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

And that kind of like return of the service provider, is that in spite of interest rates, in spite of our hesitation to spend on CapEx because SASE is a more kind of like OpEx model. So in spite of some of the headwinds that we may see from carriers during their earnings call, is it still moving in the direction of SASE.

Yes. I think for this service provider which is Carrier have infrastructure. They own infrastructure. So they do have a cost advantage because SASE, the major part of cost is really the infrastructure cost. You have to run the PoP, you have to process all the traffic, which Carrier service provider have a huge advantage long-term-wise. The same thing like how we process SASE early days. We want to build our own PoP, which costs probably half compared to some cloud provider cost, which we still use in our own PoP to handle majority of the traffic. But if there are certain locations we don't have the PoP or don't have enough traffic to invest in our own PoP, we probably will leverage the cloud provider. A lot of carriers, not only their own infrastructure, but also they have a good relation with the local customer and also certain regulation requirements, they need to have data to be progressed locally. So thus, we see the service providers to have their advantage to play the SASE game. They are just a little bit behind on the technology, on the head count and training to make their service to the enterprise, to their customer, which they do need additional secured expertise to do that. But also the other area we see strong interest-related SMB, right, which is really -- most of our competitors don't even address that market, but they do need this kind of SASE service to protect some of the data to again some ransomware attack.

Got it. Super helpful. And then with regard to the infrastructure that your SASE platform sits on top of -- I mean you were building out your skis, you still are building out your own kind of data center footprint, but you made the decision last year to partner with GCP for the access portion of the network. What was behind that decision? And what has happened to, I guess, the acceptance or your ability to penetrate the market after you've partnered with GCP?

That's where we're changing the go-to-market strategy. Before we try to do like 6 months ago, we tried to more go for a service provider -- care service provider. So 6 months ago, we announced we go direct for the SASE, has also partnered with GCP, which they bring us additional like 150 PoP. Because SASE is actually, from my point view, should be more measured by the latency, should be more measured by the uptime, all this reliability issue, instead by number of PoP, but somehow competitor uses number of PoP to measure it. We say, okay, we can play the same game. Even though a number of PoP owned by ourselves is less, but it's a much more efficient, cost much lower. Now we partner with the cloud provider. The number of PoP also is the same or even better.

Got it. And then you talked a little bit about SD-WAN, I know historically, you've pointed to the opportunity that's within your installed base for SD-WAN. How are you going to market in terms of converting those SD-WAN customers to SASE as opposed to maybe selling Secure Service Edge upfront and using that as the tip of the spear to sell SASE. I mean are you still leading with SD-WAN or converting with SD-WAN? Or are you able to sell SASE on a stand-alone basis?

Yes. First, we do believe we are probably already #1 in SD-WAN because we offer SD-WAN as a part of FortiOS, which developed internally, which were different than other top 5 top 10 players, they all come from acquisition with separate masks. We have the same operating system and in the same FortiGate -- FortiOS, which we have more than 12 million deployed in the field. . We feel quite a bigger percentage, maybe close to half already using some SD-WAN because we don't quite track enough. So we feel that they will be supporting to work remotely, using [indiscernible] some other data security they probably will be -- once we announce, we're going to do SASE directly, it's a lot of interest to okay, how we can convert from the current FortiGate, FortiOS with SD-WAN and even for the firewall to the SASE offering. SASE, we do have some active service, do have some other like software and also even using the hardware, FortiAP, FortiSwitch to sell hardware agent. So we're only starting tracking 6 months ago. We see last quarter 24% growth, but also forever fast growth. I think there is a huge SD-WAN installation base, probably millions of FortiGate enabled SD-WAN. We feel we can more easily to convert upsell, cross-sell for the additional SASE service, which will drive the additional service business for us.

Got it. And then, I guess, to spend some time on secure networking, everyone is kind of wondering when we're going to see a firewall recovery. Keith, I think you pointed to a little bit of stabilization, particularly with regard to diminishing the backlog. What is your expectation in terms of the timing of kind of a turnaround and recovery to more normalized growth? And what might we base those expectations on? I think you've cited some Gartner forecast. But to what extent is it Gartner versus talking to your own customers and maybe basing an understanding on what the real spending may look like.

