Fortinet Management Discusses Q1 2013 Results – Earnings Call Transcript

Originaly posted on http://seekingalpha.com/article/1387761-fortinet-management-discusses-q1-2013-results-earnings-call-transcript?part=single

Executives

Michelle Spolver – Vice President of Corporate Communications & Investor Relations

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Analysts

Keith Weiss – Morgan Stanley, Research Division

Sterling P. Auty – JP Morgan Chase & Co, Research Division

Brent Thill – UBS Investment Bank, Research Division

Tal Liani – BofA Merrill Lynch, Research Division

Michael Turits – Raymond James & Associates, Inc., Research Division

Priya Parasuraman – Wells Fargo Securities, LLC, Research Division

Rohit N. Chopra – Wedbush Securities Inc., Research Division

Shaul Eyal – Oppenheimer & Co. Inc., Research Division

Fatima Boolani – Jefferies & Company, Inc., Research Division

John Weidemoyer

Fortinet (FTNT) Q1 2013 Earnings Call April 30, 2013 4:30 PM ET

Operator

Good day, ladies and gentlemen, and welcome to the Fortinet First Quarter 2013 Earnings Announcement. [Operator Instructions] Today’s conference is being recorded. I would now like to turn the call over to Michelle Spolver.

Michelle Spolver – Vice President of Corporate Communications & Investor Relations

Thank you. Good afternoon, and thank you for joining us on this conference call to discuss Fortinet’s financial and operating results for the first quarter of 2013. Joining me today are Ken Xie, Fortinet’s Founder, President and CEO; and Ahmed Rubaie, our recently appointed CFO and COO. This is Ahmed’s first conference call with Fortinet, and we welcome him to our company and look forward to his contributions as we work to execute against the company’s strategic growth initiatives.

In terms of the structure of the call, I will begin by providing a quick summary of our key first quarter financial metrics, then turn the call over to Ken who will provide perspective on the market and our business and product highlights. Ahmed will then review our operating results, along with some thoughts on our outlook for the second quarter and full-year 2013 before we open up the call for questions.

As a reminder, we are holding 2 calls today. Given that we already covered some of the aspects of Q1 in our pre-announcement a few weeks ago, we’re going to try and keep this first call to about an hour. For those who have additional or more detailed questions, we will hold a second conference call at 3:30 p.m. Pacific Time. Both calls will be webcast from our Investor Relations website and are — will be accessible as detailed in our earnings release.

Before we begin, let me first read this disclaimer. Please note some of the comments we make today are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in these statements. Please refer to our SEC filings, in particular, the risk factors described in our Forms 10-K and 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 please note that we will be discussing certain non-GAAP financial measures on this call. Our GAAP results and GAAP to non-GAAP reconciliations can be found in our earnings press release and on Slides 14 and 15 of this presentation that accompany today’s remarks. Please refer to the Investor Relations section of our website at investor.fortinet.com for important information, including our earnings press release issued a few weeks ago and slides that accompany today’s prepared remarks. A replay of this call will also be available on our website. Note that we routinely post information on our website, and we encourage you to make use of that resource.

Before I turn the call over to Ken to provide perspective on the market and Fortinet’s product and business highlights, let me reiterate our Q1 financial highlights, all of which are consistent with the pre-announcement a few weeks ago. Specifically, billings were $148.5 million, increasing 8% year-over-year. Revenue was $135.8 million, up 16% over the prior year period. Non-GAAP operating margins were 18% and non-GAAP EPS was $0.10. And finally, our cash generation remained healthy with $36 million of free cash flow during the quarter. In a few minutes, Ahmed will provide additional financial and operational details, but first, let me now turn the call over to Ken.

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

Okay. Thank you, Michelle, and thanks to everyone for joining us today. So first I want to welcome Ahmed to Fortinet. I know that many of you have had exposure to him in his previous position. So we are mutually excited about the timely addition of a strong operation and finance executive to our team. Ahmed has a solid track record of delivering consistent result, contribution to strong growth and scaling global business in a highly efficient manner. So as we’re looking to scale Fortinet to our longer-term goals, we’re looking forward to Ahmed’s contributions.

Now let me give you my perspective of the business. Like several other companies that have reported to-date, we believe our Q1 result were affected primarily by the macro economic and the geopolitical challenges in Latin America and EMEA, as well as a shortfall in U.S. service provider business, which resulted in a fewer than expected larger deals in the quarter. And to a lesser extent, inventory shortages and the product transition issue also affected sales during the quarter. So from an execution standpoint, we are taking appropriate actions to improve the inventory process and better manage the transition of the new product launch in the future.

So I also want to underscore that Fortinet’s global competitive position remain very strong across all our end markets. We are now a secured market leader and continue to gain shares. Despite some of the challenge in Q1, we did not see a major change in the competitive environment and no significant deals were lost to competitors. So we believe the security industry remain healthy, though growing at a slower rate than what was previously estimated. On average, research firm have the growth rate of now secured to be somewhere between 6% to 10% year-over-year and Fortinet forecast total addressable market now is in the — just over $9 billion.

The industry drivers such as high-performance networks, advanced persistent threats, mobility and cloud-based security service and a lower total cost of ownership all bode well for Fortinet. So we continue to gain tractions within the large enterprise sector — large enterprise segment which remain an area of focus for us.

So during Q1, even with the softening across the board, we won against displaced competitors in large deal within a key vertical, such as enterprise, retail, garment, education and also service provider. Fortinet continues to win in the market due to our ability to deliver broad security and fast performance through our customer FortiASIC acceleration. The credibility of our FortiGate platform has been validated by numerous third-party certifications and award. In fact, Fortinet hold more certifications than any other security vendor. Our customer take this third-party certification and award seriously, as they are a much more accurate validation of a product effectiveness and performance credibility.

