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 third quarter 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 third quarter before providing guidance for the fourth quarter of 2020. We'll then open the call for questions. During the Q&A, we ask that you please keep your questions brief and limit yourself to one question and one follow-up question to allow others to participate.
Before we begin, I'd like to remind everyone that on today's call, we will be making forward-looking statements. 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-K and Form 10-Q for more information. All forward-looking statements reflect our opinions only as of the date of this presentation. We undertake no obligation and specifically disclaim any obligation to update forward-looking statements. 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 of the company's 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, thank you to everyone for joining this call to review our third quarter 2020 results. We are well pleased with our third quarter performance, billings increased 20% to $750 million. Our SD-WAN solution more than doubled year-over-year and represents over 13% of total billings. Total revenue increased 19% to $651 million, with product revenue growth accelerating quarter-over-quarter to 14% and service revenue up 22%. Recently, Fortinet was the only vendor recognized as a leader in both the latest Gartner Magic Quadrant for WAN Edge Infrastructure and Gartner 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 savings for the largest customer base and fastest revenue growth among major players in the space.
The COVID-19 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. Fortinet Security Fabric, which combines networking and security across the entire connected environment, provides 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 threats. Today, Fortinet announced the FortiGate 2600F for enterprise-level internal segmentation and hyperscale data center in multi-cloud environment. Powered by the new NP7 security processor, the FortiGate 2600F offers the highest performance with a Security Compute Rating 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 seven new appliance powered by our latest ASIC SPU, together with cloud and software-based virtual machines to deploy security anywhere, will enable 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-19 pandemic. Keith?
Thank you, Ken. Let's start the third quarter review with revenue. Total revenue of $651 million was up 19%. Product revenue of $224 million was up 14%, benefiting from strong demand for secure SD-WAN, high-end FortiGates, and cloud solutions. Service revenue increased 22% to $427 million. FortiGuard service revenue increased 22% to $235 million. FortiCare service and other revenue increased 21% to $192 million. The revenue mix shift from 8x5 to 24x7 support was 11 points, with 24x7 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 in 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 ending September 30th, 2020, non-FortiGate product and services totaled $668 million.
An increase of 26.5% when compared to the previous 12-month period. Revenues and solutions include the complete range of form factors and delivery methods, including physical and virtual appliances, cloud, SaaS, and professional 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 third quarter performance illustrated the benefits of our diversification across geographies, customer segments, and industry verticals. Looking at revenue by geos, as with the second 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 five, revenues in Asia Pacific increased 27.5%, as many Asian countries and economies have been able to remain largely open. Revenue growth for the Americas of 13% continue 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 third quarter of 2019 was over 24%, the highest of all three geographies. If we shift to billings, total billings increased 20% to $750 million. Looking at billings by solution segment, FortiGate billings increased 16% and accounted for 72% of total billings. As shown on slide six, high-end FortiGates posted strong billings 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 billings outperformed all geos, followed by Europe, and then the Americas, including Latin America. Turning to billings by customer segments. As we experienced in the second quarter, we saw solid billings 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 five verticals continue to account for about two-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, with 14% of total billings, also had a very strong billings growth quarter at 27%. Education, with 9% of total billings, rebounded in the third 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 million in the third quarter compared to 53 deals in the third quarter of 2019, and 30 deals in the third quarter of 2018. Secure SD-WAN accounted for seven of the deals over $1 million, and while down from eight deals over $1 million 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 four, 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 cost of our newer generation of FortiGate products, offset slightly by higher indirect costs. It's worth noting that for five quarters in a row, including two pandemic quarters, product gross margin has been over 60%. Operating margin for the third 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 into the quarter at 8,075, a 23% increase driven by the increased investments we've made to grow our business. Given the strong operating income performance, net income for the third quarter was $145 million, and earnings per diluted share increased $0.21 to $0.88 per diluted share.
