Welcome to the Third Quarter Earnings Call. I would now like to hand the call over to Peter Salkowski. Please go ahead.
Thank you, Michelle. 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 Q3 of 2020. 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 that will be available for replay via webcast on our Investor Relations website. Ken will begin our call by providing a high level perspective on our business. Keith will then follow that with a review of our financial and operating results for the Q3 before providing guidance for the Q4 of 2020. We'll then open the call for questions. Before we begin, I'd like to remind everyone that on today's call, we will be making forward looking statements and those forward looking statements are subject to risks and uncertainties, which could cause our 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 ks 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 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 on our 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 Q3 2020 results. We are very pleased with our Q3 performance, building increased 20% to 750,000,000. Dollars Our SD WAN solution more than doubled year over year and represent over 13% of total billings. Total revenue increased 19 percent to RMB651 1,000,000 with product revenue growth accelerating quarter over quarter 14% and service revenue up 22%. Recently, Fortinet was the only vendor recognized as the leader in both the latest Garmin Magic Quadrant for WAN Edge Infrastructure and the Garmin Magic Quadrant for network firewalls.
Fortinet's FortiGate SD WAN is the only organically built solution that provides networking and security integrated into a single appliance that delivers leading protection, performance and cost saving for the largest customer base and fastest revenue growth among major player in the space. The COVID-nineteen pandemic has accelerated digital transformation and organizations have to deal with new challenges to secure the whole infrastructure in a Zero Trust environment, whether it's WAN, cloud, data center, network, branch or home edge. Fortinet is helping customers solve these issues through security driven networking and our platform approach. FortiGate Security Fabric, which combines networking and security across entire connect environment, provide protection whether on premise, virtual or cloud based environment. Our recent Fortinet survey of cybersecurity leaders showed almost 70% of organizations are concerned about inside threat.
Today, Fortinet announced the FortiGate 2600F for enterprise level internal segmentation and hyperscale data center in multi cloud environment. Powered by the new MP7 secondurity processor, the FortiGate 26 Android F offered the highest performance with a secure compute reaching up to 10 times higher than our competition. Gartner has stated that over the next few years, edge and immersive technologies will begin to replace cloud and mobile. The release of several new appliance powered by our latest 40 ASIC SPU together with cloud and software based virtual machine could deploy security anywhere. We're unable Fortinet to capitalize on this investment and will fuel our growth going forward.
Before turning the call over to Keith, I would like to thank our employees, customers, partners worldwide for their continued support to manage our response to the ongoing COVID-nineteen pandemic. Keith?
Thank you, Ken. Let's start the 3rd quarter review with revenue. Total revenue of $651,000,000 was up 19%. Product revenue of $224,000,000 was up 14%, benefiting from strong demand for secure SD WAN, high end FortiGates and cloud solutions. Service revenue increased 22% to $427,000,000 FortiGuard service revenue increased 22 percent to $235,000,000 FortiCare service and other revenue increased 21% to $192,000,000 The revenue mix shift from 8x5 to 20 fourseven support was 11 points with 20 fourseven now representing over 65% of the mix.
Moving to the mix of FortiGate and non FortiGate revenue. FortiGate product and service revenue increased 16%. Non FortiGate product and service revenue grew 27%, driven by growth from cloud and fabric solutions. Given the continuing strong growth of our non FortiGate or fabric platform, it's worth noting the absolute size of this business. For example, during the trailing 12 month period ended September 30, 2020, non FortiGate products and services totaled $668,000,000 an increase of 26.5 percent when compared to the previous 12 month period.
Revenues and solutions include a complete range of form factors and delivery methods, including physical and virtual appliances, cloud, SaaS and perpetual software as well as hosted and non hosted solutions. Combined with our FortiGate business, we offer our customers the needed range of security solutions and form factors, enabling them to provide security across their entire IT infrastructure, whether it's at the WAN, cloud, data center, network branch or even home office edge. Our 3rd quarter performance illustrated the benefits of our diversification across geographies, customer segments and industry verticals. Looking at revenue by geos. As with the 2nd quarter, our geographic revenue performance aligned with the economic impact of the pandemic and with it highlighted the geographic diversification of our business.
As summarized on Slide 5, revenues in Asia Pacific increased 27.5% as many Asian countries and economies have been able to remain largely open. Revenue growth in the Americas of 13% continued to reflect the impact of the pandemic, especially in Latin America, as well as a very difficult year earlier comparison, revenue growth for the Americas in the Q3 of 2019 was over 24%, the highest of all three geographies. If we shift to billings, total billings increased 20% to $750,000,000 Looking at billings by solutions segment, FortiGate billings increased 16% and accounted for 72% of total billings. As shown on Slide 6, high end FortiGate posted strong billing growth in the quarter. Non FortiGate billings increased 29% with strong demand for fabric and cloud solutions.
