Good day and thank you for standing by. Welcome to the Fortinet Q3 2024 Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Aaron Ovadia, Senior Director of Investor Relations. Please go ahead.

Thank you and good afternoon, everyone. This is Aaron Ovadia, Senior Director of Investor Relations at Fortinet. I am pleased to welcome everyone to our call to discuss Fortinet's financial results for the third quarter of 2024. Joining me on today's call are Ken Xie, Fortinet's Founder, Chairman and CEO; Keith Jensen, our CFO; John Whittle, our COO; and Christian Agard, our CAO and sales operations leader. This is a live call that will be available for replay via webcast on our Investor Relations website. Ken will begin our call today by providing a high-level perspective on our business, Keith will then review our financial and operating results for the third quarter of 2024 before providing guidance for the fourth quarter of 2024 as well as updating the full year. We will then open the call for questions. During the Q&A session, I 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 otherwise stated. Our GAAP results and GAAP to non-GAAP reconciliations are located in our earnings press release and in the presentation that accompanies today's remarks, both of which are posted on our Investor Relations website. The prepared remarks for today's earnings call will 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 otherwise noted. I will now turn the call over to Ken.

Thank you, Aaron, and thank you to everyone for joining our call. We are pleased to report another quarter of strong execution and continued growth momentum, including record gross margin and operating margin, with operating margin increased by 830 basis points to over 36%. Total revenue growth of 13% as we returned to positive billing and product revenue growth. Unified SASE billing growth of 14%, secure operation billing growth of 32%, and secure networking returned to positive growth, all driven by a continued share gain in our total addressable market of $284 billion. As highlighted on Slide 11 of the investor presentation, Fortinet continued to be the only vendor to leverage a single operating system for the U.S., delivering solutions with 5 secure network capabilities in dynamic quality report, secure service edge, SD-WAN, single vendor network firewall, and enterprise wireless line infrastructure. For the U.S., combined with proprietary ASIC technology, significantly boosts secure computing power delivering 5 times the expected performance compared to our competitors, while reducing customers' total cost of ownership and energy consumption. In the third quarter, Unified SASE billing constituted 23% of our business, up 1.5 points, driven by secured billing growth of 220%, with pipeline growth of 130%. Fortinet is the only vendor offering all SASE functions in a single operating system, providing a unified networking security stack both on-premise and in the cloud. This allows FortiSASE to be deployed within minutes from our SD-WAN customers. Our SBS-based FortiSASE also enables sovereign SASE for service providers and large enterprises to deploy FortiSASE within their own data centers for data privacy. In addition, we were recently recognized as a clear leader in the 2024 government magic quadrant for SD-WAN for the fifth consecutive year and notably positioned highest of all vendors in ability to execute for the fourth year in a row. Leveraging our leading position in firewall and SD-WAN and our integrated FortiSASE within the same FortiOS provides the easiest and most secure path for migrating from traditional firewalls to secure SD-WAN and Unified SASE. We invested in our global infrastructure over 3 million square feet across office space, briefing centers, operation facilities, and data centers. Our own hosting capability gives us a long-term cost advantage, allowing us to utilize our own FortiStack for better security and management. Security operations was our fastest-growing pillar, outpacing the overall market with 32% billing growth, accounting for 10.5% of our total business, up 2 points. We have expanded our secured operation portfolio with the launch of new products, which together represent a new $20 billion market opportunity. We expect to cross-sell both solutions to a large installed base of customers. Our commitment to innovation and investment in R&D has enabled us to expand FortiAI, our GenAI system, into 7 key solutions. GenAI for FortiAI will be announced in early 2025, as Fortinet's AI-based secure operation business is accelerating. Before turning the call over to Keith, I would like to thank our employees, customers, partners, and suppliers worldwide for their continued support and hard work.

