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

Not in the past.

It's a. -- it's a valid question. And I think it's a question of what do you think is happening with supply to that?

Let's talk about backlog and cancellation because we're using terms here, and then we're going to confuse the audience that if we move back and forth a lot. We introduced backlog at the beginning of -- about 12 months ago, when we started to see the supply chain. It's something we never talked about before.

Things, which we appreciate as well.

There you go. And I wanted a backstop because I missed my billings number to say it made my bookings numbers. So there was some soft ...

A [ demand ]?

But we -- do I expect backlog to be here for everything? No. But with that has come a new focus on some of the metrics that Peter has talked about. The first question that we have internally and you have as well is how sticky is it? And you hear about this term of cancellation, and we talk about 4% of our backlog canceled last quarter versus down 1 point from 5% in the prior period. And that's actually overs all kinds of things, not just supply chain. It could be misordering, it gets reordered or what have you. But we're watching that. We're watching for trends. We're looking at what percentage are we delivering out of backlog. And it's about 60% of the prior quarter backlog is getting delivered because we foresee that if it extends out, it's going to get riskier. Peter talked about, most of our backlog is with existing customers, 95%. We view that as being lower risk than new logos. We talk about the fact that there aren't a lot of great big deals in our backlog because we perceive big deals to be higher risk. So you're getting all that color about the backlog. And the reason we're giving it is like you, we're trying to assess the possibility of cancellation because backlog -- backlog is not a signed contract, right? They haven't delivered on it. Unlike the service revenue contract that I talked about a moment ago, that is.

So the activation, again, probably a function of strong ordering early on, Russia, obviously, a function of Russia. One of the factors, which we didn't talk about -- you talked about linearity also..

Yes. Again, with the new world, we're in the new cost of linearity, we typically talk about lending area about my billings during -- by month or by revenue by month. Now I'm talking about deliveries from my suppliers by month, having an impact on the business. So I get my -- my appliances are delivered by contract manufacturers to us. And if they're delivered 1/3 in the first month, 1/3, 1/3, that's very nice. I can turn around, ship them and start recognizing service revenue. But when -- in the current world, they get backed up, they can be the contract manufacturers, it's not 1/3, 1/3, 1/3 anymore. Now I start to see about a 10-point shift at a month 1 into month 3 on those deliveries from my contract manufacturers. That 10% really cannot get shipped in those service contracts activated in the same quarter. In the first month, we can do it. If it's in the third month, we can't. So again, the service revenue will come. It's just been a bit of a push out here as we go through and manage part of the supply chain.

Okay. Have we beat that yet?

But to your point of view, the point has been on linearity, it's a supply side. It's not a demand side. People are pushing off there, looking for deals exactly the quarter. So again, that leads -- well, first of all, a bunch of talk about products -- talking about your product numbers in the quarter, your expectations for product for the year? I know as you guide, they're implicit not terribly implicit. So how do you feel that your product was in the quarter? Was it in terms of both the demand, product bookings and then finally, how you are able to deliver in the supply?

Yes. I think we kind of -- part of this process, we use bookings as a very good indicator of demand because I'm asking my salespeople to book orders. I'm not asking them to physically deliver the goods, right? Their job is to go out there and make sure that they're signing orders. And so I think we have that 42% growth in the bookings number. I think that's a very good number for us. And then you get into, okay, of those bookings, how much can you ship and get into your revenue numbers and how much is going to end up in backlog? And that's the growth number. I think we feel very good about the business. We feel very good about the execution we saw in the second quarter, both by the sales team as well as by the operations team to get things out the door in this world. And I think importantly, we feel very good about the pipeline growth. As you can imagine, Michael, is one of the things that we go through in the guidance setting process, and you made the inference or that comment about you can pretty much reverse engineer when I'm thinking about service revenue and product revenue by how we give the guidance. One final check about this when we go through a lot of things is to look at where is the pipeline growth compared to what I'm projecting for the bookings growth because I always want the pipeline growth to be higher than what I'm guiding to the Street. And I think we're very comfortable that what we provided again in the third quarter is very consistent with how we've done it in the prior quarters and making sure that we have some capacity there between what we guide to versus what the pipeline is showing that we could have.

So obviously, coverage is not decreasing?

No. No.

And keep in mind, we did raise full year -- because we did not -- we kept the full year revenue guidance that we had before the same, and we lowered services revenue growth quite a little bit. That implicitly implies that we brought our product revenue growth up for the year, which gives you some sense. The other thing that gives you sense is as Keith pointed out, we shipped 60% of the backlog that was at the end of the first quarter during the second quarter which includes those products. And then we replaced all that backlog with new backlog and added to our backlog by another $72 million total product and services, about 3/4 of that is product. So the demand is there for the product. It's we don't have the supply to deliver it.

Has there been -- again, now on just the demand side, in general, I mean, one of the things that we saw in post-COVID, in general, in IT was more reticence about large projects are products that had a lot of risk products that are architectural in nature. And I think there's been some pullback on those types of projects. Again, I'm not saying the [ screw your ] business just in general, the whipping horse for this is always exactly I was going to.

That's been a couple of years with SAP. So yes, it's an easy 1 for me to -- yes, I think that.

So my questions are securities like SASE or architectural SD-WAN, [ central ] products, really transformational security projects. Any change there?

