Fortinet, Inc. (FTNT) Earnings Call Transcript & Summary

Hello. Thank you for standing by, and welcome to Fortinet Fourth Quarter 2021 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Peter Salkowski, Vice President of Investor Relations. Please go ahead.

Good afternoon, everyone. This is Peter Salkowski, Vice President of Investor Relations at Fortinet. I'm pleased to welcome everyone to our call to discuss Fortinet's financial results for the fourth quarter and full year of 2021. Speakers on today's call are Ken Xie, Fortinet's Founder, Chairman and CEO; and Keith Jensen, our Chief Financial Officer. This is a live call and that will be available via replay via our website on our Investor Relations website. Ken will begin our call today by providing a high-level perspective on our business. Keith will then review our financial and operating results for the third quarter before providing guidance for the fourth -- for the full year -- for the first quarter and full year of next year. We'll then open the call for questions. [Operator Instructions] Before we begin, I'd like to remind everyone that on today's call, we will be making forward-looking statements, and these forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected. Please refer to our SEC filings, in particular the risk factors in our most recent 10-K and Form 10-Q, for more information. All forward-looking statements reflect our opinions only as of the date of this presentation, and we undertake no obligation and specifically disclaim any obligation to update forward-looking statements. Also, all references to financial metrics that we'll make on today's call are non-GAAP, unless stated otherwise. Our GAAP results and GAAP to non-GAAP reconciliations is located in our earnings press release and in the presentation that accompanies today's remarks, both of which are posted on the Investor Relations website. Lastly, all references to growth are on a year-over-year basis unless noted otherwise. I'll now turn the call over to Ken.

Thanks, Peter, and thank you to everyone for joining today's call to review our outstanding fourth quarter and full year 2021 results. For the fourth quarter, bookings increased 49% to $1.420 billion. Billings increased 36% to $1.306 billion. Global G2000 billings growth accelerated to over 90%. Secure SD-WAN billings was up 67%, accounting for 16% of total billings. Total revenue growth 29% to $964 million, with product revenue up 31%. Our team navigated well through a challenging supply chain environment to deliver outstanding results. For the full year, revenue was $3.3 billion and GAAP operation margin was 20%. We generated a record of $1.2 billion of free cash flow, and we recorded our 13th consecutive year of GAAP profitability. Three growth drivers -- convergence of security and networking, vendor consolidation with our Security Fabric mesh platform, and an elevated threat environment -- are driving our strong financial results and market share gains. The move to work-from-anywhere has rapidly expanded the attack surface, which traditional network security found hard to protect. Fortinet's security-driven networking approach converges networking of security, including next-generation firewall, SD-WAN, 5G, [ DTLE ] and OT to reduce complexity, while securing and connecting remote users to advanced security and performance and networking speed. Enterprise evolutions are increasingly consolidating to a cybersecurity mesh approach. Fortinet Security Fabric platform delivers unparalleled protection through a cybersecurity mesh architecture that provides broad, integrated and automated protection across multiple edges, from endpoint to data center and hybrid cloud environment. Today, we announced a FortiGate 3000F, the latest FortiGate next-generation firewall, powered by Fortinet ASIC NP7 SPU to deliver sustainable, high-performance convergence of networking and security for zero trust edge and core networks. The FortiGate 3000F secure computing routing offers an average 5x better performance than competitive offerings. Fortinet recently stood out amongst 19 network firewall vendors in Gartner's Critical Capabilities for network firewalls. Evaluated for their performance across 9 critical capabilities, Fortinet's FortiGate solution received overall high score in the enterprise data center, distributed enterprise edge and SMB use cases, and the second highest score in public cloud use case. Our FortiGate product is the [ only ] leader in both Gartner Magic Quadrant for network firewall and SD-WAN. Over the last several years, Fortinet's industry-leading innovation has transformed our company into one of the most influential and fastest-growing cybersecurity leaders. This, in addition to our growth drivers, strongly positions us to capture market share and move to the next level of growth. 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, and would especially like to thank our operations team for doing a great job supporting Fortinet's fast growth. Keith?

