Fortinet, Inc. (FTNT) Q3 2026 Earnings Call Transcript

Operator: Hello, and welcome to Fortinet's Third Quarter 2026 Earnings Conference Call. [Operator Instructions] Please be advised that this call is being recorded. I would now like to hand the call over to Anthony Luscri, Vice President of Investor Relations. Please go ahead.

Anthony Luscri: Thank you. Good afternoon, and thank you for joining us on today's conference call to discuss Fortinet's third quarter 2026 financial results. Joining me on today's call are Ken Xie, Fortinet's Founder, Chairman and CEO; Christiane Ohlgart, our CFO; and John Whittle, our COO. Ken will begin our call today by providing a high-level perspective on our business. Christiane will then review our financial results for the third quarter of 2026 before providing guidance for the fourth quarter and updating the full year. We will then open the call for questions. During the Q&A session, we ask that you please limit yourself to one question and one follow-up question to allow others to participate. Before we begin, I'd like to remind everyone that on today's call, we will be making forward-looking statements, and these forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected. Please refer to our SEC filings, in particular, the risk factors in our most recent Form 10-K and Form 10-Q for more information. All forward-looking statements reflect our opinions only as of 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 are located in our earnings press release and in the presentation that accompany today's remarks, both of which are posted on our Investor Relations website. As a reminder, this is a live call that will be available for replay via webcast on our Investor Relations website. The prepared remarks will also be posted on the quarterly earnings section of our Investor Relations website following today's call. Lastly, all references to growth are on a year-over-year basis unless noted otherwise. I will turn the call over to Ken.

Ken Xie: Thank you, Anthony, and thank you, everyone, for joining our call. We are pleased with our excellent third quarter results, driven by strong execution and broad-based demand. Billing grew 29%, while total revenue increased 20%, led by 37% growth in product revenue. Based on our continued strong momentum, we have raised our 2026 billing guidance for the third time this year. With the rapid evolution of the AI landscape, Fortinet is leading the next frontier of cybersecurity by securing AI workflow and protecting against AI-discovered vulnerability in real time through our core strength in network security. We believe that network security is the most critical foundation of AI security with the firewall serving as a centralized point of in-line enforcement across enterprise, operation technology and hybrid cloud environment. Fortinet's leadership in this space is driven by over 20 years of innovation, integration and improvement as shown on Slide 7, while continually expanding our AI capability and functions in FortiOS and FortiGuard services. Fortinet secured 4 critical areas of infrastructure and AI security as shown on Slide 9. First, at the network level, our SASE firewall natively protect against vulnerabilities and stop intrusions, supporting shadow AI monitoring and access control to data and applications. To address growing demand, the newly launched FortiGuard Inline AI Security Services this week transform every FortiGate into a real-time AI enforcement point. Second, in the data center and AI factories, we offer FortiAIGate to secure GPU clusters and LLM infrastructure securing the massive growth in AI traffic that require high-performance protection across data center and hybrid cloud. Third, we extend AI security together with SASE to endpoint, defining, controlling and integrating agent identity directly into access and incident response life cycle. And fourth, our SOC FortiAgent deliver a highly automated solution to solve the industry active skill shortage and tools loading by enabling autonomous incident detection and response. Our SASE firewall pillar billing grew 31%, and we are the fastest-growing SASE firewall vendor and scale, growing and nearly double the market growth rate, as shown on Slide 5. Our leadership stems from a fundamental architectural advantage as we are the only vendor in the industry to build all the key SASE Firewall and AI Security components into a single and unified operation system, FortiOS. This new SASE firewall pillar represents a large high-growth area driving long-term growth, combined with our differentiated FortiASIC technology and own global infrastructure, this allows Fortinet to deliver better performance and significantly lower total cost of ownership, as shown on Slide 14. We are also the only vendor offering an easily deployable on-premise sovereign SASE solution alongside cloud SASE, which we believe give us an addressable market 2 to 3x larger than the cloud-only competitors. To further capitalize on our large installed base, we recently launched FortiLink SASE services. This positions our FortiAP and FortiSwitch as a SASE hardware agent, allowing customers to easily overlay FortiSASE on top of their existing hardware, driving recurring service revenue. As we look ahead, Fortinet's strong momentum is a result of our vision of FortiAI era, our platform integration and a highly disciplined operation model. This combination positions Fortinet exceptionally well to drive strong cash generation, high recurring revenue and consistent GAAP profitability while executing our shareholder-focused capital allocation strategy. I would like to thank our employees, customers, partners, and suppliers worldwide for their continued support and hard work. I will now turn the call over to Christiane.

