Fortinet Q4 2023 Earnings Call Transcript

Quartr
Provided by Quartr
February 6, 2024

There are 14 speakers on the call.

Operator

Good day and thank you for standing by. Welcome to the Fortinet 4th Quarter 2023 Earnings Announcement. At this time, all participants are in a listen only mode. After the speakers' presentation, there will be a question and answer session. Please be advised today's conference is being recorded.

Operator

I'd now like to hand the conference over to your host today, Peter Salkowski, Senior Vice President of Investor Relations. Please go ahead.

Speaker 1

Thank you, Liz. Good afternoon, everyone. This is Peter Salkowski, Senior Vice President of Finance and Investor Relations at Fortinet. I'm pleased to welcome everyone to our call to discuss Fortinet's financial results for the Q4 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.

Speaker 1

This is a live call that will be available for replay via webcast on our Investor Relations website. Ken will begin our call today by providing a high level perspective on our business. Keith will then review our financial and operating results for the full year and Q4 of 2023 before providing guidance for the Q1 of 2024 and the full year. We'll then open the call for questions. To allow others to participate.

Speaker 1

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 ks and Form 10 Q for more 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 are located in our earnings press release and in the presentation that accompany 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.

Speaker 1

Lastly, all references to growth are on a year over year basis unless noted otherwise. I will now turn the call over to Ken.

Speaker 2

Thank you, Peter, And thank you to everyone for joining our call. In Q4, total billings grew 8.5% to RMB1.9 billion driven by increased focus on SecureOp, SaaS and improved execution for our sales team. We closed 6 8 figure deal across 5 industry verticals. All 6 of its transactions including all 3 of our SASE, Secure op and the secure networking solutions. It's treating our value of our integrated platform and that's spent across on premise and cloud as well as our 40 ASIC technology advantages.

Speaker 2

For the total addressable market across SecureOp, CRC and secure networking expect to increase from $150,000,000,000 in 2024 to $208,000,000,000 by 2027. Our customer base consists of 76% of Fortune 100, including 9 of the top 10 technology companies, 9 of the top 10 manufacturers and 9 of the top 10 healthcare. Our Secure Out Building grew 44%, accounted for 11% of total $1,000,000,000 with strong performance from several solutions, including EDR, SIM, email security and NDR to automatically detect, investigate and respond to threats. NewsySaaSci billing grew 19%, account 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 4 networking and security stack consisting of market leading SD WAN, ZTLA, Secure Web Gateway, CASB and firewall as a service designed for on premise and cloud.

Speaker 2

Our 4 gsizing solution is gaining momentum quickly as we closed our first 8 figure Sassy deal for 350,000 seats. In Q4, we added 40 new features to our Sassy solution, including support for over 150 POP location worldwide and the ability to protect same edge device. We see a huge opportunity to attach 40 SASE to tens of 1,000 SD WAN customers. Secure networking account for 60% of billing and represent our largest addressable market. Gartner expects the secure networking market to overtake the traditional networking market by 2,030.

Speaker 2

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 operating system, consolidate over 30 networking and security functions together. Converged security and networking require more specialized computing power than traditional networking. Our 40 ASIC powered 40 gate delivers 3 to 10x more performance as indicated by secure computing region with every new FortiGate product release. The latest for the ASIC SP5 based 4870 gs with still 5 gs in ruggedized format secure device within operation technology environment.

Speaker 2

It is off a great start as a Fortune 50 company send an 8 figure operation technology deal feature this new FortiGate in the Q4. Also included with our FortiOS operating system is a Forti featured access point controller. Recently, we announced a new secure access point product, making us the 1st vendor to announce a business grade WiFi 7 product. 49 has consistently been an innovative cybersecurity company and this earning call wouldn't be complete Without a few words about 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 apply AI and machine learning across where the industry average for detection and remediation takes several days.

Speaker 2

We have also been applying Gen AI technology entire product line, allowing customer to optimize the security effectiveness and operation efficiency. Forti AI is already available on Forti SIM and Forti SOAR and the 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 continued support and hard work.