As with revenue, our billings performance by geos aligned with the economic impact of the path of the pandemic. APAC buildings outperformed all geos, followed by Europe and then the Americas, including Latin America. Now turning to billings by customer segments. As we experienced in the 2nd quarter, we saw solid billing growth in the SMB and large enterprise segments. SMB posted strong growth across all geos, illustrating the strength of our channel programs, the solid execution by our channel employees and partners and the large diverse makeup of this multinational customer segment.
Moving to worldwide billings by industry verticals, our top 5 verticals continue to account for about 2 thirds of total billings. The worldwide government sector topped all verticals at 20% of total billings and grew at over 40%. We experienced solid performance internationally and in the U. S. At the local levels.
Service providers and MSSPs accounted for 16% of total billings. Financial Services was 14% of total billings, also had a very strong billings growth quarter at 27%. Education with 90% of total billings rebounded in the 3rd quarter as schools prepared for secure e learning in the fall semester. Now looking at deals by dollar size. We had 48 deals over $1,000,000 in the 3rd quarter compared to 53 deals in the Q3 of 2019 and 30 deals in the Q3 of 2018.
Secure SD WAN accounted for 7 of the deals over $1,000,000 and while down from 8 deals over $1,000,000 a year ago, total SD WAN billings more than doubled. And as Ken mentioned, accounted for approximately 13% of total billings. Moving back to the income statement. As shown on Slide 4, gross margin improved 130 basis points to 79.5%. Product gross margin improved 220 basis points to 62.9%.
Product gross margin continued to benefit from the lower direct costs of our newer generation of FortiGate products, offset slightly by higher indirect costs. It's worth noting that for 5 quarters in a row, including 2 pandemic quarters, product gross margin has been over 60%. Operating margin for the 3rd quarter increased 90 basis points to 27.4%, benefiting from the improvement in gross margin and continued lower travel and marketing program expenses related to the shift towards virtual events, offset by the addition of new team members. Total headcount ended the quarter at 8,075, a 23% increase given by the increased investments we've made to grow our business. Given the strong operating income performance, net income for the 3rd quarter was $145,000,000 and earnings per diluted share increased 0 point share.
On a GAAP basis, we reported net income of $123,000,000 or $0.75 per diluted share versus GAAP income of $80,000,000 or $0.46 per diluted share a year ago. The strong performance this quarter is a result of the diversification of our business and the strategic long term investments we've made to expand our global sales force, to invest in our channel partners and to expand our product offering and provide a truly integrated security platform enabling automation. Moving to the statement of cash flow summarized on Slides 7 and 8. Free cash flow came in at 186,000,000 dollars As we commented previously, we are leveraging the strength of our balance sheet as a competitive advantage to support our partners and our customers as they experience the economic challenges of the pandemic. As a result, average day sales outstanding increased to 76 days, up 3 days sequentially and 13 days year over year, in line with our expectations and reflecting our decision to provide geographically targeted extended payment plans.
We expect extended payment terms and higher inventory balances to be in effect as we move through at least the first half of twenty twenty one. Inventory turns decreased to 2.1 times as we increased our on hand inventory to mitigate supply chain risk. Capital expenditures for the Q3 were $35,000,000 including $26,000,000 related to construction and other real estate activity. We estimate capital expenditures for the 4th quarter to between $40,000,000 $50,000,000 and for all of 2020 to between $130,000,000 $140,000,000 The lower full year CapEx range is due to utilities and other delays the construction of our new campus building that are pushing more spending to 2021. Our move in date has moved to mid-twenty 21.
The average contract term for the Q3 was 26 months, flat year over year as well as sequentially. We expect full year cash taxes to be approximately $40,000,000 and our full year non GAAP tax rate to be 21%. As we look forward, I'd like to review our outlook for the Q4, summarized on Slide 9, which is subject to disclaimers regarding forward looking information that Peter provided at the beginning of the call. For the Q4, we expect billings in the range of $890,000,000 to $920,000,000 revenue in the range of $710,000,000 to 730,000,000 non GAAP gross margin of 78% to 80% non GAAP operating margin of 27% to 29% Non GAAP earnings per share of $0.95 to $0.97 which assumes a share count of between $167,000,000 $169,000,000 We expect a non GAAP tax rate of 21%. Having said that, based on this Q4 guidance, we expect to achieve the rule of 40 for the full year, making 2020 the 3rd consecutive year and the 9th year of the last 11 years that we've been able to achieve this milestone.
