The Zhitong Finance App learned that after US cybersecurity giant FTNT.US (FTNT.US) released its quarterly earnings report on Thursday morning, Beijing time, its stock price fell by more than 25% after the market, and greatly dragged down the stock price trend of the vast majority of cybersecurity companies, including cybersecurity supergiants CrowdStrike and Palo Alto Networks. This contrast shows that there seems to be an urgent need to link the expansion of security demand and stock valuations with continued strong revenue growth, profit quality, and strong speed of performance delivery in the main service business. From AI agent infringement risks to PHP vulnerabilities, the market is re-evaluating the fundamental value of cybersecurity for AI commercialization: enterprises not only need to deploy models and computing power, but also ensure that the entire process of agents accessing data, calling tools, and executing tasks is constrained. The PHP vulnerability has boosted cybersecurity stocks such as CrowdStrike, Cloudflare, and Palo Alto Networks.
Cybersecurity demand in the AI reasoning era has indeed exploded significantly, bringing important business growth opportunities to Feita; the company's product-side revenue growth is already on a path that exceeds expectations, and the market is paying more attention to whether sales of these devices can be converted into sustainable service revenue. This explains why product revenue soared by 37%, which is still not enough to dispel investors' doubts about subsequent growth. During the conference call, Feita management expected the service business revenue growth rate to improve in 2027 compared to 2026, but no official annual guidelines have been issued, and there is no clear commitment to accelerate growth.
Palo Alto Networks CEO Nikish Arora previously proposed a “cybersecurity debt” of about $1 trillion during the company's earnings call on September 1, pointing to potential renewal requirements for the old security architecture that is in urgent need of modernization. He pointed out that the world's cybersecurity technology debt of about 1 trillion US dollars from the pre-AI era is in urgent need of modernization. He emphasized that the global cybersecurity infrastructure of about 1 trillion US dollars is not ready to deal with AI threats. This gap will bring room for long-term growth for the industry.
In terms of technical mechanisms, an intelligent body advances software from “providing answers” to “holding permissions and performing operations”: it can call an application application interface (API), read enterprise data, run code, and modify business status. Once a malicious web page, email, or tool returns content that changes its behavior through prompt injection (Prompt Injection), the risk may escalate from an incorrect answer to data leakage or unauthorized operation; similar consequences may also occur if the model itself is improperly executed. Therefore, enterprises need to implement machine identity management, least privilege (Least Privilege), tool call authorization, runtime monitoring (Runtime Monitoring), and rapid isolation outside of the model, rather than relying only on model promises to comply with rules.
At the same time, AI reduces the cost of vulnerability discovery and batch attacks, and compresses the enterprise's repair window; the agents deployed by the enterprise itself also increase the number of identities, workloads, and data flows that need to be protected. Palo Alto revealed that the traffic flow of its SASE smart devices had increased more than 9 times in the previous nine months, indicating that the scale of protection is moving away from a growth model that simply depends on the number of human employees. Derived from an engineering and commercialization perspective, a cybersecurity superplatform that has endpoints, identities, network, and cloud data, and can directly execute blocking and repair, is also better equipped to turn additional protection tasks into cross-module subscriptions — that is, the value purchased by large customers, shortens the time from finding abnormalities to controlling losses.
This growing demand for cybersecurity in the AI era also means that even if the big battle between open source and closed source AI models is raging, cybersecurity requirements are still resilient across routes. Cybersecurity requirements depend on the scale and depth of authority of AI to enter the actual business, rather than the success of a certain model business model.
From traditional vulnerability prevention to AI agent access control, data protection, and tool call inspection, security requirements are expanding to more business scenarios, and Feita is expanding business opportunities through unified security platforms, special chips, and AI protection products. Product revenue increased 37% year-on-year in the third quarter, and service bill amounts increased 26%, indicating that equipment procurement and service contracts remained strong; however, service revenue increased by only 13%. At the same time, the company lowered its service revenue guidelines for the full year 2026, highlighting the revenue recognition time difference brought about by the phased deployment of large enterprises, new cloud vendors and sovereign projects. Management expects service growth to improve in 2027, and the focus of the market's attention is therefore on whether current product sales and service contracts can continue to be converted into subscription revenue as the project is launched, providing more stable support for profit growth and valuation.
Feita not only provides security protection for AI applications and agents, but also actively uses AI agent technology to greatly enhance cybersecurity defense capabilities; among them, defending against attacks launched by hackers using AI is a threat scenario that its overall security business needs to deal with. Feita's third-quarter revenue was US$2.08 billion, up 20% year on year. Adjusted earnings per share were 0.91 US dollars, up 23% year over year, both higher than the market expectations of US$2.06 billion and $0.86, both higher than the market expectations of US$2.06 billion and 0.86 US dollars quoted by the media; overall revenue on the product side, which is closely linked to the cybersecurity product line, increased significantly by 29%. The adjusted operating margin reached a record high of 38.2% in the third quarter, and free cash flow increased 52%. However, the annual service revenue guidance was lowered to US$5.15 billion to US$5.17 billion from the previous US$5.18 billion to US$5.22 billion. Therefore, the contradiction that the market is concerned about is not “whether there are any AI agent attacks and the demand for strong cybersecurity-related software products driven by accurate vulnerability targeting”, but rather why strong hardware sales and large contracts have yet to bring faster recurring service revenue and year-round service revenue growth.
The latest incremental explanation released by Feita Information's latest performance conference call includes two levels: first, large enterprises, new cloud, and sovereign deployment customers first install hardware and then gradually start services, causing a time gap between bill amounts and revenue recognition; second, network equipment and sovereign deployment businesses focus more on products, and the additional service purchase ratio is different from cloud software services. Management supported the judgment of improving service growth in 2027 with a 26% increase in service bills and a 14.5% increase in short-term deferred revenue, but the Chief Financial Officer specifically clarified that she was using “growth rate improvement” rather than promising “acceleration.” At the same time, the margin advantage brought about by low-cost inventory in the early stages is weakening, and the delivery cycle for some components is lengthening, which explains why the increase in average selling prices has not completely offset the pressure on product gross margins.
