Fortinet (TICKER: FTNT) Fortinet Inc Ftnt Ceo Ken Xie Presents Barclays Global Technology Media And

Fortinet, Inc. (NASDAQ:FTNT) Barclays Global Technology, Media and Telecommunications Conference Call December 8, 2021 1:15 PM ET Company Participants Peter Zarkowski - Vice President, Investor Relations Ken Xie - Founder, Chairman, and Chief Executive Officer Conference Call Participants Saket Kalia - Barclays Saket Kalia Okay. Well, hey, good afternoon, everyone. Welcome to day two of the Barclays TMT Conference, would not be a conference without the team from Fortinet. We're very lucky to have with us today Ken Xie, Chief Executive Officer of Fortinet as well as Peter Zarkowski, Head of Investor Relations. Just to frame out the session a little bit, we've got about 30 minutes together. Maybe we could do as I'll take the first 15 or 20 minutes to run through some fireside chat with Ken and Pete. And then I'd love to make this interactive, any questions that you've got, just feel free to shoot me an email at saket.kalia@barclays.com and I'll make sure to try to weave in as many as we can in the time that we've got. So, maybe two things first and foremost, Ken, Peter, thank you so much for being with us here today. And then secondly, Peter, I'm going to kick it over to you just to get us started here from regulatory perspective. Peter Zarkowski Thank you, Saket. Yeah. Just real quickly share my screen here. Just want to make everybody aware of our Safe Harbor statement, which you can all read very quickly, those speed readers go for it. Quick statement, I'd like to remind everyone that we may make forward-looking statements during today's fireside chat. These forward-looking statements are subject to risk and uncertainties that could cause actual results to differ materially from those projected in these statements. Please refer to our SEC filings in particular risk factors in our most recent 10-K and Forms 10-Q and to other reports that we may file from time to time with the SEC. For additional information and factors that may cause actual results to differ materially from those from our current expectations. Our 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. With that, Saket back to you. And we will go from there. Question-and-Answer Session Q - Saket Kalia Excellent. Great. Thank you, Peter. Ken, again, thank you so much for being here -- with us here today. Ken, there were so many good things to talk about from last quarter's call. Can you just maybe talk about the points that you were most proud of as CEO, and Pete maybe just you could fill in some of the financial detail in there as well, just to help us all level-set if that makes sense. Ken Xie Yeah. Last quarter we have a very strong growth, so you can see the product revenue growth 51%, billing 42% is all pretty strong -- probably stronger in the last few years. It is traveling by like a few factor. So, we do see -- it's kind of a region from our beginning, which at 21 years ago, because security driven networking, convergence of network security together is happening now. So, the traditional order security, which is another -- now to get company deployed -- product being deployed still there, still grow like a 10% in the last 20 to 30 years, but security also expend the internal -- for the internal segmentation to protect ransomware, they go to the WAN side, like secure SD-WAN, secure 5G. So we see one of our strong growth drive there. Also, we see that as kind of would drive the FortiGate growth, the same as non-FortiGate growth most like of 50%. That's the first time for the case that in catching up compared to the non-FortiGate in the -- the growth being in the last two, three years, which almost doubled the FortiGate growth. So the non-FortiGate growth already the growth driver we call that the fabric approach or the Gartner called the mash secure architecture, which is really about enterprise consolidate different vendor into a single platform. So, they are now working with end point work is web, an email or this cloud, all this anti solution while integrate automate approach so -- which we also see as a pretty strong growth driver going in the past and also going forward. And also definitely that secure landscape there, you can see reservoir makeup almost 11 times compared to one years ago, a lot of security issue, supported from work-from-home or some other parties also one of the growth driver. Probably Peter also has some other comment. Peter Zarkowski Yeah. I think from a number perspective, Saket that you were talking about, now if you look at it, I think one of the themes that has been playing out very well for Fortinet over the last couple of years is really the diversified business. We're very diversified by industry verticals. We're diversified by customer segments. We're diversified by geo. If you look at it by industry verticals, for example, one of the things we pointed out in -- it's actually in the last two quarters is we've always -- historically, if you go back and look at our transcripts over the last several years, we talk about our top five verticals, right? Service provider, governments, financial