Keith Jensen
Chief Financial Officer at Fortinet
Thanks, Ken, and good afternoon, everyone.
As Ken mentioned, billings grew 8.5%, driven by improved sales execution and early returns on our SASE and SecOp investments. The quarter benefited from what we saw as a muted seasonal budget flush in certain deals that have pushed from earlier quarters closing in the fourth quarter, driving a record six transactions, each of which for over $10 million. With these exceptionally large transactions, Secure Networking was 75% of the billings mix, while Secure Ops and SASE combined for another 20% plus, illustrating this Company's long-term commitment to both firewall and consolidation strategies.
Taking a closer look at three of these eight-figure deals. One of these deals included mid-seven figures for SecOps and another mid-seven figures for SASE. The SASE solution covers a planned 350,000-user deployment at a top US School District to provide a safer learning environment for students, regardless of their physical location. We won this deal because of our operating system's ability to integrate 30-plus networking and security functions across SecOps, SASE and Secure Networking into a single unified platform, providing consistent policies in automated responses.
Our vision encompasses creating a secure foundation for our customers, allowing them to navigate today's evolving digital landscape with confidence while empowering them to embrace innovation without compromising security. Illustrating this vision and another eight-figure deal, a large US enterprise selected Fortinet to support their hybrid cloud architecture as they transition more of their workloads to the cloud. This competitive displacement reduced complexity and the customer's total cost of ownership, while showcasing our ability to consolidate security functions onto our FortiOS platform. And the third eight-figure win, a large financial institution in the US expanded their partnership with us with their first enterprise agreement with Fortinet. This EA includes the recently announced FortiGate Rugged 70G to secure their remote working in ATM environments.
Built with AI power security, the Rugged 70G brings our customers the latest secure networking innovations, while at the same time simplifying infrastructure and driving efficiencies. In addition to exceeding the customer's performance expectations and a multi-vendor bake-off, we were successful by demonstrating the versatility of our single operating system and FortiOS platform across multiple use cases.
Over the past several years, we have successfully addressed large customer buying preferences by increasing our investments in EA programs. In the fourth quarter, these contracts represented nearly 10% of our billings with a three-year CAGR of over 80%. Today with over 35% of our billings beyond traditional and sometimes cyclical firewalls, Fortinet has become an increasingly diversified business over the past decade. Most recently, the diversification has included prioritizing investments in SASE, SecOps and other software and cloud-based solutions. A key element of this diversification is our single operating system strategy.
FortiOS is the foundation of our comprehensive and innovative solutions that drive the convergence of networking and security while also consolidating multiple security capabilities. Attempting to piece together best-of-breed solutions from multiple vendors can result in significant security gaps, slower AI-driven technology adoption, and a slower pace of identifying, reporting, and resolving security incidents.
Organizations increasingly recognize that an integrated security solution run by a single operating system is the best way to improve their security posture. Consolidation allows security solutions to share data and communicate with each other, reducing complexity, improving security effectiveness, easing the need for skilled labor, and lowering the total cost of ownership.
Consolidation drove our SecOps business to 44% growth with strong growth from EDR, SIEM, email security, and NDR. Importantly, 94% of our SecOps business was from existing customers, as companies 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 SASE solution billings increased 19% and accounted for 21% of total billings. Our SASE pipeline is up over 150% as more of our sales reps are building pipeline. As expected, the SMB segment was the largest mix of SASE customers at 55%, increasing 8 points quarter-over-quarter.
Fortinet has one of the least complex and most customer-friendly SASE pricing models. Our one bundle and one operating system solution provides all the standard capabilities, including Secure Web Gateway and Firewall-as-a-Service for secure internet access, Zero Trust Network Access and SD-WAN from our Points of Presence providing secure private access, as well as CASB and Data Loss Protection. Our single-vendor SASE solution also includes integration to SOC-as-a-Service and FortiClient, which provides the customer with endpoint protection and vulnerability scanning.
Regarding our focus and investments in SASE and SecOps, SD-WAN customers represented 37% of new SASE customers. Over 90% of our global sales force has completed mandatory sales training for both SASE and SecOps. In 2023, 60,000 customers and partners attended at least one of our 27 training workshops. Lastly, we've increased our worldwide points of presence coverage to over 150 locations.
Turning now to the quarterly financial results. Total billings were $1.86 billion, up 8.5%, driven by improved sales execution and the strong rebound in the large enterprise segment, together with 6,400 new logos. On a billings by geo basis, the US led the way with mid-teens growth, driven by strong performance in the US enterprise.
In terms of industry verticals, government and financial services, each with growth of approximately 25%, were our top two industry verticals, while service provider and retail remained under pressure. The average contract term was 30 months, up two months year-over-year and sequentially. Adjusting for the six eight-figure deals, the normalized contract term was consistent year-over-year and sequentially at 28 months.
Turning to revenue and margins. Total revenue grew 10% to $1.42 billion, driven by strong services revenue growth. Service revenue of $927 million grew 25%, accounting for 66% of total revenue, a mix shift of 8 points. Service revenue growth was driven by strength in SecOps, SASE and other security subscriptions.
