The operator welcomes listeners to the Fortinet Fourth Quarter 2023 Earnings Announcement and introduces the host, Peter Salkowski, who introduces the company's CEO, Ken Xie, and other executives. The call will discuss financial results and forward-looking statements will be made. The host reminds listeners of the risks and uncertainties and that all financial metrics mentioned are non-GAAP unless otherwise stated.

In the second paragraph, the speaker references the GAAP results and non-GAAP reconciliations for the company, which can be found on their website. They also mention a growth in total billing of 8.5%, driven by focus on Secure Op, SASE, and improved sales execution. The company closed six major deals, showing the value of their integrated platform and FortiASIC technology. The total addressable market for secure op, SASE, and secure networking is expected to increase. The company's customer base includes a majority of Fortune 100 companies. Secure Ops billing grew by 44%, while Unified SASE billing grew by 19%. The company believes they are the only ones with a Unified SASE solution integrated into a single FortiOS, including a full networking and security stack.

Fortinet's FortiSASE solution is gaining traction, with a recent eight-figure deal and the addition of 40 new features. The company sees a huge opportunity to attach FortiSASE to their existing SD-WAN customers, as secure networking makes up 60% of their billing and is expected to overtake traditional networking by 2030. Fortinet is the top network security vendor, offering a variety of physical, virtual, and cloud-based solutions. Their FortiASIC power, FortiGate, delivers high performance and is being used by a Fortune 50 company in their operation technology environment. Fortinet also offers a secure access point controller and recently announced a new Wi-Fi 7 product. The company is known for their innovation in cybersecurity and has heavily invested in AI across all functions and products.

Fortinet has been using machine learning and AI for over a decade to provide advanced threat intelligence across their products. They have recently applied Gen AI technology to their entire product line, allowing customers to optimize security effectiveness and operation efficiency. The company has seen a growth in billings, driven by improved sales execution and investments in SASE and SecOps. The quarter saw a record number of large transactions, with secure networking being the majority of the billings mix. Three of the deals were over $10 million, with a significant portion allocated to SecOps and SASE. One of the deals was for a large school district, covering 350,000 users for a safe learning environment.

Fortinet won a deal due to their operating system's ability to integrate various networking and security functions into one platform. This aligns with their vision of creating a secure foundation for customers and allowing them to embrace innovation without compromising security. They also secured another eight-figure deal with a large U.S. enterprise for their hybrid cloud architecture, showcasing their ability to consolidate security functions. In addition, a financial institution expanded their partnership with Fortinet, including the use of their AI-powered FortiGate Rugged 70G. Fortinet has seen success in their enterprise agreement programs, with these contracts representing 10% of their billings in the fourth quarter and a three-year CAGR of over 80%. This has allowed Fortinet to become a more diversified business over the past decade.

Fortinet's recent diversification strategy has focused on investing in SASE, SecOps, and other software and cloud-based solutions. This is driven by their single operating system strategy, with FortiOS as the foundation. This approach allows for integrated security solutions and consolidation of capabilities, leading to improved security posture and lower costs. Their SecOps business has seen significant growth, with a focus on existing customers and mid-enterprise companies. Internationally, emerging markets are driving success in SecOps. Additionally, their SASE solution has seen a 19% increase in billings and a 150% increase in pipeline.

The SMB segment was the largest group of SASE customers at 55%, with Fortinet having a simple and customer-friendly pricing model. Their SASE solution includes various capabilities such as secure web gateway, firewall, Zero Trust Network Access, and more. 37% of new SASE customers were also SD-WAN customers. Fortinet has focused on SASE and SecOps, with over 90% of their sales force completing mandatory training. They have also increased their global points of presence to over 150 locations. In terms of financial results, total billings were $1.86 billion, with strong growth in the U.S. enterprise and top industry verticals being government and financial services. The average contract term was 30 months, with normalized contract terms being consistent at 28 months. Total revenue grew 10% to $1.42 billion, driven by strong services revenue growth.

