Earnings Call Transcript - FTNT Q3 2025

Operator, Operator

Hello and welcome to Fortinet's Third Quarter 2025 Earnings Conference Call. Please be advised that this call is being recorded. I would now like to hand the call over to Anthony Luscri, Vice President of Investor Relations. Please go ahead.

Anthony Luscri, Vice President of Investor Relations

Thank you. Good afternoon, and thank you for joining us on today's conference call to discuss Fortinet's third quarter 2025 financial results. Joining me on the call today 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 2025 before providing guidance for the fourth quarter and updating the full year. We will then open the call for questions. Before we begin, I'd like to remind everyone on today's call that we will be making forward-looking statements, and those forward-looking statements are subject to risks and uncertainties, which could cause actual results to differ materially from those projected. Please refer to our SEC filings, in particular, the risk factors in our most recent Form 10-K and Form 10-Q for more information. All forward-looking statements reflect our opinions only as of the date of this presentation, and we undertake no obligation and specifically disclaim any obligation to update forward-looking statements. Also, all references to financial metrics that we make on today's call are non-GAAP unless stated otherwise. Our GAAP results and GAAP to non-GAAP reconciliations are located in our earnings press release and in the presentation that accompanies today's remarks, both of which are posted on our Investor Relations website. As a reminder, this is a live call that will be updated for replay via webcast on our Investor Relations website. The prepared remarks will also be posted on the quarterly earnings section of our Investor Relations website following today's call. Lastly, all references to growth are on a year-over-year basis, unless noted otherwise. I'll now turn over the call to Ken.

Ken Xie, Founder, Chairman and CEO

Thank you, Anthony. Thank you to everyone joining our call. We are pleased with our excellent third quarter performance driven by strong execution and broad-based demand across our organization. As we grow faster than the market in all three pillars of our business as shown on Slide 4. Billing and revenue both grew by 14% with a record third quarter operation margin of 37%. Unified SASE billing grew 19%, driven by FortiSASE billing growth of over 100%, making us one of the fastest-growing SASE leaders at scale. Our strong growth is driven by our key differentiated advantages. Fortinet is the only vendor to natively integrate next-gen firewall, SD-WAN, and SASE on a single operating system, FortiOS, with the flexibility to run both on-premise and in the cloud. This single OS integration allows customers to expand from our leading next-gen firewall and SD-WAN to SASE in minutes, providing a significant upsell opportunity within our large customer base. Our solution also enables sovereign SASE for service providers and large enterprises to deploy FortiSASE within their own data centers for data privacy. Additionally, Fortinet's investment in owned global cloud infrastructure, FortiCloud, delivers long-term security, performance, and cost benefits, reducing total cost of ownership by roughly one-third compared to our peers. This key advantage has led to our recognition as a leader in the 2025 Gartner Magic Quadrant for SASE platform, as shown on Slide 6. Our strong leadership position is reflected in customer adoption, with 15% of large enterprise customers now using FortiSASE, representing 55% growth as shown on Slide 10. Based on this momentum, we are confident in our ability to become the #1 SASE market leader in the next few years. In secure networking, billing growth is 10%, outperforming the overall secure networking market as we continue to gain market share. Fortinet is the #1 leader in firewall with a unit market share of over 50% and has the highest product revenue among our cybersecurity peers. Fortinet's leadership in firewall is enabled by FortiOS that integrates networking and security and is accelerated by our FortiASIC with significant secure computing power, enabling more functions and delivering 5x to 10x better performance than our competitors while lowering total cost of ownership and energy consumption. This security and performance advantage was further validated by Gartner as Fortinet was recognized as a leader in the inaugural Magic Quadrant for hybrid mesh firewall, where we ranked the highest in ability to execute. Building on this foundation, we recently launched the Secure AI data center solution, specifically designed for AI workloads, where we leverage our ASIC advantage, helping Fortinet capture a massive growth opportunity as customers scale AI globally. AI-driven SecOps was the fastest-growing pillar in the third quarter with billing growth of 33%. Fortinet's industry-leading AI patent portfolio of more than 500 issued AI patents powering over 20 AI-driven solutions offers the broadest and most integrated AI-driven secure operation portfolio in the industry. Fortinet's security leadership also extends to operational technology and cyber-physical system security, where our solutions provide deep visibility, advanced threat protection, and secure connectivity. Operational technology and critical infrastructure solutions are other significant growth drivers for Fortinet with over 30% billing growth. Lastly, as a result of the strong growth opportunities that lie ahead, we remain confident that we will continue to meet the Rule of 45 and continue to gain market share and outperform overall market growth in 2025, 2026, and beyond, consistent with our mid-term target provided at last year's Analyst Day. I would like to thank our employees, customers, partners, and suppliers worldwide for their continued support and hard work. I will now turn the call over to Christiane.

