Fortinet Q4 2021 Earnings Call Transcript

Quartr
Provided by Quartr
February 3, 2022

There are 16 speakers on the call.

Operator

Hello. Thank you for standing by, and welcome to Fortinet 4th Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen only mode. After the speaker presentation, there will be a question and answer session. Please be advised that today's conference is being recorded.

Operator

I would now like to hand the conference over to your speaker today, Peter Salkowski, Vice President of Investor Relations, please go ahead.

Speaker 1

Thank you, Josh. Good afternoon, everyone. This is Peter Salkowski, Vice President of Investor Relations at Fortinet. I'm pleased to welcome everyone to our call to discuss Fortinet's financial results for the Q4 and full year of 2021. Speakers on today's call are Ken Xie, Fortinet's Founder, Chairman and CEO and Keith Jensen, our Chief Financial Officer.

Speaker 1

This is a live call and that will be available via replay via our website 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 Q3 Before providing guidance for the 4th for the full year for the Q1 and full year of next year, we'll then open the call for questions. During the Q and A, Before we begin, I'd like to remind everyone that on today's 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 10 ks and Form 10 Q for more information.

Speaker 1

All forward looking statements reflect our opinions only as of the date of Presentation and we undertake no obligation and specifically disclaim any obligation to update forward looking statements. Also, all references Financial metrics that we'll make on today's call are non GAAP unless stated otherwise. Our GAAP results and GAAP to non GAAP reconciliation is located in the earnings press release and in the presentation that accompanies today's remarks, both of which are posted on the Investor Relations website. Lastly, all references to growth are on a year over year basis unless noted otherwise. I'll now turn the call over to Ken.

Speaker 2

Thanks, Peter, And thank you for everyone for joining today's call to review our outstanding Q4 and full year 2021 result. For the Q4, bookings increased 49 percent to 1,428,000,000,000 Billions increased 36 percent to $1,306,000,000 Global G2000 billings growth accelerated to over 90%. Securiously, one billings was up 67%, accounting for 16% of total billings. Total revenue growth, 29% to $964,000,000 with product revenue up 31%. Our team navigates well through a challenging supply chain environment to deliver outstanding result.

Speaker 2

For the full year, revenue was So it's $3,300,000,000 and GAAP operation margin was 20%. We generated a record of $1,200,000,000 of free cash Hello, and we recorded our 13th consecutive year of GAAP profitability. 3 growth drivers, Convergence of security and networking, vendor consolidation with our security fabric mesh platform and an elevated threat environment are driving our strong financial results and market share gain. The move to work from anywhere has rapidly expanded the attack surface, which traditionally network security found hard to protect. For the security driven networking approach, Convergys' networking and security, including next generation firewall, SD WAN, 5 gs, DTI and OT to reduce capacity while securing and connecting remote user To advance security and performance and networking speed, enterprise solutions are increasingly consolidating to a cybersecurity match approach.

Speaker 2

Fortinet's security fabric platform delivers unparalleled protection through its cybersecurity mesh architecture that provide broad, Integrated and automated protection across multiple edge from endpoint to data center and hybrid cloud environment. Today, we announced the FortiGate 3000F, the latest FortiGate next generation firewall powered by Fortinet ASIC MP7 SPU to deliver scalable, high performance convergence of networking and security for Zero Trust Edge and core network. The FortiGate 3 1000iF C2 computing region offers an average 5x better performance Thank competitive offerings. Fortinet recently stood out amongst 19 network firewall vendors In government critical capability for network firewall, evaluated for their performance across non critical capability, FortiGate solution received overall high score in the enterprise data center, distributed enterprise edge An SMB use case and the 2nd high score in public cloud use case. Our FortiGate product is the only leader in both Over the last several years Fortinet's industry leading innovation has transformed our Company into one of the most influential and the fastest growing cybersecurity leaders.

Speaker 2

This, in addition to our growth drivers, strongly position us to capture market share and move to the next level of growth. 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. I would especially like to thank our operation team for doing a great job supporting Fortinet's fast growth. Keith?

Speaker 3

Thank you, Ken, and good afternoon, everyone. I'll start with a summary of our very strong 2021 performance. Customer demand was strong and broad based across geographies, customer sizes, industries, use cases and security solutions, reflecting the 3 key demand drivers that Ken mentioned: convergence of security and networking vendor consolidation on our security fabric mesh platform In the elevated threat environment, convergence or security driven networking requires integrated security solutions to be delivered at networking speeds Across the company's entire threat landscape of edges, including data centers, endpoints, work from anywhere and clouds, as well as across multiple use cases such as secure SD WAN, Wi Fi, switching, 5 gs and OT. The networking speed and computing capabilities of our ASIC powered FortiGates can be 5 to 10 times more than competitor firewalls with their off the shelf silicon products. Vendor consolidation is driven by customer focus on security effectiveness, performance and cost management.

Speaker 3

We deliver vendor consolidation through our Security Fabric platform and its broad range of products integrated with a single operating system, offering increased automation. As we saw in 2021, we expect strong customer demand fueled by these key drivers to continue. And turning to our 2021 performance, billings growth accelerated to 35% or $4,200,000,000 representing our highest annual billings growth rate in 6 years. Revenue growth also accelerated, Coming in at 29%, representing the 4th consecutive year of revenue growth of 20% or more. And despite the supply chain environment, product revenue growth came in at 37% growth, our highest annual product revenue growth rate in 10 years.