So during the quarter, we added nicely to our arsenal of award and certification, such as our primary security technology and the segment [ph] price performance advantage was validated in the NSS Lab 2013 Enterprise Next Generation Firewall Group Test report issued in March, in which Fortinet recently introduced the FortiGate-3600C.

The FortiGate-3600C appliance was one of the top performance systems out of 9 next-generation firewall product tested and earned a recommendation. So this is the third consecutive award Fortinet has earned from NSS Lab in the last several months, including recommended routine IPS and firewall group testing. NSS Lab tests and rate product based on the security effectiveness and the price performance. And its funding and research are highly regarded by many enterprise customers.

Our enterprise-class FortiGate-3240C and FortiGate-1000C [indiscernible] secured appliance each were also selected as the winner by a panel of IT security professionals in the SC Award Europe 2013. With the FortiGate-3240C winning the Best Network Security Solution category and FortiGate-1000C winning the Best Integrated Security Solution category. And finally, Frost & Sullivan, a leading global industry analyst organization, award us with both their North American Market Penetration Leadership Award for Enterprise Firewall and the North American Market Share Leadership Award for Unified Threat Management. These award are presented each year to only one company within the industry. That demonstrate excellent — excellency in capture how fast a company increases a penetration of a market, measured by a rate of changing of market share. So we are proud to have our growth acknowledged by this respected global organization.

On the innovation front, we introduced a new product that strengthen our advantage across our core market. This includes a new FortiGuard cloud-based sandboxing and IP reputation service, designed to help protect against advanced persistent threats. Using behavioral attributes to detect malware by executing them within a virtual environment. This service adds an additional protection layer that complement the antivirus capability in our FortiGate appliance. Also we expand our family of FortiMail e-mail security appliance with 2 new product: the FortiMail-200D designed for SMB; and the FortiMail-3000D designed for the carriers, service providers and large enterprise. Sales of our FortiMail systems, though still modest, has been steadily increasing, growing 40% year-over-year.

And last week, we announced the new FortiWiFi wireless and FortiAP access point products. These secure wireless LAN solution are designed for distributed enterprise and are able integrate wireless and wired access security authentication, switching and management.

So we also made a small acquisition of Coyote Point Systems, a privately-held provider of application delivery controllers, load balancing and acceleration solutions. As part of our broader growth strategy, this transaction was primarily about gaining technology and engineering talent, which we believe, in the near term, will enhance our existing ADC capabilities and the product and that down the road deliver future security and ADC solution.

So I’m very excited about the technology enhancement tuck-in like Coyote, as they fit well with our continued strategy to provide our customer with the most integrated, innovative solution ahead of competitors. Coyote Point System generated approximately $5 million of revenue in the last 12 months. We expect it to be approximately $0.02 dilutive after year, and accretive next years.

So during the quarter, we also continued to invest in sales headcount and marketing activities to support long-term growth, and expect to see benefit over time as the new people and activity ramp up, which usually take about 9 to 12 months. We plan to continue to invest in the business, but as Ahmed will go into more detail, we will closely monitor this investment as we remain focused on maximizing long-term shareholder value.

As a reminder, during the last recession in the end of 2008 and early 2009, when Fortinet was still a private company, we continued to invest in the business while others pulled back. It was our focus and conviction to do what is right for the long-term that enabled us to capture strong market share when the global economy recovered. So as we’re looking forward, we feel confident about our position in the market and our ability to keep growing. We have some exciting new product on the horizon, including the release of a next-generation FortiASIC MT6 which will again raise the industry performance bar and enable even faster network security to future FortiGate systems.

Now let me turn the call over to Ahmed, who will review our quarterly financial and operational result in greater detail, and provide our outlook for the second quarter and the full year 2013.

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Thanks, Ken, and thanks, everyone, for joining us today. I’m very excited to be joining Fortinet at a pivotal point in the company’s growth journey. Together with the team, I’m looking forward to tackling the growing pains amidst the continued macro uncertainty. We are well-positioned as the market leader with a differentiated and innovative product line, and have a track record of continuous innovation that we expect will continue to avail us more global growth. As you know, Fortinet has always grown against the macro odds. Having said that and given the current macro, we are monitoring our growth investments, and will pull the requisite levers if necessary.

I’m only about a week into the job and I will keep you apprised as I ramp up in the business in coming quarters.

Since our announcement a few weeks ago, we have seen continued mixed signals from the macro where many companies are facing a more challenging environment in U.S. service provider market, continued uncertainty from EMEA and some sluggishness in the emerging Latin America market. In tandem, and as Ken mentioned earlier, we have also spent more time distilling the internal execution challenges we faced in Q1, and we are working diligently to fix them. Of course, we are doing so while taking on management changes.

Let’s go to Slide 3 and review billings. As a reminder, we generally bill in U.S. dollars. While there is no direct impact from foreign currency fluctuations, there is an impact on customers’ buying power when translating their buying capability in their the local currencies to the U.S. dollar.

Q1 billings were $148.5 million during the first quarter, an increase of $11.5 million or 8% year-over-year. From a geographic perspective, billings growth year-over-year in the Americas were flat, in part due to the macro issues in Latin America, and also in part due to the softening of larger U.S. service provider deals. EMEA billings grew 8% despite the continued macro uncertainty there. And APAC grew very nicely at 25% with good traction in Japan, Southeast Asia and India.

The number of large deals during the first quarter increased year-over-year in deals over $100,000 and $250,000, but declined in deals over $500,000. As we indicated on our call a few weeks ago, the combination of the lesser service provider deals in the U.S. and more conservative spending by customers in EMEA resulted in fewer larger deals than we expected. Specifically, the number of deals over $100,000 during the first quarter of 2013 increased to 170, compared to 153 for the same period last year. Deals greater than $250,000 increased to 55, compared to 47 in Q1 of last year. And deals over $500,000 were 13, versus 19 during the same period last year. We had several large deals over $1 million, but the number decreased year-over-year.

