NVIDIA Q1 2022 Earnings Call Transcript

Quartr
Provided by Quartr
May 4, 2022

There are 13 speakers on the call.

Operator

Good day and thank you for standing by. Welcome to the Fortinet First Quarter 2022 Earnings Call. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Peter Zalkowski, Vice President of Investor Relations.

Operator

Please go ahead, sir.

Speaker 1

Thank you, Laurie. Good afternoon, everyone. I'm pleased Welcome everyone to our call to discuss Fortinet's financial results for the Q1 of 2022. Speakers on today's call Kenzie, Fortinet's Founder, Chairman and CEO and Keith Jensen, our Chief Financial Officer. This is a live call that will be available for webcast via will be available for replay via webcast on the Investor Relations website.

Speaker 1

Ken will begin our call today by providing a high level perspective on our business. Keith will then follow or then review our financial and operating results for the Q1 before providing guidance for the Q2 and updating the full year. We will then open the call for questions. 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 Form 10 ks and Form 10 Q for more information.

Speaker 1

All forward looking statements reflect our opinions only as of the date of this presentation, and we undertake no obligation and specifically disclaim any obligation to update forward looking statements. Also, all references to financial metrics that we make on today's call Our non GAAP unless stated otherwise. Our GAAP results and the GAAP to non GAAP reconciliations is located in our earnings press release and in the presentation that accompanies 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 Relations website immediately following today's call. Lastly, all references to growth are on a year over year basis unless noted otherwise.

Speaker 1

I will now turn the call over to Ken.

Speaker 2

Thanks, Peter, and thank you to everyone for joining today's call to review our outstanding Q1 2022 results. Our better than expected first quarter results demonstrate the strong demand of our cybersecurity innovation. Total revenue growth of 34% driven by rank and product revenue growth of 54%. Total billings increased 36%. Our strong results reflect new order that was significantly greater than anticipated, partially offset by an increase in backlog.

Speaker 2

As a result, bookings increased 50% year over year to 1,276,000,000 which included book in growth from SD WAN of 54%, Global 2000 Growth of 61%, OT Growth of 76%. For the quarter, net new backlog was 9% of bookings as we continue to navigate a challenging supply chain environment. We believe that the hybrid network are here for foreseeable future and Fortinet is pushing the boundary of what is possible with innovation To enable customer to successfully operate in today's elevated threat environment, our solid performance And the market share gains are being driven by our effort to make our customers' entire infrastructure more secure and integrate Yes, Zero Trust Network. Fortinet's secure streaming network approach converge networking functionality with security capability Fueled by our powerful Forti ASIC SPU to provide the best performance and rich functionality, The new FortiOS 7.2 offers multiple new and enhanced service across FortiGuard, FortiCare and FortiTrust such as ZTNA, Identity, Inland Sandboxing, Advanced Device Protection for OT and IoT Environment, IsoCS Service and Inland CASB. IsoCS provides 1 of the broadest security service offering on an average of half the cost compared to our main competitors.

Speaker 2

In addition, we have prioritized our most organic Research and development efforts are immigrating security product into our centralized FortiOS fabric platform, which Garner referred to as Cybersecurity Mesh Architecture. Today, we announced a new thread of FortiGate powered by our Forti ASIC SPU, The FortiGate 3700F, 600F and 70F deliver high performance converged networking and security The security computed region of 5 times on average better performance than competitive offerings. During the quarter, We are pleased to receive the Gartner Peer Insight Customer Choice Award for both 1H infrastructure and Next Generation Firewall for 3 years in a row. Our innovation position Fortinet as one of the most influential cybersecurity leaders. These growth drivers and organic innovation is accelerating our growth potential to new level.

Speaker 2

Before turning the call over to Keith, I would like to thank our employees, customers, partners and suppliers worldwide for their continued support and hard work.

Speaker 3

Thank you, Ken, and good afternoon, everyone. Before adding to Ken's comments and going into more detail on our Q1 financial results, I'd like to briefly discuss a wording change in how we describe our business. FortiGate is now referred to as the core platform And non FortiGate is now referred to as the platform extension. This change helps to emphasize the importance of our FortiOS operating system. FortiOS drives our entire security platform across multiple platform extension use cases, including 0 Trust Access, cloud security, security operations and secured networking.

Speaker 3

With that in mind, let's start the more detailed Q1 discussion. Customer demand was again strong and broad based across geographies, customer sizes, industries, use cases and security solutions, reflecting 3 key demand drivers: the elevated threat environment, convergence of security and networking and customers consolidating across our platform offerings. These key growth drivers are contributing to our strong results and accelerating pipeline growth. In short, we believe we're in a period of sustained high growth for the cybersecurity industry and Fortinet. Moving to the Q1 financial results, total revenue of $955,000,000 was up 34%, driven by record product revenue growth of 54%.

