Fortinet, Inc. (NASDAQ:FTNT) Q2 2022 Results Conference Call August 3, 2022 4:30 PM ET
Peter Salkowski - VP, IR
Ken Xie - Founder, Chairman and CEO
Keith Jensen - CFO
Conference Call Participants
Brian Essex - Goldman Sachs
Fatima Boolani - Citibank
Adam Borg - Stifel
Saket Kalia - Barclays
Adam Tindle - Raymond James
Michael Turits - KeyBanc
Keith Bachman - BMO
Shaul Eyal - Cowen
Hamza Fodderwala - Morgan Stanley
Gray Powell - BTIG
John Weidemoyer - William Blair
Gregg Moskowitz - Mizuho
Andrew Nowinski - Wells Fargo
Roger Boyd - UBS
Good day, and thank you for standing by. Welcome to the Fortinet Second Quarter Earnings Call. At this time all participants are in a listen-only mode, after the speakers’ presentation, there’ll be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference call is being recorded.
I would now like to hand the conference over to your speaker today, Peter Salkowski. Please go ahead.
Thank you, Hope. Good afternoon, everyone. This is Peter Salkowski, Vice President of Investor Relations at Fortinet. I’m pleased to welcome everyone to our call to discuss Fortinet’s financial results for the second quarter of 2022.
Speakers on today’s call are Ken Xie, Fortinet’s Founder, Chairman and CEO; and Keith Jensen, our Chief Financial Officer. This is a live call that will be available for replay via webcast on our Investor Relations website.
Ken will begin our call today by providing a high-level perspective on our business. Keith will then review our financial operating results for the second quarter before providing guidance for the third quarter, updating the full year. We’ll then open the call for questions. During the Q&A, we ask that you please limit yourself to one question and one follow-up question to allow for others to participate.
Before we begin, I’d like to remind everyone that on today’s call, we will be making forward-looking statements, and these forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected. Please refer to our SEC filings, in particular, the risk factors in our most recent Form 10-K and Form 10-Q for more information. All forward-looking statements reflect our opinions only as of the date of this presentation, and we undertake no obligation and specifically disclaim any obligation to update forward-looking statements.
Also, all references to financial metrics that we mine in 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 accompany today’s remarks, both of which are posted on the Investor Relations website.
Ken and Keith’s prepared remarks today for the earnings call will be posted on the quarterly earnings section of our Investor Relations website immediately following today’s call. Lastly, all references are on a year-over-year basis, unless noted otherwise.
I’ll now turn the call over to Ken.
Thanks Peter. Thank you to everyone for joining today’s call to review our outstanding second quarter 2022 results.
Total billings increased 36%; the fifth consecutive quarter of at least 35% year-over-year billings growth. Revenue grew 29% driven by 34% product revenue growth. SD-WAN and OT bookings grew over 60% and 75%, which together accounted for 25% of total second quarter bookings. Our better-than-expected performance demonstrates the strong demand for our cybersecurity innovation.
Fortinet is at the forefront of networking and security convergence, enabling our customers to reduce complexity, while securing and connecting hybrid and remote users to advanced security with superior performance.
Today we announced the FortiGate 4800F, our latest innovation in converged Network Security. The 4800F is the world’s fastest compact firewall for hyperscale data centers and 5G networks. Powered by Fortinet’s NP7 SPU, the 4800F delivers Security Compute Ratings of on average 5-10 times better performance than competitive solutions, across the six most common and important functions.
A leader in the Gartner Magic Quadrant for WAN Edge Infrastructure, Fortinet continues to take market share for Secure SD-WAN. Our integrated secure SDWAN solution, powered by Fortinet’s SPU SOC4, delivers huge performance, security and efficiencies over traditional offerings.
In addition to convergence, consolidation of vendors and product functionality is another major trend, particularly in Network Security. In a recent CISO survey, Gartner found the percentage of companies surveyed who want fewer security providers increased to 75% from only 29% in 2020. With over 30 products lines built mostly by our in-house strong engineering and development innovation, Fortinet is benefiting from this consolidation with our Security Fabric MESH offering. The Fortinet Security MESH platform delivers unparalleled protection with broad, integrated and automated protection across multiple edges, from endpoint, to data center, and hybrid cloud environments. These two major trends, convergence and consolidation, position Fortinet well for long-term growth.
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, that are contributing to Fortinet’s strong growth.
Thank you, Ken, and good afternoon, everyone.
Let’s start the more detailed quarterly discussion. Second quarter results were solid and broad-based across geographies, customer sizes, industries, and use cases, driving market share gains and demonstrating the strong support from our three key growth drivers: first, an elevated threat environment; second, the convergence of security and networking; and third, the consolidation of security products across our platform offerings.
Total revenue of $1.03 billion was up 29%, passing the $1 billion milestone in quarterly revenue for the first time in our history. Total product revenue growth was up 34%. Core Platform and Platform Extension product revenue growth was up 35% and 33%, respectively.
We continued to see robust product revenue growth from a wide range of security use cases, including Secure SD-WAN and Operational Technology, or OT. Total service revenue growth increased sequentially to 25%, resulting in service revenue of $629 million. Support and related service revenue was up 26% to $289 million, while security subscriptions service revenue was up 25%, or 2 points sequentially, to $340 million.
Service billings, defined as total billings minus product revenue, were up 36%. The year-over-year growth rate for short-term deferred revenue has increased for six quarters in a row from just under 21% in Q4 of 2020 to just over 31% in Q2 of 2022, the highest short-term deferred revenue growth rate in over six years.
The accelerating growth rates for service billings and short-term deferred revenue reflect the earlier pricing actions that quickly appeared in product revenue and that are now beginning to appear in service revenue.
The pricing benefit more than offset various service revenue headwinds, including suspending services in Russia, an increase in the average number of days between when a customer purchases and subsequently activates a security service contract, and the impact of contract manufacturers delaying deliveries to later in the quarter, which limits our service revenue on new sales recognized in the quarter.
With growth and pricing benefits more than offsetting these headwinds, we expect service revenue growth will continue to accelerate through 2022 and into next year. As summarized on slide 6, total revenue in the Americas increased 23%, EMEA revenue increased 28%, and APAC posted revenue growth of 42%.
Despite macro conditions that may be more readily impacting other industries, our pipeline growth remains strong. In particular, EMEA’s pipeline growth indicates continued strength in our European business.
Moving to a summary of our success with large enterprises. Large enterprises continue to favor Fortinet’s leading cost for performance advantage and are increasingly more appreciative of our integrated platform. The platform strategy allows customers to converge networking functionality with security capabilities and consolidate multiple point products.
Our success with large enterprise customers includes: global 2000 bookings growth of over 65% year-over-year and on a rolling four quarter basis; large enterprise bookings growth of over 55% year-over-year and on a rolling 4 quarter basis; and the number of deals over $1 million increased over 50% to 122 deals and the total billings value of these transactions doubled.
Secure SD-WAN bookings grew over 60%, reflecting the convergence of networking and security as well as a strong ROI for our customers. OT bookings were up over 75%, reflecting the continued response to the elevated threat environment.
Shifting to billings. Billings of $1.3 billion were up 36%, as Ken pointed, representing the fifth consecutive quarter of billings growth in excess of 30%.
I’ll pause here to offer thoughts on product refresh cycles and their impact on our financial results. Specifically, we do not believe new product releases drive a near term spike in our top-line growth; rather, we believe the continual nature of our product releases drives long-term growth.
For example, each new ASIC is included in a series of products released over several years. Our most recent ASIC chip, the NP7 Security Processing Unit, was introduced in Q1 of 2020. Including the 4800F announced today, we have released 9 high-end Core Platform products with the NP7 chip. Over the next several quarters we will release several additional midrange and high-end products with the NP7. Lastly, I would note that since the start of 2019, we have released over 23 new FortiGate models.
While some of our competitors with much shorter product SKU lists may have shown clear signs of product refresh cycles, our strong long-term performance illustrates an extended series of overlapping product maturity curves.
Core Platform billings were up 32% and accounted for 69% of total billings. As shown on slide 7, mid-range FortiGates posted very strong billings growth with the mix shifting 5 points in their favor driven by demand as well as supply availability.
Platform Extension billings were up 44% and accounted for 31% of total billings, a mix shift of over one 1.5 points. Average contract term was up one month year-over-year at 29 months, driven by the strength from large enterprise customers and the 50% plus increase in the number of deals greater than $1 million.
Worldwide government billings grabbed the largest share of the mix at 15% and were up 45%. The top five verticals accounted for 60% of total billings.
Moving back to the income statement. Total gross margin of 76.5% exceeded the midpoint of the guidance range by approximately 125 basis points, even as component, labor and freight costs increased, and the year-over-year revenue mix shifted 2 points to product revenue from higher margin service revenue.
Product gross margin of 61.9% was up 20 basis points year-over-year and 450 basis points sequentially as pricing actions, product mix, and lower discounting offset higher component and other costs.
