AutoZone Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 2, 2023

There are 14 speakers on the call.

Operator

Day and

Speaker 1

thank you for standing by. Welcome to the Fortinet Q3 2023 Earnings Announcement. At this time, all participants are in listen only mode. After the speakers' presentation, there will be a question and answer Please be advised that today's conference is being recorded. I would now like to hand the conference over to Peter Salkowski, Senior Vice President of Investor Relations.

Speaker 1

Please go ahead.

Speaker 2

Thank you, Angela, and good afternoon, everyone. This is Peter Salkowski, Senior Vice President of Finance and Investor Relations at Fortinet. I'm pleased to welcome everyone to our call to discuss Fortinet's financial results for the Q3 of 2023. Speakers on today's call are Ken Zee, 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.

Speaker 2

Ken will begin our call today by providing a high level perspective on our business. Keith will I'll review our financial and operating results for the Q3 of 2023 before providing guidance for the Q4 of 2023 and updating the full year. We'll then open the call for questions. During the Q and A, we ask that you please 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 today's call will be making forward looking statements, and these forward looking statements are subject to risks and uncertainties, which could cause Actual results could differ materially from those projected.

Speaker 2

Please refer to our SEC filings, in particular, the risk factors in our most recent Form 10 ks and Form 10 Q for more information. All forward looking statements reflect our opinions only as of the date of this presentation and we take no obligation and specifically disclaim any obligation to update forward and 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 are located in our earnings press release and in the presentation that accompanies today's remarks, both of which are posted on the Investor Relations website. Ken and Keith's prepared remarks today for the earnings call will be posted on the quarterly earnings section of the Investor Relations website immediately following today's call.

Speaker 2

Lastly, our reference to growth are on a year over year basis unless noted to other ones. I'll now turn the call over to Ken.

Speaker 3

Thank you, Peter. Good afternoon and thank you to everyone for joining our call. In Q3, we exceeded Street expectation in our operating margin and free cash flow. However, building and product revenue fall below our expectation due to a slowdown in secured networking growth, along with challenging in sales execution and the marketing efficiency. In response to the slowdown in secure networking market, We are shifting our marketing and sales team's focus towards a faster growing and secured operation and SaaS team market over the next few quarters, All while maintaining our consistent focus on leading innovation in secure networking and the convergence of security Networking where we have been a leader for 23 years.

Speaker 3

While we anticipate limited near term growth in secure networking market, It is very important for Fortinet as we believe enable us our platform strategy with a massive footprint in the market leader as the market leader in both firewall revenue and unit shift. The secure networking market is valued at 62,000,000,000 and is projected to increase high single digit annually to $86,000,000,000 by 2027. Our consistent focus on innovating our industry leading 4 gs OS, which supported over 30 network function, Network and security application combined with our ASIC driven performance capability, which provide 5 to 10x better performance on average than competitors continue to drive market share gains. Secure networking remain a vital part of our strategy and the market that we believe will return to double digit annual growth over time. We have been innovating for some time in the faster growing segment of a secure operation and SASE.

Speaker 3

Security operation, also known as Secop, is a $46,000,000,000 market growing at the mid teens annually to $78,000,000,000 by 2027. 49 Sec, our platform is comprehensive and integrated, Offering EDR, SIEM, SOAR, NDR and other integrated solutions, consolidation in the Security demand seamless integration and underlying security tools. Fortinet's strength lies in its innovation and its ability to enable automation through a high degree of product integration. Our AI and our product empower automatic response within 2nd, all underpinned by a single consolidated management and analytic platform. In addition to Secop, we have continued to increase our focus on SaaS, Our $17,000,000,000 market expect to grow and 20% compound annual growth rate to $36,000,000,000 by 2027.

Speaker 3

We believe Fortinet is the only company with a SaaS service solution that can perform all function in the cloud, all email and clients, All with a common operation system, including 4 networking and security stack, marketing leading SD WAN, ZPA and the management console. Our SaaS service solution is supported by Google Cloud with over 100 worldwide SaaS cloud location together with our own 30 plus point of presence and the data centers. For our client base use case, We accelerate SaaS's service function using our ASIC technology. For instance, we recently announced the FortiGate 1.8 gs with the security process of 5, which supported our 4 SASE offering, which including SD WAN, firewall, secure web gateway, data log prevention and boost secure computing regions 6 to 54 times better than our competition. We anticipate that success in SaaSie market will first come from upselling SaaSie service to our installed base of tens of thousands of IT WAN customers and from attracting new customer looking to leverage our single vendor integrated SASE service solution.

Speaker 3

Our industry leadership in both firewall and SD WAN, The 2 largest components of Sassy provide us with a significant competitive advantage. We have a track record of successful execution and believe we are the only company with strong SASE service and the SecOps solution combined in the same operation system. This differentiation set us apart and provide us with a significant talent advantage over peers. While we expect top line growth to be modest For the next few quarters, due to challenging secured networking comparison and our business transformation realignment towards secret operation and SaaS, we anticipate growth return to double digit by the second half of twenty twenty four. We remain committed to generating healthy operation margin of 25% or greater in 20242025.

Speaker 3

Before turning the call over to Keith, I would like to thank our employees, customers, partners and suppliers worldwide for their continued support and hard work. Keith?

