Q2 2023 Fortinet Inc Earnings Call
Okay.
Good day, and thank you for standing by.
Welcome to the Fortinet Q2, 23 earnings call.
This time, all participants are in a listen only mode.
After the speaker's presentation, there will be a question and answer session.
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Please be advised that today's conference is being recorded.
I would now like to hand, the conference over to your speaker today, Peter So Koski senior Vice President of Finance.
Okay.
Thank you curious good afternoon, everyone. This is pizza Gatzke senior Vice President Finance and Investor Relations at Fortinet I am pleased to welcome everyone to our call to discuss Fortinet. Its financial results for the second quarter of 2023 speakers on todays call are can be fortinet as founder chairman and CEO and Keith Jensen, Our Chief Financial Officer is a live call that will be available for replay via webcast on the investor.
<unk> website, Ken will begin our call today, providing a high level perspective of our business to keep it under review our financial and operating results for the second quarter of 2023 before providing guidance for the third quarter of 2023 and updating the full year. We'll then open the call for questions. During the Q&A session. We ask you. Please limit yourself to one question and one follow up question to allow others to participate.
Great.
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.
It 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 the 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.
The financial metrics that we make today 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.
Kevin keeps 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 will now turn the call over to Ken.
Thanks Peter.
To everyone for joining today's call to review, our second quarter 2023.
Total revenue in the second quarter increased 26% driven by strong revenue growth service, which topped 30% for the second consecutive quarter with 34% growth is typically subscription on a nominal 40 gig product grow over 45%, which is nearly 2 billion annual run rate.
Building growth of 18% mix to more normalized product revenue growth of 18%. We believe our building performance reflect large on the price concerns with the macro environment and the addition.
Duchenne to some inventory digestion. After two years of elevated 30 plus percent product good growth during the supply chain shortage.
According to Idc's latest quarterly security tracker. In addition to having the number one union firewall category for 10 consecutive year with over 50% market share.
Fortinet is now the market share leader in both units and revenue.
Based on the Navy's Westland Advisory OTC acuity in our cybersecurity report Fortinet was named but only one.
<unk> network protection platform leader.
Currently one of the top on the fastest growing Ot security vendor in the market not the west limb advisor expects to grow to 73 billion by 2030.
Fortinet success line broad illiquid platform, our proprietary EC security processor, and our ability to converged network at acuity, both on Prem and in the cloud across a single 40 horse operation system.
To leverage these advantages on slide future growth. In addition to our leading network security solution. We have increased our go to market investments in Universal SaaS fee.
<unk> <unk> security class acuity on the secure accretions.
We will dedicate more resource to support hybrid infrastructure and hybrid award.
Today, we announced a new 40 days 90 Chi.
<unk> next generation firewall and secure SD Wan clients with the new security process of five <unk> that deliver industry, leading security function performance, Skype entity and power efficiency and cost effective price.
The 40 day magnitude afforded immigrated retail 40 cloud AI powered security service and have secure computing region that is up to 16 ton Guizhou the average of our competitors similar price model by using over 90% less power than competing solution.
We also announced two new SD Wan service.
<unk> performance monitoring service to simplify operation.
Teaching experience as well when they service two facility rapid deployment redundancy seamless interconnection of location with 40 sites using the <unk> technology.
This new SD Wan service showcase our commitment to expanding our service Levy shall lead installation base.
Additional future growth.
We see a single vendor a SaaS solution opening a large new not new market and one where our sizable <unk> installed base can be leveraged as a significant market access point.
Together with newly announced the ATM service, we plan to accelerate our global pulling our pricing pop deployment with a dual strategy of investing in Bihar on Pops as well as working with service providers.
Fortinet as recently announced we thought of ITV pendant analysis by Forrester.
After cost savings and the business benefit of the 40 date Nextgen firewall and 40 part AI powered secure service within the enterprise data center, which includes more than 100% return on investment.
Over three years payback in six months and a 90% reduction in planned spend on menu updates.
In addition, <unk>.
Pendant analysis by Enterprise strategy group established customers, who deployed Fortinet security operation solution, such as 40 ETR for the MBR.
It is their time to detect and respond to incidents.
Average our three weeks to one hour.
These demonstrate the substantial impact that artificial intelligence machine learning and the integration of a fortinet secure fabric.
Fabry product.
<unk> ability to secure today's rapidly expand the attack surface.
Finally, new development in AI, such as to generate two contingent show a lot of promise to awareness applications and cyber security. We believe AI technologies kind of help us significantly improve productivity and can be scaled to a large customer base in areas such as a malware.
<unk>.
Hunting, we then coronation and automation as well as 15 network design and the troubleshooting.
Before turning the call over to Keith I'd like to thank our employees customers partners and suppliers worldwide for their continued support and hard work.
Keith.
Thank you Ken and good afternoon, everyone.
Let's start with the key highlights from the second quarter billings growth was 18% as well as product revenue growth service revenue growth held firm at 30%, resulting in a total revenue growth of 26%.
Okay, and SD Wan revenue continued to perform well as revenue from these products were up 60% and 40% respectively.
And a sign of our strength in the small and mid sized customer segments. We added a record 6500 new logos.
Operating margins of 26, 9% exceeded the high end of the guidance range by 140 basis points.
Free cash flow was strong at $438 million, representing a margin of 34% benefiting from the deferral of certain cash tax payments to the fourth quarter.