Service gross margin of 85.9% was down 100 basis points due to increased costs associated with the expansion of our data center footprint as well as labor cost and other costs; partially offset by benefits from FX and some of the earlier pricing actions. Operating margin of 24.8% exceeded the midpoint of the guidance range by approximately 200 basis points. The year-over-year comparison saw the FX benefit offset by lower gross margins, increased travel and marketing costs and other costs. Headcount increased 27% to 11,508.
Looking to the statement of cash flows summarized on slides 8 and 9. Free cash flow was $284 million and was impacted by increases in DSO and cash taxes. DSO increased 14 days year-over-year and 5 days sequentially to 80 days due to the change in billing linearity driven by the timing of inventory deliveries from contract manufacturers. New R&D capitalization rules increased second quarter cash taxes by $85 million to $110 million. Second half cash taxes of approximately $135 million are expected to be more evenly spread across the third and fourth quarters.
For the first half of the year, our adjusted free cash flow margin, which excludes real estate spending, was 34%. Capital expenditures for the quarter were $39 million, including $21 million for real estate investments.
We repurchased approximately 14.4 million shares of our common stock for a cost of $800 million, bringing the total year-to-date shares repurchased to 25.8 million for a total cost of $1.5 billion. The Board increased the share repurchase authorization by $1 billion. The remaining repurchase authorization is now $1.03 billion. Inventory turns of 3.1 times were up a half turn year-over-year and down a half turn sequentially.
Moving to bookings and backlog. As a reminder, backlog is excluded from the current quarter billings and revenue. Nonetheless, it is expected to provide increased visibility and a top-line tailwind in future quarters. Bookings were up 42% to $1.4 billion.
Total backlog of $350 million is up $72 million sequentially and reflects very strong demand. Of the total backlog, networking equipment accounted for about 50%, while FortiGates accounted for 40%. We believe our backlog is very strong and sticky. Existing customers account for over 95% of total backlog and no single end customer accounts for more than low single digits as a percentage of backlog. There are four deals in backlog, all from previously existing customers, with a remaining balance of over $2 million that together account for 6% of total backlog. Just 4% of ending Q1 backlog was canceled in Q2 and about half of the deals in backlog have been partially fulfilled suggesting that double ordering is not a significant contributor to backlog.
Consistent with the first quarter, we shipped approximately 60% of the prior quarter’s backlog in the current quarter, as our operation and R&D teams did an excellent job navigating the tough supply chain environment. Nonetheless, we still expect supply chain constraints to be challenging throughout the remainder of the year. We are continuing to address the supply chain challenges in a number of ways, including by increasing inventory purchase commitments, redesigning products, qualifying additional suppliers, and certain pricing actions. We believe that even with these actions, demand will continue to outstrip supply. As a result, we expect backlog to continue to increase in 2022; and while the situation is very dynamic, we believe we will have access to sufficient inventory to meet our guidance.
As we balance our pricing actions with the opportunity for continued market share gains, we have passed along most, but not all cost increases. As such, we expect ongoing gross margin volatility from these increases as well as shifts in our product mix related to inventory availability.
Before reviewing our guidance, let’s offer a few Fortinet specific observations in areas you may have heard discussed elsewhere. In Q2, we noted certain larger transactions with increased or elongated negotiating cycles. Also, linearity pushed to later in the quarter, and later in the last month of the quarter, mainly due to supply constraints and the deliveries. Lastly, close rates were strong and, importantly, the aggregate value of deals that pushed out were within our historical norms.
Now, I’d like to review our outlook for the third quarter as summarized on slide 10, which is subject to the disclaimers regarding forward-looking information that Peter provided at the beginning of the call.
For the third quarter, we anticipate our solid third quarter pipeline growth across deal types, sizes and geographies to support the following: Bookings in the range of $1,455 million to $1,485 million, which at the midpoint represents bookings growth of 36%; billings in the range of $1,385 million to $1,415 million, which represents growth of 32%; revenue in the range of $1,105 million to $1,135 million, which represents growth of 29%; non-GAAP gross margin of 75% to 76%; non-GAAP operating margin of 25% to 26%; non-GAAP earnings per share of $0.26 to $0.28, which assumes a share count of between 810 million and 820 million; we estimate third quarter capital expenditures to be between $105 million and $115 million; we expect a non-GAAP tax rate of 17%.
For the full year, we anticipate backlog that could approach or possibly exceed $500 million that will be offset by robust industry growth, pipeline strength, and market share gains fueling our growth and support the following: Billings in the range of $5,560 million to $5,640 million, which at the midpoint represents growth of 34%; revenue in the range of $4,350 million to $4,400 million, which represents growth of 31%; total service revenue in the range of $2,620 million to $2,670 million, which represents growth of 27% and implies full-year product revenue growth of 38%; we expect non-GAAP gross margin of 75% to 76%; non-GAAP operating margin of 25% to 26%; non-GAAP earnings per share of $1.01 to $1.06, which assumes a share count of between 810 million and 820 million; we estimate full year capital expenditures to be between $300 million and $330 million; we expect our non-GAAP tax rate to be 17%; we expect cash taxes for the year to be $265 million, as I mentioned earlier, cash taxes paid are higher in 2022 due to the new R&D capitalization rules in the U.S.
Along with Ken, I would like to thank our partners, customers, suppliers, and all members of the Fortinet team for all of their hard work, execution and success.
I’ll now hand the call back over to Peter to begin the Q&A session.
Thank you, Keith. As a reminder, during the Q&A session, we ask that you please limit yourself to one question and one follow-up question to allow others to participate. With that, Hope, please open the call for questions.
Thank you. [Operator Instructions] Our first question comes from the line of Brian Essex with GS.
Great. Thank you. Good afternoon and thank you for taking the questions. Congrats to team on a nice set of results for the quarter. I was wondering if maybe -- and Keith, I certainly appreciate the commentary and the granularity with the full year revenue guide. Can we maybe unpack some of the commentary on the services side and the lower, I guess, services revenue guide for the year? Maybe help us understand what’s going on there. And maybe pair that with your comments on delays in activations and how much insight you might have there that gets folks comfortable that there isn’t pull-forward? Thank you.
Yes. I don’t think -- Brian, I don’t think pull forward really applies to the service revenue line, but maybe -- it’s actually a couple of questions at once. I think the answer to your question about service revenue, I think the biggest change from where we started the year is really about Russia. If you think about Russia, we talked at the very beginning, it’s about 1.5% of our total revenue. And it applies to the service revenue line as well. Earlier in the year, we stopped recognizing revenue on existing contracts for services that provide in Russia in conjunction with our suspending of services. At that time, we did not anticipate it would be a full year event, but we are now. And if you kind of think through that 1.5% of service revenues in Russia, so we really backed out now for the full year about $25 million of revenue related to Russia. That’s the largest change there.
I think the delay in registrations from when contracts are sold, when they’re actually registered by customers, I think we pretty much got out of the quarter what we expected on that. That seems to be something in the current environment with inventory constraints that we’re going to continue to see. I think the linearity part of it is a little bit new in that because the shipments occurred later in the quarter, there really wasn’t the opportunity to get the service revenue from those Q2 shipments that we would normally get. And so, I think those are really the parts to put together there.
On the other side, I would probably point to, again, the short-term deferred revenue billings and the number that we’re putting up here and the growth that you’re seeing with that number as well as service billings itself.
And I think the last comment on this, and we haven’t talked about it before, is that the service contracts are really a use it or lose it contract, meaning it’s not that they have the ability to cancel, they just have the ability to postpone the registration for a period of time, whether -- depending upon the geography, whether that’s 90 days or one year or what have you. So, eventually, it comes to revenue, but the timing has been pushed out to that aspect.
Our next question comes from Fatima Boolani with Citibank.
Hey. Keith, this one’s for you. Just with respect to some of the backlog detail and commentary that you shared, I want to hone in on the cancellation rates that you quantified for us. I believe you said it was about 4%. Can you give us a sense of what are some of the reasons behind the cancellation? And what gives you confidence that that 4% isn’t going to stretch or escalate into maybe mid to high single digits? Thank you.
Yes. I think I would point to some of the factors that we’ve talked about before. I think that last quarter, we talked about the cancellation rate being 5%, I think we’re seeing it now 4%. I think it’s unlikely that existing customers, particularly those that have received partial shipments are going to cancel. Also, I don’t want to -- that it’s naïve that as backlog gets older, and it’s also why we provide that 60% of shipments from prior backlog number for The Street to try and understand it. But if that number starts to tick up, obviously, there’s more risk in it. I think it’s important to understand the guidance that we provide really isn’t reflecting in any sort of shift in the backlog that we’re going to ship a lot of things from backlog. So, I think we’re fairly prudent in that regard, and I think we’re also comfortable with described as the stickiness of the backlog number.