In terms of technology and business model, Feita hopes to expand network security inspection to model interaction, agent identity, data center internal isolation, and automated security operation based on the unified FortiOS operating system, self-developed special integrated circuit, and existing equipment deployment foundation. The addition of AI security services provides a path for existing customers to make additional purchases, while major customers and the expansion of AI data centers expand hardware requirements. The core investment proposition of this conference call is that AI-driven security requirements have been transformed into product sales and cash flow, and the next stage is to prove that these deployments can continue to be converted into service subscription revenue. Furthermore, management made a clear correction at the end of the meeting: the price increase contributed about 10 percentage points of the year-on-year increase in bill amounts, not 10 percentage points of the revenue growth rate.
The following is the full text of the Feita Information (Fortinet) performance conference call (AI tool assisted translation):
Operator: Hello everyone, welcome to Feita's 2026 third quarter results conference call. Currently, all participants are in listen-only mode. After the speaker's presentation, we will have a question and answer session. Please note that this conference call will be recorded. I'm now entrusting the meeting to Anthony Lucrey, VP of Investor Relations. Please get started.
Anthony Lucrey, Vice President of Investor Relations at FITA: Thank you. Good afternoon everyone. Thank you for attending today's conference call to discuss Feita's financial results for the third quarter of 2026. Also attending the conference today were Feita's founder, Chairman and CEO Xie Jian, Chief Financial Officer Christiana Olgart, and Chief Operating Officer John Whittle. Xie Jian will first introduce our business on an overall level. Christiana will then review financial results for the third quarter of 2026, provide guidance for the fourth quarter, and update the full year outlook. Afterwards, we'll move on to the Q&A session. To make it easier for others to participate, please limit your questions to one question and one question during the Q&A session.
Before we begin, I would like to remind you that we will be making forward-looking statements during today's conference call. These statements are subject to risks and uncertainties, which may cause actual results to differ materially from predictions. For more information, please refer to our SEC filings, in particular risk factors in our most recent annual and quarterly reports. All forward-looking statements only reflect our views as of the date of this statement, and we do not assume and expressly disclaim any obligation to update the forward-looking statements. Additionally, unless otherwise specified, the financial measures mentioned in today's conference call are in non-GAAP caliber. Our GAAP results and reconciliation statements between GAAP and non-GAAP are included in the earnings press release and presentation materials to accompany today's statement, both of which have been posted on the Investor Relations website.
As a reminder, this is a live conference call, which can be listened to later via webcast on the Investor Relations website. After the conference, a preliminary statement will also be posted in the quarterly results section of the investor relations website. Finally, unless otherwise stated, all growth figures are on a year-over-year basis. Let's leave the meeting to Xie Jian.
Xie Jian, Founder, Chairman and CEO of Feita: Thank you, Anthony, and thank you all for participating in our conference call. Strong execution and broad market demand drove us to excellent third quarter results, and we are very pleased. Bill amounts increased 29%, and total revenue increased 20%, with product revenue increasing by 37%, which played a leading role. Based on continued strong business momentum, we raised our 2026 bill amount guidance for the third time this year. With the rapid evolution of the AI field, Feita is leading the next stage of cybersecurity development by protecting AI workflows and defending against threats caused by vulnerabilities discovered by AI in real time. We believe that network security is the most critical foundation for AI security, and firewalls are centralized execution points for online security policies across enterprises, operational technology, and hybrid cloud environments.
As shown in the presentation on page 7, Feita's leading position in this field stems from more than 20 years of innovation, integration, and improvement, while we continue to expand the AI capabilities and capabilities of FortiOS and FortiGuard services. As shown on page 9, Flying Tower protects four key areas of infrastructure and AI security. First, at the network level, our secure access service edge firewall can natively prevent exploits, prevent intrusions, support shadow AI monitoring, and access control to data and applications. To meet growing demand, our FortiGuard online AI security service launched this week can turn every FortiGate into a real-time AI security strategy execution point. Second, in data centers and AI factories, we protect graphics processor clusters and large language model infrastructure through FortiAIgate to protect rapidly growing AI traffic and meet the high performance security requirements of data centers and hybrid cloud environments.
Third, we are extending the AI security and secure access service edge to terminals, directly incorporating the definition, control and integration of agent identity into the entire life cycle of access and incident response. Fourth, through autonomous event detection and response, our FortiSoC agent provides highly automated solutions to address the industry's serious skills shortage and tool overflow. [There is a transcription error in the original text, which has been translated according to the meaning expressed in the official preliminary statement.] Our secure access service edge firewall business bill increased by 31%; among existing large-scale vendors, we are growing the fastest, close to double the market growth rate, as shown on page 5. Our leadership stems from infrastructure advantages: we are the only vendor in the industry to integrate all critical components of secure access service edge, firewall, and AI security into a single unified operating system, FortiOS. This new secure access service edge firewall business pillar represents a large and rapidly growing market that will drive long-term growth.
As shown on page 14, in combination with differentiated FortiASIC technology and its own global infrastructure, Flying Tower can provide better performance and significantly reduce total cost of ownership. We are also the only vendor that offers both an easy-to-deploy local sovereign secure access service edge solution and a cloud solution. We believe this makes our serviceable market two to three times larger than competitors that only offer cloud-based solutions. To further leverage the value of our vast deployment base, we recently launched the FortiLink Secure Access Service Edge Service, which enables FortiAP and FortiSwitch to act as hardware agents for this architecture, making it easy for customers to superimpose FortiSase on top of existing hardware, thereby driving recurring service revenue. Looking forward to the future, Feita's strong momentum comes from our strategic vision for the AI era, our ability to integrate platforms, and our highly autonomous operating model.
The combination of these factors enables Feita to maintain strong cash generation capacity, high recurring revenue, and consistently achieve GAAP profits while implementing a shareholder-centered capital allocation strategy. I would like to thank our employees, customers, partners and suppliers around the world for their continued support and hard work. Let's leave the meeting to Christiana.
Christian Olgart, CFO of Feita: Thank you Xie Jian, good afternoon everyone. We had another excellent quarter, with key growth and earnings metrics such as bill amounts, revenue, operating margin, and earnings per share all surpassed the guideline median. Based on strong momentum, we have raised our 2026 bill amounts and revenue guidance. The total bill amount increased 29% to $2.34 billion, reflecting the broad demand and strong execution performance of different customer groups, industries, regions, and our integrated and innovative solution portfolio, further validating the advantages of the platform strategy. As customers respond to the new threat environment, AI, secure access service edge, and network upgrades and expansion are key growth drivers. Demand from large enterprises was strong, and the total value of transactions worth more than $1 million increased by 51%, and the large enterprise business in the US contributed particularly significantly to this.