Leaving deal count to the side, let me now give you some color on the deals we closed in Q1, validating our innovative edge against competitors and why we continue to gain market share with impressive wins across geographies and verticals.

To highlight a few: in the Americas, we won a 7-figure deal with a large U.S. based wireless carrier where we replaced Palo Alto Networks. We were selected because of our superior reliability, scalability and overall firewall performance. The customer plans to deploy our high-end FortiGate-3950 appliances as core firewalls in their infrastructure. We also expanded our footprint with an existing U.S. Fortune 50 technology customer and closed another 7-figure deal for a full corporate, external data center security deployment, replacing the incumbent, Cisco. Our unmatched performance was a key factor in us winning this deal. And we won a U.S. deal with one of the world’s largest retailers who was looking for a consolidated next-generation firewall to protect its network edge. We beat out Check Point, Juniper, Palo Alto Networks and Cisco in this deal, based again on performance and breadth of functionality we offer, which will allow the customer to easily and cost effectively add additional security technologies down the road.

In EMEA, we had a sizable government win with one of the largest cities in Europe to be the security and content filtering solution for a statewide public network. We sold a variety of products, including our enterprise-class ForitGate, FortiMail, FortiAnalyzer and FortiManager appliances and won based on our ability to provide the best performance, security and availability. We beat Cisco, Check Point, McAfee and Blue Coat in this deal.

Fortinet was also chosen as the ultra-low latency firewall to secure a trading network of a large European bank. Our experience in protecting these very fast, mission-critical trading infrastructures, along with a very low latency and superior price/performance was paramount in this customer’s decision to purchase our products. We were the sole vendor considered for this deal.

And finally, we closed a large deal in APAC with a leading mobile telecommunications provider who selected our FortiGate-5000 series products to secure its core network that serves millions of mobile subscribers. We competed against Check Point and F5 for this deal and were selected based on scalability for future network expansion, overall performance reliability.

Let’s move to Slide 4 and discuss billings by product segments. As you can see, product billings remained well diversified across all segments, with high-end FortiGate products accounting for 30%, mid-range 32%, and entry-level 38%. A reminder that the product billings mix varied a bit from quarter-to-quarter based on the models of products that make up all size deals. For example, a large distributed enterprise deal could contain hundreds or thousands of low-end products.

Aside from the shortfall in Service Provider segment, the other verticals remained relatively consistent. Our key vertical breakdown was service provider at approximately 25%, government at 13%, retail at 11%, financial services at 9%, and finally, education at 6%.

Turning to revenue, please go to Slides 5 and 6. During the first quarter, total revenue was $135.8 million, up 16% year-over-year. Geographically, revenues continued to be diversified globally, which remains a key strength of our business. Specifically, in the Americas revenues were $52.6 million, up 13% year-over-year. EMEA revenues were $47.3 million, up 16% year-over-year. And APAC revenues increased to $35.9 million, up 20% year-over-year.

Let’s go to Slide 7 and review the revenue breakdown by product and services. Product revenues increased 9% year-over-year to $58 million, in line with the lower billings growth. There was also an impact from the inventory shortages related to the greater-than-expected demand of the FG-100D and product transition issues with our newly introduced FortiGate-60D. The product revenue growth in Q1 was across all product segments, but particularly from some of our newer models such as the entry-level FortiGate-100D and 60D, and FortiAP wireless products, mid-range FortiGate-800C and high-end FortiGate-3240C appliances.

Service revenues grew to $75.9 million or 22% year-over-year growth. The increase was primarily due to consistent growth in subscription — excuse me, in support and subscription offerings, as well as growth in our professional services revenues as a result of more large enterprise customers who require ongoing resources on site. Renewal rates continue to be in the mid- to high-70% range, and finally, ratable and other revenue was $2 million, including $600,000 from patent licensing revenue during the first quarter.

Let’s now move to Slide 8 and look at headcount. We continued to hire for expected growth and ended Q1 with 2,077 employees. We are very pleased with the quality of talent we’re hiring across all geographies, and the focus is all about continuing to be the innovative product leader and to continue growing our business and gaining market share.

Turning to non-GAAP expenses and profitability. Q1 gross profit was 72%, product gross margins were 60%, down slightly from prior quarters due to a higher mix of entry-level products sold. Services gross margins were 81% as we continued to invest in support to meet the needs of our growing enterprise customer base. Total operating expenses were $73.6 million during the first quarter, up 20% year-over-year, and as a result of the investments we announced last quarter in sales and marketing. This resulted in non-GAAP operating net income of $24.2 million or 18% of revenue.

Non-GAAP net income during the first quarter was $17.3 million or $0.10 per share, based on approximately 168 million diluted shares outstanding. GAAP net income totaled $12.2 million or $0.07 per share, compared to $14.2 million or $0.09 per share in the prior year period. The effective tax rate for the first quarter of 2013 was 28%. A reconciliation of non-GAAP and GAAP can be seen on Slides 13 and 14.

Highlighting key items on the balance sheet, as you can see on Slide 10, we ended Q1 with $783 million in cash, cash equivalents and short- and long-term investments, or $4.66 per share, up from $740 million during Q4.

Looking at Slide 11, the increase was driven by the $38 million in cash generated from operations. This is our 29th consecutive quarter of generating cash from operations, exclusive of one-time items. Free cash flow for the quarter was $36 million. DSOs were 68 days and remained within our targeted range of 65 to 75 days. And our deferred revenue balance of $376 million increased $62 million or 20% year-over-year and $13 million sequentially. The sequential increase was primarily in our services deferred revenue balance which increased by $15 million and was offset by a $2 million decrease in ratable and products.

