Q3 2024 Fortinet Inc Earnings Call
Thanks for watching!
Speaker Change: Good day and thank you for standing by. Welcome to the Fortinet Q3 2024 Earnings Conference Call.
At this time, all participants are in a listen-only mode.
Speaker Change: After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1 1 again.
Speaker Change: Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Senior Director of Investor Relations. Please go ahead.
Speaker Change: Thank you and good afternoon everyone. This is Aaron Ovadia, Senior Director of Investor Relations at
Speaker Change: I am pleased to welcome everyone to our call to discuss Fortinet's financial results for the third quarter of 2024.
Speaker Change: Joining me on today's call are Ken Xie, Fortinet's founder, chairman, and CEO, Keith Jensen, our CFO, John Whittle, our COO, and Christiane Augarde, our CAO and sales operations leader.
Speaker Change: This is a live call that will be available for replay via webcast on our Investor Relations website.
Speaker Change: Ken will begin our call today by providing a high-level perspective on our business. Keith will then review our financial and operating results for the third quarter of 2024 before providing guidance for the fourth quarter of 2024 and updating the full year.
We will then open the call for questions.
Speaker Change: During the Q&A session, we ask that you please limit yourself to one question and one follow-up question to allow others to participate.
Speaker Change: Before we begin, I'd like to remind everyone that on today's call, we will be making forward-looking statements, and these forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected.
Speaker Change: Please refer to our SDC filings, in particular the risk factors in our most recent Form 10-K and Form 10-Q for more information.
Speaker Change: All 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.
Speaker Change: Also, all references to financial metrics that we make on today's call are non-GAAP unless otherwise stated.
Speaker Change: Our GAAP results and GAAP to non-GAAP reconciliations are located in our earnings press release and in the presentation that accompanies today's remarks, both of which are posted on our investor relations website.
Speaker Change: The prepared remarks for today's earnings call will be posted on the quarterly earnings section of our Investor Relations website following today's call. Lastly, all references to growth are on a year-over-year basis unless otherwise noted. I will now turn the call over to Ken.
Ken Xie: record gross margin and operation margin with the operation margin increased by 830 basis points to over 36 percent. Total revenue growth of 13 percent as we return to cost of building and product revenue growth.
Ken Xie: Unified SASE building growth of 14%, Secure Operation Building growth of 32%, and Secure Networking returned to positive growth, all driven by a continuous share gain in our total addressable market of $284 billion.
Ken Xie: As highlighted on slide 11 of the investor presentation, Fortinet continues to be the only vendor to leverage a single operating system for DOS, delivering solutions in five secure networking dynamic quality reports.
Ken Xie: Secure Service Edge, SC1, Single Vendor SACI, Network Firewall, and Enterprise Wireless LAN Infrastructure.
Ken Xie: FortiOS, combined with proprietary FortiASIC technology, significantly boosts secure computing power, delivering 5x to 10x better performance than our competitors, while lowering customers' total cost of ownership and energy consumption.
Ken Xie: In the third quarter, unified SASE building was 23% of our business, up one and a half point, driven by secure service age building growth of 220%, with pipeline up 130%.
Ken Xie: Fortinet is the only vendor offering all SASE functions in a single operation system and providing a unified networking and security stack on-premise and in the cloud. This allows Fortis SASE to be deployed within minutes from our SD-WAN customers.
Ken Xie: Our single-OS-based 4D SASE also enables sovereign SASE for service providers and large enterprises to deploy 4D SASE with their own data centers for data privacy.
Ken Xie: In addition, we were recently recognized as a clear leader in the 2024 Ghana Magic Quadrant for SD-WAN for the fifth consecutive year, and notably, are positioned highest of all vendors in ability to execute.
Ken Xie: for the fourth year in a row. Leveraging FullerNet's leading position in Firewall and SD-WAN and our integrated 40-SASI within the same 40-OS.
Ken Xie: Fortinet provides the easiest and most secure path for migrating from traditional firewall to secure IC1 and a unified chassis.
We continue to invest in our global infrastructure.
Ken Xie: In over three million square feet across office space, briefing center, operation facility, and data centers, our own hosting capability gives us a long-term cost advantage by allowing us to use our own FortiStack for better security and management.
Ken Xie: AI security operation was a fast-growing pillar, outpacing the overall market with a 32% building growth, accounting for 10.5% of a total business, up two points.
Ken Xie: We have expanded our security operation portfolio with the launch of Lacework 40CNAP and 40DLP, which together represent a new $20 billion market opportunity.
Ken Xie: And we expect to cross-sell both solutions to a large install base of customers.
Ken Xie: Our commitment to innovation and investment in R&D has enabled us to rapidly expand FortiAI, our Gen AI assistant, into seven key solutions, FortiAnalyzer, FortiManager, FortiSIM, FortiSOAR, FortiDLP, and recently announced FortiNDR and FortiCMAP.
Speaker Change: Mojang AI-enabled 4D AI product will be announced in early 2025, as 4DNA's AI-based secure operation business accelerates.
Speaker Change: Before turning the call over to Keith, I would like to thank our employees, customers, partners, and suppliers worldwide for their continuous support and hard work.
Thank you. Thank you.
Thank you, Ken. Thank you, Aaron. And good afternoon, everyone.
Speaker Change: Let's start with the key highlights from the third quarter. We are very pleased with our strong execution and financial performance in the third quarter, repeating our second quarter performance by again achieving record gross margins and record operating margins while delivering top-line results at the top of our guidance range.
Speaker Change: Total revenue grew 13%, driven by strong growth in services revenue and product revenues returned to growth.
Speaker Change: We again added over 6,000 new logos, driven by the resilience of small enterprise customers and the strength of our robust channel partner ecosystem.
Speaker Change: As you will hear in a moment, we are pleased to again raise our revenue and operating margin guidance for the full year, and we believe we are on track to achieve our seventh consecutive year of exceeding the rule of 40.
