Fortinet, Inc.

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 speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. And please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Peter Salkowski, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Lori. Good afternoon, everyone. I'm pleased to welcome everyone to our call to discuss Fortinet's financial results for the first quarter of 2022. Speakers on today's call are Ken Zee, 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 the Investor Relations website. Kendall 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 first quarter before providing guidance for the second quarter and updating the full year. We will then open the call for questions. During the Q&A session, we ask that you please keep your questions brief and limit yourself to one question to allow others to participate. Before we begin, I'd like to remind everyone that on today's call, we will be making forward-looking statements, and these forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected. Please refer to our SEC filings, in particular the risk 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 make on today's call are non-GAAP unless stated otherwise. Our GAAP results and the GAAP to non-GAAP reconciliations is located in an 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 Investor Relations website immediately following today's call. Lastly, all references to growth are on a year-over-year basis unless noted otherwise. I will now turn the call over again.

Thanks, Peter, and thank you to everyone for joining today's call to review our outstanding first quarter 2022 results. Our better-than-expected first quarter results demonstrate the strong demand of our cybersecurity innovation. Total revenue growth of 34%, driven by record product revenue growth of 54%. Total buildings increased 36%. A strong result reflects new order that was significantly greater than anticipated, partially offset by an increase in backlog. As a result, bookings increased 50% year-over-year to $1,276,000,000, which included booking growth from ICD-1 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 customers to successfully operate in today's elevated threat environment. Our solid performance and market share gains are being driven by our effort to make our customers' entire infrastructure more secure and integrated in a zero-trust network. Fortinet's secure streaming network approach converges networking functionality with security capability fueled by our powerful FortiASIC SPU to provide the best performance and reach functionality. The new FortiOS 7.2 offers multiple new and enhanced service across FortiGuard, FortiCare, and FortiTrust, such as ZTNA, Identity, In-Line Sandboxing, Advanced Device Protection for OT and IoT Environment, Associated Service, and In-Line CASB. N49 provides one of the broadest security service offerings on an average of half the cost compared to our main competitors. In addition, we have prioritized our most organic research and development efforts on integrating security products into our centralized 40OS fabric platform, which Gartner referred to as a cybersecurity mesh architecture. Today, we are now the new threat of FortiGate powered by our FortiASIC SPU. The FortiGate 3700F, 600F, and 70F deliver high-performance converged networking and security with security computer reaching of five 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 three years in a row. Our innovation positioned Fortinet as one of the most influential cybersecurity leaders. These growth drivers and organic innovation is accelerating our growth potential to a new level. 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. It is their collective effort and trust that will contribute to Fortnite's strong growth and market share gains.

