Hello and welcome to Fortinet's third quarter 2026 earnings conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, we will conduct a question and answer session. 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.

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, specifically disclaim any obligation to update forward-looking statements. Thank you. Thank you. Thank you. Thank you. Lastly, all references to growth are on a year-over-year basis unless noted otherwise.

I will turn the call over to Ken. Thank you, Anthony, and thank you everyone for joining our call. We are pleased with our excellent third quarter result, driven by strong execution and broad-based demand. Building growth 29%, while total revenue increased 20%, lead by 37% growth in product revenue. Based on our continuous strong momentum, we have raised our 2026 building guidance for third time this year. With the rapid evolution of AI landscape, Fortinet is leading the next frontier of cybersecurity by secure AI workflow and protecting against AI-discovered vulnerability in real time through our core strengths in network security. We believe that network security is the most critical foundation of AI security, with the firewall serving as the 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 seven. while continually expanding our AI capability and functions in 40OS and 40GAR services. Fortinet secured four critical areas of infrastructure and AI security as shown on slide 9. First, on the network level, our SASE firewall natively protects 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 FortiGate to secure GPU clusters and the LRM 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, define, controlling and integrate agent identity directly into access and incident response lifecycle. And fourth, a SOC for the agent deliver a highly automated solution to solve industry accuracy shortage and tool spoiling by enabling autonomous incident detection and response. Our SASE firewall pillar building grows 31%, and we are the fastest growing SASE firewall vendor and scale, growing at nearly double the market growth rate, as shown on slide five. Our leadership starts from a fundamental architectural advantage, as we are the only vendor in the industry to build all the key SASE firewall and AI security component into a single and a unified operating system for DOS. This new satisfiable pillar represents a large, high-growth area driven by long-term growth. Combined with our differentiated 40ASIC technology and our own global infrastructure, this allows Fortinet to deliver better performance and significantly lower total cost 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 addressable market two to three times larger than the cloud-only competitors. To further capitalize on our large installed base, we recently launched FortiLink SASE services. These positions of 40 AP and 40 switches as a SASE hardware agent allowing customer to easily overlay 40 SASE on top of their existing hardware driven recurrent service revenue. As we look ahead, 49 strong momentum is a result of our vision for the AI era. A platform integration and a highly disciplined operation model. This combination positioned Fortinet exceptionally well to drive strong cash generation, high recurring revenue, and consistent gap 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.

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 40-gauge 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 ramped 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 a 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 five 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 longstanding 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 datasets. 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 seven-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 five 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 firewalls 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, 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 five 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 eight-figure competitive win to secure its mission-critical OT infrastructure. The win was driven by the customer's 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. The 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 US retailer selected Fortinet in an eight-figure deal to standardize and secure its footprint for 1,500 store locations. The strategic win was driven by the customer's 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. The 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. The 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 nine 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 and $745 million. Infrastructure investments of $180 to $210 million, a non-GAAP tax rate of 18%, and cash taxes of $80 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 and $743 million, infrastructure investments of $390 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 40 guard 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.

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

Thank you. If you would like to ask a question, please click the raise hand button at the bottom of your screen. When it is your turn, you will hear your name called and receive a message on your screen notifying you that you may un-meet yourself. We will allow a moment for the queue to form. Our first question is from Shawl Isle from TD Cowan. Please unmute your line and ask your question.

Thank you. Good afternoon. Congrats on the solid results all around. One for Ken, one for Christiane. Ken, can you talk about the criticality of network security on SASE, firewalls, psychops, 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 look absolutely solid?

Thank you, Shao. It's a great question. I actually prepared slides for that on the slide four. You can see we starting call is a SASE firewall because we believe SASE is the function Thank you very much. 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 thus give us a lot of data can train, make a better kind of a SASE firewall model, and at the same time kind of innovate, keep up all this technology, plus investing like ASIC. That's where we have the confidence we can grow faster than the market. So that's what combines 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 the last quarter actually we almost doubled the market growth rate and you've already become the biggest sassy firewall player in the space and we continue to grow faster than the market. We feel it's still a 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.

Let me follow up on your second question regarding services. As I mentioned in the prepared remarks, we see strong services billings, and so many of the indicators for service revenue improved.

It's really a timing issue.

The strength in our enterprise segment, I think, is a is part of the reason that we see some delays in the conversion because we saw a number of really nice big deals and they have some ramped service activation. So it's Thank you very much. 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.

Thank you.

Thank you. Our next question is from Saket Kalia from Barclays. Please unmute your line and ask your question.

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?