Speaker 3

Taking into account an $80,000,000 sequential increase in product backlog, Product bookings growth was 87%. Product revenue growth was broad based with core platform and platform extension product revenue growth at 50% 59%, respectively. While we continue to see robust product growth From our SD WAN and Operational Technology or OT, the core platform product revenue growth was mainly driven by the wide range of other use cases embedded in our operating system. Service revenue was up 24% to 584,000,000 Support and related services was up 26 percent to $271,000,000 while security subscription services revenue was up 23% to $313,000,000 To offer one observation about how customers may be responding to the supply chain challenges, We are seeing indications that a subset of customers placed product orders further in advance and may have delayed purchases or registrations of the related service contracts. This, together with the timing differences related to product and service revenue recognition, creates a lag between product and service revenue growth rates.

Speaker 3

We expect quarterly service revenue growth to accelerate throughout the rest of the year. As summarized on slide 6, Total revenue in the Americas increased 32%. EMEA revenue increased 25%. And APAC posted revenue growth of 57%, which includes the contribution from Alexia. EMEA's growth includes the impact of suspending operations in Russia.

Speaker 3

Nonetheless, EMEA easily exceeded their internal targets. Looking forward, EMEA's pipeline growth indicates continued strength in our EMEA business. Despite the situation in Eastern Europe and its potential impact on European Economies, Platform Extension revenue grew 49% in account for 34% of total revenue, up 3 percentage points. Moving to bookings, backlog and billings. We are experiencing exceptionally strong demand, demand that continues to exceed supply by more than historical norms.

Speaker 3

Bookings were up 50 percent to $1,300,000,000 reflecting exceptional demand and a $116,000,000 quarter over quarter increase In total backlog, bringing backlog to $278,000,000 Larger enterprises continue to favor Fortinet's industry leading cost performance advantage and are increasingly more appreciative of our integrated platform strategy. The platform strategy allows The following key metrics illustrate growing demand from enterprise customers. Global 2000 bookings were up over 60%. Large enterprise bookings were up over 65%. Secure SD WAN bookings grew 54%, reflecting the convergence of networking and security as well as a strong economic case.

Speaker 3

OT bookings were up 76%, Illustrating the continued response to the elevated threat environment. As a reminder, backlog is excluded from the current quarter billings and revenue. However, it is expected to provide increased visibility and a top line tailwind in future quarters. At $1,200,000,000 billings were up 36%. Core platform billings were up 30% and accounted for 67% of total billings.

Speaker 3

As shown on slide 7, high end FortiGate's posted very strong billings growth with a mix shifting 6 points towards high end appliances. Platform extension billings were up 50% and accounted for 33% of total billings, Up 3 percentage points. Average contract term was consistent year over year and down 1 month sequentially at 27 months. Moving back to the income statement. Total gross margin was 74.4% as the revenue mix tilted 5 percentage points to product revenue from higher margin services.

Speaker 3

Product gross margin of 57.4% reflects the impact of component and freight cost increases as well as higher less predictable component expedite fee expenses and the impact of consolidating Alexa's results. Service gross margin of 85.2% was impacted by Alexa, costs associated with the expansion of our data center footprint and increased labor costs. Operating margin of 22% exceeded the midpoint of our guidance range by 200 basis points due to increased sales productivity and efficiencies in other OpEx areas offsetting the gross margin decline. Headcount increased 26% to $10,860 Moving to the statement of cash flow summarized on slides 89. Free cash flow was $273,000,000 representing a margin of 29%.

Speaker 3

Capital expenditures for the quarter were $123,000,000 including $93,000,000 for real estate investments. Adjusted for real estate purchases, our free cash flow margin was 38%. Our capital expenditure strategy includes investing in cloud and data center infrastructure as well as our office and warehouse capacity to support our higher levels of growth. We repurchased approximately 2,300,000 shares of our common stock for a cost of 691,000,000 At the end of the quarter, the remaining share repurchase authorization was approximately $830,000,000 with the authorization set to expire in February 2023. Inventory turns at 3.5 times were up nearly 1.5 times year over year.

Speaker 3

Now let's spend some time reviewing backlog in a bit more detail. As I mentioned earlier, very strong demand drove a $116,000,000 increase Total backlog to $278,000,000 To put this in perspective, total backlog at the end of the Q1 was approximately 6% of our trailing 12 months total billings. We shipped 60% of the Q4 ending hardware backlog in the quarter. Consistent with prior quarters the prior quarter, 73% of the backlog relates to expected future product shipments, while the remaining 27% relates to various services. We believe our backlog is very strong and should provide a billings and revenue tailwind to growth And there are several reasons and comments we make to support our view, including existing customers Account for 93% of our backlog and no single end customer accounts for more than a low single digit percentage of backlog.

