Good day, ladies and gentlemen, and welcome to the Fortinet First Quarter 2018 Earnings Conference Call. At this time, all As a reminder, this conference call is being recorded. I would now like to turn the conference over to Mr. Peter Salkowski, Vice President of Investor Relations. Sir, you may begin.
Thank you, Takiya. Good afternoon, everyone. This Peter Salkowski, Vice President of Investor Relations at Fortinet. I'm pleased to welcome you to our call to discuss Fortinet's financial results for the Q1 of 2018. Speakers on today's call are Ken Xie, Fortinet's Founder, Chairman and CEO and Keith Jensen, our CFO.
This is a live call that is available for replay via webcast on our Investor Relations website. Ken will begin our call today by providing a high level of perspective on our business. Keith will then follow our financial and operating results and conclude by providing our forward guidance outlook before opening up the call for questions. During the Q and A session, we ask that you please be aware of the limited time we have for this call and make your questions brief to allow others to participate as we have discontinued the practice of hosting a second call. Before we begin, I'd like to remind you that on today's call, we will be 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 results of risk factors in our most recent Form 10 ks and Forms 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 otherwise stated. Our GAAP results and GAAP to non GAAP reconciliations can be found in our earnings press release and in the presentation that accompany today's remarks, both of which are posted on our Investor Relations website.
As for the presentation, the last slide summarizes the impact of the accounting change to ASC 606 with regards to the Q1 results. Lastly, all references to growth are on a year over year basis unless otherwise noted. I will now turn the call over to Ken.
Thanks, Peter, and thank you for everyone for joining today's call to discuss our Q1 2018 results. Once again, we demonstrate our market leadership by our strong first quarter performance. In the quarter, Billing were up 15% to $463,000,000 and revenue was up 17% to $399,000,000 both above the high end of our guidance. We continue to invest to fuel our above market growth, especially in sales and marketing, while remain focused on improving profitability. During the quarter, we host our 1st ever Financial Analyst Day together with Accelerate, our global partner and customer conference.
The event provided us with a forum to review the strong performance of our financial model as well as highlight our significant opportunities for growth with our security fabric architecture. The feedback we received from both analysts and investor were extremely positive. An important message we covered during the Financial Analyst Day was the evolution of network security in this period of digital transformation. Fortinet pioneered and lead the current generation of UTM and next gen firewall network security and is pioneering and leading the new generation of network security, which we refer to as the 3rd generation. The 3rd generation of network security, which is the security fabric, is in the early stage and delivers integrated protection and detection across entire digital attack surface.
We expect that this evolution will drive growth within our installed base and also with new customers. In the Q1, our core FortiGate network security business account for 3 quarter of the billions. This market leading network security business is driven by our unmatched security functionality and performance of a highly differentiated Forti ASIC technology security processor unit, SPU. Developing customized ASIC to enhance application performance is a growing trend among leading technology companies such as NVIDIA with its GPU and Google with its TPU ASIC. FortiOS 6.0 was released in Q1 and is the most widely deployed network security operation system in the market.
It is the central building block for the latest evolution of Fortinet Security Fabric as well as applications such as IoT, SD WAN and hybrid cloud security. Billions for our non FortiGate part of our fabric grow faster than our FortiGate business and accounted for a quarter of a 1,000,000,000. The Fortinet Security Fabric delivers a broad and widely integrated and automated security solution for enterprise worldwide, offering huge opportunity for growth. Additionally, cloud security continues to be a faster growing part of our business. We work with all of the major cloud provider and will continue to expand our fabric offering for multi cloud environments.
As of Q1, the security fabric is fully available within AWS environments. During the quarter, we announced 11 new fabric ready partners, including Arista, IBM, McAfee, ServiceNow and VMware. To date, Fortinet has 43 fabric ready partners, which further expand our security fabric across the hybrid cloud. The transition into the 3rd generation of network security is expected to drive our growth as well as market share gains in the next few years. We continue to balance investment to make sure Fortinet remain our technology and market leader, while improving operation margin as we work towards our goal of achieving our long term operation margin target of 25% by 2022.
Now before I turn the call over for a review of our Q1 financial results, I would like to congratulate Keith Jensen for being appointed by our Board of Directors to be our Chief Financial Officer. Congratulations, Keith. I will now turn the call over to you for a close look at our Q1 performance and our Q2 and full year guidance.
Thank you, Ken. I look forward to working with you and the entire Fortinet team. I also appreciate the support of the Board and the Fortinet executive Now turning to the quarter. I'm very pleased with our Q1 results. Revenues, margins and earnings per share all performed well.
We posted strong year over year billings growth and we repurchased over $100,000,000 of stock. Security remains a growing industry and we are well positioned to outpace the market. Our product portfolio, geographic diversity and our mission to deliver the most innovative and highest performing network security fabric in the industry places us in a strong leadership position. We remain committed to achieving above industry growth, improving profitability and as Ken mentioned, achieving our non GAAP operating margin goal of 25% by 2022. Now for our Q1 results, starting with revenue.
