Keith Jensen
Chief Financial Officer at Fortinet
Thank you, Ken, and good afternoon everyone.
Let's start with the key highlights from the second quarter. Billings growth was 18% as well as product revenue growth. Service revenue growth held firm at 30%, resulting in total revenue growth of 26%, OT and SD-WAN revenue continued to perform well as revenue from these products were up 60% and 40%, respectively. In a sign of our strength in the small and midsized customer segments, we added a record 6,500 new logos.
Operating margins of 26.9% exceeded the high end of the guidance range by 140 basis points. Free cash flow was strong at $438 million, representing a margin of 34%, benefiting from the deferral of certain cash tax payments to the fourth quarter. Looking at billings in more detail, billings of $1.54 billion were led by non-FortiGate billings of over 30% growth, representing 34% of total billings. Non-FortiGate billings growth was driven by networking, FortiGate VM, NAC and cloud. And as Ken mentioned, non-FortiGate is nearing a $2 billion annual revenue run-rate.
In terms of industry verticals, government and manufacturing topped the list as a percentage of total billings, with manufacturing up almost 50%, government and construction were up over 30%, while service provider and retail were up 1% and down 5% respectively. Retail was impacted by a very difficult compare, as the industry vertical nearly doubled in the year earlier period. Billings growth varies by geos with international emerging leading, followed by Europe and LatAm. APAC and to a lesser extent U.S. enterprise were challenged by difficult prior year comparisons. Deals over $1 million increased from 122 deals to 134 deals.
Turning to revenue and margins. Total revenue grew 26% to $1.29 billion, driven by non-FortiGate growth of over 45% and service revenue growth of 30%. This was the second consecutive quarter of greater than 30% service revenue growth. Security subscriptions represent over 55% of all service revenue and continue to streak a strong increasing sequential quarterly growth dating back to Q1 of '22 of 23% to Q2 of '23 at 34%. Product revenue of $473 million increased 18%. Product lead times and backlogs are expected to approach normal levels in the third quarter.
Total gross margin of 77.9% was up 140 basis points driven by 160 basis point increase in product gross margin to 63.5%. Product gross margin has benefited from earlier pricing actions and easing cost pressures and were partially offset by certain inventory charges. Service revenues were 63% of total revenues and delivered gross margin of 86.2%. Higher service revenue, offset higher labor costs and increased cloud delivery costs, as we continue to expand our cloud SASE delivery models.
We see our single vendor SASE solution opening a large new market and one where our sizable SD-WAN install base can be leveraged as a significant market access point. We plan to accelerate our point of presence or POP deployment, with a dual strategy Ken mentioned investing in our own POPs, as well as working with third party providers to accelerate our deployment.
Operating income of $348 million, grew 36%, outpacing revenue grew by more than 10 points as operating discipline resulted in significant operating leverage. Operating margins of 26.9% exceeded the high-end of the guidance range and was up 210 basis points due to the strong gross margin performance and operational efficiencies. Earnings per share increased 58% to $0.38 per share, and also exceeded the high-end of the guidance.
Looking into the statement of cash flow summaries on Slide 7 and 8, free cash flow increased 55% to $438 million. Adjusted free cash flow, which excludes real estate investments was $498 million, representing it 38.5% adjusted free cash flow margin. Free cash flow benefited from the deferral of approximately $190 million in cash tax payments. As mentioned last quarter, these tax payments together with other deferred 2023 tax payments are due to be paid in the fourth quarter.
Capital expenditures were $77 million, including $59 million of real estate investments. Cash taxes on the quarter were $38 million. The Board recently increased the Company's share repurchase authorization by $500 million. And the total available share buyback authorization is now approximately $2 billion.
Now I'd like to share a few significant wins from the quarter that exemplifies the strength of our broad and integrated platform. First, a global pharmaceutical leader signed an eight-figure deal with our Fortinet Cybersecurity Fabric, investing in our OT aware secure networking architecture, as well as our AI ops and threat intelligence solution. Recognizing the market shift to a platform-based approach to security, this company selected Fortinet to secure its highly regulated and sensitive medical data that continues to drive global operational and financial efficiencies through our broad integrated and automated platform approach to cybersecurity.
In another deal, one of the largest U.S. school districts which had recently refreshed its datacenter firewalls to FortiGate was seeking to improve its network security posture with a NAC solution that offers better visibility to the devices connected to the network. Fortinet competed against multiple peers, and was able to win due to FortiNAC's ease of implementation, centralized management capability and superior risk remediation, as well as the tight integration to the district's existing Fortinet security fabric. This high seven-figure deal was the largest NAC deal in Fortinet's history.
Finally, in the seven-figure displacement in our largest FortiSASE deal ever, a large bank on its digital transformation journey, who was searching for a single vendor SASE solution for its hybrid workforce. This selected our FortiSASE solution for its over 5,000 users, as it integrates SD-WAN and SASE into a holistic solution and delivers comprehensive security, both from the cloud and on-prem, while ensuring consistent security policies for all users regardless of their location, and wherever applications are being accessed. These transactions illustrate how Fortinet's platform strategy, integrated operating systems and proprietary ASIC technology continue to resonate with customers.