Speaker 3

There are 10 deals in backlog, 9 from existing customers, with a remaining balance of over $1,000,000 that together account for less than 10% of total backlog. Remaining balance is defined as the original order amount less the partial shipments we've made. Just 5% of Q4 backlog was canceled in Q1, suggesting that double ordering is not a significant contributor to our backlog. We do not believe that customers are meaningfully pivoting to software form factors from hardware. The software is frequently a more costly option and may require architectural redesign and investment and changes in form factors and other equipment beyond just the firewalls.

Speaker 3

We believe our competitors are similarly impacted by the supply chain. And finally, more customers are accepting the supply chain challenges and working with us to mitigate the issues by switching products, adjusting deployment schedules and accelerating evaluations of new products. Similar to others, we are experiencing ongoing supply chain challenges. Our responses to these challenges include significantly increasing inventory purchase commitments, redesigning products, Qualifying additional suppliers and working closely with our suppliers to further enhance our resiliency and mitigate the effects of disruptions. We expect supply chain constraints to be challenging throughout the remainder of the year.

Speaker 3

As a result, we expect component and logistics costs remain elevated and backlog to increase through the course of the year. 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 pressure to gross margins. While the situation is very dynamic, we believe we will have access to sufficient inventory to meet our guidance. The outlook is also subject to the disclaimers regarding forward looking information that Peter provided at the beginning of the call.

Speaker 3

For the Q2, We anticipate bookings in the range of $1,325,000,000 to 1,385,000,000 which at the midpoint represents bookings growth of 40% and we expect billings in the range of 1,225,000,000

Speaker 1

to $1,265,000,000

Speaker 3

which at the midpoint represents growth of 30 percent revenue in the range of 1,005,000,000 to $1,035,000,000 non GAAP gross margin of 74.5 percent to 76%, Non GAAP operating margin of 22% to 23.5 percent non GAAP earnings per share of $1.05 to 1 $0.10 which assumes a share count of $165,000,000 to $167,000,000 We estimate 2nd quarter capital expenditures We anticipate backlog could approach or possibly exceed $500,000,000 and expect billings in the range of 5,500,000,000 to $5,580,000,000 which at the midpoint represents growth of 32.5 percent Revenue in the range of $4,350,000,000 to $4,400,000,000 which at the midpoint represents growth of 31%. This assumes the current supply chain environment remains constrained throughout the year. Total service revenue in the range of 2,640,000,000

Speaker 2

to $2,700,000,000

Speaker 3

which represents growth of approximately 28% and applies full year product revenue growth of approximately 36%. Given our current view of component costs and other supply chain pressures, we expect non GAAP gross margin of 74% to 76%, Non GAAP operating margin of 24% to 26%. Non GAAP earnings per share of $5 to $5.15 This assumes a share count of between $166,000,000 $168,000,000 We estimate full year capital expenditures to be between $270,000,000 $300,000,000 We expect our non GAAP tax rate to be 17%. We expect cash taxes to be approximately 260,000,000 Lastly, I want to remind everyone that we'll be holding an Analyst Day on May 10th, coinciding with Accelerate 2022. A link to register for the webcast is located on the Events and Presentation page of Fortinet's Investor Relations website.

Speaker 3

And Along with Canada, I'd like to thank our partners, customers, suppliers and all members of the Fortinet team for all their hard work, execution and success. I'll now hand the call back over to Peter to begin the Q and A.

Speaker 1

Thank you, Keith. As a reminder, in the Q and A session, we ask that Please limit yourself to one question to allow others to

Speaker 2

go to the stage.

Speaker 1

You can always come back into the queue. We're going to test that theory on the first

Operator

Call. And our first question is from Fatima Balani from Citi. Your line is open. Good afternoon. Thank you for taking my questions.

Speaker 4

Keith, a question for you is on the Product revenue performance, clearly one of the more standout metrics among others in the front. You gave us a sense of the top down dynamics that are helping with respect Demand environment, the threat environment and consolidation activity as it relates to discrete products. But from a bottom up or a more micro perspective, can you talk to us about the net impact of the pricing Increases that you've realized in the quarter and if you can speak to linearity in the quarter, if there might potentially have been some acceleration or pull forward of demand that you might have seen later on

Operator

in the year? Thank you.

Speaker 3

Yes. I think the color I can offer on that is, I think linearity was again strong in the quarter. We've been, I think, seeing strong linearity For probably 4 quarters in a row now, measuring month 1 versus month 2. And we did we've talked before about the price increases. I think the And we've talked previously that after discounting, you probably get 55% or something like that.

Speaker 3

Pardon me, you get 45% afterwards. That was probably a little bit optimistic on my part to think I was going to get 45%. There was a little more discounting than maybe I anticipated through that process. And I forgot your 3rd area that you mentioned. I didn't write it down, I'm sorry.

