Fortinet, Inc.

Ladies and gentlemen, thank you for standing by, and welcome to the Fortinet fourth quarter 2020 earnings announcement. At this time, all participant lines are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star then 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star then 0. I would now like to hand the compass over to your host today, Peter Sarkowski, Vice President of Investor Relations. Please go ahead.

Thank you, Sarah. Good afternoon, everyone. This is Peter Sarkowski, Vice President of Investor Relations at Fortinet. I am pleased to welcome everyone to our call to discuss Fortinet's fiscal results for fourth quarter of 2020. Speakers on today's call are Ken Vee, Fortinet's Founder, Chairman and CEO, and Keith Jensen, CFO. This is a live call that will be available for replay via webcast on our Investor Relations website. 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 fourth quarter, providing guidance for the first quarter of 2020 and the full year. We'll then open the call for questions. During the Q&A session, we ask that you please keep your questions brief and limit yourself to one question and 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. Please refer to our SEC filings, in particular the risk factors in our most recent Form 10-K 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 stated otherwise. Our gap to results and gap to non-GAAP reconciliations is located in our earnings press release and in the presentation that accompanies today's remarks, both of which are posted on the Investor Relations website. Lastly, all references to growth are on a year-over-year basis unless noted otherwise. I will now turn the call over to Ken.

Thanks, Peter, and thank you to everyone for joining today's call to review our first quarter and four-year 2020 result. First quarter building increased 20% to $961 million. Our secure SD-WAN offering accounted for over 13% of first quarter building. Product revenue accelerated quarter over quarter to 21%, contributing to a total revenue growth of 21%. Operation margin benefits from solid revenue performance we achieved an all-time company record non-gap opportunity margin of 29.4% for the fourth quarter. Given the many opportunities ahead, we plan to shift our focus more to growth for at least the next few quarters. Today, we announced Fortinet 7.0 with 300 new features and updates. With this release, Fortinet is the only leading cybersecurity vendor to offer firewall-based, zero-trust network access enabling remote access to replace the traditional VPN. This reduced the attack surface while improving the user experience. 14S Zero Trust network access solution also simplified management by using the same access policy whether on or off networks. Tight integration of a SASE solution with the 4DOS 7.0 gave enterprise the flexibility they need to enable their workforce to work from home with consistent enterprise-grade security delivered on-premise or now more cloud-based SaaS consumption for security as a service. The 40OS M.0 extends network connectivity and security beyond the one age with innovation in 5G and LTE that improve the web's network performance and increase resilience. Our 5G offering enables organizations to achieve secure, scalable, and highly available network connectivity anywhere. The release of FortiWire 7.0 expands the Fortinet security fabric delivering on our mission to provide broad, integrated, and automated security to any device, any application, everywhere. Cybersecurity is an inflection point and increasingly organizations are consolidating towards a platform approach and not just a separate platform for endpoint network security or cloud security, but a holistic platform that is integrated, automated across all these areas. The 49 Security Fabric is a cybersecurity platform built on broad and deep set of networking and security technology from endpoint to network to cloud. organically built to seamlessly communicate and operate together. This consolidation with our secure driven networking approach will be key drivers going forward. Today Fortinet is recognized in eight Gardner magic quadrants. Our FortiGate product is a leader in both SD-WAN and next-generation firewall magic quadrants. We continue to experience excellent adoption of a secure SD-WAN and expect our unique solution to become the market share leader within a few years. In addition to our growth drivers, we estimate our total addressable market will grow at an annual compound rate of 10% over the next four years to reach 93 billion by 2024. The recent solar wind security incident and the pandemic elevated the need for a broad, integrated, and automated platform and we expect companies to raise the percentage of IT spending used for security as they work to secure their entire infrastructure across multiple edges in a zero-trust environment. Before turning the call over to Keith, I would like to thank our employees, customers, and partners worldwide for their continued support to manage our response to the ongoing COVID-19 pandemic.