Speaker 3

Driven by strong demand for our fabric and cloud security solutions, non FortiGate billings and revenue, Each exceeded $1,000,000,000 for the first time in our history. Non FortiGate billings increased 46% to $1,250,000,000 and non FortiGate revenue increased 42% to 1,100,000,000 Gross margin was 77.5 percent and operating margin was 26.2%. Our GAAP operating margin was 19.5%. It's one of the highest in the industry, and we were GAAP profitable, as Ken mentioned, for 13 consecutive years. Free cash flow was a record $1,200,000,000 exceeding $1,000,000,000 for the first time in our history.

Speaker 3

Free cash flow margin was 36% and when adjusted for real estate investments came in at 43%. Total deferred revenue increased 33 percent to $3,500,000,000 and short term deferred revenue increased 28% to 1,800,000,000 We are experiencing exceptionally strong demand, demand that exceeds supply by more than historical norms. As a result, we are expanding our disclosures to include bookings and backlog to provide greater visibility into the strength of our business. Bookings represent the value of all orders received from customers. Backlog represents the value of all orders received, but not fulfilled.

Speaker 3

When the order is fulfilled, we recognize both billings and product revenue. Turning to Q4 results, as noted on Slide 4, Bookings were $1,400,000,000 up 49%. On a sequential basis, backlog increased $122,000,000 Due to very strong demand, on a year over year basis, backlog increased $150,000,000 to end the year at 162,000,000 Breaking down the backlog between product and services, approximately 75% relates to future product shipments, while the remaining 25% relates to various services. While it's difficult to forecast if an order might be canceled, Several factors support our view that our backlog is strong and should provide a tailwind of growth later this year and into next year. Existing customers account for approximately 90% of our backlog.

Speaker 3

No single end customer Accounts are more than, I'd say, a low single digit percentage of backlog. Many competitors are also impacted by supply chain constraints.

Speaker 1

Our

Speaker 3

products, along with our integrated operating system, are not commodities readily exchanged with We actively manage our own supply chain and for most for the most deployed security network solution over And as for 1 third of all firewall unit shipments, we are an attractive volume buyer for many suppliers. And lastly, our price or performance advantage may be difficult for our competition to match. And I apologize for the sound in the background. We don't know what's causing it, but I'll continue on. Moving to Q4 billings.

Speaker 3

At $1,300,000,000 billings are up 36%, which compares to 49% bookings As noted earlier, Enterprises favored Fortinet's leading cost for performance and integrated platform. This is especially evident in the 5 point increase in the large enterprise billing mix. To add more color to this, we can share Global 2,000 billings were up over 90%, The 3rd consecutive quarter of accelerated growth. The number of deals over $1,000,000 increased 79% to 122 deals, breaking the 100 deal threshold for the first time in our history. We saw a record of 4 8 figure transactions in the quarter, all in the Americas.

Speaker 3

And lastly.

Speaker 1

We're going to take one second to

Operator

Please remain on the line. Your conference will resume shortly.

Speaker 1

Joshua, back, can you hear us?

Operator

Yes, I can hear you. You're in the main room

Speaker 1

That was better, Josh.

Operator

I'm sorry, but the sound is still coming in pretty bad.

Speaker 1

Okay. We're going to drop this line off the phone. Okay. Sounds good. Sorry, just hang on, please.

Speaker 1

Right back there.

Operator

Please remain on the line. Your conference will resume shortly.

Speaker 1

Yes. Josh, can you hear me? Hello. Hello. I guess I can hear

Speaker 3

you, but the noise came back

Operator

as soon as you got connected again.

Speaker 1

Yes. We're on a totally different phone.

Speaker 4

I'm on

Speaker 1

my cell phone now.

Speaker 3

It's not our phone.

Speaker 1

Sounds like it's on your end, guys.

Speaker 3

Let me chat with you on ClearView and we'll get

Speaker 1

this fixed in just a moment. Okay. Put everybody on hold, please. I will put the music holder back in the call.

Speaker 4

You are connected at this time, sir. You may proceed.

Speaker 1

Josh, are you there?

Speaker 5

Okay. I'm going to assume everybody can hear.

Speaker 1

Sorry, we're going to start Keith's going to back up a little bit. Hopefully, you can hear us now. And we'll start where he kind of left off and go from there. Apologies for the interlude there.

Speaker 3

I'll back up a couple of paragraphs to my best recollection of where the challenge started. So and I believe that was around when I was mentioning that We were breaking down our backlog between product and services. Approximately 75% relates to product future product shipments, while the remaining 25% relates to various services. While it's difficult to forecast if an order might be canceled, several factors support our view that our backlog is strong and should provide a tailwind for growth later this year and into next year. Existing customers account for approximately 90% of our backlog.

Speaker 3

No single end customer accounts for more than a low single digit percentage of backlog. Many competitors are also impacted by supply chain constraints. Our products, along with our integrated operating system, are not commodities readily exchanged with offerings from other vendors. We actively manage our own supply chain and as the most deployed network security solution with over 1 third of all firewall unit shipments, We are an attractive volume buyer for many suppliers. And lastly, our price for performance advantage can be difficult for our competition to match.