Christiane Ohlgart, CFO

Thank you, Ken, and good afternoon, everyone. As Ken mentioned, Fortinet's growth and momentum remains strong, and we are very pleased with our third quarter performance, solid operational execution, and healthy broad-based demand for our solutions. Total billings grew by 14% to $1.81 billion, driven by 19% growth in Unified SASE, 33% growth in SecOps, continued growth in sales to large enterprises, and robust performance in OT and critical infrastructure. Unified SASE and SecOps now account for 26% and 11% of total billings, respectively, up a combined 3 points. FortiSASE delivered exceptional results with billings growth of over 100%, positioning Fortinet as a leader in the SASE space. Furthermore, SASE adoption momentum has remained strong as 15% of our large enterprise customers have purchased FortiSASE, an increase of over 55%, highlighting our continued expansion of FortiSASE in our customer base. As I mentioned earlier, continued momentum in large enterprise contributed to growth in the third quarter as the number of deals greater than $1 million increased by 26%, while the total dollar value grew by over 30%. As in prior quarters, operational technology use cases contributed to our success with billings growth of over 30% and broad-based demand for both our hardware and software solutions. In addition, we continue to expand our customer base. Approximately 6,600 new organizations chose our Unified single FortiOS platform to power their cybersecurity strategy, which exemplifies our continued strong position in all segments of the market. Regarding ARR, Unified SASE increased by 13% to $1.22 billion and SecOps increased by 25% to $472 million. Total revenue grew by 14% to $1.72 billion, led by EMEA, followed by APAC and the Americas. Product revenue increased by 18% to $559 million, benefiting from strong performance in multiproduct deals across a variety of use cases and OT security as we continue to gain market share. FortiGate firewalls, networking equipment, and software all delivered strong double-digit growth, with software license revenue up 20% and representing a mid- to high-teens percentage of total product revenue. Hardware revenue growth was broad-based, which included growth from ongoing technology upgrades, expansion across products along our various customer journeys, and expansion into new use cases. The 2026 end of support cohort was not a significant driver of product revenue growth in the third quarter. Service revenue grew by 13% to $1.17 billion. We see our improved product revenue growth and customer expansions in 2025 as leading indicators for improving service revenue growth expected for the second half of 2026. Now I'd like to highlight some key deals that demonstrate our market leadership and the variety of use cases that our products are supporting. In a competitive win, a global Fortune 150 e-commerce company operating a worldwide logistics and fulfillment network expanded its investment in Fortinet with a new AI data center project. Already leveraging Fortinet firewalls across their data centers and hundreds of warehouses, the customer selected Fortinet to secure and optimize their new AI workloads, requiring extreme throughput and reliability. They chose Fortinet for our ASIC-based FortiGate architecture, which delivers high performance, low latency, and lower power consumption as well as advanced security that protects AI data flows and models without compromising speed. The customer is achieving improved workload control, lower operating costs, and is now looking to further expand their data center footprint with Fortinet. This customer win highlights the energy consumption advantages of our proprietary ASIC, which has become even more important to our customers in a new era of AI data centers. Next, in an eight-figure deal, a large city police force purchased Fortinet SD-WAN, SD-Branch, and Sovereign SASE, displacing multiple vendors, including their previous SASE provider. The customer sovereign SASE deployment ensures compliance with local data governance requirements, gives full control of critical assets, and resolves performance issues experienced with their prior provider. The police force chose Fortinet for its flexible and consistent security enforcement and single operating system. This enables secure access to both on-premises and cloud applications while supporting a network transformation project that will enhance public safety and trust. In a competitive new customer win, an operational technology organization purchased more than 10 Fortinet solutions across all three pillars, consolidating multiple security functions onto our single FortiOS operating system. The customer selected Fortinet for our Unified Security Fabric platform, which simplifies operations due to a significant reduction of required integrations, improves visibility, and lowers total cost of ownership. With centralized management and streamlined operations, they now have the agility and scalability to grow securely and enable their digital transformation. Lastly, a retail organization that has been a long-time Fortinet customer upgraded their FortiGates across more than 10,000 retail locations. They continue to choose Fortinet for our stable performance, consolidated FortiOS operating system, and highly automated operations, building on a trusted relationship strengthened by their use of several other Fortinet solutions and our price and performance advantages. The customer is now expanding their Fortinet footprint by exploring adoption of our ZTNA solution to further enhance security and operational efficiency. Turning to margins and cash flow, total gross margin of 81.6% was better than expected, driven by strong execution and cost control. Operating margin of 36.9% reached a third quarter record and was up 80 basis points. The increase was primarily due to operational efficiencies and strong cost management. Free cash flow was very strong at $568 million, and adjusted free cash flow was $646 million, up $41 million and represented a margin of 37%. On a year-to-date basis, free cash flow reached $1.63 billion, up $135 million, notwithstanding continued investments in data center infrastructure and increased inventory purchases to meet customer demand. Infrastructure investments were $88 million, up $51 million as we continue to build out our infrastructure footprint. We repurchased 23.3 million shares of our common stock for an aggregate purchase price of $1.83 billion in the third quarter, which reduced our total share count by approximately 3%. In August, our Board of Directors approved a $1 billion increase in the authorized stock repurchase amount, and the remaining share buyback authorization as of today is $796 million. Now moving on to guidance. As a reminder, our fourth quarter and full year outlooks, which are summarized on Slides 20 and 21, are subject to the disclaimers regarding forward-looking information that Anthony provided at the beginning of the call. For the fourth quarter, we expect billings in the range of $2.185 billion to $2.285 billion, which at the midpoint represents growth of 12%. Revenue in the range of $1.825 billion to $1.885 billion, which at the midpoint represents growth of 12%; non-GAAP gross margin of 79% to 80%; non-GAAP operating margin of 34.5% to 35.5%. Non-GAAP earnings per share of $0.73 to $0.75, which assumes a share count between 751 million and 755 million. Infrastructure investments of $60 million to $110 million, a non-GAAP tax rate of 18%, and cash taxes of $66 million to $116 million. For the full year, we continue to remain on track to achieve the Rule of 45 for the sixth consecutive year and expect billings in the range of $7.37 billion to $7.47 billion, which at the midpoint represents growth of 14%. Revenue in the range of $6.72 billion to $6.78 billion, which at the midpoint represents growth of 13%. Service revenue in the range of $4.575 billion to $4.595 billion, which at the midpoint represents growth of 13%, non-GAAP gross margin of 80.25% to 80.75%; non-GAAP operating margin of 34.5% to 35%. Non-GAAP earnings per share of $2.66 to $2.70, which assumes a share count of between 764 million and 768 million. Infrastructure investments of $380 million to $430 million, a non-GAAP tax rate of 18% and cash taxes of between $400 million and $450 million. Looking ahead to the next few years, consistent with the framework that we provided at our Analyst Day last year, we remain confident that we will continue to meet the Rule of 45 and expect to grow faster than the market in all three of our pillars. Our confidence is supported by both secular and company-specific tailwinds. We expect continued strong growth in the demand for our products, driven by increased investments in cybersecurity and the convergence of networking and security and vendor consolidation. We expect to continue to outperform the overall market growth due to continued organic innovation and leadership in price performance, which drives a lower total cost of ownership in network security, including operational technology as well as Unified SASE and SecOps. We plan to continue to invest in our go-to-market strategy, including our cloud delivery infrastructure, strategic partner relationships, and increased sales capacity. Finally, the rise of AI is expected to further increase demand for our solutions due to the need to secure LLMs and data movement. We remain committed to continued investments in innovation and the ongoing development of our product portfolio. I will now hand the call back over to Anthony to begin the Q&A session.