Keith. Thank you, Kim. Let's start the fourth quarter review with revenues. Total revenue of $748 million was up 21%. Product revenue was up 21%. Service revenue was up 21%. Product revenue of $288 million saw a substantial sequential acceleration in growth relating from strong demand for security fabric platforms and FortiGates across all form factors, hardware, software, and virtual machine. While secure SD-WAN use cases continued their dramatic growth, The majority of product revenue was driven by the wide range of other operating system capabilities embedded in FortiGates and their related use cases. Service revenue of $460 million benefited from strong demand for fabric and cloud security solutions. Support and professional services revenue increased 21% to $210 million. The revenue mixture from 8x5 to 24x7 support was 12 points, with 24 by 7 now representing 66% of the mix. Security, subscription services, and cloud provider revenue increased 21% to $249 million. Moving to the mix of FortiGate and non-FortiGate revenue, network security revenue increased 18%, driven by the high-end and entry-level FortiGate product families. Non-FortiGate product and service revenue increased 29%, driven by a 34% increase in revenue for fabric and cloud security solutions. Before continuing with the fourth quarter results, I'd like to highlight our 2020 full-year revenue performance. In the midst of a pandemic-induced recession, total revenue for the year grew 20% to $2.6 billion. We take great pride in our focus on organic growth, and 2020 represents the third consecutive year with revenue growth of 20%. This consistent performance speaks to our geographic and customer diversity, the continued success of the integrated platform strategy, and our proprietary ASIC advantage that enables a shared operating system across the platform, drives our cost for performance advantage, increase the capacity to add features and functions while maintaining price points. Total non-FortiGate revenue for the year grew over 25%. to more than $725 million. In other words, our fabric, cloud, and other security products and services are on a pace to be a $1 billion business as we exit 2021. Our non-FortiGate and FortiGate products and solutions include a complete range of form factors and delivery methods, including physical and virtual appliances, cloud, SaaS, and professional software, as well as hosted and non-hosted solutions. Together, they provide a range of security solutions and form factors, enabling integrated protection for hybrid environments and their expanding digital attack surface and edges. Moving back to our Q4 results, let's turn to revenue by geo. Our geographic revenue performance continued to align with the pandemic's economic path and with it highlighted a geographic diversification of our business. As summarized on slide 7, revenue in Asia Pacific increased 23%. as many Asian countries and economies continue to remain largely open. EMEA revenue increased 22%, and the Americas posted revenue growth of 20%. Let's shift to billings. Total fourth quarter billings were $961 million, up 20%. FortiGate billings increased 16%, and accounted for 71% of total billings. As shown on slide 9, high-end and entry-level FortiGates posted strong billings growth over the quarter. Non-forti-gate buildings increased to 29% of polar buildings, driven by demand for fabric and cloud security solutions. As with revenue, geo-buildings performance aligned with the economic path of the pandemic. In terms of growth, APAC buildings outperformed all geos, followed by Europe and the Americas. The Americas reflected continuing impact of the pandemic, especially in Latin America. Moving to buildings by customer segments, The small enterprise segment posted solid growth across all geos, illustrating the strength of our Engage channel partner program. This segment is driven by new customer acquisitions, customer security fabric expansions, solid execution by our channel partners, and the large, diverse makeup of this multinational customer segment. Moving to worldwide buildings by industry verticals, The worldwide government sector topped all verticals at 17% of total billings and grew 28% with another strong performance from our international team. Service providers and MSSBs accounted for 16% of total billings. Retail accounted for 10% of total billings, up two percentage points quarter over quarter. And education continued to rebound with billings growth up 26% year over year. Looking now at deals by dollar size, we had 68 deals over $1 million in the fourth quarter compared to 64 deals in the fourth quarter of 2019. Secure SD-WAN accounted for 16 deals over $1 million versus 11 deals in the fourth quarter of 2019. On a full year basis, SD-WAN accounted for approximately 11% of our total billings and doubled year over year. Moving back to the income statement, As shown on slide four, gross margin improved 40 basis points to 78.5%. The strong 29% quarter-over-quarter product revenue growth created a mix shift from services to product revenue. The mix shift was a headwind for quarter-over-quarter gross margin comparisons. Product gross margin improved 130 basis points to 63.2%. Product gross margin continued to benefit from a higher mix of software products and the lower direct cost of our newer generation of FortiGate products. Operating margin for the fourth quarter increased 210 basis points to 29.4%, benefiting from the gross margin improvement and continued lower travel and marketing program expenses, offset by the addition of new sales team members as we continue to prepare for additional growth. At the end of the year, the total headcount was 8,238, an increase of 16%. Moving to the statement of cash flow, summarized on slides 10, 11, and 12. Cash flow for the fourth quarter came in at $264 million. In the fourth quarter, we repurchased approximately 300,000 shares of our common stock for a total cost of $34 million. For the full year, we repurchased 11.7 million shares for a total cost of $1.1 billion. At the end of the fourth quarter, the remaining share repurchase authorization was $1 billion, with the authorization set to expire at the end of February in 2022. Throughout the pandemic, we have leveraged the strength of our balance sheet as a competitive advantage to support our partners and customers as they experience geospecific economic challenges. As a result, average day sales outstanding increased eight days to 87 days, in line with our expectations and reflecting our decision to provide geographically targeted extended payment plans. Inventory returns improved to 2.7 times from 2.1 times in the third quarter and was relatively flat year over year. We expect extended payment terms and higher inventory balances to be in effect as we move through at least the first half of 2021. Capital expenditures for the fourth quarter were $32 million, including $22 million related to construction and other real estate activity. We estimate capital expenditures for the first quarter to between $50 and $60 million and and for all of 2021 to be between $150 and $170 million. 2021 CAPEX projects include expanding our data center footprint and spending that was moved from 2020 due to delays in the new campus building. The average contract term in the fourth quarter was approximately 28 months, up less than two months from the fourth quarter of 2019. The growth in SD-WAN and other large enterprise deals contributed to the increase. As we look forward, I'd like to review our outlook for the first quarter and full year 2021, summarized on slide 13, which is subject to disclaimers regarding forward-looking information that Peter provided at the beginning of the call. For the first quarter, we expect billings in the range of $765 million to $780 million. Revenue in the range of $670 million to $685 million. Non-GAAP gross margin of $78.5 to $79.5%. Non-GAAP operating margin of 22.5 to 23.5%, reflecting the typical revenue seasonality associated with the first quarter. Non-GAAP earnings per share of 70 to 75 cents, which assumes a share counted between 167 and 169 million. We expect a non-GAAP tax rate of 21%. Before providing our 2021 guides, I'd like to congratulate every member of the Fortinet team for the truly outstanding execution in 2020 in the face of unprecedented challenges and rapidly changing and unpredictable dynamics. The effort and results have been outstanding. And this is on top of now several years of consistent, predictable performance and continuing improvements in key growth and profitability metrics. Today, we report our third consecutive year of total revenue growth of 20%, while increasing our non-GAAP operating margin an average of over 200 basis points a year for the same period. Our goal remains to balance growth and profitability within the framework we have provided. As Ken mentioned, given the many growth opportunities that lie ahead, we currently plan to tilt our bias within this framework more towards growth for at least the next several quarters. The opportunities we see are supported by a strong pipeline heading into 2021, increased sales capacity, and our development efforts, which include the MP7 chip and our new 40OS 7.0 operating system. With that, for 2021, we expect buildings in the range of $3,560,000 to $3,640,000, which at the midpoint represents growth of approximately 17%. Revenue in the range of $3,025,000 to $3,075,000, which at the midpoint represents growth of 18%. Total service revenue remains at $2.15 billion to $2.45 billion, which represents growth of approximately 21%, and implies product revenue growth of approximately 11%, and $1 billion in product revenue for 2021, quite the milestone for Fortinet. Non-GAAP gross margin of 78% to 80%, non-GAAP operating margin of 25% to 27%, When backing out the 2020 T&E benefit, the midpoint of guidance represents a 50 to 100 basis point increase in operating margin for 2021. Non-GAAP earnings per share are $3.60 to $3.75, which assumes a share count of between $170 and $172 million. We expect our non-GAAP tax rate to be 21%. We expect cash taxes to be approximately $89. Along with Ken, I'd like to thank our partners, customers, and the Fortinet team for all their support and hard work during these difficult and unique times. I'd also like to offer a special welcome to the Panox team. And I now hand the call back over to Peter to begin the Q&A session.