In the most recent quarter, service revenue for the company increased by 25% and accounted for 66% of total revenue. This growth was driven by strong performance in SecOps, SASE, and other security subscriptions. Product bookings were also up, but product revenue decreased due to a tough comparison with the previous year. Gross margin exceeded expectations due to the increase in service gross margin and a shift towards higher margin security subscription services. Operating margin was also strong, and the company aggressively managed costs. In terms of cash flow, total cash taxes paid were $341 million and free cash flow was $165 million. The company also repurchased shares and added over 25,000 new customers. In the full 2023 fiscal year, billing surpassed $6 billion, total revenue grew 20%, and service revenue increased by 28%.

Fortinet reported a 8% increase in product revenue to $1.9 billion, with a gross margin of 77.4% and operating margin of 28.4%. Earnings per share also increased by 37%, and the company had a record free cash flow of $1.7 billion. They have returned $5.3 billion to shareholders through share repurchases in the past three years and have an additional $1 billion remaining in their share repurchase authorization. Looking ahead, guidance for 2024 is impacted by factors such as the firewall industry cycle, supply chain challenges, and customer buying behavior. The current product cycle decline is expected to bottom out in early 2024, and the company is currently experiencing project and product digestion due to elevated purchasing and record backlog caused by supply chain challenges.

The backlog drawdown in the first half of 2023 will positively impact billings and product revenue growth. However, the year-over-year product revenue comparisons in the first half of 2024 will be challenging due to project and product digestion. The selling environment is expected to improve in the second half of 2024 and into 2025. For the first quarter of 2024, the company expects a decline in billings and growth in revenue. For the full year, they anticipate growth in billings and revenue, with a significant increase in service revenue.

The company expects non-GAAP gross margin, operating margin, and earnings per share to be within a certain range, and plans to update on its progress in future quarters. The Q&A session will be limited to one question and one follow-up per person. The company's expenses are being managed to maintain profitability despite revenue and billings volatility. The impact of large deals on free cash flow is uncertain.

The speaker discusses the impact of generative AI on network traffic and firewall refresh. They believe that the adoption of generative AI will lead to increased network traffic and automation of security operations. They also see potential for new opportunities, even beyond the typical firewall refresh cycle.

The speaker, Ken Xie, is responding to a question about the performance of SASE in the quarter. He mentions that in the last earnings call, they started focusing more on SASE SecureOps and have trained 90% of their field sales force in this area. They are seeing good traction with SASE and are getting better deals in the pipeline, particularly with secure service edge.

The company has seen significant growth in its six eight-figure deals, particularly in the areas of secure networking, SASE, and SecureOps. This is due to a refresh cycle in the current business environment. The company is redirecting its focus and resources towards these areas, which has resulted in a large pipeline and successful deals. The company's advantage lies in its SD-WAN deployment, firewall deployment, and single OS-based SASE solution. The company's SSE and SecOps businesses are both growing in the 40% range, with SecOps outperforming in the current quarter. The company also reported a 150% increase in pipeline growth in the SSE component.

The operator introduces a question from Tal Liani of Bank of America, who has two questions. The first is about the increase in CapEx and the outlook for free cash flow margin. The second is about the strong billings in the current quarter and the expected decline in the next quarter. Keith Jensen responds, stating that CapEx is going towards building out engineering teams and improving hosted solutions. He also mentions the challenging comps in the first quarter of 2024.

The speaker discusses the growth of the company's SASE business, particularly in the fourth quarter. They mention the record number of six eight-figure deals and the benefits of owning infrastructure and real estate. They also mention the impact of these factors on future growth and margin. When asked about free cash flow, the speaker declines to provide guidance but mentions potential factors such as CapEx and operating profits. The next question asks about the dynamics of SASE in the lower end of the market, including competition and average deal sizes.

Ken Xie, CEO of S&B, discusses the company's success in the SMB market, which is larger than any other competitor in the traditional firewall space. However, he also notes that there is a low percentage of SMB customers actually using network security due to management and cost issues. The implementation of SASE has helped some SMB customers, and the company's strong solutions for remote work and retail branch offices have also contributed to their success in the SMB market. The new product refresh, which leverages SP5, is expected to further strengthen their position. John Whittle, a spokesperson for the company, adds that their success in the enterprise market, with numerous eight-figure deals and over half a million customers, also bodes well for their position in the SMB market. This success gives both enterprise and SMB customers confidence in the company's products and services.