Anthony Luscri, Vice President of Investor Relations

Thank you, Christiane. Operator, please open up the line for questions.

Operator, Operator

Our first question is from Tal Liani from Bank of America.

Tal Liani, Analyst

I want to start from the same line of questions that we had last quarter. Product revenues went up 18%, materially below the street. The street expected about 12%. What are the drivers? And what is the impact of refresh related to end of service?

Ken Xie, Founder, Chairman and CEO

Yes, this is Ken. It’s driven by strong demand. There are several growth drivers I mentioned, such as SASE, SecureOps, and OT, which is growing at 30%. However, I don't believe the end of service significantly contributes to growth, and we will likely stop tracking that. To put it simply, it's a bit amusing to think that one would wait for their old car to completely fail before buying a new one. The motivation for purchasing a new car typically comes from wanting new features or better performance, not just waiting for the old car to stop working. This reflects my view that it's not a growth driver. The reasons we continue to gain market share are due to the new features we develop and enhanced hardware, including the anticipated new ASIC next year. I also believe that product revenue will typically average around 10% to 15%, which represents low double-digit growth and aligns well with our performance over the last 16 years since going public. In my view, product revenue growth is quite normal.

John Whittle, COO

Yes. Tal, this is John Whittle. And just to follow up on what Ken said. What we see is not a shortage of potential growth drivers and opportunity. If anything, the opportunity is so great that we have to prioritize where we drive growth. We've got a track record of growing faster than the market across all three pillars. And like both Christiane and Ken mentioned, we're seeing significant growth in Unified SASE, SecOps, sales to large enterprises, OT, and critical infrastructure. If anything, our challenge is where do we focus on in terms of the growth drivers? It's not a lack of growth drivers. We have a lot of growth drivers out there. I talk to a lot of customers, and I see just a ton of opportunity out there to grow. We do have that track record of growing faster than the market across all three pillars for some time.