Thank you, Keith.

Operator, please open the call for questions.

Thank you.

As a reminder to ask a question, you need to press star then 1 on your telephone. To withdraw your question, please press the pound key. We ask that you limit yourself to one question and one follow-up. Our first question comes from the line of Brian Essex with Goldman Sachs. Your line is now open.

Hi, good afternoon. Thank you for taking the question, and congrats on a great set of results. Maybe, Ken, if I could ask, you know, you've got a number of different product cycles ahead of you this year. You've got NP7. You've already talked about SD-WAN. You've got hyperscale penetration and potential exposure to 5G. Can you maybe talk about the contribution from each of those that's embedded in your guidance and what are you seeing currently in the market and what's yet to come?

I think for MP7, it's still in the ramp-up stage. We continue to build a new hardware platform using MP7, especially for the high and the middle range. The 40-0 at 7.0 is also a growth trend, but we are in the beta-3 process right now with this quarter. That's what's helping contribute to the additional growth, especially in the zero-trust environment, and also with infrastructure security later this year. So far I see that the product grows like a 21%. It's a lot of contribution from whether the SD-WAN or we call security-driven networking and also in the probably like one or two years ago when we released the ISOC-4. So that's a little bit towards the low end side of the 48 which you can see nicely grows over there. And also the team doing a great job in the sales marketing.

Yeah, I think the guiding study process is not so much about individual products or even, in some cases, individual use cases. We identified 15 or 20 different use cases for firewalls. It's more about what we see in terms of market opportunity, what we see in pipeline, than maybe by geography or deal opportunity or what have you. some of the key inputs that go into it. But I wouldn't really think of it as – I certainly would not want you to walk away from the conversation thinking that the guidance that we provided is dependent upon some degree of 5G or SASE or something that's above and beyond.

Got it. That's helpful. Maybe just a quick follow-up. You know, nice large deal activity, certainly more than we picked up in the channel. Maybe if you could talk a little bit about the competitive dynamics on the large end of your, you know, market scale, you know, Where are you seeing that business come from? How much is displacement? How much is, you know, expansion of, I guess, existing customer opportunity?

Yeah, definitely. What if our customer, our partner, they see deciding to get a much better, more competitive, and a lot of advantage using the Fortinet product? Whether the Fortinet leverage new ASIC, the new OS with much more additional function compared to competitor, So that's where, like, increase the gap we have ahead of competitor now. And that's actually helping to drive the accelerate of the product revenue growth. And on the other side, we have a little bit different approach for whether the SASE or cloud or endpoint. So we more emphasize if they integrate together, automate together, especially in the OS level. None of our competitors have that. And also most of it is also organically internally developed, designed to work together, automate together from day one. That's also different from competitor acquisition, which is more difficult to integrate and also difficult to manage long-term. So we do feel we have more and more advantage in the marketplace right now.

Got it. Very helpful. Thank you again. I appreciate it. Thank you, Brent.