Thank you, Ken, and good afternoon, everyone. I'll start with a summary of our very strong 2021 performance. Customer demand was strong and broad-based across geographies, customer sizes, industries, use cases and security solutions, reflecting the 3 key demand drivers that Ken mentioned: convergence of security and networking, vendor consolidation on our Security Fabric mesh platform, and the elevated threat environment. Convergence, or security-driven networking, requires integrated security solutions to be delivered at networking speeds across a company's entire threat landscape of edges, including data centers, endpoints, work from anywhere and clouds, as well as across multiple use cases such as secure SD-WAN, Wi-Fi, switching, 5G and OT. The networking speed and computing capabilities of our ASIC-powered FortiGates can be 5x to 10x more than competitor firewalls with their off-the-shelf silicon products. Vendor consolidation is driven by customer focus on security effectiveness, performance and cost management. We deliver vendor consolidation through our Security Fabric platform and its broad range of products integrated with a single operating system, offering increased automation. As we saw in 2021, we expect strong customer demand fueled by these key drivers to continue. And turning to our 2021 performance. Billings growth accelerated to 35% or $4.2 billion, representing our highest annual billings growth rate in 6 years. Revenue growth also accelerated, coming in at 29%, representing the fourth consecutive year of revenue growth of 20% or more. And despite the supply chain environment, product revenue growth came in at 37% growth, our highest annual product revenue growth rate in 10 years. Driven by strong demand for our fabric and cloud security solutions, non-FortiGate billings and revenue each exceeded $1 billion for the first time in our history. Non-FortiGate billings increased 46% to $1.25 billion, and non-FortiGate revenue increased 42% to $1.1 billion. Gross margin was 77.5% and operating margin was 26.2%. Our GAAP operating margin was 19.5%. It's one of the highest in the industry, [indiscernible] GAAP profitable, as Ken mentioned, for 13 consecutive years. Free cash flow was a record $1.2 billion, exceeding $1 billion for the first time in our history. Free cash flow margin was 36%, and when adjusted for real estate investments came in at 43%. Total deferred revenue increased 3% to $3.5 billion, and short-term deferred revenue increased 28% to $1.8 billion. We are experiencing exceptionally strong demand, demand that exceeds supply by more than historical norms. As a result, we are expanding our disclosures to include bookings and backlog to provide greater visibility into the strength of our business. Bookings represent the value of all orders received from customers. Backlog represents the value of all orders received but not fulfilled. When the order is fulfilled, we recognize both billings and product revenue. Turning to Q4 results. As noted on Slide 4, bookings were $1.4 billion, up 49%. On a sequential basis, backlog increased $122 million due to very strong demand. On a year-over-year basis, backlog increased $150 million to end the year at $162 million. Breaking down the backlog between product and services, approximately 75% relates to future product shipments, while the remaining 25% relates to various services. While it's difficult to forecast if an order might be canceled, several factors support our view that our backlog is strong and should provide a tailwind of growth later this year and into next year. Existing customers account for approximately 90% of our backlog. No single end customer accounts for more than a say -- a low single-digit percentage of backlog. Many competitors are also impacted by supply chain constraints. Our products, along with our integrated operating system, are not commodities readily exchanged with offerings from other vendors. We actively manage our own supply chain, and for the most employed security network solution, over 1/3 of all firewall unit shipments, we are an attractive volume buyer for many suppliers. And lastly, our price-for-performance advantage may be difficult for our competition to match. And I apologize for the sound in the background. We don't know what's causing it, but I'll continue on. Moving to Q4 billings. At $1.3 billion, billings are up 36%, which compares to 49% bookings growth noted earlier. Enterprises favors Fortinet's leading cost for performance and integrated platform. This is especially evident in the 5-point increase in the large enterprise billing mix. To add more color to this, we could share Global 2000 billings were up over 90%, the third consecutive quarter of accelerating growth. The number of deals over $1 million increased 79% to 122 deals, breaking the 100-deal threshold for the first time in our history. We saw a record of 4 low 8-figure transactions in the quarter, all in the Americas. And lastly...

We're going to take one second to see if we can fix the phone line. We think it might be our phone for some reason, we're going to dial back in, and be right back. Everybody else, stay put. [Technical Difficulty]

[Operator Instructions]

Josh, we are back. Can you hear us?

Yes, I can hear you. You're in the main room right now, and I can still hear these sounds.

Is it better, Josh?

I'm sorry, but the sound is still coming in pretty bad.

Okay. We're going to drop this line. I'll call on a different phone. [Technical Difficulty]

[Operator Instructions]

Josh, we're back. Can you hear me? Josh, can you hear me?

Hello. Yes, I can hear you, but the noise came back as soon as you got connected again.

Yes. Josh, we're at a totally different line, I'm on my cellphone now. Sounds like it's on your end, guys.

Let me chat with you on Clearview. We'll get this fixed in just a moment.

Okay, put everybody on hold, please.

I will put the mute [indiscernible] back on the call. You are connected at this time, sir, you may proceed.

Josh, are you there? Okay. I'm going to assume [indiscernible]. We're going to start. Keith's going to back up a little bit. Hopefully, you can hear us now, and we'll start where he kind of left off and go from there. Apologies for the interlude there.

