Fortinet Inc

NASDAQ:FTNT

Earnings Call Transcript 2020-Q4

[Operator]

Ladies and gentlemen, thank you for standing by. And welcome to the Fortinet Fourth Quarter 2020 Earnings Announcement. At this time, all participant lines are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] Please be advised that today’s conference is being recorded. [Operator Instructions]

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

[Peter Salkowski, VP, IR]

Thank you, Sarah. Good afternoon, everyone. This is Peter Salkowski, Vice President of Investor Relations at Fortinet. I’m pleased to welcome everyone to our call to discuss Fortinet’s fiscal results for fourth quarter of 2020.

Speakers on today’s call are Ken Xie, Fortinet’s Founder, Chairman and CEO; and Keith Jensen our CFO. 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 fourth quarter, providing guidance for the first quarter of 2020 and the full year. We’ll then open the call for questions. During the Q&A session, we ask that you please keep your questions brief and limit yourself to one question and one follow-up question, to allow others to participate.

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-K and Form 10-Q for more information. All forward-looking statements reflect our opinions only as of 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 GAAP to non-GAAP reconciliations is located in our earnings press release and in the presentation that accompanies today’s remarks, both of which are posted on the Investor Relations website. Lastly, all references to growth are on a year-over-year basis, unless noted otherwise.

I will now turn the call over to Ken.

[Ken Xie, Founder, Chairman and CEO]

Thanks, Peter, and thank you to everyone for joining today’s call to review our fourth quarter and full year 2020 results.

Fourth quarter billing increased 20% to $961 million. Our secure SD-WAN offering accounted for over 13% of fourth quarter billing. Product revenue accelerated quarter-over-quarter to 21%, contributing to a total revenue growth of 21%. Operating margin benefited from solid revenue performance. We achieved all-time company record non-GAAP operating margin of 29.4% for the fourth quarter.

Given the many opportunities ahead, we plan to shift our focus more to growth for the at least next few quarters.

Today, we announced the FortiOS 7.0 with 300 new features and updates. With this release, Fortinet is the only leading cybersecurity vendor to offer firewall-based zero trust network access enabling remote access to replace the traditional VPN. This reduces attack surface while improving the user experience. Fortinet’s Zero Trust Network Access solution also simplifies management by using the same access policy, whether on or off network.

Tighter integration of a SASE solution with the FortiOS 7.0 gives enterprises the flexibility they need to enable their workforce to work from home with consistent, enterprise-grade security delivered on-premise, or now, via cloud-based SASE consumption for security-as-a-service.

The FortiOS 7.0 extends network connectivity and security beyond the WAN Edge with innovations in 5G and LTE that improve the wireless network performance and increase resiliency. Our 5G offering enables organizations to achieve secure, scalable and highly available network connectivity anywhere. The release of FortiOS 7.0 expands the Fortinet Security Fabric delivering on our mission to provide broad, integrated and automated security to any device, any application everywhere.

Cybersecurity is at an inflection point. And increasingly, organizations are consolidating towards a platform approach and not just a separate platform for endpoint, network security or cloud security but a holistic platform that is integrated, automated across all this area. The Fortinet Security Fabric is a cyber security platform built on broad and deep set of networking security technology from endpoint to network to cloud, organically built to seamlessly communicate and operate together. This consolidation with our security-driven networking approach will be key drivers going forward.

Today Fortinet is recognized in 8th Gartner Magic Quadrant. Our FortiGate product is a leader in both, SD-WAN and the Next Generation Firewall Magic Quadrant. We continue to experience excellent adoption of our secure SD-WAN and expect our unique solution to become a market share leader within a few years.

In addition, for our growth drivers, we estimate our total addressable market will grow at an annual compound rate of a 10% over the next four years to reach $93 billion by 2024. The recent SolarWinds security incident and the pandemic elevated the need for a broad, integrated and automated platform. And we expect companies will raise the percentage of IT spending used for security as they work to secure their entire infrastructure across multiple edges in a zero trust environment.

Before turning the call over to Keith, I would like to thank our employees, customers and partners worldwide for their continuous support to manage our response to the ongoing COVID-19 pandemic. Keith?

[Keith Jensen, CFO]

Thank you, Ken.

Let’s start the fourth quarter review with revenue. Total revenue of $748 million was up 21%. Product revenue was up 21%. Service revenue was up 21%. Product revenue of $288 million saw substantial sequential acceleration in growth relating from strong demand for fabric -- Security Fabric Platform and FortiGate across all form factors, hardware, software, and virtual machine. While secure SD-WAN use cases continued their dramatic growth, the majority of product revenue was driven by the wide range of other operating system capabilities embedded in FortiGates and their related use cases.

Service revenue of $460 million benefited from strong demand for fabric and cloud security solutions. Support and professional services revenue increased 21% to $210 million. The revenue mix shift from 8x5 to 24x7 support was 12 points, with 24x7 now representing 66% of the mix. Security subscription services and cloud provider revenue increased 21% to $249 million.

Moving to the mix of FortiGate and non-FortiGate revenue. Network security revenue increased 18%, driven by the high end and entry-level FortiGate product families. Non-FortiGate products and service revenue increased 29%, driven by a 34% increase in revenue for fabric and cloud security solutions.