Thank you. Our next question comes from the line of with Oppenheimer. Your line is now open.

Thank you. Good afternoon, guys. Congrats on the ongoing strong execution levels. I want to start with a gross margin related question. So, gross margins guidance for 21 indicates an improvement, you know, one to two basis points on average. And I'd like to understand whether it is driven by the ongoing shift to more cloud activities, i.e., more subscription services, or is it driven by some improvement with your ASIC-driven strategy?

Yeah, I think the last part is probably the headline, which is that the successive generation of the ASICs you know, in addition to creating more speed, more capacity, if you will, more throughput, it also creates capacity to consolidate features of the BOM that were previously separate. And eSuccessive Generation has shown the benefit of that. And I think over the last year or two that we've done a very good job of retaining that cost benefit in terms of the structure. You can look back and see what's happened with the gross margins and the product gross margin line. Obviously, you do then also get the benefit, you know, in total when you – you add in the two-thirds of the business that are services that are coming in at a much more attractive margin. So the combination of those two, I think, are working very, very well for us as we exit 2020 and move into 2021.

Got it. Got it. Thank you for that, Keith. And maybe high level on the Sunverse breach, have you seen any incremental interest, starting in mid-December, maybe building into year-end, again, just aside from the typical healthy year-end seasonality trend?

I'd say probably we do see a lot of need, interest, especially to secure the whole infrastructure, including the supply chain with all different third-party kind of products, all these things. But it's still, I'd say it's definitely more people studying interest in this area. But the business side has probably not changed that much yet. But we do see probably later this year will be, because it's definitely with security concern, like I mentioned, the security spending amount, our IT spending probably will keep increasing.

Understood. Very helpful. Thank you so much. Good luck. Thank you.

Thank you. Our next question comes from the line of Kyle Leone with Bank of America. Your line is now open.

Hi, guys. I have two questions. The first one is, Ken, in your prepared remarks, you said that this year is going to be a year of focus on growth. What does it mean? Does it mean that you're going to increase expenses and the margins? margin increases will moderate. Can you elaborate on the meaning behind your statement that you're going to focus on growth this year, and how is it different from previous year, for example?

We do see, like, whether some investment we made in the sales and marketing, like we say, we have increased sales capacity, and also we also have better visibility. We increased the marketing. And at the same time, from the product, from infrastructure side, We also will keep in mind especially the organic internal development like building the new infrastructure and the way to address the cloud and the networking endpoint and also working with service provider. So basically we do see that the market itself also starting kind of accelerating especially in some new area. whether the critical security network, including both SE1 and 5G, and thus have a new infrastructure, but also some kind of a service model, leverage the infrastructure, which we will keep investing more in there. So that's where we feel, so this will give us a much more growth opportunity, and both internally, like whether the MP7 or the 4GOS 7.0, it's all timing quite well, so it will help us drive the faster growth.

And does this have any impact on the margins?

That's all I'll just add to that. I think the – sorry to interrupt you. Look, I think we were very successful throughout 2020, even during the pandemic of, you know, maintaining and growing our operating margins very dramatically, but at the same time adding sales capacity. You know, and I think when we sat down to build the guidance out in the plan for 2021 – you know, coming into the year with the capacity levels that we have, together with the increase in tenure that we're seeing as well as the pipeline, you know, I think we feel very good about this opportunity to take advantage of the growth. And I think we're still, you know, I think the margin guidance and midpoint at 26% is very much within the framework and actually up a little bit.

Got it. My second question is, is about the needed investment in infrastructure to accommodate SASE and similar business models. What is the company doing in order to address it? Can you just elaborate on what's happening behind the scenes?

Yeah, the SASE approach on Fortinet is different than some other competitors. We do want to have a more integrated, automated approach. And also, we're the only one in the OS level, both the SASE and also Zero Trust network access. So that's making whether working with a 49-0 service provider or even a customer enterprise themselves to develop their own kind of SaaS approach, which will be much better fit for their own kind of privacy, whether GDPR, some other requirement, it's much better secure compared to some other approach. So that's where we feel we do have some investment, but some of the investment like infrastructure We're also working with our service provider together. Got it. Thank you.

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

Hi, this is Ben Schmidt. I'm for Rob. Thanks for taking my questions. As much of the attention in the space begins to shift towards cloud and SASE, how do you think about your longer-term strategy from a remote connectivity perspective? And what do you think, and what do you expect for the branch office?

I think for all technology, we can support in both the thin branch and the thick branch office approach. And also, even for the , so we need the flexibility to enterprise, which we can leverage the vendor, or they can leverage their service provider or carrier, or they can build themselves. So that's what we say. We put in the OS level. It's much more integrated, automated compared to some other approach, which has to let it render infrastructure. So for us, like, this OS level integration of SASE do leave a lot of flexibility and gradually for the customer to transition whether they're more service-based or they still want to, like, have a, we call, secure infrastructure approach. So that's where we have the flexibility to have customers select their own approach based on their own need. At the same time, we'll make the whole infrastructure secure, like we say, whether it's secure-driven networking with IC1 5G or internal segmentation, whether in the data center or the enterprise campus environment. So that's where we feel even we take a little more time to build this kind of highly integrated OS level But the result is much better and more advanced than some other loosely – another approach.