Ken Xie, Founder, Chairman and CEO

Yes. That's where the three pillars we showed in last year's Analyst Day and also shown on Slide 4 here. So in each pillar, we have a huge advantage compared to other competitors. We believe we'll gain market share in each pillar. That's the growth driver behind.

Tal Liani, Analyst

If that's the case, my follow-up is why is the guidance for next quarter somewhat disappointing? Revenue growth is slightly below expectations, at less than 12%. What distinguishes this quarter from the next?

Ken Xie, Founder, Chairman and CEO

I think the main factor is the revenue primarily coming from the service. Looking at last year, it's probably better understood by finance, but product revenue serves as an indicator for service revenue. Our average service term is around 29 months. Last year, product revenue declined by about 2%, which affected service revenue over the next 20 to 30 months. We anticipate that by the end of next year, service revenue will begin to improve, especially with the strong growth in product revenue this year. In Q4 of last year, we saw product revenue increase by 18%, and in Q3 as well, it also grew by 18%. This growth is a key indicator for future service revenue. Most service revenue is recognized at the start of the quarter, with about 90% already accounted for. Thus, total revenue may be slightly impacted by service revenue, but with product revenue beginning to rise, we believe future service revenue will improve.

Operator, Operator

Our next question is from Fatima Boolani from Citibank.

Fatima Boolani, Analyst

I wanted to stick to this discussion area with respect to the services revenue trajectory. I think for all of us very, very familiar with your model, we can appreciate the very attached nature of services, both in the form of subscriptions and support to the appliances. But I'm wondering, Christiane, if you can help put a finer point on what the trajectory of services growth could look like in the next 12 months. And this is just optically looking at services growth that has decelerated for the ninth consecutive quarter, understanding that there's a 29-month period in which there is a catch-up as well as maybe some of the commentary you shared last quarter with respect to a slower billings to revenue conversion as it relates to some of the customer behavior. So just wondering if we should think about 13% services growth as trough or near trough or if that's maybe not the right way to think about it. I would appreciate any feedback on that.

Christiane Ohlgart, CFO

Fatima, you're right. I provided color in my prepared remarks that we expect the service revenue growth to improve in the second half of 2026. The main reason for that is that, as Ken just said, we had negative billings growth last year, which impacts the attach rate. We are now seeing product pick up. So that is going to attach more services. But some of our customers are buying product ahead of the services until they roll them out. We are confident that at the end of the second half of next year, we will see a pickup.

Operator, Operator

Our next question is from Shaul Eyal from TD Cowen.

Shaul Eyal, Analyst

I have a quick question about the eight-figure transaction involving SD-WAN, SASE, and other components with the police force. Can you provide some insight on whether the SD-WAN aspect is larger than the SASE contribution, or the other way around? Any information you can share would be greatly appreciated, especially since these eight-figure amounts related to SASE are somewhat unusual.

Christiane Ohlgart, CFO

So the eight-figure deal is related to billings. It is a combination of product and services, but we also pointed out they are building out a software and SASE. That means they're buying more product and not the cloud-delivered SASE solution. The strength of Fortinet is that we deliver all options to our customers, so they can decide whether they want it cloud-delivered by Fortinet or whether they want to host it themselves and create their own SASE service that they have full control over and, in this specific case, also meets local data governance requirements. So yes, it's less SASE and more SD-WAN and SD-WAN in that deal.

Ken Xie, Founder, Chairman and CEO

Yes. I think the Sovereign SASE is the key reason for the win. Also, that’s a unique advantage for Fortinet because whether some government or certain big enterprise, they want to keep the data within their own data center, the privacy or some other regulation requirement. That’s where we combine all SASE together in the same appliance, which can be in the appliance, in the cloud and also especially attractive for this kind of bigger customer or government or service provider, that's a huge advantage. Some of the functions like SD-WAN also can use an ASIC to accelerate. So that’s the advantage we have compared to other SASE providers who only have a cloud delivery that has to go through their cloud infrastructure to process the data. A lot of customers really don't like that. At the same time, we have almost close to 1 million customers. We have more than half of the global firewall deployment. For all the current customers, it's very quick and easy to adopt, whether SD-WAN or SASE. That's a huge advantage. Our sales cycle is much shorter. If you remember, we only launched SASE 2 years ago. You can see how quickly we ramp up with all this over $1 billion business there and still growing probably the fastest among all the SASE players with the scale over $1 billion. So that gives us the confidence we'll be the #1 leader within a few years.