Secure Access Service Edge Firewall business bills increased 31%. Enterprise customers have adopted our cybersecurity solutions, upgraded infrastructure for the AI era, and expanded Feita security products to operational technology and AI data center scenarios to drive continued growth in FortiGate demand. Operational technology business bills increased by nearly 40%, validating our leadership in protecting mission-critical infrastructure. These results reflect our focus on sustainable demand drivers, leading growth and innovation, and seizing long-term expansion opportunities in emerging high-value application scenarios. The AI-driven security operations bill increased 15%, mainly due to strong purchasing momentum: existing customers are integrating standalone single-point solutions into our broader platform. Next, let's talk about revenue. Total revenue increased 20% to US$2.08 billion; product revenue increased 37% to US$765 million despite extended delivery cycles for some components. Demand for products remained strong throughout the quarter.
As in the previous quarter, customers turned to higher-performing models, boosting average sales prices, and benefiting product revenue. Service revenue increased 13% to $1.31 billion, but was affected by several adverse factors: we won new large enterprise customers, and their services needed to be phased in; at the same time, some large-scale new expansion deals integrated different existing service arrangements into corporate agreements. We still believe that the first quarter of 2026 was the low point of service revenue growth. As shown on page 19, several key leading indicators support continued positive trends in service revenue, including a strong 26% increase in service bill amounts, a 19% increase in total deferred revenue, and a 14.5% increase in short-term deferred revenue, which was the highest growth rate in five quarters. Additionally, we are continuing to launch new AI security services, including the FortiGuard online AI security service released this week.
Judging from overall performance, there are several fundamental changes in the way companies deal with cybersecurity issues, driving our continued growth. We're seeing a shift in the threat landscape: bad actors actively use artificial intelligence to organize rapid and highly targeted attacks. This change raised security from a back-office IT issue to an enterprise risk management priority at the board level, and accelerated related investments. The third quarter results reflect our continued business momentum and how our product portfolio evolved at an accelerated pace as the market changed. Specifically, the reasons we won include the integration of networks and security, the urgent need for enterprises to secure the use of AI and respond to the threat of AI enhancement in advance, the integration of information technology and operational technology fields, and the rise in global demand for architectures that meet sovereign compliance requirements. Sovereignty requirements are particularly prominent among European companies and the global public sector, and are in line with our long-standing leadership in these markets.
In this environment, protecting proprietary data sets has become a major challenge for enterprises to expand the scale of AI projects while facing increasing threats. This shift requires high-volume security architectures that can inspect massive amounts of data and speed up traffic processing without compromising performance. Information technology and security teams are actively looking for integrated platforms that provide centralized visibility and faster automated response rather than deploying point products that are fragmented and increase operational friction. By protecting physical AI data centers, distributed AI applications, and directly embedding AI into secure operations, Feita is in an advantageous position to grasp this demand. For example, an AI company developing cutting-edge models chose Feita and signed a million-dollar expansion deal to protect its rapidly growing AI workload. This strategic victory builds on the successful deployment of the customer's first AI data center last year.
With the success of the initial deployment, the deep relationship of trust, and our technical prowess, this customer has chosen Feita as the standard solution to deploy our high-end data center firewalls in five additional data centers. Our solution addresses the challenge of protecting high-value AI workloads while maintaining the highest possible performance, availability, and scalability as their infrastructure expands. This deal reflects the leading-edge throughput and resilience of our platform, making Feita a foundational security partner in the world's most demanding next-generation AI environments. The rapidly changing threat landscape has made high-performance security a structural requirement. Businesses and governments are paying close attention to AI-enhanced attack vectors and expanding regulatory requirements, so they are investing in secure access service edge firewalls that can protect complex, distributed environments. To adapt to different operating and regulatory environments, Feita provides a high degree of flexibility.
By natively blending firewalls, secure access to service edges, and hybrid mesh security capabilities in a single operating system, we can seamlessly protect people, customers, applications, and sensitive assets in physical locations, cloud environments, and remote teams. This flexible deployment model is an important competitive advantage, enabling customers to establish secure access service edge protection systems that meet their own enterprise risk and regulatory requirements. Next, let's talk about operational technology. Protecting the edge of industrial networks has become one of the most pressing topics currently being discussed by customer boards. Security boundaries are blurring, putting critical supply chains, utility grids, and manufacturing systems at unprecedented risk. The manufacturing industry has been the most attacked industry for five years in a row. Coupled with the escalating attacks on critical infrastructure in the region, it can be clearly seen that the operating technology environment, which has been underinvested for a long time, is highly vulnerable.
To mitigate these issues, agencies are speeding up network segmentation, protecting older devices that cannot be patched, and establishing secure remote access. As AI empowers attackers, corporate boards and leadership are directly accelerating these security decisions. The Feita FortiOS platform, combined with the FortiGuard security subscription, provides enterprises with complete and unified visibility covering the company's information technology and operational technology fields, and enables them to control the new attack surface brought about by AI. This architectural advantage continues to drive the demand for our specialized industrial product portfolio. For example, a major transportation company selected Flying Tower in a competitive procurement and struck a $10 million deal to protect technical infrastructure for mission-critical operations. The key to winning was that the customer needed to modernize and protect the distributed environment through Feitower's integrated network and security capabilities.
By integrating firewalls, secure routing, fifth-generation mobile communication connections, and deep operational technology testing into a single platform on a unified device, customers have significantly improved operational resilience while simplifying overall network design. This significant deployment demonstrates our ability to protect highly specialized and demanding operational technology environments while optimizing total cost of ownership and improving operational efficiency. Another deal that further validated the advantages of our edge architecture came from a major US retailer. The customer chose Feita and signed a 10 million dollar contract to standardize deployment and security protection for 1,500 of its stores. This strategic victory stems from customers wanting to improve network performance and digital resilience while improving the in-store customer experience. To support distributed business, the retailer needed to simplify the network design and standardize the architecture to scale smoothly while drastically reducing overall costs.