Christiane Ohlgart: Thank you, Ken, and good afternoon, everyone. We delivered another exceptional quarter, exceeding the midpoint of our guidance across our key growth and profitability metrics, including billings, revenue, operating margin and earnings per share. Based on our strong momentum, we've raised our 2026 billings and revenue guidance. Total billings grew 29% to $2.34 billion, reflecting broad-based demand and strong execution across customer segments, industry verticals, geographies, and our integrated and innovative portfolio of solutions, further validating the strength of our platform strategy. AI, SASE and network upgrades and expansions are key growth drivers as customers prepare for new threat environments. We saw strong demand in large enterprises with the total value of deals greater than $1 million, growing 51%, driven by an outsized contribution from our U.S. large enterprise business. SASE firewall billings grew 31% as sustained FortiGate demand was driven by enterprise customers turning to our network security solutions to upgrade their infrastructure for the era of AI and expand their Fortinet security footprint into operational technology and AI data center use cases. Our OT billings grew nearly 40%, validating our leadership in protecting mission-critical infrastructure. These achievements highlight our focus on leading growth and innovation in the durable demand drivers as we capture long-term expansion opportunities across emerging high-value use cases. Billings from AI-driven security operations grew 15%, driven by strong upsell momentum as our installed base increasingly consolidates point solutions onto our broader platform. Turning to revenue. Total revenue grew 20% to $2.08 billion with product revenue increasing 37% to $765 million, even though we saw increasing lead times for certain components. Strong product demand persisted throughout the quarter. As in the prior quarter, our product revenue benefited from customers shifting towards higher-performing models lifting ASPs. Service revenue grew 13% to $1.31 billion and faced some headwinds from winning new large enterprise customers with ramp service activations and large new expansion deals that also consolidated various existing service arrangements into enterprise agreements. We continue to believe the first quarter of 2026 marked the trough for our services revenue growth rate. As shown on Slide 19, we have key leading indicators supporting a continued positive trajectory, specifically robust 26% service billings growth, 19% total deferred revenue growth and a 14.5% increase in short-term deferred revenue, which represents our highest growth rate in 5 quarters. In addition, we continue to roll out new AI Security Services, including the FortiGuard Inline AI Security Service announced this week. To put our overall performance in perspective, our sustained growth is being propelled by several fundamental shifts in how enterprises approach cybersecurity. We are witnessing a transformed threat landscape where bad actors aggressively use artificial intelligence to orchestrate rapid, highly targeted attacks. This shift has elevated security from a back-office IT concern to a board-level enterprise risk management priority accelerating investments. Our third quarter results highlight our continued momentum and how our portfolio evolves with accelerated market shifts. Specifically, we are winning because of the convergence of networking and security, the urgent push to safeguard AI use and get ahead of increased threats enabled by AI, the merging of IT and OT domains and the rising global demand for sovereign compliant architectures. Sovereignty is especially prominent throughout European enterprises and the global public sector, matching our long-standing market leadership in those markets. In this environment, as enterprises scale their AI projects and experience the increased threat environment, they face the massive challenge of safeguarding proprietary data sets. This transition requires high-capacity security architectures that can inspect vast amounts of data accelerating traffic flows without degrading performance. Rather than deploying disconnected point products that add friction, IT and security teams are actively looking for integrated platforms that offer centralized visibility and accelerated automated responses. Fortinet is strongly positioned to capture this demand by securing the physical AI data center, protecting distributed AI applications and embedding AI directly into our security operations. For example, an AI company developing frontier models, selected Fortinet for a 7-figure expansion to secure its rapidly growing AI workloads. This strategic win builds on the successful deployment of the customer's first AI data center last year. Driven by that initial success, a deep trusted relationship and the strength of our technology, the customer has standardized on Fortinet, deploying our high-end data center firewalls across 5 additional data centers. Our solution addresses the challenge of protecting high-value AI workloads while maintaining maximum performance, availability and scalability as the infrastructure expands. This deal exemplifies the leading throughput and resilience of our platform, positioning Fortinet as a foundational security partner for the world's most demanding next-generation AI environments. This fast-changing threat environment has turned high-performance security into a structural necessity. Because enterprises and governments are highly aware of AI-powered attack vectors and expanding regulatory oversight, they are directing investments towards SASE firewall that can defend complex, decentralized environments. To address these distinct operational and regulatory environments, Fortinet provides significant flexibility. By natively converging firewall, SASE and Hybrid Mesh capabilities into a single OS, we deliver a seamless way to protect people, customers, applications and sensitive assets across physical sites, cloud environments and remote teams. This flexible deployment model is a significant competitive advantage, allowing customers to build a SASE posture that matches their specific enterprise risks and regulatory requirements. Turning to operational technology. Safeguarding the edge and industrial networks has become one of the most urgent issues discussed at Board levels of our customers today. Security boundaries have blurred, exposing critical supply chains, utility grids and manufacturing systems to unprecedented risk. Manufacturing has been the single most targeted sector for 5 consecutive years. Combined with escalating attacks on regional critical infrastructure, it