Operator, Operator

Our next question comes from Brian Essex from JPMorgan.

Brian Essex, Analyst

I would like to ask Ken about your SASE business. Your situation is somewhat unique because a significant portion of your SASE business is coming from upgrades within your existing customer base, whether from SD-WAN or firewall. Could you discuss the rate at which SASE is penetrating your SD-WAN installed base? Additionally, what steps would you need to take to increase the volume of business where you can promote SASE as the primary offering rather than relying on your existing customer base?

Ken Xie, Founder, Chairman and CEO

Yes. I think that leverages our #1 market share in whether firewall or SD-WAN. We do see the customer much quicker, easy to adopt our SASE solution. Right now, we're more tracking the enterprise. That's what we gave the percentage. I feel it's a good representation of some customer base. We also have a lot of SASE going through our service provider, through our channel partner, which is a little bit difficult for us to track in. Just like our SD-WAN, sometimes we offer SD-WAN for free. We see we are the #1 player in SD-WAN, and that’s also very different than all the other competitors. Most of the other top 5, top 10 players come from acquisition. So if they do their SASE, they have to have a separate SD-WAN box, which we think is kind of weaker or more difficult to manage compared to our single box solution. SASE is ramping up quickly, creating good growth opportunities, supported by our channel partners. We believe the service provider will also pick up the SASE like when we went public 16 years ago, over 30% of business came from service providers. We do believe that eventually telecom service providers and some other cloud providers may also pick up FortiSASE because it's so easy to deploy and adopt what customers need, whether it's private SASE or Sovereign SASE and it's easy to integrate with other security functions. We do give every quarter a disclosure more based on the enterprise since we have kind of a direct registration that we can track.

Brian Essex, Analyst

Any way to see what percentage of your SD-WAN installed base is remaining where you might convert it to SASE, like how much of an opportunity that is?

Ken Xie, Founder, Chairman and CEO

I feel the slides I showed in the presentation are a good representation. On the other side, we keep gaining market share in firewall and SD-WAN. So I think with our installation base, you can see on Slide 10. Now we believe within 2 years, now 15% of the enterprises have started using SASE. But we're also starting to see more and more new SASE, which are not firewall or SD-WAN customers before and also replacing some other SASE players because of our lower cost advantage. It's also much simpler with our one box solution compared to having two, three, four boxes. So we're seeing more new cases replacing other SASE players.

Operator, Operator

Our next question comes from Gabriela Borges from Goldman Sachs.

Gabriela Borges, Analyst

Christiane, you're giving us an early look into directionally services growth improving into the back half of '26 because of the strength in product revenue this year. My question is on your visibility into product revenue for next year. Certainly, the year-over-year growth has been good year-to-date, but on comps that are much lower. So my question for you is, how do you think about the product growth trajectory into next year? Are there any idiosyncratic drivers either tied to the COVID cycle or to what you're seeing across your pipeline that you can give us some color on that we should be aware of as we think about the trajectory of product growth next year?

Christiane Ohlgart, CFO

Yes. We are confident about continued product growth, not only next year. I think Ken said 10% to 15% is a good growth rate because there are multiple growth drivers. There is continued upgrade and refresh activity in our installed base, additional use cases that we see, and we also are growing with new customers in OT and other areas. So from our perspective, we are confident about continued growth of product as well as attached services and our SecOps portfolio, which is predominantly nonattached services.

Ken Xie, Founder, Chairman and CEO

Yes. Like I mentioned, I feel the growth drivers are more the new functions or the new hardware. In March next year, we are going to launch FortiOS 8.0, which is in the beta process. Early March, we will host in Las Vegas, the Accelerate. Welcome all to attending like before. The new function will drive the growth. Also, like I mentioned, Gabriela, in your conference, we'll have a new ASIC, MPA, coming out next year, probably a few times faster, more functions, almost the same cost. That will drive additional growth, especially in the data center firewall market. All this is our growth driver, plus we see the SASE customers quite excited about our SASE solution compared to other competitors. The OT is another growth area we see pretty strong. We are probably the only leader in the market, which we have invested over 10 years. I believe all this will keep driving product revenue growth in double digits.

Operator, Operator

Our next question comes from Junaid Siddiqui from Truist Securities.

Junaid Siddiqui, Analyst

I just wanted to drill a bit on OT security. That seems to be a continued driver of growth for you. If I'm not mistaken, I think growth accelerated from last quarter. Could you just talk about some of the factors driving that? And how are you differentiated versus some of the competitors out there?