Yes, it's a great question. It's certainly a very common question these days. What's the date that it's actually going to happen? I think it will be easier to look back in hindsight and say that was the date, then we'll be able to look forward and say, we expected that date. I think the things that we look at beyond the Gartner and obviously is talking to companies about what their expectations are. One is our own pipeline. And as I indicated, we're starting to feel better about our pipeline as we look further out now in terms of it being a better growth rate and cleaner than it had been in the past. I think in conversations with customers, and we spend a lot of time on the road, one-on-one with customers and getting a sense of what their spending plans are for 2024 and how they feel about 2025. I think if I were to compare and contrast it to, say, a year ago, I think that certainly, we and some of our customers are a little bit surprised at how fast spending got shut down in the security space in Q2 of last year. I think it's quite the opposite now. It's not that this [ spigot ] is completely reopened, but they can now sit down and have a meaningful conversation with their own leadership team in terms of what their plans are. In terms of supporting things like go-to-market or AI or SASE or other initiatives, I think it's a more open conversation now. But again, I don't think it's fully backed, there's no way to go there.

Got it. And then who you're seeing most on the competitive front. I mean is it more reliant on what your customer base is spending? Or is there more reliant on what maybe your competitors' customer base is spending or the rate of refresh that they're seeing? I mean, how do you -- what kind of dynamics do you see within...

In terms of the -- we track our firewall or our pipeline and we break it down by segments, firewall being one, for example, I guess I'm calling it FortiGate right now. Is that the new name that we've [indiscernible] and those competitors, both in terms of who they are. You know the names, the top 3 and the mix really hasn't shifted for an extended period of time. We have more overlap with Cisco, both in terms of our product suite and our customer footprint than we do with say Checkpoint or Palo Alto. But again, that mix hasn't really shifted. We certainly have seen, as you look to the other 2 pillars, SASE and SecOps some of these other names that you talk about are now much more prominent in terms of being competitors, whether that's Zscaler or Netskope or some of the others that you mentioned. And we see those and we obviously track those as well. So I think there's been a new class of citizens, so to speak, that have entered our pipeline that we're probably not there 12 months ago and certainly not 24 months ago.

I think that's where you look at all the -- by region, by vertical. But region outside U.S. we're #1 pretty much in every country. And then the U.S. like say we are probably a little bit behind Palo Alto and Cisco. But Cisco still the same issue for the last 10, 20 years, they don't quite have the product. They have to acquire a company to have a separate product, whether for SD-WAN or firewall for some other security solution there. So we have a single OS with ASIC, keeping accelerate on the performance and all the costs. And on the other side, in the U.S., in the -- we kind of because the business model in the U.S. is a little bit different on international, than more depend on the partner, depending on the channel. The U.S. -- the vendor has to go direct, invest in the marketing, direct sales force, which we started to invest. So that's why in the U.S. enterprise, we're starting more gaining market share quickly. Especially some vendor there, they kind of try to do the [indiscernible], they try to whatever. And when the renewal comes, you can see the price tag go very high. On the other side, if they lose in advantage in some areas, whether in the network security, in some other area and also they have much less coverage use case. Whether supporting the internal high-speed segmentation, whether supporting the branch office or supporting work from home [indiscernible]. And then we are more convenient than gradually replacing some of the competitors. Like I said, we are very focused on network security, both secure networking, both on SASE and just want to make sure we win there first. And then gradually, we see that secure op that's upsell cross-sell. So that's the strategy, very different than a competitor. We continue to believe we are the best on a secure network in our network security and also the best in the SASE offering. So we'll leverage that advantage and go up this way. So that's where in the U.S., we are more gaining market share quickly because the competitor whether lack the product or they lack of kind of the performance or the cost advantage as we are.

Maybe that's a good segue into -- I guess I'll ask the -- is hardware going away question. I guess you have a lot of competitors who talked about migration to cloud and everything is moving into the cloud. And what are the technical merits of actually having hardware either in a branch office or in your infrastructure that support the argument for firewalls or hardware not going away as we kind of walk through this increasing migration to the cloud.

We're happy if our competitor [ give up ] hardware, which is not the case. Even during their earnings, they just mentioned still hardware is quite important, more than half of their business comes from the hardware side. I mean on the product revenue. Because always a hybrid mode and you do need to have a physical security on premise appliance and also especially a lot of new area, and that's what we're keeping using a convergence because the traditional networking gear, routing switching, they cannot give you the way to manage the data level, the application level, the content level or the other -- the user level and only the secure networking can do that. So that's where secure networking will be bigger than the networking by 2030. That's the Gartner forecast. On the other side, we do see there's a lot of a new total addressable market, not a new use case, the traditional enterprise security, enterprise firewall market or enterprise secure gateway market kind of go beyond that one, especially OT/IoT security and internal data center security and remote SMB work from home area with a lot of new use cases, we see a quite strong growth, which is mostly dependent on the hardware appliance. And also, that's also compared to the company technology because we do believe in the hardware beginning, that's also the reason from 24 years ago, we decided to invest in ASIC. So none of our competitors really have that long-term investment strategy because ASIC will take probably 10 years to build, new generation and also big investment there. So that's where we're keeping player advantage because none of our competitors have this advantage competing with us, so that's where they say the firewall hovers that, but which is not the case. You can talk to all the customers, even one of our new SASE customer. SASE is really additional to the traditional firewall. So they do need additional network security firewall gateway. And on top of that, there are some additional SASE service or some other part. So we don't see the firewall or the hardware being able go away. And that's why I do believe the market will continue to grow like around 10% in the next 10, 20 years, and the convergence also will happen. So that's what's keeping driving the growth because we only want to have some advantage from the single OS, from the ASIC advantage, none of our competitors have. So we feel we're keeping growing and still quite a big business like a 67% business come from that portion. And after SASE, probably even more -- much more.

