The speaker, Peter Salkowski, welcomes participants to the Fortinet 1Q 2024 Earnings Announcement Conference Call and introduces the other speakers, Ken Xie, Keith Jensen, and John Whittle. He reminds listeners that the call will be recorded and available for replay. Ken Xie will provide an overview of the business, followed by Keith Jensen who will review financial and operating results and provide guidance for the second quarter and full year. The call will then be opened for questions, with a request to limit to one question and one follow-up. A reminder is given about the risks and uncertainties of forward-looking statements.

In the second paragraph, the speaker discusses the company's strong financial performance in the first quarter, including increased operation margin and record cash flow from operations. They also highlight their focus on investing in the fast-growing unified SASE and secure operation market, with these solutions accounting for one-third of first quarter billings. The speaker also mentions the success of their annual accelerate conference and plans for promotions to introduce customers to their new unified SASE solution.

Fortinet is a leading company in the SASE market due to their differentiated unified SASE solutions. These solutions are built into one single operating system, FortiOS, and include a full range of networking and security features such as ZTNA, Secure Web Gateway, CASB, and SD-WAN. This allows for increased efficiency and reduced security risks. Fortinet's unified SASE solution can be deployed on-premise or in the cloud, making it more versatile and easier to deploy. Their platform approach has earned them third-party awards and they are the only vendor recognized in the Gartner Magic Quadrant Report for multiple categories. All of Fortinet's offerings are built on one operating system, FortiOS, and utilize FortiASIC for increased secure computing power. Fortinet's solutions accounted for 9% of total billings and their advanced AI technology, FortiAI, is being deployed across both networking and security products. They have also announced the industry-first IoT security generative AI assistant.

In the fourth paragraph, it is mentioned that Fortinet offers support in over 30 languages for its FortiAI service. The company is a leader in OT security solutions and has announced the release of the FortiGate 200G, which is powered by a new SD FortiASIC. The company also thanks its employees, customers, partners, and suppliers for their support. In the next part, Keith Jensen discusses the highlights of the first quarter, including a record operating margin of 28.5% and strong free cash flow of $609 million. While total billings declined as expected, unified SASE and SecOps showed strong growth.

The company's cross-selling efforts have been successful, with existing customers accounting for a large portion of SecOps and unified SASE billings. Larger enterprises are the company's biggest customer segment, and both pillars have strong pipeline growth. The company's investment in SASE has been recognized by third-party agencies, and customer interest in the unique SASE platform is increasing. At a recent conference, the SASE demo booth was the most active and a significant number of attendees joined the breakout session to learn more about the offering.

The customer partner of SASE Fast Track training program at Fortinet has become the second most attended technical training session, after only a single vendor SASE partner, SD-WAN. Fortinet is committed to driving effective security solutions worldwide and welcomes partnerships with other industry peers. The company is also expanding its Google and Fortinet PoPs to meet the demands of large enterprises. A seven-figure education deal is on track to have 300,000 seats on board for the new school year. The company has also launched Fortinet Gen AI assistant, which supports and guides SOC and NOC teams in managing network changes and investigating threats. SMB was the top-performing customer segment, and international emerging was the best-performing geography. The three largest industry verticals are worldwide government, service providers, and financial services. Service provider and worldwide government experienced the highest growth, while retail and financial services faced challenges. The company's average contract term and DSO were elevated due to six eight-figure deals in Q4 2023.

The average contract term decreased slightly year-over-year and quarter-over-quarter, while DSO decreased significantly. Revenue grew by 7%, driven by service revenue growth. Service revenue accounted for 70% of total revenue and saw over 30% growth from unified SASE and SecOps. Product revenue decreased as expected, while software license revenue increased. Total gross margin increased and exceeded guidance, driven by the mix shift to higher-margin service revenues. Service gross margins also increased, while product gross margin was pressured due to challenges related to inventory levels. Operating margin was above guidance, reflecting strong gross margins and cost management. Free cash flow and adjusted free cash flow were $609 million and $821 million, respectively.