The Feita can provide a complete and unified safety net and can be centrally managed through FortiManager, which has become a key differentiating advantage. Winning this large-scale deployment project also shows the irreplaceable role of Feita's network of well-trained and specialized partners: its deep technical capabilities are critical to deploying complex enterprise-grade solutions. This excellent quarter reflects our continued focus on the dynamic market themes that are shaping the cybersecurity industry. We believe Feita's integrated platform model is conducive to expanding market share, achieving continuous growth, and maximizing long-term shareholder value. Next, let's talk about profit margins and cash flow. Non-GAAP and GAAP gross margins of 79.6% and 79%, respectively, were affected by the continued high contribution of product demand. The non-GAAP operating margin was 38.2%, a record for the third quarter, an increase of 130 basis points over the previous year. Driven by better-than-expected revenue growth and strict cost management, this performance exceeded the guideline limit.
Furthermore, the GAAP operating margin of 33.9% continues to be among the highest in the industry. Strong operating performance translates into final profit. Non-GAAP earnings per share increased 23% to $0.91; GAAP earnings per share increased 39% to $0.86, all outpacing revenue growth, reflecting the high quality of profit supported by our long-term focus on total shareholder returns. Driven by rising bill amounts and strong operating margins, free cash flow increased 52% in the third quarter to reach US$865 million; year-to-date growth of 74% to reach US$2.84 billion. Adjusted free cash flow was $912 million, corresponding to an excellent profit margin of 44%. Excellent execution and ability to generate continuous cash continue to support a sound financial position. Based on a strong balance sheet and a commitment to continue to create long-term shareholder value, the board approved an increase of approximately $1.2 billion in share repurchase authorizations.
This brings our remaining share repurchase authorization to $2 billion, providing us with the flexibility to continue returning capital to shareholders while investing in core growth pillars. Let's talk about performance guidelines. Please be reminded that the fourth quarter and full year outlook summarized on pages 24 and 25 is subject to the forward-looking information disclaimer at the beginning of the session. We have always set our guidelines in a prudent and self-disciplined manner, and our strong performance in the first nine months of this year supports us in improving our outlook for the full year. We are increasing our annual bill amounts, revenue, operating margin, and earnings per share guidelines. For the fourth quarter, we expect the bill amount to be between $2,775 billion and $2,925 million, an increase of 20% year-on-year in median terms.
Revenue was $2,155 billion to $2,245 million, up 15% year over year in median terms. Non-GAAP gross margins range from 78% to 80%. Non-GAAP operating margins ranged from 35.5% to 37.5%. Non-GAAP earnings per share were $0.93 to $0.95, assuming a share count of between $741 million and $745 million. Infrastructure investments ranged from $180 million to $210 million. The non-GAAP tax rate is 18%, and cash payments range from $80 million to $130 million. For the full year, we expect bills to be between $9.568 billion and $9.718 billion, up 28% year over year in median terms. Revenue was $8.125 billion to $8.215 billion, up 20% year over year in median terms. Service revenue was between $5.15 billion and $5.17 billion, up 13% year over year in median terms. Non-GAAP gross margins ranged from 79.7% to 80.3%. Non-GAAP operating margins ranged from 36.5% to 37.5%.
Non-GAAP earnings per share were $3.54 to $3.58, assuming a share count of 741 million to 743 million shares. Infrastructure investments ranged from $390 million to $420 million. The non-GAAP tax rate is 18%, and cash payments range from $400 million to $450 million. Compared with the 2026 guidance initially issued in February, the current full-year bill amount and revenue guidance have increased by US$1.14 billion and US$570 million, respectively. Looking ahead to 2027, we expect total bill amounts and revenue growth to exceed the growth rate of the overall serviceable market. We expect service revenue growth in 2027 to be higher than 2026 because we believe short-term deferred revenue growth is a good indicator of future service revenue growth.
The following is the performance conference Q&A session (AI-assisted summary and translation):
Additionally, we are seeing a continued increase in potential project reserves for edge firewall application scenarios for secure access services, and expect the new FortiGuard service to be highly compatible with the needs of existing and new customers. Let's return the meeting to Anthony and begin the question and answer session.
Anthony Lucrey, Vice President of Investor Relations at FITA: Thank you, Christiana. As a reminder, to make it easier for others to participate, please limit your questions to one question and one question during the Q&A session. Operator, please be open to questions.
Operator: Thank you. If you want to ask a question, click the raise hand button at the bottom of the screen. When it's your turn, you'll hear your name and get a notification on the screen to unmute. Let's wait a moment and let everyone join the queue for questions. The first question came from TD Cowen's Shore Eyal. Please unmute and ask a question.
TD Cowan Analyst Shore Eyal: Thank you and good afternoon. Congratulations on your steady performance in all areas. I had one question for Xie Jian and another for Christiana. Xie Jian, can you talk about the importance of network security for secure access to service edge firewalls, secure operation, or the entire Feita platform in the AI era? In what specific ways does Feita meet the needs of AI application scenarios? How will this opportunity impact your growth rate and the sustainability of demand? Christiana, can service revenue be further broken down? You are adding new services and anticipating improved growth in 2027 ahead of time. Can we talk about the situation in the third quarter? Given that the overall performance of leading indicators is very steady, is this more a question of when revenue is confirmed?
Xie Jian, Founder, Chairman and CEO of Feita: Thanks Shore, this is a great question. Actually, I've prepared the relevant content on page 4. As you can see, we are beginning to call this business secure access service edge firewall because we believe that secure access service edge is a feature that needs to be integrated with traditional FortiGate operating systems, as is AI security. As I said in my preliminary remarks, we believe that cybersecurity is the most important component of AI security because it can implement online security policies for large amounts of AI traffic and provide better visibility. With our leading position in the global cybersecurity market, we account for more than half of the world's equipment deployments. We believe this gives us greater visibility and a wealth of data to train and build better secure access service edge firewall models. At the same time, we continue to innovate, follow up on technological developments, and invest in fields such as special purpose integrated circuits.
This is why we are confident that we will grow faster than the market. It integrates AI security, secure access service edge, and traditional security. Judging from the current market growth rate, we think the overall serviceable market will grow by about 16%. We continue to achieve faster growth, and the growth rate in the last quarter was actually close to double that of the market. We have become the largest secure access service edge firewall player in this field and continue to grow faster than the market. We believe this is still a very large market, and we will continue to grow over the long term, just like in the past 20 or 30 years. I think our position in the cybersecurity market is conducive to solving AI security issues.