is clear that historically underfunded OT environments are highly vulnerable. To mitigate this, organizations are rushing to segment their networks, shield unpatchable legacy machinery and establish secure remote access. With AI now arming attackers, these security decisions are being fast-tracked directly by corporate boards and leaders. Fortinet's FortiOS platform enhanced by FortiGuard security subscriptions gives enterprises complete unified visibility over both their corporate IT and OT domains and a way to control the new attack surfaces AI creates. This architectural advantage is driving sustained demand across our specialized industrial portfolio. To illustrate, a large transportation company selected Fortinet in an 8-figure competitive win to secure its mission-critical OT infrastructure. The win was driven by the customers' need to modernize and secure its distributed environments through Fortinet's converged networking and security capabilities. By consolidating firewall, secure routing, 5G connectivity and deep OT inspection into a single platform on one unified appliance, the customer is simplifying its overall network design while significantly improving operational resilience. This significant deployment highlights our leading ability to protect highly specialized demanding OT environments while delivering an optimized total cost of ownership and streamlined operational efficiency. Further proving our architectural advantage at the edge, a large U.S. retailer selected Fortinet in an 8-figure deal to standardize and secure its footprint for 1,500 store locations. The strategic win was driven by the customers' need to enhance network performance and digital resilience while wanting to offer an improved in-store customer experience. To support its distributed operations, the retailer required a simplified network design and architectural standardization that allowed them to scale seamlessly while dramatically reducing overall costs. Fortinet's ability to deliver a comprehensive unified security fabric managed centrally via FortiManager proved to be a key differentiator. The successful competitive win of this large rollout demonstrates also the invaluable role of Fortinet's highly trained and specialized partner network, whose deep technical expertise is essential in deploying complex enterprise-grade solutions. Our exceptional quarter highlights our relentless focus on the dynamic market themes shaping the cybersecurity industry. We believe Fortinet's integrated platform approach positions us well to capture share, deliver sustained growth and maximize long-term shareholder value. Turning to margins and cash flow. Non-GAAP and GAAP gross margins were 79.6% and 79%, respectively, and were impacted by the continuously high contribution of product demand. Non-GAAP operating margin of 38.2% was a third quarter record, up 130 basis points. This performance exceeded the high end of our guidance, driven by stronger-than-expected revenue growth and disciplined cost management. Moreover, our GAAP operating margin of 33.9% continues to be one of the highest in the industry. This strong operating performance translated to the bottom line. Non-GAAP earnings per share increased 23% to $0.91, while GAAP earnings per share grew 39% to $0.86, outpacing our top line growth, reflecting high-quality earnings supported by our long-term focus on total shareholder returns. Free cash flow grew 52% to $865 million in the third quarter and 74% year-to-date to $2.84 billion, driven by higher billings and operating margin strength. Adjusted free cash flow was $912 million, representing an exceptional margin of 44%. Our excellent execution and consistent cash generation continue to support our strong financial position. Reflecting the strength of our balance sheet and our ongoing commitment to delivering long-term shareholder value, our Board of Directors approved an approximately $1.2 billion increase to our authorized stock repurchase program. This brings our remaining share repurchase authorization to $2 billion, giving us flexibility to continue returning capital to our shareholders while investing in our key growth pillars. Now moving on to guidance. As a reminder, our fourth quarter and full year outlooks, which are summarized on Slides 24 and 25 are subject to the disclaimers regarding forward-looking information that was provided at the beginning of the call. Consistent with our disciplined and prudent approach to guidance, our strong performance through the first 9 months support a higher full year outlook. We are raising our full year guidance for billings and revenue as well as operating margin and earnings per share. For the fourth quarter, we expect the following: billings in the range of $2.775 billion to $2.925 billion, which at the midpoint represents growth of 20%. Revenue in the range of $2.155 billion to $2.245 billion, which at the midpoint represents growth of 15%. Non-GAAP gross margin of 78% to 80%, non-GAAP operating margin of 35.5% to 37.5%. Non-GAAP earnings per share of $0.93 to $0.95, which assumes a share count between 741 million and 745 million. Infrastructure investments of $180 million to $210 million, a non-GAAP tax rate of 18% and cash taxes of $80 million to $130 million. For the full year, we expect billings in the range of $9.568 billion to $9.718 billion, which at the midpoint represents growth of 28%. Revenue in the range of $8.125 billion to $8.215 billion, which at the midpoint represents growth of 20%. Service revenue in the range of $5.15 billion to $5.17 billion, which at the midpoint represents growth of 13%. Non-GAAP gross margin of 79.7% to 80.3%. Non-GAAP operating margin of 36.5% to 37.5%. Non-GAAP earnings per share of $3.54 to $3.58, which assumes a share count of between 741 million and 743 million. Infrastructure investments of $390 million to $420 million, non-GAAP tax rate of 18% and cash taxes of $400 million to $450 million. Our current 2026 fiscal year guidance represents an increase for billings and revenue guidance by $1.14 billion and $570 million, respectively, compared to our initial 2026 guide in February. As we look ahead to 2027, we expect our total billings and revenue growth to outpace the growth of our overall addressable market. Our 2027 service revenue is expected to grow at a higher rate compared to 2026 as we consider short-term deferred revenue growth as a good indicator for future service revenue growth. In addition, we see continued pipeline building for SASE firewall use cases and expect that the new FortiGuard services will be highly relevant for existing and new customers. I will now hand the call back over to Anthony to begin the Q&A session.