Revenue grew 17% to $399,000,000 driven by service revenue growth of 25% to $256,000,000 As a reminder, we provide 2 subscription based services attached to most of our product sales. Our traditional support offering, FortiCare, generated 1st quarter revenue of $110,000,000 up 35%. And our security subscription offering, OtiGuard, generated revenue of $137,000,000 up 20%. Consistent with my commentary at the Analyst Day regarding predictability, existing deferred revenue accounted for 60% of our Q1 revenue. In the Q1, deferred revenue itself grew to $1,400,000,000 up 27%.
Our mix of short term and long term deferred revenue was consistent quarter over quarter at 59% current and 41% long term. In the Q1, product revenue was $143,000,000 versus $135,000,000 in the year earlier period. Product revenue in the Q1 of 2018 included a $5,700,000 benefit from the change to 606 accounting. We expect a similar to smaller impact to revenue throughout the rest of 2018. The average contract length decreased sequentially 1 month to 25 months in the Q1.
48 unit shipments increased 20% year over year. As you can see on Slides 56, we remain a geographically diversified business. 1st quarter revenue from the Americas represented 44% of our business and grew 20%. EMEA represented 36% of our business and grew 15%. APAC represented 20% of our business and grew 16%.
Now turning to billings. 1st quarter billings of 463,000,000 dollars grew 15%, solid growth despite a difficult year earlier comp due to an 8 figure deal in the Q1 of 2017. We saw continued growth in both enterprise and UTM service bundles during the quarter. The security fabric and cloud continued to outpace our growth. The Security Fabric, which is the largest component of our non FortiGate offerings, benefited from customers' recognition of its value, performance and comprehensive security coverage.
Our enterprise successes in the quarter included a mid-seven figure renewal and cross sell deal with a major U. S. Technology company. The cross sell component was a competitive displacement using our advanced threat protection element of the security fabric providing stronger integration and effectiveness against an existing point solution. Further, our licensing model provided the customer with the ongoing choice of appliance or cloud deployments.
Regarding cloud billings, while the billings are relatively small versus the rest of the business, we experienced triple digit growth in both on demand cloud consumption and bring your own license. Across our cloud partners, AWS continues to be the leader with contributions coming from Azure. Oracle, Google and IBM each came online with initial billings during the Q1. Bring your own license growth was fueled by 5 and 6 figure engagements across the major cloud providers, along with a 7 figure cloud engagement with a large enterprise U. S.
Retailer. Let's now turn to the breakdown of our billings across our top 5 verticals in midenterprise and enterprise markets. Service providers accounted for 20% of billings, followed by government at 14%, financial services at 11%, retail at 9% and education at 7%. The billing breakdown by vertical as well as the percentage of billings coming from the top 5 verticals is consistent with the average of the last 10 quarters. On a geographic basis, billings in the Americas grew 11%, EMEA billings grew 21%, and APAC billings were up 13%.
The number of deals over $50,000 grew 20%, illustrating the continued strength of our network security business among small and medium sized enterprise. Meanwhile, the number of deals over $1,000,000 were up 21%, demonstrating growth in our enterprise business. Looking at our top 25 customer billings, which were all over $1,000,000 we saw a pattern similar to prior quarters. These billings showed a predictable balance across business verticals and geographies with a slight uptick in the Americas. The top two deals were mid 7 figure deals in the EMEA Carrier Group.
In the Q1, we saw customer billings weighted towards renewals in line with our seasonal pattern. Returning to the income statement, our Q1 gross margin was up year over year from 74.5% to 76.7 percent or 2.1 points. Our product gross margin was consistent with the prior year at about 60%, while services gross margins expanded 1.6 points to 86%. Our gross margin remains strong due to the mix shift in our revenue to higher margin, more predictable subscription services, providing a tailwind to longer term gross margins. Excluding a benefit of $11,700,000 from the new accounting standards and how it impacted commissions, total first quarter operating expenses were up 17% to $247,000,000 The increase in operating expenses was driven by a $7,000,000 headwind from FX and a 16.8% increase in sales and marketing.
Hiring in the Q4 of 2017 and the Q1 of 2018 was a significant driver of the increased operating expenses. Since September 30, 2017, the headcount for sales and marketing has increased 12%. As we have mentioned previously, we continue investing in sales capacity in order to fuel growth. However, our goal remains to balance growth with near term to balance it with near term and long term profit goals. That said, we are now entering a phase of more normalized headcount activity.
Including a benefit of approximately 3.90 basis points associated with the 606 accounting change, the 1st quarter operating margin was 17.7%, up 5 10 basis points year over year. Excluding the 3.90 basis points benefit, the 1st quarter operating margin would have been 13.8%. This is 130 basis points higher in the midpoint of our 12% to 13% guidance range under the old accounting rules. The upside in operating margin is due to strong gross margin performance resulting from slightly better than expected revenue growth and the mix shift discussed a moment ago. Please refer to the last slide in the earnings deck where we posted on our Investor Relations website this afternoon a line by line comparison between our non GAAP results and our non GAAP results excluding the impact of 606.
For the remainder of 2018, we now expect the operating margin benefit from 606 to be around 2 50 basis points. Net income for the Q1 was $57,000,000 or $0.33 per share based on approximately 172,000,000 diluted shares. Excluding the full 606 benefit, our first quarter earnings per share would have been $0.26 versus our guidance of $0.21 to 0.22 with the upside attributable to better than expected margin performance. As expected, the annualized non GAAP tax rate was 24%. Slides 89 review our balance sheet and provide more information for your reference on our cash flow.