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 40OS operating system. 40OS drives our entire security platform across multiple platform extension use cases, including zero trust access, cloud security, security operations, and secure networking. 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 three 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 million was up 34%, driven by record product revenue growth of 54%. Taking into account an $80 million 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% and 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 million. Support and related services was up 26% to $271 million, while security subscription services revenue was up 23% to $313 million. 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. We expect quarterly service revenue growth to accelerate throughout the rest of the year. As summarized on slide six, total revenue in the Americas increased 32%. EMEA revenue increased 25%, and APAC posted revenue growth of 57%, which includes a contribution from Alexula. EMEA's growth includes the impact of suspending operations in Russia. 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% and accounted 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. Bookings are up 50% to $1.3 billion, reflecting exceptional demand and a $116 million quarter-over-quarter increase in total backlog, bringing backlog to $278 million. Larger enterprises continue to favor Fortinet's industry-leading cost for performance advantage and are increasingly more appreciative of our integrated platform strategy. The platform strategy allows customers to converge networking functionality with security capabilities and consolidate multiple point products. 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. 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 $1.2 billion, billings were up 36%. Core platform billings were up 30% and accounted for 67% of total billings. As shown on slide 7, high-end FortiGates posted very strong billings growth with a mix shifting six points towards high-end appliances. Platform extension billings were up 50%, and it counted for 33% of total billings, up 3 percentage points. Average contract term was consistent year over year and down one 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. 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 Alexia's results. Service gross margin of 85.2% was impacted by Alexia, 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 8 and 9, pre-cash flow was $273 million, representing a margin of 29%. Capital expenditures for the quarter were $123 million, including $93 million 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 2.3 million shares of our common stock for a cost of $691 million. At the end of the quarter, the remaining share repurchase authorization was approximately $830 million, with the authorization set to expire in February 2023. Inventory returns at 3.5 times were up nearly 1.5 times year-over-year. Now let's spend some time reviewing backlog in a bit more detail. As I mentioned earlier, very strong demand drove a $116 million increase in total backlog to $278 million. To put this in perspective, total backlog at the end of the first quarter was approximately 6% of our trailing 12 months total billings. We shipped 60% of the Q4 ending hardware backlog in the quarter. In 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 in future periods. 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. There are 10 deals in backlog, nine from existing customers, with a remaining balance of over $1 million. 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. As software is frequently a more costly option, and may require architectural redesign and investment in changes in form factors and other equipment beyond just the firewalls. 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. As a result, we expect component and logistics costs to 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. For the second quarter, 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 to $1,265,000,000 which at the midpoint represents growth of 30%. Revenue in the range of $1.5 billion to $1.35 billion. Non-GAAP gross margin of 74.5% to 76%. Non-GAAP operating margin of 22% to 23.5%. Non-GAAP earnings per share of $1.05 to $1.10, which assumes a share count of $165 to $167 million. We estimate second quarter capital expenditures to be between $75 and $85 million. We expect a non-GAAP tax rate of 17%. For the full year, we anticipate backlog could approach or possibly exceed $500 million and expect billings in the range of $5 billion, $500 million to $5 billion, $580 million, which at the midpoint represents growth of 32.5%. Revenue in the range of $4,350,000 to $4,400,000, 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 to $2,700,000, 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 percent, non-GAAP operating margin of 24 to 26 percent. Non-GAAP earnings per share are $5 to $5.15, which assumes a share count of between $166 and $168 million. We estimate full-year capital expenditures between $270 and $300 million. We expect our non-GAAP tax rate to be 17 percent. We expect cash taxes to be approximately $260 million. 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. And along with Ken, 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 now have a call back over to Peter to begin the Q&A.

Thank you, Keith. As a reminder, in the Q&A session, we ask that you please limit yourself to one question to allow others to participate. You can always come back into the queue. We're going to test that theory on the first Q&A. We're going to take your operator. We can open the line, please.

Yes. And as a reminder, to ask a question, you will need to press star 1 on your telephone. Again, to ask a question, that is star 1. And our first question is from Fatima Bolani from Citi. Your line is open.

Good afternoon. Thank you for taking my questions. Keith, the question for you is on the product revenue performance, clearly one of the more standout metrics, among others in the print. You gave us a sense of the top-down dynamics that are helping with respect to the 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 in the year. Thank you.

Yeah. Yeah, 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 four quarters in a row now, measuring month one versus month two. 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. Pardon me, you get 45% afterwards. That was probably a little bit optimistic on my part to think I was gonna get 45% was a little more discounting than maybe I anticipated to that process. And I forgot your third area that you mentioned, I didn't write it down. I'm sorry. The area pricing. Something else.

That's good enough. Thanks.

Okay.

Thank you.

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

Great. Thank you very much for taking the question and congrats on the results. Really impressive acceleration. You know, maybe for my one question, I'll commit to keeping to that. Would like to know where you're seeing, you've got some nice traction up market, 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 involved, and Maybe if you can hit on lead times as well. I've heard you've done a pretty good job of keeping lead times much lower than your peers. Is that winning you business off market substantially as you go to market?

Definitely the food and operation team did a very, very good job. And also the model we have working with the manufacturer, working with the doing our own ASIC chip directly is also helping. So that's where compared to a lot of other vendors using like third-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's some more strong requests for some discount and which also We have actual discount probably discount more easy to go to a product side and compare to the service side There's a certain revenue recognition rules. You cannot discount service too much but also since we have a Very strong product we use in the security computing region So that's what for the same cost same function our performance and will be five times better than competitors So we do have a market pricing power which convince customer to move towards our product and the same time and 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 bundle auditions so that's where we do have the pricing power both on the product and the service that's worth their customer during this time to towards our solution. And also, there's a lot of new case which our competitors don't have in solution, like whether the SD-WAN, whether it goes to OT, some other part, which also drives quite a lot of additional growth for us.

