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spk00: Good day and thank you for standing by. Welcome to the Fortinet fourth quarter 2023 earnings announcement. At this time, all participants 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'll need to press star 1 1 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 1 1 again. Please be advised that today's conference is being recorded. I'd now like to hand the conference over to your host today, Peter Salkowski, Senior Vice President of Investor Relations. Please go ahead.
spk15: Thank you, Liz. Good afternoon, everyone. This is Peter Salkowski, Senior Vice President of Finance and Investor Relations at Fortinet. I'm pleased to welcome everyone to our call to discuss Fortinet's financial results for the fourth quarter of 2023. Joining me on today's call are Ken Zee, Fortinet's founder, chairman, and CEO, Keith Jensen, our Chief Financial Officer, and John Whittle, our Chief Operating Officer. 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 full year in the fourth quarter of 2023 before providing guidance for the first quarter of 2024 in the full year. We'll then open the call for questions. During the Q&A session, we ask that you please 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 GAAP results and our GAAP to non-GAAP reconciliations are 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. The prepared remarks for today's earnings call will be posted in the quarterly earnings section of our Investor Relations website immediately following the call. Lastly, all references to growth are on a year-over-year basis unless noted otherwise. And we'll now turn the call over to Ken.
spk11: Thank you, Peter, and thank you to everyone for joining our call. In Q4, total billing grew 8.5% to $1.9 billion, driven by an increased focus on secure ARP, SASE, and improved execution for our sales team. We closed six eight-figure deals across five industry verticals. All six of these transactions, including all three of our SASE, secure ARP, and secure networking solutions, is treating our value of an integrated platform and that's spent across on-premise and cloud, as well as our 40 ASIC technology advantages. Food in a total addressable market across secure app, SASE, and secure networking expect an increase from $150 billion in 2024 to $208 billion by 2027. Our customer base consists of 76% of Fortune 100, including nine of the top 10 technology companies, nine of the top 10 manufacturers, and nine of the top 10 health care. Our secure building growth, 44%, accounted for 11% of total building, with strong performance from several solutions, including EDR, SIM, email security, and NDR, to automatically detect, investigate, and respond to threats. Unified society building growth, 19%, account for 21% of the total building. We believe Fortinet is the only company with a unified SaaS solution all integrated into a single FortiOS that including a full networking and security stack consisting of a market leading SD-WAN, ZTLA, Secure Web Gateway, CASB, and firewall as a service designed for on-premise and cloud. Our 40-size solution is gaining momentum quickly as we close our first eight-figure SASE deal for 350,000 seeds. In Q4, we added 40 new features to our SASE solution, including support for over 150 POP locations worldwide and the ability to protect thin-edge device. we see a huge opportunity to attach Fortinet SASE to tens of thousands of SE1 customers. Secure networking accounts for 60% of our building and represents our largest addressable market. Gartner expects the secure networking market to overtake the traditional networking market by 2030. Fortinet is the number one network security vendor with over half the global firewall deployment. In addition to physical firewall, we offer virtual, cloud-native, and firewall-as-a-service solution, all based on our 4D OS operation system, consolidate over 30 networking and security functions together. Converged security and networking require more specialized computing power than traditional networking. Our 4D ASIC-powered 4D gate delivers 3 to 10x more performance as indicated by secure computing routing with every new FortiGate product release. The latest FortiASIC SP5 based FortiGate 70G with DL5G in recognized format secure device within operation technology environment. It is of a great start as a Fortune 50 company and an eight-figure operation technology deal feature this new FortiGate in the fourth quarter. Also included with our 40OS operating system is a fully-featured access point controller. Recently, we announced a new secured access point product, making us the first vendor to announce a business-grade Wi-Fi 7 product. Fortinet has consistently been an innovative cybersecurity company, and this earning call won't be complete without a few words about our AI. We have invested heavily in AI across every function and product. For over a decade, Fortinet has used machine learning and AI to provide advanced threat intelligence across more than 40 products from network, endpoint, and application security. Our solution applies AI and machine learning across expanded digital attack service automatically, containing and remediating incidents within seconds. where the industry average for detection and remediation takes several days. We have also been applying GenAI technology across our entire product line, allowing customers to optimize the security effectiveness and operation efficiency. 4D AI is already available on 4DSIM and 4DSOAR, and more products will be adding this function in the coming months. Before turning the call over to Keith, I would like to thank our employees customers, partners, and suppliers worldwide for their continued support and hard work.