And now turning to our guidance. As we look towards the remainder of this year, we continue to believe that the demand for network security solutions remains strong, and that Fortinet is well-positioned to grow market share due to the strength and innovative differentiation of our product line.

Keeping our eyes on the longer term and learning from prior macro shifts, we intend to continue our growth investments in the U.S. enterprise business, emerging markets and other related areas as I mentioned earlier. We are also prepared to pull back the levers, if necessary. Of course, we will apply the same logic to our M&A strategy. Turning to the shorter term. We currently see a temporary softening in the business continuing on from Q1.

So let me outline the guidance for Q2 and the full year. During Q2, we expect billings to be in the range of $157 million to $161 million, up approximately 9% year-over-year at the midpoint. Total revenue is expected to be in the range of $141 million to $144 million, up 11% year-over-year at the midpoint. Gross margin is expected to be approximately 72%.

Non-GAAP operating margin is expected to be approximately 17%, reflecting continued growth investments. Non-GAAP earnings per share is expected to be approximately $0.09 per share, based on an expected diluted share count in the range of 169 million to 171 million shares. Pro forma tax rate is expected to remain at approximately 33%.

Now turning to the full year of 2013. Due to the lower-than-expected performance in the first half of the year, we currently expect the following: Billings to be in the range of $665 million to $675 million, up approximately 11% year-over-year at the midpoint; total revenue to be approximately $595 million to $605 million, up approximately 12% year-over-year at the midpoint. Please keep in mind that products and services revenue would grow at a combined 14% if we exclude the patent sale in 2012 and ratable revenue.

Gross margin to be approximately 72% and non-GAAP operating margin to be approximately 20% for the year. We do expect our operating margin to increase over the course of the year as it is seasonally lower in the first half of the year due to certain payroll-related tax expenses in the U.S. and Canada.

EPS to be approximately $0.49 based on an expected diluted — weighted diluted share count of approximately 170 million to 172 million. This includes $0.02 dilution from the Coyote Point technology enhancement transaction which we expect to be accretive next year.

We expect free cash flow to be in the range of $140 million to $150 million. As we’ve mentioned to you in recent quarters, we are considering a technology infrastructure upgrade and we’ll be moving our headquarters to a nearby location on or before March 31, 2014. I will keep you posted on both items as I gain more time in the business.

Let me now wrap up with some final points. With 1 week on the job, having studied Fortinet’s historical growth trends against macro dynamics, a high-level understanding of growing pain execution challenges with some management changes and the impact of continued mixed signals from the current macro dynamics, we believe the better part of wisdom is to continue our emphasis on growth with a prepared agility to adjust if necessary. No journey is free of bumps, and we, as a team, are laser-focused on continuing to be the market leader in providing innovative solutions to our customers and working with them as their dynamics and demands change. We are also keenly focused on improving our internal challenges and building the right foundation to scale our business to the $1 billion goal. We know the destination and are navigating accordingly.

I look forward to seeing some of the faces from my Ariba journey and meeting the rest of you in coming weeks. In closing, I’d like to thank the Fortinet employees, partners, customers and shareholders for their continued confidence and support in Fortinet.

With that, Ken, Michelle and I will now take your questions. Operator, you can start the Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Keith Weiss from Morgan Stanley.

Keith Weiss – Morgan Stanley, Research Division

Definitely appreciate taking down the guidance range for the full year in light of a uncertain macro environment. I was hoping maybe you could dig into us — with us a little bit the constituents of that. You definitely saw more weakness on the service provider side of the fence in Q1. When we look at your guidance for the full year, can you walk us through what you’re assuming in terms of service provider, the purchasing behavior that’s going to go on there and what kind of growth you’re going to see from service provider versus the rest of your business?

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Yes. Thanks for the question, Keith. I think for the time being, and again, mind you, and I’ll let Ken add or subtract, being a week on the job and having seen where other companies where enterprise is at large, I would give you the following color. In where we sit today, on April 30, things are pretty much the same relative to what we saw in the first quarter. Now having said that, I’ve also given you some color that within the U.S. provider space, we still feel very strong. From a competitive perspective, we’re still winning deals. The point is that there are lesser of them and that the buying behavior where somebody might be willing to extract a large deal a quarter ago, they’re looking at lesser buying capacity over coming months. I think until that changes, we probably will stick to that. And the full year guidance does take that into consideration, with some acceleration obviously in the back end of the year as more related to our historical performance in Q4 being our largest quarter.

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

Keith, I think — I believe the service provider is long-term wise still is a great space to be because you can see the press release we made yesterday is a joint release with Hughes Network. So that’s where the joint solutions is really have the service provider offer a lot of security service to their customer is one of the best way to manage security going forward. Because security, I think, are much more complicated and more difficult to manage just by the enterprise end user there. So that’s where we believe is a good space and we are very — I mean, at a much better position than other competitor in this space. And we’ll continue keeping invest and is one of the — long-term wise is one of the fast growing space going forward.

Keith Weiss – Morgan Stanley, Research Division

Got it. And if I could maybe sneak in one follow up. In terms of the execution issues in the quarter, to the extent that they were on the sales management side of the fence, and I think you mentioned some of that on the preliminary call. Any changes that you guys are enacting today in terms of improving, particularly sales management on a go forward basis?

Michelle Spolver – Vice President of Corporate Communications & Investor Relations

I don’t think on the pre call that we talked about sales management challenges. We talked about in Latin America that we had a lot of hiring that was happening there, and that we did acknowledge there was a change in management in the U.S. for our America sales, but I don’t believe we talked about management challenges.

