true shooter advantage wines.
For the internal segmentation or securities done data center, so because of the ASIC.
It can be happy empty mile high speed environment, which a lot of service provider they do need to secure there.
Kind of internal segmentation, there and the other part is I think somewhat finance service also setting supporting work from home working remotely, which we also have a large super solution.
Our asset base.
Michael small appliance.
In this kind of of our broad infrastructure approach combined with that SD Wan or the <unk>.
And then we will integrate it together so that gave us huge advantage on the part of our angle.
Got it got it thanks, a lot Ken Keith.
Just a quick follow up.
Of course upon the expansion opportunity in the form factors of course as our peers have spoken about unit expansion pressure then how the progress. Your next job growth is kind of normalizing.
Just wondering given that you guys gave at samples off.
This eight figure expansion and upsell opportunity.
Replacing firewall with holistic solutions can you talk about expansion drivers broadly.
You're seeing mostly upsell and expansion and form factors versus the units.
Just wanted to get some clarification there.
Property, both yeah, we do see the spending of both the unit and also upsell cross sell.
<unk> 40 for the security fabric, which has a 53.
Product so thats for.
Both our internal sales force our partner Southern will not offset cross sell off of the whole fabric.
At the same time.
We combined networking security and more function together.
Deploy case, which also the unit shipment also set in keeping keeping grow quite nicely.
Got it thanks, Good luck, Ken I appreciate it.
Yes. Thank you.
Thank you that concludes the Q&A segment I will now turn it back over to Peter Sikorsky for closing remarks.
Thank you Chris apologies to the 17th when we left in the queue I'd like to thank everyone for joining today's call Fortinet will be attending investor conferences hosted by Jpmorgan and Bank of America during the second quarter webcast.
Webcast links will be posted on the events and presentations section to the Fortinet Investor Relations Web site. If you have any questions. Please feel free to contact me have a great rest of your day. Thank you.
Thank you for your participation in today's conference. This does conclude the program you may now disconnect.
Okay.
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