Q3 2023 Fortinet Inc Earnings Call

Good day, and thank you for standing by.

Welcome to the Fortinet Q3 2023.

Earnings announcements.

At this time, all participants are in listen only mode.

After the speaker's presentation, there will be a question and answer session.

To ask a question. During this session you will need to press star one one on your telephone you would be any here an automated message advising your hand is raised.

To withdraw your question. Please press star one again.

Please be advised that today's conference is being recorded.

I'd now like to hand, the conference over to Peter for Koski Senior Vice President of Investor Relations. Please go ahead.

Thank you Angela and good afternoon, everyone. This is Peter sorry, Cascade Senior Vice President of Finance and Investor Relations at Fortinet and pleased to welcome everyone to our call to discuss Fortinet as financial results for the third quarter of 2023 speakers on today's call are Ken Xie, Fortinet, founder, Chairman and CEO and Keith Jensen, our Chief Financial Officer.

It is a live call that will be available for replay via webcast on our Investor Relations website, Ken will begin our call today, providing a high level perspective on our business Keith will review, our financial and operating results for the third quarter of 2023 before providing guidance for the fourth quarter of 2023, and the up and updating our full year well then open the call for questions. During the Q&A we ask.

Could you please limit yourself to one question and one follow up question to allow others to participate.

Again, I'd like to remind everyone that today's call will be made 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.

Forward looking statements reflect our opinions only as of the date of this presentation already takes no obligation and specifically the skiing 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 in our GAAP to non-GAAP reconciliations are located in our earnings press release and in our presentation.

<unk> that accompanies today's marks both of which are posted on the Investor Relations website, Ken and Keith prepared remarks today for the earnings call will be posted on the quarterly earnings section of the Investor Relations website immediately following today's call lastly, all references to growth are on a year over year basis, unless noted otherwise I will now turn the call over to Ken.

Good afternoon, and thank you to everyone for joining our call in Q C. We exceed street expectation operation margin and free cash flow.

However building on product revenue of 40 below expectation due to a slowdown in secure networking growth along with challenging in sales execution and marketing efficiency.

In response to the slowdown in <unk> market, we are shifting our marketing and sales teams focus towards the hostile growing and secured operation SaaS market over the next few quarters, all while maintaining our costs and focus on BD Alicia insecure networking.

<unk> of the acuity and networks and where we have been a leader for 23 years.

While we anticipate limited near term growth in secure networking market. It is very important for fortinet as we believe eight enable us.

Our platform strategy with a massive footprint in the market leader.

As the market leader in both firewall revenue on a units shipped to.

<unk> now with the market is valued at 62 billion and is projected to increase high single digits annually to 86 billion by 2027.

Our consistent focus.

King.

And that's really the 40 OS.

We just appointed over serving our function now working at acuity application combined with our <unk> performance capability, which provides five to <unk> better performance on average than competitors continuing to keep our market share gains.

Secure networking remain a vital part of our strategy and the market that we believe will return to double digit annual growth overtime.

We have been reaching for some time in the hospital growing in segments of <unk> accretion and the SaaS.

Syncrude opposition Awesome Satcom is a 46 billion market growing.

Teens annually to seven to 8 billion by 2027.

Fortinet stack or platform is comprehensive and integrated.

<unk> offering Edr Sim saw MTR and other integrated solutions.

In addition in the security industry demand seamless integration and underlying so Q2s.

Fortinet strength lies in its evolution and its ability to enable automation through a high degree of product integration.

On the <unk> product.

Sure automatic.

The stomach.

All underpinned by a single consolidated management and analytic platform.

Yes, do you see for Satcom.

Have continue to increase our focus on SaaS.

Our 17 billion market expect to grow in the 20% compound annual growth rate to 36 billion by 2027.

We believe Fortinet is the only company with a SaaS service solution at a time.

All function in the cloud.

Highs all with a common operating system, including for networking security stack market, leading SD Wan VPI and the management console.

Our southeast service solution is supported by Google cloud with over 100 worldwide SaaS Colocation to catch up with our own 30 popcorn are present and the data centers.

For our client base use case, we are salaries SaaS service function using our <unk> technology for instance, we recently announced that <unk> achieved with just the acuity process of five which supported our <unk> offering, which including SD Wan firewall secure web gateway.

The block correlation and boost secure computing region, six to 54 times better than our competition.

We anticipate success as SaaS market will first come from outstanding SaaS service to our installed base.

Of sell them often when customers.

And some attractive new customer looking to leverage our single vendor integrated SaaS service solution.

Our industry leadership in both firewall and SD Wan to cool the largest component of SaaS E provide us with a significant competitive advantages.

We have a track record of successful execution and PV, we're the only company with strong SaaS service and the set up solution combined in the same I appreciate system.

This differentiation set us apart and provide us with a significant competitive advantage over our peers.

Why we expect top line growth to be modest for the next few quarters due to challenges in situ metalworking comparison.

Business transformation, our alignment towards secret operation SaaS here, we are.

Anticipate grocery tend to double digits by the second half of 'twenty organic form.

We've remained committed to generating healthy operation margin of a quantified percent return in 2020 for an appointment.

Before turning the call over to Keith I would like to thank our employees customers partners and suppliers worldwide for their continued support and hard work.

Yes.

Thank you Ken and good afternoon, everyone as Ken mentioned, we are confident in our integrated four at 40 OS driven platform strategy, which is summarized on slides six through 10 of the earnings slide deck.

As we look forward, we believe shifting our R&D and go to market investments to the faster growing SaaS and set top market markets is consistent with near term market opportunities.

As shown on slide 10, SaaS, <unk>, and SEC ops account for 20% and 10% respectively of our business today.

And as shown on slide seven these markets are expected to grow in the mid to high teens annually.

Secure networking, which currently accounts for 70% of our business is expected to experience slower growth. Following two years of very robust growth as a result for the near term, we expect to deliver healthy profitability along with more modest growth.

With execution and continued investment in the SaaS set top markets. We believe we can return to delivering mid to high teens top level growth top line growth and.

And while continuing to deliver operating margins of 25% or greater.

In other words, I returned to balanced growth and profitability, which has led us to achieve the rule of 40 status and 12 to 15 years as shown on slide 19.

In a moment I'll expand on the strategic shift by sharing a few of the tactical steps and investments, but first I'd like to review some highlights from the quarter.

We continue to add new logos at an impressive rate as our topline performance of small enterprise and software with strong operating margin and free cash flow were above expectations.

We added over 6400, new logos supported by small enterprise customers, which grew bookings by 19%.

Our efforts to manage personal personnel and other costs drove our operating margin to 27, 8% 230 basis points above the high end of the guidance range.

Free cash flow was strong at $481 million.

Taking a margin of 36%.

Looking at billings.

Starting from the third quarter of 2022.

Saw a three year compounded annual billings growth rate or CAGR of 26%.

Illustrating our ability to drive strong and sustained growth over an extended period.

In Q3, however, billings of $1 49 billion represented growth of 6% as we experienced one month shorter contract duration, and importantly, lackluster implants demand, resulting from elevated product growth in earlier periods.

In terms of in terms of industry verticals education, and government billings were strong while service provider and retail billings were weak.

Small enterprise billings growth was strong while growth rates with larger enterprises disappointed.

Billings growth varied by Geo with international emerging showing strong growth, while our much larger GFS of Europe, and the U S were weaker.

Turning to revenue and margins.

Revenue of 16%.

Probably total revenue grew 16% to $1 33 billion, which compares to our three year CAGR of 27%.

The three year CAGR was largely consistent with our 14 year CAGR illustrated on slide 18.

Product revenue of $466 million, representing a three year CAGR of 28% was down 1%.

Reflecting product lead times and backlog aligning with historical levels and the lighter levels of network security demand can referred to.

Service revenues of $869 million grew 28%.

Representing a three year CAGR of 27%.

Service revenue accounted for 65% of total revenues.

Driven by 34% growth in higher margin security subscriptions, which represents 57% of total service revenue.

We mentioned the three year CAGR is to illustrate how consistent they are.

With these same CAGR starting from our 2009, IPO, which are illustrated on slide 18.

Each of the three year CAGR billings product revenue service revenue and total revenue.

Within five points of the 2014 year CAGR for the same top line metrics.

Adding to our confidence in returning to higher growth levels.

Product gross margins were down 310 basis points as we saw margin pressure related to inventory levels.

Service gross margin was up 60 basis points as service revenue growth outpaced higher levels of cloud and hosting costs.

Total gross margin of 76, 9% was up 70 basis points driven by the increase in service gross margins and a six point shift from product revenue to service revenue.

Operating margin of 27, 8% exceeded the high end of the guidance range and operating income of $371 million was $33 million higher than consensus and $20 million above the high of the high end of our guidance range, reflecting our efforts to control spending.

Looking to the statement of cash flow summarized on slides 15 through 17 free.

Free cash flow increased 22% to $481 million.

Representing a free cash flow margin of 36% or nine points above consensus.

Operating cash flow increased 68, million% to 41% of revenue.

Capital expenditures of $70 million, including $50 million of real estate investments.

Cash taxes paid in the quarter with $26 million.

As a reminder.

Free cash flow benefited from regulatory relief in the form of deferred estimated and other tax payments in the second and third quarters totaling $192 million and $18 million respectively.

In the fourth quarter, we expect cash taxes to totaled $345 million, including the $210 million of deferred tax payments.

We repurchased 10 4 million shares of our common stock for an aggregate cost of $605 million in the third quarter.

In October we purchased an additional seven 7 million shares for $444 million and our remaining share repurchase authorization stood at approximately $980 million at the end of October.

Now I'd like to share a couple of key SaaS wins for us in the quarter.

A seven figure upsell in an existing financial services customer initiated their single vendor SaaS solution for 50000 users.

That was able to displace another incumbent as the customer continue their consolidation journey with us supplementing their earlier SEC ops cloud and network security purchases.

And then a six figure deal an existing SD Wan customer continue their strategic transition to SaaS and cloud based applications by adding our SaaS solution for 2000 users.

We believe existing SD Wan customers such as this one offer a rich cross sell opportunity for our SaaS solution.

It's worth noting these deals closed before our recently announced partnership with Google cloud with significantly expand expands our pop coverage by adding over 100 locations and prior to gardeners release of inaugural single vendor SaaS Magic quadrant, where we were named a challenger.

By 2025, one third of new SaaS deployments are expected to be single vendor.