Operator

Thank you, Ken, and good afternoon, everyone. As Ken mentioned, We are confident in our integrated FortiOS driven platform strategy, which is summarized on Slide 6 through 10 of the earnings slide deck. As we look forward, we believe shifting our R and D and go to market investments in the faster growing SaaS and Secop markets is consistent with near term market opportunities. As shown on slide 10, SaaSie and SecOps account for 20% and 10% respectively of our business today. And as shown on Slide 7, these markets are expected to grow in the mid to high teens annually.

Operator

Secured networking, which currently accounts for 70% of our business, is expected to experience slower growth following 2 years of very robust growth. As a result, for the near term, we expect to deliver healthy profitability along with more modest growth. With execution and continued investment in the Sassy and Secop markets, we believe we can return to delivering mid to high teens top level growth top line growth and while continuing to deliver operating margins of 25% or greater. In other words, a return to balanced growth and profitability, which has led us to achieve the Rule of 40 status in 12 or 15 years as shown on Slide 19. In a moment, I'll expand on the strategic shift by sharing a few of the tactical steps and investments.

Operator

But first, I'd like to review some highlights from the quarter. We continue to add new logos at an impressive rate and saw top line performance in small enterprise and software was strong, while operating margin and free cash flow were above expectations. We added over 6,400 new logos, supported by small enterprise customers, which grew bookings by 19%. Our efforts to manage personnel and other costs drove our operating margin to 27.8 percent, 2 30 basis points above the high end of the guidance range. Free cash flow was strong at $481,000,000 representing a margin of 36%.

Operator

Looking at billings, Starting from the Q3 of 2022, we saw a 3 year compounded annual billings growth rate or CAGR of 26%, illustrating our ability to drive strong and sustained growth over an extended period. In Q3, however, billings of $1,490,000,000 represented growth of 6% as we experienced 1 month shorter contract duration and importantly lackluster appliance demand resulted from elevated product growth in earlier periods. In terms of industry verticals, education and government billings were strong, while service provider and retail billings were weak. Small enterprise billings growth was strong, while growth rates with larger enterprises disappointed. Billings growth varied by geo with International emerging showing strong growth, while our much larger geos of Europe and U.

Operator

S. Were weaker. Turning to revenue and margins. Total revenue of 16% probably total revenue grew 16% to $1,330,000,000 which compares to our 3 year CAGR of 27%. The 3 year CAGR was largely consistent with our 14 year CAGR illustrated on slide 18.

Operator

Product revenue of $466,000,000 representing a 3 year CAGR of 28%, was down 1%, reflecting product lead times and backlog aligning with historical levels and the lighter levels of network security demand Ken referred to. Service revenues of $869,000,000 grew 28%, representing a 3 year CAGR of 27%. Service revenue accounted for 65% of total revenues, driven by 34% growth in higher margin security subscriptions, which represents 57% of total service revenue. We mentioned the 3 year CAGR to illustrate how consistent they are With these same CAGR starting from our 2,009 IPO, which were illustrated on Slide 18, each of the 3 year CAGRs billings, product revenue, service revenue and total revenue are within 5 points of the 14 year CAGRs for the same top line metrics, adding to our confidence and returning to higher growth levels. Product gross margins were down 3 10 basis points as we saw margin pressure related to inventory levels.

Operator

Service gross margin was up 60 basis points as service revenue growth outpaced higher levels of cloud and hosting costs. Total gross margin of 76.9 percent was up 70 basis points, driven by the increase in service gross margins and the 6 point shift from product revenue to service revenue. Operating margin of 27.8 percent exceeded the high end of the guidance range and operating income of $371,000,000 was $33,000,000 higher than consensus and $20,000,000 above the high end of our guidance range, reflecting our efforts to control spending. Looking to the statement of cash flow summarized on Slides 15 through 17. Free cash flow increased 22 percent to 481000000 representing a free cash flow margin of 36 percent or 9 points above consensus.

Operator

Operating cash flow increased $68,000,000 to 41 percent of revenue. Capital expenditures were $70,000,000 including $50,000,000 of real estate investments. Cash taxes paid in the quarter were 26,000,000 As a reminder, free cash flow benefited from regulatory relief in the form of deferred estimated and other tax payments in the 2nd and third quarters, totaling $192,000,000 $18,000,000 respectively. In the 4th quarter, we expect cash to total $345,000,000 including the $210,000,000 of deferred tax payments. We repurchased 10,400,000 shares of our common stock for an aggregate cost of $605,000,000 in the 3rd quarter.

Operator

In October, we purchased an additional 7,700,000 shares for $444,000,000 and our remaining share repurchase authorization stood at approximately 9 $80,000,000 at the end of October. Now I'd like to share a couple of key Sassy wins for us in the quarter. In a 7 figure upsell win, an existing financial services customer initiated their single vendor SaaS solution for 50,000 users. Fortinet was able to displace another incumbent as the customer continued their consolidation journey with us supplementing their earlier SecOps, cloud and network security purchases. And in a 6 figure deal, an existing SD WAN customer continued their strategic transition to SaaS and cloud based applications by adding our SaaS solution for 2,000 users.

Operator

We believe existing SD WAN customers such as this one offer a rich cross sell opportunity for our SaaS solution. It's worth noting these deals closed before Our recently announced partnership with Google Cloud, which significantly expands our POP coverage by adding over 100 locations and prior to Gartner's release of the inaugural single vendor Sassy Magic Quadrant where we were named a challenger. By 2025, 1 third of new SaaS deployments are expected to be single vendor. I should also note Fortinet is recognized in 9 Gardena Magic Quadrants as shown on slide 3. Now I'd like to expand on Ken's strategic commentary with some of the tactical investments we're making to increasingly focus our efforts on SASE and SecOps.