spk05: Thank you, Ken, and good afternoon, everyone. As Ken mentioned, billings grew 8.5%, driven by improved sales execution and early returns on our SASE and SECOP investments. The quarter benefited from what we saw as a muted seasonal budget flush, and certain deals that had pushed from earlier quarters, closing in the fourth quarter, driving a record six transactions, each of which were over $10 million. For these exceptionally large transactions, secure networking was 75% of the billings mix, while SecOps and SASE combined for another 20% plus, illustrating these companies' long-term commitment to both firewall and consolidation strategies. Taking a closer look at three of these eight-figure deals, one of these deals included mid-seven figures for SecOps, and another mid-seven figures for SASE. The SASE solution covers a planned 350,000 user deployment at a top U.S. school district to provide a safe learning environment for students regardless of their physical location. We won this deal because of our operating system's ability to integrate 30-plus networking and security functions across SecOps, SASE, and secure networking into a single unified platform providing consistent policies and automated responses. Our vision encompasses creating a secure foundation for our customers, allowing them to navigate today's evolving digital landscape with confidence while empowering them to embrace innovation without compromising security. Illustrating this vision in another eight-figure deal, a large U.S. enterprise selected Fortinet to support their hybrid cloud architecture as they transition more of their workloads to the cloud. This competitive displacement reduced complexity and the customer's total cost of ownership while showcasing our ability to consolidate security functions onto our Fortinet OS platform. And a third eight-figure win, a large financial institution in the U.S. expanded their partnership with us with their first enterprise agreement with Fortinet. This EA includes a recently announced FortiGate Rugged 70G to secure their remote working in ATM environments. Built with AI power security, the rugged 70G brings our customers the latest secure networking innovations, while at the same time simplifying infrastructure and driving efficiencies. In addition to exceeding the customer's performance expectations and a multi-vendor bake-off, we were successful by demonstrating the versatility of our single operating system and 40 OS platform across multiple use cases. Over the past several years, we have successfully addressed large customer buying preferences by increasing our investments in EA programs. In the fourth quarter, these contracts represented nearly 10% of our billings, with a three-year CAGR of over 80%. Today, with over 35% of our billings beyond traditional and sometimes cyclical firewalls, SportNet has become an increasingly diversified business over the past decade. Most recently, the diversification has included prioritizing investments in SASE, SecOps, and other software and cloud-based solutions. A key element of this diversification is our single operating system strategy. 40OS is the foundation of our comprehensive and innovative solutions that drive the convergence of networking and security, while also consolidating multiple security capabilities. Attempting to piece together best-of-read solutions from multiple vendors can result in significant security gaps, slower AI-driven technology adoption, and a slower pace of identifying, reporting, and resolving security incidents. Organizations increasingly recognize that an integrated security solution run by a single operating system is the best way to improve their security posture. Consolidation allows security solutions to share data and communicate with each other, reducing complexity improving security effectiveness, easing the need for skilled labor, and lowering the total cost of ownership. Consolidation drove our SecOps business to 44% growth, with strong growth from EDR, SIM, email security, and NDR. Importantly, 94% of our SecOps business was from existing customers, as companies looked to execute their vendor consolidation strategy with Fortinet. Digging a little deeper into the 11% of billings that SecOps contributed to our business, the mid-enterprise segment is growing the fastest as these companies respond to the cybersecurity labor shortage and look to reduce complexity. Geographically, international emerging is leading the way for SecOps, likely reflecting stronger economic conditions and extending the success of their 2022 pilot project. Extending the single operating system and consolidation strategy further Our single vendor SASE solution, billings increased 19% and accounted for 21% of total billings. Our SASE pipeline is up over 150% as more of our sales reps are building pipeline. As expected, the SMB segment was the largest mix of SASE customers at 55%, increasing eight points quarter over quarter. 4Net has one of the least complex, and most customer-friendly SASE pricing models. Our one bundle and one operating system solution provides all the standard capabilities, including secure web gateway and firewall as a service for secure internet access. Zero trust network access and SD-WAN from our points of presence, providing secure private access, as well as CASB and data loss protection. Our single vendor SASE solution also includes integration to SOC as a service and FortiClient, which provides the customer with endpoint protection and vulnerability scanning. Regarding our focus and investments in SASE and SecOps, SD-WAN customers represented 37% of new SASE customers. Over 90% of our global sales force has completed mandatory sales training for both SASE and SecOps. In 2023, 60,000 customers and partners attended at least one of our 27 training workshops. Lastly, we've increased our worldwide points of presence coverage to over 150 locations. Turning now to the quarterly financial results, total billings were $1.86 billion, up 8.5%, driven by improved sales execution and a strong rebound in the large enterprise segment, together with 6,400 new logos. On a buildings by geo basis, the U.S. led the way with mid-teens growth driven by strong performance in the U.S. enterprise. In terms of industry verticals, government and financial services, each with growth of approximately 25% were our top two industry verticals, while service provider and retail remained under pressure. The average contract term was 30 months, up two months year-over-year and sequentially. Adjusting for the six eight-figure deals, the normalized contract term was consistent year-over-year and sequentially at 28 months. Turning to revenue and margins, total revenue grew 10% to $1.42 billion, driven by strong services revenue growth. Service revenue of $927 million grew 25%, accounting for 66% of total revenue, a mid-shift of eight points. Service revenue growth was driven by strength