Barfresh Food Group Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
November 7, 2024

There are 17 speakers on the call.

Operator

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. After the speakers' presentation, there will be a question and answer session. Please be advised that today's conference is being recorded.

Operator

I would now like to hand the conference over to your first speaker today, Senior Director of Investor Relations. Please go ahead.

Speaker 1

Thank you, and good afternoon, everyone. This is Aaron O'Vadia, Senior Director of Investor Relations at Fortinet. I am pleased to welcome everyone to our call to discuss Fortinet's financial results for the Q3 of 2024. 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 Algar, our CAO and Sales Operations Leader. This is a live call that will be available for replay via webcast on our Investor Relations website.

Speaker 1

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 Q3 of 2024 before providing guidance for the Q4 of 2024 and updating the full year. We will then open the call for questions. During the Q and A session, we ask that you please limit yourself to one question and then 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 these forward looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected.

Speaker 1

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 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 otherwise stated. Our GAAP results and GAAP to non GAAP reconciliations are located in our earnings press release and in the presentation that accompany today's remarks, both of which are posted on our Investor Relations website. 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.

Speaker 1

Lastly, all references to growth are on a year over year basis unless otherwise noted. I will now turn the call over to Ken.

Speaker 2

Thank you, Irene, and thank you to everyone for joining our call. We are pleased to report another quarter of strong execution and continued growth momentum, including record gross margin and operation margin, with the operation margin increased by 8 30 basis points to over 36%. Total revenue growth of 13% as we return to positive billing and product revenue growth, unified SaaS billing growth of 14%, secure operation building growth of 32% and secure networking returned to positive growth, all driven by a continued share gain in our total addressable market of $284,000,000,000 As highlighted on the Slide 11 of the investor presentation, Fortinet continued to be the only vendor to leverage a single operating system for the OS delivering solution with 5 secondured networking Thunder Magic Quadrant report, Secure Service Edge, SD WAN, Single Vendor SASE, Network Firewall and Enterprise Wireless LAN Infrastructure. FortiOS combined with the proprietary Forti ASIC technology significantly boosts secure computing power, delivering 5x to 10x better performance than our competitors by lower customers' total cost of ownership and energy consumption. In the Q3, Unify SaaS building was 23% of our business, up 1.5 point, driven by secure service edge building growth of 2 20% with pipeline up 130%.

Speaker 2

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 allowed Forti SASE to be deployed within minutes from our SD WAN customers. Our single OS based Forti SASE also enables sovereign SASE for service providers and large enterprise to deploy Forti SASE with their own data center for data privacy. In addition, we were recently recognized as a clear leader in the 2024 government Magic Quadrant for SD WAN for the 5th consecutive year and notably are positioned highest of our vendor in ability to execute for the 4th year in a row, leveraging Fortinet's leading position in firewall and SD WAN and our integrated Forti SASE within the same Forti OS, Fortinet provide the easiest and most secure path for migrating from traditional firewall to secure SD WAN and a unified asset. We continue to invest in our global infrastructure, bringing over 3,000,000 square feet across office space, our existing center, operation facility and data centers.

Speaker 2

Our own hosting capability will give us a long term cost advantage while allowing us to use our own FortiStack for better security and management. AI security operation was a fast growing pillar, outpacing the overall market with a 32% building growth, accounting for 10.5% of our total business, up 2 points. We have expanded our secured operation portfolio with the launch of Lacework 40 CNAP and 40 DRP, which together represent a new $20,000,000,000 market opportunity. And we expect to cross sell both solutions to a large installed base of customers. Our commitment to innovation and investment in R and D has enabled us to rapidly expanding Forti AI, our Gen AI system into 7 key solutions FortiAnalyzer, FortiManager, Forti SIM, Forti SOAR, Forti DRP and recently announced Forti NDR and Forti CMAP.

Speaker 2

More Gen AI for the Forti AI product will be announced in early 2025 as Fortinet AI based secure operation business accelerated. 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?

Speaker 3

Thank you, Ken. Thank you, Aaron, and good afternoon, everyone. Let's start with the key highlights from the Q3. We are very pleased with our strong execution and financial performance in the 3rd quarter, repeating our 2nd quarter performance by again achieving record gross margins and record operating margins, while delivering top line results at the top of our guidance range. Total revenue grew 13%, driven by strong growth in services revenue and product revenues returned to growth.

Speaker 3

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. 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 7th consecutive year of exceeding the rule of 40. Looking at billings in more detail, RPO grew 15% to $6,100,000,000 and total billings grew 6% to $1,580,000,000 driven by robust growth in security operations at 32% and unified SASE at 14%. SSE and related cloud technologies were again the fastest growers in unified SASE, benefiting from our large SD WAN customer base. Our Unified Sassy and Security Operation Pillars are gaining considerable traction, with over 90% of the billings coming from our secured networking installed base and combining to drive our SaaS solution, organic ARR growth rate of 74%.