Our next question comes from Adam Borg with Stifel.
Maybe just on the macro. You talked a little bit about the demand environment and highlighted some delayed deals and elongated linearity. Can you maybe go a little bit deeper here and talk about what these customer conversations look like? Are these tied to any particular verticals or geographies? You talked a little bit about large enterprise or larger deals. I’d love to hear about the midsize to smaller deals, too. Thanks.
It’s Ken. So, we do see a lot of customers, especially enterprise, they’re starting to design some new infrastructure to support and work from anywhere and also expand security beyond the traditional network security and to whether like internal segmentation to prevent nowadays ransomware attack or go to work from home and at the same time, have multiple security products, need to be automated together. So we call the consolidation, both on the product side, on the vendor side.
I see this kind of trend will be last for the next few years, will be pretty long-term change. And at the same time, Keith also mentioned elevated security environment also other drive. So, that’s where we see the trend we’re keeping going for the next few years. If you look at the billing number compared to two years ago, I mentioned in my script is -- we have over 35% of billing increase in the last five quarters compared to two years ago, Q1 2020 is only about 14%. So, we do see the change in acceleration and also the convergence consolidation going on in the whole space right now will be pretty much the amount of growth.
Our next question comes from Saket Kalia with Barclays.
Keith, maybe for you. I’d like to talk a little bit about bookings. Can you just talk about how bookings did versus your expectation this quarter? I think the guide coming into Q2 was for about 40% growth. We came in at 42%, clearly better, but a bigger delta on the billings versus the guide. And so, can you just talk about how to read into that, if there’s anything to consider there with just those two kind of in relation to each other?
Yes. I don’t -- I think, obviously, 42% bookings. I think we’ve been over 40% now for 3 quarters, maybe 4 quarters in the bookings line, we feel really, really good about it. I think the one thing that we’re looking at internally, it’s just that the interplay between bookings, backlog and billings and trying to really get a sense of the direction of the business. And the example I kind of gave is we had a very good quarter on the midrange of the product. But some of that was due to availability. Demand was very strong, but it was also because we had the midrange product available. We didn’t have as much product available in the low end. Now, as we shifted to this third quarter, I think we’re probably going to see the low end availability improved fairly dramatically. And so, when you’re looking at billings information that we have historically disclosed and trying to gauge the direction of the business, it gets a little bit distorted now just in terms of what’s available. And I think of the total when you look at bookings and backlog, there’s some of that as well in terms of the characterization of what the booking is versus the characterization of what’s available to ship and what comes in the billings line.
Also compared to one year ago, maybe a tough comparison because we’re started to see the acceleration about five quarters ago.
Our next question comes from Adam Tindle with Raymond James.
Keith, you talked in the prepared remarks about still expecting supply challenges for the rest of the year and to offset you’re thinking increased purchase commitments, qualifying additional suppliers and pricing actions. I wanted to zoom in on that last point on pricing actions to see if you would maybe put a finer point on timing and magnitude for expected pricing actions? And secondly, you sounded positive on elasticity and confident on the elasticity moving forward. But just curious what underpins that confidence, especially in international markets with dollar strengthening in local currencies and fixed budgets, et cetera? Thank you.
Yes. Great question. And I’ll take the last one first because I think it’s probably very important, and I probably forgot the first one already. So one of the things that we do is we track very religiously in our CRM tool when a customer -- if we lose a deal, we want to know why, right? Is it because we could not overcome the incumbency, is it because the channel partner may have had a bias, if you will, to one of our competitors, a feature issue, a functionality issue or something like that, but also very specifically, do we lose on price. And we’ve been tracking that now for over a year. And that percentage, which is low -- lower than the other ones that I just gave in to you, has been extremely consistent. And so with that very consistent loss percentage, if you will, I translate that into price elasticity, which tells me that the question is always how far can you push the envelope. We know we come into the conversation with a significant price and performance advantage, The Street sometimes -- or channels just may say 30% or 40%. We have known that from the beginning of this phase of the economic cycle. And the question has become how far can we push that.
But again, keep in mind, our goal is really to try over a longer period of time just match the cost increases and maintain a consistent margin. It’s not that we’re really trying to take down more margin. Now you will get volatility quarter-to-quarter because of the mix and things like that. So, a long-winded way to say, I think I really hang my head on what I’m seeing and we’re tracking on the CRM data about reasons that we lose deals and reasons that we win deals.
Yes. And also a few other comments about pricing. Our policy tends to be just by the price by small step, but also kind of more open, like we do have a new price book basically released every quarter. Also, the other thing is really like the product we released today, on average for the same function, for the same price range, our product has a performance factor 10 times better than competitors. Like Keith mentioned, on the CRM on the tracking, we don’t see any big loss on kind of changing or even -- if you do not -- actually improved because we still have a huge price advantage compared to competitors.
The other thing also may be mentioned to the service. I think one we may try to Excellerate a little bit going forward is really even in the last few quarters, we increased some of the price more on the new product release, but we are not changing the price for the expired product. Basically, the product is still added to the service like 5, 6 -- right? So, that’s one thing we made because the labor cost on the service and supporting, so we may have to increase the price of the outdated product no longer shipping because all the service or the renew still tied to the old product, which is no longer shipping but is the customer still buying the renewal, buying the service based on the old product. So, that’s probably -- we can also help in the improving the service and also helping the margin and compensate our additional costs, especially on the labor.
Our next question comes from Michael Turits with KeyBanc.
So, Keith, two questions. First, maybe it seems obvious in some ways, but do you feel like -- and this is the first time that you’ve talked about this linearity issue as well as the extension of the negotiation cycle. So, do you simply tie it to macro being worse right now, or do you have any other insights to it? And then, I just wanted to make sure that in your mind, second question, you really think that it’s really primarily services as a result of those things, this shortfall in the year and you’re happy with product?
Yes. So, I think the -- well, putting aside the -- Mike, you broke the rule and you asked two questions and Peter said only one and a follow-up.
Sorry about that...
I think what we’re seeing in linearity, unlike a “normal world” where you can kind of look at linearity and DSO and you can get a sense for whether or not a company is pushing to close deals at the end of the quarter and maybe it’s a more challenging quarter. Because of the timing of when the finish -- when the inventory is delivered from the contract manufacturers, we see a shift in that linearity of when we receive inventory from our contract manufacturers. That shift then it translates into when we can turn around QA, et cetera, and ship it out to our customers and sell it. So, there’s a different aspect of linear that’s come into play here now. So, service contracts that maybe would have been sold in the first month of the quarter, actually got sold in the third month of the quarter. So, we lose service revenue from that. And you see that appearing in the DSO and you see it appearing in the free cash flow.
On the negotiating side of it, I think what we saw, and I don’t know if this is common to others -- what we saw was probably the first two weeks of June and maybe there was more conversation around recession and concerns there, if you will, a bit of a pause in terms of deal closure rates for those first 10 days of June and then a reacceleration as we got through the end of June. We did notice or I did notice during that time frame maybe additional parties were being introduced to either as an approver or a negotiator, if you will, on some of the larger deals just to make sure on the customer side that they were making the right decision. And I think that’s why I went on to say in the prepared remarks, not only did we notice this shift, but the close rates, which were important actually were up just a tad in the quarter. So, I think there was just for whatever reason, there was a slight pause there for a couple of weeks in June and everybody came back and got the deals done by -- on the customer side and our side at that last week in June.
The other reason for a little bit longer closing time really the bigger deal grow faster. So, like I mentioned, the deal over $1 million grew over 50% year-over-year. So, that’s the bigger deals also tend to be -- take a little bit longer time to close. And also, we see more like a deal involving multiple products, not just the FortiGate, but also we call the non-FortiGate, call the platform retention, which also take a little bit long time to test -- evaluate to close.
On the supply chain, since really compared to before the pandemic, we probably ship majority -- most of the products by sea. Now we’re pretty much shipping every product by air. That’s where the timing of the supply shipping the product to us is pretty critical automatically. And so last quarter, we did experience a lot of product being shipped in end of the quarter from suppliers to us, that drives the linearity. Even we have the booking -- but we are the way -- like a few weeks or even a couple of months before the product was shipped to the customer more towards the quarter end because the supply shipping goes pretty much in the end of the quarter. So, we do see long term, this will be changing, improving. We’ll keep increasing some of the product inventory and improving the product turn and also balance among not just shipping everything by air, but some by air, some by ocean.
Our next question is from Keith Bachman with BMO.
Good segue from Michael’s question. Keith, I want to try to understand, you talked about a few different things impacting the year guide. To put context around it, your revenue guide for ‘22 isn’t changing, which I think is viewed as a disappointment to investors. Now underneath that, services revenues is getting compressed a little bit. And so, as you think about why the revenue estimates are going higher for the year, is there a change in, a, the demand level, whether it’s the elongation because you said, in fact, there was two weeks, sort of weak at the end of June, but it sounds like during the last -- through the 3rd of August, things have normalized, or is it b, supply chain issues that are causing you to not raise your revenue guidance even as you’re raising billings modestly? I’m just trying to understand what are the forces that are impacting the lack of raise, if you will? Is it the demand side and/or is it the supply side?