Christian Olgart, CFO of Feita: Let me answer your second question, which is the service business.
Xie Jian, Founder, Chairman and CEO of Feita: OK.
Christian Olgart, CFO of Feita: As I mentioned in my preliminary statement, service bill amounts are showing strong performance, and many service revenue indicators are improving. It really is a matter of timing. I think the strong performance of the corporate business is the reason for the delay in the conversion of revenue from some services, because we have signed quite a few very good large-scale deals, and the services in these transactions were launched in stages. This shows how strong the business is. Furthermore, we continue to focus on service, and new services and solutions certainly play a key role in driving existing customers to buy more. All existing FortiGuard services continue to evolve, and the new FortiGuard online AI security service requires continuous FortiGuard updates in response to some specific new risks brought about by AI. This service will be highly relevant to customer needs.
Xie Jian, Founder, Chairman and CEO of Feita: Thank you.
Operator: Thank you. The next question comes from Barclays's Saket Kalya. Please unmute and ask a question.
Barclays Analyst Saket Kalya: OK, thank you so much. Thank you all for taking my questions. Xie Jian and Christiana, maybe ask them both to answer this question together. The product business performed very well this year, which is of course the result of a combination of factors such as pricing, changes in product portfolio, and sales volume. I know it's still too early to talk about 2027, but based on the current situation in the fourth quarter, and considering that 2026 has formed a very high comparative base, how should we view next year's product growth?
Xie Jian, Founder, Chairman and CEO of Feita: I think it may be three months before the 2027 guidelines are issued, but we are confident that we will grow faster than the market. If we look at the secure access service edge firewall market, the current growth rate is 16%, and we believe we will continue to increase our market share. Also, our operating model is strong. With self-developed dedicated integrated circuits, self-managed manufacturing arrangements, and direct operating capabilities, we believe we have an advantage over most of our competitors in dealing with supply chain issues. Therefore, we are confident that we will continue to increase our market share in this area by relying on better technology, operations, and execution.
Fita CFO Christiana Olgart: Let me add —
Barclays Analyst Saket Kalya: Understood, very helpful.
Christian Olgart, CFO of Feita: Yes, let me add Xie Jian's opinion. If you look at the demand environment, it is currently quite stable. Not only is AI being deployed, but AI attacks are also taking place, and the level of threat has increased significantly. This has really encouraged customers to upgrade their cybersecurity, and of course it has brought about new application scenarios. Therefore, we are confident that we are well positioned in 2027.
Barclays Analyst Saket Kalya: Understood. My question is for Xie Jian. One growth factor we just mentioned is pricing. Can you share your latest thoughts on pricing? You have passed on the rising cost of memory devices to your customers. Perhaps the question is: what stage is this process currently in progress? Of course, it's hard to accurately predict next year, but how do you think pricing can play a role in 2027?
Xie Jian, Founder, Chairman and CEO of Feita: I think the price increase has contributed about 10% to revenue so far. On the other hand, if we look at the first half of the year, we did benefit from the inventory on hand. We've always said that in a normal year, we keep inventory for about six months. Therefore, in the early stages of supply chain changes, we have a certain buffer and can benefit from it. But starting in the third quarter, we saw that this situation became normal. That means we have to keep buying like any other company. At the same time, despite our larger purchases and more direct relationships with suppliers, we did see extended delivery times. I think the price has probably stabilized, but it hasn't improved. Compared with the first quarter and the second quarter, the rate of price increase has slowed down.
In the third quarter, I'd say prices stabilized, but they haven't improved and are still slowly rising. However, future trends are difficult to predict. Our policy and strategy has always been to maintain roughly the same gross profit margin: if costs rise, we raise prices accordingly; if costs fall, we cut prices accordingly. We want to maintain the same gross margin on the product side. In fact, this is a strategy that the company has been adhering to for the past 20 years.
Barclays Analyst Saket Kalya: Very helpful, thank you all.
Xie Jian, Founder, Chairman and CEO of Feita: Thank you.
Operator: Thank you. The next question comes from BTIG's Grey Powell. Please unmute and ask a question.
BTIG Analyst Grey Powell: OK, thanks for taking my questions. Can you hear me clearly?
Xie Jian, Founder, Chairman and CEO of Feita: Yes, very clear.
BTIG ANALYST GREY POWELL: Great. I'd like to ask a broader question. Many investors we've talked to are trying to compare the spending environment you've seen this year with post-pandemic periods such as 2021 and 2022. If I were to judge, I think the current AI-driven cycle might be larger. My question is, from your perspective, how is this time different compared to the post-pandemic period a few years ago, or even the security spending cycle after the 2014 and 2015 Target data breaches? Do you think this cycle lasts longer than in the past?
Xie Jian, Founder, Chairman and CEO of Feita: I personally agree with you. I really think the scale is bigger this time than it was five or six years ago. At the time, it was more of a supply chain demand driven by remote work-from-home work, but now it involves extensive AI infrastructure construction. On the other hand, AI is also driving demand, as AI security has recently become a greater focus, especially the question of how many companies use AI, which is also driving demand. As a result, we're not currently seeing a slowdown in demand. [This sentence in the original text is transcribed as “seeing a slowdown in demand”, which contradicts the two clear statements that immediately followed; it is translated here according to the context.] Demand has remained very strong over the past few quarters, and we didn't see any slowdown in demand even in the third quarter.
On the supply side, as we mentioned, the delivery cycle has been lengthened, and prices have not risen as fast as in the first and second quarters, but they are still rising slightly. I would say that prices have stabilized to a certain extent, which may mean more normalization. We believe we have strong operational capabilities and have established direct relationships with all component manufacturers to be able to directly negotiate; in comparison, some of our competitors have much smaller procurement volumes. As a result, we think we're still better at it.
John Whittle, Chief Operating Officer of Flying Tower: I think your point is very good; our business development follows the changes in threat. You mentioned the Target data breach, the outbreak, etc. As someone just said, no one can accurately predict the future, but AI threats seem to be more enduring and persistent than some of the previous threat drivers. So I think it's still early days. As you said, our business does change with threats, and the current threat level is high, and it looks like it will continue.
BTIG Analyst Gray Powell: OK, very helpful, thank you.
Operator: Thank you. The next question comes from Peggy's Rob Owens. Please unmute and ask a question.
