Fortinet Inc (FTNT) 2013 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fortinet First Quarter 2013 Earnings Financial Analyst Q&A. (Operator Instructions.)

I would now like to turn the call over to Michelle Spolver.

Hi, everybody, good afternoon. Thank you for joining us again for those who were on our first call, [as we] made our earnings announcement earlier today. Joining me is Ken Xie, our Fortinet Founder and CEO, and Ahmed Rubaie, who is our new CFO and COO.

So, I think, [as] you guys know, the purpose of this call is really to do follow-up questions now that you've had a chance to dig in deeper a little bit in our numbers. We'll try and keep the call to an hour, and it is all Q&A session.

Before we start, let me just remind you that the forward-looking statements that I read at the start of our earlier call tied to all forward-looking statements that we make during this call.

So, let's see. With that, Operator, you can take the first question.

Jayson Nolan from Robert Baird.

Great, thank you. Ahmed, just a couple clarifying questions. You were talking about your responsibility as COO. Is it purely operational to start, or do you have a dotted line to sales and marketing?

It's actually across the board. There are no lines defined yet. I think the best way to look at it is I will come in as the steward of the business as CFO, and will work towards helping scale the business on both the sales end, as well as the operating end. And then, that's probably the best way to answer it.

Okay. And a second clarifying question on the guidance. Are you factoring the pipeline any differently than your predecessor, that you're aware of?

I'm not aware of what my predecessor has done, so I apologize. I don't know the comparison. All I can tell you is, from my perspective, I've studied bottoms-up, tops-down, and formulated guidance with the team based on what we know today.

Okay. A couple higher level questions, and maybe these are for Ken. But, there was the secure wireless LAN solution, Ken, and then Coyote Point on the ADC side. And I guess just more broadly, what's the -- where are we headed with these other categories? Then, there's companies out there that just do these, obviously, so I could understand how this may be confusing to sales within Fortinet possibly. They're small still, but they are different market, so maybe if you could talk about the strategy behind the Tam expansion.

Yes. The wireless Wi-Fi solution, the request come from our customer base, especially this (inaudible) enterprise. Sometime they do need a secure both the wire and the Wi-Fi together. So, we'll be helping to manage them more easily, unify all this together. So, that's where the request come from the customer base, and we see [work] demanding in this combined solution.

The ADC is also similar, because we have some kind of ADC product before. It's really [from a time] some customer using ADC for (inaudible) among a few firewall, a few UTM product. And we see -- we [will] not try to target the traditional ADC market, it's more in the data center, was really among some of our customer base which they're using to balance among the solutions. So, that's where the tool solution keeping come up. And we also feel some technology, long-term-wise, can be combined into UTM solution. So that's where, short-term, we try to offer the product, and long-term, also some of that may be also starting integrate into the whole UTM.

Okay. And last question for me on the MT6. Do you expect to see any changes to typical seasonality in the second half as MT6 product comes out the door?

Like I mentioned, both the MT and also the FortiOS -- I mean, the FortiASIC, the FortiOS, we're not selling directly, will be gradually built into the FortiGate product. And the MT6 will be -- improve the performance a lot, but it also will take some time gradually build into the product, because the silicon [ACON] is three to four time larger than the previous version. So, that's where -- will be towards the second half of this year. We're starting to see -- if I was (inaudible) on schedule, will be towards the second half of this year we're starting build into the product.

Okay. Thanks, Ken, and great to have you aboard, Ahmed.

Thank you.

Michael Turits from Raymond James.

Hey, guys, a couple questions. First, I asked this question on the call, but can you go back into the services down 1% this quarter, which again you haven't seen a decline in services before, the sequential decline?

We believe we covered the two -- we have two less building day.

So, Michael, there were two less active business days to build.

Okay. But, is that normal accounting function? I mean, you had 2% up last year in this quarter, so -- again, I haven't done the math on it, but typically you don't come anywhere near this.

Yes, I mean -- yes, Michael. So, one, it is partly -- there's two things. One, two less days, that is true. The other one is that less revenue for professional services. Just know that professional services as an overall component of our services line item is still small, but we did see less professional services revenue come in during the quarter. And that was sort of -- that would equate with the fact that we had less larger deals. So, the professional services usually get attached to the large deals.

