Fortinet (TICKER: FTNT) Fortinet Inc Ftnt Q4 2023 Earnings Call Transcript

Fortinet, Inc. (NASDAQ:FTNT) Q4 2023 Earnings Conference Call February 6, 2024 4:30 PM ET Company Participants Peter Salkowski - Senior Vice President of Finance & Investor Relations Ken Xie - Founder, Chairman & Chief Executive Officer John Whittle - Chief Operating Officer Keith Jensen - Chief Financial Officer Conference Call Participants Fatima Boolani - Citi Hamza Fodderwala - Morgan Stanley Brian Essex - JPMorgan Tal Liani - Bank of America Gabriela Borges - Goldman Sachs Saket Kalia - Barclays Andrew Nowinski - Wells Fargo Brad Zelnick - Deutsche Bank Keith Bachman - BMO Ittai Kidron - Oppenheimer Adam Tindle - Raymond James Operator Good day and thank you for standing by. Welcome to the Fortinet Fourth Quarter 2023 Earnings Announcement. [Operator Instructions] 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. Peter Salkowski Hey viewers, 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 Xie, 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 options 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 and the fourth quarter of 2023 before providing guidance for the first quarter of 2024 and the full year. We'll then open the call for questions. [Operator Instructions]. 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 on the quarterly earnings section of our Investor Relations website immediately following the call. Lastly, I'll reference to growth are on a year-over-year basis unless noted otherwise. I will now turn the call over to Ken. Ken Xie Thank you, Peter, and thank you to everyone for joining our call. In Q4, total billing grow 8.5% to $1.9 billion, driven by increased focus on Secure Op, 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 Ops, and secure networking solutions [Indiscernible] our value of an integrated platform and that span across on-premise and cloud, as well as our FortiASIC technology advantages. Putting a total addressable market across secure op, 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 healthcare. Our Secure Ops billing grow 44%, accounted for 11% of total billing, with strong performance from several solutions, including EDR, SIEM, email security, and NDR, to automatically detect, investigate, and respond to threats. Unified SASE billing grow 19%, accounted for 21% of total billing. We believe Fortinet is the only company with a Unified SASE solution, all integrated into a single FortiOS, that including a full networking and security stack, consisting of a market-leading SD-WAN, ZTNA, secure web gateway, CASB, and firewall as a service, designed for on-premise and cloud. Our FortiSASE solution is gaining momentum quickly, as we closed our first eight-figure SASE deal for 350,000 seats. In Q4, we added 40 new features to our SASE solution, including support for over 150 PoP location worldwide, and the ability to protect thin edge device. We see a huge opportunity to attach FortiSASE to our tens of thousands SD-WAN customers. Secure networking accounts for 60% of billing, and represent 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 FortiOS operation system, consolidate over 30 networking and security functions together. Converged security and networking require more specialized computing power than traditional networking. Our FortiASIC power, FortiGate, delivers 3x to 10x more performance as indicated by secure computing region with every new FortiGate product release. The latest FortiASIC SP5, based on FortiGate 70G, with dual 5G in ruggedized format, secure device within operation technology environment. It is off a great start as a Fortune 50 company signed a eight figure operation technology deal, feature this new FortiGate in the fourth quarter. Also included with our FortiOS operation system is a Forti featured access point controller. Recently, we announced a new secure 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 tech service automatically, containing and remediating incident within seconds, where the industry average for detection and remediation takes several days. We have also been applying Gen AI technology across our entire product line, allowing customers to optimize the security effectiveness and operation efficiency. FortiAI is already available on FortiSIEM and FortiSOAR and more product 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 continuous support and hard work. Keith Jensen 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 customers' total cost of ownership while showcasing our ability to consolidate security functions onto our FortiOS platform. In 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 the recently announced FortiGate Rugged 70G to secure their remote working and ATM environments. Built with AI-powered 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 in a multi-vendor bake-off, we were successful by demonstrating the versatility of our single operating system and FortiOS 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, Fortinet 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. FortiOS 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-breed 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, SIEM, 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. Fortinet 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 a 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 billings-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 mixed 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 backlog. 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 mixed shift from product revenue to service revenue. Service gross margins were up 140 basis points as service revenue growth outpaced labor costs and benefited from the mixed 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%, three and a half 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 state of the 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 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, billing 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 going 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 2023, suggesting that we should experience the bottom of the cycle in early 2024.