On a GAAP basis, we reported net income of $123 million, or $0.75 per diluted share, versus GAAP income of $80 million, 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 offerings and provide a truly integrated security platform enabling automation. Moving to the statement of cash flow, summarized on slides seven and eight. Free cash flow came in at $186 million. 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 three days sequentially, and 13 days year-over-year. In line with our expectations in 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 2021. Inventory turns decreased to 2.1x as we increased our on-hand inventory to mitigate supply chain risk. Capital expenditures for the third quarter were $35 million, including $26 million related to construction and other real estate activity. We estimate capital expenditures for the fourth quarter to between $40 and $50 million, and for all of 2020 to between $130 and $140 million. The lower full-year CapEx range is due to utilities and other delays in the construction of our new campus building that are pushing more spending to 2021.
Our move-in date has moved to mid-2021. The average contract term for the third quarter was 26 months, flat year-over-year, as well as sequentially. We expect full-year cash taxes to be approximately $40 million, and our full-year non-GAAP tax rate to be 21%. As we look forward, I'd like to review our outlook for the fourth quarter, summarized on slide nine, which is subject to disclaimers regarding forward-looking information that Peter provided at the beginning of the call. For the fourth quarter, we expect billings in the range of $890 million-$920 million. Revenue in the range of $710 million-$730 million. Non-GAAP gross margin of 78%-80%. Non-GAAP operating margin of 27%-29%. Non-GAAP earnings per share of $0.95-$0.97, which assumes a share count of between 157 million and 169 million. We expect a non-GAAP tax rate of 21%.
We said that based on this fourth quarter guidance, we expect to achieve the rule of 40 for the full year, making 2020 the third consecutive year, and the ninth year of the last 11 years that we've been able to achieve this milestone. 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&A.
Thank you. Operator, please open the call for Q&A.
Our first question comes from Brian Essex of Goldman Sachs. Your line is open.
Hi, good afternoon, 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 sounded like you had a really nice quarter of Fabric growth and SD-WAN demand. We also picked up physical firewall strength in the quarter. Maybe, from the standpoint of what you're hearing from CIOs and what actually surprised you the most about the demand in the quarter?
Brian, this is Ken. That's a good question. We also closely monitor watching the whole things changing the space. Basically, that's where we keep promoting, we call Security-Driven Networking, and also that's the concept we try to, the thinking we have in the last 20 years. We can see definitely the SD-WAN starting come to the networking side, and probably in the next 10 years can grow over $20 billion. That will be huge. We want to be the leader, number one in the space, I hope target next year. At the same time, the security is at the zero trust concept starting to get very PoPular. We need to make the whole infrastructure very secure. Also the work from home also starting changing a lot.
Like in early this year when the pandemic just started and enterprise just tried to see how IT can support you work from home. Now they're starting try to see what's the long-term solution, whether some service-based SASE or some other way. They call the home is the new branch, right? That's where you can have the FortiGate installed in the home, can manage much broader device, can also like traffic shaping, manage different priority for different application, different user, and same time can secure the whole infrastructure that sometimes they also call the SD-Branch solution. That's where manage the Wi-Fi, manage other switch, other networking equipment altogether, and also even the printer or the other home appliance. That's we're starting to see.
Even some big enterprise or some working with service provider, some companies starting offer the employee, or because they call them the new branch, they not only giving some kind of FortiGate planning, but also including the internet access, including whether 3G, 4G, 5G or some other thing altogether. It's a packaged solution, and to help in security, they call the whole infrastructure security. That's why we see both kind of approach. We're closely working with service provider, whether through the service-based SASE or through this whole infrastructure security approach, the home is the new branch approach. It's definitely changing the whole environment. The security no longer just security the gateway, the border, and it expands the whole infrastructure. At the same time, the networking also need to be more application awareness, like a base application like SD-WAN or some other based on the content.
There are certain content CDN providers also starting getting a security space. That's what keeping saying the security of the network is starting to ramp up quickly.
Got it. That's super helpful. Maybe just to follow up on that SASE comment, any, and I know I'm going to mispronounce this, but any initial traction with OPAQ or OPAQ through the MSSP channel, and how much progress have you made with that relationship so far?