Looking at billings in more detail.
Billings of $1 $5 4 billion led by non Florida gate billings at over 30% growth.
Presenting 34% of total billings.
Non Florida gave billings growth was driven by networking 40 gig VM neck and cloud.
And as Ken mentioned non 40 gate is nearing $2 billion annual revenue run rate.
In terms of industry verticals government and manufacturing copper lift as a percentage of total billings.
With manufacturing up almost 50%.
Government and construction were up over 30%.
While service provider and retail were up 1% and down 5% respectively.
Retail was impacted by a very difficult compare as the industry vertical nearly doubled in the year earlier period.
Billings growth varied by Geos with international emerging leading followed by Europe and Latam.
APAC and to a lesser extent U S enterprise were challenged by difficult prior year comparisons.
Deals over $1 million increase from 122 deals to 134 deals.
Turning to revenue and margins total revenue grew 26% to $1 9 billion driven by non Florida growth of over 45% service revenue growth of 30%.
This was the second consecutive quarter of greater than 30% service revenue growth.
Security subscriptions represented over 55% of all service revenue.
And continued our streak of strong increasing sequential quarterly growth dating back to Q1 of 'twenty two or 23%.
Q2 of 'twenty three at 34%.
Product revenue of $473 million increased 18%.
Product lead times and backlog are expected to approach normal levels in the third quarter.
Total gross margin of 77, 9% was up 140 basis points.
Driven by a 160 basis point increase in product gross margin to 63, 5%.
Product gross margin benefited from earlier pricing actions and easing cost pressures and were partially offset by certain inventory charges.
Service revenues were 63% of total revenues and delivered gross margin of 86, 2%.
Higher service revenue offset higher labor costs and increased cloud delivery cost as we continue to expand our cloud SaaS delivery models.
We see our single vendor SaaS solution opening a large new market and one where our sizeable SD Wan installed base can be leveraged as a significant market access point.
We plan to accelerate our point of presence or pop deployment.
With the dual strategy, Ken mentioned investing in our own pops as well as working with third party providers to accelerate our deployment.
Operating income of $348 million grew 36%.
Outpacing revenue growth by more than 10 points.
As operating discipline resulted in significant operating leverage.
Operating margins of 26, 9% exceeded the high end of the guidance range and was up 210 basis points due to the strong gross margin performance and operational efficiencies.
Earnings per share increased 58% to 38 per share and also exceeded the high end of the guidance.
Looking to the statement of cash flow summarized on slides seven and eight.
Free cash flow increased 55% to $438 million.
Adjusted free cash flow, which excludes real estate investments was $498 million reps.
Representing a 38, 5% adjusted free cash flow margin.
Free cash flow benefited from the deferral of approximately $190 million in cash tax payments.
As mentioned last quarter. These tax payments together with other deferred 2023 tax payments are due to be paid in the fourth quarter.
Capital expenditures were $77 million, including $59 million of real estate investments.
Cash taxes in the quarter were $38 million.
The board recently increased the company's share repurchase authorization by $500 million.
And the total available share buyback authorization is now approximately $2 billion.
Now I'd like to share a few significant wins from the quarter and exemplifies the strength of our broad and integrated platform.
First a global pharmaceutical leader signed an eight figure deal to adapt for that cyber security fabric.
Investing in our <unk> secure networking architecture.
As well as our AI ops and threat intelligence solution.
Recognizing the market shift to a platform based approach to security. This company selected fortinet to secure its highly regulated insensitive medical data as it continues to drive global operational and financial efficiencies through our broad integrated and automated platform approach to cyber security.
In another deal.
We are the largest U S school districts, which had recently refreshed that data center firewall for 40 days.
We're seeking to improve its network security posture with an ax solution that offers better visibility to the devices connected to the network.
For net competed against multiple peers and was able to win did a 40 Max ease of implementation centralize.
Centralized management capability.
And superior risk remediation as well as the tight integration with the district's existing Fortinet security fabric.
This high seven figure deal was our largest Mac deal in <unk> history.
Finally in a seven figure displacement and our largest 40 SaaS deal ever.
A large bank on its digital transformation journey, who are searching for a single vendor SaaS solution for its hybrid workforce.
If selected our 40 SaaS solution for us over 5000 users and integrate SD Wan and SaaS fee into a holistic solution and delivers comprehensive security both from the cloud and on Prem.
I think consistent security policies for all users regardless of their location.
And wherever applications are being accessed.
These transactions illustrate how far less platform strategy integrated operating systems and proprietary ASIC technology.
Continue to resonate with customers.
Given the heightened interest in AI technology, we cannot do this call without discussing fortinet investments and innovations in AI.
Fortinet has been at the forefront of AI and machine learning innovation for many years.
Leveraging deep learning artificial neural networks to power our products and security services.
Enabling a faster stronger and more accurate defense for our customers.
One of our first AI powered use cases was the introduction of the virtual Florida Guard threat analysts.
Courtyard addresses threats in real time with machine learning coordinated protect protection and is extensively used in malware detection and threat hunting.
Every time a threat has identified.
Accordingly, our generates threat intelligence that automatically updates defense signatures across the fabric.
And cloud environments, where scale and speed are critical.
AI and machine learning can help security teams keep pace with threats on multiple fronts.
All of this happens seamlessly and behind the scenes.