Given the heightened interest in AI technology, we could not do this call without discussing Fortinet's investment and innovations in AI. Fortinet has been at the forefront of AI and machine learning innovation for many years, leveraging deep learning, artificial neural networks to power our products and security services, enabling a faster, stronger and more accurate defense for our customers.
One of our first AI-powered use cases was the introduction of the virtual FortiGuard Threat Analyst. FortiGuard addresses threats in real time with machine learning, coordinated protection and is extensively used in malware detection and threat hunting. Every time a threat is identified, FortiGuard generates threat intelligence that automatically updates defense signatures across the fabric.
In cloud environments where scale and speed are critical, AI and machine learning can help security teams keep pace with threats on multiple fronts. All of this happens seamlessly and behind the scenes. Today, our platform [indecipherable] and Analyzer on average more than 100 billion events every day, to deliver over 1 billion security updates daily across the Fortinet security fabric and ecosystem. While many of our competitors OEM get security from different security vendors, our AI-driven FortiGuard threat intelligence has been built in house, which allows us to use AI across different sources. Adversaries increasingly are using AI in their playbooks to drive cyberattacks, which only increased the rapidly evolving cybersecurity threat landscape.
We continue to invest in AI and machine learning technologies across our products, including generative AI, natural language models, and other implementations to enhance, simplify and automate security for our customers. Before moving to guidance, I'd like to offer some observations about the second quarter and about the industry. Regarding the second quarter, we believe macro uncertainty impacted our billing performance to average contract duration, and in the second half of June, and the elevated level of enterprise deals pushing the future quarters.
We saw shorter contract duration, with the average term decreasing by 1.5 months to 28 months, creating a 4 to 5 point billings headwind year-over-year. Normalizing billings growth with a change in contract duration, yields billings growth in the low-20% range. Having some level of enterprise deals pushed to future quarters, is not unusual. In Q2 '23 however, an unusually large volume of deals that we expected to close in June, instead pushed to future periods. From a market perspective, CIOs continue to prioritize and invest in securing their organizations in the face of rising cybersecurity threats.
We see new regulatory requirements, such as the recently announced -- those recently announced by the SEC and the EU Cyber Resilience Act announced earlier this year. They will continue to provide market tailwinds as organizations further increase their cybersecurity investments to comply with new stringent cyber regulations.
The cybersecurity industry remains highly relevant as CIOs prioritize cyber spending within their overall IT budgets. As such, the longer term demand drivers for Fortinet net remained very solid. That said, we do see a return to more normal seasonality for Fortinet in the back half of the year as tailwind such as the supply chain driven growth subsides and we cycled prior period price increases.
Moving on to guidance. As a reminder, our third quarter and full year outlook, which are summarized on Slides 11, and 12, are subject to the disclaimers regarding forward-looking information that Peter provided at the beginning of the call. For the third quarter we expect billings in the range of $1,560 million to $1,620 million which at the midpoint represents growth at 13% and is consistent with our quarter-over-quarter seasonality prior to the pandemic. Revenue in the range of $1,315 million to $1,375 million which at the midpoint represents growth of 17%.
Non-GAAP gross margin of 75.5% to 76.5%. Non-GAAP operating margin of 24.5% to 25.5%. Non-GAAP earnings per share of $0.35 to $0.37, which assumes a share count of between $795 million and $805 million. Capital expenditures of $100 million to $130 million, non-GAAP tax rate of 17%, cash taxes of $25 million. And as previously mentioned, backlog is expected to approach normal levels in Q3.
For the full year, we expect billings in the range of $6,490 million to $6,590 million, which at the midpoint represents growth of 17% and implies slightly below normal seasonality in Q4. Revenue in the range of $5,350 million to $5,450 million, which at the midpoint represents growth of 22.3%. Service revenue in the range of $3,350 million to $3,410 million which at the midpoint represents growth at 28.2%. The service revenue guidance implies product revenue growth at 13.5%.
Non-GAAP gross margin of 75.25% to 76.25%. Non-GAAP operating margin of 25.25% to 26.25%. Non-GAAP earnings per share of $1.49 to $1.53, which assumes a share count of between $795 million and $805 million. Capital expenditures of $335 million to $385 million due to our continued cloud data center and facilities investments. Non-GAAP tax rate of 17%, cash taxes of $460 million was approximately $380 million in the fourth quarter.
We continue to execute our long-term strategy and remain confident in the strategy and our solutions. While it's a little early to be providing guidance for next year, we would expect our near term performance represents a short term trough, given our confidence in our solutions, our offerings and taking into account that growth comparisons will ease as we move through 2024, at this early stage we would expect billings growth to approach high-teens by the fourth quarter of 2024.
And with that, I'll now hand the call back over to Peter to begin the Q&A session.