I'll back up a couple of paragraphs to my best recollection of where the challenge started. So -- and I believe that was around when I was mentioning that we were breaking down our backlog between product and services. Approximately 75% relates to product -- future product shipments, while the remaining 25% relates to various services. While it's difficult to forecast if an order might be canceled, several factors support our view that our backlog is strong and should provide a tailwind for growth later this year and into next year. Existing customers account for approximately 90% of our backlog. No single end customer accounts for more than a low single-digit percentage of backlog. Many competitors are also impacted by supply chain constraints. Our products, along with our integrated operating system, are not commodities readily exchanged with offerings from other vendors. We actively manage our own supply chain, and as the most deployed network security solution with over 1/3 of all firewall unit shipments, we are an attractive volume buyer for many suppliers. And lastly, our price-for-performance advantage can be difficult for our competition to match. Moving to Q4 billings. At $1.3 billion, billings were up 36%, which compares to the 49% bookings growth noted earlier. Enterprises favored Fortinet's leading cost for performance and integrated platform. This was especially evident in the 5-point increase in the large enterprise billings mix. To add more color to this, we can share that Global 2000 billings were up over 90%, the third consecutive quarter of accelerating growth. The number of deals over $1 million increased 79% to 122 deals, breaking the 100-plus deal threshold for the first time in our history. We saw a record of 4 low figure-8 -- 8-figure transactions, all in the Americas, in the quarter. And lastly, Secure SD-WAN deals over $1 million increased 63% to 26, contributing to SD-WAN use case billings growth of 67% and putting SD-WAN at 16% of total billings. FortiGate billings were up 33% and accounted for 69% of total billings. As shown on Slide 11, high-end FortiGates posted very strong billings growth. Non-FortiGate billings were up 43%, driving 1.5 points mix shift to non-FortiGate. Top 10 non-FortiGate solutions with growth over 40% included virtual firewalls, endpoints and switches. At the same time, several smaller solutions posted triple-digit growth rates. Consistent with the elevated threat environment and the breadth of ransomware and other attacks, OT use case billings were up 70% and accounted for 8% of total billings. Average contract term was consistent year-over-year and quarter-over-quarter at 28 months. For the third consecutive quarter, we added approximately 6,000 new logos. Worldwide government billings grabbed the largest share of the mix at 16%. Financial services accounted for 14% of billings, on billings growth of 63%. Billings in manufacturing, transportation, utilities, construction and other verticals that have not consistently been in our top 5 remained elevated with billings growth of 40%. We believe the growth of these verticals is an indication of the broadening nature and greater awareness of the threat landscape, which is driving cybersecurity investments in industries that have historically perhaps spent a little bit less on security budgets. Moving over to the income statement. Revenue growth was 29%. Product revenue growth was 31%, illustrating the impact of backlog on product revenue growth. If backlog had remained flat quarter-over-quarter, the product revenue growth would have been as high as the mid-60%s. Service revenue was up 27% to $585 million. Support and related services revenue was up 31% to $275 million, while security subscription services were up 24% to $309 million. Non-FortiGate product and service revenue of $324 million grew 41% and accounted for approximately 34% of total revenue, up 3 percentage points. FortiGate product and services revenue of $639 million grew 23% and accounted for 66% of total revenue. Total gross margin of 77.3% was 180 basis points above the midpoint of our guidance range and up 80 basis points quarter-over-quarter. A lower-than-expected drag from acquisitions and pricing actions taken to offset supplier cost increases contributed to the better-than-expected total gross margin and product gross margin. Product gross margin of 62.1% increased 140 basis points sequentially. Service gross margin of 87.1% increased 50 basis points sequentially. Operating margin of 28.5% improved 270 basis points sequentially and exceeded the midpoint of our guidance range by 100 basis points. Better-than-expected gross margin performance and a slightly less-than-expected impact from acquisitions contributed to the better-than-expected operating margin. Headcount increased 24% to 10,195. Moving to the statement of cash flow, summarized on Slides 12 and 15. Capital expenditures were $151 million, including $129 million for real estate investments. Our capital strategy includes increasing our office and warehouse capacity to support our higher levels of growth. We repurchased 1.8 million shares of common stock for a cost of $541 million. For the year, we repurchased approximately 2.6 million shares for a cost of $742 million. At year-end, the remaining share authorization was approximately $1.5 billion and set to expire in February of 2023. Inventory turns of 2.7x were flat year-over-year and on par with 2.9x in the prior quarter. Overall, with what we believe was better than market growth for the fourth quarter and full year, we believe we again gained market share. Supported by strong pipeline growth and the key growth drivers outlined earlier, we believe we are in the early innings of a sustained high growth period for the cybersecurity industry and Fortinet, driven by digital transformation, hybrid cloud and the moving of data and security to the edge. The products we've created, the channel and customer relationships we've developed and the investments we've made to build a broad and integrated security fabric platform powered by our proprietary ASIC FortiGates are expected to drive our continued growth and market share gains. Now I'd like to review our outlook for the first quarter, summarized on Slide 16, which is subject to disclaimers regarding forward-looking information that Peter provided at the beginning of the call. For at least the first half of the year, we expect elevated demand to outpace supply chain capacity, increasing backlog. An increase in backlog is a headwind to billings and revenue growth and provides interim pressure on margins. For the first quarter, assuming bookings in the range of $1.100 billion to $1.150 billion, which at the midpoint represents bookings growth of 32%, we expect billings in the range of $1.50 billion to $1.90 billion, which at the midpoint represents growth of 26%; revenue in the range of $865 million to $895 million; non-GAAP gross margin of 75.5% to 76.5%; non-GAAP operating margin of 19.5% to 20.5%; non-GAAP earnings per share of $0.75 to $0.80, which assumes a share count of between 166 million and 168 million. We estimate first quarter capital expenditures to be between $140 million and $150 million. We expect a non-GAAP tax rate of 18%. Before providing our full year 2022 guidance, I'd like to congratulate every member of the Fortinet team for the truly outstanding execution in 2021. The efforts and results have been outstanding. And this is on top of now several years of consistent, predictable performance and improvements in key growth and profitability metrics. In 2022, we expect a small shift in our seasonality towards the second half of the year by 2 or 3 points. And for the full year, assuming bookings in the range of $5.580 billion to $5.680 billion, which at the midpoint represents growth of 30%, we expect billings in the range of $5.400 billion to $5.480 billion, which at the midpoint represents growth of 30%; revenue in the range of $4.275 billion to $4.325 billion, which at the midpoint represents growth of 29%. Total service revenue in the range of $2.685 billion to $2.715 billion, which represents growth of approximately 29% and implies full year product implies full year product revenue growth of approximately 27%; non-GAAP gross margin of 74% to 76%; non-GAAP operating margin of 24% to 26%, non-GAAP earnings per share of $4.85 to $5, which assumes a share count of between 169 million and 171 million. We estimate full year capital expenditures to be between $270 million and $300 million. We expect our non-GAAP tax rate to be 18%. We expect cash taxes to be approximately $210 million. Lastly, I want to inform everyone that this -- we will be holding an Analyst Day on May 10 coinciding with Accelerate 2022, where we expect to update our medium-term financial model. Along with Ken, I'd like to thank our partners, customers, suppliers and all members of the Fortinet team for all their hard work, execution and outstanding success. I'll now hand the call back over to Peter.