Yeah, I'd probably offer a little more color behind Ken's comments there, if I could, Brian. I think, you know, if you think about the market, you know, 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, you know, more traditional networking companies have any more availability in those products than anybody else. And, you know, when we look at our backlog, you know, that mix seems to certainly support that. You know, firewalls, you know, I don't see a lot of customers switching over availability. I offered the comment earlier in the script that 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 in that number, not a very big number. And if I look at new logos in terms of the billings and the counts that we got from the quarter, you know, it was very, very normal in terms of both of the billings and the new logos. I think we're about 5,500 or so in new logos. So, yeah, I don't really, you know, see that, if you will, to the concern. And then if I can pivot back to Fatima just quickly, I think her final question was about pull forward, and that's just going to 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 placed orders for longer period deployment schedules? Certainly, and I think some of the comments in the script cover that.

Great, thank you.

Thank you. And our next question is from Seket Kelya from Barclays. Your line is open.

Okay, great. Hey, guys, thanks for taking my question here. Maybe a question for both of you, Ken and Keith. You know, I feel like we've talked 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 ease some of those supply chain issues and how helpful those changes could be in terms of fulfilling the demand that you're seeing.

Yeah, we're starting the redesign effort at the end of last year with all the supply restrictions. You can see the product we announced today, the 40K70F and even the 600F, probably would move to a kind of redesign. And then some of them also leverage our new food ASIC chip. That's really helping customers have a different choice if certain products have some shortage. But also in general, we have a much broader product, both in what we call the 40K core platform and also the platform extension. So that gives customers a much better choice. So if certain products, I'm sure they can easily steer to the next product but still offer a much better solution compared to other competitors. So that's where the redesign is actually helping a lot. to reduce the supply chain limitation we have and also give customers more choice. So we kind of are keeping that effort and keeping offer of our product portfolio, which we do feel during the supply chain issue, maybe we'll last you towards the whole year this year. We'll be definitely helping us and helping customers.

Very helpful. Thanks. Thank you.

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

Great. And thanks so much for taking the question. Either for Ted or Keith, I'm sorry if I missed it, but, you know, in the past few quarters, you've 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, how are you thinking about making any additional investments to just better capitalize on the opportunity there? Thanks so much.

Yeah, Peter's got me on a war limit on the script, so I apologize that that got taken out because I thought it was a worthwhile comment. But in any event, yeah, we got more of the same. We've been looking at about a three- or five-point shift to that other group. The other group is everything outside the top five, and we got that again in the current quarter. I think that if you look at it in that other group, the one vertical that continues to stand out, and I don't think it's surprising when you think about it, has been manufacturing, and I think that that really speaks to you know, the threat environment, ransomware, OT, things of that nature. You know, manufacturing is trying desperately to break into the top five of our verticals and getting closer and closer every quarter. Great. Thanks so much.

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

Sorry about that. I have myself on mute. Yeah, this is John White. I work for Jonathan O. Thanks for taking my question. If I heard you correctly, when you 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?

The HCVA and the OT definitely grow faster than the overall company base there.

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

Yeah, and also the underpriced is also above average.

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

Thank you. Yeah, we kind of view the real estate as kind of considered some long-term investment. We started doing that like 10, 15 years ago. It ended up our rental cost probably less than half compared to competitors similar of our size. So that's where the $100 million is saved every year. Probably what we're putting both the real estate and also the R&D and some other investments. Sorry, I misunderstand. R&D is not real estate. Yeah, R&D definitely will continue to invest in a lot of long-term R&D projects. From the ASIC, which we made investment more than 20 years, it was a huge, huge advantage on technology and also unable us pretty much to become an only vendor. they can meet this converging of security networking trend to offer very high-speed security, whether inside the company, in the one solution, within the data center, you drive tremendous growth, and also much better, we call the secure computing region, and also the service, which with large quantity of product being deployed, we can offer the service much cheaper than competitor for the same service, and that's really drive a huge value-add to the Cosmos.

Yeah, 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&D. We can move by a point or two in a given period. And if you peel back in a little bit and just look at the R&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. 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, you know, with some of these platform extensions, using the right term, we're seeing, you know, 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, but just giving some insights in terms of where we see spending.

That's very helpful. Thank you very much.

Thank you. And our next question is from Michael Turitz from KeyBank. Your line is open.