Before continuing with the fourth quarter results, I’d like to highlight our 2020 full-year revenue performance. In the midst of a pandemic induced recession, total revenue for the year grew 20% to $2.6 billion. We take great pride in our focus on organic growth. And 2020 represents the third consecutive year with revenue growth of 20%. This consistent performance speaks to our geographic and customer diversity, the continued success of the integrated platform strategy, and our proprietary ASIC advantage that enables a shared operating system across the platform, drives our cost per performance advantage, increase the capacity to add features and functions while maintaining price points.

Total non-FortiGate revenue for the year grew over 25% to more than $725 million. In other words, our fabric, cloud and other security products and services are on a pace to be a $1 billion business as we exit 2021. Our non-FortiGate and FortiGate products and solutions include a complete range of form factors and delivery methods, including physical and virtual appliances, cloud, SaaS and perpetual software, as well as hosted and non-hosted solutions. Together, they provide a range of security solutions and form factors, enabling integrated protection for hybrid environments, and their expanding digital attack surface and edges.

Pivoting back to our Q4 results, let’s turn to revenue by geo. Our geographic revenue performance continued to align with the pandemic’s economic path, and with it highlighted the geographic diversification of our business.

As summarized on slide 7, revenue in Asia Pacific increased 23% as many Asian countries and economies continue to remain largely open. EMEA revenue increased 22%, and the Americas posted revenue growth of 20%.

Let’s shift to billings. Total fourth quarter billings were $961 million, up 20%. FortiGate billings increased 16% and accounted for 71% of total billings. As shown on slide 9, high-end and entry-level FortiGates posted strong billings growth for the quarter. Non-FortiGate billings increased 29% of total billings, driven by demand for fabric and cloud security solutions. As with revenue, geo billings performance aligns with the economic path of the pandemic. In terms of growth, APAC billings outperformed all geos, followed by Europe and the Americas. The Americas reflect the continuing impact of the pandemic and especially in Latin America.

Moving to billings by customer segments. The small enterprise segment posted solid growth across all geos, illustrating the strength of our Engage channel partner program. This segment is driven by new customer acquisitions, customer security fabric expansions, solid execution by our channel partners and the large diverse makeup of this multinational customer segment.

Moving to worldwide billings by industry verticals. The worldwide government sector topped all verticals at 17% of total billings and grew 28% with another strong performance from our international team. Service providers and MSSPs accounted for 16% of total billings. Retail accounted for 10% of total billings, up 2 percentage points quarter-over-quarter. And Education continued to rebound with billings growth up 26% year-over-year.

Looking now at deals by dollar size. We had 68 deals over $1 million in the fourth quarter compared to 64 deals in the fourth quarter of 2019. Secure SD-WAN accounted for 16 deals over $1 million, versus 11 deals in the fourth quarter of 2019. On a full year basis, SD-WAN accounted for approximately 11% of our total billings and doubled year-over-year.

Moving back to the income statement. As shown on slide 4, gross margin improved 40 basis points to 78.5%. The strong 29% quarter-over-quarter product revenue growth created a mix shift from services to product revenue. The mix shift was a headwind for quarter-over-quarter gross margin comparisons.

Product gross margin improved 130 basis points to 63.2%. Product gross margin continued to benefit from a higher mix of software products and the lower direct cost of our newer generation of FortiGate products.

Operating margin for the fourth quarter increased 210 basis points to 29.4%, benefiting from the gross margin improvement and continued lower travel and marketing program expenses, offset by the addition of new sales team members as we continue to prepare for additional growth. At the end of the year, the total headcount was 8,238, an increase of 16%.

Moving to the statement of cash flow summarized on slides 10, 11 and 12. Cash flow for the fourth quarter came in at $264 million. In the fourth quarter, we repurchased approximately 300,000 shares of our common stock for a total cost of $34 million. For the full year, we repurchased 11.7 million shares for a total cost of $1.1 billion.

At the end of the fourth quarter, the remaining share repurchase authorization was $1 billion with the authorization set to expire at the end of February in 2022. Throughout the pandemic, we have leveraged the strength of our balance sheet as a competitive advantage to support our partners and customers as they experience geo-specific economic challenges. As a result, average days sales outstanding increased 8 days to 87 days, in line with our expectations and reflecting our decision to provide geographically targeted extended payment plans. Inventory turns improved to 2.7 times from 2.1 times in the third quarter and was relatively flat year-over-year. We expect extended payment terms and higher inventory balances to be in effect as we move through at least the first half of 2021.

Capital expenditures for the fourth quarter were $32 million, including $22 million related to construction and other real estate activity. We estimate capital expenditures for the first quarter between $50 million and $60 million, and for all of 2021 to be between $150 million and $170 million.

2021 CapEx projects include expanding our data center footprint and spending that was moved from 2020 due to delays in the new campus building. The average contract term in the fourth quarter was approximately 28 months, up less than 2 months from the fourth quarter of 2019. The growth in SD-WAN and other large enterprise deals contributed to the increase.

As we look forward, I’d like to review our outlook for the first quarter and full-year 2021, summarized on slide 13, which is subject to 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 $765 million to $780 million; revenue in the range of $670 million is $685 million; non-GAAP gross margin of 78.5% to 79.5%; non-GAAP operating margin of 22.5% to 23.5%, reflecting the typical revenue seasonality associated with the first quarter; non-GAAP earnings per share of $0.70 to $0.75, which assumes a share count of between 167 million and 169 million. We expect the non-GAAP tax rate of 21%.