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

Yes, the U.S. sales metric, we try to be more focused on the enterprise. That’s we have the fast growing sector, like last year we grew 55%, so that’s where we want to keep you less [ph] in the enterprise area. At the same time, we started hiring a lot of new sales people, which take about 9 to 12 months to ramp up. So that’s where the area we mentioned in the prepared announcement.

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Keith, just to give you a little more color on that, perhaps the other point I wasn’t obviously on the pre announcement call, but I did read the script. The other change is the fact that I’m walking in also as Chief Operating Officer. So part of the reason for joining is to help out on many fronts in the operations. Obviously, it’ll take time to both learn the business as well as try to figure out optimal solutions, so that we have a foundation to grow this business to its potential scale. So part of the answer to your question is, as I ramp up and learn the business, I’ll be a little more conversant on what it is we’re doing and helping across both the operating aspects and the challenges we had we saw in Q1, but as we face other challenges going forward.

Operator

The next question comes from Sterling Auty from JPMorgan.

Sterling P. Auty – JP Morgan Chase & Co, Research Division

I just wanted to follow on that last question in a slightly different way. Now that you’ve had a little bit more time to go through the data, in the service provider segment in North America, how much of a sense of the weakness was decisions by the service provider to delay contracts and purchase decisions versus was there any sales execution issues on that?

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Okay, let me take that, Sterling. Long time no hear. So in terms of where we are 2 weeks after the pre announcement having analyzed the data, it’s actually a mixed bag of fact patterns. But the overall the overarching answer to your question is the general softening in the economy is causing a mixed bag of behaviors. Some are delaying, some are buying less, some are dividing their purchasing capacity over time. So I think, until further notice, we’re going to make the assumption that it’ll continue to be that way in the current quarter, and we’re laser focused because, as Ken pointed out, it is a competitive differentiating area in terms of what we can do for the larger enterprises. And I can also tell you that in my first week on the job, believe it or not, I did find time to go out and talk to a couple of customers that fit that category. And it’s abundantly clear to me that this is really more macro and we do stand out, and the positioning of our growth in this area will pay off in due time.

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

We have a great product and also the best team, so that’s why we feel it’s long term why we’re in the best position in the space.

Sterling P. Auty – JP Morgan Chase & Co, Research Division

Got you, got you. And I should have started with Ahmed, welcome to the team. Congratulations. One more question and I’ll turn it over. As you look at the guidance for the June quarter, if nothing changes from a macro perspective, would you then say the midpoint of the range is the appropriate thought? Meaning, just trying to gauge if you’re factoring in any macro improvements not only in service provider, but more holistically into the guidance range?

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Yes, so I would say, Sterling, in respect to Q2, I would stick to the ranges I gave. And obviously, the midpoint is the safest bet. And as you know, much like where you and I have worked in the past, it’s pretty back end loaded. So we will not know anymore color really until the end of the quarter. But I certainly would not go above and beyond the range because it really is a continuation of what we saw from Q1.

Operator

The next question comes from Brent Thill from UBS.

Brent Thill – UBS Investment Bank, Research Division

Ahmed, welcome aboard. Just so I understand on the billings, you took the growth the guidance to 11% for the year versus, I believe, high teens, low 20%. Beyond the service provider market, you’re making assumptions I would assume for enterprise and SMB, and your assumptions are that both those categories are also going to be weaker. How should we think about that? Because that’s a fairly big change in terms of how you’re thinking about it now given what happened in Q1, if this truly was only a few, handful of service provider deals that slipped.

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

That’s a good question, Brent, and thanks. So the way I would look at it, I would extrapolate from what we learned in Q1. And that is, there was an element of lesser larger deals, which, as you know, is predominantly out of the U.S. provider market but service provider market, that is. But similarly in Europe, we saw more conservative buying behavior. So it’s not really so much about segmentation as it is about less larger deals, more conservative buying behavior in Europe, and some of it is also here in the U.S. In terms of Latin America, as you’ve seen with other companies, it’s a bit sluggish and volatile. One day up, one day down. For now, we’re staying the course in terms of what we saw in Q1. And obviously we remain very optimistic on our business in APAC. So it’s really more about the geographies, the macro impact than it is about segmentation.

Brent Thill – UBS Investment Bank, Research Division

Okay. And just as a quick follow up. The inventory issue was obviously a smaller piece of the shortfall, but you feel like you’ve got a good handle on that now as you’re deeper in?

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

I think as a team, we do. To be frank, Brent, in 1 week on the job, I still have more diligence myself to get into. So I will as we get to know each over time, I’ll be more conversant. But we have action plans in place, and I plan to dive deep into those issues to make sure we’re mitigating, not only for the current quarter, but that we have a process to mitigate going forward because we’re scaling the business.

Operator

The next question comes from Tal Liani from Bank of America.

Tal Liani – BofA Merrill Lynch, Research Division

Just first, would you mind to repeat the billing by vertical? I missed it, and you said it at the beginning. And second, which is a more kind of broader question. I’m trying to understand, you said on the call, at the beginning of the call, you said that it’s not a competitive issue, and what you’re seeing here is more the macro. But when I look back at your numbers, and the year over year growth in revenues, there was a major deceleration since 2011, and it goes every quarter. It was the growth year over year growth declined from 33%, 35% then 25%. Now we’re talking about 10%. So certain aspects of it is maybe cyclicality and the macro environment. But even if I add back the numbers, you’re still growing less than last year. And last year, you grew less than the previous year. So the question is, what drives this deceleration in your view? How this could turn up? And then we started seeing you purchasing a company recently. Is this a trend? Do you have intentions to acquire more companies in order to expand the addressable market and maybe accelerate the growth through M&A?

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

Do you want to take that one?

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Yes. So let me cover the segments for you first. The service provider was 25%; government, 13%; retail, 11%; financial services, 9%; and education, 6%.