in SecOps, SASE, and other security subscriptions. Product bookings were up, however, product revenue decreased 10% to $488 million due to a tough compare. Product revenue grew 43% in the prior year period, benefiting from the drawdown of backlogs. Total gross margin of 78.5% was up 90 basis points and exceeded the high end of the guidance range by 200 basis points, driven by the increase in service gross margin and the eight-point mix shift from product revenue to service revenue. Service gross margins were up 140 basis points as service revenue growth outpaced labor costs and benefit of the mix shift towards higher margin security subscription services. Product gross margins were down 510 basis points as we continued to see margin pressure related to inventory levels and product transitions. Operating margin was very strong at 32%, 3.5 points above the high end of our guidance range, and operating income of $454 million was $40 million above the high end of the implied guidance range, reflecting aggressive cost management. Looking to the statement of cash flow summarized on slides 17 and 19, total cash taxes paid in the quarter were $341 million, including $210 million estimated tax payments that were deferred from earlier quarters in accordance with U.S. and California one-time regulatory relief, resulting in a free cash flow of $165 million. Capital expenditures were $27 million. We repurchased approximately 16.8 million shares at a cost of $895 million for an average cost per share of $53.29. Moving to an overview of our 2023 full-year results, buildings surpassed the $6 billion mark, totaling $6.4 billion and up 14%. Total revenue grew 20% to $5.3 billion, and we added over 25,000 new customers. Service revenue grew 28%, to $3.4 billion, driven by a 33% increase in security subscriptions. Product revenue grew 8% to $1.9 billion, on a very tough compare after growing 42% in 2022. Gross margin was up 110 basis points to 77.4%, benefiting from the revenue mix shift to service revenue. Operating margin also increased 110 basis points to a calendar year record of 28.4%. resulting in operating income of $1.5 billion. The GAAP operating margin of over 23% continues to be one of the highest in the industry. Earnings per share increased 37% to $1.63. Free cash flow was a record at over $1.7 billion. Free cash flow margin was 33%. Including real estate investments, the adjusted free cash flow margin came in at 35%. For the year, we repurchased approximately 20 million shares at a cost of $1.5 billion for an average cost per share of $55.25. And to summarize on slide 20, Fortinet has returned $5.3 billion to shareholders via share repurchases in the past three years. Earlier this year, the Board increased the share repurchase authorization by an additional $500 million. bringing our remaining share repurchase authorization to approximately $1 billion. Moving on to guidance. As we look to 2024, several factors impact guidance, including the firewall industry cycle, remnants of 2022 and 2023 supply chain activity, and customer buying behavior. Prior firewall product life cycles have lasted approximately four years, with eight quarters of higher growth followed by eight quarters of slower growth. Looking at our bookings, the current product cycle decline started approximately four quarters ago in Q1 of 23, suggesting that we should experience the bottom of the cycle in early 2024. Worldwide supply chain challenges resulted in elevated purchasing and record backlog, distorting year-over-year growth comparisons, and creating a period of project and product digestion. The backlog drawdown in the first half of 2023 provided a mid to high single-digit percentage tailwind to billings and low double-digit tailwind to product revenue growth for that period. The year-over-year product revenue comparisons in the first half of 2024 will be the most challenged. While we expect service revenues to grow sequentially in the low single digits in the first quarter and to grow sequentially at low to mid single digits for the remainder of 2024. In addition, we expect product revenue growth will continue to be impacted by project and product digestion in 2024, and we believe the selling environment should improve in the second half of 2024 and into 2025. As a reminder, our first quarter and full year outlook, which are summarized on slides 23 and 24, subject to the 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 $1,390,000 to $1,450,000, which at the midpoint represents a decline of 5.5%. Revenue in the range of $1,300,000 to $1,360,000, which at the midpoint represents growth of 5.4%. Non-GAAP gross margin of 76.5% to 77.5%. Non-GAAP operating margin of 25.5%. and 26.5%. Non-GAAP earnings per share are 37 to 39 cents, which assumes a share counted between $775 and $785 million. Capital expenditures of $220 to $250 million, including a real estate transaction that closed earlier in the quarter. A non-GAAP tax rate of 17%, and cash taxes of $30 million. For the full year, we expect billings in the range of $6,400,000,000, to $6,600,000. Revenue in the range of $5,715,000 to $5,815,000, which at the midpoint represents growth of 9%. Service revenue in the range of $3,920,000 to $3,970,000, which at the midpoint represents growth of 17%. Non-GAAP gross margin of 76% to 78%. non-GAAP operating margin of 25.5% to 27.5%, non-GAAP earnings per share of $1.65 to $1.70, which assumes a share count of between 785 and 795 million, capital expenditures of 370 to 420 million, non-GAAP tax rate of 17%, and cash taxes of 520 million. I look forward to updating you on our progress in the coming quarters. And I now have to call back over to Peter to begin the Q&A session.
spk15: Thank you. As a reminder, during the Q&A session, we ask that you please limit yourself to one question and one follow-up question to allow others to participate. Operator, please open the call for questions.
spk00: As a reminder, to ask a question, you'll need to press star 1 1 on your telephone and wait for your name to be announced. To withdraw your question, please press star 1 1 again. Please stand by while we compile the Q&A roster. Our first question comes from the line of Fatima Bulani with Citi.
spk01: Good afternoon. Thank you for taking my questions. Keith, I really appreciate you fleshing out some of the factors that are going to be creating volatility in your top-line performance, but what I wanted to focus on was how you are able to hold the line on the expense structure in light of these volatilities, both on the revenue and billing front. So if you can just help us appreciate how you're able to manage for profitability. And then by extension, these top line volatilities, how should we think about the free cash flow cadence against your assumptions on the OPEX structure, along with the fact that you have seen lumpy, very large deals that have positively influenced duration for now. Thank you.
