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    Fortinet Inc (FTNT)

    Q2 2024 Summary

    Published Jan 10, 2025, 5:10 PM UTC
    Initial Price$68.73April 1, 2024
    Final Price$59.85July 1, 2024
    Price Change$-8.88
    % Change-12.92%

    What went well

    • Record operating margin of 35.1%, increasing by 820 basis points, driven by strong execution and cost efficiencies, demonstrating Fortinet's ability to balance growth and profitability. ,
    • Software license revenue growth accelerated to 26%, with combined revenue from software licenses and software services increasing 32%, highlighting the successful shift towards high-margin, recurring revenue streams.
    • Significant investments in high-growth markets such as Unified SASE and SecOps, including recent acquisitions like Next DLP, expanding total addressable market by $10 billion and enhancing Fortinet's position in fast-growing segments. ,

    What went wrong

    • 1. Delay in Hardware Refresh Cycle to 2025:* The expected hardware refresh cycle is postponed to 2025, potentially impacting product revenue growth in 2024. "Listening to Keith's commentary about the potential refresh cycle not taking place in the second half of this year, but most likely during 2025."
    • 2. Reduced Organic Billings Guidance:* While the company maintained full-year billing guidance, this includes contributions from recent acquisitions, effectively reducing organic billings for the next two quarters. "You didn't change the billing guidance for the year, but you did beat the numbers for this quarter by $20 million, so in effect, you reduced the billing for the next 2 quarters."
    • 3. Underinvestment in Sales and Marketing:* Operating expenses are flat, particularly in sales and marketing being lighter than desired, which may hinder growth opportunities. "I think the OpEx is probably a little lighter on the sales and marketing line than maybe we would like to see."

    Q&A Summary

    1. Margin Sustainability
      Q: Are higher margins sustainable going forward?
      A: Management believes the improved gross margins are sustainable, having returned to a more normalized state with inventory levels. They anticipate continued benefits from service revenue, which has a higher margin compared to product revenue. However, as product revenue starts to grow, it may impact margins due to its lower gross margin. They plan to invest more in sales and marketing, which may slightly reduce margins.

    2. Firewall Refresh Cycle
      Q: When will the firewall refresh cycle pick up?
      A: Management does not expect a firewall refresh recovery in 2024 due to the tough macro environment. They believe the refresh cycle will start in 2025, as companies begin to invest in infrastructure after a typical 4 to 5-year cycle. The previous supply chain issues had artificially accelerated purchases, and they expect customers to start refreshing products purchased 4–5 years ago.

    3. Software License Growth
      Q: What is driving the software license growth and mix shift?
      A: Software license growth accelerated to 26% year-over-year, now making up a high-teens percentage of product revenue. This is driven by customers turning on more functions, enabling additional services. Management expects the software mix to continue growing, providing tailwinds to the business. However, when firewall and FortiGate products return, the mix may shift slightly.

    4. Impact of Acquisitions
      Q: How will recent acquisitions affect billings and guidance?
      A: The two acquisitions made this quarter are expected to contribute to billings, but management did not change the full-year billing guidance. They are offsetting the acquisitions' contributions with a slight reduction in organic business expectations, leaving the full-year range intact. The acquisitions will also increase operating expenses, particularly in sales and marketing.

    5. Operating Expenses and Buybacks
      Q: What's the outlook for operating expenses and share buybacks?
      A: Operating expenses were flat, particularly in sales and marketing, which was lighter than desired. Management plans to invest more in sales and marketing in the second half of the year. Regarding share buybacks, they remain opportunistic and are evaluating opportunities given the more friendly market multiples.

    6. Billings and Contract Duration
      Q: How is the shift to software affecting billings and contract duration?
      A: Management does not see the form factor impacting visibility in the pipeline. For new accounts, software deals may have shorter contract durations. However, when selling SecOps or SASE solutions to the installed base, customers tend to sign up for longer-duration contracts, similar to historical patterns.

    7. Service Provider Segment Performance
      Q: What's happening in the service provider segment?
      A: The service provider segment was more challenged this quarter after strong performance previously. Management attributes this to the lumpy nature of the industry. They are seeing increased interest from telecom service providers in offering their own SASE solutions using Fortinet's products.

    8. Sales and Marketing Investment
      Q: Are there plans to invest more in sales and marketing?
      A: Management acknowledges that sales and marketing expenses were lighter than preferred. They plan to increase investments in go-to-market efforts in the second half of the year. They are behind on hiring in sales and marketing and intend to accelerate hiring.

    9. Pricing Dynamics
      Q: What are the pricing dynamics in the core firewall business?
      A: Fortinet has not increased prices in the last few quarters. They believe they have a huge advantage with their FortiASIC and FortiOS technology, offering better performance and lower total cost of ownership, including energy costs. They do not see pressure to reduce prices or increase discounts. Some prices were reduced at the end of 2023 and the beginning of 2024.

    10. Market Outlook by Region
      Q: What are you seeing across different customer sizes and regions?
      A: Fortinet's business is 70% international and less than 30% in the U.S.. International emerging markets have been very strong for several quarters. In the U.S., they need more direct marketing and sales, requiring more investment.

    11. Sales Force Productivity in SASE and SecOps
      Q: How is sales force productivity for SASE and SecOps?
      A: Management is focused on broad sales enablement and training the sales force. It takes time to ramp up productivity, but they are seeing success in expanding sales beyond the firewall into SASE and SecOps solutions.

    12. Product Performance Drivers
      Q: What drove better product performance this quarter?
      A: They had two 8-figure deals in Q2, compared to one in Q1. In the last month of the quarter, especially the last week, many deals closed as part of a strong market finish.

    13. Next DLP Acquisition
      Q: What attracted you to the Next DLP acquisition?
      A: The technology is great, and they plan to offer it standalone and integrate it with their FortiSASE solution. This bolsters their SASE offerings and aligns with their strategic focus on securing customers.

    14. Billings Reacceleration Confidence
      Q: What's your confidence in billings reacceleration in the second half?
      A: Management does not think the form factor (hardware vs. software) impacts visibility into the pipeline. They suggest that the reacceleration would not be significantly affected by the mix shift and remains confident in their projections.

    15. Sales Enablement and Opportunities
      Q: What are the opportunities for improving sales force productivity?
      A: There's a big focus on training and enabling the sales force. They are ensuring they have the right incentives and support when qualifying different opportunities across solution sets.

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