I should also note fortinet is recognized in nine Gartner magic quadrants as shown on slide three.

Now I'd like to expand on <unk> strategic commentary with some of the tactical investments, we're making to increasingly focus our efforts on SaaS <unk> and SEC ops.

And the areas of research and development and solution delivery.

In addition to the new Google Cloud partnership I, just mentioned and our own data center investments.

We're continuing to integrate single vendor SaaS features into <unk> and.

And continuing to expand our setup keep about capabilities with AI technology, and additional functions and enhanced integration.

And finalizing co development agreements with existing large enterprise customers to accelerate continuous improvement of our integrated enterprise level, a SaaS solution.

Got a go to market strategy. Our investments include actively promoting our challenger position in Gardner single vendor SaaS Magic quadrant, focusing on third party certification of our broad and integrated solutions, including <unk>, and SD Wan and aggressively marketing.

<unk> competitive advantages and the key components of SaaS SEC ops and network security is summarized on slide 10.

Certifying 5504, net sales professional or SEC ops solutions. After already certified these same sellers in SaaS, which.

Which was the largest sales enablement motion in company history.

Divesting our sales comp plans to include incentives to sell SaaS, <unk> and set top capabilities to existing and new customers.

Spanning partner roles deeper into channel partners specializing in SaaS and Tech ops.

And developing channel training, but.

And his focus on differentiating flooring is comprehensive and integrated SaaS and <unk> capabilities.

We believe fortinet remains well positioned to the cyber security market and the market shift to platform strategies is in early stages. According to Gartner, 75% of companies are pursuing a vendor consolidation strategy, reflecting the evolving landscape of cyber security in a highly fragmented industry with thousands of vendors.

As shown on slide nine.

That brings consolidation across SEC ops, SaaS <unk> and network security the three key growth drivers in our strategy.

Organizations are recognizing that an integrated security solution with a single operating system is the best method to improve their security posture. As this approach allows each security solution to share data and communicate with each other reducing complexity and improving security effectiveness.

Attempting to piece together best of breed solutions.

Multiple vendors can result in slower AI, driven technology adoption significant security gaps and a slower pace of identifying reporting and resolving security incidents.

Moving to guidance, we continue to see increased deal scrutiny and longer sales cycles, which is constraining our near term results.

We expect these longer sales cycles to continue along with the associated budgetary scrutiny.

In our fourth quarter guidance takes into consideration.

As a reminder, our fourth quarter and full year outlook, which are summarized on slides 20 and 21.

So subject to the disclaimers regarding forward looking information that Peter provided at the beginning of the call and.

In the fourth quarter, we expect billings in the range of $1 billion $560 million to $1 billion 700 million, which at the midpoint represents a decline of 5%.

Revenue in the range of $1 billion $380 million to $1.440 billion, which at the midpoint represents growth of 10%.

non-GAAP gross margin was 75, 5% to 76, 5%.

non-GAAP operating margin to 27, 5% to 28, 5%.

GAAP earnings per share of <unk> 42 to <unk> 44.

Which assumes a share count of between 780 $790 million.

Capital expenditures of $40 million to $60 million.

Our non-GAAP tax rate of 17%.

And cash taxes, as I mentioned of $345 million.

For the full year, we expect billings in the range of $6 billion 95 million to $6 $235 million, which at the midpoint represents growth of 10%.

Revenue in the range of $5 $270 million to $5 billion $330 million.

The midpoint represents growth of 20%.

Service around the range of $3 billion $355 million to $3 billion $375 million, which at the midpoint representing growth of 28%.

The service revenue guidance implies product revenue growth of 9%.

non-GAAP gross margin of 76% to 77% non-GAAP operating margin of $26 5 million to 27, 5%.

non-GAAP earnings per share was <unk> 54 to <unk> 56, which assumes a share count of between 790 $800 million.

Capital expenditures of $220 million to $240 million non.

non-GAAP tax rate of 17%.

And cash taxes of $430 million.

As we look forward to 2024 and transition from a period of elevated product growth. We can offer a few thoughts looking forward.

In the near term, we will continue to focus on improving profitability.

We expect product gross margins to be pressured in 2024.

Nonetheless, we expect healthy operating margins that are 25% or greater.

We expect to gradually increased billings growth through the year and approach double digit growth by the second half of 2024.

Reflecting to progressively easier comps due to the easing of the headwinds from backlog drives in the first half of 2023 and the benefit of our SaaS insect top focus.

We expect contract term to remain below our high watermarks of 2022.

Consistent with prior years, we expect that the timing of service revenue growth trends will lag product growth trends.

Longer term, we remain confident in our solutions and our ability to adapt our strategy to shifts in the market taking market share as we increase our investments in SaaS and SEC ops, ultimately returning to balanced growth and profitability.

I look forward to updating you on our progress in the coming quarters and with that I'll hand, the call back over to Peter to begin the Q&A.

Operator, as a reminder, during the Q&A session. We ask you to please limit yourself to one question and one follow up question to allow others to participate operator, you can open the call for questions.

Thank you.

We will now conduct a question and answer session to ask a question. Please press star one on your telephone and wait for your name to be announced.

To withdraw your question. Please press star one again, please standby while a compile the Q&A roster.

Our first question comes from Hamzah.

Fabio <unk> from Morgan Stanley. Please go ahead.

Thank you for taking my question and good evening.

Ken maybe just for you.

To what extent are you seeing.

SaaS.

Start to eat into the firewall and network security budgets, because clearly there is a.

With a bigger focus there there is a dedicated go to market effort there so.

You think that SaaS is starting to cannibalize the firewall market to some degree.

I think it's a <unk>.

Little bit different business model.

It's more.

Service Opex compared to.

The networking keeping low capex.

Given the slow economy environment.

Customer definitely multiple tours.

Survey spaced opex.

So it will be also.

Some of our.

Our service provider kind of.

A little slower to adopt some of the SaaS and that is one for you.

We have been involved in SaaS you for a long time and.

Some of that.

Provider kind of.

Lower than expected, so that's where we kind of changing some of the strategy.

More aggressively.

Cocoa and SaaS ourself at the same time, we're working closely with our partner.

Okay. Thank you.

Thank you.

Thank you.

For our next question.

Our next question comes from Brian Essex from JP Morgan. Please go ahead.

Hi, good afternoon, and thank you for taking the question I guess, maybe Keith for you as we look at.

The trajectory of <unk>.

Product declines this quarter in billings growth.

And I guess guy.

Guidance implies that this is a billings trough this quarter.

Or what observations you have from other we'll call them spending cycles, where you've hit negative product or low single digit product revenue growth.

And a degree of recovery that you've seen after those spending cycles and what gives you the level of confidence in your ability to.

I guess I guess returned to double digit.

Growth for either product or billings or both.

In the second half.

Understanding you're going to have easier comps as well.

Alright, great questions questions I should say one of the slides that we added to the investor presentation for this earnings call actually maps out what you can see that as a <unk>.

Cycle more cyclical nature of the business that maybe we've talked about in the past with product revenue.

For example, 2017 I think we have product revenue growth of 5% and that was somewhat of a low watermark.

The market may have been due and I think there is some analyst studies out there from other members of Wall Street that have kind of suggested that the market was due for a little bit of a pause in firewalls and I think we're seeing that now and perhaps there was some delay of that pause because of supply chain issues and so forth something that may have more naturally occurred in 2021 or two in 2022.

<unk>.

I think in terms of confidence broadly I think that was the intention of looking at the CAGR and the success of the company that Canada has led the company through since its IPO and what those CAGR are and if you look at that combined with that new slide in the deck you understand that there's going to be there has been in the past been volatility in the industry and in the company.

But over the longer stretch do you see some very attractive CAGR on that.

Long term, we still believe the comp <unk> not working to balance acuity.

Will it be happen.

Also <unk> by an icon Vascepa 2030.

The network security and networking will be larger than the traditional networking, especially.

Especially in a campus environment in the enterprise and so we do believe it's a huge market opportunity. We have a unique advantage result, integrated operating system with our ACI solution.

Keeping gaining market share in both network and also in the in the SaaS market.

Alright Thats helpful. Thank you.

Thank you.

One moment for our next question.

Our next question comes from Fatima <unk>.

From Citi. Please go ahead.

Good afternoon, and thank you for taking my question.

Keith in your prepared commentary.

Basically called out the service provider and retail.

Vertical.

It's exceptionally weak and they are buying and Ken was just sort of a leading some of the challenges stemming from the service provider buying behavior, but I was hoping you could provide a little bit more detail as to.

Why.

Pending patterns in this particular vertical.

<unk> become.

So we can kind of magically week and.

And the scope of your assumptions if you were thinking about the pipe just wanted to get a better understanding of.

How and why.

Buying in pension has sort of rolled over in the <unk> area specifically thank you.

Yes, I think the service provider commentary has probably been reported by a number of other companies through this earnings cycle I don't think thats.

The headline itself is not a surprise I think.

The significance of the slowdown in the service provider at least for what we saw in our business was a surprise, particularly because it is a worldwide service provider number and not just in the U S. But as I also noted in our prepared comments, we saw weakness in both the U S and the Europe European markets and that applies to service provider and to the retail sector.

The retail sector, probably is perhaps a little bit more prone to some of the digestion of SD Wan projects that they're still working their way through and maybe that's a little bit different as well as some of the economic headlines are probably a little bit disconcerting to the retail sector in the earlier part of the quarter.

Thank you.

One moment for our next question.

Our next question comes from Teo Lamy from <unk>. Please go ahead.

Thank you.

I have two questions on the same topic.

If you go back to the last two years.

You talked a lot about non appliance sales meaning.

Upsell SD Wan, which is.

Add on service and then non 40 gate and when things start to slow.

Quote unquote, we only blame the appliances.

So the question is.

In retrospect, when you look at things and you look at the other parts of the business and you look at the add on sales and the other features.

Are they all based on the ability of you selling appliances, meaning even if it's a non 40 gate is being attached to a 40 gig sell and that's why it's going down with it.

SD Wan et cetera.

So first just to understand kind of the total exposure of the company.

From all the successful products that they were you were able to sell over the last two years and now in retrospect just to understand how how is the exposure to a client.

And then the second question, which is related to it is.

If really it's about appliance sales what is the outlook for 2024 when it comes to do you have any big refresh cycle.

What could drive outside of easy comps that our comps are getting easier through the year is there any anything that you are planning on year end to.

To drive some kind of replacement or a refresh of the appliances.