We ended the quarter with a strong balance sheet, including $1,400,000,000 in cash and investments. During the quarter, we repatriated $130,000,000 of overseas cash. We expect to be able to repatriate an additional $150,000,000 over the remainder of 2018. We ended the Q1 with inventory of $80,000,000 Inventory turns were 2.4x, up from 1.6x in the year earlier period and above our average of approximately 2.2x. Cash from operations was $140,000,000 representing growth of 8%.
Free cash flow in the Q1 was $128,000,000 up 10%. Capital expenditures in the Q1 were $12,000,000 2nd quarter capital expenditures should be between $25,000,000 $30,000,000 Construction of our new headquarters is expected to start in the Q3. We estimate 2018 spending on this project to be approximately $20,000,000 to $30,000,000 occurring mostly in the second half of the year. Capital expenditures for all of 2018 are expected to be $85,000,000 to $100,000,000 In the Q1, we returned $115,500,000 to our shareholders through the repurchase of 2,500,000 shares of short of net for net stock. As of March 31, 2018, approximately $327,000,000 remained in share repurchase authorization for the plan that expires in January 2019.
We believe share repurchase is a good method for returning value to shareholders and expect to continue this practice. Now turning to guidance. First, I'd like to remind everyone that the forward looking of the forward looking disclaimer Peter presented at the start of the call and how it applies to the guidance specifically that I'm about to provide. In the 2nd quarter, guidance including the benefit of 606, we expect billings in the range of $485,000,000 to $495,000,000 revenue in the range of $420,000,000 to $430,000,000 non GAAP gross margin of 75% to 76% non GAAP operating margins of 18.5 percent to 19%. This guidance includes an operating margin benefit of 200 basis points from 606.
Non GAAP earnings per share of $0.34 to $0.36 which again includes a benefit of $0.05 from 606 and assumes a share count of $173,000,000 to $175,000,000 For 2018, the full year, including the benefit of 606, we expect billings in the range of $2,040,000,000 to 2,065,000,000 dollars Revenue in the range of $1,715,000,000 to 1,735,000,000 dollars non GAAP gross margin of 75% to 76%, non GAAP operating margin of 20.2% to 20.7%. This includes an operating margin benefit of 250 basis points from 606. Non GAAP tax rate still at 24%. Non GAAP earnings per share of $1.51 to $1.55 which includes a benefit of $0.19 from ASC 606 and assumes a share count of $175,000,000 to $177,000,000 Slide 12 in the earnings slide deck I referenced a moment ago contains a summary of our guidance for the Q2 and for the full year. And with that, I'll now hand the call back to Peter.
Thank you, Keith. We are ready to open the call for questions.
40 minutes.
Thank Our first question comes from Shaw Yul of Oppenheimer. Your line is now open.
Thank you. Good afternoon, guys. Congrats on strong performance and guidance. Congrats, Keith, on the promotion. Great work across the board when even excluding the 6/0/6 impact.
Great work on deferred revenue up nicely year over year. My question is on EMEA. Another set of strong results. In your case, is it GDPR specifically or is it the ongoing good execution, demand environment, pricing, all of the above, how would you characterize that? Thank you.
Sean, it's Ken.
It's a good question. I think it's a combination of both. We have strong team in EMEA and also GDPR also help. And compared to some other region, the EMEA team is pretty long term stable. They're keeping doing quite well.
Got it. Thank you for that. I'll step aside this time. Thank you. Good luck.
Thank you. And our next question comes from the line of Fatima Boolani of UBS. Your line is now open.
Thank you for taking the questions. A quick one for Ken. Ken, 2017 marked a year in which you saw sort of divergent strength in the carrier vertical, whereas international was strong, domestic was weak. I was wondering, what sort of trends you're seeing in 2018? And then a quick follow-up for Keith around large deal.
In your prepared remarks, you mentioned a ton of large deal momentum, both on the new product side as well as renewal side. Can you help us walk through sort of how you discount large deal and large deal momentum in your guidance? And that's it for me. Thank you.
Okay. I think the carrier service provider space using a stabilized starting recover, but not quite as the like not quite there yet. And especially international, they're little bit ahead of American here in U. S. And also kind of little bit related to the previous question, Sean asked because our top two deal come from the Europe service provider carrier space.
That's also kind of helping both on Europe carrier space a lot. But if you compare to year over year, it's pretty much on a percentage wise, pretty much flat. So I'd say, there's still a lot of opportunity. And also we launched a new product, the high end more target carrier to big service provider, the big enterprise account, which also takes some time, because it tend to be long sales cycle. That's also kind of a when we say, when is some time to ramp up?
Hi, Fatima. Good question. To really get to the quick of it, we look at large deals we split large deals between the U. S. And the rest of the world.
It's a larger population oftentimes in the U. S. As compared to the rest of the world. And so we want to kind of bifurcate that when we look at our forecasting and guidance setting process. We look at our historical rates of number of deals, the dollar value associated with those deals and our historical close rates.