services, and a couple of others. But if you really look at the non-top-five verticals, the last two quarters, they've seen really strong growth. And I think that's due to a lot of different factors. But this last quarter, for example, they used to be a third of our business in terms of billings. In this last quarter, they were 40% of billings and they grew 68% on year-over-year basis, which just talks about the different verticals and how diversified we are. The other one to look at is customer segments or customer sizes. If you look at our Global 2000, for example, that the billings in the Global 2000 were up over 50%. So, again, very strong growth in different customer size businesses. And then if you look at it from a geo perspective, all of our geos did very, very well. It was strong growth in America. There was strong growth in Europe. There was strong growth in Asia-Pac. So, across all those different sort of ways to slice the business, we just saw really strong growth. And so, there was nothing to point out that was a weakness. It was just sort of which ones can we point out that are stronger than the others, which is a good thing to have. Saket Kalia Yeah. Probably. Absolutely. Peter Zarkowski Yeah. Exactly. Saket Kalia Yeah. For surely. Peter Zarkowski Well, by the way, we have margins that are above 25%, non-GAAP operating margins that were north of 25%, which has been a target of ours for several years. Saket Kalia Yeah. And maybe just double down on that point, right? I mean, certainly well above a little 40%, which has also been a hallmark of the model here for some time. So, totally understood. Ken, maybe back to you, even in this industry for decades, and I know you've spent a lot of time with customers, what are they telling you about their willingness to spend on firewall and also about their willingness to consolidate security spending with platforms like Fortinet? Ken Xie Yeah. That's where like -- we did our own survey, but also you can look at Gartner survey, they say 80% enterprise is in the process doing to consolidate, not have a different vendor for their whole security infrastructure that's actually met recently quite well, which we can feel like -- that's our FortiGate fabric approach, which is, we do see pretty strong growth, and also consolidate, integrate automate altogether, which not only helping customers save the cost -- management costs, but also make security more secure by ultimately response is always tool with all AI, with all this machine learning, or all this big data approach. On the other side, they definitely extend that bigger infrastructure now, which also see -- is a huge kind of opportunity. And also like work-from-home and all this kind of -- it's also kind of open up a lot of new tech service, and also a lot of us need to be protected. And so that's where we see where strong demand right now. Saket Kalia Got it. Peter Zarkowski I think, Saket, it's important to point out, I think, this is not an overnight decision that Fortinet made. We've been building ASICs. We are designing ASICs for 20 years. And so, having the ASICs and having that capability allowing us to add a lot of functionality to the operating system. Ken pointed out the security fabric or Gardner's view on what they call -- they actually call it their cybersecurity mesh architecture, CSMA, for their acronym. And we've been building that platform for over 10 years. So, I think we're getting to a point now of maturity on a lot of the different products that are in there and continuing to add additional functionality, and we'll continue to do so and can do so because of our ASICs. But I think we're getting to a point of sort of critical mass on maturity for some of those products where vendor consolidation is actually a reality for customers now. Partly because of our ASICs, but also because of our operating system. Saket Kalia Yeah. Absolutely. Definitely want to dig into that a little bit more as we go on. Ken, maybe -- I maybe love to dig into the FortiGate part of the business for you a little bit. And you touched on this a little bit more, but I wonder if you could expand, you've talked about more use cases for firewall in the past, which do you think -- can you talk about which of -- the more newer use cases that you're seeing and which ones are sort of growing the fastest and why? Ken Xie I think in the last few quarter or last two, three years, we mentioned SD-WAN helping drive a lot about FortiGate growth, basically half our SD-WAN customers, new customers network using Fortinet product before. So that's where is the kind of operation to we call secure driven networking as a convergence from traditional networking into the security -- network security, which can see the content, kind of based on application or user device with all the traffic, instead of just kind of everything together in the same trust level. So, we see that nice studying taking off on not just SD-WAN, but also 5G. The other area we also first time disclosed last quarter is OT. So you can see SD-WAN, OT together is over 20% of our total business right now. And the OT last