Operator

In the areas of research and development and solution delivery, In addition to the new Google Cloud partnership I just mentioned and our own data center investments, we're continuing to integrate single vendor SaaS features into FortiOS and continuing to expand our SecOps capabilities with AI technology and additional functions in enhanced integration and finalizing co development agreements with existing large enterprise customers to accelerate continuous improvement of our integrated Enterprise level Sassy solution. Our go to market strategy, Our investments include actively promoting our challenger position in Gartner's single vendor Sassy Magic Quadrant, focusing on third party certification of our broad and integrated solutions, including SSD and SD WAN and aggressively marketing Fortinet's competitive advantages and the key components of SaaS, SecOps and network security as summarized on slide 10. Certifying 5,500 for net sales professionals and SecOps solutions after already certifying these same sellers in Sassy, which is the largest sales enablement motion in company history. Divesting in sales comp plans to include incentives to sell SaaS and Secop capabilities to existing and new customers Expanding partner roles deeper into channel partners specializing in SaaS and SecOps and developing channel training and is focused on differentiating Fortinet's comprehensive and integrated SASE and SecOp capabilities.

Operator

We believe Fortinet remains well positioned in the cybersecurity market and the market shift to platform strategies is in early stages. According to Gartner, 75 percent of companies are pursuing a vendor consolidation strategy, reflecting the evolving landscape of cybersecurity in a highly fragmented industry with thousands of vendors. As shown on Slide 9, Fortinet brings consolidation across SecOps, SaaS and network security, The 3 key growth drivers in our strategy. Organizations are recognizing that an integrated security solution with a single operating system is the best method to improve their security posture as this approach allows each security solution to share data and communicate with each other, reducing complexity improving security effectiveness. Attempting to piece together best of breed solutions from multiple vendors can result in slower AI driven technology adoption, significant security gaps and a slower pace of identifying, reporting and resolving security incidents.

Operator

Moving to guidance. We continue to see increased deal scrutiny and longer sales cycles, which is constraining our near term results. We expect these longer sales cycles to continue along with the associated budgetary scrutiny and our 4th quarter guidance takes us into consideration. As a reminder, our Q4 and full year outlook, which are summarized on slides 20 21, are subject to disclaimers regarding forward looking information that Peter provided at the beginning of the call. In the Q4, we expect billings in the range of 1,560,000,000 to $1,700,000,000 which at the midpoint represents a decline of 5 percent revenue in the range of 1,380,000,000 to $1,440,000,000 which at the midpoint represents growth of 10%.

Operator

Non GAAP gross margin of 75.5 percent to 76.5 percent. Non GAAP operating margin to 27.5 percent to 28.5 percent. Non GAAP earnings per share of $0.42 to $0.44 which assumes a share count of between $780,000,000 to $790,000,000 capital expenditures of $40,000,000 to $60,000,000 and non GAAP tax rate of 17% and cash taxes as I mentioned of 345,000,000 For the full year, we expect billings in the range of $6,095,000,000 to $6,235,000,000 which in the midpoint represents growth of 10%. Revenue in the range of $5,270,100,000 to $5,330,100,000 which in the midpoint represents growth of 20%. Service revenue in the range of $3,355,000,000 to $3,375,000,000 which at the midpoint represent growth of 28%.

Operator

The service revenue guidance implies product revenue growth of 9%. Non GAAP gross margin of 76% to 77%, Non GAAP operating margin of 26.5 percent to 27.5 percent. Non GAAP earnings per share of $1.54 to 1.56 which assumes a share count of between $790,000,000 $800,000,000 capital expenditures of $220,000,000 to 240,000,000 non GAAP tax rate of 17% and cash taxes of $430,000,000 As we look forward to 2024 Transition from a period of elevated product growth, we can offer a few thoughts looking forward. In the near term, we will continue to focus on improving profitability. We expect product gross margins to be pressured in 2024.

Operator

Nonetheless, we expect healthy operating margins that are 25% or greater. We expect to gradually increase billings growth through the year and approach double digit growth by the second half of twenty twenty four, reflecting the progressively easier comps due to the easing of the headwind from backlog draws in the first half of twenty twenty three and the benefit of our Sassy insect op focus. We expect contract term to remain below our high watermarks of 2022. Consistent with prior years, We expect that the timing of service revenue growth trends will lag product growth trends. Longer term, we remain confident in our solutions and our ability to adopt our strategy shifts in the market, taking market share as we increase our investments in SaaS and SecOps, ultimately returning to balanced growth and profitability.

Operator

I look forward to updating you on our progress in the coming quarters. And with that, I'll hand the call back over to Peter to begin the Q and A.

Speaker 2

Operator, as a reminder, during the Q and A session, we ask you to please limit yourself to one question and one follow-up question to allow others

Speaker 1

Our first question comes from Hamzah Fardarwala from Morgan Stanley. Please go ahead.

Speaker 4

Thank you for taking my question and good evening. Ken, maybe just for you, To what extent are you seeing SASE start to eat into Firewall and network security budgets because clearly there's a bigger focus there. There is a dedicated go to market effort there. So Do you think that SaaS is starting to cannibalize the firewall market to some degree?

