Fortinet, Inc. (FTNT) Earnings Call Transcript & Summary

All right. Hello, everyone, and thanks for joining us on the 2nd day of Oppenheimer's 24th Annual Technology Conference. My name is Ittai Kidron and I'm a technology analyst at the firm. And I've got the pleasure of hosting Fortinet here with us and more specifically Keith, the CFO; John, who's got lots of hats. John, boy, you're a busy guy. EVP of Products, Chief Marketing Officer and probably a bunch of other things that are not listed here because we're out of space. And -- but before we get started, of course, Keith has to do a little tango. So Keith, I'll kick it to you and we'll get started. And we'll start with a fireside chat, and then open it up also for the audience for questions. Keith?

Happy to. I just want to make reference to our safe harbor slide and language that appears here. I will not take the precious time up and read through it, but I do suggest that you take a chance to check through that. Thank you very much. Bye.

Very good. Short and painless. So let's get into business, guys. Quite an impressive quarter this last quarter: product revenue, 41%; services, 24%; billings, 35%. These are very high numbers and point to an acceleration in your business. So help me understand what's behind this. I mean it can't be the traditional firewall place is growing that much. So what's driving the growth for you?

Yes. I just -- we'll get into more detail as it essentially goes on, I'm sure. Obviously, we're really pleased with the results of the execution by the team in the quarter. I think from a high level, I would say that both the benefit from the cost performance advantage certainly resonated with our customers throughout the quarter. We saw that both in the FortiGate, the firewalls, where our cost of performance, I think, is fairly well known, whether you measure on throughput or features or functions. And we also saw it in what we call the non-FortiGate of the platform, that broad set of products that we have. And there, I think it's not as -- in addition to the unit cost, it's also the management cost. When you offer a broad suite of products that are integrated, you're really enabling customers to take cost out of the organization. We saw that segment of business put up 40% growth for back-to-back quarters. And I think that's affirmation of our strategy. I would also say that I think the backdrop of the heightened awareness of security events throughout 2021 has brought probably a lot of new companies and customers that we want to the table that may have renewed or a heightened sense of concern about their own security architecture. And some of the things that we bring and offer in terms of cost performance and the broad suite of products, I think, played very, very well. It was a good quarter for us. We're happy.

Very good. Let's break it down a little bit more, perhaps, focusing on the FortiGate business more specifically. Clearly, you're outgrowing competition. But is there a point -- a way to a point of focus the finger, Keith, on how much of this is cost versus performance that's resonating with customers?

Yes. It's a great question. I think the combination of the ASIC, which enables the operating system or the OS 7. The history of the ASIC, together with the operating system, is one in which we just continue to add features and functions to it. SD-WAN is probably a very clear example of that. We try and encourage our salespeople not to lead with price because we've already won the price argument. Not the easiest thing sometimes with sales people to break that out, if you will. So where value comes into play versus performance, I'd like to argue it's all performance, but I suspect that there's some pricing actions in there as well. Look, I think we also benefit from having a very broad customer footprint when you look at the size of our customers, the geographic diversity, the industry that they're in. And so when you have this wide range of use cases and functionalities in the operating system, as we see customers now pushing more to the edge and having more conversations about micro segmentation, us having the ability to push back into the data center, I think it really wraps up very nicely in turn...

Did we lose Keith?

Keith is frozen. John, do you want to pick up perhaps on the features? As I think about the FortiGate platform, when I think about what features are resonating more and interesting more to customer or higher priority, I would like to call it, for customers more here and now versus what was the case perhaps a year ago, is there a big change?

There's a subtle change. And as you go back -- if you go back 15 years of firewall's a firewall, well, there's probably 10 different applications now that can sit on there. 3, 4 years ago, we integrated SD-WAN in there, which has proven to be a very good decision. About 2 years ago, we decided the Zero Trust architecture needed that network proxy as well. Not only you can do it in the cloud, but you can do it in the data center. You can do it on-premise. So you just continue -- a lot of times people go, "Well, you build these specialized ASICs so that you can run faster and faster and faster." Yes, we can. We announced a couple of quarters ago 1 terabit per second next-gen firewall. That's fine. There's only a certain number of customers who can take that.

Right.

What's more important is if I'm a customer, I can run my SSL inspection. I can run my -- I now got a Zero Trust capability in there. I can switch on SD-WAN. The more things you switch on, regardless who you are, it takes more compute. And the specialized ASICs inside there offload. Just like a GPU does on a gaming system, it offloads the CPU so you can run more applications on there and get more value. So it's not just performance, it's adding applications on there so that they can get more value and they can start to consolidate. There was an interesting Gartner survey done late last year, stating that about 25% of enterprises and businesses now are thinking about consolidating. That's going to rise to 75% over the next 2 years. So performance is good. But the ability to run, consolidate multiple appliances and services on to the same system is just as important to customers.