Peggy Analyst Rob Owens: Thank you so much for taking my questions. I would like to continue with the answers I just gave about threats to the environment. Obviously, the headlines in October about smart devices and related events are quite worrying. I know it's only been a month since the fourth quarter, but I'd love to know what's trending right now. Has there been a noticeable acceleration over the past month? Given what's happening in terms of the bug, can you provide some quantitative information to let us know how the fourth quarter started? Thank you.
Xie Jian, Founder, Chairman and CEO of Feita: Yes, demand is still very strong, and we haven't seen any slowdown. AI has indeed discovered more bugs, such as PHP and others. We believe FortiGate is well-positioned to stop some of these attacks and intrusions. We have corresponding detection characteristics that can block the use of some vulnerabilities, which is a very effective way to help many enterprises defend themselves. Additionally, we're seeing AI accelerate some convergence trends. As a result, we are seeing more and more high-end devices being deployed within enterprises for internal network segmentation isolation. We also mentioned sovereign AI, where growth is also strong. We believe that in the long run, hybrid AI combining a sovereign environment and the cloud will be the best solution for customers, and we believe that we have a huge advantage in this regard.
I want to emphasize that demand is still very strong and shows no signs of slowing down.
Operator: Thank you. The next question comes from Morgan Stanley's Mehta Marshall. Please unmute and ask a question.
Morgan Stanley Analyst Mehta Marshall: Thank you. I have two questions. We've noticed a strong bill for operating a technology business, or a technology security business. Are you seeing a growing customer base? Can you tell us if there are any significant new customers? The second question is, are you finding that customers lack relevant services or personnel when deploying a large number of devices? Can you help these customers through your own service team or better connect them with other services that can help install them? Thank you.
Fita CFO Christiana Olgart: Meta, I'll answer. In terms of operational technology, I'd say we've been strong in some regions and are now expanding that advantage to others. This is because we have more and more customer success stories, and customers are able to see the benefits of devices we have developed specifically for these uses. As a result, the coverage of advantages is expanding, and the business continues to expand. As the attack surface expands, so do these products. In terms of installation, flying tower services usually focus more on configuration, and do not necessarily include equipment installation and installation. As a result, we have an extensive channel of distributors and partners, and have certified them to do these jobs locally for our customers. I haven't really heard of a lack of deployment capabilities.
I think it's less a question of channel capability or capacity, but rather how quickly customers can complete deployments. This usually depends on the customer's business. The fourth quarter may be a little challenging, as many customers are preparing for year-end business, etc. If a company uses a natural fiscal year, it usually won't make any major adjustments until the next year.
Xie Jian, Founder, Chairman and CEO of Feita: Yes. Also, what is unique about Flying Tower is that we have established our own service infrastructure system, or FortiCare. Currently, about half of Forticare services can be processed and improved with AI. We are also doing further research to bring service personnel closer to customers, which helps customers understand other new services we are launching. Therefore, we believe this will also help drive additional growth in the service business in the future.
John Whittle, Chief Operating Officer of Feita: Meta, in response to your question, I just spoke with a retailer who is considering deploying our solution to 4,000 stores across the country. As Christiana mentioned, we're introducing a hosting provider. But at this scale, we've found that customers want to work directly with us, so our service team can provide additional support to the customer's own team as well as the managed service provider. So, we do see that in large-scale deployments, in addition to working with partners, customers also want to work directly with us.
Morgan Stanley Analyst Mehta Marshall: Great, thank you.
Operator: Thank you. The next question comes from Stiffel's Adam Borg. Please unmute and ask a question.
Stiffel Analyst Adam Borg: Thank you so much for taking my questions. Let's take a step back. We just talked about the very strong demand environment and the steady trend of price increases that continue but are weaker than in the first half of the year. Can you further explain why there was a deceleration in growth in the third quarter compared to the second quarter? Demand is still very strong, but what is causing the growth rate of many indicators to slow down? Thanks again.
Xie Jian, Founder, Chairman and CEO of Feita: Yes. As I said, demand remained strong in the third quarter, probably even stronger than in the first half. But in the first half of the year, we did benefit from about six months of inventory we usually keep. As a result, some of the strong product growth you are seeing is due to on-hand inventory. I think starting in the third quarter, we have more returned to normal, and the on-hand inventory advantage has begun to subside. At the same time, delivery times for some components have also been extended. However, the demand side continues to grow.
Stiffel Analyst Adam Borg: To clarify, are you saying supply is limited to a certain extent, or is the price of newly purchased inventory higher, which has had some impact? Thanks again.
Xie Jian, Founder, Chairman and CEO of Feita: I would say that there are two aspects, and the procurement and delivery cycle for some components has also been extended.
Stiffel Analyst Adam Borg: Great, thanks again.
Xie Jian, Founder, Chairman and CEO of Feita: OK.
Operator: Thank you. The next question comes from Jefferies's Joe Gallo. Please unmute and ask a question.
Jefferies Analyst Joe Gallo: Hello everyone, thank you for taking the questions. My question about the service business is in two parts. First, I understand that some large enterprise license agreement services need to be delayed and gradually activated, but if this type of customer is excluded, is the additional purchase rate for services the same as the historical level? Obviously, the current product business is very successful, but can we say that the strong growth in some network businesses and AI data center businesses may have lowered the additional purchase rate of services? Is there any reason to think this will change?
Christian Olgart, CFO of Feita: Of course, the product portfolio did lean slightly towards network components over the years. This is an area where we've always been strong, and it's part of the platform integration, but the add-on purchase rate for its services is low. I don't think this changed from the second quarter to the third quarter. We're seeing very good growth in FortiGate, which will benefit the additional purchase rate for services. On the other hand, we have had success with sovereign deployments or sovereign solutions, but these businesses focus more on products than cloud-based software-as-a-service solutions. As a result, it also affected the overall product and service portfolio to a certain extent. Yes, there is indeed a product mix factor.
Sovereign deployments involve fewer services because we deliver more customer-owned products than cloud solutions. We believe this will structurally support the product business over the long term, as this is clearly an important trend. Next, we need to attach more relevant FortiGuard security subscriptions to these products. That's why it's so important to launch these services.
Jefferies Analyst Joe Gallo: Very helpful. Just ask, do you have an independent subscription sales process, or are subscriptions completely hardware-dependent? The reason I'm asking this is because the product business is cyclical, and when its growth rate slows, service obviously becomes more important. I'm just wondering if there are any other tailwinds for the subscription business as this cycle progresses.