Before providing our 2021 guidance, I’d like to congratulate every member of the Fortinet team, for the truly outstanding execution in 2020 in the face of unprecedented challenges and rapidly changing and unpredictable dynamics. The effort and results have been outstanding. And this is on top of now several years of consistent, predictable performance, and continuing improvements in key growth and profitability metrics.

Today, we reported our third consecutive year of total revenue growth of 20%, while increasing our non-GAAP operating margin, an average of over 200 basis points a year for the same period. Our goal remains to balance growth and profitability within the framework we have provided. As Ken mentioned, given the many growth opportunities that lie ahead, we currently plan to tilt our bias within this framework, more towards growth for at least the next several quarters. The opportunities we see are supported by a strong pipeline heading into 2021, increased sales capacity and our development efforts, which include the NP7 chip and our new FortiOS 7.0 operating system.

With that, for 2021, we expect billings in the range of $3,560 million to $3,640 million, which at the midpoint represents growth of approximately 17%; revenue in the range of $3,025 million to $3,075 million, which at the midpoint represents growth of 18%; total service revenue in the range of $2,015 million to $2,045 million, which represents growth of approximately 21% and implies product revenue growth of approximately 11% and $1 billion in product revenue for 2021, quite the milestone for Fortinet; non-GAAP gross margin of 78% to 80%; non-GAAP operating margin of 25% to 27%. When backing out the 2020 T&E benefit, the midpoint of guidance represents a 50 to 100 basis-point increase in operating margin for 2021. Non-GAAP earnings per share of $3.60 to $3.75, which assumes a share count of between 170 million to 172 million. We expect our non-GAAP tax rate to be 21%. We expect cash taxes to be approximately $80 million.

Now, with Ken, I’d like to thank our partners, customers and the Fortinet team for all their support and hard work during these difficult and unique times. I’d also like to offer a special welcome to the Panopta team. And I’ll now hand the call back over to Peter to begin the Q&A session.

[Peter Salkowski, VP, IR]

Thank you, Keith. Operator, please open the call for questions.

[Operator]

Thank you. [Operator Instructions] Our first question comes from the line of Brian Essex with Goldman Sachs.

[Brian Essex, Goldman Sachs]

Hi. Good afternoon. Thank you for taking the question. And congrats on a great set of results. Maybe, Ken, if I could ask, you’ve got a number of different product cycles ahead of you this year. You’ve got NP7. You’ve already talked about SD-WAN. You’ve got hyperscale penetration and potential exposure to 5G. Can you maybe talk about the contribution from each of those that’s embedded in your guidance? And, what are you seeing currently in the market, and what’s yet to come?

[Ken Xie, Founder, Chairman and CEO]

I think for NP7, it’s still in the ramp-up stage. We continue to build a new our platform using NP7, it’s better for the high end and middle range. The FortiOS 7.0 is also a growth driver, but we are in the beta-3 process right now this quarter. That’s what’s helping contribute to the additional growth, especially in the zero trust and SASE environment and also this infrastructure security later this year, but it’s -- so far, I see the product growth, like 21% is a lot of contribution from whether the SD-WAN or we call security-driven networking and also in the probably like 1 to 2 years ago, when we released the SoC4. So, that’s a little bit towards the low end side of the FortiGate, which you can see nicely grows over there. And also the team is doing a great job in the sales and marketing.

[Keith Jensen, CFO]

Yes. I think the guidance, the process is not so much about individual products or even in some cases, individual use cases. We identified 15 to 20 different use cases for firewalls. It’s more about what we see in terms of market opportunity, what we see in pipeline than maybe by geography or deal opportunity or what have you as some of the key inputs that go into it. But, I wouldn’t really think of it as -- I certainly would not want you to walk away from the conversation thinking that the guidance that we provided is dependent upon some degree of 5G or SASE or something that’s above and beyond.

[Brian Essex, Goldman Sachs]

Got it. That’s helpful. Maybe just a quick follow-up. Nice large deal activity, certainly more than we picked up in the channel. Maybe if you could talk a little bit about the competitive dynamics on the large end of your market scale. Where you’re seeing that business come from? How much is displacement, and how much is expansion of I guess existing customer opportunity?

[Ken Xie, Founder, Chairman and CEO]

Yes, definitely, whether from our customer or our partner is starting to get a much better, more competitive and a lot of advantage using the Fortinet product, whether the FortiGate leverage new ASIC, the new OS with much more additional function compared to competitor. So, that’s where like increased gap we have ahead of competitor now. And that’s actually helping to drive -- accelerate the product revenue growth. And on the other side, we have a little bit different approach for whether the SASE or cloud endpoint. So, we more emphasize, integrate together, automate together, especially in the OS level, that’s -- none of our competitors has that. And also, most of this also organically internally developed, designed to work together, automate together from day one. That’s also different from competitor, come from acquisition, which is more difficult to integrate and also difficult to manage long term. So, we do feel we have a more and more advantage in the marketplace right now.

[Operator]

Our next question comes from the line of Shaul Eyal with Oppenheimer.

[Shaul Eyal, Oppenheimer]

Congrats on the ongoing strong execution levels. I want to start with a gross margin related question. So, gross margins guidance for ’21 indicates an improvement, 1 to 2 basis points on average. And I’d like to understand whether it is driven by the ongoing shift to more cloud activities, i.e., more subscription services, or is it driven by some improvement with your ASIC-driven strategy?