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

To answer some of your growth questions. I think it was last year this time, we involving one of the bigger deals, which can help in the growth. I think last year at this time, I mean Q1, probably growth, I think 30 some%.

Michelle Spolver – Vice President of Corporate Communications & Investor Relations

28%.

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

Oh, 28%.

Michelle Spolver – Vice President of Corporate Communications & Investor Relations

Q2 was a tough comp. The growth there was 32%, which is close to double what we would normally grow at.

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

Yes, that’s helped in by one of the deal. Right now at the forecast we have not considered any major deal yet. But I think, going forward, once the new team in the position ramp up, we do see some potentials.

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Tom, another way to cut at your question and I fully understand your question. I don’t have the depth in terms of the historical numbers. But I can tell you, having studied the company a fair bit before joining it, is to also look at how much the addressable market has grown over that same time period and our differentiated position against that addressable market, is another way to look at it. And overall, as you look at the world where I come from, the cloud world and other areas, the UTM market is clearly going to be in demand and in more demand as time goes on. So the cyclicality piece you’re referring to, if anything, these are temporary blips based on everything we know right now, and they should correct. In terms of actual raw numbers and comps that Ken and Michelle were giving you, at the end of the day, that’s what I was trying to allude to in my comments, larger deals last year have actually made it a tougher comp in the current environment because we’re seeing less larger deals. But we’re seeing a lot more attractive deals at the same time. It’s just the number of larger deals slowed down in Q1, and we expect it to be the same in Q2.

Operator

The next question comes from Michael Turits from Raymond James.

Michael Turits – Raymond James & Associates, Inc., Research Division

A couple questions. First, I just wanted to make sure, Ken, you said that you were seeing slowing overall in terms of your outlook [indiscernible]. I assume, from your perspective, is this completely macro or are you seeing anything structural that changes your growth prospects?

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

I think, it’s more macro and also on the service provider, like I mentioned, some of the buying pattern changed and come from like kind of CapEx to OpEx kind of behavior. But I think, long term, with all the space, including the service provider, the [indiscernible] enterprise is also pretty strong. And we see the fast growing in the enterprise sector, so that’s where, last year Q1, that’s the strongest growing areas in enterprise.

Michael Turits – Raymond James & Associates, Inc., Research Division

And then on services were down sequentially in the quarter. So is that a professional services components, or what was the issue for that? Because that is the fastest growing company as you’ve been, you haven’t seen any kind of sequential declines in services before?

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

No, not in the professionals. Professional is a pretty small part of it. So that’s where I think, probably more relate to the what was the…

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Number of days, services.

Michelle Spolver – Vice President of Corporate Communications & Investor Relations

Oh, there’s no number of days to recognize the revenue, the services revenue.

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

There were 2 less business days to recognize services revenue.

Michael Turits – Raymond James & Associates, Inc., Research Division

Okay. And last question. On the free cash flow guide, you mentioned that you’ll be the investing for facilities change. Is there a particular large impact from CapEx relative to that? Or is there does cash flow from ops also have a similar kind of growth change?

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

We’re still about 1 year away from the facility. I think it’s a little bit too early to give the forecast right now.

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

I think that’s right. I think if you’re trying to reconcile the guidance on the free cash flow, it’s more commensurate with the decrease in billings. So billings have gone down, and in turn, I took the guidance down on free cash flow. In terms of the technology upgrade and the building, it’s too early now. But as I get my feet more wet in the business, I’ll be more conversant with numbers in future quarters.

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

Probably towards the end of year, we probably will be. But we need to reserve some of that because both are big spending there.

Operator

The next question comes from Tom Ernst from Deutsche Bank.

Unknown Analyst

It’s Tas [ph] on behalf of Tom. I had a question about the behavior change you referred to for the service providers. When you talk about CapEx to OpEx change, what exactly does that mean? Are you now getting paid ratably for the appliances you’re selling versus getting paid the full price upfront?

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

No, it’s not so much about payment terms. I think what Ken was alluding to, and I know you guys discussed it in the pre announcement call as well, is the notion in these large enterprises where CFOs may have been easily signing checks for larger deals, they’re signing lesser checks until they see the macro change for their own business. So it’s really more in that context versus payment terms and collecting it upfront and later, if that makes sense.

Unknown Analyst

Yes, it does. I mean, we spoke of [indiscernible] and they said there was some change in the behavior from the service providers, where they were not paying upfront. Instead of that they were actually tying in payment with their own revenue collection from the own end users. You’re not seeing any of that on your side?

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

We’re in the middle of the course. I can’t comment on current deals. And as you know, we’re back end loaded. These things happen when the macro shifts, people look at all sorts of different things. But for the time being, as you can tell from our receivables, our DSOs, all the other metrics, cash included, we didn’t see an impact of that in the first quarter. So in our case, I would assume business as usual until we tell you otherwise.

Unknown Analyst

Just one more follow up. You spoke about the growth in the space slowing down to 6% to 10%. And then if I look at your own guidance for the year, 11% billings guidance for the year. It seems like you’re pretty much growing in line with the market versus you’re getting share for the last couple of years.

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

Yes, I think the market growing from IDC’s forecast about 6% gone probably about 10%. We still growing almost double the market growing rate, so we’re still keeping gaining market share there.

Operator

The next question comes from Gray Powell from Wells Fargo Securities.

Priya Parasuraman – Wells Fargo Securities, LLC, Research Division

It’s actually Priya Parasuraman for Gray. I wonder in the longer term margin profile, I understand this is an investment year, but when do you think we should expect a snap back to more of 24% margin profile?

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

I think the question, I apologize, is premature. I think you need to give me some time to learn the business and get a better handle on the business model and where we’re going prospectively. I think for the current year, you should assume the numbers we’ve given you. As I get to know the business better, we’ll consider giving you guys more longer term targets that are also commensurate with our strategic plan and where we want to take the business.