Today, our platform Ingests and analyses on average more than 100 billion events every day.
To deliver over $1 billion security updates daily across a fortinet security fabric and ecosystem.
While many of our competitors OEM their security from different security vendors.
Our AI driven affording our threat intelligence has been built in house.
Which allows us to use AI across different sources.
Adversaries increasingly are using AI in their playbook to drive cyber attacks.
Which only increase the rapidly evolving cyber security threat landscape.
We continue to invest in AI and machine learning technologies across our products, including generative AI natural language models and other implementations to enhance simplify and automate security for our customers.
Before moving to guidance I'd like to offer some observations about the second quarter and about the industry.
Regarding the second quarter, we believe macro uncertainty impacted our billings performance through average contract duration and in the second half of June and elevated level of enterprise deals pushing the future quarters.
Vishal, we saw shorter contract duration with the average term decreasing by one five months 28 months.
Creating a 4% to five billings headwind year over year.
Normalizing billings growth for the change in contract duration yields billings growth in the low 20% range.
Having some level of enterprise deals pushed to future quarters, that's not unusual in.
In Q2, 23, however, an unusually large volume of deals that we expected to close in June instead pushed to future periods.
From a market perspective.
<unk> continues to prioritize and invest in securing their organizations in the face of rising cyber security threats.
We see new regulatory requirements, such as the recently announced those recently announced by the SEC and the EU Cyber Resilience Act announced earlier. This year, we will continue to provide market tailwind is.
As organizations further increase their cyber security investments to comply with new stringent cyber regulations.
The cyber security industry remains highly relevant CIO is prioritized cyber spending within their overall it budgets.
The longer term demand drivers for Fortinet remained very solid.
That said, we do see a return to more normal seasonality for fortinet in the back half of the year.
As tailwind such as the supply chain driven growth subsides, and we cycled prior period price increases.
Moving onto guidance.
As a reminder, our third quarter, our full year outlook, which are summarized on slides 11, and 12 are subject to the disclaimers regarding forward looking information that Peter provided at the beginning of the call.
For the third quarter, we expect.
Billings in the range of $1 billion $560 million to $1 billion $620 million, which at the midpoint represents growth of 13%.
And is consistent with our quarter over quarter seasonality prior to the pandemic.
Revenue in the range of $1 billion $315 million to $1 billion $375 million, which at the midpoint represents growth of 17%.
non-GAAP gross margin of 75, 5% to 76, 5% non.
non-GAAP operating margin of 24, 5% to 25, 5%.
non-GAAP earnings per share of <unk> 35 to 37.
This assumes a share count of between 795 at $805 million.
Capital expenditures of $100 million to $130 million.
non-GAAP tax rate of 17% cash.
Cash taxes of $25 million.
And as previously mentioned backlog is expected to approach normal levels in Q3.
For the full year, we expect billings in the range of $6 billion $490 million to $6 billion $590 million, which at the midpoint represents growth of 17%.
And apply slightly below normal seasonality in Q4.
Revenue in the range of $5.350 billion to $5 billion $450 million.
Which at the midpoint represents growth of 22, 3%.
Service revenue in the range of $3 billion $350 million to $3 billion $410 million.
At the midpoint represents growth of 28, 2%.
The service revenue guidance implies product revenue growth of 13, 5%.
non-GAAP gross margin of 75, 2% to 5% to 76, 5%.
non-GAAP operating margin of 25, 5% to 26, 5%.
non-GAAP earnings per share of $1 49 to a doctor and three which assumes a share count of between 795% and $805 million.
Capital expenditures of $335 million to $385 million due to our continued cloud data center and facilities investments.
non-GAAP tax rate of 17%.
Cash taxes of $460 million with approximately $380 million in the fourth quarter.
We continue to execute our long term strategy and remain confident in our strategy and our solutions.
It's a little early to be providing guidance for next year, we would expect our near term performance represents a short term trough.
Our confidence in our solutions, our offerings and taking into account the growth comparisons will ease as we move through 2024.
This early stage, we would expect billings growth to approach high teens by the fourth quarter of 2024.
And with that I'll now hand, the call back over to Peter to begin the Q&A session.
Thank you operator.
Yes, just one quick reminder, before doing the Q&A. If you can please limit yourself to one question and one follow up question.
Sure.
Operator, you can open the call.
Thank you Andrew there are 98, everyone two quick questions.
Just one on the telephone ethylene needs to be.
And to withdraw your question Press Star one again.
Our first question is from.
Morgan Your line is open.
Hi, good afternoon, and thank you for taking the question Ken I think you noted that.
Keith commentary you commented to it as well reflected.
I guess that billings.
Performance and guidance reflects enterprise concerned about the macro.
Could you give a little bit more color there and what you saw from a macro perspective, and I think you pointed to weak service provider business I think investors might draw parallels to what they saw at Juniper last week on the carrier side maybe.
Maybe if you could include a few thoughts on how dynamics there may be similar or different with regard to what you see in that.
All right.
Sure.
For the.
Carrier service provider, we do see there probably maybe behind offer some surveys.
Does the <unk> provider in Peru.
Many years ago is our biggest market.
About 70% market share count on the past service provider, but nowadays.
Secured Anita additional service.
<unk> is a function of additional security function in the SaaS.
Reached service provider kind of behind.
So we're still working with them closely tied to help us in our salary to service.