Speaker 3

The customer buying journey from FortiGate to SD WAN to SaaSie supports our customers' drive towards consolidation and is gaining traction. This consolidation journey first begins with a firewall and FortiOS and typically expands to SD WAN and next to SASE. I should share that 2 thirds of our large and mid enterprise customers have deployed our SD WAN technology, providing them with a gateway to 40 SASE. Of these large customers, our 1st year of SASE delivered high mid single digit penetration rates, highlighting both the dramatic expansion opportunity as well as customer demand for vendor consolidation. Including all elements of Unified Sassy, pipeline growth was over 30%.

Speaker 3

And while the SSE technologies are seeing pipeline and ARR growth of 130% and over 500%, respectively. Larger enterprises continue to drive our expansion in the Unified SaaS and the security operation markets, with large and mid enterprises representing 91% and 76% of SaaS and SecOps billings, respectively. As we work through the wind down of last year's backlog and the related year over year headwind to growth this year, secured networking has returned to growth as we expected. Rounding out the billings commentary. SMB and large enterprise were our top 2 performing customer segments, while EMEA was our best performing geography with double digit growth.

Speaker 3

Among our top 5 verticals, manufacturing buildings grew by over 20%, driven by OT buildings growth of 19%. Retail returned to growth for the first time in 6 quarters, up 9%, while the service provider vertical reached its highest growth rate over that same 6 quarter period. Turning to revenue and margins. Total revenue grew 13% to $1,508,000,000 driven by 19 percent service revenue growth and product revenues return to growth. Service revenue of $1,034,000,000 grew 19%, accounting for 69% of total revenue.

Speaker 3

Service revenue growth was driven by growth in our SaaS solution, including 50% services growth in SecOps and 27% services growth in Unified SaaS. Product revenue returned to growth for the first time in 5 quarters, increasing 2% to $474,000,000 Excluding the impact of backlog, product revenue grew sequentially at double digit rates, outpacing historical norms for Q2 to Q3. And following a similar storyline on what we saw in Q2, the sequential growth also outpaced historical norms. A moment ago, we talked about solution consolidation and described the customer's journey around firewalls to SD WAN and on to SASE. A second customer buying journey is supporting customers' convergence of security and networking.

Speaker 3

Their journey begins with Fortinet firewalls and expands to leverage our FortiLink technology to manage Fortinet switches and access points. It's worth noting that over 95% of our larger enterprise switch customers previously or simultaneously purchased FortiGate firewalls. At the same time, our switch penetration rate for these larger customers is around 50%, highlighting both our success and the future opportunity. Software license revenue continued its double digit growth, driven by SecOps solutions and represented a mid to high teens percentage of total product revenue. Combined revenue from software licenses and software services such as cloud and SaaS security solutions increased 33%, accelerating from 32% in the 2nd quarter and providing an annual revenue run rate of over $900,000,000 Total gross margin increased 6.30 basis points to a quarterly record of 83.2 percent and exceeded the high end of our guidance range by 3 20 basis points.

Speaker 3

Gross margins benefited from higher product and service gross margins as well as a 4 point mix shift to higher margin service revenue. Product gross margin of 71.6 percent was also a quarterly record and increased 13.70 basis points, which includes a 3.20 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%. Service gross margin of 88.5 percent increased 130 basis points as service revenue growth outpaced labor cost increases and benefited from the mix shift towards higher margin FortiGuard security subscription services. Operating margin increased 8 30 basis points to a quarterly record of 36.1 percent and was 360 basis points above the high end of our guidance range.

Speaker 3

Excluding the one time benefits of product gross margins, operating margins would have been 35.1%. Taken together with our reported Q2 margins, the Q3 margins, excluding the one time benefit, provide directional insights to our financial performance.

Speaker 4

Before moving on to the

Speaker 3

statement of cash flows, I'd like to provide a few details related to the impact of Lacework and Next BOP acquisitions. These acquisitions increased Q3 billings and revenue by approximately 60 90 basis points respectively, and increased gross and operating margins by about 30 and 2.20 basis points respectively. And actually, I said decreased gross margin and operating margins. Looking at the statement of cash flow summarized on Slides 16 17. Free cash flow was $572,000,000 representing a margin of 38%.

Speaker 3

And adjusted for real estate investments, the margins came in at 40%. In the 1st 9 months of the year, free cash flow was 1,500,000,000 dollars or $1,750,000,000 after adjusting for real estate investments. Cash taxes were $140,000,000 up $114,000,000 reflecting the prior year's regulatory extensions of estimated tax payments. Infrastructure investments totaled $36,000,000 The average contract term in the Q3 was 28 months, flat year over year and quarter over quarter. DSO decreased 6 days year over year and quarter over quarter to 62 days, reflecting stronger than usual linearity.

