Fortinet Inc (FTNT) 0 Q0 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Fortinet third-quarter preliminary financial results conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference is being recorded.

I would now like to hand the floor over to Michelle Spolver, Chief Communications Officer. Please go ahead, ma'am.

Good afternoon, everyone, and thank you for joining this conference call on short notice to review Fortinet's preliminary financial results for the third quarter 2016. The purpose of this call is to provide perspective on these results to the extent that we can at this time. Additional details will be provided during our Q3 2016 earnings call scheduled for October 27 at 4:30 p.m. Eastern time.

Joining me today are Fortinet's Founder and CEO, Ken Xie, and CFO, Drew Del Matto. Following our prepared remarks we will open up the call for questions.

Before we begin, let me read the disclaimer. Please note some of the comments we make today are forward-looking statements. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected in these statements. Please refer to our SEC filings -- in particular, the risk factors described in our most recent forms 10-K and 10-Q -- for more information. All forward-looking statements reflect our opinions only as of today and we undertake no obligation and specifically disclaim any obligation to update forward-looking statements.

Also please note the financial information provided is preliminary. It's not final and is subject to change based on the completion of our normal quarter-end review process and may be impacted by the implementation of an ERP system in July as well as some other factors. We will provide additional financial details and customary metrics on our quarterly earnings call on October 27.

Please refer to the investor relations section of our website for important information including our preliminary earnings results press release issued about an hour ago. A replay of this call will also be available on our website.

Let me now turn the call over to Ken.

Thank you, Michelle, and thank you, everyone, for joining us on the call on short notice. Our preliminary results of the third quarter fell short of expectations and we wanted to provide you that information quickly. We are disappointed with our third-quarter performance and we are working to address and resolve the execution-related factors that contributed to the shortfall. I have been in network security for more than 20 years and I have seen highs and lows in the market. [New] spending patterns are not same as what we saw in 2015. It is clear that cyberthreats are not going away and security remains a priority. The market is still healthy and the customers are seeking strategic security vendors who can provide an end-to-end solution from IoT to cloud. Fortinet delivers this better than anyone else with our Fortinet Security Fabric.

We continue to feel very good about the technical superiority of our products and strong competitive advantage. Fortinet is one of the few vendors continues to outgrow and take share within the network security market. We remain confident of the underlying strength of our business and in our long-term growth opportunity and in our ability to deliver return to our shareholders.

We believe our third-quarter billing and revenue underperformance was the result of several factors relating to both our own execution, primarily in North America, as well as certain macro conditions. In North America, the full benefit of a sales force expansion and enterprise team realignment has taken longer than expected to materialize as a result of (inaudible) within operations. We are laser focused on making improvements in this area and on getting our sales team more productive.

From a market perspective, we saw a moderate spending environment. We believe this primarily relates to a [digestion phase for the] elevated purchase last year. In line with this digestion, customers are being more strategic in their purchases, taking longer to make purchase decisions or buying only for what they immediately need. This trend was particularly pronounced in the last [three] weeks of the quarter and in North America enterprise and server provider market, which accounted for the majority of our shortfall.

Finally, we were also impacted by the economic challenges of Brexit in the UK as well as the ongoing geopolitical issue and turmoil in Latin America. As a reminder, we noted this risk on the Q2 earnings call and we saw these challenges materialize.

We remain committed to deliver operation margin improvement over the long term and are not backing off on our long-term goal of 20% operation margin (inaudible) 2020. Our unexpected third-quarter billing performance put us back a bit on the margin front but we believe we can make up this in future quarters and years. We have made investment in the US to better position us to capture our market opportunity.

I will now turn the call over to Drew to provide our estimated preliminary result of the third quarter 2016.

Thank you, Ken. In terms of the preliminary Q3 2016 financial information, billings are expected to be in the range of $343 million to $348 million compared to our guided range of $372 million to $376 million. Revenue is expected to be in the range of $311 million to $316 million compared to our guided range of $319 million to $324 million. Non-GAAP operating margin is expected to be approximately 12% to 13% compared to our guided range of 14% to 15% and non-GAAP EPS is expected to be approximately $0.15 to $0.16 compared to our guided range of $0.17 to $0.18.

I am pleased to share that our Board has approved a $100 million increase in Fortinet's authorized share repurchase program, bringing the amount authorized under that program to $300 million. Additionally, Fortinet repurchased $25 million of our common stock in the third quarter at an average price of $36.04. As of September 30, we purchased a total of $75 million of our common stock under our now authorized $300 million share repurchase program, leaving $225 million available.