quarter grow like a 77%, is over 6% of the company business right now. So, we do see OT eventually will be bigger. And the SD-WAN also can grow faster there, because like Peter mentioned there's a lot of a newer tech service, especially when the 5G connect lot of device together. So all this OT area need to be secured. It's a huge opportunity for us. Definitely, we also see how to secure the cloud, how to secure within the data center, within the compass to protect, there is ransomware attack is also pretty big. So with our new FortiASIC NP7, which the single chip can process 200 gig traffic, which really help into study and deploy this kind of network security in the high speed, the internal network environment, which almost impossible in the past, too costly 200 gig to manage. So, we see a lot opportunity open up and is Non-FortiGate space, so the network security space will gradually take over the traditional network space because secure driven networking So convergence is going on right now. Saket Kalia Really interesting. Peter Zarkowski Ken mentioned SD-WAN is a growth driver for the firewalls, and I totally agree with that statement. I think the other thing that we've looked at the last couple of quarters is now how much of the growth in the FortiGate businesses coming from SD-WAN versus just other use cases that we don't specifically track necessarily because it's not as easy to track as SD-WAN wan is. And what we found in the last couple of quarters is more of the growth in the FortiGate business is coming from all the other use cases that firewalls can do. And Ken mention that the micro segmentation sort of capability or the different use cases for the firewalls that we have, whether it's micro segmentation zero trust, SSL inspection, for example, to giving you, I heard my Chief Marketing Officer say yesterday, our 7000 series machine, it's got multiple NP7 chips in it that are our latest chip, that machine can do 300 gigs of throughput of SSL inspection, right? There's nobody who can match that in the industry. So, that's a big differentiation for Fortinet and driving growth in our business. Saket Kalia Yeah. Absolutely. Lots of different use cases there. Really interesting. Peter maybe for you. While we always stay on the topic of FortiGate. Supply chain is obviously the buzzword, not just the firewall industry, but a lot of other companies as well. Can you just remind us how Fortinet sources and manufacturers most of its appliances. And to the extent that you are, or Ken want to comment, what's your gut feel on kind of how long this disruption -- how long it'll take for this disruption to start to abate? Peter Zarkowski Ken, do you want to start? Ken Xie No. Go ahead. Peter Zarkowski Okay. We can take on this one as well. I mean, I think, what we've said in the last couple of earnings calls is like, we have some advantages relative to our supply chain and the fact that we hold a lot of inventory. Our inventory turns have been between two times and three times over the last multiple quarters, which would recommend or suggest that we have four to six months of inventory at any given time, within our own inventory, our channel partners hold inventory as well to some extent -- although we limit what they can hold. So, we've been able to mitigate some of the risks that's been involved with the supply chain. You don't put up a 51% product revenue growth number without having product ship. So, we certainly been able to mitigate that. Some of the reasons for that is one, we hold our own inventory; two, we manage our supply chain internally through our own operations group. So we have a team of people who are out of there, every single day trying to source different products from different vendors. We use a multiple -- we use a lot of different contract manufacturers for different supplies, so we can try to work around them in terms of getting supply from one or the other or in any way we can. We have a very large skew list, so we can move things around a little bit. If something short in one place, we may be able to sell them a different firewall, for example, because we've got a different firewall capability that we can use that we'd have availability for. So, there's a lot of different ways around that. We did have backlog at the end of the third quarter. We did say on the third quarter earnings call that there was some backlog that most of it was in the network -- networking equipment side of it. We expect backlog to be greater in the fourth quarter, partly because it's a seasonally strong quarter for us, probably some more networking capabilities there'll be in there. We did say it probably is going to flow a little bit into the firewalls as well, just because it's a supply constrained situation. Certainly a lot of demand constrain situation. But that's all factored into our guidance for the quarter. What we think our backlog is going to be as already been in there. It's not in the billings number, because it's not something we're going to ship. So, I think that get -- that in the fact that we ship a lot of units. If you look at the latest IDC data, which I think is