Speaker Change: Looking at buildings in more detail, RPO grew 15% to $6.1 billion, and total buildings grew 6% to $1.58 billion, driven by robust growth in security operations at 32%, and unified SASE at 14%.
Speaker Change: SSE and related cloud technologies were again the fastest growers in Unified SASE, benefiting from our large SD-WAN customer base.
Speaker Change: Our unified SASE and security operation pillars are gaining considerable traction.
Speaker Change: with over 90% of their billing is coming from our secure networking install base and combining to drive our SaaS solution, organic ARR growth rate of 74%.
Speaker Change: The customer buying journey from FortiGate to SD-WAN to SASE supports our customers' drive towards consolidation and is gaining traction.
Speaker Change: This consolidation journey first begins with a firewall on 40 OS and typically expands to SD-WAN and next to SASI.
Speaker Change: I should share that two-thirds of our large and mid-enterprise customers have deployed our SB WAN technology.
providing them with a gateway to 40-SASI.
Speaker Change: these large customers. Our first year of SASE delivered high mid-single-digit penetration rates.
Speaker Change: highlighting both the dramatic expansion opportunity as well as customer demand for vendor consolidation.
Speaker Change: including all elements unified SASE pipeline growth was over 30% and while while the SSE technologies are seeing pipeline and ARR growth of 130% and over 500% respectively.
Speaker Change: Larger enterprises continue to drive our expansion into unified SASE and the security operation markets, with large and mid enterprises representing 91% and 76% of SASE and SEC possibilities respectively.
Speaker Change: As we work through the wind-down of last year's backlog and the related year-over-year headwind to growth this year, secure networking has returned to growth as we expected.
Speaker Change: Rounding out the building's commentary, SMB and large enterprise were our top two performing customer segments, while EMEA was our best performing geography with double-digit growth.
Speaker Change: Among our top five verticals, manufacturing buildings grew by over 20%, driven by OT buildings growth of 19%.
Speaker Change: while the service provider vertical reached its highest growth rate over that same six-quarter period.
Speaker Change: Turning to revenue and margins, total revenue grew 13% to $1.508 billion.
Speaker Change: driven by 19% service revenue growth and product revenues return to growth.
Speaker Change: Service revenue $1.034 billion through 19%, accounting for 69% of total revenue.
Speaker Change: Service revenue growth was driven by growth in our SAS solutions, including 50% services growth in SecOps and 27% services growth in Unified SASing.
Speaker Change: Product revenue returned to growth for the first time in five quarters, increasing 2% to $474 million.
Speaker Change: Excluding the impact of backlog, product revenue grew sequentially at double digit rates, outpacing historical norms for Q2 to Q3.
Speaker Change: And following a similar storyline on what we saw in Q2, when sequential growth also outpaced historical norms.
Speaker Change: A moment ago we talked about solution consolidation and described the customer's journey around firewalls to SD-WAN and on to SASE.
Speaker Change: The second customer buying journey is supporting customers' convergence of security and networking.
Speaker Change: Their journey begins with Fortinet Firewalls and expands to leverage our FortiLink technology to manage Fortinet switches and access points.
Speaker Change: It's worth noting that over 95% of our larger enterprise switch customers previously or simultaneously purchased FortiGate firewalls.
Speaker Change: At the same time, our switch penetration rate for these larger customers is around 50%.
highlighting both our success and the future opportunities.
Speaker Change: Software license revenue continued its double-digit growth driven by SecOps solutions and represented at mid to high teens percentage of total product revenue.
Speaker Change: combined revenue from software licenses and software services such as cloud and SAS security solutions increased 33 percent accelerating from 32 percent in the second quarter and providing an annual revenue run rate of over 900 million dollars
Speaker Change: Total gross margin increase 630 basis points to a quarterly record of 83.2%.
Speaker Change: and exceeded the high end of our guidance range by 320 basis points.
Speaker Change: Gross margins benefited from higher product and service gross margins as well as a four-point mix shift to higher margin service revenue.
Speaker Change: Product gross margin of 71.6% was also a quarterly record and increased 1,370 basis points.
Speaker Change: which includes a 320 basis point benefit related to the renegotiation of supplier contractual commitments.
excluding this one-time benefit.
The product gross margin would have been 68.4%.
Speaker Change: Service gross margin of 88.5% increased to 130 basis points as service revenue growth outpaced labor cost increases and benefited from the mixed shift towards higher margin FortiGuard security subscription services.
Speaker Change: Operating margin increased 830 basis points to a quarterly record of 36.1%.
Speaker Change: and with 360 basis points above the high end of our guidance range.
excluding the one-time benefit to product growth margins.
Operating margins would have been 35.1 percent.
taken together with our reported Q2 margins.
Speaker Change: The Q3 margins, excluding the one-time benefit, provide directional insights to our financial performance.
Speaker Change: Before moving on to the statement of cash flows, I'd like to provide a few details related to the impact of Lacework and Next DLP acquisitions.
Speaker Change: These acquisitions increased Q3 buildings and revenue by approximately 60 and 90 basis points, respectively, and increased gross and operating margins by about 30 and 220 basis points, respectively. And I said decreased gross margin and operating margins.
Speaker Change: Looking at this statement, the cash flow is summarized on slides 16 and 17.
Speaker Change: Pre-cash flow was $572 million, representing a margin of 38%. And adjusted for real estate investments, the margins came in at 40%.
Speaker Change: In the first nine months of the year, free CAFSA was $1.5 billion, or $1.75 billion after adjusting for real estate investments.
Speaker Change: Cash taxes were $140 million, up $114 million, reflecting the prior year's regulatory extensions of estimated tax payments.
The infrastructure investment is a total of $36 million.
Speaker Change: The average contract term in the third quarter was 28 months, flat year-over-year, and quarter-over-quarter.