To reiterate what Michelle said at the opening of this call, this financial information is preliminary and subject to change based on the completion of our normal quarter-end review process and may be impacted by our implementation of an ERP system in July and other possible factors. We will provide additional financial details and customary metrics on our quarterly earnings conference call on October 27.

Before I hand it over to the operator for questions, I want to mention that we will not be holding discussions with the investment community between now and our October 27 earnings call, when we will issue our complete Q3 results.

Operator, you may now begin the Q&A.

(Operator Instructions). Michael Turits, Raymond James.

Hi, guys. Thanks, Ken, for your comments about the margin guide and the margin targets [still being] out there. What will be your response to this in terms of how you look at investment expenditures and your philosophy towards margins into fourth quarter and into next year, given the shortfall here?

We're still early in the close process and right now we're actually focused on closing out whatever deals were left in Q3 and really getting to the bottom of how we improve our productivity and sales effectiveness in North America. So we clearly will have more around that certainly for Q4 on the call in a few weeks. That's what I have for now.

I don't know if I get a follow-up but is there anything that in terms of the shortfall -- I don't know if things are diversifying in terms of customer spend beyond core firewall. You guys do sell a wide variety of products but a, are you observing that diversification of spend; and b, what does that mean for your potential to still, even with this shortfall, be in the market for acquisitions if there is a need to diversify?

We see the pattern still the same. We don't see much difference. The detail we can come up in the 27, the formal earnings call but so far, from early results, we see not big difference.

Michael, just wanted to make sure I understand your question. You were talking about product diversification. You know, there were two parts there, because I think you were asking about what happened in Q3 and I just want to make sure I understand that question and then the M&A question is a longer-term question, right?

Yes. I just want to know if people are diversifying their spending in security, is that part of what was the issue here and does that prompt you to be more actively in the markets in terms of M&A?

I see what you're saying. Yes, you know, I think the trends that we have been seeing -- again, it's very early but what we have been saying in the past is we've been seeing a move to platforms consolidation theme and more strategic buying and we believe that's really what we're seeing in terms of the buying pattern than if you think of the enterprise, you see more elongated cycles. It would be premature, I think, to get into anything more than that, and as we have more we will be willing to share it on the call in a few weeks.

Melissa Gorham, Morgan Stanley.

Great. Thanks for taking my question. Ken, I just wanted to follow up on the comments on the salesforce realignment and the impact there. So is this still the changes that you made at the beginning of the year or did you make any additional changes in the past few months? Why do you think it's taking so long to kind of work through those transitions?

We have one of the best teams --[management team] sales team in the space and very experienced especially doing good on international. So we're starting to have just a global strategy in the beginning of the year and also starting to bring some new team people in the US early part of this year. Like I said in the script, it's really the newness of the operation and also some of the realignment takes a little longer than we expected so that's where we see some impact of our Q3. We can give the more detailed numbers once we know like deals by size or by some vertical but at this time we don't quite finish the analysis yet.

Just one thing to add, Melissa, I think to the question is we didn't make any major changes. I think the question was is this -- are we running with the same basic organizational structure under the realignment earlier this year and yes, we are.

Okay, that's helpful. And then, just one quick follow-up. So last quarter, you noted some weakness in the service provider space. Was that contributing to weakness this quarter or is it mostly on the enterprise non-service provider business?

In my script I said the service provider and also some enterprise takes longer time to make decisions so that's had the impact of Q3 especially in US. So that's where you still see it's compared to one year ago we [caused elevated] purchasing pattern and now things take a longer time to close.

Brent Thill, UBS.

Good afternoon. This is Fatima Boolani on for Brent. Just to drill into the salesforce reorganization issue, could you just drill a little bit deeper into why the execution issues are surfacing now versus six months ago and a follow-up, if I may.

Right. Well, we always thought it would be the back half of the year. I think there's some remapping of accounts and some newness to the organization as you go under a global leadership model, for instance, that's one piece and then obviously just some of the leadership in the US. I think it just takes some time to come to fruition. We thought back half of the year and it just really kind of towards the end and the quarter kind of became -- really, as we got right at the end of the corner quarter, became -- deals started slipping and so that's really where you see it. So what we're thinking is that what we need to really focus on one, is just make sure that we're all as an executive team clearly focused on watching every aspect of the deal, drilling down to make sure we understand what went wrong. Because ultimately that's what you're trying to do, is figure out what is it that we can fix. It's a bit early to point to too many things but we know, for instance, that marketing is one thing we need to focus on, which we're going to do. You know, obviously you want to be focused on closing deals, which we need to do and then just understanding every way we can improve. So I think just sometimes it takes a little -- you need to get a little bit of time to figure out what you need to fix sometimes. Look, we're continuing to evaluate all the factors that contributed to the miss and we expect to deliver more on the call on the 27th.