spk05: Yeah, I think kind of going backwards in terms of the very large deals that we talked about, you know, I think experience has showed us in the second half or the middle part of last year that we're well served not to get too far ahead of ourselves in terms of forecasting those deals. And it's difficult to understand when they're actually going to close and what the specific terms are going to be with those. So I think we kind of set those aside, and you saw that in some of the performance in the fourth quarter. In terms of margins, you know, I think that sometimes the business model is easier than people think it is when it comes to margin because services provides so much of the business. You know, if the business model is two-thirds services and it's throwing out a very rich margin, even in a period of time where you're going through the firewall refresh cycle, you're still seeing your margins hold up fairly nicely. I think there's also significant economies of scale involved in the services line, whether it's the support or the security subscriptions. And then the last one I would offer is that I think the breadth of both the SecOps solutions and the SASI solutions together are serving to spread some of the incremental costs for the hosting solutions and bringing those to market.
spk00: Thank you. Our next question will come from the line of Hamza Fadarwala with Morgan Stanley.
spk16: Good evening. Thank you for taking my question. Ken, over the last several years, we've seen some pretty significant increases in network traffic, whether it be more cloud adoption, more work from home, et cetera, and that's led to pretty healthy firewall refresh over the last several years. I'm curious, and I know it's very early innings, but how do you see the adoption of generative AI, particularly in some of these hybrid contexts, impacting network traffic going forward? And do you think that that's going to incent more firewall refresh to secure that growing network traffic? Thank you.
spk11: Long term, definitely we see that gen AI will increase the traffic a lot and also automate a lot of security operation. We also see the refresh of the file cycle. We do provide some kind of data there. But we also see a lot of new opportunity. We now come at the refresh. Like we mentioned in the script, some of the OT technology area and even supporting some work from home. And also some other enterprise internal segmentation replacing the traditional switch with a network security firewall that we call the convergence, also starting to get more and more adopted by the big enterprise. So that's also the new market compared to the traditional firewall. But I agree with you, the next phase of connection, the traffic will keep increasing, especially more devices will be connected online and also more people will work remotely. And at the same time, the AI also kind of generates quite a lot of additional data, which also kind of need to be secured. So we see a pretty good potential for the long-term growth.
spk16: Thank you.
spk11: Thank you.
spk00: Our next question will come from the line of Brian Essex with J.P. Morgan. Brian, your line is now open.
spk13: Great. Thank you very much, and thank you for taking the question. I guess maybe for Ken, could you dig in a little bit to the SASE performance of the quarter? If I recall correctly, and I don't know what kind of metrics you can break out to give us a little bit more color behind that, but if I recall, you were doing quite well with kind of the SD-WAN component, and we're trying to kind of pivot to better penetrate the secure service edge component Maybe a little bit of color as you've pivoted towards, I guess, focusing a little bit more on SecOps and SASE. What is the nature of the deals look like this quarter? What do you see in the pipeline for SASE? And are you getting better traction with Secure Service Edge? And does that include SD-WAN or is it relatively agnostic to SD-WAN? Thank you.
spk11: I think you probably can recall in the last earning call, we started more focused on SASE SecureOp and started tracking that separately. And also during key script, we also mentioned 90% of our sales force also being trained certified for SASE SecureOp. And also all the six eight-figure deal, including all the three, Secure Networking, SASE, and the SecureOp. So we do see it grow faster, especially during the current kind of environment of refresh cycle. We do see the SASE, which is more consumption model, and also SecureUp, which can lower operation costs, probably grow faster than the traditional secure networking area. So that's where we kind of redirect some focus, resource, more focus on these two areas. We see a pretty huge success grow both the pipeline and also even the deal we close some of the first eight figures that he deal, which also makes the field pretty excited. I think that it's a we didn't see this is we have some advantage actually, leverage the whether the SD one huge deployment we have all the firewall huge deployment and also the single OS-based SASE solution, which integrates all the IC1, all the SASE functions into a single 40 OS, which is a huge advantage for whether the customer themselves or even for some service provider offer the SASE service to their customer base. So it's a pretty strong growth. This is a pretty good move we have.
spk05: Yeah, Brian, I would kind of follow that up with some of the results, if you will, of what Ken just talked about. And to your point, I think you were kind of asking us, if you focus more on the SSE element of SASE and less on SD-WAN, what does that mean? And I think that we have a pretty interesting horse race developing internally. If you look at what you would probably think of as the SSE component and the SECOPS business, both growing in the 40% range. SecOps won the quarter. We'll see how SASE does, but they're very, very close at this point in time in terms of growth. And then I think the other metric we gave, we talked about the pipeline growth, and that 150% would really be around what you would think of as the SSE component.
spk13: Got it. That's really helpful. We'll keep it to one and keep it efficient, but thank you so much, both of you. Appreciate it.
spk09: Thank you.
spk00: Thank you. Our next question will come from the line of Tal Liani with Bank of America.
spk08: Hi, guys. I'll ask two questions together. It's easier. CapEx is going up materially next year, this year. What is the outlook for free cash flow margin? What happens to free cash flow this year? Can you actually drill down to the CapEx? What drives the increase and then what happens to free cash flow margin? The second question I have is on the business. This quarter, billings were supposed to be weak, but they're very strong. Next quarter, we expected roughly 5%, 6% declines, and that's what you're guiding to. So that means maybe there was some pull forward, but kind of in line-ish. So what happens this quarter that billings is so strong versus expectations? What drove the strength? and why don't we see it continue into the next quarter? Thanks.
