Good day and thank you for standing by. Welcome to the Fortinet Fourth Quarter 2023 Earnings Announcement. Please be advised that today's conference is being recorded. I’d now like to hand the conference over to your host today, Peter Salkowski, Senior Vice President of Investor Relations. Please go ahead.

Good afternoon, everyone. This is Peter Salkowski, Senior Vice President of Finance and Investor Relations at Fortinet. I'm glad to welcome you to our call discussing Fortinet's financial results for the fourth quarter of 2023. Joining me today are Ken Xie, our Founder, Chairman, and CEO; Keith Jensen, our Chief Financial Officer, and John Whittle, our Chief Operating Officer. This is a live call that will be available for replay via webcast on our Investor options website. Ken will start by providing a high-level overview of our business. Following that, Keith will discuss our financial and operating results for the entire year and the fourth quarter of 2023, along with guidance for the first quarter of 2024 and the full year. After that, we will open the call for questions. Before we begin, please note that we will be making forward-looking statements, which are subject to risks and uncertainties that could cause actual results to vary significantly from those projected. For more information, please refer to our SEC filings, particularly the risk factors in our most recent Form 10-K and Form 10-Q. All forward-looking statements reflect our views only as of today and we have no obligation to update them. Furthermore, all financial metric references made during this call are non-GAAP unless stated otherwise. Our GAAP results and the related reconciliations can be found in our earnings press release and the accompanying presentation, both available on our Investor Relations website. The prepared remarks for this earnings call will be posted in the quarterly earnings section of our Investor Relations website right after the call. Lastly, all growth references are on a year-over-year basis unless noted otherwise. I will now turn the call over to Ken.

Thank you, Peter, and thank you to everyone for joining our call. In Q4, total billing grew 8.5% to $1.9 billion, driven by an increased focus on Secure Ops, SASE, and improved execution by our sales team. We closed six eight-figure deals across five industry verticals. All six of these transactions, including all three of our SASE, Secure Ops, and secure networking solutions, demonstrate the value of an integrated platform that spans across on-premise and cloud, as well as our FortiASIC technology advantages. Our total addressable market across Secure Ops, SASE, and secure networking is expected to increase from $150 billion in 2024 to $208 billion by 2027. Our customer base consists of 76% of Fortune 100 companies, including nine of the top 10 technology companies, nine of the top 10 manufacturers, and nine of the top 10 healthcare providers. Our Secure Ops billing grew 44%, accounting for 11% of total billing, with strong performance from several solutions, including EDR, SIEM, email security, and NDR, which automatically detect, investigate, and respond to threats. The unified SASE billing grew 19%, accounting for 21% of total billing. We believe Fortinet is the only company with a unified SASE solution fully integrated into a single FortiOS, which includes a complete networking and security stack, consisting of a market-leading SD-WAN, ZTNA, secure web gateway, CASB, and firewall-as-a-service designed for both on-premise and cloud environments. Our FortiSASE solution is gaining momentum quickly, as we closed our first eight-figure SASE deal for 350,000 seats. In Q4, we added 40 new features to our SASE solution, including support for over 150 points of presence worldwide and the ability to protect thin-edge devices. We see a huge opportunity to attach FortiSASE to our tens of thousands of SD-WAN customers. Secure networking accounts for 60% of billing and represents our largest addressable market. Gartner expects the secure networking market to overtake the traditional networking market by 2030. Fortinet is the number one network security vendor, with over half of global firewall deployments. In addition to physical firewalls, we offer virtual, cloud-native, and firewall-as-a-service solutions, all based on our FortiOS operating system, consolidating over 30 networking and security functions together. Converged security and networking require more specialized computing power than traditional networking. Our FortiASIC powered FortiGate delivers 3x to 10x more performance as indicated by secure computing regions with every new FortiGate product release. The latest FortiASIC SP5, based on FortiGate 70G, with dual 5G in ruggedized format, secures devices within operational technology environments. It had a great start as a Fortune 50 company signed an eight-figure operational technology deal featuring this new FortiGate in the fourth quarter. 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 first vendor to announce a business-grade Wi-Fi 7 product. Fortinet has consistently been an innovative cybersecurity company, and this earnings call wouldn't be complete without a few words about our AI. We have invested heavily in AI across every function and product. For over a decade, Fortinet has used machine learning and AI to provide advanced threat intelligence across more than 40 products from network, endpoint, and application security. Our solution applies AI and machine learning across expanded digital tech services, automatically containing and remediating incidents within seconds, whereas the industry average for detection and remediation takes several days. We have also been applying generative AI technology across our entire product line, allowing customers to optimize security effectiveness and operational efficiency. FortiAI is already available on FortiSIEM and FortiSOAR, and more products will be adding this function in the coming months. Before turning the call over to Keith, I would like to thank our employees, customers, partners, and suppliers worldwide for their continuous support and hard work.