Speaker 3

The annuity pricing, Something else.

Speaker 4

That's good enough. Thanks.

Speaker 3

Okay. Thank you.

Operator

Thank you. Thank you. And our next question is from Brian Essex from Goldman Sachs. Your line is open.

Speaker 5

Great. Thank you very much for taking the question and congrats on the results, really impressive acceleration. Maybe for Mike, one question and I'll commit to keeping to that. Would like to know where you're seeing you've got some nice traction Good, it seems. And I'd like to know how we should think about product as you go up market as well as services, the margin And maybe if you can hit on lead times as well.

Speaker 5

I've heard you've done a pretty good job of keeping Lead times much lower than your peers, is that winning new business upmarket substantially as you go to market?

Speaker 2

Definitely, the Fortinet operation team did a very, very good job. And also the model we have working with manufacturer, working with doing our own ASIC chip directly is also helping. So that's We're compared to a lot of other vendor using like 3rd party on time supply, which has more difficult to deal with the current supply chain issue. So we do see like with the price increase, sometimes like Keith mentioned, there are some more strong Request for some discount and which also we have extra discount, probably the discount more easy to go to product side and But also since we have Very strong product. We're using security computing region.

Speaker 2

So that's what for the same At the same time, same thing for the service, we do offer a very broad service similar better than competitor, But we probably only charge about average about half, especially with all the bundled auto sales. So that's where we do have the Pricing power, both on the product and the service, that's where the customer during this time to move towards our solution. And also there's a lot of new case, Which our competitor don't have in solution like whether the SD WAN, vertical to OT is another part, which also drive Quite a lot of additional growth

Speaker 3

for us. Yes. I'd probably offer a little more color to behind Ken's comments there, if I could, Brian. I think If you think about the market, let's take the networking equipment, switches and access points, I think the constraint exists all around the board, if you will. I don't know that us versus more traditional networking companies have any more availability in those products than anybody else.

Speaker 3

And when we look at our backlog, that mix seems to certainly Support that. Firewalls, I don't see a lot of customers switching over availability. I offered the comment earlier in the script, the prepared remarks that 93% of our existing backlog pardon me, of our backlog is with existing customers. So there's 7% of new logos information That number, not in a very big number. And if I look at new logos in terms of the billings and accounts that we got from the quarter, it was very, very normal in terms of the billings and the new logos, I think we're about 5,500 or so in new logos.

Speaker 3

So I don't really see that, if you will, to the concern. And then if I can pivot back to Fatima just quickly, I think your final question was about pull forward and that's just how it will come up again. But Again, I think if we were seeing that in light of these tremendous results, I don't think I'd sit here and see a pipeline with such a significant growth as what we're seeing. So I don't really know that I would Describe this as any sort of pull forward. Are there customers, large enterprises that came to us and place orders for longer period deployment schedules?

Speaker 3

Certainly, and I think some of the comments in the script cover that.

Speaker 5

Great. Thank you.

Operator

Uh-huh. Thank you. And our next question is from Saket Kalia from Barclays, your line is open.

Speaker 6

Okay, great. Hey, guys. Thanks for taking my question here. Maybe a question for both of you, Ken and Keith.

Speaker 1

I feel like we've talked

Speaker 6

a little bit about some of the redesign efforts with some of the newer appliance families recently. I was wondering if you could just talk about some of those efforts that Fortinet has done to maybe help Some of those supply chain issues and how helpful those changes could be in terms of fulfilling the demand that you're seeing.

Speaker 2

Yes. We're starting the redesign effort end of last year, based on the supply restriction also. You can see the product we announced today, the 40 gigabytes 70F and even the 600F probably would move to like redesign and some of them also leverage our Neo4 ASIC chip. That's really helping customer have a different choice if certain product has some shortage. But also in general, we have a much broader product, both in the, we call the core platform FortiGate core platform and also The platform extension, so that's the customer much better choice.

Speaker 2

So if certain products, I'm sure they can easily to the next product and but still offer a much better solution compared to other competitors. So that's where the redesign actually Helping a lot to reduce the supply chain limitation we have and also give customer more choice. So we kind of We're keeping that effort and keeping offer of our product portfolio and which we do feel during the supply chain issue maybe will last Towards the whole year this year, definitely we're helping us and helping customers.

Speaker 6

Very helpful. Thanks.

Speaker 2

Thank you.

Operator

Thank you. And our next question is from Adam Borg from Stifel. Your line is open.

Speaker 7

Great and thanks so much for taking the question. Either for Ken or Keith, I'm sorry if I missed it, but in the past few quarters Talked about increasing traction in some of your non traditional verticals. I was just curious how they perform this go around and assuming you saw continued traction there, are you thinking about making any additional investments to just better capitalize on the opportunity there? Thanks so much.