The speaker discusses the success of the company in the market and how it bodes well for both smaller and larger segments. They also mention the expected growth in billings for the year and the breakdown of growth in the three segments of secure networking, SASE, and SecOps.

Keith Jensen and Ken Xie discuss the potential growth rates for the three segments of their business (firewall, SASE, and SecOps) in the context of average contract term. They believe that the contract term will not be significantly impacted by SASE and SecOps in the near future and are excited about the potential for outsized growth in those segments. They also mention that the firewall market may be under some pressure in the first half of the year but they expect it to continue growing at a rate of around 10% in the next few years. They also note that SASE and SecOps may grow faster due to their smaller base and existing customers who may want to adopt these services.

The company is seeing strong growth in the SecOps sector due to customers' need for better security and lower management costs. This is also driven by the merging of networking and security, making SecOps an important component. The consumption model of SASE also fits well with the current environment, despite its higher cost. The threat landscape is also influencing customer behavior in this sector.

John Whittle, Fortinet's newly appointed COO, is excited about his role and has been with the company for 17 years, learning from the leadership team. He believes that the company's focus on innovation and technology is a core differentiator. Keith also mentioned that the selling environment is expected to improve in the back half of the year and into 2025, possibly due to the company's focus on its new solution and the overall economy.

John, who has been with the company for 17 years, describes the culture as straightforward and focused on innovation, hard work, and customer satisfaction. He is taking on new responsibilities in corporate real estate, systems, manufacturing, and logistics, while still working closely with the sales team. The company values teamwork and is disciplined in managing costs. John is excited to contribute to the company's growth and support the team in putting the customer first.

The company's culture of teamwork, openness, and innovation was instilled by John in the beginning and will continue to be maintained as the company grows. The decrease in firewall purchasing and digestion of products and projects may impact the company's performance. On the strategy front, the company is focusing on go-to-market efforts and potentially incremental R&D to strengthen their unified SASE and SecOps portfolio. The guidance for the year appears to be conservative compared to the outperformance in the previous quarter.

The speaker is discussing the company's conservative guidance for the back half of the year and how it may be impacted by their focus on SASE (Secure Access Service Edge) technology. They believe that their investment in infrastructure and internal R&D will give them an advantage in the SASE market, both in terms of technology and go-to-market strategy. They also mention the potential for on-premise and private SASE solutions. The speaker ends by acknowledging the previous year's challenges and expressing optimism for the future.

The speaker discusses the impact of backlog on revenue and mentions opportunities in SecOps and SASE for the year. They also mention that their current full year guidance is appropriate. The questioner asks about changes in sales comp for 2024 and competition in the SecOps and SASE categories.

Ken Xie and Keith Jensen discuss improvements to the sales compensation plan at the company. They are aligning the plan with company goals and investing in the sales force. They also mention making the structure more efficient and providing training for new areas such as SASE and SecOps. Jensen adds that the quotas for 2023 may be lower but they are investing in building the sales team. They are seeing early success in the SMB and SASE market and are pleased with the feedback they are receiving. SD-WAN customers are also a focus for success.

The speaker discusses the differences between SecOps and SASE, with large enterprises providing the majority of business for SecOps. The success of these segments is tied to repeat customers, with incentives for sales and partners who sell all three solutions. The company's large customer base provides a strong foundation, with new logos representing a small portion of the business. The speaker expects continued success in selling more products to existing customers.

The speaker asks three questions to different company representatives about their focus on SASE and SecOps. Ken Xie highlights the company's competitive advantage in these areas, while John is asked about logistics and Keith is asked about sales productivity. Ken mentions that they are the only company with all SASE functions and their internally developed products are more integrated and automated. They have seen success with their fabric approach and are now seeing growth with the SecureOp approach.

The speaker discusses the advantage of the SASE single OS approach and how it can be used to accelerate and secure apps. They also mention that there will be no change in quota retirement, and sales productivity is expected to remain similar to 2023. The speaker suggests that if the mix shifts towards SASE and SecOps, there may be something to discuss, but overall, the focus is on the growth of these areas. The speaker also mentions an upcoming investor conference hosted by Morgan Stanley and encourages any further questions to be directed to Fortinet.

This summary was generated with AI and may contain some inaccuracies.