Speaker 3

Thank you, Ken, and good afternoon, everyone. As Ken mentioned, billings grew 8.5% driven by improved sales execution and early returns on our Sassy 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 4th quarter, driving a record 6 transactions, each of which were over $10,000,000 For these exceptionally large transactions, secured networking was 75% of the billings mix, while SecOps and Sassy combined for another 20% plus illustrating these companies' long term commitment to both firewall and consolidation strategies. Taking a closer look at 3 of these 8 figure deals. One of these deals included mid 7 figures for SecOps and another mid-seven figures for Sassy.

Speaker 3

The Sassy 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 systems 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.

Speaker 3

Illustrating this vision, in another 8 figure deal, A large U. S. Enterprise selected Fortinet to support their hybrid cloud architecture as they transition more of their workloads to the cloud. This competitive displacement reduced complexity and the customer's total cost of ownership while showcasing our ability to consolidate security functions on to our FortiOS platform. And a third 8 figure win, a large financial institution in the U.

Speaker 3

S. Expanded their partnership with us with their 1st enterprise agreement with Fortinet. This EA includes the recently announced FortiGate Rugged 70 gs to secure their remote working and ATM environments. Built with AI powered security, the rugged 70 gs brings customers the latest secured 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.

Speaker 3

Over the past several years, we have successfully addressed large customer buying preferences by increasing our investments in EA programs. In the Q4, these contracts represented nearly 10% of our billings with a 3 year CAGR of over 80%. Today, with over 35% of our buildings 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.

Speaker 3

FortiOS is the foundation of our comprehensive and innovative solutions to 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 an integrated security solution run by a single operating system is the best way to improve their security posture. Consolidation allows security solutions to share data and communicate with each other reducing complexity, improving security effectiveness, easing the need for skilled labor and lowering the total cost of ownership. Consolidation drove our SecOps business to 44% growth with strong growth from EDR, SIM, email security and NDR.

Speaker 3

Importantly, 94% of our SecOps business was from existing customers as companies look 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 Sassy solution Billings increased 19% and accounted for 21% of total billings. Our SaaS pipeline is up over 150% as more of our sales reps are building pipeline.

Speaker 3

As expected, the SMB segment was the largest mix of Sassy customers at 55%, increasing 8 points quarter over quarter. Fortinet has one of the least complex and most customer friendly SaaS pricing models. Our 1 bundle and 1 operating system solution provides all the standard capabilities including secure web gateway and firewall as a service for secure Internet access, 0 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 40 client which provides the customer with endpoint protection and vulnerability scanning. Regarding our focus and investments in SaaS and SecOps, SD WAN customers represented 37% of new SaaS customers.

Speaker 3

Over 90% of our global sales force has completed mandatory sales training for both SaaSie 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 $1,860,000,000 up 8.5 percent driven by improved sales execution and the strong rebound in the large enterprise segment together with 6,400 new logos.

Speaker 3

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.

Speaker 3

In terms of industry verticals, government and financial services, each with growth of approximately 25% were our top 2 industry verticals, while service provider and retail remain under pressure. The average contract term was 30 months, up 2 months year over year and sequentially. Adjusting for the 68 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 $1,420,000,000 driven by strong services revenue growth.

Speaker 3

Service revenue of $927,000,000 grew 25%, Accounting for 66% of total revenue, a mix shift of 8 points. Service revenue growth was driven by strength in SecOps, Sassy and other security subscriptions. Product bookings were up. Our product revenue decreased 10% to $488,000,000 due to a tough compare. Product revenue grew 43% in the prior year period, benefiting from the drawdown of backlog.

Speaker 3

Total gross margin of 78.5 percent 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 8 point mix shift from product revenue to service revenue. Service gross margins were up 140 basis points as service revenue growth outpaced labor costs and benefit of the mix shift towards higher margin security subscription services. Product gross margins were down 510 basis points as we continue to see margin pressure related to inventory levels and product transitions. Operating margin was very strong at 32%, 3.5 points above the high end of our guidance range And operating income of $454,000,000 was $40,000,000 above the high end of the implied guidance range, reflecting aggressive cost management. Looking to the statement of cash flow summarized on Slide 17 and 19.

Speaker 3

Total cash taxes paid in the quarter were 341,000,000 including $210,000,000 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 $165,000,000 Capital expenditures were 27,000,000 We repurchased approximately 16,800,000 shares at a cost of $895,000,000 for an average cost per share of $53.29 Moving to an overview of our 2023 full year results. Building surpassed the $6,000,000,000 mark, totaling $6,400,000,000 and up 14%. Total revenue grew 20 percent to $5,300,000,000 and we added over 25,000 new customers.