Speaker 3

Yes. Peter's got me an award limit on I apologize that I got taken out because I thought it was worthwhile comment. But in any event, yes, we got more of the same. We've been looking at about 3 or 5 point shift to that other group. The other group is everything outside the top 5.

Speaker 3

And we got that again in the current quarter. Yes, I think that if you look at in that other group, the one vertical that continues to stand out, I don't think it's surprising when you think about it, It's been manufacturing. And I think that that really speaks to the threat environment, ransomware, OT, things of that nature. Manufacturing is trying desperately to break into the top five of our verticals and getting closer and closer every quarter.

Speaker 7

Great. Thanks so much.

Operator

Thank you. And our next question is from Jonathan Ho from William Blair and Company. Your line is open.

Speaker 8

Sorry about that. I have myself on mute. Yes, this is John Wyden, working for Jonathan Ho. Thanks for taking my question.

Speaker 1

If I heard you correctly, when you

Speaker 8

mentioned use cases SD WAN and NoT, you mentioned Did you say that the other use cases contributed more to growth or just grew faster?

Speaker 2

The ACV and OP definitely grow faster than the overall company base there. And also I

Speaker 3

think the growth rates were faster, but the total contribution was greater than the other use cases that we're trying to parse there.

Speaker 2

Yes. And also the other prices are very strong also above beverages.

Speaker 8

Okay. I just want to clarify that. And I'm hoping that doesn't That's actually my question, but I'll make it easier one for my question. R and D spending going forward, what are your intentions? Do you anticipate any stepped up investment Or do you anticipate pretty much typical of what you've done in the past?

Speaker 2

Thank you. We kind of view The real estate is kind of considered some long term investment, but starting doing that like 10, 15 years ago, it end up Our rental cost probably less than half compared to competitors similar of our size. So that's where the $100,000,000 we Probably we're putting both the real estate and also the R and D, some other investment. Sorry, I misunderstand as R and D is not real estate. Yes, R and D definitely we will continue to invest in a lot of long term R and D From ASIC, which we made the investment more than 20 years, it was a Huge advantage on technology and also Eibos pretty much become the only vendor.

Speaker 2

They can lead this conversion of Security networking trend to offer of our high speed security, whether inside the company, in the WAN solution within the data center, you drive Tremendous growth and also much better we call the secure computing region and also the service With large quantity of product being deployed, we can offer the service much cheaper than competitor for same service and that's where we drive a huge value add

Speaker 3

Yes. I think from a business model viewpoint, I think we kind of like where we're at with the level of investment that we're making in R and D. We can move by a point or 2 in a given period. I mean if you peel back in a little bit and just look at the R and D team, there's certainly a significant number of engineers and percentages that are working on the ASIC and the chips and so forth. But I would also offer that we have more software engineers than we do hardware engineers.

Speaker 3

And I think the reason for that is it goes back to some of the early comments in the text About how important the operating system is to us. The ASIC enables the operating system. They have to work together, but there's a significant investment there. And I think also the other places Yes, with some of these platform extensions, excuse me, right term, we're seeing the opportunity there, I think, To make some more discrete investments and maybe mature some of those products along a little bit more. Just not suggesting significant changes in total spending, Just giving some insights in terms of where we see spending.

Speaker 8

That's very helpful. Thank you very much.

Operator

Thank you. And our next question is from Michael Turits from KeyBanc. Your line is open.

Speaker 9

Hey, guys. I was interested in the comments that you made about the strength of hardware and not seeing form factors Switch over significantly to software and obviously your product numbers were great. So can you talk about and I know you've done it before, but both Keith and Ken Talk about that the sources of the hardwareappliance security demand and What the sources are and really how sustainable that strong growth should be for how long into the future?

Speaker 3

I think you got to be a little bit bullish for this. I think the high end FortiGate's taking 6 points of market share is a pretty good indicator. Obviously, the high end FortiGates are very much targeted at large enterprises. And I think that dovetails very nicely with some of the growth numbers that we gave On G2000 and on the large enterprises as well. I still think that that's an opportunity for us where We have sometimes not always viewed as being viewed as the incumbent.

Speaker 3

But I think if you look at our progress over the years in the enterprise Sector, particularly in the U. S, which maybe has a little further to go. We're very, very pleased with that. And I would maybe supplement that in Enterprise success with a metric that we've talked about from time to time in the past, I think maybe 3 or 4 years ago, we talked about in the U. S.

Speaker 3

Of having And account rep ratio of about 65 accounts to 1 rep in the U. S. And that's not really an enterprise model. And then we made a comment that continuously that we would work to move that number down within the framework with balanced growth and profitability. That number today is about 13 or 14 accounts per rep.