Yes. I don’t really think it’s necessarily either demand or supply. I would start the conversation off by saying I think the pipeline growth is extremely strong. We feel very, very good about that. I do think there’s a fair amount of uncertainty as we look out beyond the third quarter to the fourth quarter in terms of directions the economies may go, what inflation may do and a little bit of supply chain. I don’t think -- we did, as you point out, cover the shortfall, if you will, in the service revenue -- economies may go, what inflation may do and a little bit of supply chain. I don’t think -- we did, as you point out, cover the shortfall, if you will, in the service revenue, in the product revenue. So I think that’s a fairly good size of us being bullish and feeling very, very good about our competitive advantage.
And I think that the other aspect we talked about is just the large deals and how we’re seeing the success in the enterprise and getting a little more dependent on large deals than we have in prior years and some of the close rates around those. I think that while we’re bullish, we think we have competitive advantages. I don’t know as we get to the fourth quarter, if this is really a good time to think about that in a very, very aggressive fashion.
Okay. So, as I just clarify, so it sounds like you want to be a little bit conservative or you don’t want to get ahead of yourself on particularly the Q4 guide, so lead numbers where they are on revenues, in particular?
Yes, I think that’s a fair description.
Our next question comes from Shaul Eyal with Cowen.
Maybe segueing from the prior question from revenue maybe to OpEx. So, your hiring plans appear to remain largely on track. What’s the current thinking on second half? Is it becoming a little easier in recent months, given some layoffs at some private competitors?
We want to maintain healthy margins and then also keeping growth and gaining market, agreed hiring is relatively a little bit easier compared to like a few quarters ago, especially in the cybersecurity space. So for us, we feel we have a good pace on hiring, especially we still -- we’re keeping gaining market share. And the margin -- and it’s a healthy margin, basically, both on the gross margin and also on the operating margin side. So, we feel we have pretty solid plan and balance among the growth and margin.
Yes. I think Ken’s spot on with that. I would probably offer a couple of things to support. One is you continue to hear us talk about our inventory commitments looking out now 6 quarters or more. I think the read through that is that we still feel fairly bullish about it. And the other aspect of it. And the other aspect of it and Ken made reference to it is we talk about 25% operating margins in different ways over the years as being an average or target, what have you. And obviously, to -- in this environment to -- with high inflation, to come in successfully and still be providing guidance for the full year of 25% to 26%, while growing the top line aggressively while taking market share, I think we feel very good about how the sales team, the engineering team, the operation teams and support teams, et cetera, are all working together and driving the growth of the Company and the execution.
The next question comes from Hamza Fodderwala with Morgan Stanley.
Maybe a question for both, Ken and Keith. Ken, just given the general pressure on budgets in the macro environment, are you seeing a little bit more impetus to -- from customers to want to consolidate to a converged security networking platform like Fortinet? And then for Keith, if you’re seeing any weakness, let’s say, elongating, negotiating cycles and whatnot? Is it more weighted towards the core platform FortiGate side or the platform extension side, which is in access points?
It’s a very good question. Definitely, we see the convergence among the network and security. Also the pandemic accelerated this kind of change, especially inside the company, campus network and also work from remote anywhere. So that’s where we see that pretty strong growth. And also a lot of connected devices like in the OT space, also, we see very strong growth. Like we mentioned, SD-WAN grew 60% and the OT growth 75%, and we’re still keeping growth and gaining market share there.
And at the same time, have to secure the whole infrastructure not only expanding our network security to the networking side, but also like beyond the network security, with the end point, with the cloud with all the other like application level from email, web, working together. So we do see all these -- we keep saying the convergence and consolidation will benefit Fortinet multiple years going forward, it’s more long-term growth driver for us. And we prepared this in the last like 22 years since start company with investment like from ASIC technology for the R&D with most of the product internally developed to integrate, automate together. And so, we do see the time is starting coming and for all this investment starting to see some good return. And also, we feel we have a very healthy business model since IPO now is about 13 years now, want to maintain the balanced growth and also healthy margin. And that is what makes the company to last longer. And at the same time, we’re also kind of keeping invest in the long term to follow the change and also keep up the innovation and quickly customer benefit from our innovation and also the long-term investment.
Yes. And Hamza, I think your speculation about where the larger or the timing comes in is accurate and that it’s going to be in that 1/3 of our business that is large enterprise. One, the dollars are larger, obviously. And so, they’re going to -- customers spend a little more time with the ROI. But I think more importantly, and to your kind of second point, your question on, by adding in more of the platform products into a deal, you’re perhaps a little more likely to run into additional competitors or people internally that are champions of those competitors. And so, there’s a little more than it takes to get across the finish line because they are more complex in that way.
I’ll fill the void here. As a reminder, we did 122 deals over $1 million in the quarter, which -- that’s a pretty fantastic number for us.
Our next question is from Gray Powell with BTIG.
So, Keith, I know you hit on this once or twice already, but I just want to make sure I understand a dynamic on the services billings. So, if I back out product revenue from short-term billings, it looks like the annual recurring component of billings actually accelerated pretty nicely. I’m calculating like 29% in Q1, improving to 40% in Q2. I don’t need you to bless the numbers, but directionally, does that seem right to you? And then, if so, how much of that was driven by pricing dynamics that you talked about versus just the natural cadence of the business?
I do think your math is directionally correct, but it’s lot more time to get anything more about how actually it may or may not be because kind of looking at a different way. And I would say, again, if you think about the timing of where -- when a price increase is effective, right? It’s got to go through the process of being preannounced to the channel partners, they get, I think, 60 days of advanced notice and then whether it’s actually start to have an impact on it. But keeping that in mind, you do see the impact on pricing actions fairly quickly on product revenue and on billings, whether it’s a product or whether it is a service item, right? You will see it there. But on service revenue, you won’t see that benefit for an extended period of time.
And I think one thing that may help people, if you think back of our shift from 8 by 5 support to 24 by 7 support. We talked about that for several years because when we turned off the 8 by 5 support, with that came a price lift. And the question that we were addressing, seen for 8, 12 quarters probably in a row, was how was that mix shifting and how was that coming into it. And we were providing information back then about all the buildings, so to speak, are in the 24 by 7, but you’re not seeing the revenue mix that way because it’s kind of -- that mix has to evolve over time as you go through the installed base. Price increases for service revenue, this is just another flavor of the same thing that way. You’re going to see the benefit over a much longer period of time on the service revenue line. You will see the benefit in billings much sooner, and that’s why we gave that information earlier, and you kind of -- Gray, you’re looking at it, that’s a very good leading indicator of where service revenue growth is going to go in the future.
Okay. That’s really helpful. And then just a real quick follow-up. You mentioned $25 million headwinds on service revenue from Russia, which is a new headwind. Does that apply to billings as well, or was that purely a revenue dynamic?
That was a revenue dynamic, and I would probably say 40% of that probably, 30% to 50% of that would have been a billings dynamic, in terms of where we were from the beginning of the year where we’ll end up now.
Our next question is from John Weidemoyer with William Blair.
On your platform extension, cloud security capabilities. I’m curious of the type of customer profile that’s interested there. I suspect they’re probably an existing Fortinet customer that’s transitioning to the cloud. And I’m curious if there are also maybe a fabric mesh. And so there might be an all-in customer -- an all-in Fortinet type customer. Can you talk about the characteristics of the people that are going down?
We do see the cloud security growing well, pretty much on a similar pace as other networking appliance growth. And also, we do see a lot of cloud security come from the service providers, especially carrier service provider, someone also combined with an offer SDWAN and some also with OT, all this together. So that’s what we keep saying, for better security, the new secured whole infrastructure, not just the cloud, but also appliances and some other product infrastructure. So, we do see more and more customers want to consider overall together. So basically, cost security also drive a lot of other part of cybersecurity, other part of infrastructure for cyber security. And also, we do believe long term, the service provider, both in the telecom space, also in the securities integrate and also like even a cloud provider, will play a very, very important role on this security, especially in the service part. And that’s where we also want to keep supporting them. So, that’s where we see that is kind of a still more hybrid environment going forward and especially with more and more device connected with a lot of other, we see kind of the whole infrastructure security more and more important connect, consider all parts of security together is quite important.
Our next question is from Gregg Moskowitz with Mizuho.
I’d like to ask about your backlog, which has significantly and consistently increased for each of the last three quarters. It’s dramatically above year ago levels. So, Keith, you made it clear that the backlog should further rise by year-end, which is great. But at the same time, it’s not going to grow forever. And it’s common to see dips in the company’s backlog due to seasonality, significant order shipments, cancellations, et cetera. And so, it would just be helpful to get your sense of perhaps when we begin to see ebbs and flows in the backlog metric. If you could offer anything there, that would be helpful.