Speaker 2

The

Speaker 3

$106,000,000 gain on bargain purchase from the Lacework acquisition relates to NOL carry forwards and the related recognition of the deferred tax assets. The gain is excluded from our non GAAP financials, but it is included in the GAAP financials, adding $0.14 per share to our GAAP EPS. Share buybacks in the quarter totaled $600,000 and last month the Board increased the share repurchase authorization by an additional $1,000,000,000 bringing our remaining share repurchase authorization to approximately $2,000,000,000

Speaker 2

Now I'd like to share

Speaker 3

a few significant wins from the Q3. 1st, in a 7 figure upsell deal, an existing SD WAN customer in the retail industry continued their consolidation journey, adding FortiSASE for 16,000 users. This customer selected our Forti Sassy solution for its simplicity, ease of management and consistent security enforcement across their infrastructure. We outperformed the competition by leveraging our FortiOS operating system, streamlining operations and reducing cost of ownership, while showcasing our ability to consolidate multiple security functions onto a single platform. In another 7 figure win, a medical device company purchased FortiSassy to replace their existing solution.

Speaker 3

This customer chose Fortinet for a simplified and consistent security management, significant cost savings and FortiSassy's enhanced functionality, particularly the bidirectional connectivity between their data center and remote users, enabling to push policies more effectively. In an 8 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. This customer was particularly impressed with our integrated security end to end visibility and automated response capabilities of our FortiOS operating system. Before discussing our guidance, I'd like to offer a couple of comments on the firewall recovery and refresh opportunity. During last quarter's remarks, we mentioned that the continued improvement in the days to register FortiGuard contracts indicated the inventory digestion at end users was returning or had returned to normal.

Speaker 3

In the Q3, this metric was stable, further validating our view that the firewall market is recovering. Today, we'd like to add to this commentary by noting that in 2026, a record number of FortiGates will reach the end of their support lifecycle and we expect these customers to start the refresh cycle for these products sometime in 2025. Moving on to guidance. As a reminder, our Q4 and full year outlook, which are summarized on Slides 1920, are subject to the disclaimers regarding forward looking information that Aaron provided at the beginning of the call. Before reviewing our outlook, I should note we expect Lacework and Next DLP for those acquisitions to increase Q4 billings and revenue by 75 and 135 basis points respectively and decrease operating margins by 230 basis points.

Speaker 3

All right. For the Q4, we expect billings between $1,900,000,000 $2,000,000,000 which at the midpoint represents growth of 5 percent revenue in the range of $1,560,100,000 to $1,620,100,000 which at the midpoint represents growth of 12 percent Non GAAP gross margin of 79.5 percent to 80.5 percent. Non GAAP operating margins of 33% to 34%. Non GAAP earnings per share of $0.58 to $0.62 which assumes a share count of between 768 $778,000,000 capital expenditures of $100,000,000 to $120,000,000 a non GAAP tax rate of 17% and cash taxes of $127,000,000 to 177,000,000 For the full year, we expect billings in the range of $6,430,000,000 to $6,530,000,000 Revenue in the range of $5,856,000,000 to $5,916,000,000 which at the midpoint represents growth of 11 percent service revenue in the range of $4,015,000,000 to $4,045,000,000 which at the midpoint represents growth of 19 percent Non GAAP gross margin of 80.3 percent to 81.3 percent, non GAAP operating margin of 32.9% to 33.9 percent, non GAAP earnings per share of $2.20 to $2.28 which assumes a share count of between $766,000,000 $776,000,000 capital expenditures of $380,000,000 to $400,000,000 non GAAP tax rate of 17% and cash taxes of between $550,000,000 $600,000,000 I look forward to seeing you at the Analyst Day later this month and updating you on our progress in the coming quarters.

Speaker 3

I'll now hand it back to Karl Erik to begin the Q and A session.

Speaker 1

Thank you, Keith. As a reminder, during the Q and A session, we ask that you please limit yourself

Operator

Thank you. At this time, we'll conduct a question and answer session. Our first question comes from Hamzah Fodderwala with Morgan Stanley. Your line is now open.

Speaker 5

Great. Good afternoon. Thank you for taking my question. Ken, I couldn't help noticing in your investor presentation, you talked about a market growth that you see over $200,000,000,000 growing 12% over the next 4 years. Obviously, a big chunk of that growth is driven by the Sassy market and your share gain there.