Yeah. We acquired OPAQ last quarter, and we working together to making the whole solution for the SASE. Also, we are work closely working with a lot of service provider, because we do keep in saying for the few years, you see the service provider has the best position to offer a lot of service, so we help them. FortiGate is one of the best platform they can build, whether within their PoP or even expand into the branch or expand through inside a company. It's a good change in the space.
Got it. Thank you very much.
Thank you.
Next question comes from Fatima Boolani of UBS. Your line is open.
For taking the questions. Keith, I have two 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 third quarter performance you just put up. I have a follow-up as well.
Sure. Look, I think 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, also what we're seeing in Europe. 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. 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 25% operating margin watermark that you've spoken to historically. 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-off and some of the acceleration you've undertaken on the sales hiring front. Would love to parse through that out with you. That'd be really helpful. Thank you.
Yeah. To 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% for, I think, five quarters in a row. There were some periods of time there where it was probably in the higher 50s. We like very much in terms of the structure that we're seeing, in terms of our pricing and our cost structure and gross margin. Even as we continue to introduce new products, hopefully we'll be successful, that 60% gross margin number. As you 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 benefit, excuse me, of having salespeople not travel, as well as marketing programs being virtual.
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 grow up to 23%. Hopefully that we time this right such that when those newer salespeople are coming online, they're fully productive, will 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 on the SD-WAN opportunity, and given the ongoing strength you're seeing. Have you started to see some displacement opportunities, given the potential disruption that one of your competitors, smaller competitors in this space, could be seeing, given a consolidating market?
We still see very strong interest, no competitor come close to what we have. We see that it's more than double year-over-year, also we are the only one has two Magic Quadrant, both from SD-WAN from also the network firewall come to the same plans. Same time, it's a certain % of last quarter's billings, we have a huge installation base. A lot of customers even enable that one, we are not quite even count on that one. We believe we are much bigger user base, about like we call secure SD-WAN solution. Also going forward, I 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.
We feel we have a market position technology and also the only one built internal organically and also have ASIC SPU or the performance on average about 10 times faster than any other competitor. That's where we see the huge opportunity. The market grow like 50% year-over-year, and we grow more than double year-over-year. We're keeping gaining market shares.
Yeah, Shaul Eyal.
Got it.
Keith, I think Ken's spot on with that. I think if we look forward in terms of the opportunities, what Ken's referring to, 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 think we're very focused on. As we start to see that SD-WAN is a critical component of SASE and the cloud on-ramp. I think to Ken's point, that market's going to continue to expand for us.
Got it. No, that is super helpful. 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?
Yeah, I think the U.S., well, there's three components to the Americas. Latin America, which is a very difficult place currently, and we saw that in the numbers. We expected a difficult quarter out of Latin America, and we've certainly got that. Canada, on the other hand, has actually done fairly well throughout this. 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 third quarter than it did in the second quarter. 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.
Yeah. Thank you.
Our next question comes from Brad Zelnick of Credit Suisse. Your line is open.
Great. Thanks so much, 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 5G on your business. It seems we're approaching a tipping point in terms of broader 5G coverage. My question is: how should we think about the benefit to your business and why you feel that Fortinet's competitively advantaged as we approach this tipping point?
5G so far I see is more connect to the device than connect to the people, like the 3G, 4G in the past. Also, it depend on the vertical industry, and we also leading a lot of OT/IoT security. Also, like when work from home could be also a good backup for this one access. We see quite a lot of successful case on international right now that seems more a bit ahead on some of the 5G deployment. 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 5G contribute for our growth.
Great to hear. Thank you. 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.
Nothing to call out. I guess the way to give that color, I think we felt a little more pressure in the second quarter. We did not feel that same pressure in the third quarter.
Great to hear. Thank you so much for taking the questions, guys.
Thanks, Brad.
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. 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.
We had a little housekeeping to go through with a subset of our FortiCare contracts. Historically, this goes back many years, we probably should've been recognizing revenue a little bit sooner, starting the amortization period than we had been. There's a little bit of a pickup on quarterly FortiCare service revenue. It's very small. It ranges from a tenth of a % to about a half a % 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, that's all. Just a little bit of housekeeping to pick up some revenue there.