Speaker 3

Moving to Q4 billings. At $1,300,000,000 billings were up 36%, which compares to the 49% bookings growth noted earlier. Enterprises favored Fortinet's leading cost for performance and integrated platform. This was especially evident And the 5 point increase in the large enterprise billings mix. To add more color to this, we can share that Global 2,000 billings are up over 90%, The 3rd consecutive quarter of accelerating growth.

Speaker 3

The number of deals over $1,000,000 increased 79% to 122 deals, Breaking the 100 plus deal threshold for the first time in our history. We saw a record of 4 low figure 8 figure transactions All in the Americas in the quarter. And lastly, secure SD WAN deals over $1,000,000 increased 63% to 26%, Contributing to SD WAN use case billings growth of 67% and putting SD WAN at 16% of total billings. FortiGate billings were up 33% and accounted for 69% of total billings. As shown on Slide 11, High end FortiGate's posted very strong billings growth.

Speaker 3

Non FortiGate billings were up 43%, driving a 0.5 percent mix Shift to non FortiGate. Top 10 non FortiGate solutions with growth over 40% included virtual firewalls, endpoints and switches. At the same time, several smaller solutions posted triple digit growth rates. Consistent with the elevated threat environment And the breadth of ransomware and other attacks, OT use case billings were up 70% and accounted for 8% of total billings. Average contract term was consistent year over year and quarter over quarter at 28 months.

Speaker 3

For the 3rd consecutive quarter, we added approximately 6,000 new logos. Worldwide government billings grabbed the largest share of the mix at 16%. Financial Services accounted for 14% of billings On billings growth of 63%. Billings in manufacturing, transportation, utilities, construction and other verticals that have not Consistently been in our top 5, remained elevated with billings growth of 40%. We believe the growth of these verticals An indication of the broadening nature and greater awareness of the threat landscape, which is driving cybersecurity investments and industries that have historically perhaps spent a little bit less on security budgets.

Speaker 3

Moving over to the income statement. Revenue growth was 29%. Product revenue growth was 31%. Illustrating the impact of backlog on product revenue growth, If backlog had remained flat quarter over quarter, the product revenue growth would have been as high as the mid-60s. Service revenue was up 27 percent to $585,000,000 Support and related services revenue was up 31% to $275,000,000 while security subscription services were up 24% to 309,000,000 Non FortiGate product and service revenue of $324,000,000 grew 41% and accounted for approximately 34% of total revenue, up 3 percentage points.

Speaker 3

FortiGate product and services revenue of $639,000,000 grew 23% and accounted for 66% of total revenue. Total gross margin of 77.3 percent was 180 basis points above the midpoint of our guidance range and up 80 basis points quarter over quarter. A lower than expected drag from acquisitions and pricing actions taken to offset supplier cost increases contributed to the better than expected total gross margin and product gross margin. Product gross margin of 62.1% Increased 140 basis points sequentially. Service gross margin of 87.1 percent increased 50 basis points sequentially.

Speaker 3

Operating margin of 28.5 percent improved 270 basis points sequentially and exceeded the midpoint of our guidance range by 100 basis points. Better than expected gross margin performance and a slightly less than expected impact from acquisitions contributed to the better than expected operating margin. Headcount increased 24 percent to 10,195. Moving to the statement of cash flow summarized on Slides 1215. Capital expenditures were $151,000,000 including $129,000,000 for real estate investments.

Speaker 3

Our capital strategy includes increasing our office and warehouse capacity to support our higher levels of growth. We repurchased 1,800,000 shares of common stock for a cost of $541,000,000 For the year, we repurchased approximately 2,600,000 shares for a cost of $742,000,000 At year end, the remaining share authorization was approximately 1,500,000,000 and set to expire in February of 2023. Inventory turns of 2.7 were flat year over year and on par with 2.9 times in the prior quarter. Overall, with what we believe was better than market growth for the Q4 and full year, We believe we again gained market share. Supported by strong pipeline growth and the key growth drivers outlined earlier, We believe we are in the early innings of a sustained high growth period for the cybersecurity industry and Fortinet, Driven by digital transformation, hybrid cloud and the moving of data and security to the edge.

Speaker 3

The products we've created, The channel and customer relationships we've developed and the investments we've made to build a broad and integrated security fabric platform powered by our proprietary HACIG FortiGates, are expected to drive our continued growth and market share gains. Now I'd like to review our outlook for the Q1 summarized on Slide 16, which is subject to disclaimers regarding forward looking information that Peter provided at the beginning of the call. For at least the first half of the year, we expect elevated demand to outpace supply chain capacity, increasing backlog. An increase in backlog is a headwind to billings and revenue growth and provides interim pressure on margins. For the Q1, assuming bookings in the range of $1,100,000,000 to $1,150,000,000 which at the midpoint represents bookings growth of 32%.