Ken Xie, Founder, Chairman and CEO

The OT security really is trying to secure a lot of devices, especially in like health care, utility, and manufacturing. I continue to say that in the next few years, 10x more devices will connect online, including a lot of home appliances. Most security for these devices typically relies on network security because they run on different operating systems and have limited computing power, making it difficult to install security software. Thus, network security is the optimal approach. We see huge potential, but the difficulty is that different protocols may not be as standard as like laptops or phones. On the other hand, it needs a different kind of physical platform, sometimes ruggedized, to operate in different environments. That’s where we have invested long term, more than 10 years. If you look at the Westland report for the last 3 years, we are the only leader. I believe there’s huge potential with many use cases from securing infrastructure to robotics or connected cars. Each kind has unique needs, but I believe each can represent a huge market. We don’t see much competition entering this space. I am confident this will be a significant growth driver for us.

Operator, Operator

Our next question comes from Patrick Colville from Scotiabank.

Patrick Colville, Analyst

I guess the question I'm getting in my inbox is about these refresh cycles. Can you just clarify why the 2026 end of service cohort was not a contributor for this quarter? I just want to talk about the next super cycle. In 2021 and 2022, Fortinet had just incredible years. In Christiane's comments a couple of questions ago, she didn't mention the super cycle refresh as being a driver for 2026 and 2027. So I guess kind of why that absence?

Christiane Ohlgart, CFO

I wouldn't say absence. We said we are confident with our growth of product in the next years. The upgrade activity, as Ken said, is a portion of our growth drivers, but it has different reasons. Of course, as we come out with new features and functionality and another version of EOS, there are benefits for customers who've purchased a couple of years ago to upgrade their devices. As they need more security and more speed, that will naturally happen. It's a growth driver, but there are multiple growth drivers that contribute to overall product growth.

Ken Xie, Founder, Chairman and CEO

In every earnings call, I emphasize technology and our new products because I believe they are key to our growth. This focus has been vital to Fortinet’s success over the past 25 years as we’ve gained market share. I believe customers are more inclined to purchase or refresh products for improved functionality, speed, and cost efficiency. I want to make it clear that choosing to buy a new car is more appealing when you can explore innovative features and performance rather than settling for an old, non-functional vehicle. It’s also crucial to differentiate between the end of service and a regular refresh; the end of service is just a small aspect of the broader refresh cycle. I’m not concerned with tracking the exact percentage since what matters is that customers upgrade based on enhanced features, new technologies that meet their needs, AI-driven applications, and our ongoing investments for the future.

John Whittle, COO

And your point is good; that normal refresh that Ken is talking about, which can be about 4 years, aligns well with the new tech we are launching next year with the new network processor and the new operating system. The fact we didn't stress that does not mean that we don't view it as an opportunity. It was kind of bundled in with Ken's commentary about the technology that’s coming out, which has driven growth for Fortinet for 25 years and compels customers to refresh devices because the technology is so much better.

Ken Xie, Founder, Chairman and CEO

Yes. My belief is that a key differentiation that has built Fortinet over the last 25 years is really the engineering resources and the innovation capability we have, I feel is better than that of other competitors. That’s where we can continue introducing new functions and also keep up with market changes, also internally developing all these functions. You can look at whether it's the next-gen firewall, SD-WAN, SASE, secure ops, AI-driven security—all these secure operation solutions come predominantly from internal R&D innovation, compared to most competitors that have to rely on acquisitions. That’s a key differentiator and gives us a huge advantage in driving long-term growth, whether from ASIC chips, the OS, or the infrastructure we continuously build. Hence, I believe the company will keep growing and gaining market share long-term.

Operator, Operator

Our next question comes from Meta Marshall from Morgan Stanley.

Meta Marshall, Analyst

I just wanted to ask a question about the Q4 gross margins. Wanting to see if there were any headwinds from any tariffs or componentry cost increases that were embedded in that guidance.

Christiane Ohlgart, CFO

No, it's really the mix between hardware and service revenue. We had some benefits in Q3 from some reserve releases that we don't expect in Q4. It's pretty normalized from a product gross margin versus service gross margin. It's more of a mix.

Operator, Operator

Our next question comes from Rob Owens from Piper Sandler.

Rob Owens, Analyst

I was hoping you could parse for us the different geos, especially North America, which seemed to lag from a growth perspective. Was there something unique there to call out during the third quarter in terms of share losses or anything else that might have been weak within this theater?

Christiane Ohlgart, CFO

No. North America or U.S. was very strong in Q2. There are some quarters where big deals come in and then other quarters, not so much. They performed well, and there was no share loss.

Operator, Operator

Our next question comes from Saket Kalia from Barclays.