And then we have conversations with the key salespeople that are involved to get a sense of where we should be with our expected close rates in the current quarter as we set our guidance.
Very helpful and congratulations on the formal appointment.
Yes. Thank you very much.
Thank you. Our next question comes from Sterling Auty of JPMorgan. Your line is now open.
Yes, thanks. Hi, guys. Just want to make want a little help reconciling. I think Keith, you mentioned unit volumes were up 20%, you have billings up 15%. How much of the difference was mix, which you talked about?
How much was duration? And were there any other factors to bridge the growth rates?
Yes. I think the we're very pleased with the 20% growth in our unit shipments, right? That provides a footprint for us to continue to sell services. So 1st and foremost, that's very, very attractive. I think when you look at the mix quarter to quarter year over year, what we did not have was the large high end deal in the Q1 of 2018 that we had in the Q1 of 2017.
And so when you look at the mix between high end, low end and mid range, we saw more low end in the quarter than we did a year ago.
Got it. Go ahead.
No, go ahead. Sorry.
I see that's the one single deal 8 digit 1 years ago pretty much all high end. And also in the last few quarters, we launched 6000, 7000,000, new 7000, which also take a little bit long time to sell because as our bigger carrier. That's also contribute to some of the high end percentage will be lower, but what we do see is a more competitive product, which we feel we're confident we'll be keeping gaining share also in the high end later.
That makes sense. And then Keith one more just working capital impact on cash flow in the quarter. I think cash from operations may have been down or flattish year over year. What was happening in working capital? And what should we expect as we look to the full year on the cash from operations side?
We don't typically model to free cash flow or operating cash flow. My recollection was it was up slightly 8% on operating cash flow year over year. So we feel good about that. I think I've spoken previously that some of the large drivers in addition to obviously earnings, monitoring inventory changes, deferred revenue and such are among the large drivers as you go forward and model it.
Okay. Thank you.
Thank you. Our next question comes from Gabriella Borges of Goldman Sachs. Your line is now open.
Great. Good afternoon. Thanks for taking my question. Keith, on the outlook for the full year, you mentioned the elevated hiring in 4Q and 1Q. Just curious how you're and for guidance in the second half?
The follow-up is for Ken on SD WAN technology. What we tend to see with communications technologies is they take multiple years to ramp. So the question is, are you starting to see SD WAN come up in more conversations? And how does your solution compare to something like a Zscaler or a Cisco when you think about the competitive environment there? Thank you.
Hi, Gabriela. Thank you very much for the question. I think the we would expect in remodeling seasonality in the current year that's not inconsistent what we've seen in earlier years. I think that's one part of your question. The second part, I think, was productivity.
I would say I feel very comfortable with the required productivity level based upon the current headcount and the net headcount planning as we go forward for the rest of the year.
Yes. For the question related to the SD WAN, the other cloud related player and also like Cisco. We have SD WAN fully integrated into the FortiOS, which we have a one box. They offer both the security, the SD WAN, the other like Wi Fi access, the other networks function, access function like Wi Fi all these things. It's different than the other vendor they have to use in multiple box.
Because today's actually one offering, they don't have a processing power, don't have computing power to do any security things there. So that's a huge advantage for the customer. And also different compared to some cloud provider, which IT WAN is really the benefits more come from the branch office, a lot of big deployment for the service provider. And that's where it's a huge benefit if they can integrate together with the security function, with other network and access function together. So that's we see a lot of advantage and a lot of interest, a lot of trial from the field.
So we do believe we're leading this space and we'll be benefiting a lot from this well integrated and automated approach.
Thank you for the color.
Thank you.
Thank you. Our next question comes from Keith Bachman of Bank of Montreal. Your line is now open.
Thank you very much. And Keith, congratulations on the appointment. I had 2 and I'll just ask them at once. First, Keith for you, you indicated that the 606 benefit, the revs, which is in the thank you very much for the helpful chart was about $6,000,000 or a little bit overall in. I think you said it was less going forward, but I just wanted to see if you could clarify pursuant to the top line guidance that you provided for 2018 what the benefit is?
Again, you've been very helpful in providing the operating income and EPS, but just want a little bit of granularity on the top line. The second, Ken, is for you. When we gathered in Vegas a few months ago, you were talking about operating or the margins post this year and you were going to take some investor feedback on the dilemma or challenge or opportunity of pursuing more market share versus the margins. And I just wanted to see if you had any additional comments pursuant to any feedback you might have gotten. My take from the call, you sounded positive on certainly reaching the milestone that you've established for 20 22 of 25%.
But I just wanted to see if you want to offer any follow-up color. That's it for me. Thanks very much.
Hi, Keith. Thank you for your comments. So don't want to make too much of accounting granularity, but two things that impact us really on the revenue line for 606. One is some time based software licenses revenue and that's the kind of the small item that we continue to see benefit from the rest of the year. The second change was how we recognize revenue in the U.
S. Market. Previously, we were on a sell in basis probably sell through basis. And we are now on a sell in basis. And so that change probably lifted revenue about $4,000,000 in the quarter.
And I would not expect that one time change, given their small numbers, I would not expect to see that one time type change again in future quarters. That's why I'm guiding a lower impact on the revenue line going forward.