Got it. Got it. Interesting. Keith, we're glad to have you back. That was probably Cisco router that kind of failed there. But let's talk about SD-WAN, John. John did a very good job of picking up the baton, Keith. Let's talk about SD-WAN here. Clearly, an area you're kind of shifting and focusing on and you seem to have a very good, strong early success with. Can you give me a sense of how much of your business today in FortiGate is driven by SD-WAN? And how frequent is the discussion with customers in this? I know SASE is something that people talk about long term. But how much of a focus is it really here and now for people that, "I got to make this move here now"? Or this is a multiyear planning process execution?

I'll jump in with some quick numbers. And then maybe John can give you some good insights into the customer buying cadence. It's up to 14% of our total billings now. It pretty much came from a standing start in 2018, '19, when we entered the market, too. So to be at that level is very good. The pipeline is very strong. And our goal is, of course, to be the #1 SD-WAN provider. John, do you want to talk a little bit more and give a little more context of who's buying it, how they're buying it?

Yes. I think one of the themes that I'm seeing is some people are forgetting that the digital experience requires a really highly secure, fast network. We're not moving everything to the cloud and you're not just sitting at home. There's something in-between core network, which is extremely important to give you that digital experience. And so we saw SD-WAN as being the foundation. I hear SASE a lot and I'll ask customers. Every single one has a different vision of what it is, what it means and when it's going to come. Definitely, I see more people say it's more of a framework versus a product. I think the majority, depending on the definition of SASE, majority of the revenue today is either SD-WAN or secure gateway as a service. This firewall as a service doesn't make any sense to me in terms of the numbers people are talking. CASB, yes, but it's becoming -- I mean becoming a feature. And then Zero Trust, which I think will be its own market, its own right. So the foundation, if you believe the definition of SASE, is SD-WAN.

Right. Absolutely. Got it.

So you go from SD-WAN, the WAN edge. You go back towards a LAN edge. You go to the 5G edge. You go to the cloud edge. It sits right in the middle. That's why it's absolutely critical that we are #1 in SD-WAN, and that's what we're pushing very hard for.

Got it. That's great. Keith, just from a -- to make sure I understand the characterization. When you talk about SD-WAN being 14%, is that -- is it of billings or of ARR, remind me?

It's a billing number, 14% billings.

Billings? And that would be included within what you'd call FortiGate, yes?

It's like any -- part of it is, yes, but not all of it.

Not all of it?

So with SD-WAN -- and SD-WAN solution will attach, of course, services just like a traditional firewall sale, security updates we call FortiGuard for the care and support product. And you can get into secure SD-WAN solutions that will include access points and switches and things like that. And you also see an SD-WAN sale like a FortiGate sale. They'll buy products out of the platform so you can call the manager, the analyzer and things like that.

Got it.

It was interesting last year that a lot of people were saying because of COVID and work from home that maybe SD-WAN slows down because the branch offices are not -- it grew 40% in the marketplace.

Interesting. Interesting. But I kind of wonder why, right? I mean -- John, I mean those branch offices are still largely empty. So is this just future proofing and companies taking advantage, frankly, of the fact that people are not there to do this?

Different verticals. It became absolutely critical for retail to have that connectivity for online orders. And so just -- it moves around. And so now we're seeing people build out some more branches, et cetera. But back then, it was just retail, making sure they had absolute connectivity.

Got it. Got it. Okay. Keith, going back to your answer on how the SD-WAN, I guess, billings are kind of split between FortiGate and non-FortiGate. I guess I was trying to think about how does the FortiGate growth look like without SD-WAN. Is there a way to think about that?

It's certainly something that we track about -- we track internally. We don't comment about it specifically. I would say that it bounces around some quarters. The SD-WAN use case is greater than the other use cases. In the second quarter, it was quite the opposite. The other use cases were much larger than the SD-WAN. SD-WAN itself grew very, very nicely in the quarter. But the rest of the platform and suite of products just grew fantastically during the quarter.

Got it. Okay. And then, John, drilling again into the SD-WAN, what is it exactly that you are selling? Is this a software? Is this an appliance that's -- a router that sits in the branch? Help me understand what is this that you're actually selling here?

Yes, all of those things. It's -- SD-WAN is application routing, which replaces the traditional IP routing. So that's the first most basic application. And you buy it so you have higher availability. But eventually, really, you're buying it to make sure you're routing applications correctly long term. There's some other -- but for us, that mainly is our entry-level FortiGates, which are built on our SoC4, which is an ARM-based system on a chip. I don't know if you noticed that over the last 2 years, just about everyone is switching to ARM because of the power consumption, the performance.

Right.

This is our fourth generation. And we'll continue building those out because we can get much better performance. So there's a hardware component, there's a software component and then there's a security component. And then there's an orchestration and management component. All of those things come together to give you an SD-WAN solution.

Got it. And if I deploy this -- if I think about the traditional branch architecture, with the Cisco ISR, that's what's going to get kicked out. Is that the right way to think about this?