When supply chain is going to get better Ken. So, I’ll let you handle that one.
If you compare to end of Q1, we increased backlog $120-some million. And then end of Q2, we increased about $72 million. It’s a little bit better increase, less than end of Q1 and also less than end of Q4. So, there is some kind of improvement on increased backlog. But also, we put a lot of effort to sourcing different parts or different vendor designed products. So, you see the product line we got quite broad right now. And also can help leverage some kind of -- I mean, some alternative of kind of a more broad supply chain for us. So, that’s why I do believe because the demand is still very, very strong, and so we do see probably keeping -- get a little bit better and better. But like Keith said, we probably not expect backlog will reduce in Q3, Q4. But the increase probably will be less each quarter, I’ll put it this way.
And then maybe next year, we’ll see -- starting to see some kind of improvement within the backlog. But overall, with our engineering effort, with the kind of the investment we’ve made in the operation in the manufacture, we do see since that get improved a little bit better now.
I think it was a logical place to have questions and Ken’s comments are great. I would just add to that, keep in mind, the -- this is why we provide some of the metrics there. We’re not -- there’s not airplane orders, right? These are relatively small dollar items compared to what you may see in other industries. And that’s why we gave some of the metrics on the size, if you will, and the fact also that their existing customers and many of those have been partially fulfilled. And we all have the same concern and the question is, how do you get comfortable that that backlog is sticky and it’s going to be here when the product and the supply chain loses up. And that’s why we’re giving those metrics for people to get some sort of context. But keep in mind these are comparatively to other industries, construction industry, airline, what have you, these are very small dollar amounts.
Also, the age of our backlog probably much better than our competitors. Like Keith mentioned in the last 2, 3 quarters, every quarter, even if we increase the backlog and we fulfill probably like 60%, even over 60% of previous quarter backlog. So, that’s making our age in the backlog also pretty short, few months compared to most other competitors sometimes may take 1 to 2 years to deliver. So, that gives us a pretty good position and also the customer trust continue working with us during this supply chain issue. And at the same time, we offer quite a broad product. There’s always some kind of alternative product because suggest out customer to use if 1 or 2 provide some shortage. I think we deliver over 90% of any booking in every quarter, I believe.
Yes, the bookings...
Between 90% to 95% of the booking, we deliver the product.
Our next question comes from Andrew Nowinski with Wells Fargo.
Congrats on another great quarter. I had a question on free cash flow. So I think you said you expect the low-end supply appliances to dramatically Excellerate in Q3. So is there a margin or free cash flow impact that mix shift in Q3? And then related to that, given the shortfall on services that we saw in Q2 and the negative impact it had on your free cash flow, should we expect free cash flow to rebound in Q3 and Q4, or are you assuming the linearity remains unchanged in those quarters? Thanks.
Yes. I’m assuming the linearity is -- I don’t really have any reason to think that’s going to be any different. I’m looking for a reason to find, but I certainly have not found one yet. So, when we look at what our expectations are internally, we don’t guide to free cash flow, we’re trying to give information is helpful to others. I would assume that -- I have no reason to assume anything other than we’ll still see more of the same, if you will. And then, I think the first part of your question was -- you asked about low end and about margin. And maybe I can offer a little bit of commentary there. When you look at our FortiGate firewall product families, the entry level, the low end, you call it, mid-range and high end. In general, the margins increase -- the gross margin increases as you move up from the entry level to the higher end of it.
So from that aspect of it, and that’s why the comment in the script that there can be gross margin volatility both from the pricing actions that we’ve taken and the discounting as well, but also the mix of our product. So, in a quarter that we see a higher mix of higher-end firewall shipments, margins will be higher by definition. But there’s many puts and takes in there that we -- when we go through the gross margin guidance that we give, hopefully, we’re considering all the different puts and takes that are in there, not just the mix of the inventory and the pricing actions.
Our last question comes from Roger Boyd with UBS.
Keith, I was curious just to go back to the backlog for a second. You had mentioned the split being about 50-50 between FortiGate and networking portfolio. Just wondering if you could talk about how you expect that mix to trend through the end of the year? And I guess, the follow-up to that is what you’re seeing around the supply constraints between those two product portfolios? Thanks.
Yes, I might double check the numbers. I think it was 50%, 50-40 between FortiGate and networking equipment. I have it backwards. Networking equipment is 50% and firewalls 40% and then cash and dollars the remainder of it. I think everything that we’ve seen to read in here can probably know more, the pressure certainly seems to be for the term, more intense on switches and access points than they do on firewalls. And for a lot of the reasons I think we’re more successful with firewalls.
Yes, I agree. Probably on the direction wise, we do see the FortiGate inventory will keep improving. So probably the percentage, maybe a little bit more on the backlog, probably a little bit more towards the switching and AP side, which is probably the whole industry is suffering some play issue, because we are more able to redesign and also use our own ASIC, which is also helping kind of reduce the backlog and supply on time for the customer. But it’s -- from the beginning of this backlog issue almost one year ago, definitely, we see the shifting a little bit more towards the networking side that have longer backlog.
I would now like to turn it back to Peter Salkowski.
Thank you, Hope. I’d like to thank everyone for joining the call today. Fortinet will be attending investor conferences hosted by KeyBanc, Citibank, Evercore, Stifel and Goldman Sachs during the third quarter. Fireside chats will be available through our IR website. Please let me know if you have any follow-up questions, feel free to contact me and have a great rest of your day. Thank you very much.
Thank you for your participation in today’s conference. This does conclude the program. You may now disconnect.
Software company Fortinet lowered its forecast for fiscal-year service revenue and the stock dropped sharply early Thursday.
Fortinet (ticker: FTNT) said it expects adjusted earnings for the fiscal year of $1.01 to $1.06 a share, vs. analysts’ estimates of $1.03. Revenue was predicted at $4.35 billion to $4.4 billion, vs. estimates of $4.39 billion. But the company lowered its forecast for service revenue to $2.62 billion to $2.67 billion, down from previous expectations of $2.64billion to $2.7 billion.
The stock fell 7.8% in premarket trading to $58. Coming into Thursday, the shares have declined 12.5% this year.
Fortinet reported second-quarter adjusted earnings late Wednesday of 24 cents a share, higher than 19 cents a share a year earlier and above Wall Street forecasts of 22 cents. Revenue rose 29% to $1.03 billion.
Analyst Dan Bergstrom at RBC Capital Markets said Fortinet’s forecast “remains mindful of the macro and set-up into year-end.” Bergstrom rates the stock at Sector Perform, with a price target of $69.
Bergstrom noted that the largest change in Fortinet’s service revenue guidance was the “removal of service revenue from Russia that is already sitting in deferred revenue” and wasn’t previously removed from guidance when the company stopped doing business in Russia in early March.
“Beyond this, there remains some impact from linearity with customers receiving product later in the quarter and some deferral around turning service contracts on,” the analyst added.
Citi analysts reiterated their Buy rating on the stock and price target of $78. The analysts said in a note that “still robust backlog growth expectations, steady aging, and stable (low) cancellation rates herein give us confidence growth + profitability execution momentum remains solid.”
Write to Joe Woelfel at email@example.com
Second Quarter 2022 Highlights
SUNNYVALE, Calif., Aug. 03, 2022 (GLOBE NEWSWIRE) -- Fortinet® (Nasdaq: FTNT), a global leader in broad, integrated and automated cybersecurity solutions, today announced financial results for the second quarter ended June 30, 2022.
“We delivered strong revenue and billings growth in the second quarter driven by an over 50% year-over-year increase in the number of transactions larger than one million dollars. Large enterprise companies continue to favor Fortinet’s industry leading cost for performance advantage and integrated platform strategy,” said Ken Xie, Founder, Chairman, and Chief Executive Officer. “Fortinet’s market share gains are being driven by the convergence of networking and security and an accelerating focus on vendor consolidation with our Core Platform and Platform Extension solutions designed to secure our customers’ entire infrastructure from the data center to the cloud.”
Financial Highlights for the Second Quarter of 2022
For the third quarter of 2022, Fortinet currently expects:
For the fiscal year 2022, Fortinet currently expects:
These statements are forward looking and actual results may differ materially. Refer to the Forward-Looking Statements section below for information on the factors that could cause our actual results to differ materially from these forward-looking statements.
Our guidance with respect to non-GAAP financial measures excludes stock-based compensation, amortization of acquired intangible assets and gain on intellectual property matters. We have not reconciled our guidance with respect to non-GAAP financial measures to the corresponding GAAP measures because certain items that impact these measures are uncertain or out of our control, or cannot be reasonably predicted. Accordingly, a reconciliation of these non-GAAP financial measures to the corresponding GAAP measures is not available without unreasonable effort.