Thank you, Ken. Thank you, Aaron, and good afternoon, everyone. Let's start with the key highlights from the third quarter. We are very pleased with our strong execution and financial performance in the third quarter, repeating our second quarter performance by again achieving record gross margins and record operating margins while delivering top line results at the top of our guidance range. Total revenue grew 13%, driven by strong growth in services revenue, and product revenues returned to growth. We again added over 6,000 new logos driven by the resilience of small enterprise customers and the strength of our robust channel partner. We are pleased to again raise our revenue and operating margin guidance for the full year, and we believe we are on track to achieve our seventh consecutive year of exceeding the rule of 40. Looking at billings in more detail, RPO grew 15% to $6.1 billion, and total billings grew 6% to $1.58 billion, driven by robust growth in security operations at 32% and Unified SASE at 14%. SSE and related cloud technologies were again the fastest growers in Unified SASE, benefiting from our large SD-WAN customer base. Our Unified SASE and security operations pillars are gaining considerable traction, with over 50% of their billings coming from our secure networking installed base and combining to drive our SaaS solution, organic ARR growth rate of 74%. The customer buying journey from FortiGate to SD-WAN to SASE supports our customers' drive towards consolidation and is gaining traction. This consolidation journey first begins with a firewall in FortiOS and typically expands to SD-WAN and next to SASE. I should share that two-thirds of our large and mid-enterprise customers have deployed our SD-WAN technology, providing them with a gateway to FortiSASE. These customers in our first year of SASE delivered high mid-single-digit penetration rates, highlighting both the dramatic expansion opportunity as well as customer demand for vendor consolidation. Including all elements of unified SASE, pipeline growth was over 30%. While the SSE technologies are seeing pipeline and ARR growth of 130% and over 500%, respectively, larger enterprises continue to drive our expansion into Unified SASE and the security operation markets, with large and mid-enterprises representing 91% and 76% of SASE and security operations' billings, respectively. As we work through the wind-down of last year's backlog and the related year-over-year headwind to growth this year, secured networking has returned to growth as we expected. Rounding out the billing commentary, SMB and large enterprises were our top two performing customer segments, while EMEA was our best-performing geography with double-digit growth. Among our top 5 verticals, manufacturing billings grew by over 20%, driven by OT billings of 119%. Retail returned to growth for the first time in 6 quarters, up 9%, while the service provider vertical reached its highest growth rate over that same 6-quarter period. Turning to revenue and margins, total revenue grew 13% to $1.508 billion, driven by 19% service revenue growth, and product revenues returned to growth. Service revenue of $1.034 billion grew 19%, accounting for 69% of total revenue. Service revenue growth was driven by growth in our SaaS solutions, including 50% services growth in security operations and 27% services growth in Unified SASE. Product revenue returned to growth for the first time in 5 quarters, increasing 2% to $474 million. Excluding the impact of backlog, product revenue grew sequentially at double-digit rates, outpacing historical norms for Q2 to Q3. A moment ago, we talked about solution consolidation and described the customer's journey around firewalls to SD-WAN and on to SASE. The second customer buying journey is supporting the customer's convergence of security and networking. Their journey begins with Fortinet firewalls and expands to leverage our FortiLink technology to manage Fortinet switches and access points. It's worth noting that over 95% of our larger enterprise customers previously or simultaneously purchased FortiGate firewalls. At the same time, our switch penetration rate for these larger customers is around 50%, highlighting both our success and the future opportunity. Software license revenue continued its double-digit growth, driven by security operations solutions and represented a mid- to high-teens percentage of total product revenue. Combined revenue from software licenses and software services such as cloud and SaaS security solutions increased 33%, accelerating from 32% in the second quarter and providing an annual revenue run rate of over $900 million. Total gross margin increased 630 basis points to a quarterly record of 83.2%, exceeding the high end of our guidance range by 320 basis points. Gross margin benefited from higher product and service growth margins as well as a 4-point mix shift to higher-margin service revenue. Product margin of 71.6% was also a quarterly record and increased 1,370 basis points, which includes a 320 basis point benefit related to the renegotiation of supplier contractual commitments. Excluding this one-time benefit, the product gross margin would have been around 68.4%. Service gross margin of 88.4% increased 130 basis points as service revenue growth outpaced labor costs and benefited from a mix shift towards higher-margin FortiGuard security subscription services. Operating margin increased 130 basis points to a quarterly record of 36.1% and was 360 basis points above the high end of our guidance range. Excluding the one-time benefit to product