second quarter data, we ship 38% of all firewalls in the industry, were Fortinet firewalls. So, it's multiple times more again. Ken Xie Yeah. Peter definitely well covered. The few other states ready, I think the supply chain issue probably will be bought in this quarter, next quarter will start to recovering. So probably Q2 we'll meet next year. And the same time, like Peter mentioned, because we have the quantity probably like a sweet hand more than the next competitor and like the 12, 15 times more than compared to other network, the quantity can give us a better negotiation power whether the component supplier, the manufacturer, which we also have our own manufacturer team. We have our own operational team and own warehouses where we had kind of more manages directly compared to some other competitor using the third-partly just in time, which can save some costs, but definitely has more risk on the inventory side, on the manufacturer operation side. So that's where for us, we kind of more look into for long-term, just treat as long-term investment just like ASIC. So, we feel investing the supply chain, manufacturer as a moderate part is also very important for company for the healthy growth. So we kind of have a better position than most of the competitive right now. Saket Kalia That makes a ton of sense. Ken, maybe just a double-click on one of the topics you brought up earlier, which is SD-WAN. It's a fun thing, but I mean Fortinet pricing strategies here to beat -- it was tough to beat, right, with sort of free with SD-WAN. But I guess the question is, customers have the option of having a dedicated SD-WAN appliance or maybe even a cloud service. Why do you think that customers want to combine SD-WAN with a firewall? And for those that, that don't want to combine them, for those that do go with other options, what's the reasoning for not combining them. Ken Xie So even competing just for the SD-WAN function using FortiGate still cheaper, has a better performance because the shift company empowered advantage come from a FortiASIC chip. So that that's the beauty, that's the benefit of using FortiGate and the plus you have more function. So, like I said, when you kind of do this secured SD-WAN -- SD-WAN is the first part, it can deliver all different traffic based on different application. But combined with security not only can -- with all different application accounts and based on the content, based on a device, based on the user, anything secured you can see, you can make a decision on the networking side. So that's a huge benefit for the customer. And same time there's a lot of other functions you're kind of able -- basically, if you don't kind of work-from-home or some branch office, because you see one box to be replaced sweatbox, replacing the traditional networking box, replaced the SD-WAN box, replacing the security box. So that's all -- it's only a single box solution we'll either to manage and wherever a high-performance and the low cost. So that's the benefit we see. So, strongly we can -- when we look into, it's pretty much all the -- like a carrier service provider and also the other big enterprise, like we announced with AT&T, Verizon, Comcast, BT, Orange, all this kind of working together with us, try to support in different size enterprise, whether work-from-home or kind of use that we want to lower their kind of like cost. I think so far we see very strong, I think we are probably the leader -- number one leader in the space. Now the number one -- will be very close and also could be grow probably fast growth in the whole industry. Saket Kalia Yeah. Absolutely. Peter, maybe since we brought up pricing, I think this was talked about a little bit in the last call, but just to make sure we're all on the same page. Can you just remind us of some of the pricing changes that the Fortinet has made recently? And again, just to sort of put a bow on that topic, how should we be thinking about that in terms of impact in Q3 and going forward? Peter Zarkowski Yeah. So we did -- we've done two price increases, one of which effective August 1st of course, we have to announce that 30 to 60 days ahead of time. So -- was effective August 1st, we announced that I think in July 1st. And then we had another pricing increase that was 7%, by the way, across the board. We had another price increase on November 1st. That one was a little different. We had a little more time to kind of evaluate what prices to raise and where, but on average, I would say that was probably about a 5% across the board price increase on product, but that affects services because services get attached to product. So, it really is across the entire entity. I'd say from an effective perspective, there is some buying that occurs ahead of the price increase. We notified them on July 1st, they start buying in the month of July to kind of get ahead of the price increase. And then we do control how much -- and that's mostly channel, not customer that would be buying in that scenario. But we do regulate how much they would buy in that case. And then you do have existing sort of bids that are already out there