Ladies and gentlemen, thank you for standing by. Welcome to the Fortinet first quarter earnings conference call. At this time, all participants' lines are in a listen-only mode. After the speakers' presentation, there will be a question- and- answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today. Thank you, Peter Salkowski, Vice President, Investor Relations. Please go ahead, sir.
Thank you, Michelle. Good afternoon, everyone. This is Peter Salkowski, Vice President of Investor Relations at Fortinet. I am pleased to welcome everyone to our call to discuss Fortinet's financial results for the first quarter of 2020. Speakers on today's call are Ken Xie, Fortinet's founder, chairman, and CEO, and Keith Jensen, our Chief Financial Officer. This is a live call that will be available for replay via webcast on our investor relations website. Ken will begin our call today by providing a high-level perspective on our business. Keith will review our financial and operating results for the first quarter, provide some additional details regarding our first quarter performance and some insights into how April performed, and provide our guidance for the second quarter of 2020 before opening the call for questions.
During the Q&A session, we ask that you please keep your questions brief and limit yourself to one question and one follow-up question to allow others to participate. Before we begin, I'd like to remind everyone that on today's call, we will be making forward-looking statements. These forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected. Please refer to our SEC filings, in particular, the risk factors in our most recent Form 10-K and Form 10-Q for more information. All forward-looking statements reflect our opinions only as of the date of this presentation. We undertake no obligation and specifically disclaim any obligation to update forward-looking statements. All references to financial metrics that we make on today's call are non-GAAP unless stated otherwise.
Our GAAP results and GAAP to non-GAAP reconciliations is located in our earnings press release and in the presentation that accompanies today's remarks, both of which are on our investor relations website. Lastly, all references to growth are on a year-over-year basis unless noted otherwise. I would like to now turn the call over to Ken.
Thank you. Thank you, Peter, and thank you to everyone for joining today's call to review our first quarter 2020 result. I would like to thank our employees, customers, partners, suppliers worldwide for their commitment to manage our response to the COVID-19 pandemic. We are well pleased with our strong first quarter performance. Billings increased 21% to $668 million, driven by solid execution and growth across all three major regions. Revenue increased 22% to $577 million. The solid performance of our core firewall, Security Fabric, SD-WAN, and work from home solutions results in an 18% increase in product revenue and a 24% increase in service revenue. Shipment of FortiGate units increased 30% in the first quarter, driven by our home secure VPN and secure SD-WAN products built with our ASIC-powered appliance.
In addition, demand for broad, integrated, automated Security Fabric platform, especially the FortiClient, FortiAuthenticator, and FortiToken, was very strong. Our ability to directly manage our supply chain and shipping logistic allowing us to quickly adjust to the current dynamic environment. Today, Fortinet released the FortiGate 4200F, another milestone in our ability to deliver the industry highest performance and the most cost-efficient security solution on the market. Powered by the new NP7, the 4200F is engineered to meet the scale and performance demand of today's enterprise and service provider companies. With 10 extra VPN performance of our competitors, its ability to scale teleworker solution will be a key competitive advantage for Fortinet as enterprise looks for cost-efficient way to support a large remote workforce.
During the quarter, we released the FortiOS 6.4 with over 350 new features, including new automation, scalability, performance, and AI capability, providing full protection across the entire digital infrastructure. Included in the FortiOS 6.4 are several enhancements to our secure SD-WAN offerings. Fortinet is one of the fastest-growing SD-WAN providers and the only major player in this market with the internally developed offering that provides security and SD-WAN networking in a single solution. We believe we'll continue to gain SD-WAN market share in 2020. Fortinet is an important strategic partner, especially as companies look to efficiently deploy their security budget. Our industry-validated work from home and secure SD-WAN offering, along with our SD-driven FortiGate Security Fabric platform and hybrid cloud offering, provide the best security with the most cost-efficient solution for companies across their entire digital infrastructure.
I would now like to hand the call over to Keith for a closer look at our first quarter performance and our guidance.
Thank you, Ken. Let me first note, I would like to join Ken in wholeheartedly thanking our employees and their families, and our customers, partners, and suppliers for their outstanding support in managing our response to the COVID-19 pandemic. With that in mind, let's start the first quarter review with revenue. Total revenue of $577 million was up 22%. The Fabric and Cloud segment revenue growth was over 24%, and FortiGate Network Security revenue growth was 21%. Both our Fabric and FortiGate Network Security segments growth continue to benefit from our secure SD-WAN solutions. The strong first-quarter revenue growth once again illustrates the benefit of our diversification across geographies, customer segments, and industry verticals. The momentum our business has experienced is the result of our strategic internal investments made to broaden our product offerings, penetrate adjacent security markets, expand our global sales force, and invest in our channel partners.
Product revenue grew 18% to $192 million, benefiting from strong demand for our FortiGate appliances, secure SD-WAN offering, integrated Fabric platform appliance and software solutions, as well as our embedded and standalone work-from-home security solutions. Our growth rates and industry reports suggest we continue to take market share in both the firewall and SD-WAN markets. Markets where we have contributed leadership and innovation. Moving to service revenue. Service revenue grew 24% to $385 million, representing 67% of total revenue. Over 90% of service revenue was from deferred revenue at the beginning of the quarter and continues to provide an increased level of revenue predictability. FortiGuard security subscription revenue increased 25% to $211 million. FortiCare technical support and other service revenue increased 23% to $173 million.