So along with Ken, I'd like to thank our partners, our customers and the Fortinet team for their support and hard work during these difficult and unique times. I'll now hand the call back over to Peter to begin the Q and A.
Thank you. Operator, please open the call for Q and A.
Our first question comes from Brian Essex of Goldman Sachs. Your line is open.
Hi, good afternoon and thank you for taking the question and congrats on a nice quarter of results.
I was wondering maybe if
you could
touch on what you're seeing in the spending environment, particularly it sounds like you had a really nice quarter of fabric growth and SD WAN demand, but we also picked up fiscal firewall strength in the quarter. So maybe from the standpoint of what you're hearing from CIOs and what actually surprised you the most about the demand in the quarter?
Yes, Brian, this is Ken. That's a good question. We also closely monitor watching the whole things change in the space. Basically, so that's where we keep in promoting, we call security driven networking and also that's concept we try to the thinking we have in the last 20 years. So you can see the definitely the SD WAN starting come to the networking side and probably in the next 10 years can grow over $20,000,000,000 So that's going to be huge.
We want to be the leader, number 1 in this space, I hope to target next year. And at the same time, the security is that the Zero Trust concept starting to get very popular. So we need to make the whole infrastructure very secure. And also the work from home also starting to change in a lot. Like in early this year, once the pandemic just started and people enterprise just tried to see how IT can support your work from home.
Now they're starting to try to see what's the long term solution, whether some service based SASE or some other, they call the home is the new branch, right? So that's where you can have the FortiGate install and home can manage much broader device, can also like traffic shaping, like many different priority for different application, different user and at the same time can secure the whole infrastructure that sometimes you also call it SD branch solution. That's where managed WiFi, managed other switch, other networking equipment altogether and also even the printer or the other HAWA appliance. So that's we're starting to see some even some big enterprise or some working with water service provider, some companies starting to offer the employee or they call it because they call them the new branch, they not only given some kind of 40 ks planning, but also including the Internet access, including like whether 4, 5, 3, 4, 5 gs or some others altogether, It's kind of a package solution and to help them secure as they call them the whole infrastructure security. So that's where we see both kind of approach.
So we're closely working with service provider, whether through the service base, SaaSee outdo this kind of a whole infrastructure security approach, but the new branch holds the new branch approach. So it's definitely changing the whole environment. So the security no longer just security the gateway, the border and the whole infrastructure. At the same time, the networking also need to be more application awareness like based on application like SD WAN or some other based on the content, like there are certain content CDN provider also starting to get in the security space. So that's what keeping saying the security of the network is starting to kind of ramp up quickly.
Got it. That's super helpful. And maybe just a follow-up on that SaaSy comment. Any and I know I'm going to mispronounce this, but any initial traction with OPAC or OPAC through MSSP channel and how much progress have you made with that relationship so far?
Yes. We acquired OPEC last quarter and we're working together to making the whole solution for the sales. Also we are closely working with a lot of service provider because we do keep it saying for the few years, you see the service provider has the best position to offer a lot of service. So we help them and also FortiGate is one of the best platform. They can build whether within their pop or even extend into the branch or extend to inside the company.
So it's a good change in the space.
Got it. Thank you very much.
Thank you. Our
next question comes from Fatima Boolani of UBS. Your line is open.
Thank you
for taking the questions. Keith, I have 2 for you. Just looking at your outlook and your billings guidance, I wanted to unpack that a little bit and get your sense of where you are being a little bit more cautious relative to the performance this quarter and how we should think about some of the puts and takes into the guidance that implies a deceleration from the Q3 performance you just put up? And I have a follow-up as well.
Sure. Look, I think it's shown 2020 has shown to be a very interesting year for setting guidance. Q1 was very, very strong. Q2 was challenging. Q3 is a nice bounce back.
It's really a function of watching media reports almost on a daily basis in terms of what's happening with the pandemic. What we see happening in the U. S, we can also layer into that the U. S. Election, but also what we're seeing in Europe.
And I think, in the current environment, I think the guidance does a pretty good job of trying to reflect our current understanding of the pandemic.
Fair enough. And just a bigger picture question for you. As I think about the complexion of your 2021 margin profile, If I look at 2020, you are head and shoulders above the sort of the 25% operating margin watermark that you've spoken to historically. So I'm wondering as we think maybe longer term over the next couple of quarters, what are some of the structural versus temporal impacts on the margin trajectory from here, considering the pandemic trade offs and some of the acceleration you've undertaken on the sales hiring front? I'd love to parse through that out with you.
That'd be really helpful. Thank you.