Yes.

All right. Very good. Okay. If I remember correctly, they, gosh, nominated a good 80%, 85% of the branch footprint with that device. So there's a massive footprint there for -- up for replacement, I guess, the displacement?

Still is. I mean I think that's why I think Cisco bought -- spent a lot of money on company internal development. I mean they have 3, 4 solutions, I think they still do. But in the end, what customers are looking for is an integrated solution. So the next evolution for us is SD branch, with ads in the WiFi, the switching, eventually the Zero Trust, the 5G. And that's when it becomes a much larger platform but built on the foundation of the WAN-Edge or SD-WAN.

Got it. Interesting. If we talk about things from a customer perspective, is there any common denominator for the customers on SD-WAN? Size? Region? Are they buying this as a stand-alone capability or part -- as a whole platform? Help me think about that.

Yes. I mean some separated out because there's still this kind of siloed mentality in many larger customers that networking is here and security is over here. It's all separated out. Service providers kind of have the same still, but I think they're eventually coming to the realization that these edges, WAN edge, LAN edge, 5G edge, cloud edge, has to have security, enterprise security on it. You can't just put an edge in there and say, "Oh, don't forget about security." So the -- this is actually -- SD-WAN is one of the applications which really brings the security and the networking teams together.

Got it. Got it. That makes sense. You've touched actually, I think, in one very interesting point, which is the blending of security and networking, right? And I always remember -- because John Chambers, right, he was famous in saying that if you have 16 security vendors, you don't have security. And I guess Cisco and you guys, Fortinet, are probably one -- the only ones that can claim that's trailing both sides of the equation, right? The networking side of the equation, the security. How important do you think that's going to be going forward? What is the advantage it really gives you, I guess, other security vendors that are perhaps not as close to that networking layer as one perhaps should be?

Well, obviously, we're not going to say it's critical. But I think it gives you a lot of -- there's a lot of security vendors who do detection, "I found something." Well, okay...

Very simple.

Now from an end point vendor, maybe I can do something because I'm an agent on there. But there's a lot of people with detection either in the cloud or on the network. The real benefit of being able to fit in the network and behave like a networking device is to be able to prevent things and stop things. And then after that, you've got to be able to then integrate multiple components together. And so I think if you look in history, there's a lot of cybersecurity vendors. The end point vendors -- between 2000, 2010, the end point vendors trying to bring together everything together in an end point platform. Between 2010 and 2020, the networks -- networking vendors try to bring things together in a network platform. I think recently, these cloud platforms -- we believe, long term, a platform has to include end point, network and application or cloud to truly be able to provide the use cases end-to-end. Now if you just have an end point platform or you just have a networking platform or you just have an application platform, it's not enough.

Right. Interesting. All right. Keith, let me ask you about -- I want to kind of go back to the drivers of growth and try to kind of break it down between new customers, expanding customers, land, expand. I want to understand if you're -- help me understand how much of the growth is coming from increasing the number of customers versus getting more dollars and more footprint from your existing ones. Help me think about the puts and takes of that.

Yes. I think like with any -- most tech companies, the vast, vast majority of your revenue and new billings are from existing customers. And for us, we have 500,000 customers. So it's going to be a fairly large number each quarter. But the new logos are key to the growth that comes from future quarters. And we have a very strong new logo quarter. We haven't given specific numbers historically, but we have provided information to allow people to think around the order of magnitude, about 5,000 new customers in the quarter in the logos. The second quarter, this quarter was -- this year was very strong. It was a 50% growth year-over-year. So you need the new ones to feed the growth engine for the future years. But given our size of our footprint with our customer base, the installed base is always going to be dominant in terms of the mix of revenues.

Got it. Is there a way to think about attach rates? Meaning -- so I understand that, clearly, a lot of the focus is -- a lot of the growth comes from existing customers expanding footprints. But how much -- how do I get my hands around how much of the growth is driven by expansion of the portfolio, meaning buying more and more different products rather than the same thing, just more of them?

Yes. I think internally, we track metrics by size of customer, if you will, the small businesses, the mid- and the large in terms of what their buying patterns are and how long it takes them to buy the third product and the fifth product and so forth. But they're not numbers that we necessarily talk about openly in terms of that penetration rate. We do, however, believe that the penetration opportunity for us, we're proving it is real, but it's still very significant in front of us.

Got it. When you talk about your $1 million customers, maybe perhaps if you focus on that type of cohort, is there an average product count that you should think about when you think about that cohort?

No, I think you've got to look at it. When you start peeling back the onion, you start to see the MSSPs and the telcos, for example, have very large attach rates of additional products, which kind of makes sense when you think about a service provider or an MSSP. They're looking to gain that management cost advantage. And so if they are buying from a single -- if they're consolidating vendor purchases, they're taking costs out of their organization. As you move through the mid-enterprise is probably another place that you see a very rich mix of attach rates.