Anthony Luscri: Thank you, Christiane. As a reminder, during the Q&A session, we ask you to please limit yourself to 1 question and 1 follow-up question to allow others to participate. Operator, please open the line for questions.

Operator: [Operator Instructions] Our first question is from Shaul Eyal from TD Cowen.

Shaul Eyal: Congrats on the solid results all around. One for Ken, one for Christiane. Ken, can you talk about the criticality of network security, SASE firewall, SecOps? Or in other words, the overall Fortinet platform in the age of AI specifically. Where does Fortinet address AI use cases? How does this opportunity impact your growth rate and sustainability of demand? And maybe for Christiane, can you maybe double-click on the service revenue? You're adding new services. You provided an early view on improved growth in 2027. Talk about it in the context of the third quarter. Is this more of a timing issue on revenue given the leading indicators, all in all, look absolutely solid?

Ken Xie: Thank you, Shaul. It's a great question. I actually prepared slides for that, on Slide 4. You can see we started calling it a SASE firewall because we believe SASE is a function, it will integrate with the traditional firewall OS and the same for the AI security. And like in my script, we believe network security is the most important part of AI security because they are the inline enforcer to a lot of AI traffic and also provide better visibility. So with our kind of leadership in the global network security market, we have like over half of the global unit deployment. We believe we have a much better visibility, and that gives us a lot of data, can train and make a better kind of SASE firewall model and at the same time, kind of innovate, keep up all the technology plus investing like ASIC. That's where we have the confidence we can grow faster than the market. So that's where combine all this AI security, all the SASE, all the traditional security, we believe the total addressable market will grow about 16% in the current market growth rate. and we continue to grow faster. And last quarter, actually, we doubled -- almost doubled the market growth rate. And we've already become the biggest SASE firewall player in the space, and we continue to grow faster than the market. We feel it's still pretty big market, and we're keeping growth for a long, long time, just like we did in the last 20, 30 years. I think it's network security in the market position to address the AI security concern.

Christiane Ohlgart: And let me follow up on your second question regarding services. So as I mentioned in the prepared remarks that we see strong services biddings. And so many of the indicators for service revenue improved. It's really a timing issue. And the strength in our enterprise segment, I think, is part of the reason that we see some delays in the conversion because we sold a number of really nice big deals and they have some ramped service activation. So it's a lot of strength in the business, plus we continue to focus on services, and this is where the newer services and solutions play, of course, a critical role to continue to upsell our existing customers. They -- of course, all our existing FortiGuard services are evolving, but the new FortiGuard Inline AI Service addresses some specific risks that are new with AI and that require constant FortiGuard updates. So it's going to be highly relevant to our customers.

Operator: Our next question is from Saket Kalia from Barclays.

Saket Kalia: Ken and Christiane, maybe for both of you. This has been a very strong year for the product line. And of course, that's sort of a combination of a variety of different things, whether it's pricing or mix shift or volume. Now I realize it's early to talk about 2027. But based on what we see here in Q4, how should we sort of think about product growth next year given what is a very tough compare here in '26?

Ken Xie: I think probably we're still 3 months early to give the '27 guidance, but we do have a confidence we will grow faster than the market, right? So if you look at the SASE firewall market, current growth rate is 16%, and we do believe we're keeping gaining market share there. And plus, we have pretty strong operation model. We kind of -- with our own ASIC chip, with our kind of manufacturer managed by ourselves, plus operation directly, we feel we have more advantage in this supply chain issue compared to most other competitors. So that's where we have confidence we're keeping gaining market share in this space with better technology, with a better operation and execution.

Christiane Ohlgart: Yes. Let me add to what Ken said. If you look at the demand environment, the demand environment is pretty solid. The AI attacks are happening, not only the deployment of AI, it's also the threat environment that has increased quite significantly. And so that really drives the requirement for customers to upgrade their network security and of course, new use cases as well. So we are confident that we are well positioned for 2027.

Saket Kalia: Got it. Maybe for my follow-up, again, for you, Ken. One of the building blocks there that we hit on was pricing. I was wondering if you could just talk about your latest thoughts on pricing, right? I mean you've passed through the cost increases from memory. But maybe the question is, where are we in that journey? And of course, it's tough to have a crystal ball going into next year, but how do you think about that as a lever in 2027?

