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

Good morning, everybody. Welcome to our Fortinet fireside chat. We have the honor of having Christiane Ohlgart, the CFO of Fortinet; Anthony Luscri, I hope I said that correctly from IR and Aaron with us today. [Operator Instructions] In the meanwhile, I'll kick it off with one.

So we just finished the quarter. And can you walk through some of the highlights and what stood out to you the most during the quarter? It was really a fantastic quarter.

Yes. No, I agree it was a fantastic quarter. What stood out, and it really started, I would say, last year already, but that we see broad-based demand across all our geos, very successful in -- across the world and accelerating demand for hardware and build-out of networks. So that's where some of the growth in FortiGate hardware growth was extreme, I would say, not that we haven't had it years ago, but not lately. So it was a great quarter, accelerating from prior quarters, and we continue to see good demand for multiple use cases that -- whether it's OT, whether it's the build-out of SD-WAN networks and improvements, whether it's the build-out for AI infrastructure and AI-enabled networking and then also the fact that basically all our devices improve your security posture, even a switch or even an IP shows that this one OS and one security fabric is really resonating with our customers. So I think that the Q2 showed nicely how it all comes together when demand is there.

Yes, it was really impressive. One of the things I wanted to ask on unified SASE grew 35%, now represents 1/4 of the sales and Forti SASE billings more than double. So which part of the unified SASE port is doing the heavy lifting, the SD-WAN networking, the cloud security or the on-premise enterprise deployment. I was trying to really get a better handle on that because it seems like you have a large SD-WAN installed base.

We do have a large SD-WAN installed base, and that's where we are benefiting because the customers have everything they need to extend it to the cloud platform. And so get a unified posture for in-network and remote users. And we continue to embark on that story and trying to sell more of the SASE, but also depending on the needs of the customer, making it available with more functionality that allows them a unified SASE play. And this is where Ken created that SASE firewall market where he really wants to say it's not either/or. It is a big market, you need functionality at the edge of your network, which our OS can do that is similar to what you do in the cloud with the SASE platform. But you don't always need to go out to the cloud. And also as our competitors start selling hardware to improve their cloud SASE platforms, it's really -- it's a big market that if you want to have unified security for your users, you need both. And that's where we will continue to innovate and believe successful in the market. We were late with the cloud, but we've always had the hardware. Our competitors were faster with the cloud. Now they need some hardware. So it's playing all in our favors.

And then on the metrics, which metrics you think we should focus on more billing, ARR on this because you get both. And always when I do the post earnings call, I try and figure out which one I should really concentrate on. I mean they're both important, but...

Yes. I think they signal different parts of what's going on in the business. Billings is current quarter activity, but it's also impacted by the mix of hardware and services. ARR gives you a good impression on how successfully we are selling services and growing our service portfolio in all the different stacks. And it also gives you in contrast to revenue and in contrast to billings, a little bit more of an idea, is this a more service-centric pillar? Or is this a more hardware-centric pillar? And so I think between all these metrics, you get good insights into what are we selling.

Okay. No, that's fair. And then Ken described the combination of secure networking and unified SASE as a SASE Firewall, which I thought was really interesting. And that's over $2 billion, growing 34%. So is there -- is he framing that because of the buying pattern you're seeing? Or is there -- what's the reasoning behind that?

Yes. I think the reasoning behind it is that we are seeing success in the combination of hardware and software or hardware and services. And with sovereign SASE being an important aspect in Europe and more legislation around sovereignty. I think it's an important differentiator that SASE is not only a cloud-delivered service, but that SASE is a broader market that includes the firewall at the edge of the network in the data centers, not so much for SASE. And also our continued innovation in what do customers really need when they want to have a holistic security picture that is also -- has low latency and good speed for security. And if you listen to -- or if you heard about our press release that we came up that we launched in combination with earnings around the outpost functionality, it's actually very innovative. Even though we are using a firewall to do the work, it's functioning as a SASE PoP that is controlled by SASE, but then can be used in very rural areas or very locally. And so you're reducing your dependence on cloud PoPs that may not be close to where your customers need SASE security. So we are continuing to innovate between software and hardware and the cloud posture to make sure that our customers get what they need to secure their users.

Yes. And Jim mentioned that the SD-WAN and SASE bundle was launched a few months ago and it is growing very strongly. So this bundle raising per dollar deployment, I mean, I thought that was a pretty interesting way to bundle it.