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 hardware slash appliance security demand, and what those sources are and really how sustainable that strong growth should be for how long into the future?

I think you've got to be a little bit bogus. I think the high-end Florida Gates taking six 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 being viewed as the incumbent, 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 terms of enterprise success with a metric that we've talked about from time to time in the past. I think maybe three or four years ago we talked about in the U.S. of having an account rep ratio of about 65 accounts to one rep in the U.S. And that's not really an enterprise model. And then we made a comment 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. 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.

Also, from our beginning, we've been looking at how to secure a whole infrastructure, especially in certain areas. In the past, whether in the high-speed environment or kind of a branch or remote access, It's very difficult to involve in security because of speed requirement, because all these are kind of difficult to manage. So that's what we see with our own ASIC and the long-term investment from ASIC, which will enable us to really get into this new area that traditional network security cannot solve. So that's where we see huge growth in this area. And at the same time, we do keep promoting what we call the convergence of network security. So that's where we saw the competing power from ASIC and also the new 40 OS 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.

Operator, next question, please.

Yes, and our next question is from Hans Faderweiler from Oregon Stanley. Your line is open.

Hey, guys. Thank you for taking my question, and thanks for all the great detail earlier in the call. Keith, maybe one for you. 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 billed in Q1. So in terms of your Q2 billings guide, how do you think about that backlog to billings conversion, you know, particularly in a perhaps less certain macro environment and perhaps a little bit more of an uptick in early ordering?

Yeah, I think it relates to how we think about what the backlog might mean. And just to remind people, we made the switch, I think, in the middle of the fourth quarter to ask our sales team to run the business on bookings, and then we would convert it to buildings here, which means 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 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 sold out on that is that I get a weekly update from the sales team in terms of what their expectations of backlog are going to be, and we'll be doing that every week this year and I think some of last year. And they've shown to be fairly darn accurate. I think that what you see right now in the first quarter was very high bookings, which dragged along some backlog, but I think that the operations team has done a very good job. One thing that we do now use... is this concept of how much was net backlog increased as a percentage of bookings. And that number is hovered right around 8.5% to 9% in the fourth 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 six months ago in terms of a little bit of history, and we apply that metric to it and say, does that seem reasonable? For all their hard work, when you get done, does it seem like it's a reasonable number? And we think it has been.

Thank you.

Thank you. And our next question is from Adam Tindall from Oregon. Raymond James, your line is open.

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. 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 increase as 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.

Yeah, I think the – I probably want to check the numbers. I'm looking at a bookings number in the first quarter was about $1,275. and a bookings number in the second quarter that 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.

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, two to three points to the back half of the year. 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.

Yeah, I think where we ended up on the full-year number, you know, through all the analysis that we do, you know, I think the raise for the full year is roughly the beat that we had in the first quarter plus the raise that we had in the second quarter. You know, and we sanitized it. Sanity check that with 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're not getting too far ahead of ourselves and over our skis. 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.

Understood. I'm looking forward to the analyst day. I'm sure Peter will plug it.

On that note, next question, please.

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

Great. Thank you, and congrats on the next quarter. I just want to ask about your pipeline, because this is the second quarter in a row that 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. Thanks.

I think it's pervasive, right? And we look at the three different sources of pipeline the way we talk about the channel, the marketing team, and the direct sales force. I think we're pleased with the contribution from all three of them, no doubt about that. We've talked for an extended 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. I think that the channel is holding up their side of the bargain as well. 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, you know, the direct sales team continues to perform at a very high level, and you're seeing the numbers. And obviously, you know, to the extent that you were able to continue to add headcount, like the metric I gave earlier, you know, more people are going to drive more pipelines. 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. I mean, it's been strong throughout, Ken, I don't know.

Yeah, great. Yeah, both additional investment we made in the market itself, and also restructure the team, make it more efficient, and drive quite a lot of additional pipeline for us.

OK, got it. Thank you.

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

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 on backlog lead times procurement, but interested in how you think the elevated level of appliance placement this year could influence demand for services even beyond 2022.