Speaker 3

We expect billings in the range of 1,050,000,000 to $1,090,000,000 which at the midpoint represents growth of 26 percent revenue in the range of $865,000,000 to $895,000,000 non GAAP gross margin of 75.5 percent to 76.5 percent Non GAAP operating margin of 19.5 percent to 20.5 percent. Non GAAP earnings per share of $0.75 to $0.80 which assumes a share count of between 166,000,000 168,000,000. We estimate 1st quarter capital expenditures to be between 140,000,000 150,000,000 We expect a non GAAP tax rate of 18%. Before providing our full year 2022 guidance, I'd like to congratulate every member of the Fortinet team For the truly outstanding execution in 2021, the efforts and results have been outstanding. And this is on top of now several years of consistent, Predictable performance and improvements in key growth and profitability metrics.

Speaker 3

In 2022, we expect a small shift in our seasonality towards the second half of the year by 2 or 3 points. And for the full year, assuming bookings in the range of 5,580,000,000 to $5,680,000,000 which at the midpoint represents growth of 30%. We expect billings in the range of 5,400,000,000 to $5,480,000,000 which at the midpoint represents growth of 30 percent revenue in the range of 4,275,000,000 to $4,325,000,000 which at the midpoint represents growth of 29 percent. Total service revenue in the range of $2,685,000,000 to $2,715,000,000 which represents growth of approximately 29% Innoply's full year product implies full year product revenue growth of approximately 27%, non GAAP gross margin of 74% to 76%, Non GAAP operating margin of 24% to 26% non GAAP earnings per share of $4.85 to $5 which assumes a share count of between $169,000,000 $171,000,000 We estimate full year capital expenditures to be between $270,000,000 $300,000,000 We expect our non GAAP tax rate to be 18%. We expect cash taxes to be approximately 210,000,000 Lastly, I want to inform everyone that we will be holding an Analyst Day on May 10, coinciding with Accelerate 2022, where we expect to update our medium term financial model.

Speaker 3

Along with Ken, I'd like to thank our partners, customers, suppliers and all members of the Fortinet team for all their hard work, execution and outstanding success. I'll now hand the call back over to Peter.

Speaker 1

Thank you, Keith. As a reminder, everyone, please limit yourself to one question. I know we lost a little time there due to the technical delays. Apologies for all of that. But, operator, can you open it up

Speaker 4

I show our first question comes from the line of Brian Essex from Goldman Sachs. Please go ahead.

Speaker 6

Hi, good afternoon. Thank you for taking the question and thank you. Congratulations on a nice set of results. Thanks as well for the additional disclosure. And I guess maybe on that point, maybe could you help us understand what Qualifies as a booking from a timing perspective, if an order is placed with a Timing event maybe 9 months from now, is that still included in bookings?

Speaker 6

And then maybe any other incremental color you can provide us on the supply chain Management, how are you managing the supply chain? You mentioned pricing increases offsetting Any incremental supplier costs, but maybe a view on are the issues abating at all? Are lead times still consistent with where they were last quarter? And any other nuances we should be aware of like channel partners pre buying inventory, which is one of the things that we picked up a little bit this quarter? Thank you.

Speaker 3

Yes, a lot of good stuff there.

Speaker 2

I don't

Speaker 3

know if we'll get through all of it, Brian, maybe I'm taking my questions.

Speaker 6

That's my one question.

Speaker 3

Yes, I know you did really well. Keep in mind our business model, right? End users buy from resellers who buy from distributors who buy from us. So it's not like a very large complex $50,000,000 solution that's going to be deployed over time. When we get orders, it's typically the customers want the product.

Speaker 3

So I don't know that we would see something like we described at the beginning of the conversation in terms of Order what a booking is. For us a booking is, a distributor sends an order to us, and they would like to have shipment. So that counts as a booking. And if we ship it, then it becomes a billing and it becomes product revenue. And if we don't, it becomes backlog.

Speaker 3

I'll just pause it that way, sorry. So in terms of supply chain and maybe Ken would offer some additional thoughts on that. I do We talked previously, I think, that we felt that September, October and maybe very early in November could turn out to be the low watermark for supply chain at least in terms of what we call de commitments from our contract manufacturers and from our component suppliers. And I think that to this point has shown to be the case. We do still from time to time have the commitments, but they're much, much smaller than they were back in that timeframe.

Speaker 3

I think the general tone, if you will, with our channel, whether it's components or it's contract manufacturers, is much, much better than it was. We do, like everybody else, we read the reports and we see conversations and commentary around things like Particularly in consumer electronics, where there's going to be some improvement in auto manufacturing. I think we have reason to believe that The situation continues to improve as we move forward. At the same time, we're working extremely closely with our suppliers, Conversation is at very high levels and talking about maybe some longer term projects that we may work on together, for example, making them aware of what our volume of business is. And also a bit of a tip of the cap to our engineering team We've been going through the process of redesigning and recertifying some of the components and some of the other changes, if you will.

Speaker 3

All of that, I think, kind of gives us a feeling that the second half of this year should see improvement. Yes.

Speaker 2

I think very confident about all of them. I think just Different compared to most of our competitors. We handle the design, manufacture operation, putting them out directly Ourself and also we have a bigger quantity compared to our competitors can better negotiate with supplier. And also the engineer also starting Last year also starting to redesign some of the product to avoid certain shortage of the component, which are working well with us, but some of the redesign may take about 6 months. Overall, that's why we feel pretty confident the second half of this year since we'll be improving both because The supply chain itself and also some alternative design and also kind of a better planning.