Yes. I think the to kind of start top down on that, I think the product gross margin, and probably why we made reference to it in the call, being over 60 percent for, I think, 5 quarters in a row. There were some periods of time there where it was probably in the higher 50s. We're not very much in terms of the structure that we're seeing, in terms of our pricing and our cost structure on gross margin. And even as we continue to do some new products, hopefully, we'll be successful that 60% gross margin number.
And as you kind of move your way down the income statement, I think it's really a sales and marketing conversation in terms of spending. Clearly, we're continuing to get the benefit of not having salespeople travel and not the financial benefits, excuse me, of having salespeople not travel as well as marketing programs being virtual. And to the extent that the world stays that way, we're going to continue to get that benefit. Now obviously, and I think we've talked previously that we're very committed to use this as an opportunity to bring in more salespeople. We talked about our headcount growth of 23%.
Hopefully, that we time this right such that when those newer salespeople are coming online and they're fully productive, we'll be around the time that they're adding to the top line. At the same time, travel and marketing programs revert to historical norms.
Appreciate the detail. Thank you, Keith.
Our next question comes from Shaul Eyal of Oppenheimer. Your line is open.
Thank you. Good afternoon, guys. Congrats on the solid performance and outlook. I had a question see some displacement opportunities given the potential disruption that one of your competitors, smaller competitors in the space could be seeing given a consolidating market?
This Ken, no. We still see very strong interest and no competitor come close to what we have. So we see that it's more than double year over year. And also, we are the only one has 2 Magic Quadrant, both from SD WAN and also the network firewall come to the same appliance. And at the same time, it's a 13% of last quarter's billion, but we have a huge installation base.
A lot of customers even enabled that one, we are not quite even comfortable that one. So we believe we have much bigger user base about like we call secure SD WAN solution. And also going forward, I'd say that the work from home is also will be helping driving this whether you treat home as a new branch or whatever, this kind of solution. So we feel we have a market position technology and also the only one built internal organically and also have ASIC salary out of performance on average about 10 times faster than any other competitor. So that's where we see it's a huge opportunity.
And the market grow like 50% year over year and we grow more than double year over year. It's we're keeping gaining market share.
Yes. Shaul, it's Scott. I think Ken's spot on with that. I think if we look forward in terms of the opportunities, what Ken's referring to is, look, I think there's still the opportunity in front of us to help the service providers unpack their existing relationship with their incumbents on the SD WAN side, and that's something I we're very focused on. And as we start to see that SD WAN is a critical component of SASE and the cloud on ramp.
So I think, to Ken's point, that market is going to continue to expand for
us. Got it. Got it. No, that is super helpful. And maybe a question on the Americas performance.
Keith, when you isolate the mixed Latin American performance and strictly focusing on the northern part of the Americas. How would you characterize the performance slightly more in line with your internal expectations heading into the quarter?
Yes, I think the U. S. Where there's 3 components to the Americas, Latin America, which is a very difficult place currently, and we saw that in the numbers. We expect a difficult quarter out of Latin America, and we certainly got that. Canada, on the other hand, has done fairly well throughout this.
It's just a different footprint in terms of the pandemic. To your specific question related to the U. S, I think the U. S. Did much better in the Q3 than it did in the Q2.
But clearly, I would not say that we're at pre pandemic levels for the U. S. There's still opportunity there for us.
Got it. Thank you so much. Good luck. Good job.
Thank you. Thank you.
Our next question comes from Brad Zelnick of Credit Suisse. Your line is open.
Great. Thanks so much and congrats on the acceleration of the business. It's great to see. My first question for you, Ken, I wanted to ask about the impact of 5 gs on your business. It seems we're approaching a tipping point in terms of broader 5 gs coverage.
So my question is how should we think about the benefits of your business and why you feel that Fortinet is competitively advantaged as we approach this tipping point?
5 gs so far I see is more connect to the device than connect to the people like under 3 gs, 4 gs in the past. And also it depends on the vertical industry. And we're also leading a lot of our OT, IoT security. But also like when work from home could be also a good backup for this like a one access. But it's so we see quite a lot of successful case on international right now that seems more a little bit ahead on some of the 5 gs deployment and also working closely with the carrier service provider.
Like I said, in the last quarter earnings, it's kind of growing faster than we expected and probably still on a very small base, but we do believe next year could be material, the 5 gs contributes for our growth.
Great to hear. Thank you. And for Keith, last quarter you mentioned the discounting had picked up for the first time in a couple of quarters. How do you characterize discounting in Q3 at this point? Thanks.