And a quick follow-up if I may and Ken did mention that you are still on track to hit the 20% operating margin target goal exiting 2020. So as you think about realigning your investment posture to deliver the 20% billings growth you'd also talked about historically, what should we think about as drivers in obtaining that 400, 500, 600 basis point expansion in the medium/long term? What are the drivers that we should think about at this point to get to that 20% operating margin level?

Sure, Fatima. What we have said in the past -- we really -- there's nothing at this point that we would change from the past. We are committed to the long-term guidance of the 20% operating margin in 2020. The driver is clearly productivity. We have made big investment in sales and marketing so we need to see the payoff there, especially in North America. That would be the first thing.

We've said all along, as we -- and again, without getting into Q3 numbers or Q4 but just historically we've seen more of a shift into the subscription and services side of things, software. So that's a long-term growth margin driver that tends to fall -- you know, you want to capture that in the op margin line. There's other things we can -- as we scale as an organization you could see some benefit probably in G&A or whatever as you scale longer term. I think primary factors really are productivity and keep driving the high-margin recurring revenue streams over time.

Before we go to the next question, I'm going to instruct everybody on the call that they can ask just one question. We have several in the queue and we need to keep this to a reasonable timeframe. So everybody just please ask one question. Thank you.

Gray Powell, Wells Fargo.

Great. Thanks for taking the question. I'll be quick. So I know you did not want to give Q4 guidance. Personally I like to get my model straightened out in one shot. How should we think about Q4 operating margins relative to Q3? Anything directionally that you can give us to help would be appreciated. Thanks.

Yes, Gray, it's just too early. We haven't even closed the books yet. So it would really be premature to give you that and we're certainly looking forward to sharing that information in a few weeks.

Saket Kalia, Barclays.

Hi, guys. Thanks for taking my question here. The question I have is would you have been within your billings guidance if the service provider vertical would have come in as planned and I guess if not, were those or are those deals still in the pipeline?

Well, what we said was that the shortfall is due to execution challenges in the US and I would start with the enterprise. So it's more than service provider. Nothing -- we're not aware of anything. It's early to get into this but as far as getting into what deals have closed, we're not aware at this point of any deals slipping out of the pipeline.

Also the feedbacks really we are not seeing (inaudible) competitors there's no change in that competitor landscape. It's really taking longer to make decisions from the customer compared to one year ago.

Sterling Auty, JPMorgan.

Hi. This is [Nina Cantor] in for Sterling. Thanks for taking the question. I'm just going to ask about the revenue breakdown quickly, if you can give some kind of color around the product revenue growth just roughly. Anything you can comment on would be really helpful. Thank you.

Yes, again, we're really just still in the process of closing the books. We don't have a product versus services split to share at this point. We'll absolutely have that in a few weeks.

The only thing I would point out, if you look at the recent history there's been more of a shift obviously to services. Without even getting into the split or looking at the numbers, I'm just really referring to the past. I think that's what we've been saying in the past. We haven't seen anything that would tell us to change that.

Walter Pritchard, Citi.

Hi. Thanks. Sorry for the background noise. I'm wondering if you can talk about not necessarily what action you would take your framework around thinking about whether or not you would actually see a reduction in force in response to a softness in demand [if] you're seeing here. What would it take for you to make a more sort to drastic move like that versus maybe an implied kind of slowing in your OpEx growth to (inaudible) lower revenue numbers?

Walter, we didn't actually get the whole question. You were saying what changes would we make to what?

Sorry. I'm trying to ask you, from an expense profile perspective, just trying to understand your thought process around potentially a reduction in force versus just slowing down your OpEx over the next (inaudible)?

Yes, Walter, look, we're going to take a hard look at everything here. I think our first step is one, let's focus on closing whatever deals we think slipped in the quarter. We have an intense focus on that. We're having intense conversations on finding out what we think we need to fix, what we can do better and we're talking to our salespeople and sales leaders to understand what that is. That's really the first step here, along with ensuring that we do continue to invest in marketing, for instance. So there's some investment we need to make, we believe.

We are laser focused on productivity. We've been saying that. We are saying -- we continue to say that. But as far as getting into directional OpEx, it's just really premature at this point. As I pointed out, just one, we're still closing the books. Two, I think we're more focused on just understanding what happened before we make any rash decisions at this point. But I'm sure will be talking more about that on our October 27 call.

Hendi Susanto, Gabelli & Co.