[Keith Jensen, CFO]

Yes. I think, the last part is probably the headline, which is that each successive generation of the ASIC in addition to creating more speed, more capacity, if you will, more throughput. It also creates capacity to consolidate features of the BOM that were previously separate. And the success of generation has shown the benefit of that. I think over the last year or two, we’ve done a very good job of retaining that cost benefit in terms of the structure. You can look back and see what’s happened with the gross margin, on the product gross margin line. Obviously, you do then also get the benefit in total, when you add into two-thirds of the business that are services that are coming at a much more attractive margin. So, the combination of those two, I think, is working very, very well for us as we exit 2020 and move into 2021.

[Shaul Eyal, Oppenheimer]

And maybe high level on the Sunburst breach. Have you seen any incremental interest starting in mid-December, maybe building into year-end, again, just aside from the typical healthy year and seasonality trend?

[Ken Xie, Founder, Chairman and CEO]

I’d say probably -- we do see a lot of need -- interest, especially to secure the whole infrastructure, including supply chain with all different third-party kind of product, all these things. But it’s still -- I’d say it’s definitely more people certainly interest in this area, but it’s -- the business side is probably not changing that much yet. But, we do see going forward, probably later this year will be, because it’s definitely with the security concern, like I mentioned, the security spending among our IT spending probably will keeping increase.

[Operator]

Our next question comes from the line of Tal Liani with Bank of America.

[Tal Liani, Bank of America]

I have two questions. The first one is, Ken, in your prepared remarks, you said that this year is going to be a year of focus on growth. What does it mean? Does it mean that you’re going to increase expenses and the margin increases will moderate? Can you elaborate on the meaning behind your statement that you’re going to now focus on growth this year? And how does it differ from previous year, for example?

[Ken Xie, Founder, Chairman and CEO]

We do see like whether some investment we made in the sales and marketing, like we said, we have increased sales capacity and also we also have a better visibility, we increased the marketing. And at the same time, from the product, from infrastructure side, we also will keeping invest, especially organic internal development, like building the new infrastructure, and where to address the cloud and the networking endpoint and also working with service provider. So, basically, we do see -- the market itself also is starting kind of accelerating, especially in some new areas, whether the security-driven networking, including both SD-WAN or 5G, and that has the new infrastructure, but also some kind of a service model, leverage the infrastructure, which we will keeping invest more in there. So, that’s what we feel. So, this will give us a much more growth opportunity and both internally like whether the NP7 or the FortiOS 7.0 is timing quite well. So, it will help us drive the faster growth.

[Tal Liani, Bank of America]

And does it have any impact on margins.

[Keith Jensen, CFO]

Yes. Tal, I’ll just add to that. I think the -- sorry to interrupt you. Look, I think, we were very successful throughout 2020, even during the pandemic, maintaining our -- and growing our operating margins very dramatically, but at the same time, adding sales capacity. And I think, when we sat down to build the guidance out in the plan for 2021, coming into the year with the capacity levels that we have, together with the increase in tenure that we’re seeing as well as the pipeline, I think we feel very good about this opportunity to take advantage of the growth. And I think, we’re still -- I think, the margin guidance at the midpoint of 26% is very much within the framework and actually up a little bit.

[Tal Liani, Bank of America]

Got it. My second question is about the needed investment in infrastructure to accommodate SASE and similar business models. What is the company doing in order to address it? Can you just elaborate on what’s happening behind the scene?

[Ken Xie, Founder, Chairman and CEO]

Yes. The SASE approach for Fortinet is different than some other competitors. We do want to have a more integrated automated approach. And also, we are the only one in the OS level, both the SASE and also zero trust network access. So, that’s making whether working with Fortinet or service provider or even customer enterprise themselves to develop their own kind of SASE approach, which will be much better fit for their own kind of privacy, whether it’s GDP or some other requirement, it’s much better secure compared to some other approach. So, that’s where we feel -- we do have some investment, but some investments, like infrastructure, we’re also working with our service provider together.

[Operator]

Our next question comes from the line of Rob Owens with Piper Sandler.

[Ben Schmidt, Piper Sandler]

Hi. This is Ben Schmidt on for Rob. Thanks for taking my questions. As much of the attention in the space begins to shift towards cloud and SASE, how do you think about your longer term strategy from a remote connectivity perspective? And what do you think -- and what do you expect for the branch office?

[Ken Xie, Founder, Chairman and CEO]

I think, for our technology, we can support in both the thin branch and the thick branch office approach. And also, even for the SASE, so we leave the flexibility to enterprise, which we can whether leverage the vendor or they can leverage their service provider or carrier or they can build themselves. So, that’s why we say, we put in the OS level, it’s much more integrated, automated compared to some other approach, which has to let vendors infrastructure.

So for us, like this OS level integration of SASE will leave a lot of flexibility and gradually for the customer to transition, whether they move service-based or they still want to like have, we call security infrastructure approach. So that’s where we have the flexibility to have customers select their own approach based on own need. And at the same time, we’ll make the whole infrastructure secure, like we say, whether the security-driven networking with SD-WAN, 5G or internal segmentation, whether in the data center or with the enterprise campus environment. So, that’s why we feel, even we take a little bit more time to build this kind of a highly integrated OS level approach, but the result is much better and more advanced than some other loosely -- other approach.