The mix shift from 8x5 to our higher priced 24x7 support was six points, and 24x7 support now represents just over 60% of this mix. Let's shift to billings. Total billings increased 21% to $668 million. FortiGate Network Security billings increased 21% and accounted for 75% of total billings. Fabric and Cloud billings combined increased 32%, driven by our secure access and our work-from-home related offerings including FortiToken, FortiAuthenticator, and FortiClient. Once again, the diversification of our business model by industry vertical was on display in the first quarter, with our top five verticals continuing to account for about 2/3 of our total billings. Service providers and MSSPs, which we believe serve a large portion of the SMB market, topped all verticals with 19% of total billings, representing its highest percent of total billings in five quarters.
Financial services had a very strong quarter, with billings growth of over 40% and represented 14% of total billings. At the end of the first quarter, total deferred revenue increased 26% to $2.2 billion. Short-term deferred revenue increased 24% to $1.2 billion. Looking at deals by dollar size. For deals over $250,000 and $500,000, the billings value increased 22% and 20% respectively. The dollar value of deals over $1 million increased 27%, illustrating our continued ability to move upmarket into the enterprise segment. Moving back to the income statement. As shown on slide four, gross margin improved 150 basis points to 78.7%. Product gross margin improved 300 basis points to 61.4%. Product gross margin benefited from over 40% growth in software products and lower indirect costs. Services gross margin increased 30 basis points to 87.4%.
Operating margin for the first quarter increased 190 basis points to 22.3%, benefiting from the improvement in gross margin and lower employee travel expenses related to the shift towards work from home. During the quarter, we entered into a seven-year mutual covenant not to sue agreement with a competitor related to our patent portfolio in return for a $50 million cash payment to Fortinet. We recognized a gain, a GAAP gain, of $36.8 million as a credit to operating expenses and will recognize the remainder over the term of the agreement. We have excluded the $50 million cash received from our free cash flow and the $36.8 million gain from our non-GAAP margins and other results.
Total headcount ended the quarter at 7,448, an increase of 24%, driven by increased investments we made to leverage the positive momentum in our business while seeing improving attrition rates over the last few quarters. We do not anticipate any COVID-19 related layoffs for the foreseeable future. Given our strong operating income performance, net income for the first quarter was $104.4 million. Our earnings per diluted share increased $0.14 to $0.60 per diluted share. On a GAAP basis, we reported net income of $104 million or $0.60 per diluted share. Excluding the patent-related gain noted above, GAAP earnings per share would have been $0.44 or an increase of 29%. Moving to the statement of cash flow summarized on slide seven and eight. Free cash flow increased 27% to $242 million.
Due to the shelter in place orders, construction was halted on the new campus building in mid-March and resumed this week. Capital expenditures for the first quarter were $28 million, including $20 million related to construction and other real estate activity. We estimate capital expenditures for the second quarter to between $40 million and $50 million, and for all of 2020 to between $200 million and $220 million. We expect full-year cash taxes to be approximately $40 million and our full-year non-GAAP tax rate to be 22%. In the first quarter, we utilized a portion of our cash and investments to repurchase approximately 10 million shares of our common stock for an aggregate purchase price of approximately $900 million. At the end of the first quarter, the remaining share buyback authorization was $693 million.
In light of the buyback activity, together with a lower interest rate environment, let me offer two modeling insights. First, the full-year share count should be 10 million shares lower than previously guided. Second, interest income will likely be insignificant for the remainder of 2020. Before moving to guidance, we wanted to offer some thoughts in two areas related to COVID-19, including steps that we have taken to contribute and certain observations about our business in Q1 and early Q2. First, in response to the pandemic, we've taken a number of steps, including one, substantially increasing our employee charitable match program for COVID-19 related donations to a total of $2 million. Secondly, expanding our free to the public Network Security Expert program or what we call NSE. Last week, we further expanded the free NSE program from the first three levels to all eight levels.
NSE is a self-paced online security training and certification program. By making this program free and more advanced, we hope to narrow the shortage of security-skilled workers around the world and position people to emerge from COVID-19 with new and very marketable skills. In the first week, we've had over 50,000 registrations from over 5,000 different organizations. I'd now like to share some observations about our business in Q1 and early Q2. We don't anticipate that these observations will continue on future quarters. In light of COVID-19, we thought they might be helpful and informative. Looking at linearity, monthly linearity for the first quarter was consistent with prior quarters at around 50% through the first two months. While March linearity was typical, we did see an elevated level of buying during the middle two weeks of the month.