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

Yes, and also we feel the best use of the cash will be investing in the business, so that’s where we feel the long term model will be keeping reasonable profit, but also investing the growth keeping gaining market share and also investing in the technology. So that’s where probably the model, I think about 27%, maybe a little bit higher, we would rather invest in the growth, so that’s where we feel will be a better long term position compared to make a lot of profit.

Priya Parasuraman – Wells Fargo Securities, LLC, Research Division

Okay. And then just on the enterprise vertical, if you could just talk qualitatively about it. And what kind of impact has it had overall?

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

I’m sorry, can you repeat the question please.

Priya Parasuraman – Wells Fargo Securities, LLC, Research Division

I’m curious if you could just comment qualitatively on your enterprise vertical, and how it did compared to your expectations? And if it has had any impact possibly on the ASPs?

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

Enterprise.

Michelle Spolver – Vice President of Corporate Communications & Investor Relations

I could take a little bit if it. So, Priya, it’s Michelle. We talked about that our enterprise the only thing we basically said is enterprise business in the U.S. did well. Some of it in relation to EMEA and the more conservative spending in EMEA was with the enterprises. But our U.S. enterprise, the area that we’ve been focused on growing, did very well this quarter. Not giving anything out quantitatively. And the second part of your question was what again?

Priya Parasuraman – Wells Fargo Securities, LLC, Research Division

No, that’s it for now.

Operator

The next question comes from Rohit Chopra from Wedbush.

Rohit N. Chopra – Wedbush Securities Inc., Research Division

Welcome, Ahmed. I had 3 questions. I just wanted to know, on the last call, you talked about some recapture of some slipped deals. I just wanted to get a status update, Ken, if you could. The other question was on government. You talked about the billings number being about 13% government. Can you just maybe break out U.S. federal from that, if you could? And then lastly, Coyote Point, when do you anticipate maybe an integrated product, if you will, if that’s what you’re thinking of, and maybe just talk about the investment required?

Michelle Spolver – Vice President of Corporate Communications & Investor Relations

I’m going to let Ahmed take most of it, but let me at least address the federal. We don’t that is our vertical breakdown is worldwide numbers, so it’s all government worldwide. We don’t break out and never have broken out federal.

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

The Coyote Point product, probably more towards the second half of the year. So will take some time because we it’s more acquire the technology, the team and then long term product integration. But right now we just want to take some time to gradually integrate.

Michelle Spolver – Vice President of Corporate Communications & Investor Relations

No, you get to talk about the deals.

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Can you repeat the question? I’m sorry.

Rohit N. Chopra – Wedbush Securities Inc., Research Division

No problem. I think…

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

I’m answering you exactly what you look for.

Rohit N. Chopra – Wedbush Securities Inc., Research Division

That’s fine. At the first call, the pre announcement call, Ken mentioned that they had that the company did recapture some deals that had slipped post the quarter. And I just wanted to see if you could give us an update of some of the deals that slipped, if you don’t mind.

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Well, so as customary, we don’t talk about deals within the quarter. And I think it also because, as you know, customarily that most of the deals close in the last couple weeks of the quarter. Here’s what I will tell you. I think what we’ve learned since the pre announcement is, it’s the same logic I gave earlier, that a lot of this is actually tied to the macro and the ability to write checks at those companies. So our current guidance for Q2 assumes our best capability in the current quarter in terms of sales delivery. And I answered the question earlier that the midpoint is where I would hang my hat. So there really isn’t any more color to give you at this point.

Michelle Spolver – Vice President of Corporate Communications & Investor Relations

Yes, I mean, just to clarify though, in the pre announcement call, we did not say that deals have already any of those deals had already closed back. Let’s go back to what we said a few weeks ago. We said based on what we knew at the time, those deals hadn’t been lost, just for clarification.

Operator

The next question comes from Shaul Eyal from Oppenheimer & Co.

Shaul Eyal – Oppenheimer & Co. Inc., Research Division

Ahmed, welcome onboard. Two quick questions in my end. Specifically on Latin America, was that more macro or just kind of internal kind of execution driven?

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

I think probably a little bit of both. I don’t think it was execution. We hired some people, which also take some effort, and also they need some time to ramp up. And on the other side also, there’s some like macro environment challenge there in a few countries in Latin America. And that also impact some number.

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

I think that’s exactly right. So when you look at the bellwethers in Latin America, Brazil has been up and down over the last several quarters. So we saw an element of that. And to Ken’s point, there were some geopolitical issues, while smaller in number, also impacted. And our internal bit was focusing on the growth. And we’re on top of that. That’s one of the areas that I’m actually personally working on, having lived in Latin America in the past, to make sure that we’re going about the market with all the investments that we’ve made to date. So we’re excited about what Latin America may still bring in coming quarters.

Shaul Eyal – Oppenheimer & Co. Inc., Research Division

And one more question. Obviously, you’re coming in also as not only the CFO, but also kind of the COO. In the past few weeks, ever since you came onboard, what’s your thinking of the company strategy, systems in place, any deficiencies you have in mind that might need some improvement down the road? What’s kind of the overall view in the very, very kind of near term that you have been with Fortinet.