1 Bookings represents the total value of all orders received during the period. Backlog represents orders received but not fulfilled and excludes Alaxala Networks Corporation. When an order is fulfilled, billings and revenue are recognized.
2 A reconciliation of GAAP to non-GAAP measures has been provided in the financial statement tables included in this press release. An explanation of these measures is also included below under the heading “Non-GAAP Financial Measures”.
3 All share and per share amounts presented herein have been retroactively adjusted to reflect the five-for-one forward stock split which was effective June 22, 2022.
Conference Call Details
Fortinet will host a conference call today at 1:30 p.m. Pacific Time (4:30 p.m. Eastern Time) to discuss the earnings results. A live webcast of the conference call and supplemental slides will be accessible from the Investor Relations page of Fortinet’s website at https://investor.fortinet.com and a replay will be archived and accessible at https://investor.fortinet.com/events-and-presentations.
Third Quarter 2022 Conference Participation Schedule:
Members of Fortinet’s management team are expected to present at these conferences and discuss the latest company strategies and initiatives. Fortinet’s conference presentations are expected to be available via webcast on the company’s web site. To access the most updated information, pre-register and listen to the webcast of each event, please visit the Investor Presentation & Events page of Fortinet’s website at https://investor.fortinet.com/events-and-presentations. The schedule is subject to change.
About Fortinet ( www.fortinet.com )
Fortinet (NASDAQ: FTNT) makes possible a digital world that we can trust through its mission to protect people, devices and data everywhere. This is why many of the world’s largest enterprises, service providers and government organizations choose Fortinet to securely accelerate their digital journey. The Fortinet Core Platform and Platform Extension products deliver broad, integrated and automated protections across the entire digital attack surface, securing critical devices, data, applications, and connections from the data center to the cloud to the home office. The Fortinet NSE Training Institute, an initiative of Fortinet’s Training Advancement Agenda, provides one of the largest and broadest training programs in the industry to make cyber training and new career opportunities available to everyone. Learn more at https://www.fortinet.com, the Fortinet Blog or FortiGuard Labs.
Copyright © 2022 Fortinet, Inc. All rights reserved. The symbols ® and ™ denote respectively federally registered trademarks and common law trademarks of Fortinet, Inc., its subsidiaries and affiliates. Fortinet’s trademarks include, but are not limited to, the following: Fortinet, the Fortinet logo, FortiGate, FortiOS, FortiGuard, FortiCare, FortiAnalyzer, FortiManager, FortiASIC, FortiClient, FortiCloud, FortiMail, FortiSandbox, FortiADC, FortiAI, FortiAIOps, FortiAntenna, FortiAP, FortiAPCam, FortiAuthenticator, FortiCache, FortiCall, FortiCam, FortiCamera, FortiCarrier, FortiCASB, FortiCentral, FortiConnect, FortiController, FortiConverter, FortiCWP, FortiDB, FortiDDoS, FortiDeceptor, FortiDeploy, FortiDevSec, FortiEdge, FortiEDR, FortiExplorer, FortiExtender, FortiFirewall, FortiFone, FortiGSLB, FortiHypervisor, FortiInsight, FortiIsolator, FortiLAN, FortiLink, FortiMoM, FortiMonitor, FortiNAC, FortiNDR, FortiPenTest, FortiPhish, FortiPlanner, FortiPolicy, FortiPortal, FortiPresence, FortiProxy, FortiRecon, FortiRecorder, FortiSASE, FortiSDNConnector, FortiSIEM, FortiSMS, FortiSOAR, FortiSwitch, FortiTester, FortiToken, FortiTrust, FortiVoice, FortiWAN, FortiWeb, FortiWiFi, FortiWLC, FortiWLM and FortiXDR. Other trademarks belong to their respective owners. Fortinet has not independently Verified statements or certifications herein attributed to third parties and Fortinet does not independently endorse such statements. Notwithstanding anything to the contrary herein, nothing herein constitutes a warranty, guarantee, contract, binding specification or other binding commitment by Fortinet or any indication of intent related to a binding commitment, and performance and other specification information herein may be unique to certain environments.
This press release contains forward-looking statements that involve risks and uncertainties. These forward-looking statements include statements regarding any indications related to future market share gains, guidance and expectations around future financial results, including guidance and expectations for the third quarter and full year 2022, statements regarding the momentum in our business and future growth expectations, and any statements regarding our market opportunity and market size, and business momentum. Although we attempt to be accurate in making forward-looking statements, it is possible that future circumstances might differ from the assumptions on which such statements are based such that actual results are materially different from our forward-looking statements in this release. Important factors that could cause results to differ materially from the statements herein include the following: general economic risks, including those caused by the COVID-19 pandemic, the war in Ukraine, economic challenges, fears of a recession, and any actual recession, and the effects of increased inflation in certain geographies; significantly heightened supply chain challenges due to the current global environment; negative impacts from the COVID-19 pandemic on sales, billings, revenue, demand and buying patterns, component supply and ability to manufacture products to meet demand in a timely fashion, and costs such as possible increased costs for shipping and components; global economic conditions, country-specific economic conditions, and foreign currency risks; competitiveness in the security market; the dynamic nature of the security market and its products and services; specific economic risks worldwide and in different geographies, and among different customer segments; uncertainty regarding demand and increased business and renewals from existing customers; uncertainties around continued success in sales growth and market share gains; uncertainties in market opportunities and the market size; actual or perceived vulnerabilities in our supply chain, products or services, and any actual or perceived breach of our network or our customers’ networks; longer sales cycles, particularly for larger enterprise, service providers, government and other large organization customers; the effectiveness of our salesforce and failure to convert sales pipeline into final sales; risks associated with successful implementation of multiple integrated software products and other product functionality risks; risks associated with integrating acquisitions and changes in circumstances and plans associated therewith, including, among other risks, changes in plans related to product and services integrations, product and services plans and sales strategies; sales and marketing execution risks; execution risks around new product development and introductions and innovation; litigation and disputes and the potential cost, distraction and damage to sales and reputation caused thereby or by other factors; cybersecurity threats, breaches and other disruptions; market acceptance of new products and services; the ability to attract and retain personnel; changes in strategy; risks associated with management of growth; lengthy sales and implementation cycles, particularly in larger organizations; technological changes that make our products and services less competitive; risks associated with the adoption of, and demand for, our products and services in general and by specific customer segments, including those caused by the COVID-19 pandemic; competition and pricing pressure; product inventory shortages for any reason, including those caused by the COVID-19 pandemic, the war in Ukraine and the effects of increased inflation in certain geographies; risks associated with business disruption caused by natural disasters and health emergencies such as earthquakes, fires, power outages, typhoons, floods, health epidemics and viruses such as the COVID-19 pandemic, and by manmade events such as civil unrest, labor disruption, international trade disputes, international conflicts such as the war in Ukraine, terrorism, wars, and critical infrastructure attacks; tariffs, trade disputes and other trade barriers, and negative impact on sales based on geo-political dynamics and disputes and protectionist policies; any political and government disruption around the world, including the impact of any future shutdowns of the U.S. government; and the other risk factors set forth from time to time in our most recent Annual Report on Form 10-K, our most recent Quarterly Report on Form 10-Q and our other filings with the Securities and Exchange Commission (SEC), copies of which are available free of charge at the SEC’s website at www.sec.gov or upon request from our investor relations department. All forward-looking statements herein reflect our opinions only as of the date of this release, and we undertake no obligation, and expressly disclaim any obligation, to update forward-looking statements herein in light of new information or future events.
While the broader implications of the COVID-19 pandemic on our employees and overall financial performance remain uncertain, we have seen certain impacts on our business and operations, results of operations, financial condition, cash flows, liquidity and capital and financial resources. Going forward, the situation is uncertain, rapidly changing and hard to predict, and the COVID-19 pandemic may have a material negative impact on our future periods, including our results for the three months ending September 30, 2022, our annual results for 2022, and beyond. To highlight the uncertainty remaining for the three-month period ending September 30, 2022, it should be noted that, due to customer buying patterns and the efforts of our sales force and channel partners to meet or exceed quarterly quotas, we have historically received a substantial portion of each quarter’s sales orders and generated a substantial portion of each quarter’s billings and revenue during the last two weeks of the quarter. Additionally, significantly heightened supply chain challenges are impacting businesses around the globe. If we experience significant changes in our billings growth rates or if we are unable to supply product to meet demand, it will impact product revenue in the current quarter and FortiGuard and FortiCare service revenues in subsequent quarters, as we sell annual and multi-year service contracts that are recognized ratably over the contractual service term. In addition, the broader implications of the pandemic on our business and operations and our financial results, including the extent to which the effects of the pandemic will impact future results and growth in the cybersecurity industry, remain uncertain. The duration and severity of the economic downturn from the pandemic may negatively impact our business and operations, results of operations, financial condition, cash flows, liquidity and capital and financial resources in a material way. As a result, the effects of the pandemic may not be fully reflected in our results of operations until future periods.