Speaker Change: DSO decreased six days year-over-year and quarter-over-quarter to 62 days reflecting stronger than usual linearity.
Speaker Change: The $106 million gain on bargain purchase from the Lacework acquisition
Speaker Change: Relates to NOL carry-forwards and the related recognition of the deferred tax assets.
Speaker Change: The gain is excluded from our non-GAAP financials, but it is included in the GAAP financials, adding 14 cents per share to our GAAP EPS.
Speaker Change: share buybacks in the quarter total $600,000 and last month the board increased the share repurchase authorization by an additional $1 billion.
bringing our remaining share repurchase authorization to approximately $2 billion.
Speaker Change: Now I'd like to share a few significant wins from the third quarter. First, in a seven-figure upsell deal, an existing SD-WAN customer in the retail industry continued their consolidation journey, adding 40 SASE for 16,000 users.
Speaker Change: This customer selected our 40 SASE solution for simplicity, ease of management, and consistent security enforcement across their infrastructure.
Speaker Change: We outperformed the competition by leveraging our 40 OS operating system.
streamlining operations, and reducing cost of ownership.
Speaker Change: while showcasing our ability to consolidate multiple security functions onto a single platform.
Speaker Change: In another seven-figure win, a medical device company purchased 40-SASI to replace their existing solution.
Speaker Change: This customer chose 4NET for its simplified and consistent security management, significant cost savings, and 40 SASE's enhanced functionality, particularly the bidirectional connectivity between their data center and remote users, enabling them to push policies more effectively.
Speaker Change: In an eight-figure competitive displacement win, a multinational bank commenced their partnership with us by selecting our FortiGate firewalls and multiple SecOps solutions to secure their hybrid architecture.
Speaker Change: This customer was particularly impressed with our integrated security end-to-end visibility and automated response capabilities of our 4DOS operating system.
Go to Beadaholique.com for all of your beading supply needs!
Speaker Change: Before discussing our guidance, I'd like to offer a couple of comments on the firewall recovery and refresh opportunity.
Speaker Change: During last quarter's remarks, we mentioned that the continued improvement in the days to register 40-guard contracts indicated the inventory digestion at end users was returning or had returned to normal.
Speaker Change: In the third quarter, this metric was stable, further validating our view that the firewall market is recovering.
Speaker Change: Today, we'd like to add to this commentary by noting that in 2026,
Speaker Change: A record number of FortiGates will reach the end of their support life cycle, and we expect these customers to start the refresh cycle for these products sometime in 2025.
Speaker Change: Moving on to guidance, as a reminder, our fourth quarter and full year outlook, which are summarized on slides 19 and 20, are subject to the disclaimers regarding forward-looking information that Aaron provided at the beginning of the call.
Speaker Change: Before reviewing our outlook, I should note we expect Lacework and Next DLP, or those acquisitions, to increase Q4 billings and revenue by 75 and 135 basis points, respectively, and decrease operating margins by 230 basis points.
Speaker Change: All right, for the fourth quarter, we expect billings between $1.9 billion and $2 billion, which at the midpoint represents growth of 5%.
Speaker Change: Revenue in the range of $1,560,000,000 to $1,620,000,000 which at the midpoint represents growth of 12%.
Speaker Change: Non-GAAP gross margin at 79.5% to 80.5%. Non-GAAP operating margins of 33 to 34%.
Speaker Change: Non-GAAP earnings per share at $0.58 to $0.62, which assumes a share accounted between $768 and $778 million.
Speaker Change: Capital expenditures of $100 to $120 million, a non-GAAP tax rate of 17%, and cash taxes of $127 to $177 million.
Speaker Change: For the full year we expect, buildings in the range of $6,430,000,000 to $6,530,000,000.
Speaker Change: Revenue in the range of $5,856,000,000 to $5,916,000,000 which at the midpoint represents growth of 11%.
Speaker Change: Service revenue in the range of $4,015,000,000 to $4,045,000,000, which at a midpoint represents growth of 19%.
Speaker Change: Non-GAAP gross margin of 80.3% to 81.3%. Non-GAAP operating margin of 32.9% to 33.9%.
Speaker Change: Non-GAAP earnings per share of $2.20 to $2.28, which assumes a share count between $766 and $776 million.
Capital expenditures of $380 to $400 million.
Speaker Change: Non-GAAP tax rate of 17%, and cash taxes of between $550 million and $600 million.
Speaker Change: I look forward to seeing you at the analyst day later this month and updating you on our progress in the coming quarters. I will now hand it back to Colin O'Haran to begin the Q&A session.
Colin O'Haran: Thank you, Keith. As a reminder, during the Q&A session, we ask that you please limit yourself to one question and one follow-up question to allow others to participate.
Operator, please open the line for questions.
Speaker Change: Thank you. At this time, we'll conduct a question-and-answer session. As a reminder, to ask a question, please press star-1-1 on your telephone and wait for your name to be announced.
Speaker Change: To withdraw your question, you may also press star 1 1 again. Please stand by.
Thank you.
Please stand by while we load our first question.
Speaker Change: Our first question comes from Hamza Fotowal with Morgan Stanley. Your line is now open.
Speaker Change: Good afternoon. Thank you for taking my question. Ken, I couldn't help noticing in your investor presentation, you talked about, you know, a
Speaker Change: a market growth that you see over $200 billion growing 12% over the next four years. Obviously, a big chunk of that growth is driven by
the SASE market and your share gain there.
Speaker Change: I'm curious if you could talk a little bit more about Fortinet's approach in terms of sovereign SASE. How is that differentiated versus some of the competitors out there, and what is it that you're doing differently, particularly for those highly regulated verticals out there? Thank you.
Speaker Change: We invest in the SASE for about five to ten years in the market, including all the SD-WAN and also all the SASE functions in the same 40 OS, both on-premise and also in the cloud. So there's a huge differentiation without a competitor, which they cannot run the SASE, whether in the same OS or even different box.