Okay. And on the growth investment, can you guys add just a little bit more to how much of the capacity has already been added and how much you're expecting to add – I guess how much more needs to be added for this year? Can you remind us what the normal RAMP time period is for new REFs?

For the new REF, probably a little bit different for each vertical, like the channel probably within a few months, like three months time frame, and then the enterprise probably like six or four months. So we're going to also, like, I think based on how the pandemic, how the other progress going and also the market opportunity there. But I say we do kind of planning to increase more capacity when we see more opportunity there and try to match the investment. with the, I think, whether the internal, like, new product and also the market opportunities will definitely help us to keep improving the fast growth.

Thanks, guys. Thank you.

Thank you. Our next question comes from the line of Fatima Bulani with UBS. Your line is now open.

Good afternoon. Thank you for taking the questions. Ken, maybe I'll start with you. Just drilling into your vertical-based performance, you talked about the global government vertical being a fifth of your billings in the quarter, and that's some of the highest levels we've seen. And so I'm wondering if you can remind us what your U.S. public sector exposure is within that government exposure? And then more specifically, how is Fortinet positioned both from a product and go-to-market perspective in the U.S. federal, especially as we sort of think about the $10 billion cybersecurity spending protocol from the new Biden administration? And then I have a quick follow-up for Keith.

Yeah, the government business for Fortinet is global-based. It's about 17% of a total business for us right now, and compared to, like, a few years ago, the care service providers, the number one is over 20%. Now they are, like, 16%. For the U.S. government, we still see a lot of opportunity, and the same thing for the U.S. market, and so we're going to keep in building the the team and increase capacity and to take this opportunity and grow faster, larger. What's the second question?

I think we've talked before that the U.S. Fed is no single digits of our government business, of our business. I think we can't leave that at that.

Gotcha. Very helpful. Keith, just sticking to America. We saw very nice acceleration in 4Q in the Americas theater and against what was maybe an uneven geographical performance for the U.S. over the course of 2020. So I'm wondering if you can just put a finer point on the types of things that went right and the types of things that really went on in the quarter and the key drivers of the strength, particularly in America. And that's it for me. Thank you.

Yeah, so I think good question, but a lot of ways different answers. If you look at it geographically, Latin America continues to be by far the most challenged, if you will. Canada probably did the best of the three, and I would put the U.S. right in the middle. I do think that we're very pleased with how the U.S. has come back. The second quarter, now that we all are pandemic experts about what to expect out of the business and looking at Q1, Q2, Q3, Q4, It's pretty obvious that, you know, and we kind of felt this coming out of the second quarter, that Q2 was a low-water mark, both for the company in total, but also for the U.S. And I think you've picked up on, since that point, there's been a steady progression of, for lack of a better term, recovery in that part of the business.

Thank you.

Operator, next question, please.

Our next question comes from the line of Brad Zelnick with Credit Suisse. Your line is now open.

Thank you so much, and congratulations to the entire Fortinet team on a great end to a great year. My first question for you, Ken, in your comments, you basically said that you aspire to be the market share leader in SD-WAN, which I think is a really important goal that you have. And I just was curious, from your perspective, what needs to happen to get there? How do you take share from your two largest competitors that have significant install-based relationships, And over what time can this play out?

I think for us, we have a unique advantage of we build IC1 with security together, and we also leverage ASIC to, like, increase computing power load, computing cost a lot. So that's none of our competitors have that. And also the other two big data, they come from acquisition. That's where Going forward, they probably will be slower on whether the innovation or the market change dynamic there. So that's what you can see from the 40OS 7.0 release. We do keep increasing additional function, whether the IC1, the 5G, and other parts. So we do also believe going forward, like half or majority of the IC1 market will need a security. So we have a huge advantage there. So that's where even have a bigger installation base, but the advantage we have from the product, from the function, from the cost side, I think will be huge, and will have us keep improving the market share. And so far, like, year-over-year, like, we almost doubled as given business compared to the 2019 in the 2020.

Great. And maybe just, you know, quickly for Keith. Keith, what are the levers to think about in light of sales headcount? in the plans for this year.

I'm not quite sure I fully understand the question, but maybe I'll give it a shot in that to share one data point. Coming into this year, if I look at the level of sales capacity we have versus, you know, what the plan is that we're talking about, I don't think I've – this is as well positioned as we have been coming into a year. to pivot towards this growth model that Ken has talked about. And I think that the pipeline feels very good. The tenure feels very good. The use cases, the TAM feels very, very good to us. The new 40OS, the MP7 chip that's coming out, the platform advantage, the cost advantage that we have for performance. You know, I think that we are in a very good position to execute this. And, again, we're maintaining it within the framework that we've talked about previously.

Fantastic. Thank you so much for taking the questions. Thanks, Brent.

Thank you. Our next question comes from the line of Sterling Audie with J.P. Morgan. Your line is now open.