spk05: You want to take CapEx or deals? Hi, Tal. How are you? Thanks for calling in. On CapEx, I think we'll continue to build out both things that we need for our engineering team as we look forward, and best places to work and labs and so forth. So I think you're seeing an element of that. But also, you know, our ability to continue to deliver the wide range of hosted solutions. I think those are the things that are driving CapEx. And as we said before, you know, we know that there's a bias here of making real estate investment decisions with an eye as a long-term investor. And with that, you know, the ROI over a longer period of time has always been very enticing to us. And I think to your second question on, you know, the spike that we saw in performance that we're very pleased with in the fourth quarter, And then what does that translate to in the first quarter? A couple things. One is, as we talked about during the call, the comps in the first quarter of 2024 are probably among the most challenging on the billings line and the product revenue line that we think we're going to see. And then I think also the read-through on doing six eight-figure deals in the fourth quarter and being a record obviously put a lot of tailwind into that fourth quarter number. We like eight-figure deals, but I don't know that we're really in the business of forecasting them each and every quarter as we go forward.
spk11: Also, we kind of own probably a high percentage of some infrastructure, some real estate, and some of our competitors. That actually gave us much lower cost, operation cost, going forward, which also will help drive the future growth, especially on the service like SASE. And that also gave us a better margin long-term.
spk08: in free cash flow specifically because your stock trades on free cash flow should we expect free cash flow to go down or is it is it can you offset the increase in capex with something else well yeah obviously there's a lot of levers that come into free cash flow you know i think that where we look at in terms of where the street was for free cash flow in in 2024 for the full year
spk05: You know, I think that's in the ballpark at this early stage. We don't really guide to free cash flow, as you know. But I think the puts and takes, one is CapEx, which is not all that far away from what we saw in 2023. But then you have the operating profits, you know, the buildings growth, et cetera. You know all the components that go into it. Got it. Thank you.
spk00: Thank you. Our next question will come from the line of Gabriela Borges with Goldman Sachs.
spk10: Good afternoon. Thank you. I'm looking to better understand the SASE dynamics that you're seeing at the lower end of the market versus the higher end. So maybe any commentary on the SMB part of the SASE pipeline, what you're seeing in terms of willingness and readiness to convert, what you're seeing in terms of competition, and what you're seeing in terms of average deal sizes in terms of uplift when you get a SASE deal versus a regular firewall deal. Thank you.
spk11: SMB is pretty interesting. We do quite well in the SMB market, even for the traditional firewall, bigger than any other competitors. But also SMB has a pretty low percentage of a customer actually using any network security because whether the management costs or some other people cost, all these kind of things. So that's where SASE applied there, definitely helping some SMB customer. but also we see kind of the long-term combined both by the work from home, we're pretty strong like a couple years ago in the retail branch office solution there, also helping us kind of like doing well in SMB. And also the new product, Refresh, which leveraged SP5, We're only half the way, probably towards the second half of this year, we have more product come in using the new SP5. That's also keeping a hands-up position there. Yeah, it's a kind of, like I said, it's a more kind of consumption model. In a current environment, probably be more attractive compared to a CapEx model. So that's where we see both SMB Enterprise, they do have some more interest to do this kind of OpEx model. Maybe, excuse me, John, any additional?
spk04: I would just say that the success we had in enterprise, this is John Whittle, by the way, with the number of eight-figure deals and having over a half million customers out there, really bodes well both in enterprise and in the SMB market because we've got so many customers out there that are testing our product. and so many customers that are providing feedback along the way to improve our products, that it's a real testament to the products and gives both enterprises and the SMB comfort in buying our products going forward. And you can kind of put yourself into a customer's shoes and say, okay, some of the most discerning customers are spending eight figures on these products and services, and we have strength in SMB and upmarket. I think that bodes really well for kind of the smaller segments of the market and the larger segments of the market going forward. I think that's a real headline from this quarter in terms of the real success we had with some of the most discerning customers out there.
spk10: Thank you for the call.
spk00: Thank you. Our next question will come from the line of Saket Kohia with Barclays.
spk06: Okay, great. Hey, guys, thanks for taking my questions here, and well done. Keith, maybe for you, I just want to talk about the shape of Billings a little bit here in 2024. I think at the midpoint for this year, Billings is about 2%, give or take, at the midpoint. How should we sort of think about the exit rate on Billings this year? I know that was something we talked about in prior quarters. I'm not sure if that's something that we could just revisit. And then maybe relatedly, It was great to get the segment detail, by the way, across the three segments. How are we sort of thinking about the rough growth ranges for those three segments as part of this guide?
spk05: Yeah, I think on the billings trend, if you will, I would go back to our prior conversations about, you know, the backlog created, the headwind, if you will, in the first half of the year. And I think you heard some of the tone of that, if you will, right before I gave the guidance this year. And that would suggest that You know, our expectations are that, you know, billing's growth rate should be improving as we move through on a quarterly basis as we move through the year. I think we probably made it a little bit tougher on the sales team for the fourth quarter of 2024 by having such a strong fourth quarter of 2023, but I think they're going to do pretty well there. And then, I'm sorry, the second part of the question socket was?
spk06: It was just on the three segments, right, secure networking, SASE, and SecOps. it was helpful to get sort of the growth ranges for this quarter. Not going to hold you to it, but how do you think about sort of the relative growth rates for those three segments this year?