Speaker 3

I think it's a little bit Different business model, SaaS is more the service OpEx compared to The networking will be more CapEx. During the slow economy environment, customer definitely more towards service based OpEx. So we will be also Some of our service provider kind of a little bit slower to adapt some of the SaaS. That's what we feel. We have been involved in SaaS Q4 a long time.

Speaker 3

And some of the service provider kind of Lower than we expected. So that's where we kind of changes on the strategy more aggressively Going Sassy ourselves, at the same time, still working closely with the partner.

Operator

Okay. Thank you. Thank you.

Speaker 1

Thank you. One moment for our next question. Our next question comes from Brian Essex from JPMorgan. Please go ahead.

Speaker 4

Hi, good afternoon and thank you for taking the question. I guess maybe Keith for you, as we look at the trajectory of product declines this quarter and billings growth. And I guess Guidance implies that this is a billings trough this quarter. What observations might you have from other, we'll call them spending cycles where you hit Negative product or low single digit product revenue growth and the degree of recovery that you've seen after those Spending cycles. And what gives you the level of confidence in your ability to, I guess, return to double digit growth for either product or billings or both in the second half, understanding you're going to have easier comps as well?

Speaker 4

Yes.

Operator

Brian, great questions, I should say. One of the slides that we added to the investor presentation for this earnings call actually maps out What you could see is a cycle more cyclical nature of the business than maybe we've talked about in the past with product revenue. For example, 2017, I think had product revenue growth of 5% and that was somewhat of a low watermark. The market may have been due and I think there's some analyst studies out there from other members of Wall Street That have kind of suggested that the market was due for a little bit of a pause in firewalls, and I think we're seeing that now. And perhaps there was some delay of that pause because of supply chain issues and so forth, something that may have more naturally occurred in 2021 or in 2022.

Operator

I think in terms of confidence broadly, I think that was the intention of looking at the CAGRs and the success of the company that Canda has led the company through since its IPO and what those CAGRs are. And if you look at that combined with that new slide in the deck, you There has been in the past volatility in the industry and in the company, but over the longer stretch you see some very attractive CAGRs in that.

Speaker 3

Yes, long term, we still believe the convergence of network into network security will be happen, which also by like on, as you say, by 2,030, the network security security networking will be larger than the Traditional networking, especially in the campus environment, in enterprise. And so we do believe it's a huge market opportunity. We have a unique advantage with our integrated operating system, with our ASIC acceleration. We're Gaining market share in both security network and also in the SaaS market.

Speaker 4

Got it. That's helpful. Thank you.

Speaker 1

Thank you. One moment for our next question. Our next question comes from Fatima Boolani from Citi. Please go ahead.

Speaker 5

Good afternoon. Thank you for taking my questions. Keith, in your prepared commentary, you specifically called out the service provider and retail Vertical, perhaps exceptionally weak in their buying. And Ken was just sort of alluding to some of Challenges that are stemming from service provider buying behavior. But I was hoping you could provide a little bit more detail as to Why have the spending patterns in these particular verticals become so dramatically weak?

Speaker 5

And was this in the scope of your assumptions as you were thinking about the pipe? Just wanted to get a better understanding of how and why The buying intentions have sort of rolled over in these two areas specifically. Thank you.

Operator

Yes. I think the service provider commentary has probably been reported by a number of other companies through this earnings cycle. I don't think that's The headline itself is not a surprise. I think the significance of the slowdown of service provider, at least for what we saw in our business, was a surprise, particularly because it's a worldwide service provider number and not just in the U. S.

Operator

But as I also noted in the prepared comments, we saw weakness in both the U. S. And the Europe, European markets. And that applies to service provider and to the retail sector. I think the retail sector probably is perhaps a little bit more prone to some of the digestion of SD WAN projects that they're still working their way through, maybe that's a little bit different, as well as some of the economic headlines were probably a little bit disconcerting to the retail sector in the earlier part of the quarter.

Speaker 1

Thank you. One moment for our next question. Our next question comes from Teo Lani from BOA. Please go ahead.

Speaker 6

Thank you. I have two questions on the same topic. If you go back to the last 2 years, you talked a lot about non appliance sales, meaning Upsell SD WAN, which is an add on service and then non FortiGate. And when things start to slow, We only blame the appliances. So the question is, in retrospect, When you look at things and you look at the other parts of the business and you look at the add on sales and the other features, are they all based On you the ability of you selling appliances, meaning even if it's a non-forty gate, it's being attached to a Forti gate sale and that's why it's going down With it or SD WAN, etcetera.

Speaker 6

So first, just to understand kind of the total exposure of the company From all the successful products that you were able to sell over the last 2 years and now in retrospect just to understand how is the exposure to appliance? And the next the second question, which is related to it is, if really it's about appliance sales, what is the outlook for 2024 when Comes to do you have any big refresh cycle, what could drive outside of easy comps that our comps are getting easier through the year. Is there anything that you're Planning on your end to drive some kind of replacement or refresh of the appliances? Thanks.

Speaker 3

Yes, this is Ken. I think for SD WAN, they do need our plans to be in place to deliver all this SD WAN function there. We really offer SD WAN as Part of the FortiOS FortiGate function for free, and we started launching the SD WAN service last quarter. So it's still in the ramp up stage. We do believe long term all these surveys we're keeping Accelerating like the SaaS market will be grow faster than the secure networking market.