Christian Olgart, CFO of Feita: We do have an independent service sales process. I would say that initial purchases always come with some services, most often FortiCare, while smaller customers buy a package of services. Larger enterprise customers are more likely to buy additional purchases: make sure the hardware is deployed before we sell them the relevant security subscriptions. Therefore, I think the heightened threat environment is also a focus, as intrusion prevention systems, virtual patches, and certain operational technology subscriptions are critical to ensure that FortiGate always has the right level of threat intelligence and continuous customer protection. As a result, I think there will be a significant increase in this type of sales activity.
Jefferies Analyst Joe Gallo: Thank you so much.
Operator: Thank you. The next question comes from Goldman Sachs's Gabriela Borges. Please unmute and ask a question.
Goldman Sachs Analyst Gabriela Borges: Good afternoon everyone, thank you. Christiana, I want to continue discussing large corporate transactions and their impact on service revenue. Compared to your original expectations, is the US corporate business stronger? Did you originally anticipate that a transaction would not require phased activation of the service, but then the customer requested it? Maybe I can explain what happened in the second quarter, since large enterprises have been the driving force for Feita's growth for a while, but I don't remember you talking about this specific phased launch issue affecting service revenue before. I just wanted to understand how different this time was.
Christian Olgart, CFO of Feita: As we disclosed, in the third quarter, there were not only many large corporate deals that also existed in the past, but also many newer customers. The deals were real expansion projects, not necessarily just equipment updates or large-scale contract renewals for large customers. In this case, when the customer deploys the infrastructure, they may not want to start paying for the service right away. In the third quarter, this situation increased, and there were also arrangements to integrate different business activities. That is why I specifically stated this in my preparatory statement.
Goldman Sachs Analyst Gabriela Borges: Regarding the fourth quarter guidance, can you understand that you expect this trend to continue? Can you describe the potential project reserves for such new customers and related customer groups? Do you think the gradual introduction of services will also affect the fourth quarter, or even longer?
Fita CFO Christiana Olgart: It's definitely going to have some impact in the fourth quarter. This is why you are seeing the current revenue guidance and the 2026 service revenue guide adjusted accordingly. But the good news is that customers are actually purchasing services, which can be seen from deferred revenue and service bill amounts. There will be more services in the future. We're actually happy with how strong the business is, with just a slight delay in revenue recognition.
Goldman Sachs Analyst Gabriela Borges: Thank you for today's conversation.
Operator: Thank you. The next question comes from Citi's Fatima Blarney. Please unmute and ask a question.
Fatima Blarney, Citibank Analyst: Good afternoon, thank you so much for taking my questions. I had one question for Xie Jian and another for Christiana. Xie Jian, when you answered questions about product growth trajectories earlier, you mentioned supply-side restrictions that seem to be increasing, as well as different and ever-changing inventory management situations. I'm wondering if you can talk about customer behavior in extending the useful life of assets on an overall level? In other words, is the customer making the device last longer because of these factors or in anticipation of these factors? As we consider the 2027 product growth trajectory, and these broader factors, how are you protecting your business and dealing with this potential risk? After that, I'd like to ask Christiana.
Xie Jian, Founder, Chairman and CEO of Feita: Yes, I think new security features, especially AI security, require higher-end, more computationally capable devices to run. As a result, we do see customers moving more towards high-end, more computationally powerful FortiGate systems, and the average selling price has increased as a result. [The original text “40K System” is translated according to the product in the context.] We commonly see extended life spans sometimes occur in low-end products or certain vertical industries, such as retail. These customers are also weighing whether to move to the edge of secure access services or other zero-trust network access environments. We do see some retailers leading the shift, but other customers may still want some products to last longer. However, they also suddenly realized that the threat environment had changed, and AI revealed many vulnerabilities and triggered related attacks.
As a result, we think customers may be more concerned about these new vulnerabilities than extending the useful life of existing hardware. Because if the hardware continues to be used for five, seven, or ten years, many features will be difficult to function, or we will no longer support some of the new features. Therefore, we don't think extending the useful life of devices will become a future trend. New threats and new demands for these capabilities will bring additional growth. At present, we see that the first wave of demand comes more from enterprises, especially internal network segmentation isolation and some AI data centers. However, as AI applications increase further, we expect more demand to continue to drive growth.
Citibank Analyst Fatima Blaney: Thank you Xie Jian. Christiana, I'd like to talk about gross margin performance. Regarding gross margin compression, how should we understand the relationship between an increase in average selling price and customers upgrading to high-end models that are likely to sell for a higher price? Why haven't these factors at least brought about a stable gross profit margin? Despite these favorable factors, product-side gross margin compression is still significant. Can you explain these two dynamics and how they might evolve over the next two to four quarters? Thank you.
Christian Olgart, CFO of Feita: In terms of product gross margin, we have indeed seen a rise in costs. In the first half of the year, we benefited from on-hand inventory: costs were lower at the time, and product prices had increased, so gross margins increased. By the second half of the year, costs gradually increased and began to affect the product's gross profit margin. However, service gross margins are improving well, offsetting part of the impact. After all, price increases to customers are limited, and so are their budgets. Therefore, we are looking for a balance between increasing prices and increasing our market share, and I think we have been quite successful in this area this year.
The overall gross margin guideline for the whole year is still 80%, which is consistent with the statement at the beginning of the year.
Citibank Analyst Fatima Blaney: Thank you.
Operator: Thank you. The next question comes from Truist's Junaid Siddiqui. Please unmute and ask a question.
Truist Analyst Junaid Siddiqui: Thank you for taking my questions. Regarding the open weighting model, if enterprises move to an open weighting model, will they shift more AI security requirements to infrastructure controlled by customers themselves, thereby structurally expanding your opportunities? Have you seen this translate into incremental security requirements?
Xie Jian, Founder, Chairman and CEO of Feita: Yes, we're seeing more and more companies running open source or open weighting models internally. This also creates additional requirements for how to monitor and manage these AI models within the enterprise. As a result, the demand for enterprise cybersecurity is increasing. As I said, this is speeding up the convergence of cybersecurity. With the advantages of high-performance dedicated integrated circuits, we believe we are in a leading position in the deployment of high-speed network security within the enterprise and the isolation of a large number of network segments within data centers.