Okay. And then, obviously you've brought down the numbers for the year, but it's still a pretty healthy ramp, and back half seasonality on the license or product side if I -- have you grown services a couple of percent next quarter sequentially, and then mid single digits in the back half would -- which seems right, given the slower pace.

Can you still ramp from -- you still have, again, pretty healthy growth in the third quarter, almost 10%-ish in product (inaudible) modeling out and mid-teens sequentially in product in the fourth. So, what gives you guys the confidence at this point that you can come back to that kind of sequential growth?

Well, I think in terms of -- let's back the train to Q1 and go forward from there.

In terms of Q2, we really -- it's business as usual. We see a softening in the macro that's going to continue to impact our business.

The reason you're seeing the acceleration in the second half of the year -- first of all, one quarter doesn't make a trend. Second of all, our fourth quarter is seasonally our largest quarter. And thirdly, we have been investing in the sales and marketing apparatus for a number of quarters. So, we're hoping the combination of all those things will, in fact, help the ramp-up later in the year.

From my own perspective, Michael, I'm zeroed in and focused on Q2, and I'll give you more color. Obviously, with one week, I don't know enough to tell you what's going to happen later in the year, but enough to say it's going to be down relative to the July guidance, and enough to know that there are certain things in the works that should help us make those numbers later in the year.

Okay. And then, one of the things that you guys mentioned is -- I can't remember which deal it was on, but [moving on to] competitive issues, you did say that you saw F5 in one deal. But, can you just remind me where that is, and have you seen them before? And obviously, they've made a big deal about trying to get into security. So, what are you seeing with those guys?

Yes, let me just [clear up]. We don't see them on a everyday basis, so we don't look at them as a primary competitor. When we do see them, it's usually a data center or high-end deal.

Yes, the transaction was in APAC.

Yes, and this was in APAC. So, this one was a Telco provider, and they were looking for a data center firewall. And that would be the only case that we'd see F5, and we still don't see them all that often.

Yes. So, this was in APAC. It was a service provider looking for a data center firewall?

Yes. Yes.

Okay.

Exactly. Yes, and it was our FortiGate-5000 series that we sold.

Yes. Yes.

Okay. All right, guys, thanks very much, appreciate it. Ahmed, looking forward, again, as I said, to working with you.

(Inaudible.)

Walter Pritchard from Citi.

Talk about just -- you have refreshed your operating system and your ASICs, and I know that it did cause somewhat of an inventory issue in the quarter that you addressed. I'm just wondering if you could talk about how you expect customers to uptake those products, how you expect that to roll out through -- that architecture to roll out through the product line, and how should we expect that to have an impact on how you think the year will shape up in terms of product revenue with refresh activity?

Okay, yes, these is two parts. First is software FortiOS, I don't think will have a much direct impact because the FortiOS, all the current customer, they bought a service, which is about 80%, they all get a free upgrade. And also, we are not selling FortiOS separately. It's all kind of part of the whole system.

And the FortiASIC will take some time to gradually build into the system. Actually, even (inaudible) issue we see a little bit, so I think probably also because Q4 we are very strong, the inventory relatively a little bit low. Some of the component may take like a couple of months to get kind of certain component. Some of them, even like Windows (inaudible) component, it may even take, like 16, 18 weeks from some other major network vendor there.

So, that's [where] from time to time we probably try to keep improving and try to do better forecast on some of the inventory. But also, from time to time, certain deals, certain bigger deals, certain (inaudible) may kind of [twist] the inventory level, which take a little bit of time to recover. So, that's the whole [sense].

But, it's -- I think the FortiOS and the -- will -- don't have much impact on other inventory, and also the FortiASIC will be more long-term improvement of the platform performance.

And just I guess maybe to make it just a finer point [on that], do you expect -- I think we've seen some of your competitors or your peers refresh their product lines, and it had an uptick in growth rate, ala Sourcefire. We've seen others. I think Check Point last year came out new appliances and talked about seeing customers actually trade down because of the macro and getting sort of the same performance for a lower price.

And I'm wondering, do you expect, I guess as a whole for fiscal '13, is the refresh a positive driver in your business, a negative driver in your business, or is it sort of a non-event?