Flat, consistent with what it was a year ago. Nothing to call out. So I guess if we could give that color, I think we felt a little more pressure in the Q2. We did not feel that same pressure in the Q3.
Great to hear. Thank you
so much for taking the questions, guys.
Thanks, Ben.
Our next question comes from Saket Kalia of Barclays. Your line is open.
Hey, guys. Thanks for taking my questions here. Keith, maybe first for you a housekeeping question. Can you just talk about some slight changes to the deferred revenue balance historically? I know there's a footnote in the earnings slide, but maybe you could just expand on what the adjustment is and how that impacted deferred and billings just so that we're all on the same page?
Yes. We had a little housekeeping to go through with a subset of our 40 Care contracts. Historically, and this goes back many years, we probably should have been recognizing revenue a little bit sooner, starting the amortization period than we had been. So there's a little bit of a pickup on quarterly FortiCare service revenue. It ranges it's very small.
It ranges from a 10th of a percent to about a half a percent of revenue for any particular period. When we file the 10 Q, there'll be a long footnote that shows every possible period and so forth. But that's all. Just a little bit of housekeeping to pick up some revenue there.
Okay, got it. So just to be clear, the billings that was reported in the quarter, the 7.50 that really wouldn't have been impacted by sort of that change, right?
No. No. No.
Okay, got it. Got it.
Understood. The follow-up for you, Ken, just on the product side. I guess as opaque becomes a bigger part of the offering, how do you think about the strength of the FortiGate line that maybe helps differentiate when you're offering a SASE solution? Does that make sense?
Yes. I think FortiGate is a very important part of SASE because they are the best firewall, SD WAN, all the other things, can be positioned within the PoP or sometimes we can working with service provider to use it for the gate to be part of their service, their solution there. And at the same time, we also do believe sometimes you also need to have a kind of a different approach like appliance can be in the home or can be in the branch or can be in the within the data center and the secure like east west traffic. So that's where we see FortiGate as a market platform to keeping expanding we call the whether the whole infrastructure security or security driven networking including both inside SaaS, power, all kind of a secured other part of infrastructure.
Very helpful. Thanks guys.
Thank you.
Our next question comes from Sterling Auty of JPMorgan. Your line is open.
Hi, guys. This is Matt on for Sterling. Thanks for taking the question. I wanted to ask a little bit more on SD WAN. I was wondering if you guys could give additional color on what you make of the competitive landscape currently and what you've seen on pricing on that front.
Thanks.
Yes. We offer the most the best pricing performance and also more function SD WAN and other competitors. And SD WAN, I can see probably a wild fast growing area, also wilds the biggest market potential. So there's a multiple research say it would be reached over $20,000,000,000 in like 5 to 20 years, probably even bigger than the network security. And that's why also we want to combine these 2 together.
So you see the same platform offer both. So that's where compared to other competitor, which is only the software approach or sometimes even to whether they call the universal CPU loading some other appliance. So we have this ASIC dedicated hardware and the plus like both in the low, mid to high end range can be within the PAB or go to the home branch or go to within the data center inside the cloud. So that's where we see it's a huge advantage compared to other competitors and also from the Magic Quadrant from the growth we have. And we do believe we'll be the number one leader in the space.
Yes. Matt, I can spot on with that. I think he's probably being a little bit humble because I think really what's going on is because of the ASIC strategy and what he's built. He's been able to increase the capacity in the firewall virtually each and every year. And it's a matter of how you use that capacity.
Different SD WAN vendors have different pricing methods, but for Fortinet, it's embedded in the operating system of firewall. We do not charge for it separately. When you purchase a firewall, you receive the SD WAN functionality. So I don't really think that and certainly we do not see anything in terms of our discount as we talked about that suggested any sort of change.
Great. That's very helpful. And then just one quick housekeeping question. So going back to Saket's question on billings, if we just take the change in deferred on the balance sheet and the revenue, it seems like there's a disconnect to that in what you reported on billings. Just wondering if there was anything there to kind of unpack?
No, I don't think so. I mean, it's a pretty darn good definition and billings is really defined as being revenue or minus a change in deferred revenue, unless you have an acquisition or something like that. There should not be a difference there.
Okay. Thanks guys.
Yes. Thank you.
Our next question comes from Andrew Nowinski of D. A. Davidson. Your line is open.
Great. Thank you and congrats on a nice quarter. So you called out strength in high end billings this quarter, but it's actually been very strong for the last three quarters, which is somewhat surprising given that we're in the middle of a pandemic. So can you just provide any more color on driving that consistently strong growth in high end?
