Earnings Call Transcript - FTNT Q3 2020

Peter Salkowski, Vice President of Investor Relations

Thank you, Michelle. Good afternoon, everyone. This is Peter Salkowski, Vice President of Investor Relations at Fortinet. I'm pleased to welcome everyone to our call to discuss Fortinet's financial results for the third quarter of 2020. Speakers on today's call are Ken Xie, Fortinet's Founder Chairman and CEO; and Keith Jensen our Chief Financial Officer. This is a live call that will be available for replay via webcast on our Investor Relations website. Ken will begin our call by providing a high-level perspective on our business. Keith will then follow that with a review of our financial and operating results for the third quarter, before providing guidance for the fourth quarter of 2020. We'll then open the call for questions. During the Q&A, we ask that you please keep your questions brief and limit yourself to one question and one follow-up question, to allow others to participate. Before we begin, I'd like to remind everyone that on today's call we will be making forward-looking statements and those forward-looking statements are subject to risks and uncertainties which could cause our actual results to differ materially from those projected. Please refer to our SEC filings, in particular, the Risk Factors in our most recent Form 10-K and Form 10-Q for more information. 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. Also all references to financial metrics that we make on today's call are non-GAAP unless stated otherwise. Our GAAP results and GAAP-to-non-GAAP reconciliations is located in our earnings press release and in the presentation that accompanies today's remarks, both of which are on our Investor Relations website. Lastly, all references to growth are on a year-over-year basis unless noted otherwise. I'll now turn the call over to Ken.

Ken Xie, Founder Chairman and CEO

Thanks, Peter, and thank you to everyone for joining today's call to review our third quarter 2020 results. We are very pleased with our third quarter performance. Billing increased 20% to $750 million. Our SD-WAN solution more than doubled year-over-year and represents over 13% of total billings. Total revenue increased 19% to $651 million, with product revenue growth accelerating quarter-over-quarter to 14% and service revenue up 22%. Recently, Fortinet was the only vendor recognized as a leader in both the latest Gartner Magic Quadrant for WAN Edge infrastructure and Gartner Magic Quadrant for network firewalls. Fortinet's FortiGate SD-WAN is the only organically built solution that provides networking and security integrated into a single appliance that delivers leading protection, performance, and cost savings for the largest customer base and fastest revenue growth among major players in the space. The COVID-19 pandemic has accelerated digital transformation. Organizations have to deal with new challenges to secure the whole infrastructure in the zero-trust environment, whether it's a WAN, cloud, data center, network, branch, or home edge. Fortinet is helping customers solve these issues through security-driven networking and our platform approach. FortiGate Security Fabric, which combines networking and security across the entire connected environment, provides protection whether on-premise, virtual, or cloud-based environment. Our recent Fortinet survey of cybersecurity leaders showed almost 70% of organizations have concerns about insider threat. Today, Fortinet announced the FortiGate 2600F for enterprise-level internal segmentation and hyperscale data centers in a multi-cloud environment. Powered by the new NP7 security processor, the FortiGate 2600F offers the highest performance with secure computing up to 10 times higher than our competition. Gartner has stated that over the next few years, edge and immersive technologies will begin to replace cloud and mobile. The release of several new appliances called by our latest FortiASIC SPU, together with cloud and software-based virtual machine could replace security anywhere, will enable Fortinet to capitalize on this investment and will fuel our growth going forward. Before turning the call over to Keith, I would like to thank our employees, customers, and partners worldwide for their continued support to manage our response to the ongoing COVID-19 pandemic.

Keith Jensen, Chief Financial Officer

Thank you, Ken. Let's start the third quarter review with revenue. Total revenue of $651 million was up 19%. Product revenue of $224 million was up 14%, benefiting from strong demand for secure SD-WAN, high-end FortiGate, and cloud solutions. Service revenue increased 22% to $427 million. FortiGuard service revenue increased 22% to $235 million. FortiCare service and other revenue increased 21% to $192 million. The revenue mix shift from 8x5 to 24x7 support was 11 points, with 24x7 now representing over 65% of the mix. Moving to the mix of FortiGate and non-FortiGate revenue. FortiGate product and service revenue increased 16%. Non-FortiGate products and service revenue grew 27%, driven by growth in cloud and fabric solutions. Given the continuing strong growth of our non-FortiGate or fabric platform, it's worth noting the absolute size of this business. For example, during the trailing 12-month period ended September 30, 2020, non-FortiGate products and services totaled $668 million, an increase of 26.5% when compared to the previous 12-month period. Revenues and solutions include the complete range of form factors and delivery methods including physical and virtual appliances, cloud, SaaS, and perpetual software as well as hosted and non-hosted solutions. Combined with our FortiGate business, we offer our customers the needed range of security solutions and form factors enabling them to provide security across their entire IT infrastructure, whether it's at the WAN, cloud, data center, network branch, or even home office edge. Our third quarter performance illustrates the benefits of our diversification across geographies, customer segments, and industry verticals. Looking at revenue by geos, as with the second quarter, our geographic revenue performance aligned with the economic impact of the pandemic and highlighted the geographic diversification of our business. Revenues in Asia Pacific increased 27.5% as many Asian countries and economies have been able to remain largely open. Revenue growth for the Americas of 13% continues to reflect the impact of the pandemic, especially in Latin America as well as a very difficult year-over-year comparison.