Speaker 2

I have to say, last Quarter, the demand environment strong with the booking growth 49%, which even kind of beyond our kind of So that's caused some of the shortage. But overall, we have a much better shape compared to our competitors in the inventory and in the supply. And also the Hi. And also the other question, we don't see increased inventory in the channel in the distributor there, pretty much the same as they have in the last few years. So we don't see any increase of the channel to stop at the product.

Speaker 2

So that's not the case for us.

Speaker 3

Yes. And since Brian you did such a good job of only answering one question, I'm going to have jump also in and can give some more color on it. Yes, I do did somebody order a product early I'm sure that happened. When we try and look at our own business, we try to identify possibilities of that happening. And the best number we can come up with is something that represents extremely low single digits of our business, may have been impacted by that.

Speaker 3

And at the same time, you immediately pivot over to look at your pipeline. And even if that was happening, it's certainly not evident in the We're extremely pleased with what we're seeing in terms of the pipeline growth. And then just to follow on to Ken's comment about distributor inventory levels again with our model, We do have visibility of the inventory that's in the channel.

Speaker 5

And that is

Speaker 3

that inventory those inventory levels are actually down a little bit year over year. So I don't think we're seeing the types of things that maybe you may have some concerns about.

Speaker 2

Yes. And also the shortage more limit, Pretty much mostly limited in the very low end. And so the middle and the high end for the day, we do have all enough inventory even for the We're strong like a 49% growth. And also we have a very broad product portfolio. So there's a lot of The product, the customer, the channel controls, at the same time, some of the redesign are already working, So we'll be ready in a few months.

Speaker 6

Fantastic color. Thank you.

Speaker 4

Thank you. Our next question comes from the line of Fatima Boolani from Citi. Please go ahead.

Speaker 7

Good afternoon. Thank you for taking my questions. Keith, I'm going to focus this one for you. At the risk of oversimplification, I know you've given us the bookings growth, you've given us the billings growth and certainly the product growth and the guidance for fiscal 'twenty two. So between the 49% growth you saw in bookings, 36% billings growth that you saw this quarter and the 31% in product, Can you talk us through how that is dovetailing into your guidance for next year?

Speaker 7

And frankly, how much of this backlog you're Expecting to amortize into your revenue and billings profile over the course of 2022. And as related to that, I understand you've taken some pretty substantial pricing increases for your subscription packages For the portfolio, I'm curious how much of that is contemplated in your guidance across these metrics? Thank you.

Speaker 3

Okay. Brian set the standard and Adam is following it for how many questions there will count as 1. I'll start with the easy one. First pricing, when we raised prices, we've talked about before, we raised prices in August and again in November. On our price list, keep in mind those get discounted down.

Speaker 3

The price because services, whether it's support or security, Attaches the pricing attaches to the box, so to speak. When you raise prices on the appliance, you're also effectively raising prices on the services. But then if you think through revenue recognition, obviously, you'll get some you'll get the price increase in revenue for the product More currently than you will for the services, you're going to recognize that over time. And I think your question of What are we expecting in terms of backlog and amortization or what have you? As you can imagine, we've done a fair amount of scenario planning To go through the year, and I don't know that there is a one scenario that we would point to as opposed to a combination of scenarios.

Speaker 3

I think you can kind of solve for that, I mean, on the phone right now, with some of the information that we've provided in terms of our expectation for backlog Increasing, right, for the year. And so if backlog is increasing for the year, I don't think that would be reflective of us bleeding into the income statement Backlog that currently exists. The components of the backlog will shift, but net net, it's going up.

Speaker 4

Thank you. Thank you. Our next question comes from the line of Ittai Kidron from Oppenheimer. Please go ahead.

Speaker 8

Thanks, guys. Great numbers. I had a clarification and a question. Just on Keith, on the 2 point shift in Now to the second half, is that just tied to supply chain fulfillment? I just want to make sure I got that right and there's no other cause here.

Speaker 8

And then Ken, maybe you could talk about from a competitive standpoint, are you seeing any changes? And I wonder if you have any thoughts with respect to Check Point's recent Production of their Lightspeed firewall, which is extremely price aggressive.

Speaker 3

How do

Speaker 8

you think about that in the market? Any thoughts there will be great.

Speaker 3

Yes, I'll just jump in quickly on the linearity. We just wanted to make sure we open the door to have the conversation You guys about how linearity may be a little bit different this year than what has been historically for us. And yes, you can point back to the supply chain on that.

Speaker 2

Yes. I also listened to Check Point earning this morning. I probably thank you Gil We mentioned Fortinet. And so they say their newest product probably like 20% faster than Fortinet product, 1800F, but that's the product we released more than 2 years ago. I think based on the Moore's Law, So every 2 every 18 months, the speed was double.

Speaker 2

So I think the latest probably is much faster now. So I do see because We see a security driven networking conversion of network and security. So the network security is having deployed pretty much in all the infrastructure, not just So when we deploy internally in a much higher speed and that's where the high speed Fire was needed to do the internal segmentation, security server, segment different department, all these kind of things. So that's where we see quite a strong demand and very strong growth with the current ransomware environment. But also we see the with working from anywhere, a lot of News have to call in remotely or can't connect remotely.