I think probably we're still three months early to give the 27 guidance, but we do have a confidence we'll grow faster than the market, right? So if you look in the sassy far world 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 a 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 our confidence with keeping gaining market share in this space, with better technology, with better operation and execution.

Got it, got it, very helpful.

Yeah, 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.

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?

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 six months on-hand inventory. So that's where in the early phase of 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 in 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 say the price probably stabilized, but not improved yet. I think the price increase kind of slowed down compared to the first one, Q1, Q2, Q3 kind of a, kind of a, I say stabilized, but kind of not improved. Yeah, still kind of a 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, we'll increase accordingly. If our costs get lower, we also will decrease accordingly. So that's where we want to maintain the same gross margin on the product side. So that's the company strategy in the last 20 years, actually.

Very helpful. Thanks, guys.

Thank you.

Thank you. Our next question is from Gray Powell from BTIG.

Please unmute your line and ask your question.

Okay, great. Thanks for taking the question. Can you hear me okay?

Yep, all good.

Excellent. 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 that 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, you know, past cycles?

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

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

Thank you.

Thank you. Our next question is from Rob Owens from Piper Sandler. Please unmute your line and ask your question.

Great. Thank you very much for taking my question 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 one month into your fourth quarter here, but just How things are trending? Have they picked up much over the last month? And 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? Thanks.

Yeah, the demand is still very strong, and we don't see any slowdown. And there's definitely AI discovered more vulnerability, like all the PhDs and others, and we do believe all firewalls are in the best position to stop some of this attack intrusion. We do have the signature that can block some of this vulnerability, which is a very effective way to help a lot of enterprises to defend it. And also we see kind of a also accelerate some of the convergence. So we do see more high-end union 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 people long-term, the hybrid AI, both sovereign and also cloud combination will be the best solution for customer which we feel we have a huge advantage. Let's say that the demand is still very, very strong and no sign of slowdown.

Thank you. Our next question is from Meta Marshall from Morgan Stanley. Please unmute your line and ask your question. Great.

Thank you. A couple of questions for me. Noted kind of the strong OT billings or OT security billings. 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? Thanks.

Let me take your questions. So on the OT side, I would say we we've been strong in certain geos and we are expanding that strength into 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 now because it's also becoming more and more relevant with the attack 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's 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 are in, in Q4, probably a little bit more challenging because many get ready for year-end business and so on. So if you're a calendar year company, you don't make major changes until the next year, yeah.

Yeah, also, yeah, Fortinet kind of uniquely, we build 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 study more about the service personnel local to customer, which also will be helpful to customer to 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.

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.

Great. Thank you. Thank you. Our next question is from Adam Borg from Steinfeld. Please unmute your line and ask your question.

Awesome. And thanks so much for taking the question. 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, you know, 2Q is incredibly strong, but any color, just what led to the deceleration across a number of the metrics? Thanks again.

Yeah, like I said, the Q3 we see demand continues strong, probably even stronger than the first half of the year. But the first half of the year we do benefit from some kind of inventory we usually keep for six 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 treat it as normal now. So the unhand inventory advantage kind of starting to disappear. And also some of the component we see a little bit longer lead time. But the demanding side is still keeping growing.

And just to clarify, are you saying that you're somewhat supply constrained? Or are you saying that the new inventory is at higher prices now? and that had an element. Thanks again.

I see a little bit both and also the lead time kind of get a little bit longer to get some of the component.

Excellent. Thanks again.

Thank you. Our next question is from Joe Gallo from Jefferies. Please unmute your line and ask your question.

Hey, guys. Thanks for the question. I've got a two-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?

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 deployments or Sovereign solutions, they are a little bit more product heavy compared to Cloud SaaS solutions. So that's impacting the overall kind of product service mix a little bit as well. but yeah, there's 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, yeah.

That's really helpful. And then maybe just to 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. And so I'm just curious if there's any other tailwinds to subscription as we go through this cycle.

There is a separate services motion. I would say the initial purchase always attaches certain services. Most of the time it's 40 care 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're upselling on relevant services. 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 security. Intelligence circulating through the 40 gates all the time to be protected. So I think that the motion will pick up quite significantly.

Thank you very much.

Thank you. Our next question is from Gabriela Borges from Goldman Sachs. Please unmute your line and ask your question.

Hi, good afternoon. Thank you, 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 asked 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 quite some time now. I don't recall this specific ram tissue impacting services before. So I'm just trying to understand what's different this time.

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 large customers may 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.

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?

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.

Thank you for the call.

Thank you. Our next questioner is from Fatima Boulani from City. Please unmute your line and ask your question.

Good afternoon. Thank you so much for taking my questions. 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, you know, sweating their appliances for a little bit longer, you know, in response to this or in anticipation of this and why you are, you know, Yeah, I think for...