Thank you, Keith. [Operator Instructions] We lost a little time there due to the technical delays, apologies for all of that. But operator, can you open it up for Q&A, please?

Sure. [Operator Instructions] I show our first question comes from the line of Brian Essex from Goldman Sachs.

Congratulations on a nice set of results. Thanks as well for the additional disclosure. And I guess maybe on that point, maybe could you help us understand what qualifies as a booking from a timing perspective? If an order is placed with a timing event maybe 9 months from now, is that still included in bookings? And then maybe any other incremental color you can provide us on the supply chain management? How you're managing the supply chain? You mentioned pricing increases offsetting an incremental supplier cost. But maybe a view on are the issues abating at all? Are lead times still consistent with where they were last quarter? And any other nuances we should be aware of, like channel partners prebuying inventory, which is one of the things that we picked up a little bit this quarter?

Yes. A lot of good stuff there. I don't know if we'll get to all of it, Brian, maybe a couple of...

My one question.

Yes, I know you did really well. Keep in mind our business model, right? End users buy from resellers who buy from distributors who buy from us. So it's not like a very large, complex $50 million solution that's going to be deployed over time. When we get orders, it's typically the customers want the product. So I don't know that we would see something like we described at the beginning of the conversation in terms of order -- what a booking is. For us, a booking is a distributor sends an order to us, and they would like to have shipment. If we -- so that counts as a booking. And if we ship it, then it becomes a billing and it becomes product revenue, and if we don't, it becomes backlog. I'll just pause at that, sorry. So in terms of supply chain, and maybe Ken would offer some additional thoughts on that, I do -- we talked previously, I think, that we felt that September, October, and maybe very early in November could turn out to be the low-water mark for supply chain challenges, at least in terms of what we call decommitments from our contract manufacturers and from our component suppliers. And I think that, to this point, has shown to be the case. We do still, from time to time, have decommitments, but they're much, much smaller than they were back in that time frame. I think the general tone, if you will, with our channel, whether it's components or it's contract manufacturers, is much, much better than it was. We do, like everybody else, we read the reports, and we see conversations and commentary around things like -- particularly in consumer electronics, where there seems be some improvement, and auto manufacturing. I think we have reason to believe that the situation continues to improve as we move forward. At the same time, working extremely closely with our suppliers, conversations at very high levels and talking about maybe some longer-term projects that we may work on together, for example, making them aware of what our volume of business is and also a bit of a tip of the cap to our engineering team, who's been going through the process of redesigning and recertifying some of the components and some of the other changes, if you will. All of that, I think, kind of gives us a feeling that the second half of this year should see improvement. Ken?