Thank you, Ken, and good afternoon, everyone. As Ken mentioned, billings grew 8.5%, driven by improved sales execution and early returns on our SASE and SecOps investments. The quarter benefited from what we saw as a muted seasonal budget flush and certain deals that had pushed from earlier quarters, closing in the fourth quarter, driving a record six transactions, each of which were over $10 million. For these exceptionally large transactions, secure networking was 75% of the billings mix, while SecOps and SASE combined for another 20% plus, illustrating these companies' long-term commitment to both firewall and consolidation strategies. Taking a closer look at three of these eight-figure deals, one of these deals included mid-seven figures for SecOps and another mid-seven figures for SASE. The SASE solution covers a planned 350,000-user deployment at a top U.S. school district to provide a safe learning environment for students, regardless of their physical location. We won this deal because of our operating system's ability to integrate 30-plus networking and security functions across SecOps, SASE, and secure networking into a single, unified platform, providing consistent policies and automated responses. Our vision encompasses creating a secure foundation for our customers, allowing them to navigate today's evolving digital landscape with confidence while empowering them to embrace innovation without compromising security. Illustrating this vision, in another eight-figure deal, a large U.S. enterprise selected Fortinet to support their hybrid cloud architecture as they transition more of their workloads to the cloud. This competitive displacement reduced complexity and the customers' total cost of ownership while showcasing our ability to consolidate security functions onto our FortiOS platform. In a third eight-figure win, a large financial institution in the U.S. expanded their partnership with us with their first enterprise agreement with Fortinet. This EA includes the recently announced FortiGate Rugged 70G to secure their remote working and ATM environments. Built with AI-powered security, the Rugged 70G brings our customers the latest secure networking innovations while at the same time simplifying infrastructure and driving efficiencies. In addition to exceeding the customer's performance expectations in a multi-vendor bake-off, we were successful by demonstrating the versatility of our single operating system and FortiOS platform across multiple use cases. Over the past several years, we have successfully addressed large customer buying preferences by increasing our investments in EA programs. In the fourth quarter, these contracts represented nearly 10% of our billings, with a three-year CAGR of over 80%. Today, with over 35% of our billings beyond traditional and sometimes cyclical firewalls, Fortinet has become an increasingly diversified business over the past decade. Most recently, the diversification has included prioritizing investments in SASE, SecOps, and other software and cloud-based solutions. A key element of this diversification is our single operating system strategy. FortiOS is the foundation of our comprehensive and innovative solutions that drive the convergence of networking and security while also consolidating multiple security capabilities. Attempting to piece together best-of-breed solutions from multiple vendors can result in significant security gaps, slower AI-driven technology adoption, and a slower pace of identifying, reporting, and resolving security incidents. Organizations increasingly recognize that an integrated security solution run by a single operating system is the best way to improve their security posture. Consolidation allows security solutions to share data and communicate with each other, reducing complexity, improving security effectiveness, easing the need for skilled labor, and lowering the total cost of ownership. Consolidation drove our SecOps business to 44% growth, with strong growth from EDR, SIEM, email security, and NDR. Importantly, 94% of our SecOps business was from existing customers, as companies looked to execute their vendor consolidation strategy with Fortinet. Digging a little deeper into the 11% of billings that SecOps contributed to our business, the mid-enterprise segment is growing the fastest as these companies respond to the cybersecurity labor shortage and look to reduce complexity. Geographically, international emerging markets are leading the way for SecOps, likely reflecting stronger economic conditions and extending the success of their 2022 pilot project. Extending the single operating system and consolidation strategy further, our single vendor SASE solution, billings increased 19% and accounted for 21% of total billings. Our SASE pipeline is up over 150% as more of our sales reps are building pipeline. As expected, the SMB segment was the largest mix of SASE customers at 55%, increasing eight points quarter-over-quarter. Fortinet has one of the least complex and most customer-friendly SASE pricing models. Our one bundle and one operating system solution provides all the standard capabilities, including secure web gateway and firewall-as-a-service for secure internet access, Zero Trust Network Access, and SD-WAN from our points of presence, providing secure private access, as well as CASB and data loss protection. Our single vendor SASE solution also includes integration to SOC as a service and FortiClient, which provides a customer with endpoint protection and vulnerability scanning. Regarding our focus and investments in SASE and SecOps, SD-WAN customers represented 37% of new SASE customers. Over 90% of our global sales force has completed mandatory sales training for both SASE and SecOps. In 2023, 60,000 customers and partners attended at least one of our 27 training workshops. Lastly, we've increased our worldwide points of presence coverage to over 150 locations. Turning now to the quarterly financial results, total billings were $1.86 billion, up 8.5%, driven by improved sales execution and a strong rebound in