Okay. That 4% was part of the 6% Keith?
Yes. Okay. Thank
you. Like I said, I kind of repeat the target of a 25% margin by 2022 in my script there. But also we see the market opportunity. I think it's probably the next 1 or 2 years you will see some refreshing cycle come up. And we do believe we kind of in the last couple of quarters, we add additional hiring effort and catch up the hiring shortfall we have in early part of last year.
And so we do add sales capacity, but at the same time we also want to improving the productivity and also make sure we also make sure the efficiency also there. So that's where we try to balance upon these 2. So the end goal is the same. We may try to leave a little bit of room on the way to reach there. But as we also depend on the market condition, the product launching and the other things we're doing within the company.
But the goal is the same. We want to reach 25% operating margin in the next 3 years. But it's also we still try to balance among both the growth and also the profitability of the margin.
Okay. Thank you, Ken.
Thank you.
Thank you. Our next question comes from Melissa Franchi of Morgan Stanley. Your line is now open. Yes. Thanks for taking my question.
Ken, you mentioned 20% unit growth, but I'm just wondering if you could characterize to what extent is that coming from the refresh of your existing base or is there a greenfield opportunity? And then when the customer refreshes an appliance, is there any way to think about the additional spend that they are spending with Fornett either through a bigger appliance or spending additional around the services?
I think the high end is a little bit more time to close the deal because we launched the high end 6000, 7000 in the last few quarters. So that's where the percentage come from high end a little bit lower, but the total union growth 20% above the building growth of 15%. A lot of come from helping come from whether I think we started to have SD WAN function in 5.6 which is the FortiOS we launched almost 2 years ago. And then the FortiOS 6.0 keeping enhancing that. That's also drive a lot of our branch deployment of other interest from the field.
So that's where helping drive a lot of like SMBs and low end unit growing there. But we do believe the high end will keep coming back after maybe couple of quarter once the customer like fully evaluate the benefit of the high end unit and also sometimes the carrier service provider and the big account also take a little bit long time to close the deal. So the unit is more drive by the low end side is above average.
Okay. And then just one quick follow-up for Keith. I just wanted to hear your views on continued return of cash now that you're repatriating cash throughout 2018 and how investors should think about the use of cash across buybacks versus potential M and A?
Thanks Melissa. I think we've talked before that in Q1, we said we thought we'd be aggressive in our buyback approach. And you should expect to I would offer the same commentary that I'd expect Q2 as we move through the year to be consistent with Q1, if that's what you're looking for. I think our overall
revenue Just balance relative to
M and A.
Yes. I think we have a history of looking at tuck ins as we build out the fabric. I don't sense a change of that in the last couple of months. We continue to be very, very proud with organic approach to building out our fully integrated product suite. We continue to believe that there is significant benefit from that methodology and we're very happy with it.
Also for the unit growth, like we have based on the ITC data, we almost have a 30% of total global deployment. And in some region, country like APAC, we almost more than half of the deployment is already the Fortinet product. And we do expect keeping gaining the share. I hope in a few years we can have a global more than half, more than 50% global deployments really for FortiGate product. And that's also keeping driving by the new AC come up later this year and also the new FortiOS 6.0 which add a lot of function like SD WAN helping driving the additional growth.
Okay. Thank you very much.
Thank you.
Thank you. Our next question comes from Saket Kalia of Barclays. Your line is now open.
Hi, guys. Thanks for taking my questions here and congrats as well to you Keith on the permanent seat.
Thank you very much.
Hey, maybe just to start with you Keith. Can you just talk a little bit about the cloud security part of the business? I think you said it's the fastest growing part of the business. But can you talk about how much of those may be coming from new customers versus existing?
Don't know. So we would have probably 3 key elements to the cloud. When we talk about cloud, we would talk about on demand or pay as you go, as we call it. We would talk about BYOL and we would also talk about on prem or hybrid clouds. I don't know obviously the on demand, I don't could speak to the words source of new customers or existing customers.
And I really don't have color in terms of new logos versus existing logos on BYOL or hybrid or on prem. Okay. Overall, I would say we're very I'm very, very excited about the cloud opportunity, particularly with them all coming online now. I understand they have somewhat different models sometimes. You may have some that are more focused on on demand, others that are maybe focused on leveraging their current customer or client base and more of a BYOL model.
But there's a lot of exciting things happening in the cloud for us.
Yes. Keith mentioned in the earnings group is cloud is a triple digit growth. But also beside cloud, we also are leading and see strong growth potential in the IoT, OT space. So we demonstrate in United States a connected car security and a lot of IoT, OT security also we're starting to see a lot of potential going forward.
Yes. I would probably just come back to the one example we gave in my text earlier. It was an existing customer, but we also use that opportunity to displace a competitor, and we would call it a hybrid cloud type of a situation. The total universe remains small, but that was very noticeable and very positive for us.
I also mentioned in the AWS, we offered a full fabric in the cloud environment. That's not only the network security, but also from like email, from the web, from the log analysis, from all the management. So there's just a lot of fabric approach in the cloud environment. I think we have the most broad solution and that's really the fabric approach also doing well in the cloud environment.