gross margins, operating margins would have been 35.1%. Taken together with our reported Q2 margins, the Q3 margins excluding the one-time benefit provide directional insights into our financial performance. Before moving on to the statement of cash flows, I’d like to provide a few details related to the impact of Lacework and Next DLP acquisitions. These acquisitions increased Q3 billings and revenue by approximately 60 and 90 basis points, respectively, and increased gross and operating margins by about 30 and 220 basis points, respectively. Looking at the statement of cash flow summarized on Slides 16 and 17, free cash flow was $572 million, representing a margin of 38%. Adjusted for real estate investments, the margins came in at 40%. In the first 9 months of the year, free cash flow was $1.5 billion or $1.75 billion after adjusting for real estate investments. Cash taxes were $140 million, up $114 million, reflecting the prior year's regulatory extensions of estimated tax payments. Infrastructure investments totaled $36 million. The average contract term in the third quarter was 28 months, flat year-over-year and quarter-over-quarter. DSO decreased 6 days year-over-year and quarter-over-quarter to 62 days, reflecting stronger linearity. The $106 million gain on a bargain purchase from the Lacework acquisition relates to NOL carryforwards and the related recognition of the deferred tax assets. The gain is excluded from our non-GAAP financials but included in the GAAP financials, adding $0.14 per share to our GAAP EPS. Share buybacks in the quarter totaled $600 million, and last month, the Board increased the share repurchase authorization by an additional $1 billion, bringing our remaining share repurchase authorization to approximately $2 billion. Now, I’d like to share a few significant wins from the third quarter. First, in a 7-figure upsell deal, an existing SD-WAN customer in the retail industry continued their consolidation journey, adding FortiSASE for 16,000 users. This customer selected our FortiSASE solution for simplicity, ease of management, and consistent security enforcement across their infrastructure. We outperformed the competition by leveraging our FortiOS operating system, streamlining operations and reducing costs of ownership while showcasing our ability to consolidate multiple security functions onto a single platform. In another 7-figure win, a medical device company purchased FortiSASE to replace their existing solution. This customer chose Fortinet for simplified and consistent security management, significant cost savings, and FortiSASE's enhanced functionality, particularly the bidirectional connectivity between their data center and remote users, enabling them to push policies more effectively. In an 8-figure competitive displacement win, a multinational bank commenced their partnership with us by selecting our FortiGate firewalls and multiple set-top solutions to secure their hybrid architecture. This customer was particularly impressed with our integrated security, end-to-end visibility, and automated response capabilities of our FortiOS operating system. Before discussing our guidance, I would like to offer a couple of comments on the firewall recovery and refresh opportunity. During last quarter's remarks, we mentioned the continued improvement in the days of registered FortiGuard contracts, indicating that inventory digestion at end users was returning or had returned to normal. In the third quarter, this metric was stable, further validating our view that the firewall market is recovering. Today, we'd like to add to this commentary by noting that in 2026, a record number of FortiGates will reach the end of their support life cycle, and we expect these customers to start their refresh cycle for these products sometime in 2025. Moving on to guidance, as a reminder, our fourth quarter and full year outlook, which are summarized on Slides 19 and 20, are subject to the disclaimers regarding forward-looking information. Before reviewing our outlook, I should note we expect Lacework and Next DLP acquisitions to impact Q4 billings and revenue by 75 and 135 basis points, respectively, while decreasing our audit margins by 230 basis points. For the fourth quarter, we expect billings between $1.9 billion and an indiscernible amount, which at the midpoint represents growth of 5%. Revenue in the range of $1.56 billion to $1.62 billion, which at the midpoint represents growth of 12%. Non-GAAP gross margin of 79.5% to 80.5%; non-GAAP operating margins of 33% to 34%; non-GAAP earnings per share of $0.58 to $0.62, assuming a share count of between $768 million and $778 million; capital expenditures of $100 million to $120 million; a non-GAAP tax rate of 17% and cash taxes of $127 million to $177 million. For the full year, we expect billings in the range of $6.43 billion to $6.53 billion; revenue in the range of $5.856 billion to $5.916 billion, which at the midpoint represents growth of 11%. Service revenue in the range of $4.15 billion to $4.45 billion, which at the midpoint represents growth of 19%. Non-GAAP gross margin of 80.3% to 81.3%, non-GAAP operating margin of 32.9% to 33.9%, non-GAAP earnings per share of $2.20 to $2.28, assuming a share count of between $766 million and $776 million. Capital expenditures of $380 million to $400 million, non-GAAP tax rate of 17% and cash taxes of between $550 million and $600 million. I look forward to seeing you at the Analyst Day later this month and updating you on our progress in the coming quarters. I'll now hand it back to Aaron to begin the Q&A session.