[Ben Schmidt, Piper Sandler]

Okay. And on the growth investment, can you guys add just a little bit more to how much of the capacity has already been added? And how much you’re expecting to add, I guess, how much more needs to be added for this year? And, can you remind us what the normal ramp time period is for new reps?

[Ken Xie, Founder, Chairman and CEO]

For the new rep, probably a little bit different for each second vertical, like the channel probably within a few months, like 3 months time frame, and then the enterprise probably 6 to 12 months [ph]. [Indiscernible] take like 1 to 2 years like that carry all the things. So, we’re going to also like differentiate, I think based on how the pandemic, how the other progress going and also the market opportunity there. But, I’d say, we do kind of plan into increase more capacity when we see more opportunity there and try to match the investment with -- I think whether the internal, like the new product and also the market opportunities, so definitely will help us keep driving the SASE growth.

[Operator]

Our next question comes from the line of Fatima Boolani with UBS.

[Fatima Boolani, UBS]

Ken, maybe I’ll start with you. Just drilling into your vertical-based performance, you talked about the global government vertical being -- comprising a fifth of your billings in the quarter and that some of the highest levels we’ve seen. And so, I’m wondering if you can remind us what your U.S. public sector exposure is within that government exposure? And then, more specifically, how is Fortinet positioned, both from a product and go-to-market perspective in the U.S. federal, especially as we sort of think about the $10 billion cybersecurity spending protocol from the new Biden administration? And then, I have a quick follow-up for Keith.

[Ken Xie, Founder, Chairman and CEO]

Yes. The government business for Fortinet’s global base, it’s about 17% of our total business for us right now. And compared to like a few years ago, the carrier service provider is the number 1 is over 20%. Now, they are like 16%. For the U.S. government, we still see a lot of opportunity and the same thing for the U.S. market. And so, we’re going to keep in building the team and increase capacity and to take this opportunity and grow faster and larger. What’s the second question?

[Keith Jensen, CFO]

I think, we’ve talked before that the U.S. fed is low single digits of our government business -- of our business, nothing to add that.

[Fatima Boolani, UBS]

Got you. Very helpful. Keith, just sticking to Americas, we saw a very nice acceleration in 4Q in the Americas theater, and against what was maybe an uneven geographical performance for the U.S. over the course of 2020. So I’m wondering if you can just put a finer point on the types of things that went right and the types of things that really went on in the quarter, and the key drivers of the strength, particularly in the Americas. And that’s it for me.

[Keith Jensen, CFO]

Yes. So, I think a good question, but a lot of ways, different answers. If you look at geographically, Latin America continues to be, by far, the most challenged, if you will. Canada probably did the best of the three, and I would put the U.S. right in the middle. I do think that we’re very pleased with how the U.S. has come back. The second quarter, now that we all are pandemic experts about what to expect out of the business and looking at Q1, Q2, Q3, Q4. It’s pretty obvious that -- and we kind of felt this coming out of the second quarter that Q2 was a low watermark, both for the Company in total, but also for the U.S. And I think you’ve picked up on -- since that point, there’s been a steady progression of, for lack of a better term, recovery in that part of the business.

[Operator]

Our next question comes from the line of Brad Zelnick with Credit Suisse.

[Brad Zelnick, Credit Suisse]

Thank you so much. And congratulations to the entire Fortinet team on a great end to a great year. My first question for you, Ken, in your comments, you basically said that you aspire to be the market share leader in SD-WAN, which I think is a really important goal that you have. And I just was curious, from your perspective, what needs to happen to get there? How do you take share from your two largest competitors that have significant installed base relationships? And over what time can this play out?

[Ken Xie, Founder, Chairman and CEO]

I think, for us, we have a unique advantage of we build SD-WAN with security together, and we also leverage ASIC to like increase computing power, lower competing cost a lot. So, that’s none of our competitors have not. And also the other two big leaders, they come from acquisition, that’s where going forward, they probably will be slower on whether the innovation of the market change dynamic there. So, that’s what you can see from the FortiOS 7.0 release. We did see the increased additional function, whether the SD-WAN, the 5G and other parts. So, we do also believe, going forward, like half or majority of the SD-WAN market will need security. So, we have a huge advantage there. So, that’s where -- even have a bigger installation base, but the advantage we have from the product, from a function, from the cost side, I think will be huge, and what have us keeping driving the market share. And so far, like year-over-year, we almost doubled the SD-WAN business compared to the 2019 in the ‘20.

[Brad Zelnick, Credit Suisse]

Great. And maybe just quickly for Keith. Keith, what are the levers to think about, in light of sales headcount, and the plans for this year?

[Keith Jensen, CFO]

Brad, I’m not quite sure I fully understand the question, but maybe I’ll give it a shot and that to share one data point of coming into this year, if I look at the level of sales capacity we have versus what the plan is that we’re talking about. I don’t think I’ve -- this is as well positioned as we have been coming into a year to pivot towards this growth model that Ken has talked about. And I think that -- the pipeline feels very good. The tenure feels very good. The use cases, the TAM feels very, very good to us. The new FortiOS, the NP7 shift is coming out, the platform advantage, the cost advantage that we have for performance. I think that we are in a very good position to execute this. And again, we’re maintaining it within the framework that we’ve talked about previously.

[Operator]

Our next question comes from the line of Sterling Auty with JP Morgan.

[Sterling Auty, JP Morgan]

Just one question from my side. Ken, in your prepared remarks, I think, you talked about that the industry is finally raised, the customers move to consolidation on fewer vendors, more of a broad platform approach. With that in mind, where would you gauge the Fortinet platform and what are the areas that you would like to bolster to improve your position moving forward?