I'm, Tom we also starting in less likely more ourself, which also competitive with the new service, we announced today the two new SD Wan service with you.
You mentioned southern infrastructure, that's all helping drive a lot of new services going forward in the security space.
And also kind of how can service provider.
<unk>, Canada.
Our salaries and some of our security service.
Beyond the traditional.
Security services.
Yes, I would probably add to <unk> comments.
Particularly as we talked about service providers, because some of the other verticals and as customer segments.
And I think there are some lessons that we can see from for example, manufacturing which did extremely well in the quarter.
They continue to have I feel that I think there are under pressure and the threat environment. So you see them spending fairly richly sales.
So no surprise if you look at the government sector, which was strong also they have governments and as long as they have budget for the Florida economy than maybe some of the other industries.
And the other in the spectrum, Ken talked about service provider and people I think are aware of that story there more broadly.
But also retail I think retail is really a very clear indicator of a vertical that can be.
One of the first half sometimes impacted by a slowing economy, but also again made reference to this in his comments. This concept of digestion a lot of purchasing around SD Wan technologies and implementations.
A year ago, you saw a very very high growth a year ago, and now going through a digestion period as such the point that it's actually negative growth in the retail vertical.
Also interesting some cloud providers are also starting to head into the security space.
Also Canada.
Confused some of the enterprise customer.
So thats also sometime may take a little more time to evaluate all different solutions. So we do believe there's a hybrid approach.
On premise in the cloud and our SaaS for the customer.
Evan.
The cloud probably.
Much more expensive.
<unk> averaged about students buybacks among expensive compared to off premise.
The combined assets together, it probably won't be divested wishing to customers.
Got it that's helpful and maybe a quick follow up for Keith.
I think you talked about re inflection to high teen billings growth next year, how does performance this quarter and your outlook for the rest of the year.
The impact of 2025, I guess $10 billion billings target that you'd previously throwing out there.
Yes, I think that.
As we go through the second half of the year and we enter into our normal planning cycle for 2024, I'll take that will be a larger logical output at that point in time to think through what we're seeing in terms of our 2025 targets.
Okay. That's helpful. Thank you.
Yes.
Thank you very much for your question.
One moment.
Our next question comes from Gabriela Borges with Ges Your line is open.
Hi, good afternoon. Thank you.
Keith I wanted to stay on the medium term outlook I'll comment on high teens billings growth.
For Q4, if I heard it right.
Maybe just talk us through how you thought about derisking the six months on the 18 month kind of outlook.
What are some of the leading indicators, you're all looking to determine when billings growth in product revenue will trough. Thank you.
Yes, I don't know, Ken if you want to talk about longer term trends in the industry.
And I'll avoid guidance for 2024, if you do that.
If you look back you will make.
Yes.
Three.
Now I will say acuity still have a pretty.
Good pace of growth probably between 20% on average in the last night 30, yes.
And we feel we have.
Unique huge advantage solution, which we we had only one two to one <unk>.
You can see the product, we announced today, which has a probably average about <unk> better performance more function compared to competitive solutions and also a much less energy.
Consumption, probably like a 90% less energy consumption.
So that's where the new S&P five actually.
But the first part of our announced actually is that we have a 14 application engine.
Integrating that ASIC chip profit more than doubled compared to the previous solution.
That's also helping drive the next few quarter growth, which probably every quarter, we may plan to announce a new product using <unk>.
That's a huge advantage and then also a class with a lump on conversions alpha networking on network security, which cannot agree by 2030.
And that will security will be larger than the traditional networking there.
So that's what we'll continue to drive with a novel Securities had growth on the other side. We also mentioned a few other area.
It's kind of the non <unk> part also growing pretty strong, 45% as part of that because consolidation product because.
Like our security budget.
Location.
Certain cloud spending can be located to some security and the other part also.
Michael how to manage among different caliber.
Vertical and also some inventory side. That's also we tried to balance we do believe seems will be to recover.
In the later part of next year and because.
At the last two years, we see quite a strong product revenue growth quarter in the over 50%.
It should not quite normal, but it's <unk>.
Normal.
So.
B Pro two month returns of the industrial which in the last 2030 years, which is about 10% to 20%.
Yes, as I kind of take that commentary and pull it forward.
A little bit into say Q3, and Q4, I suspect I'll get a fair amount of chance opportunities.
Talk about the guidance setting process for Q3 and Q4.
I will start off by saying, we certainly seen over the last two years or three years in various environments. We've been in.
Fairly nimble in terms of your assumptions and what Youre, what youre looking for.
And with that in mind, I think I called out on the comments to see the level of deals that pushed in the second part of June .
New development, we always have linearity of the deals close to say the deals push and I think one comment I would offer is that as you look as I go through the Q3 guidance setting and the rollout the assumptions for Q3, whether to close rates and term and things of that nature and push.
I would say look a lot more like the assumptions that we saw on actual results for Q2 than maybe what we saw with some higher rates or better rates earlier on so I think there is some some caution built into that if you will.
I think also if you kind of look at the results.
The guidance ends up.
You can look at top line growth in Q3 versus Q2 that I think is in the low single digit growth sequentially.
And thats pretty much in the range of where we've seen Q2 to Q3 historically.
We would expect that again.
And then maybe just a little more caution in the fourth quarter, where again made a comment earlier.