As for April linearity, it was slightly better than our first-month performance for any second quarter in the last three years. Turning to contract length and payment terms, in Q1, the average contract length remained flat at 25 months year-over-year. Average contractual payment terms increased, but less than 15%. In terms of supply chain concerns, our product backlog was in line with historical averages, and our suppliers delivered over 90% of their commitment to us. To offer some context on the puts and takes in Q1 billings, three of our Fabric platform products, FortiToken, FortiAuthenticator, and FortiClient, benefited from their increased value in securing organizations' employees in the shift towards work from home. Combined billings for these three products were about $10 million above expectations. In April, we saw these billings again significantly outperform expectations.
Looking at channel inventory, the total balance was flat quarter-over-quarter and up slightly year-over-year, which may relate to a small level of early buying by our customers. Regarding SD-WAN solutions, secure SD-WAN billings for the quarter were a high single-digit percentage of total billings. April billings continued this trend. The Q2 pipeline for secure SD-WAN is strong. Looking to customer segments, our G2000 billings increased 25%, SMB billings as a percentage of total billings increased slightly. Renewal rates remained within the guardrails that we provided at the Analyst Day. As a percentage of total billings, the worldwide retail segment remains one of our top five verticals, and as a percentage of total billings remained unchanged year-over-year.
As our performance indicates, we did not see a material impact due to COVID-19 for the first quarter, and the second quarter is starting well. That said, there is a lot of uncertainty about future economic conditions. I'd like to review our outlook for the second quarter, summarized on slide nine, which is subject to the disclaimers regarding forward-looking information that Peter provided at the beginning of the call. For the second quarter, we expect billings in the range of $700 million-$725 million. Revenue in the range of $590 million-$605 million. Non-GAAP gross margin of 77.5%-78.5%. Non-GAAP operating margin of 23%-24%. Non-GAAP earnings per share of $0.64-$0.66, which assumes a share count of between 165 million and 167 million. We expect a non-GAAP tax rate of 22%.
For 2020, due to the increased uncertainty associated with the economic impact from COVID-19, we believe the prudent thing to do is to withdraw our previously issued full-year guidance. Along with Ken, I would like to thank our partners, customers, and the Fortinet team for all their support and hard work during these difficult and unique times. Lastly, I also would like to invite all of you to listen to the management keynote presentations at our virtual Accelerate being held on May 12th. You can contact Peter for a registration link. With that, I'll hand the call back over to Peter.
Thank you, Keith. Michelle, we're ready to do the Q&A. If you can open up the line for questions, please. Operator, are you there?
As a reminder, to ask a question, you will need to press star one on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Your first question comes from Sterling Auty from JP Morgan.
Yeah, thanks. Hi, guys. You mentioned that the June quarter, so April's off to a fast start. Wondering, are you seeing the same products in high demand in April that you did in March, and do you think that that demand actually can continue perhaps into the back half, or is this a temporary lift that you're seeing?
I think, yeah, pretty similar. Like we mentioned, we do see the Fabric continue, especially work-from-home related, some are low end, and also like FortiClient, Authenticator, FortiToken are still very strong. Overall, I think it's the same. Also the new product we introduced, both in the last quarter, the 1800F, and also introduced the 4200F, see a very strong interest. Yeah, I think so far we see pretty similar demand.
Yeah. Sterling, I'd probably frame a response to add on to what Ken said by saying obviously we gave some insights in terms of what we were seeing in April. As part of the guidance setting process, you would obviously normally look at what's your month one activity, what does your pipeline look for month two, and what does your pipeline look like in month three. I think you can assume that we looked at those factors as part of setting the guidance for the second quarter.
Yeah. Also, a lot of feedback is really because our product have a good reputation. It's very cost efficient, like the new one we announced and also the last few quarter, have average VPN performance 10x faster or can handle more capability compared to any other competitor. We use in the Security Fabric region. That's actually a lot of company, a lot of enterprise, they used to have a work-from-home population, probably less than 10%. Now they jumped over 90%. That's a huge demand for both headquarter, for office, and also for some other work-from-home solutions. That's where VPN is very critical for all this enterprise. We see a lot of need for our customer require our solution compared with the other competitors.
That makes sense. The one follow-up would be, you mentioned 19% of revenue from the MSSP channel. I think investors are always worried about that SMB exposure. Can you give us a sense of what you saw in terms of renewal rates in March and April, as well as just the demand pipeline from that segment?
Yeah, that's actually the very interesting area. We also kind of a little bit surprised. Yeah, our overall SMB as a percentage of our business actually increased 1%-2%, that's where they grow faster than average. We kind of did some research. Probably there's two, three reasons. The first, whether the SMB or the work-from-home using network security as the endpoint, still very low percentage, probably on average only about 5% or even low single digit. It's a very small percentage, SMB or work-from-home has a network security solution. That's where they may take this time, opportunity to start kind of implement more work-from-home SMB solution. The second one, we also believe whether because SD-WAN or some other solution combined with both SD-WAN and Wi-Fi can also save a lot of cost, very cost efficient.
That's where probably also the chance for customer to also using the new product. The third one, we do believe if you look in last few quarter, we refreshed the low end first with all the F model. From like 80F the first almost three quarters ago, then the 60F and the 40F we announced, it's all helping driving the SMB or work-from-home solution. Maybe these two, three factor contribute SMB actually even grow faster than average.