the large enterprise segment, together with 6,400 new logos. On a billings-by-geo basis, the U.S. led the way with mid-teen growth driven by strong performance in the U.S. enterprise. In terms of industry verticals, government and financial services, each with growth of approximately 25%, were our top two industry verticals, while service provider and retail remained under pressure. The average contract term was 30 months, up two months year-over-year and sequentially. Adjusting for the six eight-figure deals, the normalized contract term was consistent year-over-year and sequentially at 28 months. Turning to revenue and margins, total revenue grew 10% to $1.42 billion, driven by strong services revenue growth. Service revenue of $927 million grew 25%, accounting for 66% of total revenue, a mixed shift of eight points. Service revenue growth was driven by strength in SecOps, SASE, and other security subscriptions. Product bookings were up; however, product revenue decreased 10% to $488 million due to a tough comparison. Product revenue grew 43% in the prior year period, benefiting from the drawdown of backlog. Total gross margin of 78.5% was up 90 basis points and exceeded the high end of the guidance range by 200 basis points, driven by the increase in service gross margin and the eight-point mix shift from product revenue to service revenue. Service gross margins were up 140 basis points as service revenue growth outpaced labor costs and benefited from the mixed shift towards higher margin security subscription services. Product gross margins were down 510 basis points as we continued to see margin pressure related to inventory levels and product transitions. Operating margin was very strong at 32%, three and a half points above the high end of our guidance range and operating income of $454 million was $40 million above the high end of the implied guidance range, reflecting aggressive cost management. Looking to the state of the cash flow, summarized on slides 17 and 19, total cash taxes paid in the quarter were $341 million. Including $210 million estimated tax payments that were deferred from earlier quarters in accordance with U.S. and California one-time regulatory relief, resulting in free cash flow of $165 million. Capital expenditures were $27 million. We repurchased approximately 16.8 million shares at a cost of $895 million for an average cost per share of $53.29. Moving on to an overview of our 2023 full year results, billing surpassed the $6 billion mark, totaling $6.4 billion and up 14%. Total revenue grew 20% to $5.3 billion, and we added over 25,000 new customers. Service revenue grew 28% to $3.4 billion, driven by a 33% increase in security subscriptions. Product revenue grew 8% to $1.9 billion, on a very tough compare after growing 42% in 2022. Gross margin was up 110 basis points to 77.4%, benefiting from the revenue mix shift to service revenue. Operating margin also increased 110 basis points to a calendar year record of 28.4%, resulting in operating income of $1.5 billion. The GAAP operating margin of over 23% continues to be one of the highest in the industry. Earnings per share increased 37% to $1.63. Free cash flow was a record at over $1.7 billion. Free cash flow margin was 33%. Including real estate investments, the adjusted free cash flow margin came in at 35%. For the year, we repurchased approximately 20 million shares at a cost of $1.5 billion, for an average cost per share of $55.25. And to summarize, Fortinet has returned $5.3 billion to shareholders via share repurchases in the past three years. Earlier this year, the board increased the share repurchase authorization by an additional $500 million, bringing our remaining share repurchase authorization to approximately $1 billion. Moving on to guidance. As we look to 2024, several factors impact guidance, including the firewall industry cycle, remnants of 2022 and 2023 supply chain activity, and customer buying behavior. Prior firewall product life cycles have lasted approximately four years, with eight quarters of higher growth followed by eight quarters of slower growth. Looking at our bookings, the current product cycle decline started approximately four quarters ago in Q1 of 2023, suggesting that we should experience the bottom of the cycle in early 2024. 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 at low to mid-single digits for the remainder of 2024. In addition, we expect product revenue growth will continue to be impacted by project and product digestion in 2024, and we believe the selling environment should improve in the second half of 2024 and into 2025. As a reminder, our first quarter and full-year outlook, which are summarized on slides 23 and 24, are subject to the disclaimers regarding forward-looking information that Peter provided at the beginning of the call. For the first quarter, we expect billings in the range of $1.390 billion to $1.450 billion, which at the midpoint represents a decline of 5.5%; revenue in the range of $1.300 billion to $1.360 billion, which at the midpoint represents growth of 5.4%; non-GAAP gross margin of 76.5% to 77.5%; non-GAAP operating margin of 25.5% to 26.5%; non-GAAP earnings per share of $0.37 to $0.39, which assumes a share count of between $775 million and $785 million; capital expenditures of $220 million to $250 million, including a real estate transaction that closed earlier in the quarter; a non-GAAP tax rate of 17% and cash taxes of $30 million. For the full year, we expect billings in the range of $6.400 billion to $6.600 billion; revenue in the range of $5.715 billion to $5.815 billion, which at the midpoint represents growth of 9%; service revenue in the range of $3.920 billion to $3.970 billion, which at the midpoint represents growth of 17%; non-GAAP gross margin of 76% to 78%; non-GAAP operating margin of 25.5% to 27.5%; non-GAAP earnings per share of $1.65 to $1.70, which assumes a share count of between $785 million and $795 million; capital expenditures of $370 million to $420 million; a 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.