Thank you, Keith. As a reminder, 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. Operator, please open the line for questions.

Our first question comes from Hamza Fodderwala with Morgan Stanley.

Ken, I couldn't help but notice in your investor presentation, you talked about a market that you see over $200 billion, growing 12% over the next 4 years. Obviously, a big chunk of that growth is driven by the SASE market and your share in there. I'm curious if you could talk a little bit more about Fortinet's approach in terms of Sovereign SASE. How is that differentiated versus some of the competitors out there? And what is it that you're doing differently, particularly for those highly regulated verticals out there?

Thank you, Hamza. It's a great question. We have been investing in SASE for 5 to 10 years in the market, including our SD-WAN and also all SASE functions in the same FortiOS, both on-premises and in the cloud. So with huge differentiation from competitors who cannot run SASE either in the same OS or even on different boxes. And that's for the Sovereign SASE. We call it private SASE. If you look back probably a year ago, we were more focused on providing a lot of services to service providers, which is quite important for them to play the SASE within their own data centers to process data while keeping the data secured in their own kind of data center. So that's the two important factors there. They have to be local and secure the data while also processing and managing it within their own data center. So that's a huge advantage in the same OS and with many functions we can leverage through FortiASIC technology. The other differentiation comes from the business side. We are the number one on network security firewalls and also number one on SD-WAN. So leveraging our installation base and both the firewall function and IT function on the same OS with SASE provides customers with the easiest migration path from a traditional firewall vendor—many traditional firewall customers to SD-WAN and then to SASE. It's only a few minutes of reconfiguration that can enable SASE based on their previous SD or firewall contributions there. So it's a very easy migration path. As you can see, the pipeline growth is also significant with an increase from SSE exceeding 200%, and the pipeline growing over 100%. We believe we will be the number one leader in the SASE market in the next few years.

Our next question comes from the line of Brian Essex from JPMorgan.

Ken or Keith, could you dig into the commentary around the firewall refresh cycle that you provided? With respect to conversations you're having with customers and a little bit of color on what you've seen historically, how far before the renewal point do customers tend to refresh? And do you have any insight into the mix of F&B, large enterprises, service providers, retail, and what the timing and magnitude might be, whether this might be a first-half event, second-half event? Any insight you could provide would be really helpful.

Yes, I'll jump in a little bit on this. I think we see the end-of-life of these products starting in the second half of 2026. We don't expect the customers to wait until the last moment to make the change. For larger enterprises, they would go through another certification or POC project as part of that before they place them in service. We saw a similar lift, although not identical, in 2023, but the magnitude in 2026 is much larger. And why this is relevant to 2023 is that if you look back at product revenue growth in 2022, it was very different, considering the supply chain issues with switches, and et cetera, but I think in 2022, the product revenue growth was a little over 40%. So we believe there's a relationship there. We expect it to start earlier though. To the second part of your question, as I mentioned, the absolute number as we look at 2026 is by far the largest we've seen in the last 5 or 6 years. It is dominated by the entry-level firewalls, however, in 2026, we see a significant portion being mid-range firewalls as well, which is a very unusual and positive situation. I don't have a breakdown by SMB or something similar right now. Maybe Christian can add more to that.