Yes, its Ken.

Four.

When they do need appliance to be in place to deliver all of this SD Wan function there.

The unit all for SD Wan part of the <unk>.

For free and we started launching the ICT service.

Last quarter.

So it's still in the ramp up stage.

We do BD.

<unk>.

This survey as well we're keeping.

Celebrating.

The SaaS market will grow faster than the us.

We are now working market.

I think that.

That's where for certain like.

There is a charm.

Presentation shows some of the core dotcom.

Service.

Page 19.

You can see some of the cycle up and down there.

Also some of <unk> related to that.

Our new <unk> and also product launch because we're just starting the new cycle.

The new ISP five <unk>, we have a while to podcasts that inbound <unk>, which gave us a leg up.

Five to 10 times better performance and more function in the same cost.

Which also.

Combined with the supply chain kind of elevated.

Shipment of building in the last two or three years I think all of this combined together.

<unk>.

Effect that applies south as fuel buyers.

But I do believe this will go back to normal.

In the second half of next year.

After the new product being 40 launch after the supply digestion.

Inventory take actions kind of go through.

Because we can see that the long tunnel congruent story still holding well.

The position with a better integrated otherwise the visa visa asos valuation.

And.

And.

It's a part of the whole solution as a hybrid solution both of apartment com, especially what we call the universal SaaS fee.

So thats, where there is some kind of cycle. If you will refer to the page 19 of the presentation.

Probably.

So that cycle right now.

Yes, Todd maybe to add to <unk> comments, I think you're you're correct in that your interest.

The vast majority of the time, our first sale of our customers a firewall it can be a virtual firewall or it could be a physical appliance and really that is the beachhead that then go sell these other secure.

Security functions and products.

I think what youre seeing and part of the shift of strategy. When we talk about making the investments in knowledge SaaS, but also secure ops is really that secure office product a family like Edr and Sam and solar is such that you are seeing is doubling down on the investments there because while it's not the largest of the three market segments. It is the fastest growing and I think we have the opportunity to participate in those mark.

What's more particularly now that some of our products reached a greater level of maturity.

Got it thank you.

Okay.

Thank you.

For our next question.

Our next question comes from second Kelly you from Barclays. Please go ahead.

Okay great.

Ken Hey, Keith Thanks for taking my questions here.

I'm going to I'm going to ask two together.

So maybe for the first one Ken for you.

Just maybe thinking about the long term and specifically on the SaaS part of the business.

Do you feel like Fortinet will have a solution that can compete head to head with other SaaS solutions, maybe the answer is now right, but I just want to hear how you think about it.

And how big do you think this part of the business can be longer term. That's the first question the <unk>.

Second question for you Keith is.

It's great to see the operating margin being.

And maybe you could just talk about how youre thinking about sort of mid term profitability because clearly the business can generate higher margins and 25%. How do you sort of think about that balance now kind of given some of the changes here.

Yes. The first answer is yes now.

Head to head competing and we also believe we have a much better solution better integrated.

At the same time, much better cost compared to other competitors on the SaaS fee.

And also the Universal SaaS is rather unique because they offer.

Both in the cloud on the Pons off campus are the same solution, which allows our customer.

More like our solution instead of some time, you'll have to deal with.

Traffic whether enough is that all of us have reported a pop because our solution you can process some traffic locally on campus meeting.

<unk>.

Yes.

It's a great point about whether you're talking about free cash flow Youre talking about operating margin. The company does very very well on the bottom line and the strategy has been to continue to reinvest that back robustly in both innovation and a form of R&D spending, but also in go to market, whether that's marketing and whether that selling.

I think we're looking at right now with the slower firewall market, obviously, where we're trying to bring new solutions better solutions to to our sellers to sell when the firewall is a little bit slower.

But I do think it's worth current worthwhile conversation I'm looking at.

The sales coverage if you will we've talked for several years about how many in North America. For example, how many accounts do we want per Rep. We started with 65, I think four or five years ago. When we're talking about that that number is now down to 10 and 10, you're probably reaching a point of where you are on the enterprise side, you probably reaching at a pretty good coverage model for our business you can.

Probably a little bit lower but that feels pretty good I think theres another opportunity right now immediately in front of us in terms of how do we continue to support our channel partners be they distributors will be their resellers.

And make sure that we're getting the right level of mind share from them. So I suspect there'll be some some investments in that part of the business as we go forward.

At the same time I think there's some opportunities here and Ken talked about it with us about how to be more efficient in how we're spending our money, whether thats in selling and marketing or back office functions or what have you. So.

Not trying to guide to 2024 today, obviously, but we did think that it was important to provide at least some early thoughts in terms of maybe a floor for 2024 should look like for us on the bottom line.

Got it very helpful. Thank you.

Okay.

Thank you.

Our next question.

As a reminder, if you would like to ask a question. Please.

Please press star one one and wait for your name to be announced.

Our next question comes from Brad Zelnick from Deutsche Bank. Please go ahead.

Great. Thank you very much for taking the question I appreciate it as you lean into SaaS and security operations Youre, most obvious advantages in having an industry leading installed base.

Those of us that have always viewed fortinet has distinct advantages the price performance of your purpose built hardware.

<unk> also had a go to market, both direct and indirect that know how to showcase that.

I'm just trying to get my head around all the changes in distribution, both direct and indirect which I. Appreciate Keith you made comments about sales enablement, but how do you think about the investment in dollars and time needed to get distribution properly ramped and can you ever achieve the same level of sales productivity that you enjoy.

When the motion was more box centric.

You to believe.

And it's a fast growing SaaS.

Tech op market.

The sales training south restructuring at the same time more efficient market gains.

We are importing.

And and.

Also we are continuing working closely with all our channel partner with our distributor network.

To reach our broad customer base so.

And we also think in the upsell cross sell opportunities are huge.

It actually goes through our partner network there.

So I don't feel that the investment we've made in our <unk>.

<unk> will be.

Any issue or kind of any.

Hello hostile we do believe will actually helping us to expand in this more service based assay market and also.

More consolidation.

<unk> approach.

Yes, and I would just build on <unk> comment credit and a good and fair questions.

It's not by accident, we're talking about SaaS.

If you go back and think about it a little bit we've been talking about it and in a number of different ways to kent's talked about the pop strategy, which now youll see.

As accelerating that pop strategy with the cloud providers to come to market more quickly.

The Gartner Magic quadrant, and I think are the catalysts for the single vendor strategy and having us on the challenger quadrant gives us the <unk>. If you will that to have a lot of conversations.

Single vendor strategy that installed base that you referred to.

We went back and looked and.

Over the last two quarters, we've done several hundred SaaS deals already.

And to be quite honest that was without any real wood behind the arrow in terms of marketing support or sales support that was really just how it grew.

And it's interesting you while I would've expected those first sales would've been clearly dominated by SD Wan they were not SD Wan customers. They were oftentimes. They are just as many brand new customers coming to us for the SaaS solution as they were SD Wan customers or somewhere we ended the third part of the pie, where our customers that our borrowers for other firewall use cases so.

Yes.

The expectation that we're going to be successful initially and a smaller part of the market.

We disagree with that when I look at that same mix of SaaS customers nearly 50% of those of SaaS customers that we've signed already would be in the SMB space and.

And then the remainder was kind of divided up between the larger enterprises on the mid enterprise. So.

I don't think we got here by accident, we maybe just not to talk about it publicly but I think we're well positioned now because of the investments that we've made in the data centers. The pops the operating system. The Gartner Magic quadrant. The fact that a single vendor and install base I think this is the right strategic strategic shift for us to make at this point.

Thanks for that Keith and just a quick follow up and I know, it's a topic we've spoken about in the past, but SaaS fee increases as part of the mix and I know strategically you've partnered with Google.

To help deliver the infrastructure how should we think about the capex required to do this in a competitive way over the longer term. Thank you.

We do have a good partnership with Google at the same time, some other service provider due.

Each one of our key and we are.

So appeals tomo alone.

Like a datacenter pop.

Earnings on by Ourself, which is about 18 months or more cost advantage.

So we're continuing with our strategy.

Two needed time to ramp up to the approval of our <unk>.

Solution.

Hospital customer.

Also we few separate we cannot we are aligned.

Market industry different segment.

Networking SaaS DSA queue up it's much cleaner.

In line with the customer need and also meet different customer demand.

So that's much better market compared to the previous one we have a budget of 40 gain lost a module.

Non of quality product, we feel decent tier III segment.

With our customer demand. So we are starting tracking based on this one also we starting.

Compensate itself on the trend of marketing among others three separate.

Segment.

If the market obviously with asthma.

Clearly to us the internal forecast month club partner.

To provide a panel what's customer need.

Amen.

Yes, Brian sorry.

Sorry to Ken's 0.2 points, we were.

Last quarter, we were talking about 20 Pops, because we are building them ourselves right. Now you are talking about over 100 locations well over 100 locations. So I think there's a go to market opportunity. There that this brings to us I think longer term, let me know that one of our competitors. This is the approach they take and we have pretty good visibility obviously to what their margins are and their investments there.

Fourth player in the space, that's much more building their own Pops. If you will perhaps individually are not huge things right. I mean, there are single digit number of racks are really have a pop I think so.

I do believe you need some forward Sage Datacenters and I think thats consistent with our strategy that we've talked about about increasing more and more hosted delivery services and particularly in the tech ops.

So I think this is not something that we're going to surprise people with in terms of our capex spending.

Makes perfect sense. Thank you.

Thank you.

Our next question.

Our next question comes from Adam title.

From Raymond James Please go ahead.

Alright, thanks, good afternoon.

Keith It sounds like you're confident in profitability and free cash flow, which makes sense. Obviously the model has proved itself over the years. So I wanted to ask about capital allocation the balance sheets already very healthy you've got a lot of capacity right now the markets pivoting towards Universal SaaS, <unk> and SEC ops as you mentioned.

Curious how the conversations have gone internally to potentially accelerate your pivot towards that with larger M&A and Conversely, if we look at the after hours action here the ROI on share repurchases looking potentially very strong.

The opportunity to potential step up share repurchases just in general how youre thinking about using the balance sheet as a weapon during a time, where the business and stock has pressured thanks.

Yes, I think we included a comment in the in my prepared remarks that the available, but we still have nine as of the start of the month, sorry, the week I guess.

We had $980 million of available authorization for that for the buyback and I think you saw some of the numbers that we provided in the prepared remarks about being.