Yes. I think you covered all of it. I think it's just different compared to most of our competitors; we handle the design/manufacture operation pretty much all directly ourselves. And also, we have a bigger quantity compared to our competitors. We can better negotiate with suppliers. And also the engineering, also starting -- last year also starting redesigned some of the product to avoid a certain shortage of the components, which are working well with us, but some of the redesign may take about 6 months. I think overall, that's why we feel pretty confident in the second half of this year since we'll be improving, both because the supply chain itself and also some alternative design and also kind of better planning. I have to say, last quarter the demand was very, very strong with booking growth of 49%, which even kind of beyond all kind of our planning. So that's caused some of the shortage. But overall, we have a much better shape compared to competitors in the inventory and in the supply. And also the other question, we don't see increased inventory in the channel, in the distributor there, pretty much the same as they have in the last few years. So we don't see any increase of the channel to step up the product. So that's not the case for us.

Yes. And since Brian did such a good job of only answering one question, I'm going to jump also in and give some more color on it. I do -- did somebody orders a product early, some place in the world? Sure. I'm sure that happened. When we try and look at our own business, we try to identify the possibilities of that happening. And the best number we can come up with is something that represents extremely low single digits of our business may have been impacted by that. And at the same time, you immediately pivot over to look at your pipeline. And even if that was happening, it's certainly not evident in the pipeline. We're extremely pleased with what we're seeing in terms of the pipeline growth. And then just to follow on to Ken's comment about distributor inventory levels, again, with our model, we do have visibility of the inventory that's in the channel. And that inventory -- those inventory levels are actually down a little bit year-over-year. So I don't think we're seeing the types of things that maybe you may have some concerns about.

Yes. And also the shortage more limit -- and pretty much most limited in the very low end and -- so the middle and the high-end FortiGate, we do have enough inventory even for the more strong like 49% booking growth. And also, we have a very broad product portfolio. So there's a lot of alternative products that the customer, the channel controls. And at the same time, some of the redesign already working, it will be ready in a few months.

I show our next question comes from the line of Fatima Boolani from Citi.

Keith, I'm going to focus this one for you. At the risk of oversimplification, I know you've given us the bookings growth, you've given us the billings growth, and certainly the product growth and the guidance for fiscal '22. So between the 49% growth you saw in bookings, 36% billings growth that you saw this quarter and the 31% in product, can you talk us through how that is dovetailing into your guidance for next year? And frankly, how much of this backlog you're expecting to amortize into your revenue and billings profile over the course of 2022? And as related to that, I understand you've taken some pretty substantial pricing increases for your subscription packages for the portfolio. I'm curious how much of that is contemplated in your guidance across these metrics?

Okay. I think Brian set the standard and Fatima is following it through. How many questions are counted as one here? I'll start with the easy one first, pricing. We raised prices, we've talked before about we raised prices in August and again in November. On our price list, keep in mind, those get discounted down. The price -- because services, whether it's support or security, attaches -- the pricing attaches to the box, so to speak. When you raise prices on the appliance, you're also effectively raising prices on the services. But then if you think through revenue recognition, obviously, you'll get some -- you'll get the price increase in revenue for the product more currently than you will for the services; you're going to recognize that over time. And I think your question of what are we expecting in terms of backlog and amortization or what have you, as you can imagine, we've done a fair amount of scenario planning to go through the year. And I don't know that there is a one scenario that we would point to as opposed to a combination of scenarios. I think you can kind of solve for that maybe not on the phone right now, with some of the information that we've provided in terms of our expectation for backlog increasing, right, for the year. And so if backlog is increasing for the year, I don't think that would be reflective of us bleeding into the income statement backlog that currently exists. The components of the backlog will shift, but net-net, it's going up.

I show our next question comes from the line of Ittai Kidron from Oppenheimer.

Great numbers. I had a clarification and a question. Just on -- Keith, on the 2-point shift in seasonality to second half. Is that just tied to supply chain fulfillment? I just want to make sure I got that right and there's no other cause here? And then, Ken, maybe you could talk about, from a competitive standpoint, are you seeing any changes? And I wonder if you have any thoughts with respect to Check Point's recent introduction of their Lightspeed firewall, which is extremely price aggressive? How do you think about that in the market? Any thoughts there would be great.

Yes, I'll just jump in quickly on the linearity. We just wanted to make sure we open the door to have the conversation with you guys about how linearity may be a little bit different this year than what has been historically for us. And yes, you can point back to the supply chain on that.