Ken Xie: I think the price so far has about 10% benefit on the top line. On the other side, you can look at the first half of the year, we do benefit from our kind of on-hand inventory which we keep saying in the normal year, we keep about 6 months on-hand inventory. So that's where in the early phase of the supply chain, we kind of have a buffer we can benefit from. But now starting from Q3, we see this become more normal. So that's where we have to continue to source like others. And at the same time, even we have a bigger quantity, we have more direct relation. But we do see the lead time get longer. I'd say the price probably stabilized, but not improved yet. I think the price increase kind of slowed down compared to the first -- Q1, Q2, Q3 kind of stabilized, but kind of not improving yet, still kind of slowly increase, but it's difficult to forecast going forward. Our policy -- our strategy always we want to keep in the same gross margin. And if our costs go higher, will increase accordingly. If our costs get lower, we also will decrease accordingly. So that's why we want to maintain the same gross margin on the product side. So that's the company's strategy in the last 20 years, actually.

Operator: Our next question is from Gray Powell from BTIG.

Gray Powell: Great. So maybe just a higher-level question. A lot of the investors that we speak with, they're just trying to compare the current spending environment that you're seeing this year to kind of the post-COVID period like in 2021 and 2022. If I had to guess, the current AI-driven cycle is probably bigger. But the question is just how does it feel on your side relative to post-COVID a few years back or even the post-target era spending cycle that we saw in 2014 and 2015? And do you think that this cycle is more durable than past cycles?

Ken Xie: I personally agree with you. I do feel these times are bigger than like 5, 6 years ago. And also now times more kind of work from -- remotely from home drive to some kind of supply chain, but now it's kind of AI built a lot of infrastructure kind of things there. But it's -- on the other side, AI also drive up the demand because now most recently, the AI security become a bigger concern, especially a lot of enterprise, how they're using AI, and that's also drive up the demand. So that's where we have not seen demand slowdown. So demand is still very strong in the last few quarters. And even in Q3, we have not seen any slowdown in the demand. But supply, we mentioned the lead time get longer and also the price kind of not grow as fast as Q1, Q2, but still kind of go up a little bit, but I would say it stabilized somehow, that's probably more become normal, but we believe we have pretty strong operation and a direct relation with all the component manufacturer, which we can negotiate kind of compared to some of our competitors, much small quantity. So that's where we feel we still have more advantage.

John Whittle: I think your point is also good that our business follows the threat. You mentioned the target breach, COVID, et cetera. This AI threat, no one has a crystal ball as someone mentioned earlier, just seems a lot more durable and sustainable in some of those earlier kind of threat drivers. And so I think it feels like early days. And like you said, our business does follow that threat and that threat environment is elevated, and it seems like it's durable.

Operator: Our next question is from Rob Owens from Piper Sandler.

Robbie Owens: Great. And maybe dovetailing that last answer around the threat environment. Obviously, headlines have been somewhat scary, I guess, for the month of October relative to agentic and what's going on. Would just love to understand, I realize we're only 1 month into your fourth quarter here, but just how things are trending? Have they picked up much over the last month? And are there any -- is there anything you can quantify for us relative to, I guess, how the start of fourth quarter has looked given what's going on from a vulnerability perspective?

Ken Xie: Yes. The demand is still very strong, and we don't see any slowdown. And there's definitely AI discovering more vulnerability, like all the PHP, some other, and we do believe our firewall in the best position to stop some of these attack intrusion, and we do have the signatures that can block some of these vulnerability, which is a very effective way to help in a lot of enterprise to defend it. And also, we see kind of also accelerate some of the convergence. So we do see more high-end unit being deployed inside the company to do internal segmentation. And also, we mentioned the sovereign AI, also we see pretty strong growth. And that's where we do believe long term, the hybrid AI, both sovereign and also cloud combination will be the best solution for customers, which we feel we have a huge advantage. I say that the demand is still very, very strong and no sign of slowdown.

Operator: Our next question is from Meta Marshall from Morgan Stanley.

Meta Marshall: Great. A couple of questions for me. Noticed kind of the strong OT billings or OT security billings. Just are you seeing a broadening customer base there? Any kind of contextualization of how you see of any major new customers there? And then a second question, just in terms of -- are you running into your customers kind of having any issues of having the services or even the staff to kind of install a lot of the equipment? And is there anything you can do with your own services organization to kind of help those customers out or align them better with additional services that can help them with the installation?

Christiane Ohlgart: Meta, let me take your questions. So on the OT side, I would say we've been strong in certain geos, and we are expanding that strength into other regions just because we have more and more customer references. They see the benefits of our specialized devices that we have for that. So it's a broadening of the strength and continued expansion because it's also becoming more and more relevant with the tech surface expanding. On the installation side, so typically, Fortinet services are more on the configuration side, not necessarily on the racking and stacking. That's why we have an extensive reseller and partner channel that we qualify to do these things locally with our customers. I've not really heard that there is a shortage in the ability to roll out. I think that's more -- it's not the channel capability or capacity. It's more so how quickly can the customers do that. And that's always, I think, depending on the business you're in, in Q4, probably a little bit more challenging because many get ready for year-end business and so on, yes. So if you're a calendar year company, you don't make major changes until the next year.