Truist Analyst Junaid Siddiqui: Great, thank you. What was the early adoption of your secure access service edge combination solution? What price increases do you see when customers switch to a combined plan?
Christian Olgart, CFO of Feita: Regarding price increases, I think it probably depends on how you define price increases first. FortiCare and SD-WAN pricing is calculated as a percentage of the hardware price. The question is how much more the customer is buying. We've seen some increases, but some customers are still only using the software-defined WAN features that come with FortiCare without purchasing the additional subscriptions we offer. It will take some time for all SD-WAN customers to actually adopt these new subscriptions.
Truist Analyst Junaid Siddiqui: Great, thank you so much.
Christian Olgart, CFO of Feita: New customers are more likely to adopt this solution.
Operator: Thank you. Thank you. The next question comes from Raymond James's Adam Tyndall. Please unmute and ask a question.
Raymond James Analyst Adam Tyndall: OK, thanks. Xie Jian, I want to ask a question from a broader business perspective. You're winning over bigger customers, such as the sovereign deployment customers and new cloud service providers I just talked about. These customers grew very fast, leading to significant product growth, but also caused the performance of some of the services we discussed to be out of sync with product growth, and the stock price dropped sharply as a result. I have two questions. First, can you talk about the advantages and disadvantages of serving this type of customer group? Is this a type of customer worth serving? Second, have you considered different business models, similar to the way chip companies serve these customers, that is, they mainly sell much larger products and reduce the focus on the service business?
Xie Jian, founder, chairman and CEO of Feita: In fact, many large enterprises, new cloud service providers, and even some service providers may require slightly different services. Sometimes they also use our technology to provide their own services, so we become the second or third tier supplier behind them. Additionally, there is the gradual activation process that Cristiana mentioned. Many customers deploy hardware first and then gradually add services because FortiOS has many features and services they can use and utilize. The gradual roll-up of the different services does take time. This is what we saw and what Cristiana said. The good news is that we have gained many larger customers, but on the other hand, the service takes time to gradually increase, and customers will gradually use more and more services.
Furthermore, once a so-called corporate agreement is adopted, revenue recognition methods are also involved, and sometimes revenue recognition for some services will be slightly slow. However, judging from metrics such as bill amounts and short-term deferred revenue, the trends we are seeing are quite healthy, so we are confident. These major customers have also provided very strong feedback on the latest AI security requirements, and continue to drive our innovation and development of new technologies. We work closely with them to make the entire internet safer.
Raymond James Analyst Adam Tyndall: I'd like to ask a quick question. Christiana, I think this is probably the last question, so I want to give you a chance to fully explain it. Tomorrow's key question will be: Why are service business expectations for FY2027 being given in advance on this conference call? We get lots of related questions. People will say, “You told us before that the second half of this year would accelerate, but apparently we haven't seen this happen.” Now you're talking about longer-term acceleration. People will think that there is a structural difference in the additional purchase rate of new customers for services, and the 2027 fiscal year judgment requires a fuller basis.
I'd like to give you the chance to elaborate on what exactly makes you confident to discuss the acceleration of service growth in FY2027. Thank you all.
Christian Olgart, CFO of Feita: I'd like to say that I'm not using the word “acceleration,” I'm using “improving the growth rate.” I think we clearly saw that the growth rate bottomed out in the first quarter. The question is how quickly we can turn part of our service bill into revenue. This will always take a little while, but we still believe that we sell our customers services that meet their needs, that will turn into revenue and continue to grow during 2027.
Raymond James Analyst Adam Tyndall: Thank you.
Operator: Thank you. The last question came from Scotiabank's Patrick Colville. Please unmute and ask a question.
Patrick Colville, Scotiabank Analyst: Thank you for taking my questions and for arranging a time at the end. I'd like to link several aspects of discussions over the past hour. You mentioned that large new customers in the third quarter required pre-arranged service agreements, and the speed of implementation of these services was lower than expected when the guidelines were given three months ago. As a result, revenue and bill amounts fell short of expectations, but you are still confident that this will support the creation of value for customers in 2027. Is this understanding correct, or are there other aspects that need to be explained? [The second half of this question in the original text is not clearly transcribed; the translation preserves its recognizable meaning.]
Christian Olgart, CFO of Feita: Patrick, your voice is a little hard to hear, but I think I understand the problem. Let me sum it up. The third quarter was a great one, and we received major new customers and signed major new expansion deals, all of which benefited us. However, these transactions are accompanied by delays in the launch of the service, which is actually a more typical or more common situation in larger transactions. Overall, this is an important factor that we probably didn't fully anticipate. Of course, the service business also involves many different aspects. As prices have increased, discount arrangements between hardware and services have increased. In the US, we do see procurement skewed towards hardware because depreciation can provide tax benefits to customers.
There are other different factors, and their impact was less prominent in the third quarter, but when analyzing the reasons, we did observe these trends.
Scotiabank Analyst Patrick Colville: If I could, I'd like to --
FITA CFO CHRISTIANA OLGART: Thank you.
Patrick Colville, Analyst at Scotiabank Canada: I'd like to ask a very specific question about channel inventory and contract periods corresponding to billing. Can we talk about it separately?
Christian Olgart, CFO of Feita: The contract period is still roughly the same, with no significant increase. Channel inventory remained flat or declined as a percentage of the bill amount. As a result, we continue to manage inventory, hoping that the channel has enough inventory to support our day-to-day business, but we don't want to allocate too much to avoid misallocations when inventory is needed in other regions. Therefore, we have always been very careful in managing channel inventory levels.
Patrick Colville, Scotiabank Analyst: Thank you.
Operator: Thank you. That's the last question. I will now return the meeting to Anthony Lucri to make a closing statement.
Anthony Lucrey, Vice President of Investor Relations at FITA: Thank you. First, clarify a previous statement: the price increase contributed about 10 percentage points to the year-on-year growth rate of bill amounts, not to revenue growth. Other than that, thank you all for attending today's conference call. In the fourth quarter, we will attend investor meetings hosted by Bank of Montreal, UBS, and Barclays. A link to the live webcast of the fireside conversation will be posted in the event and presentation materials section of the Investor Relations website. If you have any follow-up questions, feel free to contact me or my team. I wish you all the best for the future.