The seasonality assumption that falls out of the guidance for the full year and is applied to the fourth quarter actually suggests a lower level of growth in the fourth quarter than we've seen in other periods, you're offering a certain degree of caution number one but also acknowledging that Q4 last year was a very strong quarter in pretty tough compare.
Also we do see some strong growth in the new area like SD Wan, Ot, which grew 40% or 60% of total comment.
Percent of units and also the <unk> growth not noncash stock yet so we all have the best product portfolio in this new solution. So that's an additional growth driver. So we're keeping developing.
That all makes sense. Thank you and just to clarify is it safe to assume that for Q4 are you assuming that for Q billings will be the trough for billing Scott.
Yes, I'd have to go back and look at the actual compares because the comparisons are easing and I don't want to mix up bookings and billings in this conversation because the timing is a little bit different.
But I think that the growth in billings in Q4, and Q1 of last Q4 of last year in Q1 of this year were very very strong.
We also refer to the financial presentation.
Tun page, which will go back to 13 years since we IPO.
And years ago.
So there is some kind of growth.
The margin reclamation.
Yes, I do I do like that slide Tim. Thank you for calling that out okay. Thank you.
Thank you.
Yes.
Thank you very much.
Our next question will come from Karl Johnny with Bank of America. Your line is open.
Yes. Thank you.
I'm going to ask my my two questions together with your permission.
The first one is Palo Alto is posting their quarterly call for Friday evening, which is always a bad sign historically for that quarter.
And then you are reporting weaker than expected. Although you are very positive last quarter I remember the calls.
So does it mean that the environment deteriorated in the last three months.
If the environment deteriorated.
What is the source for it meaning is it the backlog drove down issue that we were concerned with before.
Or is it that customers are.
Deciding not to buy pushout that I'm trying to understand the meaning of both you and Palo Alto to successful companies kind of comments.
The second question is.
Keith in your remarks, you said that.
Projects were pushed out but if it were pushed out why do we see a deceleration continued deceleration into <unk> and <unk> because they can back out your <unk> guidance in billings is declining from 18% to 13% to 11%.
If it was a push out than we would have seen recovery in the second half from push outs from <unk>. So.
How do you connect your comments about push outs versus quote unquote cancellation to the numbers to the guidance. Thanks.
Yes.
Ill go first and then Kevin can talk about what it's running down the street is doing or not doing it for the divestment of knowledge.
As I kind of alluded to I'm, not yes, I had pushed out in the quarter.
I'm happy with what I saw in terms of July on deals getting closed.
I retain the concept of continuing push outs in Q3, and Q4 Im not here to suggest that there's going to be a one quarter recovery and that I think that this is going to be take a little bit longer.
Through this economy kind of normalizes in this digestion process goes on.
So I think it's really picking up something in Q3 from Q2, but I'm also anticipating I'm going to see some things move from Q3 to Q4 and also the compares if you go back and look at it Q3 and Q4 on the billings line Theres, a pretty attractive numbers that we put up in Q3 and Q4 of last year.
Let's see up too.
Alright.
I don't know what <unk> put out a selective <unk>, which is.
Im not a one to answer that question.
But on the on the industry.
We do see some company special large company be more tied on the budget and.
Also kind of takeaway.
Particularly the longtime total closing is not not just this quarter basically pretty much starting early this year.
Some some signs of that one.
How long the loss is tough to say, but.
Usually the security into the study and Underspent.
And then they probably at least I didn't go back up.
After probably a pause a few quarter.
The other side you can see.
Linda the beta environment, starting kind of a toff tied.
They tend to be more on that.
Current product current solution and then buy more service, which will also try to helping customers navigate whatever they have on hand at all for more service <unk> service, we announced today.
So now let's see the service revenue is that kind of.
Doing well leveraged all kind of the last few years.
<unk> revenue growth, which we are number one in the in our product revenue in the whole network security space, which is over 20% market share and also the unit shipment in over 62% market share.
We will continue to want to keep leading.
Leading in our space and there is new technology solution like the 40 billion 90 achieved we announced today.
But as.
So more focus on long term. So we do believe the long term convergence of network to network security and we feel we have the best technology products.
To meet that challenge.
And the same time that the short term environment, we tend to be.
Also sees the opportunity to to keeping that gain in market share.
Got it.
Is.
Can you talk about I know you don't provide backlog, but can you talk about the backlog trends.
How much of what we're seeing last quarter this quarter and next quarter is still supported by backlog versus the environment itself.
We are all looking through this.
The question is whether first half of 'twenty. Four for example, we can get to single digit growth instead of the double digits you talk about the end of the end of the year. So I'm not asking you for guidance for first half, but trying to understand how much of current trends are supported by backlog.
Yes, the backlog I see already back to normal now back towards that could be for the supply chain issue.
You can see last year towards the.
And we already see the 40, K, we already soft than usual.
Most of that all come from now on from a data product that also being stopped.
First half of this year.
Backlog kind of back to normal before the supply chain issue.
Southern consultation with transformation probably double digit.
I think Kansas, giving you and not the accounting answer on backlog numbers, but the CEO version that he has done worrying about it and he knows the company can manage their way through it.
From a numbers viewpoint, we still have some backlog that we.
We'll pick up some benefit low single digit benefit in Q3, and then to Ken's point, we've picked that largely as you get out of Q3, we'll have a we'll be back to very close to normal backlog numbers.