Got it. Thank you, guys.
Thank you.
Your next question comes from the line of Fatima Boolani from UBS.
Thank you for taking the questions. Ken, maybe to start with you, just on the SD-WAN momentum you're seeing. I think there's some confusion around how SD-WAN conflicts or is accretive to your branch office business. I'm wondering if you can just give us a sense of how SD-WAN is accretive to the overall branch footprint that you have. As you think about the next 12- 24 months, as branch office architectures do change, how do you think that would impact the lower-end SKUs you have in your portfolio? I have a follow-up for Keith.
Like I said in the script, we are the only company internally develop SD-WAN and also build with security from our beginning. It's very cost efficient and also combine multiple function together. That's where the customer see a lot of value. At the same time, like I said, somehow SMB or some other work from home. That may also helping, because overall SD-WAN is still relatively small market and grow very fast. We already become a top three and also grow the fastest one. Also is a little bit different offer than the other. Other probably only SD-WAN function, but we do combine security with those other function inside our offering, and the same time performance much better because our own ASIC has a huge computing power advantage to handle multiple function the same time.
I think overall, this all contribute both SMB. The FortiGate unit shipment grow 30%. That's also the highest one we see in the last few years. That's also probably whether contribute to SD-WAN or contribute to a work from home or SMB. It's pretty interesting. We still continue to see that in April. We're still closely watching and also try to address any requirement from the customer to react quickly, both in SD-WAN and also for the SMB work from home solution. Like I said, because we develop internally of all the solution product, we can react much quicker compared with other competitor. They have to find a way to integrate. They have to have different SD-WAN than the security or the other thing. I think that does give us quite some advantage compared to other competitors.
That's super helpful. Keith, just for you, appreciate that color on the shipment volume and shipment trends in the quarter and in April. I'm wondering if you can characterize for us how much of that is maybe pulled forward activity, if you can contextualize that with the pipeline for the rest of the year. Just want to get a sense of if there was actually rush buying or any accelerated buying activity. That's it for me. Thank you.
Yeah, I think any quarter you've got puts and takes, and that's kind of why we titled that section that way. There's some things that come in that maybe weren't in your commit to begin with that you weren't expecting, and there's some things that push out. I don't think that the Q1 was really any different any other way. I think in terms of how we're looking at it in that regard, the purpose of providing some commentary about what we saw in April would seem to be contradictory to a thought that there was a bunch of pull forward from Q2 into Q1 because we're happy with April.
Thank you.
Your next question comes from the line of Brian Essex with Goldman Sachs.
Hi, good afternoon. Thank you for taking the question and congratulations on the results in some pretty challenging economic times. I guess the first question maybe for Ken, if I heard that right, you had some pretty strong financial services billings growth. Can you maybe comment on growth by vertical, where you saw maybe better strength in the quarter versus maybe some weakness? It also seemed as though you actually did pretty well, surprising at the mid and entry level range of your product spectrum. Any change anticipated for the rest of the year in terms of product release driven activity versus maybe what might be more near term work from home driven expansion type sales?
First, the vertical product Keith state I can help add, is that we still see service provider starting pretty strong and probably the fast growing the last few quarter, even few years. Also the finance service, some government sector also pretty strong. Retail a little bit weak, it's just a little bit. It's not as I think it's still among the top five. Enterprise is probably still pretty okay, especially the big enterprise. We see grow faster than the overall growth, like grow 25% for the top 2,000 enterprise. I think going forward, we do see the new NP7 provide a lot of interest for big enterprise, especially work from home. They found out suddenly the workload, especially the VPN, need almost 10x compared to before the pandemic. A lot of competitor product cannot handle it anymore.
We get a lot of requests from this enterprise IT starting to see the advantage of our solution because we accelerate all of the VPN using ASIC, which on average, 10x better performance. That's actually, before maybe they not need that much VPN, but now they suddenly see, oh, that's a huge advantage, and which competitors cannot handle. We see very strong demand, and that's where the product we released today, the 4200F, and also last quarter, 1800F. Also the previous middle high-end, we're also starting to see pretty strong growth now.
Yeah, I think Ken did a very good job of recapping the verticals. Just to put a little more color on it, I think the government vertical, which for us, as far as the international, state, and local, performed very well. We didn't really call it out in the script. It was clearly in the top three MSSPs. We talked about financial services, we talked about, and as Ken indicated, retail was flat-ish year-over-year in terms of his percentage of billing. Tech had a pretty good quarter as well, but not enough to get it in the top five.
Got it. That's helpful. Maybe if I can hit one more quick one on SD-WAN. I had a lot of questions this quarter from investors just concerned about potential branch office closures. Did you see any change in the deployment within the branch office environment due to closures? Or maybe was it accelerated because of the closures and maybe better access to networks as a result? Maybe just a little quick color there would be helpful.
Yeah. I think we have a deployment we call a zero-touch deployment. Probably some IT, they leverage this opportunity to upgrade some infrastructure. We don't see a slowdown, actually. We even see things accelerate a little bit.
Super helpful. Thank you so much.