Speaker 2

So that's where the security WANs and 5 gs, some other also see wireless strong demand. So that's what we see. We're leading the innovation in both space with our own ASIC, with all the secure SD WAN5 gs connection. It's a much bigger total addressable market compared to the traditional network security. So that's what we identify as over $170,000,000,000 total C.

Speaker 2

Wei:] Market for us in the next 3, 4 years. It's a huge potential and Market large enough pretty much for all the competitor to compete, but definitely have to keep up the innovation, keep up the change

Operator

Got it.

Speaker 8

Very good. Thanks.

Speaker 4

Thank you. I show our next question comes from the line of Shaul Eyal from Cowen. Please go ahead.

Speaker 9

Thank you. Good afternoon, guys. Congrats. I'll behave myself limiting to one question. Back to the supply chain, Keith, I just want to make sure, Is that predominantly non-forty gig products or do we have some 40 gig products also included in that and tariffs supply chain discussion.

Speaker 9

Thank you.

Speaker 3

Yes. And I think Ken touched upon that a little bit. I'll just build it out for a little more clarity. If you look at More traditional, what we call, secured networking products such as switches and access points, you're looking at probably something in the order of 60%, maybe 2 thirds The backlog would fit into that category and the remainder is in FortiGate. And then Ken was making sure that we understood that within FortiGate that Roughly 1 third, the majority of that is in the entry level or low end fornicates.

Speaker 3

We're not really experiencing the same pressure in the mid range and the high end that we see in the low end.

Speaker 9

Thanks, guys.

Speaker 1

And on that note, operator, just a quick one. I just want to let everybody know on the call, Given the technical difficulties we had earlier, we'll post the prepared remarks for both the CEO script and the CFO script See the IR website as soon as we can after the call. Next question please.

Speaker 4

Thank you. Our next question comes from the line of Ben Bollman from Cleveland Research. Please go ahead.

Speaker 10

Good evening, everyone. Thank you for taking the question. Ken or Keith, when you think about the elevated demand and placements on the product front, Can you share any thoughts about how coincident that demand is or leading as it relates to additional fabric traction? Any thoughts or hooks around number of applications that are being deployed typically with that initial rollout versus what comes later?

Speaker 2

Thanks. We see a lot of enterprise, they need to protect their internal networks Because ransomware attack, like we released the research few months ago, is 11 times higher on the ransomware attack compared to 1 years ago. So it's a big demand for to secure a company whole infrastructure. Also working from home and working from anywhere also need Most security, especially like secure SD WAN, secure 5 gs, all these connections, so we see the demand environment is strong. So that's where and also for supplier, for some other chip manufacturer, even we design own chip, There's a lead time, so that's where we see the backlog and we hope now will be go back, hope will be more normal towards the end of the year.

Speaker 3

Yes. Hi, Ben. How are you? Jen is pointing at me, so I'll follow-up a little bit. I think in terms of pull through of non FortiGate products, Maybe I kind of came to the conversation a few years ago thinking that that was going to be a more of a commercial and mid enterprise area where we see the quantity.

Speaker 3

In actuality, it seems to kind of move with customer size. The SMB is somewhat limited as we still see other products attaching And building that out, and then the mid enterprise, the enterprise. And then the service providers are very strong buyers of multiple products. And I think that why that's relevant is that that's affirmation of the platform strategy. I think they very early on realized the overhead cost Managing point solutions from different vendors can be fairly onerous and that was pretty challenging.

Speaker 3

And so it is moving its way through the rest of the customer chain, if you will. I think the other thing that's happening more currently now as we've seen, we talk about these other verticals that represent not in the top 5, But coming to the table and buying security. And I think they're very clear with us in conversations that I've had with them And Ken as well that they're looking for a total solution and the ability to cobble together a series of integrated products into one solution, not only does that save them in terms of the initial purchase, but also the management costs. So I do think there's definitely a tailwind in that area.

Speaker 2

Yes. The other validation point is really the Global 2,000 account grew over 90%. So it's almost double year over year as a very strong demand there.

Speaker 1

Thank you.

Speaker 4

Thank you. I show our next question comes from the line of Hamzah Fodderwala Morgan Stanley, please go ahead.

Speaker 11

Hey guys, thanks for taking my question. I wanted to ask a question about just the appliance demand More broadly, maybe a question for Ken. How do you think about the demand for hardware between Factors like return to office, campus refresh, data center, What's really driving that appliance demand as we go through 2022?

Speaker 2

I think the convergence of network and security will be long term. And I think during the pandemic and even after pandemic, you see a lot of things changing, whether the working environment or Mode access, that's what the 0 Trust since starting to build out Barber's strong demand there. And also the internal, they need to secure a whole infrastructure, Both in the within the like campus network, data center or remote and connecting branch office. So that's where you see the whole infrastructure need to be secured. And also, all kind of consolidation among different vendor also starting to happen Quickly because like Keith mentioned, the management cost is very high if they have a different vendor for different part of cybersecurity.