Fairly aggressive during the quarter itself as well in terms of buying back stock.

Okay. So let me go shopping for companies very often so I'll defer to him in terms of his thoughts on that.

We are definitely keeping lukin I think right now the market, Paul probably more reasonable and the last one to two years.

And also we do realize the marketing also changing pretty quick.

We're continuing to the internal utilization, we feel we had a strong is sounding and tunnel.

Alicia Engineering all of this space player, but on the same time.

We also are open to looking for some other company, which we can.

Working together joined together.

Okay, and one quick follow up just to make sure Peter kicks me off the call next time for this one but it'll be in the weeds Keith sorry.

I wanted to ask about supply.

Bin monitoring inventory commitments, they've been elevated for a little while now obviously demand is deteriorating faster than expected and we're just trying to think about how to manage inventory and future inventory given this new state of the demand.

That might manifest itself in results I think you mentioned product gross margin pressured I wonder if that was related to that but any comments on kind of managing this oncoming inventory relative to the current demand. Thanks.

Yes, it is related to inventory levels and I think we've been managing it for the better part of the second half of this year.

And Thats some of the commentary that Youre getting as we look into 2024 in terms of where the pressure may come from.

Any way to quantify it though.

For now.

Yes, we feel SKU in the healthy level and.

We tend to keep about six months inventory.

Like when we get to go to supply change will happen in market position because also a lot of time on customer.

Some urgent deliver certain products and we probably still keeping the same on a policy there.

But also in the room.

Refresh cycle.

New product, especially on the land.

I think so far we.

I think as we.

It also kind of refill price in the last two or three years.

Now, it's starting to stabilize.

China pharma shortly just maybe more towards even some oversupply.

We have few we are in pretty good position because we handle these operation manufacturer directly so we handle it better than most of our other competitors.

On the inventory right now.

Very helpful. Thanks, Ken.

Yes, we also don't see a big issue about the current inventory level.

Okay.

Thank you.

One moment for our next question.

Our next question comes from Adam Borg from Stifel. Please go ahead.

Awesome. Thanks, so much for taking the questions.

Maybe just on the sales execution issues that you talked about in his script, maybe go a little deeper on what exactly what exactly happened in a little bit more about the steps youre, taking and maybe just as a follow up just on the.

SaaS partnered partnership with GCT I know, there's obviously thats been a couple of weeks, but maybe talk about early customer feedback from initial conversation. Thanks. So much.

Yes.

If you look at the last two three years, we grow in a lot of.

<unk> also hired a lot of salespeople.

And the last two three years, we probably top of happiness and same time.

During the supply chain issue somehow certain cells Q2 easy to deal.

Because.

Our winter shortly Charles.

Southern part out there.

So that's where we feel we need to enhance the training enablement.

The same.

Same time I'll also need to be more disciplined about the performance.

Same time, we also when we shifted to more like a service based SaaS kind of consolidation cross out Mark as Hell.

Second half sales also need to keep on learning.

And same kind of marketing needs to be kind of.

More efficient and also kind of a position to the new <unk> growth opportunity.

That's the focus we have right now so we are definitely keeping looking to be more efficient in both our sales and marketing going forward.

Great and what about the early feedback on <unk>.

TCP.

On Google Cloud.

It's a market that's.

Gave us a very quick start to match any other competitor.

The location.

Number one a cushion that mom pop and they also have a lot of our broad coverage. So it's a good partnership.

At the same time, we continue to working with some other partner. We also will continue to build ourself.

Longtime a few we're more of an advantage then.

Some of our competitors because we always have a strategy.

Asking the term long term.

Kind of.

Investment strategy, including some real estate some other part.

Which gave us a much better long term return.

Great. Thanks, so much.

Thank you.

Thank you one moment for our next question.

Our next question comes from Patrick <unk>.

<unk> from Scotia Bank. Please go ahead.

Alright. Thank you so much for taking my question, Ken Keith Pizza.

My question is about the I guess kind of qualitative guidance you guys gave for 2020 for billings.

If I remember correctly last quarter. It was expect kind of high teens billings growth.

Exiting fiscal.

Fiscal 'twenty four.

The commentary this quarter expect double digit growth exiting 2024.

I'm not sure I'm following your math.

I'm just trying to so last quarter you guys gave some kind of a forward look for 2020 for billings and <unk>.

Right.

Look was expect exiting.

Earnings growth.

To be in high teens.

Earlier in your prepared remarks, there was a comment which is expect double digit growth in the second half.

Yes.

Yes, we can.

Going from high teens double digit is that the change yes.

Yes, yes, and I think that's I think that's prudent given what we've just seen in terms of the third quarter performance.

Yes.

Okay, great. Thank you so much.

Yeah.

Thank you.

For our next question.

Our next question comes from Joseph Gallo from Jefferies. Please go ahead.

Thanks for the question I've got two harder one for each of you and Keith as a follow up to that last question. Appreciate the commentary on Bottomline floor for 24 can you just talk about the methodology of topline guidance is this a rip the band aid off guide or what underpins the confidence and visibility in a reacceleration of billings is it SaaS returning.

On or just.

Hardware digestion, only taking two to three quarters and then Ken.

Given what youre seeing with AI do you believe adoption of AI workloads, eventually shift workloads back to on premise and drives a higher need for firewalls long term. Thanks guys.

And I wasn't quite sure. If the question was about the Q4 guide or the 2020 for commentary about numbers more for next year, but both it has the methodology for your topline guidance change.

Following the past two quarters.

Yes, I would say that while we just deal with it actually.

Actually giving guidance for the fourth quarter.

Absolutely I think the assumed.

Close rates. If you will are dramatic I think theyre, the lowest assume close rates ive seen that I've used in over five years here for context.

And then obviously lower than what I saw on the FERC, what I use for the first half of the year.

Yeah.

<unk>.

I would say there are indicators of the pipeline quality is better and the fourth quarter, but and given light of what we've done for the last two quarters I don't think that should put much stock in that so im content to just assume a much lower close rate that I have more recently.

Slide 24, and not really giving guidance I think that.

Again, we're talking about buildings here and I know, we're all aware of it but really focused perhaps more on the impact of backlog and what it did to billings in Q1 of last year in Q2 of last year and how that eased throughout the year until you're really going to see comps change.

Know that we're necessarily assuming a dramatic growth ramp bookings. If you will at this early stage, where 2024, we do expect it's going to improve as we bring SaaS online more successfully and secure operations, but I think it really part of what you are hearing there is really getting clarity on how the backlog impacted 2023 numbers.

Yes.

It's a.

Good interesting question about that.

And the security.

I have to see.

That's on the AI.

Was that in.

Kind of got into the security learn quickly both spine a good kind of bad Guy.

But.

Jennifer the AI side a few.

In some degree the bank I, probably more language them off that one.

The.

The protect side still more using what we have been doing the last 10 plenty of smaller position in AI.

And make sure we block the attack.

Have a nonprofit and you could traffic but also.

Also helping to slow or stop hauling costs and also helping Mr calibration.

So.

Definitely we're keeping driving the security grow.

Both.

Cloud and also our clients we do see Alpine is also long tons of our healthy growth, especially our record of convergence network into networking and security, especially in the enterprise in the campus environment.

And we see that trend will continue.

To grow well.

Our unique advantage.

<unk> will continue to lead in the market and keeping gaining market share.

So im not I don't see any slowdown of the appliance category.

Cyber security space.

Thank you.

Thank you.

One moment for our next question.

Our next question comes from Gray Powell from BT IAG. Please go ahead.

Alright, great. Thank you from working in here really appreciate it.

So.

Maybe a clarification.

Follow up.

So you laid out the breakdown for billings or the new breakdown.

Between secured networking SaaS <unk> and SEC ops.

Did you all talk about the relative growth rates that youre seeing today for each segment and then within secured networking is there a way to think about how much of the slowdown you're seeing there is related to the core firewall business versus some of the networking components like switches and access points.

And stuff that may have been more.

They may have benefited more from like supply chain and budget flush and things like that.

Yes, actually we do give the market growth for these three segments going forward.

And we also believe we're growing faster than the market growth can you can assure urologist III segment.

A link to the firewall of 40 K losses some other.

For AEP switch, we can see more headwind.

AP switch for the <unk>.

40 switch because now supply chain issue kind of a pretty much over.

And.

So some of them.

Thats, probably more headwind compared to the.

The firewall.

Networking firewall side.

Alright fair enough. Thank you very much.

Thank you.

Thank you.

One moment for our next question.

Yeah.

Our next question comes from Eric Heath.

From Keybanc capital markets. Please go ahead.

Great. Thank you and thanks, Peter for coming in here.

Just for you curious how the economics to the top line.

For Fortinet change, but when our customers kind of do an apples to apples switchover from kind of a firewall customer over to SaaS.

And then secondarily with the shift away from firewall, just probably means more of a shift to annualized billings. So curious how you're thinking about duration of that impact of free cash flow going forward. Thanks.

Yes, the second one probably easier, but we have such a large footprint right now of the firewall business that it's going to take a while for.

Any significant changes in SaaS billings, if you really think about it coming into and having an impact on our total term.

I don't know that we gave the number but we know that we've come back to a more to come down about a month year over year in terms of contract term and in 2023 compared to 2020.

Two we went from 28 months roughly last year to about 27 months of this year and maybe I could be off by a month, but.

And you saw the impact.

Impacting the financials, we've talked about that one.

It impacts the billings number I think it could take a while for Saturday as I mentioned, we've already done several hundred SaaS deals, we expect to be more successful early on with water and F&B spaces into with our installed base.

So I would imagine that.

It's going to take a while to really have an impact on free cash flow.

We also will be keeping salary training for your internal sales force also to our partner.

Since it's a new SaaS <unk>.

Operation, we can may be different than the <unk>.

Traditional secure networking side.

So thats, we also filled with a huge installation base, we have an ICU Wang firewall, which we are leading were number one in pretty much in all of these areas.

Yes, we feel with a huge potential to up sell cross sell SaaS and unsecured debt.

The sales force and partner <unk> trend.

Thank you.

At this time the Q&A session has now indeed, I will now turn the call over to PD, So koski for closing remarks.

Thank you Angela and I'd like to thank everyone for joining the call today Fortinet will be attending investor conferences hosted by Barclays Staples and Wells Fargo. During the fourth quarter RSA chat webcast links will be posted on the events and presentation section that Fortinet Investor Relations Web site. If you have any follow up questions. Please feel free to contact me have a great day. Thank you.