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 billion to $1.450 billion, which at the midpoint represents a decline of 5.5%, revenue in the range of $1.300 billion to $1.360 billion, 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% to 26.5%, non-GAAP earnings per share of $0.37 to $0.39, which assumes a share count of between $775 million and $785 million. Capital expenditures of $220 million 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 billion to $6.600 billion, revenue in the range of $5.715 billion to $5.815 billion, which at the midpoint represents growth of 9%. Service revenue in the range of $3.920 billion to $3.970 billion, 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 million and $795 million. Capital expenditures of $370 million 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'll now hand the call back over to Peter to begin the Q&A session. Peter Salkowski 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. Question-and-Answer Session Operator [Operator Instructions] Our first question comes from the line of Fatima Boolani with Citi. Fatima Boolani Good afternoon. Thank you for taking my questions. Keith, I really appreciate you flushing 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 the volatility both on the revenue and billings 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 OPEC structure along with the fact that you have seen lumpy, very large deals that have positively influenced duration for now? Thank you. Keith Jensen Yes, I think kind of going backwards in terms of the very large deals that we talked about, 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, I think that sometimes the business model is easier than people think it is when it comes to margin because services provide so much of the business. 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 thing I would offer is that I think the breadth of both the SecOps Solutions and the SASE Solutions together are serving to spread some of the incremental costs for the hosting solutions and bringing those to market. Operator Thank you. Our next question will come from the line of Hamza Fodderwala with Morgan Stanley. Hamza Fodderwala 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, etcetera, 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 sort of 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. Ken Xie Long-term, definitely we see that gen AI will increase the traffic a lot and also automate a lot of security operations. We also see the refresh of the firewall cycle. We do provide some kind of a [Indiscernible] 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 refreshed traditional firewall. But I agree with you, the next phase 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. Hamza Fodderwala Thank you. Ken Xie Thank you. Operator Our next question will come from the line of Brian Essex with JPMorgan. Brian, your line is now open. Brian Essex 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're 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. Ken Xie I think you probably can recall in the last earnings call, we started more focus on SASE SecureOps and started tracking that separately. And also, we also mentioned 90% of our field sales force also being trained certified for SASE SecureOps. And also, all the six eight-figure deals, including all the three, secure networking, SASE and the SecureOps. 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 SecureOps, which can lower the operation cost probably 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 closed some of the first eight figure SASE deal, which also makes us feel pretty excited. I think we have some advantage, actually, leverage the SD-WAN huge deployment we have, all the firewalls, huge deployment, and also the single OS-based SASE solution, which integrates all the SD-WAN, all the SASE functions into a single FortiOS, which is a huge advantage for whether the customer themself or even for some service provider, offer the SASE service to their customer base. So it's a pretty strong growth. We see it's a pretty good move we have. Keith Jensen Yes, 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're kind of asking us, if you focus more on the SSE element of SASE and less on SD-WAN, what does that mean. 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. Brian Essex 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. Operator Thank you. Our next question will come from the line of Tal Liani with Bank of America. Tal Liani 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-is. 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. Keith Jensen 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 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, we know that there's a bias here of making real estate investment decisions with a high as a long-term investor, and with that the ROI over a longer period of time has always been very enticing to us. And I think your second question on 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 of things. One is, as we talked about during the call that 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 reentry one 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. Ken Xie 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 a service like a SASE. And that also gives us a better margin long-term. Tal Liani And then free cash flow specifically because your stock trades on free cash flow, should we expect free cash flow to go down, or is it -- can you offset the increase in CapEx with something else? Keith Jensen Well, obviously, there's a lot of levers that come into free cash flow. I think that where we look at in terms of where the street was for free cash flow in 2024 for the full year, 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, the buildings throughout, etcetera. You know all the components that go into it. Tal Liani Thank you. Operator Thank you. Our next question will come from the line of Gabriela Borges with Goldman Sachs. Gabriela Borges 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 S&B 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. Ken Xie S&B 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 of whether the management costs or some other people cost, all these kinds of things. So that's where SASE applied