So Ken that's actually a great segue to my follow-up for you. I know that we said the non FortiGate business is still about 25% of total. But could you just talk about your conversations with customers? And just anecdotally, how willing are they to consolidate perhaps some of their security vendors and adopt other parts of the fabric outside of FortiGate?
I think so far we're leading gaining share based on the most comfort of FortiGate. But then the advantage we have with all the other part of fabric integrate together that has huge advantage because the number one issue customer facing today is really the management cost is very high. And on the big enterprise average they have to deal with 20 to 30 different security vendor and most of them don't even connect a top of the charger which making the fabric of the code infrastructure security defense is very difficult. If you cannot integrate, you cannot automate a defense, you cannot make all these different part infrastructure working together to defend attack. So that's the huge advantage of the fabric.
Not only just our own product, but also the fabric ready program. I mentioned we have a 43 fabric ready partner. That's also make sure each all different part of our infrastructure can talk to each other. So FortiGate had Fortinet product have all the API to integrate with other different partners also. So this approach we see huge advantage and the lowered management cost make it more secure, more automated to defense.
So that's where the enterprise like it a lot. So we do see a huge potential going forward both within our own product, which we tend to build from the beginning to integrate automate together and also working with our partner product. So it's a grow faster than the FortiGate and also is a huge opportunity to upsell, cross sell our installation base. Like I mentioned, we have almost 30% global deployment on the union base, which also give us a huge base to potentially grow from the current base. And then the new opportunity mostly come from enterprise.
We also see a lot of potential there.
Very helpful. Thanks guys.
Thank you.
Thank you. Our next question comes from Gray Powell of Deutsche Bank. Your line is now open.
Great. Thanks for taking the questions. Maybe just at the industry level, how do you feel about the pace of appliance or product revenue growth in 2018 versus 2017?
I feel the market condition probably improving a little bit. And like I mentioned every 4, 5 years the refresh cycle come up. The last refresh cycle come from like 2013, 2014. That time mostly come from the we call the current generation UTM, replacing the traditional firewall. And now we see the new refresh come in.
I would rather say this is the new generation using the infrastructure fabric approach, which connect from the network side to the endpoint to the cloud to the access to the application like email web together to defend replacing just the network security only. So that's where we feel this is a new trend and it just started and may take a few years to even for some both the customer partner to realize the benefit of this infrastructure protection approach. But I do believe this is a great opportunity to refresh to accelerate some of the growth both in the appliance and also in the cloud environment because the fabric do include in the cloud, which is a part of the infrastructure. So that's kind of an addition to the traditional plans, which also needed in a lot of CPE environment and also in a lot of branch office also in the high quarter data center.
Understood. And then
yes This is Keith again. I would just add to that again. 20% unit shipment growth year over year, and I think we've been talking about that for a couple of quarters now on our calls. I'm excited about the shipment growth and I'm not concerned about whether it shows up in product or services longer term. We just want to continue to have our footprint with our customers and the opportunity to continue to add more services to them.
Got it. Okay. And then you actually hit on my follow-up, which is, I mean 2014, it was a really good year for you guys after the target breach. Are you starting to see that refresh activity hitting now or should we expect that coming in the next call it 6, 12, 18 months?
Base special as customer study evaluate, it's not like last time they are rushed to buy because there are few bigger case make it a lot of customer concern. But this time because every 4, 5 years, the hardware tend to get too slow and then lack of the additional performance of function. So the customer starting to do some evaluation, but they now like last time they are like more rush to buy upgrade. But this time they probably may take some time. But also the fab approach they all like it.
They also starting to evaluate whether the network part can work with other part of infrastructure. So that's where probably the sales cycle take a little bit longer. Not like last time, the news drive some of the decision, but this time they are pretty carefully evaluate and see what's the true benefit. But definitely the hardware just like any other networking gear or server after few years they need to be upgraded.
Understood. Okay. Thank you. Thank you.
Thank you. Our next question comes from Walter of Citi. Your line is now open.
Hi, thanks. Just a question on Q2 margins. It looks like you are guiding them down year over year relative to, if I look at it, at 606. And I'm just wondering if we think about where the additional spending is going? And I guess maybe kind of longer term, where do you think you have the most leverage between sales and marketing and R and D on driving top line growth by
spending? Yes. I don't know that we think we're guiding down sequentially on margins from
I'm sorry, just year over year, it looks like the margins are lower this year than the guidance is for lower margins in Q2 than they were last year if I adjust for 606?
Yes. I think a lot of things were happening in last year's number, right? I think if you look at Q1 to Q2 OpEx by itself, the total OpEx last year was down $4,000,000 from Q1 to Q2. I've got the headwind coming in of FX that has impacted the quarter as well. So I think looking at the quarter where we went out last year 5.5 points from Q1 to Q2 and trying to match that again this quarter is a little rough, right?
So I think we're looking more to the sequential margin is probably more applicable as we try to get to a smoother glide path.
And then just longer term on where you see the most stability to accelerate the top line through investing? Is it on the product side or is it on the sales
marketing side? The sales market we started adding capacity in the last couple of quarters. If you look at Q2 last year, the sales headcount capacity actually is down compared to Q1. So that's actually limit our potential growth. So in the last 2, 3 quarters, we're starting accelerated hiring.