Speaker 3

Service revenue grew 28% to 3,400,000,000 driven by a 33% increase in security subscriptions. Product revenue grew 8% to 1,900,000,000 On a very tough compare after growing 42% in 2022, gross margin was up 110 basis points to 77.4% benefiting from the revenue mix shift to service revenue. Operating margin also increased 110 basis points to a calendar year record of 28.4 percent, resulting in operating income of $1,500,000,000 The GAAP operating margin of over 23% continues to be one of the highest in the industry. Earnings per share increased 37 percent to $1.63 Free cash flow was a record at over $1,700,000,000 Free cash flow margin was 33%. Excluding real estate investments, The adjusted free cash flow margin came in at 35%.

Speaker 3

For the year, we repurchased approximately 20,000,000 shares at a cost of $1,500,000,000 for an average cost per share of $55.25 And to summarize on Slide 20, FloridaNet has returned $5,300,000,000 to shareholders via share repurchases in the past 3 years. Earlier this year, the Board increased the share repurchase authorization by an additional $500,000,000 bringing our remaining share repurchase authorization to approximately $1,000,000,000 Moving on to guidance. As we look to 2024, several factors impact guidance, including the firewall industry cycle, remnants of 20222023 supply chain activity and customer buying behavior. Prior firewall product life cycles have lasted approximately 4 years with 8 quarters of higher growth followed by 8 quarters of slower growth. Looking at our bookings, the current product cycle decline started approximately 4 quarters ago in Q1 of 2023, suggesting that we should experience the bottom of the cycle in early 2024.

Speaker 3

Worldwide supply chain challenges resulted in 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 twenty twenty three 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 twenty before 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 by project and product digestion in 2024 and we believe the selling environment should improve in the second half of twenty twenty four and into 2025.

Speaker 3

As a reminder, our Q1 and full year outlook, which are summarized on slides 2324 subject to the disclaimers regarding forward looking information that Peter provided at the beginning of the call. For the Q1, we expect billings in the range of $1,390,000,000 to $1,450,000,000 which at the midpoint represents a decline of 5.5 percent. Revenue in the range of $1,300,000,000 to $1,360,000,000 which at the midpoint represents growth of 5.4 percent non GAAP gross margin of 76.5 percent to 77.5 percent non GAAP operating margin of 25.5 percent to 26.5 percent Non GAAP earnings per share of $0.37 to $0.39 which assumes a share count of between $775,000,000 785,000,000 Capital expenditures of $220,000,000 to $250,000,000 including a real estate transaction that closed earlier in the quarter. A non GAAP tax rate of 17% and cash taxes of $30,000,000 For the full year, we expect billings in the range of $6,400,000,000 to

Speaker 1

$6,600,000,000

Speaker 3

revenue in the range of 5,715,000,000 to $5,815,000,000 which at the midpoint represents growth of 9%. Service revenue in the range of 3,920,000,000 to $3,970,000,000 which at the midpoint represents growth of 17%. Non GAAP gross margin of 76% to 78%, non GAAP operating margin of 25.5 percent to 27.5 percent non GAAP earnings per share of $1.65 to 1.70 which assumes a share count of between $785,000,000 $795,000,000 capital expenditures of $370,000,000 to $420,000,000 non GAAP tax rate of 17% and cash taxes of $520,000,000 I look forward to updating you on our progress in the coming quarters. I'll now hand the call back over to Peter to begin the Q and A session.

Speaker 1

Thank you. As a reminder, during the Q and A session,

Operator

Our first question comes from the line of Fatima Boolani with Citi.

Speaker 4

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 these volatilities, both on revenue and billing front. So if you can just help us appreciate, how you're able to manage for profitability?

Speaker 4

And then by extension, these top line volatilities, how should we think about the free cash flow cadence against your assumptions on the OpEx structure along with the fact that you have seen lumpy, very large deals that have positively influenced duration for now? Thank you.

Speaker 3

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 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 Q4.

Speaker 3

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 provides so much of the business. The business model is 2 thirds services 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 subscription. And then the last comment 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.