Speaker 3

So I don't think it's a coincidence that you're seeing the success in the large enterprise with the large appliances Given the level of investment that we've been able to make in that segment of the market.

Speaker 2

Yes. Also, from our beginning, we won't look at How to secure a whole infrastructure, especially certain area in the past, whether in the high speed environment or kind of Branch of Revolt access is very, very difficult to involve in security because of speed requirement, because all these Kind of difficult to manage. So that's what we see with our own ASIC and the long term investment from ASIC, which enable us To get into this new area, the traditional network security cannot solve. So that's where we see huge growth in this area. And at the same time, we do keep in promoting because convergence and network security.

Speaker 2

So that's where we said that I get the convenient power from ASIC and also the new FortiOS keeping up with every year. So we do see more and more Security case and more security being deployed in the whole infrastructure just beyond the traditional network security deployment.

Speaker 1

Operator, next question please.

Operator

Yes. And our next question is from Hamzah Fodderwala from Morgan Stanley. Your line is open.

Speaker 10

Hey, guys. Thank you for taking my question and thanks for all the great detail earlier in the call. Keith, maybe one for you. Just You attributed the gap in the product and the services growth to customers At least a slight uptick in early ordering versus last quarter, it sounds like. I think that you mentioned that About 60% of the hardware backlog that you had in Q4 was built in Q1.

Speaker 10

So in terms of your Q2 billings guide, How do you think about that backlog to billings conversion, particularly in a perhaps less certain macro environment and perhaps A little bit more of an uptick in early ordering.

Speaker 3

Yes. I think this is related to how we think about what the backlog might mean. I think we've Just to remind people, we made the switch I think in the middle of Q4, asked our sales team to run the business on bookings and then we would convert it to buildings here, which Working very, very close with our manufacturing team and our operations team in terms of what they're seeing in terms of availability and what levers they have to pull. And with that in mind, I think the key now I just want to say I spend a lot more time with operations as part of the forecasting guidance process than I do with the sales team. And where we've kind of settled out on that is that I get a weekly update from the sales team in terms of what their expectations of backlog are going And we've been doing that every week this year and I think some of last year.

Speaker 3

And I mean, he's shown to be they've shown to be fairly darn accurate. I think that what you see right now in the Q1 was very high bookings, which was dragging on some backlog. But I think that Yes, the operations team has done a very good job. One thing that we do now use is this concept of what how much was Net backlog increased as a percentage of bookings and that number has hovered right around 8.5% to 9% in the 4th quarter and the first quarter. And so when we want to sanity check what we're hearing from the operations team, we now have a metric that we didn't have 6 months ago in terms of a little bit of history And we apply that metric to it and say does that seem reasonable?

Speaker 3

For all their hard work, when you get done, does that seem like it's a reasonable number? And we think it has been. Thank you.

Operator

Thank you. And our next question is from Adam Tindle from Raymond James. Your line is open.

Speaker 11

Okay. Thanks. Good afternoon. Keith, I just wanted to ask a question to try to get to the heart of real time demand and Certainly appreciate all the disclosures you've been giving. I'm looking at bookings.

Speaker 11

Obviously, it's been strong on a year over year basis. But from Q4 to Q1 sequentially, it was kind of the same level of increases last year. And if I heard you correctly, you can correct me if I'm wrong, but I think your guidance for Q2 bookings implied maybe down a little bit sequentially. And I'm wondering if that's starting to signal that we're plateauing on incremental growth in demand and Returning to a new or a more normal orders cadence.

Speaker 3

Yes. I think the Yes. I'm probably going to check the numbers. I'm looking at bookings number in the Q1. It was about $12.75 and a bookings number in the second I think we talked about being at the midpoint $13.55 So I don't know that I'm seeing a deceleration that you may be concerned about.

Speaker 11

Okay. I misheard you on the Q2 guidance. I was just looking at from Q4 to Q1. And maybe another one To tackle while we're at it, you talked about the seasonality shift last quarter, 2 to 3 points to the back half of the year. It looks like that might be a little bit more Smooth based on the updated Q2 guidance and full year guidance, maybe just what changed on that expectations for a back half versus now?

Speaker 3

Yes. I think where we ended up on the full year number through all the analysis that we do, Yes. I think the raise for the full year is roughly the beat that we had in the Q1 plus the raise that we had in the Q2. And we Sandy checked that. We're looking at our pipeline growth, our sales capacity, what we think the price increases are going to deliver, some more metrics around the backlog and want to make sure that we We're not getting too far ahead of ourselves and over our skis.

Speaker 3

And I think that's a pretty good number to be at right now in the current environment. There remains a lot of uncertainty as you know out there and getting overly bullish on Q3 and Q4 right now. I think we'd like to see how this plays out a little bit more.