The high count hiring rate, we see starting to normalize now. And but on the other side, we also started improving the productivity and try to improve in both on the top line and the bottom line.
Okay. Thank you.
Thank you.
Thank you. Our next question comes from Gregg Moskowitz of Cowen and Company. Your line is now open.
Okay. Thank you. And Keith, I'll add my congratulations on a well deserved promotion. Actually, I have a couple of very quick ones. For you, Keith, wondering if you're still factoring in a slightly longer average duration in 2018 or if that's changed in one direction or another?
And then just for Ken, realize that it's still somewhat early, but what are you hearing from customers in regards to the threat intelligence service that you've announced? Thanks.
Hey, Greg, it's Keith. Thanks for that comment. And I think we've talked before that we experienced we modeled out a small uptick in term throughout the year. I'd probably pull back just a little bit from that, probably feeling we've had good conversations about term internally, like the results that we've seen recently in our numbers. All the right people are focused on it.
I wouldn't say it's a big shift, but I'm certainly not extending the term, let's put it that way in the models.
Yes. I think threat intelligence always is a big value added to our customer because we have the biggest deployment globally and help us collect a lot of valuable information. And also we have a big one of the biggest team and the best team in the industry. And also working with some other partner in the CTA, Cyber Threat Alliance, which also cooperate and sharing some intelligent information. So we feel this is pretty valuable good intelligent information service.
A lot of customer service provider can benefit, but it's still in the very early stage. We try to see what's the best way to share with some of the partner and the customer.
Thank you.
Thank you.
Thank you. Our next question comes from Brad Zelnick of Credit Suisse. Your line is now open.
Thanks very much for taking my question. Ken, I think it's fair to say there's a lot of conversation, if not even debate amongst investors trying to appreciate the impacts of cloud and the opportunities and hearing triple digit growth both in BYOL and on demand in cloud, very, very compelling. And I was particularly intrigued to hear you speak about the 7 figure large retail deal that you took down in the quarter. And I was hoping perhaps you can just provide a little bit more color as an example. I'm assuming a transaction that large is an existing customer.
And if you can just perhaps talk a little bit about the architecture, the use case in cloud, what it is that they're moving to cloud? And then ultimately, what is their total spend with you today versus might have what been in the past? I think that would be helpful to us.
Hey, Brett, this is Keith. I'm just going to jump in front of Ken a little bit on this. So the first point is that's a new logo for us. That's not an existing customer. So we're very excited about that.
And we did some economics in the back of the envelope of what it would have been if it had been an appliance sale. It's actually bigger as a software deal than it is as a hardware deal. So I'll hand that over back to Ken.
Yes. Like I said, it's really they also consider this as a part of the whole infrastructure approach. And that's actually but we have a very strong offering in the cloud environment also and especially the very broad. Like I mentioned, like we have the most broad cloud offering, not just network security, but also cover all different kind of application from the sandboxing, the e mail, the web, the management and all the analysis. So that's make us our strong the strongest player in the cloud space and also matched well in the fabric approach.
So we're the only vendor can offer this infrastructure fabric approach in the cloud environment. That's also driven the winning of some of the key customer.
Thanks very much. And if I could just a very quick housekeeping question for Keith. On duration, I heard the answer to Greg's question about the full year. But can you remind us even just a year ago in Q1, I don't think I have it in my model, was that 23 months on billings duration a year ago?
I think sequentially, the duration was down 1 month, year over year, it was up 1 month.
Great. Thank you so much.
Yes, that's probably like making the product revenue a few percent lower if it's the same lens.
Yes. Thanks again.
Thank you.
Thank you. Our next question comes from Rob Owens of KeyBanc. Your line is now open.
Great. And thanks for taking
my question. I want to touch on something you said earlier with regard to the change in rev rec from sell through to sell in. And is that the balance of the delta in product? And is that persistent throughout this year? And not to get into the accounting side of it, but I'm curious what drives that change effectively?
The rule is certainly consistent throughout the year, but I don't anticipate we don't typically keep a lot of inventory in the channel. You can go back and check the Ks and the Qs. We have a mid single digit number of weeks that we like to keep in the channel of inventory. That's certainly not a large number. So what you saw in the Q1 was really just bringing the U.
S. Up to where the international distributors have been. To the extent that the U. S. Has continued growth throughout 2018, there would likely be some uplift in that.
But I don't see us making significant changes in how much inventory we keep in the channel at the moment.
And you're talking growth in partners? Or are you talking growth in kind of sell through when you mentioned growth in the U. S?
I mean shipments and revenue growth, whether it's with the I mean the I'm quite sure I follow the question.
If you're now recognized revenue on sell in growth in partners is going to afford you more opportunity to sell into a broader base. So I guess I'm trying to understand the velocity side of the equation more so.
We sell to distributors who then sell on to resellers, and we have a fairly short list of distributors in the U. S. To sell into.
Okay, great. Thanks.
Thank you. Our next question comes from Andrew Nowinski of Piper Jaffray. Your line is now open.
Great. Thank you. Just wanted to ask a quick question on the competitive landscape. It looks like your product revenue and subscription revenue growth clearly outpaced what Checkpoint reported this quarter. So I was wondering if you could give us any color on your competitive win rates versus Checkpoint?