Speaker 1

Jamie, you still there?

Operator

Thank you. Our next question will come from the line of Hamzah Fodderwala with Morgan Stanley.

Speaker 5

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 a 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?

Speaker 5

Thank you.

Speaker 2

Long term, definitely, we see that GenaI will increase the traffic a lot and also also made a lot of security operation. We also see The refresh of the file cycle, we do provide some kind of historic data there, but we also see a lot of new opportunity That is, we now come to 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, So 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 refresh the traditional firewall. But I agree with you, The next phase of connection, the traffic will keep increase, especially most device will be connected online and also more people work remotely.

Speaker 2

And at the same time, the AI also kind of generate quite a lot of additional data, which also kind of need to be secured. So we see a pretty good potential for the

Speaker 3

long term growth. Thank you.

Speaker 2

Thank you.

Operator

Our next question will come from the line of Brian Essex with JPMorgan. Brian, your line is now open.

Speaker 6

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 Sassy performance of the quarter? If I recall correct, 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.

Speaker 6

Maybe a little bit of color As you've pivoted towards, I guess, focusing a little bit more on SecOps and Sassy, what is the nature of the deals look like This quarter, what do you see in the pipeline for Sassy? And are you getting better traction with Secure Service Edge? Does that include SD WAN or is it relatively agnostic to SD WAN? Thank you.

Speaker 2

I think you probably can recall in the Last earnings call, we started more focused on SaaS U Secure Op and starting tracking that separately. And also during the script, we also mentioned 90% of our field sales force also being trained certified for SaaS Secure Up. And also all the 6, 8 figure deal, including all the 3, security networking, SaaS and the security op, So we do see it grow faster, especially during the current kind of environment of refresh cycle. We do see The SaaS, which is more consumption model and also Secure Up, which can lower the operation cost, proper growth faster than the traditional secure networking area. So that's where we kind of redirect some focus resource, more focused on these two areas.

Speaker 2

We see a pretty huge success, grow both the pipeline and also Even the deal we closed some of the first 8 fever Sassy deal, which also makes the field pretty excited. I think it's a we do see this is we have some advantage actually leverage the whether the SD WAN huge deployment we have, all the firewall huge deployment and also the single OS based SASE solution, which integrate all the SD WAN, all the SaaS function into a single 40 OS, which is a huge advantage for whether the So, I see it's a Pretty strong growth. We see it's a pretty good move we have.

Speaker 3

Yes, Brian, I would kind of follow that up with The results, if you will, what Ken just talked about and to your point, I think you're kind of asking us, if you take if you focus more on the SSE element of SASE and less on SD WAN, What does that mean? And I think that we have a pretty interesting horse race developing internally. If you look at what you would probably think of as the SSE component and the Sec business both growing in the 40% range. SecOps won the quarter. We'll see how Sassy does, but they're very, very close at this point in time in terms of growth.

Speaker 3

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. Got it. That's really helpful. We'll keep it to

Speaker 6

1 and keep it efficient, but thank you so much both of you. Appreciate it.

Speaker 2

Thank you.

Operator

Thank you. Our next question will come from the line of Tal Liani with Bank of America.

Speaker 7

Hi guys. I'll ask 2 questions together, it's easier. CapEx is going up materially next 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?

Speaker 7

What drives the increase and then what happens to free cash flow margin? The second question I have is on the business. This quarter, billings were supposed to be weak, but they're very strong. Next quarter, we expected roughly 5%, 6% declines and that's what you're guiding to. So that means Maybe there was some pull forward, but kind of in line ish.

Speaker 7

So what happens this quarter that billings is so strong versus expectations, what drove the strength and why isn't it why don't we see continue into the next quarter? Thanks.

Speaker 3

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.

Speaker 3

So I think you're seeing an element of that, but also our ability to continue to deliver hosted 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 Hai 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 The spike that we saw in performance that we're very pleased with in the Q4.

Speaker 3

And then how does that what does that translate to in the Q1? A couple of things. One is, As we talked about during the call, the comps in the Q1 of 2024 are probably among the most challenging on the billings line and the product revenue line that we think we're going to see. And then I think also the read through on doing 6, 8 figure deals in the 4th quarter and being a record, Obviously, put a lot of tailwind into that 4th quarter number. We like 8 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.