there, definitely helping some SMB customers. But also we see kind of the long-term combined both where to 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. It's kind of like I said, it's a SASE more kind of consumption model. In a current environment, probably it would 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 John Whittle. John Whittle 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. Gabriela Borges Thank you for the color. Operator Thank you. Our next question will come from the line of Saket Kalia with Barclays. Saket Kalia 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? Keith Jensen Yes, I think on the billings trend, if you will, I would go back to our prior conversations about, the backlog created a 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, our expectations are that, billings growth rates 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 fairly well there. And then, I'm sorry, the second part of the question, Saket was? Saket Kalia 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? Keith Jensen 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 have been raised about, will that shorten the contract term? And you heard the data that we gave during the call. These two segments, 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, 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 for SASE or SecOps. Ken Xie Yes, for the three segments, I don't have the latest market data, but from Q3, the firewall market is kind of flat here. Q4, we probably will read 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 converging story will hold quite well because the company also needs to manage the kind of application level, which is how to use network security to do that. So that's where long-term we do see 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 SecOps come from maybe smaller base, which also grow faster. And we also have a lot of existing customers. I want to adopt all this together with us. They probably already are firewall customers, D1 customers. They can easily adopt additional solutions, additional products. So that's where we see the other two sectors grow faster than the company average and probably continue to grow faster in the next few quarters. Saket Kalia Very helpful. Thanks, guys. Operator Thank you. Our next question will come from the line of Andrew Nowinski with Wells Fargo. Andrew Nowinski 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 billing 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? Ken Xie Yes, the SecOps is actually helping customers more like better security and more efficient and also lower the total management costs. That's where I need to have multiple solutions, multiple products integrated together, automated together. So that's what we see in the current environment of our company. And because small, they do see the SecOps already. The area they probably work on the investment there. And also we do see the merging of networking and security together, which also SecOps plays 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 SecOps, we see pretty strong growth. SASE is more like consumption model. We also see kind of fit the current environment well. Even the cost could be a little bit higher than the appliance. But it gives the customer flexibility. And so that's where we see that. John, you want to answer? John Whittle Yes, and 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 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, 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. Operator Thank you. Our next question will come from the line of Brad Zelnick with Deutsche Bank. Brad Zelnick 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. John Whittle 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. 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 I think our culture is really around what I call almost a straightforward baritocracy. 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 I really - 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. 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 are very disciplined at kind of managing and monitoring the costs on a real-time basis. And, sometimes you can control the costs, more quickly than other things. And so what I've noticed is, we're very good at kind of managing that on a real-time basis, and we'll continue to do that as well. Brad Zelnick Welcome, John. John Whittle Thank you. Ken Xie Thank you, John. And John also helped us form the company culture in the very beginning, which is the teamwork and also openness and also innovation. So we'll continue to maintain this culture and keep growing the company together. Keith Jensen And then quickly, Brad, on the other - I mean, yes, obviously, the view of the firewall cycles has some part of it. But I think probably more of 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. Brad Zelnick Great. Thank you, guys. Operator Thank you. Our next question will come from the line of Keith Bachman with BMO. Keith Bachman 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 Gardner Magic Quadrant or however you want 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, 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 that 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 buildings guide? Thank you very much. Ken Xie 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 trying to do a SASE. I helped them do a 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 pub worldwide, probably can match any other competitor, and same kind of function, the innovation, and also put all the SASE in a single OS, and then a lot of functions that are using ASIC will accelerate, and that also make our SASE solution much better, more advantaged compared to other competitors, and also more easy to deploy, more easy to manage. So we see 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. Keith Jensen And just on the guidance, Keith, appreciate the thought after kind of a tough middle of the year last year for us, or for me. I think keep in mind that we do probably have between $150 million and $200 million of headwind related to backlog, or year-over-year comparisons, if you want a 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 can kind of get a sense of what we're thinking about for product revenue. I think I do see that some opportunities on the service revenue line with things that come from SecOps and SASE 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. Keith Bachman Okay, all right, many thanks. Congratulations, guys. Operator Thank you. Our next question will come from the line of Ittai Kidron with Oppenheimer. Ittai Kidron Thanks, guys. A couple for me. First, on the comp side, as you move into 2024, 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 2023? 