We don't feel we'll be -- have a much (inaudible) -- I think our philosophy to operate a product, really, once the new generation come in, we pretty much keep it the same lease price as the old generation, like whether the FortiGate 300C replaced the old 300B. So, we would kind of keep the same price, but also, each new generation can have a better performance because the Moore's Law still apply every 18 to 24 months. You can see that speed double both on the semiconductor and the network side.

So, that's where every new generation tend to have a much better performance than the old one. So, that's where -- but for us also, every quarter we may refresh a couple product. We have -- on the FortiGate platform, we have, like, 20 to 30 different models covered from SMB, [then] the price of a service provider. So, that's where the -- the whole process we see. Basically, we try to replace new generation at the same price as the old generation, but it's better performance.

But, Walter, we're not seeing -- we haven't seen the trend that Check Point has been talking about in terms of customers trading down. That's not something that we've been seeing.

Yes. And also, like the current speed also starting to get faster and faster, I see this year customer starting to deploy the 40 gig, even the 100 gig. And then, a few weeks ago, the new standard for the 400 gig also come out. So, you can see the (inaudible) -- with the networks speed keeping go faster. And also, once the more function also start integrating into the secure gateway because the inline device had to cover all the application, you also see the function requirement, also multi-function required also in the gateway.

So, that's where the platform performance starting getting more and more important, which we kind of [reach in] this a long time ago trying to build technology to address the issue way ahead of our other competitors.

Okay, great. Thank you.

Rick Sherlund from Nomura.

Yes. Can you tell me on the Coyote Point, when did that close?

I think we closed the end of March.

March 20.

Okay, so that was in the quarter. What were the terms on that? Have you disclosed that?

We're not disclose the detail, but is -- the number we gave is really -- is an impact $0.02 for this year, and there will be more favored next year, I believe.

But, what are their revenues expected to be for this year?

We only disclose the last 12 months is $5 million.

All right. So, there's no reason to believe the revenues are going to go down when you buy it, right?

We hope not.

Okay.

Yes, we're not actually -- we're not guiding you to say that it's going to be $5 million this year. We're -- just say what they did last year.

Yes, I understand. So, if we -- and how much of that is product versus services for their business?

Pretty much most is all product. They are not like the FortiGATE had the subscription part. They're more like -- just like traditional infrastructure is more product plus some support.

And was it cash or stock that you paid?

We're not disclosing the terms. I think here's the way to summarize it. I think the way to think about it is it's a technology enhancement tuck-in. And in general, we're very cheap, so we don't pay high multiples. And I say that with only one week on the job, but I learned that very quickly, and I subscribe to the same theory.

And to the collective team's point, I think the only numbers we're comfortable discussing are the trailing 12-month revenue at approximately $5 million. It will be $0.02 dilutive in the current year, and it will be accretive next year. And we're working very hard on integrating it from a product perspective, with hopes of a release in the summertime and some impact, going forward.

Yes, thanks. I'm just trying to model [in] without knowing whether I should bump the share count up or what. It's still hard to do. But, I did notice the expenses jumped up a lot. G&A was up a lot, for example, in Q1. Is that something that's going to be sustained? I'm not sure what's behind--.

(Inaudible) -- Yes. No, we had a couple of one-time impacts, but G&A should drop back down to 4% in the current quarter. So that's what we've modeled for Q2, Q3, Q4.

Got it. Okay, thank you.

(Operator Instructions.) Erik Suppiger from Jolson Merchant Partners.

Yes, apologize if you already addressed this, but can you review again what you mean when you say you saw some of your carriers or service providers adopt more of an OpEx spend rather than a CapEx spend?

Yes, I think -- let's speak financial guy to financial guy. I think what Ken was describing is purchasing behavior. And it's not so much CapEx versus OpEx. It's more of guy sitting in my shoes controlling the checkbook and saying, "Instead of spending of $1,000, you're going to spend $200, or you're going to spend it over the next several quarters." That's really all he meant to tell you.

So, it's really a timing of payment rather than an allocation between OpEx, CapEx. Is that the right idea?