Speaker 2

Also, we kind of own probably high percentage of some structure 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 Sassy. And that's also give us a better margin long term.

Speaker 7

And 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?

Speaker 3

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.

Speaker 6

Got it. Thank you.

Operator

Thank you. Our next question will come from the line of Gabriela Borges with Goldman Sachs.

Speaker 8

Good afternoon. Thank you. I'm looking to better understand the Sassy dynamics that you're seeing at the lower end of the market versus the higher end. So maybe any commentary on the SMB part of the Sassy pipeline? What you're seeing in terms of willingness and readiness to convert?

Speaker 8

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 Sassy deal versus a regular firewall deal? Thank you.

Speaker 2

Yes, SMB has a pretty interesting we're doing quite well in the SMB market even for The traditional firewall bigger than any other competitors, but also SMP has a pretty low percentage of a customer actually using any network security because whether the management costs or some other people costs, all these kind of things. So that's where SASE, our prior year definitely helping some SMB customer, but also we see kind of The long term combined both virtual work from home, we're pretty strong like a couple of 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 leverage 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 on position there.

Speaker 2

Yes, it's kind of like I said, it's a set is more kind consumption model in the current environment probably a bit 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

Speaker 9

I would just say that the success we had in enterprise is John Whittle by the way, With the number of 8 figure deals and having over a half 1000000 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

Speaker 3

our product

Speaker 9

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 customers are spending 8 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.

Speaker 8

Thank you for the color.

Operator

Thank you. Our next question will come from the line of Saket Kalia with Barclays.

Speaker 10

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.

Speaker 10

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, how 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?

Speaker 3

Yes. I think on the billings trend, if you will, I would go back to our prior comments 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 rate should be improving as we move through on a quarterly basis as we move through the year. I think we probably made it a little bit tougher on the sales team for the 4th of 2024 by having such a strong Q4 of 2023. But I think they're going to do fairly well there.

Speaker 3

And then I'm sorry, the second part of the question, Saket, was?

Speaker 10

Was just on the 3 segments, right, Secure Networking, SaaSy 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?

Speaker 3

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 2 years, 2.25 if you will. A SaaS and SecOps business mix would probably be billing 1 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 Sassy and SecOps to really impact that contract term or duration.

Speaker 5

And I think the read through

Speaker 3

of that in terms of we're excited about the opportunity with Sassy and SecOps. If we have outsized growth there, we'll be very pleased with it. But I don't know that we're hanging our head on something completely out of the realm of reality, if you will, for 2024 from SaaS here SecOps.

Speaker 2

Yes. For the 3 segment, I don't have the latest data, but from Q3, the firewall market is kind of flat year over year. Q4, we probably will wait out company reporting. That is we do see probably still under some pressure this year, especially the first half of this year. But I do believe the long term conversion story will hold quite well because the company also need to manage like a content application level, which is how to use network security to do that.

Speaker 2

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 3 to 5 years. SASE and Secure Up come from a bit smaller base, which also grow faster. And we also have a lot of existing customer Once they adopt all this together with us, they probably already for our customers, D1 customers, they can easily adopt additional solution additional product. So that we see the other two sectors grow faster than the company average and probably will continue to grow faster in the next few quarters.

Speaker 10

Very helpful. Thanks, guys.

Speaker 1

Thank you.

Operator

Thank you. Our next question will come from the line of Andrew Nowinski with Wells Fargo.

Speaker 11

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?

Speaker 11

And then second, I was wondering, if you look at your billings guidance for the year, Where do you see the most risk as it relates to that guidance in terms of the 3 pillars and the performance you're expecting from those 3 pillars?

Speaker 2

Yes, the Secure Up is actually helping customer more like better security and more efficient and also lower the total management costs. That's where we need to have multiple solution, multiple product integrated together, automate together. So that's where we see during the current environment, a lot of our company, big or small, they do see the security opportunity. Area they probably is market on the investment there. And also we do see the merging of networking and security together, which also SecureAuth play a quite important role to make sure the 2 operations can be operated together, which we are leading this area.

Speaker 2

So that's where Secure obviously pretty strong growth. SaaS is more like consumption model. We also see kind of see 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 we see that. John will answer.