Okay. Got it. Just to be clear, the billings that was reported in the quarter, the $750, that really wouldn't have been impacted by sort of that change, right?
Nope. No.
Okay. Got it.
No impact.
Understood. The follow-up for you, Ken, just on the product side. I guess as OPAQ 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?
Yeah. 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 sometime we can working with service provider to using FortiGate to be part of their service, their solution there. Same time, we also do believe sometimes you also need to have a different approach, like appliance can be in the home or can be in the branch or can be within the data center and secure east-west traffic. That's where we see FortiGate as a larger platform to keeping expanding whether the whole infrastructure security or Security-Driven Networking, including both inside the SASE, PoP or all kind of secured other product infrastructure.
Very helpful. Thanks, guys.
Thank you.
As a reminder, to ask a question, please press star then one. Our next question comes from Sterling Auty of JP Morgan. 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.
Yeah. We offer the best pricing performance and also more function SD-WAN and other competitors. SD-WAN can see probably one of the fast-growing area, also one of the biggest market potential. There's a multiple research, say, will be reached over $20 billion in five- 10 years, probably even bigger than the network security. That's for us, also, we want to combine these two together, so you see the same platform offer both. That's where, compared to other competitor, which is only the software approach or sometimes even have to whether they call the universal CPE load in some other appliance. We have this ASIC dedicated hardware and the plus, both in the low, mid, high-end range, can be within the PoP or go to the home branch or go to within the data center inside the cloud.
That's where we see the huge advantage compared to other competitors. Also from the Gartner Magic Quadrant, from the growth we have, and we do believe we'll be the number one leader in the space.
Yeah. Matt, Ken's 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. 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. 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. Just one quick housekeeping question. 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. I was wondering if there was anything there to kind of unpack.
No, I don't think so. It's a pretty darn good definition, and billings is really defined as being revenue plus or minus the change in deferred revenue. Unless you have an acquisition or something like that, there should not be a difference there.
Okay. Thanks, guys.
Yeah. Thank you.
Our next question comes from Andrew Nowinski of D.A. Davidson. Your line is open.
Great. Thank you. Congrats on a nice quarter. 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. Can you just provide any more color on what's driving that consistently strong growth in high-end?
There are some relate to the new NP7, because as compared with NP6, they improve in the performance by almost 5x, and also now can process a 200 gig traffic per chip compared to the 40 gig, and also more function there. That's where we started to roll out the new NP7 base. NP7 product only go to the high-end and middle range. At the same time, we do see certain vertical also help drive some high-end, like a financial service, some government sector, which they're mostly by the high-end, which had the less impact by the pandemic. Maybe Keith has other thoughts.
No, I think I would point to the 1100E or 1100F, excuse me.
On this too, yeah.
Yeah. The product that's been out there for about a year now, and it's done very well, but performed extremely well in the fourth quarter, and I think it's been ramping up, as we expect typically with the high-end products.
Yeah. Also SD-WAN, I say probably half of profit probably comes from the high-end contribution.
That makes sense. Thank you. Then why do you think you saw fewer $1 million deals this quarter, given the strength in the high-end billings that we've seen?
Yeah. 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. When we got through the quarter, obviously the mix actually shifted on us a little bit. We've all read reports that maybe, in general, that 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 what you get every quarter always differs from the pipeline. I don't know why that particular item differed this time.
Yeah, the deal over $500K increased a lot. Also compared to one year ago, Q3 last year, we grow $1 million deal, quite a large number. That's where it's more comparison.
Yeah, Ken makes a very good point. In fact, if you look at SD-WAN deals over 250,000, those were up well over 200% year-over-year.
That makes sense. Thanks, guys.
Our next question comes from Hamza Fodderwala of Morgan Stanley. Your line is open.
Hi, guys. This is Calvin Patel for Hamza. 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?
Yeah.