Thank you.
Your next question comes from the line of Brad Zelnick with Credit Suisse.
Excellent. Thank you so much, and congrats to you all for the strong momentum and being there for all your constituents during these crazy times. Ken, I've got another SD-WAN question for you. One of your competitors recently made an acquisition in the SD-WAN space with plans to leverage their technology in a thin branch architecture. Can you maybe just help us by comparing and contrasting your approach to SD-WAN and whether one solution is inherently more cost-effective or has more efficacy? Thanks.
Yeah. We already spent quite a long time to develop SD-WAN, 5- 10 years. Also from our beginning, combined that with the security together, so can use the security side, how SD-WAN, how this WAN function can be routed. Right? That's very different than all the other major competitor, whether in the networking side or in the security side. They have to come from acquisition, which they have a lot of limitation, whether on the performance or combine the networking function, security function together. That's the huge advantage we continue to enjoy. At the same time, all this function is also ASIC accelerated, which can easily give a 10x performance boost, and also much lower total cost of ownership. That's how we see the benefits get more and more.
On the other side, SD-WAN can be part of the total solution, whether the cloud infrastructure or the other part. Combined security SD-WAN together definitely have a huge advantage, whether easy to deploy or easy to manage a single box solution. At the same time, we also balance among how the cloud and how the edge computing working together. While some function need to be processed in the edge, some function need to be processed in the cloud. That's also working well with the hybrid cloud approach. Also combine the headquarter, the branch office, work from home, we found out is that's also the Fabric keeping growth faster, and even a lot of product within a Fabric suddenly double, triple than the previous year, previous quarter. Like we mentioned about whether FortiClient or FortiAuthenticator or FortiToken, it's all related to the work from home product.
Suddenly see huge increase. The Fabric approach also, we benefit a lot from that.
Thank you, Ken. That makes a lot of sense. If I can just follow up with you, Keith, how are you thinking about your hiring plans in light of the limited visibility you have? It actually seems like you're off to a pretty strong start in Q1.
I think the hiring has been We talked about this in the context over the last couple of quarters, end of quarter, that within this balanced framework of profitability and growth that we're executing against, we thought coming into 2020 that we were going to tilt towards growth. I think we saw that with some of the investment we made towards the end of last year, and we continued those hiring investments throughout the first quarter of this year. I think as we'll start to lap some of those higher hiring percentages or growth in Q3 or Q4, at that point in time, we'll start moving back in line with what we've seen historically.
Awesome. Thanks so much, guys.
Your next question comes from the line of Shaul Eyal from Oppenheimer.
Thank you. Good afternoon, guys. Congrats on the ongoing strong performance. You had a very solid European performance over the course of the past few quarters, but I think especially in the first quarter. Some other companies have been reporting mixed views, mixed outlook with respect to the European performance. What are you doing different? Or is it also driven by your strong partner relations in that region?
Yeah, I probably look at it this way. I think that when we say Europe, this also includes our emerging part of the business as well. Emerging meaning everything from Southern Africa through the Middle East and into Eastern Europe. I think that latter component has been strong now for many quarters in a row. Yes, I do think that, one, it's great execution by that team, and I think also they do a very good job of how they, in some ways, are forced to go to market with that. I think if you look at the quarter overall, we probably saw, as you would kind of expect with the pandemic, the U.S. and the Americas probably outperformed Europe, continental Europe, a little bit more, during the quarter. That's kind of consistent with what we saw with the pandemic.
Got it. Keith, while we have you, gross margins, also probably highest in recent quarters. What should we be expecting going forward, and what's been driving that little bit of an uptick that we have seen with gross margins, specifically for the company, which is slightly more appliance driven?
Yeah, I think that the guidance that we provided for gross margin is good for the quarter. I feel comfortable with that. I do think that we're benefiting as our cost structure changed a little bit with some of our newer products. I think that we're partnering perhaps a little bit more effectively with our channel partners over the last couple of years than we have in the past. Okay.
Good job. Thank you.
Your next question comes from the line of Melissa Franchi from Morgan Stanley.
Thank you very much for taking my question. I want to go back to the discussion on the branch business. I think investors are trying to understand what the trajectory looks like for the branch, just given some exposure to economically sensitive verticals like retail. I know that it's probably pretty early, but as you look into your pipeline, are you anticipating any change in terms of renewal rates for the branch? I know that April is shaping up to be pretty well, but what should we expect for the second half of the year?
Yeah. We didn't guide in the second half of the year, and we don't give a lot of specifics on renewal rates, but I think I made a comment that what we saw in the first quarter, was that renewal rates were within that band that we provided at the Analyst Day, and I really don't see that changing based upon what I'm seeing. I think it's probably helpful to kind of consider the context of our diversification. I kind of made reference to it just a moment ago when I talked about the U.S. performed very strongly and Europe was probably hit by the pandemic a little bit harder.
You're talking about a company now that's less than 30% of its business is in the U.S., and there may be a lot of focus on retail headlines in the U.S., but it's probably passing over perhaps the recovery that's already started in Europe and the impact from Latin America and other geographies.