Great. Thank you.
Thank you.
Thank you for your question.
One moment, please only compile the roster.
Our next question is from Brad Zelnick with Deutsche Bank.
Nothing.
Thanks, very much for taking my questions I wanted to ask one of Tom's questions, maybe a little bit differently.
A lot of what you've shared suggest your market position remains strong and we've always thought that that.
The price performance advantage of your architecture.
Should enable you to actually take share in a tougher environment.
Many are trying to figure out if it's tough for Fortinet does that implicitly mean, it's tougher for others out there and is there anything maybe you can share on competition that would be helpful. Perhaps win rates or pricing dynamics that youre seeing in the market.
I think we still have the best solution.
Especially level the ASIC chip so the product revenues to grow by 18% compared to some checkpoints of minus 12% I believe some other vendors at the low single digits.
Sure.
There will be continued market share.
On the other side.
<unk> also see some consolidation.
Leverage our installation base, we see some of the other products starting in kind of helping us sell.
But on the other side, probably 200 kind of may be timing related issue.
You can see the last two years.
On the part of our revenue growth.
Okay.
Since the launch.
Three.
Okay.
<unk>.
Yes.
The previous four finance statement here.
You can see the product revenue growth, probably like a 40% to 50% in some quarter, but all over 70% in the last two years.
So I do believe some kind of.
Inventory has been honed by southern customer or some under.
<unk>.
Han and all kind of service provider.
Channel and we also kind of changing.
Policy.
Survey scores purely policy early this year I think in March or April .
Instead, our teams keep some of the channel.
One year and a valuable service, we tightened that up to 90 days, which can help reduce.
Inventory levels at certain partner, they're on the same time, we do announce the ISP side.
It's early this year.
Today is the first product available based on the new ASIC SP five weeks.
Which probably like four five comparator performance among application beyond <unk> and.
At the same time the same cost.
And it's kind of.
I do believe southern partner certain customer may be also waiting for some of the new products leveraging the latest technology.
So not so maybe also has certain.
Certain kind of impact.
Okay great.
Great question, and it's kind of fallen with Ken there when I look at the win rates for say our top three competitors.
So they are in the firewall market.
I'm not really seeing a change in win rates the win loss rates stay where they were quite consistent maybe improved and one of the one of the three cases.
Let me now.
I think that.
But what we don't know is how much it is.
Specific to US was that we had deals teed up for the last couple of weeks of the quarter.
That we're on a path to close and they did not close.
So I think the question becomes is that something that about the macro and the enterprises that are pushing out spending a little bit or is it some area that we need to improve on in terms of how we go about our own internal inspection and forecasting and looking at the detailed deals right. We will know more about that as time plays out.
Yes, Thanks, Charles slowdown is more because of our strong growth letting us ago, almost double last kind of slowdown.
The carrier service provider still not around pop yet so we do hope they will ramp up sooner.
Thanks for that color and just my follow up Keith as we think about pricing, which has been a tailwind.
The whole market I think given supply constraints over the last couple of years.
Can you give us any update on <unk>.
What the trends are now as supply eases in and what's embedded in your assumptions for your guide on billings for this year.
Our next thanks.
Yes, I think that.
When we look at.
Rebecca.
We've had for many years when we introduce a new product and you heard about the 90. The 90 G. Today, our starting point is even though it has superior functionality capacity throughput et cetera, as we generally priced along the lines of his predecessor.
I think one thing that we're seeing as we as we move into the second half of this year with some opportunities to take maybe some targeted pricing actions around use cases. For example, maybe you could get really far down the low end of the market, where you're dealing with some low cost franchisee models.
Maybe if we would take some opportunities there to perhaps offer some incentives to our channel partners and such to participate in that market.
The margins are obviously very very strong on the product side and we have that benefit there. So I do think it gives us the opportunity to make certain investments in the second half of this year, whether you want to call it price lists or discounts or rebates or incentives to the channel partners.
Thank you very helpful.
Yeah.
Yeah.
Thank you for your call.
Our next question is from Angie <unk> with Morgan Stanley . Your line is open.
Hi, Thank you guys. So much for taking my question today.
In terms of cancellation rate could you give us any directional color on backlog cancellation rate.
What assumed in your guidance by year end, Thank you and I ask follow up after.
Last quarter I think cancellation rate, we said it was high single digits. This quarter, we'd say, it's low low double digits right.
Backlog continues to subside as Ken pointed out a moment ago.
So it sounds like it to make that much of a difference whether that cancellation rate goes from low double digits to mid teens or something or even 'twenty.
Got it thank you and just as a follow up what percent of what percentage of revenue came from SD Wan and Ot security this quarter.
We think together over 25% cut is similar to past few quarter, but also put a strong.
40%.
Since 2% okay.
You have a 25% of the bookings number I don't think we can get.
Even a revenue number for that.
Alright, Thank you guys.
Okay.
Thank you.
Our next question comes from Socket Korea.
Yes, excuse me from Barclays. Your line is open.
Okay, Great Hey, guys. Thanks for taking my questions here.
Ken maybe maybe just to double click on the competitive question a little bit.
But but but zero in on one segment Im wondering how youre seeing SaaS vendors.
In this market, meaning do you feel like the <unk>.