that may close in August or September, but you would be promising the prior quotes in terms of prices. So, we certainly didn't get all the 7% in the third quarter from that price increase. Plus you also have to take into account discounting. There's sort of a 40% discount immediately off the top to the channel. So, we don't think we got much of that price increase in the third quarter, maybe a percent or so of impact actually in the quarter. Similarly this price increase that would have gone effective November 1st would go through the same cadence. You're going to get buying in October, which is in quarter, but you're still going to get a little bit of pull forward into October. That'll normalize in November and then you'll start getting more of it in December. So, again, 5% you don't -- you probably -- maybe we get half, if we're lucky in terms of that. Now in 2022, we should get a bigger percentage of that, but keep in mind, you're still going to have the channel discount. So maybe we get half of those next year after everything is all said and done. As long as our quotas are increased for our salespeople, right, to offset that. So they don't discount it all away. It's all part of the manage -- all part of the management then. Saket Kalia Yeah. Absolutely. That's really helpful detail. Ken, I maybe want to switch gears a little bit and talk about SASE a little bit, right? One of the questions that I get every once in a while from investors is, whether branch firewalls, which isn't the biggest part of the business here, but it is a decent part of the business. Whether branch firewalls will see more competition from SASE offerings, right? So like the Zscaler of the world, for example. Can you just talk about, Ken, just how much of a risk do you think that is? What do you sort of see out there maybe just to start? Ken Xie Actually we see the SASE approach a little bit differently and also Gartner also just changing their SASE definition right now, like in the past, it being SASE, all kind of cloud deliver, now and they change it all has to be local deliver. Some is a local, some is a cloud. So, that's where -- for us, we believe SASE will be better, like in the branch office, all this handled by local, like an edge. And that's also the reason we announced the FortiOS 7.0 in March this year, early this year. And integrate all the SASE functioning into the same OS in the same appliance, which we also we're working well with service provider, like put them out all the major service provider, working with us for their SASE service based on their infrastructure. And you can see that's kind of different strategy. There are some other SASE provider like Zscaler, which all -- based on their own cover on the cloud. So that's where if you'll process lot of the data traffic locally will be much faster, more efficient. And the same time, kind of make it easy to manage. And that's the reason we have. And so far we found out most of the service provider also supporting this product, even Gartner changing their view of how SASE should be delivered or should be managed. And we see pretty strong interest in our own SASE solution, which is, take long time to build. We had to integrate all this in together, not just SD-WAN we already have, but also CASB, firewall service, all other since there in the same OS, the same appliance and same time how to manage cognate -- or this different traffic together within a service provider, within all this kind of different infrastructure globally. So that's what we see pretty, pretty interesting kind of partnership Gartner forming right now with all the carrier service provider and the offer a SASE tool to support a lot of enterprise work-from-home and the branch office. Saket Kalia That's really interesting, actually just on that go-to-market, because there's so much of a service provider business here as well. So that'll be interesting to see unfold. Peter, maybe for you. Just -- also ask you a little bit of a product question or just maybe a space question, how does Fortinet sort of defining SASE? And then as part of that question, maybe we could compare it to others, how others in the market talk about SASE? Particularly the ones that have maybe started more so as secure web gateway. Does that make sense? Peter Zarkowski I know who you're talking about. But -- yeah, I mean to Ken's point, I mean, this is a recent change by Gartner. They're talking more about their on-premise capabilities relative to SASE, for example, SD-WAN, right? You need to deliver the traffic to the cloud to be able even to do, the cloud capabilities, whether it's CASB or firewall as a service or secure gateway, which you just mentioned. And so, there are certain on-premise capabilities that they say are going to be in existence for a long time, which is what we believe in a hybrid cloud world that you're going to do some things as part of that SASE model on prem. And you're going to do some of those things in the cloud. Our view is that, it doesn't make any sense to send things to the cloud that are happening on premise. So really for an example, OT, right? We talked about it a little