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 or regions, frankly. So we'd love to get a little bit more color into who do you see more versus less in those categories. Thank you. Ken Xie Yes, we kind of keep improving the sales comp plan and also trying to line up what the company goal and what's 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 and the margin and also reflect more on some kind of a service based kind of model there behind. So that and also kind of keeping investing in the sales force and also kind of making the structure more efficient that's other area and also training the sales and make sure because there's a lot of new area whether the SASE and SecOps do need a lot of training that's also the big enhancement we are kind of going through right now. Keith Jensen Yes, I'd probably add to that as well 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 after the 2023 results the quotas are probably a little bit lower on an individual basis than they have been in the past, and we probably put some things to work in the other direction on it. But to Ken's point, we really want to make sure that we're investing in building on the sales team and making the adjustments in the quota for 2024, I think is appropriate. On the SMB and SASE, probably -- the SASE and SecOps conversation. And I think it goes back to some of Gabriela's question before, at this stage, they'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, SecOps is almost the opposite, but 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 SecOp product being very, very high. And that's what we would expect both of those business segments. Ken Xie And maybe for all three sales and also sometimes even for a partner, if they sell all 3 solutions, secure networking, SASE and SecOps, they get more comp compared to only sell 1 or 2 solutions. So that's the additional incentive we offer to the field. Ittai Kidron Maybe as a follow-up, Keith, how much of the opportunity here in SecOps and SASE is outside of our customer footprint. Is the vast majority of traction here just with your existing installed base? Or it also pulls you outside. Keith Jensen Yes. Given as John pointed out, we have over 500,000 customers. So I'm okay with an installed base, right? And I don't think that's anything new for several years. We've talked about new logos representing large numbers, hundreds -- 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 the price of performance advantage because of how more and more security have embedded into the operating system and the ASIC empowers that, that I'm not a salesperson if I was, I'm probably 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. Ittai Kidron Thank you. Operator Thank you. Our next question will come from the line of Adam Tindle with Raymond James. Adam Tindle Okay. 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? 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 it's just what you're seeing from a sales productivity perspective as you pivot to those areas. Thank you. Ken Xie Yes. For SASE, we are the only company, we believe, has all the SASE function, SD-WAN, all the CASB, web service, all in a single operating system can be deployed on our premise [ph] using ASIC [indiscernible] or in a cloud form there. So that's a huge advantage, both for the customer, for the service provider. I think on the SecureOps side, we also most the product we internally develop whether from endpoint or from all these different like e-mail application, web, all this is because when we internally develop it integrate, automate much better than other competitor, more comp acquisition, which is a separate product that's more difficult to integrate, automate together. So that's the two huge advantage we have. We usually call the SecureOps more like a fabric approach. I've been doing that for 10 years, which is pretty successful, but now we have the same time which customer wants to hear is the SecureOp, which they see the huge advantage that drives a huge growth going forward and also the field training and also kind of help a lot. So that's the advantage we have, whether the SASE single OS approach can use as AC [ph] to accelerate and then the secure app is integrated automate together much better than other competitors gave us huge advantage. John Whittle In terms of the quota retirement question, Keith may have additional comments on that, but there's really no change there. Keith Jensen Yes. I think OTE and numbers targets are very much the same. I think on sales productivity in terms of what we saw in 2023, as we move through the year, 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 exited 2023. On the -- there's a part of that I think in terms of what SASE and SecOps dramatically changed those numbers. I kind of go back to the earlier conversation about contract term share at some level if the mix shifts and becomes 50-50 or 60-40 to get the direction, then we probably have something to talk about, although I'd probably be talking a lot more about the fantastic growth in the SecOps and SASE than the fact that they had to pay salespeople to make that growth happen. Operator That concludes today's question-and-answer session. I'd like to turn the call back to Peter Salkowski for closing remarks. Peter Salkowski 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 fireside chat website link will be posted on the Events and Presentations section of the Fortinet Investor website starting soon. If you have any questions, please feel free to reach out. Have a great rest of your day. Thank you. Operator This concludes today's conference call. Thank you for participating. You may now disconnect.