Maybe backing up Keith very helpful comment just on how the competitive win rates trend versus the other the other traditional network security providers, but when you look at SaaS do you feel like the growing prevalence of SaaS is impacting firewall appliance decisions at all.
I think it's a little bit different market.
Somehow.
Service provider the traditional telecom service provider or the software led be behind in the last five to 10 years. So thats gave the SaaS provider opportunity too.
To offer the service, but I do believe a lot.
A lot of.
Telecom service provider cloud provider.
Huge advantage on infrastructure on a cost advantage.
Offer some additional security service.
Which we also working closely with them at the same time, we also invest some of our own kind of infrastructure.
It was also a lot of additional service beyond SaaS related IC land to module 40 cough footage.
For the trough for the peso was also need some other infrastructure, which will make him more profit model cost efficient model compared to some other SaaS provider they have to either lease or whatever which tend to like double or triple the cost compared to similar surveys on their.
Owning the infrastructure.
But as you.
Yes.
The new service offer better SaaS provider, we do see.
Maybe just sort of enterprise <unk>, which we also studied and invest more in this area.
Got it got it Keith maybe for you for my follow up.
Helpful commentary just on the billings duration in the quarter I think.
It helps bridge the gap with at least the guide on billings in Q2, but maybe looking forward. How are you thinking about billings duration for the second half of this year and I don't know is there a way to kind of do the same exercise like what would billings have been if the duration would have been in line with your original plan.
Yes.
Mainly the spreadsheet for the second part of that question then I'll.
I'll come back no no problem, we can take it offline.
That's right.
I think theres, a big conversation over the last say three or four quarters about what duration slowdown.
We commented that we had seen some slowdown in duration, not one month or quarter, but it was kind of bounce around a little bit.
The point I'm, making is when you're measuring year over year growth. We lost one five points of duration, which works out to be about four five points of growth so when youre, making the comparison.
On a growth basis, it really is a factor there.
And then if you want to get into the specialty part of it remember that product is not impacted by duration of these services are so you get a partial impact.
I think if youre looking forward as I made the point as we look at Q3 and Q4.
<unk> assumptions I would say is in that pool of things that I've looked at what we saw in Q2 in terms of actual results.
How those some of those metrics in the assumptions that go into the guidance setting process differed from what I've been seeing for the prior few quarters and place a very heavy reliance on what I saw in Q2, whether that skills that push with that term or a bucket of other things, but without going into specifics I would probably answer that question that way.
Very helpful.
Some additional point all sizes, sweaty, especially not compensating returned to work.
Office.
So we do see a lot of.
Regarding universal SaaS, which is supporting both on premise in the office and also work from home.
Because if you back and also as forward owned office traffic to the pod Santee, providing process sent back to the office not make much sense.
And at the same time, we do see a lot of.
Uh huh.
Leverage our ICT one leadership there we do see a lot of required a single vendor SaaS and also some bigger company also the 'twenty two the Codell private SaaS solution. So you setup.
Process SaaS traffic in the service provider partly.
Profits in their own kind of data center infrastructure.
Also it will be there will be a big potential market going forward.
Thanks, guys.
Thank you.
Thank you.
Our next question comes from Shaul Eyal with TV Colin Your line is open.
Thank you for taking my question good afternoon.
Key.
Or.
Ken.
Can you maybe talk about.
The performance that you've seen with your go to market as it relates to your top from sellers or anything.
Non balance this quarter.
So im not quite sure.
Are you looking for.
The distribution of salespeople hitting quota or.
I'm not sure I follow the question he tried to get another <unk> <unk>.
Actually I'm looking for more value added reseller.
Notable ones the biggest one.
And whether performance was even or balanced or not during the quarter.
Yes, I don't have that data handy here to be honest with you.
Yes, we do see some release from <unk>.
<unk> network.
Probably one of our biggest distributor also.
Wow.
Distributor, probably 30% business confidence, but they're a little bit more sorry.
I'm, sorry, you're right.
Youre asking the right question.
It's clear that our distributors there.
Yes, I think.
Similar similar.
Come in that we.
Yes, we are seeing.
Yes, I don't think the mix.
Our business if you will shift.
Shifted at all significantly.
Look at our top three in our top six distributors.
Concentrated in that regard.
That mix doesn't really change all that much maybe a point or two in a quarter and there wasn't something that we saw that jumped out there.
Also even go back to the history also going forward.
Also pretty similar.
Similar kind of a forecast I believe.
Yes.
Thank you.
Thank you for your question.
Our next question comes from Joseph Gallo with Jeffrey.
Your line is open.
Hey, guys. Thanks for the question.
Given the breadth of your platform you have a better vantage point than most when you talk to <unk>, whereas the relative health from a cyber budgets and where are you seeing the most resistance and then given your optimistic comments on 'twenty four when's confidence that this is only a one to two quarter digestion period is there any historical context to support that.
In terms of size those spending.
Obviously, there is things.
Things that are getting media attention out there now.
<unk> sold out of the cycle that we're talking about it.
Whether that's SaaS fee or something.
Some of the AI technologies or what have you but.
But I don't think Thats, a cio's and get away from having to take care of telling their knitting, if you will with their infrastructure.
There are always seem to be new use cases for firewalls.
Opportunities. If you will there's use cases still exist on prem that need to be secure theres, new cases of the cloud <unk> et cetera.
I think it's a very difficult career positioned to be a cycle right now, but budgets and threats that are out to them as.