Non-GAAP Financial Measures
We have provided in this release financial information that has not been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP). These non-GAAP financial and liquidity measures are not based on any standardized methodology prescribed by GAAP and are not necessarily comparable to similar measures presented by other companies. We use these non-GAAP financial measures internally in analyzing our financial results and believe they are useful to investors, as a supplement to GAAP measures, in evaluating our ongoing operational performance. We believe that the use of these non-GAAP financial measures provides an additional tool for investors to use in evaluating ongoing operating results and trends and in comparing our financial results with peer companies, many of which present similar non-GAAP financial measures to investors.
Non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measures provided in the financial statement tables below.
Billings (non-GAAP). We define billings as revenue recognized in accordance with GAAP plus the change in deferred revenue from the beginning to the end of the period, less any deferred revenue balances acquired from business combination(s) and adjustment due to adoption of new accounting standard during the period. We consider billings to be a useful metric for management and investors because billings drive current and future revenue, which is an important indicator of the health and viability of our business. There are a number of limitations related to the use of billings instead of GAAP revenue. First, billings include amounts that have not yet been recognized as revenue and are impacted by the term of security and support agreements. Second, we may calculate billings in a manner that is different from peer companies that report similar financial measures. Management accounts for these limitations by providing specific information regarding GAAP revenue and evaluating billings together with GAAP revenue.
Free cash flow (non-GAAP). We define free cash flow as net cash provided by operating activities minus purchases of property and equipment and excluding any significant non-recurring items, such as proceeds from intellectual property matter. We believe free cash flow to be a liquidity measure that provides useful information to management and investors about the amount of cash generated by the business that, after capital expenditures and net of proceeds from intellectual property matter, can be used for strategic opportunities, including repurchasing outstanding common stock, investing in our business, making strategic acquisitions and strengthening the balance sheet. A limitation of using free cash flow rather than the GAAP measures of cash provided by or used in operating activities, investing activities, and financing activities is that free cash flow does not represent the total increase or decrease in the cash and cash equivalents balance for the period because it excludes cash flows from significant non-recurring items, such as proceeds from intellectual property matter, investing activities other than capital expenditures and cash flows from financing activities. Management accounts for this limitation by providing information about our capital expenditures and other investing and financing activities on the face of the cash flow statement and under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” in our most recent Quarterly Report on Form 10-Q and Annual Report on Form 10-K and by presenting cash flows from investing and financing activities in our reconciliation of free cash flow. In addition, it is important to note that other companies, including companies in our industry, may not use free cash flow, may calculate free cash flow in a different manner than we do or may use other financial measures to evaluate their performance, all of which could reduce the usefulness of free cash flow as a comparative measure.
Non-GAAP operating income and operating margin. We define non-GAAP operating income as operating income plus stock-based compensation, impairment and amortization of acquired intangible assets, less gain on intellectual property matter and, when applicable, other significant non-recurring items in a given quarter, such as non-recurring gains or losses on litigation-related matters. Non-GAAP operating margin is defined as non-GAAP operating income divided by GAAP revenue. We consider these non-GAAP financial measures to be useful metrics for management and investors because they exclude the items noted above so that our management and investors can compare our recurring core business operating results over multiple periods. There are a number of limitations related to the use of non-GAAP operating income instead of operating income calculated in accordance with GAAP. First, non-GAAP operating income excludes the items noted above. Second, the components of the costs that we exclude from our calculation of non-GAAP operating income may differ from the components that peer companies exclude when they report their non-GAAP results of operations. Management accounts for these limitations by providing specific information regarding the GAAP amounts excluded from non-GAAP operating income and evaluating non-GAAP operating income together with operating income calculated in accordance with GAAP.
Non-GAAP net income and diluted net income per share attributable to Fortinet, Inc. We define non-GAAP net income as net income or loss plus the items noted above under non-GAAP operating income and operating margin. In addition, we adjust non-GAAP net income and diluted net income per share for gains or losses on investments in privately held companies, a tax adjustment required for an effective tax rate on a non-GAAP basis and adjustments attributable to non-controlling interests, which differs from the GAAP effective tax rate. We define non-GAAP diluted net income per share as non-GAAP net income divided by the non-GAAP diluted weighted-average shares outstanding. We consider these non-GAAP financial measures to be useful metrics for management and investors for the same reasons that we use non-GAAP operating income and non-GAAP operating margin. However, in order to provide a more complete picture of our recurring core business operating results, we include in non-GAAP net income and non-GAAP diluted net income per share, the tax adjustment required resulting in an effective tax rate on a non-GAAP basis, which often differs from the GAAP tax rate. We believe the non-GAAP effective tax rates we use are reasonable estimates of normalized tax rates for our current and prior fiscal years under our global operating structure. The same limitations described above regarding our use of non-GAAP operating income and non-GAAP operating margin apply to our use of non-GAAP net income and non-GAAP diluted net income per share. We account for these limitations by providing specific information regarding the GAAP amounts excluded from non-GAAP net income and non-GAAP diluted net income per share and evaluating non-GAAP net income and non-GAAP diluted net income per share together with net income or loss and diluted net income per share calculated in accordance with GAAP.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in millions)
|Cash and cash equivalents||$||710.0||$||1,319.1|
|Marketable equity securities||24.3||38.6|
|Prepaid expenses and other current assets||83.3||65.4|
|Total current assets||2,952.9||3,600.6|
|PROPERTY AND EQUIPMENT—NET||814.6||687.6|
|DEFERRED CONTRACT COSTS||456.9||423.3|
|DEFERRED TAX ASSETS||480.2||342.3|
|GOODWILL AND OTHER INTANGIBLE ASSETS—NET||166.7||188.7|
|LIABILITIES AND EQUITY (DEFICIT)|
|Accrued payroll and compensation||187.4||195.0|
|Total current liabilities||2,634.9||2,318.1|
|INCOME TAX LIABILITIES||67.1||79.5|
|COMMITMENTS AND CONTINGENCIES|
|Additional paid-in capital||1,237.3||1,253.6|
|Accumulated other comprehensive loss||(23.4||)||(4.8||)|
|Total Fortinet, Inc. stockholders’ equity (deficit)||(392.9||)||781.7|
|Total equity (deficit)||(379.6||)||798.4|
|TOTAL LIABILITIES AND EQUITY (DEFICIT)||$||5,294.5||$||5,919.1|
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited, in millions, except per share amounts)
|Three Months Ended||Six Months Ended|
|COST OF REVENUE:|
|Total cost of revenue||250.8||186.9||504.6||343.5|
|Total gross profit||779.3||614.2||1,480.3||1,167.9|
|Research and development||124.3||106.6||249.2||203.8|
|Sales and marketing||415.5||326.9||803.1||630.9|
|General and administrative||45.4||34.4||84.0||66.4|
|Gain on intellectual property matter||(1.2||)||(1.2||)||(2.3||)||(2.3||)|
|Total operating expenses||584.0||466.7||1,134.0||898.8|
|OTHER INCOME (EXPENSE)—NET||(9.3||)||0.8||(18.4||)||(1.2||)|
|INCOME BEFORE INCOME TAXES AND LOSS FROM EQUITY METHOD INVESTMENT||183.9||145.0||322.6||264.4|
|PROVISION FOR (BENEFIT FROM) INCOME TAXES||2.4||7.5||(5.7||)||19.7|
|LOSS FROM EQUITY METHOD INVESTMENT||(8.1||)||—||(16.6||)||—|
|NET INCOME INCLUDING NON-CONTROLLING INTERESTS||173.4||137.5||311.7||244.7|
|Less: NET LOSS ATTRIBUTABLE TO NON-CONTROLLING INTERESTS, NET OF TAX||(0.1||)||—||(0.2||)||—|
|NET INCOME ATTRIBUTABLE TO FORTINET, INC.||$||173.5||$||137.5||$||311.9||$||244.7|
|Net income per share attributable to Fortinet, Inc.(a):|
|Weighted-average shares used to compute net income per share attributable to Fortinet, Inc.(a):|
(a) All share and per share amounts presented herein have been retroactively adjusted to reflect the five-for-one forward stock split which was effective June 22, 2022.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in millions)
|Six Months Ended|
|CASH FLOWS FROM OPERATING ACTIVITIES:|
|Net income including non-controlling interests||$||311.7||$||244.7|
|Adjustments to reconcile net income to net cash provided by operating activities:|
|Amortization of deferred contract costs||107.1||81.8|
|Depreciation and amortization||50.6||36.2|
|Amortization of investment premiums||2.8||2.9|
|Loss from equity method investment||16.6||—|
|Changes in operating assets and liabilities, net of impact of business combinations:|
|Prepaid expenses and other current assets||(18.2||)||(16.4||)|
|Deferred contract costs||(140.6||)||(124.8||)|
|Deferred tax assets||(136.3||)||(25.8||)|
|Accrued payroll and compensation||(6.8||)||18.7|
|Net cash provided by operating activities||719.5||734.1|
|CASH FLOWS FROM INVESTING ACTIVITIES:|
|Purchases of investments||(389.1||)||(1,262.5||)|
|Sales of investments||3.0||71.4|
|Maturities of investments||797.3||600.3|
|Purchases of property and equipment||(162.5||)||(75.6||)|
|Purchases of investment in privately held company||—||(75.0||)|
|Payments made in connection with business combinations, net of cash acquired||—||(10.3||)|
|Net cash provided by (used in) investing activities||248.7||(751.7||)|
|CASH FLOWS FROM FINANCING ACTIVITIES:|
|Proceeds from long-term borrowings, net of discount and underwriting fees||—||989.4|
|Payments for debt issuance costs||—||(2.4||)|
|Repurchase and retirement of common stock||(1,491.2||)||(91.6||)|
|Proceeds from issuance of common stock||15.9||15.8|
|Taxes paid related to net share settlement of equity awards||(99.9||)||(76.0||)|
|Net cash provided by (used in) financing activities||(1,576.3||)||835.1|
|EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS||(1.0||)||—|
|NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS||(609.1||)||817.5|
|CASH AND CASH EQUIVALENTS—Beginning of period||1,319.1||1,061.8|
|CASH AND CASH EQUIVALENTS—End of period||$||710.0||$||1,879.3|
Reconciliations of non-GAAP results of operations measures to the nearest comparable GAAP measures
(Unaudited, in millions, except per share amounts)
Reconciliation of net cash provided by operating activities to free cash flow
|Three Months Ended|
|Net cash provided by operating activities||$||323.4||$||418.2|
|Less: Purchases of property and equipment||(39.9||)||(23.5||)|
|Free cash flow||$||283.5||$||394.7|
|Net cash provided by (used in) investing activities||$||294.1||$||(278.2||)|
|Net cash used in financing activities||$||(830.3||)||$||(120.9||)|
Reconciliation of GAAP operating income to non-GAAP operating income, operating margin, net income attributable to Fortinet, Inc. and diluted net income per share attributable to Fortinet, Inc.