Brian Essex, Analyst

Hi, good afternoon and thank you for taking our question and congrats on a nice quarter of results. I was wondering maybe if you could touch on what you're seeing in the spending environment. Particularly it sounded like you had a really nice quarter of fabric growth and SD-WAN demand. But we also picked up physical firewall strength in the quarter. So, maybe from the standpoint of what you're hearing from CIOs and what actually surprised you the most about the demand in the quarter?

Ken Xie, Founder Chairman and CEO

Yes. Brian, this is Ken. That's a good question. We also closely monitor watching the whole landscape in the space. Basically, that's where we're continuing to promote what we call secure-driven networking. And also that's the concept we've been thinking about for the last 20 years. You can see that definitely, the SD-WAN is starting to come to the networking side and probably in the next three years can grow over $20 billion. So that will be huge. We want to be the number one leader in the space and hope to target that next year. At the same time, the security Zero Trust concept is starting to get very popular. So we need to make the whole infrastructure very secure. The work from home model is also changing a lot. Early this year, when the pandemic just started, enterprises just tried to figure out how IT can support work from home. Now they're starting to look for long-term solutions including service-based SASE or other means, treating home as the new branch. That's where we can have the FortiGate installed in the home to manage many devices. It can also manage traffic shaping with different priorities for different applications, different users, while securing the whole infrastructure that sometimes they also refer to as the SD branch solution. This includes managed Wi-Fi and managing other switches or networking equipment altogether, even printers or other home appliances. So that's a direction we're seeing. Some big enterprises or service providers start offering employees what they refer to as the new branch. They're providing them with FortiGate plans including Internet access like 4G, 5G, and other technologies bundled together as a package solution to help secure the whole infrastructure. That's why we see both initiatives. We're closely working with service providers, whether towards service-based SASE or towards this whole infrastructure security approach. The new branch concept is indeed changing the whole environment. Thus, security no longer just means securing the gateway. We expect it to encompass the entire infrastructure. The network also needs to be more application-aware, supporting various applications or content, as some providers are starting to add in the security space. This is why we say secure-driven networking is rapidly ramping up.

Fatima Boolani, Analyst

Thank you for taking the question. Keith, I have two for you. Just looking at your outlook and your billings guidance I wanted to unpack that a little bit and get your sense of where you are being a little bit more cautious relative to the performance in the quarter and how we should think about some of the puts and takes into the guidance that implies a deceleration from the third quarter performance you just put up?

Keith Jensen, Chief Financial Officer

Sure. Look, I think 2020 has shown to be a very interesting year for setting guidance. Q1 was very strong. Q2 was challenging. Q3 was a nice bounce back. It's really a function of watching media reports almost on a daily basis in terms of what's happening with the pandemic, and what we see happening in the U.S. We can also layer onto that the U.S. election, but also what we're seeing in Europe. In the current environment, I think the guidance does a pretty good job of trying to reflect our current understanding of the pandemic.

Shaul Eyal, Analyst

Thank you. Good afternoon, guys. Congrats on the solid performance and outlook. I had a question on the SD-WAN opportunity. And given the ongoing strength you're seeing, have you started to see some displacement opportunities given potential disruption that one of your competitors' smaller competitors in the space could be seeing given a consolidating market?

Ken Xie, Founder Chairman and CEO

This is Ken. No. We still see very strong interest and no competitors come close to what we have. So we see that it's more than double year-over-year. We are also the only ones who have two Magic Quadrants, both on SD-WAN and the network firewall, available for the same appliance. At the same time, it accounts for 13% of last quarter's billings, but we have a huge installation base. Many customers are enabling that one. We’re really confident about our secure SD-WAN solution. Going forward, I believe the work-from-home model will continue to drive this, whether you treat home as a new branch or leverage this kind of solution. Hence, we have a significant market position, technology advantage, and we are the only ones building organically and have ASIC to accelerate performance—on average about 10 times faster than any other competitor. This shows a huge opportunity. The market is growing like 50% year-over-year, and we grew more than double year-over-year. We keep gaining market share.

Patrick Colville, Analyst

Thank you for taking my question. And congrats on a very impressive quarter. Can we just talk about SD-WAN again? The result you guys put out was super-impressive: doubling of growth year-on-year. We have been hearing in media about some firms kind of closing or rationalizing their branch offices. So clearly that hasn't had any effect on your business. But can you just talk me through whether you've heard that among your customers, or anything related to that point would be great?

Ken Xie, Founder Chairman and CEO

Yes. The secure SD-WAN provides a huge benefit for customers. It offers probably more than a 50% cost saving. Also, SD-WAN helps manage multiple links across different types of applications. Traditional fixed connections like MPLS have had a difficult time managing various applications, especially with different cloud solutions. SD-WAN enables dynamic traffic management based on applications, security needs, and various types of content. This capability drives growth even during the pandemic. Long-term work-from-home will also significantly expand our base of home users. We are working with many service providers and large enterprises right now to improve service levels from that angle. There's certainly customer interest in the market growth of this model, which could seamlessly merge the future of networking solutions.

Peter Salkowski, Vice President of Investor Relations

Thank you. Operator please open the call for Q&A.