Yeah, thanks. Hi, guys. Just one question from my side. Ken, in your prepared remarks, I think you talked about that the industry is finally ready to see customers move to consolidation on fewer vendors, more of a broad platform approach. With that in mind, Where would you gauge the Fortinet platform, and what are the areas that you would like to bolster to improve your position moving forward?

You can see the, like we call the security fabric has a pretty nice growth, almost double compared to the 48 growth there. And that's also because Cosmo one have all these whole infrastructure secured integrated automatic solution. So that's where we're continuing to see we're keeping gaining share there. So that's involving probably like 20, 30 different products. And on the other side, on the FortiGate part, we call it security-driven networking. That's whether the SD-WAN, the 5G, and now with integrated SASE and some other parts working closely with service provider carrier, we also see a lot of opportunity within the FortiGate side. So that's where we see So far, we are keeping, like, if the market itself grows like 10%, we do see we can grow much faster than the market, keeping daily share, and both on the FortiGate and also on the, we call it the broad fabric approach, which involves both the endpoint and the networking and the cloud all together, and all this integrates together based on the FortiOS and some other connectivity related to the FortiOS.

Understood. Thank you.

Thank you. Our next question comes from the line of Adam Tindall with Raymond James. Your line is now open.

Okay, thanks. Good afternoon. Ken, I just wanted to start on the focus more on growth comment and how you're investing some of your healthy margin in some sales and marketing initiatives. We also heard a similar message from a competitor yesterday. And just thinking about the broader industry implications of that, an outsider could maybe make the case that we enter a period of greater industry competition and pricing pressure. as, you know, major competitors are investing heavily in sales and marketing, certainly doesn't seem to be the case based on your full-year margin guide. So maybe some thoughts on why that scenario does not play out.

Okay, can I jump in and answer on your behalf for a little bit? I think the reference probably is to, you know, a company that has a very, very different business model, whether you're looking at growth rates or you're looking at product-service mix or what have you. So I don't know that that would draw that straight-line comparison there. I think the business model that we're executing here has been extremely successful, and I expect it will continue to be so. In terms of discounting, you know, I think that, you know, there's days that I don't like hearing it, but we're viewed as being, you know, the price for performance leader, that our pricing is really – we're oftentimes, I think, brought into RFPs and opportunities to set the milestone that the competitors are forced to react to as opposed to the other way around. If you go back and look at the comments that we've offered throughout 2020, even in a pandemic, more often than not, discounting, if you will, has been a tailwind for us in our ability to execute against it, as opposed to a headwind. And by that, I define discounting mean lower discounting pressure in that quarter than the prior period. So I don't think we have the concerns that may have been described there.

Okay, that's helpful. Maybe just a quick follow-up, Keith, and sorry, a little bit in the weeds on this one, but the billing's guidance for Q1, it's down about 20% sequentially at the midpoint, and typically down low double digits or so, mid-teens in that range. Last year at the start of COVID, it was down 17%. So part of the question is why would the sequential decline in billings be worse than the environment when we entered COVID during Q1 of last year? You talked about having a strong pipeline, supporting the desire to invest. Maybe just some help with the color on the disconnect between those two items. Thank you.

Yeah, I think one which we should talk about is just the tremendous performance in the fourth quarter of 2020. I know the fourth quarter of 2019 was a good quarter, but Q4 2020, on top of that 19 performance, I think is part of it. And, you know, this is typically the smallest quarter for us in the year. Historically, you've seen some sort of shift, and it's nothing new from going from Q4 to Q1, and then you start to see the progression thereafter.

Okay. Thank you very much. Helpful.

Thank you. Our next question comes from the line of Keith Botchman with Bank of Montreal. Your line is now open.

Hi. Thank you very much. Ken, I wanted to ask my first question of you. You've talked about 5G. Why is that an opportunity? Who's your customer, and why does Fortinet win in that instance of the deployment of 5G? And if you could just talk a little bit about When do you think that you'll get some benefits from this?

I think we do see 5G connect a lot of devices to the Internet, which also includes a lot of security risks. We call this a new attack service, a new edge needs to be covered. So that's where especially we're working with a lot of service providers for the 5G services to a lot of enterprises and connect all these different devices in the OT, IoT space So that we do see is a huge opportunity and so with our provision with the carer service provider and we do see the 5G can be one of the driving growth driving factor for us this year and it could be material towards the end of the year. Yeah, it's going forward is also is a huge, huge opportunity even secure water. Yeah, it's a part of the whole infrastructure, which grow more and more fast, and a lot of our care service providers starting to have an investment in this area also.

Okay, interesting. Okay, and then, Keith, one for you. For the guidance of 21, you talk about CapEx. Any other puts and takes you want us to think about as it relates to OCF or operating cash flow?

No, not really. I mean, I made the point about inventory. Returns came in for us, you know, pretty strong in the fourth quarter, but I think that's a direct reflection of the success that we had on the product revenue line in the fourth quarter, so that was probably a little bit better than we expected. You know, I do think during this pandemic era that we'll continue to maintain somewhat higher levels of inventory. I think that's in our best interest. The extended payment term program, I think that, you know, every CFO wants to wind that down as fast as possible, and every distributor wants to hold on to it for dear life, so. That will be an ongoing battle for us throughout 2021, I think.