earlier in terms of seeing really strong growth in OT. If you're doing an OT security situation, you have operational technology, you have a manufacturing floor that's being run, and you're trying to secure that data that's being created at that location. It makes no sense to take that physical location, shoot the data to the cloud is secured and then shoot it back down to the floor to protect it. You should protect it exactly where it is. And so, we have products that will work in an OT environment to allow that to happen. So I think that's part of the thinking there. There are certain things that will that work in the cloud and therefore you should be able to secure them in the cloud. And so that really comes back to the operating system and the holistic approach of being able to do things on premise, as well as in the cloud. The difference in philosophy, I think from us and some of our competition is we don't feel it's a profitable business to build out 150 different pops around the world and try to manage all of that cost as well as just to manage all those data centers, but we would prefer to partner with our service provider friends to provide that -- leverage their existing infrastructure, provide them the security capabilities with our operating system in our appliances and allow them to act as the service provider, which is what some of the current secure web gateway companies are doing. Saket Kalia Got it. Got it. That's really helpful. Sorry, Ken, you were saying something. Ken Xie No. I am good. Saket Kalia Okay. Got it. Ken, maybe I'll ask you a strategic finance question now as well. I mean, some of your competitors have talked about more attached subscriptions. Does Fortinet have an opportunity with something like this? And if so, what areas do you think could be interesting from -- again, an attach subscription to the firewall? Ken Xie FortiGate, because their ASIC capability, they have a much more competent power and more function there, like now we offer a lot of function for free like SD-WAN for example, all competitor like [indiscernible] 20% now on semi-state with service. Maybe long-term was caused by some more need, that was the part we can touch on, but also you can see FortiGate today has almost 20 function now, and the longer than we can add additional service and that's all how the part of our revenue growth eventually can helping driving the service revenue growth going forward. And that's the one we were keeping improving, is the new ASIC, we're keeping add -- additional company power and also we're keeping -- improving the FortiOS, more function there. So that's we do see long-term is healthy model. That's also we want to keep a reasonable margin, whether for our customer, our partner or ourself and then eventually, it's what benefit the whole industry. Peter Zarkowski SASE question, just for a second. Right now a lot of SASE revenue is SD-WAN and Zero-Trust, right? It's not all -- there's are 13 different components to the SASE statement that Gardner made a couple of years ago that define SASE. But really if you look at it -- and I guess secure web gateway, which is what each is doing, right? So it's really a limited of those, it's not all 13 products that are generating a lot of that revenue. SD-WAN which we believe as a market, that's really important. You can't deliver the data anywhere if you don't have that capability at that location. So that's going to be really important. And then Zero-Trust becomes a big part of that. It really goes back to Ken's philosophy of the security driven networking then, right? The ability to move security and networking together, and being able to handle those two markets within our appliances or within our operating system to do anything, that's going to be related to the security and certainly the SASE aspect of it. And your question on subscriptions, given that we do have subscriptions, we have FortiCare and FortiGuard. Two-thirds of our revenue is subscription based, right? So there is a, what I would call hybrid SaaS model in our income statement, that -- those services are coming off the balance sheet, revenue that the services revenue coming off the balance sheet. So, we do have services there. Ken Xie Yeah. We also have a search service. We call FortiTrust announced last week -- last quarter, is more like based on the user base, Zero-Trust kind of based so you can cover multiple device and go through the whole infrastructure to support your work-from-home, all of these kinds of work from anywhere. Saket Kalia Really interesting. Always fun to see the innovation at Fortinet. Well, folks, it's -- as I'm telling a lot of my management teams, 30 minutes goes awfully quick, and I've got so many more questions to continue learning about the business, but also want to be respectful of everyone's time. Ken, Peter, thank you so much for the time today. Really appreciated it and great to see all the good things happening at Fortinet. Ken Xie Yeah, Saket, great to discuss being together. Saket Kalia Yeah. Same here. All right. Thanks folks. Enjoy the rest of your day. Ken Xie Thank you. Peter Zarkowski Thank you.