Ken Xie: Yes. Also, Fortinet kind of uniquely, we built our own kind of a service infrastructure system, we call the FortiCare, which now like half of the FortiCare service kind of can use AI to handle, to help in improving there. So that's also we started more have the service personnel local to customer, which also will be helpful to customer to like understand the additional new service we are launching now. So that's also we feel -- that's what helping drive the additional service business going forward.

John Whittle: And Meta, I think to your question, I just talked to a retailer who's considering rolling out our solution to 4,000 stores around the country. And we're going to engage in MSP, like Christiane mentioned. But at that scale, we are seeing demand where they want to work directly with us. And so our service team can augment their service team and the MSP as well. And so we are seeing large-scale rollouts where the customer wants to work directly with us in addition to working with a partner.

Operator: Our next question is from Adam Borg from Stifel.

Adam Borg: So maybe just to take a step back, we just talked about the really strong demand environment, continued pricing tailwinds, albeit less than in the first half of the year. Any more color on just what led to the growth deceleration in 3Q relative to 2Q is incredibly strong, but any color just what led to the deceleration across a number of the metrics?

Ken Xie: Yes. Like I said, Q3, we see demand continued strong, probably even stronger than the first half of the year. And -- but the first half year, we do benefit from some kind of inventory we usually keep for 6 months. So that's where you see some strong product growth benefit from some of the inventory we have on hand. I think starting from Q3, we more treated as a normal now. So the on-hand inventory advantage kind of starting to disappear. But that's -- and also some of the components, we see a little bit longer lead time. But it's -- the demand side is still keeping growing.

Adam Borg: And just to clarify, are you saying that you are somewhat supply constrained? Or are you saying that the new inventory is at higher prices and that added element?

Ken Xie: I'd say a little bit both. And also the lead time kind of gets a little bit longer to get some of the components.

Operator: Our next question is from Joe Gallo from Jefferies.

Joseph Gallo: I've got a 2-parter on services. First, I understand the delayed ramp with some of these large ELAs. But when you remove that cohort, are you seeing the same attach rates as historical? I mean you obviously have a ton of product success right now, but is it fair to say that some of the networking strength and AI data center strength may be hurting the attach rates? And is there any reason to expect that to change?

Christiane Ohlgart: There -- of course, over the years, there has been a little bit of a product mix shift towards networking components that we've been very strong in and part of the consolidation play, which have fewer attach rates. I think that's something that hasn't changed from Q2 to Q3. What we've been seeing is really good FortiGate growth. So that will help us with attach rates. On the other hand, compared to, let's say, our success with sovereign deployment or sovereign solutions, they are a little bit more product heavy compared to cloud solutions. So that's impacting the overall kind of product service mix a little bit as well. But yes, there is product mix. Sovereign has less services because we are delivering more product that the customer has versus cloud solutions. And we believe that this will be structurally helping us with product long term because it's definitely an important trend. And then it's on us to attach more relevant FortiGuard security subscriptions. That's why it's so critical to roll these out.

Joseph Gallo: That's really helpful. And then maybe just a follow-up. Is there a discrete subscription selling motion? Or is that entirely attached to hardware? The reason I ask is just as product is cyclical and decelerates, service is obviously more important. So I'm just curious if there's any other tailwinds to subscription as we go through the cycle.

Christiane Ohlgart: There is a separate services motion. The initial -- I would say, the initial purchase always attaches certain services. Most of the time, it's FortiCare and smaller customers buy services in a bundle. With larger enterprise customers, it is more of an upsell motion to make sure they roll-out the hardware first and then we are upselling on relevant security subscriptions. And that's why the focus, I think, is also on the increased threat environment because IPS, virtual patching, certain OT subscriptions are really critical for our customers to have the right level of intelligence circulating through the FortiGate all the time to be protected. So I think the motion will pick up quite significantly.

Operator: Our next question is from Gabriela Borges from Goldman Sachs.

Gabriela Borges: Christiane, I want to stay on this topic of large enterprise deals and the impact that they're having to services revenue. Maybe just relative to your expectations, was U.S. enterprise stronger than what you expected? And then did you go from expecting it not to be a ramp deal and then the customers ask for it to be a ramp deal? Maybe just explain to us the dynamic that happened in 2Q because I don't recall you talking about large enterprise has been a growth driver for Fortinet for quite some time now. I don't recall the specific ramp issue impacting services before. So I'm just trying to understand what's different this time.

Christiane Ohlgart: So I think Q3, as we reported, had a lot of not only large enterprise deals, which we had in the past, it had a lot of newer customers that had truly expansion deals and not necessarily just refresh activity or also sometimes it's large customers might have big renewals. So this is where as customers roll-out their infrastructure, they may not want to pay services right away, and we had more of that in Q3 also consolidating different activities. That's why I addressed it specifically in my prepared remarks.