Yeah. We've been right at that. Despite what maybe some other competitors expected to see a year or a year and a half ago, I think we've been very consistent throughout that timeframe at about 25, 26 months.
All right, perfect. Just as a follow-up, if you could comment a bit more on the competitive landscape in firewall this time, not just in the SD-WAN segment, and if you think there'll be some level of digestion to occur over the next year or not?
We keeping gaining market share quickly in the firewall market. Also, I believe going forward, we will keeping saying this for a long, long time, almost since beginning of we start the company 20 years ago, that the new networking will be more Security-Driven. Instead of the network and routing switching all about connectivity and speed, they need to make sure they can deal with application. That's why SD-WAN is an application-based routing networking, and also they can deal with all the content and also user device level. That's all security handling. That's what we see, whether the traditional network security, which only secure the border or the traditional networking, probably also need doing some transition change. The network security is about $20 billion market probably, and the traditional networking may be $70 billion-$80 billion market.
There probably will be start emerging and transition changing. We feel we're leading this changing, and we also in a market position, market 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. I'm for Rob. I just had a quick one on the federal government vertical strength in the quarter. Just how that was trending relative to your expectations, and maybe if there is anything that we can unpack on what drove the strong quarter?
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. fed is not a large part of our business.
Got you. 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 fourth quarter, just given it's usually historically your biggest.
Yeah. Well, pipeline is probably the biggest input to the guidance setting process, right? There's all kinds of different ways of slicing and dicing it, and we go through that, whether it's deal size, whether it's a new logo versus an existing customer, whether it's a new deal versus a renewal deal or what have you. I think that clearly the pipeline supports the guidance.
Got it. Thank you.
Our next question comes from Patrick Colville, 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-over-year. We've been hearing in the media and in our checks around some firms kind of closing or rationalizing branch offices. Clearly that hasn't had any effect on your business, but can you just talk me through whether you've heard that amongst your customers or anything related to that point would be great.
Yeah, because it's a huge benefit for what enterprise or some other customer, even including the home user consumer to using SD-WAN. On average, it costs probably more than 50% cost saving. They offer 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 different application based on different cloud or different dynamic environment. SD-WAN technology, they can manage the traffic based on different application, even different content or some other security need as FortiGate doing. It's a huge benefit for the user. That's driving the growth even during this pandemic. We believe the long-term work from home can also quickly expand into a lot of consumer home user base, and to try to improving the service supporting level from that angle.
We should be working with a lot of service providers, some big enterprise right now. As a long term, we do believe they may change in the whole networking space. It's just like whether you can software define or whatever application or content-based networking, which can offer a lot of additional benefit compared to the fixed networking or VPN access. 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 shorter, longer. Eventually, we do believe half or majority of the whole networking space may make this kind of SD-WAN approach, to base on application content.
That's very clear. One of the points you made was around, I guess, the devices at the branch office. How often does the FortiGate SD-WAN solution sit alongside a traditional router? How often is it a replacement of the traditional router?
We only need one FortiGate to replace all the router, all the security, all the Wi-Fi access controller, all this kind of thing. It's a single device, has a multifunction, can replace like a three, four, five device, including router, including the SD-WAN, and including the security gateway VPN, and then also the Wi-Fi controller.
Well, just a clarification. Is your point that in most cases, FortiGate is a replacement for those devices?
Yeah, replace multiple device 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?
That's where you can see sort of vertical, whether retail, whatever, we still see pretty strong growth. I believe Keith mentioned maybe grow 40%, something like that. The bigger potential is really the home is the new branch. That's where probably even bigger. That's still in early stage because you still need to helping the home user to manage some of that. I know a lot of service provider right now working with us, at the same time, certain enterprise also try to do that.
Thanks. As a follow-up, can you just talk about the linearity that you saw in the third quarter? 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. Did they come in the third quarter? The answer to that would be yes.
Yes.
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 Franco 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 in bake-offs? How important is that performance boost to customers? 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's making decision?