Speaker 5

I'm curious if you could talk a little bit more about Fortinet's approach in terms of sovereign Sassy. 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 2

Yes. Thank you, Hongzah. It's a great question. We invest in the SASE for probably 5 to 10 years in the market, including all the SD WAN and also all the SASE function in the same FortiOS, both on premise, 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 2

And that's for the sovereign SASE. We usually call private SASE. Actually, if you look at probably 1 years ago, we're more focused in that area with a lot of service provider, which is quite important for them to deploy the SaaS 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. So that's the 2 important factors there. So they have to be local and to secure the data and same kind of process data locally.

Speaker 2

So that's a huge advantage in the same OS and also a lot of function can use in 40 ASIC or salary. The 100 differentiation comes from the business side. So we have a we are the number 1 on the network security firewall. We are also the number 1 on the SD WAN. So leverage our installation base and also both the firewall function and also IT WAN function in the same OS with the SASE.

Speaker 2

So that's for the customer, they have the most easy migration pass from the traditional firewall vendor, I mean from traditional firewall customer to the SD WAN customer go to SASE. It's only need a few minutes reconfiguration. They can enable SASE based on their previous SASE 1 or the firewall configuration there. So it's a very easy migration path. Now as you can see, the pipeline grows and also the business growing there from SASE like over 200%, the pipeline grew over 100 percent.

Speaker 2

So we do believe we'll be the number one leader in the SaaS space in the next few years.

Speaker 5

All right. Thank you.

Speaker 2

Thank you.

Operator

Thank you. Our next question comes from the line of Brian Essex from JPMorgan. Your line is now open.

Speaker 6

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 maybe with a little bit of color of what you've seen historically, how far before the renewal point do customers tend to refresh?

Speaker 6

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 3

Yes. I'll kind of jump in a little bit on this. I think that we see these end of life of these products starting in the second half of twenty twenty six. We don't expect the customers to wait till the 11th hour to make the change. For larger enterprises, they would go through another certification, POC project perhaps as part of that before they place them in service.

Speaker 3

So we saw a similar not similar, we saw a lift, if you will, and similarly in 2023, although the magnitude in 2026 is much, much larger. 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 and switches, etcetera. 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 3

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 5 or 6 years. It is each year is dominated by the entry level firewalls. However, in 2026, we see a significant portion of that actually being in the mid range firewalls as well. And that is a very unusual and positive situation. I don't have a breakdown by SMB or something else.

Speaker 3

So maybe Christiana wants to offer something more on that.

Speaker 6

Or by vertical. I think you've mentioned before that you need large enterprise retail and service provider in order to recover. So if you have any insight there, how that how their cycles and spending patterns may impact that, that would be helpful.

Speaker 3

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?

Speaker 7

Yes. You were asking whether or how early customers would refresh. And many of the enterprise customers have enterprise agreements where they have account level support and subscriptions. So they don't really wait until something expires. They will probably I would expect what we typically see refresh about a year before U.

Speaker 7

S. And for smaller customers, they will probably try to wait until the contracts expire. But because we don't allow them to renew for less than a year, you also see these refresh cycles happening about 15

Speaker 6

to 18 months out. Got it. Super helpful. Thank you so much.

Operator

Thank you. Our next question comes from the line of Fatima Boolani from Citi. Your line is now open.

Speaker 8

Good afternoon. Thanks for taking my questions. Ken, a question for you. There was a discussion about the routes to the market in terms of gaining your market share within the Sassy universe. And one of those important routes is leverage our installed base by converting and saturating a lot of the SD WAN customers.

Speaker 8

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 transpires from SD WAN to SaaS? And then I just have a follow-up for Keith, if I may.

Speaker 2

Yes, it's Arthur. Very great question. I think if you look on the customer, a lot of SASE is really supporting the ZTNA and also remote work environment. So they are not counted as any network security firewall deployment, which tend to be more in the office in the headquarter there. On the other side, it's most of if you look at our current SaaS growing strong, it's mostly come from the current SD WAN customer base or even the firewall customer base there.

Speaker 2

So that's where they do need a hardware firewall SD WAN there to support in the SASE with additional SASE user license, with additional all these other function service add on there. So that's where we see like both 3 pillars, whether the secure networking side and also the SaaS side, which will help in add additional service and plus the other, we call it, secure operation side, all kind of starting growing now. We do believe we can keep growing all these three areas faster than the market, keep gaining market share, especially SASE, the technology we can put all in the same OS with AC to accelerate and also supporting both the cloud based SASE or the co private SASE or sovereign SASE is a huge advantage. And also, we also believe eventually the service provider carrier will play some important role in the SASE and offer a lot of their own kind of SASE to their customer. So that's where we have very strong support in all the service provider, build their own SASE infrastructure and we do feel it's a huge growth potential on top of the traditional network firewall

Speaker 8

market. Thank you, Ken. And just Keith for you to double back on the end of support catalyst around the refresh that you're talking to and telegraphing for 2026. Any way you can give us the lens on either the proportion of the shipment footprint or the installed base footprint or the customer footprint that this applies to in the aggregate? Thank you.