No. No. No. So, it's not CapEx-OpEx, nor is it timing of payment. It's more the CFO of X Enterprise saying, "Let's not go spend $1,000 right now. You can cut your teeth in the $200 for now, or start with $200. You can ramp up in the next quarter." So it's more about conservative buying behavior than it is about CapEx versus OpEx or payment terms.

Maybe I'd say it's already break out one big a deal in a few smaller deal.

That's another way to put it, yes.

Okay. Okay, that's very helpful. Second question, just on the software, the FortiOS, were there any stability issues or any issues from a technical perspective as you rolled out 5.0 that were contributing to your product shortages and issues?

No, no. I think the FortiOS, we can load on all the previous version of the current FortiGate there. I don't think the product shortage relate to the FortiOS. The product shortage more relate to a certain model has certain shortage because they ramped up quicker than we expected. And sometime, especially when we ship in some international order, the distributor, they tend to have all the model all come in altogether. So, instead of -- sometime we can separate the shipment, because some international distributor, they don't want to do like a multiple time for import-export process. So that's the part sometime we need to -- have certain model shortage sometime may impact [maybe] more shipment. So, that's the -- like we mentioned, the FortiGate-100D, and also the FortiGate-60D, that's the two model we have shortage.

Okay. In terms of the FortiOS, the 5.0 release, has that been -- have there been any stability issues with that?

So far, the feedback is more [and more] positive because we see much more enhancement. And also, the three things I mentioned really once addressed the mobile security, the BYOD issue, which enterprise is facing, and the second really address APT, especially the cloud base and the sand-boxing, the reputation.

And also, the other part is really easy to manage when -- and as you can really automatic profile what's the normal traffic, what's -- the normal traffic don't have to depend on a fixed policy to do it. We have not seen that has much like a issue, because, remember, this is a product we have beta for more than a year. And so far, the feedback is very, very positive in the field.

Very good. Okay, thank you very much.

Thank you.

Keith Weiss from Morgan Stanley.

Hi, guys, two questions from me. One is kind of a longer-term vision question. In terms of buying Coyote and getting that technology on board, I was wondering if you could talk to us about sort of how you see sort of the ADC world and the network security world coming together. Why is that an important purchase for you guys to be making and sort of getting that technology in-house?

I think we have shipped in the ADCs more kind of OEM version in the last couple of years. And from time to time, when customer deploy, whether the FortiGate or some other system, they also try to use -- I think using the ADC to balance a little bit.

On a technology side, the ADC, [although] balance it, has -- leverage the same layer technology as a firewall address translation. So, basically, both on the session layer try to translate the address. A firewall just translate from outside to the internal address. We're [low] balance, try to translate address to certain server. So, technology, there are some similarity, but it's more on the firewall level.

But for us, since we start a company as compared to my previous company, so we tried to more address the content application security, which is in the higher layer. So, sometime you may, using a lower layer, try to balance or [forward] some traffic to the higher layer processing gateway there. So, that's kind of a -- it's the whole solution deployment, which is ADC is a part of some total network security solution. So, that's where we see certain feed into the whole structure there.

Got it. Got it. That's helpful. And then, two, more tactically, when you guys are talking about the changing purchasing behaviors with service providers, any kind of indication you could give us to kind of what percentage of your service provider base does this actually impact, or what percentage do you guys think this is going to be seen across, or is it just a couple of isolated incidents here and there?

I think, like we said in the number from one years ago, the service provider is about 30%, Q1 is about 25%.

And also, I see there's two kind of service provider model. One is really the bigger box, the [outer] data center, this kind of a centralized solution. That's more [levered] to 5000, the FortiGate-5000. The other one is more like the press release we made yesterday, the huge network, they are [more] to the CPE deployment, and then they can use a FortiManager to try to manage remotely of a lot of a smaller CP [block] on the customer side.

So, I think it's a -- I mean, so far, we see the CP base (inaudible) or how (inaudible) are strong, and also the leverage and the new product, new chip we have. The kind of centralized, sometime they depend on how quickly the service provider build their own infrastructure to support a customer. So, we see some kind of -- I mean, some kind of a -- we'll not see a slowdown, but more cautious spend impact in that area. So, that's probably depend on later if the whole service provider, the whole macro environment changes. They may change the pattern. But, so far, we see a little bit cautious in the last quarter.