Yeah. The ASIC give them like almost 10x more computing power. That's where they can add a security function, manage other, like a Wi-Fi, some other device, and same time can process traffic much quicker. It can also, working with service providers and other one, make sure it's a total infrastructure security solution. That's a huge advantage compared to the other software approach, which they have a more limited CPU computing power to manage, whether it's security or SD-WAN or some other, like the platform which can only handle single function, compared we build this for the ASIC, with FortiOS, can handle multifunction, replace multiple device. That's where we see the huge advantage.
Okay, thanks. Just to follow up, looking ahead, more than just a few quarters, looking kind of a couple years out, what kind of rule of 40 margin profile are you targeting? You focus solely on top line growth, or can we expect to see some margin drop through to the bottom line?
Yeah. I'm managing Ken very closely.
He's managing me very closely.
Yeah. We talk about our midterm range of being, we want to have 25% 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. 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 sum to $720 million in the quarter. I just wanted to appreciate that $30 million 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 one of three things. You can have something that's so small you just run it through 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 recast financials. That's what this is. That $30 million, when you see the 10-Q, will come out of the opening retained earnings back in December 31 of 2017, I believe it is. It's from that point forward that the amortization starts being corrected. 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? That's not in the financials that you have, right?
$30 million came out of deferred revenue three years ago for something that's been going on for many, many years on this small transaction size.
It finally became large enough to correct, right? The number that we've reported is based upon recast revenue and recast deferred revenue for billings.
Fair enough. It's essentially a cumulative impact that we'll see the details for in the filings.
That's why I gave the quick soundbite earlier that the quarterly impact to revenue typically runs, three to the quarters that we looked at, between a tenth 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. 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 SASE paradigm. I'm wondering how Fortinet is positioned in the former, so in the thin branch arena. If we think about the thick branch environment maybe under potential duress in an increasingly uncertain macro environment. That's it for me. Thank you.
I think both branch can fit into different environment. The thin branch, sometime it can solve certain mobile end device issue. The thick branch also can process the things locally in real time, a lot of application need that. The FortiGate is more like a PoP in local, whether in home or whatever, in the office or sit as a PoP in a SASE environment, which you can see how they process the traffic within the SASE infrastructure. That's how FortiGate is the key point where the data is processed. That's also because our ASIC advantage, so we have a huge computing power advantage over other approach, which give us a much better performance, also lower cost.
That's where we have the flexibility, can whether do the appliance and on-premise, or can be the virtual fit in the cloud or be part of the PoP SASE solution. 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, within a data center. We can extend beyond that one, go to the edge, go to the home, and go to a lot of even other remote location. That's also, using my quote from the Gartner, is really, in the next few years, that work come from the Gartner Research. They say the edge and the immersive technology will replace in the cloud and mobile.
That's where you see you need to have more computing everywhere in the real-time application environment. That's why we developed this ASIC and all these different technology to working with all different service provider or different kind of vertical space to address this issue, especially the infrastructure keeping changing with the 5G and with all this. That's where the ASIC side have a more advantage compared to the software-only approach.
Very clear. Thank you so much, Ken.
Yeah, thank you.
Our next question comes from Patrick Colville of Deutsche Bank. Your line is open.
Hey there, I'm copying Fatima and 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. Was that something that, in your opinion, might have changed the dialogue a bit and got Fortinet on more RFPs?
It helped on certain enterprise, but we also have much broader sector and also the geo-diversity. It's probably not dependent too much on the Magic Quadrant. We also have, because the new Magic Quadrant only come up end of the quarter. It's come up in the September 30. It's last day of the quarter. I don't think.
We don't close that fast.
Yeah. I don't think we can get that much business in the last day of the quarter in Q3, but it's helped and 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 Salkowski for closing remarks.
Thank you, Michelle. I'd like to thank everyone for joining today's call. Fortinet will be attending conferences in the fourth quarter. The Credit Suisse conference is on November 13th as well as December 2nd. We are in the Jefferies conference on December 7th, the UBS conference on December 8th, and a Barclays conference on December 9th. Events with presentations will be webcast, and the links will be available on our website, the investor relations website of 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.