And then same thing versus maybe the other enterprise vendors Palo Alto and Cisco? Thanks.
I think our advantage over any other competitors, competitors, first on the network security side, we are the only one building our own ASIC chip and that's from day 1 with that company even come from my previous company. This philosophy actually helping driven the performance additional functionality. You can see some other bigger company doing the GPU, TPU also for the similar parts now and it's a huge benefit. We're keeping gaining share no matter which competitor we feel, we're more comfortable to compete with the network. And then we also offer much broader approach and most of all this part also built internally whether from endpoint, from the management, from the Wi Fi access, from the web, e mail.
So all these are also helping drive that we call the infrastructure fabric approach, which from day 1, they built together, working together, integrate together, automate together. So none of our competitor can compete in on this broad and automate integrate approach. So that's where we're keeping gaining from both on the network side and also we call fabric infrastructure side. Yes, I cannot comment on particular competitor, but I do see we starting to grow faster, we could be gaining share. And with additional sales and marketing capacity that we started building in the last couple of quarter, we feel very confident of keeping gaining share.
Okay. Thanks, Ken. Keep up the good work.
Thank you.
Thank you. Our next question comes from Jason Nolan of Baird. Your line is now open.
Okay, great. Thank you. I wanted to ask on verticals. They look pretty consistent against F-seventeen with the exception of a see continue through this year?
No, I don't think there's anything to call out. I mean, the large deal we had in Q1 of 2017 was in EDU. So maybe that's skewing the numbers a little bit. But I'm not I wouldn't say there's a vertical that has me concerned like that.
And then Ken, as a quick follow-up, any customer conversation perspective coming out of RSA that was different this year versus previous years?
RSA is starting to get a lot of noise now I have to say. But it's no particular, but we do see the customer like the February approach and which helping defend all this infrastructure from multiple layer defense on the infrastructure side. And also they are very excited about the new high end we launched even still in the early ramp up stage, but we do see a lot of potential will come from both the high end and also the fabric approach.
Okay. Congrats. Thanks, guys. Thank you. Thank you.
Thank you. Our next question comes from Michael Turits of Raymond James. Your line is now open.
Hey guys, Michael Turits. Thanks. So, Keith, congratulations on the appointment. And so a question for you. Thanks for the guide on CapEx this year of 85 to 100.
Can you give us a sense for what that trajectory might be in the next couple of years as you get through the headquarters build? And also maybe you could help us out in terms of the trajectory from last year going forward on cash taxes, so we just try to get our cash flow right?
Yes. The cash taxes in reverse order has not changed from the number that I think we had out before, which is about $44,000,000 I don't know that we've talked about quarterly cash taxes. I could offer that if you took that 40%.
Just full year is fine.
Okay. Okay.
And then we don't guide on free cash flow. We don't guide long term on free cash flow. But I could offer that the new building will probably be about 175,000 square feet going on our existing land that we already own. We would like to move in by the end of 2019.
So that's
probably enough data that you probably model how that might roll through.
Thank you. Our next question comes from Ken Talanian of Evercore ISI. Your line is now open.
Hi, thanks for taking the question. I was wondering if
you could discuss where your pipeline of both service provider and enterprise deals stand today relative to last quarter?
I don't know that we wouldn't go to that level of granularity. But I would say that we feel very good about the uptick in the pipeline. There's a lot of people focused on it, doing a lot of good things, and we're seeing results there. Carrier specifically, you got 2 different models. You have EMEA and you have the U.
S. We see indications in the U. S. That they may be moving a little bit more away from some of their maintenance mode of projects to some new projects, but I think that's very early on.
There's a
bit of a pattern in terms of how Carrier comes in over the last several years. It has a lot of year end activity, Q2 not so much.
Yes. Also with the additional investment we made in the marketing, in the sales capacity, that's also helping driven the pipeline, the awareness. I think that's all helping to accelerate the growth.
Great. Thank you very much.
Thank you. Our next question comes from Patrick Colville of Arete Research. Your line is now open.
Thank you very much for taking my question. Can you just help explain how the BYO bring your own license works? And then also, how the economics work for you guys? So someone brings their own license, yes, how that flows through? Thank you so much.
I think the simple response is they would buy the license from us and then they would take it to the cloud service provider.
Okay. So no change in this. It's just one for 1?
Right.
And that's measured on throughput?
Measured on throughput. Now?
That depends on how different application and where they deployed. Sometime like when you put something in the cloud, you also need to access that application. I mean, we may increase the need for secure access of that. So it's really I'd say it's difficult to it's case by case, vertical by vertical for how this may impact or maybe increase the current business there.
Got it. Thank you so much. Up the good work.
Thank you.
Thank you. Ladies and gentlemen, this concludes today's question and answer session. I would like to turn the conference back over to Peter Salkowski for closing remarks.
Thank you, Takeda. Again, thanks everybody for joining the call. We will be at the JPMorgan conference with Ken and Keith on May 16th. Look forward to seeing a bunch of investors there. And thank you very much for the call.
Again, as a reminder, we're not having a second call today. If you have any questions, please feel free to follow-up with me. A good day. Take care.
Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone, have a great