Okay. That's very helpful. Just following up with you, Keith, I'm wondering if you could just maybe give a little bit more color on some of your underlying assumptions for the Q2 guide? I know April seems to be pretty healthy so far, but are you assuming that continues through the rest of the quarter, or are you expecting a more challenging close? Thank you.
Yeah. I think we feel very good about the business, about the products, about the strategy that we're executing, about the sales team's ability to execute, about our ability to support our customers, and the ability to support our partners. With that in mind, I'm looking at the pipeline, I'm looking at the slicing and the dicing of the pipeline. As I kind of made reference a moment ago, I'm looking at different assumptions for different geographies based upon the status of the pandemic in those geographies. We're looking at deal sizes. Larger deals have typically more risk than smaller deals do as part of our assessment. We look at whether or not it's a new logo or an existing customer or a renewal. All those things go into the mix in terms of setting the guidance for the quarter.
Thank you.
Your next question comes from the line of Saket Kalia from Barclays.
Hey, guys. Thanks for taking my questions here. Hey, Ken, maybe first for you, a lot of questions on the branch, and understandably so, but maybe even just thinking about the enterprise. How do you think your enterprise customers are thinking about their VPN strategies longer term, and how do you sort of expect Fortinet to play into that?
I think this pandemic probably changing some of the working pattern. Like I said before, there's probably less than 10% people work remotely, access on VPN. During this lockdown, we see probably over 90%, maybe even go back, reopen, whatever, maybe still 30%-50%, and it all depend on the vertical. That's making this remote access work from home starting to get more and more important, and especially the networking need to be combined with endpoint. Endpoint, sometimes you can address certain device, but if you have the network side, you can actually secure the whole branch or the whole home and whatever, the whole house there, and even different, like with Wi-Fi, without other, different member of the family can kind of manage all these different bandwidths. That's actually, we see We see this enterprise headquarter office VPN side have a pretty strong demand there.
Some other, like Authenticator products, some other products in the Fabric, we also see pretty good growth, actually even double, triple some of these different component of Fabric.
Got it. That's very helpful. Maybe as my follow-up for you, Keith. Can you comment on any trends in the FortiGuard bundles as a result of increased work from home? I know you talked about some of the trends in FortiCare with that nice uptick in customers opting for 24x7 . Curious if you've seen any material shifts in the makeup of FortiGuard subscription with the different bundles that you have as a result of work from home.
No. Not really.
Okay. Got it. Very helpful. Thanks, guys.
Your next question comes from the line of Rob Owens with Piper Sandler. Rob, your line is open.
Hi, can you hear me?
We can.
Okay, sorry about that. You mentioned in your prepared remarks your ability to directly manage supply chain and shipping logistics. I'm curious, as you look forward towards the second quarter, should you still see strong surge in demand around the FortiGate solutions, any supply chain concerns, or are those all relatively put to bed at this time?
I think.
I think I feel good about it, but the head of manufacturing has some work to do.
Yeah, so far we don't see any issue. We see a pretty good, yeah, they also would recover pretty quick. Not only the supply chain, but also we manage our own shipment, shipping logistics, and also our own supporting. We're not outsourcing any shipment or customer supporting. That's also with all this, the facility, with all the team, we can quickly adjust wide and can kind of make it more like redundant or whatever, resistant to any kind of downside to adapt quickly.
Yeah, I think we can still have a spot or two of components that may be lined up in Japan or the Philippines or Malaysia or something like that on an individual component. Keep in mind, part of our business model is looking at our inventory turns, which have been less than three recently. Really that means we're carrying about four months of inventory at any point in time. Even at that level, we weren't at 100% execution, even though the backlog was consistent with other quarters. Probably we're looking at our inventory level and thinking maybe as we go through the next quarter or two to move that up just ever so slightly as we start transitioning to further guard against this possible risk for pandemic.
I appreciate the color. Just briefly, if I may, I know there's been a lot of discussions around work from home branch office, but where do you guys come down as you're talking to customers on kind of that cloud SASE arguments? Strategically, as people are considering work from home, what's kind of been the response of customers as they're looking at your solution versus others?
As I said a few years ago, we feel the SASE, the best model is really working with a service provider. Like today, this morning, we also announced a partnership with NTT West offer all this, like where the work from home kind of a closer service provider solution for both SD-WAN, also security. Even ourself, we do have the technology, but we do believe this cloud approach need to be working with Edge and on-premise together. We have the structure, It's all in the testing and also working with a lot of service provider right now. We call the FortiSASE approach. It's a little bit different than a traditional SASE approach, which they forward all the traffic, whether from endpoint to your device, from home, and also in the office to the cloud.
We believe the better approach for the SASE, we call FortiSASE, is really for the endpoint of some work from home, your mobile device maybe makes sense to forward to the cloud to process, which we have all this solution. When in the office, you forward office traffic to the cloud, it not quite makes sense. It's not very secure because when you forward, it's not quite encrypted, and also, it increase a lot of network traffic and much high latency, much slow. Most of the SASE companies, quite interestingly, more leverage their, like whether open source or freeware to do the security.