As it relates to 2024 I think.
Pardon me.
Four we will go through our planning cycle more religiously as we can through the second half of the year.
The point that Ken I was making is really.
As we move back to a more normal buying pattern. After we move through the supply chain the pandemic and so forth. That's what the industry has been historically and we would have every expectation that we'd be able to get back in that sweet spot. If you will.
And I would also note that.
As the.
It's not a static comparison and by that I mean, the compares get easier it seems each and every quarter as we go through 2024.
This also will talk to this do you have a certain shortage of people they can leverage to support them.
For hybrid environment.
So that's where they tend to <unk>.
It would be more tied to what you've seen certain service kind of approach.
On the other side and they do see it and they need to make sure that the new infrastructure.
Like what are supporting back office are supporting Mike.
We call it Universal chassis unit most of the Q&A.
Ireland because.
Sure.
<unk> service, starting kind of impact on the pass a new area like Ot security.
That's kind of.
But also certain security budget also because.
Some company they commit to certain cloud spending.
Some times leveraged.
Meade.
Spending.
Hi.
Certain security, we also see some of that pace, so that that's what's happening so.
So thats why we also kind of.
Keeping our heads.
Helping the secure operation, which is also mostly most of the <unk> field.
Supporting the operation is a pretty big.
To help.
Yeah.
And two to solve the issue there and also leverage some kind of AI technology and also kind of.
More broadly the point that will see acuity inside infrastructure.
It is also supporting the hybrid work environment is also quite quiet.
High priority for them.
Thanks, that's very helpful. And then I guess as we work through this digestion period, how should we think about investments in hiring.
<unk> outperformed in the first half on profit that Youre guide doesn't necessarily reflect a continuation of that.
Where should we think there'll be incremental investments from here and the classic growth versus profit debate at billings moderate thanks.
We are still hiring and but also the high and probably will be a little bit.
The high number on the top line growth make sure and keeping that.
Improving the productivity and efficiency.
But also we probably will also tie to <unk>.
Certain.
Hygiene process, which we kind of are not quite at two in the lost time.
Three years during the pandemic, which southern low pro forma we probably need to be.
Kind of more disciplined not to.
To have certain performance.
We will kind of discipline there.
Yes, I would use that to kind of come back to <unk> question maybe.
And maybe make a couple of times I think that that's getting kind of pointed out that we've had a lot of salespeople. We certainly have sales capacity to deliver on our numbers.
At the same time I think we've been very faithful to that when we talk about 25% operating margin and.
And you'll see us continually coming in above that so we have the opportunity there to invest more in them.
No I think that the conversations with the channel partners and distributors that were having I think they are much more.
Informative deep detailed at the right levels now than they were a few years ago. There is a lot more cooperation of information sharing with.
With the distributors and I think a byproduct of that is I think there is some opportunities for us to invest in our channel partners in a variety of different ways.
As we go through this this next 12 months, probably six to 12 months.
Yes.
Keeping refer to the page 10.
The last 13 years.
Gross margin.
So thats, where we have the margin we've been GAAP profit or the 13 years since IPO and so if we need to investment growth, we definitely have the margin to do that.
But on the other side, we also wanted to keep a healthy healthy model.
Take care, both on the growth and margin.
Thank you.
Thank you.
And our next question comes from Andrew Nowinski with Wells Fargo.
Mr. Lin Malinski. Your line is now open.
Alright, Thank you I wanted to ask about.
The geographic demand trends that you saw I think you saw strength in international regions in Europe . I was just wondering how sustainable do you think that demand is in those regions or are they just maybe one to two quarters behind the U S. In terms of seeing the impact from the macro.
Okay.
Yes, I think that.
We have a competitive advantage when you look at Europe and parts of international emerging where we're oftentimes viewed as being the incumbent to have number one market share.
So in an environment in which maybe that VIP prices start to suffer more.
In Europe than they do in the U S, which is not what we're seeing currently currently we are seeing the it budgets are lower in the U S and they are in Europe based on some recent surveys.
We are better prepared.
To work our way through that in Europe , because of our dominant position in that market.
Okay got it and then I think you talked about seeing strength in the SMB segment, adding about 6500 new logos.
I was wondering as it relates to your universal.
Universal SaaS solutions can you just talk about maybe how you're competing against if at all against Microsoft New Entrust solutions that are targeting that market.
Yes.
On a more leverage.
Huge installation base.
And also the technology of the products, which address the network security.
Microsoft definitely have some some.
The customer base on the enterprise side.
But on the network security wishes address multi year on the enterprise desktop we have some some advantage there and also we have not seen Microsoft will have any solution address network security.
Nevertheless, if you are in the area. So we do believe is.
Yes.
Opportunities for both company.
Got it thank you.
Thank you.
That concludes our question and answer session I would now like to turn the call back to Peter still Koski for closing remarks.
Hey, good curious I'd like to thank everyone for joining today's call Fortinet will be attending investor conferences hosted by Deutsche Bank Goldman Sachs Oppenheimer, Rosenblatt and Stifel. During the third quarter Fireside chat webcast links will be posted on the events and presentations section afforded us Investor Relations website. If you have any follow up questions. Please feel free to contact me.
Have a good rest of your day. Thank you.
Okay.
This concludes today's conference call. Thank you for participating.
May now disconnect.
Okay.
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