Speaker 11

Understood. I'm looking forward to the Analyst Day. I'm sure Peter will plug it.

Speaker 1

On that note, next question please.

Operator

Thank you. And our next question is from Andrew Nowinski from Wells Fargo. Your line is open.

Speaker 8

Great. Thank you and congrats on the nice quarter. I just want to ask about your pipeline because this is the 2nd quarter in a row You've talked about pipeline strength. At the end of Q4, I think you said you had a strong pipeline entering 2022 and now you're saying You have an accelerating or you're seeing accelerating pipeline growth. I'm just wondering if you could put a finer point on that accelerating growth comment and where you're seeing That growth accelerating.

Speaker 8

Thanks.

Speaker 3

I don't I think it's pervasive, right? And I we look at the 3 different sources of pipeline, the way we talk about the channel, the marketing team and the direct sales force. Yes. I think we're pleased with the contribution from all three of them, no doubt about that. We've talked for an A period of time a few years about the importance of the channel and investments that we make and partnering with them and working together on that.

Speaker 3

I think that the channel is holding up their side of the bargain as well. Yes, I think the marketing team, I give them a ton of credit. I love the Fortinet Championship event And the continued success for it and how they've now leveraged that in other geographies as well. And the direct sales team continues to perform at a very high level, you're seeing the numbers. And obviously, to the extent that you were able to continue to add headcount like the metric I gave earlier, More people are going to drive more pipeline.

Speaker 3

So I don't know that I would isolate it to any one-three plenty of those one-three areas of where it's coming from or even geographically. It's been strong throughout, Ken. I don't know.

Speaker 2

Yes, great. Yes, both the additional investment we made in the marketing sales and also the structure the Make it more efficient and drive quite a lot of additional pipeline for us.

Speaker 8

Okay, got it. Thank you.

Operator

Thank you. And our next question is from Ben Bollin from Cleveland Research. Your line is open.

Speaker 8

Thanks everyone. I appreciate you taking the question. I was hoping you could address a little bit about how you view Service opportunities longer term, you suggested you're expecting some catch up or acceleration on services through back half based Backlog lead times procurement, but interested in how you think the elevated level of appliance placements this year Could influence demand for services even beyond 2022?

Speaker 2

Yes. It's a great question. We do The service will be drive additional growth, additional margin for us going forward, especially the new FortiOS 7.2, we offer Quite a lot of new service and a lot of service today, we don't charge customer and also on average, Our service cost is about half of our online competitors. So there's a lot of room we can grow the service And improving the margin there. So that will be and also with other, we call the platform extension product, which is upsell, cross sell, which will also kind of drive quite a lot of additional service on the total solution there.

Speaker 2

So that's why we do believe the service is I think in Q1, you see the product revenue growth was strong. And but on the other side, the short term service revenue also very, very strong. That's probably starting to come in later this year. And at the same time, the new additional service we launched with FortiOS 7.2 Like the FortiTrust on the CTNA, on Identity, there's some other service, the Caspi, some other We have we do believe will be additional revenue, additional sales, additional margin for us.

Speaker 3

Ben, it's Keith. And just from a modeling point of view, keep in mind that those price increases that we had in the second half of last year and the first quarter of this year Yes, we get that lift in product revenue immediately. It takes a little bit longer to see it in the services line because of how the timing of rev rec. And I think you're going to start to see Between new sales and renewals, the new price points that have been created for the services will start to have an impact and that's part of the acceleration that we talked about.

Speaker 2

Thanks guys.

Operator

Thank you. Thank you. And our next question is from Rob Aumens from Piper Sandler. Your line is open.

Speaker 7

Hey, guys. This is Justin on for Rob. I just wanted to follow-up on the OT You guys have quantified the success in selling into this use case for a couple of quarters now. I'm just curious how you view the OT as a driver into 2022 and beyond, especially when you consider the Explicit federal government guidance and broader spending intentions around protecting critical infrastructure?

Speaker 2

Yes. The OT definitely sees Bigger market going forward, probably bigger than SD WAN, which we see pretty strong growth and also so that's where the total OTs are catching up. I think last one, we ran our O2 maybe close to 10% of the business, but the growth is very, very So that's where we do see a lot of potential and we also invest a lot in this area to meet the demand.

Speaker 7

Got it. Thanks.

Speaker 2

Thank you.

Operator

Thank you. Our next question is from Gray Powell from BTIG. Your line is open.

Speaker 12

Great. Thanks for taking the questions and Congratulations on the really strong results.

Speaker 2

So yes, I guess I was

Speaker 12

just hoping to drill in on the SD WAN side. How should we think about the growth of your SD WAN business this year with just within the context of guidance or maybe relative to the overall company growth. And then how do you feel about the competitive environment in that category and just your ability to maintain growth atorabovemarketrates the next few years?