Speaker 3

I think that's where for certain like I think there's a chart On the presentation, it shows some of the product and service, which is on Page 19. You can see some of the cycle up and down there. Also some of I do believe relate to the new ASIC and also broader launch Because we just started the new cycle of the new SP5, which we have 1 or 2 product just starting launching, which gave us like 5 to 10 times better performance and more function and the same cost, which also Combined with the supply chain kind of elevated shipment of building in the last 2, 3 years. I think all this combined together, I feel have affected our plans sales in the last few months. But I do believe this since we'll go back to normal probably in the second half of next year.

Speaker 3

After the new product being fully launched, after the supply digestion, inventory digestion kind of go through Because we do see the long term convergence though is still holding well. We have a big position With a better integrated OS with AC acceleration and our plans is a Part of the whole solution is a hybrid solution both are part of the cloud, especially we call it universal SASE. So that's where there's some kind of cycle. If you refer to the Page 19 of the presentation, we kind of probably go through that cycle right now.

Operator

Yes, Tal, I'll maybe add to Ken's comments. I think you're correct in that, your inference that the vast majority of time 1st sale of a customer is a firewall. It can be a virtual firewall or it can be a physical appliance and really that is the beachhead that then go sell these other security functions and products. I think what you're seeing is in part of the shift of strategy when we talk about making the investments in not only SaaS but also Secure Ops. It's really that secure ops product of family like EDR and SIM and SOAR and such that you're seeing us doubling down on the investments there because While it's not the largest of the 3 market segments, it is the fastest growing and I think we have the opportunity to participate in those markets more, particularly now that some of our products have reached a greater level of maturity.

Speaker 6

Got it. Thank you.

Operator

Uh-huh.

Speaker 1

Thank you. One moment for our next question. Our next question comes from Saket Kalia from Barclays. Please go ahead.

Speaker 7

Okay, great. Hey, Ken. Hey, Keith. Thanks for taking my questions here. I'm going to ask 2 together.

Speaker 7

So maybe for the first one, Ken for you. Just maybe thinking about the long term and specifically on the Sassy part of the business, When do you feel like Fortinet will have a solution that can compete head to head with other SaaS solutions? Maybe the answer is now, right? But just want to hear how you think about And how big do you think this part of the business can be longer term? Right, so that's the first question.

Speaker 7

The second question for you, Keith, is It's great to see the operating margin beat. Maybe you could just talk about how you're thinking about sort of mid term profitability Because clearly the business can generate higher margins than 25%. How do you sort of think about that balance now kind of given some of the changes here?

Speaker 3

Yes. The first answer is yes, it's now. We are head to head competing and we also believe we have a much better solution, better integrated And at the same time, much better cost ROI compared to other competitors on the Sassy. And also the Universal SaaS is very unique because they offer both in the cloud on the plans of Compass All the same solution, which a lot of customer more like our solution instead of sometimes you have to deal with Traffic, whether in office or office have to forward to the park because our solution, you can process some traffic locally on campus within their appliance.

Operator

Yes. And Saket, you made a great point about whether you're talking about free cash flow, you're talking about operating margin. The company does very, very well on the bottom line and Yes. The strategy has been to continue to reinvest that back robustly in both innovation in the form of R and D spending, but also in go to market, Whether that's marketing and whether that's selling, I think we're looking at right now with a slower firewall market. Obviously, we're trying to bring new solutions or better solutions to our sellers to sell when the firewall is a little bit slower.

Operator

But I do think it's a worthwhile conversation. I'm looking at The sales coverage, if you will, we've talked for several years about how many in North America, for example, how many accounts do we want per rep? We started with 65, I think, 4 or 5 years ago, we were talking about that. That number is now down to 10. And at 10, you're probably reaching a point of where you're on the enterprise side, you're Probably reaching a pretty good coverage model for our business.

Operator

You could probably go a little bit lower, but that feels pretty good. I think there's another opportunity right now immediately in front of us in terms of How do we continue to support our channel partners, be they distributors or be they resellers and make sure that we're getting the right level of mindshare from them. So I would suspect there'll be some investments in that part of the business as we go forward. At the same time, That's in that part of the business as we go forward. At the same time, I think there's some opportunities here and Ken's talked about it with us about How to be more efficient and how we're spending our money, whether that's in selling and marketing or back office functions or what have you.

Operator

So, we're not Trying to guide to 2024 today obviously, but we did think that it was important to provide at least some early thoughts in terms of maybe a floor for what 2024 should look like for us on the bottom

Speaker 7

Got it. Very helpful. Thank you.

Speaker 1

Thank you. One moment for our next question. Our next question comes from Brad Zelnick from Deutsche Bank. Please go ahead.

Speaker 8

Great. Thank you very much for taking the question. I appreciate that as you lean into Sassy and Security Operations, Your most obvious advantage is in having an industry leading installed base. But for those of us that have always viewed Fortinet's distinct advantage is the price performance of your purpose built hardware. And you've also had a go to market both direct and indirect that know how to showcase that.

Speaker 8

I'm just trying to get my head around all the changes in distribution both direct and indirect, which I appreciate, Keith, you made comments about sales enablement. But how do you think about the investment in dollars and time needed to get distribution properly ramped? And can you ever achieve the same level of sales productivity that you've enjoyed when the motion was more box centric?