In the first quarter, infrastructure investments totaled $222 million, with $212 million in real estate investments. Cash taxes were $31 million. Although no shares were repurchased in Q1, $5.3 billion has been spent on buybacks in the past four years and there is still $1 billion remaining in the authorization. Significant wins in the quarter include a large deal with a US financial institution, a competitive win with a hospitality company, and another 7-figure deal with a hotel and restaurant chain for various Fortinet solutions. These wins were driven by Fortinet's experience in highly regulated industries, cost-effectiveness, and operational simplicity.

In order to secure wins in the retail industry, Fortinet's Security Fabric platform offers a comprehensive range of solutions, including unified South, AI-driven SecOps, and secured networking. This integrated platform allows for consolidation of security solutions, reducing costs and increasing effectiveness. For the second quarter, Fortinet expects a decline in billings but growth in revenue. The company also expects the backlog headwinds to ease in the second half of 2024 and believes the firewall digestion cycle is nearing completion.

The company expects a decrease in headwind in the fourth quarter and is seeing early signs of a more normalized firewall market. One metric they watch is the average days to register security service contracts, which has decreased by 25% and is on pace to return to normal levels in the second half of 2024. This suggests that customers are completing the inventory digestion process and returning to a more normal buying behavior. The company also provided guidance for the year, including expected billings, revenue, service revenue, gross margin, operating margin, earnings per share, capital expenditures, tax rate, and cash taxes. The call was then opened for questions.

The speaker asks about the lower end of the company's billings in Q1 and what gives the company confidence in maintaining its guidance and reaccelerating in the back half of the year. The company explains that there was some weakness in Europe, but overall they are not far off from their plan and feel better about their pipeline and hygiene improvements. They also mention outperformance in service and product revenue and an increase in margin on the bottom line.

The speaker discusses the company's pricing strategy, which focuses on maintaining healthy gross margins and margins for partners. They mention that they may adjust prices due to increased costs, such as supply chain shortages, but overall their product remains competitive and they are seeing interest from customers in their new products. They also mention a shift towards OpEx models and the potential for increased cross-selling opportunities.

In the current market, costs have come down and margins have been returned to partners. The focus is now on new products with healthy margins, rather than adjusting prices for existing products. SASE traction has been strong, with over 90% of customers being existing ones. The majority of sales were expansion sales, and there has been a shift in how customer mix and expansion opportunities are reported.

The speaker discusses the performance of different geographic regions in the company's business, noting a significant deceleration in the Americas, resilience in EMEA, and a shrinkage in APAC. They also mention the success of cross-selling SASE to existing SD-WAN customers.

The speaker is asked to provide insight into the demand and buying patterns in different geographic markets, as well as the pipeline growth for secure SD-WAN. The speaker highlights that SMB continues to perform well, while Europe was slightly below expectations due to enterprise sales. The speaker also mentions the impact of 8-figure deals on the US enterprise growth rate and notes that the opportunities for these deals are primarily in the US market. They also mention the growth of the firewall industry.

In the paragraph, the speaker discusses the current state of the SASE and SecOps solutions market, noting that there is more interest and maturity in these solutions in the US and Europe compared to APAC. However, they also mention that there is a strong market in Japan and that many customers are converting to SD-WAN in order to save costs. The speaker also briefly mentions signs of recovery in the firewall market and potential changes in market share.

The company believes it will continue to gain market share even in the current market conditions, with a decline in the network security and medical markets. This is due to their strong performance advantage and ability to provide better ROI and security compared to traditional firewalls. The delay in registering service contracts that attach to hardware contracts, which started during the pandemic, has now decreased. This was likely due to customers buying equipment and delaying registration due to supply chain issues.

The company is seeing a return to normalcy in their inventory levels and customer buying patterns. They expect to reach pre-COVID levels by the second half of the year. Non-FortiGate products are also seeing growth, particularly in areas such as FortiWeb and FortiMail. There is also interest in using their full WiFi AP and FortiSwitch as a hardware agent for SASE. The company also has a technology called FortiLink which allows for integration between FortiGate, WiFi, and FortiSwitch.