There are some related to the new MP7 because it's compared to MP6, they're improving the performance by almost 5x and also now can process like a 200 gig traffic per chip compared to the 40 gig and also more function there. So that's where we started to roll out the new MP7 base MP7 probably only go to the high end and middle range. And at the same time, we do see certain vertical also help drive some high end like a finance service, some government sector, which they're mostly by the high end, which has less impact by the pandemic. Maybe Keith has other
thoughts? No, I think I would point to 1100E or 1100F, excuse me. The product has been out there for about a year now and it's done very, very well. It performed extremely well in the Q3, and I think it's been ramping up as we expect typically with the high end products.
Yes. Also SD WAN, I'd say probably half of probably comes from the high end contribution.
That makes sense. And then why do you think you saw fewer $1,000,000 deals this quarter given the strength in the high end billings that we've seen?
Yes, I think it's a very good question. We came into the quarter looking at the pipeline and actually had a little bit of risk I thought because we had a larger mix of larger deals. And then when we got through the quarter, obviously, that the mix actually shifted on us a little bit. I mean, we've all read reports that maybe in general that the deals are getting a little bit smaller or what have you and maybe that has something to do with it. I really don't have good information in terms of why what ended up.
I mean, what you get every quarter always differs from the pipeline. I don't know why that particular item differs this time.
Yes. But the deal over 500 ks increased a lot, right? And also compared to 1 year ago, Q3, last year, we grow the
1 year ago, we grow
$1,000,000 deal, quite a large number. So that's where it's more comparison.
Ken makes a very good point. In fact, if you look at deals over SD WAN deals over 250,000, dollars those were up well over 200% year over year.
That makes sense. Thanks, guys.
Our next question comes from Hamzah Fodderwala of Morgan Stanley. Your line is open.
Hi, guys. This is Calvin Patel on for Hamzah. Congrats on the quarter and thank you for taking my question. I was wondering if you could first comment a bit more on invoice durations and how you see that trending in your more recent conversations as we go forward?
Invoice duration? I'm sorry, was that the question? Yes. Yes. We've been right at that.
Despite what maybe some other competitors expected to see a year, a year and a half ago, think we've been very consistent throughout that timeframe at about 25, 26 months.
All right, perfect. And then just as a follow-up, if you could comment a bit more on the competitive landscape in firewall this time, not just on the SD WAN segment? And if you think that there will be some level of digestion to occur over the next year or not?
We keep gaining market share quickly in the firewall market. But also I believe going forward, we in saying this for a long, long time, almost since the beginning, we started the company 20 years ago. So the new networking will be more secure driven. So instead of the networking routing switching all about connectivity and speed, they need to be make sure they can give us application. That's where SD WAN is application based on the routing networking and also they can deal with all the content and also user device level.
That's all security handling. So that's what we see probably the traditional whether the traditional network security, which only secure the border or the traditional networking probably also needs doing some transition change. So the network security is about $20,000,000,000 market probably and the traditional networking maybe $70,000,000,000, 80 $1,000,000,000 market. But there probably will be starting merging and transition change and we feel we lead in this changing and we'll be we're also in a very good position, very good technology to really address the new security driven networking.
Thank you, guys.
Thank you.
Our next question comes from Rob Owens of Piper Sandler. Your line is
open. Hey, guys. This is Justin
on for Rob. I just had a quick one on the federal government vertical strength in the quarter. Just how it was trending relative to your expectations? And maybe if there is anything that we can unpack on what drove the strong quarter?
Yes, it's not. If you go back and look at the phrase very closely, we're not talking about U. S. Federal. We're talking about government, which for us is more international government as well as local governments.
U. S. Federal is not a large part of our business.
Got you.
And then also just a quick follow-up, maybe just on your pipeline relative to where it's sitting now relative to last year and how you feel going into the Q4 just given it's usually historically your biggest?
Yes. Well, pipeline is probably the biggest input to the guidance setting process, right? And there's all kinds of different ways of slicing and dicing and we go through that, whether it's deal size, whether it's new logo versus an existing customer, whether it's a new deal versus a renewal deal or what have you. And I think clearly the pipeline supports the guidance.
Got it. Thank you.
Our next question comes from Patrick Koles with Deutsche Bank. Your line is open.
Hey there. Thank you for taking my question and congrats on a very impressive quarter. Can we just talk about SD WAN again? The result you guys put out was super impressive, doubling of growth year on year. We've been hearing the media in our checks around some firms kind of closing or rationalizing like branch offices.
So clearly that hasn't had any effect on your business. But can you just talk me through whether you powered that amongst your customers or anything related to that point would be great?