Saket Kalia, Analyst

Christiane, maybe this is for you. There's been a lot of focus on the call on services revenue, understandably so. But I'm curious a little bit on services billings in the quarter, just given the strong product result. Can you talk about whether there was any sort of change in attach rate on appliances? Should we think about changing attach rates as software becomes a bigger part of the product? Or maybe talk about another item, which is the unattached portion of services billings. I'm just curious, given the sequential decline in services billings, combined with a really strong product result, what were some of the moving parts that we should consider?

Christiane Ohlgart, CFO

If you look at Q2, Q2 actually had significant enterprise agreements that we signed. So we had high services billings. In Q3, some of the products were sold into these enterprise agreements. We also had, as I mentioned earlier, some customers buying hardware ahead of the deployment next year. We expect more service billings for these specific hardware purchases in 2026. So it's really more—think about it more on a longer-term basis and not just quarter-to-quarter.

Operator, Operator

Our next question comes from Shrenik Kothari from Baird.

Shrenik Kothari, Analyst

Ken, Christiane, you highlighted the launch of your secure AI data center offering. It seems like a pretty foundational growth pillar. So just stepping back a bit, how large do you think is the addressable opportunity here? And who are you targeting? Are these the AI-native players, cloud providers, hyperscalers, or just enterprise data centers using the refresh cycles? I had a quick follow-up.

Ken Xie, Founder, Chairman and CEO

Since we are the only network security vendor with our ASIC, we perform well in high-speed environments, especially in AI data centers. We're starting to see opportunities in this sector. Security for network infrastructure is built after the infrastructure is set up, but we engage early with AI players or data center service provider players because we have the highest performance network security solution. We've begun testing their infrastructure on how to secure AI, especially at the data and agent levels. It's difficult to estimate how big this market will be, but I truly believe it can be huge with AI growth exploding.

Shrenik Kothari, Analyst

Got it. Super helpful. And just a follow-up for Christiane. I know it's still early days, but as a revenue driver, given the inflection we are seeing in AI, how should we think about the monetization here next year? Is it mostly be still skewed towards, as I said, product and hardware, or should we also think about the services layering on top for the AIOps and Unified SecOps stuff?

Christiane Ohlgart, CFO

No, definitely, the services piece as well. I would say with regards to AI, the use cases are really broad-based. If we secure an AI data center, it's going to be more hardware-centric. If we secure AI applications, it's going to be more software-centric. And then, of course, we have our own AI-enabled solutions that benefit from AI and help the customers automate network security or SecOps. So AI has a broad implication for us because it opens up different use cases and different benefits for the customers.

Ken Xie, Founder, Chairman and CEO

That's where the AI-driven secure operation is the fast-growing segment in the last few quarters. We've launched over 20 AI-driven solutions, and AI is driving enormous growth opportunities, I believe.

Operator, Operator

Our next question comes from Ittai Kidron from Oppenheimer & Co.

Ittai Kidron, Analyst

Christiane, I want to make sure I understand the linearity of your product billings going forward. You mentioned that services are expected to accelerate in the second half of next year. What should we expect?

Christiane Ohlgart, CFO

That’s the revenue, right? Sorry. Sorry to interrupt, but yes, that was the revenue comment.

Ittai Kidron, Analyst

Then if I think about the product revenue, should potentially see an inverse pattern just given that the end of life, you're meaningfully into it right now and somewhere around early mid-next year, you're largely completed on that front, making it a difficult comp. So is it fair to say that the product growth potentially decelerates in the second half of next year?

Christiane Ohlgart, CFO

We are confident that our product revenue growth is solid for next year as well based on all the growth drivers that we've just provided. We haven't guided for next year yet, so from that perspective, I don't want to get ahead, but we are confident with our growth trajectory for product as well as services.

Ken Xie, Founder, Chairman and CEO

I refer back to Slide 4. Each of these pillars represents a large market, and it's still a very fragmented market. I don't see any player holding more than 10% to 20% market share. It's still a huge growth potential to continue gaining market share. That's why we believe in each pillar we offer a unique advantage, and we're continuing to gain market share. This will drive product revenue growth. It's probably not the case where we dominate the market, leading to limited growth; this is much more a greenfield opportunity across all three pillars. That’s why we believe strong players will keep gaining share and drive product growth over the next 5 to 10 years.

Ittai Kidron, Analyst

Very good. And then maybe if you could just clarify on the SASE billings, what percent of those are still just stand-alone SD-WAN versus not?