Thank you. As a reminder, during the Q&A session, we ask that you please limit yourself to one question and one follow-up question to allow others to participate. Operator, please open the call for questions.

Our first question comes from Fatima Boolani with Citi.

Good afternoon. Thank you for taking my questions. Keith, I really appreciate you flushing out some of the factors that are going to be creating volatility in your top-line performance, but what I wanted to focus on was how you are able to hold the line on the expense structure in light of the volatility both on the revenue and billings front. So if you can just help us appreciate how you're able to manage for profitability, and then by extension, these top-line volatilities, how should we think about the free cash flow cadence against your assumptions on the OPEX structure along with the fact that you have seen lumpy, very large deals that have positively influenced duration for now? Thank you.

Yes, I think kind of going backwards in terms of the very large deals that we talked about, I think experience has shown us in the second half or the middle part of last year that we're well served not to get too far ahead of ourselves in terms of forecasting those deals. And it's difficult to understand when they're actually going to close and what the specific terms are going to be with those. So I think we kind of set those aside, and you saw that in some of the performance in the fourth quarter. In terms of margins, I think that sometimes the business model is easier than people think it is when it comes to margin because services provide so much of the business. If the business model is two-thirds services and it's throwing out a very rich margin, even in a period of time where you're going through the firewall refresh cycle, you're still seeing your margins hold up fairly nicely. I think there's also significant economies of scale involved in the services line, whether it's the support or the security subscriptions. And then the last thing I would offer is that I think the breadth of both the SecOps Solutions and the SASE Solutions together are serving to spread some of the incremental costs for the hosting solutions and bringing those to market.

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

Good evening. Thank you for taking my question. Ken, over the last several years, we've seen some pretty significant increases in network traffic, whether it be more cloud adoption, more work from home, etcetera, and that's led to pretty healthy firewall refresh over the last several years. I'm curious, and I know it's very early innings, but how do you see sort of the adoption of generative AI, particularly in some of these hybrid contexts, impacting network traffic going forward? And do you think that that's going to incent more firewall refresh to secure that growing network traffic? Thank you.

Long-term, definitely we see that generative AI will increase the traffic a lot and also automate a lot of security operations. We also see the refresh of the firewall cycle. We do provide some kind of data there. But we also see a lot of new opportunity. We now come at the refresh. Like we mentioned in the script, some of the OT technology area and even supporting some work from home, and also some other enterprise internal segmentation replacing the traditional switch with a network security firewall that we call the convergence, also starting to get more and more adopted by the big enterprise. So that's also the new market compared to refreshed traditional firewall. But I agree with you, the next phase of connection, the traffic will keep increasing, especially as more devices are connected online and also more people work remotely. At the same time, the AI is also generating quite a lot of additional data, which also needs to be secured. So we see pretty good potential for long-term growth.

Thank you.

Thank you.

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

Great. Thank you very much. And thank you for taking the question. I guess maybe for Ken, could you dig in a little bit to the SASE performance of the quarter? If I recall correctly, and I don't know what kind of metrics you can break out to give us a little bit more color behind that. But if I recall, you're doing quite well with kind of the SD-WAN component. And we're trying to pivot to better penetrate the secure service edge component. Maybe a little bit of color as you've pivoted towards, I guess, focusing a little bit more on SecOps and SASE what is the nature of the deals look like this quarter? What do you see in the pipeline for SASE? And are you getting better traction with secure service edge? And does that include SD-WAN or is it relatively agnostic to SD-WAN? Thank you.

I think you probably can recall in the last earnings call, we started more focus on SASE SecureOps and started tracking that separately. And also, we also mentioned 90% of our field sales force also being trained certified for SASE SecureOps. And also, all the six eight-figure deals, including all the three, secure networking, SASE and the SecureOps. So we do see it grow faster, especially during the current kind of environment of the refresh cycle. We do see the SASE, which is more a consumption model, and also SecureOps, which can lower the operation cost probably faster than the traditional secure networking area. So that's where we kind of redirect some focus, resource, more focus on these two areas. We see pretty huge success, growing both the pipeline and also even the deal. We closed some of the first eight-figure SASE deals, which also makes us feel pretty excited. I think we have some advantage, actually, leveraging the SD-WAN huge deployment we have, all the firewalls, huge deployment, and also the single OS-based SASE solution, which integrates all the SD-WAN and all the SASE functions into a single FortiOS, which is a huge advantage for both the customer themselves and even for some service providers, offering the SASE service to their customer base. So it's a pretty strong growth. We see it's a pretty good move we have.