[Ken Xie, Founder, Chairman and CEO]

You can see that, like we call the security fabric has a pretty nice growth, almost double compared to the FortiGate growth there. That’s also because customers want to have all these whole infrastructure secure integrated automated solution. So, that’s where we’re continuing to see -- we’re keeping gaining share there. So, that’s involving probably 20, 30 different products. And on the other side, on the FortiGate part, we call the security-driven networking, that’s whether the SD-WAN, the 5G and now with integrated SASE and some other part working closely with service provider carrier, we also see a lot of opportunity within the FortiGate side.

So, that’s where we see -- so far, we are keeping like -- if the market itself grows like 10%, we do see we can grow much faster than the market keeping gaining share. And both, on the FortiGate and also on the -- we call it, the broad fabric approach, which is involved in both the endpoint and the networking and the cloud altogether. And all this integrated together, based on the FortiOS and some under connectivity related to the FortiOS.

[Operator]

Our next question comes from the line of Adam Tindle with Raymond James.

[Adam Tindle, Raymond James]

Ken, I just wanted to start on the focus more on growth comment and how you’re investing some of your healthy margin and some sales and marketing initiatives. We also heard a similar message from a competitor yesterday. And just thinking about the broader industry implications of that an outsider could maybe make the case that we enter a period of greater industry competition and pricing pressure as major competitors are investing heavily in sales and marketing, certainly doesn’t seem to be the case based on your full year margin guide. So, maybe some thoughts on why that scenario does not play out?

[Keith Jensen, CFO]

Ken, can I jump in and answer on your behalf? I think, the reference probably is to a company that has a very, very different business model. Whether you’re looking at growth rates or you’re looking at product service mix or what have you. So, I don’t know that that would draw that straight-line comparison. I think, the business model that we’re executing here has been extremely successful, and I expect it will continue to be so.

In terms of discounting, I think that there’s days that I don’t like carrying it, but we’re view as being the price for performance leader, that our pricing is really -- we’re oftentimes, I think, brought into RFPs and opportunities to set the milestone that the competitors are forced to react to as opposed to the other way around. If you go back and look at the comments that we’ve offered throughout 2020, even in the pandemic, more often than not, discounting, if you will, has been a tailwind for us in our ability to execute against it as opposed to a headwind. And by that, I define discounting, mean lower discounting pressure in that quarter than the prior period. So, I don’t think we have the concerns that may have been described there.

[Adam Tindle, Raymond James]

Okay. That’s helpful. And maybe just a quick follow-up, Keith. And sorry, a little bit in the weeds on this one. But, the billings guidance for Q1, it’s down about 20% sequentially at the midpoint and typically down low double digits or so, mid-teens in that range. Last year, at the start of COVID, it was down 17%. So, part of the question is, why would the sequential decline in billings be worse than the environment when we entered COVID, during Q1 of last year? You talked about having a strong pipeline, supporting the desire to invest. Maybe just some help with the color on the disconnect between those two items. Thank you.

[Keith Jensen, CFO]

Yes. I think one -- which you’re talking about is just a tremendous performance in the fourth quarter of 2020. I know that 20 -- fourth quarter of 2019 was a good quarter, but Q4 2020 on top of that ‘19 performance, I think is part of it. And this is typically the smallest quarter for us in the year. Historically, you’ve seen some sort of shift, and it’s nothing new and from going from Q4 to Q1 and then you start to see the progression thereafter.

[Operator]

Our next question comes from the line of Keith Bachman with Bank of Montreal.

[Keith Bachman, Bank of Montreal]

Ken, I wanted to ask my first question of you. You’ve talked about 5G. Why is that an opportunity? Who’s your customer? And what -- why does Fortinet win in that instance of the deployment of 5G? And if you could just talk a little bit about when do you think that you’ll get some benefits from this?

[Ken Xie, Founder, Chairman and CEO]

I think we do see 5G connect a lot of devices to the Internet, which also increased a lot of security risk. We call there’s a new attack service, a new edge need to be covered. So, that’s where especially, we’re working with a lot of service providers for the 5G service to a lot of enterprise and connect all these different devices in the OT/IoT space. So that we do see as a huge opportunity. And so, with our position with the carrier service provider and we do see the 5G can be one of the driving -- growth driving factor for us this year and it could be material towards the end of the year. Going forward, it’s also huge, huge opportunity, even secure whether -- it’s part of the whole infrastructure, which grow very, very fast and a lot of our carrier service providers starting to have investment in this area also.

[Keith Bachman, Bank of Montreal]

Okay, interesting. Okay. And then, Keith, one for you. For the guidance of ‘21, you talked about CapEx. Any other puts and takes you want us to think about as it relates to OCF or operating cash flow?

[Keith Jensen, CFO]

No, not really. I mean, I made the point about inventory. The turns came in for us pretty strong in the fourth quarter, but I think that’s a direct reflection of the success that we had in the product revenue line in the fourth quarter. So that was probably a little bit better than we expected. I do think during this pandemic era that we’ll continue to maintain somewhat higher levels of inventory. I think that’s in our best interest. The extended payment term program, I think that every CFO wants to wind that down as fast as possible and every distributor wants to hold on to it for life. So, that will be an ongoing battle for us throughout 2021, I think.