Yes. I'd probably like to say more about SASE and Zero Trust architecture, but still that's pretty massive for us, and we'll get to that as we move forward. But SD-WAN is really the good one. And I think that why you see -- continue to see such success with SD-WAN is because the ROI is so compelling, the ROI out of the payback period -- and what companies are doing is they're avoiding the MPLS fees. If you're not familiar with SD-WAN, SD-WAN is basically a routing, with security functionality that you can put your high-profile traffic, voice and video that you don't want to be jittery, run that through the higher, the more expensive MPLS or dedicated line, but e-mail, you don't have to. You can pivot that out to something cheaper. And when you make that pivot, the payback for SD-WAN is very dramatic, right? And it's a fairly low-risk installation because you're doing the same thing at branch by branch by branch or store by store by store, right? You're putting it typically a small box inside of one of those things. ERPS..

It's still an architectural change?

Yes, it's not..

You think of it. Other boxes you may be buying. And again, because you pointed out your contracts with the carriers around MPLS. So it's transformational.

Absolutely. And -- but again, I think it has a very -- when you do an ERP -- the ERP vendors, they are very helpful in giving you go the ROI tieback and how many people you're going to only in the count space you just milestone the model. It's like, yes, okay. SD-WAN is very real, right? Here's the invoice from the carrier for MPLS. It goes away right.

Okay. I want to make sure that you just gave, again, relative to your guidance at Analyst Day, you just gave guidance for 2025 for $10 billion in billings and $8 billion in revenue. And that was well received. Let's just say -- everything.

Yes. I think Peter probably has the numbers off the top of head of how that might work there. But I think we feel very, very comfortable about hitting those numbers as we go forward and look the 8-year revenue -- pardon me, the revenue number at $8 million and the billings number of $10 million, absolutely.

And I think to add to that, I think, we said that from the end of 2022, the 3-year CAGR to 2025 for both of those numbers, $10 billion in billings and $8 billion in revenue, the CAGR would be 22% over those 3 years. And everyone seemed to receive that really well, except now we're hearing that, that means a deceleration because we're going to do 31% according to current guidance in, I think, billings growth this year are in a high 20 number on the revenue number. So you got to decide, is $10 billion in billings by 2025, a good number? Or is that 22% because it's a 22% CAGR, a bad number?

Shouldn't we be quick to point out your prior guidance was in the high teens?

Yes, absolutely. I know -- but I'm telling you what we're hearing from everybody.

It's a little bit challenging guys -- to point that out.

I think another thing to point out, I just did some simple math this morning because I was curious. Currently, right now, 60% of our revenue is coming from Services. If you went back 2 years ago, that would have been 66%. And the question would be, well, why did that go down? Well, we've had a renaissance in product revenue growth lately for a lot of different reasons. And we saw 50% product revenue growth last year. Think about that in 1 quarter, 50% product revenue growth, and we've been doing very well against those comps this year. And that's the reason why Services revenue has dropped from 66% to 60% because of that product revenue growth. And because of price increases, right? Those price increases are immediately showing up in the product, but they're being deferred under the balance sheet for deferred revenue in the services contracts. As you roll that out of the income statement, out of the balance sheet into the income statement on Services, if you assume that in the next 3.5 years, that Services gets back to 66%, I don't know if that's really going to happen, but I just made that assumption to see what the numbers would look like. That doesn't seem unrealistic over the next 3.5 years to get back to 66% for Services revenue. That means my Service revenue growth has to grow at a 27% CAGR over the next 3 years. We guided to 27% for this year and the price increases aren't even in this year very much, right? There is still to come. And my product revenue growth has to be in the mid-teens, mid- to low teens actually, I believe. So -- the point is how realistic is those numbers can we make them? Does 22% CAGR makes sense? Yes, if that's the way things work out.

We're pretty much finished, but anybody have any questions from the audience?

How is that [indiscernible] business from now -- going forward, a little bit longer, you -- how much can [indiscernible] businesses people are shooting that way?

Yes. I don't know that we think that SASE per se is cannibalization or cloud. I think we kind of view those as just an expansion of a reaction to the expanding attack surface. You just have the reality is -- and ransomware has made this message very clear to every company around there about how big your attack surface is? Is the manufacturers are now exposed on the shop floor and they didn't realize that before driving OT. That's an expansion of the attack service. Having your data not only in a cloud, but in multiple clouds and having to manage those clouds, if you will. We clearly believe that there will be is a hybrid world, and it will be for a long period of time that means you're going to have data and applications in the cloud that need to be secured in the cloud. You're going to have data and applications at various edges, right? It can be a branch, you can be at the shop floor or what have you. You're going to have a data center, you're going to have it. So -- and I think with customers and what CIOs want right now, we didn't talk about consolidation is they're just getting overwhelmed by the so many different vendors that they have to manage. And they're looking not for a single vendor like ERP that does everything. They're looking for a vendor that can maybe consolidate 4, 5, 6, 7 different technologies. And that's to do that, you've got to have an expansive offering. I think we do.

And then we don't have a lot of time, but Gartner also changed definition of SASE last year. If you go back to 2018 to today, they now call it a hybrid model, that there's going to be on-premise. There's going to be cloud capabilities, and we completely buy into that, including their cybersecurity mesh architecture, which is really what we call our platform extension products.

[indiscernible]

In some ways, they're the same. I just think there's just another way to deploy security across on-premise and cloud. And we think that the mesh sort of concept in the hybrid cloud concept is much more important. We're going to go after SASE a different way. We think it's much more important to partner with the service providers than build out our own 200 POPs around the world or whatever it's going to take. We just think of physically as an economic model, we think it's better to partner and you just saw us if you haven't, we announced the deal last week with Comcast and a FortiSASE model, where we're going to supply them what they need and they're going to offer that to their customers, and I think growth.

We got you. Thank you.

Michael, thank you for your time. Peter is available always to answer your questions. So if you can't answer them, then I'll try.