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

Okay.

[music].

Yeah.

[music].

Yes.

[music].

[music].

Good day, and thank you for standing by.

Welcome to the Fortinet Q3, 2023 earnings announcement at.

At this time all participants are in listen only mode. After the speaker's presentation, there will be a question and answer session.

To ask a question. During this session you will need to press star one on your telephone you would be in here in an automated message advising your hand is raised.

To withdraw your question. Please press star one again.

Please be advised that today's conference is being recorded I would now like to hand, the conference over to Peter for Koski Senior Vice President of Investor Relations. Please go ahead.

Thank you Angela and good afternoon, everyone. This is Peter <unk> Senior Vice President of Finance and Investor Relations at Fortinet I am pleased to welcome everyone to our call to discuss Fortinet as financial results for the third quarter of 2023 speakers on todays call are kenzie, Fortinet, founder Chairman and CEO and Keith Jensen, our Chief Financial Officer.

This is a live call that will be available for replay via webcast on our Investor Relations website, Ken will begin our call today, providing a high level perspective on our business. Keith will then review our financial and operating results for the third quarter of 2023 before providing guidance for the fourth quarter of 2023, and the up and updating our full year well then open the call for questions during the Q&A we.

Ask that you please limit yourself to one question and one follow up question to allow others to participate.

Again, I'd like to remind everyone that today's call will be made 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.

Forward looking statements reflect our opinions only as of the date of this presentation or it takes no obligation and specifically the skiing 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 in our GAAP to non-GAAP reconciliations are located in our earnings press release and in the press.

Dentation that accompanies today's marks both of which are posted on the Investor Relations website, Ken in Keith's prepared remarks today for the earnings call will be posted on the quarterly earnings section of the Investor Relations website immediately following today's call lastly, all references to growth are on a year over year basis, unless noted otherwise I will now turn the call over to Ken.

Good afternoon, and thank you everyone for joining our call in Q C. We exceed street expectation operation margin and free cash flow.

However building on product revenue for below our expectation due to a slowdown in secure networking growth along.

Along with challenging in sales execution and marketing efficiency.

In response to the slowdown into Qunar working market, we are shifting our marketing and sales teams focus towards the hostile growing and secured our pollution on SaaS market over the next few quarters.

All while maintaining our cost and focus on BD, Alicia insecure networking and the convergence of security networks, and where we have been a leader for 23 years.

While we anticipate limited near term growth in secure networking market. It is very important for fortinet as we believe eight enable us.

Our platform strategy with a massive footprint in the market leader.

As the market leader in both firewall revenue and units shipped.

The <unk> market is valued at 62 billion and is projected to increase high single digits annually to 86 billion by 2027.

Consistent focus.

<unk> you.

That's really the 40 OS.

We just appointed over serving our function now working at acuity application combined with our <unk> performance capability, which provides five to <unk> better performance on average than competitors continuing to increase our market share gains.

Secure networking remain a vital part of our strategy and the market that we believe will return to double digit annual growth over time.

We have been reaching for some time in the faster growing segments of <unk> accretion and the SaaS.

Syncrude operation also Noah Satcom is a 46 billion market growing.

Teens annually 278 billion by 2027.

Fortinet stack or platform is comprehensive and integrated.

Also in Edr Sim saw MTR and author integrate solutions.

Foundation in the security industry demand seamless integration and underlying so Q2s.

Fortinet strength lies in its evolution and its ability to enable automation through a high degree of product integration.

AI and the Sip product.

Our automatic.

These forward.

All underpinned by a single consolidated management and analytic platform.

Additionally for stock comp.

Have continued to increase our focus on SaaS fee.

17 billion market expect to grow in the 20% compound annual growth rate to 36 billion by 2027.

We believe Fortinet is the only company with a SaaS service solution that can perform all function in the cloud.

Im highs.

All with a common operating system, including for networking security stack market, leading SD Wan <unk> and the management console.

Our southeast service solution is supported by Google cloud with over hundred worldwide SaaS cloud location to catch up with our own 30 popcorn are present and the data centers.

For our client space use case, we are salaries SaaS service function using our <unk> technology for instance, we recently announced a 40 gig <unk>.

With just the acuity process of five <unk>.

Which supporting a full SaaS, offering, which including SD Wan firewall secure web gateway deadlock correlation and boost secure computing region, six 254 times better than our competition.

We anticipate success as a SaaS market will first come from outstanding SaaS service to our installed base.

The sell down of <unk>.

Customers and attracting new customer looking to leverage our single vendor integrated SaaS seven solution.

Our industry leadership in both firewall and SD Wan.

The largest component of SaaS <unk> provide us with a significant competitive advantage.

We have a track record of successful execution and PV. We are the only company with strong SaaS service and the set up solution combined.

Same operation system. This.

This differentiation set us apart and provide us with a significant competitive advantage over our peers.

Why we expect top line growth to be modest for the next few quarters due to challenges in situ metalworking comparison, and our business transformation, we our alignment towards secret operation SaaS year.

We anticipate growth returned to double digits by the second half of 'twenty coming forward.

We remain committed to generating healthy operation margin of a quantified person now Greta in 2024 and appointed identified.

Before turning the call over to Keith I would like to thank our employees customers partners and suppliers worldwide for their continued support and hard work Keith Thank.

Thank you Ken and good afternoon, everyone as Ken mentioned, we are confident in our integrated 440 OS driven platform strategy, which is summarized on slides six through 10 of the earnings slide deck.

As we look forward, we believe shifting our R&D and go to market investments to the faster growing SaaS set top market markets is consistent with near term market opportunities has.

As shown on slide 10, SaaS, <unk>, and SEC ops account for 20% and 10% respectively of our business today.

And as shown on slide seven these markets are expected to grow in the mid to high teens annually.

Secure networking, which currently accounts for 70% of our business is expected to experience slower growth. Following two years of very robust growth as a result for the near term, we expect to deliver healthy profitability along with more modest growth.

With execution and continued investment in the SaaS set top markets. We believe we can return to delivering mid to high teens top level growth top line growth.

And while continuing to deliver operating margins of 25% of our greater.

In other words, I returned to balanced growth and profitability, which has led us to achieve the rule of 40 status and 12 to 15 years as shown on slide 19.

In a moment I will expand on the strategic shift by sharing a few of the tactical steps and investments, but first I'd like to review some highlights from the quarter.

We continue to add new logos at an impressive rate, yes, our topline performance of small enterprise and software was strong while operating margin and free cash flow were above expectations.

We added over 6400, new logos supported by small enterprise customers, which grew bookings by 19%.

Our efforts to manage personal personnel and other costs drove our operating margin to 27, 8% 230 basis points above the high end of the guidance range.

Free cash flow was strong at $481 million.

Taking a margin of 36%.

Looking at billings.

Starting from the third quarter of 2022.

A three year compounded annual billings growth rate or CAGR of 26%.

Illustrating our ability to drive strong and sustained growth over an extended period.

In Q3, however, billings of $1 49 billion represented growth of 6% as we experienced one month shorter contract duration, and importantly, lackluster implants demand, resulting from elevated product growth in earlier periods.

In terms of in terms of industry verticals education, and government billings were strong while service provider and retail billings were weak.

Small enterprise billings growth was strong while growth rates with larger enterprises disappointed.

Billings growth varied by Geo with international emerging showing strong growth, while our much larger GFS of Europe, and the U S were weaker.

Turning to revenue and margins total revenue of 16%.

Total revenue grew 16% to $1 33 billion, which compares to our three year CAGR of 27%.

The three year CAGR was largely consistent with our 14 year CAGR illustrated on slide 18.

Product revenue of $466 million, representing a three year CAGR of 28% was down 1%.

Reflecting product lead times and backlog aligning with historical levels and the lighter levels of network security demand can referred to.

Service revenues of $869 million grew 28%.

Representing a three year CAGR of 27%.

Service revenue accounted for 65% of total revenues driven.

Driven by 34% growth in higher margin security subscriptions, which represents 57% of total service revenue.

We mentioned the three year CAGR is to illustrate how consistent they are.

With these same CAGR starting from our 2009, IPO, which are illustrated on slide 18.

Each of the three year CAGR billings product revenue service revenue and total revenue.

Five points of the 2014 year CAGR for the same top line metrics.

Adding to our confidence in returning to higher growth levels.

Product gross margins were down 310 basis points as we saw margin pressure related to inventory levels.

Service gross margin was up 60 basis points as service revenue growth outpaced higher levels top cloud and hosting costs.

Total gross margin of 76, 9% was up 70 basis points driven by the increase in service gross margins and a six point shift from product revenue to service revenue.

Operating margin of 27, 8% exceeded the high end of the guidance range and operating income of $371 million was $33 million higher than consensus and $20 million above the high of the high end of our guidance range, reflecting our efforts to control spending.

Looking to the statement of cash flow summarized on slides 15 through 17 free.

Free cash flow increased 22% to $481 million.

Representing a free cash flow margin of 36% or nine points above consensus.

Operating cash flow increased 68, million% to 41% of revenue.

Capital expenditures of $70 million, including $50 million of real estate investments.

Cash taxes paid in the quarter with $26 million.

As a reminder.

Free cash flow benefited from regulatory relief in the form of deferred estimated and other tax payments in the second and third quarters totaling $192 million and $18 million respectively.

In the fourth quarter, we expect cash taxes to totaled $345 million, including the $210 million of deferred tax payments.

We repurchased 10 4 million shares of our common stock for an aggregate cost of $605 million in the third quarter.

In October we purchased an additional seven 7 million shares for $444 million and our remaining share repurchase authorization stood at approximately $980 million at the end of October.

Now I'd like to share a couple of key SaaS wins for us in the quarter.

A seven figure upsell win an existing financial services customer initiated their single vendor SaaS solution for 50000 users.

That was able to displace another incumbent as the customer continue their consolidation journey with us supplementing their earlier SEC ops cloud and network security purchases.

And then a six figure deal an existing SD Wan customer continue their strategic transition to SaaS and cloud based applications by adding our SaaS solution for 2000 users.

We believe existing SD Wan customers such as this one offer a rich cross sell opportunity for our SaaS solution.

It's worth noting these deals closed before our recently announced partnership with Google Cloud, which significantly expands our pop coverage by adding over 100 locations and prior to gardeners release of inaugural single vendor SaaS Magic quadrant, where we were named a challenger.