Yes. And I also mentioned to Check Point earnings this morning. I probably sent a deal we mentioned Fortinet. And so they say their newest product probably like 20% faster than Fortinet product 1800F, but that's the product we released more than 2 years ago. I think based on Moore's law, so every 2 year -- every 18 months, the speed will double. So I think the latest product is much faster now. So I do see, because the -- we see secure-driven networking converging of network and security. So the network security [indiscernible] deployed pretty much in all the infrastructure, not just secure the border. So when deployed internally needs a much higher speed and that's where the high-speed firewall is needed, to do the internal segmentation, secure the server, segment different departments, all these kinds of things. So that's where we see quite a strong demand and very strong growth with the current ransomware environment. But also, we see that with working from anywhere, a lot of our users have to call in remotely or kind of connect remotely. So that's where the secure SD-WANs and 5Gs and other also see very strong demand. So that's what we see. We're leading innovation in both spaces with our own ASIC, with all the secure SD-WAN and 5G connection. It's a much bigger total addressable market compared to the traditional network security. So that's what we identify as over $170 billion total addressable market for us in the next 3, 4 years. It's a huge potential and a market large enough pretty much for all the competitors to compete, but definitely have to keep up the innovation, keep up the change to keeping gaining market share.

I show our next question comes from the line of Shaul Eyal from Cowen.

Congrats. I'll behave myself, limiting to one question. Back to the supply chain, Keith, I just want to make sure, is that predominantly non-FortiGate products? Or do we have some FortiGate products also included in that entire supply chain discussion?

Yes, and I think Ken touched upon that a little bit. I'll just build it out for little more clarity. If you look at more traditional, what we call secure networking products such as switches and access points, you're looking at probably something on the order of 60%, maybe 2/3 of the backlog would fit into that category, and the remainder is in FortiGate. And then Ken was making sure that we understood that within FortiGate, that roughly 1/3, the majority of that is in the entry level or low end FortiGates. We're not really experiencing the same pressure in the midrange and the high end that we see in the low end.

And on that note, operator, just a quick one. I just want to let everybody know on the call, given the technical difficulties we had earlier, we'll post the prepared remarks about the CEO script and the CFO script to the IR website as soon as we can after the call. Next question, please.

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

Ken or Keith, when you think about the elevated demand and placements on the product front, can you share any thoughts about how coincident that demand is or leading as it relates to additional fabric traction? Any thoughts or hooks around number of applications that are being deployed typically with that initial rollout versus what comes later?

We see a lot of enterprises they need to protect their internal network, because the ransomware attacks, like we released our research few months ago, is 11x higher on the ransomware attack compared to 1 years ago. So it's a big demand for to secure the company's whole infrastructure. Also working from home, work from anywhere, also need more security, especially like secure SD-WAN, secure 5G, all these connections. So we see that the demand is very, very strong. So that's where -- and also for supply, for some other chip manufacturer, even if it's our own chip, usually there's a lead time. So that's where we see the backlog, and we're hoping that will be -- go back, I hope it will be normal towards the end of the year.

Yes. Ken's pointing at me, so I'll follow up a little bit. I think in terms of pull-through of non-FortiGate products, maybe I kind of came to the conversation a few years ago thinking that that was going to be more of a commercial and mid-enterprise area where we see the quantity. In actuality, it seems to kind of move with customer size. The SMB is somewhat limited as we still see other products attaching and building that out, and then the mid-enterprise, the enterprise, and then the service providers are very strong buyers of multiple products. And I think that why that's relevant is that's affirmation of the platform strategy. I think they very early on realized the overhead cost of managing point solutions from different vendors could be fairly onerous, and that was pretty challenging. And so it is moving its way through the rest of the customer chain, if you will. I think the other thing that's happening more currently now is we've seen -- we talk about these other verticals that represent, not in the top 5, but coming to the table and buying security. And I think they're very clear with us, in conversations that I've had with them and Ken as well, that they're looking for a total solution. And the ability to cobble together a series of integrated products into one solution, not only does that save them in terms of the initial purchase, but also the management cost. So I do think there's definitely a tailwind in that area.

Yes. The other validation point is really the Global 2000 account grow over 90%, so it's almost double year-over-year, it's a very, very strong demand in there.

I show our next question comes from the line of Hamza Fodderwala from Morgan Stanley.

I wanted to ask a question about just the appliance demand more broadly. Maybe a question for Ken. How do you think about the demand for hardware between factors like return to office, campus refresh, data center? What's really driving that appliance demand as we go through 2022?

I think the convergence of network and security will be long term and I think during the pandemic and even after pandemic, you'll see a lot of things changing, whether the working environment or the access, that's where the zero trust seems starting build up more of a strong demand there. And also internally, they need to secure the whole infrastructure, both in the -- within the like campus network data center or remote internet in the branch office. So that's where we see the whole infrastructure need to be secured. And also kind of consolidation among different vendors also starting to happen more quickly because, like Keith mentioned, the management cost is very high, if they have a different vendor for different parts of cybersecurity. So that's where the vendor can provide more products integrated, automate together definitely has more advantage and lower the total management cost. Actually, that's why we see the, like I mentioned, the 3 driver convergence of our network and security and the consolidation of the vendor, and at the same time, the strong elevated cybersecurity threat right now, especially like ransomware is a big impact to the businesses, is all driving the strong growth.