Speaker Change: And that's for the sovereign SASI. We usually call private SASI. Actually, if you look at probably one years ago, we were more focused on that area.
Speaker Change: with a lot of service providers, which is quite important for them to...
Speaker Change: deploy the SAS in their own data center to process data and also to keep the data in their own kind of data center and also process also within their own data center.
Speaker Change: So that's the two important factors there. So they have to be.
Speaker Change: local and to secure the data and same time to process data locally. So that's our huge advantage in the same OS and also a lot of function can use in 40 ac class salary.
Speaker Change: The other differentiation comes from the business side. So we have, we're the number one on the network security firewall.
Speaker Change: We are also the number one on the ITU-1. So leverage our installation base, and also both the firewall function and also ITU-1 function in the same OS with the SASE. So that's for the customer. They have the most easy migration path.
Speaker Change: from the traditional firewall customer to the SD-WAN customer go to SASI. It's only a few minutes reconfiguration. They can enable SASI based on their previous SD-WAN or the firewall configuration there. So it's a very easy migration path.
Speaker Change: Now as you can see, the pipeline grows, and also the business growing there for SSE, like over 200%. The pipeline grew over 100%. So we do believe we'll be the number one leader in the SaaS space in the next few years.
Thank you. Thank you.
Speaker Change: Thank you. Our next question comes from Brian Essex from J.P. Morgan. Your line is now open.
Speaker Change: Hi, good afternoon. Thank you for taking the question. Stick to one topic. I guess either Ken or Keith, could you dig into the commentary around the firewall refresh cycle that you provided? So with respect to conversations you're having with customers and
Speaker Change: You know maybe with a little bit of color what you've seen historically
How far before the...
Speaker Change: renewal point, do customers tend to refresh and do you have any insight into the mix of SMB, large enterprise, service provider, retail, and what the timing and the magnitude might be, whether this might be a first half event, second half event, any kind of insight you could provide would really be helpful.
Speaker Change: Yeah, I'll kind of jump in a little bit on this. I think that, you know, we see these end-of-life these products starting in the second half of 2026.
Speaker Change: We don't expect the customers to wait until the 11th hour to make the change.
Speaker Change: For larger enterprises, you know, they would go through another certification POC project perhaps as part of that before they place them in service.
Speaker Change: We saw a similar, not similar, we saw a lift, if you will, similarly in 2023.
although the magnitude in 2026 is much, much larger.
Speaker Change: And why it's relevant to 2023 is that if you go back and look at product revenue growth in 2022, very different world, supply chain, switches, et cetera, but I think in 2022, the product revenue growth was a little bit over 40%. So we do think there's a relationship there. We do think it starts earlier.
Speaker Change: To the second part of your comment, as I mentioned, the absolute number that we see in 2026 is by far the largest we've seen probably ever, but certainly in the last five or six years. Each year it's dominated by the entry levels.
Speaker Change: firewalls. However, in 2026, we do see a significant portion of that actually being in the mid-range firewalls as well, and that is a very unusual and positive situation.
Speaker Change: I don't have a breakdown by SMB or something else, so maybe Christiana wants to offer something more on that. Or by vertical. I think you've mentioned before that you need a large enterprise retail and service provider in order to recover. So, you know, if you have any insight there, how their cycles and spending patterns may impact that, that would be helpful.
Speaker Change: Well, again, I think 2022 was a robust year for those industries that you just talked about, retail in particular, and pretty much manufacturing across the board. And I would expect that they would be active players, if you will, in the refresh cycle that we see in 2026. But, Christiana? Yeah, you were asking whether...
Speaker Change: for how early customers would refresh. And many of the enterprise customers have enterprise agreements where they have account levels.
Speaker Change: support and subscriptions. So they don't really wait until something expires. They will probably, I would expect what we typically see, be fresh about a year before EOS.
Yeah, 15 to 18 months out.
Got it. Super helpful, thank you so much.
Speaker Change: Thank you. Our next question comes from the line of Fatima Boulani from Citi. Your line is now open.
Oh, good afternoon. Thanks for taking my question.
Speaker Change: Ken, a question for you. You know, there was a discussion about the routes to the market in terms of gaining your market share within the SASE universe, and one of those important routes is leverage your install base by converting and graduating a lot of the SD-WAN customers.
Speaker Change: So my question for you is, how should we think about the potential for the cannibalization of some of your refresh potential as that migration journey progresses?
Speaker Change: transpires from SD-WAN to SASI. And then I just have a follow-up for Keith. Bye May.
Speaker Change: Yeah, it's a very good question. I think if you look at the customer, a lot of SaaS is really supporting the ZTNA and also remote work environment.
Speaker Change: So they're not kind of like any network security firewall deployment, which tend to be more in the office, in the headquarter there.
Speaker Change: On the other side, if you look at our current SASI growth and strength, it mostly comes from the current SD-WAN customer base or even the firewall customer base there.
Speaker Change: So that's where they do need a hardware firewall SD-WAN layer to support SASI with additional SASI user license, with additional other function service add-on layer.
Speaker Change: So that's what we see, like both three pillars, whether the secure networking side and also the SASE side, which will help you add additional service, and plus the other, we call the secure operations side, all kind of starting growing now.
Speaker Change: So we do believe we can keep on growing in all these three areas, faster in the market, keep on gaining market share. Especially SaaS, the technology we can put all in the same OS with easy to accelerate.
Speaker Change: and also supporting both the cloud-based SASE or the private SASE or sovereign SASE is a huge advantage. And also, we also believe eventually the service provider carrier
Speaker Change: will play some important role in SASE and offer a lot of their own kind of SASE to their customers.
Speaker Change: And so that's where we are very strong supporting all the service provider build their own SASE infrastructure. And we do feel it's a huge growth potential on top of the traditional malware market.
Speaker Change: Thank you, Ken. And just, Keith, for you to double back on.