Yes. You were asking whether—or how early customers would refresh. Many enterprise customers have agreements where they have account-level support and subscriptions, so they don't really wait until something expires. They will probably, I would expect, refresh about 15 to 18 months prior to expiration. Smaller customers might wait until the contracts expire, but because we don't allow them to renew for less than a year, you also see refresh cycles occurring around that 15 to 18 month mark.

Our next question comes from the line of Fatima Boolani from Citi.

Ken, a question for you. There was a discussion about the routes to market in terms of gaining your market share within the SASE universe. One of those important routes is leveraging your installed base by converting and migrating a lot of the SD-WAN customers. My question for you is how should we think about the potential cannibalization of some of your refresh potential as that migration journey transpires from SD-WAN to SASE? And I have a follow-up for Keith, if I may.

Very good question. If you look at the customer base, a lot of SASE solutions are supporting the DTA and also remote growth environments. They are not really like any network security firewall deployments, which tend to be more in the office settings. On the other hand, most of our current SASE growth comes from our existing SD-WAN customer base or even the firewall customer base. They need hardware firewall and SD-WAN layers to support SASE along with additional SASE user licenses and additional functions. That's where we see three pillars: the secure networking side, the SASE side, and the secure operations side, all of which are starting to grow. We believe we can continue to grow in all these three areas faster than the market, keeping our market share positive, especially in SASE, where we can put out technology in the same OS, along with support for both cloud SASE and private SASE. This provides a huge advantage. We also believe that service provider carriers will play an important role in SASE, offering their own SASE to their customers. This represents a huge growth potential on top of the traditional network firewall market.

Yes, just to double back on the end-of-support analysis around the refresh schedule you're talking about for 2026. Any way you can provide a lens on either the proportion of the shipment footprint or installed base footprint or customer footprint that this applies to in the aggregate? Yes. At the risk of taking all the fun out of the Analyst Day in 10 days, I would say 2023 was one of the second best years. 2026 is a little bit more than 2x compared to 2023. So you're not coming to the Analyst Day.

Our next question comes from the line of Saket Kalia from Barclays.

Maybe for Keith or Christian, I think you mentioned a Solutions ARR growth number in the prepared remarks. Could you just remind us, is that an organic or inorganic number? And could you touch on what are the solutions that are driving that growth?

Christian, do you want to answer this?

Yes. The growth number that Keith referenced was an organic growth number. We did not include the ARR that we acquired from Next DLP and Lacework, so the growth would be even higher year-over-year—about 150%. The organic solutions driving this ARR growth are really FortiEDR, FortiClients, FortiNDR clouds, and FortiWeb; so a variety of our cloud solutions and solutions that we've started to offer, with some of them being acquired and others internally developed.

Got it. Keith, maybe for my follow-up for you. Just to shift gears a little bit, it was great to see the profitability again. Could you just remind us what—you mentioned something about being one-time in nature in the quarter. It sounded small, but could you just remind us what that was? And more importantly, do you think about this as a more sustainable level of profitability?

Yes. I think if I were to use the headline first, I would say the pro forma margins, if you back out that one-time benefit, the product gross margin would have been about 68.4% and the operating margin, if you backed out that benefit, would be 35.1%. As you may recall, we have two different things impacting our margins. One is the traditional excess and obsolete inventory calculation related to inventory you have on hand, which is pretty straightforward. The second one is Q2 deliverables. Our operations team has worked hard negotiating with last year, and we saw a benefit that kind of pencils out to those margins I gave you. In round numbers, we got a benefit of about $15 million. That's very unusual; we've not seen that in the past.

And anything on sort of the sustainability of that margin? I totally understand but I wanted to make sure that question was asked.

Yes. I think we feel really good about the profitability of the business. It comes back to focusing on where those investment vectors that Ken and John will address as we move forward. But I think we certainly have ample room to invest in the growth of the company.

Our next question comes from the line of Tal Liani from Bank of America.

You have Tomer Zilberman on for Tal Liani. Just wanted to ask about the billings guidance for next quarter. The organic billings ex Lacework and Next DLP came in well below Street expectations. Just wanted to ask where you see the weakness and how you measure that against the comments of seeing stable firewall demand this quarter and the expected refresh cycle in 2025?