When you do the testing of the security, their security regional research or the intelligence, not as good as some other dedicated security company, because we have a few hundred people just doing all the intelligence research and has do this for 20 years. Some offer as pro, if you're using on-site premise, more like a AWS have this on-premise network, they call it Outpost solution. To process a lot of traffic locally will be much better than forward all this office traffic to the cloud. That's where we have this FortiSASE, but a little bit different. Also, we're working with service provider to also make it as a profit model compared to a lot of other SASE company, they have to invest a lot of proper data center, which making them keep losing money.
Eventually, all these service provider, they do have their own kind of infrastructure. Leverage their current infrastructure, leverage what they can process on-site, in the office, will be much more secure and a cost-effective way to solve this issue, right? Whether you need to manage all this mobile security solution. That's where we have little bit different approach. More leverage our service provider and also leverage both on the cloud and also on-premise, on the edge solution. I think that's got very good feedback from all these, both in the enterprise side, in the service provider, also in the customer. We feel that will be the right approach.
Thanks for the color.
Thank you.
Your next question comes from the line of Michael Turits from Raymond James.
Thanks, Keith. You commented that in the quarter you got strong demand for VPN, authentication, token, endpoint, all clearly work from home driven, and you were seeing those same trends so far into April. The question is, do you have some feel for where we are in terms of customers getting up to the level of capacity they need in terms of that product? Is that a 2Q finish or does it extend further?
Like I said, whether the SMB or work from home is still very low percentage, probably U.S. maybe around 5%, some other region even lower than that. It's still huge potential. Whether SMB or work from home. When you try to access to home to the office, suddenly you need a huge increase, almost 10x increase on the headquarter on whatever the office VPN need to support all these home worker, every remote worker. The same time, you also need on a secure solution in the other side, whether from home or the device level authenticator. That's why we see quite strong demand there.
Okay. Keith, I don't know if you have anything to add to that, but my follow-up question for you is about payment terms. I think you commented that duration was about 25 months on invoicing. Just remind us where it was, and if you have any concern about that shortening. You talked about 15% extension, yeah, in payment terms. Again, any concern about that in terms of your need to help out customers and the impact of either one of those on cash flow?
Look, I think the headline would be that we have a strong balance sheet, and we're certainly going to leverage our balance sheet, where there's opportunities to gain market share and to support our customers and our channel partners. There's no real doubt about that in my mind. We don't guide the free cash flow, but there's probably some adjustment that you want to make to your free cash flow model for the second quarter, because I do think that Fortinet's in a position to help others, and I expect us to use our balance sheet to do that on a case-by-case basis.
Okay. Thanks, guys.
Your next question comes from the line of Walter Pritchard from Citi.
Thanks. Two questions. One, I guess for Ken, just around the low end of the product line looked pretty strong. I'm wondering how strong of a trend it was that you saw actual work from home customers taking low-end boxes and that being part of what you shipped, understanding that FortiClient was strong and the token authenticator products and so forth. Just wondering how much that contributed on the appliance side.
I think they're both pretty strong. The FortiClient probably even double, triple, but come from relatively small base. The appliance, the low end, whether SMB or some high-end work from home, also pretty strong. If you see the unit shipment increased 30%, that's mostly contributed from the low end, because the high and middle range will not impact that much of the unit shipment. I think the trend still, like I said, we still get a lot of enterprise and also, they see the current, whether their competitor's product cannot handle suddenly the huge increase of the VPN or some other kind of work from home solution. We get a lot of interest. IT guy also super busy try to do the deployment or whatever.
At the same time, we also try to help them, supporting them, and we have this called a zero touch deployment, help them to deploy, whether the branch or some other headquarter solution quickly, to meet all this strong demand. I don't see the trend slow down yet. Even after the pandemic, we do see the percentage of people starting work from home probably will be higher, maybe like a few times higher compared to before the pandemic.
Yeah, I think the-
Got it.
I'll just add to that. I think the model, so to speak, that you'd be more likely to see is that when people start working from home, it's not that they're going home and taking a firewall with them. I think they're installing FortiClient on their laptop. That's probably really not going to drive a low-end business by itself. On the other side is the corporate IT organization. Now, they need greater throughput and greater capacity because of things like VPN and authentication and so forth. You may see the corporate buyers actually moving up, if you will, in terms of what they're buying. Again, it's not firewalls at home. I think the other aspect of it is we have a new product called the 60F, which was a real beast in the quarter, at least in terms of the volumes that it produced.
In our favor, it has a little bit different cost structure than its predecessor, so it's giving us a little bit of lift on margins.
I think it's also interesting, right? Interesting, really. The FortiClient probably can load on your laptop or your mobile, but that only secure one device. When you work from home, you also probably competing with your kids for the pipe and the bandwidth, and also some other things you need to manage together, some other plans could be, like how this remote monitor device, all the things. That's where the FortiGate come in as wherever handy, wherever give solution, so they can manage different device from different load or bandwidths, or they secure Wi-Fi together, and even some I'm not sure how much user go to the SD-WAN, but it's still more. It's really the product can offer so much function. They can have the whole house be managed much better, secure much better compared to the one device.