Yes, Brian, I would kind of follow that up with some of the results, if you will, of what Ken just talked about. And to your point, I think you're kind of asking us, if you focus more on the SSE element of SASE and less on SD-WAN, what does that mean? I think that we have a pretty interesting horse race developing internally, if you look at what you would probably think of as the SSE component and the SecOps business, both growing in the 40% range. SecOps won the quarter. We'll see how SASE does, but they're very, very close at this point in time in terms of growth. And then I think the other metric we gave, we talked about the pipeline growth, and that 150% would really be around what you would think of as the SSE component.

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

Hi, guys. I'll ask two questions together. CapEx is going up materially next year, this year. What is the outlook for free cash flow margin? What happens to free cash flow this year? Can you actually drill down to the CapEx? What drives the increase? And then what happens to free cash flow margin? The second question I have is on the business. This quarter, billings were supposed to be weak, but they're very strong. Next quarter, we expected roughly 5%, 6% declines, and that's what you're guiding to. So that means maybe there was some pull forward, but kind of in line-is. What happens this quarter that billings is so strong versus expectations? What drove the strength? And why don't we see it continue into the next quarter? Thanks.

You want to take CapEx or deals? Hi, Tal. How are you? Thanks for calling in. On CapEx, I think we'll continue to build out both things that we need for our engineering team as we look forward, and best places to work and labs and so forth. So I think you're seeing an element of that. But also our ability to continue to deliver the wide range of hosted solutions. I think those are the things that are driving CapEx. And as we said before, we know that there's a bias here of making real estate investment decisions with a high return as a long-term investor, and with that, the ROI over a longer period of time has always been very enticing to us. And I think your second question on the spike that we saw in performance that we're very pleased with in the fourth quarter, and then what does that translate to in the first quarter, a couple of things. One is, as we talked about during the call that the comps in the first quarter of 2024 are probably among the most challenging on the billings line and the product revenue line that we think we're going to see. And then I think also the reentry of doing six eight-figure deals in the fourth quarter and being a record obviously put a lot of tailwind into that fourth quarter number. We like eight-figure deals, but I don't know that we're really in the business of forecasting them each and every quarter as we go forward.

Also, we kind of own probably a high percentage of some infrastructure, some real estate, and some of our competitors. That actually gave us much lower cost, operation cost going forward, which also will help drive future growth, especially on services like SASE. And that also gives us a better margin long-term.

And then free cash flow specifically because your stock trades on free cash flow, should we expect free cash flow to go down, or can you offset the increase in CapEx with something else?

Well, obviously, there are 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 operating profits, billings throughout, etcetera. You know all the components that go into it.

Thank you.

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

Good afternoon. Thank you. I'm looking to better understand the SASE dynamics that you're seeing at the lower end of the market versus the higher end. So maybe any commentary on the SMB part of the SASE pipeline, what you're seeing in terms of willingness and readiness to convert, what you're seeing in terms of competition, and what you're seeing in terms of average deal sizes in terms of uplift when you get a SASE deal versus a regular firewall deal. Thank you.

S&B is pretty interesting. We do quite well in the SMB market, even for the traditional firewall, bigger than any other competitors. But also SMB has a pretty low percentage of customers actually using any network security because of whether it's management costs or other people costs, all these kinds of things. So that's where SASE applied there, definitely helping some SMB customers. But also we see kind of the long-term combined both where to work from home, we're pretty strong like a couple of years ago in the retail branch office solution, also helping us kind of like doing well in SMB. And also the new product refresh, which leveraged SP5, we are only halfway probably towards the second half of this year, we have more product come in using the new SP5. That's also keeping a hands-up position there. It's kind of like I said, SASE is more a consumption model. In the current environment, probably it would be more attractive compared to a CapEx model. So that's where we see both SMB and enterprise, they do have some more interest to do this kind of OpEx model. Maybe John Whittle.

I would just say that the success we had in enterprise, this is John Whittle, by the way, with the number of eight-figure deals and having over a half million customers out there, really bodes well for both enterprise and the SMB market because we've got so many customers out there that are testing our product and so many customers that are providing feedback along the way to improve our products that it's a real testament to the products and gives both enterprises and the SMB comfort in buying our products going forward. And you can kind of put yourself into a customer's shoes and say, okay, some of the most discerning customers are spending eight figures on these products and services, and we have strength in SMB and upmarket. I think that bodes really well for kind of the smaller segments of the market and the larger segments of the market going forward. I think that's a real headline from this quarter in terms of the real success we had with some of the most discerning customers out there.