Speaker 9

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.

Speaker 9

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 3 months ago and then we had a record Q4. 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 is working. We're sticking to the plan.

Speaker 9

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.

Speaker 6

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?

Speaker 6

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.

Speaker 9

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 straightforward veritocracy and Ken and Michael drive this throughout the organization.

Speaker 9

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 17 years, some people say I need to get more accretive 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.

Speaker 9

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 work very closely with the sales teams.

Speaker 9

I will not be managing the sales teams, but I will continue to work closely. Teamwork is one of our top three culture items here. And we're not really boxed in here in a way. We really work together and so we've got great sales leaders. I look forward to working with them.

Speaker 9

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.

Speaker 9

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.

Speaker 3

Welcome, John.

Speaker 9

Thank you.

Speaker 2

Thank you, John. And John also helped us form the company culture We're beginning, which is a teamwork and also openness and also innovation. So we'll continue to maintain this culture and keeping growing the company together.

Speaker 3

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 to the point is the digestion of products and projects. And if you look back at where the peak was of firewall purchasing and you kind of play that out, you should be coming to us logical end of deployment cycles.

Speaker 6

Great. Thank you, guys.

Operator

Thank you. Our next question will come from the line of Keith Bachman with BMO.

Speaker 12

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.

Speaker 12

Ken, on the strategy question, I wanted to ask you on your perspective on the unified SaaS excluding the SD WAN and SecOps. There's 2 broad variables that I think about. 1 is go to market and 1 is product or R and D. You've clearly increased the go to market efforts surrounding Unified Sassy and SecOps. I'm wondering, do you feel the need to also incrementally focus On the product side or incremental R and D, if you will, to strengthen the portfolio, for things such as improving your positioning with The Gargant Magic Quadrant or however you want us to think about it.

Speaker 12

So is it more go to market that you think incremental efforts or it's both incremental, both the R and 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, just given the performance in the quarter, 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.

Speaker 12

And so I guess I'm just trying to reconcile, but it seems like very conservative guidance. And perhaps the way to ask the question is, How do you think about the product side as we get to the back half of the year? Do you think that industry demand returns to normal levels or do you still think there's some pressure on the product side or anything else you want to draw comments on associated with what seems to be conservative billings guide? Thank you very much.

Speaker 2

Yes. Very good question about Sassy. Definitely, we want to do both, even more than that. So we definitely see the opportunity changing our go to market strategy because a few months ago we were more dependent on the Service provider carrier try to do SASE, help them to build SASE. Now it's more go to market, direct ourselves, at the same time working with our service provider, But also more important, really internal R and D, internal investment in the infrastructure.

Speaker 2

Like we mentioned, now we have over 150 POP probably can match any other competitor and the same kind of function, the innovation and also put out a SaaS in a single OS And then a lot of functions that are used in ASIC will accelerate and that's also make our SaaS solution much better, more advantaged compared to other competitors are also more easy to deploy, more easy to manage. So we see that there's a huge opportunity for Sassy. It's not just Sassy using the traditional approach, but also on premise Sassy, the private Sassy. So we see a lot of opportunity for Sassy going forward both on the technology which we also work at our innovation developing technology. At the same time, The go to market strategy, once we focus, we see huge excess behind.

Speaker 3

And just on the guidance, Keith, appreciate the thought after kind of a tough middle of the year last year for us. So for me, I think keep in mind that we do probably have between 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 we I do see that some opportunities on the service revenue line with things that come from SecOps and SaaS 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.

Speaker 12

Okay. All right. Many thanks. Congratulations guys.

Speaker 2

Thank you.

Operator

Thank you. Our next question will come from the line of Ittai Kidron with Oppenheimer.

Speaker 6

Thanks. Hey, guys. Couple for me. First, on the comp side, as you move into 2024, can you you share a little bit more color on the changes you're making or have made to the sales comp and what kind of incentives have you laid in place in a way that's different than 23%. And then on the competitive front, just given where your position On SecOps and SaaS, I think you've talked about kind of more meat enterprise on the SecOps and more SMB is the largest category in SaaS.

Speaker 6

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'll love to get a little bit more color into who do you see more versus less in those categories? Thank you.