Speaker 3

Yes. At the risk of taking all the fun out of the Analyst Day in 10 days, I would say that the second 2023 was or 2022 was the 2nd best 2nd highest I looked at. 26 is more than is a little bit more than 2x 23.

Speaker 8

Thank you.

Speaker 3

So you're not coming to the Analyst Day.

Operator

All right. Thank you. Our next question comes from the line from Saket Kalia from Barclays. Your line is now open.

Speaker 9

Awesome. Hey, guys. Thanks for taking my questions here. Maybe for Keith or Christiane, I think we mentioned a SaaS Solutions ARR growth number in the prepared remarks. Could you just remind us, is that an organic or inorganic number?

Speaker 9

And maybe just touch on what are the solutions that are driving that growth?

Speaker 3

Shoshana, you want to?

Speaker 7

Yes. So the growth number that Keith referenced was an organic growth number. We did not include the ARR that we acquired from Nextelp and Lacework. So the growth would be even higher year over year would be 150%. What are the solutions, the organic solutions that are driving the SaaS ARR growth is really 40 EDR, 40 Client, 40 NDR Cloud, 40 Web.

Speaker 7

So a variety of our cloud solutions and SaaS solutions that we've started to offer. Some of them are acquired, some of them are internally developed.

Speaker 9

Got it. Keith, maybe 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 what 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 3

Yes. I think if I were to use the headline first, I would say the pro form a margins, if you back out that one time benefit, product gross margin would have been about 68.4%, 0.5 percent and operating margin, if you backed out that benefit, would be 35.1%. As you may recall, we have 2 different things that are impacting our margins in that regard. 1 is the traditional excess and obsolete inventory calculation with inventory you have on hand. That's pretty straightforward in comparison.

Speaker 3

The second one is future deliverables. And the operations team has worked really hard with 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 $15,000,000 That's very unusual. We've not seen that in the past.

Speaker 9

And anything on sort of the sustainability of that margin? And if that risks pulling anything from the Analyst Day, I totally understand. But wanted to make sure the question was asked.

Speaker 3

Yes. 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.

Speaker 9

Very helpful. Thanks.

Operator

Thank you. Our next question comes from the line of Tal Liani from Bank of America. Your line is now open.

Speaker 10

Hey guys, you have Tomer Zilberman on for Tal Liani. Just wanted to ask about the billings guidance for next quarter. The organic billings ex lacework and next DLP came in well below Street expectations. 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 3

Yes, great question. And I think what we're seeing when we look at the Q4 right now, we're really pleased with what we got out of the very first month for the Q1. And I think that the 2nd month is it's early yet it's tracking. What's giving us pause are some chunky deals that are teeing up for the final month of the quarter. And they just need to mature a little bit more before we start thinking about them as part of our guidance number.

Speaker 3

So I think it's really that population of large 7 figure and a few 8 figure deals that are kind of coming into play there a little bit.

Speaker 10

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 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?

Speaker 10

And how are you participating with that as well?

Speaker 3

Yes. I think the maybe Christian 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, 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.

Speaker 3

But maybe Christiana has some thoughts as well.

Speaker 7

Yes. I think that overall the discounting, we expect to be pretty stable. But of course, it depends on the product set a little bit. And then, yes, we have incentives in the market for channel partners specifically, but also for our customers to buy more 4 d net solutions.

Speaker 10

Got it. Thank you very much.

Operator

Thank you. Our next question comes from the line of Gabriela Borges from Goldman Sachs. Your line is now open.

Speaker 11

Hi, good afternoon. Thanks for taking my question. 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?

Speaker 11

What do you think is working well? And what do you think is incrementally a focus as we go into 2020 5 where you think you can maybe up level some more? Thanks.

Speaker 2

Yes. You can see the last 12 months, we made a huge progress in the SaaS, SSE go to market directly. But also you can see Q3, some of the service provider also starting finally starting to turn growth now and realize the importance of the SaaS into their customer base. But it's probably still take some time. But on other side, we see our own customer base, really like the SASE and we're easy migrate from the firewall SD WAN into SASE.

Speaker 2

So that's kind of probably 90% of our SASE business come from existing network security and also SD WAN customer. And that actually help us sell additional service, additional margin there. On the other side, the technology we have, whether the single OS, the ASIC, kind of set out this function, give us huge advantage and to expand beyond traditional SASE market, which is only focused on a cloud based SASE. So that's where we see the whether the sovereign SASE, private SASE or even beyond go to the edge computing area with all kind of technology with our clients also see especially for the OT, IoT area, both the hardware agent, software agent who's supporting all this OT device, we see also huge growth potential there. So that's where we're pretty confident.