By 2025, one third of new SaaS deployments are expected to be single vendor.

I should also note fortinet is recognized in nine Gartner magic quadrants as shown on slide three.

Now I'd like to expand on Ken strategic commentary with some of the tactical investments, we're making to increasingly focus our efforts on SaaS <unk> and SEC ops.

And the areas of research and development and solution delivery.

In addition to the new Google Cloud partnership I, just mentioned and our own data center investments.

We're continuing to integrate single vendor SaaS features into <unk> and.

And continuing to expand our set top Keith about capabilities with AI technology, and additional functions and enhanced integration.

And finalizing co development agreements with existing large enterprise customers to accelerate continuous improvement of our integrated enterprise level, a SaaS solution.

Got a go to market strategy. Our investments include actively promoting our challenger position in Gardner single vendor of SaaS Magic quadrant, focusing on third party certification of our broad and integrated solutions, including SFC, and SD Wan and aggressively marketing.

<unk> competitive advantages and the key components of SaaS SEC ops and network security is summarized on slide 10.

Certifying 5504, net sales professional and SEC ops solutions. After already certified these same sellers in SaaS, which.

Which was the largest sales enablement motion in company history.

Divesting in sales comp plans to include incentives to sell SaaS, <unk> and set top capabilities to existing and new customers.

Spanning partner roles deeper into channel partners specializing in SaaS and Tech ops.

In developing channel training, but.

But his focus on differentiating <unk> comprehensive and integrated SaaS and <unk> capabilities.

We believe fortinet remains well positioned in the cyber security market and the market shift to platform strategies is in early stages. Okay.

Adding to Gardner, 75% of companies are pursuing a vendor consolidation strategy, reflecting the evolving landscape of cyber security in a highly fragmented industry with thousands of vendors.

As shown on slide nine.

That brings consolidation across SEC ops, SaaS <unk> and network security the three key growth drivers in our strategy.

Organizations are recognizing that an integrated security solution with a single operating system is the best method to improve their security posture. As this approach allows each security solution to share data and communicate with each other reducing complexity and improving security effectiveness.

Attempting to piece together best of breed solutions.

Multiple vendors can result in slower AI, driven technology adoption significant security gaps and a slower pace of identifying reporting and resolving security incidents.

Moving to guidance, we continue to see increased deal scrutiny and longer sales cycles, which is constraining our near term results.

We expect these longer sales cycles to continue along with the associated budgetary scrutiny.

In our fourth quarter guidance takes into consideration as.

As a reminder, our fourth quarter and full year outlook, which are summarized on slides 20 and 21 to.

Subject to the disclaimers regarding forward looking information that Peter provided at the beginning of the call and.

In the fourth quarter, we expect billings in the range of $1 billion $560 million to $1 billion 700 million, which at the midpoint represents a decline of 5%.

Revenue in the range of $1 billion $380 million to $1.440 billion, which at the midpoint represents growth of 10%.

non-GAAP gross margin of $75 5 million to 76, 5%.

non-GAAP operating margin for 27, 5% to 28, 5%.

GAAP earnings per share of <unk> 42 to <unk>, 44, which assumes a share count of between 780 $790 million cap.

Capital expenditures of $40 million to $60 million.

Our non-GAAP tax rate of 17%.

And cash taxes, as I mentioned of $345 million.

For the full year, we expect billings in the range of $6 billion 95 million.

To $6 $235 million, which at the midpoint represents growth of 10%.

Revenue in the range of $5 $270 million to $5 $330 million.

The midpoint represents growth of 20%.

Service around the range of $3 billion 355 million to $3 $375 million, which at the midpoint represents growth of 28%.

The service revenue guidance implies product revenue growth of 9%.

non-GAAP gross margin of 76% to 77% non-GAAP operating margin of $26 5 million to 27, 5%.

non-GAAP earnings per share with <unk> 34 to <unk>, 56, which assumes a share count of between 790 $800 million.

Capital expenditures of $220 million to $240 million non.

non-GAAP tax rate of 17%.

And cash taxes of $430 million.

As we look forward to 2024 and transition from a period of elevated product growth. We can offer a few thoughts looking forward.

In the near term, we will continue to focus on improving profitability.

We expect product gross margins to be pressured in 2024.

Nonetheless, we expect healthy operating margins that are 25% or greater.

We expect to gradually increased billings growth through the year and approaching double digit growth by the second half of 2024.

Reflecting the progressively easier comps due to the easing of the headwind from backlog drives in the first half of 2023 and the benefit of our SaaS insect I'll focus.

We expect contract term to remain below our high water marks a 2022.

Consistent with prior years, we expect that the timing of service revenue growth trends will lag product growth trends.

Longer term, we remain confident in our solutions and our ability to adapt our strategy to shifts in the market taking market share as we increase our investments in SaaS and SEC ops ultimately returning good balanced growth and profitability.

I look forward to updating you on our progress in the coming quarters and with that I'll hand, the call back over to Peter to begin the Q&A.

Operator, as a reminder, during the Q&A session. We ask you to please limit yourself to one question and one follow up question to allow others to participate.

And you can open the call for questions.

Thank you.

We will now conduct a question and answer session to ask a question. Please press star one on your telephone and wait for your name to be announced.

To withdraw your question. Please press star one again, please standby while a compile the Q&A roster.

Our first question comes from Hamzah.

Fabio <unk> from Morgan Stanley. Please go ahead.

Thank you for taking my question and good evening.

Ken maybe just for you.

To what extent are you seeing.

SaaS.

Start to eat into the firewall and network security budgets, because clearly there is a there is.

The bigger focus there there is a dedicated go to market effort. There. So do you think that SaaS is starting to cannibalize the firewall market to some degree.

I think it's a little bit different business model SaaS is moe.

Service Opex compared to.

The networking keeping low capex.

The slow economy environment.

Customer definitely multiple tours.

Service space Opex.

So it will be also.

Some of our service provider kind of.

A little slower to adopt some of the SaaS that's one for you.

We have been involved in SaaS you for a long time and.

Some of that.

As provider kind of.

Slower than expected, so thats, where we kind of changes on the strategy.

Aggressively.

Coca Cola SaaS ourself on the same path here working closely with our partner.

Okay. Thank you.

Thank you.

Thank you one moment for our next question.

Our next question comes from Brian Essex from JP Morgan. Please go ahead.

Hi, good afternoon, and thank you for taking the question I guess, maybe Keith for you as we look at.

The trajectory of.

Product declines this quarter in billings growth.

And I guess guide.

Guidance implies that this is a billings crossed this quarter.

What observations might you have from other we'll call them spending cycles, where you've hit negative product or low single digit product revenue growth.

And a degree of recovery that you've seen after those spending cycles and what gives you the level of confidence in your ability to.

Yes, I guess I guess returned to double digit.

Growth for for either product billings or both.

In the second half.

Understanding you're going to have easier comps as well.

Alright, great questions questions I should say one of the slides that we added to the investor presentation for this earnings call actually maps out what you can see that as a <unk>.

Cycle more cyclical nature of the business that maybe we've talked about in the past with product revenue.

For example, 2017 I think we have product revenue growth of 5% and that was somewhat of a low watermark.

The market may have been due and I think there is some analyst studies out there from other members of Wall Street that have kind of suggested that the market was due for a little bit of a pause in firewalls and I think we're seeing that now and perhaps there was some delay of that pause because of supply chain issues and so forth something that may have more naturally occurred in 2021 or two in 'twenty.

'twenty two.

I think in terms of confidence broadly I think that was the intention of looking at the CAGR and the success of the company that Canada has led the company through since its IPO and what those CAGR is are and if you look at that combined with that new slide in the deck you understand that there is going to be there has been in the past been volatility in the industry and in the company.

But over the longer stretch do you see some very attractive CAGR in that.

Long term leased you won't believe com <unk> not working to balance the acuity.

We'll be happen.

I also wanted to buy an icon and see by 2030.

The network security architecture, and networking will be larger than the traditional networking, especially.

Especially in a campus environment in the enterprise and so we do believe it's a huge market opportunity. We have a unique advantage result, integrate operations system with our ACI solution.

Keeping gaining market share in both network and also in the in the SaaS market.

Alright Thats helpful. Thank you.

Thank you.

One moment for our next question.

Our next question comes from <unk> <unk>.

From Citi. Please go ahead.

Good afternoon, and thank you for taking my question.

Keith in your prepared commentary.

Typically called out the service provider and retail.

Vertical.

Exceptionally weak and their binder and tenants just sort of alluding to some of the challenges stemming from service provider buying behavior, but I was hoping you could provide a little bit more detail as Q.

Why.

Pending patterns in this particular vertical.

Become.

So we can kind of magically week and.

And the scope of your assumptions if you were thinking about the pipe just wanted to get a better understanding of.

How and why.

Buying and taking sort of rolled over in the <unk> area specifically thank you.

Yes, I think the service provider commentary has probably been reported by a number of other companies through this earnings cycle I don't think Thats a.

The headline itself is not a surprise I think.

The significance of the slowdown in the service provider at least for what we saw in our business was a surprise, particularly because it is a worldwide service provider number and not just in the U S. But as I also noted in the prepared comments, we saw weakness in both the U S and the Europe European markets and that applies to service provider and to the retail sector.

The retail sector, probably is perhaps a little bit more prone to some of the digestion of SD Wan projects that they're still working their way through and maybe that's a little bit different as well as some of the economic headlines are probably a little bit disconcerting to the retail sector in the earlier part of the quarter.

Thank you.

One moment for our next question.

Our next question comes from Teo Lamy from <unk>. Please go ahead.

Thank you.

I have two questions on the same topic.

If you go back to the last two years.

You talked a lot about non appliance sales meaning.

Upsell SD Wan, which is.

On service and then non 40 gate and when things start to slow.

Quote unquote can we only blame the appliances.

So the question is.

In retrospect, when you look at things and you look at the other parts of the business and you look at the add on sales and the other features.

Are they all based on the ability of you selling appliances, meaning even if it's a non 40 gave its being attached to a 40 gate sale and that's why it's going down with it.

The Wan et cetera.

So first just to understand kind of the total exposure of the company.

From all the successful products that they were you were able to sell over the last two years and now in retrospect just to understand how how is the exposure to a client.

And the next the second question, which is related to it is.

If Randy it's about appliance sales what is the outlook for 2024 when it comes to do you have any big refresh cycle.

What could drive outside of easy comps that our comps are getting easier through the year is there any anything that you are planning on year end to.