Yes. Great question. What we are seeing when we look at the fourth quarter right now is we're very pleased with what we got out of the very first month of the first quarter. The second month is tracking, giving us pause due to some chunky deals that are teeing up for the final month of the quarter. They just need to mature a little bit before we start factoring them into our guidance numbers. So I think it’s that population of large 7-figure and a few 8-figure deals that are coming into play there a little bit.

Got it. And maybe to follow up, I am asking more generally about the competitive landscape. We've seen over the last couple of quarters that some of the larger vendors are now focusing even more on discounting, bundling, and vendor financing. How do you see the competitive landscape? Do you see pricing pressure because of that? And how are you participating with that as well?

Yes. I think the discounting is very similar to what it's been in prior periods. We've certainly allowed our margins some room to invest in a wide range of ways, and we're encouraging our sales team and our channel partners to take part in that. There have also been some other changes in terms of incentives that we offer. Maybe Christian has some thoughts as well.

Yes. I think that overall, discounting will be expected to remain stable. But of course, it depends a bit on the product set. We also have incentives in the market, specifically for channel partners and customers to buy more Fortinet solutions.

Our next question comes from the line of Gabriela Borges from Goldman Sachs.

Keith and Ken, I wanted to ask you about the go-to-market. More specifically, I think it's been about a year since you up-leveled your sales force around SSD. What are some of your learnings? What do you think is working well, and what do you think should be an incrementally focused area as we go into 2025 where you think you can maybe up-level some more?

Yes. You can see over the last 12 months, we've made huge progress in the SASE SSD go-to-market. We've begun to see some service providers finally recognizing the importance of SASE within their customer base. It likely will take some time, but our customer base appreciates SASE and the smooth transition from firewall services. About 90% of our SASE business comes from existing customers. This reality helps us sell additional services, while at the same time, the technology we have—the single OS, the ASICs selling all functions—gives us an edge and allows us to reach beyond the traditional SASE market, which typically only focuses on cloud-based solutions. We see great growth potential in edge computing, OT, and IoT areas, both through software and hardware agents for these OT devices. Hence, we are quite confident that we’re leading the SASE market just like we did in the firewall and SD-WAN space.

Yes, I think Ken is spot on with that. If you look at our customers’ responses when they meet with us, they're excited about SASE's architectural design that we've taken. The moment customers hear our approach, it resonates, which is evident in the strong pipeline and ARR numbers we are discussing. We are still in early days. Part of this initiative is getting more reference customers involved and ensuring that the channel partners work closely with us on SASE opportunities.

Yes. SASE and our infrastructure are different from our competitors. We own 3 million square feet of our infrastructure, which is our data center, enabling us to deliver SASE functions possibly at less than half the cost compared to pure hosted solutions. That's a significant advantage. We are working with key competitors, as they also have good coverage. So we feel we have substantial advantages in technology, infrastructure, and the existing customer base for firewalls and SD-WAN. This gives us a distinctive edge over our SASE competitors.

It's also interesting to note, as you said, we started really focusing on SASE a year ago. Like Ken mentioned, we've been building the solution for some time. A year ago, at the November '23 earnings call, we broke out those two pillars, SASE and SecOps, both externally and internally to focus on them. We've seen nice growth from those over the past year. Over a very brief period, there’s a lot more focus to come in the future.

Our next question comes from the line of Shaul Eyal from TD Cowen.

Ken or Keith, in your press release, you mentioned Fortinet being well positioned to lead in its three core growth areas and drive sustained growth. Keith, I don't want to spoil the fun at the Analyst Day, but what are we talking about here? Low teens, mid-teens? Any color will be highly appreciated.

I appreciate the opportunity to discuss this, but I think we'll pause on answering it for now.

Yes, I agree. We're probably waiting for the Analyst Day. You can also refer to the investor slides for some insights around our total addressable market and how we want to grow faster than the market in each sector.

Our next question comes from the line of Rob Owens from Piper Sandlin.