Speaker Change: the end-of-support catalyst around the refresh that you're talking to and telegraphing for 2026.
Speaker Change: Anyway, you can give us a lens on either the proportion of the shipment footprint, or the install base footprint, or the customer footprint that this applies to in the aggregates. Thank you.
Speaker Change: Yeah, at the risk of taking all the fun out of the analyst day in ten days. I would say that the second, 2023 was, or 2022, was the second best, second highest I looked at. 26 is more than, is a little bit more than 2x23.
Thank you. So you're not coming to the LFA?
Speaker Change: All right, thank you. Our next question comes from Saket Kalia from Barclays. Your line is now open.
Awesome. Hey, guys. Thanks for taking my questions here.
Speaker Change: Maybe for Keith or Christian, I think we mentioned a SAS Solutions ARR growth number in the prepared remarks. Could you just remind us, is that an organic or inorganic number? And maybe just touch on what are the solutions that are driving that growth?
Shani, you want to? Yeah.
Speaker Change: So, the growth number that Keith referenced was an organic growth number. We did not include the ARR that we acquired from Next GLP and Lacework. So, the growth would be even higher. Year-over-year would be 150%.
Speaker Change: What are the solutions, the organic solutions, that are driving this AR growth is really...
Speaker Change: 40 EDR, 40 client, 40 NDR, clouds, 40 web. So a variety of our cloud solutions and the solutions that we've started to offer. Some of them are core, some of them are internally developed.
Speaker Change: Thank you for my follow-up for you. Just to shift gears a little bit, it was great to see the profitability again. Could you just remind us, you mentioned something about being one time in nature in the quarter. It sounded small, but could you just remind us what that was? And more importantly, do you think about this as a more sustainable level of profitability?
Speaker Change: Yeah, I think if I were to use the headline first, I would say the pro-forma margins if you back out that one-time benefit.
Speaker Change: Product gross margin would have been about 68.4, .5 percent and operating margin if you backed out that benefit would be 35.1 percent.
Speaker Change: As you may recall, we have two different things that are impacting our margins in that regard. One is the traditional excess and obsolete inventory calculation with inventory you have on hand. That's pretty straightforward in comparison. The second one is future deliverables.
Speaker Change: and the operations team has worked really hard over the last year negotiating and renegotiating those. And we saw a benefit there that kind of pencils out to those margins I gave you in round numbers. We got a benefit there of about $15 million. That's very unusual. We've not seen that in the past.
Speaker Change: and anything on sort of the sustainability of that of that margin and if that risks pulling anything from the annals, I totally understand, but wanted to make sure the question was asked.
Speaker Change: Yeah, I think we feel really good about the profitability of the business and I think it comes back to where those investment vectors that Ken and John Will and others are going to really focus on as we go forward and how we want to invest there. But I think we certainly have ample room to invest in the growth of the company.
Very helpful. Thanks.
Speaker Change: Thank you. Our next question comes from the line of Tal Liani from Bank of America. Your line is now open.
Hey guys, you have Tomer Zilberman on for Taliani.
Speaker Change: I just wanted to ask about the billings guidance for next quarter. The organic billings X Lacework and Next DLP came in well below street expectations. I just wanted to ask where you see the weakness and how you measure that against the comments of seeing stable firewall demand this quarter and the expected refresh cycle in 2025.
Speaker Change: Yeah great question and I think what we're seeing when we look at the fourth quarter right now
Speaker Change: We're really pleased with what we got out of the very first month of the first quarter.
Speaker Change: And I think that the second month is, you know, it's early at its tracking. What's giving us pause are some chunky deals that are, you know, teeing up for the final month of the quarter.
Speaker Change: And they just need to mature a little bit more before we start thinking about them as part of our guidance number. So I think it's really that population of a large seven-figure and a few eight-figure deals that are kind of coming into play there a little bit.
Speaker Change: Got it and maybe to follow up asking more generally about the competitive landscape we've seen over the last couple of quarters some of the larger vendors are now focusing
Speaker Change: even more on discounting, bundling, and vendor financing. So how do you see the competitive landscape? Do you see any pricing pressure because of that? And how are you participating with that as well?
Speaker Change: Yeah, I think maybe Christiane will add a couple of comments here as well, but I think the discounting was very similar to what it's been in prior periods, as I mentioned.
Speaker Change: We certainly have ample margin to invest in a wide range of ways And we're encouraging our sales team and our channel partners to take part of that But I think there's also been some other changes in terms of incentives that we offer as well But maybe Christiana has some thoughts as well
Christiana: Yeah I think that overall the discounting we expect to be pretty stable but of course it depends on the product set a little bit.
to buy more 4DNet solutions.
Got it. Thank you very much.
Speaker Change: Thank you. Our next question comes from the line of Gabriela Borges from Golden Sachs. Your line is now open.
Hi, good afternoon. Thanks for taking my question.
Speaker Change: Keith and Ken, I wanted to ask you about the go-to-market, and more specifically, I think it's been about a year since you up-leveled your sales force around SSE. What are some of your learnings? What do you think is working well? And what do you think is incrementally a focus as we go into 2025 where you think you can maybe up-level some more? Thanks.
Speaker Change: You can see the last 12 months we made a huge progress in the
Speaker Change: SASE SSE go to market directly. But also you can see Q3, some of the service providers also starting, finally starting to turn world now and realize the importance of the SASE into the customer base.
Speaker Change: security and also IC1 customer and that actually helped us sell additional service, additional margin there.
Speaker Change: and to expand beyond traditional SASE market, which is only focused on the cloud-based SASE.
Speaker Change: So that's where we see whether the Sovereign Statsky, Private Statsky, or even beyond, go to the edge computing area.
Speaker Change: with our kind of technology with our clients, also here, especially for the OT, IoT area, both the hardware agent, software agent who's supporting all these OT device, we see also huge growth potential there.