spk05: And maybe I'll answer that in the context of average contract term or duration, because I know there's a lot of concern or questions that have been raised about, you know, will that shorten the contract term? And you heard the data that we gave during the call. You know, these two segments, you know, we have a business that basically runs on, Average contract terms, we call it two years, two and a quarter, if you will. A SASE and SECOPS business mix would probably be billing one year in advance when you look at the competitors and so forth. So that kind of gives you the range. It's going to take a while for SASE and SECOPS to really impact that contract term or duration. And I think the read-through to that in terms of, you know, we're excited about the opportunity with SASE and SECOPS. If we have outsized growth there, we'll be very pleased with it. But I don't know that we're hanging our head on something completely out of the realm of reality, if you will, for 2024 from SAS here at SecOps.
spk11: For the three segments, I don't have the latest market data, but from Q3, the firewall market is kind of flat here over here. Q4, we probably will wait out company reporting. But we do see probably still under some pressure this year, especially the first half of this year. But I do believe the long-term convergence story will hold quite well because the company also needs to manage the account application level, which is how to use network security to do that. So that's where long-term we do see that the firewall market or the network security market will continue to grow. I feel probably around 10% year-over-year in the next maybe three to five years. SASE and SecureOps come from maybe smaller base, which also grow faster. And we also have a lot of existing customer. I want to adopt all this together with us. They probably already are firewall customer, SD-WAN customer. They can easily adopt additional solution, additional product. So that we see the other two sector grow faster than the company average and probably continue to grow faster in the next few quarters. Very helpful. Thanks, guys. Thank you.
spk00: Thank you. Our next question will come from the line of Andrew Nowinski with Wells Fargo.
spk14: Great, thank you for taking the questions. So I was just wondering if you could, and we've talked a lot about your other pillars, I was wondering if we could touch on SecOps and maybe what's driving that. Is that related to the recent SEC regulation? And then second, I was wondering if you look at your billings guidance for the year, where do you see the most risk as it relates to that guidance in terms of the three pillars and the performance you're expecting from those three pillars?
spk11: Yeah, the secure up is actually helping customer more like better security and the more efficient and also lower the total management costs. That's where I need to have a multiple solution, multiple product integrate together, automate together. So that's we see during the current environment, a lot of our company and because small, they do see the security, the area, they probably work it on the investment there. And also, we do see the merging of networking and security together, which also secure play a quite important role to make sure the two operations can be operated together, which we are needing in this area. So that's where secure operations see pretty strong growth. SaaS is more like a consumption model. We also see it kind of fit the current environment well. Even the cost could be a little bit higher than the appliance, but it's a give the customer flexibility so that we see that.
spk04: I think for SecOps, what we're seeing is the threat landscape out there is driving a lot of the customer behavior as well. You see these ransomware attacks that are really debilitating to customers, and so prevention is important, but time to detection and time to remediation is critical, and it's real money. And these are These are really important issues for our customers. And also I would note, we've really been building this solution over many, many years, but we really just started to focus on it as a separate pillar three months ago. And then we had a record Q4. And so I think that degree of focus internally coupled with how we can actually help our customers, putting our customers first, really is driving a lot of the success there. And that new focus, you know, we're pretty much sticking to the plan. The plan's working. We're sticking to the plan. And so we see a lot of opportunity there.
spk00: Thank you. Our next question will come from the line of Brad Zelnick with Deutsche Bank.
spk07: Great, thank you so much. I think I've got one for John Whittle and one for Keith. First, just for you, John, given your recent appointment as Fortinet's first ever COO, can you talk about your perspective stepping into the role and how you plan to help drive Fortinet's business forward? And Keith, for you, in your guidance comments, you said for the full year that you expect the selling environment to improve in the back half and into 2025. And I'm not saying I disagree with you, but I'm just curious why you say that and if it's just relative to the comments that you also made on the firewall cycle dynamics or if it's something else more broadly in the economy that you're expecting. Thanks.
spk04: Thanks for the question. I'm really excited about the role. I've been working here for 17 years through a lot of growth, and my focus over those 17 years has really been learning from Ken and Michael and the team. And it's like an MBA on steroids. You know, they're brilliant business people in addition to focusing on the innovation and the technology, which I think is a core differentiator for Fortinet. We are an innovation-first company. And, you know, I think our culture is really around what I call almost a straightforward meritocracy. And Ken and Michael drive this throughout the organization. It's very straightforward. It's work hard, work smart. innovate and put the customer first and deliver results. And so I really like the culture. Obviously, I've been here 17 years. Some people say I need to get more creative with my career, but it really gets me excited to make a difference. And it's a positive difference. We're protecting our customers so they can get about their business. So I really like that. And in terms of how I can contribute, up until now, I've focused on legal and corp dev. I'm taking over corporate real estate. I'm adding systems, manufacturing, and logistics, and so I have a broad set of responsibilities. I also have always worked very closely with the sales teams. I will not be managing the sales teams, but I will continue to work closely. Teamwork is one of our top three culture items here, and we're not really boxed in here in a way. We really work together, and so we've got great sales leaders and I look forward to working with them. We've got a huge opportunity to grow. We want to grow and capture that opportunity by putting the customer first. I want to support that, and to the extent I can help the team, I want to do that. To Fatima's question earlier, we're also very disciplined on the cost side, and as Keith said, we have this services model where we have a lot of visibility based on the deferred revenue on the top line, but we also very disciplined kind of managing and monitoring the costs on a real-time basis and you know sometimes you can control the costs you know more quickly than than other things and so what I've noticed is you know we're very good at kind of managing that on a real-time basis and we'll continue to do that as well welcome John thank you thank you John and John also help us form the company culture
spk11: on the very beginning, which is the teamwork and also openness and also innovation. So we'll continue to maintain this culture and keeping growing the company together.