Good afternoon and thank you for taking my questions. Ken and Drew, when you think about longer sales cycle, execution challenges and macro weaknesses in UK and Latin America, how should we think whether or not they will persistent into Q4 and whether we would see like those type of magnitudes again in Q4?

Again, we are really focused on -- at this point the leadership team, we're focused on understanding what we need to fix. As far as the sales teams go, they're still in the process of basically building up their forecasts. So it would be really too early to talk about that at this point. But again, that's something that we will obviously get into on the call in a few weeks.

Tanner Hoban, Oppenheimer.

Hi, this is Tanner Hoban for Shaul Eyal. I just have a quick question on your performance in -- or I guess the UK and how you're seeing some softness there. Is that mostly related to Brexit or is there any other factors that we should consider?

We think Brexit.

But that's also because the currency changing rate. So that's part of the Brexit issue.

Gregg Moskowitz, Cowen and Company.

Thank you. A bit of a follow-up to Saket's question from earlier. Wondering if you had any commentary on the two large service provider deals that had slipped out of the Q2. Are they still out there, and if so, what's your confidence level on closing those deals at some point?

Yes, I think Drew did mention it but we did close those -- the deals we called out, there were a few of them into two and they did close in Q3.

Jonathan Ho, William Blair.

I just wanted to go back to sort of structural issues and competition. What gives you the confidence that the slowdowns that you were running into aren't a little bit more than just sort of macro issues. Can you just maybe give us a little bit of color in terms of win rates and stability within the market from a pricing standpoint?

Well, look, we feel like we have -- Jonathan, we feel like we have best-of-breed technology. Clearly, the trends we've been talking about, we believe will continue consolidation on a platform. Our Fortinet Security Fabrics, for instance, customers are looking to go end to end or for something that goes end to end, which we deliver, gives them a better line of sight, single pane of glass and also gets to consolidate the spend. We believe that's resonating. We obviously want to close more deals but we believe that's resonating. For us, without getting into win/loss it's just early. We're still trying to understand the results. What we're trying to do is really intensify our focus to drill down to understand what actually happened on the execution side because we do believe that it's execution and we do believe that our focus and energy is well-placed in trying to fix that. I mean, part of that comes from the fact that we've done very well historically internationally and we really want to take those best practices behind a strong leader and deliver those results in the US and that's really how we're thinking about it.

Ken Talanian, Evercore ISI.

Hi, guys. Thanks for taking my question. So last quarter, one of your competitors mentioned seeing an increased level of discounting on maintenance. I'm just curious, have you seen any changes to the level of discounting on renewals?

Too early to tell. We're still getting into the process. As I probably said in the past, you always see some discounting but I don't have any direct information at this point in terms of pricing on renewals. I think it's fair to acknowledge that our competitors are saying that publicly so that's probably out there but as far as our discounting, we've always felt we've done well on a competitive basis anyway. If we have more information on that we'll be glad to share it on the call in a few weeks.

Jayson Noland, Robert Baird.

Thank you. Ken, you described the underlying market as healthy. Are you describing this report as mostly company-specific and not an issue that you're seeing across the industry?

I think we probably still need to do some more analysis a few weeks so we can give more detail on the 27th. This time I see is more normalized compared to like a year ago so it's elevated purchases. So that's where -- but the detail we need to see some deal sales closing rate, all these kinds of things. We will give information maybe in a few weeks.

Scott Zeller, Needham & Company.

Thank you. When you said people are taking longer to make decisions and being more strategic, could you give us a little more color around that? Is it a situation where they're looking to combine several categories and be strategic or are they starting over from scratch? Just what color would be helpful.

Sure, Scott. I think the consolidation theme is one that I think we have been talking about and for the points I just mentioned. I'd be glad to say those again if you'd like but I think everybody probably gets those. More strategic -- I think companies spent a lot of money over the last several years on security. They've hired a lot of new people. I think they're getting just wiser, more information about cybercrime, cyber criminals, the threats and I think they're going to -- they're getting better at understanding risk and how to prevent it or address it. I think that that just becomes more of a conversation with more and new people involved, which tends to extend the conversation, if you will. People are just thinking more architecturally and I think those are the elements of the strategic notion we're talking about.

Just to follow up, wouldn't that benefit Fortinet?

We are technology strategy -- I mean, product focused and are closely working with customers to see what's the future trend, including from IoT to cloud. So that's where we want to stay close with the customer, with the service provider, to offer the best product solution there. Some detail of the market analysis we can provide in a few weeks but we do see some of the trends changing. We also [address] by ourselves a little bit. But the detail we will probably give out in a few weeks.