|Three Months Ended June 30, 2022||Three Months Ended June 30, 2021|
|GAAP Results||Adjustments||Non-GAAP Results||GAAP Results||Adjustments||Non-GAAP Results|
|Amortization of acquired intangible assets||6.0||3.5|
|Gain on intellectual property matter||(1.2||)||(1.2||)|
|Adjustments attributable non-controlling interests||(0.4||)||(d)||—|
|Net income attributable to Fortinet, Inc.||$||173.5||$||20.6||$||194.1||$||137.5||$||21.2||$||158.7|
|Diluted net income per share attributable to Fortinet, Inc.(e)||$||0.21||$||0.24||$||0.16||$||0.19|
|Shares used in diluted net income per share attributable to Fortinet, Inc. calculations(e)||810.1||810.1||835.4||835.4|
(a) To exclude $55.3 million of stock-based compensation and $6.0 million of amortization of acquired intangible assets, offset by a $1.2 million gain on intellectual property matter in the three months ended June 30, 2022.
(b) To exclude $53.5 million of stock-based compensation and $3.5 million of amortization of acquired intangible assets, offset by a $1.2 million gain on intellectual property matter in the three months ended June 30, 2021.
(c) Non-GAAP financial information is adjusted to an effective tax rate of 17% and 21% in the three months ended June 30, 2022 and 2021, respectively, on a non-GAAP basis, which differs from the GAAP effective tax rate.
(d) Adjustments related to the non-GAAP results attributable to non-controlling interests, which were adjusted to an effective tax rate of 31% for the subsidiary of Alaxala Networks Corporation in the three months ended June 30, 2022.
(e) All share and per share amounts presented herein have been retroactively adjusted to reflect the five-for-one forward stock split which was effective June 22, 2022.
Reconciliation of total revenue to total billings
|Three Months Ended|
|Add: Change in deferred revenue||274.1||159.8|
|Investor Contact:||Media Contact:|
|Peter Salkowski||Sandra Wheatley|
|Fortinet, Inc.||Fortinet, Inc.|
Comcast Business announced a strategic partnership with Fortinet, a global leader in broad, integrated and automated cybersecurity solutions, to deliver enterprises a new set of secure access service edge (SASE), and security service edge (SSE) solutions to help enterprises protect their distributed workforces using a cloud-delivered approach to security policy enforcement.
This collaboration expands Comcast Business’s managed services expertise, while giving enterprises greater flexibility to choose the cloud architecture and vendor mix that is right for them.
In today’s work-from-anywhere world, IT leaders are challenged with balancing employee convenience with securing their networks. New security architectures, such as SASE, which converges networking and security via SD-WAN and cloud-delivered security, and SSE, the security foundation of SASE, enable enterprises to strengthen their security posture while enhancing employees’ experience, regardless of their location. In fact, according to a recent Foundry CIO research study sponsored by Masergy (a Comcast Business company) and Fortinet, the overwhelming majority (98%) of enterprise IT leaders surveyed cited the convergence of network and security as critical or very important, while 94% said their adoption of SASE solutions has accelerated.
The new Comcast Business offerings — delivered through Comcast Business Secure Gateways —
give enterprises the option to choose from either SASE or SSE solutions backed by Fortinet’s security-driven networking technology and Equinix’s flexible cloud connection Equinix FabricÔ for a complete secure network service. Enterprises wanting to enable safe access to cloud and web services can take advantage of the Comcast Business SSE solution, which brings together multiple cloud-delivered network security technologies in a fully-hosted environment. The Comcast Business SASE solution provides this hosted SSE security architecture combined with zero trust capabilities and any of Comcast Business’s SD-WAN solutions.
Comcast Business Secure Gateways provide a fully-hosted set of SASE or SSE services covering a broad range of security networking solutions for Firewall-as-a-Service (FWaaS), Intrusion Prevention (IPS), Data Loss Prevention (DLP), Cloud Access Security Brokers (CASB), and Zero Trust Network Access (ZTNA). Comcast Business Secure Gateways are hosted across the United States at Equinix data centers, offering up to 10 gigabits per second (Gbps) of cloud connectivity for public, private, or hybrid cloud deployments. The Equinix FabricÔ enables support of Amazon Web Services, Microsoft Azure, Google Cloud, IBM and more than 200 SaaS providers.
Amit Verma, Chief Technology Officer, Enterprise Solutions, Comcast Business
By expanding our relationship with Fortinet, we are offering our clients more choice and the flexibility to choose a solution that works for them – while providing some of the latest security solutions to help keep them ready for the day – today and tomorrow.
John Maddison, EVP of products and CMO, Fortinet
In order to enhance user experience, reduce complexity, and Excellerate their security posture against today’s most advanced and persistent threats, organizations must adopt solutions that converge networking and security. We’re pleased to work closely with Comcast Business to build SASE services that support customers at any stage of digital innovation with Fortinet’s industry leading security-driven networking technology.
UNION CITY — Fortinet has widened its shopping spree for Union City properties that could provide the foundation of a future expansion zone in the East Bay for the tech company.
Sunnyvale-based Fortinet, in the most recent deal, bought a site that at present is occupied by a Coca Cola bottling plant, documents filed on July 19 with the Alameda County Recorder’s Office show.
The cybersecurity tech company paid $65 million for the building, which is located at 1551 Atlantic St.
Fortinet began collecting properties in Union City in 2016. Over the last six years, Fortinet has completed several property purchases in the East Bay municipality, this news organization’s review of the Alameda County public documents shows.
The company also has been assembling older industrial and commercial sites in the vicinity of its headquarters in Sunnyvale, according to Santa Clara County property records.
All told, Fortinet has spent at least $290.9 million assembling properties in Sunnyvale and Union City.
With the most recent purchase of the Coca-Cola site, Fortinet has spent at least $166.9 million acquiring properties in Union City.
The Union City property deals now exceed the total amount that Fortinet has spent purchasing sites in Sunnyvale.
Fortinet has paid at least $124 million buying up sites in Sunnyvale, a review by this news organization of Santa Clara County property records shows.
Fortinet also has built a modern new corporate headquarters in Sunnyvale.In Union City, at least three large properties, including the most recent purchase of the beverage bottling plant site on Atlantic Street, are adjacent to each other. Included in the trio of sites is a Macy’s Furniture Outlet on Whipple Road, which Fortinet bought in March for $65.7 million.
That means the sites could in theory be combined into a single large campus. The other purchases by Fortinet are also in the immediate vicinity, but not all are directly connected — at present.
SUNNYVALE, Calif. (AP) _ Fortinet Inc. (FTNT) on Wednesday reported second-quarter profit of $173.5 million.
On a per-share basis, the Sunnyvale, California-based company said it had net income of 21 cents. Earnings, adjusted for one-time gains and costs, came to 24 cents per share.