Okay. Well, congratulations to the whole team. Good set of results. Thank you.

Thank you. Our next question comes from the line of Ben Ballin with Cleveland Research. Your line is now open.

Good afternoon, Ken, Keith, Peter. Thanks for taking the question. My first question, you've made your aspirations pretty clear in SD-WAN. Could you share with us a little bit about aspirations and tensions as you move into SAFI and Zero Trust, how you see yourself positioned?

Yeah, SD-WAN is a part of the SAFI offering. What we do is a little bit different competitor. We build within the 4840 OS, which also can be offered, whether it's based on the physical appliance or the virtual device. software or kind of cloud delivering and that's where the new 40OS 7.0 gave all this flexibility and connect a lot of other part of infrastructure and security service together. So that's where we're continuing to see SD-WAN and keeping growing probably by market start it probably was keeping growing like 30-40% year over year this year. We do believe we're also keeping gaining market share and at the same time The 5G is another opportunity to come up. We already offered in the new 40OS M.0, which also could be a pretty good drive for the additional growth we have.

Could you also talk a little bit about how you envision 40OS 7 rolling out once available? How backwards compatible will it be for legacy appliances? And if you've looked at, you know, some of the historical OS refreshes, how long does it take the footprint to roll over as this rolls through the base? Thank you.

It's really dependent on customer. Some, I have to say, the channel probably reacts a little bit faster, and then there's enterprise. Then the service providers sometimes take a little bit of time. because some service providers, they also have to support in some of that. But we do see this enable a lot of new opportunity, and they also like this tightly immigrate approach, whether it's EY and SACI, we call it secure-driven networking, which do enable them to offer the additional service, additional kind of a business, and additional edge services. That's why we say you need to protect all different edge together and automate, integrate together instead of have a different product, different kind of a vendor for each part, which is difficult to integrate, automate. So that's where we see the response from like there's like 300 new features and updates in this OS to cover quite a broad area. And that's where we see customers do need some time to to gradually, like, train, pick up all these new functions. But a lot of them, they see the huge benefit of this new function, and that's what we see is a huge opportunity for us. But probably towards the second half of the year, we'll see a lot of benefit of it. Thank you. Thank you.

Our next question comes from the line of Michael Terz with KeyBain Capital Markets. Your line is now open.

Hi, this is Eric Keith down from Michael. Thanks for taking the question. Just one from me. Keith, it seemed like you got a billings for 4Q, assuming some macro headwinds. How did that play out differently than you expected, especially on the product side? And in the end, did you see deferrals of hardware refreshes in 2020 that might snap back in 2021?

Yeah, we have such a long product list. I don't think that we really saw deferrals of refreshers, you know, the sweaty asset concept. You know, I think the I don't think Q4 was unusual in terms of what you normally see with other years. And by that, I mean I think there was probably some element of the typical budget flush flowing through. I think there was probably some element of salespeople working really hard to hit accelerators. And I think there was also some element of deals that simply pushed. I don't think that Ken kind of made a good point earlier to build on a little bit. I think the SolarWinds event happened so late in the quarter, you know, at least for us and probably for many other security companies, it seems doubtful that that activity really had much impact on the last two weeks of December and the quarter. You know, I do think, and Ken made this point, that it certainly raises awareness of security and, you know, events like that, unfortunately, for the world at large, you know, create focus on security matters and the importance of it that people are going to suffer because of it. So I don't know that you know, in terms of learning to be cautious, if you will, going back to the beginning of your question, in a guidance setting, you know, I do think there was an element of caution, you know, once we came out of the second quarter and saw how the pandemic impact close rates, and you saw that come through in the guidance setting process in both Q3 and Q4.

Also, we see a pretty nice growth in SMB, but overall, SMB still have very low percentage leverage, whether the network security or cybersecurity. That's where including retail. So that's where you see they still have a huge growth opportunity over there.

Great. Thank you both.

Thank you.

Thank you. Our next question comes from the line of Andrew Nowinski with DA Davidson. Your line is now open.

Great. Thank you, and congrats on the next quarter. Maybe just starting with a high-level question. So as we think about the mix of your revenue, Do you think the SolarWinds attack will create a positive tailwind for more spending in the firewall market? Or do you think it will pressure your product growth as customers perhaps shift spending towards some of your cloud-based and subscription solutions?

I'd say probably they would try to have a more integrated and bigger infrastructure security. So that's where probably Yeah, definitely, it's sort of more like kind of come from the network side. On the other side, they are also trying to, like, cover what the pandemic is, what is work from home. There's a lot of other, like, business trying to digitalize during this process, which also increased the security need. That's why I say the security spending kind of the overall IT spending probably will keep increasing this year, and that's what also will help inflight the So just like a few years ago, there's a case where the targets and monitoring definitely raised awareness of the importance of cybersecurity.

Great. Thanks, Ken. And then just a follow-up. As we think about the growth phase you're entering here this year and your go-to-market strategy to drive that growth, if you look back over the last few years, your playbook has certainly been to lead with the firewall. I'm just wondering in this new growth phase, Are you using the same playbook to accelerate your growth, or are you seeing more deals come to you via your SIM products and your virtual solutions and your other subscriptions and perhaps changing your go-to-market strategy to drive that growth?