Speaker 2

So we're leading the SaaS market and just like we did in firewall SD WAN space.

Speaker 3

Yes, I think that Ken will

Speaker 11

follow-up on that. That makes sense. Thank you. Yes. Just to add, I

Speaker 3

think that if you compare and contrast where we are today versus a year ago, what I would say is that given the response that we get from customers when they meet with us, they're very excited about the architectural design of Sassy 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 is still very early days. And I think part of that is getting more reference customers involved. And I think also the channel needs to we need to partner more closely with the channel to make sure that we're getting more at bats on those SaaS opportunities.

Speaker 11

Yes. Thank you.

Speaker 2

Our Sassy also had infrastructure, we're also different than what we might call our competitor. I think we like I said, we own more than 3,000,000 square feet of our own kind of facility, which if our own data center can deliver the SaaS function, probably less than half compared to all these colo and 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. So that's where for us we do have a cost advantage infrastructure side plus on the OS technology, on ASIC acceleration can lower the energy cost within the data center, within all the SaaS processing. I think we do have a huge advantage both on technology, from infrastructure and also leverage a business customer base we have on the far west D WAN.

Speaker 2

So that's the 3 advantage we have overall other SaaS competitors.

Speaker 4

I think it's also interesting to note like you said, we started really focusing on SaaS a year ago. Like Ken said, we've been building the solution for some time, of course. A year ago at the November 23 earnings call right around that, we broke out those 2 other pillars, SASE and SecOps, externally and also internally to focus on those pillars. And you've seen really nice growth when we focus on solutions like that over the past year. It's only been a year.

Speaker 4

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 then we've risen to be the leader in the GardenFagic Quadrant, It steadily grew over time. And so I think that those past 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 we had really good results over the course of that year in

Speaker 3

a very short period of time and

Speaker 4

a lot more focus to come going forward.

Speaker 11

Absolutely. Good stuff. Thank you.

Speaker 3

Thank you.

Operator

Thank you. Our next question comes from the line of Fowal Yal from TD Cowen. Your line is now open.

Speaker 12

Thank you. Good afternoon, guys. Ken or Keith, in your press release, you're talking about Fortinet being well positioned to lead in its 3 core growth areas and drive sustained growth. Keith, again, I don't want to spoil 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 3

Yes. I appreciate the opportunity to talk to it, but and maybe Ken wants to a little bit, although I would probably be careful what he says. I think we'll obviously, we'll talk about 2025 as we get to the February earnings call. And we understand that the November Analyst Day is probably going to bake in some of the 2025 conversation. So I think that's a it's a well structured question, but I think we'll pause on answering it for now.

Speaker 2

Yes, I agree. So probably waiting 10 days. And also you can look at the investor slides, probably number 6, there's some information there. We probably provide more detailed information about total addressable market, how we want to grow faster than the market in each sector.

Speaker 12

Thank you.

Operator

Thank you. Our next question comes from the line of Rob Owens from Piper Sandler. Your line is now open.

Speaker 13

Great. Thanks for taking my question. And Keith, I want to, I guess, double back on your comment around Q4 and some of the chunky deals setting up for 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?

Speaker 13

Just curious why the additional conservatism around them now? Thanks.

Speaker 3

Yes. 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 Q3 as they got teed up for the Q4. 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 3

All right. I appreciate

Speaker 13

the color.

Speaker 2

It's another factor, it's really probably the first time we also starting gave RPO number. And also compared to 1 year ago, some of the deal probably Christiana can give you more detail. Instead of finance from the channel, get $1,000,000,000 right away for multiple ADOs, some of them may just use an IPO, just bill annually. Maybe Christiana knows his better.

Speaker 7

Yes. As you can imagine, the customers won't pay multi years upfront. And so we have internal discussions around either getting the tenant financed or do it ourselves. And this has 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 2

Yes. This maybe has a little bit short term impact, but also will benefit the company long term with better margin, better customer relation. So that's what we're looking for long term success.

Operator

All right. Thank you. Our next question comes from the line of Catharine Trebnick from Rosenblatt. Your line is now open.

Speaker 14

Hi, Catharine Trebnick here. Thanks for taking my question. Can you discuss how your 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?

Speaker 14

Thank you.

Speaker 3

Yes. I think that the virtual firewalls have done very, very well. It is a component of unified SaaS as well as part of our network security portfolio. So and I think the other thing we look at is the crossover that we see, which is a very strong relationship between

Speaker 14

Sorry, I'm on another call.

Speaker 3

You still there, Catherine? Well, I'll just finish the thought by saying and the only thing we will 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.

Operator

All right. Thank you. Our next question comes from the line of Adam Borr from Stifel. Your line is now open.