Speaker Change: So that's where we're pretty confident that we're beating the SASE market and just like we did in the 401c1 space.
Yeah, I think that can be thought of. Thank you.
Yeah, please go ahead.
Speaker Change: Spot on with that. I think that if you compare and contrast where we are today versus a year ago, what I would say is that
Speaker Change: Given the response that we get from customers when they meet with us. They're very excited about the
Speaker Change: the architectural design of SASE that we've taken. And what we really want now is just more at that. When customers sit down with us and hear that story, it resonates with them, and you see that in some of the pipeline numbers and some of the ARR numbers that we're talking about, which are still very early days.
Speaker Change: And I think part of that is getting more reference customers involved. And I think also, you know, the channel needs to, we need to partner more closely with the channel to make sure that we're getting more advance on those SASE opportunities.
Thank you.
Also, the infrastructure is also different than all other competitors.
Speaker Change: I think, like I said, we own more than three million square feet of our own kind of facility.
Speaker Change: which if our own data center can deliver the SASE function, probably less than a half compared to all these colo and then also kind of only 10 to 20% cost compared to some cloud provider. But we're definitely working with them because they have also good coverage.
Speaker Change: So that's where, for us, we do have a cost advantage.
Speaker Change: on the infrastructure side. Plus on the OS technology on ASIC acceleration can lower the energy costs within the data center within all this SASE processing. I think we do have a huge advantage, both on technology, from the infrastructure, and also leverage the business customer base we have on the far west event.
Speaker Change: So that's the three advantages we have over all other SASE competitors.
I think it's also interesting to note
Speaker Change: Like you said, we started really focusing on SASE a year ago. Like Ken said, we've been building the solution for some time, of course.
Speaker Change: A year ago, at the November 23 earnings call, right around that, we broke out those two other pillars, SASE and SEC Ops.
externally and also internally to focus on those pillars.
and you've seen really nice growth.
Speaker Change: when we focus on solutions like that over the past year. It's only been a year.
Speaker Change: And I think it's a little analogous when you think about kind of Fortinet's ability to execute. If you look at SD-WAN, which we started to really focus on in 2018, and now we've risen to be the leader in the Garden of Magic Quadrant, it steadily grew over time. And so I think that those past...
Speaker Change: results delivered around SD-WAN are illustrative of what Fortinet can do when they focus on things and we've really been focused on SaaS and SecOps for that year and so I think you know we've had really good results over the course of that year in a very short period of time and a lot more focus to come going forward.
Absolutely. Good stuff. Thank you.
Thank you.
Speaker Change: Thank you. Our next question comes from Saoul Eyal from TD Cohen. Your line is now open.
Thank you, good afternoon guys. Ken or Keith?
Speaker Change: In your press release, you're talking about Fortinet being well-positioned to lead in its three core growth areas and drive sustained growth.
Speaker Change: Keith, again, I don't want to spoil, you know, the analysts, they will front-run it in advance, but sustained growth, what are we talking here? Low teens, mid-teens, any color will be highly appreciated.
Speaker Change: Yeah, I appreciate the opportunity to talk to it, and maybe Ken wants to a little bit, although I would probably be careful what he says. I think we'll obviously, you know, we'll talk about 2025 as we get to
Speaker Change: You have the February earnings call, and we understand that the November Analyst's Day is probably going to bake in some of the 2025 conversation, so I think that's a well-structured question, but I think we'll pause on answering it for now.
Speaker Change: Yeah, I agree. We're probably waiting for 10 days. And also, you can look at the investor slides, probably number six, there's some information there. And we probably provide more detailed information about total addressable market, how we want to grow faster in the market in each sector.
Thank you. Thank you.
Thank you.
Thank you.
Speaker Change: Thank you. Our next question comes from the line of Rob Owens from Piper Sandler. Your line is now open.
Speaker Change: Great, thanks for taking my question and Keith, I wanted to...
Speaker Change: I guess double back on your comment around Q4 and some of the chunky deals setting up for the
Speaker Change: the final month of the quarter, giving you a bit of caution. Was that not in your purview, I guess, when you were looking at the setup for the second half before? Have these things somewhat slipped relative to maturation, your ability to get them across the line? Just curious why the additional conservatism around them now. Thanks.
Speaker Change: Yeah, great question and I do think that compared to what I've seen in other quarters maybe a little bit less or a little bit slower progress on the maturation on those larger deals in the third quarter as they got teed up for the fourth quarter.
Speaker Change: Certainly not shutting them out. I just I think it's more prudent right now to take a more cautious approach and let them mature a little bit.
Speaker Change: It's an honor, it's really probably the first time we also started
Speaker Change: gave the RPO number and also compared to one year ago.
Speaker Change: Some of the deal, probably Christiana can give more detail, is instead of finance from a channel, get a building right away,
Speaker Change: for multiple ADO. Some of them may just use an RPO, just bill annually. Maybe Christiana knows this better.
Speaker Change: As you can imagine, the customers won't pay my two years up front, and so we have internal discussions around either...
Speaker Change: getting the channel finance or do it ourselves and this is also not matured enough to be comfortable guiding in that direction, but gives us some pause because some customers just don't want to sign up for long periods without financing.
Speaker Change: This maybe has a little bit short-term impact but also a benefit company long-term with better margin, better customer relation. So that's what we're looking for long-term success.
John , John , John , John
All right, thank you.
Speaker Change: Our next question comes from the line of Katherine Trebnick from Rosenblatt. Your line is now open.
Speaker Change: Oh, hi, Catherine Trebnick here. Thanks for taking my question. Can you discuss how you're...
Speaker Change: virtual firewall is performing this quarter or the trends for it and Competitively, we've been picking up that Microsoft and Google have been doing a really good job with their virtual firewall So how is that standing? Competitively with you. Thank you
Speaker Change: Yeah, I think that the virtual firewalls have done very, very well. It is a component of Unified SaTC as well as part of our network security portfolio. And I think the other thing that we look at is the crossover that we see, which is a very strong relationship between... Sorry, I have another call.