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Sure. I appreciate the question. Look, from my perspective, obviously, with 1 week on the job, the best illustration I can give you is drinking out of a firehose. And those of you that have interacted with me know that I dig deep into the business and learn as much as I can. And so it’s going to take me some time to ramp up in terms of an understanding of our products, where we are. And I also plan to spend a lot of time at customers, with our engineers, and connecting all the dots from product to commercial commercialization of our products. So having said that, what can I tell you after the first week? Look, I joined this company for a reason. As most of you know, we sold Ariba back in October, and I’ve been very selective. I picked Fortinet because it has an advantage product, and that is most important. So the fact that there was a pre announcement, the fact that there’s a bit of a softening in the macro at the moment is really neither here nor there. We’re well positioned, and I have the conviction that that’s where we’re going. We obviously have some internal challenges that come along with growing any business, and that’s why I call them growing pains. But those of you that have interacted with me in the past know that I’ve gone through all of that. So I would summarize it as follows: I’m going to spend a lot of time learning. Even in my first week, as I mentioned, I’ve gotten out to customers, and I really appreciate Ken and the team taking me in. And there’s going to be a lot of mentoring and teaching in coming weeks until I really figure out where things are, where the bathroom is and so on. But once we get past that, I’ll be a little more conversant on where we’re going prospectively. In terms of the strategy, I think the strategy is pretty obvious. Look, the product is advantaged in one particular context, and that is, it can do more with higher performance, far more reliable, far more scalable. So having just graduated from a cloud business, having been in other businesses, these are ever increasing areas of demand for companies to reckon with, of all sizes, across all verticals and across all geographies. And so while Q1 was soft, Q2 continues to be soft, we did see a handsome uptick in APAC as an example. And that is terrific validation also. And in a very large wireless company, as I talked about earlier. So the strategy is growth, both organic and inorganic. The company’s history to date is we’ve looked at technology enhancements to add to our portfolio of products. You have as you know, this is all public information, the number of patents is very impressive at this company. And so we will work together as a team to keep growing this company. And as I indicated earlier, have the agility to pull back if we ever need to. So hopefully that gives you a little bit of color, at least at a high level.

Operator

The next question comes from Fatima Boolani from Jefferies.

Fatima Boolani – Jefferies & Company, Inc., Research Division

This is Fatima on behalf of Aaron. I just wanted to drill down on the service provider a little bit more and understand better the mechanics of the sale. What sort of subscription attach rates do you see on that? And I guess what I’m trying to ask is, how would continued weakness in this vertical impact cash flow, cash flow growth?

Ken Xie – Co-Founder, Chairman, Chief Executive Officer and President

I think we not quite gave the specific sector renewal rate. But we our renewal rate is above or high, consider we’re tracking the renewal based on the product, not based on the customer. So the current renewal rate is in the higher 70%. If you look in the on the average life of the product in the customer hand, probably average about 4 years. So that’s probably more like a high 90% of renewal if you kind of do some kind of math there. So that’s where the I think, that the service provider probably similar to that, we don’t see much difference.

Fatima Boolani – Jefferies & Company, Inc., Research Division

Maybe to ask the question in a different way. Do you see more firewall only sales within this vertical?

Michelle Spolver – Vice President of Corporate Communications & Investor Relations

Yes, I think that’s you were saying services or subscription attach rate. In general, to go from Ken’s point, is we don’t break out by sector, but it’s not all that different. In general, it’s about 80% of the people who buy our FortiGate products buy them with subscriptions, so roughly 20% or so firewall only. I think most of it, it depends on how it’s deployed. When most of our service provider deals are for those companies using our systems to provide managed security services. A lot of those times, they’re using it with our bundled subscriptions. Where we see firewall only deployments most often are large enterprises.

Fatima Boolani – Jefferies & Company, Inc., Research Division

Understood. That’s helpful. And then an immediate follow up. The service provider vertical has just been a challenging one for many companies. As this turns and recovers for your business, what is your outlook on the product mix shift as the year progresses? And that’s it for me.

Michelle Spolver – Vice President of Corporate Communications & Investor Relations

Yes, your first part, we forgot to address it. That was about ASPs. I mean, in general, it depends on how that really, we don’t give out the ASPs, but the product mix shift really depends on the type of products that are sold within that quarter. So it changes a bit quarter to quarter. Service providers tend to, not always, but tend to buy the higher end products, unless its a CPE based deployment. And in that type of instance, they’ll buy a few very, very high end products, and then it could be hundreds or thousands or more of low end products. So that could alter the product mix or ASPs.

Operator

[Operator Instructions] The next question comes from Jonathan Ho from William Blair & Company.

John Weidemoyer

This is John Weidemoyer for Jonathan. Ahmed, I realize you’re new on the job, recently. I’d like to make sure I understand though. When you’ve reassessed the near term impacts of demand in the market, particularly in the service provider space, it seems like it was more of a top down, so to speak, assessment of your outlook as opposed to I’m wondering, the extent to which you could do a bottom up assessment and poll and query customers in the pipeline, and especially the service provider space. Can you talk a little bit about that, please?

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Are you asking about the process we went through in understanding what took place in Q1 and how we thought about Q2?

John Weidemoyer

And the rest of the fiscal year, yes.

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Right, right. So I think it was both, tops down and bottoms up, as well as qualitative input from customers, as well as other external market data. So we went about it from all angles, and feel very comfortable that we understand what took place in Q1. Also feel very comfortable that this is not about conservatism. This is just reality. What we saw in Q1 continues on in Q2. And we’ve got our fingers crossed, all pedals pushed to generate what we need to in Q2. And as you know, we will not see that until the last couple of weeks of the quarter. Extrapolating that into the last the latter part of the year, we took a little bit of both all the angles I described to you, plus the fact that we’ve been making investments all along for several quarters. So we’re expecting some ramp up to come in and help out later in the latter part of the year.

Operator

At this time, I am showing no further questions. I would now like to turn the call back over to Ahmed for closing remarks.

Ahmed Rubaie – Chief Operating Officer and Chief Financial Officer

Thanks, everybody. And for those of you that have more detailed questions, we look forward to talking to you at 3:30. And again, we appreciate your continued confidence in Fortinet. I look forward to working with all of you.

Operator

Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.

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