To drive some kind of replacement or a refresh of the appliances.

Yes, its Ken.

Four.

IC land on the two new appliance to be in place to deliver all of this SD Wan function there.

The unit all for SD Wan part of the <unk>.

For free and we started launching the <unk> service.

Last quarter.

So it's still in the ramp up stage.

We do PD.

<unk> August survey as well we're keeping.

Celebrating.

The SaaS market will grow faster than the us.

Secure networking market.

I think that's where for certain like.

I think it's.

There is a charm.

The presentation shows some of the Florida.

Service.

Thank you Michelle.

Each 19.

You can see some of the cycle up and down here.

Also some of <unk> related to the new.

<unk> <unk> and also product launch because we're just starting the new cycle.

The new ISP five.

While two product as that and launching which gave us tonight.

Five to 10 times better performance and more function in the same cost.

Which also.

Combined with the supply chain kind of elevated.

Shipment of building in the last two or three years I think all of this combined together a few have.

Fact that applies south as fuel buyers.

But I do believe this will go back to normal.

In the second half of next year.

After the new product being 40 launch after the supply digestion.

Inventory take actions kind of go through.

Because we can see that the longtime congruent story still holding well.

<unk> position with a better integrated OIS.

Mr Asos valuation.

And.

And I'll pause as part of the whole solution. It's a hybrid solution. Both are part of our cloud, especially we called the Universal SaaS fee.

So thats, where there is some kind of cycle. If you will refer to the page 19 of the presentation.

We can probably.

Of course with our cycle right now.

Yes, Todd maybe to add to <unk> comments, I think you're you're correct in that your interest.

The vast majority of the time, our first sale of our customers a firewall it can be a virtual firewall or it could be a physical appliance and really that is the beachhead that then go sell these other.

Security functions and products.

I think what Youre seeing is in part of the shift of strategy. When we talk about making the investments in knowledge SaaS, but also secure ops is really that secure office product family like Edr and salmon Soar is such that you are seeing is doubling down on the investments there because while it's not the largest of the three market segments. It is the fastest growing and I think we have the opportunity to participate in those mark.

It's more particularly now that some of our products reached a greater level of maturity.

Got it thank you.

Okay.

Thank you.

For our next question.

Our next question comes from second Kelly you from Barclays. Please go ahead.

Okay great.

Ken Hey, Keith Thanks for taking my questions here.

I'm going to I'm going to ask two together.

So maybe for the first one Ken for you just.

Just maybe thinking about the long term and specifically on the SaaS part of the business.

When do you feel like Fortinet will have a solution that can compete head to head with other SaaS solutions, maybe the answer is now right, but just want to hear how you think about it.

And how big do you think this part of the business can be longer term. That's the first question. The second question for you Keith is.

It's great to see the operating margin.

Maybe you could just talk about how youre thinking about sort of mid term profitability because clearly the business can generate higher margins and 25%. How do you sort of think about that balance now kind of given some of the changes here.

Yes, the first answer.

He is now.

As competing and we also believe we have a much better solution better integrated and.

The same time.

Much better cost compared to other competitors on the SaaS fee.

And also the Universal SaaS is very unique because they offer.

Both in the cloud on the plans off campus are the same solution, which a lot of customer.

Like our solution.

Sometimes you have to deal with traffic.

Traffic whether enough is that all of us have reported a pop because our solution you can process some traffic locally on campus meeting.

<unk>.

Yes.

It's a great point about whether you're talking about free cash flow you are talking about operating margin. The company does very very well on the bottom line and the strategy has been to continue to reinvest that back robustly in both innovation and a form of R&D spending, but also then go to market.

Marketing and whether that's selling.

I think we're looking at right now with the slower firewall market, obviously, where we're trying to bring new solutions better solutions to our sellers to sell when the firewall is a little bit slower.

But I do think it will work.

Ill conversation I'm looking at.

The sales coverage if you will we've talked for several years about how many in North America. For example, how many accounts do we want to wrap up we started with 65 I think four or five years ago. When we're talking about that that number is now down to 10 and it <unk> you probably reaching a point of where you are on the enterprise side, you, probably reaching a pretty good coverage model for our business you can see.

I was a little bit lower but that feels pretty good.

Theres another opportunity right now immediately in front of us in terms of how do we continue to support our channel partners be the distributors will be their resellers.

And make sure that we're getting the right level of mind share from them. So I suspect there'll be some investments in that part of the business as we go forward.

At the same time I think there's some opportunities here and Ken talked about it with us about how to be more efficient in how we're spending our money, whether that's in selling and marketing or back office functions or what have you. So.

We're not trying to guide to 2024 today, obviously, but we did think that it was important to provide at least some early thoughts in terms of maybe a floor for what 2024 should look like for us on the bottom line.

Got it very helpful. Thank you.

Okay.

Thank you.

Well move to our next question.

As a reminder, if you would like to ask a question.

Please press star one one and wait for your name to be announced.

Our next question comes from Brad Zelnick.

From Deutsche Bank. Please go ahead.

Great. Thank you very much for taking the question I appreciate it as you lean into SaaS and security operations Youre, most obvious advantages in having an industry leading installed base.

For those of us that have always viewed fortinet has distinct advantages the price performance of your purpose built hardware.

<unk> also had a go to market, both direct and indirect that know how to showcase that.

I'm just trying to get my head around all the changes in distribution, both direct and indirect which I. Appreciate Keith you made comments about sales enablement, but how do you think about the investment in dollars and time needed to get distribution properly ramped and can you ever achieve the same level of sales productivity that you've enjoyed when the.

Motion was more box centric.

We do believe.

And it's a fast growing SaaS fee.

Our market.

The south training south restructuring at the same time more efficient market gains are important.

And and.

And also we are continuing working closely with our channel partner retail distribution network.

To reach our broad customer base.

So we also think in the upsell cross sell opportunities are huge.

It's Patrick goes through our partner network there.

So I don't feel that the investment we've made.

<unk> will be.

Any issue or kind of any.

Slow us down we do believe we're actually helping us to expand in this most service based assay market and also.

More consolidation secular off approach.

Yes, and I would just build on <unk> comment credit and a good and fair questions.

It's not by accident, we're talking about SaaS.

If you go back and think about it a little bit we've been talking about it and in a number of different ways to kent's talked about pop strategy, which now youll see.

As accelerating that pop strategy with the cloud providers to come to market more quickly.

The Gartner Magic quadrant, I think are the catalysts for the single vendor strategy and having us on the challenger quadrant gives us the <unk>. If you will that to have a lot of conversations.

Single vendor strategy that installed base that you referred to.

We went back and looked and.

Over the last two quarters, we've done several hundred SaaS deals already.

And to be quite honest that was without any real wood behind the arrow in terms of marketing support or sales support that was really just how it grew.

And it's interesting you while I would've expected those first sales would've been clearly dominated by SD Wan they were not SD Wan customers. They were oftentimes. They are just as many brand new customers coming to us for the SaaS solution as they were SD Wan customers or somewhere we ended the third part of the pie, where our customers that our borrowers for other firewall use cases so.

Yes.

The expectation that we're going to be successful initially and a smaller part of the market.

We disagree with that when I look at that same mix of SaaS customers nearly 50% of those SaaS customers that we've signed already would be in the SMB space and.

And then the remainder was kind of divided up between the larger enterprises in the mid enterprise. So.

I don't think we got here by accident, we maybe just not to talk about it publicly but I think we're well positioned now because of the investments that we've made in the data centers. The pops the operating system. The Gartner Magic quadrant. The fact that a single vendor and install base I think this is the right strategic strategic shift for us to make at this point.

Thanks for that Keith and just a quick follow up and I know, it's a topic we've spoken about in the past, but SaaS fee increases as part of the mix and I know strategically you've partnered with Google.

To help deliver the infrastructure how should we think about the capex required to do this in a competitive way over the longer term. Thank you.

We do have a good partnership with Google at the same time, some other service provider due.

Each one of our key and we also appeals to a mobile home.

Unlike a datacenter pop.

Earnings on by yourself, which is really give us a more cost advantage.

So we're continuing with our strategy.

Two needed time to ramp up to the approval of our quick <unk>.

Solution.

As for customer.

Also we few separate Tom we cannot we have aligned our marketing to see different segment. Thank you and that work in SaaS <unk>, it's much cleaner much better line up with the customer need and also meet different customer demand.

So that's much better market compared to the previous one we have a budget of hurricane lost a modular.

Mike.

Non <unk> product, including tier III segment.

Well with the customer demand so when I started tracking based on this one also we starting.

Compensated to sell some of the <unk> sales and marketing among others three separate.

Segment of the market, obviously with asthma.

Clearly to us our internal forecast month club partner.

Two body panel, what's customer need.

Amit.

Yes, Brian.

Sorry to Ken's 0.2.

Points.

We were the.

Last quarter, we were talking about 20 Pops, because we are building them ourselves right. Now you are talking about over 100 locations well over 100 locations. So I think there is a go to market opportunity. There that this brings to us I think longer term, let me know that one of our competitors. This is the approach they take and we have pretty good visibility, obviously that what their margins are and the investments there.

Another player in the space that's much more building their own Pops. If you will perhaps individually are not huge things right. I mean, there is a single digit number we're actually really have a pop I think so.

I do believe you need some forward Sage Datacenters and I think thats consistent with our strategy that we've talked about about increasing more and more hosted delivery services and particularly in the tech ops.

So I think this is not something that we're going to surprise people with in terms of our capex spending.

It makes perfect sense. Thank you.

Thank you we'll move on our next question.

Our next question comes from Adam <unk>.

From Raymond James Please go ahead.

Alright, thanks, good afternoon.

Keith It sounds like you're confident in profitability and free cash flow, which makes sense. Obviously the model has proved itself over the years. So I wanted to ask about capital allocation. The balance sheet is already very healthy you've got a lot of capacity right now the market's pivoting towards universal SaaS, <unk> and SEC ops as you mentioned.

Curious how the conversations have gone internally to potentially accelerate your pivot towards that with larger M&A and Conversely, if we look at the after hours action here the ROI on share repurchases looking potentially very strong.

The opportunity to potential step up share repurchases just in general how youre thinking about using the balance sheet as a weapon during a time, where the business and stock has pressured thanks.

Yes, I think we included a comment in my prepared remarks that the available, but we still have nine.

As of the start of the month, sorry, the week I guess.