Yes. So it's a combination of factors, I think that is important. One is in this SD-WAN bundle, we are including all the services that are improving your SD-WAN functionality and security. And so you don't need it necessarily for SD-WAN technology, but it improves what you want to do. It speeds up the traffic and so on. The other part is we added kind of a teaser license for SASE. So customers don't need to go through a buying cycle to buy the cloud SASE. Just if they want to roll it out to the whole organization, they will probably need more licenses because this teaser license per device only includes, I don't know, 10 or 20 users. So it's a good way for customers to explore our cloud solution if they have a competitor. And because it's so easy to roll out the policies from the firewall to the cloud SASE, we believe it's a good way to potentially grab more market share.

Yes. So it's a really good starter package, but you can insert it in maybe a competitor domain where they dominant.

Exactly.

Okay. All right. So then I shouldn't think that there's going to be a huge jump in billings or ARR right now because of that. It's just it's minimum, right, but it's a good marketing.

Correct. It's a good starting point. The increase in ARR, we will see over time from the service attached, the SD-WAN service attached to the firewall. But then the driver for SASE growth will come from upselling on these starter licenses, yes.

Very clever marketing point. All right. So then on the SASE billings grew 35% and the unified SASE ARR grew 18%. So one of the things I had some people ask me about, was that because the contract length or the hardware content that drove the difference of those 2 metrics?

So it's mostly the hardware component that drives the difference between what you see in ARR growth or service growth and what you see on the billing side, yes.

Okay. And then 40 SASE adoption reach 19% large enterprise. That was one thing I have to say when you first launched it because you have such a large mid-market space that I really felt that, that would be where it would be attractive, but you have done really well in the large enterprise. So what's happening on the AR side of that? And then are you -- and who do you see the most in these bake-offs? Or who are you taking share from on the large enterprise with your FortiSASE?

I would say, yes, in the large enterprise, we typically need to displace competitors, and it's a little bit harder. Who are we taking share of? We are taking share of -- or end customers that have a very distributed environment. If you're cloud only, you may not benefit as much from Fortinet. And this is where I think actually larger enterprises are our sweet spot because they are not born in the cloud. Most of the larger enterprises have their own data centers. They have multi-locations. So a different setup. Smaller entities, SMB, they don't need as much security, and they are probably more born in the cloud and fine with some of our competitors. And yes, it's a gradual upsell motion. And I think we've said it in the past, about 90% of our SSE customers are in our installed base, so upsell from existing SD-WAN solutions. And so that we continue to do that.

Es. And then the other one is that can size the sovereign and on-premise opportunity to be 2 to 3x the cloud-only market. So what do you expect in financial results over the next 2 years that would confirm that market size or show your traction? What should we look for in metrics?

So I mean, there will be no necessarily new metrics related to the sovereign SASE. You will see it in hardware growth. You will see it in ARR growth over time. And since the -- I mean, typically, who would be the buyer of sovereign SASE. It could be large enterprise. But in general, I would say it's the large telcos that have -- that want to set up sovereign environments for specific customers, for example, public sector customers or that want to compete with the cloud providers, which for them right now is harder because they can only resell that. And we believe because we have good relationships with the telco customers that this is going to be a good growth market for us.

Yes. And then on your pipeline, would you say that it's equally split between the sovereign opportunity and the hybrid?

From a pipeline perspective, I would say Sovereign is still developing. So the hybrid is still a bigger part of the overall pipeline. Specifically, sovereign is also more a -- right now, a European play where regulations are going to drive that. And then once that's successful, I think more countries may go down that route because they want to be in control of the infrastructure.

Well, one thing we've always noticed, and I think it came out back in 2025 when you did the presentation in New York. And you talked about international and you brought in all your salespeople from Europe and Latin America and Canada. I left that so impressed on how much share you really have in Europe and Latin America and Canada. And why -- how did you end up having such a good ground game in those different regions?

I think our focus has been on global sales for a long time. And many of our competitors have focused first on the U.S. And so it has allowed us to grow faster internationally. And that's why if you look at the sales force from a people perspective, we are smaller in the U.S. compared to our competitors, but we have more people and also more channel partners in many of the larger countries abroad, and that has given us an advantage. Of course, I mean, if you're ahead, others are trying to chase you. So it's always a game, right, where the markets are.

Yes. No, no. I just spend -- your international always stands out every quarter. Okay. Then we're switching over to firewall hardware cycle. So on the product revenue grew 52%. That was just phenomenal, second consecutive quarter acceleration. So I want to kind of dive into the number. Is it was a unit growth versus higher prices? Have you just had that price increase? Or what was really you think some of the drivers behind that, demand, refresh? I was just trying to get into.

It is clearly demand driven, and we couldn't achieve that growth without unit growth and without the demand. That said, and that is why I had this in my prepared remarks, what we saw in addition to unit growth and even if we normalize for price increases, we saw ASP increases for the hardware, which means that customers are moving to a little bit bigger boxes. And that's a clear trend that we've seen, I think, since Q4. And we believe that AI plays a big role in it, not necessarily only for AI security, but also for traffic. Customers are more -- are looking at upgrading their networks and making them more performant because they know there will be more network traffic in the future.