Speaker 2

So that's where The vendor can provide more product integrated automate together, definitely has more advantage and lower the total management cost. That's what we see. Like I mentioned, the 3 drivers converging of our network and security and the consolidation of The vendor and at the same time, the strong elevated service security threat right now, especially like Ransomware is a big impact to the business. It's all driving the strong growth.

Operator

Thank you.

Speaker 3

Yes. I would share that I think one of the things that Ken asked us to go look at was what would product revenue growth have been if we didn't have backlog, right? And that's that You kind of who knows when to call that with that point, but it was 65% or 66% product revenue growth if we had the product to deliver. I mean, that's a huge number. And I think it speaks to the kind of description of this is a the demand is extremely high for appliances right now.

Speaker 4

Thank you. I show our next question comes from the line of Sterling Auty from JPMorgan. Please go ahead.

Speaker 12

Yes, thanks. Hi, guys. Keith, one for you. If I'm looking at it correct, if it wasn't for the gross margin pressure, It looks like operating margins would have expanded nicely in 2022. And I'm curious with things like Return to office, maybe a pickup in business travel and maybe even wage inflation, how are you able to deliver that Kind of underlying margin expansion in the operating line?

Speaker 3

For 2022 versus 2021, I think we're guiding to 24%. I think we're guiding to basically 25% to midpoint. And I just closed out a year at 26. 26. So I don't know that that's up, Sterling.

Speaker 3

Am I thinking about that?

Speaker 1

I'm saying if the gross margin wasn't

Speaker 3

On the operating the leverage that's coming through on the operating expenses?

Speaker 13

Yes, exactly.

Speaker 3

Yes, I think that You can look at the percentages in terms of what we're spending. I think sales productivity in the current Environment is probably the biggest driver, if you will, in terms of the leverage that we get out of this. Obviously, if you go back to 2021, Not a lot of sales productivity, obviously, probably in 2020. With COVID, very nice sales productivity numbers in 2021. Now we're looking at tailwinds.

Speaker 3

Let's be honest, the price increases will indeed increase sales productivity.

Speaker 12

Got it. Thank you.

Speaker 1

Okay. Thanks, John.

Speaker 4

Thank you. Our next question comes from the line of Adam Borg from Stifel. Please go ahead.

Speaker 5

Hey guys, and thanks so much for taking the question. Maybe just on SD WAN, it's great to see the strength there continuing. Maybe you could comment just on, I guess, first, the sustainability of those Trends in coming years, are you seeing this growth coming more from greenfield opportunities or some brownfield displacement? Thanks so much.

Speaker 2

It's pretty broad. As you can look at SD WAN, probably, I see more than half majority of product go to the middle or high end range. At the same time, a lot of enterprise Customer model are all starting to use leverage SD WAN. So it's quite broad, much more beyond the retail.

Speaker 1

Operator, next question please.

Speaker 4

Thank you. Our next question comes from the line of Jonathan Ho from William Blair. Please go ahead.

Speaker 13

Hi, good afternoon. And let me echo my congratulations on John Quarter. Yes, I guess, just given that you've delivered a quarter that's been particularly strong this

Speaker 2

Can you give us a

Speaker 13

bit of a sense of what's happening with the pipeline and maybe what is giving you the confidence that you can continue to drive that sustained growth for several more years. I think you've gone through some of the factors 1 by 1, but what are you seeing in sort of the immediate term that allows you to continue growing at these rates?

Speaker 1

Thank you.

Speaker 3

Yes. I'm looking at Ken if he wants to get more strategic. I'll give you a very tactical conversation about it. And Peter is making a shameless plug to the Analyst Day in May and saying that we'll talk about that then. Look, I'm really, really pleased with what the pipeline looks like at the moment.

Speaker 3

We go through our usual we've talked before, I think Jonathan, is slicing and dicing it in terms of how much are new customers, renewals, expansions inside customers, what's the deal size, what's the geography. And it's I don't want to just gloss over some of the numbers that we saw in the enterprise segment in the 4th quarter. Yes, I think we're at 90% growth on the G2000 for 3 quarters in a row. The U. S.

Speaker 3

Did extremely well. And without getting into a lot of details, They too have accelerated for 3 quarters in a row. Looking at the pipeline and looking at, again, more enterprise growth that's coming, we think we have a good position in the SMB, love the execution. We've had some people in other settings commented The maturity that the sales and marketing execution level has reached now as a company. So I think that the pipeline and our ability to execute, I don't see why that would change.

Speaker 2

Yes. And also, we have a lot of growth potential, especially in the Global 2000. So we like we said last year last Quarter growth like 90% year over year. And also, this is the bigger account. You also can upsell, cross sell a lot of other product.

Speaker 2

So we do see the pipeline is very, very strong. And also we're keeping enhancing the marketing and keeping I've put it aggressively higher in the sales, add sales capacity. So far, some are some are regions, some are logical, we still have much less capacity than some of our competitors. I think with additional marketing and sales capacity, we do see the growth will continue in the next few weeks.

Speaker 4

Thank you. Actually, our next question comes from the line of Michael Turits from KeyBanc. Please go ahead.

Speaker 14

Hey, guys. Thanks, Keith, for making the statement that demand is very high for appliances. I guess I'd just like to re ask Hamzah's question about The sources of demand for appliances right now, particularly in the context though of how strong cloud is, I mean, we just had Very strong cloud numbers coming in from Amazon as well as from others. So how should we really understand why so much is being spent in physical boxes right Now as opposed to even some of your products that are in the cloud.