Gabriela Borges: And so as it pertains to the 4Q guide, is it fair to say that you're also expecting the trend to continue, meaning the pipeline -- give us some color on how the pipeline looks for those types of new customers in that type of cohort. Do you think the services ramp dynamic is going to impact 4Q and maybe longer term as well?

Christiane Ohlgart: I mean, it definitely has some impact on Q4. This is why you see our revenue guidance and respective adjustment of the 2026 service revenue guide. But the good news is the customers are buying services, which you can see in deferred revenue, which you can see in service billings. And there are more services to come. So we are actually happy with the strength in the business. It's just a little bit of a delay from when it gets recognized.

Operator: Our next question is from Fatima Boolani from Citi.

Fatima Boolani: Ken, one for you and one for Christiane, please. Ken, in your comments earlier in response to a question around the product growth trajectory and some of what appears to be some supply side constraints, some increasing supply side constraints, but also sort of different and changing levels of inventory management. I'm wondering if at a high level, you can comment on how customers are behaving with respect to asset sweating, so sweating their appliances for a little bit longer in response to this or in anticipation of this? And why you are protecting or defending the business against that potential risk as all of us think about what the 2027 product growth trajectory is going to look like in the face of these -- some of these bigger picture macro factors? And then a follow-up for Christiane, please.

Ken Xie: Yes. I think for the new security functions, especially like AI security, they need kind of more high end, more computing power to run all this function there. That's where we do see the move more towards the high end and also more computing power of FortiGate system. And that's where the ASP also go higher. We see usually the stretching size sometimes come from some low end of certain vertical like retail which they also kind of balance try to see whether they want to move to some kind of SASE or some other ZTNA environment. We do see some retail actually leading the change, but some other probably still try to hang on some of the products for longer. But they also start to realize it's a new threat environment, and there's a lot of attack or vulnerability exposed by the AI. So that's where we feel probably customers more try to concern of this new vulnerability instead of try to stretch in some of the current existing hardware because if you're keeping the hardware like 5, 7, 10 years longer, a lot of function kind of difficult to run, kind of no longer supporting some of the new function there. So that's where we don't feel this stretching will be a trend going forward and because it's a new threat and the new demand for this function what will drive the additional growth. But right now, we do see that the first wave more come from the enterprise and also especially some internal segmentation and some of the data center, AI and -- but once more application -- I mean, once AI starting getting more application, we do see there's additional demand will keep in drive the growth.

Fatima Boolani: Christiane, I want to touch on the gross margin performance. That compression, how do we reconcile the ASP uplift commentary, the commentary of customers trading up to higher-end models with presumably higher ASPs. Why is that essentially not following through into at least stable gross margins, because compression on the product side in spite of those factors was still pretty high. So wondering if you can kind of reconcile those 2 dynamics for us and how this should trend over the next 2 to 4 quarters?

Christiane Ohlgart: So on the product gross margin side, we definitely see the increase -- so we had the benefit in the first half year that we had inventory on-hand. And so we had lower cost while we had already increased the prices. So that benefited our gross margin. In the second half, you see that the costs are creeping up and then impacting the product gross margin. But on the other hand, our service gross margin is picking up nicely. So it's offsetting some of the impact. There are -- you can only increase the prices so much, right, for your customers. They also have limited budgets. So we are trading a balance between increase of price and gaining market share. And I think we've done this quite successfully this year. So our -- I mean, the guidance for the overall gross margin remains at 80% for the full year, right, which was what we said at the beginning of the year.

Operator: Our next question is from Junaid Siddiqui from Truist.

Junaid Siddiqui: Just regarding open-weight models, does this shift towards open-weight models by enterprises structurally expand your opportunity by moving more AI security into customer controlled infrastructure? And are you seeing that translate into incremental security demand yet?

Ken Xie: Yes, we do see more enterprise running whether it's an open-source, open-weight model internally. And that also drive some additional demand for how to monitor and manage all this kind of AI model within the enterprise. So that's where there's more demand for enterprise network security. Like I said, it's kind of accelerating all this convergence of network-network security. And with our high-performance ASIC advantage, definitely, we feel we're leading in this area for like internal high-speed network security deployment for a lot of internal segmentation within the data center.

Junaid Siddiqui: Great. And just regarding the SASE bundles that you've rolled out, what are you seeing in early adoption? And what kind of pricing uplift are you seeing as customers move on to the bundle?

Christiane Ohlgart: So the pricing uplift, I think, is about maybe -- so the question is how you define the pricing uplift, right? So FortiCare and SD-WAN is priced as a percent of the hardware price. And so the question is how much more are they buying? We see some uptick, but some customers are still using SD-WAN just what is provided through FortiCare versus the incremental subscriptions that we're offering. So it's going to take a little bit longer to really get it adopted by all our SD-WAN customers. So you see it more on the customers.