Speaker 2

Yes, we kind of are keeping improving the sales comp plan and also try to line up what's The company goal was the fuel cells 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 like a service based kind of model there behind. So that and also kind of keeping invest in the sales force and also kind of making the structure more efficient, that's other area and also training the sales and make sure because there's a lot of new area, whether the SaaS you secure do need a lot of training. That's also the big enhancement we are kind of goes right now.

Speaker 3

Yes. I'd probably add to that. It's all just a couple of things. On the comp plan conversation, this is the time of year where comp plans go out and I think every company makes 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.

Speaker 3

And we've 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 and building on this sales team and Making the adjustments in the quota for 2024, I think is appropriate. On the SMB and Sassy or probably the Sassy 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 SaaS was about 55% of the business.

Speaker 3

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 success with the SaaS product, but that together with our SD WAN customers is the logical place to see success. On the flip side, SecOps It's 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.

Speaker 3

E. Firewall customers are now buying the Secop products being very, very high. And that's what we would expect out of both of those business segments.

Speaker 2

Yes. And maybe for all things sales and also sometimes even for partner, If they sell all three solutions, secure networking, SaaS and secure update, they get more comp compared to only sell 1 or 2 solution. So that's the additional incentive we offer to the field.

Speaker 6

Maybe as a follow-up, Keith, how much of the opportunity here in SecOps and SaaS is outside of your customer footprint, is the vast majority of traction here just with your existing install base or it also pulls you outside?

Speaker 3

Yes, given as John pointed out, we have over 500,000 customers. So I'm okay with the install base, right? And I don't think that's anything new for Several years we've talked about new logos representing large numbers, 100, 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'd probably looking for those opportunities in the white space accounts.

Speaker 3

And then you want them like any other enterprise company come back and sell more into that company. And that's really what you're seeing with the SecOps and SaaS products that Ken and John have been talking about.

Speaker 6

Thank you.

Operator

Thank you. Our next question will come from the line of Adam Tindle with Raymond James.

Speaker 13

Okay, thank you. Let me see if I can get everybody involved here. So Ken, I wanted to start with Sassy and SecOps was obviously 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.

Speaker 13

What did you land on for logistics? And lastly for Keith, expectations for sales productivity as a result of that Pivot towards Sassy and SecOps. Just wondering your early observations on what you've seen, because it looks like you do expect total margins down, but I think it's somewhat related to gross margin, not much efficiency drain. So just what you're seeing from a sales productivity perspective as you pivot to those areas? Thank you.

Speaker 2

For SASE, we are the only company we believe who has all the SASE function SD WAN, All the like a CASB, web, file service all in a single operation system can be deployed on premise using AC So that's a huge advantage both for the customer, for the service provider. I think on the SecureAuth side, we also most of the product we internal develop, whether from endpoint or from all these than other competitors more comfort acquisition, which is a separate product that's more difficult to integrate, automate together. That's the 2 huge advantage we have. We really call the secure more like a fabric approach. We've been doing that for 10 years, which pretty successful, but now we have the same term which customer want to hear is a secure op, which they see the huge advantage.

Speaker 2

That's why we have a growth going forward and also the field trimming also kind of help a lot. So that's the advantage we have, whether the SASE GoOS approach can use AC to accelerate and then the Secure ARP is integrate automate together much better than other competitor gave us huge advantage.

Speaker 9

In terms of the quota retirement question, Keith may have additional comments on it, but there's really no change there.

Speaker 3

Yes, I think the 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 no part of that.

Speaker 3

I think in terms of what SaaS and SecOps dramatically changed those numbers, I kind of go back to the earlier conversation about contract term, sure at some level if the mix shifts and becomes fifty-fifty or 64 to the other direction, then we probably have something to talk about, although I probably talked a lot more about the fantastic growth in SecOps and SaaS than the fact that I had to pay salespeople to make that growth happen.

Operator

That concludes today's question and answer session. Like to turn the call back to Peter Salkowski for closing remarks.

Speaker 1

Thank you, Liz. I'd like to thank everyone for joining today's call. Fortinet will be an investor conference hosted by Morgan Stanley during the Q1. The FireXpert chat website link will be posted on the Events and Presentations section of the Fortinet's investor website

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Earnings Conference Call
Fortinet Q4 2023
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