Thank you.
Are you still there, Catherine?
Speaker Change: Well, I'll just finish the thought by saying, and one thing we'll talk about later this month is just the strong overlap that exists between our enterprise customers that are buying both physical appliances and virtual appliances.
Thank you.
All right, thank you.
Speaker Change: Our next question comes from Adam Boer from Stiefel. Your line is now open.
Speaker Change: Great and thanks so much for taking the question. Maybe for Ken, just on the Lacework for the Steam App offering now, I'd love to hear a little bit about initial customer feedback, partner feedback, and kind of near-term R&D and sales and marketing priorities. Thanks so much.
Good job guys.
great product, great engineering team.
Speaker Change: It's an incremental TAM of, you know, $10 billion for us.
Speaker Change: So it really opens up that incremental TAM. Now we have cloud security, endpoint, network.
And we have great threat intelligence from all three.
the quality of the product.
Speaker Change: You know, we're continuing on the roadmap to improve the user interface in other areas and really make it a really, really, really strongly competitive product. I think it's very competitive against.
Speaker Change: Some who have kind of pieced their solutions together based on multiple acquisitions forming their CNAP solution. And so what we find is in that context, oftentimes we hear this feedback from customers a lot, their solution does not work well together. It's poorly integrated. It's not lace work.
Speaker Change: CMAP solution was largely developed organically by them to all seamlessly work together, so we're hearing really positives.
Speaker Change: on that front, and then also versus other competitors, we do have this broad suite of products.
Speaker Change: that we can offer together versus other kind of single point, single product vendors who just offer CNAP. So we have real competitive differentiators against the others in this space that we see working to our advantage.
market-leading technology and the team there also pretty strong.
Speaker Change: on the same time also kind of better as a company. So we're keeping our hands on our own kind of solution, integral solution there. And that's probably better than other competitor actually leverage our customer base, leverage our also strong R&D resource.
Speaker Change: have both combined solution and also stand-alone solution to supporting customer units in new $20 billion total addressable market. I think it's definitely add a huge growth potential both in the secure op and also in the safety space.
Speaker Change: That's great. And maybe just as a quick follow-up, just on the government vertical, obviously 3Q is important for the U.S. Fed. I know the Fed's a little bit smaller of a vertical for foreign debt, but maybe talk about the government vertical more broadly in the quarter and how you think about it in coming periods. Thanks so much.
Speaker Change: Yeah, to your point, we're not really aligned with the U.S. as part of the market for us. The government part is more state and local as well as international government, so you don't really get the same sort of 930 benefit that maybe some other companies see.
Great. Thanks again.
and Ken Ovadia. Thank you.
Speaker Change: Thank you. Our next question comes from Patrick Culver from Scotia. Your line is now open.
Speaker Change: Hi, this is Joe Vandrick on for Patrick Colville. Can you guys talk more about how you're enabling or incentivizing partners to kind of lead with Fortinet SASE when they may already have existing relationships with
with more established vendors in this space. Thanks.
Yes, you can see the...
for Fulbright Channel Partner.
Speaker Change: You can see a lot on the actuality. He's our partner for network security and also SD-WAN. So it's a very easy upgrade path to SASE. And a lot of them also compare to what are the...
Speaker Change: The cost, the security, the performance, the flexibility, the broad range, we also not better than any other competitor. So it's quite easy to migrate from some of the competitors to Fortinet. We do see some kind of acceleration there.
Speaker Change: The other part is also we have a pretty big SMB customer base. SMB right now probably only a single digit has any kind of network security deployment. We also see that's also one of the fast-growing areas because they do suffer a lot of events that will attack all these kinds of things.
Speaker Change: for Big Enterprise to do this private solvency assay. That's also none other competitor can offer whether in the same OS or...
Speaker Change: to the local data center deployment within the customer premise there. So that's where we feel we have quite some differentiation can give us a huge advantage over other competitors.
Got it. Thanks, Ken.
Thank you.
and Ken Ovadia. Thank you. Thank you.
Speaker Change: Thank you. Our next question comes from the line of Joseph Gallo from Jeffreys. Your line is now open.
Joseph Gallo: Hey guys, thanks for the question. It was great to see the OT grew 19% billings growth. How should we think about the sustainability of that business and then are there any changes in that competitive landscape?
Well, I think that...
Very bullish on the OT market.
the leadership opportunity for us.
Speaker Change: Yeah, OT is out of the area. We already lead in the space. In some reports, we are the only leader in OT security.
Speaker Change: We do believe, also investing this year for a long time, and also we believe the next 5 to 10 years, probably most of the connections all come from this device level.
Speaker Change: The agent software on this device had to use network security, so we see a huge opportunity.
Speaker Change: This OT combined with all this edge computing we feel is what will be the strongest growing area in the next five to ten years. And so leverage whether the OS or ASIC technology and also the infrastructure we have, we feel this is a huge opportunity there.
will definitely drive the long-term growth.
Speaker Change: And then maybe just to double click on retail and some of the verticals, it was great to see that that grew for the first time I think in six quarters. Now that we're post-election, are there any verticals that you expect to rebound or are there any changes going forward over the next couple quarters that we should expect? Thank you.
Speaker Change: We see the manufacturer already pretty strong in Q3. We feel the post-election probably that's why we're also keeping our salary in there.
Speaker Change: Also, the other one, like a carrier service provider is out of market. We finally see some growth after probably six quarters. And, yeah, probably some other, like...
Speaker Change: like a retail like it's a pretty strong growth in 2001-2002.
Speaker Change: 2021-2022, almost like 100% growth. So I think that like, that's probably will be most starting getting a refreshing cycle starting whether next year or 2026, because we see a...
Speaker Change: The number of units in mass space registered has been like a ghost route for the last four years. We probably won't reach the time to refresh now.