Speaker 2

I'll probably borrow one comment Gil mentioned this Good morning. In their call, definitely the network security is much bigger total addressable market. The cloud security probably by 2025 is just going to be over $20,000,000,000 compared to current or total addressable market, Kuin network security, converging network security, end point 100, that will be RMB170,000,000,000. It's much bigger market. And at the same time, there's a lot of innovation going on and have to secure a home infrastructure.

Speaker 2

So that's where we see the plans also. Even access You need all these appliance. You also need this SD WAN, 5 gs connection, all these to access the cloud. So that's where we see there is a huge market

Speaker 4

Thank you. I'm showing we have time for one more question coming from Keith Pachman from BMO Capital Markets. Please go ahead.

Speaker 15

Yes. I'm going to ask a similar question to Michael before. Your product revenue growth has You know, it's been 40%, 50% and now the underlying growth this quarter was north of 60%. Your competitors are also experiencing good product revenues, not nearly to the extent that you are. And so it's more than Check Point that's experiencing demand and it's more than the, what I characterize as the consolidation when you're taking share from the likes of Cisco and SD WAN.

Speaker 15

And so I'm trying to understand, if you thought about the aggregate demand is in the last three quarters have been far exceeded anything that's happened in, say, the last 5 years between not only yourself, but your 3 primary competitors ex Cisco. And so The question is, if traffic is normally one of the key drivers, but what are some other drivers for not just yourself, but for The 3 primary vendors, just trying to understand that really I think consistent with some of the other questions about the durability of demand, not just for yourself, but for the industry in general.

Speaker 2

Yes. I think the industry, I do believe they need to I can secure the whole infrastructure, both internal LAN and also the WAN connection to the outside. And that also like We see very strong demand to secure inside the company and also like all this data center, all this internal which is before the network security too slow to deploy it in a high speed environment internally. And then also the SD WAN can see pretty strong growth. And I think the overall is the convergence of, we keep in saying, the network and network security, that's the sweet driver we I think probably in the Analyst Day, Peter Kipp mentioned May 10.

Speaker 2

So we'll probably give some more details, some data, some analysis and We'll see how long. I do believe this will be pretty long term changing in the whole space. We're keeping growth in the next 5 to 10 years. And also, ASEK Advantage and the content of scale and scope of study working for us because we have the quantity, which can help in lower the per chip cost, which none of our competitors have. And also we're probably only A cybersecurity company designed our own ASIC chip and we also leverage any other commercial chip available, We order whatever Intel, NVIDIA, GPU, TPU, IP, all the other things we're using, but we have unique advantages of our own ASIC Which helping drive our high speed, low cost network security solution.

Speaker 2

On the other side, the economy of scope also working because we have like a Some different products cover what we call the fabric and now going to call the mesh, that basically mesh architecture, which Helping upsellcross sell, I think last quarter's first time, the over 30%, I think right now is 40 ks count about 69%, another 40 ks is 41% and also over $1,000,000,000 last year. I also We see VARVA's strong growth grow faster than the 40 ks. So that's also helping to supporting the whole infrastructure security On converging on network and security and also elevate the threat environment.

Speaker 5

Yes, Peter,

Speaker 3

it's Puneet. Earlier in the life cycle of cybersecurity industry, maybe 10 or 15 years ago, where firewalls had a very specific use and the environment, if you will, was more stable. It may have been easier to identify refresh cycles that we keep looking for and have not yet seen in the last 5 years. And I think that's perhaps going back to Ken's point, I think that's because the environment is not stable at all. I think the reality is what you're seeing out there right now in terms of use And data volumes, data is all over the place.

Speaker 3

And it's lots and lots of data. It's just getting more and more. And the use cases, I mean, 5 years ago, a lot of things that were air gapped away from the Internet aren't anymore. And now you're seeing this probably was driving the manufacturing vertical for us. I just I don't know that you can presume that the environment, so to speak, and the political interest in it, the insurance company's interest in it, CIOs, management team's interest in it, It is a hot topic of conversation.

Speaker 3

So even if you are due for a refresh cycle in the industry, and I don't know that we are, I don't think you're going to see that because of what's happening in the world out there.

Speaker 15

Okay. Thank you, gentlemen.

Speaker 4

Thank you. This concludes our Q and A session. At this time, I'd like to turn the call back over to Peter Ziolkowski for any closing comments. Please go ahead.

Speaker 1

Thank you. Again, apologies for the technical difficulties today. As I said earlier, we are planning to post the prepared remarks up on our website as soon as we can, so you can All the numbers that Keith shared that I think help answer some of the questions with regards to bookings backlog and the sustainable growth in our business. I'd also like to remind everybody we'll be at the Morgan Stanley Conference on March 9, an in person conference, our first and gosh, I don't even know how long. Fireside chat at that event and the webcast link for the Morgan Stanley conference will be on our Investor Relations website For you all to listen, if you have any follow-up questions, please feel free to contact me.

Speaker 1

Thank you very much for your time. Again, apologies for the technical difficulties and have a great day.

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Fortinet Q4 2021
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