Keith discusses the term "whipsawing" in relation to the growth of the company and the number of large deals they have seen in recent quarters. He mentions that they have a strong pipeline and expect similar results in terms of large deals throughout the year. He also notes that their business model typically sees stronger performance in Q4 and Q2, and they may see more concentration of 8-figure deals in those quarters.

Ken Xie, CEO of Fortinet, was asked about the company's conversations with customers regarding their plans to refresh their firewall appliances. He mentioned that the supply chain issues have been resolved, but in the current economic climate, some customers may delay their refresh and stretch their current products longer. However, they are seeing growth in replacement cases where customers are switching to Fortinet's products for better performance and efficiency. They are also seeing growth in new areas such as OTT security.

The CEO believes that the OTT market is growing due to the lack of protection and difficulty in running endpoint software on these devices. He also believes that the network security market will continue to grow, with a shift towards more OpEx models such as SASE. Customers are starting to adopt the SASE function first and then additional services. There has been no pricing pressure or discounts for Fortinet due to their superior performance and functions compared to competitors.

Keith Jensen, COO of Fortinet, explains that the company's FortiOS has all the new SD-WAN and SASE functions built in, making it easy for customers to add new features without replacing their existing hardware. This has resulted in a strong growth in enterprise customers, with many choosing to replace their current solutions with Fortinet's more efficient and cost-effective FortiGate. When asked about the company's buyback strategy, Keith states that they remain opportunistic and there has been no change in their approach to buybacks or M&A.

The company has a program in place with a Wall Street firm each quarter and they have been buying back $5 billion over the last four years. They are open to M&A opportunities but have a disciplined approach. They see a lot of opportunities in the securities base and have a pipeline for potential acquisitions. They are balancing their investments while also maintaining gross margin.

Keith discussed the company's continued investment in long-term products and selective hiring, as well as their efforts to improve management structure and efficiency. The company's business model has shifted to a mix of rich services, leading to achievable margin targets. Keith also addressed a question about the decrease in receivables and DSO performance, attributing it to the impact of large deals and potential changes in working capital management.

Keith Jensen, in response to a question about changes in the company's DSOs, explains that there were no major changes but points to the pressure caused by several large deals closing in the last week of the previous quarter. He also mentions that financing programs are being offered by partners and resellers, but good credit is not an issue for the company. In the next question, Ken is asked about the increase in traction with enterprise agreements.

In response to a question about the company's strategy for driving enterprise agreements (EA), CEO Ken Xie and COO Keith Jensen discuss the trend of more enterprise customers opting for EA, which typically involves larger deals and longer-term relationships. They also mention the success of the new FortiPoints program in facilitating EAs. When asked about the breakdown of FortiGate sales by size, Jensen states that it is no longer a significant factor.

The speaker discusses the company's focus on SASE and the increase in information being added to it. They also mention the breakdown of billings from SASE and the interesting patterns in SecOps purchases. The speaker also briefly touches on FortiCare and its correlation to recent product sales.

FortiGuard, which offers security subscriptions, is gaining momentum from SASE and SecOps solutions. The growth rates between FortiCare and FortiGuard are expected to diverge, with FortiGuard having higher margins. The non-hardware and non-attached service contracts have a run rate of $750 million. The pipeline for unified SASE is growing at 45% and the SSE pipeline is growing at over 150%. There is strong interest from customers in SASE and SD-WAN, with many converting to additional services. Some customers are also participating in trial programs, using FortiWiFi AP as a hardware agent for free SASE services.

Fortinet's differentiated and unified SASE approach has driven a lot of interest in their products, particularly in AI. While it is still in the early stages, there is high interest and potential for materialization. Fortinet is charging for AI separately and it may require an additional purchase by the customer. There was no mention of seasonality in the registration metric.

In response to a question about potential fluctuations in the company's stock, Fortinet CEO Ken Xie explains that there is typically a surge in demand after a major cyberattack, but otherwise, the company has seen normal levels of customer registration. The supply chain has also stabilized, leading to faster delivery times. CFO Keith Jensen notes that there is no significant seasonality in the company's quarterly performance. The company will be attending investor conferences in the second quarter.

This summary was generated with AI and may contain some inaccuracies.