Speaker 2

First, I do think the device T1 will continue to grow like 30%, 40% year over year in probably next 5 years. And because it's a technology definitely can result in traffic based application, all these things is a very big set for the Consumer for the customer. So for us, we offer the only security combined with And also leverage only ASIC to have a huge performance advantage and give us more function. So that's where we so far, the SD WAN we sell is a part of the platform, the FortiGate platform. We don't even charge a service, but that's also additional Compared to our other vendor, they do have some kind of service charges related to SD WAN.

Speaker 2

So we do see we have a huge advantage both on the function, on the And we'll continue keeping gaining market share. We do feel we'll be keeping growing above the market growth. But also we feel this is the part that we call convergence of our security and networking together. So SD WAN is more address on one side, but also we're

Operator

Thank you. And our next question is from Ervin Liu from Evercore ISI. Your line is open.

Speaker 6

Hi, thanks for the question. So I was surprised to hear that 93% of backlog is from your existing customers. But I was wondering if you can help us parse through some of that strength within your existing customers. How much of this is Addressing the broader growth of their IT workloads and more tax surfaces versus a like for like Growth in or versus, let's just say, installed base refresh? Or is this more of you displacing other vendors within your current customer base?

Speaker 3

Yes. I can't really quantify it. I just haven't looked That way it's a good question and a good approach. If I were to make informed judgments, if you will, I think that expansion is by far the largest opportunity for us. It's just the nature of the business.

Speaker 3

And I think the refresh and the competitive placements are probably fairly close to each other, I would imagine, for the remainder. There is refresh for us is we have a very long product suite, so we tend to always have a new product. You saw the 3 new products come out being announced today. So there's always refresh activity in our own product list going on there. But we are I would also note that we are consistently getting more at bats, if you will, More opportunities with sales for competitive displacement.

Speaker 3

So I would imagine just my gut is again refreshing competitive displacements are Probably in the similar neighborhood, but expansion is the biggest.

Speaker 2

But also we have the biggest customer installation base in the industry. So we have probably close to 40% of total hotlines deployed in the industry, probably more than the number 2, number 3, number 4, add together. So Daseke was a quite broad customer base and I think it's close to 600,000 customer. Some of them may only use in Fortinet solution in part of infrastructure. So now we do see the benefit of expand to the additional infrastructure and also whether we call fabric So we do see a lot of expansion beyond the initial deployment.

Speaker 6

Thank you. That's helpful.

Speaker 3

Thank you.

Operator

Thank you. And our next question is from Gregg Moskowitz from Mizuho. Your line is open.

Speaker 11

Okay. Thank you for taking the question. Keith, just a follow-up on early ordering. Last quarter, you You'd estimated that low single digits of your Q4 business came from products ordered in advance. How would you size this for the Q1?

Speaker 11

And then just a clarification, if I may, because obviously the backlog went up very impressively. Are switches and access points still about 2 thirds of your backlog today? Thank you.

Speaker 3

I think the backlog is getting closer to fifty-fifty between networking equipment, or I guess I should call it Platform extension because it's in there. And the firewalls were the core platform. I think it's kind of balanced out. I do think it's low end FortiGates that are still dominating in the Fortinet space, if you will. I don't remember quantifying Early ordering as a percentage, if you will, is certainly something we've talked about here internally as a way of measuring that.

Speaker 3

I think that's Why don't we kind of provide Peter is going to give me some coaching here.

Speaker 1

Well, I think what we said in the Q4 last year was that we had we knew of some Transactions, a couple of deals that were that we knew were going to be ordered in that would be delivered into 2022 that were ordered. They're part of backlog and We're in the backlog in 2021 at the end of the year. That was a few a couple of $1,000,000 deals is what we were doing too.

Speaker 3

Yes. I think the constraint, if you will, on that is more around when is the supply going to be available, Because it's in backlog, we can deliver it as soon as the supply arrives. But it's more a function of how we're working with our suppliers than anything else.

Speaker 11

That's helpful. Thank you. Thank

Operator

you. And there are no further questions on Do you have any closing remarks?

Speaker 1

Thank you, Laurie. I'd like to thank everyone for joining us on the call today. As a reminder and a plug, Fortinet will be hosting an Analyst Day on Tuesday, May 10 next week. A link to register for the webcast can be found on the Events and Presentations page of the company's Investor Relations website. If If you register now, it's just a little quicker next Tuesday.

Speaker 1

You can also register day out. But again, thank you very much for your time. Appreciate the interest in Fortinet. Everybody, have a great day. Take care.

Speaker 1

Bye bye.

Operator

Thank you. And this concludes today's conference call. Thank you for participating. You may now disconnect.

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NVIDIA Q1 2022
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