Product bookings were up, however, product revenue decreased 10% to $488 million due to a tough compare. Product revenue grew 43% in the prior year period, benefitting from the drawdown of backlog.
Total gross margin of 78.5% was up 90 basis points and exceeded the high end of the guidance range by 200 basis points, driven by the increase in service gross margins 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 benefitted from the mix shift towards higher margin security subscription services.
Product gross margins were down 510 basis points as we continued to see margin pressure related to inventory levels and product transitions. Operating margin was very strong at 32%, 3.5 points above the high end of our guidance range, and operating income of $454 million was $40 million above the high end of the implied guidance range, reflecting aggressive cost management.
Looking to the statement of cash flows summarized on Slides 17 and 19. Total cash taxes paid in the fourth quarter were $341 million, including $210 million in estimated tax payments that were deferred from earlier quarters in accordance with US and California one time regulatory relief, resulting in free cash flow of $165 million. Capital expenditures were $27 million. We repurchased approximately 16.8 million shares at a cost of $895 million for an average cost per share of $53.29.
Moving to an overview of our 2023 full-year results. Billings surpassed the $6 billion mark, totaling $6.4 billion and up 14%. Total revenue grew 20% to $5.3 billion, and we added over 25,000 new customers. Service revenue grew 28% to $3.4 billion, driven by a 33% increase in security subscriptions. Product revenue grew 8% to $1.9 billion on a very tough compare after growing 42% in 2022.
Gross margin was up 110 basis points to 77.4%, benefiting from the revenue mix shift to service revenue. Operating margin also increased 110 basis points to a calendar year record of 28.4%, resulting in operating income of over $1.5 billion.
The GAAP operating margin of over 23% continues to be one of the highest in the industry. Earnings per share increased 37% to $1.63. Free Cash Flow was a record at over $1.7 billion. Free cash flow margin was 33%. Excluding real estate investments, the adjusted free cash flow margin came in at 35%.
For the year, we repurchased approximately 20 million shares at a cost of $1.5 billion for an average cost per share of $55.25. And, as summarized on Slide 20, Fortinet has returned $5.3 billion to shareholders via share repurchases in the past three years. Earlier this year, the Board increased the share repurchase authorization by an additional $500 million, bringing our remaining share repurchase authorization to approximately $1 billion.
Moving onto guidance. As we look to 2024, several factors impact guidance, including the firewall industry cycle, remnants of 2022 and 2023 supply chain activity, and customer buying behavior.
Prior firewall product cycles have lasted approximately four years, with eight quarters of higher growth followed by eight quarters of slower growth. Looking at our bookings, the current product cycle decline started approximately four quarters ago in Q1 of '23, suggesting that we should experience the bottom of the cycle in early 2024.
Worldwide supply chain challenges resulted in elevated purchasing and record backlog, distorting year-over-year growth comparisons and creating a period of project and product digestion. The backlog drawdown in the first half of 2023 provided a mid-to-high single-digit percentage tailwind to billings and a low-double-digit tailwind to product revenue growth for that period.
The year-over-year product revenue comparisons in the first half of 2024 will be the most challenged, while we expect service revenues to grow sequentially in the low single digits in the first quarter and to grow sequentially in the low-to-mid single digits for the remainder of 2024. In addition, we expect product revenue growth will continue to be impacted by project and product digestion in 2024. And, we believe the selling environment should improve in the second half of 2024 and into 2025.
As a reminder, our first quarter and full-year outlook, which are summarized on Slides 23 and 24, is subject to the disclaimers regarding forward-looking information that Peter provided at the beginning of the call.
For the first quarter, we expect billings in the range of $1.390 billion to $1.450 billion, which at the midpoint represents a decline of 5.5%, Revenue in the range of $1.300 billion to $1.360 billion, which at the midpoint represents growth of 5.4%, non-GAAP gross margin of 76.5% to 77.5%, non-GAAP operating margin of 25.5% to 26.5%, non-GAAP earnings per share of $0.37 to $0.39, which assumes a share count between 775 million and 785 million, capital expenditures of $220 million to $250 million, including a real estate transaction that closed earlier in the quarter, a non-GAAP tax rate of 17%, and cash taxes of $30 million.
For the full year, we expect billings in the range of $6.400 billion to $6.600 billion, revenue in the range of $5.715 billion to $5.815 billion, which at the midpoint represents growth of 9, service revenue in the range of $3.920 billion to $3.970 billion, which at the midpoint represents growth of 17%, non-GAAP gross margin of 76% to 78%, non-GAAP operating margin of 25.5% to 27.5%, non-GAAP earnings per share of $1.65 to $1.70, which assumes a share count of between 785 million and 795 million, capital expenditures of $370 million to $420 million, non-GAAP tax rate of 17%, and cash taxes of $520 million.
I look forward to updating you on our progress in the coming quarters. And I'll now hand the call back over to Peter to begin the Q&A session.