Speaker 15

Great. And thanks so much for taking the question. Maybe for Ken, just on the Lacework for the STNAP offering now. I'd love to hear a little bit about initial customer feedback, partner feedback and kind of near term R and D and sales and marketing priorities. Thanks so much.

Speaker 4

Yes, I mean, I think the feedback we're getting is similar to what we found this is John Whittle by the way. What we found when we did our diligence, great product, great engineering team. It's an incremental TAM of $10,000,000,000 for us. So it really opens up that incremental TAM. Now we have cloud security endpoint network and we have great threat intelligence from all three.

Speaker 4

So I think it's very, very positive feedback in terms of the quality of the product. 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 some who have kind of piece 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.

Speaker 4

It's portably integrated, it's not. Lacework, CNAP solution was largely developed organically by them to all seamlessly work together. So we're hearing really positives on that front. And then also versus other competitors, we do have this broad suite of products that we can offer together versus other kind of single point, single product vendors who just offer CNAV. So we have real competitive differentiators against the others in this space that we see working to our advantage.

Speaker 2

Yes. So both company has market leading technology and the team there are also pretty strong. On the same time also kind of better as a company, so we are keeping our own kind of solution, integrated solution there and that's probably better than other competitor who actually leverage our customer base, leverage our also strong R and D resource, have both combined solution and also standalone solution to support your customer in this new $20,000,000,000 total addressable market, I think it definitely adds a huge growth potential, both in the Secure Op and also in the SaaS space.

Speaker 15

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 is a little bit smaller of a vertical for Fortinet.

Speaker 15

But maybe talk about the government vertical more broadly in the quarter and how you think about it in commentary? Thanks so much.

Speaker 3

Yes. 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.

Speaker 3

So you don't really get the same sort of 9.30 benefit that maybe some other companies see.

Speaker 15

Great. Thanks again.

Operator

Thank you. Our next question comes from the line of Patrick Colville from Scotia. Your line is now open.

Speaker 15

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 Sassy when they may already have existing relationships with more established vendors in this space? Thanks.

Speaker 2

Yes. You can see the for Fortinet channel partner, you can see a lot of the actuality is our partner for network security and also SD WAN. So it's a very easy upgrade cost to our SASE. And a lot of them also compared to whether the cost, the security, the performance, the flexibility, the broad range, we're also much better than any other competitor. So it's quite easy migrate from some of our competitor to Fortinet.

Speaker 2

So we do see some kind of acceleration there. The other part is also we have pretty big SMB customer base. SMB right now probably only single digit has any kind of network security deployment. And we also see that's also one of the fast growing area because they do suffer a lot of ransomware attack out this concerns. So we do see there's additional segment we can grow and at the same time for service provider for big enterprise to do this private sovereign strategy, that's also not other competitor can offer whether in the same OS or to the local data center deployment within the customer premise there.

Speaker 2

So that's we feel we have quite some differentiation can give us huge advantage over other competitors.

Speaker 15

Got it. Thanks, Ken.

Operator

Thank you. Our next question comes from the line of Joseph Gallo from Jefferies. Your line is now open.

Speaker 13

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?

Speaker 3

Well, I think that very bullish on the OT market, but the leadership opportunity for us.

Speaker 2

Yes. OT is the other area we already lead in the space. In some report, we're the only leader in OT security. We do believe also investing this year for a long time. And also, we believe in the next 5 to 10 years, probably most of the connections all come from this device level, and which most of them probably have a difficult way to deploy the agent software on this device to use network security.

Speaker 2

So we see a huge opportunity. This OT combined resulted edge computing we feel is a will be the strongest growing area in the next 5 to 10 years. And so leverage whether the OS or ASIC technology and also the infrastructure we have, we feel this is a huge opportunity there. We'll be driving definitely what drives the long term amount of growth.

Speaker 13

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 6 quarters. Now that we're post election, like are there any verticals that you expect to rebound? Or are there any changes going forward over the next couple of quarters that we should expect? Thank you.

Speaker 2

We see the manufacturer already pretty strong in Q3. We feel the post election properties as well also keeping us celebrating there. Also the other one like carrier service provider is other market. We feel finally see some growth after probably 6th quarter. And probably some other like retail, like it's a pretty strong growth in 2,000 and 1, 2002 2020 2, almost like 100% growth at some point in last year.

Speaker 2

So I think that's probably will be most starting to get in the refreshing cycle starting whether next year or 2026 because we see the number of units in that space registered being like goes throughout this last like 4 years, we probably more reach to the time to refresh now.

Operator

Thank you. Our next question comes from the line of Keith Bachman from BMO. Your line is now open.