spk05: And then quickly, Brad, on the other, I mean, yes, obviously the view of the firewall cycles has a part of it, but I think probably more to the point is the digestion of products and projects. And if you look back at where the peak was of firewall purchasing and you kind of play that out, you should be coming to a logical end of deployment cycles.
spk07: Great.
spk13: Thank you, guys.
spk00: Thank you. Our next question will come from the line of Keith Bachman with BMO.
spk02: Hi. Many thanks. And Peter and Keith, thank you again for the disclosures on the segments within Billings. It's very helpful. Two questions. One is on strategy and one is on guidance. Ken, on the strategy question, I wanted to ask you on your perspective on the unified SASE excluding SD-WAN and SecOps. There's two broad variables that I think about. One is go-to-market and one is product or R&D. You've clearly increased the go-to-market efforts surrounding unified SASE and SecOps. I'm wondering, do you feel the need to also incrementally focus on the product side or incremental R&D, if you will, to strengthen the portfolio for things such as improving your positioning within the Gargent Magic Quadrant or however you want us to think about it. So is it more go-to-market that you think incremental efforts, or it's both incremental, both the R&D side and as well as the go-to-market? And just in the interest of time, I'll ask my second question. Keith, on the guidance, it's just given the performance in the quarter, and I'm really focused on the year, not the March quarter. It does seem very conservative. You very much outperformed your expectations associated with the December quarter. And you're guiding for kind of 2%. And even if you normalize for the backlog burn, you're sort of mid single digits, maybe a little bit better than that. And so I guess I'm just trying to reconcile the, it seems like very conservative guidance. And perhaps the way to ask the question is, how do you think about the product side as we get to the back half of the year? Do you think that industry demand returns to normal levels or do you still think there's some pressure on the product side or anything else you want to draw comments on associated with what seems to be conservative billings guide? Thank you very much.
spk11: Yes, a very good question about SASE. Definitely we want to do both, even more than that. So we definitely see the opportunity changing our go-to-market strategy because a few months ago we were more dependent on the service provider carrier, try to do SASE, help them to do SASE. Now it's more go-to-market, direct ourselves, and at the same time, working with our service provider. But also more important, really, internal R&D, internal investment in the infrastructure. Like we mentioned, now we have over 150 POP worldwide, probably can match any other competitor. At the same time, the function, the innovation, and also put all the SASE in a single OS, And then a lot of functions that are used in ASIC will accelerate, and that also makes our SASE solution much better, more advantage compared to other competitors, and also more easy to deploy, more easy to manage. So we see that that's a huge opportunity for SASE. It's not just SASE using the traditional cloud approach, but also on-premise SASE, the private SASE. So we see a lot of opportunity for SASE going forward, both on the technology, which we also work at our innovation developing technology, and at the same time, the go-to-market strategy, once we focus, we see huge success behind.
spk05: And just on the guidance, Keith, I appreciate the thought after kind of a tough middle of the year last year for us. So for me, I think keep in mind that we do probably have between $150 and $200 million of headwind related to backlog or year-over-year comparisons, if you will, the backlog impact in the year. I think also in some of the commentary that we provided right before guidance where we talked about the relative impact, specifically the product revenue and what you should see from service revenue for the year, you know, you can kind of get a sense of what we're thinking about for product revenue. I think we – I do see that some opportunities on the service revenue line with things that come from SECOP and SASI in the year But I think all in all, I think where we're at right now in terms of the full year guidance number is an appropriate number for us.
spk02: Okay. All right. Many thanks. Congratulations, guys. Thank you.
spk00: Thank you. Our next question will come from the line of Itai Kidron with Oppenheimer.
spk03: Thanks. Hey, guys. A couple for me. First, on the comp side, As you move into 24, can you share a little bit more color on the changes you're making or have made to the sales comp and what kind of incentives have you laid in place in a way that's different than 23? And then on the competitive front, just given where your position on SecOps and SASE, I think you've talked about kind of more meat enterprise on the SecOps and more SMB is the largest category in SASE. Can you talk specifically on who do you see more as competition in those categories, because you don't seem to kind of stretch the entire customer profile. So or regions, frankly, so we'll love to get a little bit more color into who do you see more versus less in those categories? Thank you.
spk11: Yeah, we kind of keeping improving the the sales comp plan and also try to learn what's the company goal and what's the the field sales and also how we can move kind of a tie together and success together so that there's some modification of the comp plan which move towards the company long term both on the growth on the margin and also reflect more on some kind of a like a service based kind of model there behind. So that and also kind of keeping invest in the sales force and also kind of making the structure more efficient. That's out of the area. And also training the sales and make sure because there's a lot of new area, whether the SaaS you secure up, do need a lot of training. That's also the big enhancement we are kind of going through right now.