That's making work from home with a much better security and also It's much better than just one device.
Then, Keith, just on the guidance, understanding we're seeing lots of companies pull the guidance because of the unprecedented times. I'm just wondering, if you look at your forecast and think about 90 days from now, what sort of things are you looking for in your forecasting to be able to get back to giving annual guidance? Specifically, what sort of things are unstable there or sort of too wide of a range to be able to call at this point that you'll be watching?
Yeah, I think, like everybody else, I think our concerns or our interests are, is there going to be a second wave? What's the severity of a second wave going to be? What geography is it going to hit, and when is it going to hit in those geographies? Really, ultimately, what economy are you trying to provide guidance into? That's just the unknown right now in the second half of the year.
Okay. Thank you. Understandable.
Your next question comes from Tal Liani from Bank of America.
Thanks. Hey, guys, this is John Bardis in for Tal. Just wondering if you can share some thoughts on overall security budgets and how you think they might trend this year. Curious if you're hearing from any customers that they're looking to already cut back, maybe in 2Q or second half. Just a quick follow-up for Keith, probably. Can you just help us think about how much of your SD-WAN business is driven by MSPs and MSSPs? Thanks.
I think from my past experience in 2000, 2008, security budget hold pretty well during this recession. This time is different. That's where we also try to be very careful for any guidance. So far, we see in the first quarter, also in April, we see pretty good and no impact, no any material impact. If things not get worse, we feel pretty comfortable. Like Keith said, these times are different.
I think in terms of the SD-WAN and the MSSPs, I would characterize that as being a market that we're very interested in because it's a very large market. Obviously, the MSSPs have already come to it with an incumbent that we're trying to displace. But that opportunity, without quantifying it, if you will, is something that I would say we're very focused on internal.
Great. Thanks, guys.
Your next question comes from the line of Amit Daryanani from Evercore.
Hey, thanks for taking my question, guys. I have a question and a follow-up as well. I guess, first off, you guys have seen fairly impressive share gains over the last couple of years. I'm wondering, how do you think these share gains stack up over the next few years as you go through a recession effectively? Do you think share gains can actually accelerate given the TCO proposition that you guys have with enterprises, or is that unlikely to happen given no one probably wants to replace legacy gear at this point?
We probably continue to leverage the strong technology product, whether leverage we call the SPU, security process unit, ASIC, which gave a huge performance advantage on its VPN function or quite a broad function. Also, the fabric approach, which is really 2030 product, or mostly internal develop, working, integrate, automate together, which none of competitor have this advantage. At the same time, we're continue to invest, we're continuing to hire, but also we found out it's more easy to hire some high-quality people. The other part also we found, we probably have the biggest training program in this whole service security industry.
We decided open up all this for free, and not only we working with few hundred university to train all the student, but also a lot of a big enterprise, a lot of service provider, lot of our work from home user all starting to see it's a huge need for the training. We actually found that we set up a new registration every few second. Every few second, we get a new registration sign up for the training, and it is a huge benefit because in this security space, at least last year, there's a 3.5 million shortage of trained people to help handle the security. That's also the opportunity we found out to train the people, and then we can recruit them also quickly and help us solve the whole industry problem.
We see it as huge opportunity for us based on the investment we made before and also where we continue to work very hard with all the team and all the partner, all the customer try to make it whole even more secure.
Yeah, I think there's three things that Ken's been making a point to make a reference of. I'd probably summarize them this way. I think these three things are working in our favor at the moment. One is our fabric product set has continued to expand and has continued to mature and become even more competitive, if you will, in terms of features and functions with some of the best of breed. You are seeing more and more customers, at least those that I'm talking to, and prospects, much more interested now in a platform approach that enables automation and integration and moving away from a best-of-breed solution for every aspect of a security platform. The third aspect of it, we are probably moving into an environment where cost effectiveness is a premium in your go-to-market messaging.
By that I mean, if you can argue that successfully and produce that and deliver that lower cost, more cost-effective option, you can be successful in this market.
That's really helpful, guys. Keith, a quick one for you. You talked about average contractual terms pushing out to about 15%. What's the impact of that, and what's the best way for us to read that statement?
It's payment terms, not the length of the contract, right? I mentioned that it was slightly less than 15% increase, if you will, and I would probably think you just want to take a little bit of a second looking at what your cash collection assumptions are in your free cash flow model for Q2.
Got it. Thank you.
I would now like to turn the conference back over to Peter Salkowski, Vice President, Investor Relations.
Thank you, Michelle. I'd like to thank everyone for joining today's call and extend an invitation to listen to the management keynote presentation at the Americas Virtual Accelerate event on May 12th. Please contact me for the registration link. Also, Fortinet will be attending the following virtual investor conferences during the second quarter, including the JP Morgan conference also on May 12th, the Bank of America conference on June 4th, and the William Blair conference on June 9th. Presentations for these events will be webcast, and links to these webcasts are available or will be available on our investor relations website. If you have any follow-up questions, please feel free to contact me. Have a great rest of your day. Thank you very much. Have a good day.
Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.