Speaker 3

We do believe it's a faster growing and Sassy, market. The sales training, sales restructuring and at the same time more efficient marketing is very, very important. And also we are continuing to working closely with our channel partner, with our distribution network to reaching very broad customer base. So we also thinking the upsellcross opportunity is huge And especially goes through our partner network there. So I don't feel the investment we made in the past will be any issue or kind of any slow us down.

Speaker 3

We do believe it will actually helping us to Spending is more service based SASE market and also more consolidation, secular approach. Yes. And I would

Operator

just build on Ken's comment, Brad, and all good and fair questions. It's not by accident we're talking about SaaS. If you go back and think about it a little bit, we've Talking about it in a number of different ways. Ken has talked about the POP strategy, which now you see us accelerating that POP With the cloud providers to come to market more quickly, the Gartner Magic Quadrant, I think are the catalyst for the single vendor strategy and having us in the Challenger Quadrant It gives us the bonafides, if you will, to have a lot of conversations. The single vendor strategy, that installed base that you referred We went back and looked and over the last two quarters, we've done several 100 Sassy deals already.

Operator

And to be quite honest, that was without any real wood behind the arrow in Marketing support or sales support, that was really just how it grew. And it's interesting, while I would have expected those first sales to would have Then clearly dominated by SD WAN. They were not SD WAN customers. They were oftentimes they were just as many brand new customers coming to us for the SaaS solution As there were SD WAN customers or somewhere around the 3rd part of the pie were customers that are VARs for other firewall use cases. So I don't and the expectation that our we're going to be successful initially in the smaller part of the market, I don't think we disagree with that.

Operator

When I look at that same mix of SaaS customers, nearly 50% of those SaaS customers that we signed already would be in the SMB space. And then the remainder was kind of divided up between the larger enterprises and the mid enterprise. So, I don't think we got here by accident. We may chose not talk about it publicly, but I think we're well positioned now because of the investments that we've made in the data centers, the pops, the operating system, the Gardner Magic Quadrant, the fact that the single vendor and the installed base. I think this is the right strategic shift for us to make at this point.

Speaker 8

Thanks for that Keith. And just a quick follow-up and I know it's a topic we've spoken about in the past, but As Sassy increases as part of the mix and I know strategically you've partnered with Google to help deliver the infrastructure, How should we think about the CapEx required to do this in a competitive way over the longer term? Thank you.

Speaker 3

We do have a good partnership with Google and same time some other service provider like Digital Reality. We also build some of our own, like a data center pop over 30s owned by ourselves, which is really give us a more cost advantage. So we're continuing that strategy, but that's too little time to ramp up. So the Google is a very quick solution for us, for customer. And also we feel we separate, we kind of realigned the market in the 3 different segments, Secure networking, SaaS and Secure Op is much clearer, much better lineup with the customer need And also with different customer demand.

Speaker 3

So that's much better, more clear compared to the previous one we have further the 40 ks or some other like enhanced non-forty ks product. We feel these are clear 3 segments line up quite well with the customer demand. So we're starting tracking based on this one. Also we're starting compensated sales and the trend sales and marketing along all these 3 separate Segment aftermarket. That will be more clearly to us internal for customers to our partner to validate kind of what customer really need in the current environment.

Speaker 8

Yes. And Brad, Yes. Sorry to

Operator

Ken's point, look, we were last quarter we're talking about 20 POPs because we're building Right. Now you're talking about over 100 locations, well over 100 locations. So I think there's a go to market opportunity there that this brings to us. I think longer term and we know that one of our competitors, This is the approach they take and we have pretty good visibility obviously to what their margins are and their investments there. And there's another player in the space that's much more building their own pops, if you will.

Operator

PoPs individually are not huge things, right? I mean, they're a single digit number of racks really have a pop, I think. So I do believe you need some forward stage data centers. I think that's consistent with our strategy that we've talked about increasing more and more hosted delivery services and particularly in psych ops. So I think this is not something that we're going to surprise people with in terms of our CapEx spending.

Speaker 8

Makes perfect sense. Thank you.

Speaker 1

Thank you. One moment for our next question. Our next question comes from Adam Tiedl from Raymond James. Please go ahead.

Speaker 9

All right. Thanks. Good afternoon. Keith, it sounds like you're confident in profitability and free cash flow, which makes sense. Obviously, The model has proved itself over the years.

Speaker 9

So I wanted to ask about capital allocation. The balance sheet is already very healthy. You've got a lot of capacity. Right now the market is pivoting towards Universal Sassy and SecOps as you mentioned. Curious how the conversations have gone internally to potentially Accelerate your pivot towards that with larger M and A.

Speaker 9

And conversely, if we look at the after hours action here, the ROI on share repurchase is looking potentially very strong. The opportunity to potential step up share repurchases. Just in general, how you're thinking about using the balance sheet as a weapon during a time where the business and stock pressured. Thanks.

Operator

Yes. I think we included a comment in my prepared remarks that the available We still have 9 as of the start of the month start of the week, I guess, we had $980,000,000 of available authorization for the buyback. And I think you saw some of the numbers that we provided in the prepared remarks about being fairly aggressive during the quarter itself as well in terms of buying back stock. Ken doesn't let me go shopping for companies very often, so I'll defer to him in terms of his thoughts on that.