[Operator]

Our next question comes from the line of Ben Bollin with Cleveland Research.

[Ben Bollin, Cleveland Research]

My first question, you’ve made your aspirations pretty clear in SD-WAN. Could you share with us a little bit about aspirations, intentions as you move into SASE and zero trust, how you see yourself positioned?

[Ken Xie, Founder, Chairman and CEO]

Yes. SD-WAN is a part of the SASE offering. What we do is a little bit different than competitors. We build within the FortiGate, FortiOS, which also can be offered, whether based on the physical price or the virtual software or kind of cloud delivering. And that’s where the new FortiOS 7.0 gives all this flexibility and connects a lot of other part of infrastructure security service together. So, that’s where we’ll continue to see SD-WAN and keeping growing probably -- by much, it probably was keeping grown like 30%, 40% year-over-year this year. We do believe we’re also keeping gaining market share. And at the same time, the 5G -- the other opportunities come up, we already offered in the new FortiOS 7.0, which also could be a pretty good driver for the additional growth we have.

[Ben Bollin, Cleveland Research]

Could you also talk a little bit about how you envision FortiOS 7 rolling out, once available? How backwards compatible will it be for legacy appliances? And if you’ve looked at some of the historical OS refreshes, how long does it take the footprint to roll over, as this rolls through the base? Thank you.

[Ken Xie, Founder, Chairman and CEO]

It’s really dependent on customer. Some -- I have to say, the channel probably reacts a little bit faster and then there’s enterprise, then the service providers sometimes take a little bit time. Because large service providers, they also have to support in some of that. But we do see this enables a lot of new opportunities. And they also like this tightly integrated approach, whether the SD-WAN, SASE, we call security driven networking, which do enable them to offer the additional service, additional kind of business and protect additional edge. That’s why we say, you need to protect all different edge together and automate -- integrate together instead of have a different product, different kind of a vendor for each part, which is difficult to integrate and automate. So, that’s where we see the response from like 300 new features and updates in this OS to cover quite a broad area. And that we do see customers do need some time to gradually like train, pick up on this new function. But, a lot of them, they see the huge benefit of this new function. And that’s where we see, it’s a huge opportunity for us. But probably towards the second half of the year, we’ll see a lot of benefit of it.

[Operator]

Our next question comes from the line of Michael Turits with KeyBanc Capital Markets. Your line is open.

[Unidentified Analyst]

Hi. This is Eric Heath [ph] on for Michael. Just one for me. Keith, it seemed like you guided billings for 4Q, assuming some macro headwinds. How did that play out differently than you expected, especially on the product side? And in the end, did you see deferrals of hardware refreshes in 2020 that might snap back in 2021?

[Keith Jensen, CFO]

Yes. We have such a long product list. I don’t think that we really saw deferrals of refreshes, despite the asset concept. I think the -- I don’t think Q4 was unusual in terms of what you normally see, with other years. And by that, I mean, I think, there was probably some element of the typical budget flush flowing through. I think, there was probably some element of salespeople working really hard to hit accelerators. And I think there was also some element of deals that simply pushed. I don’t think that -- Ken kind of made a good point earlier to build on a little bit. I think, the solar wins event happened so late in the quarter, at least for us and probably for many other security companies. It seems doubtful that that activity really had much impact on the last two weeks of December in the quarter. I do think, and Ken made this point that it certainly raises awareness of security and events like that, unfortunately, for the world at large, keep focus on security that matters and the importance of it that people are going to suffer because of it.

So, I don’t know that in terms of learning to be cautious, if you will, going back to the beginning of your question and the guidance setting, I do think there was an element of caution, once we came out of the second quarter and saw how the dynamic impact close rates. And you saw that come through in the guidance setting process in both Q3 and Q4.

[Ken Xie, Founder, Chairman and CEO]

Also, we see a pretty nice growth in SMB, but overall, the SMBs still have very low percentage leverage, whether the network security or cybersecurity. That’s where -- including retail. So that’s where we see there’s a -- still have a huge growth opportunity over there.

[Operator]

Our next question comes from the line of Andrew Nowinski with D.A. Davidson.

[Andrew Nowinski, D.A. Davidson]

Great. Thank you. And congrats on the nice quarter. Maybe just starting with a high-level question. So, as we think about the mix of your revenue, do you think the SolarWinds attack will create a positive tailwind for more spending in the firewall market, or do you think it will pressure your product growth as customers perhaps shift spending towards some of your cloud-based and subscription solutions?

[Ken Xie, Founder, Chairman and CEO]

I said, probably they would drive to have a more integrated and bigger infrastructure security. So, that’s where probably -- definitely, it’s sort of when it’s more like kind of come from the network side. On the other side, they are also trying to like cover what the pandemic is, whether it’s work from home, there’s a lot of other like business trying to digitalize during this process, which also increased the security need. That’s why I say, the security spending kind of on the overall IT spending probably will keep increasing this year, and that’s what’s also helping drive. The SolarWinds is just like a few years ago, there’s a case where the target and other things, definitely awareness of the importance of cybersecurity.

[Andrew Nowinski, D.A. Davidson]

Great. Thanks, Ken. And then, just a follow-up. As we think about the growth phase you’re entering here this year and your go-to-market strategy to drive that growth, if you look back over the last few years, your playbook has certainly been the lead with the firewall. I’m just wondering in this new growth phase, are you using the same playbook to accelerate the growth, or are you seeing more deals come to you via your SIM products and your virtual solutions and your other subscriptions and perhaps changing your go-to-market strategy to drive that growth?