Yes. Let me actually -- and then, also, I think the cases that we talked about in Q1 that contribute to the mix was isolated with those cases. But, as we've seen from other companies and we've kind of seen since then, is that there is some softness we don't expect. We hope it turns around, but we're not building that into our guidance. Our guidance reflects that everything sort of stays the same within the service provider space.

Yes. Also, none of our competitors really play much in that space. We have a huge advantage both on the high end and also on the CP device, and plus the function plus the virtualization. A lot of things really make us way ahead of our other competitors.

Got it. Excellent. Thank you very much for the color.

[Okay.]

(Operator Instructions.) Tom Ernst from Deutsche Bank.

Hi, it's (inaudible) on behalf of Tom. Just a clarification on the free cash flow. Your guidance is down from last year for free cash flow. I know you said that you have CapEx going up because of investment in IT and investment on a new office building. How much is CapEx going up from '12?

Yes. So, just to be clear, I'm glad you asked the question. In the prior guidance, prior to my arrival, meaning back in January, we had already thought through the potential technology upgrade and also anticipating the potential move next year. So, the guidance down is not related to incremental CapEx. It is strictly because billings are down, therefore, free cash flow is down. There's no change in our assumptions.

And it's too early for me after one week. I need to gut those numbers out and get comfortable that, in fact, these are the right numbers for the technology upgrade. And as we start, we know we have to move, so we've allocated money for that, but we're not moving in until next year, either.

So in short, the guidance being lowered is strictly related to billings coming in lower for the year.

But slower compared to 2012 also. If you look at the midpoint of the guidance, we're not even midpoint if you look at the top end of the guidance. $150 million is lower than what you guys reported in 2012, so it's actually going down on an absolute dollar basis from last year.

And I'm assuming the operating cash flow would grow at least in line with the billings, which kind of -- if I do a rough math, that kind of implies that CapEx is doubling '13 over '12.

We're also (inaudible) a growth. I think that's where -- like I say, we have almost $800 million cash. We want to make sure we're keeping invest in the growth, going forward. That we feel is the best use of the cash and also improve company value in the long-term position.

In terms of ongoing company CapEx, there are no changes from the past.

No, no. Sorry. Just a slight correction. So in 2012, we did not have any CapEx dollars allocated for technology upgrade or for moving for the building. So Tom, that would be in the range of, I think, about $10 million, but otherwise it's the same year-over-year.

Yes, sorry. The point I was making is that ongoing business CapEx, it's business as usual. There's nothing going on from a CapEx perspective.

Anything incremental in 2013 would be because of the IT investment and the move to the new office. Is that -- anything incremental on top of regular CapEx would be just because of those--?

Those are the only two items. And the point I was trying to clarify for you is that was thought through back in January. The difference between January and April is strictly billings.

Got it. Thank you.

And in terms of your underlying question, there is no changing CapEx behavior at the operating company level.

Got it. No, but if I just do a rough math, it seems like CapEx would double on a dollar basis from '12 to '13.

Well -- but I think, as Ken pointed out to you, and you could see it also in the heart of the P&L, because the investments have been ramping up -- so I don't have the number right in front of me, but we finished the 2,077 headcount. We were at roughly 1,500-something last year at this time. So, that's one point of reference.

Another point is obviously we've done an acquisition, as well. So, it isn't anything -- again, just to repeat, anything at the operating CapEx level.

Yes. I think, like I mentioned (inaudible), we see in end of 2008, early 2009 is the best time to hiring and also do some acquisition, because it's more easy to get good people on board. And also the valuation, when we acquire some company or technology is much cheaper, and that's kind of better valuation compared to the other time.

Got it. Thank you.

Thank you.

Thank you.

At this time, I am showing no further questions. I would now like to turn the call back over to Ahmed for closing remarks.

Thanks, everybody, for joining us. We'll hopefully see you on the road in this coming quarter. There are a couple of -- several events actually scheduled. And to the extent you have follow-on questions or clarification questions, please reach out to Michelle, and she'll coordinate accordingly.

Thank you.

Great. Thanks a lot, everybody.

Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.