That's a few. In the next few years, the network security market is still the biggest market, also probably the fast-growing market, not just because there's more connectivity like 5G, SD-WAN, and some other power from home. but also that's the center of the whole infrastructure security. But also, you cannot just do network security only. You also need to have network security working closely with endpoint, with some other infrastructure, cloud, or some other part together. That's what we call the integrate ultimate solution to respond to any of these quick-changing dynamic industry here. That's where it's important we keep the organic growth, and we also keep developing the product from day one to make it integrate, automate together. It's a little bit different compared to the competitor, which whether it comes from acquisition or some other part, it's more challenging to integrate and also keep the innovation going forward.

Okay, understood. Thank you. Thank you.

Thank you. Our next question comes from the line of Gray Powell with PBS. B-T-I-G. Your line is now open.

All right, great. Thanks for taking the questions, and congratulations on the good results. So maybe circling back on the 5G questions, in past telecom upgrade cycles, maybe 3G was too long ago, but looking back at, like, the 4G upgrade cycle, how did that play through to Fortinet? What kind of tailwind did you see then? And then how does the 5G cycle feel in comparison?

Yeah, compared to 3G, 4G is more connect people, whether the phone, whatever, together. The 5G is more connect to the device. And that's also the number of connections probably will increase as it may be 10X at least, because there's much more device to be connected. And that's also kind of more address a lot of industry need, whether... a certain small city or also drive a lot of a bigger infrastructure so that's we do see a lot of a business opportunity because so far the network security maybe more towards the B2B towards the business side compared to towards the consumer part that's we do see huge opportunity going forward it's just like a couple years ago the SD-WAN right so SD-WAN can help in drive a lot of smart connection with the application and more dynamic based on application have a different connection there. So that's where the 5G definitely have a lot of additional opportunity but also bring a lot of risk to the business there which need to be protected. And also service provider we see play quite an important role there which is we have probably the best service provider care regulation among all the service security vendors there. So we do see a lot of potential in this area.

Understood. Okay. Thank you very much.

Thank you.

Thank you. Our last question will come from the line of Irvin Liu with Evercore ISI. Your line is now open.

Hi. Thanks for letting me on. I have one question and one follow-up. First, I was wondering if you can perhaps update us on your business mix by customer size maybe a breakout buy, enterprise, commercial, or S&B, and whether you've seen a shift up or down market, and how do you see this mix trending through calendar 21?

Yeah, I think we had a slide in our analyst day in November of 2019 that basically answered one-third, one-third, one-third. And then to explain it, a little bit of NSSP gets allocated between them, but you end up with something that's very, very much like that. Small business, small enterprise one-third, mid one-third, enterprise one-third. I think the thing that has been a very pleasant surprise to us throughout 2020 in the pandemic was how well the enterprise and the small enterprise segment of the business held up. It really did very well.

Got it. And for my follow-up, you know, we're now one year into the current pandemic. And assuming things normalize in the back half of calendar 21, do you anticipate any changes or shifts in demand or customer buying patterns assuming a return to normal environment?

I think during the pandemic, the customers, especially enterprise customers, tend to hold on to the current vendor, especially in the developed country. But it's a But for us, like whether in the U.S. or some U.S. country, we are keeping gaining market share. So we do get into a lot of new customer, which will probably take more effort during the pandemic because it's difficult to meet people or do certain testing there. Once it's open, we do see there's more opportunity, more window open for us, especially with the new hardware, new OS, and the new infrastructure. So that's also lead us to kind of a little bit towards the investing in the growth for us going forward in the next few quarter at least.

Yeah, I think Ken is spot on with that. I think the quote unquote nice thing about the pandemic is I think we have a lot of understanding about our business and what to expect in pandemic quarters. And I think that, you know, all of us here at Fortinet and I think throughout the country are looking forward to at some point in time, you know, when there's herd immunity, there's vaccine, And then the other growth drivers kick in, and that seems destined to be sometimes towards the second half of this year. I think we're all very aware of some of those GDP numbers and the year-over-year swings that we're seeing from negative 3% to positive 6% or 7%. Those are pretty dramatic numbers, but I think most people's expectations are that that's really going to come when the economies in the country start opening up further.

Thank you, Sarah. We're going to close the call at this point. As you read in today's press release, I'd like to point out to everybody that the Fortinet Accelerate 2021 virtual conference will be held on March 9th for the U.S. As part of that conference, we'll be doing an analyst day. So you can register. There's a link in the press release as well as up on the website to register for investors and analysts. So please do that prior to March 9th if you're interested in attending that morning event. In addition, we'll be hosting – in addition to hosting Accelerate, we're also going to be attending the Goldman Sachs Conference next week on February 10th and the Morgan Stanley Conference on March 2nd. Links to those webcasts will be on our website, available on the Industrial Events page of our Industrial Relations website. Thank you very much for your time today. If you have any questions, please feel free to contact me. Have a great rest of your day.

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.