Thank you for the color.

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

Okay, great. Hey, guys, thanks for taking my questions here and well done. Keith, maybe for you, I just want to talk about the shape of billings a little bit here in 2024. I think at the midpoint for this year, billings is about 2%, give or take at the midpoint. How should we sort of think about the exit rate on billings this year? I know that was something we talked about in prior quarters. I'm not sure if that's something that we could just revisit. And then maybe relatedly, it was great to get the segment detail, by the way, across the three segments. How are we sort of thinking about the rough growth ranges for those three segments as part of this guide?

Yes, I think on the billings trend, if you will, I would go back to our prior conversations about, the backlog created a headwind, if you will, in the first half of the year. And I think you heard some of the tone of that, if you will, right before I gave the guidance this year. And that would suggest that, our expectations are that, billings growth rates should be improving as we move through on a quarterly basis, as we move through the year. I think we probably made it a little bit tougher on the sales team for the fourth quarter of 2024 by having such a strong fourth quarter of 2023. But I think they're going to do fairly well there. And then, I'm sorry, the second part of the question, Saket was?

It was just on the three segments, right, secure networking, SASE, and SecOps. It was helpful to get sort of the growth ranges for this quarter. Not going to hold you to it, but how do you think about sort of the relative growth rates for those three segments this year?

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 raised about whether that will shorten the contract term. You heard the data that we gave during the call. These two segments, we have a business that basically runs on average contract terms of about two years. A SASE and SecOps business mix would probably be billing one year in advance when you look at the competitors and so forth. So that kind of gives you the range. It's going to take a while for SASE and SecOps to really impact that contract term or duration. I think the read-through to that in terms of, we're excited about the opportunity with SASE and SecOps. If we have outsized growth there, we'll be very pleased with it. But I don't know that we're hanging our head on something completely out of the realm of reality, if you will, for 2024 for SASE or SecOps.

Yes, for the three segments, I don't have the latest market data, but from Q3, the firewall market is kind of flat here. Q4, we probably will read out company reporting. But we do see probably still under some pressure this year, especially the first half of this year. But I do believe the long-term converging story will hold quite well because the company also needs to manage the kind of application level, which is how to use network security to do that. So that's where long-term we do see the firewall market or the network security market will continue to grow, I feel, probably around 10% year-over-year in the next maybe three to five years. SASE and SecOps come from maybe smaller bases, which also grow faster. And we also have a lot of existing customers wanting to adopt all this together with us. They probably already are firewall customers, D1 customers. They can easily adopt additional solutions, additional products. So that's where we see the other two sectors grow faster than the company average and probably continue to grow faster in the next few quarters.

Very helpful. Thanks, guys.

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

Great. Thank you for taking the questions. So I was just wondering if you could, and we've talked a lot about your other pillars. I was wondering if we could touch on SecOps and maybe what's driving that. Is that related to the recent SEC regulation? And then second, I was wondering if you look at your billing guidance for the year, where do you see the most risk as it relates to that guidance in terms of the three pillars and the performance you're expecting from those three pillars?

Yes, the SecOps is actually helping customers with better security and more efficiency while also lowering total management costs. That's where I need to have multiple solutions, multiple products integrated together, automated together. So that's what we see in the current environment of our company. And because small, they do see the SecOps already. The area they probably work on the investment there. We also see the merging of networking and security together, which also SecOps plays a quite important role in ensuring the two operations can operate together, which we need in this area. So that's where we see pretty strong growth. SASE is more like a consumption model. We also see it fits the current environment well. Even though the cost could be a little bit higher than the appliance, it gives the customer flexibility. And so that's where we see that. John, you want to answer?

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 remediation is critical. And it's real money. And these are really important issues for our customers. And also I would note, we've really been building this solution over many, many years. But we really just started to focus on it as a separate pillar three months ago. And then we had a record Q4. And so I think that degree of focus internally, coupled with how we can actually help our customers by putting our customers first, really is driving a lot of the success there. And that new focus, we're pretty much sticking to the plan. The plan's working. We're sticking to the plan. And so we see a lot of opportunity there.

Thank you. Our next question will come from the line of Brad Zelnick with Deutsche Bank.

Great. Thank you so much. I think I've got one for John Whittle and one for Keith. First, just for you, John, given your recent appointment as Fortinet's first ever COO, can you talk about your perspective stepping into the role and how you plan to help drive Fortinet's business forward? And Keith, for you, in your guidance comments, you said for the full year that you expect the selling environment to improve in the back half and into 2025. And I'm not saying I disagree with you, but I'm just curious why you say that. And if it's just relative to the comments that you also made on the firewall cycle dynamics or if it's something else, more broadly in the economy that you're expecting. Thanks.