[Ken Xie, Founder, Chairman and CEO]

In the next few years, the network security market is still the biggest market, also probably the fast-growing market, not just because there’s more connectivity, like 5G, SD-WAN and some other part, work from home, but also that’s the center of the whole infrastructure security. But also, you cannot just -- to network security only, you also need to have network security working closely with endpoint, with some other infrastructure, cloud, some other parts together. That’s why we call the integrated automated solution to respond to any of this quick changing dynamic industry here. That’s where it’s important, we keep the organic growth and we also keep -- develop the product on day one to make it integrated, automated together. It’s a little bit different compared to competitor, which whether come from acquisition or some other parties is more challenging to integrate and also keep the innovation going forward.

[Operator]

Our next question comes from the line of Gray Powell with BTIG.

[Gray Powell, BTIG]

Thanks for taking the questions. And congratulations on the good results. So, maybe circling back on the 5G questions. In past telecom upgrade cycles, maybe 3G was too long ago, but looking back at like the 4G upgrade cycle, how did that play through to Fortinet? What kind of tailwinds did you see then? And then, how does the 5G cycle feel in comparison?

[Ken Xie, Founder, Chairman and CEO]

Yes. Compared to 3G, 4G is more connect people, whether the phone, whatever, together, the 5G is more connect to the device. And that’s also the number of connection probably will increase as it may be 10x at least, because there’s much more devices to be connected, and that also kind of more addresses a lot of industry need, whether certain smart city or auto drive or a lot of bigger infrastructure. So that’s -- we do see a lot of a business opportunity, because so far, the network security will be more towards B2B towards the business side compared towards the consumer part. That’s we do see huge opportunity going forward. It’s just like a couple of years ago, the SD-WAN, right? So, SD-WAN can help in drive a lot of smart connection with the application and more dynamic, based on application, have a different connection there.

So that’s where the 5G definitely has a lot of additional opportunity but also bring a lot of risk to the business there, which need to be protected. And also service provider, we see play quite important role there, which is we have probably the best service provider carrier relation among other cybersecurity vendors there. So we do see a lot of potential in this area.

[Operator]

Our last question will come from the line of Irvin Liu with Evercore ISI.

[Irvin Liu, Evercore ISI]

I have one question and one follow-up. First, I was wondering if you can perhaps update us on your business mix by customer size, maybe a breakout by enterprise, commercial or SMB. And whether you’ve seen a shift up or down market? And how do you see this mix trending through calendar ‘21?

[Keith Jensen, CFO]

Yes. I think, we had a slide in our Analyst Day in November 2019 that basically answered one-third, one-third, one-third. And then, to explain it a little bit of MSSP gets allocated between them. But, you end up with something that’s very, very much like that. Small business, small enterprise, one-third; mid, one-third; enterprise, one-third.

I think, the thing that has been a very pleasant surprise to us throughout 2020 in the pandemic was how well the enterprise -- the small enterprise segment of the business held up. It really did very well.

[Irvin Liu, Evercore ISI]

Got it. And for my follow-up, we’re now one year into the current pandemic. And assuming things normalize in the back half of calendar ‘21, do you anticipate any changes or shifts in demand or customer buying patterns, assuming a return to normal environment?

[Ken Xie, Founder, Chairman and CEO]

I think, during the pandemic, the customer, especially enterprise customer turned to hold down to the current vendor, especially in the developed country. But it’s -- but for us, like whether in the U.S. or some of these countries, we’re keeping gaining market share. So, we do get into a lot of new customer, which will probably take more effort during the pandemic because it’s difficult to meet people or do certain testing there. Once it’s open, we do see there’s more opportunity, more windows open for us, especially with the new hardware, new OS and the new infrastructure. So, that also leads us to kind of a little bit towards investing in the growth for us going forward in the next few quarters at least.

[Keith Jensen, CFO]

Yes. I think, Ken is spot on with that. I think, quote unquote, nice thing about the pandemic is I think we have a lot of understanding about our business and what to expect in pandemic quarters. And I think that all of us here at Fortinet, and I think throughout the country are looking forward to, at some point in time, we need a vaccine and then the other gross drivers kick in, and that seems destined to be sometimes towards the second half of this year. I think, we’re all very aware of some of those GDP numbers and the year-over-year swings that we’re seeing from negative 3% to positive 6% or 7%. Those are pretty dramatic numbers. But, I think most people’s expectations are that that’s where they going to come when the economies and the countries start opening up further.

[Peter Salkowski, VP, IR]

We’re going to close the call at this point. As you read in today’s press release, I’d like to point out to everybody that Fortinet’s Accelerate 2021 virtual conference will be held on March 9th for the U.S. As part of that conference, we’ll be doing an Analyst Day. So, you can register, there’s a link in the press release as well as up on the website to register for investors and analysts. So, please do that prior to March 9th, if you’re interested in attending that morning event. In addition, we’ll be hosting -- in addition to hosting Accelerate, we’re also going to be attending the Goldman Sachs conference next week on February 10th and the Morgan Stanley conference on March 2nd. Links to those webcasts will be on our website available on the Investor Relations -- Investor Events page of our Investor Relations website.

Thank you very much for your time today. If you have any questions, please feel free to contact me. Have a great rest of your day.

[Operator]

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.