Ken Xie, Founder, Chairman and CEO

We have some insights on SD-WAN, which is part of the FortiOS function. While we have good tracking, it can be challenging to be fully accurate since customers can enable SD-WAN and continue to use it without informing us. However, we believe we are the leading SD-WAN player in the market. One of the main reasons customers appreciate SASE is that they find the SD-WAN experience enjoyable and can transition to SASE easily. Although the SD-WAN market is experiencing some slowdown, we are still gaining market share. If you look at other SD-WAN competitors, many of the top players have grown through acquisitions, which has hindered their new feature developments. This is why we keep increasing our SD-WAN market share; our SD-WAN is integrated with FortiOS, meaning if you purchase FortiOS, you already get SD-WAN included.

John Whittle, COO

Also, regarding the acquisitions, there's disruption in the SD-WAN market, creating opportunities for us as customers with a separate firewall and SD-WAN solution come talk to us about a combined solution that is just a no-brainer in terms of cost-effectiveness. We are already positioned in the far upper right quadrant of the Gartner Magic Quadrant for SD-WAN. With that leadership position and the disruption from these acquisitions, along with our compelling value proposition, we see strong opportunities ahead.

Operator, Operator

Our next question comes from Brad Zelnick from Deutsche Bank.

Brad Zelnick, Analyst

I'm hoping you can help reconcile your comments about growing above market in each of your pillars with 13% ARR growth in SASE this quarter. Is there something specific one-off we should consider in Q3? And as well, it would be great if you can comment on pricing trends and competition that you're seeing in SASE more broadly?

Christiane Ohlgart, CFO

The Unified SASE ARR, as we just said, includes also the SD-WAN. We are pleased that actually, quarter-over-quarter, we had good ARR growth. The flat part has an element of the CNAP component in that ARR. From that perspective, we now see positive momentum.

Brad Zelnick, Analyst

Okay. Great. Can you provide any comments on how often customers are seeking a SASE solution through competitive bidding at the branch level? Also, have there been any changes in win rates and pricing trends? Any insights would be appreciated.

Christiane Ohlgart, CFO

Competitive bids depend on the customer size and type. In government, you have more competitive bids than in smaller enterprise customers, but large enterprise customers will always go out for competitive solutions. The key is that we now have a seat at the table when we talk to our customers and say how easy it is to implement SASE and just extend your policies from the firewall to the SASE platform. That makes the incremental cost for our customers significantly lower than if they deploy a third-party solution. That's what we hear from customers; not having to maintain multiple policies is a huge operational benefit.

Ken Xie, Founder, Chairman and CEO

There are some SASE players talking about how branch SASE may replace a firewall, but I don't see that's the case. Competitors often have to use multiple boxes for branch—one for networking devices, one for SD-WAN, and others for SASE. For us, it's a single box solution combining networking, SD-WAN, and SASE. You can see in the example Christiane gave of the 10,000 retail locations; they are using FortiGate to deploy SASE, SD-WAN, and network security solutions, all managed on a single OS. That’s a huge cost-saving and easier management ability compared to competitors needing several different boxes for different functions. We also dominate in the SMB space. Hence, customers can adopt SASE quickly, not just in SMBs but also for remote workers. We are starting to see a lot of new cases to support work-from-home settings using home security SASE.

Operator, Operator

Our last question comes from Gray Powell from BTIG.

Gray Powell, Analyst

Hopefully, I can ask this question correctly. I want to make sure I understood some of the commentary during the Q&A. You mentioned an expectation for 10% to 15% growth in product revenue for 2026. I'm guessing there’s a reason this statement was not included in the prepared remarks. Is the 10% to 15% really what you think you'll achieve in 2026 as the year progresses? I'm asking because in the past, you've provided investors with a conservative estimate when guiding for a new year. I'm not seeking guidance; I just want to ensure I'm considering both aspects correctly.

Ken Xie, Founder, Chairman and CEO

Let me clarify. My comment is that the normal growth rate should be around 10% to 15%, not specifically for 2026. That's what I believe over the next 5 to 10 years. The normal product hardware growth will be 10% to 15%. That tracks quite well with the last 16 years. I feel we have an advantage in hardware with ASIC. We offer a better OS, more integration than any other competitor. That's why we have a strong customer base. I believe product and hardware will keep growing at 10% to 15%, which will be the normal growth rate for us, while also gaining market share. The market might grow a little slower than that. That’s reflected in our combined market growth shown on Slide 4—we see that secure networking may be slower, but Unified SASE and SecOps might not. It’s important to note that the normal growth rate over the next 5 to 10 years might be between 10% and 15%.

Operator, Operator

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

Anthony Luscri, Vice President of Investor Relations

Thank you. I'd like to thank everyone for joining today's call. We will be attending investor conferences hosted by Wells Fargo, UBS, NASDAQ, and Barclays during the fourth quarter. The fireside chat, web links, and webcast links will be posted on the Events and Presentations section of our Investor Relations website. If you have any follow-up questions, please feel free to contact me, and have a great day.