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. It's like an MBA on steroids. They're brilliant business people in addition to focusing on the innovation and the technology, which I think is a core differentiator for Fortinet. We are an innovation-first company. And I think our culture is really around what I call almost a straightforward baritocracy. Ken and Michael drive this throughout the organization. It's very straightforward. It's work hard, work smart, innovate and put the customer first and deliver results. I really like the culture. Obviously, I've been here 17 years. Some people say I need to get more creative with my career, but it really gets me excited to make a positive difference. We're protecting our customers so they can get about their business. So I really like that. 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. I have a broad set of responsibilities. I also have always worked very closely with the sales teams. I will not be managing the sales teams, but I will continue to work closely. Teamwork is one of our top three culture items here. We're not really boxed in here in a way. We really work together. We've got great sales leaders, and I look forward to working with them. We've got a huge opportunity to grow. We want to grow and capture that opportunity by putting the customer first. I want to support that. And to Fatima's question earlier, we're also very disciplined on the cost side. 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 about managing and monitoring costs on a real-time basis. Sometimes you can control the costs more quickly than other things. And so what I've noticed is, we're very good at kind of managing that on a real-time basis, and we'll continue to do that as well.

And then quickly, Brad, on the other – I mean, yes, obviously, the view of the firewall cycles has some part of it. But I think probably more of the point is the digestion of products and projects. If you look back at where the peak was of firewall purchasing and you kind of play that out, you should be coming to a logical end of deployment cycles.

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

Hi. Many thanks. And Peter and Keith, thank you again for the disclosures on the segments within billings. It's very helpful. Two questions. One is on strategy and one is on guidance. Ken, on the strategy question, I wanted to ask you about your perspective on the Unified SASE, excluding SD-WAN and SecOps. There are two broad variables that I think about. One is go-to-market and one is product or R&D. You've clearly increased the go-to-market efforts surrounding unified SASE and SecOps. I'm wondering, do you feel the need to also incrementally focus on the product side or incremental R&D, if you will, to strengthen the portfolio for things such as improving your positioning within the Gartner Magic Quadrant or however you want to think about it. So is it more go-to-market that you think incremental efforts or is it both, both the R&D side and the go-to-market? And just in the interest of time, I'll ask my second question. Keith, on the guidance, given the performance in the quarter, and I'm really focused on the year, not the March quarter, it does seem very conservative. You very much outperformed your expectations associated with the December quarter. 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. I guess I'm just trying to reconcile that it seems like very conservative guidance. And perhaps the way to ask the question is, how do you think about the product side as we get to the back half of the year? Do you think that industry demand returns to normal levels, or do you still think there's some pressure on the product side or anything else you want to draw comments on associated with what seems to be conservative billings guidance? Thank you very much.

Yes, a very good question about SASE. Definitely, we want to do both, even more than that. So we definitely see the opportunity changing our go-to-market strategy because a few months ago, we were more dependent on the service provider carrier trying to do a SASE. I helped them do a SASE. Now it's more go-to-market, direct ourselves, and at the same time working with our service providers, but also more important, really, internal R&D, internal investment in the infrastructure. Like we mentioned, now we have over 150 points of presence worldwide, probably can match any other competitor. And same kind of function, the innovation, and also putting all the SASE in a single OS, and then various functions that are using ASIC will accelerate, and that also makes our SASE solution much better, more advantaged compared to other competitors, and also more easy to deploy and manage. We see a huge opportunity for SASE. It's not just SASE using the traditional cloud approach, but also on-premise SASE, the private SASE. So we see a lot of opportunity for SASE going forward, both on the technology, which we are also working on, our innovation, developing technology, and at the same time, the go-to-market strategy. Once we focus, we see huge success behind.

And just on the guidance, Keith, appreciate the thought after kind of a tough middle of the year last year for us, or for me. I think keep in mind that we do probably have between $150 million and $200 million of headwind related to backlog, or year-over-year comparisons, if you want to think about backlog impact in the year. I think also in some of the commentary that we provided right before guidance, where we talked about the relative impact, specifically on product revenue, and what you should see from service revenue for the year. You can kind of get a sense of what we're thinking about for product revenue. I think I do see that some opportunities on the service revenue line with things that come from SecOps and SASE in the year, but I think all-in-all, I think where we're at right now, in terms of the full year guidance number, is an appropriate number for us.

Okay, all right, many thanks. Congratulations, guys.

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

Thanks, guys. A couple for me. First, on the comp side, as you move into 2024, can you share a little bit more color on the changes you're making or have made to the sales comp and what kind of incentives have you laid in place in a way that's different than 2023? And then on the competitive front, just given where your position on SecOps and SASE, I think you've talked about kind of more mid-enterprise on the SecOps and more SMB is the largest category in SASE. Can you talk specifically about who do you see more as competition in those categories? Because you don't seem to kind of stretch the entire customer profile or regions, frankly. So we'd love to get a little bit more color into who do you see more versus less in those categories. Thank you.