Yes, because it's a huge benefit for what enterprise or some other customer, even including the home user consumer to use SD WAN. It's on average, it costs probably more than 50% cost saving. And also they offer like how to manage multiple link among different kind of application and because the fixed connection whether the MPLS or some other one has a difficult time to manage like different application based on different cloud or kind of different dynamic environment. So SD WAN is a technology they can manage traffic based on different application, even different content or some other security need as FortiGate is doing. It's a huge benefit for the user.
That's driving the growth even during this pandemic. And also we believe the long term work from home can also quickly expand into a lot of consumer home user base and just try to improve in the service supporting level from that angle. We should be working with a lot of service providers or some big enterprise right now. But as long term, we do believe they may change in the whole networking space. It's just like whether you software define whatever application or content based networking, which can offer a lot of additional benefit compared to the fixed network in all kind of VPN access.
So it's got a lot of customer interest. That's the reason the market grow like 50% and believe probably, I don't know how long, maybe 10 years or could be short or longer. Eventually, we do believe half or majority of the whole networking space may be this kind of SD WAN approach to based on application content.
Very clear. I mean, one of the points you made was around, I guess, the devices at the branch office. I mean, how often does the FortiGate SD WAN solution sits alongside a traditional router? And how often is it a replacement of the traditional router?
We only need a 140 gig to replace all the router, all the security, all the Wi Fi access controller, all this kind of thing. It's a single device, as a multifunction can replace like a 3, 4, 5 device including router, including the SD WAN and including the
replacement for those devices? Yes. FortiGate is a replacement for those devices?
Yes, replace multiple devices altogether and become only device stay there.
Got it. Thank you so much for your time. Really appreciate it.
Thank you.
Our next question comes from Gray Powell of BTIG. Your line is open.
Hi, this is Stefan on for Gray. Thanks for taking my question. Piggybacking off the last question with the branch office, have you seen any meaningful change in demand or mix of growth between the branch office and data center firewall?
Yes. That's where you can see sort of vertical whether retail, whatever we still see pretty strong growth. I think I believe Keith mentioned maybe grow 40% something like that. And also the bigger potential is really the home is the new branch. So that's probably even bigger.
But that's still in early stage, because you still need to help in the home user to manage some of that. I know service a lot of service provider right now are working with us, but at the same time certain enterprise also try to do that.
Thanks. And as a follow-up, can you just talk about the linearity that you saw in the Q3? There was some mention of deal delays in the U. S. Did those end up landing this quarter?
I think you're talking about deals from Q2 that delayed, do they come in the 3rd quarter? The answer to that would be yes. We were pleased with what we saw. We were pleased with what we saw in July in terms of the start that we got on the quarter.
All right. Thank you.
Our next question comes from Adam Tindle of Raymond James. Your line is open.
Hi. This is Alex Franckwitz on for Adam. Thanks for taking my questions. I just wanted to touch on SD WAN one more time. I was wondering just how important is your ASIC and bake offs?
How important is that performance boost to customers? And on SD WAN, are you finding that it's becoming more of a driving factor in purchasing decisions? Or do other core capabilities and functionalities come first when a customer is making decision?
Yes. The AC gave them like almost 10x more computing power. So that's where they can add like a security function, manage other like a Wi Fi, some other device and same time can process traffic much quicker. And can also like working with service providers and other one make sure it's a total infrastructure security solution. So that's a huge advantage compared to the other software approach, which they have a limited CPU computing power to many, whether security or SD WAN or some other like the platform which can only handle single function compared we build this 40 ASIC with 40 OS can handle multifunction replace multiple device.
So that's where we see the huge advantage.
Okay. Thanks. And then just a follow-up. Looking ahead more than just a few quarters looking kind of a couple of years out, What kind of rule of 40 margin profile are you targeting? Are you focused solely on top line growth?
Or could you expect we expect to see some margin drop through the bottom line?
Yes. I'm managing Ken very closely. He's managing me very closely. Yes. When we talk about our midterm range of being we wanted to have 25 percent operating margin, right?
The strategy remains the same, balancing growth and profitability. We started the year believing that we would tilt towards growth. As we went through the year, I think the pandemic obviously impacts the ability to grow in a couple of those quarters. But longer term, we still believe it's a balanced strategy towards balancing profitability and growth we do believe there is an opportunity for growth, no doubt about it.
Okay, perfect. Thank you, guys.
Thank you.
Our next question comes from Fatima Boolani of UBS. Your line is open.
Thank you, gentlemen, for allowing me to hop back in. I wanted to double back on the billings questions earlier on. The calculated billings based on your deferred revenue disclosure and disclosed reported revenue, some to $720,000,000 in the quarter. And so I just wanted to appreciate that $30,000,000 delta between what you have in the press release and in the reported numbers and calculating the billings off the balance sheet deferred revenue metrics?