Thank you.
Speaker Change: Our next question comes from Keith Bachman from BMO. Your line is now open.
Speaker Change: Hi, many thanks. Good evening. I wanted to ask two questions, sort of a micro and a macro, and I'll just...
Speaker Change: ask them concurrently in the interest of time. Keith, just on the sassy...
Speaker Change: is with Large Enterprise. If you took out the SD, and it's a very impressive figure, if you took out the SD-WAN,
Speaker Change: What would that penetration rate or share look like in terms of customer type? I'm just trying to understand the SD-WAN versus the other bucket.
Speaker Change: And then the second question is a broader question, but how are you thinking about Europe as you look out over the next quarter or two?
Speaker Change: T-plus-one in terms of the election and what economic growth may be as a consequence. But just how are you looking at Europe over the next couple quarters, not just in Q4? And that's it for me. Thank you.
Speaker Change: Yeah maybe we've confused you or I've confused myself on slide 9. I don't think that's showing penetration. I think that's showing mix of customers. Yeah yeah that's what I sorry that's what I meant but what would the just mix of customers if you took out ST WAN of the SASE piece alone?
Speaker Change: You're going to find a mix of customers that's more tilted to the larger enterprises if you look at SASE alone than when you look at the entire universe would be my expectation.
I think that I think you said yeah
Okay.
Speaker Change: When you look at dollar values, right? Not customer accounts. Okay. Yep.
Europe was, I think we mentioned on the call,
Speaker Change: EMEA was number one, I think US was number two, and Europe was right behind them in number three. You know, it's a little bit like the SMB headlines that we talk about every quarter, that the economy is slow, everybody worries about SMB, and it continues to do well. I'm not saying there aren't pressures in Europe.
Speaker Change: And as we look forward to the fourth quarter, I don't know that we're expecting anything like an outsized performance from Europe, but we'll see how the quarter comes out.
Okay, thank you.
and Peter Salkowski.
Speaker Change: Thank you. Our next question comes from a line of Junaid Siddiqui from Cheweth. Your line is now open.
Speaker Change: Great. Thank you for taking my question. I just wanted to drill down in your hardware appliances and if you could maybe just give us a little bit more color how, you know, the high-end family performed versus the mid-range and the lower end. Thank you.
So overall, I would say mid-range and high-end has
Thank you.
Speaker Change: I guess what we're saying is there's something that jumped off the pages when we looked at our numbers.
Great.
Speaker Change: Greg Your line is now open.
Speaker Change: Oh, great. Thanks for working me in.
Speaker Change: Greatly appreciate it.
Speaker Change: So yes. It was really helpful to see the product level billings growth rate disclosures on the slide deck.
Speaker Change: Within Universal SaaS fee could you maybe give us a ballpark sense as to how fast the SD Wan piece is growing.
Speaker Change: My understanding is that's probably been under pressure over the last 18 months. So I guess my question is really like do you see potential for that product to reaccelerate.
Speaker Change: Particularly as being more customers start looking for alternative solutions.
Speaker Change: Okay.
Speaker Change: Yes, I think if you look at our SPT SD Wan space and I think we made reference to the penetration in the larger enterprises or something on the order of 65% or 70%.
Speaker Change: That is of our of our customer base.
Speaker Change: Great you are pointing out the opportunity for us to see greater growth areas by.
Speaker Change: White space accounts, and bringing them onboard with the Florida, getting an SD Wan solution and starting them on that customer journey that goes for to gate SD Wan SaaS fee.
Speaker Change: I think youre going to get some renewals from the early adopters of SD Wan here as we start looking into 'twenty.
Speaker Change: 2025, and enter 2026 that would be natural I think that those same we've just as we're going through a renewal cycle for SD Wan our competitors will be also and we have historically shown where we have a superior product like SD Wan, that's an opportunity for us to dislodge the encumbrance yeah.
Speaker Change: Yes.
Speaker Change: If you look on the top five SD Wan provider, we're the only one internally develop integrated with security.
Speaker Change: Also the SaaS and the other thing on other comp acquisition.
Speaker Change: <unk> also been solid after you acquire some of SD Wan.
Speaker Change: So they're kind of.
Speaker Change: Our technology already stopped stop development.
Speaker Change: You can see a few years now and.
Speaker Change: Come after refresh we do see it's a huge opportunity is there's still love our fragmented space, but we do see a lot of replacement.
Speaker Change: Opportunities deal right now and we also feel we are not only lithium technology, but also performance cost energy consumption.
Speaker Change: So thats why we feel the SD Wan, while keeping our salary retain and grow faster than the market gaining market share there.
Speaker Change: Understood Alright, thank you very much.
Speaker Change: Thank you.
Speaker Change: This does conclude the question and answer portion I will now turn it back over to Aaron for closing remarks.
Speaker Change: Okay.
Aaron Ovadia: Thank you I'd like to thank everyone for joining today's call as a reminder.
Aaron Ovadia: We'll be holding an analyst day on November 18th marketing, our 15 year IPO anniversary.
Aaron Ovadia: We will share the company's vision for the future of cyber security and provide an update on our strategy and mid term financial model.
Speaker Change: You will also be attending investor conferences hosted by Barclays Needham Scotiabank and Wells Fargo during the fourth quarter the.
Speaker Change: The webcast link will be posted on the events and presentations section of Fortinet Investor Relations website do you have any follow up questions. Please feel free to contact me have a great rest of your day.
Speaker Change: This does conclude the conference call. Thank you for being here.
Speaker Change: Now assigned to disconnect.
Yes.
Speaker Change: Okay.
[music].
Speaker Change: Okay.
Speaker Change: Okay.
Speaker Change: [music].
Speaker Change: Okay.
Speaker Change: [music].
Speaker Change: Yes.
Speaker Change: Yes.
Speaker Change: [music].
Speaker Change: [music].