What's the algebra behind that 10% growth rate is -- I mean, Gartner may have done it, but is there some sort of a bottoms-up analysis -- analysis they've done to get to there? Or do they just look at the historical -- what historical rates have been to kind of arrive at that number.

The historic data is probably even higher than that, maybe 15%, even close to 20% for us, in the last 15 years since IPO, the CAGR probably 25% because we're keeping gaining share. There's a traditional enterprise firewall secure gateway market, but a lot of other new use cases to go beyond the traditional enterprise might go to SMB, secured OT/IoT security, supporting work from home. And I think eventually with all the home appliance or connect online, the home gateway market also may take off, maybe leverage AI to lower supporting costs to address that. And right now, the current model, especially supporting cannot really supporting the work from home consumer network security because operating costs will be too high. So that's a lot of new technology may be needed to bring the market to lower the supporting costs.

Got it. I just realized we're running up -- like we've got a few minutes left, and I wanted to give people in the audience opportunity to ask questions, if anyone has some. I can keep going. Just wanted to make sure I checked. So in terms of -- I wanted to give you an opportunity to talk about AI. You recently announced Gen AI, IoT security assistant and new Gen AI capabilities for network and SecOps. Can you dig into that a little bit in terms of capabilities for FortiAI and walk us through Gen AI for IoT vulnerabilities.

Yes. Right now, the FortiAI already applied in the FortiSIEM, FortiSOAR, FortiAnalyzer, FortiManager. We will apply more product with GenAI. Basically, we're helping the security, IT guy to like lower operation costs, more quickly responsible on the attack. We're also using AI probably can handle close to half of supporting right now. So that eventually can enable us to expand the market into like whether some consumer SMB, some other area. But also in R&D, we do build our own kind of language model. It's more like an expert model to handle certain security on the intelligence side. And also apply on operations side, even on the R&D side. So that's where there's a multiple things going on with AI. And also, we're waiting when AI starting to apply into certain verticals, certain areas, whether in health care, in some manufacturing than earlier, they also bring some other how to secure all these AI, all this application using AI, which we're also working with quite some experts and vertical to address that issue right now.

Got It.

I think AI is going to be interesting journey. I would say that there's almost 2 classes of use cases. And one is the mundane labor-intensive exercise. The example that CFOs like to give is that we will get rid of our Investor Relations person, and we'll ask the ChatGPT -- he is paying attention, draft the script. I mean it feels almost one step removed from offshoring type resources and that sort of thing. I think the other part of it is when you talk to customers, it's really a focus on top line. It just consistently when you talk to a customer right now about their own plans for AI, it's always about the top line and how they're enabling sales, whether it's in retail, whether it's financial services and so many different use cases. And then behind that comes the security part of it. There was a -- in our accelerated kickoff speech as we did [indiscernible] great job on an example of how we use AI internally in local language modules and 30 different languages, to do the "routine" investigation of logs and checking logs and data. I think you'll see that type of a log. I think you'll also see from us a lot of conversation about the sheer volume of AI -- of data that we have to sort through as part of our security operations team and our FortiGuard team. And there's tremendous opportunity there to continue to expand. What Ken talked about earlier, our use of AI. So I think that AI is really -- you can look at it in different ways, the mundane things, the top line things and then also really how you're going to be forced to go about securing it. I think it's -- to come back to your question about Gartner and Gartner's growth rate. I think what Gartner has been trained to understand and Ken mentioned this, is that every so often, there seems to be another use case for firewalls and cybersecurity whether that's OT or whether that's micro segmentation or whether it's the edges, more things are coming. I mean, it's the nature of our industry because the bad actors are unfortunately, very creative in how they go about things. And with that, that generates new use cases for security.

Great. With that, I think we're out of time. So Ken and Keith, thank you for joining us, and thank you for joining us. Appreciate it.