Yes, we keep improving the sales comp plan and also try to align what the company goals and the field sales and how we can move kind of a tie together and succeed together. So that there are some modifications to the comp plan which move towards the company's long-term growth and margin and also reflect more on some kind of a service-based model there. Behind that and also kind of keeping investing in the sales force and making the structure more efficient that's other areas we are kind of going through right now.

I would like to add a few points regarding the compensation plan discussion. This time of year usually sees companies making changes to their compensation plans. This year, what stands out to me is that, following the 2023 results, quotas for individuals are likely to be somewhat lower than in previous years, and we may implement some measures to address this. To Ken's point, it's crucial for us to invest in enhancing our sales team and adjusting the quotas for 2024 accordingly. Regarding the SMB and SASE sectors, there are unique customer mixes emerging. The SMB segment constitutes about 55% of the SASE business, and we are encouraged by our early successes in this area, along with positive feedback from third parties about the SASE product. This, combined with our SD-WAN customers, positions us well for success. Conversely, the SecOps segment primarily serves large enterprises, which account for approximately 55% of that business. The key takeaway here is about consolidation; success will largely come from our existing firewall customers who are now purchasing the SecOps product, which we anticipated for both business segments.

And maybe for all three sales and also sometimes even for a partner, if they sell all three solutions, secure networking, SASE, and SecOps, they get more compensation compared to only selling one or two solutions. So that's the additional incentive we offer to the field.

Maybe as a follow-up, Keith, how much of the opportunity here in SecOps and SASE is outside of our customer footprint? Is the vast majority of traction here just with your existing installed base? Or is it also pulling you outside?

Yes. As John mentioned, we have over 500,000 customers, so I'm comfortable with our installed base. This is not new information; we've discussed how new logos make up large numbers—hundreds or thousands—but they have historically accounted for no more than 10% of our business, and I don't anticipate that changing. The firewall is a compelling product due to its price-performance advantage, especially as more security features are integrated into operating systems and supported by ASIC technology. I'm not a salesperson, but if I were, I would be looking for opportunities in the unexplored accounts. Like any enterprise company, we aim to deepen our relationships within those companies, and that's evident in the SecOps and SASE products that Ken and John have been discussing.

Thank you.

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

Okay, let me see if I can get everybody involved here. So Ken, I wanted to start with SASE and SecOps was obviously a key pivot point on the last call. As you focus on that more internally, could you summarize your competitive advantage technologically in those areas? And John, logistics from a sales perspective, I know it's been kind of kicked around a percent of quota retirement might be related to those areas. What did you land on for logistics? And lastly, for Keith, expectations for sales productivity as a result of that pivot towards SASE and SecOps? Just wondering your early observations on what you've seen because it looks like you do expect total margins down, but I think it's somewhat related to gross margin, not much efficiency drain. So it’s just what you're seeing from a sales productivity perspective as you pivot to those areas. Thank you.

Yes. For SASE, we believe we are the only company that offers all SASE functions—SD-WAN, CASB, web service—within a single operating system that can be deployed on-premise using ASIC or in a cloud format. This provides a significant advantage for both customers and service providers. On the SecureOps side, most of our products are developed internally, including those for endpoints and various applications like email and web. This internal development allows us to integrate and automate more effectively than competitors who rely heavily on product acquisitions, which complicates integration and automation. These are two major advantages we hold. We refer to SecureOps as a fabric approach and have been implementing this for 10 years with considerable success. Now, customers are recognizing the significant benefits of SecureOps, driving substantial growth for us, supported by effective field training. Thus, we have the advantage of a single OS approach for SASE that can leverage ASIC for acceleration, along with a SecureOps environment that is far better integrated and automated compared to other competitors, giving us a considerable edge.

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

Yes, I believe OTE and numerical targets align closely. Regarding sales productivity, we observed a decline throughout 2023, but it seems to have stabilized as we move into 2024. The expectations for 2024 are similar to where we ended 2023. It's worth noting that SASE and SecOps have significantly impacted these figures. If the contract mix shifts to a 50-50 or 60-40 distribution, then we would have more to discuss, but my focus would likely be more on the remarkable growth in SecOps and SASE rather than on the sales costs associated with that growth.

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

Thank you, Liz. I'd like to thank everyone for joining today's call. Fortinet will be attending an investor conference hosted by Morgan Stanley during the first quarter. The fireside chat website link will be posted on the Events and Presentations section of the Fortinet Investor website starting soon. If you have any questions, please feel free to reach out. Have a great rest of your day. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.