Sure. When you have some housekeeping going on, Fatima, I'll jump into this, Keith. You can have 1 or 3 things. You can have something that's so small, you just want to do in the current period. You can have something so large that you restate the prior period financial statements.
You can have something in the middle, which is called a little R, where you're going to be cash financials. That's what this is. That $30,000,000 when you see the 10 Q will come out of the opening retained earnings back in December 31, 2017, I believe it is. And it's from that point forward that the amortization starts being corrected. So internally, we have the information for you to actually track right now with the billings recalculation of that, you need to see Q2's number as recast, right?
And that's not in the financials that you have, right? So $30,000,000 came out of deferred revenue 3 years ago for something that's been going on for many, many years on this small transaction time. And it finally became large enough to correct, right. The number that we've reported is based upon recast revenue and recast preferred revenue for billings.
Fair enough. So it's essentially a cumulative impact that we'll see the details for in the filings. Yes.
That's why I gave the quick sound bite earlier that the quarterly impact to revenue typically runs 3 to the quarters that we looked at between a 10th of a point and about a half point of revenue. It's a very small item in any one quarter.
Understood. That's very clear. Thank you. And since I have you, Ken, a question for you, just around the SD WAN discussion. From a product standpoint, I think there's a debate that's brewing between the thin branch architecture versus a thick branch deployment architecture within the SaaSy paradigm.
So I'm wondering how Fortinet is positioned in the former, so in the thin branch arena, if we think about the sick branch environment maybe under potential duress in increasingly uncertain macro environment? And that's it for me. Thank you.
I think both branch can fit into different environment. The SIM brand sometimes they can solve certain mobile device issue. And the SIM branch also can process the SIMs locally in real time, a lot of application need that. So the FortiGate is more like a pop in local, whether in home or whatever, in the office or cities popping in a SaaS environment, which you can see how they process the traffic within the SaaS infrastructure. That's how FortiGate is the key point to really get this processed.
So that's also because our ASIC advantage, so we have a huge computing power advantage over other approach, which give us kind of much better performance, also lower cost. So that's where we had the flexibility converted to the appliance and on premise or can be the virtual fit into the cloud or be part of the POP SASE solution. So give us the flexibility and also can extend beyond some other competitor, other player can do, which because if they're only limited for the software approach, they can only sit in certain server within a pop up, within the data center. So we can extend beyond our go to the edge, go to the home and go to a lot of even other remote location. That's also kind of using my quote from the Gartner is really so in the next few years, that's where come from the Gartner Research.
They say the edge and the immersive technology would replace in the cloud and mobile. So that's where you see you need to have more computing everywhere in the real application environment. So that's where we developed this ASIC and all these different technology to working with our different service provider or different kind of vertical space to address this issue, especially the infrastructure keeping changing with the 5 gs and with all these like that's what ASIC study have more advantage compared to the software on approach.
Very clear. Thank you so much, Jim.
Yes. Thank
you.
Our next question comes from Patrick Colville of Deutsche Bank. Your line is open.
Hey, there. I'm copying Fatima hopping back in. Appreciate you letting me ask another question. How much did the Gartner's inclusion of Fortinet in the top right corner of the SD WAN MQ influence customer decision making. This time a year ago, you guys were just outside of the top right corner and now you are in it.
And so was that something that, in your opinion, might have changed the dialogue a bit and got a force on more RFPs?
It's helped on certain enterprise, but we also have much broader sector and also the geo diversity is probably not dependent too much on the Magic Quadrant. But it's and we also have like because like the new Magic Quadrant only come on end of the quarter, it's come up in September 30, it's last day of the quarter. So I don't think
We don't close that fast?
Yes. So I don't think we think there's not much business in the last day of the quarter in Q3, but it's helped in probably more going forward.
We certainly expect it's going to be helpful in the tailwind for us going forward, yes. Great.
Thank you so much.
Thank you.
There are no further questions. I'd like to turn the call back over to Peter Stalkowski for closing remarks.
Thank you, Michelle. I'd like to thank everyone for joining today's call. Fortinet will be attending conferences by the way, yes, attending conferences in the 4th quarter, the Credit Suisse conferences on November 13 as well as December 2, the Raymond James Conference on December 7, the UBS on December 8, and a Barclays Conference on December 9. Events with presentations will be webcast and the links will be available on our website, the Investor Relations website at Fortinet. If you have any follow-up questions, please feel free to contact me.
Have a great day. Thank you very much. Take care.
Ladies and gentlemen, this concludes the conference. You may now disconnect. Everyone, have a great day.