We had $980 million of available authorization for the buyback and I think you saw some of the numbers that we provided in the prepared remarks about being fairly aggressive during the quarter itself as well in terms of buying back stock.

Ken There's a let me go shopping for companies very often so I'll defer to him in terms of his thoughts on that.

We are definitely keeping routine I think right now the market, Paul probably more reasonable.

Yes.

And also we do realize the marketing also changing pretty quick.

We're continuing to the internal utilization, we feel we had a strong is sounding and tunnel.

<unk> engineering all of this space player, but on the same time.

We are open to looking for some other company, which we can.

Working together joined together.

Yes.

Okay, and one quick follow up just to make sure Peter kicks me off the call next time for this one but it'll be in the weeds Keith sorry.

I wanted to ask about supply.

We've been monitoring inventory commitments, they've been elevated for a little while now obviously demand is deteriorating faster than expected and we're just trying to think about how to manage inventory and future inventory given this new state of the demand.

Where that might manifest itself in results I think you mentioned product gross margin pressured I wonder if that was related to that but any comments on kind of managing this oncoming inventory relative to the current demand. Thanks.

Yes, it is related to inventory levels and I think we've been managing it for the better part of the second half of this year.

Some of the commentary that Youre getting as we look into 2024 in terms of where the pressure may come from.

Any way to quantify it though.

For now yes.

Yes, we feel SKU in the healthy level.

We tend to keep about six months inventory.

That's where like a win two three years ago to supply change will happen in market position because also a lot of time our customer need.

Some urgent deliver all of a sudden products. So we probably still keeping the similar policy there.

But also.

Refresh cycle.

New product, especially on the land.

I think so far I think.

It also kind of recent price in the last two or three years.

Now since starting to stabilize.

China pharma shortages may be more towards even some oversupply.

So we have feel we are in pretty good position because we have more handled.

Handle this operation manufacturer directly so we had a better than most of our other competitors on the inventory right now.

Very helpful. Thanks, Ken.

Yes, we also don't see a big issue about the current inventory level.

Okay.

Thank you.

One moment for our next question.

Our next question comes from Adam Board from Stifel. Please go ahead.

Awesome. Thanks, so much for taking the questions maybe.

Maybe just on the sales execution issues that you talked about in his script, maybe go a little deeper on what exactly what exactly happened in a little bit more about the steps youre taking.

And maybe just as a follow up just on the.

SaaS Department partnership with GCT I noticed obviously thats been a couple of weeks, but maybe talk about early customer feedback from initial conversation. Thanks. So much.

Yes.

If you look at the last two three years, we grow in la.

Opinions also hire a lot of salespeople.

For the last three years, we probably top of the business and the same time.

During the supply chain issue somehow certain cells few too easy to deal.

Because all.

All winter shortly Charles.

Southern part out there.

And so that's where we feel we need to enhance the training enablement.

The same time I also need to be more disciplined about the performance.

Same time, we also when we shift in mix to more like a service based SaaS kind of consolidation cross out Marcus Hell.

Second of all Pakistan also need to keep on learning and.

And same kind of market you need to be kind of.

Amortization and also kind of a position to the new <unk> growth opportunity.

That's the focus we have right now so we are definitely keeping looking to be more efficient in both our sales and marketing going forward.

Great and what about the early feedback on <unk>.

TCP.

On Google Cloud.

Yes.

That gave us of our quick start to match any other competitor.

The location.

Number one I will caution that mom pop and they also have a lot of our broad coverage. So it's a good partnership.

Longtime a few where more advantage then.

Some of our competitors because we always have a strategy.

Kind of.

Investment strategy included some real estate some other part.

Which gave us a much better long term return.

Great. Thanks, so much.

Thank you.

Thank you one moment for our next question.

Our next question comes from Patrick <unk>.

<unk> from Scotia Bank. Please go ahead.

Alright. Thank you so much for taking my question, Ken Keith Pizza.

My question is about the I guess kind of quality.

Qualitative guidance you guys gave for 2020 for billings.

Hi.

Remember correctly last quarter, it was expected kind of high teens billings growth.

Exiting.

Fiscal 'twenty four.

The commentary this quarter expect double digit growth exiting 2024.

Let's try and follow the math.

I'm just trying to so last quarter you guys gave some kind of afford look for 2020 for billings and <unk>.

Remember right knee.

Luke was expect exiting.

Earnings growth.

Being high teens.

Earlier in your prepared remarks, there was a.

Comment just expect double digit growth in the second half.

Yes.

Are we going from high teens double digit is that the change.

Yes, yes, and I think that's I think that's prudent given what we've just seen in terms of the third quarter performance.

Yes.

Okay, great. Thank you so much.

Okay.

Thank you.

One moment for our next question.

Our next question comes from Joseph Gallo from Jefferies. Please go ahead.

Thanks for the question I've got two harder one for each of you and Keith as a follow up to that last question. Appreciate the commentary on Bottomline floor for 24 can you just talk about the methodology of topline guidance is this a rip the band aid off guide or what underpins the confidence and visibility in a reacceleration of billings is it SaaS return.

On or just.

Hardware digestion, only taking two to three quarters and then Ken.

Given what youre seeing with AI do you believe adoption of AI workloads, eventually shifts workloads back to on premise and drives a higher need for firewalls long term. Thanks guys.

Yeah, and I wasn't quite sure. If the question was about the Q4 guide or the 2020 for commentary about numbers.

More for next year, but both it has the methodology for your topline guidance change.

Following the past two quarters.

Yes, I would say that while we just feel that we're.

We're actually giving guidance for the fourth quarter.

Absolutely I think the assumed.

The close rates if you will.

Our dramatic I think theyre, the lowest assume close rates ive seen that I've used in over five years here for context.

And then obviously lower than what I saw on the FERC, what I use for the first half of the year.

And I think that I would say there are indicators of the pipeline quality is better than the fourth quarter.

But and given light of what we've done for the last two quarters I don't think that should put much stock in that so im content to just assume a much lower close rate that I have more recently.

1024, and not really giving guidance I think that.

Again, we're talking about buildings here and I know, we're all aware of it but really focused perhaps more on the impact of backlog and what it did to billings in Q1 of last year in Q2 of last year and how that ease throughout the year and so you're really going to see comps change I don't know that we're necessarily assuming a dramatic growth ramp.

<unk> if you will.

This early stage, where 2024, we do expect it's going to improve as we bring SaaS online more successfully and secure operations, but I think it really part of what you are hearing there is really getting clarity on how the backlog impacted 2023 numbers.

Yes.

Yes.

Good interesting question about that.

And the security.

I have to see.

That's on the AI.

Was that in.

Kind of got into the security learn quickly both spent a good kind of bad Guy.

But.

Jennifer the AI side a few.

Some degree the bank I, probably more leverage some of that one.

The.

Protect side still more using what we have been doing the last 10 plenty of smaller makeup position AI and make sure we block the attack a non-profit me you could traffic but also.

Also helping to sort of stop hauling costs and also helping the sick calibration.

So.

Definitely we're keeping driving the security grow.

Both.

Cloud and also on <unk>, we do see Alpine is also long tons of our healthy growth, especially our record a convergence of networking networking security, especially in the enterprise in the campus environment.

We see that trend will continue.

Oh Wow.

Our unique advantage that <unk> will continue to lead in the market and keeping gaining market share.

So im not I don't see any slowdown.

These are clients getting to that type of security space.

Thank you.

Thank you.

One moment for our next question.

Our next question comes from Gray Powell from BT IAG. Please go ahead.

Alright, great. Thank you from working me in here I appreciate it.

So maybe a clarification.

A follow up.

So you laid out the breakdown for billings or the new breakdown.

Between secured networking SaaS <unk> and SEC ops.

Digital will talk about the relative growth rates that youre seeing today for each segment.

And then within secured networking is there a way to think about how much of the slowdown you're seeing there is related to the core firewall business.

We're seeing some of the networking components like switches and access points and stuff that may have been more.

They may have benefited more from like supply chain and budget flush and things like that.

Yes, actually we do give the market growth for these three segments going forward.

And we also believe we're growing faster than the market growth can you gain ensuring geologist III segment.

The link to the firewall of 40 K losses, some other AEP switch, we do see more headwind in.

In AP switch.

The AP 40 switch because now supply chain issue kind of a pretty much over.

And.

So thats, probably more headwind compared to the.

Firewall.

Networking firewall side.

All right fair enough. Thank you very much.

Okay.

Thank you.

One moment for our next question.

Our next question comes from Eric Heat.

Keybanc capital markets. Please go ahead.

Great. Thank you and thanks, Peter for getting me in here.

For you curious how the economics to the top line.

For Fortinet change.

When a customer is kind of doing an apples to apples switchover from kind of a firewall customer over to SaaS.

And then secondarily with the shift away from firewall, just probably means more of a shift to annualized billings. So curious how you're thinking about duration of that impact of free cash flow going forward. Thanks.

The second was probably easier, but we have such a large footprint right now of the firewall business that it's going to take a while for.

Any significant changes in SaaS billings, if you really think about it coming into and having an impact on our total terminal term.

I don't know that we gave the number but we know that we've come back to a more to come down about one month year over year in terms of contract term and in 2023 compared to 2020.

Two we went from 28 months roughly last year to about 27 months of this year and maybe I could be off by a month, but.

And you saw the impact in the financials, we've talked about that while month, one month impacts the billings number I think it could take a while for SaaS as I've mentioned, we've already done several hundred SaaS deals we expect to be more successful early on with one in SMB spaces into with our installed base.

So I would imagine that that's.

It's going to take a while to really have an impact on free cash flow.

We also will be keeping salary training for your internal sales force also to our partner.

Since it's a new SaaS <unk> operation, we can may be different than the traditional secure networking side.

So thats, we also filled with a huge installation base, we have an ICU Wang firewall, which we are leading were number one pretty much in all of these areas.

Yes, we feel with a huge potential to up sell cross sell SaaS and unsecured.

<unk> the Salesforce western partner <unk> trend.

Okay.

Thank you.

At this time the Q&A session has now indeed.

I will now turn the call over to PVC Koski for closing remarks.

Thank you Angela and I'd like to thank everyone for joining the call today are fortinet will be attending investor conferences hosted by Barclays Staples and Wells Fargo. During the fourth quarter RSA chat webcast links will be posted on the events and presentation section of Fortinet Investor Relations website. If you have any follow up questions. Please feel free to contact me have a great day. Thank you.

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