spk05: Yeah, I'd probably add to that. It's all just a couple of things on the comp plan conversation. This is the time of year where comp plans go out and I think every company seems to make some changes. I think the real thing that jumps out at me this year is that I think, you know, after the 2023 results, you know, the quotas are probably a little bit lower on an individual basis than they have been in the past. And we've probably put some things to work in the other direction on it. But to Ken's point, you know, we really want to make sure that we're investing in building on this sales team and, you know, making the adjustments in the quota for 2024, I think is appropriate. You know, on the SMB and SASE or pardon me, the SASE and SECOPS conversation and, I think it goes back to some of Gabriella's question before. At this stage, we're really shaping up in terms of having different customer mixes. The SMB portion of SASE was about 55% of the business, and we're not surprised to see us having very, very early success there. We're pleased with the development and the feedback we're getting from third parties about the success of the SASE product, but that together with our SD-WAN customers is the logical place to see success. On the flip side, tech ops is almost the opposite, with large enterprises providing about 55% of the business. And I think the read-through to that is all about consolidation, where you're really going to have successes, and it ties into the mix of repeat customers, i.e. firewall customers are now buying the tech op products, being very, very high. And that's what we would expect out of both of those business segments.
spk11: For all of these sales, and also sometimes even for partners, If they sell all three solutions, Secure Networking, SASE, and SecureOps, they get more comp compared to only sell one or two solutions. So that's the additional incentive we offer to the field.
spk03: Maybe as a follow-up, Keith, how much of the opportunity here in SecOps and SASE is outside of your customer footprint? Is the vast majority of traction here just with your existing install base, or it also pulls you outside?
spk05: Yeah, as John pointed out, we have over 500,000 customers, so I'm okay with the install base, right? And I don't think that's anything new. For several years, we've talked about new logos representing large numbers, thousands of new logos, but they've never really been more than 10% of the business. So I don't think that this is really going to change with that. I expect that. The firewall is such a compelling product because of the price or performance advantage, because of how more and more security have embedded into the operating system, and the ASIC empowers that. I'm not a salesperson. If I was, I'd probably be looking for those opportunities in the white space accounts. And then you want them, like any other enterprise company, to come back and sell more into that company. And that's really what you're seeing with the SecOps and SASE products that Ken and John have been talking about.
spk17: Thank you.
spk00: Thank you. Our next question will come from the line of Adam Tindall with Raymond James.
spk12: Okay, thank you. Let me see if I can get everybody involved here. So, Ken, I wanted to start with SASE and SecOps was obviously a key pivot point on the last call. As you focus on that more internally, could you summarize your competitive advantage technologically in those areas? And, John, logistics from a sales perspective, I know it's been kind of kicked around. A percent of quota retirement might be related to those areas. What did you land on for logistics there? And lastly, for Keith, expectations for sales productivity as a result of that pivot towards SASE and SecOps. Just wondering your early observations on what you've seen, because it looks like you do expect total margins down, but I think it's somewhat related to gross margin, not much efficiency drain. So just what you're seeing from a sales productivity perspective as you pivot to those areas. Thank you.
spk11: Yeah, for SASE, we are the only company, we believe, who has all the SASE functions, SD-WAN, all the CASB web service, all in a single operation system, can be deployed on on-premise using AC for Accelerate or using CloudFormat there. So that's a huge advantage, both for the customer, for the service provider. I think on the SecureOps side, we also most importantly internally developed, whether from endpoint or from all these different email application, web, all these things, it's because when we internally develop, it's integrate, automate much better than other competitors, more comfort acquisition, which is a separate product that's more difficult to integrate, automate together. So that's the two huge advantages we have. We usually call the secure app more like a fabric approach. I've been doing that for 10 years, which is pretty successful, but now we have the same term, which customer wants to hear is a secure app. which they see the huge advantage. That's why we have a huge growth going forward. And also the field training also kind of help a lot. So that's the advantage we have, whether the SASE single OS approach, I can use ACETA, accelerate, and then the secure op is an integrated automate together much better than other competitors. It gave us a huge advantage.
spk04: In terms of the quota retirement question, Keith may have additional comments on it, but there's really no change there.
spk05: Yeah, I think OTE and numbers, targets are very much the same. I think on sales productivity, you know, in terms of what we saw in 2023, as we move through the year, you know, obviously productivity kind of came down. It seems to have leveled off now as we exit 2023. And I think that the modeling, if you will, is pretty much a similar expectation for 2024 in terms of where we exit at 2023. On the – there's another part of that I forgot. I think in terms of would SASE and SACOPS dramatically change those numbers, I kind of go back to the earlier conversation about contract term. Sure, at some level, if the mix shifts and becomes 50-50 or 60-40 in that direction, then we probably have something to talk about, although I'd probably be talking a lot more about the fantastic growth in SACOPS and SASE than the fact that I had to pay salespeople to make that growth happen.
spk00: That concludes today's question and answer session. I'd like to turn the call back to Peter Salkowski for closing remarks.
spk15: Thank you, Liz. I'd like to thank everyone for joining today's call. Fortinet will be attending an investor conference hosted by Morgan Stanley during the first quarter. The Fireshare Chat website link will be posted on the events and presentation section of the Fortinet's investor website starting soon. If you have any questions, please feel free to reach out. Have a great rest of your day. Thank you.
spk00: This concludes today's conference call. Thank you for participating. You may now disconnect.
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