Keith, I wanted to double back on your comments around Q4, specifically regarding some of the larger deals that are developing for the final month of the quarter. Was that not in your purview earlier when you were looking at the setup for the second half? Have these things slipped relative to their maturation, or has it been your ability to get them across the line? I'm curious why the additional caution around them now.

Yes. Great question. I do think compared to previous quarters, we have seen a slower maturation of larger deals occurring in the third quarter as they are being prepped for the fourth quarter. Certainly, we're not shutting them out; I believe it's just prudent to take a cautious approach and let them mature a little more.

Another factor is this probably marks the first time we’ve started giving out RPO numbers compared to a year ago; some of the deals are processing through various channels, which might just use an IPO to bill annually. Christian can elaborate further on that.

Yes. As you can imagine, customers generally prefer not to pay in advance for years. We’ve had internal discussions about either getting channel financing or doing it ourselves. But it’s still not matured enough for us to guide confidently in that direction; that uncertainty is giving us a bit of a pause since some customers don't want to commit to long-term agreements without financing.

This may have a short-term impact but also an extended benefit for the company with better margins and strengthened customer relations. That's what we're all aiming for in terms of long-term success.

Our next question comes from the line of Catharine Trebnick from Rosenblatt.

Can you discuss how your virtual firewall is performing this quarter or the trends for it? We've noticed that a competitor has been doing very well with their virtual firewall. How does that compare to your performance?

Yes. I think the virtual firewalls have performed very well. It is a component of Unified SASE as well as our network security portfolio. Additionally, we are looking at the crossover that exists between our enterprise customers buying both physical and virtual appliances.

Our next question comes from the line of Adam Borg from Stifel.

Great. Maybe for Ken, just on the Lacework FortiCNAPP offering now. I'd love to hear about initial customer feedback, partner feedback, and kind of near-term R&D and sales and marketing priorities.

Yes. The feedback we’re getting is similar to what we found when we did our diligence: great product, great engineering team. It's an incremental TAM of $10 billion for us, opening up that incremental market. We now have security, endpoint, network capabilities, and great threat intelligence coming from all three. It's very positive feedback concerning product quality, and we continue improving the user interface and other areas to make it a competitive product. Our solution offers seamless integration as opposed to other companies piecing their solutions together from multiple acquisitions. Lacework’s CNAPP solution was developed organically by their team, leading to a more cohesive experience with our offerings. This provides real differentiation against other competitors in the space, which we see working to our advantage.

Both companies have market-leading technology, and the team there is quite strong. Our commitment to integrated solutions allows customers to leverage our strong R&D resources, combining both solutions and providing additional support to our customer base. This opens a $200 billion total addressable market and represents significant growth potential in both secure applications and the SASE space.

That's great. And maybe just as a quick follow-up on the government vertical. Obviously, Q3 is important for the U.S. Fed. I know the Fed is a smaller vertical for Fortinet, but could you talk about the government vertical more broadly and how you think about it in the coming periods?

Yes. To your point, we are not highly aligned with the U.S. portion of the market. Our government vertical primarily includes state and local, as well as international government. Therefore, we won’t see the same sort of 9/30 benefit that some other companies might experience.

Our next question comes from the line of Patrick Colville from Scotia.

This is Joe Andrew on for Patrick Colville. Can you talk more about how you're enabling or incentivizing partners to lead with Fortinet SASE when they may already have existing relationships with more established vendors in this space?

Yes. You can see many partners, especially those with network security and SD-WAN, are easily moving to upgrade to SASE. In fact, many of our advantages in terms of cost, security, performance, and flexibility make it easy to migrate from competitors to Fortinet. We see acceleration in this space. Additionally, we have a large SMB customer base where SASE has only seen single-digit growth concerning network security deployment. This area is fast-growing because SMBs are prone to significant security threats. We also see growth potential with service providers and large enterprises developing private SASE strategies, giving us another significant competitive edge in this arena.

Our next question comes from the line of Joseph Gallo from Jefferies.

It was great to see the OT grew 19% billings growth. How should we think about the sustainability of that business? And are there any changes in that competitive landscape?