Yes, it's a great question. We do see the service will drive additional growth, additional margin for us going forward, especially the new 4DOS 7.2. We offer quite a lot of new service. And a lot of service today, we don't charge customers. And also, on average, our service cost is about half of our main competitors. So there's a lot of room we can grow the service and improving the margin there. So that's what the, and also with the 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. So that's what we do believe. The service is, I think it's in Q1, you see the product revenue grow so strong. 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 the same time, the new additional service we launched with 4G OS 7.2, like the 4G Trust on the ZTA, on Identity, there's some other service, the CASB, some other we have. We do believe it will be additional revenue, additional sales, additional margin for us.

Dennis, Keith, in terms of a modeling point of view, keep in mind that you know, those price increases that we had in the second half of last year and the first quarter of this year, that 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 RevRec, and I think you're going to start to see, you know, between new sales and renewals, you know, 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. Great. Thanks, guys.

Thank you.

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

Hey, guys. This is Justin on for Rob. I just wanted to follow up on the OT topic. 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.

Yeah, the OT definitely sees a bigger market going forward, probably bigger than SD-WAN, which we see pretty strong growth. So that's where the total OT starting catching up. Right now, OT may be close to 10% of the business, but the growth is very, very strong. So that's where we do see a lot of potential, and we also invest a lot in this area to meet the demand. Got it. Thanks. Thank you.

Thank you. And again, if you would like to ask a question, please press star 1 on your telephone. Our next question is from Gray Powell from BTIG. Your line is open.

Great. Thanks for taking the questions, and congratulations on the really strong results. So, yeah, I guess I was just hoping to drill in on the SD-WAN side. How should we think about the growth of your SD-WAN business this year 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 at or above market rates the next few years?

First, I do believe that ISD-1 will continue to grow like 30-40% every year in the probably next five years. And because it's a technology, definitely can resolve the traffic-based application, all these things. It's a very benefit for the consumer, for the customer. So for us, we offer the only security combined with ISD-1 and also leverage only 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 charging with the regular SD-WAN. So we do see we have a huge advantage both on the function and the cost in the SD-WAN. I will continue to be 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 security and networking together. So I see one small address on one side, but also we're helping drive the land side, the inside company, the segmentation, the data center, and eventually make the whole infrastructure very secure for the customer.

Understood. That's really helpful. Thank you very much. Thank you.

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

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 versus, let's just say, install-based refresh? Or is this more of you displacing other vendors within your current customer base? All right.

Yeah, I can't really quantify it. I just haven't looked at it that way. It's a good question, 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. 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 three new products come out and be announced today. So there's always some sort of refresh activity in our own product list going on there. But I would also note that we are consistently getting more at-bats, if you will, more opportunities with sales for competitive displacement. So I would imagine just, you know, my gut is, again, refresh with competitive displacements are probably in a similar neighborhood, but expansion is the biggest.

Also, we have the biggest customer installation base in the industry. So we have probably close to 40% of total deploy in the industry, probably more than the number two, number three, number four add together. So that's give us a quite broad customer base. And I think it's close to 600,000 customer. Some of them may only using solution in part of infrastructure. So now we do see the benefit of expand to the additional infrastructure and also what we call fabric of mesh network to manage it together. a lot of expansion beyond the initial deployment.

Thank you. That's helpful. Thank you.

Thank you. And our next question is from Greg Moskovitz from Izuho. Your line is open.

Okay. Thank you for taking the question. Keith, just a follow-up on early ordering. Last quarter, you had estimated that low single digits of your Q4 business came from product ordered in advance. How would you size this for the Q1? And then just a clarification, if I may, because obviously the backlog went up very impressively. Are switches and access points still about two-thirds of your backlog today? Thank you.

I think the backlog is getting closer to 50-50 between networking equipment, or I guess I should call it platform extension because it's in there, and the firewalls or 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. It's certainly something we've talked about here internally as our way of measuring that. I think that's why we kind of provide – Peter's going to give me some coaching here.

Well, I think what we said in the fourth quarter last year was that we knew of some transactions, a couple of deals that we knew were going to be delivered into 2022 that were part of backlog and were in the backlog in 2021 at the end of the year. That was a couple of million dollar deals is what we were going through.

Yeah. I think the constraints, 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.

That's helpful. Thank you. Thank you, Greg.

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

Thank you, Lori. 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 10th, 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 you register now, it's just a little quicker next Tuesday. You can also register day of. But again, thank you very much for your time. Appreciate the interest in Fortinet. Everybody have a great day. Take care. Bye-bye.

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