Yes, I would share that I think one of the things that Ken asked us to go look at was what would product revenue growth have been if we didn't have backlog, right? And that's that kind of who knows when to call with that point, but it was 65% or 66% product revenue growth if we had the product to deliver. I mean that's a huge number. And I think it speaks to -- the kind description of this is -- the demand is extremely high for appliances right now.

I show our next question comes from the line of Sterling Auty from JPMorgan.

Keith, one for you. If I'm looking at it correct, if it wasn't for the gross margin pressure, it looks like operating margins would have expanded nicely in '22. And I'm curious, with things like return to office, maybe a pickup in business travel and maybe even wage inflation, how are you able to deliver that kind of underlying margin expansion in the operating line?

I don't -- for 2022 versus 2021, I think we're guiding to 24% to -- I think we're guiding to basically 25% at the midpoint and just closed out a year at...

26%.

26%. I don't know that that's up, Sterling. Am I thinking about that..

I'm saying if the gross margin wasn't down...

On the operating -- the leverage is coming through on the operating expenses?

Yes. Exactly.

Yes. I think that -- well, you can look at the percentages in terms of what we're spending. I think sales productivity in the current environment is probably the biggest driver, if you will, in terms of the leverage that we get out of this. Obviously, if you go back to 2021, not a lot of sales productivity average probably in 2020. With COVID, very nice sales productivity numbers in 2021. Now we're looking at tailwinds. And let's be honest, the price increases will indeed increase sales productivity.

I show our next question comes from the line of Adam Borg from Stifel.

Maybe just on SD-WAN, it's great to see the strength there continuing -- maybe you could comment just on, I guess, first, the sustainability of those trends in coming years? And are you seeing this growth coming more from greenfield opportunities or some brownfield displacements?

It's pretty broad. As you can look at SD-WAN, probably, I'd say, more than half, majority products go to the middle or high-end range. And at the same time, a lot of enterprise customers, a lot of are all starting using leverage SD-WAN. So it's quite a broad -- much more beyond the retail.

Operator, next question, please?

I show our next question comes from the line of Jonathan Ho from William Blair.

Let me echo my congratulations on the strong quarter. Yes, I guess, just given that you've delivered a quarter that's been particularly strong this year, can you give us a bit of a sense of what's happening with the pipeline, and maybe what is giving you the confidence that you can continue to drive that sustained growth for several more years? I think you've gone through some of the factors one by one, but what are you seeing in sort of the immediate term that allows you to continue growing at these rates?

Yes, I'm looking at Ken if he wants to get more strategic, I'll give you a very tactical conversation about it. And Peter is making a shameless plug for the Analyst Day in May and saying that we'll talk about that then. Look, I'm really, really pleased with what the pipeline looks like at the moment. We go through our usual -- we've talked before, I think, Jonathan, just slicing and dicing it in terms of how much are new customers, renewals, expansions inside customers, what's the deal size, what's the geography? And it's -- I don't want to just gloss over some of the numbers that we saw in the enterprise segment in the fourth quarter. I think we're at 90% growth on the G2000 for 3 quarters in a row. The U.S. did extremely well, and without getting into a lot of details, they too accelerated for 3 quarters in a row. Looking at the pipeline and looking at, again, more enterprise growth that's coming, we think we have a good position on the SMB. Love the execution. We've had some people in other settings comment upon the maturity that the sales and marketing execution level has reached now as a company. So I think that the pipeline and our ability to execute, I don't see why that would change.

Yes. And also, we have a lot of growth potential in the Global 2000. So like we said last year -- last quarter grew like 90% year-over-year. And also, this is the bigger account, you also can upsell, cross-sell a lot of other products. So we do see the pipeline is very strong. And also we're keeping enhancing the marketing and keeping pretty aggressively [ higher ] sales and sales capacity. So far, some regions, some of the verticals, we still have much less capacity than some of our competitors. I think with the additional marketing sales capacity, we do see the growth will continue in the next few years.

I show our next question comes from the line of Michael Turits from KeyBanc.

Thanks, Keith, for making the statement that demand very high for appliances. I guess I'd just like to re-ask Hamza's question about the sources of demand for appliances right now, particularly in the context, though, of how strong cloud is. We've just had very strong cloud numbers coming in from Amazon as well as from others. So how should we really understand why so much is being spent in physical boxes right now as opposed to even some of your products that are in the cloud?