For the new security function, especially like AI security, they need kind of a more high-end, more computing power to run out this function there. That's where we do see the move more towards the high-end and also more computing power for the gate system. And that's where the ASP also go higher. We see... Usually, the stretching side sometimes comes from some low end or certain vertical, like retail, which they also kind of try to see whether they want to move to some kind of SASE or some other GTMA environment. We do see some retail actually leading the change, but some others probably still try to hang on some of the product for longer. But they also suddenly realize it's a new threat environment, and there's a lot of attack of vulnerability exposed by the AI. So that's where we feel probably Cosmo more try to concern of this new vulnerability instead of try to stretching some of the current existing hardware, because if you're keeping the hardware like five, seven, ten years longer, a lot of function kind of difficult to run up, kind of no longer supporting some of the new function there. So that's where we don't feel this will Stretching will be a trend going forward and because it's a new thread and a new demand for all this function, what will drive the additional growth. But right now we do see that the first way is more come from the enterprise and also especially some internal segmentation and some of the data center AI. But once more application I mean, once AI started getting more application, we do see there's additional demand what will keep driving the growth.

Thank you, Ken. Christiane, I wanted 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 margin? 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 two dynamics for us and how this should trend over the next two to four quarters. Thank you.

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. You can only increase the prices so much 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. 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.

Thank you.

Thank you. Our next question is from Junaid Siddiqui from Truist. Please unmute your line and ask your question.

Great. Thank you for taking my question. 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?

Yeah, we do see... More enterprise running, whether some open source, open way model internally. And that's how to drive some additional demand for how to monitor, manage all this kind of AI model within enterprise. So that's where there's more demanding for enterprise network security. Like I said, it's kind of accelerating of all this AI. Convergence on network security. And with our high-performance ASIC advantage, definitely we're leading in this area for internal high-speed network security deployment for a lot of internal segmentation within the data center.

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

So the pricing uplift, I think, is about maybe... So the question is how you define the pricing uplift, right? So... 40 Care 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 40 Care 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.

Great. Thank you so much.

So you see it more on your customers. Thank you.

Thank you. Our next question is from Adam Tindall from Raymond James. Please unmute your line and ask your question.

Okay, thank you. Ken, I just wanted to ask a question thinking about the business bigger picture. You're getting bigger customers like Sovereign and Neoclouds 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 two-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?

Actually, a lot of this is and so on. So, you know, bigger enterprise and also near clouds, even some service provider, they probably need a little different service. And sometimes they also, like, offer some of their own service using our technology. So we become a tier two, tier three behind. So that's probably, and also there's a ramp up, like Christiane mentioned. they first get hardware deployed and then they gradually keep adding servers because we have so many functions, so many servers in the 4D OS they can use, they can leverage. They do take time to ramp up different kind of servers. So that's what we see, that's what Christiane mentioned, sometimes, the good news, we do get a lot of bigger customers, but the other side is really the servers need some time to ramp up. and gradually enable more and more service. And then there's also a way how to recognize once we have, they call it 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 building, from the short-term and the deferred revenue. So that's where we have the confidence. But it's, yeah, this bigger customer also kind of a, gave us a very strong feedback on what was the latest new kind of air security needed, and that's kind of keeping drive our innovation, keeping develop new technology, working closely to making the whole internet more secure.

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 twenty seven 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 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. Thanks, guys.

I would say I haven't used the word acceleration. I've used the word improved growth rates. 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 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.

Thank you.

Thank you. Our final question is from Patrick Colville from Scotiabank. Please unmute your line and ask your question.

Thank you for taking my question, and thank you for squeezing me in here. So I guess I want to tie some of the pieces together from the last hour. The points you made are that enlarged new customers, 3Q, service agreements, Browner. all of them slowly and then you'd expect to be guided three months ago. And that's what's caused the, it's the revenue mess, but the confidence I had was negative. And that's why it was going around 4,000 times in 2017. Is that the message interpreted correctly or is there something else?

A little bit hard to understand, but I think I got the question. So let me summarize. Q3 was a good quarter. We had large new customers. We had large new expansion deals that benefited us. But they also can't... came with some of delayed service activation, which is actually typical or happens more often in large deals. So overall, that was one bigger factor that we may not have as anticipated. 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 tech's 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 analyzed where it was coming from.

And if I may, just a very tactical question about channel inventory and billings duration.

Duration is still pretty similar. It didn't increase significantly. And our channel inventory is flat in percent of, or down in percent of billings, yeah. So we continue to manage Thank you.

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

Thank you. One clarification to an earlier statement. Our pricing increases at 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. have a great rest of your day.