Got it. And then on -- the other thing that I noticed when I do my quarterly channel checks with everybody that all your VARs, one thing that comes out is the CVs. You've had several of them, you patch them. I get feedback from the channel that well, we're still buying that you guys are quick to patch, you find when you're quick to patch. So any -- and that's been like some of the bear case on the stock. So I'm giving you an opportunity to kind of like talk about your CVEs and how that's really -- do you see it impacting sales? I know last quarter, a couple of people were worried that maybe they wouldn't buy as much because of the VPN one, but I'm just letting you kind of tell me what you think of that and how fast you patch and it really is a pipeline problem or not.

So I think what we saw in -- at the end of Q2 was not a new vulnerability, right? It was really cyber hygiene. And then our competitors are always good to blame Fortinet on their CVEs. The key challenge that we have is we have so many products, and we have so many firewalls that we've sold that are being used that, of course, Fortinet is a prime target, and it gives everybody a good talking point when somebody has a problem, it doesn't necessarily need to be a new vulnerability. That said, I think the reason that on the one hand, we still sell very well despite having vulnerabilities because we've been very open and upfront with the fact that we are searching for vulnerabilities to improve our code quality and to patch them as quickly as possible versus others that may not have that rigor internally to find problems in their own code. And we will see what happens over the next couple of months with some of the [ Mythos ] capabilities or similar AI capabilities to identify code issues faster. But Fortinet has been extremely transparent. We've signed up to these transparency guidelines. We patch fast. We are constantly reviewing our code to make sure that we are ahead of the game. But that said, we have a lot of customers. We have a lot of devices running and not every customer is as diligent as a highly regulated enterprise customer or public sector customer with their patching. So there is always risk for us in our customer base that certain vulnerabilities can be exploited. We are working on a number of different initiatives, including virtual patching through the IPS engine to do save the devices until the customer patches them themselves. But it is a constant worry of ours. We need to keep our customers secure, but we can only keep them secure if we validate our code as well. We want to be the first ones to find something.

Yes. And then let's talk a little bit about memory. So we on the last call that you adjust prices monthly up or down based on the component costs such as memory in order to keep the gross margin steady. Since the memory costs have leveled off, how are you thinking about pricing changes for the rest of the year? And then in that last recent increase, how much did that add to billing growth? I know I've had a couple of people ask me that question.

O as we said, the price increase to billings growth was high single digits. And the reason that we can't be more specific is because we really need to look at what have we been selling. In the end, it's a mix of software and hardware. Hardware, of course, had more increases, but all the service components did not necessarily increase. So if you look at the billings mix, it was high single digits. On the price increases for hardware, we still see the kind of shortages in the market for memory components where the prices have leveled off, or stabilized, it's still hard to get memory components. So there may be certain parts that still you need to pay expedite fees or something to get enough memory, and we are evaluating on a product-by-product basis, whether we need to increase the price or not. But also, of course, Fortinet always wants to remain competitive. And we are evaluating extremely well what the competitors are doing. And I mean, they've been increasing their prices also, right? Everybody has the same situation.

Yes. All right. And then a little bit on the refresh cycle, which I have a little bit of a hangover on. But -- so what -- what share of the units shipped in the 2020 to '22 window that have already been upgraded? I mean -- and then are you seeing the firewall cycle shortening from the 5 years because of the amount of traffic? And it seems like there must be -- you said earlier, people are moving to larger performance throughput boxes. So how much has been upgraded? And you have another upgrade cycle for 2027, too, but it doesn't seem like the refresh is really like the #1 driver of your revenue either, right?

No. So the refresh is not the #1 driver. The refresh or upgrade cycle, how we wanted to frame it a little bit more carefully is something that gives us good talking points and also inspect with the customer whether they need new architectures, whether they can expand whether more products that we can sell. Fortinet will always have customers that have devices they need to upgrade. I think we've seen good success that our existing customers continue to buy from us. But you also have very different use cases that have, I would say, different useful lives. OT has a little bit of a different useful life than maybe network security because you typically put a device out there into a, let's say, manufacturing plant or into a pipeline to secure pipeline traffic and so on. And these don't always get upgraded every 5 years. You also have different cycles for APs because APs with the Wi-Fi 5, 6, 7, 8, I mean, there's going to be continuous upgrade and refresh cycles. And we are rolling out more security into these devices because, for example, an AP can also be a SASE access point for us. So for us, every device has a security posture. And so that's where we see good success, our customers adopting not only firewalls, but also the adjacent devices that help them secure their networks.