Operator: Our next question is from Adam Tindle from Raymond James.

Adam Tindle: Ken, I just wanted to ask a question thinking about the business bigger picture. You're getting bigger customers like sovereign and neocloud that you talked about. Those are growing very, very fast and driving a ton of product growth, but disconnecting some of the services that we're talking about and stocks down a lot on this. So a 2-parter for you. I wonder if you might just opine on the pros and cons of servicing that customer base in the first place. Is that a good customer set to be servicing? And secondly, have you contemplated maybe even a different business model, almost like how chip companies serve that cohort that might be just much higher volume product and lower focus on service?

Ken Xie: Actually, a lot of this bigger enterprise and also neoclouds, even some service provider, they probably need a little bit different service. And sometimes they also like offer some of their own service using our technology. So we become the Tier 2, Tier 3 behind. So that's probably -- and also, there's a ramp-up, like Christiane mentioned, a lot of this -- they first get hardware deployed and then they gradually keep adding service because we have so many functions, so many service in the FortiOS, they can use, they can leverage. And they do take time to ramp up a different kind of service. So that's where we see and that's what Christiane mentioned sometimes. The good news, we do get a lot of bigger customers, but the other side is really the service need sometimes to ramp up, and gradually enable more and more service. And then there's also a way how to recognize once we have the call enterprise agreement, sometimes a little bit slower to recognize some of the service. But we do see the trend is pretty healthy, whether from the billing from the short term and the deferred revenue. So that's where we have the confidence. But it's -- this being a customer also kind of give us a very strong feedback and what's the latest new kind of AI security needed, and that's kind of keeping drive our innovation, keeping developing new technology, working closely to making the whole Internet more secure.

Adam Tindle: If I could just a quick follow-up, Christiane. I imagine this might be the last question, so I want to give you the floor. The key question tomorrow is going to be why go out with the services expectation in fiscal '27 on this call. We're going to get a lot of questions on that. People are going to say, you told us that it was going to accelerate in the second half of this year. And obviously, we have not seen that materialize. So you're going even further out and talking about acceleration there. People are going to say that there's structural differences with the service attach rate and the new customers that you're seeing, a higher bar for fiscal '27. So I just want to give you the chance to take the floor here and give us some details on what's giving you confidence to talk about services acceleration in fiscal '27.

Christiane Ohlgart: I would say I haven't used the word acceleration. I've used the word improved growth rates. So I mean, I think we clearly see that the growth rates have bottomed in Q1. The question is how quickly can we convert some of our service billings into revenue, right? And that always takes a little bit of time, but we are -- we continue to be confident that we are selling relevant services to our customers and that they convert into revenue over the course of 2027 and continue to grow.

Operator: Our final question is from Patrick Colville from Scotiabank.

Patrick Edwin Colville: So I guess I just want to tie some of the pieces together from the last hour. The points you made are that large new customers side mandated in 3Q to have service agreements prior. They turn on slowly than you would expect that they guided 3 months ago. And that's what has caused the revenue miss and the billings miss, but the confidence I have is they are going to tell me, and that's why you are good value for the clients in 2027. Is that the message kind of interpreted correctly, or is there something about it?

Christiane Ohlgart: Patrick, you're a little bit hard to understand, but I think I got the question. So let me summarize what -- Q3 was a good quarter. We had large new customers. We had large new expansion deals that benefited us. But they also -- they came with some of delayed service activation, which is actually typical in -- or happens more often in large deals. So overall, that was one bigger factor that we may not have as anticipated. There are, of course -- there's, of course, a lot of different aspects that you see in the service line. With the increase in prices, you see a little bit more discounting between hardware and services. And then also in the U.S., you definitely see a push towards hardware because it's benefiting customers from the tax perspective to depreciate. So there are different components that are not as prevalent in what happened in Q3, but there are trends that we've been seeing as we analyze where it was coming from.

Patrick Edwin Colville: And if I may, just, I guess, a very tactical question about channel inventory and billings duration. Would you mind just commenting on those 2 pieces?

Christiane Ohlgart: Duration is still around -- still pretty similar. It didn't increase significantly. And our channel inventory is flat in percent of -- or down in percent of billings, yes. So we continue to manage the inventory in a way that we want the channel to have enough for the run rate business, but we don't want to overallocate so we have dislocation of inventory when we need it in different places. So that's where we are extremely diligent in managing how much we have in the channel.

Operator: That was our final question. I will now hand it back to Anthony Luscri for closing remarks.

Anthony Luscri: Thank you. One clarification to an earlier statement. Our pricing increases had around a 10 percentage point impact to year-over-year billings growth, not top line. But other than that, I'd like to thank everyone for joining today's call. We will be attending investor conferences hosted by BMO, UBS, and Barclays during the fourth quarter. The fireside chat webcast links will be posted in the Events and Presentations section of our Investor Relations website. If you have any follow-up questions, please feel free to contact me or my team. Have a great rest of your day.