Speaker 16

Hi, many thanks. Good evening. I wanted to ask 2 questions sort of a micro and a macro and I'll just ask them concurrently in the interest of time. Keith, just on the Sassy penetration, you indicated on Slide 9 about 45% is with large enterprise. If you took out the SD and it's a very impressive figure, if you took out the SD WAN, what would that penetration rate or share look like in terms of customer type?

Speaker 16

I'm just I'm trying to understand the SD WAN versus the other bucket. 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 2? I know it's key plus 1 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 of quarters, not just in Q4? And that's it for me. Thank you.

Speaker 3

Yes. Maybe we've confused you or I confused myself on Slide 9. I don't think that's showing penetration. I think that's showing mix of customers.

Speaker 16

Yes. That's what I sorry, that's what I meant. But what would the just mix of customers if you took out SD WAN of the SaaS piece alone?

Speaker 3

You're going to find a mix of customers that's more tilted to the larger enterprises if you look at SaaS alone than when you look at the entire universe would be my expectation. I think you said yes, okay. It has when you look at dollar values, right, not customer accounts.

Speaker 15

Yes.

Speaker 3

Europe, I mean Europe was I think we mentioned on the call, international or EMEA was number 1. I think U. S. Was number 2 and Europe was right behind them and number 3. It's a little bit like the SMB talk about every quarter that the economy is slow, everybody worries about SMB and it continues to do well.

Speaker 3

I'm not saying there are pressures in Europe. And as we look forward to the Q4, I don't know that we're expecting anything like an outsized performance from Europe, but we'll see how the quarter comes out.

Speaker 16

Okay. Thank you.

Speaker 11

Okay.

Operator

Thank you. Our next question comes from the line of Junaid Siddiqui from Tuohy. Your line is now open.

Speaker 6

Great. Thank you for taking my question. I just wanted to drill down in your hardware appliances. And if you can maybe just give us

Speaker 3

a little bit more color how

Speaker 6

the high end family performed versus the mid range and the lower end? Thank you.

Speaker 3

Good question. Looking for some numbers real quick here.

Speaker 7

So overall, I would say mid range and high end has continued to be stable, but not outgrow. We had a little bit more unit shipment in the end.

Speaker 3

I guess what we're saying is there's nothing that jumped off the pages when we look at our numbers. How's that?

Speaker 6

Great. Thank you.

Operator

Our final question comes from Gray Powell with BTIG. Gray, your line is now open.

Speaker 13

Great. Thanks for working me in. I greatly appreciate it. So yes, it was really helpful to see the product level billings growth rate disclosures on the slide deck. Within Universal Sassy, could you maybe give us a ballpark sense as to how fast the SD WAN piece is growing?

Speaker 13

My understanding is that 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, particularly as VMware customers start looking for alternative solutions? Thanks.

Speaker 3

Yes. I think we're if you look at our SD WAN space and we I think we made reference to the penetration in the larger enterprises at something on the order of 65% or 70%. That is of our customer base. As you're pointing out, the opportunity for us to see greater growth there is by in white space accounts and bringing them on board with the FortiGate and SD WAN solution and starting them on that customer journey that goes FortiGate SD WAN SaaS. I think you're going to get some renewals from the early adopters of SD WAN here as you start looking into 2025 and into 2026 that will be natural.

Speaker 3

I think that those same just as we're going through renewal cycle for SD WAN, our competitors will be also. And we've historically shown where we have a superior product like SD WAN, that's an opportunity for us to dislodge the Encompass.

Speaker 2

Yes, I agree. If you look on the top 5 SD WAN provider, so we're the only one internally develop, integrate with security, also the SaaS, all these things. All the other companies acquisition, a lot of our companies are also being sold after acquiring some of SD WAN. So they're kind of a function of technology already stopped developing in a few years now and come after refresh. We do see it's a huge opportunity.

Speaker 2

It's still a very fragmented space, but we do see a lot of replacement opportunity deal right now. And we also feel we are not only leading on the technology, but also performance, cost, energy consumption. So that's where we feel the SG and A, we're keeping accelerating and grow faster than the market, gaining market share there.

Speaker 13

Understood. All right. Thank you very much.

Speaker 2

Thank you.

Operator

This does conclude the question and answer portion. I will now turn it back over to Aaron for closing remarks.

Speaker 1

Thank you. I'd like to thank everyone for joining today's call. As a reminder, we will be holding an Analyst Day on November 18, marking our 15 year IPO anniversary. We will share the company's vision for the future of cybersecurity and provide an update on our strategy and midterm financial model. We will also be attending investor conferences hosted by Barclays, Needham, Scotiabank and Wells Fargo during the Q4.

Speaker 1

The webcast links will be posted on the Events and Presentations section of Fortinet's Investor Relations website. If you have any follow-up questions, please feel free to contact me. Have a great rest of your day.

Operator

This does conclude the conference call. Thank you for being here. You are now fine to disconnect.

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