Then, Scott, just to I think more directly answer the question, it has the risk of extending the cycles because there's more people involved, new people involved and if there is a broader architecture they may just be looking at more change versus just buying another firewall or appliance (inaudible).

Andrew Nowinski, Piper Jaffray.

Thanks a lot. I just had a question on competition. You didn't mention it as a reason but Palo Alto launched a new 7080 appliance targeted at the service provider market, Check Point has a number of new appliances out. Is it possible that some of the deal extensions that you saw in the service provider segment are attributable just to customers looking at some new options that are out there? And then same thing on the midmarket branch office space. With a lot of new virtual firewall solutions out there, is it possible that you're seeing some more competition in that market that you haven't seen before?

We have not seen competitors as a reason for the Q3 (inaudible). We deliver the best technology and also we're leaving quite a big gap compared to competitors in this high-end service provider space, especially we also have the 5000 series being sold for more than 10 years and also the new 7000 series. Also the ASICs have a huge advantage over the software load on the server blade. I think that the detailed analysis we can give out and also with the whole space may change, whether there's certain things more to the cloud and we also are working with a lot of cloud providers, service providers, try to see what's the best technology can feed their future need and also what's the best solution to customer. Because using the ASIC hardware accelerates a lot of functions including the cloud and also provides protection, both for the cloud and also has the cloud security computing really has a lot of potential going forward. You can see the ASIC [accelerator] function [1000x] compared with the regular server and also have a cost advantage, energy saving advantage. That's where [leverage similar] technology provides protection both to the cloud itself and also the secure [computing within the class] because to compute any security function, you need like 1000x more computing power process the same data traffic compared to the regular network and then the storage. So that's where we have a huge advantage here. We also try to see what's the new trend and also how to leverage our technology advantage to really adjust the future to feel better for the service provider and the customer. But it's the detail we probably can give some detailed analysis in a few weeks. But at this stage, we feel it is not a competitive situation making the Q3 shortfall.

Rohit Chopra, Buckingham Research.

Thanks, guys. I just wanted to get a sense -- do you have any thoughts around deal sizes yet or high-end versus low-end within your preliminary results so far?

Rohit, that's something certainly we will be providing as usual in the customary metrics that we provide on the call. It's just too early. We're just still absorbing the numbers and very focused on getting to the bottom of what we need to fix.

Eric Suppiger, JMP Securities.

I apologize if you addressed this already but I'm curious -- what are you seeing from some of the emerging sectors like macro segmentation and some of the cloud products in the course of the quarter?

We see this as a real growing area, like we mentioned in the last few earnings calls -- the micro segmentation and also some of the cloud protection or the secure computing cloud. The detail will probably -- we closely monitor the trend in the space and we can offer some detailed color, including some of the customer wins and feedback, in the earnings on the 27th.

Okay but no initial thoughts as to whether or not those areas saw softness in the course of the quarter?

This is the new growth potential we see. Still relatively small but we see there's a new growth potential.

Eric, as we get more information on that we'll share it. We're obviously going to do a deep dive. We understand the question. If we have more to share, we'll do that in a few weeks.

Catharine Trebnick, Dougherty & Company.

Thank you for taking my question. I just want to follow on to Eric's. Since the acceleration of the cloud, have you seen any improvement or strength in your virtual firewall series and has that impacted maybe some of the product growth at all whatsoever?

Hi, Catharine. You know, I can only refer back to the past quarters prior to Q3, so 22. We've seen more of a shift into subscriptions and I think some of that could be just -- it could be -- on the virtual side, excuse me, software and even some of the metered base billings. But again, as Ken said, it's relatively small. For Q3 it's just a bit premature to get into that. Clearly we'll take a look at that and if we have more to share we'll do that in a few weeks.

Fred Grieb, Nomura.

Thanks. Hey, guys. Sorry if I missed this but did you mention if any of the slipped deals in the enterprise space had closed yet in the last 11 days -- or the first 11 days of this quarter?

Fred, it's a little early. I mean, I would say some deals have closed. I wouldn't be able to quantify it for you at this point. It's a little early. You know, as with all these things, some have closed, some haven't. I think that's one of the things as we progress and if we have, I think, clearer information to share, we'll do that in a few weeks.

Thank you. That concludes our question-and-answer session for today. I would like to turn the conference back to the hosts for any closing comments.

Thanks and thank you, everybody, again for joining the call. I know it's later your time. A reminder: we will, as Drew mentioned, we're not going to be taking calls. We're still in our quiet period. We will not be taking calls between now and until our earnings announcement on October 27 and we look forward to speaking with you again at that time and providing more information. Thank you.

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone have a good day.