I'd probably borrow one comment deal mentioned this morning in the other call. Definitely, the network security is a much bigger total addressable market. The cloud security probably by 2025, it is little bit over $20 billion and compared to current total addressable market, including network security, converting network security, endpoint or the other will be $170 billion. It's a much bigger market. And at the same time, there's a lot of innovation going on and have to secure the whole infrastructure. So that's where we see the appliances also. Even access the cloud, you need all these appliances. You also need this SD-WAN, 5G connection, all this to access the cloud. So that's where we see that there's a huge market potential, in the very fragmented market, has a lot of growth potential.

I'm showing we have time for one more question coming from Keith Bachman from BMO Capital Markets.

Yes, I'm going to ask a similar question to Michael before. Your product revenue growth has been 40%, 50% and now the underlying growth this quarter was north of 60%. Your competitors are also experiencing good product revenues -- not nearly to the extent that you are. And so it's more than Check Point that's experiencing demand and it's more than the what I characterize as the consolidation when you're taking share from the likes of Cisco in SD-WAN. And so I'm trying to understand, if you thought about the aggregate demand is -- in the last 3 quarters has been far exceeded anything that's happened in, say, the last 5 years between not only yourself, but your 3 primary competitors ex Cisco. And so the question is, if traffic is normally one of the key drivers, but what are some other drivers for not just yourself, but for the 3 primary vendors? Just trying to understand that really, I think, consistent with some of the other questions, about the durability of demand, not just for yourself but for the industry in general?

Yes. I think the industry, I do believe they need to [ set and ] secure the whole infrastructure, both internal LAN and also the WAN connection for the outside. And then also like we see very, very strong demand to secure inside the company and also like all this data center, all this internal segmentation, which is, before, the network security is too slow to deploy in the high-speed environment internally. And then also the SD-WAN, you can see pretty strong growth. And -- I think the overall is the convergence of -- repeating saying -- the network, network security, that's the 3 driver we gave out. I think probably in the Analyst Day, Peter, Keith, you mentioned May 10, so we'll probably give some more details, some data, some analysis and we'll see how long. I do believe this will be pretty long-term changing in the whole space, where we're keeping growth in the next 5 to 10 years. And also our ASIC advantage and the [ continental ] scale and scope all started working for us, because we have the quantity which helping lower per chip cost, which none of our competitors have. And also, we're probably the only cybersecurity company to design own ASIC chip. And we also leverage any other commercial chip available, including all the -- whatever, Intel, Nvidia, GPU, TPU, IPU or the other things we're using, but we have the unique advantage of our own ASIC chip, which help in driving of our high-speed, low-cost network security solution. On the other side, the economy of scope also working, because we have like some different product harbor, we called the fabric and now going to call the mesh, cybersecurity mesh architecture, which is helping upsell, cross-sell. I think last quarter is the first time the over 30%. I think right now, it's FortiGate count about 69%, non-FortiGate 31% and also over $1 billion last year. Also see very strong growth, growth faster than the FortiGate. So that's also helping to supporting the whole infrastructure security and converging of network and security and also elevated threat environment.

Thanks very much for the question. Shame on Peter for continuing to plug the Analyst Day. Earlier in the life cycle of cybersecurity industry, maybe 10 or 15 years ago, where firewalls had a very specific use and the environment, if you will, was more stable, it may have been easier to identify refresh cycles that we keep looking for and have not yet seen in the last 5 years. And I think that's perhaps, going back to Ken's point, I think that's because the environment is not stable at all. I think the reality is what you're seeing out there right now in terms of use cases and data volumes, data is all over the place, and it's lots and lots of data. It's just getting more and more. And the use cases, I mean 5 years ago a lot of things that were air gapped away from the Internet aren't anymore. And now you see it's probably what's probably what's driving the manufacturing vertical for us. I just -- I don't know that you can presume that the environment, so to speak, and the political interest in it, the insurance companies' interest in it, CIOs management team's interest in it. It is a hot topic of conversation. So even if you are due for a refresh cycle in the industry, and I don't know that we are, I don't think you're going to see that, because of what's happening in the world out there.

Thank you. This concludes the Q&A session. At this time, I'd like to turn the call back over to Peter Salkowski for any closing comments. Please go ahead.

Thank you. Again, apologies for the technical difficulties today. As I said earlier, we are planning to post the prepared remarks up on our website as soon as we can, so you can see all the numbers that Keith shared that I think help answer some of the questions with regards to bookings backlog and the sustainable growth in our business. I'd also like to remind everybody we'll be at the Morgan Stanley conference on March 9, an in-person conference, our first in, gosh, I don't even know how long. The fireside chat at the event and the webcast link for that -- for the Morgan Stanley conference will be on our Investor Relations website for you all to listen. If you have any follow-up questions, please feel free to contact me. Thank you very much for your time. Again, apologies for the technical difficulties, and have a great day.

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