Speaker 3

We are definitely I think right now the market probably more reasonable in the last 1 to 2 years. And also we To realize the market is also changing pretty quick, we'll continue to do the internal innovation. We feel we are the strongest on the internal innovation Engineer among all the space player, but on the same time, we also were open to looking for some other company, which we can Working together, joined together.

Speaker 9

Okay. And one quick follow-up, just to make sure Peter kicks me off They've been elevated for a little while now. Obviously, demand is deteriorating faster than expected. And we're just trying to think about how to manage Tory and future inventory given this new stated demand, where that might manifest itself in results. I think you mentioned Product gross margin pressured.

Speaker 9

I wonder if that was related to that. But any comments on kind of managing this oncoming inventory relative to the current demand? Thanks.

Operator

Yes. It is related to the inventory levels and I think we've been managing it for the better part of the second half of this year. And that's some of the commentary that you're getting as we look into 2020 in terms of where the pressure may come from.

Speaker 9

Any way to quantify it though?

Operator

No.

Speaker 3

Yes, we feel still in the healthy level and we tend to keep about 6 months inventory. That's where like when 2, 3 years ago the supply chain issue happened, we are in market position because also a lot of time our customer I need some urgent delivery of certain products. So we're probably still keeping the similar policy there, but also we're in the refresh cycle of our new product, especially in the low end. I think so far we I think we also kind of re surprised in the last 2, 3 years. Now since starting to stabilize and supply changing from a shortage, little bit more towards even some oversupply.

Speaker 3

So we feel we are in a pretty good position because we more handle this operation So we handle is better than most of our other competitors on the inventory right now.

Speaker 9

Very helpful. Thanks, Ken.

Speaker 3

Yes. We also don't see a big issue about the current inventory level.

Speaker 1

Thank you. One moment for our next question. Our next question comes from Adam Borg from Stifel. Please go ahead.

Speaker 10

Awesome and thanks so much for taking the questions. Maybe just on the sales execution issues that you talked about in the script, maybe go a little deeper on what exactly happened and a little bit more about the steps you're taking. And maybe just as a follow-up, just on the Sassy partnership with GCP. I know it's obviously just been a couple of weeks, maybe talk about early customer feedback from initial conversations. Thanks so much.

Speaker 3

Yes. We if you look in the last 2, 3 years, We grow a lot of business, also hire a lot of salespeople. And the last 2, 3 years, we probably doubled the business. And at the same time, during the supply chain, you should Somehow certain sales feel get too easy to get deal because there's always a Shortage of certain product there. So that's where we feel we need to enhance the training enablement and At the same time, also need to be more disciplined about the performance.

Speaker 3

So that's at the same time, we also when we're shifting this to more like Service based SaaS CEO kind of consolidation cross sell, multi sell of secular op. The sales also need to Q3 2023 earnings announcement. And same kind of marketing need to be kind of more efficient and also kind of a Position to the new growth opportunity. So that's the focus we have right now. So we are definitely keeping looking to be more efficient in both the sales and marketing

Speaker 10

Great. And what about the early feedback on GCP?

Speaker 3

Yes, it's very good. That's give us a very quick start to match any other competitor On the location, number of locations, number of pop, and they also have very, very broad coverage. So it's a good partnership. At the same time, we continue to working with some other partner. We also will continue to build ourselves.

Speaker 3

And the long term, we feel we have more advantage than Some of our competitors because we always have a strategy, invest in some long term Kind of a long term investment strategy, including some real estate, some other part, which give us a much better long term return.

Speaker 10

Great. Thanks so much.

Speaker 1

Thank you. Thank you. One moment for our next question. Our next question comes from Patrick Colville from Scotiabank. Please go ahead.

Speaker 11

All right. Thank you so much for taking my question. Ken, Keith, Peter. My question is about The, I guess, kind of qualitative guidance you guys gave for 2024 billings. If I Remember correctly, last quarter, it was expected kind of high teens business growth exiting fiscal 2024.

Speaker 11

Was the commentary this quarter expect double digit growth exiting 2024? I'm

Operator

not sure I'm following them out.

Speaker 11

I'm just trying to so last quarter, you guys gave some kind of like a forward look for 2024 billings. And if I remember rightly, The kind of forward look was expect exiting Fins growth to be in high teens. Earlier in your kind of prepared remarks, there was a comment which was expect double digit growth in the second half. I guess, Are we going from high teens to double digit? Is that the change?

Operator

Yes. Yes. And I think that's prudent given what we've just seen in terms of the Q3 performance.

Speaker 11

Okay. Very clear. Thank you so much.

Speaker 1

Our next question comes from Joseph Gallo from Jefferies. Please go ahead.

Speaker 12

Thanks for the question. I've got a 2 parter, one for each of you. And Keith, as a follow-up to that last question, appreciate the commentary on bottom line Floor for 2024. Can you just talk about the methodology of top line guidance? Is this a rip the band aid off guide?

Speaker 12

Or what underpins the confidence And then Ken, Given what you're seeing with AI, do you believe adoption of AI workloads eventually shifts workloads back to on premise and drives a higher need for firewalls long term? Thanks guys.

Operator

Yes. And I wasn't quite sure if the question was about the Q4 guide or the 2024 commentary about numbers?

Speaker 12

More for next year, but both. Has the methodology for your top line guidance changed following the past 2 quarters?