We are very bullish on the OT market and believe there are ample leadership opportunities for us in that space.

Yes. In OT security, we're already recognized as a leader. We've been investing in this space for a long time, and we believe that in the next 5 to 10 years, the majority of connections will originate from a device level, making it challenging to deploy agent software. Therefore, OT plays a vital role in our strategy, and we see huge opportunities in this combined result, leading edge computing for growth.

Is there any specific vertical that you expect to rebound, especially now? Are there signs of change in the next several quarters?

We see the manufacturing vertical already performing strongly in Q3 and anticipate that post-election properties will also begin accelerating. Additionally, carriers and service providers have emerged from their downturn, finally showing growth after about 6 quarters. Some sectors like retail have also returned to growth for the first time in a while.

Our next question comes from the line of Keith Bachman from BMO.

I wanted to ask two questions; sort of a micro and a macro. Keith, just on the SaaS penetration: You indicated on Slide 9 that about 45% is with large enterprise. If you took out the SD-WAN— It's a significant figure. If you took out the SD-WAN, what would that penetration rate or share look like with customer types? I'm trying to understand the SD-WAN versus the other bucket. Secondly, how are you thinking of Europe as you look out over the next quarter or two? I know there’s election timing that might impact economic growth. Still, how are you looking at Europe in the next couple of quarters, not just in Q4?

I think we may have confused you or I confused myself on Slide 9. I don't think it’s showing penetration based on customer mix. When you look at SASE without the SD-WAN, the mix will be more tilted to larger enterprises than when you analyze the entire universe in dollar values. Yes, regarding Europe, I think we mentioned on the call that international EMEA was number one, with the U.S. in the second position and Europe right behind them in third place. It's a little bit like the SMB headlines we discuss each quarter; concerns about SMB continue to persist, but they remain resilient.

Our next question comes from the line of Janice Quek from CFRA.

I just want to drill down on your hardware appliances. Could you provide a bit more color on how the high-end family performed versus the mid-range and lower end?

Yes. Overall, the mid-range and high-end have continued to be stable but did not experience significant growth. We observed a slight uptick in unit shipments as a result.

Our final question comes from Gray Powell with BTIG.

It was really helpful to see the product-level growth rate disclosures in the slide deck. Within Universal SASE, could you give us a rough estimate of how fast the SD-WAN piece is growing? My understanding is that it's been under pressure over the last 18 months. So, do you see potential for that product to reaccelerate, particularly as VMware customers start looking for alternative solutions?

Yes. If you look at our SD-WAN space, we noted that the penetration in the larger enterprises is on the order of about 65% to 70% of our customer base. The opportunity for growth lies primarily in white space accounts, bringing them on board with the FortiGate and SD-WAN solution and commencing their journey that includes FortiGate all the way to SASE. As we transition into 2025 and 2026, we're additionally expecting some renewals from the early adopters of SD-WAN, which could lead to natural growth.

Yes, I agree. When analyzing the top 5 SD-WAN providers, we are the only one with an internally developed solution paired with security, while other competitors have previously acquired their solutions. This aligns with the technology development cycle and enables a refresh. We see a notable opportunity for replacements currently; we feel confident that we lead in technology, performance, and energy consumption. Thus, we anticipate our SD-WAN offerings will continue to accelerate and grow faster than the market, further expanding our market share.

This concludes the question-and-answer portion. I will now turn it back over to Aaron for closing remarks.

Thank you. I'd like to thank everyone for joining today's call. As a reminder, we will be holding an Analyst Day on November 18, marking our 15-year IPO anniversary, where we will share the company's vision for the future of cybersecurity and provide an update on our strategy and midterm financial model. We will also be attending investor conferences hosted by Barclays, Needham, Scotiabank, and Wells Fargo during the fourth quarter. The webcast link will be posted on the Events and Presentations section of Fortinet's Investor Relations website. If you have any follow-up questions, please feel free to contact me. Have a great rest of your day.

This concludes the conference call. Thank you for being here. You are now free to disconnect.