Operator

Yes. I would say that while we just deal with the we're actually giving guidance for the Q4, absolutely. I think the assumed Close rates, if you will, are dramatic. I think they're the lowest assumed close rates I've seen that I've used in over 5 years here for context. And they're obviously lower than what I saw in the first what I used for the first half of the year.

Operator

And I think that I would say there are indicators that the pipeline quality is better in the Q4. But in given light of what we've done for the last two quarters, I don't think that should put much stock in that. So I'm content Just assume a much lower close rate than I have more recently. 2024 not really giving guidance. I think that, again, we're talking about billings here and I know we're all aware of it, but really focus perhaps more on the impact of backlog and what it did to billings in Q1 of last year and Q2 of last year And how that eased throughout the year.

Operator

And so you're really going to see comps change. I don't know that we're necessarily assuming a dramatic growth ramp of bookings, if you will, At this early stage for 2024, we do expect it's going to improve as we bring Sassy online more successfully and secure operations. But I think it's really part of what you're hearing there is really getting clarity on how the backlog impacted 2023 numbers.

Speaker 3

Yes. It's a very good interesting question about the AI and the security. I have to say, definitely AI was starting kind of getting into the Q3, very quickly, both by the good guy, bad guy. But in the Genentech AI side, a few In some degree, the back half probably more leveraged some of that one. And the protect side are still more Using what we have been doing in the last 10, 20 years more like a precision AI and make sure we Blocked attack, but not blocking any good traffic, but also the general AI also helping lower supporting costs and also helping the secure operation.

Speaker 3

So it's definitely the AI will keep in driving the security growth and both in the cloud and also our clients. We do see our plans also long term very healthy growth, especially because convergence of networking to networking security, especially in the enterprise in the campus environment. And we see that trend will continue to grow well. And Our unique advantage leverage integrated OS ASIC will continue to lead in the market and keep gaining market share. So long term, I don't see any slowdown of these appliance getting to the cybersecurity space.

Speaker 4

Thank you.

Speaker 1

Thank you. One moment for our next question. Our next question comes from Gray Powell from BTIG. Please go ahead.

Speaker 13

All right, great. Thank you for working me in here. I really appreciate it. So maybe a clarification and a follow-up. So you laid out the breakdown for billings or the new breakdown between Secure Networking, SaaS and SecOps.

Speaker 13

Did you all talk about the relative growth rates that you're seeing today for each segment? And then within Secured Networking, is there a way to think about how much of the slowdown you're seeing there is related to Core firewall business versus some of the networking components like switches and access points and stuff that may have been more They may have benefited more from like supply chain and budget flush and things like that.

Speaker 3

Yes. Actually, we do give the market growth For these 3 segments going forward, and we also believe we're growing faster than the market growth, can you gain share in all these 3 segments? I believe the firewall 40 ks versus some other AP switch, we do see more headwind In AP switch for the AP40 switch because now supply chain issue kind of pretty much over. And so it's so that's probably more headwind compared to the firewall Secure networking firewall side.

Speaker 13

All right. Fair enough. Thank you very much.

Speaker 11

Thank you.

Speaker 1

Thank you. One moment for our next question. Our next question comes from Eric Heath from KeyBanc Capital Markets. Please go ahead.

Speaker 4

Great. Thank you and thanks Peter for getting me in here. Kent, just for you, curious how the economics to the top line For Fortinet change, when a customer is kind of doing an apples to apples switch over from kind of the firewall customer over to a SASE? And then secondarily, with the shift away from firewall, just that probably means more of a shift to annualized billings. So curious how you're thinking about duration and that impact Free cash flow going forward.

Speaker 4

Thanks.

Operator

Yes. The second one is probably easier. I don't we have such a large footprint right now with the firewall business that it's going to take a while For any significant changes in the Sassy buildings, if you really think about it coming into and having an impact on our total term. I don't know if we gave the number, but we know that we've come back to a more we've come down about a month year over year in terms of contract term In 2023 compared to 2022, we went from 28 months roughly last year to about 27 months this year. Maybe I could be off by a month, but And you saw the impact in the financials.

Operator

We've talked about that while 1 month impacts the billings number. I think it's going to take a while for Sassy. As I mentioned, we've already done several 100 Sassy deals. We expect to be more successful early on with 1, in SMB spaces and 2, with our installed base. So I would imagine that it's going to take a while to really have an impact on free cash flow.

Speaker 3

Yes. We also will be keeping accelerate training for internal sales force also to our partner For this new SaaSys SecOps operation, which is a little bit different than the traditional Secular networking side. So that's we also feel with a huge installation base we have in SD WAN firewall, which we are leading. We're Number 1, pretty much in all this area, we feel with a huge potential to upsell, cross sell the SaaS and secure up

Speaker 1

Thank you. At this time, the Q and A session has now ended. I will now turn the call over to Peter Sakhowski for closing remarks.

Speaker 2

Thank you, Antoine. I'd like to thank everyone for joining the call today. Fortinet will be attending investor conferences hosted by Barclays, Stifel and Wells Fargo during the Q4. Part of the chat webcast links will be posted on the Events and Presentations section of the Fortinet Investor Relations website. If you have any follow-up questions, please feel free to contact me.

Remove Ads
Powered by Quartr
Earnings Conference Call
AutoZone Q3 2023
00:00 / 00:00
Remove Ads